Obama, Tone Deaf?

I think Maureen Dowd has nailed it. Here's a bit from her latest NY Times op-ed:

The recession redo, paid for by the nonprofit White House Historical Association, was the latest tone-deaf move by a White House that was supposed to excel at connection and communication. Message: I care, but not enough to stop the fancy vacations and posh renovations.

As Obama himself said in February 2009 when he released his first budget: “There are times where you can afford to redecorate your house, and there are times where you need to focus on rebuilding the foundation.”

It might have been wise, given America’s slough of despond, to hark back to a time when presidents just went to work and took their office pretty much as they found it, without the need to make a personal statement. As the former White House curator Rex Scouten once told me, in the era from Taft to Truman, the green rug in the president’s office was changed only once, when it wore out, to a new green rug.

I can't believe that Obama doesn't hear the grumbling. But he acts like he hasn't. That or he doesn't care. Looks to me like Maureen Dowd is joining me in the Obama-as-Marie-Antoinette crowd.

Mission Accomplished?

I didn't see the point of Obama's speech about the "end of the combat mission in Iraq". It struck me as a junior partner to Bush's infamous "Mission Accomplished!" speech on the deck of the USS Abraham Lincoln aircraft carrier.

I'm not the only one to think that Obama has missed a great historical occasion by doing too little too late. Here's a bit from a Martin Wolf article in the FT:

Suppose that the US presidential election of 1932 had, in fact, taken place in 1930, at an early stage in the Great Depression. Suppose, too, that Franklin Delano Roosevelt had won then, though not by the landslide of 1932. How different subsequent events might have been. The president might have watched helplessly as output and employment collapsed. The decades of Democratic dominance might not have happened.

On such chances the wheel of history turns. But this time was different: the crisis brought Barack Obama to power close to the beginning of the economic collapse. I (among others) then argued that policy needed to be hugely aggressive. Alas, it was not. I noted on February 4 2009, at the beginning of the new presidency: “Instead of an overwhelming fiscal stimulus, what is emerging is too small, too wasteful and too ill-focused.” A week later, I asked: “Has Barack Obama’s presidency already failed? In normal times, this would be a ludicrous question. But these are not normal times. They are times of great danger. Today, the new US administration can disown responsibility for its inheritance; tomorrow, it will own it. Today, it can offer solutions; tomorrow it will have become the problem. Today, it is in control of events; tomorrow, events will take control of it. Doing too little is now far riskier than doing too much.” This was right.

While Bush and Obama are look alike twins in giving foolish speeches to celebrate non-events, they differ in fundamentals. Bush was a man in way over his head and didn't understand issues or history. But he was fearless and foolish. Obama is a smart cookie, but he is far too cautious and conservative. The times demand bold moves, radical changes in direction, new hope being given. But Obama is timid and takes baby steps.

Sadly, I agree with Martin Wolf's conclusion:

So what is going to happen? I assume that, after the midterm elections, resurgent Republicans will offer new tax cuts and ignore the fiscal deficits. They will pretend that this has nothing to do with any reviled stimulus, though it is much the same thing – increasing fiscal deficits, thereby offsetting private frugality. That would put the administration on the spot. It would have to choose between vetoing the tax cuts and accepting them, so allowing the Republicans to get the credit for their “yacht and mansion-led” recovery. Any recovery is better than none. But it could have been much better than this. Those who were cautious when they should have been bold will pay a big price.

Teaching Mathematics

Here's a nice video of a math teacher talking about his approach at a TED Conference in March 2010:



I taught high school math many years ago. I was full of enthusiasm, but I was beaten down by the hostility of the students. Sadly, I was not able to step back from the process and understand how "trying harder" was not working. The nice thing about the above video is that is shows a teacher looking at his materials and using knowledge of his students to re-shape the lesson in a way that more effectively engages the student. This is a highly inspiring talk on education.

But my experience was that educational trainers and educators and the institution generally overlook the one big elephant in the room: the students don't want to learn. Dan Meyer mentions this and his solution is to make the materials "compelling". That is great in theory but hard in practice when you have a room full of kids with very different agendas. So, I applaud Meyer's inspirational techniques. I wish all teachers could achieve this standard. But I'm not going to hold my breath. It is just plain too hard.

Police Incompetence & Indifference

I find it funny that the US likes to pat itself on the back as a "freedom loving" country, but they allow their police extraordinary powers without reasonable restraint. The following is a sad tale of how owners of a flight school get apprehended for a "stolen" plane when in fact the plane was legitimate. What the government does is recycle serial numbers on planes. So the serial number of an old 1968 Cessna that had been stolen was given to a new 2009 Cessna. But the government didn't bother to update its database. So this couple was arrested at gunpoint for a "crime" they didn't commit. The only "crime" was one of incompetence by the various police authorities in the US. And to top things off, this isn't the first time police "apprehended" this plane mistakenly. They arrested some other poor sucker a year and a half before and still hadn't bothered to update their databases to stop making this arrests of innocent people:



I find John King's advice to be inadequate. He says "If this happens to you just comply with the police officers because you are at risk of getting shot, and work it out later." Sure. But from what he says, the police authorities have shown no interest or willingness in "working it out later". In fact, he points out that this very same mistake had happened once before on this very same plane. So, his "advice" in practical terms to his fellow Americans is "just let the authorities threaten you and just put up with it". So much for "freedom loving" Americans. I find it funny that supposedly the Americans fought a revolutionary war with Britain because they were outraged over the forced quartering of the King's troops by heavy handed military/government officials. It is interesting to see that modern Americans just "put up with" police threatening innocent people and making that mistake over and over again.

More detail can be found in an article on the Aircraft Owners and Pilots Association web site.

Moral Hazard in the Minds of Conservatives

Here is a bit from a post by Robert Reich that looks at the kooky ideas that are causing the fabric of civil society to unravel in the US:

Tonight it was Harvard Professor Robert Barro, who opined in today’s Wall Street Journal that America’s high rate of long-term unemployment is the consequence rather than the cause of today’s extended unemployment insurance benefits.

In theory, Barro is correct. If people who lose their jobs receive generous unemployment benefits they might stay unemployed longer than if they got nothing. But that’s hardly a reason to jettison unemployment benefits or turn our backs on millions of Americans who through no fault of their own remain jobless in the worst economy since the Great Depression.

Yet moral hazard lurks in every conservative brain. It’s also true that if we got rid of lifeguards and let more swimmers drown, fewer people would venture into the water. And if we got rid of fire departments and more houses burnt to the ground, fewer people would use stoves. A civil society is not based on the principle of tough love.

In point of fact, most states provide unemployment benefits that are only a fraction of the wages and benefits people lost when their jobs disappeared. Indeed, fewer than 40 percent of the unemployed in most states are even eligible for benefits, because states require applicants have been in full-time jobs for at least three to five years. This often rules out a majority of those who are jobless – because they’ve moved from job to job, or have held a number of part-time jobs.

So it’s hard to make the case that many of the unemployed have chosen to remain jobless and collect unemployment benefits rather than work.

What I find repugnant is that "conservatives" bemoan any public policy that helps the bottom 98% of the society, but have no qualms over TARP funds, bailouts, big bonuses for Wall Street types that caused the financial crisis, etc.

I have a hard time trying to picture what kind of civil society these so-called "conservatives" are trying to preserve.

What Current Economics Got Wrong About the Current "Great Recession"

Paul Krugman does an excellent job of summarizing the failures of current economists. He points out that economic theory is up to the task, but unfortunately economists have unlearned the economic lessions of the 1930s so their policy prescriptions have been all wrong.

Here is the key bit out of a recent NY Times blog posting by Paul Krugman:

Contrary to what you may have heard, there’s very little that’s baffling about our problems — at least not if you knew basic, old-fashioned macroeconomics. In fact, someone who learned economics from the original 1948 edition of Samuelson’s textbook would feel pretty much at home in today’s world. If economists seem totally at sea, it’s because they have carefully unlearned the old wisdom. If policy has failed, it’s because policy makers chose not to believe their own models.

On the analytical front: many economists these days reject out of hand the Keynesian model, preferring to believe that a fall in supply rather than a fall in demand is what causes recessions. But there are clear implications of these rival approaches. If the slump reflects some kind of supply shock, the monetary and fiscal policies followed since the beginning of 2008 would have the effects predicted in a supply-constrained world: large expansion of the monetary base should have led to high inflation, large budget deficits should have driven interest rates way up. And as you may recall, a lot of people did make exactly that prediction. A Keynesian approach, on the other hand, said that inflation would fall and interest rates stay low as long as the economy remained depressed. Guess what happened?

On the policy front: there’s certainly a real debate over whether Obama could have gotten a bigger stimulus. What we do know, however, is that his top advisers did not frame the argument for a small stimulus compared with the projected slump purely in political terms. Instead, they argued that too big a plan would alarm the bond markets, and that anyway fiscal stimulus was only needed as an insurance policy. Neither of these arguments came from macroeconomic theory; they were doctrines invented on the fly. Samuelson 1948 would have said to provide a stimulus big enough to restore full employment — full stop.

So what we have here isn’t really a lack of a workable analytical framework. The disaster we’re facing is the result of the refusal of economists, both in and out of the corridors of power, to go with the perfectly good framework we already had.

It is utterly tragic that these kinds of mistakes are being made. All the unnecessary suffering. All the lost production. Gone and for no good.

I look at the US over the last 10 years and I see a series of utterly incomprehensible mistakes made by government: wars of "choice" that are presented as tiny things that end up taking ten years and thousands of lives and trillions of dollars, a hurricane disaster that was completely foreseen a year before it happened and was allowed to happen and for a week the governments at all levels did nothing while people died, and the biggest financial crash since the Great Depression and the only "mobilization" that has been done is to pump a trillion dollars onto the balance sheets of banks that party on giving their top execs obscene "bonus payments" while Main Street goes down and millions of Americans are thrown out of work and tens of millions of houses go "underwater" and foreclosed.

This is an unmitigated disaster and not a politician in sight who will stand up and declare "This is a disaster! We can do better! This must not be allowed to stand!". Nope. Instead you had a president in Bush who would crow "Heck of a job, Brownie!" or "Mission Accomplished!" showing a complete ignorance and indifference to the real situation on the ground. You have another president who trots out a "Change we can believe in slogan" and then promptly changes nothing. What a disaster!

How Goes the "War on Terrorism"?

The legal cases are a mess. Just look at this McClatchy newspaper report:

U.S. has now lost 75 percent of Guantanamo habeas cases

A federal judge has ordered the release of another Yemeni captive at Guantanamo, the 37th time a war on terror captive in southeast Cuba has won his unlawful detention suit against the U.S. government.

Judge Paul Friedman's order in the case of Hussein Almerfedi at the U.S. District Court in Washington, D.C., instructs the Obama administration to "take all necessary and appropriate steps to facilitate the release of petitioner forthwith.''

...

The U.S. government has won just 14 of the 51 decided cases filed by prisoners at Guantanamo, although an appeals court has found a flaw in one of the 14 rulings and ordered a new review in the case of Algerian captive Belkacem Bensayah.

Go read the whole article.

This is pathetic. Not only has the US held these people for years and tortured them. But they end up being released because there is no real evidence linking them to terrorism. This simply makes the US into bully and a fool. This is a great recruiting tool for Al Qaeda. Pitiful.

The Whorf Hypothesis Updated

There is an excellent article by Guy Deutscher in the NY Times on current thinking in how language shapes our view of the world. Here are some key bits:

Seventy years ago, in 1940, a popular science magazine published a short article that set in motion one of the trendiest intellectual fads of the 20th century. At first glance, there seemed little about the article to augur its subsequent celebrity. Neither the title, “Science and Linguistics,” nor the magazine, M.I.T.’s Technology Review, was most people’s idea of glamour. And the author, a chemical engineer who worked for an insurance company and moonlighted as an anthropology lecturer at Yale University, was an unlikely candidate for international superstardom. And yet Benjamin Lee Whorf let loose an alluring idea about language’s power over the mind, and his stirring prose seduced a whole generation into believing that our mother tongue restricts what we are able to think.

In particular, Whorf announced, Native American languages impose on their speakers a picture of reality that is totally different from ours, so their speakers would simply not be able to understand some of our most basic concepts, like the flow of time or the distinction between objects (like “stone”) and actions (like “fall”). For decades, Whorf’s theory dazzled both academics and the general public alike. In his shadow, others made a whole range of imaginative claims about the supposed power of language, from the assertion that Native American languages instill in their speakers an intuitive understanding of Einstein’s concept of time as a fourth dimension to the theory that the nature of the Jewish religion was determined by the tense system of ancient Hebrew.

Eventually, Whorf’s theory crash-landed on hard facts and solid common sense, when it transpired that there had never actually been any evidence to support his fantastic claims. The reaction was so severe that for decades, any attempts to explore the influence of the mother tongue on our thoughts were relegated to the loony fringes of disrepute. But 70 years on, it is surely time to put the trauma of Whorf behind us. And in the last few years, new research has revealed that when we learn our mother tongue, we do after all acquire certain habits of thought that shape our experience in significant and often surprising ways.

...

For many years, our mother tongue was claimed to be a “prison house” that constrained our capacity to reason. Once it turned out that there was no evidence for such claims, this was taken as proof that people of all cultures think in fundamentally the same way. But surely it is a mistake to overestimate the importance of abstract reasoning in our lives. After all, how many daily decisions do we make on the basis of deductive logic compared with those guided by gut feeling, intuition, emotions, impulse or practical skills? The habits of mind that our culture has instilled in us from infancy shape our orientation to the world and our emotional responses to the objects we encounter, and their consequences probably go far beyond what has been experimentally demonstrated so far; they may also have a marked impact on our beliefs, values and ideologies. We may not know as yet how to measure these consequences directly or how to assess their contribution to cultural or political misunderstandings. But as a first step toward understanding one another, we can do better than pretending we all think the same.

Read the whole article to get the exciting details of how research has teased out a new understanding of how language shapes our thinking. It doesn't constrict us in the way Whorf proposed, but its isn't irrelevant as the anti-Whorf backlash presumed. Reality is far more subtle and far more interesting!

Addendum: If you look here, you can read about the Stanford researcher Lera Boroditsky whose research forms the basis of a lot of the Guy Deutscher article.

Steven Levitt & Stephen Dubner's "Superfreakonomics"

This book was far better than I was led to believe by reviews. The reviews made it seem that this book took outrageously ideological views, unacceptable views, and flaunted common sense and decency. That just isn't true. They made it sound like the authors were fanatical climate change deniers. They aren't. It made them out as some kind of grotesque "engineer the earth at whatever cost" crazies. They aren't.

To get a taste of the book:

... Myhrvold fears that even IV's [Intellectual Ventures] gentlest proposals will find little favor within certain environmentalist circles. To him, this doesn't compute.

"If you believe that the scary stories could be true, or even possible, then you should also admit that relying only on reducing carbon dioxide emissions is not a very good answer," he says. In other words: it's illogical to believe in a carbon-induced warming apocalypse and believe that such an apocalypse can be averted simply by curtailing new carbon emissions. "The scary scenarios could occur even if we make herculean efforts to reduce our emissions, in which case, the only real answer is geoengineering."

Al Gore, meanwhile, counters with his own logic. "If we don't know enough to stop putting 70 million tons of global-warming pollution into the atmosphere every day," he says, "how in God's name can we know enough to precisely counteract that?"

But if you think like a cold-blooded economist instead of a warm-hearted humanist, Gore's reasoning doesn't track. It's not that we don't know how to stop polluting the atmosphere. We don't want to stop, or aren't willing to pay the price.

Most pollution, remember, is a negative externality of our consumption. As had as engineering or physics may be, getting human beings to change their behavior is probably harder. At present, the rewwards for limiting consumption are weak, as are the penalties for overconsuming. Gore and other environmentalists are pleading for humankind to consume less and therefore pollute less, and that is a noble invitation. But as incentives go, it's not a very strong one.

Let me translate for you: Gore is the Jimmy Swaggart of environmentalists. He has no problem preaching at you, but he hasn't cut his carbon footprint (he owns to very large mansions and runs floodlights to make sure his neighbors are aware of these imposing structures). He wants you to do as he says, not as he does. He, like most of the global warming industry, thinks nothing of jet-setting around the world to tell others to cut carbon emissions. What Levitt and Dubner point out: economics allows you to understand that you won't change human behaviour with preaching. You need to change the incentives. People respond to incentives.

I found this book to be a worthy successor of its predecessor, Freakonomics. It includes many, many insightful examples from economics to help you understand many aspects of life that you wouldn't think of as the normal subject matter of economics. The book is delightful. It is an eye-opener. It is well worth reading.

The Crazies are Loose Upon the Land

The Republican Party has a long and distinguished history of right wing nuts. The McCarthy era comes to mind. In October 2008 Paul Krugman pointed out that an Obama win would unleash the fury of the right. It has.

Here is a bit from Krugman's latest NY Times op-ed:

By the way, I’m not talking about the rage of the excluded and the dispossessed: Tea Partiers are relatively affluent, and nobody is angrier these days than the very, very rich. Wall Street has turned on Mr. Obama with a vengeance: last month Steve Schwarzman, the billionaire chairman of the Blackstone Group, the private equity giant, compared proposals to end tax loopholes for hedge fund managers with the Nazi invasion of Poland.

And powerful forces are promoting and exploiting this rage. Jane Mayer’s new article in The New Yorker about the superrich Koch brothers and their war against Mr. Obama has generated much-justified attention, but as Ms. Mayer herself points out, only the scale of their effort is new: billionaires like Richard Mellon Scaife waged a similar war against Bill Clinton.

Meanwhile, the right-wing media are replaying their greatest hits. In the 1990s, Mr. Limbaugh used innuendo to feed anti-Clinton mythology, notably the insinuation that Hillary Clinton was complicit in the death of Vince Foster. Now, as we’ve just seen, he’s doing his best to insinuate that Mr. Obama is a Muslim. Again, though, there’s an extra level of craziness this time around: Mr. Limbaugh is the same as he always was, but now seems tame compared with Glenn Beck.

Krugman is impressively accurate in his predictions. Here's what he now foresees:

So what will happen if, as expected, Republicans win control of the House? We already know part of the answer: Politico reports that they’re gearing up for a repeat performance of the 1990s, with a “wave of committee investigations” — several of them over supposed scandals that we already know are completely phony. We can expect the G.O.P. to play chicken over the federal budget, too; I’d put even odds on a 1995-type government shutdown sometime over the next couple of years.

It will be an ugly scene, and it will be dangerous, too. The 1990s were a time of peace and prosperity; this is a time of neither. In particular, we’re still suffering the after-effects of the worst economic crisis since the 1930s, and we can’t afford to have a federal government paralyzed by an opposition with no interest in helping the president govern. But that’s what we’re likely to get.

If I were President Obama, I’d be doing all I could to head off this prospect, offering some major new initiatives on the economic front in particular, if only to shake up the political dynamic. But my guess is that the president will continue to play it safe, all the way into catastrophe.

In short, it will be a bleak time in the US.

More Doomsday Worry: Giant Solar Flares

The list of things to worry about is endless. There is something morbid about working hard to find new catastrophes to worry about...



What I find funny about this new "worry" is that cycle 24, the current solar cycle that is building toward a maximum, is in fact puny. It is the weakest since the Dalton Minimum early in the 19th century. You would think that somebody who wants to scare people would pick on something that actually shows signs of being unusually big and scary. Who's afraid of puny, weak Cycle 24?

I guess you can blame NASA for Michio Kaku's decision to "go public" with dire warnings. The predicted size of this peak has been downgraded, see NASA news report. But in that release, NASA says:

It is tempting to describe such a cycle as "weak" or "mild," but that could give the wrong impression.

"Even a below-average cycle is capable of producing severe space weather," points out Biesecker. "The great geomagnetic storm of 1859, for instance, occurred during a solar cycle of about the same size we’re predicting for 2013."

The 1859 storm--known as the "Carrington Event" after astronomer Richard Carrington who witnessed the instigating solar flare--electrified transmission cables, set fires in telegraph offices, and produced Northern Lights so bright that people could read newspapers by their red and green glow. A recent report by the National Academy of Sciences found that if a similar storm occurred today, it could cause $1 to 2 trillion in damages to society's high-tech infrastructure and require four to ten years for complete recovery. For comparison, Hurricane Katrina caused "only" $80 to 125 billion in damage.

A more detailed set of updated predictions for cycle 24 is here.

I'm not going to lose any sleep over this. There are plenty of "possible" trillion dollar disasters lurking out there. You would work yourself to death and spend yourself broke trying to defend against the many, many threats. Until the science is better and can make solid predictions, I say "save your money, don't prepare for something that probably won't happen!"

For those who want to stay on top of this "coming disaster", here's the appropriate Wikipedia page to track for daily -- if not hourly -- updates.

A Canadian Economist Looks at US Federal Reserve Policy Makers

This is funny but frightening. It is funny because of the language (you Americans are so screwed!), it is funny because it points out something so incredible it is really, really had to believe, but it is tragic because this is how really, really badly the key policy makers in the US misunderstand fundamental economics. From Nick Rowe, economist at Carleton University, writing in the Worthwhile Canadian Initiative blog:

Why "everyone" should be forced to take Intro Economics

The reason is not what you are expecting. It's because maybe if he had been forced to take Intro Economics, the 12th President of the Federal Reserve Bank of Minneapolis, who holds a PhD in Economics from the University of Chicago, who is a specialist in money and macro, who has a CV that creams mine 100 times over, would not be making mistakes like this.

"To sum up, over the long run, a low fed funds rate must lead to consistent—but low—levels of deflation."

That could be interpreted two ways: a wrong way, and maybe, just maybe, a right way.

"When real returns are normalized, inflationary expectations could well be negative, and there may still be a considerable amount of structural unemployment. If the FOMC hews too closely to conventional thinking, it might be inclined to keep its target rate low. That kind of reaction would simply re-enforce the deflationary expectations and lead to many years of deflation."

Nope. He definitely meant it the wrong way. If the economy returns to normal, and the natural rate of interest rises, the Fed must raise its target rate of interest. (So far so good). If it doesn't, the result would be....deflation. ("Inflation" would be the right answer).

I never did understand how the Fed makes decisions. But if the President of the Minneapolis Fed, and people like him, have any sort of power over monetary policy, we ( OK, Americans especially, but probably Canadians too, getting caught by the implosion) are so totally screwed.

I notice he has an undergraduate in maths, then went straight into a PhD in economics. My conjecture: I bet he never took Intro Economics, or anything vaguely similar. I bet he waded straight into the mathematical deep end. And so he never really learned economics.

Nick Lowe doesn't expand on this, but this policy maker's views reflect the right wing "fresh water" economics of the University of Chicago and the pseudo-scientific economics pushed by that school, i.e. a mathematical fantasy land assuming "rational" economic actors fully informed making all decisions in a way that optimizes money and nothing else. It is a heartless, unworldly "economics" that has infected the whole discipline. For this reason, modern economics had -- and has -- no answers for the Great Recession. According to their theories, this kind of banking panic is impossible. In their world prices fully factor in all knowledge so the idea that the banking system would collapse or that companies would now sit on cash makes no sense. But in the real world, trust and credit collapse and sensible businessmen become risk-averse in a world of failing markets. But you can't find that in the equations pushed by the Chicago school.

Oh... and notice how Nick Lowe points out that "Canadians are probably screwed too". Canada's economy is deeply integrated with the US. When Bush decided to "tighten security" he didn't consult with Canadians, so immediately miles and miles of trucks started building up on the border because the "just in time" manufacturing spread across the border got screwed as over-worked border security guards started "inspecting" things not inspected before. It threatened to sink the Canadian economy and it was done by the US without a single thought.

You can see the asymmetry of the relationship by the fact that today, the anniversary of Katrina, when Obama is giving a speech in New Orleans, it is carried live on three of my cable channels (the government English language channel, the government French language channel with simultaneous translation, and the independent CTV channel). There is only one US channel carrying Obama's speech live, CNN. It isn't on NBC, ABC, or CBS. Invariably major addresses and key US political events are carried live on Canadian TV. I've never seen any major Canadian event ever carried live on any US channel. What this means is that Canadians know more about the US than most US citizens. You can see this fact when Canadian contestants show up on US game shows and are able to compete effectively. An American put onto a Canadian game show would be completely lost. Americans know nothing about Canada other than that it is the land of igloos and polar bears. Yeah, right!

Lessons of 1937

Here are some bits from a paper given on March 9, 2009 by Christina Romer, Obama's Chair of the Council of Economic Advisors. It demonstrates that she knew exactly how bad a mistake it would be to create a stimulus that was too small. But Obama went ahead and went for a stimulus which was too small and which "compromised" with Republicans and wasted a third of it on tax cuts which had little or no stimulative effect on the economy. In short, Obama's "stimulus" was a tragedy because it was known at the time that going in with too small a stimulus was a bad idea, but he went ahead and did it...

This discussion of fiscal and monetary policy in the 1930s leads me to a third lesson from the Great Depression: beware of cutting back on stimulus too soon.

As I have just described, monetary policy was very expansionary in the mid-1930s. Fiscal policy, though less expansionary, was also helpful. Indeed, in 1936 it was inadvertently stimulatory. Largely because of political pressures, Congress overrode Roosevelt’s veto and gave World War I veterans a large bonus. This caused another one-time rise in the deficit of more than 1.5% of GDP.

And, the economy responded. Growth was very rapid in the mid-1930s. Real GDP increased 11% in 1934, 9% in 1935, and 13% in 1936. Because the economy was beginning at such a low level, even these growth rates were not enough to bring it all the way back to normal. Industrial production finally surpassed its July 1929 peak in 7 December 1936, but was still well below the level predicted by the pre-Depression trend.19 Unemployment had fallen by close to 10 percentage points—but was still over 15%. The economy was on the road to recovery, but still precarious and not yet at a point where private demand was ready to carry the full load of generating growth.
In this fragile environment, fiscal policy turned sharply contractionary. The one-time veterans’ bonus ended, and Social Security taxes were collected for the first time in 1937. As a result, the deficit was reduced by roughly 2.5% of GDP.

Monetary policy also turned inadvertently contractionary. The Federal Reserve was becoming increasingly concerned about inflation in 1936. It was also concerned that, because banks were holding such large quantities of excess reserves, open-market operations would merely cause banks to substitute government bonds for excess reserves and would have no impact on lending. In an effort to put themselves in a position where they could tighten if they needed to, the Federal Reserve doubled reserve requirements in three steps in 1936 and 1937. Unfortunately, banks, shaken by the bank runs of just a few years before, scrambled to build reserves above the new higher required levels. As a result, interest rates rose and lending plummeted.

The results of the fiscal and monetary double whammy in the precarious environment were disastrous. GDP rose by only 5% in 1937 and then fell by 3% in 1938, and unemployment rose dramatically, reaching 19% in 1938. Policymakers soon reversed course and the strong recovery resumed, but taking the wrong turn in 1937 effectively added two years to the Depression.

Read the paper and weep. It is one thing for a hero to be felled by unknown forces. It is another when the hero knowingly goes into battle unprepared, with too little, and allows his enemies to talk him into "compromises" that are one-sided and simply result in him disarming himself. Obama has made ghastly errors in his "war on the Great Recession" just as he has made ghastly errors with his "double down" surge in Afghanistan.

I think the Obama approach can be summarized by the following video:



Yes... don't let facts get in the way. You know that "recovery is happening" just like these truck drivers know that their truck will fit under the trestle.

American Malaise

Here's an interesting factoid from Daniel Gross in an article in Slate magazine:

Air departures from the United States to Europe were down 6.2 percent in 2008, 4.2 percent in 2009, and were off another 6.7 percent in the first quarter of 2010. Should that decline hold up, 2010 would see U.S. visits to Europe down 17 percent from 2007 levels.

This is clearly bad news for souvenir hawkers, street performers, and the proprietors of the few brasseries that soldier on through Paris' August doldrums. And it's a sign of the malaise and fear that have gripped consumers since the onset of the great recession of 2008-09. Trends in foreign tourism are pretty good coincident signs of a nation's economic confidence. When you and your neighbors are feeling flush and optimistic and your currency has some swagger, you're much more likely to plot an ambitious foreign jaunt. Given the slowdown in growth, the punk jobs and housing markets, and the generalized fear of the future, splurging is out—up and down the income scale. For some, last year's private jet to Lake Como has been replaced by an SUV ride to Lake Michigan. Many Americans are rediscovering the charms of their backyards.

But he finds a silver lining in that threatening economic cloud:

And in the first half of 2010, when foreign tourism spending in the United States was $65 billion, up 7 percent from the year before, tourism generated a $14 billion trade surplus for America, up 29 percent from the figure for the first half of 2009.

I guess that's the "growth industry" of the future for the US: pandering to tourists come to see the threadworn glory of Imperial America in its decline.

Brad DeLong Sizes Up the US Economy's Prospects

From a post on Brad DeLong's blog. I've bolded key bits:

I have the sense that the Obama administration's economic policymakers have forgotten one of the most basic lessons taught by Robert Rubin during his stewardship of economic policy during the 1990s. The lesson is to think probabilistically: to project yourself forward into the possible futures, to ask in each one what would be the actions that you would then wish you had undertaken today, and then to actually take the appropriate action today. Looking forward into the future, (a) I see a 10% chance that something happens to create renewed cliff diving--a recession that bottoms out not with an unemployment rate in the 10-12% range that we currently anticipate but an unemployment rate that blows through 12% and keeps on rising. (b) I see a 30% chance of a rapid recovery as confidence and asset prices recover, and firms take advantage of high unemployment to hire new workers in droves at wage levels that make increasing production very profitable. But (c) I see a 60% chance of the end of the current cliff-dive in employment being followed by what happened in Japan in the 1990s, in the U.S. after 1991, in the U.S. after 2001, and to some extent in the U.S. after 1933--a recovery that does not see the market exert sufficient upward pressure on employment to return the unemployment rate to normal levels in two or three years, but that instead sees a jobless or low-job recovery during which the unemployment rate continues to drift upward for years, or falls only then to rise again.

The Obama administration's policies appear to me to be the ones that would be adopted if we believed that there was a 75% chance of scenario (b) and a 25% chance of scenario (a). But I don't think those are the probabilities.

This is the great tragedy of the Obama administration. It had the possibility of being a great Presidency. It did pass a historic (but watered down) health care bill. But it failed miserably to treat the Great Recession with full strength efforts to revive the economy. It failed to disengage the US from Bush's war's "of choice", it failed to stop the hideous torture prison of Guantanamo, it failed to stop the slide into the "security state" of Bush where rights and freedoms disappear as police and unknown, secretive agencies spy on everybody, and it has failed to face up to the evil right wing politics of the Republican party. Obama admired Lincoln. But Obama doesn't come anywhere close to a Lincoln. At best, Obama is a clever, silver-tongued politician who was mediocre in his accomplishments but failed in the big important and strategic needs of the country. Sad.

Enlightenment

Here is an excellent review of the concept underlying the traditional Enlightenment as well as a very nice examination of ways to update that enlightenment to meet modern needs:



The above was developed by the UK's Royal Society of Arts, the RSA, and reflects it re-think of its mandate.

If you enjoyed the above "animated" lecture, then check out the videos here. Or, you can go to the YouTube theRSAorg channel.

Accuracy in Prognostication

Paul Krugman pats himself on the back for his foretelling in February 2009 the stagnation and ugly politics to come caused by Obama's reticence to lead:

Failure To Rise

I’m finding it hard to read about politics these days. I still don’t think people in the administration understand the magnitude of the catastrophe their excessive caution has created. I keep waiting for Obama to do something, something, to shake things up; but it never seems to happen.

Here’s what I wrote in February 2009. It’s pretty rich that now the usual suspects are accusing me of having shared the administration’s optimism. But that’s a trivial point; the important thing is that all signs are that the next few years will be a combination of economic stagnation and political witch-hunt.

This is going to be almost inconceivably ugly.

This is a great, great tragedy. And especially bitter because some bright people, like Krugman, knew what was coming and tried very had to warn the powers-that-be of the disaster lying ahead.

Prospects for a US Recovery

Here is a nice short opinion piece in the NY Times by Mark Thoma that reviews where the recovery of the US economy could come from:

The bad news for recovery seems to be nonstop lately, with new home sales, which were at a record low in July, and durable goods orders, which came in far below expectations, continuing the trend. What does this say about the prospects for recovery?

It’s useful to break down the economy into four major sectors — households, businesses, government, and the foreign sector — and consider how each will affect both long-run and short-run prospects for growth.

Sadly he sees no sign in the near term of any recovery being led by households, businesses, or the foreign sector. That's why a federal stimulus package is so important. A new one. A bigger one. Without it, the US will have a "lost decade" of deflationary stagnation:

If government can provide the bridge across our short-run problems, then the other sectors can take over and generate long-run growth, and the hope is that the growth will be as robust as before the recent crash. But there’s no guarantee that hope will be realized.

To put it bleakly, Obama has shown no awareness of any of the above. He keeps talking "recovery" as if it were underway. But it isn't.

Reich Calls for a Dash of Populism

Here are some bits from Robert Reich's latest posting on his blog:

The public doesn’t understand specific policies but it does understand stories that link them together. The stories give the policies context and meaning, and thereby show where policymakers are taking a nation (and, by implication, where the opposition would take it).

Republicans lack specific policies but they have a story. Obama and the Democrats have lots of specific policies but don’t have a story. That spells even more trouble for Democrats.

The Commerce Department reported today (Friday) that the economy grew only 1.6 percent in the second quarter, which is a fancy way of saying what everyone on Main Street already knows. The economy has stalled. Unemployment is still in the stratosphere and shows no sign of improving. The housing market is worsening.

Why? What to do? The Republican story is simple. It’s the fault of government. They say Obama’s policies have bankrupted the nation and made businesses too uncertain to create jobs. The answer is less government. Cut taxes and spending, privatize, and deregulate.

It’s not a new story but it’s capturing the public’s mind because the Democrats offer no story to counter it with.

Obama and the Democrats respond by defending their specific policies. The stimulus worked, they say, as did the bailout of Wall Street, because the economy is better today than it would be without them. If anything, we need more stimulus. And healthcare reform will protect tens of millions.

A large and growing segment of the public believes none of this. The public doesn’t think in terms of specific policies. All it knows is the economy has stalled and there’s only one story that explains why and points the way forward – and that’s the Republican’s.

What should the Democratic story be? How can they connect the dots?

...

The underlying political debate in America is which of these is most responsible for the mess we’re in, and which can be most trusted to get us out of it – big business and Wall Street, or government.

It wouldn’t be hard for Democrats to make the case that big business and Wall Street blew it. The Street’s wild speculation took the economy off the cliff, caused the stock market to crash (and millions of 401(k)s along with it), and created a housing bubble whose burst has hurt millions more.

Big business has used the Great Recession as an opportunity to slash payrolls and cut wages and is now sitting on a $1.8 trillion mountain of cash it refuses to use to create new jobs. Instead, it’s using the cash to build more factories abroad, buy back its own shares of stock, invest in more labor-replacing technologies at home, and do mergers that will lead to even fewer jobs.

Meanwhile, a parade of “public-be-damned” actions have threatened small investors (Goldman Sachs’s double dealing), individuals trying to buy health insurance (WellPoint’s double-digit premium increases), worker safety (the Massey mine disaster), the environment (BP), and even our food (Jack DeCoster’s commercial egg operations).

And a gusher of corporate and Wall Street money has flooded Washington, exemplified by Big Pharma and the health-insurance lobby fighting heatlhcare reform, and Wall Street’s minions fighting off stricter financial reform.

If Obama and the Democrats would connect these dots they’d have a story that would make Americans’ hair stand on end. We’re in this mess because of big business and Wall Street. Government is needed to get us out of it.

I love Reich's plan. I'll ease into my sofa and watch for the peasants brandishing torches and pitchforks to converge on the malefactors of the Republican Party, Wall Street, and big corporate offices across the land. At least, that is what I would hope to see.

But something tells me the Democrats won't "get it together" and provide the needed story to inflame the populace and turn out the vote for the mid-term elections in November. Instead, I'm afraid that the "story" (the pure fiction laddled out by the Republican camp) will have the Tea Party types and their brethren seething and storming the polling stations to "throw the rascals out". It will be a tragedy. But it won't be the first time that history has delivered up a tragedy that people will have to struggle through. Instead of a populist success in seizing power back from the corrupt fat cats, I'm afraid we will have a Tea Party lynching in November with lots of innocent and ineffective Democrats left hanging from the trees (i.e. not elected). A dreadful scene with Tea Party fanatics dancing around bonfires as they burn down the hopes of a generation (i.e. put in place legislative giveaways to the rich and powerful and socially retrograde laws for everybody not in the top 2% of the population).

Words of Encouragement

I tend to get over-wrought about the economy because my retirement depends completely on it, i.e. I have no private company pension and a very small government pension. The government pension is only sufficient to keep me in cat food and living in a tent for the rest of my life. So I watch my investments closely and my mood swings up and down (lately, far too often down) with the economy.

So it is nice to hear Canadian economists uttering reassuring words:

Are we—consumers, business leaders, investors, economists—going to collectively give up on this recovery because of a few sour months for the economy? What if Churchill had said: “We shall fight on the beaches, we shall fight on the landing grounds, we shall fight on the streets, but if we see some ugly home sales numbers and a downbeat durable goods orders release, we’re so gonna throw in the towel and run”? There is no doubt the U.S. economy is skidding through a very real soft patch, which is reverberating to undermine fragile business sentiment and to pose a risk of a renewed downturn. But let’s not talk ourselves into it. Yes, we could wallow in the mire of gloom and despair, and focus exclusively on the negative (of which there is no shortage in the wake of the worst post-war recession). But, let’s recall that policy remains exceptionally accommodative globally, corporate finances are in stellar shape, spending on big-ticket items (especially homes) is already at rock-bottom levels and has little place to go but up, and the emerging market economies are forging ahead with new growth opportunities.

That's Douglas Porter writing in the Bank of Montreal's Focus weekly publication. It is a salve to my ragged, worried nerves. The ups and too many downs of the market are wearing my nerves thin. I know I can't expect robust growth and a roaring stock market, but I would appreciate something that was more consistently up. Wait a second. The US market is down 6% this year and Toronto's is down about 1%. I want something positive, not negative.

In the meantime... I'll relish the generous words of Douglas Porter and fervently hope they point to better times.

But as Douglas Porter points out, the real world can be cynically cruel. While economists around the world are scaling back expectations about GDP for the US and Canada, the situation in Europe is different:

As a sidebar, it’s ironic that the European debt turmoil appears to have taken a big toll on the U.S. recovery (through the market upset and ensuing uncertainty), yet has barely touched the European growth outlook. The 2010 GDP forecast has actually been revised higher for the Eurozone since the crisis broke wide open in the spring (thanks to the solid Q2 results). In fact, it now appears that Germany may be the fastest growing G7 economy this year (yes, topping Canada). Clearly, the Europeans learned a thing or two from Churchill.

Ow! That's like a stick poked in my eye. The Europeans wrecked the stock markets in North America with their credit crisis, but their stock markets are surging? Where's the fairness in that?

Krugman Dumps on Bernanke

Here's a bit from the latest Paul Krugman op-ed in the NY Times. Krugman isn't buying the "we are in a recovery" theme song that the Obama administration wants to sing, particularly Ben Bernanke of the Federal Reserve:

But we can safely predict what he and other officials will say about where we are right now: that the economy is continuing to recover, albeit more slowly than they would like. Unfortunately, that’s not true: this isn’t a recovery, in any sense that matters. And policy makers should be doing everything they can to change that fact.

The small sliver of truth in claims of continuing recovery is the fact that G.D.P. is still rising: we’re not in a classic recession, in which everything goes down. But so what?

The important question is whether growth is fast enough to bring down sky-high unemployment. We need about 2.5 percent growth just to keep unemployment from rising, and much faster growth to bring it significantly down. Yet growth is currently running somewhere between 1 and 2 percent, with a good chance that it will slow even further in the months ahead. Will the economy actually enter a double dip, with G.D.P. shrinking? Who cares? If unemployment rises for the rest of this year, which seems likely, it won’t matter whether the G.D.P. numbers are slightly positive or slightly negative.

All of this is obvious. Yet policy makers are in denial.

From this, Krugman deduces the grim reality. I've bolded the key bit:

Why are people who know better sugar-coating economic reality? The answer, I’m sorry to say, is that it’s all about evading responsibility.

In the case of the Fed, admitting that the economy isn’t recovering would put the institution under pressure to do more. And so far, at least, the Fed seems more afraid of the possible loss of face if it tries to help the economy and fails than it is of the costs to the American people if it does nothing, and settles for a recovery that isn’t.

In the case of the Obama administration, officials seem loath to admit that the original stimulus was too small. True, it was enough to limit the depth of the slump — a recent analysis by the Congressional Budget Office says unemployment would probably be well into double digits now without the stimulus — but it wasn’t big enough to bring unemployment down significantly.

Now, it’s arguable that even in early 2009, when President Obama was at the peak of his popularity, he couldn’t have gotten a bigger plan through the Senate. And he certainly couldn’t pass a supplemental stimulus now. So officials could, with considerable justification, place the onus for the non-recovery on Republican obstructionism. But they’ve chosen, instead, to draw smiley faces on a grim picture, convincing nobody. And the likely result in November — big gains for the obstructionists — will paralyze policy for years to come.

That is tragic! Read the whole op-ed to get all the gory details.

Krugman list a number of things that need to be done. But then summarizes with this sad realization. Again I bolded the key bit:

Which of these options should policy makers pursue? If I had my way, all of them.

I know what some players both at the Fed and in the administration will say: they’ll warn about the risks of doing anything unconventional. But we’ve already seen the consequences of playing it safe, and waiting for recovery to happen all by itself: it’s landed us in what looks increasingly like a permanent state of stagnation and high unemployment. It’s time to admit that what we have now isn’t a recovery, and do whatever we can to change that situation.

It is beyond tragic when "leaders" don't lead. It is pathetic, destructive, and will take generations to recover.

When George Bush was elected I told everyone "it will take a generation for America to recover from this mistake". Now, with Obama compounding the errors I am saying "it will take generations to recover from the last 10 years of mistake and bad policies. In fact, the US will probably never recover. Bush, and now Obama, have greased the skids for the US to plummet from world leadership to something slightly above third world status, i.e. burdened by huge debts, caught up in vicious political infighting, and with an upper class interested only in extracting as much as they can before they flee to other countries leaving a stinking cesspool behind.

Required Viewing

The following should be made required viewing by all high school and college students. This is the world they are growing up in, will inherit, and will have to live with the consequences of...

American Debt

From the Federal Reserve Bank in NY's August 2010 report on household debt, this is a nice graphic that shows how American consumer debt ballooned since 1999 and how it is now slowly being reduced...

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This is good and bad. At the level of the individual, it is great to be reducing debt. It means the person gets control back over their own life. It means that when interest rates start rising in a year or two, they will be safe from the demands of their creditors. At the level of the society, this is a tragedy because the lack of consumer demand is what is making this into a Great Recession! People need to be spending to fuel economic growth.

This paradox is the reason why government needs to step in a be the "consumer of last resource". Just like having the US government, via FDIC, act as a banker of last resort to guarantee against a run on a bank. The US government needs to step in and sustain consumption to prevent the waste of having 14 million people unemployed, idling, wasting their time, not producing goods, etc. Unfortunately, the The Party of No & Nothing (AKA "Republicans") are intent on ensuring that a bad recession will go down in history as a Great Recession by blocking attempts at saving the situation by providing more stimulus or providing any programs (other than tax cuts to billionaires!) that would help sustain consumption. Sad.

One final graph... this shows how debt per capita ballooned from 1999 to 2008 and is now starting to come down. Again this is wonderful for the individual, but this is why the "recovery" may take a decade and the US will have a "lost decade" like Japan:

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Let's hope this Great Recession doesn't drag out for a decade like the Great Depression or Japan's "Lost Decade". But the signs are not good. And the Republican Party is doing everything possible to make it last a decade and Obama is stumbling around in the dark and may "succeed" in making it last a decade because he isn't decisive enough and has as his economic advisors the same crew that created the problem! Specifically: Larry Summers, Ben Bernanke, and Timothy Geithner.

Mark Zandi on the US Economy

Here's a guy with a sound, head-on-shoulders, no hysteria view of the US economy...



My only quibble is that letting the Bush tax cuts expire on the top 2% isn't going to endanger anything. If that is a concern, then take the money that will be raised and spend it on a job creation project. Just don't let the rich sock it away with their other millions and billions! Every dollar needs to do its duty. They should all be put to work employing people not feathering the mattress of a billionaire.

Compare the reasonable, thoughtful, toned-down discussion of Mark Zandi to the following. These are the typical "talking heads" that show up on business television to sell fear and greed (this week's flavour of the day)...



You can safely ignore these talking heads. They are completely bedazzled by surface effects and ephemera. All the talk about people, what they said, what the politicians say, this-and-that. Who cares. The real economy is indifferent to opinion. Mark Zandi is looking at data, not a "he said, she said" chit-chat about opinions.

Imported Oil & Energy Costs

From the recently published US Annual Energy Review:

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Notice that Canada leads as oil supplier to the US at 2.5 million barrels/day. All the other suppliers are shrinking while supply from Canada is stable. The funny thing is that when you say "oil" most Americans think of Saudia Arabia and the Middle East. They don't think "great white north, land of igloos and polar bears".

The report is full of graphs and tables to delight any fact fanatic. One thing I enjoy is the graphs showing "peak production". Lots of peaks have been passed. But no crisis. No collapse. That's the funny thing about fear mongers. They can sell an idea but it doesn't mean that facts conform to the doomsday scenarios painted by the fanatics.

The following graph of real, constant dollar electricity prices demonstrate that the doomsters who claim that we are coming up against the limits of everything aren't reflected in the prices:

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What the graph demonstrates is that in "times of trouble" prices rise. The 1970s show a price rise and the early 2000s show a price rise. This says more about the psychology and politics of a society than it does of its underlying technology or the state of natural resources.

If you look at figure 56 in the report, you will discover that despite all the chest thumping about "renewable energy", it is a mere blip. The growth in use of renewable energy is tiny and mostly confined to transportation. What isn't stated is that billions of dollars in subsidies is buying a place for ethanol in America's fuel tanks (at the expense of a growth in world hunger and rising costs to American consumers for food on their table).

Meanwhile, those who gloat over "peak oil" and the soon-to-be disappearance of oil have to contend with this graphic. What it shows is that the "proven reserves" have a very nasty tendency to stay like a carrot on a stick, just out in front, always looking like the reserves will soon be exhausted, but puzzlingly never quite running out:

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In fact, it isn't profitable to discover reserves until they will soon be needed. That's why it always appears that within 10-20 years the reserves will be exhausted and "all the oil will be gone". It will go, but not that soon. Probably within this century, but by then other energy sources will have replaced it. So those worries about "peak oil" have been a big waste of time.

Requiem for a Country

Here is a Yahoo! article about dying American cities.

As I read this I think... what does it take for people to get a "wake up call"? It should be pretty clear to most Americans that something has gone off the rails. In the 1970s things went sour and there seemed to be an antidote in the 1980s with Ronald Reagan's "It's Morning in America" theme. But it should now be clear that this was a false lead. Thirty years of Republican ideology has led the US into even more of a boxed-in corner.

You would think that people would wake up, shake their heads, and feel the need to take a new direction. But instead, it appears that Americans want more of the lies-before-truth and below-the-belt sucker punching that the Republicans deliver as "politics". Instead of a basic honesty about the current situation and a determination to do the hard work to get onto to a better road, Americans want more drug-laden Republican feel-good pablum. Sad.

You have to be able to feel the difference. Watch a 1930s or 1940s film. These were done during the depths of the Great Depression and the horrors of WWII, but there is a solid humanity about them, strong story line, optimism, and decency. Flash forward to the 1970s and you get things turning sour with the "I'm into 'Me'" generation and the turning away from social commitment and engagement with a civil society. By the 1980s this turns into the "Greed is Good" mantra. Politics turns mean with dirty tricks. It goes from the limited meanness of Nixon's "plumbers" to where politics today is pure mud slinging. Everything has slid toward right wing messages of power and greed, shrinking government, do nothing for nobody unless there is money up front, and all the hideous bowing and scraping before the rich and powerful. It is sickening. No wonder decay is the theme of American today.

David Orrell's "Economyths: Ten Ways Economics Gets It Wrong"

David Orrell has written an excellent book for the general reader. It doesn't explain economics. It isn't theoretical. But it does explain why current economics and policy makers are wrong-headed. It does explain what needs to be done to get economics onto a solid foundation. It is good at explaining how economics was ill-founded by economists deluded by a kind of "physics envy" during the late 19th century.

The book is extensive and should give you a good understanding for why the recent financial crisis and bank panic has forced a reset to economic theory-making.

The following bits give you a flavour of the book...

The fact that money and happiness are totally different concepts somehow knocks the steam out of neoclassical theory, which assumes precise and mathematical relationsihps between utility and price. If the economic machine isn't maximising utility, then what is it maximising?

The answer, of course, is nothing. The economy is what it is. Free markets have many splendid attributes, which must be protected. They are the best way that we have come up with to make a wide variety of economic decisions. They offer individuals and companies the opportunity to either succeed, or fail and make room for others, in the process that Joseph Schumpeter called "creative destruction." Markets are a basic form of human interaction that exited before economics was invented, and they don't need neoclassical theories to justify them -- any more than human cooperation must be justified by Marxism. But if we are to base our quest for the good life on empirical facts, rather than corny 19th-century ideas, then we need to rebalance our priorities. ...

...

In unequal societies, though, it is hard for anyone to be satisfied with what they have in material terms. So the first priority is to reduce inequality, which is discussed earlier is also strongly correlated with a range of social problems. ...

...

Another plank of happiness is freedom from excessive levels of economic stress. So it is desirable that the economy be reasonably stable. Economic shocks such as financial crashes or unemployment have powerful emotional consequences. ...

...

As mentioned in Chapter 6, a large amount of labour -- including much done by women -- is unpaid. This work, which is performed according to social norms, is vitally important for maintaining the happiness of society. ...

Finally, we have to acknowledge as a society that money and happiness are completely different quantities. The reason that GDP has soard in Western economies over the last few decades, but reported happiness levels have remained relatively static, is because they are not the same thing.

Orrell traces the 19th century origin of economics and has much to say about it. For example:

It might seem strange that control theory has not had wider influence on neoclassical theory, given that they were both founded at the same time; and that market economies are famed for their creativity and dynamism, which often seems the opposite of stability. It makes sense only when you think of economics, not as a true scientific theory, but as an encoding of a particular story or ideology about money and society. Viewed in this way, equilibrium theory is attractive for three reasons. Firstly, it implies that the current economic arrangement is in some sense optimal (if the economy were in flux, then at some times it must be more optimal than at others). ...

Secondly, it keeps everyone else in the game. As discussed further in Chapter 7, the benefits of increased productivity in the last few decades have flowed not to workers, but to managers and investors. If academics and the government were to let out the fact that the economy is unstable and non-optimal, then the workers might start to question their role in keeping it going.

Thirdly, it allows economists to retain some of their oracular authority. If the market were highly dynamic and changeable, then the carefully constructed tools of orthodox economics would be of little practical use. Efficient market theory, for example, makes no sense unless equilibrium is assumed. ...

...

A property of complex systems like the economy is that they can often appear relatively stable for long periods of time. However, the apparaent stability is actually a truce between strong opposing forces -- those positive and negative feedback loops. When change happens, it often happens suddenly -- as in earthquakes, or financial crashes.

The following is one of my favourite bits that tweaks the self-confident "authority" of economists:

It might seem that financial markets are so complex that they are impossible to regulate. However, this impression is largely due to the carefully maintained myths that markets are efficient and optimal, so any attempt to interfere with their function will be counterproductive.

And this is a close second:

Our current approach to the economy is schizophrenic. We design an unregulated system that is economically and ecologically unstable; model it using techniques that assume stability; try to make predictions of the future; and then react in surprise when something goes wrong. If instead we acknowledge that the system is unstable, that opens up the opportunity to actively improve it, rather than passively try to guess its next move.

This is an excellent book to understand the current economic mess. It is written by an outsider -- an applied mathematician -- and it succeeds because understanding the crash requires an approach not compromised by years of "education" within the current theory. A mathematician has the intellectual distance and depth of sophistication to truly understand the gross errors at the foundations of economics. Others are too easily intimidated by the pseudo-scientific formalizations of modern economics. Read this book.

Update 2011oct29: If you look at the comments to this post you find some claims about economics that strike me as incredible in their ideological obtuseness. I prefer a world in which people are willing to respect viewpoints and learn from each other. In that spirit, I offer the following post from an interview with Mark Thoma, a left wing economist who shows respect for right wing views. This post is also interesting because it opens up the idea of validating economic theory (and hints at how very hard that is):

FiveBooks Interviews: Mark Thoma on Econometrics

It’s a discipline popular with the Nobel prize committee and mysterious to most of the rest of us. So we asked an econometrician to explain what he does, and why there’s such a battle of ideas (and models) in economics

A number of econometricians – economists who use statistical and mathematical methods – have won the Nobel prize in economics. We’re going to talk about the ones that influenced you in your work. Before we start, what got you excited about econometrics in the first place?

I was in high school at the time of the oil price crisis of the 1970s and I asked my mom, “What causes inflation?” She didn’t know. I think it was from then on that I started wondering about money and inflation and what caused it – how the Fed was involved et cetera. When I got to college I took economics and started answering those questions. Then when I got to graduate school I learned theories about why it happened, and I got interested in how you test those theories. How do you know if this theory is right or that theory is right? How can we figure it out? That’s where econometrics comes in. Time-series econometrics was a set of tools I could use to answer that longstanding question I had about how the Federal Reserve impacts the economy, how it creates inflation and all those things.

Time-series econometrics is a particular area of focus for you. Can you give me an example of how it works?

Right now there is this big question about how much impact the Fed can have on the economy and whether or not deficit spending, or a change in government spending, creates employment. Is there a government-spending multiplier? You can use time-series econometrics to go back and look at data from the past, then use that data to estimate a model, and from that model you can figure out whether or not government spending works, and if it does work, when it works, when it doesn’t – all sorts of questions. Almost any policy question that you can formulate, you can take to the data. That’s when the econometric technique comes in, and allows you to answer it.

So it’s more empirical than straight economics?

Exactly. Our field is divided into two groups – there’s the theorists and the applied people. I’m more of an applied person. I apply and test the theories that the more highbrow, theoretical types build. They might build two different models of the economy, and then you want to know which one fits the data best. Which one is the best explanation for the data. You can use econometrics to sort out those competing theoretical models.

What then is your conclusion on the government-spending multiplier?

There’s a lot of uncertainty about it, so I can’t say for sure whether it’s one or two, or somewhere inbetween. There’s a fairly wide range of estimates, but I think it’s pretty clear that it’s somewhere in that range. I would say it’s about 1.5 presently.

The first ever Nobel prize for economics was awarded to two econometricians, Jan Tinbergen and Ragnar Frisch. Have econometricians been well represented in the Nobel prize for economics?

I think they have. The committee has been very good at rewarding the people who are building the tools that allow us to test these models, so it’s not unusual at all for them to give Nobel prizes to econometricians.

Of more recent awards, prior to this year’s award to Thomas Sargent and Christopher Sims, there was Robert Engle and Clive Granger in 2003, and before that Daniel McFadden and James Heckman in 2000.

Yes, those are all econometricians. The older cohort are more micro-economists. This morning I was wondering whether this year’s prize was something of a make-up for the macro people, but I don’t think it was. They built their own tools and techniques that were important.

Let’s start by talking about New York University’s Thomas Sargent, who along with Lars Ljungqvist is the author of your first book choice, Recursive Macroeconomic Theory. What is important about Sargent’s work?

Sargent went into the engineering literature, he took the tools and techniques that engineers use to do things like make sure your television is clear, and he brought them over into economics. There were all these tools that scientists were using to control systems. So an engineer might build a TV that has a feedback mechanism. Somehow, it can look at the picture and if the picture isn’t right, it can go back and adjust the inputs in a way that clarifies it. If there is a horizontal scroll or a vertical scroll, it does something internally to stabilise the system, and makes sure it doesn’t get out of whack.

All the same tools that engineers use to stabilise your television picture can be used to stabilise the economy. The difference – this is an important difference, and where Sargent’s contribution comes in – is that when I do something with a TV, it doesn’t try to get out of the way to protect itself. It doesn’t say, “Oh! I don’t like having a little more green in my colour, so I’m just going to turn it back down.” Unlike TVs, people have brains and they respond to policies. If you try to tax them, they try to get out of the way of taxes. If you try to tax a TV, it has no way of getting out the way.

That’s where rational expectations comes in. When you’re trying to control a person instead of a TV, you have to take into account their expectations – how they’re going to respond to the things you do as a policymaker. Sargent took all these tools and techniques for optimal control that were being used in engineering, all this heavy mathematics, brought it over into economics, added rational expectations to it and made it even harder to use than it already was in the engineering literature.

And that’s what he won the Nobel for?

Yes. It wasn’t so much that he was this grand theorist – although he is certainly good at that – it was more the tools and techniques that he brought to the profession.

I get the feeling that the Nobel prize in economics is awarded on somewhat political grounds – based on what’s happening in the world at that particular moment – and not purely on intellectual heft. Is Sargent’s work especially relevant to the economic crisis we now face?

He gave us the tools and techniques we need to analyse the crisis and build the models that we need to build to understand it. But it’s not as though he built those models themselves. He built the hammer, not the house.

Let’s talk a bit more about the book, Recursive Macroeconomic Theory.

This is the textbook I use in my PhD macro courses. In fact, it’s used in almost all of the major PhD programmes in the US right now – any respectable programme most likely uses this book. It’s a book of tools and techniques to solve what are called recursive macroeconomic models.

I think you’d better explain.

Modern macroeconomics uses DSGE models – dynamic stochastic general equilibrium models. That’s a bit of a mouthful, but all dynamic means is that it’s a model which explains how things move through time. So it explains what GDP will be today, tomorrow, the next day and the day after that, and how it might change if the government does different things or if certain things happen in the economy. It’s really a model of how the economy transitions from one point to the next – how it goes into recessions et cetera. Those models are extraordinarily difficult to solve.

What this book shows us – and this is the recursive part in the title – is a way of breaking down this really hard problem into little tiny pieces. You can actually solve a much simpler problem when you only have to look at how the economy moves from today to tomorrow. I don’t have to look at how it moves from tomorrow to the next day and all the way out as far as I can see. We can just break down these really hard problems into a recursion between today and tomorrow.

If you’re doing a PhD in macroeconomics, how important is this textbook? Is it one of 10 you have to work through?

It’s probably one of two. In macro there really aren’t very many. There’s this book, and there’s a book by David Romer of Berkeley. So this is sort of the Bible right now.

Let’s go onto what will count as your next two books, volumes one and two of Rational Expectations and Econometric Practice, edited by Thomas Sargent and Robert Lucas of Chicago, a leader of the rational expectations revolution and winner of the 1995 Nobel prize.

These are the books I used when I first came out of grad school and was trying to get tenure as a young assistant professor. It’s a collection of papers, a lot of them by Sargent, Sims and Granger. Nobel prize-winning economists are the dominant authors in it.

The second volume, especially, taught me how to use econometrics to test a brand new class of models. At the time, there were models coming out called new classical models and real business cycle models. Both involved rational expectations, which, it turns out, made estimation techniques really hard. These books were crucial in, firstly, giving me all the theoretical models behind what we were trying to test – there’s a whole section on theory – and, secondly, going through all the econometric techniques one needs to test those classes of models.

What surprised me, looking down your list, was that I think of you as very much on the left-wing side of the economics divide. Aren’t Lucas and Sargent at the opposite end of the ideological spectrum?

They are, and that’s an important point. Both sides of the spectrum within economics use the same tools and techniques. So I can honour everything they’ve done to allow me to do econometrics and understand theory without endorsing the way they’ve used those particular tools.

So these books are about the tools rather than the conclusions they reach?

There are conclusions in there, but they are more by way of example. Once you’ve learned the techniques, you’re all set to do anything. Lucas I would peg as very conservative. Sargent is a bit more open-minded. He’s done learning models with a colleague, and I sometimes go down the hall and he’ll be sitting in his office. Sargent’s dad lived in Eugene, Oregon for a long time (though he passed away recently) so he’d show up at our apartment quite often. That’s another reason why I like him.

Before I spoke to Paul Krugman, I’d never even heard the term “freshwater economist”, which I understand refers to the University of Chicago, the Minneapolis Federal Reserve, and various places near the Great Lakes which produce economists with a right-wing bent. I gather there’s a big divide between them and the “saltwater economists” who come from universities along the seaboards – Princeton, Harvard, Berkeley, Oregon – and who are more liberal.

There’s three groups really. There’s the divide between the new Keynesians and the new monetarists, or the real business cycle economists. That’s people like Lucas and Sargent versus people like me, Krugman, Brad DeLong and others. Then there’s another, much smaller group that don’t think any of us have a clue. Those are the heterodox economists. They don’t like the tools and techniques we use, they don’t like equilibrium models. It’s people like Jamie Galbraith, who don’t agree with either side.

Is Joe Stiglitz verging on the heterodox these days?

I would describe him as traditional minded. He certainly uses the same tools, though he pushes them to a bigger extreme than others would. He’s not saying: Throw out the toolbox, throw out everything we’ve learned in the last 30 years and let’s take a completely different tack using different kinds of models altogether. Though maybe that’s where we’ll end up as a result of this crisis.

I remain concerned at how economists can disagree so much. Doctors don’t disagree about how to treat a cancer patient.

Economists don’t disagree about certain things. And doctors do disagree about things – like whether cholesterol is good. There’s a big controversy right now about whether you should take vitamins or not, whether it’s helpful or harmful. When doctors have difficulty testing things experimentally, they run into the same issues as we do. When there’s just historical data, like we have – if, for example, they try to figure out heart disease by looking back at people’s lives – then a lot of the time they get things as wrong as we do. Doctors have changed their advice many times.

Going back to fiscal stimulus, which you mentioned at the beginning as something time-series econometrics can test, I take it there isn’t overwhelming evidence in its favour? Even though you’re on the Keynesian side, do you think people that question whether it works have a point?

Yes I do, completely. The reason is that we don’t have data for historical episodes like this one. The Great Depression was like this, but our data pretty much ends in 1945. We can’t go back any further with anything close to reliable data. As an econometrician I can estimate these multipliers, but they’re for good times not bad times. I don’t have the data that I need. I don’t have enough big recessions like this one in my data set to give a precise answer.

Your next book is by the winners of the 2003 Nobel prize, Robert Engle – who is now emeritus professor at UC San Diego – and the British economist Clive Granger, who sadly has since died. What was their big insight and contribution? Tell me about their book, Long-Run Economic Relationships.

This book is about a subject for which the technical term is cointegration. What it means in everyday language is variables that are tied together in the long run, that are related in some way. For example, you might think that consumption and income are tied together in the long run. If consumption takes a big left-turn at some point in the data, income ought to take a big left-turn in the data as well. One thing they got the Nobel prize for is how, within our models, we can tie these two variables together in a way that makes sense. It sounds easy, but it’s actually a very hard econometric problem.

The other thing they got their Nobel prize for was something called ARCH, or autoregressive conditional heteroskedasticity models. What that means is that for income, over time, we can measure the variance of income – how variable it is. There is some mean of income over time that follows some trend, and the variation around that trend is the variance. They showed us how to write down economic models that track that variance through time. So it’ll tell us what’s causing the variance of a financial asset to change. The variance of a financial asset would be how risky it is. If you’re looking at a financial asset, the mean would be the expected return on the asset and the variance is its risk profile.

These tools that they developed within this ARCH framework were then used – Engle says inappropriately – to do what were called value-at-risk calculations, prior to the crisis. When you hear about all these financial firms, looking at their portfolio and doing risk assessments, at the heart of what they were doing was using these models that Engle and Granger built, that allowed you to estimate a time series of variances and see how that variance, or risk profile, changes over time.

I’m presuming that in the run-up to the crisis, their models did not flag a big risk at these banks?

Yes, and Engle would say that the reason why that happened is that they weren’t using his models correctly. In some sense he’s just protecting himself. The important point here is that at the heart of all the risk analysis for the financial industry was their models. Prior to the crash, and even after the crash, if you wanted to know how risky the portfolio that Bear Stearns was holding was, you would use those techniques.

In spite of this, you’ve kept the book on your list…

The book is more about the first topic I mentioned, cointegration, though the other stuff is in there as well. Cointegration is important because it allows us to do a better job of looking at things like causality between variables. They showed that if you have variables that are tied together over time, then the standard tools and techniques that were in use at that time would be wrong. It would be inappropriate to use them, you have to use a completely different estimation technique. They showed us how to do tests to find out if you have this problem of a long-run relationship in your data, and if you have this problem how to fix it within the models. That was an important step forward, because we learned that these relationships are all over the place. We had probably been estimating our models wrongly up to that time.

If they hadn’t been awarded the Nobel in 2003, could they have won it now, post-crisis?

The crisis wouldn’t have changed anyone’s view of cointegration. I think the value of the ARCH models might have been questioned a bit more than they were at the time, because they didn’t signal the risks in advance like we expected them to.

Your last choice is an older textbook, Macroeconomic Theory, again by Thomas Sargent. What does this one bring to the table?

This was the first book I ever had in grad school, in my very first macro class. It was a good book for me to learn macroeconomics as it existed in the early 1980s. It actually presents a very Keynesian model, because that was the dominant model of the time and the beginnings of new classical models.

The reason I like it, and still use it, is that it shows me a lot of ways to solve expectational difference equations. These are just equations that have expectations in them. You might say that GDP today is equal to some function of government spending, of interest rates and the money supply – and it might be a function of expected income tomorrow. So income today depends on what you expect to happen tomorrow. Once you put those expectations into that equation, it’s really really hard to solve. In this book, Sargent begins showing us how to solve those problems in a way that’s general and works in a lot of different cases. So he brings a brand new technology to the literature that opens up a lot of questions you couldn’t ask before.

Isn’t this covered in the other books?

The book he wrote with Lars Ljungqvist is an updated, expanded and better version of this older book. But this book is still really good at solving models that have expectations in them. I still assign one chapter of it to my students. Particularly those tools for solving difference equations – they’re called expectational difference equations – are just as good as they ever were. It’s still the best source that I know of.

How much are these econometrics methodologies tied to the rational expectations assumption? If economic agents are boundedly rational and not capable of solving dynamic optimisation problems, do these econometric methods still apply or do they need to be fundamentally modified? If people follow simple rules of thumb, would these methods still work?

There’s a lot of tools in there that would still work. My colleague George Evans does exactly what you say. He builds learning models, and he doesn’t assume agents are rational. He then sees whether by using simple learning rules the models converge to a rational solution over time. He still uses quite a few of the techniques that Sims uses, like impulse response functions, causality testing, all those kinds of techniques. There’s a set of things that aren’t very model dependent, things that you can bring to any set of data to learn about it.

But there’s another set of techniques where the techniques themselves depend on implications of the rational expectations hypothesis. The rational expectations hypothesis, for instance, will tell you that some variables have to be uncorrelated. Stock returns have to be uncorrelated over time, because if you could predict stocks tomorrow, any rational agent would arbitrage that, make money and take away the predictability. What that gives you is a zero correlation between yesterday and today. That fact that that correlation is zero is often exploited in some of these techniques, to make it work. So if your rational expectations hypothesis falls apart, a lot of what I would call the more structural-based econometric techniques would fall apart with it, because they rely on the implications of rational expectations.

In your field of econometrics, and in economics in general, is there a lot of change going on as a result of the crisis?

There should be. But not as much as I would like to see. Since I was in grad school – I graduated in 1986 so it’s been about 25 years – we’ve probably gone through two or three generations of models. When I started it was very Keynesian, then it was new classical, then we got something called the real business cycle models, then we got the new Keynesian models, and today there is an emerging set of models called the monetarist models. Within the field there’s been a lot of churning of models. The reason those first sets of models didn’t survive was because they didn’t stand up to the data.

The models that Lucas got his Nobel prize for – the new classical models, where expectations play a fundamental role, only unexpected money matters and things like that – had some really strong implications. We took that model to the data and it couldn’t explain the size, the magnitude and the duration of business cycles. It got rejected. Then we went to real business cycle models. They did better. But they had trouble explaining great depressions and other sorts of things, so we rejected those models and went to new Keynesian models. Those models were doing great, right up to the crisis. Then they did horridly. You don’t need advanced econometrics to reject that class of models – it’s clear that they just didn’t handle the crisis. So we’re going to reject those too. There’s been a lot of change, and I expect that change will speed up. I wish it was even faster, because it’s very clear to me that the models we were using prior to the crisis are not going to get the job done.

You mentioned your colleague George Evans. Are there other economists you admire, in terms of what they’re trying to do to find new, convincing models?

I like George’s learning models. I also like what John Geanakoplos is doing at Yale. Eric Maskin mentioned him in his interview with you. What was wrong prior to the crisis is that the macroeconomy wasn’t connected to the financial sector. There’s a technical reason for that which has to do with representative agent models – we just didn’t have any way to connect financial intermediation to the macro model. And we didn’t think we needed to. We didn’t think that was an important question, we didn’t think there was any reason to worry about the kind of meltdown we had in the 1930s happening in the US today. So no one bothered to build these models. Nevertheless, even before the crisis, Geanakoplos was building models that tried to explain how we could have these endogenous models and these cycles. I really like that, because it uses the same tools and techniques that we’ve been using all along, but it puts them together in a different way, and in a way that I think makes a lot more sense.

Do you think there’s too much disdain among academic economists for what’s happening in the real world?

A little bit. It’s partly that, and it’s partly that the answers you get as an econometrician aren’t always that precise. Because of that lack of precision and the lack of ability to experiment, you often find people getting different values for the multiplier, getting different answers with different data sets – and that makes it look, perhaps correctly, that we really don’t have any answers.

What happened is that the theorists retreated into their deductive world, where they weren’t taking their models to the data enough. When they did take them to the data, and found that they didn’t work, they just said, “Oh it’s because of bad econometrics, the model is logically correct so we’re going to stick with it.” I think the arrogance of the theorists, and the lack of ability to do experiments, combined to make them way too insular in terms of taking their models and forcing them to interact with the actual world.

Interview by Sophie Roell
Published on Oct 28, 2011

If you read the above, you will find that David Orrell falls in the "heterodox" camp, i.e. those who don't like the equilibrium models and is not happy with contemporary tools and techniques of traditional economics:

Then there’s another, much smaller group that don’t think any of us have a clue. Those are the heterodox economists. They don’t like the tools and techniques we use, they don’t like equilibrium models. It’s people like Jamie Galbraith, who don’t agree with either side.

Not being an economist, I fell free to express my opinion. I think the future lies with the heterodox camp. I think David Orrell's criticisms are dead right.