Globalization: What Did Paul Krugman Miss?

This is a very nice short framework-for-thinking-about-globalization-and-the-world piece by Paul Krugman: Paul Krugman (2018): Globalization: What Did We Miss?

It is excellently written. It contains a number of important insights.


I have, unusually, a number of complaints about it. I will make them stridenly:

First, Paul Krugman claims that, in Heckscher-Ohlin models at least, from the early 1970s to the mid 1990s international trade put only a little bit of downward pressure on the wages of American “unskilled” and semi-skilled workers. I think that is wrong. I think that from the early 1970s to the mid-1990s international trade, at least working through the Heckscher-Ohlin channels, put less than zero downward pressure on the wages of American “unskilled” and semi-skilled workers.

As I see it, it is important to note that “emerging markets” and “global north” are not static categories. Japan, Spain, Italy, Ireland were low-wage countries in the 1970s. From the early 1970s to the mid-1990s the relative wage levels of the then-current sources of America’s manufacturing imports were rising more rapidly than new low-wage sources of manufacturing imports were being added. The typical American manufacturing worker faced less low-wage competition from imports in the mid-1990s than they had faced in the early 1970s.

As I see it, where manufacturing workers came under pressure (and they did) it was not from increased low-wage competition from abroad but rather from:

  1. fiscal policy failures that produced the Reagan (and then Bush II) deficits as Republican governance redirected dollars earned by foreigners from buying our exports to buying our bonds
  2. managerial failures in Detroit (and elsewhere in the U.S.) and successes abroad
  3. technological failures in Pittsburgh (and elsewhere in the U.S.) and successes abroad

As I see it, yes, we could have protected Detroit and Pittsburgh from the consequences of their managerial and technological failings—but it would have been at immense cost for the rest of the economy, a very unfavorable benefit-cost tradeoff. And we should not have elected Republicans and given them the keys to the economic policy car: that rarely works. But given that we did give the Republicans the keys, and given Detroit’s and Pittsburgh’s managerial and technological failings, globalization from the early 1970s to the mid-1990s was a wonderful thing for America as a whole: it provided us with enormous benefits in every scenario, and in the unfortunate scenario we were dealt by the Reagan Democrats and the Big Three auto executives of Detroit, globalization greatly reduced the damage.

Second, I agree with Paul Krugman when he writes as though the “hyperglobalization” from the mid-1990s to the financial crisis was a big deal (which it was):

This huge surge… Containerization was not… new… [but] t took time for business to realize… [the] possibilities…. [Plus] a broad move… toward outward-looking policies…. China made a dramatic shift from central planning….

But I disagree when he writes that “hyperglobalization” was in some sense a threat to blue-collar Americans’ economic and social position:

It’s clear that the impact of developing-country exports grew much more between 1995 and 2010 than the 90s consensus imagined possible, which may be one reason concerns about globalization made a comeback…

Why? For reasons that Paul recognizes and summarizes:

A fairly novel form of trade… break[ing] up value chains, moving labor-intensive parts of the production process overseas…. The factor content of North-South trade hasn’t risen nearly as fast as the volume…

Let’s unpack this. In the age of widely-separated intercontinental value chains, we can see that there are actually more types of “blue collar” manufacturing jobs than the skilled-craft, semiskilled-assembly line, and unskilled traditional classification. Most importantly, we can see that the blue-collar jobs that are traditionally called semiskilled-assembly line are actually divided into two. The first are those jobs that require relatively literate workers with substantial experience and tacit knowledge who plug into sophisticated and highly productive divisions of labor supported by very productive communities of engineering practice. The second are those jobs that plug into those divisions of labor supported by those communities of engineering practice, but that actually do not require relative literacy or involve a great deal of tacit knowledge or experience—jobs that are doable by virtually everybody with the standard mental structure and eye-brain-hand loop of the East African Plains Ape, and that we thus call “unskilled”, even though they involve tasks that are currently regarded as very hard AI problems.

Before the coming of intercontinental global value chains, the distinction between these two types of semiskilled manufacturing jobs was of relatively little importance. Both paid relatively well for jobs requiring little formal education: both benefited from the requirement that workers be located near to engineers (and marketers, and executives) and from their participation in highly productive production processes, so both shared in the rents produced therein. But the truly unskilled portion—even though they were called “semiskilled” were not truly good jobs: they were boring, repetitive, and not very productive. An economy that could figure out a way to offshore those jobs would find that it had a global competitive advantage, and that would strengthen its truly valuable communities of engineering practice and ability to productively employ those relatively literate workers with valuable experience and tacit knowledge.

This was brought home to me most strongly in the years after the NAFTA debate. Opponents of NAFTA from Harley Shaiken and Thea Lee to Ross Perot had claimed it would be very damaging to the American automobile industry. Not so. And not just the firms executives, the shareholders, and the marketers were better off as a result than they would have been otherwise: the blue-collar workers with tacit knowledge and experience were better off as well from Detroit’s larger market share, and the truly unskilled portion—perhaps we should call them “polyester uniform”?—did not have jobs in the auto industry but had jobs about as good outside of it.

So, at least as I see it, the coming of “hyperglobalization” strengthened opportunities for U.S. workers without formal education to find jobs where their skills, experience, and tacit knowledge could be deployed in ways that were highly productive. What “hyperglobalization” did do was provide the top 1% and the top 0.1% with another lever to break apart the Dunlopian labor relations order, break the Treaty of Detroit, and redistribute the shared joint product from highly productive mass production backed by valuable communities of engineering practice upward in the income distribution. But there were many such levers in the U.S. from the 1970s to today. And “hyperglobalization” was, as I see it, one of the weakest and shortest of them. It gets blamed not because it was an important driver of the process, but because it allows one to blame others: brown people, yellow people, and, of course, the rootless cosmopolites.

Third, I quarrel with Krugman’s—and with Autor, Dorn, and Hanson’s (2013)—assessment of the China shock. Paul writes:

[While] trade deficits explain only a small part of the long-term shift toward… service[s]… soaring imports did impose a significant shock on some U.S. workers…. Fights over tariffs look very much as if they come out of a specific-factors world…. This is where the now-famous analysis of the “China shock” by Autor, Dorn, and Hanson (2013) comes in. What ADH mainly did was to shift focus from broad questions of income distribution to the effects of rapid import growth on local labor markets, showing that these effects were large and persistent. This represented a new and important insight…

Put me down as believing that, as I see it, Autor, Dorn, and Hanson’s focus on the stable absolute number of U.S. manufacturing jobs before the China shock of the 2000s and its drop as a result of the China shock is substantially misleading. One might look at the share of the workforce who have—and the share of those entering the workforce who get “good blue-colllar” jobs, in which we see not stability but rather a smooth decline in the proportion. One might look at individual towns, cities, and regions, in which case one sees patterns of regional industrial growth and collapse: the defense cycles, the collapse of New England textiles and leather, the rise of the Carolinas, the shift out of the Midwest to the falsely-called “right to work” states, plus the general desire of people after air conditioning to live in places where the winters are not so dire. It is not a new insight that such shocks to regional labor markets had effects that were large and persistent: anybody who had ever driven through Lowell or Fall RIver, MA knew that before Paul Krugman had published his first paper. It is, however, a very important insight.

Yes, the reduction in the share of the U.S. workforce in tacit knowledge and experience semiskilled blue collar jobs has been a big deal. But the overwhelming bulk of that is due to technology, not trade. Yes, there has been an additional reduction beyond technology. But the bulk of that has been a second-best compensation and adjustment for the disastrous Republican habit of running large budget deficits at full employment. Yes, the U.S. government should have done much more to support communities and workers who found themselves under the hammer. But for that blame the legacy influence of social darwinism on American politics: the U.S. government did little for Lowell or Fall River back in the day. And complaints about the failure to properly manage a process that is, globally, overwhemlingly positive-sum should be mailed to the address of the Reagan and Trump Democrats of Michigan, Pennsylvania, and Wisconsin, not to poorer brown and yellow people in Mexico and in China.

Moreover, from the perspective of the country as a whole and from the perspective of many of the communities affected, the China shock was not a big deal for local labor markets. Yes, people are no longer buying as many of the products of American factories as Chinese imports flood in. But those selling the imports are turning around and spending their dollars investing in America: financing government purchases, infrastructure, some corporate investment, and housing. The circular flow will it: the dollars are of no use outside the U.S. and so the dollar flow has to go somewhere, and as long as the Federal Reserve does its job and makes Say’s Law roughly true in practice, it is a redistribution of demand for labor and not a fall in the demand for labor.

And here is the kicker, as I see it: the types of people and the types of jobs funded by the imports of the China shock looks very much like the types of people and the types of jobs displaced from the tradeable manufacturing sector. Yes, some local labor markets got a substantial and persistent negative shock to manufacturing, often substantially cushioned by a boost to construction. Other local local labor markets got a substantial and persistent positive shock to construction. And on the level of the country as a whole the factor of production that is (truly) semiskilled blue collar labor does not look to me to have been adversely affected.

Until 2008.

Now we get to my fourth quarrel: the play is Hamlet. But where is the Prince of Denmark? Zero references to “recession”, “finance”, “financial crisis”, or “recession”. Yet, at least as I see it, the key thing that we missed about globalization was not its impact on factor prices in some Heckscher-Ohlin model or an shared rents in some specific-factors model but rather that when a big financial crisis and depression came “globaization”—and poor people elsewhere—would provide an excuse to distract blame. There was a lot of blame: Blame financiers who had no control over their derivatives books because they failed to manage. Blame financeirs who had control over their deiverative books but who thought, like Charles Price of Citigroup: “you have to keep dancing as long as the music is playing”. Blame Federal Reserve Chair Alan Greenspan. Blame Treasury Secretary John Snow. They were at the heads of the agencies responsible for controlling systemic risk when the vulnerabilities emerged. And they did not no—control it, that is. Blame Federal Reserve Chair Ben Bernanke. Blame Treasury Secretary Henry Paulson. They were at the heads of the agencies responsible for controlling systemic risk while there was still time to shore up the system—and they did not.

The Prince of Denmark here is the Greenspan-Snow shock, not the China shock. What we missed about globalization was not its impact on blue-collar semiskilled workers with experience and tacit knowledge and communities, but how it would interact with attempts to shift resoponsibility and blame off of the appropriate properties.

And then, of course, ther is 2010: Barack Obama’s declaration in his State of the Union Address that the time for bold action to boost employment was over:

We took office amid a crisis, and our efforts to prevent a second Depression have added another $1 trillion to our national debt…. Families across the country are tightening their belts and making tough decisions. The federal government should do the same. So tonight, I’m proposing specific steps to pay for the $1 trillion that it took to rescue the economy last year…. Like any cash-strapped family, we will work within a budget to invest in what we need and sacrifice what we don’t. And if I have to enforce this discipline by veto, I will…

I have never found anybody working in economic policy in the Obama administration who thought that this large a shift this quickly was a good idea. Some have admitted to believing that it was a meaningless rhetorical nothingburger—after all, it excepted “spending related to our national security, Medicare, Medicaid, and Social Security”, and you can do anything macroeconomic you want on the spending side in those categories. They were wrong. Others were strongly opposed. Others say that they were quiet, but certainly not boosters.

And, indeed it wasn’t a good idea.

If the Greenspan-Snow shock is the Prince of Denmark in this play, the idea that the crisis was over and the need for stimulative policy was at an end as of early 2010—call it the Obama-Geithner shock, perhaps—is King Claudius, or at least Queen Gertrude here.

And this gets me to my fifth quarrel with Paul Krugman here. As I see it, the most important thing we missed about globalization was how much it required support from stable and continuous full employment. That, I think, ought to have been the focus of his talk to the IMF.

It is now 81 years since John Maynard Keynes published:

Whilst… the enlargement of the functions of government involved in the task of adjusting to one another the propensity to consume and the inducement to invest would seem to a nineteenth-century publicist or to a contemporary American financier to be a terrific encroachment on individualism. I defend it… as the only practicable means of avoiding the destruction of existing economic forms in their entirety and as the condition of the successful functioning of individual initiative….

If effective demand is deficient… the public scandal of wasted resources… the individual enterpriser… is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros…. The authoritarian state systems of today seem to solve the problem of unemployment at the expense of efficiency and of freedom. It is certain that the world will not much longer tolerate the unemployment which, apart from brief intervals of excitement, is associated and in my opinion, inevitably associated with present-day capitalistic individualism. But it may be possible by a right analysis of the problem to cure the disease whilst preserving efficiency and freedom…

True. Now as much as ever.

Paul Krugman Looks Back at the Last Twenty Years of the Macroeconomic Policy Debate

Preview of Paul Krugman Looks Back at the Last Twenty Years of the Macroeconomic Policy Debate

Everybody interested in macroeconomics or macroeconomic policy should know this topic backwards and forwards by heart. My problem is that I do not see how I can add value to it. The only thing I can think of to do is to propose two rules:

  1. Paul Krugman is right.
  2. If you think Paul Krugman is wrong, refer to rule #1.

I do wish that those who were not bad actors who made mistakes would ‘fess up to them. Those who don’t will get moved to the “bad actor” category: and, yes, I am looking at you, Marvin Goodfriend.

The only remaining question, I think, is whether these should all be read in chronological or reverse chronological order. I find myself torn, with arguments on both sides having force:

Ben Bernanke (1999): Japanese Monetary Policy: A Case of Self-Induced Paralysis?

No, It Is Really Not Harder to Make the Case for Free Trade These Days…

Hoisted from Ten Years Ago: Still, I think, true today. Thus I continue to hoist my neoliberal freak flag here: Is It Really Harder to Make the Case for Free Trade These Days? Paul Krugman wonders if it is harder to make the case for free trade these days. There are more losers from trade liberalization, he thinks, and it is much less clear that the losers are in some sense undeserving.

Mark Thoma writes:

Economist’s View: Krugman: Distribution and Trade Policy: Paul Krugman adds a few more thoughts via email related to the recent trade policy discussion:

Paul Krugman: Another thought or two on distribution and trade policy: The problem of losers from trade isn’t new, obviously, either as a fact or concept. But if you look at the history of trade policy – say, in Matt Destler’s book it’s hard to avoid the sense that the issue has gotten bigger and harder. His final chapters have a definite sense both of nostalgia for the good old days and foreboding.

I’d put it like this: in the old days, when GATT negotiations were mainly with other advanced countries, the groups hurt tended to be highly specific and local – the left-handed widget makers of Northern South Dakota, worried about competition from their counterparts in Upper Lower Swabia. Economists could in good conscience argue that while individual groups were hurt by trade liberalization in their specific sector, the great majority of Americans benefitted from general trade liberalization. And politicians made trade deals by packaging together the interests of exporters, to offset the parochial interests of import-competing industries

But now we’re talking about broad swaths of the population hurt by trade. It’s a good bet that almost all US workers with a high school degree or less are hurt by Chinese manufactured exports, at least slightly. You could in principle put together win-win packages – say, trade liberalization together with an increase in the EITC paid for with higher taxes on high-income Americans, who come out winners from trade. But the reality is that we don’t make those deals.

For those who like their jargon, by the way, I’m basically saying that the right model for thinking about this has gone from many-good specific factors to Heckscher-Ohlin.

I don’t have answers to this. The moral case for open markets is their importance to poor countries: America would do OK even in a highly protectionist world, but Bangladesh wouldn’t. The domestic politics of trade, however, are now very hard, and getting harder.

Well, I think I have answers:

  1. The kinds of win-win deals that Paul says we don’t make are in fact deals that Democratic presidents do make–when they aren’t blocked from making them, that is.
  2. In an American family, both potential workers have to be working in export or import-competing manufacturing for the family as a whole to be injured by imports of manufactured goods from China. Construction workers benefit from expanded trade with China both through higher relative wages and through lower relative prices. Service-sector workers benefit through lower relative prices.
  3. The losers are not undeserving of their previous relative good fortune, but the winners are not unjustly enriched either–and odds are that there are more and bigger winners.
  4. Politics is much healthier when everybody knows that trade restrictions are temporary and fragile than when people believe that trade restrictions are permanent and durable–and thus really worth lobbying for when they are to your material advantage.
  5. A richer world is a safer world for Americans: foreigners working making textiles for export to the United States are not foreigners in caves planning to attack the Great Satan. One important import that we buy through freer trade is a safer, richer, more peaceful world.

The narrow pure-economics case for freer trade is harder to make thsee days because it is less true than it was in the 1960s or the 1950s or the 1930s or the 1910s. But the broader political-economy case for freer trade is still strong and true.

The Benefits of Free Trade: Time to Fly My Neoliberal Freak Flag High!: Hoisted from March 2016

Hoisted from March 2016: The Benefits of Free Trade: Time to Fly My Neoliberal Freak Flag High! I think Paul Krugman is wrong today on international trade. For we find him in “plague on both your houses” mode. On the one hand:

Paul Krugman: Trade and Tribulation and A Protectionist Moment?: “Protectionists almost always exaggerate the adverse effects of trade liberalization…

…Globalization is only one of several factors behind rising income inequality, and trade agreements are, in turn, only one factor in globalization. Trade deficits have been an important cause of the decline in U.S. manufacturing employment since 2000, but that decline began much earlier. And even our trade deficits are mainly a result of factors other than trade policy, like a strong dollar buoyed by global capital looking for a safe haven.

And yes, Mr. Sanders is demagoguing the issue…. If Sanders were to make it to the White House, he would find it very hard to do anything much about globalization…. The moment he looked into actually tearing up existing trade agreements the diplomatic, foreign-policy costs would be overwhelmingly obvious. In this, as in many other things, Sanders currently benefits from the luxury of irresponsibility….

But on the other hand:

That said… the elite case for ever-freer trade, the one that the public hears, is largely a scam…. [The] claims [are] that trade is an engine of job creation, that trade agreements will have big payoffs in terms of economic growth and that they are good for everyone. Yet… the models… used by real experts say… agreements that lead to more trade neither create nor destroy jobs… make countries more efficient and richer, but that the numbers aren’t huge….

False claims of inevitability, scare tactics (protectionism causes depressions!), vastly exaggerated claims for the benefits of trade liberalization and the costs of protection, hand-waving away the large distributional effects that are what standard models actually predict…. A back-of-the-envelope on the gains from hyperglobalization — only part of which can be attributed to policy — that is less than 5 percent of world GDP over a generation…. Furthermore, as Mark Kleiman sagely observes, the conventional case for trade liberalization relies on the assertion that the government could redistribute income to ensure that everyone wins—but we now have an ideology utterly opposed to such redistribution in full control of one party…. So the elite case for ever-freer trade is largely a scam, which voters probably sense even if they don’t know exactly what form it’s taking….

And, Paul summing up:

Why, then, did we ever pursue these agreements?… Foreign policy: Global trade agreements from the 1940s to the 1980s were used to bind democratic nations together during the Cold War, Nafta was used to reward and encourage Mexican reformers, and so on. And anyone ragging on about those past deals, like Mr. Trump or Mr. Sanders, should be asked what, exactly, he proposes doing now.… The most a progressive can responsibly call for, I’d argue, is a standstill on further deals, or at least a presumption that proposed deals are guilty unless proved innocent.

The hard question to deal with here is the Trans-Pacific Partnership…. I consider myself a soft opponent: It’s not the devil’s work, but I really wish President Obama hadn’t gone there…. Politicians should be honest and realistic about trade, rather than taking cheap shots. Striking poses is easy; figuring out what we can and should do is a lot harder. But you know, that’s a would-be president’s job…. [But] he case for more trade agreements—including TPP, which hasn’t happened yet—is very, very weak. And if a progressive makes it to the White House, she should devote no political capital whatsoever to such things.

So I guess it is time to say “I think Paul Krugman is wrong here!” and fly my neoliberal freak flag high…

On the analytics, the standard HOV models do indeed produce gains from trade by sorting production in countries to the industries in which they have comparative advantages. That leads to very large shifts in incomes toward those who owned the factors of production used intensively in the industries of comparative advantage: Big winners and big losers within a nation, with relatively small net gains.

But the map is not the territory.

The model is not the reality.

An older increasing-returns tradition sees productivity depend on the division of labor, the division of labor depends on the extent of the market, and free-trade greatly widens the market. Such factors can plausibly quadruple the net gains from trade over those from HOV models alone, and so create many more winners.

Moreover, looking around the world we see a world in which income differentials across high civilizations were twofold three centuries ago and are tenfold today. The biggest factor in global economics behind the some twentyfold or more explosion of Global North productivity over the past three centuries has been the failure of the rest of the globe to keep pace with the Global North.

And what are the best ways to diffuse Global North technology to the rest of the world?

Free trade: both to maximize economic contact and opportunities for learning and imitation, and to make possible the export-led growth and industrialization strategy that is the royal and indeed the only reliable road to anything like convergence.

So I figure that, all in all, not 5% but more like 30% of net global prosperity—and considerable reduction in cross-national inequality—is due to globalization. That is a very big number indeed. But, remember, even the 5% number cited by Krugman is a big number and a deal: $4 trillion a year, and perhaps $130 trillion in present value.

As for the TPP, the real trade liberalization parts are small net gains. The economic question is whether the dispute-resolution and intellectual-property protection pieces are net gains. And on that issue I am agnostic leaning negative. The political question is: Since this is a Republican priority, why is Obama supporting it without requiring Republican support for a sensible Democratic priority as a quid pro quo?

That said, let me wholeheartedly endorse what Paul (and Mark) say here:

As Mark Kleiman sagely observes, the conventional case for trade liberalization relies on the assertion that the government could redistribute income to ensure that everyone wins—but we now have an ideology utterly opposed to such redistribution in full control of one party…. So the elite case for ever-freer trade is largely a scam, which voters probably sense even if they don’t know exactly what form it’s taking…

(Early) Monday DeLong Smackdown Watch: Has Macroeconomics Gone Right?

U.S. Real GDP since 2009

After three years, how is this working out?…

Paul Krugman (2013): The Neopaleo-Keynesian Counter-counter-Counterrevolution: “OK, I can’t resist this one — and I think it’s actually important…

…Brad DeLong reacts to Binyamin Appelbaum’s piece on Young Frankenstein Stan Fischer by quoting from his own 2000 piece on New Keynesian ideas in macroeconomics, a piece in which he argued that New Keynesian thought was, in important respects, a descendant of old-fashioned monetarism. There’s a lot to that view. But I’m surprised that Brad stopped there, for two reasons. One is that it’s worth remembering that Fischer staked out that position at a time when freshwater macro was turning sharply to the right, abandoning all that was pragmatic in Milton Friedman’s ideas. The other is that the world of macroeconomics now looks quite different from the world in 2000.

Specifically, when Brad lists five key propositions of New Keynesian macro and declares that prominent Keynesians in the 60s and early 70s by and large didn’t agree with these propositions, he should now note that prominent Keynesians–by which I mean people like Oliver Blanchard, Larry Summers, and Janet Yellen–in late 2013 don’t agree with these propositions either.

In important ways our understanding of macro has altered in ways that amount to a counter-counter-counterrevolution (I think I have the right number of counters), giving new legitimacy to what we might call Paleo-Keynesian concerns. Or to put it another way, James Tobin is looking pretty good right now. (Incidentally, this was the point made by Bloomberg almost five years ago, inducing John Cochrane to demonstrate his ignorance of what had been going on macroeconomics outside his circle.)

Consider Brad’s five points:

  1. Price stickiness causes business cycle fluctuations: You clearly need price stickiness to make sense of the data. However, there is now widespread acceptance of the point that making prices more flexible can actually worsen a slump, a favorite point of Tobin’s.

  2. Monetary policy > fiscal policy: Not when you face the zero lower bound — and that’s no longer an abstract or remote consideration, it’s the world we’ve been living in for five years. And Tobin, who defended the relevance of fiscal policy, is vindicated.

  3. Business cycles are fluctuations around a trend, not declines below some level of potential output: This view comes out of the natural rate hypothesis, and the notion of a vertical long-run Phillips curve. At this point, however, there is wide acceptance of the idea that for a variety of reasons, but especially downward nominal wage rigidity, the Phillips curve is not vertical at low inflation. Again, a very Tobinesque notion, as Daly and Hobijn explain.

  4. Policy rules: Not so easy when once in a while you face Great Depression-sized shocks.

  5. ‘Low multipliers associated with fiscal policy’: Ahem. Not when you’re in a liquidity trap.

I do think this is important. Among economists who are actually looking at recent events, not doing a see-no-Keynes, hear-no-Keynes, speak-no-Keynes act, there has been a strong revival of some old ideas in macroeconomics. It’s not just new classical macroeconomics that’s in retreat; we’re also seeing, within the Keynesian camp, a distinct if polite rise of Neopaleo-Keynesianism.

I must say I find myself distinctly less optimistic than Paul here. After three years:

  • We seem to me to have had no influence on policy: IS-LM says that if the Federal Reserve wants to be able to respond to the next adverse macroeconomic shock we need a looser fiscal policy in order to normalize interest rates during this expansion. The Federal Reserve is ignoring IS-LM.

  • While it is true you no longer hear people outside of what I call “Chicago” talking about how DSGE is a progressive research program, you do hear nearly everybody still talking about it as if it were a harmless fetish and a useful neutral ground to frame the discussion.

  • As far as actual serious work as to what emergent properties we can expect from what characteristics of our really-existing structure of markets? We have made no progress…

The Clones of Jim Tobin vs. the Gravitational Pull of Chicago: A Paul Krugman Production…

2016 09 20 krugman geneva pdf

The highly-esteemed Mark Thoma sends us to Paul Krugman. In praise of real science: “Some people… always ask, ‘Is this the evidence talking, or my preconceptions?’ And you want to be one of those people…”.

Paul’s most aggressive claim is that our economics profession in 2007 would have done a much better job of economic analysis and policy guidance in real time had it consisted solely of clones of Samuelson, Solow, Tobin–I would add Modigliani, Okun, and Kindleberger–as they were in 1970: that the vector of net changes in macroeconomics in the 1970s were of zero value, and that the vector of net changes in macroeconomics since have been of negative value as far as understanding the world in real time is concerned.

This is, I think, too strong–and Paul does not quite make that claim. Doug Diamond and Phil Dybvig (1983)? Andrei Shleifer and Rob Vishny (1997)? And, of course, that keen-sighted genius Paul de Grauwe (2011).

Paul K. might respond that:

  • Paul de G. is very close to a clone of Jim Tobin who spent fifteen years as a member of the Belgian parliament, to which I can only say “touché”.
  • And you could say that Diamond-Dybvig and Shleifer-Vishny are simply mathing-up Kindleberger (1978), or perhaps Bagehot (1873). But there is great value in the mathing-up.
  • And I am going to have to think about why I have so much softer a spot in my heart for Uncle Milton Friedman than Paul K. does.

But in essentials, yes: Rank macroeconomists in 2007 by how much their intellectual trajectory had been influenced by the gravitational pull o fEd Prescott, Robert Lucas, and even Milton Friedman. Those whose trajectories had been affected least understood the most about the world in which we have been enmeshed since 2007:

Paul Krugman: What Have We Learned From The Crisis?:

We’ve seen a lot of vindication for old, unfashionable ideas–oldies but goodies that got deemphasized, and in some cases effectively blackballed, in the decades following the 1970s, but have turned out to be remarkably useful practical guides….

I was always a bit unsure about my own bona fides. Obviously I’d been a professional success, but why? Was it truly because I’d been making a real contribution to our understanding of how the world works, or was I simply good at playing an academic game?… Then came the crisis… and… several immediate questions in which popular intuitions and simple macroeconomic models were very much at odds. Would budget deficits cause interest rates to soar? Practical men said yes; economists, at least those of us with certain tools in our boxes, said no. Would huge increases in the monetary base cause runaway inflation? Yes, said practical men, politicians, and a few economists; no, said I and others of like mind. Would fiscal austerity depress output and employment? No, said many important people; on the contrary, it would be expansionary, because it would raise confidence. Yes, a lot, said Keynesian-minded economists. And my team won three out of three. Goooaaal!…

Economists from 1970 or so… might well have done a better job responding to the crisis than the economists we actually had on hand…. Tobin was one of the last prominent holdouts against the Friedman-Phelps natural rate hypothesis…. Friedman, Phelps, and their followers argued that any attempt to hold unemployment persistently below the natural rate would lead to ever-accelerating inflation; and their models implied, although this is rarely stressed, that an unemployment rate persistently above the natural rate would lead to ever-declining inflation and eventually accelerating deflation. Tobin was, however, skeptical…. Phillips tradeoffs that persist in the long run, at least at low inflation….

For reasons not completely persuasive to me, the standard response of macroeconomists to the failure of deflation to materialize seems to be to preserve the Friedman-Phelps type accelerationist Phillips curve, but then assert that expected inflation is “anchored”, so that it ends up being an old-fashioned Phillips curve in practice. We can debate why, exactly, we’re going this way. But… Tobin’s 1972 last stand against the natural rate turns out to be a better guide to the post-2008 landscape than just about anything written in the 35 years that followed….

The U.S. Federal funds rate hit zero in late 2008, with the economy still in a nosedive. The Fed responded with the first round of quantitative easing…. Meanwhile, the budget deficit soared…. What effect would these radically unusual policies have? The answer from quite a few public figures was to predict soaring inflation and interest rates. And I’m not just talking about the goldbugs… Allan Meltzer and Martin Feldstein warned about the coming inflation, joined by a Who’s Who of the Republican establishment. Academics like Niall Ferguson and John Cochrane warned about massive crowding out of private investment. But old-fashioned macro, with something like IS-LM at its base, offered startlingly contrary predictions at the zero lower bound…. And sure enough, inflation stayed low, as did interest rates.

IJT-style macro also made a prediction about the output effects of fiscal policy – namely, that it would have a substantial multiplier at the zero lower bound…. Chicago’s Cochrane insisted that the old-fashioned macro behind it had been “proved wrong.” Robert Lucas denounced Christina Romer’s use of multiplier analysis as “shlock economics,” basing his argument on a garbled version of Ricardian equivalence…. Jean-Claude Trichet sunnily declared that warnings about the contractionary impact of austerity were “incorrect”…. A few years on, and the old-fashioned Keynesian analysis looks pretty good… a multiplier around 1.5…. Which just happens to be the multiplier Christy Romer was assuming….

But wait, we’re not quite done. One aspect of the post-2008 story that apparently surprised many people, even smart economists like Martin Feldstein, was that huge increases in the monetary base didn’t seem to produce much rise in broader monetary aggregates, leading to claims that something strange was going on–that maybe it was all because the Fed was paying interest on excess reserves. But the same thing happened in Japan in the early 2000s, without any special interest payments….

The bottom line is that the crisis and its aftermath have actually provided a powerful vindication of macroeconomic models. Unfortunately for many economists, the models it vindicates are more or less vintage 1970. It’s far from clear that anything later added to our ability to make sense of events, and developments in macro over the course of the 80s and after may even have subtracted value….

What looks useful is a sort of looser-jointed approach: ad hoc Hicks-Tobin-type models, with simple models of financial market failure on the side…. For those seeking a definitive, integrated approach this will seem pitifully inadequate; and if I were a young academic seeking tenure I’d run away from all of this and either do empirical work or shun macro altogether. But models don’t have to rigorously dot all i’s and cross all t’s–let alone satisfy the peculiar criteria that modern macro calls “microfoundations”–to be very useful in practice…

Unpleasant Fiscal Dominance?

Sims highlights fiscal dominance at Jackson Hole Gavyn Davies

Paul Krugman appears confused:

Paul Krugman: Chris and the Ricardianoids:

Here’s [Chris] Sims on fiscal policy:

Fiscal expansion can replace ineffective monetary policy at the zero lower bound, but fiscal expansion is not the same thing as deficit finance. It requires deficits aimed at, and conditioned on, generating inflation. The deficits must be seen as financed by future inflation, not future taxes or spending cuts…

I think he’s saying that fiscal expansion works only if it leads to a rise in expected inflation…. [That] is certainly something I’ve heard from helicopter money types, who warn that something like Ricardian equivalence will undermine fiscal expansion unless it’s money-financed. But this is a misunderstanding of Ricardian equivalence, on two levels. First, as I’ve tried repeatedly to explain, a TEMPORARY increase in government purchases of goods and services will NOT be offset by expectations of future taxes even if full Ricardian equivalence holds. The kind of argument people like Robert Lucas made sounded Ricardian, but wasn’t–it was Ricardianoid. Second, less relevant to Sims but very relevant to other helicopter people, a deficit ultimately financed by inflation is just as much of a burden on households as one ultimately financed by ordinary taxes, because inflation is a kind of tax on money holders. From a Ricardian point of view, there’s no difference. So I’m trying to figure out exactly what Sims is saying…

As I understand where Sims and company are coming from, they are working in a model in which there are no government purchases. Or perhaps government purchases are useless, and so are not part of “true” real GDP. But in any event, either there is no difference between government purchases and tax cuts–hence no balanced-budget multiplier–or fiscal policy consists entirely of changes in taxes and transfers.

They are also working in a model in which total spending is given by something like:

C = C(r, W)

where W is the real wealth of the representative agent, and r is the real interest rate. The more wealth the more spending. The lower the real interest rate, the more spending.

The real interest rate is the difference between the nominal interest rate i and the inflation rate π:

r = i – π

And the economy is in a liquidity trap with i=0.

Now as I understand Sims, W is given by something like:

W = Y/r – T/(r + ρ)

where Y is the flow of income, T is the flow of taxes, and ρ is some sort of risk premium–that the finances of the government will become unstable and the government will not manage to collect its taxes.

Then the only ways fiscal policy can affect spending and output now are if:

  • deficits raise expectations of money-printing and so raise inflation π.
  • deficits raise expectations of future fiscal collapse and so increase current wealth by increasing the rate at which future tax liabilities are discounted.

And as I understand Sims, quantitative easing is counterproductive: it reduces the risk premium ρ, and so raises the present value of future tax liabilities and so reduces household wealth without doing anything to alter the real interest rate.

I think this is what is going on.

Is this a consistent model? I am not sure. Is this the model that Chris Sims has in mind that lies behind his talk? I am not sure. Is this the right model for the questions at hand? I am pretty sure it is not one of the first five models I would write does as most relevant.

Cf.: Gavyn Davies: Sims highlights fiscal dominance at Jackson Hole

The “Confidence Fairy” and the Ideology of Economic Theory and Policy: Alas! Still Preliminary Little More than Notes…

I promised more on this in August.

Last August.

August 20125.

I am, clearly, very late:

Paul Krugman: Fairy Tales:

Mike Konczal, channeling Kalecki, pointed out…

…arguments rejecting Keynes and declaring that only business confidence can achieve full employment serve [the] very useful political purpose… [of] empower[ing] plutocrats and big business…. And this speaks to the wider point of the politicization of macroeconomics. Why did freshwater macroeconomists refuse to learn from the lessons of the Volcker recession and recovery, which clearly refuted their approach and supported some kind of Keynesian view on monetary policy? Why has the overwhelming recent evidence for a Keynesian view of fiscal policy been ignored? You might think that business, at least, would welcome policies that boost sales; but the ideology of confidence must be defended.

At the level of academic economics it is a huge puzzle–after all, Ed Prescott and Bob Lucas decide that downturns are driven not by monetary but by real factors just at the very moment when Paul Volcker hits the economy with a brick, and demonstrates not just that contractionary policy has contractionary effects on the real economy, but that doing everything he could to make his contractionary policy anticipated and credible did not materially lessen those real effects. A bigger example of “who are you going to believe, me and Ed or your lying eyes?” would be hard to imagine.

The best excuse I have found takes off from Marion Fourcade et al.‘s analysis of the American economics profession, especially their observations on the rise of business schools and business economics in shaping what economists think about and how they think it. That they are predisposed by their social location into believing that bankers (and the businessmen) are key value-adders in the economy creates an elective affinity with the macroeconomic doctrine that the bankers and businessmen have got us by the plums, and so the only durable way to create a strong and healthy economy is to keep them confident and enthusiastic about investing in new capital equipment now–which means keeping them very confident and very secure in their expectations of future profits.

My current (very imperfect) thoughts about this are contained right now in: The Confidence Fairy in Historical Perspective.

I was going to revise it into a proper paper before letting it out of the gate into the public. But that has not yet happened. So let me at least put the slides below the “fold”, if “fold” has any meaning anymore. Or, rather, below the next “fold”:

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Correct Predictions and the Status of Economists: Hoisted from the Archives from Three Years Ago

Bradford delong com Grasping Reality with the Invisible Hand

Brad DeLong (2013): Correct Predictions and the Status of Economists:

Paul Krugman is certainly right that history has judged… for James Tobin over Milton Friedman. There is not even a smudge left where Friedman’s approach to a monetary theory of nominal income determination once stood….

Robert Waldmann points out, repeatedly and correctly, that there is nothing theoretically in Friedman (1967) that is not in Samuelson and Solow (1960)–that inflation above expectations might deanchor future inflation was not something Friedman (or Phelps) thought up, and that neither Friedman (nor Phelps) was thinking that high unemployment might deanchor the NAIRU. And Paul Krugman points out that the vertical long-run Phillips Curve of Friedman (and Phelps) is simply wrong at low rates of inflation, and so not helpful as a fundamental tool.

There is, however, one big thing Friedman got right: to stand up on his hind legs and say: ‘Expectations of inflation are becoming deanchored right now. The accelerationist mechanism is the mechanism that is going to dominate business cycle dynamics in both the short-term and the medium-term.’ That was right. And that was a powerful source of manna.

Similarly, or perhaps not, I would argue that there is one big thing (along with a large number of medium things and small things) that Paul Krugman got right: his prediction back in 1998 of The Return of Depression of Economics. Yet somehow Uncle Paul has not gained a similar amount of manna to what Uncle Milton gained in the late 1960s…

UPDATED 2016: And I note that Larry Summers has a similar extremely large important macroeconomic empirical hit with his predictions half a decade ago that not just “depression economics” but secular stagnation was something that we need to take very seriously indeed. I’m watching to see what the community makes of this…

In Which I Face My Social Media Ineptitude Squarely

Live from Cyberspace: Welcome praise for J. Bradford DeLong (2015): The Scary Debate Over Secular Stagnation – Milken Institute Review: Hiccup … or Endgame? Much appreciated. Thanks…

Paul Krugman: “Good Review by Brad DeLong: There are still real policy issues out there! The Scary Debate Over Secular Stagnation”

Paul’s tweet July 23 has 180 likes and 91 retweets… The Milken Review’s tweet June 29 has 1 like and 2 retweets… My tweet last October 17 has 11 likes and 6 retweets…

I am becoming more and more convinced that in the modern age content has to be deployed in stages so that there is never more than a tenfold gap between the length of a teaser or summary and the length of the next largest and most comprehensive version. The gap between a tweet-20 words–and a 4000 word essay is just too great to expect people to bridge.

That means that everything 10,000-70,000 words has to come with a 1,000-7,000-word version, and everything with 1,000-7,000 words has to come with a 100-700 word version, and that even 400-700-word things need to come with a super-tweet version: a screenshot paragraph…