Tag Archives: Caplan

Replies to My Critics

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Last week, I argued that the short run is short—that there is good reason to believe that we’re now past the point where monetary stimulus can do much to help the economy. Again, I am broadly friendly to market monetarism and not especially hawkish on inflation. I am not so much against QE3 as skeptical that it will work. I think that the broad facts and a lot of mainstream macro theory back me up.

My post garnered a fair bit of criticism around the blogosphere. Let me make one quick empirical point to get everyone on the same page, and then I will try to respond to my critics point by point.

The empirical point is summed up in the graph below. NGDP grew around 5 percent per year until around 2008, and then it fell, and then it grew at around 5 percent—or slightly less—per year again beginning in mid 2009. These facts are well known, but I bring them up here because they do constrain the kind of stories we can tell about the economy. Any story you tell has to contain a one-time shock that ended years ago, and it has to be consistent with NGDP that has grown at about the same rate over the last 3 years as it did before the shock arrived.

OK, now with that out of the way, let’s take the criticisms one by one.

Bryan Caplan and ADP unemployment

Bryan cites Akerlof, Dickens, and Perry on long-run unemployment as a reason why QE3 might boost employment in spite of the fact that we are out of what we would conventionally call the short run. The ADP model assumes heterogeneous firms and workers with money illusion. At any given time, some firms need to cut real wages, and since nominal cuts hurt morale, higher inflation helps those particular firms cut wages instead of jobs. Consequently, in a low-inflation environment, monetary stimulus can help lubricate the employment market.

This argument is a good one as far as it goes. Unfortunately, I don’t think it goes very far given the stylized facts. As I noted above, NGDP is growing at a rate of 4-5 percent per year, not that different from before the crash. So any long-run ADP-style unemployment should be about the same now as it was before the crash unless there was a structural change in the economy. You can’t have it both ways—if we’re in a low-inflation environment for ADP purposes now, then we were in a low-inflation environment for ADP purposes before the crash as well.

Furthermore, assuming QE3 is a temporary policy, then if unemployment is long-term ADP unemployment, the effect of QE3 on unemployment will be temporary. I would regard a temporary dip in unemployment as a result of QE3 as good but underwhelming, given the claims of many market monetarists. There may of course be interactions between short-run unemployment and ADP unemployment, and for that reason, the dip in unemployment may not literally be temporary, but I would be surprised if QE3 could fix the economy through this channel.

Bryan makes an interesting linkage between my views on the ZMP hypothesis and ADP unemployment. If there is a decreasing secular trend of low-skill labor productivity, then ADP unemployment will become more serious over time. I think this is a good point, and it pushes me at the margin to favor a higher long-run NGDP target than I otherwise would. I was previously inclined to believe that the exact value of the target doesn’t matter once you get to levels of around 3 percent, but now I see more merit in a higher target.

Insider-outsider models

Bryan and some of the commenters at MR say that it is a mistake to focus on the wage demands of the unemployed. Rather, it is the wage demands of the employed that are especially sticky. The failure of insider wages to adjust downward to long-run levels means that there’s no ability to hire outsiders at below long-run levels, either because companies can’t afford to do it or because they are afraid of hurting insider morale.

The problem is that even if this story is true, we are probably, again, out of the short run. NGDP is almost 10 percent higher now than it was at the pre-crash peak. The number of people employed, even with population growth, is still below the pre-crash peak. Even assuming that insider nominal wages are totally inflexible, nominal output per worker has grown fast enough that insider real wages have probably adjusted. Furthermore, in five years, a non-trivial fraction of insiders retire or change jobs.

More generally, I’ve never been a fan of insider-outsider models, at least not for the United States in recent times. Maybe it makes sense as a model of Europe or Detroit in the union heyday. But today in the US, “labor” is less homogeneous than ever, private sector unions have declined, and fewer workers have an expectation of lifetime employment. Yet the past three recoveries have been increasingly jobless! How can you square the fact that at a time when the insider-outsider distinction is weaker than ever, labor hoarding has basically ended and labor market adjustment has become more difficult? I do it by assuming that the insider-outsider mechanism does not play that big of a role.

But again, even if the insider-outsider story was true at the beginning of the recession, there is little reason to believe that it is still true.

Ryan Avent and corporate profits

At the Economist, Ryan Avent focuses on my point that corporate profits are at record highs.

Firms could be enjoying high profits simply because revenues have stabilised while costs are low, perhaps because low expectations for future nominal spending growth have discouraged investment.

First, note that in the series I cited, corporate profits are adjusted for inventory valuation and capital consumption. The purpose of these adjustments is to make the series less responsive to exactly the kind of behavior Ryan posits. If firms decide not to invest in production and simply sell out of inventory instead, that can increase profits, but it doesn’t increase profits adjusted for inventory valuation. Likewise, a firm can temporarily increase profits by making inefficient use of existing equipment, which could lead to faster depreciation. Are these adjustments perfect? No. But they do offset some of Ryan’s concerns. Corporate profits are high even when you subtract some of the temporary gains firms get from not investing. The unadjusted series is here, by the way; I avoided it because I anticipated Ryan’s argument.

Second, whatever firms’ expectations were, as I’ve said repeatedly, nominal spending growth has not been especially low in the last three years. A better story, if you are trying to resist structural theories, might be that firms are wary of investing due to fears of shocks from Europe or Asia, which monetary easing now does little to help. It would be great if the Fed would commit now to keeping NGDP growing at 4-5 percent when those shocks do hit, but in the meantime, I am not expecting a lot out of QE3.

Ryan also makes a couple of other points, but none of them cut to the heart of my critique of QE3 optimism. He gestures to the New Keynesian literature, but of course even the New Keynesians don’t argue that the short run lasts forever. And Mankiw, who is one of the authors Ryan cites, is a well-known proponent of the unit root hypothesis. I do not read Mankiw as expecting a return to trend, no matter what monetary policy is, although I of course do not speak for him and am happy to be corrected. Ryan also quotes Weitzman on how increasing returns creates unemployment, which is true, but tautologous: if there were no increasing returns, anyone who was unemployed could start his own firm and be just as productive as when he was employed.

Bill Woolsey

Bill Woolsey cordially welcomes me, despite my heterodoxy, to the market monetarist club. I am glad to make the cut.

I think that I failed to make myself clear in my original post. Bill says, “Dourado’s version of how shifts in nominal GDP impact real output and employment is based upon an assumption of market clearing.” This is not what I intended to convey. I think that part of the effect of nominal shocks propagates through market-clearing monetary misperceptions (Lucas islands), and the rest through non-market-clearing nominal rigidities, or as I wrote in the original post, “because some wages, prices, and contracts don’t adjust instantaneously.” I am not as New Classical as Bill seems to think. I like some elements of the New Classical school, but in the end I think the correct theory of macro for now is pluralism.

In the long run, I do think that markets mostly clear. And I think that Bill must agree, for he writes at the end of his post:

On the other hand, most of us do believe that firms eventually cut prices and wages in the face of persistent surpluses of output and labor. Most of us remain puzzled by the slow adjustment.

This is my point. If our problems were purely cyclical, “eventually” would have happened already, so our problems must not be purely cyclical. Time to start looking at structural explanations.

Scott Sumner and cutting-edge research

I was pleased to get a reply from the high priest of market monetarism himself, Scott Sumner.

I addressed the plausibility of sticky wages here, and in numerous other posts in reply to Tyler Cowen and George Selgin. I’d also point out that there is lots of cutting-edge research that tells us that the “common sense” approach to the wage stickiness hypothesis is not reliable. By common sense I mean; “Come on, wouldn’t the unemployed have cut their wage demands by now.” Yes, they would have, but that doesn’t solve the problem.  This is partly (but not exclusively) for reasons discussed in this recent Ryan Avent post.

Well ok, I followed the first link, which gives the usual argument and then ends with the line, “Until we get a more plausible theory of unemployment, I’m sticking with stickiness.” This is honest, and it certainly is a common view, but I don’t think it’s a good idea to rely so heavily on a theory just because we don’t understand competing theories well yet. Macro of the gaps, I call it.

We have a long way to go in macro, so I’m glad that Scott brings up the issue of cutting-edge research. If he has particular examples of recent work that undermines the common sense approach, he should write about them at greater length. I assume that when he says “cutting-edge” he is not referring to the papers cited in Ryan’s post, since those are both from the 1980s.

Speaking of cutting edge research, let me point everyone to a paper, “Countercyclical Restructuring and Jobless Recoveries,” by David Berger, a new PhD from Yale, and now a professor at Northwestern. Berger creates a model in which firms grow fat during expansions and respond during recessions by laying off their least productive workers. His model creates jobless recoveries and matches the new stylized facts (they have changed since the 1980s) about business cycles pretty well.

One thing that I like about the Berger paper is that it shows why some nominal shocks, if not addressed immediately, are not easily reversible by monetary authorities. Once a firm has fired its least productive workers, it is not going back. If the monetary authority wants to prevent a recession, at least post-1984, it needs to act before firms lay off their workers. This perspective actually bolsters the case for NGDP targeting, because it means that the Fed should have an apparatus in place now so that the economy will be automatically stabilized when the next shock hits. Here is Tyler on Berger.

My question for Scott, since he’s so interested in cutting-edge research, is: “What do you think about Berger’s paper?” I assume that Scott is familiar with the changes in business cycles that Berger documents. Does he not think that Berger’s model accounts for some significant fraction of our current unemployment better than simply sticky wages forever?

The bottom line

None of my critics seem to be willing to make any sort of broadly falsifiable claim about how long the short run lasts. (I should say that Bryan is not arguing that we are necessarily in the short run in the bulk of his post). There is a lot of assuming trend stationarity, talk about output gaps, and pointing to literature I am well aware of—in short, a lot of question begging.

I would like to see a greater emphasis in the blogosphere on understanding stylized facts about recessions, a greater willingness to explore micro phenomena (even if we are not using fully microfounded models), and more macro-ecumenicism. No one school of macro has it all figured out, and that includes market monetarism. There is enough ambiguity in our current situation that reasonable people can disagree about what is going on. But I don’t think that reasonable people can be totally certain that all we need is more nominal stimulus.

Caplan on the ZMP Hypothesis

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I’m puzzled by Bryan Caplan’s hostility (1, 2, 3) to the ZMP hypothesis. It is hard to think of another idea that is more Caplanian. This is after all the man who pointed out that “the lower deciles don’t contribute that much to the economy, anyway.”

Bryan’s Jock/Nerd theory of History has been so influential on my thinking about the ZMP hypothesis that I explicitly linked them in haiku form (bewildering CNBC correspondent Jane Wells, among others). The ultimate revenge of the nerds is developing tools that make jocks literally useless and, as I hypothesized in my last post, powerless.

Bryan has expressed skepticism of the discontinuities and nonconvexities necessary to push marginal product literally to zero in a recession. But nonconvexities abound in the labor market. Most importantly, there are fixed costs of employee management. If a jock is not producing much when demand is normal, is it really so unbelievable that a firm would cut him loose when demand falls, rather than keeping him at a lower wage and continuing to pay the costs of managing his unconscientious ass? The jock’s wage demands could be totally flexible, but we hit the zero wage lower bound and he is unemployable.

If you combine modest, introspectively plausible labor market nonconvexities with a secular trend of diminishing jock-labor value and a cyclical fall in aggregate demand, you would expect what we have now: a long trend of increasing income inequality and median wage stagnation and a recession that generates the most unemployment in the lower deciles. Why fight it, Bryan? In your heart, you know it’s true.

UPDATE: Bryan replies!

Peace through Political Assassination?

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Bryan Caplan writes three compelling posts on the common-sense case for pacifism. The short version of his argument is that it’s wrong to kill innocent foreigners (“collateral damage”), especially when the gain in doing so is not clearly large, as it is not in many wars.

This seems like as good a prompt as any to write about an idea I have toyed with and failed to dismiss over the past few years. Instead of going to war against a country, why do we not simply put a price on the heads of the leaders of enemy governments?

Depending on whom you ask, this is currently illegal by executive order. Ford, Carter, and Reagan all ordered that, “No person employed by or acting on behalf of the United States Government shall engage in, or conspire to engage in, assassination.” This seems to have been relaxed if not officially rescinded by the Bush and Obama administrations. In any case, assassinations are plainly constitutional, since the US Constitution explicitly authorizes Congress to issue “Letters of Marque and Reprisal,” and it seems implausible that an executive order can overrule an explicit power of Congress.

A small bounty, I believe it was $25 million, was offered by the US for information leading to the capture of Osama bin Laden and other high-level Al Qaeda officials. The problem with such small amounts is that they do not induce entry into the intelligence-gathering industry. It may cause a marginal defector to turn up information, but it does not entice new firms to form in pursuit of the bounty. Something on the order of a billion dollars would probably have done the trick; note that this is still a much smaller amount than the US government has actually spent in the hunt for bin Laden.

On humanitarian grounds, a bounty system seems like it would result in fewer innocent civilian deaths than the kinds of warfare nation-states have recently been conducting. But even if you do not have this intuition, never fear, we can insert into the bounty announcement a requirement that bounty hunters abide by the strictest standards of conduct or risk disqualification.

Would bounties be effective? There’s no way to know for certain unless they are tried, but my intuition is yes. Here is Helland and Tabarrok on bounty hunters in the criminal context. I certainly would not sleep easily if there were a large bounty on my head. And while I can imagine a hypothetical army without political leadership, this would plainly not result in the kind of warfare that modern states engage in.

So it’s possible that bounties on enemy political leadership would be cheaper, more humane, and more effective than going to war. Why don’t governments use this tactic? I have two public choice explanations.

First: rent-seeking by the professional standing military. In the US, Letters of Marque and Reprisal were used relatively often (to deal with piracy) until after the War of 1812, which resulted in a standing navy. If bounties are used extensively, what justification is there for a standing military? Very little. Therefore, the professional military has an incentive to discourage the use of bounties in order to capture a larger portion of the government’s budget.

Second: collusive rent-seeking by the international political class. If one government began to make extensive use of markets in political assassination, other governments would likely do the same. This makes all politicians worse off. International belligerence would result in the death of politicians, not in the death of grunts and civilians, which they regard as expendable. Looking out for #1 means upholding the tacit agreement not to take aim at political leaders, just as in previous centuries armies used to agree not to target officers. I prefer the tighter link between “live by the sword, die by the sword.”

My guess is that if a bounty system were widely adopted, military budgets would plunge and politicians would be less belligerent. If you have additional arguments for or against this proposal, I would love to hear them. And to the Nobel Peace Prize committee, you may use the “contact” link at the top of the page to get in touch with me.

My Theory of Time Travel

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In a post about the externalities of time travel, Tyler Cowen writes,

I believe no one understands the underlying science much at all. But there is some chance that the old science fiction movies are correct and that by time-traveling you alter the course of history, thereby obliterating the universe we used to have. I’ll count that as a net negative, while noting there is some chance we end up with a better universe.

I don’t understand the underlying science (is there any?) at all, but that will not stop me from opining on this subject.

I’m going to assume that time travel happens within only one universe, not across quasi-identical universes like in a certain Michael Crichton novel. The old science fiction time travel trope is that someone goes back in time and kills, say, their great grandfather, creating an intertemporal paradox. My theory is that the universe operates in a kind of reflective equilibrium that makes these paradoxes impossible. Let’s suppose that you time traveled and caused one of these paradoxes. The paradox would obliterate that state of the universe, not in the sense that that state of the universe is destroyed, but in the sense that it is never allowed to come into being. It is not, as Tyler claims, a state “we used to have,” even if we could come up with a non-time-biased way of saying that (note that it is in the past tense).

Intertemporal paradoxes cannot exist, just as interspatial paradoxes cannot exist (they can’t exist, right?). Therefore, our ability to move about through time is going to be limited. How limited? For the answer to that, we must turn to Bryan Caplan’s testicle-jiggling theory of causation. If anything even slightly different happened in the distant past from what actually did happen, then somewhere along the line, one of our male ancestors would have scratched himself or changed his gait and, due to the multitude of sperm from which we emerged, someone else would have been born in our place.

Since virtually any move backward in time would cause a paradox, I conclude that backwards time travel is not possible. The imperative to avoid paradoxes is what makes time’s arrow go in only one direction. To get back to Tyler’s original question—should we tax or subsidize research into time travel—the answer is clear: if backwards time travel is impossible, we should tax it so that no one wastes valuable resources exploring a dead end.

Forward time travel is trickier, but I will note that I have a mental sketch of a novel in which a character deposits money in a bank and travels forward several hundred years to collect it with massive interest. There is a wrinkle in the plan, of course.

Do Elections Matter?

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I am told that there will be an election next week. Actually nobody told me; it’s what I gathered from the yard signs. Elections, for me, are a spectator sport. I will probably be up all night watching the Prop 19 returns come in, but I haven’t participated since Bryan Caplan showed me the mathematics of voter decisiveness.

While I agree with Caplan and others that voting doesn’t matter, my own research (very much in progress, caveat emptor) is making me wonder whether it’s possible, even in theory, for an election to matter. We all know that an individual vote doesn’t change the outcome of an election. But does the outcome of an election causally change policy, or does it just correlate with policy change?

Increasingly, I think the latter. Here’s one thought experiment: what would policy in the US look like if it were an autocracy instead of a democracy and nothing else were different? That is, let’s impose a strong ceteris paribus condition and change the form of government from democracy to autocracy.

My tentative reaction is that everything would be roughly the same as it is now. Think about it in Coasian terms. Government policies impose negative externalities on some people. Those people have an incentive to bargain with other people in order to get that policy changed. That can be as simple as bribing the autocrat to change the policy, or as radical as a coup in which defectors from the regime are promised larger returns than they are currently getting.

As in any Coasian theory, transaction costs matter, and insofar as transaction costs prevent exchange, it is possible for the nominal form of government to make a difference. This is why the nasty autocrats are so nasty; they have mechanisms, based on ethnicity, ideology, or external support, of preventing the exchanges that would remove them from power. But in the US, transaction costs seem reasonable even if they are not negligible. Furthermore, transaction costs must be evaluated relative to the externalities to be addressed. Modest transaction costs mean only modest externalities remain. As the externalities increase in magnitude, holding transaction costs constant, the greater is the likelihood that exchanges will resolve them.

If the US were a ceteris paribus autocracy, with the modest transaction costs and wide distribution of power that now exist, we’d get basically the same outcomes we have today. I’m not saying it would be exactly the same, but it would be close. And if that statement is true, then it must also be the case that elections mostly just correlate with policy change, they don’t cause it. Changes in electoral outcomes reveal changes in constraints faced by the government, they don’t themselves drive the change in policy.

This is not just a semantic difference. It means that your opinion gets counted about the same whether you show up to vote or not. In the long run, it doesn’t matter if voter turnout is 90 percent or 10 percent, or if voter turnout is ideologically lopsided. The real constraint that the government faces is still the same. Elections don’t matter.

This is where I resist the urge to water down my conclusions with statements about how tentatively I hold these views. I hold these views. Tell me, is this my most absurd belief?

Are There Two Inflation Regimes?

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Arnold Kling tentatively postulates that central banks can, at most, select between a low-stable inflation regime and a high-variable inflation regime. Bryan Caplan proposes a quick test, which I hereby supply. Below are some scatterplots of inflation variance versus inflation means for 176 countries. The data is from the World Bank, which gets it from the IMF (gated). The data begins in 1961 for some countries, but later in others. If we observe two clusters, then that is strong evidence for Kling’s hypothesis.

The first scatterplot uses all available data.

It’s clear that there is a strong correlation between inflation means and variances (r=0.77, in fact) and an even stronger one, r=0.92, for means and standard deviations (see how the data appears to be quadratic?). But I don’t observe any evidence of clustering.

Because most of the data appears on the lower left, it may be helpful to zoom in. I repeat the plot for those countries where the mean is less than 150 percent. I also exclude the countries that have less than 15 observations.

Once again, there don’t appear to be discrete clusters. Just to make sure, let’s zoom in one more time on the lower left.

While Caplan’s proposed test does not support the Kling hypothesis, I am not sure that it effectively captures what Kling is postulating. For one, what counts as high and variable in the US is not the same as what counts as high and variable in Israel, Chile, Russia, or Zimbabwe. Secondly, if central banks have a choice between the two regimes as Kling postulates, then countries that spend time in both regimes are going to appear on the scatterplot in between the two hypothetical clusters (is this what we observe?). You can’t use a scatterplot of aggregated data to detect structural breaks. I’ll leave it to someone else (maybe one of my commenters?) to propose a better test.

Update: At Bryan’s request, here are three more graphs, zoomed in further on the lower left. Continue reading →

The Myth of the Rational Blogosphere

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Bryan Caplan has taken a lot of heat for his argument that on net, American women were freer in 1880 than they are today. While some of the pushback has been substantive, the majority has been disgustingly personal. Bryan, who is a pacifistic sort, has written a measured self-defense in which he points this out. Bryan is certainly capable of defending himself, but I am not yet as pacifistic or measured as he is, and therefore, I think he deserves a more forceful defense.

To be clear, I frequently disagree with Bryan, and I have no real opinion on the substantive question at hand; I know next to nothing about the laws and culture of the 1880s. But Bryan is one of the most intellectually honest people I know, one of the most willing to speak unpopular truths. He is also extremely well-read and knowledgeable. Claims that he is stupid or uninformed are, frankly, stupid and uninformed. Even more preposterous is the claim that Bryan simply hasn’t considered the effect of culture on individual liberty; Bryan has been at the center of libertarianism in America for two decades, and I am sure he is familiar with the idea.

The greatest irony is that some of Bryan’s most virulent detractors are these so-called “cultural libertarians,” who believe that culture counts as much as law in judging human liberty. Many of them seem not to realize that through their personal attacks on Bryan, they are condemning themselves, by their own standards, to whichever circle of Hell is reserved for those who impinge upon academic and intellectual freedom. Bryan will not lose his tenure for his unpopular views, but how many intellectuals are afraid to say what they really believe because of this culture of personal retaliation? Similarly, feminists do not advance their own cause (which I support!) by getting the vapors every time someone articulates an argument with which they do not agree. Many intelligent feminists, such as my wife, a former officer of a feminist organization, are rightfully appalled by this reaction.

Obviously, I cannot write an angry post every time someone, somewhere, is hypocritical on the Internet. But that hypocrisy is common does not make it acceptable. We who are academics and/or intellectuals should strive for a civil blogosphere in which people are free to articulate unpopular ideas and criticism is calmly directed at these ideas instead of their proponents. This is a proposition that all libertarians and indeed all decent people should find it easy to support.