Must-Reads: June 3, 2016

Posted on by Brad DeLong

Must-Read: Olivier Blanchard: How to Teach Intermediate Macroeconomics after the Crisis?

Posted on by Brad DeLong

Must-Read: Am I allowed to say that nearly all of this is in Paul Krugman’s 1998 The Return of Depression Economics?

Olivier Blanchard: How to Teach Intermediate Macroeconomics after the Crisis?: “The IS relation remains the key to understanding short-run movements in output…

…In the short run, the demand for goods determines the level of output. A desire by people to save more leads to a decrease in demand and, in turn, a decrease in output. Except in exceptional circumstances, the same is true of fiscal consolidation. I was struck by how many times during the crisis I had to explain the ‘paradox of saving’ and fight the Hoover-German line, ‘Reduce your budget deficit, keep your house in order, and don’t worry, the economy will be in good shape.’ Anybody who argues along these lines must explain how it is consistent with the IS relation. The demand for goods, in turn, depends on the rate at which people and firms can borrow (not the policy rate set by the central bank, more on this below) and on expectations… animal spirits… largely self-fulfilling. Worries about future prospects feed back to decisions today….

The LM relation… is the relic of a time when central banks focused on the money supply…. The LM equation must be replaced, quite simply, by the choice of the policy rate by the central bank, subject to the zero lower bound. How the central bank achieves it… can stay in the background…. Traditionally, the financial system was given short shrift in undergraduate macro texts. The same interest rate appeared in the IS and LM equations…. This is not the case and that things go very wrong. The teaching solution, in my view, is to… discuss how the financial system determines the spread between the two….

Turning to the supply side, the contraption known as the aggregate demand–aggregate supply model should be eliminated…. One simply uses a Phillips Curve…. Output above potential, or unemployment below the natural rate, puts upward pressure on inflation. The nature of the pressure depends on the formation of expectations…. If people expect inflation to be the same as in the recent past, pressure takes the form of an increase in the inflation rate. If people expect inflation to be roughly constant… pressure takes the form of higher—rather than increasing—inflation. What happens to the economy, whether it returns to its historical trend, then depends on how the central bank adjusts the policy rate in response to this inflation pressure…. This… is already standard in more advanced presentations and the new Keynesian model (although the Calvo specification used in that model, as elegant as it is, is arbitrarily constraining and does not do justice to the facts). It is time to integrate it into the undergraduate model…. These modified IS, LM, and PC relations can do a good job….

I consider two extensions… expectations… openness. Here, also, there are important lessons from the crisis…. The long interest rate… as the average of future expected short rates, with a fixed term premium. Quantitative easing… can affect this premium…. Deriv[ing]… exchange rates from the uncovered interest rate parity condition… assumes infinitely elastic capital flows. The crisis has shown… capital flows have finite elasticity and are subject to large shocks beyond movements in domestic and foreign interest rates. Periods of ‘risk on-risk off’ and large movements in capital flows have been an essential characteristic of the crisis and its aftermath…

Must-Read: Ben Thompson: Building Infrastructure

Posted on by Brad DeLong

Must-Read: Ben Thompson: Building Infrastructure: “I think the best way to think about physical retail going forward…

…is to start with what Bezos said about Amazon’s own initial foray:

The store is very different from any bookstore that you have gone into. It has a very small selection, very highly curated, only about 5,000 titles and they’re all face out on the shelves, and they’re picked based on the data that we have at Amazon from the website. If you come to the Amazon physical bookstore with a specific title in mind that you want to buy there’s a very good chance because we have such a curated selection that you’ll be disappointed. But why would we build a store that’s designed to — if you already know what book you want to buy we already have this thing called Amazon.com that’s very very good at satisfying that need, and so this is about satisfying a completely different need. It’s about browsing and discovery and having a really fun space to wander around in….

Because the design of the store starts with the assumption that Amazon.com exists, it can be totally optimized for, in Bezos’ words, ‘browsing and discovery and having a really fun space’ with little space wasted on holding inventory…. Physical retail has its benefits… the ones Bezos listed… demonstrating highly experiential and differentiated products. What will be critical, though, are business models and cost structures that start with the presumption of the Internet and its associated business models, and that is why Gap and the other merchants who built businesses around geographic limitations are (like newspapers before them) very much in trouble….

The other Bezos quote I promised you….

When I started Amazon all of the heavy lifting infrastructure to support Amazon was already in place. We did not have to invent a remote payment system. It was already there. It was called the credit card…. We did not have to invent transportation, local transportation, the last mile. There was this thing called U.S. Postal Service and UPS which was not invented for e-commerce but if we had had to deploy last mile transportation 20 years ago it would have cost hundreds of billions of dollars of capital. It would have been impossible for a company like Amazon to even conceive of doing that. Same thing deploying computer infrastructure…. And how did the Internet grow so fast? Even there the heavy lifting infrastructure had already been done for another purpose which was the long-distance phone network….

AWS and… Stripe… are building a new layer that enables entrepreneurism…. This new layer is about ongoing usage: AWS and Stripe’s value to entrepreneurs is less about reducing costs than it is controlling them on one side and enabling significantly more focus and specialization on the other…. The way organizations build, deploy and scale modern applications has fundamentally changed. Organizations must continuously bring new applications and features to market… rapid innovation…. freely experiment, quickly prototype and rapidly deploy new applications that are massively scalable…. Twilio, Stripe, and even AWS are bets on the idea that Software is Eating the World to the extent that mucking around with global communications networks is not worth whatever slight cost savings you might gain from forgoing Twilio’s margins — that your developers’ time is better spent building differentiation than it is redoing what Twilio has already done…

Must-Read: John Whitehead: The Conservative Bias in Economics?

Posted on by Brad DeLong

Must-Read: I think the rather sharp John Whitehead gets this critique of Mark Thoma wrong. Rather than being “ultra conservative”, Milton Friedman is rather a squish. The Stigler-Coase position is:

  1. If the government does not prevent it via misregulation, the private sector will contract to internalize all externalities, and
  2. Even if the private sector does not, government failure is still much worse than market failure.

Those two arguments were necessary to move away from the Henry Simons position that the government must and shall enforce competition–that the FTC should be the largest and most aggressive arm of government. If Chicago wanted to influence in the business-governed councils of the Republican Party and to please donors to the university, it needed to find a way to wriggle out of that first-generation Chicago-school economics midwestern-populist commitment. And it did.

Friedman, by contrast, was more of a wet. He wanted to make the market work, and he wanted in the here-and-now to make the market work better. That meant: a k%/year monetary growth rule. That meant: Pigovian taxes to substitute for incredibly inefficient command-and-control regulation. Via clever rhetoric Friedman could minimize his philosophical differences with the von Miseses and company. And the question of what to do after the Revolution… that would never arise…

John Whitehead: The Conservative Bias in Economics?: “Is [Thoma’s] argument liberal or conservative? I’d say neither…

…I’m tempted to add [ultra] or something like that to conservative in this excerpt because the argument is straight from the conservative economist Milton Friedman…. I pulled my copy of Free to Choose off the shelf and read the section on the environment…. Rather than a description of Coasian free-market environmentalism, it is a description of mainstream Pigouvian environmental economics. For example, on page 207:

Most economists agree that a far better way to control pollution than the present method of specific regulation and supervision is to introduce market discipline by imposing effluent charges.

Mainstream economists tend to be in favor of imposing market discipline with pollution taxes or permit markets relative to the ‘idea that markets work best when they are left alone.’

Must-Read: Olivier Blanchard: Rethinking Macro Policy: Progress or Confusion?: Fiscal Policy

Posted on by Brad DeLong

Must-Read: On this one–views of fiscal policy–put me down not for progress but for “confusion for $2000”, Alex, for on this one I think the very sharp Olivier Blanchard has got it wrong.

Graph 10 Year Treasury Constant Maturity Rate FRED St Louis Fed

The world cannot simultaneously be short of safe assets and yet there also be a correct “large consensus that [government debt] is too large today.” That just does not compute. You can say that the IMF and the exorbitant privilege-possessing reserve-currency issuers are not properly backstopping other governments (quite possibly because other governments are unwilling to allow the conditionality that would make such backstopping prudent). You can say that some countries have too much debt and other countries have too little. But you cannot say that government debt in general is too high when markets are screaming as loud as they can that the liabilities of exorbitant privilege-possessing reserve-currency issuers are the scarcest and most valuable things in the world:

Olivier Blanchard: Rethinking Macro Policy: Progress or Confusion?: Fiscal Policy: “Let me move to a brief discussion of the third pillar, fiscal policy…

…We have learned many things. Fiscal stimulus can help. Public debt can increase very quickly when the economy tanks, but even more so when contingent—explicit or implicit—liabilities become actual liabilities. The effects of fiscal consolidation have led to a flurry of research on multipliers, on whether and when the direct effects of fiscal consolidation can be partly offset by confidence effects, through decreasing worries about debt sustainability. (There has been surprisingly little work or action where I was hoping to see it, namely, on a better design of automatic stabilizers.)… Navigation by sight may be fine for the time being. The issue of what debt ratio to aim for in the long run is not of the essence when there is a large consensus that it is too large today and the adjustment will be slow in any case—although even here, Brad DeLong has provocatively argued that current debt ratios are perhaps too low….

There is no magic debt-to-GDP number. Depending on the distribution of future growth rates and interest rates, on the extent of implicit and explicit contingent liabilities, one country’s high debt may well be sustainable, while another’s low debt may not. Conceptually and analytically, the right tool is a stochastic debt sustainability analysis (something we already use at the IMF when designing programs). The task of translating this into simple, understandable goals remains to be done…

What happens if the “unicorn” bubble bursts?

Posted on by Bridget Ansel
Marc Andreessen, left, and his longtime business partner, Ben Horowitz, pose in the office of their venture capital firm, Andreessen Horowitz, in Menlo Park, California.

Take a look at the valuations of vaunted startups, the lack of initial public offerings of those startups, and the some of the available data on the earnings of those private companies and you’ll probably think very quickly there is a unicorn bubble about to burst. Certainly that’s the view of Gideon Lewis-Kraus, who took a look at the possibly impending explosion last month in the New York Times Magazine. Venture capitalists and company founders would be at the epicenter of a such a decline in the value of these companies, but could there be broader implications for the economy overall? Lewis-Kraus mentions the staff at these companies as well as the support staff as potential victims of the bubble. But could there be wider ramifications?

Well, there could be depending on how much the owners of these firms pull back on spending once these startups take a hit. As the net worth of these owners drops, they’re probably going to pull back on spending as they have fewer resources. This drop in net worth could result in a drop in consumption. But it’s not clear right away exactly how sensitive individuals are to these changes and how much this sensitivity differs by levels of wealth and the kinds of assets that are on the decline.

Thankfully, there’s research on this topic. Individuals with high levels of wealth have a lower consumption sensitivity to declines in wealth while those at the middle or the bottom have a higher sensitivity. Economists call this sensitivity the “marginal propensity to consume.” If I give you an extra dollar, how much of that dollar are you going to spend? As the research shows, the amount of wealth inequality and the distribution of ownership of assets affect the response to a bursting bubble. If an asset is broadly owned by a large chunk of the population (say close to 70 percent at one point) and its price declines by a significant amount (say about 30 percent), then that’ll affect a lot of people with high marginal propensities to consume and would (in this strictly hypothetical case) cause a major pull back in consumption and a large decline in economic growth.

So what would happen if the current Silicon Valley bubble bursts? Well, first, the size of the bubble doesn’t appear to be that large. As Lewis-Kraus points out, the size of this bubble is significantly smaller than the last major tech bubble that popped in 2001. But in addition, the bubble hasn’t spread as far. The ownership of highly valued firms whose prices may drop is definitely not widely dispersed as these firms are still privately-held and not available on publicly traded stock markets. And the current owners are wealthy individuals. In other words, the pain of the bubble likely will fall mainly on the wealthy households who have low marginal propensities to consume. Now, perhaps most of their wealth is illiquid (they can’t sell it easily) so maybe for some of the founders whose wealth is tired up almost entirely in the company will have to pull back quite a bit. But that’s only for a small segment of the population.

This isn’t to say that we don’t know everything about how households react to drops in wealth. In a chapter for the Handbook of Macroeconomics, economists Atif Mian at Princeton University and the University of Chicago’s Amir Sufi— co-authors of research highlighting variances in marginal propensities to consume—note that the data needed to understand the consequences of consumption shocks are rare. Researchers need better quality consumption data, either from private companies or from governmental sources. Given how important these underlying numbers would be to help shape policy reactions to a recession, this seems like a worthy endeavor.

Must-Reads: June 2, 2016

Posted on by Brad DeLong

Must-Read: Gideon Rachman: Xi Jinping Has Changed China’s Winning Formula

Posted on by Brad DeLong

Must-Read: Gideon Rachman: Xi Jinping Has Changed China’s Winning Formula: “What Mr Xi has done is essentially to abandon the formula that has driven China’s rise…

…created by Deng Xiaoping… and then refined by his successors…. In economics, Deng and his successors emphasised exports, investment and the quest for double-digit annual growth. In politics, China moved away from the charismatic and dictatorial model created by Mao Zedong and towards a collective leadership. And in foreign affairs, China adopted a modest and cautious approach to the world that became colloquially known in the west as hide-and-bide…. Under Mr Xi, who assumed the leadership of the Chinese Communist party towards the end of 2012, all three key ingredients of the Deng formula have changed….

China has moved back towards a model based around a strongman leader…. The years of double-digit growth are over…. The Xi era has seen a move away from hide-and-bide towards a foreign policy that challenges US dominance of the Asia-Pacific region….

In economics… the shift to a new model is perilous… an unsustainable splurge of credit and investment…. China still has to get used to lower rates of growth…. A healthy economy is crucial…. The country’s leaders have relied on rapid economic growth to give the political system a ‘performance legitimacy’, which party theorists have argued is far deeper than the mandate endowed by a democratic election…. When it comes to politics, in the post-Mao era the Communist party has… embrace[d] a collective style of government, with smooth transitions…. Mr Xi has broken with this model…. Many pundits believe that Mr Xi is now determined to serve more than two terms in office…. At the same time as economic and political tensions within China have risen under Mr Xi, so the country’s foreign policy has become more nationalistic….

The key to the Deng formula that created modern China was the primacy of economics. Domestic politics and foreign policy were constructed to create the perfect environment for a Chinese economic miracle. With Mr Xi, however, political and foreign policy imperatives frequently appear to trump economics. That change in formula looks risky for both China and the world.

Must-Read: Narayana Kocherlakota: There Goes the Fed’s Credibility

Posted on by Brad DeLong

Must-Read: By now we can no longer understand the Federal Reserve Chair as needing to maintain harmony on a committee that has on it many regional reserve bank presidents who have failed to process the lessons of 2005-2015. By now all the regional bank presidents are people whom the Federal Reserve Board has had an opportunity to veto:

There Goes the Fed s Credibility Bloomberg View

Narayana Kocherlakota: There Goes the Fed’s Credibility: “The Federal Reserve promised to keep its preferred measure of inflation…

…close to 2 percent over the longer run…. Some would say that central banks are out of ammunition…. Actually, though, the Fed has been deliberately tightening monetary policy over the past three years. Just last week, Chair Janet Yellen made a point of saying that the Fed intends to keep raising interest rates in the coming months….

Would it have started pulling back on stimulus in May 2013 if its short-term interest-rate target had been at 5 percent instead of near zero, and if it hadn’t been holding trillions of dollars in bonds? I strongly suspect that the Fed would instead have added stimulus by lowering interest rates…. The Fed’s current course is driven not by the state of the economy, but by a desire to get interest rates and its balance sheet back to what is considered ‘normal.’ Savers, bankers and many politicians agree with this objective…. The Fed, however, promised to focus on actual economic outcomes….

Investors’ doubts [about the Fed] aren’t surprising, given the Fed’s focus on ‘normalizing’ interest rates rather than on hitting its inflation target. Such concerns will create an extra drag on the economy if and when bad times do come. In other words, the Fed’s willingness to renege on its promises seems likely to make the next recession worse than it otherwise would be.

Must-Read: Heather Boushey: Investing in Early Childhood Education Is Good for Children and Good for the Economy

Posted on by Brad DeLong

Must-Read: Ross Douthat’s citations here are to journalist Joe Klein’s 2011 unprofessional trashing of Head Start and Republican Tennessee political Kevin Huffman, plus Baker, Gruber, and Milligan (2008) and Lipsey, Farran, and Hofer (2015). These are not the four citations that anybody would choose who is not actively attempting to misrepresent the state of knowledge about early childhood education programs.

This is one of the many, many things that makes me think that the New York Times does not have a long-run future. Its only possible edge is to develop a reputation as a disinterested information intermediary as the legacy position it had gained as a result of its role as central place for upper-class New York print ads ebbs. Things like this make developing such a reputation materially harder.

Smart New York Times executives would kill the op-ed page and give its budget and its newshole to David Leonhardt to fill, and then back off and let him do his thing. But these are the executives who let Nate Silver walk at least in part because of the political staff. As Nate said:

This guy Jim Rutenberg…. Jim Rutenberg and I were colleagues at the New York Times in 2012 when 538 was part of the New York Times. They were incredibly hostile and incredibly unhelpful to 538, particularly when 538 tried to do things that blended reporting with kind of more classic techniques of data journalism…. When we went to New Hampshire… the New York Times political desk is literally giving us the cold shoulder like it’s some high school lunchroom…. We filed the story pointing out… that Rick Santorum had probably won the Iowa Caucus, a story that involved a combination of data work and reporting…. They were apoplectic because their Romney sources were upset…. A story that… got things totally right pissed them off because they didn’t get the scoop and it went against what their sources wanted…

But the executives aren’t that smart…

Heather Boushey protests about the lack of journalistic quality control here:

Heather Boushey: Investing in Early Childhood Education Is Good for Children and Good for the Economy: “Ross Douthat used his New York Times column to express frustration that hoping for a “substantive debate about domestic policy” in this presidential election year is “delusional”…

…He imagines a scene from a future debate between… Hillary Clinton and… Donald Trump… over the benefits of early childhood education. Douthat even added several hyperlinks… links that alas fall short on revealing where the evidence actually stands today….

Randomized control trials that follow children from pre-school through adulthood… children who participate… do better in school, are more likely to attend and graduate college, and are less likely to smoke, use drugs, be on welfare, or become teenage mothers… the Carolina Abecedarian Study… the Milwaukee Project… Project STAR… Raj Chetty and his co-authors find that kindergarten test scores are highly correlated with outcomes at age 27, such as college attendance, home ownership, and retirement savings. Like in the Perry Preschool/High Scope study, in Project STAR, researchers found that while the cognitive effects on test scores fade as a child ages, the non-cognitive effects did not. Of course, not every study found such results… the Early Training Project….

Overall, though, the evidence points to the conclusion that investing in early childhood is important for future outcomes both for the children themselves and our economy more generally. If columnists provide hyperlinks to real-life academic studies to buttress fantasy debates between the two presidential candidates, they should at least point to the best studies available. In this case, the preponderance of evidence shows that early childhood education works for the children, their families, and the broader U.S. economy.