Martin Wolf Understands Economics... - Grasping Reality with Both Hands
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Grasping Reality with Both Hands The Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, RealityBased, and Even-Handed Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.
Economics 210a Weblog Archives DeLong Hot on Google DeLong Hot on Google Blogsearch September 27, 2010
Martin Wolf Understands Economics... ...as John Cochrane does not. John Cochrane complains about being accurately quoted by Paul Krugman: John Cochrane of the University of Chicago, who wrote that Krugman was sliming a growing enemies list: "Don't argue with them, swift-boat them. Find some embarrassing quote from an old interview. Well, good luck, Paul. Let's just not pretend this has anything to do with economics..." John Cochrane's problem is not one embarrassing quote. It is that he keeps saying, over and over again, things that are wrong on a basic level, that reduce the level of the debate, and spread ignorance. For example, Mike Sandifer: Speaking of ignorance, I saw John Cochrane on Bloomberg a couple of weeks ago... at the 3:23 mark, he said that fiscal stimulus was ineffective because a dollar of spending is a dollar that had to come from someone else. Correct me if I’m wrong, but isn’t this an obvious fallacy? The stimulus is being financed with deficit spending, with government debt being bought by at least some of that money that may otherwise be on the sidelines. The link to the video: http://www.youtube.com/watch?v=HO4E1bs4CbE Now comes Martin Wolf to--patiently--argue with John Cochrane and his ilk: We can only cut debt by borrowing: “You can’t cut debt by borrowing.” How often have you read or heard this comment from “austerians” (a nice variant on “Austrians”), who complain about the huge fiscal deficits that have followed the financial crisis? The obvious response is: so what? Shifting debt from people who cannot support http://delong.typepad.com/sdj/2010/09/martin-wolf-understands-economics.html
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it to those who can - the population at large, both now and in future - seems to make a great deal of sense if the alternative is an economic collapse that leads to a loss of output and investment now and so of income in the long term. Indeed, under the latter alternative, even the fiscal deficits may end up little, if any, smaller if one tries to slash them, as the UK could be about to discover. Before leaping to that conclusion, however, let us approach the issue of deleveraging - or debt reduction - analytically.... Since the financial balances of the household, corporate, government and foreign sectors must sum to zero, a rise in the surplus of the household sector must be offset by an offsetting move in other sectors. During a post-crisis recession, the surplus of the corporate sector always rises... because managements slash investment.... [N]on-financial corporate sectors were running substantial financial surpluses in the high-income countries before the crisis and are running still bigger surpluses now.... [S]urplus countries do not want to make the adjustments needed to allow the US, UK and other former deficit countries run huge current account surpluses at full employment levels of income.... When one has eliminated everything else, it turns out that the only sector both able and likely to offset a large move of the household sector towards financial surplus in a post-crisis slump is the government. Indeed, that is exactly what has happened. My conclusion, then, is... the only way that the private sector can de-leverage, when large economies are in a post-crisis recession, is for the government to leverage. The economy, as a whole, cannot de-leverage in any other way, other than via accelerated mass bankruptcy, which would certainly deepen the recession.... The recommended alternative of slashing the fiscal deficit while the private sector tries to slash its debt suffers from a fallacy of composition: it is impossible for all sectors of the economy to spend less than income at the same time... Brad DeLong on September 27, 2010 at 06:22 PM in Economics, Economics: Fiscal Policy, Economics: Macro | Permalink Favorite
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Comments Don the libertarian Democrat said... Martin Wolf is about as good as it gets in this crisis. It's not even a fair contest. Reply September 27, 2010 at 07:07 PM http://delong.typepad.com/sdj/2010/09/martin-wolf-understands-economics.html
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Richard said... I keep waiting for someone to ask John Cochrane: "Prof. Cochrane, do you realize the US isn't on the gold standard any more"? Mind you, I had Cochrane for a class, and he taught me some neat things about factor modeling, but I do wonder, why the hell is a finance guy trying to tell a macro guy that he doesn't understand macro; and why does he keep thinking that we're still on the gold standard? Reply September 27, 2010 at 07:19 PM Rob in FL said... Why are the right wing economists taking Dr. Krugman's professional criticism so personally? They have taken to slinging personal insults more and more frequently, rather than respond to the deficiencies in their work. They are revealing themselves to being a bunch of hacks, rather than educators and researchers. Reply September 27, 2010 at 07:22 PM Omega Centauri said... " it is impossible for all sectors of the economy to spend less than income at the same time..." I really like that. I've been trying to argue against austerity, by talking about demand. I think Martin states it in a much more understandable fashion. But sane economic policy I think is a lost cause, we are an emotion driven morality tale species, and will dismiss all cogent arguments that refute the austerity cure as mere sophistry. As a species, our total economic learning from 1937 to 2010 sums to precisely zero. Reply September 27, 2010 at 07:50 PM DrDick said in reply to Rob in FL... "They are revealing themselves to being a bunch of hacks" Ding! I think you have answered your own question. Reply September 27, 2010 at 08:11 PM howard said in reply to DrDick... i try not to post just to say "second," but given that i was prepared to respond to rob in fl virtually word-for-word the way that drdick did, i can only say "second." but my initial reason for wanting to post was to ask the prof: you know this clown, at least professionally. what's your explanation? is he just not very smart? or does he know one thing? or is it simply something in the econ department water cooler? Reply September 27, 2010 at 10:11 PM Too Much Fed said... Martin Wolf DOES NOT Understand Economics... "The obvious response is: so what? Shifting debt from people who cannot support it to those who can - the population at large, both now and in future - seems to make a great deal of sense if the alternative is an economic collapse that leads to a loss of output and investment now and so of income in the long term." TOTALLY unfair to the people who understood there was too much debt and should be benefiting. I suggest a shift of debt to Martin Wolf so all his income goes to the interest payments. Let's see how he likes that. Reply September 27, 2010 at 11:27 PM Too Much Fed said... http://delong.typepad.com/sdj/2010/09/martin-wolf-understands-economics.html
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Martin Wolf DOES NOT Understand Economics... "My conclusion, then, is... the only way that the private sector can de-leverage, when large economies are in a post-crisis recession, is for the government to leverage." False. Does not understand the difference between a deficit with currency and a deficit with debt. "The economy, as a whole, cannot de-leverage in any other way, other than via accelerated mass bankruptcy, which would certainly deepen the recession...." False. Does not understand the difference between a deficit with currency and a deficit with debt. Does not understand how debt levels rose without producing price inflation. "it is impossible for all sectors of the economy to spend less than income at the same time..." Needs to look into wealth/income inequality. Reply September 27, 2010 at 11:36 PM Too Much Fed said... Martin Wolf DOES NOT Understand Economics... "My conclusion, then, is... the only way that the private sector can de-leverage, when large economies are in a post-crisis recession, is for the government to leverage. The economy, as a whole, cannot de-leverage in any other way, other than via accelerated mass bankruptcy, which would certainly deepen the recession.... The recommended alternative of slashing the fiscal deficit while the private sector tries to slash its debt suffers from a fallacy of composition: it is impossible for all sectors of the economy to spend less than income at the same time..." Does not understand how a mishandled aggregate supply shock can later appear to be an aggregate demand shock. Reply September 27, 2010 at 11:40 PM Too Much Fed said... Rob in FL said: "They are revealing themselves to being a bunch of hacks, rather than educators and researchers." Make it political hacks instead of actual economists. Make it both the right wing (private debt) and left wing (gov't debt). Stop listening to both "wings". Reply September 27, 2010 at 11:45 PM Min said in reply to Too Much Fed... Too Much Fed: "TOTALLY unfair to the people who understood there was too much debt and should be benefiting." The thing is, we are all in this together, as Red Green says. :) Not that we should not try to have fair policies, but if we expect the people as a whole to shed debt and get their houses in order, the gov't must run high deficits. If people who were prudent and frugal feel unfairly treated by that, they can take solace in the fact that they will be better off if everyone is better, in absolute terms if not relative terms. We are facing a once in a lifetime crisis, and we need to pull together. Reply September 28, 2010 at 12:50 AM fresno dan said... "Since the financial balances of the household, corporate, government and foreign sectors must sum to zero..." http://delong.typepad.com/sdj/2010/09/martin-wolf-understands-economics.html
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I have never understood this phrase - it makes it seem like there can never be true losses. If we reduce the economy to say 3 people, and there is a total of 100$ of value in that society, (and this represents the value of all the houses, a total of 3 houses and 30% of the sum "GDP" of the society) and I burn down all three houses, has not the sum of the value of the society been reduced by 30%? Say I owned the houses outright - am I truly not poorer than I was before? Reply September 28, 2010 at 03:00 AM Herman said... The problem, I think, with John Cochrane is that he has of late become the object of much ridicule. He does not understand why, and so finds it convenient to blame Krugman. The reason people have been ridiculing Cochrane is because he has been repeatedly spouting nonsense, and being a man of deep and unshakable faith, seems completely lacking in critical ability. Try googling for "mind boggling nonsense". http://www.google.com/search?q="mind+boggling+nonsense" Reply September 28, 2010 at 03:02 AM RPLong said... DeLong, you can't possibly believe that first Sandifer quote, can you? Stimulus spending does come from someone else. Perhaps what's throwing you off is the fact that there is an intertemporal substitution issue going on. Regardless of present value, stealing from me in the future is equally as abhorrent as stealing from me today. Sometimes it pays to appreciate the subtleties of opposing opinions, rather than just make them look ridiculous. Reply September 28, 2010 at 04:36 AM Anon said in reply to RPLong... But that's not what Sandifer is saying (it's a very short quote, please read more carefully). He's replying to the claim that stimulus spending is -ineffective- because it's coming from somewhere else, i.e that it crowds out private spending. His reply is adequate. Reply September 28, 2010 at 04:58 AM Ryan said... Anon, I recognize what you and Sandifer are getting at but continue to disagree. Could it be that I actually understood Sandifer's point, DeLong's point, Cochrane's point, and still believe that stimulus spending ultimately doesn't work because it's merely an intertemporal shift? [No, it could not. It is not "merely" an intertemporal shift. That is the point. If you think that an intertemporal shift of demand is stimulus not working, than you don't understand Sandifer's point at all.] It's okay if you disagree with me (or Cochrane), but it's disingenuous to imply that I can't read a quote accurately or that Cochrane says things that aren't true. That's my point. Reply September 28, 2010 at 05:29 AM Michael Gauss said in reply to fresno dan ... http://delong.typepad.com/sdj/2010/09/martin-wolf-understands-economics.html
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Agreed. If my house burns down today whose financial balance goes up? Reply September 28, 2010 at 05:54 AM ogmb said... If posting an embarrassing old quote counts as sliming, then I'm happy to slime John "Bantam Cock" Cochrane once again... "Most of all, caveat emptor -- these are a matters for buyers and sellers, not regulators. Nobody else gets hurt if you buy a lousy mortgage pool. The government does not need to write a new rule every time someone buys a rotten tomato. Investors will demand the right transparency, complexity, and risk-sharing or monitoring of mortgage pools. That is, unless they get bailed out and learn to count on that instead! The history of the mortgage market is a grand story of bringing credit to people who need it, upon the removal of layer after layer well-intended but counterproductive "protective" regulation." -- John Cochrane, 2007 Reply September 28, 2010 at 06:35 AM Richard said... BTW, the best commentary in this discussion is here: http://freakonomics.blogs.nytimes.com/2009/02/05/economics-cage-matchdelongkrugman-vs-cochranefama/ Specifically, by Kevin H: I haven’t read beyond Cochrane’s ‘3 Fallacies’ but I already know he’s wrong about all of them: 1. “Jobs created by stimulus spending are offset by jobs lost from the decline in private spending.” Ok, but with the big exception that this offset can be delayed in time. He even makes that argument in #3 but fails to apply it back to #1. The basic idea would be to move the job losses to an economy which can sustain them with little impact on growth. The error he makes is to assume that jobs and the economy have a linear relationship. A few jobs added in a bad economy have a lot more impact than a few jobs lost in a good economy. 2. “The economy overall does not care if you buy a car, or if you lend money to a company that buys a forklift.” Nope, the economy sometimes does care very much. If you have a well capatalized economy (like ours), there are plenty of forklifts to go around. Factories to make every conceivable device are ready to rehire workers the moment they think that there will be a market for their products. There is a complex interaction between market and producer that Cochrane is dismissing. Economies are a ‘weakest link’ type phenomenon. You can only have as many goods sold as the minimum of the total amount you can produce or the total amount you are willing to buy (supply-demand curves only add a very little elasticity to that basic cap). Right now we can produce more than we are willing to buy, so encouraging our willingness to buy is the only way to increase overall economic activity. 3. Cochrane almost hits it with his thirst fallacy: “The classic arguments for fiscal stimulus presume that the government can systematically fool people.” It seems to me that this is close to the truth, if a bit overly negative. The fact is that people have had a fundamental psychological shift. When everyone is optimistic, there is an economic boost, and likewise, when everyone behaves in a pessimistic fashion, there is an economic hit. This is again because of the ‘weakest link’ type phenomenon in economics. It doesn’t just matter what people can buy, or can do, they must also believe it is the right thing to do. The underlying weaknesses in the economy are bad enough, but pessimism turns bad into disaster. Therefore, simply making people less http://delong.typepad.com/sdj/2010/09/martin-wolf-understands-economics.html
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pessimistic can have a positive impact on the economy. — Kevin H Reply September 28, 2010 at 08:07 AM Richard said... More: Fama and Cochrane miss a large point. They somehow assume that the people picking up the gov’t debt, and thereby not using the same money in the private market, would use this money in the private sector if not for the stimulus. But much of this money will come by accumulating debt from outside sources (although this scares people, I don’t think it’s so bad). And this money will not be invested currently in the private sector because the financial sector is paralyzed and private sector is consumed by uncertainty. This is the point of large government stimulus packages during times like these. It assumes that the market has been somewhat paralyzed and needs a shock to right the markets. The debt is delayed and, of course, eventually needs to be payed back, but hopefully during a time of growth and financial stability, when a small short term rise in taxes combined with budget decreases can work to lower debt without significantly hurting the economy. — Jon Reply September 28, 2010 at 08:10 AM Richard said... To add to Jon's point, Cochrane seems to assume that all actors are rational and profitmaximizing, but we know that some of the biggest actors in the arena right now ar sovereign entities (like China), and if he's going to state that China is seeking profitmaximization in its investments, then he is more out of touch with reality than I thought. For their own power/political purposes (or just flat-out investing inexperience), they would rather lend to the US government right now rather than it's consumers & corporates, yet Cochrane seems unwilling to acknowledge reality as it is rather than reality as it fits his models. Reply September 28, 2010 at 08:16 AM Ryan said in reply to Ryan... I never said anything about an intertemporal shift of demand. I was talking about an intertemporal shift of spending... [What we have hear is a failure to communicate: everyone else here, including me, uses "demand" and "spending" as synonyms. Drawing unexplained distinctions is not helpful.] Reply September 28, 2010 at 09:13 AM Min said in reply to fresno dan ... fresno dan: "I burn down all three houses, has not the sum of the value of the society been reduced by 30%?" Certainly there has been a loss in real terms. But burning down the houses is not a financial transaction, and it is the financial balances that sum to zero. Say that the houses were insured, and the insurance companies pay off. The amount of insurance that is received is a plus to the home owners, but a negative to the insurance companies. Add them together, and the result is zero. :) Reply September 28, 2010 at 10:53 AM Min said in reply to Richard...
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Kevin H: "Cochrane almost hits it with his thirst fallacy: “The classic arguments for fiscal stimulus presume that the government can systematically fool people.� It is not necessary to fool people to effect a shift between equilibria. Reply September 28, 2010 at 11:14 AM Min said in reply to Richard... "The debt is delayed and, of course, eventually needs to be payed {sic} back" -- Jon Gov't debt has been continually rolled over since Jackson paid it off in the 1830s. OC, specific bonds have been paid off, but, in a sense, we have never fully paid for the Civil War. Gov't debt never has to be fully paid off, and doing so would take a lot of money out of the economy. Reply September 28, 2010 at 11:20 AM Barry said in reply to Rob in FL... "Why are the right wing economists taking Dr. Krugman's professional criticism so personally? " Because they're used to getting their way, and having their 'lessers' bow down to them. Remember that Chicago law professor several days ago, who couldn't stand having his statements dissected and shown to be some combination of lies, BS and ignorance? What I'd like to see is the rest of eoconomics realize their chance is here, and storm the Bastille of Chicago (and George Mason, Aggie, UCLA, Stanford/Hoover, etc.). Reply September 29, 2010 at 08:34 AM Too Much Fed said... Min said: "Too Much Fed: "TOTALLY unfair to the people who understood there was too much debt and should be benefiting." The thing is, we are all in this together, as Red Green says. :) Not that we should not try to have fair policies, but if we expect the people as a whole to shed debt and get their houses in order, the gov't must run high deficits. If people who were prudent and frugal feel unfairly treated by that, they can take solace in the fact that they will be better off if everyone is better, in absolute terms if not relative terms. We are facing a once in a lifetime crisis, and we need to pull together." No, we are not in this together. We have the very few experiencing positive real earnings growth (maybe even extremely positive) with everyone else experiencing negative real earnings growth. Reply September 29, 2010 at 09:27 AM Too Much Fed said... Ryan said: "I never said anything about an intertemporal shift of demand. I was talking about an intertemporal shift of spending... [What we have hear is a failure to communicate: everyone else here, including me, uses "demand" and "spending" as synonyms. Drawing unexplained distinctions is not helpful.]" Is there a difference between an intertemporal shift of demand and an intertemporal shift of spending? Please explain. Reply September 29, 2010 at 09:34 AM Too Much Fed said... Min said in reply to Richard... "'The debt is delayed and, of course, eventually needs to be payed {sic} back' -- Jon
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Gov't debt has been continually rolled over since Jackson paid it off in the 1830s. OC, specific bonds have been paid off, but, in a sense, we have never fully paid for the Civil War. Gov't debt never has to be fully paid off, and doing so would take a lot of money out of the economy." I see two problems with this. 1) Someone has to make the interest payments thru taxes 2) The people who own the gov't debt will want a certain return (whether financial OR some other). Since the federal budget is not set up to pay back the gov't debt at maturity, there is a rollover risk. Plus, the owners of the gov't debt could sell it. Either one or both could raise interest rates. It seems to me for some reason that the U.S. gov't is willingly interest rate constrained. Reply September 29, 2010 at 09:52 AM fresno dan said... I would ask, what if the houses were not insured? I don't have a house to live in, and neither do the two other residents of "Fresno" maybe accounting says everything remains in "balance", but being without a house is a decrease in living standard I would think. I would hope the accounting accounts for reality. But it makes me wonder - the burned down houses are real, and if accounted for, it is obvious everybody is worse off. So what if I take a big pile of money and burn it up? Its just paper, and shouldn't quantitative easing, or printing dollars take us back to where we were? If say 6 trillion dollars in home value goes up in smoke, and the Federal Reserve prints up 6 trillion dollars, shouldn't everything "balance?" And should this balance be what we strive for, or be a measure of what we are seeking? But somehow, in this accounting of finance, people who had houses, but no longer do, who had jobs, but no longer do, who had health insurance, but no longer do, seems not to be accounted for. Of course, there is unemployment "insurance", and renting (and that's the same as paying a mortgage for a house? - money for a domicile - same thing?) and "cobra" for health insurance, right? So according to financial accounting, everything balances? And if you do get a job cleaning sewers, for half the pay, than the water district has more money for something else - everything balances...hmmmm, the sewer thing makes me think, food in one end, sh*t out the other...balance...but somehow, I'd rather be in imbalance, and eat only food. Reply September 29, 2010 at 03:39 PM Comment below or sign in with TypePad
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Seeking Alpha - Oct 17, 2010 No wonder Brad DeLong is always saying Krugman's right about everything. I agree, the Fed (like the Supreme Court) clearly does respond at least somewhat to ... Related Articles » « Previous Next »
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