Monthly Archives: September 2013

Tyler Cowen on the Tobin Model

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Tyler Cowen writes,

Another option is that these non-stifled sectors have seen big boosts in demand and thus their prices are rising. Again, that violates the strong empirical regularity of business cycle comovement. In a traditional deflationary downturn, virtually all sectors are negatively affected, with a few notable exceptions. What kind of business cycle would this be, if half the economy is seeing a positive 3.2% worth of demand-side pressures?

In “Inflation and Unemployment,” James Tobin (1971) proposed that there might be two sectors of the economy, one with demand expanding and the other with demand contracting. If prices and wages were flexible, then you could reach full employment at any rate of inflation. However, if nominal wages will not fall in the contracting sector, then you get a trade-off between inflation and unemployment.

What Tyler is arguing is that if this model were applicable in reality, then we would observe recessions as sharp contractions in some sectors while other sectors continue to expand. Instead, he suggests that declines are broad-based. Of course, many people claim that if many sectors are declining at once, then we must be experiencing a decline in aggregate demand, as opposed to structural unemployment.

My thoughts:

1. Has the shortfall in employment been widespread or concentrated? I think that if one looks across industries, it seems fairly widespread. Yes, health care has held its own. Yes manufacturing has taken a large share of the job losses. But overall, things look widespread.

2. However, if one looks at demographics, I think it looks more concentrated. Older workers have held their own (and moreso, relative to the previous trend). Young people are being devastated.

3. What would a central planner (or a ruthless free market) do with average young people in an “average is over” world? (I have not yet read Average is Over, but let me steal the phrase.) I think that the solution would be to have many young people become personal servants, taking care of old people or rich people. However, this is not something that young people want to do. It is not what their parents, teachers, and political leaders are telling them to do. Instead, our society has arrived at a tacit agreement that is it is preferable for young people to live off of a combination of government benefits and parental support.

4. This “tacit agreement” would hold at any rate of inflation. If we managed to raise the rate of inflation, I do not think it would do much to deal with unemployment.

Youth and Non-Work

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Tyler Cowen writes,

For Americans aged 16 to 24 who aren’t enrolled in school, the employment picture is grim. Only 36 percent are working full time, down 10 percentage points from 2007. Longer term, the overall labor-force participation rate for that age group has dropped 20 percentage points for men and 14 points for women since 1989.

…If we consider four-year college graduates only, average starting salaries, inflation-adjusted, were higher in 2000 than they are today

Some hypotheses:

1. We now have many college graduates who could not actually graduate in a rigorous major.

2. The young people I know who are not working full time have all formerly had full-time jobs, so that they are showing a lifestyle preference. I am admittedly looking at a small sample, not necessarily representative.

3. Young people who are not interested in having children do not feel compelled to work full time. Again, my evidence is anecdotal, but it seems to me that compared to when I was their age, there are a lot more young people these days who do not seem at all interested in having children. Admittedly, there could be causality running from weak job prospects to less interest in having children.

Overall, I see this as part of the Vicky-Thete polarization trend. If you do not have Vicky values, there may not be a compelling reason to work full time.

Booms, Busts, and Money

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George Selgin writes,

it seems to me that there is a good reasons for not buying into Friedman’s view that there is no such thing as a business cycle, or Sumner’s equivalent claim that there is no such thing as a monetary-policy-induced boom. The reason is that there is too much anecdotal evidence suggesting that doing so would be imprudent. The terms “business cycle” and “boom,” together with “bubble” and “mania,” came into widespread use because they were, and still are, convenient if inaccurate names for actual economic phenomena. The expression “business cycle,” in particular, owes its popularity to the impression many persons have formed that booms and busts are frequently connected to one another, with the former proceeding the latter; and it was that impression that inspired Mises and Hayek do develop their “cycle” or boom-bust theory rather than a mere theory of busts, and that has inspired Minsky, Kindleberger, and many others to describe and to theorize about recurring episodes of “Mania, Panic, and Crash.” Nor is the connection intuitively hard to grasp: the most severe downturns do indeed, as monetarists rightly emphasis, involve severe monetary shortages. But such severe shortages are themselves connected to financial crashes, which connect, or at least appear to connect, to prior booms, if not to “manias.” That the nature of the connections in question, and the role monetary policy plays in them, remains poorly understood is undoubtedly true. But our ignorance of these details hardly justifies proceeding as if booms never happened, or as if monetary policymakers should never take steps to avoid fueling them.

Read the whole thing. The conventional wisdom, as of 2007, was that no matter what happens in financial markets, the Fed can keep employment high if it avoids disappointing people’s inflation expectations. That conventional wisdom disappeared during the crisis of 2008. At that time, Chairman Bernanke decided that ordinary monetary policy was not going to work. Instead, bailouts were needed in order to prevent a catastrophic recession. In the event, we had a bad recession. Now, the conventional wisdom is that he was right and that he made the recession less catastrophic. My alternative hypothesis is that we got more or less the same recession we would have had without bailouts (and without the stimulus, for that matter). It is impossible to go back and run the relevant experiment to determine who is right. I am willing to admit I may be wrong, but I think that those who espouse the conventional wisdom ought to be equally modest.

Scott Sumner became a notorious radical by sticking with the pre-crisis conventional wisdom rather than adopting the post-crisis conventional wisdom. Meanwhile, as Selgin points out, the Austrian alternative that there is such a thing as an unsustainable boom has been picked up by everyone from erstwhile descendants of Milton Friedman to President Obama (in the latter case, it fits in with the narrative that everything bad that takes place during his Administration is the fault of George Bush and/or Congressional Republicans).

My instincts are:

1. Downplay the role of the financial crisis, as opposed to ongoing structural adjustment.

2. Having said that, rapid expansion and contraction of the banking sector is bound to require a lot of short-term structural adjustment elsewhere, particularly in the contraction phase.

3. I am finding myself more and more reverting to what I call the MIT view (before Dornbusch and Fischer) that asset shuffling by the Fed (including all the conventional tools of monetary policy as well as the unconventional ones) does not have much impact.

Miles Kimball on Currency Reform to Resolve the ZLB

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I missed this the first time Kimball posted it.

The bottom line is that all we have to do to give the Fed (and other central banks) unlimited power to lower short-term interest rates is to demote paper currency from its role as a yardstick for prices and other economic values—what economists call the “unit of account” function of money. Paper currency could still continue to exist, but prices would be set in terms of electronic dollars (or abroad, electronic euros or yen), with paper dollars potentially being exchanged at a discount compared to electronic dollars. More and more, people use some form of electronic payment already, with debit cards and credit cards, so this wouldn’t be such a big change. It would be a little less convenient for those who insisted on continuing to use currency, but even there, it would just be a matter of figuring out with a pocket calculator how many extra paper dollars it would take to make up for the fact that each one was worth less than an electronic dollar. That’s it, and we wouldn’t have to worry about the Fed or any other central bank ever again seeming relatively powerless in the face of a long slump.

…for paper dollars, the interest rate would be made at least another 1% per year lower by having the discount for paper dollars gradually change over time.

I got to that piece from this post. Thanks to Tyler Cowen for the pointer.

A country that is ready to stop hyperinflating will often go for a currency reform. We cut the budget deficit so that we have to stop printing so much money. And we issue a new shekel, which is worth 100 of the old shekels. We phase out the old shekels.

Kimball’s proposal made me think of a currency reform for when inflation is too low. Imagine issuing a new dollar that eventually will trade at parity with old dollars. However, in the first month, for currency exchanges only, the government offers 10 new dollars for 9 old dollars. The next month, it offers 9.99 in new dollars for 9 old dollars. The following month, the exchange rate is 9.98 to 9. And so on, until the parity value is reached.

With this exchange policy, the interest rate on old currency will effectively be negative. Thus, you avoid the zero lower bound on interest rates.

I am not advocating this. I am suggesting that it is perhaps related, or even equivalent, to Kimball’s proposal.

The Sociology of Business

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Peter Turchin writes,

Both states and corporations are, at some fundamental level, cooperative enterprises. Yes, political elites and corporate managers are motivated by personal gain, power, status, and prestige. And that even can be the majority of their motivations. But in addition there has to be something else, at least some of these elites (whether political or economic) some of the time must behave in a cooperative prosocial manner, that is, putting the common interest of their state or corporation above their private interests. When they stop doing that, states crumble and corporations go bankrupt.

Pointer from Jason Collins. I would add that as a business grows, it changes as its size exceeds the Dunbar number. Once there are more than 150 people, you have strangers dealing with one another within the business, and the dynamics change. In order to maintain prosocial behavior, you need a lot more formal rules at that point, and veterans of the smaller, informal company often cannot adjust.

Having said that, the formal rules help to make the company more robust. So I think it takes more than a few rogues to cause a breakdown in the company. It takes a more systemic cultural decline.

U.S. Teachers and Foreign Teachers

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About a new OECD study, Timothy Taylor writes,

The quick bottom line: the average U.S. teacher faces a similar student/teacher compared to the average for teachers in other countries, but the relative pay of US teachers compared to the average wage is lower than the similar ratio in many countries, and the number of hours worked by US teachers is higher than in other countries.

It is possible that this shows that U.S. teachers are underpaid. However, I would be interested in the ratio of non-teaching staff to teaching staff in the U.S. vs. elsewhere. When I looked into Montgomery County, Maryland a few years ago, it seemed that the ratio of students to classroom teachers was more than double the ratio of students to employees. Suppose that the ratio of non-teaching staff to teachers is much higher in the U.S., which is what I suspect is the case. Perhaps those non-teachers help make life easier for teachers, in which case perhaps our teachers are not underpaid. Or perhaps those non-teachers do not help (they may even add work).

In any case, if you raise salaries in U.S. public school education, a huge amount of that money will go for non-teaching staff. I think we ought to know more about what those non-teaching staff contribute before we throw more money at them.

Other random issues to toss into the mix:

1. In at least some non-U.S. countries, teachers come from a higher part of the IQ distribution. In theory, we could get more able teachers by paying more money, but we also might have to change the role of unions.

2. There is very little reliable evidence linking education inputs to outcomes.

I would prefer to see parents spending their own money on education. If they believe that paying for schools with high teacher salaries is a good idea, then we will arrive at an equilibrium with high teacher salaries. If not, then we won’t. I am comfortable with what emerges, especially considering (2).

Gotcha!

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Greg Mankiw (among others) points to new NBER working papers by Casey Mulligan that point out that marginal tax rates go up under Obamacare. I have not read the papers, but I assume that he counts as an increase in the marginal tax rate the fact that you lose out on subsidies as your incomes goes up. That is legitimate economic analysis, but try to do satisfy the following:

1. Use “means testing” in order to provide a significant benefit that is aimed at the poor.

2. Keep the marginal tax rate low.

3. Keep the budget cost low.

Those of us on the right tend to argue separately for all three. But collectively, they are not so easy to satisfy. (My undergraduate economics professor, Bernie Saffran, pointed this out, and I have not forgotten it.)

If you want to offer a means-tested benefit at low cost, then you have to scale-back the benefit rapidly as income rises, meaning a high marginal tax rate.

If you want to keep the marginal tax rate low and and the budget cost low, then you cannot offer a sizable benefit to the poor. So you can’t do much in terms of means-testing.

If you want to provide a significant benefit to the poor with a low marginal tax rate, then you have to phase the benefit out very slowly as incomes rise. So the budget cost is high.

If we want to, we can play “gotcha!” with any proposal that is aimed at helping people who are poor. It is bound to fail (1), (2), or (3). But how can we be constructive?

My solution was offered in the essay Bleeding-Heart Libertarianism. The idea was to offer a significant benefit with a low marginal tax rate. To hold down the budget cost, I shift away from in-kind benefits (such as food stamps or Medicaid) toward a cash benefit.

That essay is worth re-reading.

Pseudo-physics Backlash Watch

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Bart Wilson quotes from the conclusion of Frank Knight’s The Ethics of Competition.

man’s relations with his fellow man are on a totally different footing from his relations with the objects of physical nature and to give up, except within recognized and rather narrow limits, the naïve project of carrying over a technique which has been successful in the one set of problems and using it to solve another set of a categorically different kind.

In 1924, this statement evidently did not affect the direction taken by the economics profession. Perhaps we might be more receptive to it today.