MMT stabilization policy — some comments & critiques

“The central idea is that government fiscal policy, its spending and taxing, its borrowing and repayment of loans, its issue of new money and its withdrawal of money, shall all be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrine about what is sound or unsound… The principal of judging fiscal measures by the way they work or function in the economy we may call Functional Finance
Abba Lerner (1943)

First, I want to make clear that the critiques I’ll offer below are not intended to discredit or dismiss MMT. As I’ve said before, I think MMT offers a coherent and important perspective on fiscal and monetary issues that ought to be understood, on its own terms rather than in dismissive caricature, by anyone serious about macroeconomics. MMT is not “true”, but then no theory is “true”. We ultimately judge theories by how useful they are, both in making sense of “the data” we already know and in offering guidance for policy going forward. In my opinion MMT is one of the most useful perspectives in thinking about fiscal and monetary questions.

However, it is still just a perspective. Enthusiasts sometimes present MMT in a manner that’s too complete and hermetically sealed. While some MMT theorizing is based on “double entry accounting” or “obvious, unarguable facts”, when MMT adherents offer non-trivial conclusions, they rely upon assumptions about human behavior that are in fact contestable. I continue to place non-zero weight on theories of government insolvency that MMT-ers have persuaded me are, in a sense, incoherent. Life is complicated, and even absurd prophesies can prove self-fulfilling.

This will be a long post. I’ll discuss each of the seven points I outlined in my summary of MMT stabilization policy. Then I’ll offer some general comments. Before you continue, you should understand the point of view being examined. Please read my previous post first. Or much better yet, read Chapter 1 (Tymoigne and Wray) and Chapter 5 (Tcherneva) of A handbook of alternative monetary economics (ed. Arestis & Sawyer). These essays offer a polished, concise introduction to the MMT perspective. Then spend some time with the “mandatory” or “101” readings on Warren Mosler and Bill Mitchell’s websites.

The summary points from my previous post are repeated below in bold. New comments then follow. I am critiquing my own distillation of MMT stabilization policy, so there is the danger I have set up straw men. If I have, I apologize and look forward to being set straight in the comments. As usual, almost nothing I say will be original. Many of the points I’ll make have been made better by others, for example, in the comments to the previous post, which are extraordinarily good. At a Kauffman Foundation blogger convention last week, I discussed MMT informally but at some length with David Beckworth, Megan McArdle, Mish, and Mark Thoma. My comments will undoubtedly be informed by those conversations.

  1. The central macroeconomic policy instrument available to governments is regulating the flow of “net financial assets” to and from the private sector. The government creates private sector assets by issuing money or bonds in exchange for current goods or services, or else for nothing at all via simple transfers. Governments destroy private sector financial assets via taxation. MMT-ers tend to view financial asset swaps, whereunder the government issues money or debt to buy financial assets already held by the private sector (“conventional monetary policy”) as second order and less effective, although they might acknowledge some impact.

    While the flow of net private sector financial assets does strike me as an important and powerful tool for macroeconomic policy, it is not a uniquely effective tool. Changes in the relative price of financial assets (the object of conventional monetary policy) and in the distribution of financial assets can also powerfully affect behavior, and there are costs and benefits associated with each lever. What is the justification for focusing almost exclusively on managing the level of “net financial assets”?

  2. A government that borrows in its own currency cannot be insolvent in the same way as private businesses. That is, such a government will never face a sharp threshold where it cannot meet promised payments, leading to a socially unanimous or even legal declaration of insolvency and an almost certain run on its liabilities.

    It is unassailably true that a government cannot be forced into insolvency for want of capacity to pay in its own currency. But a government might find itself politically or institutionally unable to meet an obligation despite access to the printing press, and there might be a sharp run on government obligations even without the focal point of formal insolvency that usually occasions private sector runs. It strikes me as an open question the degree to which protection from formal insolvency protects government obligations from disruptive races to redeem. Point #7 below strikes me as stronger protection.

  3. However, the value of money and government claims in real terms is absolutely variable. Governments do and properly should manage their flow of obligations with an eye to supporting that value, among other competing objectives (such as, especially, full employment).

    I think almost no one would argue with this point.

  4. The real value of money and government debt is not reliably related to any theory of government balance sheets. In particular, the stock of outstanding government obligations is largely irrelevant. The value of government obligations is a function of financial flows.Government claims will retain their value so long as the private and foreign sectors wish to expand their holdings of those claims at the current price level, that is so long as agents are willing to sacrifice real goods and services today to reduce their indebtedness, improve their financial position, or stimulate their export sectors. The value of government claims will come under pressure when agents, on net, seek to increase indebtedness or redeem existing claims for real goods and services.

    This is a place where MMT-ers, quite rightly, call out conventional economists on adherence to dogma ill-supported by the data. Empirically, the relationship between government balance sheet quantities and either the price level or private/foreign willingness to absorb government claims is weak. Conventional economists intone seriously about our growing debt-to-GDP, and discuss solvency criteria that no one believes as though they were real. (I don’t think any sensible person believes indebted governments will ever run surpluses of present value greater than the accumulated stock of public debt. Yet that is the party line solvency criterion. [Update: See below]) Theories of the public balance sheet that have proven unreliable continue to be endorsed to avoid inconsistency in the edifice of neoclassical finance. It is true, in extreme cases, that governments that experience hyperinflations go through periods of high indebtedness relative to GDP, but what is cause and what is effect there is murky.

    Macroeconomic theory is often stupid about debt. Common models impose a “no Ponzi condition” that is absurd not only for governments, but also for private firms. All firms and governments eventually end, and when they do, they usually leave substantial claims unsatisfied. Agents lend to corporations and governments not because they believe the debt will be paid down, but because they believe the almost certain eventual default or debasement of claims is unlikely to happen within their investment time horizon. In the real world, governments and corporations balance actual gains from the transfer component of increased borrowing against increased hazard that the end will come quickly and potential “distress costs”. Typically, governments and firms find these costs easy to manage as long as indebtedness grows no faster that “size” (whether measured in terms of revenue or asset values). While it is risky to “lever up” — to increase debt faster than size — many firms and governments do so successfully. We have no reliable criteria of maximum leverage even for firms, let alone for governments. Governments are special. Their core asset is their taxing power. Their liabilities, whether notionally bonds or money, are best understood as preferred equity rather than debt. They face very diffuse liquidity constraints.

    All of that said, I think MMT-ers sometimes err in the opposite direction. They are right that ultimately it is flows (actual or desired) between private agents in aggregate and governments that determine the value of government obligations. But the whole purpose of balance sheet analysis, in the private sector and the public sector, is to predict future flows. That conventional theories of public balance sheets are foundationally stupid and overstate the hazards associated with large stocks of outstanding debt doesn’t invalidate the intuition that flow volatility is likely to be proportional to the outstanding stock of government claims. Suppose, because of a sunspot, private holders of government claims get nervous and try to redeem them for current goods. If the net stock of claims in private sector hands is small, it takes very little taxation to offset that flow. If the net stock of government claims is large, than the desired flows might be massive, and governments might be faced with unappetizing choices between taxation or accommodating inflation. There is little evidence that increasing the stock of government obligations, by itself, increases the likelihood that the private sector will seek (impossibly but disruptively) to divest itself of those claims. But there are undoubtedly fluctuations in the private sector’s enthusiasm for holding money and government debt, and it strikes me as implausible that the difficulty of managing those fluctuations is entirely unrelated to outstanding stock of those claims.

    Also, although MMT-ers are typically regarded as “left” economists, I think they underplay the distributional costs that attend expanding the stock of government obligations. Government obligations, like all financial assets, are disproportionately held by the wealthy. If the government did not accommodate the private sector’s demand for net financial assets, preferring different policy levers to stabilize the economy, wealthy people might be forced to store wealth in the form of claims on real resources, and would have to oversee the organization of those resources into value-sustaining projects. A large stock of “risk-free” financial assets allows people wishing to carry wealth forward to shirk their duty to steward resources carefully and bear the consequences of investment failure. Thus, the availability of government obligations simultaneously degrades the quality of real investment (by disincentivizing supervision) and magnifies the distributional injustice that attends failures of aggregate investment by shifting the burden of those shocks onto risk investors and workers. In theory, governments can mitigate this injustice by careful transfers and expenditures ex post, and that might be the right policy, but in practice those who disproportionately hold existing government obligations disproportionately hold political power, and resist the issue of new obligations which might put dilute the value of existing claims. In practice, a large stock of government claims serves as the lifeboat through which prior wealth inequality carries itself into the future. Absent an accommodative stock of government obligations, recessions would be crucibles that separate the deserving from the undeserving rich, and would thin the ranks of the rich generally. Recessions should be periods that decrease inequality, but the availability of default-risk free claims whose purchasing power is politically protected inverts the dynamic.

    MMT-ers are right, I think, to argue that, for fiat-money issuers who borrow in their own currency, conventional government solvency criteria are false. They are right to argue that such governments have a great deal more latitude to issue money and debt than conventional theories suggest. But that shouldn’t be taken as license to defend carelessness in the distribution of new claims, or to treat expansions of money or debt as entirely cost-free. To be fair, this is a bit of a straw man. Serious MMT-ers think about distributional issues and quality of expenditure, and don’t claim that deficits should be “carelessly” expanded. But in the heat of current policy debates, rhetoric about “deficit terrorists” and money being nothing more than spreadsheet entries unhelpfully obscures that. At its best, a deep point of MMT is that the absence of short-term fiscal constraints creates space for government to craft policy that focuses on the productivity of the real economy. If the mobilization of real resources is wise, fiscal maneuvers will be rendered sustainable ex post. If the real economy will be mismanaged or let to languish and decay, no amount of “fiscal discipline” will save us. The version of MMT that I like best is, oddly, wedded to an almost Austrian sensibility about real investment.

  5. The “solvency” of a government is best understood as its capacity over time to manage the economy in a manner that avoids net outflows. “Net outflows” here means attempts by nongovernment actors in aggregate to redeem government paper for current goods and services.

    I agree entirely. I think this is the best definition of government solvency.

    The MMT-sympathetic Traders Crucible objects, however, to my use of the word “solvency” here, even with the scare quotes. After all, what currency issuing governments must concern themselves with is not insolvency per its dictionary definition (an inability to pay debts), but something quite different, a decay in the value of its claims in terms of real goods and services. Here’s TC:

    [T]he impossibility of insolvency does not mean the fiat currency will have value. A government might be fully solvent even with a worthless currency… This distinction between insolvency and debasement is at the heart of MMT…

    Why is the Traders Crucible going nuts…about the difference between insolvency and debasement?

    Well, we can directly observe the debasement of a currency in an economy through the inflation rate. We can directly observe the process of debasement and loss of value of the currency through inflation. We cannot directly observe the risk of insolvency — it must be inferred from bond price action… the resulting process is one of guesswork, misstatements, boneheaded plans, wild specualtion, and dumbassery, because there is no way to observe the risk of insolvency directly even though it is one of the ideas that govern our spending. …[B]y removing the fear of insolvency, we can more directly observe the risk of debasement… [W]e don’t need to rely on the bond market to “give us signals” about the potential loss of access to their club to determine if we need to lower spending, or raise spending. We can just witness inflation and unemployment and make decisions on these two variables, instead of the three variables of unemployment, inflation, and insolvency… This is a much simpler task, and is perhaps the core strength of the MMT paradigm.

    This is an important point, but contestable. We know with some confidence that the threat of traditional insolvency can lead to powerful and unpredictable runs and a lot of turbulence in the value of private claims. I’m glad to concede that, at the margin, absence of a sharp solvency threshold reduces the likelihood of such events. But does the lack of a sharp solvency threshold eliminate the possibility of sudden stops, Wile E. Coyote moments, etc? Can we be confident that, absent the danger of outright default, any debasement of fiat claims would take the form of an observable spiral, which would start slowly and thereby offer time to apply a policy antidote? Would we in fact observe and recognize the signs, and would they be different than, for example, a 500% increase in the price of gold in the span of a few years and recurring bouts of commodity inflation? Are employment pressure and labor costs the sole true and perfectly reliable indicators of debasement hazard?

    One can make a strong case that increases in labor costs are in fact the sine qua non of uncontrollable inflation, that absent labor income to “ratify” price rises, inflation in inherently self-limiting. But you can make other cases too. Perhaps transfers and deficit spending can substitute for wage power, bidding up commodity prices and the capital share of income even while wages are held back by the reserve army of the unemployed. I’m not sure about any of these stories. But my experience as a trader in capital markets makes me wary of accounts that suggest sharp swoons in the price of any asset cannot happen, or would definitely be preceded by warning signs that would permit one to get out early.

    So, I’ll to acknowledge TC’s objection as important and potentially valid, but defend my positing of an MMT “solvency” constraint, at least with scare quotes in place. I don’t think it’s reasonable for MMT-ers or anybody else to write off the possibility of sharp and unexpected changes in the value of a fiat currency. The possibility is dangerous enough that it should focus the mind in a precautionary way. If MMT policy advice is to be taken seriously, it must offer a some assurance of safety against that scenario. The absence of formal default hazard provides some assurance, but without Point #7 as a backstop, not enough.

  6. Avoiding net outflows is easy in times like the present, when i) low quality and difficult to service debt in the private sector leaves many agents eager to reduce indebtedness and increase their holdings of financial assets; ii) there has been little inflation or devaluation in the recent past; and iii) resource utilization is slack, as evidenced especially by high unemployment. Avoiding net outflows is more difficult when private sector agents’ balance sheets are healthy, or when agents come to expect inflation or devaluation, or when real resources (especially humans) are fully employed.

    I think this point is unobjectionable.

  7. However, a sovereign government can always create demand for its money and debt via its coercive ability to tax. That is, if optimistic agents with strong balance sheets start up a spending spree, or if gold bugs fearful of devaluation ditch government paper for commodities, a government can reverse those flows by forcing private agents to surrender real goods and services for the money they will owe in taxes.

    On the one hand, I consider this point is one of MMT’s deepest insights, and its secret weapon. So long as a government’s taxing power is strong, so long as it is capable of persuading individuals to surrender highly valued real goods and services for the ability to escape liabilities imposed by fiat, exercise of that taxing power creates a floor beneath which the value of a currency, in real goods and services, cannot fall.

    However, relying too overtly on taxation to give value to a currency strikes me as dangerous and potentially counterproductive. A government’s taxing power is limited and socially costly. Governments must maintain a patina of legitimacy so that people pay taxes “voluntarily” or else they must intrusively or even brutally force compliance. In a decent society, it’s perfectly possible that governments will find it politically impossible to tax at the level consistent with price stability goals. A wise, MMT-savvy government would try very hard to regulate the issue of government obligations over time in a way that avoids the need for sharp fiscal shifts in order to stabilize the price level. Avoiding the need for sharp contractions later on might imply slower issue of obligations than would be short-term optimal during recessions. But once you acknowledge this kind of forward-looking dynamic, MMT starts to sound very conventional. We start having to trade off the short-term benefits of fiscal demand stimulation with long-term “exit costs”.

    Two other points are worth making here:

    • Even though, in principal, taxation could be used to regulate economic activity and put value underneath the currency, the institutions that would be necessary to do this successfully are simply not in place in existing democratic polities.

      Within the MMT community, smart people have given a great deal of thought to institutional forms under which which fiscal policy might be used to regulate activity. As far as I know, they have mostly converged upon the institution of a “job guarantee (JG)” or an “employer of last resort (ELR)”, whereunder the size and wage of a “buffer stock” of public labor would become the economic instrument of macro stabilization. This is an ambitious idea, both politically and technically. Not only must one develop appropriate policies for stabilizing the economy on the fiscal side (i.e. the equivalent of a Taylor Rule for ELR wage levels), but one must also plan and implement real-world projects for a variable-sized pool of (hopefully) transient workers. These projects should usefully employ and develop the productive capacity of ELR participants, while remaining distinct from and and not interfering with the ordinary private and public sector workforces. (As I understand the proposal, ELR employees would be distinct from other public employees, in that they’d be paid a standard, low but livable, package of wages and benefits. ELR employment would always be viewed as a backstop that individuals would be encouraged to transition out of, rather than as permanent employment.)

      I’m interested in and sympathetic to the project of designing a government-guaranteed full employment policy that would be complementary to a vibrant private sector and that would anchor rather than disrupt macroeconomic stability goals. But however richly MMT-ers have outlined such an institution in theory, we are very far from implementing such a thing in practice. MMT-ers participate actively in current fiscal policy debates, arguing that “sovereign” governments have sufficient space to let fiscal concerns be secondary to resource utilization goals given their power to tax. Yet the power to tax is next to worthless if we do not have well understood and broadly legitimate means of exercising it in a timely manner.

      Taking a page from status quo macro management — that is, from the world of central banks — the least costly way to meet macro stabilization goals is to maintain credible expectations among the general public that tax policy will in fact be managed with sufficient dexterity and force that those stabilization goals are rarely tested. Existing fiscal institutions are mostly quasidemocratic legislatures that act in sporadic and highly politicized bursts. Their policy ventures typically mix interventions on the liability side of the public balance sheet with ad hoc changes to programs on the asset side that are often difficult to reverse. These institutions seem poorly suited to the task of credibly managing expectations and ensuring, in high-frequency real time, an appropriate fiscal stance. Promoting fiscal license in actual policy while the institutions that would render such license sustainable do not exist strikes me as reckless. When participating in practical debates about fiscal policy, it would be better if MMT-ers would bundle their support for “fiscally loose” stabilization policy with advocacy of institutional changes that could be plausibly implemented in time to matter and that could ensure support of the value of government claims, should that become necessary.

      Some MMT-ers (Warren Mosler and Winterspeak come to mind) have proposed less ambitious institutions than an employer of last resort program, specifically using the level of existing payroll taxes as the instrument of discretionary macro policy. A government can stimulate by reducing the level of payroll taxes (and thereby increasing the flow of net financial assets to the public sector in a manner that directly encourages job formation), and could fight inflation by raising payroll taxes, rather directly reducing wages and putting pressure on employment. Macro policy by unemployment is detestable, despite its long, proud tradition at the Federal Reserve. If it can be made practical, I’d much rather we work out an effective ELR program. But ELR is not an achievable option in the time frame of the current business cycle. Delegating management of the level of the payroll tax to a “technocratic, independent” institution, whether the existing central bank or some new entity, is practically achievable on a short time frame (although the politics would be rough). Perhaps there are better easy-to-implement means of conducting credible, high-frequency macro policy. I’ve no special attachment to payroll taxes as an instrument. (I’d prefer that we use transfers as an instrument.) Whatever the specifics, relying on ad hoc interventions by Congress to thread the needle between inflation and underemployment strikes me as unlikely to work out.

    • This is a technical point that would usually apply mostly to small, open economies, but that arguably applies to the United States today. Taxation can support the value of government claims, when priced in domestically produced goods and services. Taxation cannot support the foreign exchange value of a fiat currency, except to the degree that foreigners desire to purchase domestically produced goods and require expensive domestic currency to do so. A country that runs a large current account deficit owing to decisions by foreign governments to accumulate its currency and that faces competitive export markets cannot rely on taxation to support its currency, should foreign governments revise their policy of accumulation. For a country like the United States which is structurally “short” tradables, one may view the possibility of a difficult-to-counter fall in the value of the currency as a good thing or a bad thing. People like Dean Baker and Paul Krugman argue that a weaker dollar is exactly what the US needs to eliminate the structural gap in tradables production and spur domestic demand. People like Warren Mosler argue that a very weak dollar would be a bad thing, an adverse terms-of-trade shock and a loss of opportunity to trade cheap nominal claims for valuable real resources. Regardless of how you view the event, the taxing power of the government will not be able to undo it.

  8. Therefore, a government’s “solvency constraint” is not a function of any accounting relationship or theories about the present value of future surpluses. A government’s solvency constraint ultimately lies in its political capacity to levy and and enforce the payment of taxes.

    I think this is true, a deep and powerful way to think about public finance. Note that a government’s “political capacity to levy and and enforce payment of taxes” depends first and foremost on the quality of the real economy it superintends. The value that a government is capable of taxing if necessary to sustain the value of its obligations increases with the value produced overall. A government that wishes to be solvent should first and foremost interact with the polity in a manner that promotes productivity. Secondly, the political capacity to levy taxes depends upon either the legitimacy of or the coercive power of the state. A government that wishes to sustain the value of its obligations must either gain the consent of those it would tax or maintain an infrastructure of compulsion. In theory, either choice could be effective, although along with the libertarians, I like to imagine excessively coercive regimes are inconsistent with overall productivity, so that legitimacy is a government’s best bet. The two strategies are not mutually exclusive — a government could be sufficiently legitimate as to be capable of taxing some fraction of the population without resistance and sufficiently coercive as to force the other fraction to pay up. That probably describes the best we can hope for in real governments.

I’ll end with a few miscellaneous comments:

  • I’d like to see more attention paid to quality-of-expenditure concerns. That is, if a stable economy requires continuing government deficits to accommodate growing private sector’s demand for financial surplus, then the government must actually make choices about how to spend or transfer money into the economy. These choices will undoubtedly shape the evolution of the real economy, for better or for worse. Should we rely on legislators to make direct public investment choices? Should we put funds in the hands of individuals and then allow consumer preferences and private capital markets to shape the economy? How? Via tax cuts? A job guarantee? Direct transfers? Perhaps the government should delegate management of public funds to financial intermediaries, and rely upon banking professionals to find high value investments? While MMT focuses mostly on the liability side of the public balance sheet, many critics fear that ever increasing public outlays imply increased centralization of economic decisionmaking that will lead to low quality choices. Whether that is true depends entirely on institutional and political choices. These concerns can be and should be specifically addressed.

  • MMT-ers sometimes blur the distinction between “private sector net savings”, which is necessarily backed by public sector deficits or an external surplus, and household savings, which need not be. In doing so, MMT-ers rhetorically attach the positive normative valence associated with “saving” to deficit spending by government. This is dirty pool, and counterproductive. The vast majority of household savings is and ought to be backed by claims on real investment, mediated by the liabilities (debt and equity) of firms. There is no need whatsoever for governments to run deficits to support household saving. When household savings increases, an offsetting negative financial position among firms represents increase in the amount or value of invested assets, and is usually a good thing. Household savings is mostly a proxy for real investment, while “private sector net financial assets” refers to a mutual insurance program arranged by the state. It is a category error to confuse the two. Yet in online debates, the confusion is frequent. Saving backed by new investment requires no accommodation by the state. It discredits MMT when enthusiasts claim otherwise, sometimes quite aggressively and inevitably punctuated by the phrase “to the penny”.

  • In general, the MMT community would be well served by adopting a more civil and patient tone when communicating its ideas. I’ve had several conversations with people who have proved quite open to the substance, but who cringe at the name MMT, having been attacked and ridiculed by MMT proponents after making some ordinary and conventional point. Much of what is great about MMT is that it persuasively challenges a lot of ordinary and conventional views. But people who cling to those views, even famous economists who perhaps “ought to” know better, are mostly smart people who simply have not yet been persuaded. Neither ridicule nor patronizing lectures are likely to help.

    My complaint is a bit unfair. The MMT community has been sinned against far more than it has sinned, especially within the economics profession. Whether you ultimately agree with them or not, the MMT-ers have developed a compelling perspective and have done a lot of quality work that has pretty much been ignored by the high-prestige mainstream. But a sense of grievance may be legitimate and still be counterproductive.

    The internet is a fractious place. Many MMT-ers are civil and patient, and devote enormous energy to carefully and respectfully explaining their views. There’s no way to police other peoples’ manners. Still, even by the standards of the blogosphere, MMT-ers have a reputation as an unusually prickly bunch. That might not be helpful in terms of gaining broader acceptance of the ideas.

Anyway, that was a lot. I hope that it’s not entirely useless. Despite my complaints and critiques, learning about MMT has added enormously to my thinking about economics. In practical terms, I think that MMT offers the most promising toolkit for crafting a desperately needed replacement of status quo central banking.

With that, I’ll shut up. Feel free to be as nasty as you wanna be in the comments.


Update: The always great Nick Rowe calls me out:

(I don’t think any sensible person believes indebted governments will ever run surpluses of present value greater than the accumulated stock of public debt. Yet that is the party line solvency criterion.)

No, that’s not the party line. In fact, the party line would say that is impossible. The party line says that the *expected* present value of *primary* surpluses (plus seigniorage, if that’s not included) is *equal to* the existing debt. That party line is perfectly consistent, in a growing economy, or in an economy with positive inflation, with perpetual deficits, as conventionally measured (i.e. non-primary, to include interest on debt). Basically, if Nominal GDP is growing at rate n%, then a government can run a conventional deficit of n% times the outstanding debt forever. (Because that means the debt will grow at the same rate as NGDP, so the debt/NGDP ratio stays constant over time.)

Rowe is right to call me out — my wording was sloppy. It was especially unforgivable that, in characterizing the conventional intertemporal goverment budget constraint, I omitted the modifier “primary” before surpluses.

But I was only sloppy, not mistaken. Rowe suggests that, when accurately characterized, the conventional intertemporal government budget constraint is something that sensible people actually believe. I cede no ground at all on this point. Rowe himself does not believe it. He gives himself a partial way out just in the part quoted above, when he writes “plus seigniorage, if that’s not included”. In most macro models, it is not included. There are two ways that you can incorporate seigniorage:

  1. You can treat seigniorage as a cost expected by borrowers and holders of money, in which case it is not disruptive to conventional models. It is equivalent to reducing the interest rate and taxing the value of real money balances, if those are in your model.

  2. You can treat seigniorage as a form of sporadic default. That is, you can claim that at some point the government will simply write down the real value of accumulated nominal debt, in practice by allowing debt or money growth without sufficient yield to prevent an increase in the price level.

The second view is disruptive of conventional models. Rowe may argue that we account for everything by the use of expectations rather than certain values in conventional models. That could be true, but broadly, it’s not. There are some models of default inspired by third-world debt crises, but outside of that, explosive growth in the price level and/or default are modeled are presumed or constrained not to occur. Monetary policy models are a partial exception, in that they derive conditions under which the constraint would hold, which then come to guide central bank policy. But in the limit, under standard equilibria in a decent country, it is assumed or derived that real primary surpluses will (in expectation) be generated in sufficient quantity to offset the real existing stock of debt. I view that as a very unlikely characterization for many existing governments.

Suppose that we do include the possibility of default. What happens? Rowe and I agree furiously on this:

Suppose there’s a 1% chance every year that a firm of government will disappear and default totally on its debt. The probability of default approaches 100% in the limit, going forward. But a risk-neutral investor will happily hold the debt with a 1% risk premium on the yield.

But what does this do to the intemporal government budget constraint? There is no constraint whatever in this characterization. Suppose that the government offers a 2% premium over investors’ cost of borrowing, and the probability of default is exogenously 1%. Then investors borrow and invest without limit! Obviously, we need to “close the model” somehow to make things realistic, but there are lots of ways to do so that violate any ordinary interpretation of the conventional intemporal government budget constraint.

I claim that realistic models, which incorporate consumers who face liquidity constraints and idiosyncratic risk in an economy subject to systematic risks of production shortfalls, do not conform to an intertemporal government budget constraint of remotely the conventional form. I’ve already described half of such a model here. I should add the other half, and write the math down in a way that economists can understand. The key insight is one that both quasimonetarists like Rowe and MMT-ers accept but rarely state explicitly — much of our motivation in “lending to the government” is not to capture growth, bit to self-insure against idiosyncratic risk. There is nothing novel about this — conventional treatments of the permanent income hypothesis characterize the conditions under which individuals will engage in precautionary saving. Redemption of precautionary savings in the form of money or government debt usually works not by government provision of goods and services when an individual faces shortfalls, but by virtue of transfers of real goods and services to those who face shortfalls from those experiencing surpluses. In other words, money and government debt are the medium by which we conduct a mutual insurance program. The stock of government debt then grows as a function of determinants of precautionary savings, which include income, but also risk preferences, the idiosyncratic risk that agents face, and the degree to which borrowing constraints bind. In all periods where the government does not default, participating in this insurance program is straightforwardly beneficial. The risk of rare government defaults, due to systematic shocks, may be insufficient to offset the benefits of participation in the mutual insurance program, and government debt need only be the least risky available medium, conditional on its use for insurance purposes, to rationally attract insurance-motivated lending. Under some circumstances (satiable preferences, steep reduction of incomes post-government-default combined with rationing based on prior savings, little relationship between the scale of insurance borrowing and the likelihood of default), I claim, it is reasonable to expect government debt to grow without bound. I consider these circumstances to be pretty realistic.

The MMT solvency constraint

It is good to see Paul Krugman prominently discussing “modern monetary theory”, although I don’t think his characterization is quite fair.

I am an MMT dilettante, so I’ll apologize in advance for my own mischaracterizations. But I think the MMT view of stabilization policy can be summed up pretty quickly:

  1. The central macroeconomic policy instrument available to governments is regulating the flow of “net financial assets” to and from the private sector. The government creates private sector assets by issuing money or bonds in exchange for current goods or services, or else for nothing at all via simple transfers. Governments destroy private sector financial assets via taxation. MMT-ers tend to view financial asset swaps, whereunder the government issues money or debt to buy financial assets already held by the private sector (“conventional monetary policy”) as second order and less effective, although they might acknowledge some impact.

  2. A government that borrows in its own currency cannot be insolvent in the same way as private businesses. That is, such a government will never face a sharp threshold where it cannot meet promised payments, leading to a socially unanimous or even legal declaration of insolvency and an almost certain run on its liabilities.

  3. However, the value of money and government claims in real terms is absolutely variable. Governments do and properly should manage their flow of obligations with an eye to supporting that value, among other competing objectives (such as, especially, full employment).

  4. The real value of money and government debt is not reliably related to any theory of government balance sheets. In particular, the stock of outstanding government obligations is largely irrelevant. The value of government obligations is a function of financial flows. Government claims will retain their value so long as the private and foreign sectors wish to expand their holdings of those claims at the current price level, that is so long as agents are willing to sacrifice real goods and services today to reduce their indebtedness, improve their financial position, or stimulate their export sectors. The value of government claims will come under pressure when agents, on net, seek to increase indebtedness or redeem existing claims for real goods and services.

  5. The “solvency” of a government is best understood as its capacity over time to manage the economy in a manner that avoids net outflows. “Net outflows” here means attempts by nongovernment actors in aggregate to redeem government paper for current goods and services.

  6. Avoiding net outflows is easy in times like the present, when i) low quality and difficult to service debt in the private sector leaves many agents eager to reduce indebtedness and increase their holdings of financial assets; ii) there has been little inflation or devaluation in the recent past; and iii) resource utilization is slack, as evidenced especially by high unemployment. Avoiding net outflows is more difficult when private sector agents’ balance sheets are healthy, or when agents come to expect inflation or devaluation, or when real resources (especially humans) are fully employed.

  7. However, a sovereign government can always create demand for its money and debt via its coercive ability to tax. That is, if optimistic agents with strong balance sheets start up a spending spree, or if gold bugs fearful of devaluation ditch government paper for commodities, a government can reverse those flows by forcing private agents to surrender real goods and services for the money they will owe in taxes.

  8. Therefore, a government’s “solvency constraint” is not a function of any accounting relationship or theories about the present value of future surpluses. A government’s solvency constraint ultimately lies in its political capacity to levy and and enforce the payment of taxes.

I think this is a clever and coherent view of the world. I do not fully subscribe to it — in my next post, I’ll offer point-by-point critiques. But first, let’s see where I think Paul Krugman is a bit off in his characterization:

As I understand the MMT position, it is that the only thing we need to consider is whether the deficit creates excess demand to such an extent to be inflationary. The perceived future solvency of the government is not an issue.

I disagree. A 6 percent deficit would, under normal conditions, be very expansionary; but it could be offset with tight monetary policy, so that it need not be inflationary. But if the U.S. government has lost access to the bond market, the Fed can’t pursue a tight-money policy — on the contrary, it has to increase the monetary base fast enough to finance the revenue hole. And so a deficit that would be manageable with capital-market access becomes disastrous without.

The real question here is why a deficit that would be inconsistent with price stability with “loose money” would be transformed into something sustainable with “tight money”. From an MMT-perspective, it is the flow of net financial assets from public sector to private, relative to the private sector’s willingness to absorb, that matters. Whether those net financial assets take the form of liquid cash or still very liquid Treasury securities is second order. As Krugman himself has pointed out, conventional monetary policy is just a shift in the maturity of government obligations. If the private sector is unwilling to hold the expanding stock of dollar-denominated obligations at prices (in terms of real goods and services) consistent with our definition of price stability, the private sector will be unwilling to hold those obligations whether they are bonds or money.

An obvious objection is that bonds pay yields that might induce private sector agents to hold government paper at current prices (again in terms of real goods and services), while money historically did not. Krugman’s sustainable “tight money, loose fiscal” scenario basically amounts to pointing out that the private sector can be induced to hold more paper if the public sector promises to make large ongoing transfers to holders of its paper. MMT-ers have mixed feelings about using interest payments to increase the willingness of the private sector to hold government paper. Regardless, since most central banks now pay interest on reserves, these payments no longer serve to demarcate “fiscal” obligations of the Treasury and “monetary” obligations of the central bank. Rather than being divided into “fiscal” and “monetary” policy, we end up with “flow” policy and “yield” policy. In order to stabilize the price level and real spending in the face of changes in private sector demand for government paper, the public sector can either modulate supply (by adjusting the size of the deficit / surplus), or modulate demand via the yield (by altering the interest paid on reserves or selling term bonds). As MMT-er Bill Mitchell puts it, “Our preferred position is a natural rate of zero and no bond sales. Then allow fiscal policy to make all the adjustments. It is much cleaner that way.”

MMT-ers view the size of the flow itself — that “6 percent deficit” — as the primary instrument of stabilization policy. By holding the deficit constant in his thought experiment, Krugman deprives MMT of the means by which it would manage demand. MMT-ers do not claim that fiscal policy can ignore private willingness to hold government assets. On the contrary, they take from Wynne Godley’s sectoral balance analysis that fiscal policy should do a jujitsu to accommodate the changing net demand of the private and external sectors. MMT-ers very much agree that it is important not to lose access to the bond market, broadly construed. But they suggest that the government’s power to tax is sufficient to maintain the private sector’s appetite to hold government paper, whether in the form of bonds or of money. Therefore, there is little need to fret about “confidence” and undead theories of government solvency. The government can issue paper — make transfers, deficit spend, whatever — when the private and external sectors are willing to buy, and reduce deficits or even run a surplus when those appetites have been sated.

Anyway, this is long enough. I’ll post critiques of the view I have summarized later.


Much of my understanding of MMT comes from conversations with the excellent Winterspeak. Obviously, any mischaracterizations are my own and any insights due him. I owe Winterspeak a contentious post highlighting our argument about whether it is detestable for wealthy people to maintain large holdings of money and government debt. I say, for the most part, that it is. If you want to read that argument in raw, unhighlighted form, see the comments here. I’ve also learned a lot from the mysterious JKH.

Some writers of note about MMT include Marshall Auerback, Scott Fullwiler, James Galbraith, Bill Mitchell, Warren Mosler, Rob Parenteau, Pavlina R. Tcherneva, Eric Tymoigne, and L. Randall Wray. You can find the writing of several of these authors in Levy Institute’s working paper series and at Economic Perspectives from Kansas City. Some blogs that occasionally offer an MMT perspective include Credit Writedowns, Naked Capitalism, New Deal 2.0, and Pragmatic Capitalism. See also the related links below.

Update History:

  • 27-March-2011, 7:30 p.m. EDT: Fixed misspelling of Marshall Auerback’s name (sorry!). Added lots of MMT resources and related links, many thanks to commenters Sennex and Tom Hickey as well as Winterspeak for some links. One change to the piece itself (pre-acknowledgements): Changed “modulate the yield” to “modulate demand via the yield”
  • 27-March-2011, 7:45 p.m. EDT: Changed “effects” to “impact” in Point #1, to avoid repetition of “effective” and “effects”…
  • 27-March-2011, 8:45 p.m. EDT: Obsessively removed the “i.e” before “conventional monetary policy”. Also changed “in the present and recent past” to “in the recent past”, just because the latter reads less awkwardly.

The meaning of “socialism” in American politics

So, call me a philistine, but I really think that the Tea Party types have gotten a bum rap over their whole “Keep Government Out Of My Medicare” slogan. Yes, Medicare is a government benefit. One’s Medicare card represents a claim on the government that can be redeemed for goods and services, usually delivered by private sector providers.

You know what else is a claim on government that can be surrendered for goods and services from private sector providers? Money. Yet there is no part of the political spectrum that considers it incoherent to say “Keep Government Out Of My Pocketbook”, even though the only relevant thing your pocketbook contains is government scrip. If the money analogy seems to forced, consider a retirement account chock-full of government bonds. The account contains nothing more or less than government promises to pay, but that doesn’t render it incoherent to object to the government’s altering the terms of the bundle of promises, whether by restructuring the debt or more aggressive taxation.

What the Tea Partiers are accurately if not artfully expressing is that Medicare feels a lot like a property right. Our most important property rights are often claims on people or institutions. This includes all financial wealth — dollar bills, stocks and bonds, pensions and 401-K plans, every form of insurance we buy for ourselves or others provide for us. Medicare and Social Security are, from users’ perspective, property, no different from a privately funded health or pension plan. Why should users think of them as “government benefits” any more than they think of interest payments on a Treasury bond that way? Human beings are notoriously territorial about property. All it takes to turn a human being into a urinating canine is the combination of 1) a readily comprehensible set of nonuniversal rights; and 2) some account that legitimizes differential claims to those rights. Medicare and Social Security have all that in spades. They provide rights to tangible, extraordinarily valuable, transfers and services. People endowed with those rights believe themselves to have earned them, by virtue of having contributed to the programs specifically and to society generally in a quasicontractual arrangement. People consider themselves “entitled” to their entitlements because they view them as property.

Matt Yglesias writes:

Any effort to reduce government spending on health care for the elderly is intolerable socialism, and any effort to increase government spending on health care for the non-elderly is also intolerable socialism. That’s cynical, but it also reflects the objective difference in the age structure between the parties.

I think it’s fair to point out that it’s cynically exploited, but I think the underlying feeling is not really so cynical. The meaning of socialism in American politics is government action to redistribute property rights. It is socialism in America to tax the rich and it is socialism in America to give to the poor. Similarly, it is socialism for the government to change the terms of the extraordinarily valuable set of rights that constitute property to Medicare incumbents, and it is socialism to extend those extraordinarily valuable rights to people who haven’t “earned” them. That may be objectively bizarre for a program that is universal after age 65. But the median Medicare recipient has worked and paid taxes most of those 65 years, views her benefits as earned, and takes herself as representative of Medicare recipients as a class.

Americans, for better and for worse, are unreasonably — almost limitlessly — respectful of what they understand to be property rights. That’s just a fact on the ground. Some interest groups get this: Consider the decades long project of recasting copyright, patent, trademark, and trade-secret protection into “intellectual property” that can be “stolen”, rather than narrow government dispensations intended to advance specific social purposes. People trying to design policy that will actually work in America have to keep this property fetish in mind. It creates both constraints and opportunities, but it is there.

The changing private value of oil in the ground

So oil prices are rising, and, inevitably, a debate is heating up about the role of speculation versus that of “fundamentals”. Ryan Avent makes a point that was commonplace last time our collective heads were on fire about oil prices and it was all the speculators’ fault:

[T]he easiest and most effective way to speculate on the price of oil is to leave the stuff in the ground, and there’s not a thing the American government can do about that.

I thought this was a good point in 2008, the best rejoinder to Paul Krugman’s recurring query that, if it’s speculation, where was the inventory build? But it strikes me as a less compelling point now.

Suppose you are the House of Saud. Like anyone with a position in a traded asset, you face a sell or hold decision. If you expect that the real value of your asset will rise faster than the real value of financial investments you could make at equivalent risk if you sold, then you should hold. Otherwise, you should sell.

But there’s a wrinkle. The House of Saud really must compare the private value of oil in the ground to the private value of alternative investments. Like a middle American muni investor maximizing after tax returns, the House is looking to maximize the value it can actually appropriate. Ordinary taxes aren’t that big a deal to the Saud’s, who after all run the state. But the House of Saud faces a different sort of “tax” on future oil: the possibility that by the time it is exhumed from the desert, it will no longer be theirs to sell. The expected private value of future oil to the House is proportional to the expected future oil price and inversely proportional to the probability of revolution. I’d guess that events of the last few months have significantly reduced their expected private value of oil in the ground, the current oil price spike notwithstanding.

One might even argue that current circumstances amount to a natural experiment by which we might test the question of whether Saudi Arabia in fact has 3.5M barrels a day of spare capacity they can easily bring on line, or whether they’ve basically been running full tilt already. As the probability of revolution — or else a permanent increase in wealth-sharing to forestall revolution — increases, the private value of oil in the ground falls. If flows don’t increase, that could be taken as evidence that the Saudi Arabia is pumping at capacity.

Of course, life is messy, and natural experiments are never perfect. Lots of caveats: The pump-or-store decision should be based on the relative private values of oil and financial investment. If the princes think that, after a revolution, their financial wealth would be frozen by fair-weather patrons in the West, that would tilt things in the opposite direction. The princes might believe that defending their claim to oil in the ground is a better bet than relying upon recently less than reliable Swiss bankers to protect the interests of unpopular clients. (A strange corollary of all this is that if the West wants to maximize current oil flow, it should credibly promise to recognize the House of Saud’s claims on private and sovereign wealth, come what may on the Peninsula. I do not advocate this — I think we should put longer-term interests before concerns about the moment’s oil price. But the logic is clear.)

Also, the princes would have to be mindful of potential backwards causality from pumping decisions to revolution. If it looks like the rulers are ramping production in a panic, that might signal fear and undermine the government’s legitimacy, aiding the revolutionaries’ cause. However, the current price spike and concerns of oil consumers would provide cover. There are lots of reasons besides fear of regime change why the Saudi government might choose to increase production now, if they can.

Obviously, all of this is, um, speculation. Interfluidity is not the The Oil Drum. I know little about the details of oil production or of Saudi politics. But from the perspective of several Middle Eastern regimes, I’d guess that “oil in the ground” seems less of a safe bet than it might have a few years ago.

The case for film subsidies (and other goodies)

Last week, Michael Kinsley published a jeremiad against film subsidies in the LA Times. Two of my fave Economist-oids, Ryan Avent and Will Wilkinson, follow up, Wilkinson with an endorsement of Kinsley’s piece, Avent with a more nuanced but ultimately very radical comment.

Film subsidies and other state and local programs intended to promote economic and cultural activity are sometimes smart policy and sometimes corrupt boondoggles. I certainly don’t wish to argue that they are always and everywhere good. But Kinsley argues that they are always and everywhere bad, via arguments that are as compelling as they are false. Let’s try to understand the economics a bit.

The most widely quoted, and most plainly wrong, bit of Kinsley’s piece is this:

New Mexico under [former Governor] Richardson was a pioneer in this field. In 2002, it began offering a credit of 15% — later raised to 25% — toward the cost of making a movie in New Mexico… Now, 42 states have followed its lead… In less than a decade, the absurd notion of welfare for movie producers has evolved from the kind of weird thing they do in France to an unshakable American tradition… Richardson says that the film and TV subsidy has brought “nearly $4 billion into our economy over eight years” and has created 10,000 jobs. By “our,” he means New Mexico. He says every state should emulate this success.

But of course every state cannot do that because it essentially is a “beggar thy neighbor” strategy.

Ryan Avent is not ultimately willing to endorse film subsidies. But he is too good an economist to let this go by. He writes

A subsidy allows a business to cut prices and artificially raise demand. Given generous enough subsidies, many more movies would be made, and each state could, potentially, have a thriving film industry.

To put the same point differently, film subsidies reduce the cost of production and thereby increase risk-adjusted expected returns to investors. In a world thick with aspiring directors and clever screenplays, there are always hundreds of potential films getting ranked, accepted, but mostly rejected by investors willing to support film production. At the margin, there are films — perhaps quite a lot of films, it’s an empirical question — that investors would deem almost but not quite worth funding in the absence of subsidies. These films get funded and produced when governments sweeten the pot.

Film subsidies are not entirely or even predominantly a “beggar thy neighbor” strategy. They are certainly not, as Wilkinson asserts, a zero-sum game. In many countries, a large fraction of production depends upon state subsidies, and many films would not have been produced without them. The elasticity of film production to subsidy is far from zero.

Still, this is “welfare for movie producers”, as Kinsley puts it, right? Avent describes the excess demand as “artificial”. To which I say, huh?

Kinsley’s “France” is not nearly communistic enough to discredit this pernicious practice. If we really want to drive home the idea that film subsidies are a booger floating in the soup of red-blooded capitalism, we should associate them with that most Bolshevik of all institutions, the, um, suburban American shopping mall.

The economics of a well-designed film subsidy and the economics of suburban shopping malls are identical. State governments offer film subsidies on the theory that film-making within the state will generate ancillary economic activity that will more than offset the cost of the subsidy. Suburban shopping mall developers offer what are effectively rent subsidies to stores they expect to generate extra traffic and sales for the shopping mall. Many of the “anchor stores” — the big, national-brand department stores — at your local mall pay no rent at all, despite occupying vast territories of prime space for which their specialty store neighbors pay dearly. This phenomenon has been carefully studied. Gould, Pashigian, and Prendergast write

[T]he differential contracts offered to the anchor and nonanchor stores appear to not only offset some of the externalities generated by the anchor, but do so in an efficient fashion, at least on the dimension of total sales and rent in the mall. If this were not the case, the result would likely be a misallocation of space: a failure to internalize the benefits of the anchor stores would imply too little space allocated to anchors, because anchors themselves would not consider the external benefits their presence has on the other stores when deciding how much space to lease.

The arrangement that has evolved among private parties via consensual, contractual negotiation is that shopping mall developers effectively tax non-anchor stores with high rents in order to subsidize anchor stores with mostly free rents. Far from “artificial”, if developers did not do this there would be a deadweight cost. If rents were held homogenous within shopping malls, there would be a lot fewer anchor stores, which would deprive smaller stores of the foot-traffic and sales those anchors generate, which would then deprive shopping malls of a lot of potential rent.

Still, the Macy’s, Sears, and Nieman Marcuses of the world have to live somewhere, right? And it’s got to rankle shopping mall developers — you know it does — that a substantial fraction of their hard-built space is given away for trivial or even zero rent. Suppose that all of America’s shopping mall magnates gathered in a smoke-filled room and decided to ban the practice of subsidizing rent to anchor stores. What would we call that? It turns out we have names: “price fixing”, “cartel”, “conspiracy in restraint of trade”.

If shopping mall developers could pull off such a scheme — or really if they could have pulled off such a scheme years ago — they might narrowly have benefited. There would have been fewer anchor stores and therefore fewer shopping malls, but the loss of scale might have been offset by developers ability to, um, extract rents from anchor chains, leading to increased profitability. But that extra profitability would have been an ordinary monopoly rent, of the sort we typically condemn and even criminalize, wherein higher prices are extracted by virtue of a monopolist’s power to enforce underprovision of goods. We’d have the FTC or the Department of Justice all over their asses if shopping mall developers tried to pull something like that.

Similarly, if it is true that film production generates positive externalities for local and state economies, it still might be true that having local governments band together and refuse to provide film subsidies would lead to greater overall tax receipts. The reduction of taxable economic activity due to cartelized subsidy refusal could be offset by the savings realized from withholding the subsidy. If this is so, then state and local governments (in aggregate) profit only by forcing a reduction of activity below the level economists would ordinarily call “efficient”. By not permitting filmmakers to recover some share of the value of the positive externalities they generate, we force a lot of them to take their ball and go home, leaving us all poorer in aggregate.

I don’t think it’s likely, either with respect to shopping malls or with respect to films, that “local governments” would in fact benefit by forming a cartel. In both industries, I think the externalities are real, and despite some “beggar thy neighbor” competition — between shopping malls as between states — these “governments” come out ahead by rebating some of the external benefit back to those who create it and getting a smaller piece of a bigger pie.

Kinsley, in his column, implicitly recognizes that he is calling for a cartel of state governments. “Government, in order to work, must be a monopoly,” he asserts, without explanation or justification. Governments do maintain certain monopolies within their territories, but must the fifty state governments band together and become an uber-monopoly as well? Isn’t much of the justification for federalism the notion that multiple governments experiment and compete, generating creativity and dynamism that wouldn’t exist in a monopoly public sector? How does the fact that “the landlord” is a government alter the economic logic of efficient contracting within competitive shopping malls, which is precisely the same logic that justifies film subsidy?

Distributional issues arise when subsidizing externalities. The local gag store is more sympathetic than a national chain, but the gag store ends up paying the anchor store’s rent. Local taxpayers are more sympathetic than Hollywood studios, yet local taxpayers end up funding Hollywood studio returns. With respect to private sector shopping malls, there’s little we can do about these distributional concerns. In the local government sector, however, it is perfectly legitimate to discriminate by, for example, offering the subsidies only to local filmmakers, however defined. That choice is full of trade-offs: Restricting subsidies to local filmmakers arguably implies that, from a global perspective, some less valuable films get produced in preference to more valuable films. The restriction also reduces the power of the subsidy to generate activity, both in absolute and bang-for-the-buck terms, as there are fewer films locally than globally. But local films may contribute to local culture in ways that taxpayers value, local subsidies go to people more likely to respend money in state (increasing tax recoveries), and distributional concerns are legitimate and serious. These are tradeoffs for taxpayers and their representatives to make based on particularities.

The most serious case against film subsidies, emphasized both by Kinsley and Wilkinson, is the public choice argument. Wilkinson claims that “the film and TV incentives racket is a hotbed of corruption.” That may or may not be a fair characterization, but the point is well taken. The economic logic behind subsidies is iron-clad, given activities that generate net positive externalities whose value is known to be more than the cost of the subsidy. But the externalities of future projects can only be estimated, and estimates by potential recipients of subsidies are rationally overoptimistic. If politicians, perhaps blinded by “personal friendships” with campaign contributors, fail to form independent and conservative estimates of public benefits, then they may offer excessive subsidies, which destroy value while transferring funds from taxpayers to the subsidized.

This is a very serious issue. But it needn’t be insurmountable. Subsidies can be and sometimes are attached to contractual obligations to generate promised activity. Localities do this routinely, and sometimes sue to recover the subsidies if public benefits fail to appear. There is always a lot of uncertainty surrounding indirect public benefits that may result from various activities. But, as Matt Yglesias reminds us:

Life is full of situations that demand you to make decisions under conditions of uncertainty. In almost all cases, the right thing to do is to try your best, not to simply give up.

It is conceivable that we are simply unable to organize governments capable of resisting corrupt inducements, and therefore our best option in a bad world is simply to forego all subsidies. I’m pretty cynical about government, but I don’t think we’re there yet. If that is your position, however, at least get the economics right. Don’t imagine that a blanket prohibition of subsidies, to film or any other activity with positive externalities, is “efficient”. On the contrary, a blanket prohibition is guaranteed to result in underprovision, and likely to result in lower total tax receipts than an optimal subsidy regime. You can argue that in a third-best world, we’re better off accepting very large deadweight costs than the corruption that attends differential taxation schemes. But there is nothing efficient in either of those choices.

In the real world, all successful governments subsidize activities with putative positive externalities. All unsuccessful governments do so as well. In the history of the world, I doubt there ever was a government which has not differentially taxed or subsidized in order to promote allegedly valuable activity. Under the circumstances, I think we should take Yglesias’ advice and try our best to do subsidy well. If we do it right, both theory and evidence suggest that subsidy can do a lot of good. If we do it poorly, we’ll destroy a lot of value and generate corruption. Not doing it at all, in a practical sense, is not an option. I think the case for positive externalities associated with film production is pretty strong. If so, then the right thing to do is to keep the subsidies but to administer them as wisely and as noncorruptly as we can. Distributional concerns matter a lot to me, so my preference as a taxpayer is to support subsidies that discriminate in favor of local and/or “independent” filmmaking (although that invites its own corruption in the form of “definition arbitrage”). More generally, a world without state subsidy is not a world to strive for. It would be as much a libertarian paradise as a ghost shopping mall.


FD: My wife is a film student, aspiring to become an aspiring filmmaker. Perhaps that colors my view of film subsidies.

Update History:

  • 5-March-2011, 11:15 a.m. EST: Changed “Kinsey” to “Kinsley” throughout. Thanks to Leigh Caldwell for pointing out the error, and my apologies to Michael Kinsley for making it.

The overpayers’ club

The overpayers’ club is a club I’d like to join. Somebody, please, help me pay too much. I want to overpay, but I insist on overpaying well.

Here is how the overpayers’ club would work. I’d enter a restaurant, and present my club card. The hostess would swipe the card (or perform whatever the newtech equivalent of a card-swipe is), and then either agree or apologetically refuse to accept my custom as an overpayer. If I am an overpayer, then my meal is on pay what you wish terms. At the end of the meal, an ordinary check would be tabulated and presented. But my payment of that check would be optional, and the amount I pay entirely at my discretion. After the meal, both the amount charged and the amount paid would attach to my permanent record with the club.

Service providers of many different kinds, not just restaurants, could participate in the program. The club would promote a norm, voluntary and nonbinding, that overpayers pay on average at least 10% more than amount billed at pre-agreed or ordinary prices. Providers would have instant access to members’ average overpayment (dollar-weighted), dispersion of overpayments, and any other information they contrive to mine from customers’ overpayment history, when deciding whether to offer price flexibility. The benefit for service providers in participating in the overpayers’ club is obvious. After refusing known cheapskates, they would expect to earn a substantial premium from overpayers. In exchange for that, they risk uncertainty and volatility of cash flows, which they can somewhat mitigate by delivering reliable quality.

Customers benefit from the ability to monitor and discipline relative quality among service providers, from increased agency and bargaining power within the context of isolated transactions, and, when quality is high, from the pleasure and mutual goodwill that comes from overpaying. When quality is low, customers can express that in a way that bites. At a restaurant, if I am unhappy with the quality of food or service, I can pay only half the check. Note that I cannot actually avoid the cost of my meal without putting my reputation in jeopardy. I’ll have to make up for stiffing the bad restaurant by overpaying other establishments unusually much in order to maintain my average overpayment. But I have the power to redirect funds from bad to good establishments without putting my overpayment record in jeopardy.

Besides restaurants, the overpayment club would obviously extend to businesses like hotels and salons. It could be useful for meat and produce purchases at grocery stores (whose bill would be payable after, say, a week, during which the food’s quality could be experienced). More ambitiously, a wide variety of professional services — consulting, programming, even doctoring, lawyering, and teaching — might benefit from the combination of discretionary payments disciplined by transparent and valuable customer reputations.

That’s the basic idea. There are lots of extensions and details to consider. Should merchants’ overpayment experience be accessible by club members or the general public? (Overprice transparency!) Should there be a mechanism by which members can augment past overpayments after some time has passed, both to allow a considered evaluation and in order to ensure that members who express dissatisfaction aren’t shut-out of opportunities to make up for the underpayment? Perhaps there should be a lottery that occasionally denies requests for price flexibility even by the very generous, in order to reduce the social stakes associated with refusals. How should tips and gratuities be dealt with? These are important details, but they are details.

In financial terms, this proposal can be described very simply. I want to give consumers the option to issue equity rather than debt in exchange for goods and services. You and the SEC may not have noticed, but when you sit down at a restaurant, order, and are served a meal, you issue debt. The restaurant extracts an unwritten but enforceable obligation that you pay a fixed sum of money. In exchange for that obligation, you receive an asset of uncertain consumption value. Canonically, the result of financing an asset with debt is to concentrate valuation uncertainty — risk — on the asset’s purchaser. Equity finance, on the other hand, diffuses risk, in exchange for sharing some of the upside if things works out.

Equity finance by vendors is particularly appropriate when the seller has better information than the buyer about the quality of the asset being sold. Vendors selling opaque but high quality assets can predict good realizations, and so are happy to take an equity position. Purchasers interpret sellers’ willingness to bear risk as a credible signal of quality that justifies extra cost. I think that we underutilize equity arrangements at every level of our society. We have made an error, from which we need to backtrack, that can be summed up by the word “commodification”. In the name of a false efficiency, we have struggled to cram everything from corn to cars to financial and legal relationships into the mold of widgets that can be competitively produced, objectively characterized, and then priced in fixed numeraire at arms-length by open markets. If only this could work, if things like financial services really were goods just like soda pop, the uncontroversial parts of microeconomics would vouchsafe easy, efficient commerce and we’d live happily ever after. But it can’t work. Pretending is killing us.

Commodification is a reasonable framework for managing trade in corn and manufactured goods, but is an inappropriate for any thing or practice whose quality is revealed over time. Commodities are appropriately priced in money and financed by debt. Goods and services that are not commodities require more complex forms of exchange than what’s imagined by an introductory economics textbook. What we must “buy and sell”, most of what matters, is relationships. Managing relationships is mysterious, a difficult problem. But we know more than nothing. Just as commodities are naturally exchanged for debt and money, relationship finance naturally takes the form of equity arrangements, in which cash flows are contingent upon variable outcomes. The trouble with equity is that, in most cases, the space of potential outcomes is too complex for the amount and timing of cash flows to be firmly contracted ex ante. Choices must be made, costs and benefits must be allocated, after events have unfolded. Ex post allocation implies discretion and requires trust. Trust outside of local social networks depends upon reputation. As economies have grown, we’ve gravitated to the commodity exchange model, because it is easy to scale with low information and transaction costs. We do not yet know how to reconcile large-scale open commerce with trade based on relationships, reputation, and equity. But in an IT-rich world, we should be able to make progress.

Equity arrangements, when they are successful, have positive social externalities. Fixed-price commodity exchange and ex ante contracting discourage both trust and what most of us would recognize as virtue. If a person receives poor value from a commodity purchase, the question to ask is whether she shopped well. Did she research the product or service she was buying? Did she look elsewhere for better pricing? Caveat emptor becomes a moral duty. Any hint that a transactor has not fulfilled her obligation to be energetically cynical disqualifies her from any claim to our sympathy. Sellers in a commodity world have no obligation but to maximize their advantage within bounds prescribed by law and formal contracts. After all, if buyers are informed, competitive shoppers who assume no beneficence on the part of counterparties, then anything that might go wrong after the sale must already have been priced into the contract.

Equity arrangements flip this logic 180 degrees. Equity relationships are based primarily on trust. Caveat emptor still has a role to play, in that extensions of trust should be merited. Not everyone is trustworthy or competent, so equity providers must be discriminating. But once the relationship is formed, an equity issuer who abuses her discretion and metes out an unfair distribution of risk and benefit, who seeks to maximize her own position to the disadvantage of collaborators, is justly condemned. In an equity world, well-placed trust, fair dealing, reputation, and character are rewarded, while in a debt/commodity world, shrewdness and informational advantage win the day. Designing and understanding our economic interactions more on equity rather than commodity terms would help to diminish some of what is parasitic about liberalism (ht Chris Mealy).

Both modes of commerce, debt/commodity and equity/collaboration, have their place. It’s nice that we can buy toothpaste and cereal without forming a relationship with the convenience store or much worrying about its reputation. Goods that can be standardized, that are easily understood and perform reliably, ought to trade as commodities. But most goods and services fall somewhere between toothpaste and astrology on the information spectrum. Real people in real economies have already invented hybrid schemes that mix the debt/commodity and equity/collaboration styles. Often when we buy complicated and expensive products, we trade them like commodities, but they come bundled with something called a “warranty” that shifts some of the uncertainty surrounding performance back to the seller. Most of us rely very little on the contractual fine print in these warranties, but depend instead on the reputation of the manufacturer or the retailer. We trust that these businesses will deal fairly with us ex post, even if we lack any formal assurance that they will. Without this kind of risk-sharing, a lot of markets would be severely handicapped. In restaurants, the American custom is to issue debt to the restaurant owner, but equity to the server, who is paid almost entirely from discretionary tips. This makes some sense, since we can gather information about restaurants from reputation and experience, but with each visit we patronize a server whom we do not know or choose. Still, even after wasting hours on Yelp, restaurant outcomes are highly variable. The arrangement is a rough on servers, who are at the mercy of generous clients and cheapskates alike, and who bear most of the consequences of errors made in the kitchen. The lack of any means to translate virtue on the part of clients into reputation is unfortunate.

Just as we’d be collectively poorer if no one had made workable the idea of a product warranty, we are poorer than we might be because we’ve not yet invented off-the-shelf tools to manage the information- and risk-sharing appropriate to variable-outcome services. These services resist commodification, but perhaps the infrastructure we use to manage them can be made more standard. The overpayers’ club, and its mirror image, equity finance of business by consumers and other stakeholders, amount to experiments in combining the risk-sharing of a relationship economy with the low costs, openness, and scale of a transactional economy. They are imperfect experiments, but they could be tried. Like always, we’ll stumble into the future. We might as well get started.

Two followups, in way too many words

1. Asymmetry of information about information

In the previous post, I identified government, health care, education, and finance as the “asymmetric information industry”. Arnold Kling makes an important point:

[I]nformation asymmetry is that the sellers know what they are selling much better than the buyers know what they are buying. However, I do not think this is what distinguishes those four industries. There are plenty of other situations of information asymmetry, including buying a house, buying a car, or buying a piece of electronic equipment.

I think what distinguishes these four industries is that the sellers themselves know less than what people expect. Educators do not know what, if anything, actually adds value. For all we know, test scores are determined by the backgrounds (mostly genetic) of the students, with remaining differences that are random and irreproducible.

Kling is right, of course. When writing the previous post, I considered switching to the term “uncertainty industries”, as both buyers and sellers of government, healthcare, education, and financial services are often in the dark about the degree to which transactions will provide value. But “uncertainty industries” suggests a similarity of confusion between buyers and sellers, which isn’t right. Sellers still have substantially better information. First, there is plenty of old-style information asymmetry in all of these industries: Politicians sometimes do know they are favoring or overpaying financially supportive suppliers. Health care providers sometimes do recommend tests and procedures that from a distance they would recognize as superfluous (even accounting for defensive medicine concerns). Educational institutions notoriously play up successes among graduates they know to be outliers. And, of course, the Wall Street tradition of “putting lipstick on a pig” is denied before every jury but widely and even fondly acknowledged when the context is nonspecific.

Still, as Kling observes, this kind of thing goes on in almost all industries. Sellers know more than buyers, salesman overstate benefits and downplay weaknesses of which they are aware, etc. So what makes these four industries different? Two things:

  1. Information asymmetries are unusually difficult to resolve in these industries. A substantial fraction of people who buy a low quality house, car, or stereo eventually come to notice that. This makes it possible for new purchasers of these goods to manage their information problem by researching others’ experience and seller reputations. But in the four industries I’ve described, even after we have purchased services, we are often unable to evaluate their quality.

    • Lots of Harvard grads do well, so reputation “yay!”. But people accepted to Harvard probably would have done well regardless of their choice of college. To the degree Harvard grads do unusually well, it’s hard to disentangle socialization and signaling effects from the benefits of education.
    • In finance, if a merger destroys value or an investment performs poorly, it is rare that the loss can be traced back to poor work by an intermediary. It’s clear that a lot of RMBS were constructed shoddily, even criminally. Yet impeccably produced RMBS of a 2006 vintage would also have performed poorly. Ex post, with full benefit of hindsight, most investors can’t easily tell the difference. Investment banks that put shoddy deals together have not taken reputational hits relative to their peers.
    • Government programs work well or poorly, perhaps provide some value but not as much as we hope. We rarely have apples-to-apples benchmarks by which to evaluate them.
    • Health care outcomes are jointly determined by health care services and often unobservable aspects of patient health. These are hard to disentangle just to evaluate effectiveness. Ranking health-care services in terms of value-for-money, while stakeholders with diverse interests necessarily participate in the research, is very challenging.

    In fact, despite ostentatious use of high technology and sometimes desperate fetishization of metrics, one might describe all four of these industries as premodern.

  2. More interesting is Kling’s point: “sellers themselves know less than what people expect”. That is, service providers in these industries are themselves uncertain of the value they are able to provide. Yet providers work hard to hide and downplay their uncertainty. Politicians pushing new programs offer authoritative projections of brilliant outcomes, although many initiatives fail once the lights of the bill-signing fade. Healthcare, finance, and education are built around credentials and prestige, despite questionable correlations between these tokens and value provided. Healthcare, finance, and educational institutions market themselves hard, portraying themselves as professional, competent, and above all, effective. These claims are not certain to be lies: High competence might sit within the wide confidence intervals that would surround a fair evaluation. But successful institutions do, and must, misrepresent those confidence intervals (to others, and sometimes to themselves). After all, would you go under the knife of a surgeon who told you that he thinks he might be competent? In all of these industries, there is an information asymmetry surrounding the degree of certainty that the services provided will in fact provide value. Providers have reason to be far less confident of their ability to deliver than they lead their customers to believe.

Note that these problems are not just a matter of bad actors. These industries face intrinsically difficult information problems. We can condemn a used car salesman who finesses odometers, but we can’t condemn the surgeon who thinks he is a god. We need him to think he is a god, despite the evidence, so that he is willing to come to work and we are willing to permit the violence he will do to us. Absent reliable markers of quality, we imagine that unreliable self-evaluations are probably better than nothing. “At least he his willing to put his reputation on the line,” we say of the confident doctor when we choose him over his modest colleague, although an egotist’s reputation may not suffer more than anyone else’s when things fail to work out. If our heuristic is to take self-evaluations as informative, competitive forces demand that providers offer “aggressive” self-evaluations. And so they do, in all four industries.

That doesn’t mean politicians, doctors, teachers, and bankers should get a free pass for all the ways they mislead us. There are corrupt practices in these professions that we can detect, that we should condemn and sometimes criminalize. But as long as these are fields in which providers themselves can’t reliably evaluate the quality of the services provided, the rest of us will have a very hard time distinguishing between corrupt practices and natural variability of outcomes. Moreover, these industries are likely to foster particularly insidious forms of corruption. Human beings want both to do well and to do good. Uncertainty leaves insiders ample room to persuade themselves, genuinely, that practices they find remunerative are in fact “best practices”. Under most circumstances, corrupt actors try not to be discovered, and when they are discovered, they are ashamed. When corrupt practices are discovered among bankers, lobbyists, health insurers, pharmaceutical companies, and teachers, our op-ed pages overflow with explanations of how activities that may smell questionable to the uninformed nose are in fact in the public interest. The columnists may be quite sincere. In fact, if you had the sort of detailed understanding available only to industry insiders, you would surely agree with them.

Which brings us back to the original point: We need the “information asymmetry industry”. One way or another, we’ll have bankers, health care providers, educators, politicians, and other sorts of professionals the quality of whose work is difficult to evaluate, by practitioners or by outsiders, ex ante or ex post. But we should acknowledge these are problematic industries for a capitalist economy and a democratic polity. Forecasts that they will dominate, or prescriptions that we should specialize in these sectors to exploit alleged comparative advantage, should be greeted unenthusiastically. I hope that Timothy Geithner takes note.

2. You know that you are getting old when explaining how Marx was wrong now makes you a Marxist

Okay. This is kind of trivial, but it made me giggle.

In response to the previous post, commenter john c. halasz writes:

Your Tyrone has lots of hair on his head and a gray bushy beard.

Matt Yglesias makes the reference more explicit:

[S]ome recent posts from Steve Randy Waldman and Ryan Avent that seemed to me to be walking up toward a Marx-style theory of overproduction, crisis, and the collapse of capitalism.

John Halasz is a good commenter, but I don’t know how old he is. Wikipedia tells me that Matt Yglesias is just over a decade younger than I am. What made me laugh is that the story he describes as “walking up toward a Marx-style theory of overproduction, crisis, and the collapse of capitalism” is basically a retread of the story my parents and high school history teacher told me about why Marx was wrong. That led me to wonder — were Halasz and Yglesias ever told the same story?

Specifically, the story I was told in my impressionable youth was this: Karl Marx had been a sharp analyst, but he was a terrible futurist. He did a good job of describing the dynamic of capital accumulation and the near-term stresses that dynamic would put on the 19th and early 20th century societies. But his prescriptions about how societies would and should respond to those stresses were catastrophically mistaken. In particular, Marx thought that capitalists were trapped in an unstable dynamic of capital accumulation from which they benefited, on the one hand, but which led inevitably to collapse and from which they could not, as a class, escape. Individual capitalists who tried to be “enlightened” in some sense would simply be sloughed off by competitive forces and join the ranks of masses. In modern economic lingo, there was a collective action problem. Capitalists would not, could not, surrender their privilege voluntary, therefore violent revolution by the working classes was the only possible way forward.

I remember pride in my businessman father’s voice when he explained to me that this was wrong. Marx had underestimated the ingenuity and flexibility of capitalist societies, and particularly of the United States during the New Deal. Government intervened to solve Marx’s collective action problem, enabling capitalists secure their enlightened self-interest by keeping a distribution of prosperity sufficiently broad that the predicted collapse could be avoided. My parents were (and still are) center-left, but staunchly anti-Communist. My mother had “escaped” — that was always the word — Communist Romania; she was (and remains) deeply grateful to the countries (Israel and the United States) into which she was rescued. To my father, American capitalism’s adaptability and ingenuity had proved Marx definitively wrong, in the best possible way — by producing a stable society that served the vast majority of its citizens, while countries whose politicians had followed Marx’s prescriptions grew into monsters.

I am not a particularly original thinker. Most of my posts are mutations of ideas that people better than me have whispered in my ears. I used Tyrone, in the previous post, as an exaggeratedly arrogant mouthpiece for my father’s story, with the minor twist of letting technology rather than capital dynamics be the force that would lead to collapse, but for the ability of the system to adapt via new institutions. Having heard essentially the same explanation in high school history class, I took this story to be widely shared conventional wisdom, at least within the mainstream, slightly center-left milieu in which I adolesced.

That would have been 1985 or 1986, Ronald Reagan’s America. Communism was a living rival then. Stories of our relative material success, of our system’s ability to deliver far better lives, even to the “working classes”, than the Communists, were a matter of national security. Matt Yglesias lived his 16th year in a very different world. America was triumphant and forging the “Washington consensus”. “Right-sizing” had already been invented as a euphemism for firing people. The project that Reagan had begun by “standing up to” the nation’s air traffic controllers was well underway. If a young Matt Yglesias had the misfortune of chatting with me in, say 1997, I would have had little good to say to him about labor unions but would have enthused about the transformative power of free markets and technology. I like to think of myself as unconventional, but I like to think a lot of things. I think it fair to say that the conventional wisdom that surrounded a curious, very bright teenager in 1997 would have been different from what I experienced a decade earlier, for better and for worse. I think this matters, it affects us all a lot more than we think it does.

Anyway, I really did giggle when I realized that an argument I thought of as conventional wisdom about how America proved Marx wrong sounded, perhaps because my audience was of a different generation, vaguely Marxist.

I’m not taking issue at all with the substance of Yglesias’ post, which I think is smart and quite right. Health care costs are millions of people’s livelihood, and inefficient health care costs are a big part of that. Much of how modern economies survive is by protecting information problems and barriers to competition that sustain overpayments. This broadens the wealth distribution while permitting recipients the fiction that flows of purchasing power involve no transfers (“welfare”), only proud, self-reliant income. The theory of labor unions and the theory of an inefficient health sector are identical, except one is more transparent and the other has proved more capable of buying political protection. The problem, in both cases, is not that there are transfers, but whether the distribution of transfers — to whom, from whom — is wise and fair. By forcing ourselves to pretend there are no transfers, we prevent ourselves from even posing the question.

Perhaps I am a creature of the conventional wisdom of my day, but I want to tell it strong. It is not those who advocate, but those who prevent, stabilizing transfers of purchasing power, who are the true Marxists. These self-styled capitalists do not espouse Marx’s theories, but they do something much worse: They perform them. They behave in precisely the way that Marx expected capitalists to behave. They cripple the American system’s greatest strength — its ingenuity, flexibility, adaptability. They prevent the sort of collective action through which earlier generations proved that capitalism could made be consonant with decent, stable, and broadly prosperous societies. In doing so, they risk proving Marx right.

Update: Not unusually, commenters have had much more interesting things to say than I’ve said. Nicholas Gruen @ Club Troppo has made a full post of an excellent comment by Indy. Also, Arnold Kling has responded.

Update History:

  • 21-February-2011, 7:45 a.m. EST: Added bold up about Nicholas Gruen hoising Indy’s post, and noting Arnold Kling’s response

On Tyler Cowen’s “Great Stagnation”

I’m late to this party, but I’m late to every party. Tyler Cowen’s recent microepic, The Great Stagnation, has been pretty throughly chewed over by the blogosphere. The essay is a quick read, thought-provoking, and getting to give Cowen a couple of bucks for the privilege only adds to the pleasure. The quick summary, for those who’ve been living in a cave, is that since 1973, we’ve been living in a “great stagnation”, during which the pace of growth experienced by the median American household slowed relative to expectations set in the period preceding. Cowen suggests that the explanation for this is a slowdown in the rate of technological change combined with an exhaustion of “low hanging fruit” afforded us by earlier advantages and innovations. Cowen simultaneously disputes both conventional measures of economic performance (we do not observe a “great stagnation” in headline GDP) and left-ish arguments that economic unhappiness stems primarily from maldistribution. We suffer instead from an absence of anticipated wealth. As Cowen puts it, we’re simply “poorer than we thought”.

  • I think the deepest issue Cowen brings out has less to do with technology than with problems in what economists measure (and people perceive) as “revenue” or “production”. In particular Cowen makes two related points:

    1. Many activities that generate apparent revenue are detached from reliable judgments of value. Using revenue as a measure of production requires, at a minimum, that discriminating, budget-constrained actors determine that whatever is “paid-for” offers real-economic value superior or at least comparable to activities that could be inspired by alternative expenditures of the funds.

      Cowen is appropriately general with this critique. Expenditures by government may not meet this “market test” because political actors may direct expenditures for reasons other than inspiring high-value economic activity, or because, for informational or organizational reasons, government may be unable to discern relative value. But the private sector is not immune. In spheres such as health care and education, the benefits of private sector as well as public sector expenditures are difficult to evaluate relative to alternative uses of resources. Cowen reminds us that health care and education are widely viewed as “growth” sectors, but to the degree we collectively overpay for them, “revenue” overstates economic value. A substantial portion of these expenditures should probably be accounted for as transfers and excluded from measures of aggregate production. But of course, we have no means of estimating the size of the appropriate haircut.

      I’d add another important industry to government, health care, and education: financial services. Like with health care and education, we simply are unable to evaluate the degree to which payments to financial service providers represent wise use of resources and to what degree they represent transfers to financial industry stakeholders. Inherent informational problems associated with investment quality, combined with the temptation by service providers to exploit these difficulties to extract transfers, render financial sector revenue highly suspect as a marker of value. Also, financial services are intimately involved in the other problematic sectors: One thing that binds government, health-care, and education is that all are financed in roundabout and sometimes opaque ways that soften near-term budget constraints and that shift costs and risks, both across time and onto people other than the purchasing decisionmaker. The means by which government, health-care, and education are financed help keep them vulnerable to agency and information problems.

      I think of government, education, health care, and finance collectively as the “information asymmetry industry”, and I find it terrifying that many people presume that they are the future growth industries for the United States. Dani Rodrik has pointed out that tradable goods are special, in terms of engendering development in often corrupt emerging markets. Cowen offers an astute explantion: tradables that compete in international markets are usually low-information-asymmetry goods. Apparent value (revenue from trade) and real value are likely to be closely aligned and hard to fake. I worry that specialization in the information asymmetry industry could be an antidevelopment strategy for developed countries.

    2. Conversely, Cowen points out that many new technologies generate value without generating commensurate revenue. It is clear that we would collectively pay a lot more for recorded music or news, for example, because we did in the past (and it’s likely that our reduced payments have more to do with technology and industry changes than with changes in our preferences). Cowen suggests that many of the current era’s technologies are like this, which is nice from a certain perspective (yay! free stuff!) but can cause a kind of sclerosis in an economy that nourishes itself via flows of monetary exchange.

    I think that Cowen is right on both counts. And note that these two factors, in and of themselves, go some way towards explaining “The Great Stagnation”, even before we get to the headline argument about a slowdown in technological change. I’m not referring to an argument Cowen addresses (but cannot entirely dispose of) that there is no great stagnation at all, once we account for measurement error. Instead, I wonder whether, rather than a paucity of new technologies, we might be experiencing a breakdown of an older gizmo that economists refer to as “markets”. As our economy tilts away from sectors in which value (however defined) and financial revenue are reliably cojoined, our primary means of orienting our behavior towards valuable activity, individually and collectively, become less and less effective. We simply don’t know what we ought to do. So we err. If the quality of economic decisionmaking is poorer than it was in past, that has consequences for welfare.

  • An interesting corollary of Cowen’s argument is that a substantial fraction of notional savings are in fact empty claims — no meaningful real economic activity accompanied the generation of that income, so no real investment could have attended its non-consumption. This suggests that any attempt to mobilize savings in aggregate — any net dissaving — is likely to result in either inflation or displacement of consumption by current earners. I think that this is true, that it is now and increasingly will be a source of social and political problems.

  • Despite the evidence that Cowen is able to muster (and lively internet debates about kitchen appliances and time travel), I remain agnostic on the question of whether a slowdown in the pace of technological change is largely to blame for whatever it is that ails us. I wouldn’t rule it out, but like Kevin Drum and others, I see a lot of very real “low hanging fruit” arising enhanced capabilities to coordinate and collaborate via internet and information technologies. These benefits go well beyond “cognitive surplus” and bemused infovoria. [1] Coordination technologies, ranging from assembly lines to the limited-liability joint-stock corporation, contributed mightily to past golden ages of advancement and growth.

    Cowen is clearly right that, with the exception of the internet, recent years have offered few technologies that radically and visibly altered how people live. But I think we need to think carefully about an “extensive” and “intensive” margin for technological change. The early industrial revolution largely streamlined manufacture of existing categories of goods (think textile factories rather than spinning wheels and molded products replacing hand-smithed metal). Producers saw their world turned upside-down, but consumers mostly found themselves with recognizable stuff, just more and cheaper. Still, one wouldn’t characterize it as a low-growth era.

    Cowen seems really focused on the “extensive margin” — the development of qualitatively new goods. I don’t think “growth”, in aggregate or as experienced by the median family, really captures what Cowen thinks we are missing. Instead, I think that Cowen is lamenting a scarcity of breathtaking resets. Developments like electrification and the widespread adoption of automobiles didn’t make people richer as much as they completely changed the circumstances of everyday life. Indirectly, they also made the production and marketing of previously extant goods much more efficient: Electricity helped make bread cheaper. But I don’t think cheap bread impresses Cowen as much as the fact that, post-electricity, humans colonized the night and Presidents colonized living rooms. Income statistics do end up capturing these sorts of changes, but in a manner that is arbitrary and formal. Ultimately, different technological regimes are incommensurable in welfare terms. While most of us would choose more food over inadequate nutrition and better health over worse, adoption of new technology is less a matter of individual choice than social evolution. One must adopt an automobile-centric lifestyle if workplaces move far from available housing. One must become internet proficient if current modes of employment are contingent upon it. The fact that the gas we are forced to purchase is factored into computations of real income and GDP doesn’t really imply that our preferences have been satisfied more completely than they would have been in a different-technology alternative. [2] It might be the case that the big changes whose absence troubles Cowen are welfare-destructive in and of themselves, but occurred only because they came bundled with large improvements in the productivity of prior goods, or simply because new possibilities rendered unstable earlier equilibria that were superior outright. If this is the case, we should celebrate rather than fret if recent modes of innovation have succeeded at increasing productivity without reseting the technological terms of our existence. [3] Ultimately, society is a game and big technological changes rescramble both the available strategies and payouts, leading to changes that are unpredictable both in form and in terms of welfare (under almost any welfare criterion that you might choose).

  • Suppose that it is true that we’re poorer than we’d anticipated, that past growth trends have eased. It’s not at all clear that what people conventionally think of as technology is the growth-limiting factor. Cowen looks to emerging markets for examples of how the availability of low-hanging fruit — technology and institutions already prevalent in developed economies — can hypercharge growth. But the less-developed world offers a different set of examples as well. There are many many economies where despite free and full availability of scientific information and plenty of institutions to emulate, low-hanging fruit is left to wither on the vine. We have (usually cartoonish and patronizing) explanations for other economies’ failures — “they” are corrupt and their cronies keep them down; they were scarred because of colonization by Belgians rather than Brits; (in whispers) they are culturally or even genetically inadequate to the task of development; they simply fail to make good choices. Whatever your just-so story, it’s pretty clear that from the inside, intelligent people struggle unsuccessfully to find means to overcome barriers that prevent them from picking delicacies that are hanging in front of their noses. We might be in a similar situation, with plenty of technological fruit ripe for the picking, but invisible barriers — political, cultural, whatever — that prevent us from doing so.

  • A few nights ago, a gentleman accosted me in a dream and declared himself to be “Tyrone”, Tyler Cowen’s evil twin. Tyrone told me that his brother had “as usual” got it all backwards. In fact, he told me, we’ve been in the Great Stagnation for a century as a result of, rather than for the lack of, technological progress. The median household is experiencing wealth stagnation caused by technological change. Households are feeling the pain now more than in the past, even despite a relatively modest pace of change, because over the past few decades we have managed to avoid employing the sort of durable and effective countermeasures to stagnation that have succeeded in the past.

    For the most part, Tyrone pointed out, technological progress is labor displacing. It simultaneously creates valuable new techniques for reconfiguring real resources while diminishing the number of people who are required to participate in those transformations, and who can therefore trade their participation for spending power. There is a myth among neoliberal economists that labor markets have always “adjusted” sua sponte: that when laborers were displaced from farms, “higher value” factories arose to employ them; that when the factories were downsized and offshored, a more pleasant, higher-value service economy came to be; etc. That narrative is wrong, he told me. At best it is criminally incomplete. With each technological change, new social institutions had to arise to sustain dispersed purchasing power despite a reduction of numbers and bargaining power of workers in old industries. Displaced workers ultimately did find new work, but only because the new social institutions “artificially” created buyers for all the things displaced workers reinvented themselves to sell. Without this institutional innovation, Tyrone tells me, something like the Great Depression would have been the new normal. Historically, institutions that have arisen to sustain purchasing power despite increasingly labor-efficient core production include direct government transfers and expenditures, labor unions, monetary policy interventions, financial bubbles and financial fraud.

    Cowen (Tyler, that is) argues that technological development creates opportunities for “bigger”, more extensive and intrusive government than existed during earlier periods. As Tyler tells the story, there is a progressive expansionary impulse to government, for which technological change creates opportunities, so government expands until those opportunities are fully exploited. Tyrone says his brother has the story backwards. Why, asks Tyrone, does government not only expand in absolute terms as a response to technological change, but also in relative terms? After all, as Tyler points out, private enterprise also has a natural expansionary impulse. With technological change, Tyler writes, “Everything was growing larger.” Yet, to the degree that we can measure it, government has grown dramatically in its share of the overall economy. Why does government win? Tyrone says government is a reluctant adopter of new technology (“Have you been to a government office?”), but that government outgrows the private sector despite this, because the concentration of economic power that attends technological changes demands countervailing state action if any semblance of broad-based affluence and democratic government is to be sustained. Tyrone (who is much more arrogant and less pleasant than his brother) proclaims this to be his “iron silicon law”: In (non-terminal) democratic societies, technological change must always and everywhere be accompanied by the growth of institutions that engender economic transfers from the relatively few who remain attached to older productive enterprises to the many who require purchasing power not only to live as they did before, but also to employ one another in novel or more marginal activities that were not pursued before. Inevitably those institutions develop in state or quasi-state sectors (which include the state-guaranteed financial sector and labor unions whose “collective bargaining” rights are enforced by the power of the state). Tyrone tells me that the only thing the post-Reagan “small government” schtick has accomplished is to push this process underground, so that covert transfers have been engineered by a “private” financial sector in ways that are inefficient, nontransparent, and often fraudulent according to traditional laws and norms. Some of these weak institutions upon which we relied to conduct transfers broke in 2008, so now we’re really feeling the pain. We’ll continue to feel the pain until we restore the ability of the financial system to hide widespread transfers, or until we employ some other sort of institution to provide a sustainable dispersion of purchasing power.

    Having met both brothers Cowen, I can state with some confidence that Tyler is smarter, better-looking, and much more engaging company over lunch. Tyrone is kind of icky, hygienically speaking, and he strikes me as gratuitously mean. But I think he has a point.


  • [1] Cowen does acknowledge the possibility the internet is generating low-hanging fruit, but that there are lags in the indirect process by which a communication and coordination technology translates into consumer visible improvements.

    [2] Even a thought experiment that holds health and nutrition constant but contemplates switching technologicolifestyles doesn’t cut it, because preferences are history-dependent. Emigration is a painful option even when better health and more food await on the other side of the border. We love the world that makes us. We’d really need to ask people in 1900 whether they’d prefer to move to our strange, televised world or to stay where they are but with 21st century health and wealth in terms of then-extant goods. If we allowed cross-migration between the 1900 and 2011 on those terms, giving people of both eras ample time to sample both eras, it’s not clear to me in which direction net migration would flow. To run this experiment, we’d have to correct for population differences and exclude groups that were plainly oppressed in 1900. (We’d want to exclude those groups from the sample, if what we are interested in is the welfare associated with technological, rather than social, change. It’s not obvious that the civil rights movement could not have happened independently of electricity or automobiles, although one could make a case that relaxation for the need for exploitative labor was a precondition for that movement.) Also, there’s the difficulty of simultaneously allowing both ample information for comparison and the sublime pleasure associated with not knowing what you are missing with respect to life in the other era.

    [3] I hasten to add that I, personally, am a technophile, and curious enthusiasm for technological resets is much of what I live for. But I don’t think that’s a very general or even common preference.

    Update History:

    • 14-Apr-2012, 10:00 p.m. EDT: More than a year later, Tyler Cowen and Scott Sumner have said nice things and relinked this piece. I gave it a reread, and though I remain happy with the substance, I found some textual and grammatical embarrassments. So no substantive changes, but I’ve made some small edits:
      • “…renders render financial sector revenue highly suspect as a marker of value.”
      • “it’s more likely that our reduced payments have more to do with technology”
      • “any attempt to mobilize savings in aggregate — any net dissaving — is likely to be attended by result in either inflation or displacement of consumption” (eliminated repetitive use of “attended by”)

Alison Snow Jones

Maxine Udall, “girl economist”, has been one of my favorite bloggers, a person who combines the power of economic thinking with a deep appreciation for moral and social concerns, all expressed in a very human, very charming, voice.

Today we learn that her name in real life was Alison Snow Jones, and that she is with us no more. Wow. This is an awful loss.

I don’t really know what to say. But Maxine Udall had plenty to say, so I’ll just excerpt.


From ‘Tis the season, by Maxine Udall:

I grew up in a family business and have become increasingly appalled over the last 10 years or so by what seems to me to be a very limited view of the duties, obligations, and responsibilities of business… You see, in our business we were not profit maximizers. We were business men and women, embedded in a community, our fate intertwined with that of the community. We had to make enough money to stay in business for the long-haul. That meant that our customers had to keep coming back, we had to provide value, and we had to work, to sell. No one who walked into our business was greeted with “Let me know if I can help you.” The customer was like a sacred guest. Our job was to find out what she needed, to tell him as much as we could about the merits of our merchandise, to help them identify and purchase the best match for their preferences and their pocketbook, or to send them to a competitor, with directions on how to get there, if we didn’t have and couldn’t get what they were looking for.

Our long-term survival depended on some amount of profits, but equally important were reputation and civic responsibility. These three are what we optimized over, not profits alone. We viewed all of these as interdependent. That meant that sometimes reputation and civic obligation were a constraint on profits.

I can understand that someone who has managed to capture a privileged economic and political position, one where they are backed by US taxpayers as they gamble for personal gain in financial casinos, will do whatever they must to maintain it. And I expect that over time, if unchecked and unchastized, they will take on increasing amounts of risk, underwritten by the rest of us. What I didn’t expect was the magnitude of the moral failure: that financiers would help to create securities designed to fail, sell them to clients, and then bet against them.

What I can’t understand is the willingness of the citizenry to protect and reward someone who has harmed or is continung to harm them. I do not understand voting for politicians who support tax cuts for and neutered regulation of these same destructive speculators. Nor do I understand voters’ apparent willingness to eviscerate all of the social programs and safety nets that are all that stand between them and what can only be regarded as neo-feudalism. I conjecture that the reason for this counterintuitive behavior is that the moral narrative that accompanies a technocratic tax cut for the wealthy is more compelling that the moral narrative that accompanies a technocratic stimulus of aggregate demand or support for families harmed by the financial sector’s market and moral failures.

If you had told me 10 years ago that I would become a critic of investment bankers and an advocate for labor, I would have said that you were crazy. I was weaned on horror stories about the New Deal, the WPA and CCC, wage and price controls, and the horror of unions. (And, if we ever return to a point where unions become so powerful that they impede business, I will blog against them.)

I got into this conversation because I felt I might be able to contribute clarity for those not trained in economics and a different perspective. It has been an exciting and stimulating conversation. I’ve thought and read more about macroeconomics than I ever did in grad school. I have developed a real fondness and respect for my readers and their very thoughtful comments and for my fellow economics, anthropology, sociology, and biology bloggers, especially Mark Thoma, without whom only five people would ever have read this blog.


From Sensible Deficit and Debt Reduction Will Require Investment, by Maxine Udall:

[Y]ou have to spend money now in order to reduce expenditures or increase revenues in the future. Remember that government debt in and of itself is not necessarily a bad thing, nor is personal or corporate debt. The judgement of “good” or “bad” will depend on many things, including the expected returns from any investment made with the borrowed funds, the terms under which funds must be repaid, and the financial health of the borrower, which will influence the likelihood of repayment and (I suspect) the quality of the investment.

After all, leadership of a thriving, growing business that did not borrow to fuel continued growth would be judged incompetent. By the same token, leadership of a hard-hit business in the middle of a economic downturn that focused only on debt reduction without some thought and investment (at record low costs) devoted to building a solid platform for recovery and future growth would also be judged incompetent.

The leadership of a hard-hit country in the middle of an economic downturn has additional economic and moral obligations. One economic obligation is to compensate for contractions in consumer demand by stabilizing and (in the case of a severe downturn) stimulating aggregate demand. A government stabilizes demand by providing and extending unemployment benefits and by enacting programs like Medicaid, Medicare, social security as well as other safety net programs like food stamps and Temporary Assistance to Needy Families. Cuts to any of these takes money out of the pockets of poor, working class, and middle class Americans and is likely to contract demand further.

A government can stimulate aggregate demand by accelerating investments in infrastructure, research, and defense. By borrowing at record low rates, it can bring those necessary investments that it would have made in the future forward to the present, thereby maintaining and also creating jobs that otherwise would be lost because of the current downturn. Such investment has the effect of stimulating demand now and keeps the economy from sinking deeper into recession or depression. It has the added advantage, if done wisely, of creating better health, education, and economic infrastructure that benefits our grandchildren and their grandchildren. The historically low cost of borrowing means that the cost to our grandchildren of repaying the loans for these investments are likely to be lower than the benefits they will realize from the investments, if they are made wisely.


From What’s Wrong with This Picture?, by Maxine Udall:

It’s a tribute to the GOP’s ability to engineer a morality play that plays out in politics, but is mostly about economics. If debt were all that was morally wrong, we could be purely technocratic and raise taxes. Since taxes are morally wrong, we can only cut spending. And as we decide how to cut spending, the morality play will provide us with a narrative where the least and last will benefit most from a good, swift kick to get them jump started and if they don’t “jump,” well then it’s their own fault if their kid dies of (untreated or too-late-treated) leukemia while they were unemployed and without health insurance.

It remains to be seen whether we can persuade the middle class to cut their own future safety net or that of their parents, but I’m pretty sure that a grossly distorted moral narrative can make that happen, too. Unless, of course, we come up with a compelling moral counter-narrative in support of the technocratic solutions to these moral dilemmas.

If we do, it had better be quickly and in ways that are easily expressed in 25 words or less.


From Another Conversation about Health Care Costs, by Maxine Udall:

Always a quick study, dad got it.

“So what you’re saying, Maxine, is that to reduce health care costs, I would have to run my business in a way that ultimately puts me out of business. If I do a good job of preventing illness and making my customers healthier, they won’t come see me as often or buy as much from me. Eventually, I’ll have to close my doors or figure out some other way to make money.”

“Yes, dad. That’s exactly what you would have to do, if you were serious about reducing health care costs. Or you would have to change your business so that you make money from healthy people. Now what market forces would produce that result? (And don’t say: convince healthy people that they’re in reality sick. The pharmaceutical industry already does that and you see where it’s gotten us.)”

I’m still waiting for his answer.


From On Why Sound Macro Policies Are Political Losers, by Maxine Udall:

Joan Robinson (girl economist) said something in her Richard T. Ely Lecture to the American Economic Association in 1972 during another economic crisis that I believe accounts for some of the “political loser” characteristics of good macro policies:

“A sure sign of a crisis is the prevalence of cranks. It is characteristic of a crisis in theory that cranks get a hearing from the public which orthodoxy if failing to satisfy. … The cranks are to be preferred to the orthodox because they see that there is a problem.”

I believe that the failure of “good macro policies” to be political winners is that they “fail to satisfy” on the dimension that matters most and is most visible and understandable to the public: fairness or justice.


From Company Store Redux, by Maxine Udall:

Our current situation in which 5% of the population captures and owns a disproportionate share of national output, which it then lends to the teeming masses whose share of output has been stagnant or dwindling, is really just a new variant of the company store.

Miners worked in company mines with company tools and equipment, which they were required to lease. The rent for company housing and cost of items from the company store were deducted from their pay. The stores themselves charged over-inflated prices, since there was no alternative for purchasing goods. To ensure that miners spent their wages at the store, coal companies developed their own monetary system. Miners were paid by scrip, in the form of tokens, currency, or credit, which could be used only at the company store. Therefore, even when wages were increased, coal companies simply increased prices at the company store to balance what they lost in pay.

And just in case you’re thinking that this doesn’t seem too unfair, consider that:

Miners were also denied their proper pay through a system known as cribbing. Workers were paid based on tons of coal mined. Each car brought from the mines supposedly held a specific amount of coal, such as 2,000 pounds. However, cars were altered to hold more coal than the specified amount, so miners would be paid for 2,000 pounds when they actually had brought in 2,500. In addition, workers were docked pay for slate and rock mixed in with the coal. Since docking was a judgment on the part of the checkweighman, miners were frequently cheated.

I first wrote about company stores last summer:

In Kumhof and Ranciere’s model, increasing concentration of wealth in a small “investor” class leads to higher demand for investment assets, such as securitized pools of loans made to wage earners who must borrow to maintain consumption as their real income declines. This sets up the same type of dynamic as a company store. Over time and as wage-earner bargaining power weakens, the investor class is able to capture greater proportions of workers’ declining or stagnant real wages. The effect is that an increasing portion of middle-class wages circulate back to the financial sector as interest and fees instead of into the larger economy (except, of course, as it occasionally “trickles down” from the investor class to what over time is likely to become the equivalent of a servant class).

For the last 30 years, the government has been part of the problem in this trend to increasing income inequality. It’s time for government to become part of the solution in reining in financial sector excesses and restoring workers to something that approximates a fair share of national output. Otherwise, most of us will eventually find out what its like to “owe our soul to the company store.”


From Bang per (Borrowed) Stimulus Buck, by Maxine Udall:

So here’s the question my mundane, raised-in-Appalachia, offspring-of-simple-business-men-and-women, forget-the-PhD-in-economics brain keeps asking: What does the financial sector produce, besides economic chaos? Where’s the benefit for most of us or for most of the US? And if the financial sector isn’t going to provide the service of deploying capital to support investments that benefit the rest of us, who will?

In an ideal world, the US government would. In an ideal world, where most of the populace who would benefit from such investment do not respond to the dog-whistle term “socialist” by forming political groups funded by plutonomists to protect plutonomists, US taxpayer dollars would support investment in infrastructure and human capital that would prepare us all, not just the top 1%, to be productive participants in a 21st century global economy. Instead, our tax dollars have been deployed to no-pain, no-downside bailouts of guys who turned around and awarded themselves bonuses for running us into the ditch. Now, finance and US politics seem committed to sustaining and feeding a casino and fostering an increasingly unstable and unfair plutonomy, instead of rebuilding a nation dominated by a productive, hard-working, ambitious middle class.

This is the most unsatisfying morality play I have ever watched.


From Freedom Is Not Just Another Word for Nothing Left to Lose, by Maxine Udall:

You see, in a capitalist economy, wealth and well-being are supposed to redistribute to everyone. As capital is allocated and risk managed more efficiently, more opportunities are created for all. Wealth and well-being are supposed to become less concentrated in the hands of a few and more dispersed to the hands of the (often more and increasingly) productive many. Much of Wealth of Nations is devoted to describing the instances and the conditions under which this seemed to be occurring as the economy of Great Britain transitioned from feudalism to one of commercial exchange, industrial production, and small business owners.

Some of you will point out that elected US lawmakers of both parties appear to be wholly owned by corporations and finance. Even if you believe this, it hardly argues for shrinking government, thereby giving corporate and other interests even more unfettered power. It argues for a political philosophy that believes government serves an essential purpose in an advanced, complex capitalist society: that of countervailing force against those interests when they are harmful to the rest of us and helpful to those interests when they are beneficial to us. That philosophy requires government to be as large as it needs to be to countervail. And it requires that government be viewed as capable of being efficient and that the culture and norms of government be those of public service, not public pillage.


From The Death of Capitalism?, by Maxine Udall:

[C]redit is the quintessential American capitalist thing most frequently experienced directly by consumers (IMO). I remember in grad school when one year my adjusted gross income was around $6000. Bloomingdales offered me a credit card and I took it. Never used it, but I took it. I remember feeling secretly pleased and amazed that someone so poor could carry around a credit card from an upscale, overpriced retail outlet at which one could not possibly afford to shop. I think I acquired a Neiman-Marcus card the same year. I did eventually use N-M once to buy a wedding gift for someone (after I graduated).

By my last couple years of grad school I was earning enough working part-time to qualify for an FHA mortgage on a small townhouse in the city where I was working and attending school. I cobbled together some small amount for the down payment and the closing costs and I was a homeowner.

I hit one rough patch about 8 years into my 10 year residence in the house. I was non-tenure track faculty, required to fund 100% of my salary from grants. I was about to be down 50% in salary support if a grant or two didn’t come through in time. There was a real possibility that I would lose my job (or more likely drop to part-time while I looked for a new job).

Under the misguided notion that the corporation holding my mortgage was my partner (the loan had been sold several times), I thought I should probably phone them to find out what my (our) options might be. I was thinking I could make interest payments for 3-6 months and then structure some sort of “make up” payment once I was employed full-time again. It took me 3 weeks to track down a phone number for the company that owned the loan. No 800 number. Every time I was put on hold or phoned the wrong department, I paid for it. I finally got to someone who seemed responsible, laid out my situation, explained that there was a good chance I would not lose my job, that even if I did, I was a PhD economist and most likely would have a job rather quickly, that all I wanted to know was what my options might be if I did lose my job. The person on the other end of the line very kindly informed me that there were no options, that he was putting a flag on the account that if I missed one payment they should start foreclosure proceedings immediately. He thanked me for letting him know and saving them some time.

Well, there you are. Doesn’t that make you feel better? I know it evoked some interesting feelings in me.

As luck would have it, a fairly large grant on which I was principal investigator came through, my job was saved and my house with it. Being no slouch at spotting losing propositions, I did two things…well, three things actually. I got married. I went on the job market and took a tenure-track position. And I (we) bought another house.

But this time, I knew what to avoid mortgage-wise. We found a local bank that holds all of the mortgages that it originates. We paid an extra half percentage point for this. Well worth it in my opinion. When I had cancer (and thanks to an extremely supportive employer) there was no worry that I would lose my job (at least not right away), but it helped immensely to know that if I had and we had to sell the house, the bank would have worked with us. And they did work with us in non-predatory ways on refinancing, home equity loans, and anything else we needed for the 10 years we owned the home.

Look. This is the heart of capitalism. I want to borrow money to own property. The bank wants to lend money for which it receives a return that reflects risk and the opportunity cost of what it lends. This is a marvelous arrangement for a lot of reasons. Not least, my ownership of said property is a near guarantee that it will be maintained and mowed, improved, and the loan paid off. The fact that all my neighbors face the same incentives to maintain and mow, improve, and pay off creates a web of interlinked well-being. As the neighborhood goes, so go we all.

No good can come from neighborhoods populated by home-owners who have devolved into squatters. Nor can any good come from neighborhoods wholly or mostly owned by banks, particularly large banks with no vested interest in the community. Moreover, capitalism, as experienced and lived by a population whose ancestors started out as squatters with “tomahawk rights,” that evolved over time to homesteaders and, eventually, homeowners, is getting a very deserved bad name.

If capitalism has held a special place in the hearts of US citizens, it is almost certainly because most of the working and middle class have been able over time to acquire a little bit of heaven on earth: their own home, bought and paid for by them. Their homes are tangible evidence of their hard work, their prudence, their temperance, and their perseverance. Those homes and the loans that made them possible were also tangible evidence of the partnership between labor and capital; between homeowner and banker; between mini-capitalist and serious-capitalist.

I will say it again. They are tangible evidence of a partnership, a mutually beneficial contract between banker and home buyer. Not adversaries. Partners.

What makes this worse IMHO is that the current mortgage morass appears to be the result of capital’s failure to observe and adhere to the rudiments of property rights: the proper and legal transfer and holding of a title and a promissory note; the proper and legal processing of said documents to initiate foreclosure; and a level of outright cruel and confiscatory behavior that until lately I had only associated with totalitarian governments. (If you doubt me, see here).

So this is a message to bankers and anyone else who at least putatively cares about capitalism and commercial exchange. I am probably among the most sympathetic to both and to the institutions that support them. I am losing sympathy. Nay, I have lost it. This is the stuff from which revolutions are born and you will have brought it on yourselves. The problem is that capitalism when done right yields real value, real benefits to us all. So when it dies, when you have killed it, as with all of your other financial chicanery, we will all pay the price.


p.s. Excerpts, of course, do not do justice. There is tons of wonderful writing, in long form and carefully argued, on the Maxine Udall blog. I scan and read so many blog posts every day, even great writing often fades into the background. Going through the last few months of her work makes me terribly sad that this is a person I will never meet.

Belated write-up of AEA/AFA meeting, Part I

Update: I accidentally posted an earlier draft of this post rather than the intended final draft. I’ve restored the intended final draft. Changes are listed at the end of the post.


Two weeks ago I had great fun in Denver spending three-days attending seminars and lectures given by the great and good of academic economics. Since then, I’ve been holding it all in my head precariously, until I write some things up. (Writing is the process whereby I permit myself the pleasure of forgetting.) I expect that what follows these words will be long, sprawling, and disorganized. But for what it’s worth.

A note — The AFA gave me a $1500 grant to attend. That was kind of them. Thanks.

General Impressions

This was the first time I’d attended an economics conference. But in my early adolescence, I did frequent another sort of hotel-bound gathering, and the resemblance was uncanny. The AEA is basically a Star Trek convention in suits. It’s a gathering of the same sort of geeks. The same combination of earnestness and awkwardness marks off and distinguishes the attendees from normal business travelers. Star Trek conventions have their celebrities, here’s George Takei, there’s Nichelle Nichols. The AEA has its celebrities as well: the Nobelists, the famous economists from Chicago, Harvard, and MIT whose papers you have read (or you pretend to have read). Like a kid at a Star Trek convention, I had great fun at the meetings. Still, there were undercurrents that made this affair feel less innocent — so many PhD students nervously interviewing for jobs; the networking and earnest introductions; the faint, polite stench of status competition. At a Star Trek convention, everyone wants to meet George Takei. No one is trying to become him.

The Highlight

For me, the highlight of the meeting by far was lunch with Scott Sumner and Scott Wentland. We had a grand conversation. Readers of both blogs might imagine the authors of The Money Illusion and interfluidity to be on opposite sides of a great divide, but it didn’t feel like that at all. The quality of mind I value in other people and strive for in myself is a kind of nimbleness, a fluidity of mind. The world is too complex for any particular narrative to be perfect. Good judgment, I think, comes from the ability to slip between and among stories, to understand the ways different accounts might be true, to marshall evidence and reasoning on both sides and then assign weights to a superposition of competing, sometimes contradictory ideas, all of which play a role in ones choices. Sumner and I understood our different perspectives very quickly, and took one another seriously, though we’d probably weight accounts very differently. Further, though I suspect he will bristle a bit at the characterization, within the economics profession I view Sumner as an ideologue in the very best sense. There’s both a moral and a methodological component to that. Sumner is driven, scandalized even, by what he sees as a profound and preventable failure of monetary policy. He’s shocked that the rest of his profession (which he’d previously considered himself to be in the middle of) has shrugged this off, that economists don’t get in their guts how awful an abdication of policy has occurred. So Sumner has made it his full-time preoccupation for two years to communicate and persuade, working to change his colleagues’ intuitions about what is acceptable and what is not. He has a reasonable (though not unassailable) model of how the economy works, and a coherent vision of a policy regime that would be wise under that model. Recent experience suggests that implementing Sumner’s policy regime, under which the monetary authority both commits to and is able to target NGDP, would be eased by tools that are institutionally or politically unavailable under current arrangements (e.g. NGDP futures markets, negative interest on reserves, perhaps more flexibility with respect to asset purchases). Rather than working within existing constraints, he has made lobbying to alter them part and parcel of his campaign to shift the intuitions of his colleagues with respect to the conduct and duties of monetary policy.

I’m not entirely on board with Sumner’s project. I have longstanding concerns about status quo monetary policy. I’m not sure NGDP is a sufficient statistic for a decent economy. I share some of Arnold Kling’s concerns that monetary policy may be unable to solve information problems with respect to patterns of production, consumption, and income, along with old Austrian-ish concerns that monetary expansion can lead to counterproductive distortions towards “dumb” interest-rate sensitive investment. I’m not sure that the Fed credibly could target NGDP, even with the expanded toolkit Sumner proposes, and I worry about the fiscal costs and economic consequences if markets test and manage to break a drifting NGDP peg. Sumner offered some interesting rejoinders. He pointed out that the worst distributional effects of crisis policy — the various bailouts and subsidies intended to put a floor under outcomes for “systematically important” financial institutions, the panicked money-flows post-Lehman — might have been avoided if NGDP-targeting monetary policy were sufficiently credible. If the path of NGDP is certain, it is possible that no institution would be too big to fail. The idea is that, whatever micro-level complications and litigations and reorganizations the failure of a major bank might provoke, if at a macro-level real GDP and employment remain sufficiently OK, nonintervention would become politically and morally thinkable. (Of course, you can argue this is wrong, that big bank failures cascade so disruptively that pegging NGDP would be insufficient to prevent a collapse of real production, so policymakers would continue to intervene. But note the congruence of Sumner’s view and Rajiv Sethi’s.) Sumner dislikes and generally opposed bank rescues, but he pointed out that one way to look at the subsidies to banks is government undoing costs inflicted by bad policy. Nominal debt is contracted around expectations about nominal growth, and by failing in its duty to ratify those expectations, monetary policy failure was responsible for the increased debt burdens and reduced asset values that harmed banks. Therefore, some compensation might be justified. That’s an interesting argument, but it turns on what expectations we deem reasonable ex ante. The Fed has never committed to NGDP level-targeting, so perhaps banks ought to have been expected to manage leverage cautiously and to be tolerant of fluctuations. Moreover, the argument can’t explain or justify the distribution of intervention during the crisis. If government is responsible for changes in the real debt burden associated with failure to stabilize NGDP, then there ought to have been compensation for indebted households and nonfinancial firms. But subsidies and interventions went disproportionately to banks, and disproportionately to just a few banks.

Despite some misgivings, I think Sumner’s project is serious and interesting, and we could do a lot worse. It’s not exactly what I would push, but there’s plenty of overlap and I wish him well. At a high level of abstraction, I find Sumner’s “center right” views to resemble the “far left” post-Keynesian Chartalists, or “MMT-ers”. Both Sumner and the MMT-ers choose a macro target and a policy instrument, and suggest that micro problems will work themselves out if the consolidated government/central-bank is vigilant about supporting the target. MMT-ers choose (net) fiscal spending as their instrument, while Sumner chooses monetary policy under an unconventionally expansive definition. Some MMT-ers would target unemployment (often at zero, via a direct government jobs guarantee). But others argue that the government should deficit-spend at the level that supports GDP without provoking inflation, which is not too different from Sumner’s NGDP target. (Sumner argues that, at reasonable growth rates, NGDP targets are likely to be met by sustaining real GDP rather than by inflation.) Am I alone in seeing the similarities?

Like Andy Harless (but see Sumner’s rejoinder), I think the distinction between fiscal and monetary policy has grown very blurry. Monetary reserves are now interest-bearing obligations, ultimately paid for by the state. Some Fed “liquidity facilities” involved issuing interest-bearing obligations to buy up private sector assets (at prices above those offered in private markets). That sounds like fiscal policy to me. While it can be argued that conventional open-market operations only transform the maturity of government obligations, by anchoring the yield curve and increasing the fraction of debt that can be used directly as a medium of exchange, conventional monetary policy may increase the willingness of private agents to hold US debt, reducing constraints on spending and enabling expansionary fiscal policy. Fiscal policy and monetary policy are intertwined, and it’s not clear to me that either dominates the other. (There’s an aphorism, I think Tyler Cowen’s originally, that “the monetary authority moves last”. That doesn’t persuade me. Timing of endogenous phenomena tells one very little about causality. Timing of moves in a game tells us very little about which player has the advantage.) Ultimately, I’ve come to think that the main differences between fiscal and monetary policy are institutional. Decisions about what we call “fiscal” and “monetary” policy decisions are made in different ways by dissimilar entities. Those decisions can reinforce one another, or they can offset and check one another. Some people prefer to emphasize the role of fiscal authorities for “democratic legitimacy”, while others champion action by an “independent central bank”, on the theory that isolation from overt politics will yield technocratically superior choices. You can accept these preferences on face, or more cynically argue that some groups expect one or the other decisionmaking body to execute policy in ways that that favor preferred interests. Regardless, at a macro level, Sumner’s NGDP targeting monetary policy and MMT-ers’ GDP-supporting fiscal policy look similar to me. Both perspectives arouse my sympathies but provoke misgivings. First, I’m not sure either instrument is up to the task of stabilizing the target over a long horizon, and worry that attempting but failing to stabilize may prove riskier than conventional muddling through. Second, I think the micro-level stuff really does matter. In order to ensure both high quality resource allocation and distributional legitimacy, I think it matters very much what is paid for with fiscal expansion, and precisely how monetary policy is to be conducted. (I offered a proposal a while back that now looks like a bizarre hybrid of Sumnerism and Chartalism, which tries to address micro-level concerns.)

I’ve been remiss in not saying much about Scott Wentland, who was actively engaged in our conversation but is less clearly identifiable with a position. Wentland describes himself as a devil’s advocate, but I’d characterize him more as a satanic Socrates — he’d listen, carefully reinterpret a comment, then politely punctuate his review with a challenging question. Still, for all the finance and economics I encountered at the conference, Wentland is the only person whose work suggested a way to actually turn a profit. Wentland presented a paper at the conference. I missed the presentation, but read the paper after the fact. It is empirical work very nicely done, and it tweaked the antennae of my inner, amoral arbitrageur. I now think of registered sex offenders as roving Groupons for home flippers. Wentland and his coauthors provide strong evidence that you could make a lot of money persuading an ex-cellmate to move near a nice, four bedroom home in rural Virginia, and then to move away after you’ve bought the home.

[Update: Wentland et al simply documented the effect on home prices and liquidity of nearby registered sex offenders, in a careful and empirically sophisticated way. The “arbitrage” is my poor attempt to say something clever about it. However, commenters inform me that the scheme I’m implying mirrors an old and well-known strategy with racial overtones, a parallel which I did not intend to draw. Thanks to commenters Kindred Winecoff and TGGP for pointing this out.]

Anyway, those are my musings on lunch. I’ll take a breather and leave my comments on the lectures and seminars I attended to future posts.

Update History:

  • 23-January-2011, 6:50 p.m. EST: Restored intended final draft — somehow I mistakenly posted an earlier draft! This draft differs from the previously posted draft:
    • The current draft makes clear that Scott Sumner generally opposes bank resucues, despite the argument that some bank subsidies can be viewed as compensation for bad policy
    • The current draft adds a line re Scott W’s “devil’s advocacy”
    • The current draft omits a gratuitous joke re fraud at banks;
    • The current draft adds a comparison between Sumner’s views and those of Rajiv Sethi
    • The current draft includes more links in general
    • Probably some other minor differences
  • 23-January-2011, 7:20 p.m. EST: Added update re “blockbusting”, Thanks to commenters Kindred Winecoff and TGGP.
  • 25-January-2011, 7:10 p.m. EST: Corrected mssplling of “Chartalists”, many thanks to supercommenter JKH for pointing out the error!