Must-Read: Mike Konczal: The Forgotten State: “Where Levin sees the government crowding out more worthwhile enterprises…

…Jacob Hacker and Paul Pierson argue in American Amnesia that the state is central to the success of our economy. In fact, it is impossible to separate them, and you wouldn’t want to anyway. Recovering a phrase that had gone out of fashion, Hacker and Pierson use the term ‘mixed economy’ to describe a set of practices and functions designed ‘to overcome failure of the market and to translate economic growth into broad advances in human well-being—from better health and education to greater knowledge and opportunity.’ It is this mixed economy, the authors contend, that made the United States rich and built the middle class.

Many, even on the left, have come to see the government as a giant redistribution machine. Taxes are collected on one side; income support and social insurance go out the other. But this impoverished view of the state reflects just one function of government, and Hacker and Pierson are out to reclaim the role of the state in the market economy through its role in fixing market failures, advancing science, safeguarding markets, and ensuring ‘that economic gains bec[o]me social gains.’

There is a lot of history to unpack. Since the federal government was founded, it has taken the lead in internal development, monetary policy, corporate chartering, bankruptcy law, land grants, communications law, regulation, public education, and other arenas of major economic importance. The federal government has also been a major agent in reducing incidence of communicable disease, a problem that peaked even amid the economic gains of the late nineteenth century. Not just wealth but public action was needed. Cleaner water and better infrastructure rapidly extended lifespans. Reviving this long story of the role of the federal government has been a major achievement of recent historiography, and American Amnesia puts it on display.

By focusing on the many federal activities taken for granted, Hacker and Pierson show the holes underlying libertarian logic. Milton Friedman famously saw the power of free markets at work in a single lead pencil. No one person knows how to make it, he said. Instead the magic of prices coordinates the action of people in diverse industries around the world. But while Friedman may have been right about the coordinating effect of prices, he ignored the deep network of education, infrastructure, property rights, corporate charters, and other government-enforced legal structures that make private enterprise possible. In a telling illustration, Hacker and Pierson draw on Mariana Mazzucato’s The Entrepreneurial State (2011), which shows how smartphone components—GPS, advanced batteries, cellular technology, touch-screen and LCD displays—were built on a foundation of research that was not just publicly funded but sometimes carried out by the government itself…

Must-Read: This really ain’t rocket science, people. Or brain surgery…

Paul Krugman (2013): Other Austerity Bloopers: “It’s worth recalling the other paper that swept through the ranks of the VSPs…

…briefly becoming orthodoxy, what everyone knew, until people took a hard look at the data. Remember Alesina and Ardagna? That was the paper that supposedly showed that spending cuts were actually expansionary, because of Confidence (TM). It was so influential that Peter Coy at BusinessWeek wrote:

Alberto Alesina is a new favourite among fiscal hawks…. This is Alesina’s hour. In April (2010) in Madrid, he told the European Union’s economic and finance ministers that ‘large, credible and decisive’ spending cuts to rescue budget deficits have frequently been followed by economic growth. He was…influential enough to be cited in the official communiqué of the EU finance minister’s meeting….

A-A (beware of papers where both authors have the same initial?) used a statistical technique that was supposed to identify episodes of large fiscal contraction; but if you compared that estimate with actual policy changes, it bore very little relationship. What seems to have been going on was that the statistical filter was picking up extraneous effects, often correlated with good economic developments. For example, a stock market boom would increase revenue, reducing the deficit; A-A would count this as a contractionary fiscal policy, and marvel at the expansion that followed. Mike Konczal, who co-authored another careful critique, wrote:

To be frank, when I dug into the Alesina and Ardagna paper and finally understood the work their 1.5% primary deficit reduction was doing I wandered around stunned for a day or two. I called a bunch of people I trusted on macroeconomics and tried to see if I was missing something; was our elite discourse, the Sensible People Stuff, really being driven by this?

The point, as with Reinhart-Rogoff, was that the paper told austerity-minded people what they wanted to hear, and they seized on its message without carefully examining the underlying research…. A-A didn’t crash-land the way R-R did…. It was damaged by the IMF study, and thereafter got gradually discredited as the disastrous results of austerity in Europe became apparent. So there wasn’t a sudden moment of realizing that the emperor wore no clothes. Nonetheless, the underlying story, of dubious research put on a pedestal because it was what the VSPs wanted, was the same.

And Alberto is still digging in:

Alberto Alesina (2016): “The IMF, in 2010 wrote a rather pointed criticism about my work…

…whether there are cases where spending cuts accompanied by other policies can be expansionary, and the confidence argument that [Krugman] makes fun of is actually confidence, one of the many aspects; and we can elaborate on that. But I think that there are several episodes in which fiscal spending cuts have been accompanied not by a recession, but by an expansion. So, I think that those kind of statements by Krugman are trying to push a view which is respectable but they are not proven by the facts. Or at least they are not supported by research… http://scholar.harvard.edu/files/alesina/files/fiscaladjustments_lessons-1.pdf

Remember: Alberto Alesina (2016): “Many even sharp reductions of budget deficits have been accompanied and immediately followed by sustained growth rather than recessions even in the very short run…

…These are the adjustments which have occurred on the spending side and have been large, credible and decisive…. Governments which have initiated thorough and successful fiscal adjustment policies have not systematically suffered at the polls… especially… when the electorate has perceived the sense of urgency of a crisis or in some cases in the presence of an external commitment. On the contrary, fiscally-loose governments have suffered losses at the polls…. Thus relatively painless (economically and politically) fiscal adjustments might be possible; whether government will take the opportunity remains to be seen… http://scholar.harvard.edu/files/alesina/files/fiscaladjustments_lessons-1.pdf

It’s not the adjustments that are “large, credible, and decisive” that are accompanied by expansions. It’s those that are:

1. the result of large positive supply shocks,
2. accompanied by massive monetary expansion, or
3. associated with large declines in the value of the currency.

This ain’t rocket science, people…

Must-Read: Noah Smith thinks Chicago-style macroeconomics is a diseased intellectual discipline. I believe he is correct:

Noah Smith: “In macroeconomics, falsified theories never die, and their proponents often don’t acknowledge empirical failures…”_:

In macroeconomics, falsified theories never die, and their proponents often don't acknowledge empirical failures. https://t.co/K8uf5uZhWV

— Noah Smith (@Noahpinion) July 23, 2016

Edward Prescott: RBC Methodology and the Development of Aggregate Economic Theory:

This essay reviews the development of neoclassical growth theory, a unified theory of aggregate economic phenomena that was first used to study business cycles and aggregate labor supply. Subsequently, the theory has been used to understand asset pricing, growth miracles and disasters, monetary economics, capital accounts, aggregate public finance, economic development, and foreign direct investment.

The focus of this essay is on real business cycle (RBC) methodology. Those who employ the discipline behind the methodology to address various quantitative questions come up with essentially the same answer—evidence that the theory has a life of its own, directing researchers to essentially the same conclusions when they apply its discipline. Deviations from the theory sometimes arise and remain open for a considerable period before they are resolved by better measurement and extensions of the theory. Elements of the discipline include selecting a model economy or sometimes a set of model economies. The model used to address a specific question or issue must have a consistent set of national accounts with all the accounting identities holding. In addition, the model assumptions must be consistent across applications and be consistent with micro as well as aggregate observations. Reality is complex, and any model economy used is necessarily an abstraction and therefore false. This does not mean, however, that model economies are not useful in drawing scientific inference.

The vast number of contributions made by many researchers who have used this methodology precludes reviewing them all in this essay. Instead, the contributions reviewed here are ones that illustrate methodological points or extend the applicability of neoclassical growth theory. Of particular interest will be important developments subsequent to the Cooley (1995) volume, Frontiers of Business Cycle Research. The interaction between theory and measurement is emphasized because this is the way in which hard quantitative sciences progress.

Must-Read: Gregory Clark, Kevin Hjortshøj O’Rourke, and Alan M. Taylor: The Growing Dependence of Britain on Trade During the Industrial Revolution: “Many previous studies of… the British Industrial Revolution have found little or no role for trade…

…We construct a three-region model of the world in which Britain trades with North America and the rest of the world, and calibrate the model to data from the 1760s and 1850s. We find that while trade had only a small impact on British welfare in the 1760s, it had a very large impact in the 1850s. This contrast is robust to a large range of parameter perturbations. Biased technological change and population growth were key in explaining Britain’s growing dependence on trade during the Industrial Revolution.

Must-Read: Noah Smith: Conservatism Failed: “The Republican presidential candidate was usually a gray, bland figure, a stalwart conservative but not a fire-breathing one…

…who had worked his way up the ranks. Romney, McCain, Bush II, Dole, and Bush I all fit this description[, and even] Reagan… did not deviate too far from this model. As a conservative, the Republican nominee would support tax cuts, a business-friendly attitude, a tough-guy attitude toward America’s enemies and rivals, and traditional family values based on Christianity. That’s what conservatism was.

But in the past fifteen years, the three pillars of conservatism–economic, foreign-policy, and social conservatism–have all had huge, dramatic failures…. The Bush tax cuts failed to reverse [middle-class] income stagnation… [and] a lax regulatory climate appeared to give rise to a financial crisis that devastated the job market…. The formula of ‘cut taxes[, deregulate,] and let businesses do as they see fit’ is now pretty discredited…. Older intellectuals [who] continue to fight doggedly for this economic program… are rightfully ignored….

Foreign policy conservatism… failed… when Bush turned bellicose rhetoric into bellicose reality with the disastrous Iraq War…. A more minor failure was the seeming emptiness of Bush’s bellicose rhetoric when it came to actual threats. Under Bush’s watch, Putin’s power grew inexorably, and North Korea got nukes, while Bush barked impotently…. Finally, social conservatism… [which] promised to restore family values by promoting Christianity and resisting things like gay marriage. But… Americans have resoundingly rejected the values pushed on them by Christian conservatives in the 80s, 90s, and 00s…. Add all this up, and what do you get? A massive, total failure of all three pillars of modern conservatism within a 15-year period….

The collapse of the conservative ideology… is what inevitably happens to an ideology when it succumbs to overreach, dogmatism, and an echo chamber. I hope I don’t ever have to watch the same thing happen to the American left.

Must-Read: Danny Blanchflower: “UK Headed to Recession…”:

clear now UK headed to recession unclear how deep question is how much the drop can be dissipated by action of BOE & Treasury who can't wait

— Danny Blanchflower (@D_Blanchflower) July 22, 2016