Krugman on Keynes

Vox has published Paul Krugman's speech at a conference commemorating the 75th anniversary of The General Theory.  The speech brings together a number of themes Krugman has addressed at his blog.  Among other things, Krugman says:

The brand of economics I use in my daily work – the brand that I still consider by far the most reasonable approach out there – was largely established by Paul Samuelson back in 1948, when he published the first edition of his classic textbook. It’s an approach that combines the grand tradition of microeconomics, with its emphasis on how the invisible hand leads to generally desirable outcomes, with Keynesian macroeconomics, which emphasises the way the economy can develop what Keynes called “magneto trouble”, requiring policy intervention. In the Samuelsonian synthesis, one must count on the government to ensure more or less full employment; only once that can be taken as given do the usual virtues of free markets come to the fore.

It’s a deeply reasonable approach – but it’s also intellectually unstable. For it requires some strategic inconsistency in how you think about the economy. When you’re doing micro, you assume rational individuals and rapidly clearing markets; when you’re doing macro, frictions and ad hoc behavioural assumptions are essential.

So what? Inconsistency in the pursuit of useful guidance is no vice. The map is not the territory, and it’s OK to use different kinds of maps depending on what you’re trying to accomplish. If you’re driving, a road map suffices. If you’re going hiking, you really need a topographic survey.

But economists were bound to push at the dividing line between micro and macro – which in practice has meant trying to make macro more like micro, basing more and more of it on optimisation and market-clearing. And if the attempts to provide “microfoundations” fell short? Well, given human propensities, plus the law of diminishing disciples, it was probably inevitable that a substantial part of the economics profession would simply assume away the realities of the business cycle, because they didn’t fit the models.

The result was what I’ve called the Dark Age of macroeconomics, in which large numbers of economists literally knew nothing of the hard-won insights of the 30s and 40s – and, of course, went into spasms of rage when their ignorance was pointed out.

I share Krugman's view that the "textbook" Keynesian apparatus remains a useful apparatus for thinking about the economy.  However, I think his portrayal of the turn macroeconomics has taken over the past forty or so years is a bit unfair.  As Krugman notes, contemporary macroeconomic models are grounded in microeconomic optimization.  Although a foolish desire for consistency can be the hobgoblin of our little economist minds, there is more to the story - the shift in methodology was also motivated by real deficiencies in the Keynesian framework identified by Friedman and Lucas, as well as the "stagflation" of the 1970's, which appeared to contradict Keynesian theory.

Toles on Austerity

I've been thinking I should say something about the contradiction between Washington's new obsession with budget cutting and the still-struggling economy, but this cartoon from Tom Toles nails it better than anything I could have said:

May Employment: Where are the Flowers

looks like no "green shoots" this spring....

The May employment situation report from the BLS confirms the impression from other bits of data (see Gavyn Davies and David Leonhardt from last week) that the already sluggish recovery is wobbling.  Payroll employment (from the BLS survey of firms) rose by 54,000, which is quite a bit less than the 130,000 or so needed to keep unemployment steady as the labor force grows and productivity increases.  The unemployment rate (from the survey of households), ticked up to 9.1% (from 9% in April). 

 The underlying numbers in the household survey (which gets second billing because it has a smaller sample) are slightly less unpleasant.  The number of people employed increased by 105,000, while the number of unemployed increased by 167,000.  This partly reflects re-entry into the labor force, 105,000 fewer people reported not being in the labor force, and the labor force participation rate ticked up from 64.15 to 64.22.

Mark Thoma has collected links to commentary on the report from around the econo-blogosphere.

Antidumping in Action

Today's Washington Post provides another example of our dysfunctional "Antidumping" rules in action.  This case is about antidumping tariffs imposed on furniture imports from China:

But do tariffs work? In the case of bedroom furniture, they’ve clearly helped slow China’s export machine. In 2004, before tariffs went into force, China exported $1.2 billion worth of beds and such to the United States. The figure last year was just $691 million.

Over the same period, however, imports of the same goods from Vietnam — where wages and other costs are even lower than in China — have surged, rising from $151 million to $931 million. The loss of jobs in America, meanwhile, only accelerated. 

This may be a case where the differential tariff treatment between Chinese and Vietnamese furniture which resulted from the antidumping case induced "trade diversion" - i.e., an efficiency loss because the trade preferences result in imports coming from someplace other than the low cost producer.  However, in this example, it could also be the case that comparative advantage shifted to Vietnam as China's labor costs have risen. 

Furthermore:

The only Americans getting more work as a result of the tariffs are Washington lawyers, who have been hired by both U.S. and Chinese companies. Their work includes haggling each year over private “settlement” payments that Chinese manufacturers denounce as a “protection racket.”

Fearful of having their tariff rates jacked up, many Chinese furniture makers pay cash to their American competitors, who have the right to ask the Commerce Department to review the duties of individual companies. Those who cough up get dropped from the review list.

It is clear from the article that workers in the US industry have suffered from a disruptive wave of furniture imports.  While it may indeed be the case that the US no longer has a comparative advantage in furniture production, standard comparative static trade theory fails to account for the adjustment costs associated with reallocating resources.  That is, trade theory assumes full employment and that workers will be shifted to another sector, ignoring the fact that this process involves losing their jobs in one industry and, usually, a period of unemployment before finding a job in another.

Although it is also less than perfect, a more appropriate remedy in this case would be the application of "safeguard tariffs" which the President can impose (following the recommendation of the International Trade Commission) in cases where industries are disrupted by import surges.  Relative to antidumping tariffs, safeguards have the advantages of being (i) time limited, (ii) at the discretion of the president (who presumably can consider the interest of the nation as a whole, rather than just an affected industry or region), and (iii) not requiring any allegation of "unfair" trade practices on the part of the exporters (which are usually somewhat bogus).

Resetting European Bonds

When I saw this headline on the Washington Post's website

I thought the president was going over there to work out a debt restructuring, but that's not the kind of bonds they mean.

It would be kind of weird if a US president to be directly involved in a European sovereign debt crisis (though it has global repercussions so the US is not disinterested), but Europe sure seems in need of some kind of intervention.  It is easy to understand why politicians prefer to hope they can get through the next election before things blow up rather than confronting a debt crisis.  Unfortunately the two institutions best placed to push Europe's politicians into a restructuring of Greek (and maybe Irish) debt that everyone knows is necessary - the ECB and IMF - are not being helpful, according to Steven Pearlstein:

At the time of his arrest, Strauss-Kahn was headed to a meeting with German Chancellor Angela Merkel, reportedly to talk her out of a debt restructuring plan for Greece. The official IMF view, like that of the European Central Bank, is that allowing any euro-zone country to restructure its debt will trigger another global financial crisis as investors rush to indiscriminately dump all their European bonds, forcing European banks, which hold large piles of them, into insolvency. In this scary scenario, a debt default or restructuring in any euro-zone country would cause the collapse of the euro. 

Pearlstein goes on to explain why this logic is flawed.  Indeed, Kash Mansouri argues that the ECB is, in effect, pushing Greece out of the Euro (though he seems to interpret this as an unintended consequence...).

Its not really President Obama's job to tell Europe how to sort out their debt problems - indeed, he's got his hands full with a Congress that seems to want to set off a much bigger crisis by not raising the debt ceiling - but hopefully he can give them a friendly nudge in the right direction while he's over there.  And the US should be using its influence over the IMF to get them to play a more constructive role.

April Employment Report

The BLS reports this morning that the economy added 244,000 jobs in April, but the unemployment rate ticked up to 9% (from 8.8%).  In this case, the reason for the apparent contradiction is that the two numbers come from different surveys - the first is from a survey of firms (the "establishment survey"), and the unemployment rate from a survey of households.  The household survey reported a decrease of 190,000 in the number of people employed.  In general, the two track each other well, but may diverge in any given month; when that happens people tend to trust the establishment survey more because it has a larger sample.

Nonfarm Payrolls, Seasonally Adjusted

Overall, this report seems to be consistent with an economy digging out of a very deep hole at a very slow pace.  While the increase in 244,000 jobs more than what is needed just to keep pace with labor force growth (130,000-ish), 13.7 million people remain unemployed.  The economy is about 4.6 million jobs short of a "normal" (but still not great) unemployment rate of 6% - at this pace, we'd get there in about three and a half years.

The report also included slight upward revisions of the February and March employment numbers (41,000 and 5,000 respectively).

Average hourly earnings have increased by 1.9% over the past year.  That's more evidence that inflation is not a problem: wages should rise somewhat due to productivity growth, so that's not an inflationary number at all.

Private payrolls were up 268,000, but government shed 24,000 jobs, of which 8,000 was at the state level and 14,000 at the local level.

On a non-seasonally adjusted basis, the unemployment fell from 9.2% to 8.7% in April (i.e., this is a month with a large seasonal job increase, which the BLS tries to remove from all of the numbers discussed above, which are seasonally adjusted).

The Graduate Curriculum

Macro navel-gazing turns (again) to the graduate curriculum....

Brad DeLong:

The fact is that we need fewer efficient-markets theorists and more people who work on microstructure, limits to arbitrage, and cognitive biases. We need fewer equilibrium business-cycle theorists and more old-fashioned Keynesians and monetarists. We need more monetary historians and historians of economic thought and fewer model-builders. We need more Eichengreens, Shillers, Akerlofs, Reinharts, and Rogoffs – not to mention a Kindleberger, Minsky, or Bagehot.

Yet that is not what economics departments are saying nowadays.

Perhaps I am missing what is really going on. Perhaps economics departments are reorienting themselves after the Great Recession in a way similar to how they reoriented themselves in a monetarist direction after the inflation of the 1970’s. But if I am missing some big change that is taking place, I would like somebody to show it to me.

As if it weren't bad enough that some assistant professors are writing blogs, a Michigan grad student named Noah Smith is blogging, too.  After a description of his first-semester macro class, he says:

This course would probably have given Brad DeLong the following reasons for complaint:

1. It contained very little economic history. Everything was math, mostly DSGE math.
2. It was heavily weighted toward theories driven by supply shocks; demand-based theories were given extremely short shrift.
3. The theories we learned had almost no frictions whatsoever (the two frictions we learned, labor search and menu costs, were not presented as part of a full model of the business cycle). Other than Q-theory, there was nothing whatsoever about finance* (Though we did have one midterm problem, based on the professor's own research, involving an asset price shock! That one really stuck with me.).

At the time I took the course, I didn't yet know enough to have any of these objections... 

Paul Krugman:

[M]odern graduate-level macroeconomics has managed to bury and forget what earlier generations knew, so that what was billed as intellectual progress ended up being, in crucial ways, intellectual regress. 

Hmmm.... yes and no...

Grad school is trying to produce "productive" scholars, good practitioners of what Thomas Kuhn would call "normal science", who generate publications in academic journals.  As such, much of it, especially the first year, is about learning techniques and terminology.  Most of what I remember from my first year is doing alot of algebra - and that's not a bad thing, being at least somewhat good at algebra turns out to be pretty important, as is knowing about things like Kuhn-Tucker conditions, Hamiltonians, and Bellman equations.

In that sense, I don't think economics PhD programs do such a bad job.  My first year graduate course was mostly growth theory and dynamic consumption theory, which were good vehicles for exposing us to the nuts and bolts of macroeconomic models.  What is missing, is a sense of perspective and context.  Contemporary academic models are grounded in "microfoundations" - the optimization problems of forward-looking agents - and, as such are very different from the models taught to undergraduates.  First-year graduate students learn quickly that macroeconomics is very different from what they expected (i.e., its "micro with time subscripts"), but they don't know why.  Time is precious in putting together a course, but I think a prologue which develops the motivation behind contemporary methods - principally the Lucas Critique and rational expectations revolution - would be time well spent (this article by Greg Mankiw is a good place to start).

DeLong and Krugman lament the lingering prominence of the "saltwater" Real Business Cycle (RBC) paradigm, and they have pointed out some startling statements by prominent true believers.  However, there is good reason for nonbelievers to learn these models, as the methods used by them are also at the core of many state-of-the-art New Keynesian models.

If a PhD program can get its students through some growth theory and consumption theory, which come together in the Ramsey-Cass-Koopmans model, and take the small step from there to RBC models in the first year, those students would be well-prepared to study models with frictions and market failures more relevant to current problems in the second year.

Previously, I have also argued for including history of economic thought in the graduate curriculum.  The trick would be to get people to take it seriously.  This would help recover some of the insight that Krugman (rightly) believes have been obscured.  Moreover, this might get students thinking more broadly, which would improve the likelihood that they might actually be in a position to re-think and change existing paradigms, rather than just being "productive" within them.

Null Hypothesis

XKCD:

1Q GDP: Bleh

The US economy grew at a 1.8% annual rate in the first quarter, according to the BEA's advance estimate.  That's not good - it less than the 2.5%-ish pace needed to keep the unemployment rate stable as the labor force grows and productivity increases - and way short of what we need to significantly bring unemployment down.

The slow growth wasn't a surprise, and much the slowdown is being attributed it to temporary factors, including the severe weather in January, and a slowdown in defense purchases.

The main positive contributions came from consumption, which grew at a 2.7% rate, and inventory investment, which was something of a "bounceback" effect - the actual amount added to inventories was modest, but it was an acceleration relative to the fourth quarter, when there had been a big slowdown.

The government purchases component was a drag, falling at a 5.1% annual rate (defense fell at a 11.7% rate while state and local government declined at a 3.3% pace).

The inflation rate, measured by the GDP deflator, was 1.9%.  Personal consumption expenditures (PCE) inflation was 3.8%, but excluding food and energy - i.e., "core PCE" - was 1.5%.  If one believes that the core measure is the right one to guide monetary policy, then inflation is still low.

Disposable income was up sharply due to the payroll tax cut that took effect in January - 6.9% in nominal terms - but only 2.9% in real terms (I think that's where you see the effect from energy prices).

Meanwhile the Department of Labor says that unemployment claims are rising again...

The next revision of the GDP figures comes out on May 26.

See also: Free Exchange, Ezra Klein, Calculated Risk.

FOMC TV

Ben Bernanke held his first post-FOMC meeting press conference today:



Reactions: Mark Thoma, Tim Duy, Paul Krugman, Brad DeLong, David Beckworth, Calculated Risk, Free Exchange, Catherine Rampell. The conference was liveblogged by the Times' Floyd Norris and by WSJ reporters.

The general tenor of the reactions (particularly the first five in the list above) is disappointment that it sounds highly unlikely that the Fed will undertake further expansionary policy beyond the $600 billion quantitative easing program currently in progress.  This is particularly frustrating in light of the Fed's own revised projections, released today:

The "longer run" unemployment number can be taken as the Fed's estimate of the "natural rate," the lowest rate consistent with non-inflationary growth.  The Fed is saying that it expects the unemployment rate to be significantly above the natural rate for at least three more years.

I think this statement was particularly telling:

I think that while it is very, very important for us to try to help the economy create jobs and to support the recovery, I think every central banker understands that keeping inflation low and stable is absolutely essential to a successful economy and we will do what is necessary to ensure that that happens. 

While Bernanke is always careful to explain policy decisions in terms of the Federal Reserve Act's "dual mandate" of low unemployment and price stability, here he is subtly putting more weight on the inflation part ("absolutely essential"), relative to employment ("very, very important").  I think this is because "every central banker" is deeply afraid of repeating the mistakes of the 1970's, when high inflation became embedded in the economy, and could only be brought back under control with a very painful dis-inflation in the early 1980's.  It may be that, in addition to hurting consumer sentiment, by providing a reminder of "stagflation" of the seventies, the recent run-up in oil prices is also casting a large shadow over the psyche of central bankers.

Also, the academic literature places significant emphasis on expectations and credibility, so the "hawkish" talk is likely partly motivated by a desire to keep a lid on inflation expectations. Of course, credibility ultimately depends on actions consistent with the talk.

While some of us academic types were disappointed in what we see as an excessive emphasis on inflation relative over employment (this is not universal: for a contrary view, see Steve Williamson), the markets may have read things differently.  Treasury yields rose today, which suggests that the news from the Fed was slightly less hawkish than expected.