Thursday, 19 July 2012

Tired Old Debates


                Daniel Gros has a Vox piece attacking the Krugman/Layard manifesto. Like Stephanie Flanders here, there is part of me that is tired of going over this again and again, as the arguments on the other side do not get any better. But I know that this is a battle we have to win, if only so that others do not need to fight it a third time. And I did have one new thought.
                Before that, let’s just go through the economics one more time. Macroeconomic theory is as clear as it can be that austerity in the current situation will reduce output and raise unemployment. That is the theory in undergraduate textbooks, or modern microfounded theory. The evidence is also about as clear as it ever is in macro.
                On the other hand, the ‘evidence’ Daniel Gros uses is of the following kind. The US recovery has been similar to that in the Eurozone, and the US had more initial fiscal expansion, so therefore austerity is not that important. These are the kind of arguments we use to persuade our students that they should take a course in econometrics.
But here is my new thought. Why not apply the same arguments to monetary policy. Interest rates were reduced faster and by more in the US than in the Eurozone, but the recovery has been similar, so clearly monetary policy does not matter much either. In the UK the recovery has stalled even though interest rates are zero. In addition keeping interest rates very low can cause longer term problems, so start raising them now, if not yesterday! No one (almost) makes this argument, because it is so obviously silly. So why do good economists think they can make the same argument for fiscal policy?
The only defensible argument for austerity now is that we have reached some critical debt limit, but the low level of interest rates on UK and US debt (and everywhere else besides the Eurozone) kill that dead. Everyone is agreed that once recovery is complete, we do need to start reducing debt. Everyone also agrees that when the recovery is complete, interest rates need to rise. But almost no one is arguing for higher interest rates now. So why fiscal austerity now?

26 comments:

  1. My best bet is that people like Gros would favor an interest rate raise by the ECB, but he does not dare mentioning it.

    Wikipedia tells me that Mr Gros got his PhD from the university of Chicago, and I wonder what kind of boot camp they run there for brainwashing people who might have bright intellectuals had they been studying elsewhere.

    Yes, it is a battle that economists need to fight and win. And if you could win the war afterwards, that would be great.

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  2. Two quick thoughts on Gros:

    (1) He is using the actual deficit as his metric for fiscal policy whereas any serious scholar on macroeconomics since E. Cary Brown's 1954 paper knows - we should be using some structural deficit measure.

    (2) He aggregates Europe even though Europe includes many nations with very different initial fiscal reactions to the Great Recession. For example, Germany started with fiscal stimulus and fared better than those nations that did not.

    On 1st reading of Gros's analysis, it does not even measure up to the standards of the National Review.

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    1. Yes, I did notice your first point, and I agree. Fortunately I do not read the National Review, so I could not possibly comment!

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  3. I think there's a strong element of "fighting the last war" here. A lot of small-c conservatives (esp. on the libertarian end of things) have been deeply, continually horrified for about the last three decades by the ballooning of the national debt. At a government level, of course, there hasn't been the political will to do anything about it - hence the Greek situation.

    The fear is that, once the immediate threat is over, things will go back to business as usual. I personally think that fear is misplaced - debt is back on the agenda for a good long time. But I do understand the desire to "not waste a good crisis".

    A lot of macroeconomic theory is implicitly from the point of view of a Plato-style philosopher king. It's assumed that the person reading the textbooks is willing and able to do the right thing, even when that will lose them public support. Needless to say, that's not the world we live in. And anyone who has been paying attention to debt since before 2006 is not going to have much respect for politicians' ability, in normal times, to rein it in.

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    1. I'm glad you think this fear is misplaced. I agree that some people hold the 'not wasting a crisis' view, but I think its logical basis is very weak, as I tried to explain here http://mainlymacro.blogspot.co.uk/2012/03/austerity-and-not-wasting-crisis.html

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    2. Fighting the last war harkens to the great inflation of 1967-1981 when we had high inflation during recessions. Looking back I suspect this has more to do with demographics than monetary policy. If you're employment ratio is increasing due to boomers and women entering the work force, then keeping unemployment low will result in higher inflation. So yeah not much policy makers could do during the 1970's to keep inflation to historical norms. Flip side is current policy makers shouldn't be patting themselves on the back for a job well done because inflation is low.

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    3. "Looking back I suspect this has more to do with demographics than monetary policy. "

      And some massive oil shocks, which I find that so many economists don't seem to mention.

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  4. wtf are you talking about? the Europeans that started implementing austerity re-entered recession and are again losing jobs. the austerity countries are doing far far worse . remember everything right wings say is a lie

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  5. You seem surprised that people defending austerity have few logical arguments to make. And that when you point out, in a rational way, the flaws in their argument, they do not change their original convictions but just look for another argument to support them. Or they ignore you. Or they resort to statements of "fact" as Gros does- "Public debt ratios without retrenchment would become unsustainabe." Gros offers no evidence to support this "fact". Its just something everybody knows.

    You say that there is only one defensible argument for austerity now- some kind of critical debt limit. You show that we (in the U.S. at least) are not there. I agree we are not there. Just wondering if such a limit can exist while inflation and interest rates are low.

    There is another argument that austerity types often make though. It is not really an economic argument but more of a moral one. Austerity is necessary so that we won't reward those who took on too much risk or debt. Otherwise this will keep happening again and more frequently at that. Even if you can show that austerity would hurt everyone the costs are worth it. Sort of like putting people in prison if they commit crimes-it costs us all, but we're safer overall. That those who make this argument are usually the ones who would be hurt most by any possible increase in inflation causes me to question their motives. But it still might be a defensible argument if recessions caused no serious harm to people.


    Well what is your conclusion when people like Gros make these kinds of arguments? And continue to do so after the flaws in them have been pointed out. Are they unwilling to concede that there may be something wrong with their prior convictions? Are they being dishonest about their motives for advocating such policy? Is it all political? Krugman seems to think so and is not shy to call them out about it.

    Or are they irrational, and if so, does that make you question the rationality of the superhuman representative agent? (just having fun)

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    1. "You seem surprised that people defending austerity have few logical arguments to make. And that when you point out, in a rational way, the flaws in their argument, they do not change their original convictions but just look for another argument to support them. Or they ignore you. Or they resort to statements of "fact" as Gros does- "Public debt ratios without retrenchment would become unsustainabe." Gros offers no evidence to support this "fact". Its just something everybody knows."

      Krugman pointed out in the early days of the Bush disaster that people on the right would argue for a policy based on reason A, and then casually switch to arguing for the same policy for reason ~A when the environment changed.

      His reaction was to ignore their stated reasons, and look for actual reasons. In addition, he realized that the people were dishonest liars, and treated them that way.

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  6. Re your debt limit statement: isn't it usual for the austerians to pull out the Reinhart-Rogoff 90% number at this point, to show that we are bound for slow growth if we don't immediately retrench (that word is so Jane Austen!)? I saw Niall Ferguson sucker punch Skidelsky with that on Fareed Zakaria just a few weeks ago.

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  7. You wrote:
    "But here is my new thought. Why not apply the same arguments to monetary policy. Interest rates were reduced faster and by more in the US than in the Eurozone, but the recovery has been similar, so clearly monetary policy does not matter much either".
    Which only goes to show that monetary policy is not about interest rates!
    In effect, MP was tight in both the US and EZ, maybe more so in the EZ, despite the fall in interest rates.

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  8. Stephanie may be tired of old arguments, but she still seems to feel dedicated to giving space to Dieter Helm who is simply selling a slightly modified version of the austerity argument... I find this a little odd...

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  9. You say "Everyone is agreed that once recovery is complete, we do need to start reducing debt" . This is so naive and simplistic it immediately shines a bright light on the major flaw in the arguement. There is no chance that when times are good again politicians will move to reduce debt. They love to 'kick the can down the road' easy to do when ti es are good and "we'll worry about that tomorrow". For all your macroeconomic theories you which win th big prizes you don't appear to get you are dealing with behavior here and people are flawed. Deeply flawed. If ever we are going to reduce debt we need to start NOW. Not tomorrow.

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    1. Read this: http://mainlymacro.blogspot.co.uk/2012/03/austerity-and-not-wasting-crisis.html, and then see if I'm being naive.

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    2. Just to be clear, is Japan not recovering because of insufficient government deficit spending?

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    3. Mainly Macro: Thanks for the link and yes you have addressed the issue (I am a new reader).
      It is , at least for me, frightening to see the level of debt there is in the world - EU countries, US, Canada also states and cities in US going bankrupt. Pension obligations grossley underfunded. At one time growing out of debt was a viable option but (perhaps) not anymore since industry is moving to China and India.
      I understand your arguements . A question is then why are political leaders and finance ministers, who are not stupid people, imposing austerity? And supported by some economists, not stupid people. Yes it is easy for the German finance minister to impose austerity on Spain and Ireland. But is it different this time - is the debt so much that the only solution despite the consequences is austerity before the western economies implode? Is fear the driver?

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  10. "The US recovery has been similar to that in the Eurozone, and the US had more initial fiscal expansion, so therefore austerity is not that important. These are the kind of arguments we use to persuade our students that they should take a course in econometrics. "

    "Interest rates were reduced faster and by more in the US than in the Eurozone, but the recovery has been similar, so clearly monetary policy does not matter much either."

    Actually I think for a lot of lay people, they think the above two arguements very intuitive, as I have heard about it at dinner parties many times. They are mostly not trained in economics but isn't an effective economic arguement to be able to persuade your grandmother? How would you respond convincingly to the above arguement except calling them "silly" and didn't take enough economics courses? The first accusation makes them mad and the second is just wishfull thinking in turning everyone into economists.

    I'd love to read a post that would make an argument in trying to win the debate with better logic/evidence to convince a non-economist, by how to respond to these two above arguements that are quite intuitive to many lay people.

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  11. Ehm,

    New Monetary Models says that raising interest rate (lowering inflation) is what we need because low interest rates shift the supply of loanable funds (!!!!!). See Williamson and the model he uses has 'good' neoclassical microfoundations.

    My view is that models built on neoclassical microfoundations are not 'good' models after all and, if ideologically used, can lead to absurdities like Williamson's.

    WE NEED BETTER MICROFOUNDATIONS.

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  12. You argue, rightly in my view, that this is an issue that was settled a long time ago. Yet go and read the work (and blogs) of eminent professors at elite US universities like Taylor, Cohrane and Mulligan and you come away believing that this s not settled at all. The ideological nature of the debate also becomes obvious. And I get a queasy sensation that many of us amateurs don't possess anything near the skill set necessary to distinguish between economics and pure ideology. A question : this ideology thing, is it a purely US phenomenono?

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    1. I don't think so. There are fewer economic bloggers in the UK and elsewhere than in the US, and in that sense there are no equivalents to the names you mention. However I can certainly think of one or two UK academics who could match those you mention if they did blog. However, I have a feeling that there may be fewer (in percentage terms) ideologically committed academic economists on the right in the UK than in the US - but its just a feeling.

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    2. From all this, a fundamental question arsies: if Nobel prze winners and eminent professors cannot agree on things like the effects of fiscal policy, has there been any inteelectual progress in macro? I know Krugan thinks there has been regress but I was wondering what you thought? I have read your earlier posts on ideology - does ideology enter economics in a way that it can never do in quantum physics? If so, is there any point to macro if every question has a predetermined answer, one that is predetermined by whether or not you think the government is too big or not?

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    3. I often ask myself this question. But here is a provocative thought. I think there has been clear progress in monetary policy. Things are far from perfect, but a lot better than thirty years ago. Is this perhaps because policy has been taken out of the hands of politicians? What this does is to allow central banks to sort out who is arguing from the economics rather than the ideology. Perhaps we need something similar with fiscal policy?

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  13. Logically, if monetary policy is too important to be left to politicians it is impossible to argue differently for fiscal policy.

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    1. But is there a fundamental difference between the types of disagreements over monetary and fiscal policy? Do monetary types all share essentially the same/similar model but just disagree about the size of the parameters? Whereas fiscal types rarely share the same - or even similar - model and cannot get close to agreeing the sign on the relevant parameters, let alone the size?

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  14. I see this as Economists trying not to loose their jobs !!!

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