Friday, August 27, 2010

A Classic Economics Debate

The more I explore of the blogs various leading economists write, the more I wonder whether they have private lives - I don't understand how they can blog, and comment on other peoples' blogs, as much as they do and remain productive, without their non-work lives being squeezed into basically sleeping 5-6 hours a night tops.

But that's by the by.  I've been intrigued by the debate the last few days about a speech by Narayana Kocherlakota, who is the President of the Minneapolis Fed (part of the US central banking system).  The point that has generated the debate is this:
To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation.
So someone very high up in the US Central Banking system is making the point that low interest rates must (not might, or could) lead to deflation (that's negative inflation).  This is, of course, counter to most folks' intuition - at least folk who have studied monetary economics at a basic level.  There, we teach that lower interest rates encourage investment and discourage savings, hence raising aggregate demand.  With higher aggregate demand, one expects inflation to be the result of low interest rates.

Hence, perhaps unsurprisingly, a number of people are frothing at the mouth: Paul Krugman, Scott Sumner, Nick Rowe, Mark Thoma and Andy Harless, to name but a few prominent US economists and bloggers.  I'd say it's interesting to have a read of most of these links - particularly the one for Nick Rowe as the comments there are particularly extensive.  Andy Harless has perhaps the most humorous take: Kocherlakota it seems has mistaken "must lead to" with "are a result of", and hence Harless suggests that perhaps umbrellas cause rain.

Now of course the blogosphere is full of such strongly put opinions, and I suspect the most widely read blogs are those that are particularly forthright and strong in how they put forward ideas - rather than the mild-mannered blogs that don't say anything particularly strongly.

The other side of this can be found in the comments on Nick Rowe's blog from two people: Steven Williamson and David Andolfatto.  Williamson is a particularly forthright economist, and spends most of his time bashing Paul Krugman.  I used to teach a module for which the textbook I inherited was his textbook.  If I was still teaching that module, I would have dropped the textbook by now, simply because of the outright hostility he holds to all schools of thought other than his own, and the associated intellectual arrogance he exudes in all posts.

The essence of Williamson's response is that of course you can put together a model which explains the statement Kocherlakota wrote.  That's the standard economist's response.  And because he can think of a model, then he decides he has to mock and deride all those who don't subscribe to the simple model he wrote down.

Of course, what isn't answered by Williamson is the empirical relevance of the model.  Does his mini-theory have any relevance whatsoever in the real world?  (in economist-speak is it empirically relevant?).  The model he puts forward makes one particular assumption that stands out: Prices move freely.  So prices aren't sticky at all.  This is a standard debate amongst macroeconomists, would you believe - whether prices are sticky or not.  Forget shoe-leather costs, wage contracts, etc., all the obvious empirical evidence for sticky prices.  Some people, like Williamson reject that prices are sticky - on intellectual grounds, not empirical ones.  Williamson finds the theoretical underpinning arguments for sticky prices unpersuasive, and so therefore these sticky prices can't possibly exist.

So basically we're left with a debate between people who look at the world, see the frictions and issues with the economic mechanism and design models that represent these problems and hence draw conclusions likely relevant for policymakers, who draw the conclusion that low interest rates in general should not be synonymous with deflation, and others who take a theoretical view of the world starting from the premise it functions just perfectly (I don't see a good reason why sticky prices exist therefore they don't).  In the latter world, which bears no relation to the real world, it is possible to defend the initial umbrellas-cause-rain position of Kocherlakota.  In the former world, it really isn't possible.  I'm firmly in the former world.

Thursday, August 26, 2010

A German Speaking Too Soon

Hans-Werner Sinn has always been a fairly outspoken German economist.  Not too long ago he was telling Paul Krugman that he was wrong to be telling Germans to be spending more in no uncertain terms.  Now he's giving us a rather bold statement about where the world is currently, on Project Syndicate.

He starts by asserting that the Financial Crisis is over.  I'm not totally sure about that.

He ends by talking about Germany, and how it's now booming.  We should point out that Germany grew by an impressive 2.2% last quarter, but as has been said elsewhere, this is just one data point.  Sinn, however, is convinced that Germany is now booming.  We'll have to wait and see.

He ends with a somewhat perplexing statement:
The explanation for this divided world is that countries like Greece, Spain, and the US, which experienced a long boom financed by huge capital imports, now face growing difficulties in finding foreign finance.
Now Greece and Spain I can understand having growing difficulties in finding foreign finance, but the US?!  Perhaps Sinn is taking his opposition to anything Krugman writes to new levels, but Krugman has been fairly clear, using interest rates on long-term bonds and the like (so data, not just opinions), that actually, international investors still see the US and the US dollar as a safe haven for their assets.

For your interest, Krugman himself debunks the theory that Germany is some economic miracle here.

Wednesday, August 25, 2010

Central Planning and the Market Economy

John B Taylor (of Taylor Rule fame) has a nice blog that accompanies his first year macro course at Stanford University in the US.  He has just written about a long term example of the efficacy of markets over central planning: Russia now exports grain.

Before the central planning of the Soviet Union Russia and the Ukraine exported grain.  Under the Soviet system of giant collective farms, the Soviet Union was forced to import grain due to the economic disaster that was collectivisation.  Now, 20 years after the fall of the Soviet Union, Russia is exporting again.  How about that?

Friday, August 20, 2010

Economists and Immigration

There's little doubt that one of the major news topics of recent years has been immigration.  It was an election issue, and will no doubt be a recurring issue.  Ed Balls is chipping in as he bids for the Labour leadership.  Politicians are falling over themselves to sound more and more like Joe Bloggs on the street, who is very concerned about immigration.

The Coalition government has taken steps to introduce its promised cap on non-EU immigration, and would, given the opportunity, do more.

But is this good for us?  What does economics tell us here?  It can tell us many things.  First, it begs the question: Why restrict?  By restricting the free movement of factors of production to their most productive uses, we must therefore end up with a less optimal solution.  The same or inferior output at higher cost, as we throw out the non-EU worker who was selected as the best person for that particular job.

Hard headed and brutal as it is, there simply is no economic argument for restricting immigration.  Let's think a little more about the consequences of restricting.  Poor quality British workers get jobs, they're protected, and have little incentive to be anything other than mediocre - they won't be replaced by that more highly skilled Aussie or Canadian because they are now ineligible for the job.

You will probably notice during your time even as an undergraduate in Birmingham that the overseas students you see amongst you are by some distance the most hard working and keen to learn.  They emerge with the better qualifications and knowledge, and are likely the more employable people.  But they won't be employable legally in the UK.  We'll be poorer as a result.

We'll be poorer because meals in restaurants will cost more and will be delivered by unmotivated, overpaid British waitresses instead of motivated and hard working immigrants.

I could go on.  The simple fact is, there are no good reasons for restricting immigration.  What about overcrowding, you might ask?  Well, there will become a point where migrating to the UK is no longer beneficial to people elsewhere, if we left things unrestricted.  The marginal benefit of doing so would be outweighed by the marginal cost.

We'd have more things produced because the world is not a zero-sum game.  If immigrants take some jobs, there are still plenty of others out there, and those displaced should be motivated to upskill themselves and find a new job.  If they aren't prepared, I don't want to know about them and I certainly don't want to hear their moaning - the kind of moaning that has secured the current anti-immigrant sentiment in this country.

Thursday, August 19, 2010

Robert Skidelsky on Deficit Cutting

Robert Skidelsky is a very prominent economist, not least for his biographies of Keynes.  As you can imagine, he is more Keynesian in his leaning as an economist than some.  Right now, with the austerity of the Coalition and others the flavour of the moment, people are much less inclined towards Keynesian arguments.

The feel now is that we need to cut the deficit - this is the big problem, not the fact we're stuck in an anemic recovery from the recession of 2008-9.  Skidelsky has written this article in Project Syndicate on the issue, and I think the punchline has to be:
Events and common sense drove them to deficit finance in 2009-2010, but they have not abandoned the theory that depressions cannot happen, and that deficits are therefore always harmful (except in war!). So now they vie with each other in their haste to cut off the lifeline that they themselves extended.

Wednesday, August 18, 2010

100 Days of the Coalition

Today marks 100 days since the Tories and the Lib-Dems agreed to join forces in a coalition government in the aftermath of the inconclusive election back in May.

Naturally, the Coalition is trying to put a positive spin on what it has achieved in 100 days.  Most of this is journalists trying to fill space - August is a nororiously dry time for news stories.

Econ101b teaches about monetary and fiscal policy having time lags for implementation, and we learn that the UK government actually has little power over monetary policy these days, having granted the Bank of England independence in 1997.  Given these long time lags, it is probably quite unrealistic to expect that the Coalition can have had any impact thus far on economic outcomes - at least at the macroeconomic level.

It's trying hard though - and another argument we come across in econ101b can give them some credence for trying to argue they've had an impact thus far: Expectations.

Expectations are powerful things.  Investors decide whether to invest or not based on their expectations.  Expect a downturn, and they won't invest - at least not in physical projects.  Why build a new office block if you expect a prolonged downturn?  Can you know you'll fill it?

A central emphasis when the Coalition began was that bond markets were soon likely to turn on the UK - our debt is too high, and our deficit is too high - as high as Greece!  Such talk is based on expectations: Expectations that the expectations of investors are that the UK will default like Greece.

Much has passed under the water since.  Not least, interest rates on long-term government debt have been falling - i.e. it's been getting cheaper for the UK government to borrow.  Kind of runs against what the Coalition had asserted.  The voices of austerity such as the Coalition have been mocked by various sources, not least Nobel Prizewinner Paul Krugman.  Another Nobel Prizewinner, Joseph Stiglitz, has attacked this panic in the face of financial markets: Who is governing, Robert Skidelsky has asked, is it the government, or is it the financial markets?

Of course it's far too soon to judge the coalition; even if I say bond market rates have fallen, there's no reason why they won't rise in the future.  Other unexpected events may mean that despite the austerity, the UK escapes a recession, and unemployment doesn't rise above 3m - something that looks odds on currently.  And even if we have a recession, it still will be too early to judge the coalition - it may be that the cuts are necessary to secure a longer term prosperity for the UK.  I have my doubts, but this may well be the case...

Sunday, August 15, 2010

Policy Uncertainty

One thing we'll talk about second term is the impact uncertainty can have on economic outcomes.  In other words, if people are uncertain, they do less: They don't take big decisions.  In particular, they don't make investment decisions.

A big thing in the US currently is the impact of uncertainty over government policy, and its impact on the economy.  Tyler Cowen at Marginal Revolution (a blog well worth subscribing to for both terms of your econ101 experience) has this post about it.  Some people suggest that uncertainty over policy is the reason why the US economy is not recovering strongly.  These people are generally Republicans responding to the fact they are out of power and trying to lay all the blame at the foot of the in-power Democrats.

As Cowen points out though, there's much more at stake - not least the restructuring that's going on in the US economy.

The main point I think is: Don't trust anyone who tries to tell you there's a single cause for why the economy is in the mess it's in, either this side of the Atlantic or the other.  There's many, many causes, and a huge number of alternative solutions out there that may or may not work.  The economy is a complicated beast, and far too complicated for single-cause explanations...

The Austrians

A fairly non-mainstream school of thought in economics is the Austrian School of Thought.  Austrians emphasise the price mechanism and its supremacy: Left unconstrained it leads to the best possible allocation of resources.  It may be that the market doesn't lead to be the optimal allocation, distortions are possible; but government intervention won't be helpful - the "dead hand" of government will always lead to a worse outcome.

As a result, an Austrian economist probably doesn't like very much the actual Austrian, or continental European, economic systems - social democracies with high taxes and heavy government intervention in markets.

Funny then that this Austrian economist, Don Boudreaux, seems to be gloating about strong growth in Germany vs the US.  Germany has just reported 2.2% GDP growth last quarter (which is impressive), while the US appears to be toiling towards a double dip recession.

Germany also has been embracing austerity recently, with significant spending cuts to address its large budget deficit, while the US, via Obama and the Democrats, is about the only major economy still attempting to pursue fiscal stimulus policies to encourage economic growth.

So the fact that the US, maintaining strong government intervention, is muddling towards a double dip recession, while Germany, cutting it back, has reported strong growth, is music to this Austrian's ears.

Of course, the story is so much more complicated than that.  Not least: You can't prove anything with one data point.  Then: How quickly do fiscal policies have any effect?  Finally, what is the impact of government intervention in the macroeconomy?  (the answer is it's quite slow with time lags, so the current numbers have nothing to do with recent decisions on austerity vs stimulus spending).

All these things you'll learn more about second term next year when we get to macroeconomics in the econ101 course.

Saturday, August 14, 2010

The New Year

It's mid August, but fairly soon the academic year will be starting.

A huge amount has been happening in the macroeconomy over the spring and summer of this year, and so I'll start to make posts on here for keen econ101ab students at Birmingham, and students elsewhere who might be interested.

As a taster, the big debate over the summer has been over austerity vs spending. The Tories have started drastically cutting government spending, waxing on repeatedly, with ad nauseum, about Labour's supposed recklessness. Here's an example I saw today.

Were Labour reckless? Or are the Tories the reckless ones, potentially plunging the UK back into recession? It's the kind of question that gets right to the heart of what economics is. Keep tuned for more...