Sunday, January 4, 2009

Wonk v. Wank I

by the Sandwichman

A few days ago on his blog, Paul Krugman offered up an "unreadable little paper" with a "fully-specified model" to examine the case for "big government spending in the face of a liquidity trap". The bottom line: "When the economy is depressed and monetary policy can’t set it right, the true opportunity cost of government spending is low. So let’s get those projects going."

Unreadable as Krugman's little paper may have been, seventy or so readers managed to comment on it insightfully. It's too bad Krugman doesn't reply to his commentators. I suppose it's the custom of simplistic economic model building to hide behind the abstract generality, simplicity and unreadability (to non-wonks) of the model. Nevertheless, several commentators had little difficulty identifying what was missing in Krugman's "fully-specified" model: The Big Picture.

Below are excerpts from several of the comments:
Umm… while we’re at it, Dr. Krugman, perhaps you could please explain just why consumption has to be so high to prevent economic meltdown.

... why does the economy require that people spend money they can’t afford on stuff they don’t need now, in order to keep the economy moving at all?

Better, surely, to have the government buy public goods that are at least needed–education, insulation, health care, efficient transportation.

But when, if ever, can we enter Keynes’ vision of a world at leisure, with plenty of time, jobs with family-compatible hours, and enough goods to keep us smiling? Will our economic system ever permit it? Can we use a crisis as a time to think about the possibility?


Can you please explain. Fiscal stimulus forever - or only until consumer spending resumes? Earlier this year you wrote in the NY Times that “weak spending is treatable and the economy could be saved”.

In the last 6 years everyone bought new cars, new computers, new mobile phones, new houses! These will last at least 10 years.

What now? Perpetuate the spending Greenspan ignited?

Consumer spending on “exotic” upgrades? - replacing a perfectly good car or computer with a more expensive model? $400 sun glasses, $300 joggers, the latest mobile phone? Is that the idea - spend like we use to? Maybe the government should stimulate advertising! Maybe brainwash the people - they really do need to buy these goods!
Or make it compulsory to have all cars, computers, TVs etc. destroyed if they are older than say 5 years. Then people will have to buy new ones! Creative destruction!
Spending restored and economy saved!

Keep people employed making and selling things we don’t really need = full employment in jobs nobody likes. Is that it?

The problem you face is convincing people that since excessive debt got us into this mess, even more debt (Federal this time) will get us out of the mess. And you have to do it without math.

Is there any chance that a liquidity trap is actually a manifestation of any or all of the following:

Too much debt; wealth/income inequality; and/or negative real earnings growth for most people

Why do almost all economists assume that preventing price deflation requires MORE DEBT??? I DO NOT believe that the solution to too much middle and lower class debt is MORE DEBT (whether gov’t debt or not)!!!

As was forwarned , the paper was too tough to follow. I have an equally difficult time understanding why complex wonkish academic theory and analyisis trumps and ignores common sense and the more obvious. What is right before our eyes is the fact that no matter what we do to stimulate the economy our major downfall is our lack of manufacturing ability which we gave away to China and the like. Sadly our national focus and young talent has migrated to financial ( funny money) engineering from engineering that creates new technology. And for too long the foundation of our new economy has been based on borrowed money and not on import income from making quality things. The more we borrow ( which we now have no choice but to do ) the more we dig our selves down into the black hole which may now be too deep to ever to get out of . The wonkish analysis seems to ignore what is obvious to the lesser intelligent people. Me and most of my friends who are about as equally unintelligent as me, were able to see the crazy mortgage/housing bubble and also the fact that our economy was a house of cards because it is based on borrowed and funy money. And this was obvioius to us several years ago while the wonkish lot ( ie economists such as Greenspan and company) were producing analytic outcomes that suited themselves so as to perpetuate the massive wealth accumulation for the very wealthy.

As I see it, full employment is not a binary predicate in any real economy.

You will always have sectors with over-full employment, sectors with full employment and sectors with less than full employment. The same is true for different geographic areas. There is plenty of skill and location stickiness that ensures that this is always true.

This means that there is no point in time in which you reach full employment in the whole economy, which also means that at no point in time does anything dramatic happen. The cost curve will never become a discontinuous function.

Rather, for every new job that is being added, there’s an increasing chance that the next job will appear in a tight part of the job market. As long as you have non-perfect distribution of new jobs only to the sectors and regions that have less than full employment, you will see the marginal cost increase for every created job, and from the start you’ll see faster than linear cost growth.

With government programs, it’s likely that certain sectors are stimulated more than others. Due to skill stickiness this will mean that the mismatch between available skills and requested skill grows. I believe this means that it’s highly likely that the cost curve crosses the benefit curve well before the mythical state of full employment.

Maximization of consumption is totally different from sustainable consumption. Your model is not comprehensive and tough only some parts of economy.

But the biggest point is we think only maximization but that is not sustainable. We have over consumption and over debts. The more government uses, the more the next generation will have to pay tax and the less the next generation will have to consume.

All optimization economic models we contribute cannot bring the sustainability of economy. We may look back to see Ramsey model to find why we have too much consumption, too much debts and low saving because we use optimization of consumption model that is all wrong in concepts.

Government can bring the full employment in short term to optimize consumption like we did for nearly 70 years on Keynesian tools but we cannot sustain full employment in the long run if the government and private debts stay at unsustainable high level.

8 comments:

Robert D Feinman said...

Not only not Krugman respond to comments he doesn't even read them. He has his minions read them and decide which ones to post. That's why the discussions of his NY Times articles are more lively on Mark Thoma's blog.

As for his "model" it is lacking the same thing that all such efforts do, any connection with reality.

In economics the model comes first and this is followed by the hand waving to explain why the data doesn't fit properly.

In the hard sciences the data comes first, followed by the model, followed by predictions from the model, followed by work to see if the predictions are born out, followed by reinforcement, rejection or modification of the model as needed.

Krugman's article failed all these criteria for using the scientific method.

TheTrucker said...

Scientifically speaking, latter day economics sucks.

I truly hope that there are economists that can actually throw the pretty models away and deal with the reality. The Sandwichman is right about cutting the work week while retaining current wage levels. I have tried to convince him that without public health insurance and pensions he has not a snowballs chance in hell. I think he may actually realize that but I'm not sure.

So this leads me to the conclusion that the best fiscal/government attack to this problem in the USA is, in fact, Single Payer National health insurance. We can't actually afford to screw around with this any more. If we don't do it the US dollar is going to end up in the dust bin and the US economy will be nothing but one big natural resource supply house for the Chinese.

Sandwichman said...

Trucker,

I don't know what I can say or do to convince you that I do indeed agree about the need in the U.S. for national health insurance. My only reservation is that, by itself, health insurance will not usher in the millennium.

Anonymous said...

Sorry, Chairman Ben S. Bernanke, But Quantitative Easing Won't Work.

In a Liquidity Trap although Saving (S) is abnormally high investment (I) is next to 0.

Hence, the Keynesian paradigm I = S is not verified.

The purpose of Quantitative Easing being to lower the yield on long-term savings and increase liquidity it doesn't create $1 of investment.

In a Liquidity Trap the last thing the Market needs is liquidity.

Quantitative Easing does diminish the yield on long-term US Treasury debt but lowers marginally, if at all, the asked yield on long-term savings.

Those purchases maintain the demand for long-term asset in an unstable equilibrium.

When this desequilibrium resolves the Market turns chaotic.

This and other issues are explored in my tract:

A Specific Application of Employment, Interest and Money
Plea for a New World Economic Order



Abstract:

This tract makes a critical analysis of credit based, free market economy, Capitalism, and proves that its dysfunctions are the result of the existence of credit.

It shows that income / wealth disparity, cause and consequence of credit and of the level of long-term interest-rates, is the first order hidden variable, possibly the only one, of economic development.

It solves most of the puzzles of macro economy: among which Unemployment, Business Cycles, Under Development, Trade Deficits, International Division of Labour, Stagflation, Greenspan Conundrum, Deflation and Keynes' Liquidity Trap...

It shows that no fiscal or monetary policy, including the barbaric Quantitative Easing will get us out of depression.


A Credit Free, Free Market Economy will correct all of those dysfunctions.


The alternative would be, on the long run, to wait for the physical destruction (through war or rust) of most of our productive assets. It will be at a cost none of us can afford to pay.

A Specific Application of Employment, Interest and Money
http://www.17-76.net/interest.html

Press release of my open letter to Chairman Ben S. Bernanke:

Sorry, Chairman Ben S. Bernanke, But Quantitative Easing Won't Work.
http://www.prlog.org/10162465.html

Yours Sincerely,

Shalom P. Hamou
Chief Economist & Master Conductor

Anonymous said...

While much of this is phrased in terms of consumption, it is probably better viewed in terms of production. Each hour labor is idle is lost forever. Now it may still be useful for leisure, but the unemployed are not seeking leisure by definition. As long as that labor goes towards increasing our assets we are better off.

Anonymous said...

Lord: only if you view labor as the constraint on assets. And that was the case once, when there weren't so many people and there were vast tracts of unexploited natural resources.

But the constraint on assets now is not so much labor as natural resources. We can't all afford to be vastly richer in stuff. It would take several earth equivalents to supply it!

reason said...

Could I just point out for the umpteenth time that the government in a liquidity trap environment shouldn't borrow, it should just print money. Otherwise, there IS an opportunity cost. The future interest payments on the accumulated debt.

This is surely a simple point. I cannot understand why nobody gets it. (And I have yet to see it refuted)!

Anonymous said...

I do agree with you 100%

There is no ecoomic purpose of borrowing except for the balance of the accountant.

Moreover it distributes interest to the rich and increase Income / Wealth disparity, which deepens the Liquidity Trap.

But then again my purpose is not to repair capitalism.

Let Them Borrow!