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Deficient Aggregate Demand vs. Structural Faults

Macroeconomists debate feverishly about the causes of a stagnant U.S. economy. Some such as Paul Krugman argue that demand deficiency (a Keynesian diagnosis) requires very aggressive monetary and fiscal policy until the economy reaches its potential.  Others, such as Edmund Phelps in an August 6th opinion piece in the New York Times argue that our macroeconomic problems are structural and not related to deficient demand.  He argues that

“The [aggregate demand] prescription will fail because the diagnosis is wrong.”  He goes on to argue that our focus on reviving demand “lulls us into failing to think structural.”  He cites such structural deficiencies as “short term” incentives employed by established businesses and financial managers, poor incentives for innovation, and a lack of inclusiveness in income gains that have arisen over the past two decades.  Phelps suggests a number of policy actions that might be taken to put the US economy back on a dynamic path essential for prosperity and growth.  In short, we need to move beyond short term demand stimulus to long term incentives to innovate.  In his view, “the economy needs a bit of ingenuity.”

Summer reading

My summer reading list will definitely include The Devil in the White City, by Erik Larson. It is the story of two men, one who headed the design and the construction of the 1893 World’s Columbian Exhibition, famed Chicago architect Daniel Burnham, and one who

murdered a dozen or so of the visitors to that once-in-a-century sensation. The book is completely fact-based, and paints a vivid picture of end-of-century Chicago. The exhibition was Columbian because it commemorated the 400th anniversary of Columbus’s “discovery” of America. It had to be better than the 1889 world fair in France, which gave them the Eiffel tower. Of course, little did they know that the 1896 World Fair in Budapest would trump them all. (That was to commemorate the 1000th anniversary of the Magyar hordes invading the Carpathian basin. Though important to Hungarians, it was not  even in the same ballpark as Chicago’s.)

Gulf Oil, Energy Independence, and “Drain America First”

In a recent weblog, economist Jeff Frankel makes a strong case that the best way to gain energy independence – whatever that might mean – is to leave the oil in the gulf until a real emergency arises.  He notes that the “drill, baby, drill” advocates essentially want to drain America of oil before we buy from others.  This makes no economic or security sense.

What are Companies Good For?

In today’s Economix blog, Uwe Reinhardt addresses the time honored debate regarding the role companies play in an economy.  He contrasts the Neo-Classical view, with appropriate reference to Adam Smith, with communitarian views   expressed by many critics of capitalism.  He argues that simple ideological distinctions misinform rather than inform a discussion of how wealth is generated or destroyed by business.  Reinhardt writes superbly.  I encourage all to read his regular entries to the NYTimes Economics blog.

The Fed’s Business Model Works

Today’s headlines reveal that the Federal Reserve Bank of the United States contributed its net income (PROFITS) of $47B to the Federal Government in 2009.  It is required to do so by law.  Those who go on the Chicago trip in May (or who read the article)  will learn that the Fed is a regular contributor to governmental coffers.   Furthermore, it’s not just seigniorage (for those of you in Econ 320.)

Health Insurance Reform, Massachusetts Style

In 2006, Massachusetts (with Mitt Romney as Governor) passed a health reform law that shares many of the features of the U.S. reforms recently passed in Congress and signed by President Obama.  The op-ed piece linked below suggests that when “market failure” meets “regulatory failure” the results will be ugly.

Come to Econ Tea on Monday to discuss this topic.

  1. Asymmetric information and poor incentives cause private markets to work poorly.
  2. Collectivized markets (and strict regulation) poorly serve the public when there exists a wide range of preferences.
  3. Exchanges (which Alain Enthoven once called managed competition) “can” work but only if they don’t fall into the traps provided by 1 and 2 above.

We’re doomed!


Bubble, Bubble, Toil and Trouble

This comment follows directly on Professor Gerard’s observations about the difficulties political structures have in reducing governmental debt.  Ken Rogoff, fresh off his appropriately well received recent book with Carmen Reinhardt entitled This Time is Different: Eight Centuries of Financial Folly, opines in Wednesday’s Financial Times that “Bubbles lurk in government debt.”  (Follow the link below.) He argues, persuasively in my view, that “conventional economic theory can rationalize bubbles” and that Reinhardt and he observe that large increases in both leverage (debt) and asset prices often “implode if confidence fades,” which inevitably it will.  Losses in the equity market fall directly (and often quickly) on the equity holders.  Losses in the debt market, however, generate long, drawn out negotiations about who should bear the losses.  Opportunities for shifting these losses from the politically strong to the politically weak abound, for governmental debt (and off-budget guarantees), which lacks sufficient transparency until its too late.


Greg Mankiw on CBO Scoring

The Congressional Budget Office is designated as the official scorekeeper for budgetary proposals.  It recently posited that the health insurance reform bill, passed by Congress and signed by the President, would reduce the Federal budget deficit over a 10 year.  Many economists, including Greg Mankiw and yours truly, beg to differ.  See the entry from Mankiw’s blog included below.  Don’t miss the warning label!

A Warning about CBO Scoring

There has been a lot of talk lately about the CBO scoring of the health bill.  Here is one thing people should understand about their numbers: When they estimate the budget impact of a bill like this, they assume the path of GDP is unchanged.

Recall that the bill raises taxes substantially.  Some of these tax hikes are the explicit tax increases on capital income to pay for the insurance subsidies.  Some of these tax hikes are the implicit marginal rate increases from the phase-out of the insurance subsidies as a person’s income rises.  Both of these would be expected to reduce GDP growth.

Indeed, to be very wonkish about it, these tax changes could have especially large GDP effects.  Some people like to argue that taxes have small GDP effects because income and substitution effects offset each other.  But if you give someone a subsidy and then phase it out, both the income and substitution effects work in the direction of reducing work effort.

Why does CBO assume no change in GDP?  It is not because the CBO staffers necessarily believe that result.  Rather, it is just one of the conventions of budget scoring.  Their estimates should come with a warning label:

Michael Burry Saw the Financial Crisis Coming. Why didn’t the Fed?

Michael Lewis in his recently released book The Big Short highlighted several investors who anticipated the financial crisis and took actions to gain from it.  One of them, Michael Burry was featured on a recent edition of 60 Minutes.  In Sunday’s New York Times,  Burry lays out the case.

Op-Ed Contributor – I Saw the Crisis Coming. Why Didn’t the Fed? – NYTimes.com


April 4, 2010
Op-Ed Contributor

I Saw the Crisis Coming. Why Didn’t the Fed?


Cupertino, Calif.

ALAN GREENSPAN, the former chairman of the Federal Reserve, proclaimed last month that no one could have predicted the housing bubble. “Everybody missed it,” he said, “academia, the Federal Reserve, all regulators.”

But that is not how I remember it. Back in 2005 and 2006, I argued as forcefully as I could, in letters to clients of my investment firm, Scion Capital, that the mortgage market would melt down in the second half of 2007, causing substantial damage to the economy. My prediction was based on my research into the residential mortgage market and mortgage-backed securities. After studying the regulatory filings related to those securities, I waited for the lenders to offer the most risky mortgages conceivable to the least qualified buyers. I knew that would mark the beginning of the end of the housing bubble; it would mean that prices had risen — with the expansion of easy mortgage lending — as high as they could go. Continue reading Michael Burry Saw the Financial Crisis Coming. Why didn’t the Fed?

Lawrence I&E Continues its Ascension

Ripped from the headlines. A big congratulations to Prof. Galambos.  Here’s the story:

A $23,000 grant will support Lawrence University’s growing innovation and entrepreneurship program, a university-wide initiative launched in 2008 that engages students, faculty and alumni.

The two-year grant from the National Collegiate Inventors & Innovators Alliance will target the program’s flagship course “In Pursuit of Innovation.”  Cross-taught through Lawrence’s economics and physics departments, the course incorporates the use of guest experts from various fields, intertwines innovation with entrepreneurship and employs a project-driven, hands-on component designed to develop a learning community eager to pursue innovative and entrepreneurial ventures.

Since its launch, 41 students have taken the “Innovation” course.  Operating in three-person teams and in conjunction with the FabLab, a prototyping facility at Fox Valley Technical College, students have worked on projects ranging from the development of a multi-directional split-field camera and an ergonomic student desk to a hand sanitizing system for hospitals and schools and a personal identification system that allows health records to be retrieved automatically in the event of an accident.

“From its inception, our course has focused on diverse teams creating innovative products or processes, leading to functioning prototypes,” said Adam Galambos, assistant professor of economics and one of the program’s originators, along with John Brandenberger, professor emeritus of physics and Marty Finkler, professor of economics.  “This grant will enable us to take the Innovation course to a whole new level with student ‘E-teams,’ which will translate ideas into new products or services that benefit society.

“With its long-standing commitment to the liberal arts and sciences, Lawrence is the ideal setting for a program that inspires students and faculty to create innovative new ventures that combine ideas from diverse backgrounds, fields and perspectives,” Galambos added. Continue reading Lawrence I&E Continues its Ascension

Economic Impact of Badger State Games on the Fox Cities: Are you interested?

Wisconsin Sports Development Corporation has an opportunity for a student or class to gain real-world experience in conducting an economic impact survey of the 2010 Badger State Summer Games held in the Fox Cities during the weekends of June 18-20 and June 25-27.

Wisconsin Sports Development Corporation (WSDC) is a nonprofit 501(c)(3) charitable organization devoted to fostering participation, competition and memorable experiences through our events and programs that promote health, active lifestyles and a sense of community.  WSDC’s marquee event is the Badger State Games.  The philosophy of the Badger State Games is that everyone plays regardless of age or ability. The Games embody the values of participation and good sportsmanship. BSG is Wisconsin’s only Olympic-style sports festival and is truly a grassroots organization that relies on the dedication of thousands of volunteers and the support of corporate partners.

WSDC wishes to ascertain the economic impact the Badger State Games has on the Fox Cities area.  In order to do this the following steps will need to be accomplished (see attachments):

  1. Review past processes, tools, timelines and reports
  2. Revise, update or create new processes and tools
  3. Create a timeline for implementation
  4. Recruit and train volunteer staff as needed to implement the study
  5. Collect and analyze appropriate data
  6. Prepare reports and deliver presentations to various stakeholders – eg: BSG staff, board of directors, funding sources, and other constituents.

See Professor Finkler if this project intrigues you.

Can Cities Shrink Their Way Back to Greatness?

In a recent NYTimes Economix blog entry, Edward Glaeser argues that we should watch Detroit under mayor David Bing and see if the answer is yes.  Bing, former NBA all-star guard, has formulated a plan to downsize Detroit; that is, identify policies that will help Detroit generate a sustainable comparative advantage by reducing and removing those policies that are destructive.  It’s an intriguing and very politically challenging idea.  See what you think.


Vive la Freshman Studies

Leave it to reality television to resurrect the Stanley Milgram experiments in front of a live studio audience.

The game involved contestants posing questions to another “player”, who was actually an actor, and punishing him with 460 volts of electricity when he answered incorrectly.

Eventually the man’s cries of “Let me go” fell silent, and he appeared to have died.

Not knowing that their screaming victim was an actor, the apparently reluctant contestants followed the orders of the presenter, as well as chants of “Punishment” from a studio audience who also believed the game was real.

The programme’s producer and a team of psychologists recruited 80 volunteers, telling them they were taking part in a pilot for a new television show.

Well, I think that speaks for itself.

Hidden in Plain Sight

Last week’s report by Lawrence Alum Anton Valukas on Lehman Brothers reveals that the actions taken by Lehman were assumed to be legitimate and above board. Transparency was evident. But as Andrew Ross Sorkin opines in the linked New York Times story below,  which matches Michael Lewis’s view, the incentives were wrong, and regulators did not look in the obvious places.


Happiness is a Scarce Resource

You new majors have probably been wondering why you have been a little more cheerful, had a bit more bounce in your step, a little extra rational exuberance, so to speak.

The answer, my friend, is that economics students are generally a happy bunch.

At least in Germany:

Justus Haucap, of Heinrich Heine University of Düsseldorf, and Ulrich Heimeshoff, of the University of Bochum, surveyed 918 students of economics and other social sciences in 2005, then estimated how studying each of the different fields affected individual life satisfaction…. The news is good — for economics students, anyhow… [T]he researchers identified a positive relationship between the study of economics and individual well-being.

Read all about it

For those of you looking for a boost of good cheer, look no further than right here.

Why Close Reading is Important

In the opinion piece below, Alan Blinder explains why it is critical to carefully read documents, especially if they involve legislation and even more importantly if they affect the Federal Reserve Bank.

Alan Blinder – Opinion piece on PBS
January 2010 “The Future of the Federal Reserve”

Do you ever get the feeling that this country is over-lawyered? Well, here’s another example.

Ron Paul, the libertarian congressman who wants to abolish the Federal Reserve, has long promoted a first step in that direction. The so- called Paul bill would subject the Fed’s monetary policy decisions to GAO audits. Like most economists, I find the idea, well, appalling.

But I breathed a sigh of relief when a modified version was appended to the House’s financial reform bill late last year. The Paul-Grayson amendment added what I thought was an important clause. Let me read it to you.

“Nothing in this subsection shall be construed as interference in or dictation of monetary policy to the Federal Reserve System by the Congress or the GAO.”

That sounds like a strong affirmation of the Fed’s independence, right? I certainly read it that way and so did my students. Then I talked to a lawyer.

So put on your lawyers glasses and read it again. Nothing in this subsection shall be construed as interference and so on.

Read literally, the sentence does not instruct Congress to keep its nose out of monetary policy. Instead, it asserts that the proposed law does not interfere with monetary policy even if you think it does. Orwell’s big brother would have been proud. He gave us war is peace, freedom is slavery. Now the House thought police give us interference is not interference.

Ladies and gentlemen of the House, could we please fix this?