Category: Equitablog

I truly do not understand this argument by the very sharp Daniel Davies:

Daniel Davies: Comment on Greece, Decision Theory, and the Sure-Thing Principle: “If Greece stays in the Euro it is likely to need constant transfers forever…

…If it leaves, but stays in the EU, then these can be reduced from a level in the tens of billions to something like what Romania or Bulgaria get….

The reason, of course, the transfers can then be reduced is that a Greece out of the euro re-denominates its debt in Greekeuros–drachmas–which go to a substantial discount vis-a-vis the euro, thus devalues, begins to have an export boom, and sees a strong economic recovery. What’s the problem?

Daniel continues:

Greece also loses political influence, and so can’t cause as many problems as it has in the past about things like the Balkans or Turkey…

So the Former Yugoslav Republic of Macedonia gets to call itself “Macedonia” (or “North Macedonia” or “Heartland Macedonia” or whatever), the chances of resolving Cyprus go up, etc. In short:

There’s a lot of favourable things about Greek Euro exit from the point of view of creditor states….

But then he turns on a dime:

I still think losing Greece would be a net negative for Europe (and a tragedy for Greece, albeit that if the EU had spare capacity to make transfers, Romania is a more needy candidate)…

Why is economic recovery–casting the German austerity boat anchor over the side–a tragedy for Greece?

The old argument was that Greek exit from the euro would administer a massive deflationary shock to the European economy as everybody scrambled for safety and thus dumped their southern European sovereign-debt bonds for northern European ones, that it was important to avoid such a deflationary confidence shock, and that as a result Europe would supply enough transfers to make staying in the euro more attractive to Greece than the disruption of exit followed by recovery. That chain of argument has turned out to be wrong.

Does Daniel think that the deflationary shock is not there? That would seem to be implied by his statement that Greece is a “financial liability” to the creditor states. But in that case why have we been dinking around for five years now?

Must- and Should-Reads:

• Must-Read: Richard Kogan: CBO Contradicts Itself — Long-Term Budget Picture Improving, Not Worsening
• Must-Read: Raj Chetty: Behavioral Economics and Public Policy: A Pragmatic Perspective
• Must-Read: Hoyt Bleakley and Jeffrey Lin: History and the Sizes of Cities
• Mary Daly et al.: Finding Normal: Natural Rates and Policy Prescriptions
• Nick Bunker: Are estimates of the long-term U.S. unemployment rate too high?
• Must-Read: Ali Alichi et al.: Avoiding Dark Corners: A Robust Monetary Policy Framework for the United States
• Dan Drezner: “The only lesson that the United States should draw from Greece is that the United States is not Greece…”
• Must-Read: Benjamin Golez and Peter Koudijs: Four Centuries of Return Predictability
• Must-Read: Paul Blustein: Laid Low: The IMF, the Euro Zone and the First Rescue of Greece
• Must-Read: Brendan Duke: New Data Illustrate the Failure of the Trickle-Down Experiment
• Dan Alpert: Greece Descended Into Circus With No Ringmaster

Might Like to Be Aware of:

• Doug J.: “[Charles Lane of] the Washington Post is edging closer to calling for a coup in Greece…”
• Ria Misra: [Chien-Shiung Wu’s] Experiment That Overturned A Basic Law of Physics](http://io9.com/the-experiment-that-overturned-a-basic-law-of-physics-1715265897)
• Must-Read: Nate Silver: The Polls Were Bad in Greece. The Conventional Wisdom Was Worse
• ASU Media Literacy Course
• Must-Read: Ethan Sacks: ‘Star Wars’ Standalone Film Will Be Han Solo Prequel – NY Daily News

Over at Grasping Reality: Hoisted from Five Years Ago: Paul Krugman: The Conventional Superstitions of Austerity (2010): “Calculated Risk points us to a speech by Kevin Warsh…

…that strikes me as almost the perfect illustration of the predicament we’re in, in which policy is paralyzed by fear of invisible bond vigilantes. Warsh isn’t an especially bad example — but that’s the point: this is what Serious People sound like these days. The bottom line of Warsh’s speech — although expressed indirectly — is that it’s time for fiscal austerity, even though the economy remains deeply depressed; and no, the Fed can’t offset the effects of fiscal contraction with more quantitative easing. In short, the responsible thing is just to accept 10 percent unemployment. And why is this the responsible thing? On fiscal policy: “market forces are often more certain than promised fiscal spending multipliers…”

Um, but those market forces are currently willing to lend money to the US government at an interest rate of 3.05 percent. But never mind: “unanticipated, nonlinear events can happen…”

So it’s these ‘unanticipated, nonlinear events’ that are ‘more certain’ than the direct effects of fiscal policy? I’m confused…

Must-Read: Richard Kogan: CBO Contradicts Itself — Long-Term Budget Picture Improving, Not Worsening: “The Congressional Budget Office’s (CBO) new report…

…on the budget picture opens by saying, “The long-term outlook for the federal budget has worsened dramatically over the past several years,” blaming the Great Recession and the steps taken to address it. But CBO’s own data, in that very report, show that’s not the case.

Must-Read: Raj Chetty: Behavioral Economics and Public Policy: A Pragmatic Perspective: “The debate about behavioral economics…

…the incorporation of insights from psychology into economics—is often framed as a question about the foundational assumptions of economic models. This paper presents a more pragmatic perspective on behavioral economics that focuses on its value for improving empirical predictions and policy decisions. I discuss three ways in which behavioral economics can contribute to public policy: by offering new policy tools, improving predictions about the effects of existing policies, and generating new welfare implications. I illustrate these contributions using applications to retirement savings, labor supply, and neighborhood choice. Behavioral models provide new tools to change behaviors such as savings rates and new counterfactuals to estimate the effects of policies such as income taxation. Behavioral models also provide new prescriptions for optimal policy that can be characterized in a non-paternalistic manner using methods analogous to those in neoclassical models. Model uncertainty does not justify using the neoclassical model; instead, it can provide a new rationale for using behavioral nudges. I conclude that incorporating behavioral features to the extent they help answer core economic questions may be more productive than viewing behavioral economics as a separate subfield that challenges the assumptions of neoclassical models.

Must-Read: Hoyt Bleakley and Jeffrey Lin: History and the Sizes of Cities: “We contrast evidence of urban path dependence with efforts to analyze calibrated models of city sizes…

…Recent evidence of persistent city sizes following the obsolescence of historical advantages suggests that path dependence cannot be understood as the medium-run effect of legacy capital but instead as the long-run effect of equilibrium selection. In contrast, a different, recent literature uses stylized models in which fundamentals uniquely determine city size. We show that a commonly used model is inconsistent with evidence of long run persistence in city sizes and propose several modifications that might allow for multiplicity and thus historical path dependence.

Paul Krugman succumbs once again to shrill unholy madness: Ph’nglui mglw’nafh Friedman R’lyeh wgah’nagl fhtagn!! This time it is over the observation that, as I put it, John Maynard Keynes has lots of disciples–people who believe that the macroeconomy can easily destabilize itself or be easily destabilized by inept policy rules (that should keep Nick Rowe quiet)–and Friedrich von Hayek has lots of disciples–people who believe that recessions are the market’s judgment upon the feckless, and that it would be both impious and counterproductive to interfere with the market, blessed be its unholy name–but Milton Friedman’s halfway house has no occupants today. Well, Scott Sumner. And James Pethokoukis. But even Nick Rowe is more a Clower-Leijonhufvud kind of guy. And Friedman’s wingpersons, like Allan Meltzer and Anna Jacobsen Schwartz, became more and more Hayekian as the tide of Friedman’s influence began to ebb.

At the level of economists’ ideology it is clear what is going on: If significant macroeconomic failures exist that can only be remedied if the central bak via fancy footwork adjusts and readjusts outside financial asset stocks to make Say’s Law true in practice, then the argument that the market always does well has one big huge counterexample. Friedman finessed that question by presenting fancy footwork adjusting and readjusting outside financial asset stocks to make Say’s Law true in practice as a “neutral” monetary policy. And via fast and aggressive talking he could carry the day as long as he was around. But once he was no longer around to talk faster than his interlocutors could think, those whose principal allegiance was to market perfection came under enormous psychological pressure to find a way to get rid of the anomalous macroeconomic edge case, and so fell into Hayekism.

At the level of economists’ nationality it is equally clear what is going on: German (and French) economists grew up and lived in a world where somebody else–the benevolent Kindlebergian hegemon of the United States–took on the task of maintaining a stable level of aggregate demand in the North Atlantic as a whole. With the possibility of large hemisphere-wide demand shortfalls ruled out, it made intellectual, pragmatic, and policy sense to focus on the “structural”.

But at the level of economic technocracy? Eppur si muove: Keynesianism, broadly defined, helps understand the world. Ordoliberal Hayekianism does not. The technocrats of the eurozone have a lot of explaining to do–to themselves, to their political masters, and ultimately to the continent’s worth of people whom they have failed.

Paul Krugman: Milton Friedman, Irving Fisher, and Greece: “I continue to be amazed by how many people regard debt relief and devaluation…

…as wild-eyed radical ideas; of course, it matters most that so many influential people in Europe share this ignorance. Anyway, for the record (and for my own future reference) I thought it would be helpful to post what Milton Friedman and Irving Fisher had to say about the Greek disaster. OK, they weren’t writing specifically about Greece–Friedman was writing in 1950, Fisher in 1933. But their analyses ring truer than ever.

First, Friedman (why oh why isn’t there a full electronic copy of this essay online?):

If internal prices were as flexible as exchange rates, it would make little economic difference whether adjustments were brought about by changes in exchange rates or by equivalent changes in internal prices. But this condition is clearly not fulfilled. The exchange rate is potentially flexible in the absence of administrative action to freeze it. At least in the modern world, internal prices are highly inflexible. They’re more flexible upward and downward, but even on the upswing all prices are not equally flexible.

The inflexibility of prices, or different degrees of flexibility, means and distortion of adjustments in response to changes in external conditions. The adjustment takes the form primarily of price changes in some sectors, primarily of output changes in others.

Wage rates tend to be among the less flexible prices. In consequence, an incipient deficit that is countered by a policy of permitting or forcing prices to decline is likely to produce unemployment rather than, or in addition to, wage decreases. The consequent decline in real income reduces the domestic demand for foreign goods, and thus the demand for foreign currency with which to purchase these goods. In this way, it offsets the incipient deficit.

But this is clearly a highly inefficient method of adjusting to external changes. If the external changes are deep-seated and persistent, the unemployment produce a steady downward pressure on prices and wages, and the adjustment will not have been completed until the deflation has run its sorry course.

That tells you everything you need to know about why ‘internal devaluation’ has been such a costly strategy–and why the ECB’s failure to move aggressively early on to achieve and if possible surpass its 2 percent inflation target was a major contributing factor to this disaster.

Then Fisher on why austerity hasn’t even helped on the debt:

(32) And, vice versa, deflation caused by the that reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes. In that case, the liquidation defeats itself. While it diminishes the number of dollars owed, it may not do so as fast as it increases the value of each dollar owed. Then, the very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe. The more the economic boat tips, the more it tends to tip. It is not tending to write itself but is capsizing.

The basic story of the European periphery–not just Greece–is one of a poisonous interaction between Friedman and Fisher, which has produced incredible suffering while failing to reduce the debt/GDP ratio, which even in star pupils like Ireland and Spain is far higher than when austerity began; the only success has been in suffering long enough so that some growth has finally resumed, and they can call it vindication.

The bizarreness of the whole thing is how flaky, speculative ideas like expansionary austerity became orthodoxy, while applying the economics of Fisher and Friedman became heterodoxy bordering on Chavismo.

Must-Read: Nate Silver: The Polls Were Bad in Greece. The Conventional Wisdom Was Worse: “So… the pundits are so bad that you should literally bet against whatever they say?…

…Even I wouldn’t go that far. I’m happy to mostly ignore them instead. The problem, though, is that because of [pollster] herding, it’s become harder to get what I really want–an undiluted sample of public opinion. Instead, there’s sometimes quite a bit of conventional wisdom baked into the polls. Be wary when there’s a seeming consensus among the polls, especially under circumstances that should make for difficult polling. There’s a good chance the polling will be wrong–but in the opposite direction of what most people are expecting.

Must-Read: Ali Alichi et al.: Avoiding Dark Corners: A Robust Monetary Policy Framework for the United States: “The Fed has taken several steps towards strengthening its monetary framework…

…Those steps have supported the Fed’s efforts to stimulate the economy through forward guidance despite being constrained by having policy rates at zero. We show that an optimal control approach to monetary policy, which includes the publication of a baseline forecast and a description of the uncertainties around that outlook, combined with an improvement in the Fed’s communications toolkit, could further enhance the effectiveness of Fed policy. In the current conjuncture, such a risk management approach to monetary policy would result in both a later liftoff of policy rates and a modest, but planned, overshooting of inflation.