Who cares how "deserving" the poor are?

Bryan Caplan is apparently about to debate Karl Smith on the question of "How deserving are the poor?" I want to get my two cents in ahead of this debate, by asking the counter-question: "Who cares?"

The question of "How deserving are the poor" is a matter of opinion. There is no right answer, because to say someone "deserves" something is a prescriptive statement, and you can't prove those with facts. Also, it is a somewhat pointless question, because no matter what answer you decide you like, it doesn't really imply any particular policy prescription. In practice, people who say "The poor deserve to be poor" are usually just trying to push the idea that we shouldn't try to do anything about poverty other than scolding the poor for their own mistakes (I'll come back to this idea in a bit). But this doesn't really follow.

As I see it, there are two important questions about poverty from a policy perspective: 

1. Do we want to make poor people less poor?

2. If we do want to do that, how do we accomplish it?

Bryan Caplan's answer (and Tyler Cowen's) to the question of "How deserving are the poor" is that if people are poor mainly as a result of their own actions, then they deserve to be poor. But as I see it, whether people are poor because of their own actions doesn't really help us answer either of the two questions I posed above.

Regarding the first of my questions, "Do we want to make poor people less poor", it may be that your sense of morality tells you that if someone is in a condition as a direct result of their own actions, it would be wrong to try to remove that person from that condition. Fine, good for you and your sense of morality! But for my part, I simply don't care. If I am getting mugged by a poor person, I quite frankly do not give a rodent's gluteal region whether that person is poor because he made bad life choices or because the circumstances of his birth made his poverty inevitable; I want him to stop mugging me, and if making him less poor will make him stop mugging me, then maybe this would be a good thing to do, regardless of whether he "deserves" it. When I witness the urban blight, violence, drug abuse, and other social ills that poverty may be causing, as a non-poor person I have an interest in preventing these social ills from affecting me, regardless of whether the ills are "deserved."

Also, whether people are poor because of their own actions doesn't really tell us how to get them out of poverty. Scolding and finger-wagging does not work. Just because a person's actions got him into a situation doesn't mean that his actions can get him out of it. And even if poor people could raise themselves up out of poverty at any time, scolding and finger-wagging is not likely to induce them to suddenly do so. The conservative solution to poverty - make it really, really unpleasant to be poor, and then hope people will do the smart thing and avoid it - has failed and failed and failed again.

So from my point of view, asking whether or not poor people "deserve" their poverty is asking the wrong question.

That said, I think the Caplan definition of "deserve" is not as "uncontroversial" a moral premise as Caplan declares. The reason is that it is a partial-equilibrium definition, not a general-equilibrium one. If we live in a society in which X percent of the populace must be poor, then no matter what set of actions is taken by the population, some people will wind up in poverty. To see this, imagine that we lived in a society in which the hardest-working 50% of people get to be spectacularly rich, and the other 50% are forced to live in squalid poverty. In this society, if everyone raises their effort by 1000%, the number of people in poverty stays exactly the same. I doubt that most people would say that the lower half of the population "deserved" to stay in poverty after raising their effort by 1000%! But that is exactly what Caplan's definition implies. Also, note that in such a world, whether you "deserve" to be poor depends critically on the actions of other people (since the degree of effort required for a person to raise himself out of poverty depends on how much effort others are expending)...thus, Caplan's definition doesn't really seem to capture the notion of individual responsibility.

But anyway, that is a bit beside the point, because in my opinion the whole question is a bit of a pointless one.

Update: Tyler Cowen emails to say that his view of "deserving" is a more synthetic one than Bryan Caplan's. Also, in his post he says "There is the view that desert simply is not very relevant for a lot of our choices.  We still may wish to aid the undeserving." This is pretty close to my thoughts.

Alex Tabarrok: Public goods, public goods, public goods!!!

It is difficult to overstate the intensity of the warm glow that fills my heart to see Alex Tabarrok writing this in the pages of the Atlantic:

To build an economy for the 21st century we need to increase the rate of innovation and to do that we need to put innovation at the center of our national vision...Innovation, however, is not a priority of our massive federal government. Nearly two-thirds of the U.S. federal budget, $2.2 trillion annually, is spent on the four biggest warfare and welfare programs, Medicaid, Medicare, Defense and Social Security. In contrast, the National Institutes of Health, which funds medical research, spends $31 billion annually, and the National Science Foundation spends just $7 billion... 

The federal government does spend some money on innovation, but mostly for innovation in warfare...The basic and applied non-weapons research that has the best chance of creating beneficial spillovers is a small minority of defense R&D. DARPA, the Defense Advanced Research Projects Agency, for example, helped to develop the Internet but DARPA's budget is only $3 billion. Even when we lump all federal R&D spending together regardless of quality it amounts to just $150 billion, a mere 4 percent of the budget... 

Our ancestors were bold and industrious. They built a significant portion of our energy and road infrastructure more than half a century ago. It would be almost impossible to build that system today. Could we build the Hoover Dam today? We have the technology. We seem to lack the will. Unfortunately, we cannot rely on the infrastructure of our past to travel to our future. Airports, an electricity smart grid that doesn't throw millions into the dark every few years, and ubiquitous Wi-Fi are among the important infrastructures of the 21st century, and they are caught in the regulatory thicket... 

To restore our economy and our spirits we need to become an innovation nation. An innovative nation would improve the prospects for economic growth but could do much more. The warfare-welfare state divides the pie and also divides Americans. Americans, however, are an innovative, forward-thinking people and the prospects are good for uniting them on a pro-growth, pro-innovation agenda. 

In other words: PUBLIC GOODS PUBLIC GOODS PUBLIC GOODS!!!

Also known as "public investment," "government investment," "public capital," "government capital," "partially nonrival production inputs," etc, public goods have been a major theme of this blog.

To see Alex Tabarrok trumpeting the importance of public goods is particularly gratifying to me, since Alex writes for Marginal Revolution, a blog whose leanings I would characterize as "libertarian," and works for George Mason University, an institution whose intellectual climate I would characterize as "libertarian." Which means that this article is part of the growing libertarian push for public goods, which first came to my attention from Peter Thiel.

In the 1970s and 1980s, libertarians and conservatives were so focused on shrinking the regulatory and welfare states that they were willing to throw the baby out with the bathwater. The crucial role of research and infrastructure in an advanced economy was ignored by cries to "drown the government in a bathtub," or that "government is the problem." The price of this epochal oversimplification is today's crumbling infrastructure and shrinking research budgets. 

Republican politicians, meanwhile, focused almost exclusively on distributional issues instead of on growing national wealth - "dividing the pie and dividing Americans," to use Tabarrok's pithy phrase. The national-greatness conservatism of a century ago was forgotten, replaced with a complacent belief that America's greatness was on autopilot.

I have no idea how politically conservative Alex Tabarrok is, but I do know that the conservative movement desperately needs him as a thought leader. America needs more and better public goods, and we need conservatives on board if we are going to get those goods. But conservatives are never going to listen to liberals. If Paul Krugman gets up and says "We need a strong social safety net AND more spending on research and infrastructure," conservatives are going to see public goods as a Trojan Horse for socialism. But if libertarian George Mason profs and Silicon Valley venture capitalists get up and say "We need to shift resources from the social safety net to research and infrastructure," then conservatives just may perk up and listen.

What we need in this country is an Alex Tabarrok conservatism.

(Note: I do actually have one quibble with Tabarrok's excellent article. He lumps Social Security in with the "welfare state," but most Social Security spending is really just forced saving. To maintain payroll taxes at current levels but shift Social Security spending from pension benefits to public goods would be to invest the savings of a large chunk of Americans in a set of risky projects whose payoffs would be distributed very unevenly. Not a lot of Americans are going to go for that. So I recommend leaving Social Security out of the discussion, and focusing instead on shifting resources away from health care spending.) 

Standard Republican narrative of history (John Taylor edition)

According to John Taylor, the reason that the recovery from the 2008-9 recession has not been as rapid as the recovery from the 1981-2 recession is that Reagan's policies were better than Obama's policies:

We are not really recovering from the recession, at least not compared to the period after previous big recessions such as the early 1980s...The reason is pretty clear. In the Wall Street Journal piece I refer to and quote from a memo written by President Reagan’s economic adviser George Shultz and others after the 1980 election. It laid out the long run economic strategy they recommended and which Reagan followed. Contrast that with the memo Larry Summers sent to President-elect Obama after the 2008 election, which is making the internet rounds. It laid out the short-run Keynesian policy Summers recommended and which Obama has followed. The big policy differences largely explain the big economic performance differences. (emphasis mine)

And what are those big policy differences? In the WSJ article, Taylor spends a lot of time making a general case for "economic freedom," but names only one concrete policy difference between Reagan and Obama: Reagan enacted permanent tax cuts, while Obama enacted temporary tax rebates (in the ARRA). Taylor argues that Reagan's permanent tax cuts represent policy based on predictability and stability, while Obama's policies represent short-term, unreliable interventions.

This is a very standard intellectual-Republican narrative of economic history. Which, again, does not mean it is wrong. But I do see some big problems with Taylor's analysis.

Problem 1: Reagan's permanent tax cuts were enacted in early 1981, before the steep recession. This means that any effect that those tax rates had on the 1983 recovery had to have come not from the policy change, but from the low tax rates that were in place. However, in 2010, thanks to the Bush tax cuts, stable permanent long-term income tax rates were lower under Obama than they were under Reagan. If low permanent tax rates caused a rapid recovery in 1983, why didn't even lower permanent tax rates cause a rapid recovery in 2010?

In other words, if the 1981-2 recession was fundamentally the same kind of event as the 2008-9 recession, then Taylor is concluding that Obama's temporary tax cuts (or other actions, such as saying bad things about "business") substantially prolonged the current slump. I suppose that is possible - it's a claim that many Republicans have repeated - but it seems like a difficult case to make. A lot harder of a case, in fact, than simply saying "Reagan's policies were better than Obama's."


Problem 2: There are other historical examples of deep recessions besides the one in the early 80s. When we compare policies and results between now and the Great Depression, for example, especially in Britain, we are tempted to reach conclusions very different from Taylor's. I'll outsource this part of the argument to Brad DeLong:

This many months after the start of the Great Depression, the British economy was rapidly converging back to its pre-depression level of production under Chancellor of the Exchequer Neville Chamberlain's policy of using stimulative policies to restore the price level to its pre-Great Depression trajectory. 

By contrast, the Cameron-Osborne policies of expansion-through-austerity have produced a flatline for real GDP, and the odds are high that British real GDP is headed down again. 

In less than a year, if current forecasts come true, the Cameron-Osborne Depression will not be the worst depression in Britain since the Great Depression, but the worst depression in Britain… probably ever.

So if you want to ascribe economic outcomes to broad differences in economic policy, why only look at the Reagan years? Why not look at the Depression? And why look only at the U.S. instead of at other countries as well?


Problem 3: The 2008-9 recession does not seem very comparable to the 1981-2 recession. For one thing, the early 80s recession immediately followed (and, most believe, was precipitated by) a huge hike in interest rates by the Federal Reserve (which was trying to beat inflation). That meant that as soon as rates were allowed to fall, the force that had spiked U.S. GDP growth would be removed. In contrast, the 2008-9 recession occurred during a period of historically low interest rates, which were dropped to zero shortly after the recession began. This left the Fed without its usual method of boosting GDP growth. Even more importantly, the difference also indicates that the "shocks" that caused the two recessions were fundamentally different - a policy shock in the case of the early 80s recession, but some other kind of shock in the case of the 2008-9 recession.


In other words, I think this simple standard Republican narrative does not fit the facts. It is tempting, especially for politically conservative economists, to conclude that Reagan's tax cuts made everything about the U.S. economy awesome, and that something done or said by the left-leaning Obama made everything go wrong. But that conclusion just doesn't square with the evidence that we see when we look out the window. I think a more complex narrative is needed.

Update: Paul Krugman points out that Reagan raised taxes in 1982. Which means that A) Reagan's 1981 tax cuts were not quite as predictable, stable, and long-term as Taylor claims, and B) according to Taylor, this Reagan policy should have hindered the 1983 recovery.

Thursday Roundup (1/26/2012)

New feature, y'all! I've decided to join the ranks of the aggregators, and post a weekly roundup of interesting posts from around the econ blogosphere that I didn't see get discussed very much. Here's this week's list:

1. Paul Krugman reminds us that debt bubbles are much, much worse than equity bubbles. This is relevant for my own research, since debt bubbles are often housing bubbles, and housing investors are often unsophisticated, liquidity-constrained, and prone to various behavioral biases.

2. Matt Yglesias basically reprises my "Great Relocation" idea - economic activity is moving to Asia because Asia has the densest populations. Of course, we both got the idea from Paul Krugman. Update: Ryan Avent, too.

3. Mike Konczal interviews Josh Kosman, who explains how the private equity tax arbitrage scam works.

4. Brad DeLong offers some helpful tips on the difference between behavioral relationships, equilibrium conditions, and accounting identities in economic modeling. Yay Principle #4!

5. Frances Woolley gives an excellent explanation of what econ blogs contribute to the academic discussion. Basically, assumptions are crucial to econ models, and blogs can examine the plausibility of assumptions.

6. Tyler Cowen explains the asymmetric nature of financial bets on volatility, and how a little moral hazard can go a long way.

7. My sources indicate that this email in Tyler Cowen's inbox, complaining about rude bloggers, is about me. Really? Am I really that rude? I guess it's easy to sound harsher on a blog than one intends to be (an effect that is noted in the immediately prior Tyler Cowen post).

8. Tim Duy uses Japan's experience in the 1990s to illustrate how fiscal policy can turn into fiscal capture...

9. Ryan Avent discusses how land use policies hold down real wages in Silicon Valley and transfer wealth from engineers to landholders.

Cochrane: Just don't call it "stimulus"!

John Cochrane has a long blog post up, the first half of which is a general discussion of the idea of fiscal stimulus, and the second half of which is a rant about how mean Paul Krugman and Brad DeLong are. I'm going to talk about the first half.

Cochrane writes:

Let's be clear what the "fiscal stimulus" argument is and is not about. 

It is not about the proposition that governments should run deficits in recessions. They should, for simple tax-smoothing, consumption-smoothing, and social-insurance reasons, just as governments should finance wars with debt. That doesn't justify all deficits -- one can still argue that our government used the recession to radically increase permanent spending. But disliking "stimulus" is not the same thing as calling for an annually balanced budget. 

Nor is it about debt financing of "infrastructure" or other genuine investments. If the project is valuable, do it. And recessions, with low interest rates and available workers, are good times to do it. That doesn't justify all "infrastructure" roads and rails to nowhere, of course... 

The "stimulus" proposition is that additional spending -- whether needed or not -- raises output and general welfare.  Pay people $1 to dig ditches and fill them up again, and the whole economy gains $1.5. (emphasis mine)

So Cochrane:

1. Is against austerity during recessions, and

2. Is in favor of increased public investment during recessions.

But countercyclical deficits and countercyclical public investment do not, in his terminology, represent "stimulus"; that term is reserved for the Old Keynesian hole-filling sort of spending. And what does Cochrane think about that sort of stimulus?

Stimulus [is] still an economically interesting proposition, and there is a great deal of uncertainty about whether, when, and how well it might work. There is a huge academic literature being produced right now... 

Here are the facts. Some economic models do predict a fiscal stimulus effect. Some don't...The facts are far from decisive...So, there is a lot of uncertainty and a lot we don't know about how the macroeconomy works. (emphasis mine)

And my response to this is:

!!! o_O !!!   <-- (this is an "emoticon" that indicates surprise)

If I told you that a famous economist thought that austerity is a bad idea in recessions, that recessions are a great time to boost debt-financed infrastructure investment, and that additional Keynesian stimulus spending was an "economically interesting proposition" about which the jury was still out, would you guess that the economist was John Cochrane? Before I read this post, I would not have. But hey, that's cool!

Actually, the parts of Cochrane's post that I quoted above almost perfectly sum up my views on stimulus. Although I'm convinced that recessions are caused by demand shocks, I don't really know enough to firmly believe that burying jars full of money would substantially boost aggregate demand. I don't know enough to accept or reject IS-LM or a New Keynesian model as my working model of the macroeconomy.

But right now, who cares? The fact is, we know we have a huge shortfall of infrastructure spending. Our existing roads and bridges - which clearly do NOT lead to "nowhere" - are falling apart. Even Obama's ARRA "stimulus" did very little to correct the problem. And instead of borrowing more money to fix our crumbling public goods, at a time when borrowing costs are historically low, conservatives are demanding that we tighten our belts and "starve the beast." We are not even close to addressing the question of whether to bury jars full of money.

I think the conservative push for austerity and reduced infrastructure spending is just nuts, and from what Cochrane has written above it seems he would probably agree. If we were to embark right now on a massive debt-financed program of road and bridge repair, that would not meet Cochrane's definition of "stimulus" (thought it would certainly be labeled "stimulus" in the press). It would consist entirely of policies for which Cochrane has expressed unqualified approval.

So why doesn't Cochrane stand up and loudly advocate a massive debt-financed program of road and bridge repair? Is it because the public might get the wrong idea, and start believing in "stimulus" of the hole-filling variety? Is it because infrastructure investment must be politically sacrificed in order to "starve the beast" and fight against creeping socialism? Is it just because Paul Krugman and Brad DeLong are mean mean meanies?

For crying out loud!

I may be wrong, but it seems to me that politics and/or personal feuds have contaminated the public debate over fiscal policy.


Update: Matt Yglesias says I want to "continue the argument" about stimulus. But actually, that's the opposite of what I want! What I want is for people to stop worrying about who is a meanie, and start trying to find as much common ground as they can. If a massive deficit-financed program of road and bridge repair is something that Paul Krugman and John Cochrane can agree on, then I think they should unite and push for that, and if that actually gets done, there will be plenty of time later to argue over whether "stimulus" in the strict sense is a good thing or a bad thing. But right now, it seems like there might be real common ground that is getting obscured by some of the rancor and politics.

Preparing for Winter

Wintertime and winter weather can be tremendous fun, but cold and snow can also pose danger. Slippery roads, downed power lines and limbs, and freezing cold temperatures all bring an added measure of suspense to our daily activities. There are simple steps you can take that will take the chill off your wintertime experience.

In your car. It is not enough to throw a safety kit, including emergency equipment such as blankets, candles, a shovel and traction aids into the trunk of your car and think that you are ready for operating your vehicle in inclement weather. The single most important thing we can do while driving in severe winter conditions is to slow down. A safe speed for conditions might be well under the posted speed limit. Triple the normal driving distance between you and the car in front of you. If your vehicle begins to slip, immediately take your foot off the accelerator and steer gently in the direction you want the car to go.

If your car gets stuck, clear the snow in front of and behind your tires and spread sand, kitty litter or traction mats in the front and back of your tires. Gently accelerate until you feel the tires begin to spin. Put the car in reverse and back up slowly until stopped by the snow. Rock forward again using a low, steady speed.

At home. Have your heating system inspected to make sure it is working properly. If you have an alternative heating source, it should be UL approved and inspected before using.

Good insulation will also help if power is lost. Check for possible air leaks around doors and windows. Seal electrical outlets and switches on outside walls. Stock up on easy to prepare food, first aid supplies, batteries, flashlights and a battery-operated radio.

If you do get snowed in at home and the situation isn’t dire, just relax and preserve heat by hanging blankets over windows and doors. If you use a supplemental heating device, make sure it is UL approved, in good operating condition and maintaining safe distance from flammable items.

Outside. Make sure to remove garden hoses from outside faucets. Hopefully, you remembered to clean your gutters of leaves and debris. Better yet, install gutter guards. These can help keep snow and ice from building up, which can form ice damns and damage your house. Outside heating appliances like heat pumps must be clear of snow and debris to work efficiently.

If you have to go outside, wear tight and layered clothing and sturdy watertight shoes. Make sure to cover exposed parts of the body by wearing hats, gloves and scarves. Failure to protect skin and prolonged exposure to the cold can result in frostbite. The nose, cheeks, ears, fingers and toes (your extremities) are most commonly affected.

The real multiplier vs. the nominal multiplier

I've been having some interesting email discussions with Scott Sumner, and thus it is time for a macro post.

Scott Sumner and David Beckworth have recently been arguing that, once you take the Fed into account, the Keynesian multiplier (the effect of fiscal spending on GDP) is zero. This is true, they say, because the Fed acts to counteract any unusually rapid rise in nominal GDP. The idea is basically this: after a recession ( a fall in nominal GDP), in order to return to its previous trend, NGDP must grow faster than its trend rate of growth. But since NGDP = real GDP + inflation, and since a stimulus increases aggregate demand, this will involve higher inflation as well as faster growth. The Fed, Sumner and Beckworth hypothesize, will not allow higher inflation, and so will raise interest rates, thus canceling out the effect of the stimulus on aggregate demand. The multiplier, when measured in NGDP terms, and when defined to take the Fed's "reaction function" into account, will be zero.

Now, in the past, I've argued that the Fed would have to be crazy to do this. It would have to refuse to allow NGDP to grow fast in a recovery even after NGDP plummets in a recession. But maybe the Fed is crazy! If the Fed actually does have an emotional bias against inflation - which some people argue is a desirable quality in Fed governors, because it helps anchor low inflation expectations - then it just might do something very much like what Sumner and Beckworth imagine.

However, does this mean that fiscal stimulus is ineffective? I say no. Why? Because that would only be true if fiscal and monetary policy had identical and opposite effects on inflation expectations.

Realize that when we talk about the fiscal "multiplier," we're taking about a real multiplier - the effect of spending on real gdp growth. The growth rate of NGDP is equal to the real growth rate plus the rate of inflation. So it's possible for the real growth rate to rise in response to a stimulus while the nominal growth rate stays the same. This will happen if inflation falls. For example, you could go from having a 2% RGDP growth rate with 3% inflation before the recession, to a 4% RGDP growth rate with 1% inflation after the stimulus. NGDP growth is 5% before the recession and 5% during the recovery, but RGDP growth is different.

This is called a disinflationary boom. In the case of a stimulus-induced disinflationary boom, the real multiplier is nonzero even after taking the Fed's inefficiently hawkish reaction function into account.

How can a disinflationary boom happen? Well, inflation is determined in large part by expectations of future inflation. If the combination of fiscal stimulus and higher interest rates caused inflation expectations to be lowered (perhaps by giving the Fed an opportunity to prove its hawkishness), the Phillips Curve would shift downward, meaning you could get more real growth for any given rate of inflation. That would allow a disinflationary boom. The stimulus would push RGDP back to trend after a recession, while a permanent change would remain in the NGDP time series. In fact, if the episode increased the Fed's credibility in the long term, the combination of policies would have benefits beyond the effect of the stimulus.

Some people might argue that this describes the 1980s. Reagan's tax cuts, this story would say, acted as a Keynesian demand-boosting stimulus that raised RGDP growth, but that the accompanying inflation was tamed by the hawkish Volcker Fed. I'm not sure I believe that, but it at least sounds plausible.

Anyway, the upshot is that a nominal multiplier of zero, caused by a pathologically hawkish Fed, does not necessarily mean that the real multiplier - the multiplier we care about - must be zero.

Scott Winship fails to show that Alan Krueger is a liar

Ever since Council of Economic Advisors chair Alan Krueger gave a speech on inequality, conservative media have been hard at work trying to debunk his claims. Increasingly, the go-to numbers guy on the right is Scott Winship of the Brookings Institute, who has written a series of articles at the National Review. Several of these articles have recently been linked and praised by Tyler Cowen.

Cowen's most effusive accolades were reserved for this piece, about which Cowen says "The post is excellent throughout and it contains many more points of interest." So I thought I'd take a look at this "excellent" Winship post and see what it had to offer. What I found, disappointingly, was a mix of insults, value judgments masquerading as refutations, dubious logic and concern trolling. So I thought I'd do my usual thing...go through the piece point by point, so readers can see why I reached the conclusions I reached...

Warning: This gets long.

Winship writes:

[T]he more Obama can make the election about big-picture economic issues like inequality and mobility, the less flack he will take for the more immediate problem of a still sluggish economy... 

I’ll be honest—I have a fair amount of sympathy for much of President Obama’s agenda...I am even open to the idea that our high levels of inequality are problematic...But I am exasperated by the Administration’s casual claim that opportunity in the U.S. for the typical American is on the decline...

The president’s strategy may prove successful, but it could have the shameful effect of unnecessarily raising Americans’ economic anxiety levels...Even worse, by talking down opportunity, the president could actually depress upward mobility. 

As you  can see, the concern-trolling has already begun. "I support Obama and care about inequality...I'm just pissed about his lack of empirical rigor! Oh, and also he's just trying to scare Americans and distract them from our real problems for his selfish political gain. But no really, I'm just a dispassionately concerned data guy!"

But then the real kicker comes in this line:

The latest attempts to justify this claim [of reduced opportunity], in Krueger’s speech, have crossed the line from ill-supported to deceitful.

Oh, so Krueger is a liar, is he???

I say that if you are going to call a respected economist a liar, you had better have some pretty damn good evidence to back that up. Let's see if Winship has the goods on Krueger.

The first thing Winship does is to recap his past successes against the Obama administration. He links back to an earlier piece of his that cast doubt on an earlier administration claim that economic mobility in America has decreased in recent years. On balance, that earlier piece is much more convincing (and less calumnious) than the current piece, so I will give Winship a pass on this point; let's assume that it's not clear that mobility has really fallen in America. However, as Winship notes, the numbers he criticized in the earlier piece were not included in Krueger's speech...so let's turn to what Krueger actually said in his supposedly "deceitful" speech.

Winship next attacks Krueger's contention that the American middle class is shrinking:

Krueger presented estimates indicating that the percentage of American households who were in the middle class fell from 50 percent in 1970 to 42 percent in 2010...I was surprised to realize that the Administration had defined “upward mobility into the middle class” in such a way that it did not count “upward mobility into higher-than-the-middle-class.” This…unusual definition had the effect of understating how many poor people become at least middle class, which is certainly the relevant figure. 

Krueger’s claim of a shrinking middle class relies on the same peculiar definition. Specifically, “middle class” is defined as having a household income at least half of median income but no more than 1.5 times the median. I re-ran the numbers using the same definition and data source as Krueger and found that the entire reason the middle class has “shrunk” is that more households today have incomes that put them above middle class... 

A shrinking middle class is only a problem if it reflects fewer people reaching the middle class. That is clearly the impression the administration wants to give, but it is entirely dishonest to do so.

Winship presents this as a refutation, but it is actually a value judgment. Krueger is talking about inequality, and he presents numbers on inequality. Winship is saying "No, you shouldn't care about inequality, you should only care about absolute income levels and the upward mobility of the poor." 

Put another way, imagine if everyone makes $10,000. Then imagine a couple of people's income goes up to $1,000,000 while everyone else stays the same, thus shrinking the middle class. Would you, the voting citizen, have a problem with this if it happened? You might, and you might not. But if Krueger and Obama think that inequality is a problem in and of itself, who is Winship to tell them to think otherwise? Just because Krueger chose not to focus on what Winship believes is "the relevant figure" and the "only important" issue does not mean that Krueger is "dishonest." A value judgment is not a refutation! (Time for a Principle #8?)

But there's another problem with Winship's claim. Yes, it is true that from 1970 to 2011, the shrinking of the middle class, on net, reflected (unequal) upward mobility out of the middle class. That is because absolute incomes themselves increased a lot between 1970 and 2011. But if you look at the period from 2001-2011, it is a different story entirely. In that period, median household income fell substantially. The "middle class," which is defined relative to median income, thus became poorer over that time. In other words, since 2001, poor people could move into the "middle class" without making a dime more in income; the middle class came to them. And this is what Winship calls "upward mobility"!

Winship paints a picture of an America that is becoming more unequal only because a rising tide is lifting some boats faster than others. That may have been an accurate picture in the 80s, but it has not been accurate for over a decade.

Next, Winship takes on the much-talked about "Great Gatsby curve," which shows a cross-country correlation between income inequality and intergenerational mobility. The first thing he does is to cast doubt on the cross-country data, citing several ways in which these might be mismeasured. These complaints are certainly valid, but do they refute Krueger's point...or reinforce it? I hereby outsource my argument to Justin Wolfers of the Freakonomics blog:

Basically, Winship has a bunch of complaints about how the data are constructed — and many are valid...It’s a standard play from the wonk-fight playbook: throw lots of mud at the data, and hope that this leads people to mistrust the conclusions that follow. 

Here’s the thing: his criticisms actually strengthen the original finding. 

Think about it. Imagine how strong the “true” relationship must be if it shows up even when using only rough proxies for the “true” levels of inequality and immobility. In light of Winship’s criticisms, the high correlation in this chart is all the more remarkable.  If his gripes are correct, then graph understates the correlation between inequality and mobility... 

[If] the data are a pretty poor proxy for what’s really happening...there’s actually a very strong link that’s being disguised by imperfect data.

So if the relationship between inequality and immobility holds across multiple data specifications, then Winship's "critique" is just proving Krueger's point. But maybe the Obama administration just cherry-picked the one data specification that seemed to show a relationship? Ah, but no. In his next paragraph, Winship writes:

Admittedly, all of the charts like this that researchers have created show a relationship between inequality and immobility.

So Winship's argument is: "Any way you slice it, the data seem to support Krueger. But those data are noisy! Therefore Krueger is a liar!" 

Refutation FAIL.

Winship's last substantive point is to attack Krueger's projections of future immobility:

There is one other big problem with [Krueger's figures]...particularly when a researcher is estimating future mobility, as Krueger did. If one believes that inequality diminishes opportunity, one should look at how inequality experienced in childhood affects mobility between childhood and adulthood. Krueger’s immobility data are, for the most part from people who were in their 30s during the 1990s, so they should be matched with inequality data from the 1960s, when those people were children. But instead they are matched with inequality data from 1985... 

[A]ll of this means that Krueger’s prediction of immobility for “today’s children” is not so much a projection of what today’s children will experience as adults as it is an estimate of what today’s adults have already experienced.

This is just not right, for two reasons. Reason 1 is that inequality levels may be persistent. If inequality in 2011 predicts inequality in 2036, and if the contemporaneous correlation between inequality and immobility that was observed in 1990 continues to holds in 2036, then the rise in inequality from 1990 to 2011 predicts a rise in immobility from 2011 to 2036 (even if that rise has not yet made itself apparent in the 2011 immobility data!).

Reason 2 is that inequality may contain a persistent trend. If the rise in inequality from 1990 to 2011 predicts a similar rise from 2011 to 2036, and (again) if the Great Gatsby contemporaneous correlation holds, then we should expect to see much higher immobility by 2036.

So Winship's complaint - that the Great Gatsby curve measures a contemporaneous correlation - does not invalidate Krueger's warning of increased immobility. Ironically, there are some good arguments Winship could have trotted out against Krueger's immobility forecast - 1. correlation does not equal causation, and 2. the Great Gatsby curve could all be due to country fixed-effects, thus making longitudinal predictions invalid. However, for some reason, Winship does not choose to make these arguments, and instead relies on some very weak tea.

Winship concludes his article with some more concern-trolling:

[The Obama administration is] needlessly scaring the middle class into doubting their own security...So the president’s strategy is likely to hinder recovery from the Great Recession. In fact, there is reason to believe that Americans are more generous when they feel they are doing well than when they feel they are at risk, in which case the Administration’s strategy is doubly counterproductive if it wants to help the bottom.

Yeah, yeah. "Obama is slaughtering the economy with his socialist rhetoric, but really I'm only complaining because I care so much about helping the poor and disadvantaged." Gotcha.

But OK, let's back up. Winship called Alan Krueger "deceitful"! And nowhere in this article do I see anything even remotely resembling convincing evidence that this is true; instead I see a mix of value judgments and fallacious arguments. I say that if you are going to call someone a liar, you should back up your allegation really really well. Winship has not done this.

If I were Tyler Cowen, I would not have lavished such unqualified, effusive praise on this article.


Update: Winship responds to my point about the shrinking middle class by basically reiterating his point that if the middle class shrinks because people are moving to higher parts of the distribution, that's OK, because there's no downward mobility. He completely ignores my point that if the median is falling - if the middle class as a whole is getting poorer - then this does not seem very OK, even by his definition. As an example, consider a country in which everyone makes $10,000. In this country everyone is middle-class. Now suppose that two-thirds of the people see their incomes fall to $5000, while the rest are unchanged. The middle class, defined as median income +/- 50%, has shrunk, and it has happened without anyone moving to the lower extreme of the distribution. By Winship's definition, this constitutes "upward mobility". And has the median income been falling in the U.S., thus defining "middle class" downward? Yes. The median American household was about as rich in 2010 as it was in 1987, while working a lot more for that income.

Downward mobility refutation FAIL, and Krueger "deceitfulness" evidence FAIL.

Does mercantilism "work"?

I recently had a Twitter conversation with (probably) Karl Smith Adam Ozimek (who shares a Twitter account with his co-bloggers), about whether or not mercantilism - export subsidies and import protection - is ever sound policy. Probably-Karl Adam's answer was "No." In giving this answer, probably-Karl Adam has the vast bulk of the economics profession behind him; in fact, it is often said that free trade is the only area of policy where economists agree. Naturally, this means that I must quixotically attempt to challenge the conventional wisdom.

In defense of the "free trade is always good" proposition, probably-Karl Adam directs me to this Brad DeLong post from 2007, in which DeLong referees an exchange between Dani Rodrik and Don Boudreaux:

In the ring, Dani Rodrik stumbles into a knockout punch from Don Boudreaux:

Don Boudreaux:

...If it's true that theory and evidence in favor of protectionism are sufficiently strong to warrant economists abandoning their conclusion that free-trade policy is generally sound, then why shouldn't economists -- led by Dani Rodrik -- also start exploring the potential benefits of intra-national protectionism?  Surely a scholar not benighted with the free-trade "faith" ought to take seriously the possibility that, say, Tennesseeans could be made wealthier if their government in Nashville restricts their ability to trade with people in Kentucky, Texas, Rhode Island, and other states?... 

I suspect that if someone proposed to Dani Rodrik that he explore the wealth-creating potential of state-level protectionism, he would refuse.  He would likely (and correctly) say that it's ridiculous on its face to suppose that such protectionism would make the people of Tennessee as a group wealthier over time...

I score this for Don: a knockout. 

So in order to defend the hypothesis that mercantilism might be sound policy, I must attempt to smack down Brad DeLong (always a dangerous endeavor). Very clever, probably-Karl Adam..So be it. I will attempt to smack down Brad DeLong.

The argument that Boudreaux uses is this: "If mercantilism is good policy at the nation level, why isn't it good policy at the U.S. state level?" DeLong finds this argument convincing. I do not, because I think it conflates two very different notions of what "good policy" means.

Suppose that trade policy is like a Prisoner's Dilemma game between two countries, where "cooperating" represents free trade and "defecting" represents mercantilism. The outcome that maximizes the total payoff - the Pareto optimal outcome - is for both countries to adopt free trade. But mercantilism is a dominant strategy.

Applying this conjecture to the case of U.S. states, there is a federal government that explicitly disallows states from pursuing most mercantilist policies (export subsidies, import taxes, etc.), thus forcing the Pareto-optimal outcome. But there is no world government, so nations should be mercantilist, since it is rational to play dominant strategies. As a result, in this conjectured world, it is perfectly reasonable to disallow mercantilist policy at the state level while pursuing it at the national level. Thus, DeLong and Boudreaux's point does not seem obviously right to me, since there may be strategic aspects to international trade.

Now, you may ask, in what model would trade policy really be a Prisoner's Dilemma? Well, I can think of one off of the top of my head - the New Economic Geography, my favorite development theory. In the international-trade version of this theory, countries undergo development one by one, not all at the same time. Beginning a development explosion requires investment from developed nations. Thus, whichever country with the lowest unit labor costs in the exportable goods sector (net of transport costs) will be the first to develop. In this world, undeveloped countries can compete to be the next country to develop, by subsidizing their exports (even though this subsidy can create a global inefficiency). Trade policy is a Prisoner's Dilemma between undeveloped nations.

I am not claiming that this is the world in which we live (but it might be!). I am simply making a point: Just because a world of free trade is the best possible world doesn't mean that free trade policy is always optimal for a country to adopt. I have not made an airtight case for mercantilism in this post, but I think I've addressed one of the main arguments against it.

Filling a hole or priming the pump?

Who knew that neoclassical economists had something perspicacious to add to the stimulus debate? Steve Williamson sends me to this AEA talk by Jim Bullard of the St. Louis Fed. The presentation is mostly a rebuttal of the common liquidity-trap arguments for stimulus, but at the end, there was this one really interesting slide:

An alternative theory

• An alternative theory is much less studied but closer to the rhetoric on fiscal policy effectiveness.

• Suppose two regimes exist, one involving high growth and the other involving low growth.

• Heavy government borrowing might signal that the high growth regime is likely; this might then influence private sector expectations and private sector decisions.

• The high growth equilibrium could be encouraged as a self-fulfilling prophecy.

• However, if government spending is viewed as wasteful, the private sector could coordinate on low growth.

Williamson adds:

As Bullard states, the type of coordination failure that some Keynesians appear to have in mind - self-fulfilling beliefs about the future driven by fiscal policy - has not really been formally studied.

Verrrrrrry interesting. Bullard is saying "All you Keynesians are bending over backward trying to make stimulus all about countering a shock to Aggregate Demand, when actually you have a mental model of an economy riddled with coordination failures and multiple equilibria, where stimulus is all about expectations."

I think he might be right about that.

To me it seems obvious that a recession is a coordination failure. There are all these unused workers sitting around wishing they had jobs, and all this capital sitting around not being used! Even if you are believe a "recalculation" story, in which recessions are the sluggish response of a complex system to a structural shock, there is no guarantee that the adjustment proceeds at the fastest possible rate. Basically, unused capacity means we are not making as much stuff as we could be.

Now, the commonly used Keynesian models do involve some kind of coordination failure. In the classic Keynesian Cross model, buyers and sellers fail to coordinate their plans, resulting in an inefficient buildup of inventories. In modern New Keynesian models, sellers (including workers) fail to coordinate their price changes, resulting in too-high wages and unemployment. In both of these models, fiscal stimulus works - if it works - by "filling the hole" in aggregate demand.

But the thing is, both of these models are short-term models. The Keynesian Cross offers only a very short window for stimulus to work, since inventories typically get run down in a few months. In New Keynesian models, prices adjust over a period of perhaps a couple years. If Congress doesn't "fill the hole" in AD, the hole will fill itself. That is because both of these models are single-equilibrium models - for a given fiscal policy, there is one level of output and prices to which the economy must move.

In a world with multiple equilibria, however, there is no such certainty. In a world of multiple equilibria, different initial conditions can have devastating and persistent effects on the economy. That is a world of lost decades, debt overhangs, self-fulfilling pessimism, and "sunspots." In that world, fiscal policy may not be important only in the short term, but in the medium or even long term. That is scary, given how uncertain and slow and inefficient the political process can be. But it is also optimistic in a way, since a relatively small stimulus might be able to nudge the economy from a bad equilibrium to a good one, thus "priming the pump" rather than "filling the hole".

Bullard and Williamson say that this is the type of model that modern supporters of fiscal stimulus really have in mind. I don't know to what degree that is true. It certainly is true that Keynesians and others have spent some time and effort trying to construct multiple-equilibrium theories to explain why fiscal policy seems to make a difference. And it certainly is true that the often-used metaphor of "priming the pump" invokes a multiple-equilibrium situation. For my part, I find it much easier to believe in a world of multiple equilibria, for reasons both theoretical and anecdotal. I even have some conjectures about what kind of equilibria those might be, though that is the subject for another post.

So should we be focusing on building multiple-equilibrium models in order to evaluate fiscal policy? In practice, it's hellishly hard to make those models both tractable and predictive (especially when forced to work in a clunky DSGE framework!). That is probably why stimulus advocates have used New Keynesian models with liquidity traps to make their case in intellectual circles. But progress is being made on the multiple-equilibrium front - for an example, see this recent paper by Angeletos and La'O (about which I also intend to blog more).(Update: Whoops! Wrong paper...thanks to Steve Williamson in the comments for pointing that out!). For some examples, see various work by Roger Farmer. I say that this is a very important direction for research.

It also means that we shouldn't assume that fiscal policy questions will simply become moot as time goes on. Depending on the type of equilibria the economy faces, stimulus may not only be a policy for the short term. It's interesting that neoclassical economists are the ones bringing attention to this idea.

Update: In the comments, Roger Farmer adds so much information about his work on multiple-equilibrium coordination-failure models that his comment is substantially more interesting than my entire blog post. Hence, I will post the comment here in its entirety:

Thanks for drawing attention to co-ordination failure models Noah. Let me clarify a couple of points about how my views differ from those of the new-Keynesians.  

First; as you point out in your post, I have been working on a new generation of co-ordination failure models in which a high unemployment equilibrium can persist forever. The clearest exposition of these models is here 

http://www.rogerfarmer.com/NewWeb/PdfFiles/fa-con-cra.pdf 

I call these, second generation coordination failure models. They are different from the first generation models that Stephen refers to (for example, Farmer-Guo (1994) JET). First generation co-ordination failure models have multiple non-stationary equilibrium paths all converging to the same steady state. Second generation models have multiple steady state equilibria. This is a significant difference since first generation models, like new-Keynesian and classical models, cannot account for persistent high unemployment. Second generation models can. 

Second; Steve is correct that I am reluctant to support large fiscal stimulus programs. I have written two papers on the role of fiscal stimulus in second-generation co-ordination failure models, one in an overlapping generations model here 

http://www.rogerfarmer.com/NewWeb/PdfFiles/Farmer_Roger_Carnegie.pdf 

and a second paper joint with Dmitry Plotnikov, in a representative agent framework here 

http://www.rogerfarmer.com/NewWeb/PdfFiles/Farmer-Plotnikov.pdf 

In both of these models, a fiscal stimulus will decrease unemployment. But if confidence remains low, the fix will be temporary. In both models, the fiscal stimulus reduces welfare because it crowds out private consumption.  

Recall that in Keynesian models, increased government expenditure is supposed to "crowd in" private consumption. That is the whole idea behind the consumption-income multiplier. My reading of the evidence is that "crowding in" (an increase in consumption caused by an increase in government purchases) is not supported by the data. 

If fiscal stimulus is to have a permanent effect in the models I work with, it must work through a non-economic mechanism. One channel would be a temporary boost to employment that restores the confidence of the private sector by influencing market psychology: A confidence booster. That is a possibility. But I think it is implausible that increased government expenditure will have that effect. 

My reading of the evidence is that consumption depends primarily on wealth rather than income. That was the lesson of work by Ando and Modigliani, Modigliani, and Friedman in the 1950s. It is for that reason that I support interventions in the asset markets that try to jump-start the economy and reduce unemployment by boosting private wealth. That, in my view, is what quantitative easing has done.

A standard Republican narrative of history

John Cochrane has a new post up in which he discusses the historical importance of Milton Friedman's book Free to Choose (a book I have never read. The first half of the post is a discussion of the difference between negative and positive rights, with which I largely (but not completely) agree. But the second half consists of a reading of events since 1980 with which I take a number of exceptions:

Here are a few "freedom, democracy and prosperity" events...since 1980:

• The Reagan and Thatcher revolutions, including deregulation, tax reform, victory over inflation and inauguration of a 20-year economic boom. 

• A billion Chinese released from abject poverty. (Hint to China: read Capitalism and Freedom next.)

• A billion Indians, also starting to join the modern world, having begun to overturn their Keynesian / English-socialist model. 

• We won the cold war. East and West Germany reunited. Eastern Europe freed.

• The number of democracies, for example as scored by Polity, doubled since 1980. Many in Latin America and Africa too.

1980...was an end to US and UK inflation -- the result of mindless "stimulus" -- and the end of widespread acceptance of simpleminded Keynesian economics. It was the end of a brief interlude of unquestioning belief in the power of the Federal Government to solve all problems. It was the end of stagnation in the US and UK.  

1980 was an inflection point for the advance of freedom, not its end! Yes, some of the Friedmans' dark worries did not pan out. Why not? Because people read the book! The Friedmans were fighting against the "tide of history." And turned it back....   

We have a long way to go, and we've been heading backwards in the last few years, on all indices of economic and political freedom. Our 30 years of liberalizations may indeed now be coming to an end. The economic and political ills of the 1970s seem to be returning.

This appears to me to be a very standard intellectual Republican narrative of recent history; if you surveyed registered Republicans with postgraduate degrees, and then took an  average of their responses, it seems like you might get something like this. Now, standard narratives are not necessarily wrong. But this narrative happens to be one about which my feelings are quite mixed.

I agree with a number of Cochrane's points. I agree about China. I basically agree about India (though where did Keynes support a "license raj"??). I agree about the Cold War and the spread of democracy. I agree about inflation. None of these positive developments should be forgotten or ignored.

But there are some points with which I strongly disagree. Let me address these:

1. "[1980] was the end of stagnation in the US and UK." What? Really?? What about the Bush years? You know, the 8 years when the inflation-adjusted stock market did worse than in the 1970s, income stagnated, and GDP growth underperformed past booms, all despite massive tax cuts and substantial deregulation?

2. "The economic and political ills of the 1970s seem to be returning." Really? Inflation?? No. I know there are some people who believe that a fiscally induced hyperinflation is just around the corner, but that is pure speculation...

3. "US and UK inflation -- the result of mindless "stimulus"" Really?? But budget deficits were low in the 1970s, and only exploded in the Reagan years (and again in the Bush years). And most economists believe that the 70s inflation was caused by loose monetary policy (and possibly oil shocks), not by fiscal policy.

Basically, in 2000, this Republican narrative was looking pretty good - though not entirely thanks to Republicans. Bill Clinton seemed to have proven that market liberalism did not require exploding deficits and exploding inequality (the ills of the Reagan years) in order to create prosperity. But then came the Bush years, and America doubled down on the Milton Friedman program with more tax cuts, more deregulation, more privatization. And income stagnated, stocks stagnated, and growth was lackluster, while debt and inequality resumed the explosive growth of the Reagan years. By the eve of the financial crisis, the Republican narrative was looking pretty shopworn.

I did not live through the 70s (and was a little kid in the 80s). My generation has seen all of the results of the Milton Friedman revolution, both good and bad. But we missed the revolution itself. The sense of idealism, promise, and heroism that some older intellectuals seem to feel when they recall that revolution is just a little alien to me. I like to think that this makes my generation a little more dispassionate when it comes to evaluating how it all turned out.

Seven principles for arguing with economists

In the increasingly contentious world of pop economics, you - whether an educated layperson, an economist-in-training, or even a professional economist unused to the rough-and-tumble of the mediasphere - may find yourself in an argument with an economist. And when this happens, you should be prepared, because many of the arguments that may seem at first blush to be very powerful and devastating are, in fact, pretty weak tea. 

For this reason, I have constructed a short list of (a few of) the fallacious arguments that you may encounter in your travels, along with suggested responses. Remember, forewarned is forearmed! I give you:

Noah's First Seven Principles For Arguing With Economists

Principle 1: Credentials are not an argument.

Example: "You say Theory X is wrong...but don't you know that Theory X is supported by Nobel Prize winners A, B, and C, not to mention famous and distinguished professors D, E, F, G, and H?"

Suggested Retort: Loud, barking laughter.

Alternative Suggested Retort: "Richard Feynman said that 'Science is the belief in the ignorance of experts.' And you're not going to argue with HIM, are you?"

Reason You're Right: Credentials? Gimme a break. Nobody accepts received wisdom from sages these days. Show me the argument!

Principle #2: "All theories are wrong" is false.

Example: "Sure, Theory X fails to forecast any variable of interest or match important features of the data. But don't you know that all models are wrong? I mean, look at Newton's Laws...THOSE ended up turning out to be wrong, ha ha ha."

Suggested Retort: Empty an entire can of Silly String onto anyone who says this. (I carry Silly String expressly for this purpose.)

Alternative Suggested Retort: "Yeah, well, when your theory is anywhere near as useful as Newton's Laws, come back and see me, K?"

Reason You're Right: To say models are "wrong" is fatuous semantics; philosophically, models can only have degrees of predictive power within domains of validity. Newton's Laws are only "wrong" if you are studying something very small or moving very fast. For most everyday applications, Newton's Laws are very, very right.

Principle 3: "We have theories for that" is not good enough.

Example: "How can you say that macroeconomists have ignored Phenomenon X? We have theories in which X plays a role! Several, in fact!"

Suggested Retort: "Then how come no one was paying attention to those theories before Phenomenon X emerged and slapped us upside the head?"

Reason You're Right: Actually, there are two reasons. Reason 1 is that it is possible to make many models to describe any phenomenon, and thus there is no guarantee that Phenomenon X is correctly described by Theory Y rather than some other theory, unless there is good solid empirical evidence that Theory Y is right, in which case economists should be paying more a lot attention to Theory Y. Reason 2 is that if the profession doesn't have a good way to choose which theories to apply and when, then simply having a bunch of theories sitting around gathering dust is a little pointless.

Principle 4: Argument by accounting identity almost never works.

Example: "But your theory is wrong, because Y = C + I + G!"

Suggested Retort: "If my theory violates an accounting identity, wouldn't people have noticed that before? Wouldn't this fact be common knowledge?"

Reason You're Right: Accounting identities are mostly just definitions. Very rarely do definitions tell us anything useful about the behavior of variables in the real world. The only exception is when you have a very good understanding of the behavior of all but one of the variables in an accounting identity, in which case the accounting identity acts like a budget constraint. But that is a very rare situation indeed.

Principle 5: The Efficient Markets Hypothesis does not automatically render all models useless.

Example: "But if your model could predict financial crises, then people could use it to conduct a riskless arbitrage; therefore, by the EMH, your model cannot predict financial crises."

Suggested Retort: "By your logic, astrophysics can never predict when an asteroid is going to hit the Earth."

Reason You're Right: Conditional predictions are different than unconditional predictions. A macro model that is useful for making policy will not say "Tomorrow X will happen." It will say "Tomorrow X will happen unless you do something to stop it." If policy is taken to be exogenous to a model (a "shock"), then the EMH does not say anything about whether you can see an event coming and do something about it.

Principle 6: Models that only fit one piece of the data are not very good models.

Example: "Sure, this model doesn't fit facts A, B, and C, but it does fit fact D, and therefore it is a 'laboratory' that we can use to study the impact of changes in the factors that affect D."

Suggested Retort: "Nope!"

Reason You're Right: Suppose you make a different model to fit each phenomenon. Only if all your models don't interact will you be able to use each different model to study its own phenomenon. And this is highly unlikely to happen. Also, it's generally pretty easy to make a large number of different models that fit any one given fact, but very hard to make models that fit a whole bunch of facts at once. For these reasons, many philosophers of science claim that science theories should explain a whole bunch of phenomena in terms of some smaller, simpler subset of underlying phenomena. Or, in other words, wrong theories are wrong.

Principle 7: The message is not the messenger.

Example: "Well, that argument is being made by Person X, who is obviously just angry/a political hack/ignorant/not a real economist/a commie/stupid/corrupt."

Suggested Retort: "Well, now it's me making the argument! So what are you going to say about me?"

Reason You're Right: This should be fairly obvious, but people seem to forget it. Even angry hackish ignorant stupid communist corrupt non-economists can make good cogent correct arguments (or, at least, repeat them from some more reputable source!). Arguments should be argued on the merits. This is the converse of Principle 1.

There are, of course, a lot more principles than these, and I'll include some in a later post. The set of silly things that people can and will say to try to beat an interlocutor down is, well, very large. But I think these seven principles will guard you against much of the worst of the silliness. Keep them always with you at your side...Happy arguing!

Buckle Up Your Best Friend

Dogs are a man’s best friend. So it only makes sense that dogs often travel in vehicles. Sometimes those are trips that are necessary for the dog such as doggy daycare or the vet. However, a lot of the time they are just to keep the driver company as they drive around town or go on a short road trip.

Dogs can be great companions as you drive around in your vehicle but they can also be great distractions. There are times you will see dogs sitting on the laps of the drivers or sitting dead center of the back seat which blocks the driver’s view out of the rear of the car.

In an accident dogs can also be a major hazard. When auto accidents happen they often stop a vehicle cold in its tracks. However, anything not buckled into the vehicle continues to travel at the speed the vehicle was traveling. Often, dogs are not strapped in and therefore become a large moving object in your vehicle. This can cause major damage to your pet as well as possibly to you or anyone else in the vehicle. It is best to have a dog strapped into your car, not only for your dog’s safety but also for your safety and for the safety of those in your vehicle. Visit a pet store near you and pick up an attachment that enables you to comfortably seatbelt in your dog.

Welcome, economist, to the desert of the real

One more post before I stop my unprecedented blogging frenzy. I'll make it a philosophy-of-science one.

Back in September, Frances Woolley of Worthwhile Canadian Initiative wrote one of the most telling posts I've ever read on the culture of the econ profession:

Economists like to begin with a general model, work out its implications, and then go to the data to test the theory...facts in and of themselves are uninteresting unless they illuminate economists' view of the world, and can be explained in economic language. 

Psychologists begin by observing people's behaviour, looking for generalizable patterns...Yes, psychologists have conceptual explanatory frameworks, such as prospect theory, to explain such phenomena,but these theories are not the elegant mathematical creations favoured by economists... 

It's a dilemma for behavioural economists. Yes, it's possible to go into the lab or into the field, run experiments, and see how people actually behave...But what do you do next?... 

[I]f people's demands are just a product of framing, salience, [etc.], how can we...make any inferences about the efficiency of different [policies]? 

The economic approach to policy analysis is deductive - economists begin with assumptions about consumers' and firms' preferences and behaviour...Perhaps there is some way of including behavioural considerations into that framework...But that doesn't feel right to me - if a consumer's marginal benefit from consumption is something other than what is revealed by his or her demand I could just make up anything as a marginal benefit curve, and economics would become a completely ad hoc exercise. 

Dabbling in economic psychology or behavioural economics is a little like taking the red pill -  you go down the rabbit hole, and wake up realizing that the entire world is an illusion. 

How can economists evaluate policy if they can't use people's preferences as revealed by their choices? We still need some way of figuring out which policies help people and which policies hurt people... 

Once you fall down the rabbit hole, you just have to keep on going. If people's choices are not a reliable guide to their well-being, you have to turn to something else. Ask people how happy they are and measure well-being in terms of happiness. Evaluate health care spending by looking at objective measures of health, such as mortality, morbidity, or survival rates. Chuck out the entire elegant theoretical framework of welfare economics. 

That idea has me, for one, reaching for the blue pill - after all, people aren't stupid, so standard economic analysis isn't a bad approximation of the real world, is it? 

But I can't find one. I can't get all of that behavioural stuff outside of my head.

This post is an absolutely wonderful window into the world of the economist's mind. I'll talk about what it means for the profession in a moment, but first let me do the philosophy-of-science bit.

Science proceeds through a reciprocal process of deduction and induction. You look at the world, you try to make sense of what's going on, then you look at the world some more to see if you really managed to make sense of it. And you just keep repeating that.

It doesn't really matter whether you start with deduction or induction. If you start with a theory that you just made up because it sounded reasonable, that's fine! You just have to go test it before you believe it. If you start with some observations, that's fine too...you just have to try to make a theory to make sense of them, or your observations will not allow you to make inferences from what you observed. And making inferences - i.e., increasing humanity's power to control our Universe - is what science is really all about.

If your science is only "deductive" or only "inductive," what it really means is that you are stuck. You can't get to the next step. Either you don't have theories that match the data, or you have observations you can't explain. That's fine. Getting stuck happens all the time; you just have to recognize it and keep trying, and then maybe someday you'll get unstuck, and that's called a scientific revolution.

What you don't want to do is accept being stuck. There is a temptation for a scientist to try to convince herself that her field doesn't need one of the two steps - to say "My field is an inductive science, we don't need theories," or "My field is a deductive science, we don't need to test our theories." If a field as a whole accepts one of these seductive errors, it can stagnate for long periods of time. Some people argue that psychology is stagnating by ignoring the need for theory. Others argue that particle physics is stagnating by ignoring the need to test string theory.

At least since Kahneman started doing economics experiments back in the 70s, people have been arguing that economics has stagnated by not paying enough attention to the real world - by valuing theories that seem intuitive, or tell a good story, so highly that we refuse to admit any evidence to the contrary. Behavioral economics is a response to that criticism, as is the increased focus on natural experiments.

This has been a good development. But the battle for more attention to evidence is still an uphill one, as Woolley's post demonstrates. The profession as a whole is very enamored with the elegance of certain foundational ideas - revealed preference, Von Neumann-Morganstern expected utility, the First and Second Welfare Theorems, Arrow-Debreu equilibrium, etc. And for a long time, economists were not held to the same standards as natural scientists - we didn't have to prove our theories. Our field grew out of a literary tradition, not an engineering tradition. Smith and Hume were brilliant people, but folks in those days didn't read their books and go "Oh yeah? Well, prove it!"

And so we got spoiled. With no one forcing us to move on from deduction to induction, we were able to shy away from the cold, bitter snowstorm of reality, slam our doors, and simply choose to keep believing in things that sounded good to us. You can see the remnant of this longing in Woolley's desire to "reach for the blue pill" - instinctively, she doesn't want behavioral results to be right, she feels a primal urge to huddle close to the warm fire of classical theory.

But in the end, she can't. As our society became more scientifically oriented, the literary tradition in economics died out - a process that was aided, ironically, by the mathematics that made the foundational results of classical theory so elegant and beautiful. When you make quantitative arguments, eventually people are going to ask where they can find those quantities in the real world. The door to reality has been wedged open, and snow is pouring in. That's why Woolley can't bring herself to "take the blue pill" - for better or worse, we're scientists now, not philosophers.

The only hope for our science - for any science - is to keep alternating between deduction and induction, no matter how long each switch may take. For microeconomics, the challenge is to get a more complete picture of both human behavior and the effects of markets, and to craft coherent theories that make sense of that picture. This effort precedes apace. (As just one example, check out this paper by Dan Benjamin, Matt Rabin, and Collin Raymond, which integrates a bunch of behavioral anomalies into one interesting theory.)

For macro, though, I fear that many of us are still telling ourselves that deduction is all we need - that we should keep putting "theory ahead of measurement," that we should continue to believe in theories after the data has rejected them. That needs to stop, or we'll never get anywhere. I like to think that the awarding of last year's Nobel prizes to two macro empiricists - one who created an alternative to DSGE, and one who rejected a ton of rational-expectations models - is a sign that other people have realized this as well. But it's going to be an even more uphill battle than in micro. Macro has much worse data, after all. It's almost certain that, unlike in micro - where additions like Prospect Theory often represent only moderate tweaks to existing frameworks - most or all of our existing macro theories will turn out to be not even close to right. But we have no choice but to reject those models, or we will eventually fade into noodling irrelevance.

Welcome, economist, to the desert of the real.

(It's, you know, a snowy desert. Like Antarctica.)