Monthly Archives: September 2011

Dean Baker, co-director of the Center for Economic and Policy Research based in Washington, DC, will kick start the conference of the Union for Radical Political Economics, to be held at our college on October 1, 2011. Baker’s lecture will start at 10am.

Baker writes a column for the Guardian and blogs sharp criticisms of the economic ineptitude of the media on his Beat the Press.  (At some point, I will start my own, Be Depressed!)  Perhaps Baker’s most well-known achievement as an economist was his call on the U.S. housing market bubble in 2002, way before its peak and eruption.  Baker predicted that, given the size of the bubble, its popping would lead to a serious recession. Needless to say, he was right!

Extra credit will be granted to students who attend and email me a one-paragraph answer to each of the following questions:

1. What was the most relevant factual economic information given in the lecture?

2. Did the presenter offer a model or theory to organize or explain those facts? If the answer is yes, describe it shortly.

3. What were the conclusions drawn by the presenter from the facts discussed?

4. State your opinion and/or comments regarding the content of the lecture?

Please do not create a Word document or attach anything. Just write the answers in a plain email to me.


The recent history of what the classics called “political economy” is summarized here by one of the key participants in this history, Paul Krugman.  Today, it is not called “political economy” but “economics” — macroeconomics, in particular.  Why did I call it “HOPE”?  Oh, because History Of Political Economy = HOPE! 🙂

September 26, 2011, 9:54 AM

Lucas In Context (Wonkish)

Via Mark Thoma, Noah Smith is puzzled by Robert Lucas. I thought it might be helpful to think of Lucas now in terms of the history of economic thought. By the way, I basically lived through the story I’m about to tell, so this is more or less first-hand.

So, here’s the history of macro in brief.

1. In the beginning was Keynesian economics, which was ad hoc in the sense that on some important issues it relied on observed stylized facts rather than trying to deduce everything from first principles. Notably, it just assumed that nominal wages are sticky, because they evidently are.

2. In the 1960s a number of economists started trying to provide “microfoundations”, deriving wage and price stickiness from some kind of maximizing behavior. This early work had a big payoff: the Friedman/Phelps prediction that sustained inflation would get “built in”, and that the historical tradeoff between inflation and unemployment would vanish.

3. In the 1970s, Lucas and disciples take it up a notch, arguing that we should assume rational expectations: people make the best predictions possible given the available information. But in that case, how can we explain the observed stickiness of wages and prices? Lucas argued for a “signal processing” approach, in which individuals can’t immediately distinguish between changes in their wage or price relative to others — changes to which they should respond by altering supply — and overall changes in the price level.

4. In the 1980s, the Lucas project failed — pure and simple. It became obvious that recessions last too long, and there are too many sources of information, for rational confusion to explain business cycles. Nice try, with a lot of clever modeling, but it just didn’t work.

5. One response to the failure of the Lucas project was the rise of New Keynesian economics. This basically went back to ad hoc assumptions about wages and prices, with a bit of hand-waving about menu costs and bounded rationality. The difference from old Keynesian economics was the effort to use as much maximizing logic as possible to interpret spending decisions. I find NK economics useful, if only as a way to check my logic, although it’s not really clear if it’s any better than old-fashioned Keynesianism.

6. The other response, by those who had already invested vast effort and their careers in the Lucas project, was to drop the whole original purpose of the project, which was to explain why demand shocks matter. They turned instead to real business cycle models, which asserted that the ups and downs of the economy are caused by technological shocks magnified by rational labor supply responses. Full disclosure: this has always seemed absurd to me; as many have pointed out, the idea that the unemployed during a recession are voluntarily choosing to take time off is something only a professor could believe. But the math was impressive, and RBC became a self-contained, self-replicating intellectual world.

7. The Lesser Depression arrives. It’s clearly not a technological shock; clearly, also, nobody is confused about whether we’re in a slump, as the old Lucas model required.

In fact, it looks a lot like what Keynes described, and old-Keynesian models work very well, thank you, both at explaining it and in making predictions about such things as interest rates and the effects of fiscal austerity. But the descendants of the Lucas project know that Keynes was wrong — it’s what their teachers and their teachers’ teachers have been saying all these years. They cannot accept anything resembling a Keynesian explanation without devaluing everything they’ve done with their intellectual lives.

So it must be Obama’s fault!


Lucas’ interview with the WSJ:

Noah Smith’s piece:



Here’s from Joseph Stiglitz, twice Nobel laureate (one in economics) and Columbia University professor, on how fiscal policy is needed:

JOSEPH STIGLITZ: Achieving the impossible

22/09/2011 |

How to escape the debt-unemployment dilemma through fiscal policy

There is much hand-wringing about the impossible situation of the global economy: there is insufficient aggregate demand to sustain growth in Europe and America, and high debt levels seem to rule out fiscal policies.

Misguided monetary policies, combined with inadequate regulation, may have helped get the world into its current mess. But seemingly aggressive monetary policies are incapable of getting us out. Some argue that there is a liquidity trap – so pumping more money into the system, while it may pose a risk of inflation down the line, is not going to get the economy’s engines revving again.

Only part of this is true: the economy is in fact seriously weak, and at most, monetary policy can only do a little. But monetary policy in conjunction with appropriately designed fiscal policy could do a lot more—even within today’s fiscal constraints.

First, a diagnosis: this crisis is more than just a financial sector crisis. The series of bubbles served to paper over the more fundamental weaknesses – structural transformation that is the result of the successes in increasing manufacturing productivity at a pace exceeding demand, so compelling labour to move elsewhere. The financial crisis compounded these existing problems, leaving a legacy of overleveraged households, deeply indebted governments, falling real estate prices, and excess real estate capacity.

Moreover, for most countries, including the US, the weak economy is the most looming problem, not the debt and deficits. Eliminating the deficit will not restore growth, and more than likely would push the US into a serious double dip. Even back-loaded deficit reductions could be problematic: if average citizens are told their taxes are going up next year, it’s likely to dampen spending.

Further, with interest rates at historic lows, standard models would suggest a flood of investment. The lack of one suggests something else is going on: what matters is the availability of credit, and the unprecedented levels of macroeconomic risk.

Monetary policy hasn’t worked, and isn’t likely to, for a couple of simple reasons. It does a far better job of restraining an overheated economy than reigniting a stalled one. With globalization, matters are worse: money goes to where the returns are highest. Right now, that means emerging markets, where money isn’t needed – not the US, where it is.

Traditionally, monetary policy is supposed to affect lending, but lending is still circumscribed, especially to small and medium-sized enterprises. The reason is simple: for all the fanfare of the Troubled Asset Relief Program (TARP) and the bank bailouts, a disproportionate share of the money went to the big banks – which are more focused on making money from speculation, trading, and M&As – than on the smaller regional and community banks, many of which are very weak. If the Obama and Bush Administrations had done more to fix the banks and the real estate market, monetary policy might have been more effective, but, alas, this was not the case.

Fiscal policy can still do the trick: if financial markets weren’t so shortsighted, they would realize that if, say, the US borrows at 3% for a long-lived project yielding 20%, in the medium term the national debt – and even more, the debt/GDP ratio – will be down.

Opponents of this approach argue, for one, that that public investment will crowd out private investment, because interest rates will supposedly rise. But in the current context, with the Fed committed to low interest rates for years, that argument seems absurd. Secondly, they argue that individuals, worried about future tax liabilities, will save more. Evidence for this, especially in the US, is almost nil: the Bush tax cuts, which set the country into its deficit, were followed by a dramatic fall in the savings rate. America’s savings rate has recently gone up not because of a far simpler reason than concern about future tax liabilities: the bottom 80% had been spending 110% of their income, and that was simply not sustainable. They have been forced to live within their means; but they are not saving for their future.

If financial markets demand more immediate gratification, the balanced budget multiplier says that if the government increases taxes and spending by an equal amount, GDP increases. If taxes on upper income Americans are increased by just 1% of GDP, rough calculations suggest that GDP could be increased by as much as 2% to 3%. Using Okun’s law, which relates changes in output and unemployment rates, the unemployment rate could fall by 1 to 3 percentage points. This approach would, in the medium term, markedly decrease the debt and debt/GDP ratio.

The fact is, we can reduce the long-term deficit and stimulate growth, but it won’t happen on its own. It won’t happen if we rely on monetary policy, and it won’t happen if we stick with what is on the table in today’s political discourse.

Joseph Stiglitz is Professor of Economics at Columbia University and a Nobel Laureate



Jim Surowiecki, who writes the Financial Page for the New Yorker magazine and is a resident of Brooklyn, takes a look at the short-run political dimension of fiscal policy making:




SEPTEMBER 26, 2011

There is no truer truism in American politics than James Carville’s catchphrase from the 1992 election “It’s the economy, stupid.” When people discuss Barack Obama’s current approval rating, which is at its lowest level ever, they may invoke his supposed lack of toughness or his tendency toward moderation, but the only really important factor is the dismal state of the U.S. job market. The American Jobs Act, which Obama is now promoting across the country, is an attempt to change this, by giving the economy a temporary boost with a mixture of tax cuts and government spending amounting to $447 billion. It’s an excellent idea: many independent analysts suggest that it could boost G.D.P. growth over the next year by 1.5 per cent or better, and create as many as one and a half million jobs. And it’s ideologically canny. A hefty chunk of it comes in the form of tax cuts, which Republicans typically love, and much of the rest would go toward more spending on infrastructure, which House Majority Leader Eric Cantor has expressed support for. Even so, it’s unlikely that House Republicans will pass the bill, and there’s a good chance that they’ll stop it even from coming up for a vote.

Read it all here:

In the context of the last 3 months, today’s drop in the stock markets doesn’t look like anything we haven’t seen before.  I mean, recently.  It’s just that stocks are stuck.  That’s the S&P 500, by the way.  Oh, and also by the way, gold dropped today as well.




I will just copy the entire post by Krugman in his blog, because it puts “Operation Twist” in perspective.  The link to Krugman’s blog entry is given at the end:

September 22, 2011, 9:30 AM

Meh — And I Mean That

OK, the Fed moved. It was a bit stronger than expected — and BB and company stood up to the GOP.

But seriously, they’re trying to use a water pistol to stop a charging rhino.

Conventional monetary policy operates by changing the supply of monetary base, which is a unique, uniquely liquid asset. Increase the supply of green pieces of paper with pictures of dead presidents, and you start a hot-potato process in which people try to get out of that asset into higher-yielding but less liquid assets, interest rates fall all along the curve, and big real things can happen.

Right now, however, people are holding monetary base at the margin simply for its role as a store of value, so conventional monetary policy doesn’t do anything. The Fed is therefore trying to operate on a different margin, swapping short-term for long-term securities. The trouble here is that it’s not at all clear that this has much traction. To a first approximation, long-term interest rates are determined by expected future short-term rates, and if that were the whole story, the Fed would be accomplishing nothing at all.

Now, to a second approximation, risk plays a role; and what the Fed is trying to do is play on the margin created by the difference between the first and second approximations. OK. But we’re talking about very big markets here. Total nonfinancial debt in the US is around $36 trillion, and the Fed is talking about shifting $400 billion of that total from short-term to long-term assets. How much effect can that have?

The main way in which unconventional Fed policy can work is by changing expectations — especially expected future inflation. And that’s not happening. In fact, expectations of inflation over the next 5 years have been falling fast:

So kudos to the Fed for defying the right’s threats, and I guess this is better than nothing. But is it remotely enough? No.

The Fed is going to swap some short-term (<3 year) Treasuries into long-term (6-30 year) Treasuries to push down the long-term interest rates.  This is intended to stimulate business investment (the build up of their capital stock), since businesses decide to invest on the basis of the comparison between:

  1. the benefits they expect to receive from their investment (i.e. the return rate) and
  2. the cost of using money (i.e. the interest rate, once they adjust for inflation, risk, and other premia).
If the interest rate goes down, then it costs less for businesses to expand their capital stock and hire labor.  So, this move by the Fed is intended to alleviate conditions in the labor market, which — at a 9.1% unemployment rate — is in a very tough spot.  Doing something is better than doing nothing, especially when fiscal policy is not an option due to political conditions.
Here’s the statement by the FOMC: