Economics and Politics

Ketchup and the housing bubble

krugman — Sun, 19 Jul 2009 23:25:39 +0300

I’m working on the relationship between economic theory and the current crisis, and one thread obviously involves the role of efficient market theory in breeding complacency. So I ran across this revealing late-2007 interview with Eugene Fama. In it, Fama dismisses the whole idea of bubbles:

Well, economists are arrogant people. And because they can’t explain something, it becomes irrational. The way I look at it, there were two crashes in the last century. One turned out to be too small. The ’29 crash was too small; the market went down subsequently. The ’87 crash turned out to be too big; the market went up afterwards. So you have two cases: One was an underreaction; the other was an overreaction. That’s exactly what you’d expect if the market’s efficient.

The word “bubble” drives me nuts. For example, people say “the Internet bubble.” Well, if you go back to that time, most people were saying the Internet was going to revolutionize business, so companies that had a leg up on the Internet were going to become very successful.

I did a calculation. Microsoft was an example of a corporation that came from the previous revolution, the computer revolution. It was hugely profitable and successful. How many Microsofts would it have taken to justify the whole set of Internet valuations? I think I estimated it to be something like 1.4.

And he expresses confidence over housing (rather late in the game, wouldn’t you say?):

Housing markets are less liquid, but people are very careful when they buy houses. It’s typically the biggest investment they’re going to make, so they look around very carefully and they compare prices. The bidding process is very detailed.

What this made me think of was an old paper by Larry Summers mocking finance economists as the equivalent of “ketchup economists”, who believe that they’ve demonstrated market efficiency by showing that two-quart bottles of ketchup always sell for twice the price of one-quart bottles.

In the case of housing, buyers do carefully compare prices — with the prices of other houses. That is, they make sure that two-quart bottles of ketchup are the same price as one-quart bottles. As we’ve seen, however, they don’t do a very good job of checking whether the overall level of housing prices makes sense.

Yes, it was a bubble — and as Larry said way back when, the ketchup test just isn’t enough.

Morning Joe

krugman — Sun, 19 Jul 2009 18:39:17 +0300

I think this Michael Hirsch piece on Joe Stiglitz somewhat misses the point.

Yes, Joe should be playing a bigger role — he’s an insanely great economist, in ways you can’t really appreciate unless you’re deep into the field. I’d say that he’s more his generation’s Paul Samuelson than its John Maynard Keynes: as with Great Paul, almost every time you dig into some sub-field of economics — finance, imperfect competition, health care — you find that much of the work rests on a seminal Stiglitz paper.

But the larger story is the absence of a progressive-economist wing. A lot of people supported Obama over Clinton in the primaries because they thought Clinton would bring back the Rubin team; and what Obama has done is … bring back the Rubin team. Even the advisory council, which is supposed to bring in skeptical views, does so by bringing in, um, Marty Feldstein.

The point is that even if you think the leftish wing of economics doesn’t have all the answers, you’d expect some people from that wing to be at the table. Yet I don’t see Larry Mishel, or Jamie Galbraith … Jared Bernstein is it.

Joe Stiglitz stands out because in addition to being on the progressive wing, he’s also, as I said, a giant among academic economists. But I think the real story is more about excluded points of view than excluded people.

Carbon tariffs

krugman — Sun, 19 Jul 2009 18:16:03 +0300

The Times editorial page says they make sense, done right. I agree on both the economics and the legal aspects.

A few days off

krugman — Sun, 19 Jul 2009 18:13:09 +0300

No column tomorrow, and limited posting until late in the week. I’ll be ~~hiking the Applalachian Trail~~ taking some personal time.

Summers at IIE

krugman — Sat, 18 Jul 2009 15:54:59 +0300

The speech Larry Summers gave at the IIE was sensible and clear-headed. But his discussion of the stimulus and its size was disappointing — and, I hope, somewhat disingenuous.

What Larry said:

The size of the stimulus reflected a balance of several considerations: the size of the likely output gap that the economy was facing, the difficulties of ramping up spending and then ramping it back down after recovery in a high budget-deficit environment, the question of how much could be spent both quickly and productively, and the recognition that the Recovery Act was just one of several initiatives by the Administration that would have a dynamic impact on the state of the economy.

Look: it was really clear, even in January, that the stimulus wasn’t remotely big enough to close the output gap. My analysis at the time here and here.

It was also clear, at least to me, that the stimulus should, in fact, be aggressive — enough to achieve something close to full employment.

Now, you can argue that given the political realities it just wasn’t possible to pass a bigger stimulus, which may or may not be true. But that’s not the argument Larry is making — he’s saying that the plan was just right in economic terms. And I can only hope they didn’t really think that.

What about the argument that the stimulus was just one of “several initiatives”? Well, I did hear that at the time. But as we now know, not much is happening on other fronts. Foreclosure relief has been mostly a nonstarter; the PPIP has turned more or less into a joke; policy toward the banks is basically a muddle-through strategy, which might work out in terms of avoiding the need for further direct intervention, but certainly isn’t jump-starting lending.

The point is that I can respect the argument that this was all the administration could do, politically. I can’t feel equal respect for the argument that this was all it should have done, economically.

Beware the bounce

krugman — Sat, 18 Jul 2009 15:30:13 +0300

The really terrible numbers earlier this year had a lot to do with inventories: businesses decided they had too much stuff in warehouses, so they slashed production well below final sales. Correspondingly, the green shoots we’re seeing are to an important extent the result of the end of this de-stocking process.

The question is, how much has the underlying situation changed? Are we seeing anything more than the inventory bounce most of us have been expecting for three or four months?

Jan Hatzius at Goldman (no link) is skeptical. His latest suggests that final demand is still going nowhere:

The six deadly hypocrites

krugman — Sat, 18 Jul 2009 03:28:02 +0300

Will the destructive center kill health care reform? It looks all too possible.

What’s especially galling is the hypocrisy of their claimed reason for delaying progress — concern about the fiscal burden. After all, in the past most of them have shown no concern at all for the nation’s long-term fiscal outlook.

Case in point: the Medicare Modernization Act of 2003, which denied Medicare the right to bargain for lower drug prices, locked in overpayments to private insurance companies, and did nothing, nothing at all, to pay for its proposed outlays. How many of these six self-proclaimed defenders of solvency voted no on the crucial procedural vote? One. (Joe Lieberman, to my surprise.)

And let’s not forget that Ben Nelson, who appears to be the ringleader, has fought tooth and nail against competition from a public option — which would almost certainly save a significant amount of money, as well as providing much-needed competition.

If the Gang of Six really does kill reform, remember their names; they will bear the responsibility for vast, unnecessary suffering over the years to come.

Views differ on shape of macroeconomics

krugman — Sat, 18 Jul 2009 00:21:11 +0300

I’ll mostly weigh in on Brad DeLong’s side with regard to this Economist piece on the state of macroeconomics. The Economist reaches, I think, for a false symmetry, and glosses over too easily the sheer ignorance that has become obvious in the debates over fiscal policy.

On the other hand, the common claim that economists ignored the financial side and the risks of crisis seems not quite fair — at least from where I sit. In international macro, one of my two home fields, we’ve worried about and tried to analyze crises a lot. Especially after the Asian crisis of 1997-98, financial crises were very much on everyone’s mind. There was a substantial empirical literature from economists like Carmen Reinhart and Graciela Kaminsky (with Ken Rogoff joining in latterly); there was modeling from Guillermo Calvo, ~~Jose~~ Andres (grrr) Velasco, Nouriel Roubini, Paolo Pesenti, and others, including yours truly.

Speaking for myself, I saw the housing bubble and expected the bust; but I hadn’t appreciated in advance either the vulnerability of the shadow banking system or the leverage of American consumers. Once the crisis was underway, however, I had a more or less ready-made intellectual framework to accommodate these revelations: at a meta level, this was very much the same kind of crisis as Indonesia 1998 or Argentina 2002.

Domestic macro people may have been more astonished by what happened. But the prevailing trend now is to assert that there are more risks in the economy than were dreamed of in our philosophy; I don’t think that’s fair.

Who coined the term “macroeconomics”?

krugman — Fri, 17 Jul 2009 23:47:46 +0300

The Economist sez the term first appeared in the journals in a 1945 article by Jacob Marschak. But according to an authoritative source — Krugman and Wells — the term was coined in 1933 by Ragnar Frisch.

Opinions for sale

krugman — Fri, 17 Jul 2009 17:49:44 +0300

Politico has a scoop:

The American Conservative Union asked FedEx for a check for $2 million to $3 million in return for the group’s endorsement in a bitter legislative dispute, then flipped and sided with UPS after FedEx refused to pay.

For the $2 million plus, ACU offered a range of services that included: “Producing op-eds and articles written by ACU’s Chairman David Keene and/or other members of the ACU’s board of directors. (Note that Mr. Keene writes a weekly column that appears in The Hill.)”

This reminded me of another story that was sort of disappeared from polite discussion: Think Tank’s Ideas Shifted as Malaysia Ties Grew:

For years, the Heritage Foundation sharply criticized the autocratic rule of former Malaysian prime minister Mahathir Mohamad, denouncing his anti-Semitism, his jailing of political opponents and his “anti-free market currency controls.”

Then, late in the summer of 2001, the conservative nonprofit Washington think tank began to change its assessment: Heritage financed an Aug. 30-Sept. 4, 2001, trip to Malaysia for three House members and their spouses. Heritage put on briefings for the congressional delegation titled “Malaysia: Standing Up for Democracy” and “U.S. and Malaysia: Ways to Cooperate in Order to Influence Peace and Stability in Southeast Asia.”

Heritage’s new, pro-Malaysian outlook emerged at the same time a Hong Kong consulting firm co-founded by Edwin J. Feulner, Heritage’s president, began representing Malaysian business interests. The for-profit firm, called Belle Haven Consultants, retains Feulner’s wife, Linda Feulner, as a “senior adviser.” And Belle Haven’s chief operating officer, Ken Sheffer, is the former head of Heritage’s Asia office and is still on Heritage’s payroll as a $75,000-a-year consultant.

Despite everything that’s happened, I don’t think many people grasp just how raw, how explicit, the corruption of our institutions has become.

Anti-American

krugman — Fri, 17 Jul 2009 17:32:05 +0300

For some reason Princeton Township is demolishing the bridge that takes Rosedale Road over Stony Brook. This happens to be a huge inconvenience, adding miles to my trip into the office (and creating major traffic jams along the route, because I’m not the only person forced into a detour.) But that’s not what struck me today, when I walked over to see the destruction in progress; what I found odd was the name of the company doing the work: Nacirema Group.

Is this deliberate? Is the owner of a demolition company a fan of anthropological satire?

More multipliers (double super wonkish)

krugman — Fri, 17 Jul 2009 17:23:01 +0300

I’ve been thinking a bit more about contrasting results about fiscal multipliers in different New Keynesian models. Here are some further thoughts:

The simplest NK model is one in which there’s only consumption, no investment, and in which there’s a one-period “short run” in which prices are fixed, followed by an infinite-horizon long run of flexible prices. That’s the kind of model I used in my original analysis of Japan’s liquidity trap, and in my more recent stab at analyzing optimal fiscal policy.

In this kind of model, the key thing tying down consumption is an Euler condition:

MU1/DMU2 = (1+i)(P1/P2)

where MU1, MU2 are the marginal utilities of consumption in periods 1 and 2, D<1 is a subjective discount factor, i is the nominal interest rate, and P1, P2 are price levels in the two periods. Future consumption and prices are tied down by full employment and the future money supply; that leaves i and the initial price level to play with. Even if i is up against zero, short-run price flexibility can ensure full employment — but not in the usual way: a lower current price level increases expected inflation (by reducing current prices compared with expected future prices), and thereby reduces the real interest rate. If prices aren’t flexible, and i=0, the marginal utility of period 1 consumption, and hence its level, must move in lockstep with long-run consumption.

What does this say about fiscal multipliers?

If the fiscal expansion is temporary, consumption does not change; so the multiplier is exactly 1. If the fiscal expansion is permanent, it must crowd out an equal amount of consumption in the long run, and hence do the same in the short run. So the multiplier on a permanent expansion is zero.

Now, how does that fit with the results in Eichenbaum et al and Cogan et al?

I understand Eichenbaum et al pretty well, I think. They have a multi-period model in which the liquidity trap can extend for some time, and lead to disinflation or even deflation. Expected deflation, in the equation above, raises the real interest rate and depresses current consumption. Fiscal expansion reduces the expected rate of deflation, and therefore has a positive effect on consumption — but not through the conventional Keynesian channel.

Cogan et al is harder to puzzle out. In their initial policy exercise they assume that the fiscal expansion is permanent, which should imply a zero multiplier; I’m not sure why that doesn’t happen exactly. In their attempt to reproduce the actual stimulus plan, some of the spending comes after the zero bound has lifted, so there’s some crowding out there. But I don’t think that’s the whole story.

My guess — but it’s really hard to decipher — is that in Cogan et al the zero lower bound isn’t really binding; they think the Fed is being too expansionary. So imposing a zero rate is, in their view, inflationary — and forces a period of tight money and depressed spending later on. Fiscal expansion adds to this inflationary problem. And through the Euler equation this feeds back to current consumption.

So, how seriously should we take any of this?

Bear in mind that all these models assume perfectly rational, perfectly informed consumers engaged in optimal forward-lookin behavior. Economists are in vast disagreement about the right model to use — but consumers are assumed to know the true model, and base their spending decisions on that knowledge. Um, I think we have a problem here.

And for what it’s worth, my sense is that the empirical literature on consumption behavior casts doubt on the underlying model of long-run intertemporal maximization: consumer spending is much more responsive to short-term fluctuations in income than it “should” be. If so, a bigger multiplier would be appropriate.

What I really think is that consumers rely on rough rules of thumb, which leads in the short run to something much more like a Keynesian consumption function than is currently fashionable to admit.

But the true bottom line is that New Keynesian models, while they can help you clarify your thought, aren’t a literal description of how things work, and they certainly shouldn’t be taken as “proof” of anything.

Winning the narrative

krugman — Thu, 16 Jul 2009 22:09:43 +0300

Yesterday I had a conversation with someone who, like me, spent most of the Bush years as a voice in the wilderness. And he pointed out something remarkable: although those of us who said the obvious — that the Bush administration was fundamentally monstrous — were ridiculed by all the respectable people at the time, at this point our narrative has become everyone’s narrative.

The AMA — as good guys????

krugman — Thu, 16 Jul 2009 21:51:26 +0300

If you know anything about the history of health care in America, you know that the American Medical Association has played a consistently nefarious role. It helped block Truman’s plan for national health insurance, in alliance with Southern politicians who feared that a national system would force them to integrate hospitals. It sponsored Operation Coffee Cup, in which doctors’ wives were encouraged to rally their friends against Medicare — with the help of a recorded message from Ronald Reagan.

But now the AMA has endorsed the House health reform bill.

Now, the WSJ has just warned that the pharma and insurance lobbies, babes in the woods that they are, are being snookered by the health reformers. (Let nobody say that the Journal lacks sympathy for innocent victims!) Has the same thing just happened to the AMA?

“At a time like this”

krugman — Thu, 16 Jul 2009 21:38:44 +0300

Kevin Drum does a righteous smackdown of Bryan Caplan for arguing that we should oppose the House health reform bill because it would raise taxes in the midst of a recession. As Kevin points out, the provisions wouldn’t take effect for several years; it takes real chutzpah, given that obvious point, for Caplan to accuse me of being disingenuous.

Actually, it’s even worse: Caplan frames the argument in terms of the nasty effects of raising labor costs. Um, we have a problem with demand, not supply; time to reread Keynes on wages.

Kevin also mentions similar arguments being made against climate-change policy. Indeed: it’s really sad to see Martin Feldstein arguing that Waxman-Markey amounts to a tax increase in the face of a recession, using numbers that, aside from being misleading, refer to the projected impact of the bill in — wait for it — 2020.

What’s striking here is the cynicism. Feldstein, in particular, is surely a good enough economist to know better. But he and Caplan and others are prepared to grab any argument they can to block progressive reform.

Food for thought

krugman — Thu, 09 Jul 2009 17:18:17 +0300

According to a new site called Mediaite, Mark Bittman of the Times is the 8th most influential columnist in America, ahead of Arianna Huffington.

It’s also noteworthy that Glenn Greenwald of Salon is #10.

On the other hand, Christopher Hitchens is #5. Why would God allow that?

And the less said about #1, the better …

Bond panic subsiding?

krugman — Wed, 08 Jul 2009 23:24:17 +0300

Wall Street Journal Interest rate on 10-year Treasuries

Unpersons

krugman — Wed, 08 Jul 2009 16:14:47 +0300

One of the mysteries of the way issues are covered in much of the news media is how certain views get ruled “out of the mainstream” and just don’t get covered — even when many well-informed people hold those views.

The most notorious example was during the buildup to the Iraq war: skepticism about the case for war was treated as a fringe view, even though the evidence being presented by the hawks was flimsy on its face, and the ranks of the skeptics included a number of people with excellent national-security credentials.

But in a way, the implicit censorship on the stimulus debate is even stranger. During the initial discussion of the stimulus, the debate was framed almost entirely as a debate between Obama and those who said the stimulus was too big; the voices of those saying it was too small were largely frozen out. And they still are — if it weren’t for my position on the Times op-ed page, there would be hardly any major outlet for Keynesian concerns.

And here’s the thing: in this case, there isn’t any hidden evidence — you can’t argue that the CIA knows something the rest of us don’t. And the voices calling for stronger stimulus are, may I say, sorta kinda respectable — several Nobelists in the bunch, plus a large fraction of the prominent economists who predicted the housing crash before it happened.

But somehow, the pro-stimulus people are unpersons. Who makes these decisions?

Oil speculation

krugman — Wed, 08 Jul 2009 16:01:18 +0300

Oil speculation is back in the news. Last year I was skeptical about claims that speculation was central to the price rise, because what I considered the essential signature of a speculative price rise — physical withholding of oil from the market, in the form of high inventories — just wasn’t showing.

This time, however, oil inventories are bulging, with huge amounts held in offshore tankers as well as in conventional storage. So this time there’s no question: speculation has been driving prices up.

Now, “speculation” isn’t a synonym for “bad”. If the underlying assumptions that seem to have been driving oil markets were right — namely, that a vigorous recovery is just around the corner, and demand will shoot up soon — then it would be perfectly reasonable to accumulate oil inventories right now. But those assumptions are looking less reasonable by the day.

Anyway, the moral of this post is that the oil story this time looks very different: this time, the signature of large-scale speculation is clearly visible.

An unknown country

krugman — Tue, 07 Jul 2009 16:04:13 +0300

A correspondent writes in, denouncing my latest column, and says that if things go my way we’ll end up with the government providing health care to everyone, which will “destroy the American way of life.”

Hmm. There’s a country this correspondent — and many others who denounce “socialized medicine” — should look at. It’s a country where there is, indeed, a substantial private health insurance industry, which pays 35 percent of medical bills. But the government pays a larger share — 46 percent. (Most of the rest is out-of-pocket spending.)

The country is called the United States of America.

The paradox of thrift — for real

krugman — Tue, 07 Jul 2009 15:48:58 +0300

The paradox of thrift is one of those Keynesian insights that largely dropped out of economic discourse as economists grew increasingly (and wrongly) confident that central bankers could always stabilize the economy. Now it’s back as a concept. But is it actually visible in the data? The answer is, and how!

The story behind the paradox of thrift goes like this. Suppose a large group of people decides to save more. You might think that this would necessarily mean a rise in national savings. But if falling consumption causes the economy to fall into a recession, incomes will fall, and so will savings, other things equal. This induced fall in savings can largely or completely offset the initial rise.

Which way it goes depends on what happens to investment, since savings are always equal to investment. If the central bank can cut interest rates, investment and hence savings may rise. But if the central bank can’t cut rates — say, because they’re already zero — investment is likely to fall, not rise, because of lower capacity utilization. And this means that GDP and hence incomes have to fall so much that when people try to save more, the nation actually ends up saving less.

The theoretical picture looks like this:

Short Jewish guys

krugman — Mon, 06 Jul 2009 21:29:43 +0300

Apropos of this: Tom Friedman emails to say that in St. Petersburg someone thought he was me.

French/Dutch health care

krugman — Mon, 06 Jul 2009 21:28:26 +0300

Good piece by Jonathan Cohn. But hey, we’re not supposed to have anything to learn from cheese-eating surrender monkeys, let alone wooden-shoe-wearing tulip-lovers.

And more on Bernstein-Romer

krugman — Mon, 06 Jul 2009 21:05:58 +0300

Comments on this post suggest that people aren’t quite understanding how to read the graph. So, a bit more.

First, there are two elements here: there’s a baseline, which is the prediction of what the economy would have done without the stimulus, and there’s the predicted change from that baseline that is the effect of the stimulus.

Clearly, the baseline was way too optimistic. But the question under discussion was how much effect relative to the baseline the stimulus was supposed to have had by now. The figure actually shows predictions by quarter. Roughly, the stimulus was supposed to reduce unemployment — again, relative to the baseline — by about 0.2 percentage points in the second quarter of this year; by about 0.7 percentage points in the third quarter.

The most recent unemployment data we have are for June, which was the end of the second quarter. So the prediction was that the stimulus would cause unemployment to be something like 0.3 or 0.4 percentage points lower in June than it would have been otherwise.

That’s not much. The stimulus wasn’t ever expected to be having a large effect this early.

A bit more on administrative costs

krugman — Mon, 06 Jul 2009 20:48:34 +0300

After rereading my earlier post, it occurred to me that it might be useful to lay out the logic of the argument. What we observe is that private insurers spend a much larger fraction of their receipts on administration than Medicare does. Heritage asserts that this is because administration costs are proportional to the number of beneficiaries, not spending, so Medicare has low percentage costs because its elderly beneficiaries are so much more expensive than average.

So how would you test this assertion? I can think of two obvious approaches: (1) Compare the administrative costs of different systems serving similar populations (2) Compare the administrative costs of similar systems serving different populations.

And we can do both of these things.

Medicare Advantage plans are private insurance serving the elderly population. So this is a case of different systems serving similar populations. (Medicare Advantage clients are probably somewhat healthier than the average senior, but the average cost of their health care is still very high.) If costs depended mainly on number of people, these plans should have low administrative costs as a percentage of spending. They don’t — their numbers look like those of private insurance in general.

Meanwhile, other countries have Medicare-like systems that cover low-cost as well as high-cost individuals. Canada’s system is actually called Medicare. So this is a similar system covering a different, lower-cost population. If costs depended on the number of people, Canada should have high administrative costs; in fact, its numbers look like those of American Medicare (actually even better.)

This seems like fairly overwhelming evidence that single-payer systems do, in fact, have low administrative costs compared with private insurers. To argue that this doesn’t clinch the case, you have to resort to pretty desperate expedients; for example, one of my commenters says that the CBO study of administrative costs can’t be trusted, because Democrats control Congress. (The CBO bends over backwards to be nonpartisan — and anyway, the study was done in 2006, when Republicans were still in control.)

I know that some people find that answer unacceptable: they know that the private sector is always more efficient than the government, and no amount of evidence will shake their faith. But that’s what the evidence shows.