Author Archive
Revenge of the Aggregates
| Peter Klein |
I first studied macroeconomics back in the dark days before the microfoundations revolution had filtered down into the undergraduate curriculum. We learned Y = C + I + G and that was about it. Fluctuations in aggregate demand cause fluctuations in aggregate output, Hayek be damned. Relative price changes — between markets at the same place in the time-structure of production, or between higher- and lower-order sectors — were completely ignored.
Supposedly mainstream macroeconomics has moved beyond this crude level of aggregation. But you’d never know if from the discussions of the last few weeks. “Banks” aren’t “lending” enough. “Businesses” and “consumers” can’t get “loans.” “Firms” have too many “bad assets” on their books. The key question, though, is which ones? Which banks aren’t lending to which customers? Which firms have made poor investments? Newsflash: a loan isn’t a loan isn’t a loan. I hate to break it to the Chattering Class, but not every borrower should get a loan. The relevant question, in analyzing the current mess, is which loans aren’t being made, to whom, and why? The critical issues revolve around the composition of lending, not the aggregate amount. Focusing on total lending, total liquidity, average equity prices, and the like merely obscures the key questions about how resources are being allocated across sectors, firms, and individuals, whether bad investments are being liquidated, and so on. (more…)
Humorous Headline of the Day
| Peter Klein |
OK, it’s bailout related, so the humor is macabre, but here goes, courtesy of the Financial Times:
Iceland in emergency talks to prevent bank meltdown
When even the ice is melting, it’s getting serious.
Nobel Pickin’ Time
| Peter Klein |
The econommics Nobel chatter has already begun (1, 2, 3, probably many more). I’ll just borrow from last year’s post for those who follow such things:
How about a prize for organizational economics? Coase, of course, whose 1937 paper is foundational to the field, has already won, as have Akerlof, Spence, Stiglitz, Mirrlees, Vickrey, Hayek, and others whose work has greatly informed the study of organizations. But, for a prize recognizing organizational economics per se, whom would you pick? Williamson, Holmström, Milgrom, Roberts, Hart, Tirole, Aghion? Perhaps Alchian, Demsetz, or Jensen. Maybe a personnel economist (Lazear) or someone in corporate finance or accounting (Bill Schwert, Stewart Myers, René Stulz, Raghuram Rajan, Cliff Smith, Milton Harris, Artur Raviv)? Suggestions?
An entrepreneurship Nobel for, say, Baumol and Kirzner isn’t out of the question, but seems unlikely. What do you think?
Self-Fulfilling Prophecy?
| Peter Klein |
Commentators seem to take it for granted that this week’s crazy stock-market performance, particularly Monday’s 700-point drop in the Dow, proves the reality of the financial crisis. But in today’s Fed-watching age, in which even the most cryptic pronouncements of Federal Reserve officials send traders rushing to their keyboards, do you think the repeated statements by the Fed chair, Treasury secretary, and other insiders that the economy is on the verge of total collapse might just have a teensy, weensy effect on financial markets?
“Henry, banks are still lending. Hurry, say ‘credit crunch’ again and maybe we can scare ’em off!”
BTW isn’t it interesting that the phrase “not lending” has become a synonym for “lending less”? The Paulson plan “could channel enough money to enough banks to get them to resume lending,” says Knowledge@Wharton. So banks are currently making zero loans? Wow. I sense a profit opportunity. Hmmm, Don Boudreaux points to a Christian Science Monitor piece revealing that “only 63 percent of consumers applying for a car loan are being approved compared with 83 percent a year ago.” Yep, sounds like zero lending to me.
More Bailout Humor
| Peter Klein |
In dark times, sometimes all you can do is laugh.
StrategeryCapital Management LLC
“Putting your money where our mouth is.”About Strategery
Strategery is a unique hedge fund.
It is the largest in the world, with expected initial capital of $700 billion. It has a free and unlimited credit line should it need more. It has no fixed mandate, though it is expected to initially focus on mortgage-backed securities. And it is the only fund backed by the full faith and credit of the U.S. Government.
Strategery is a way for you to be more patriotic. Supporting this fund is an American duty. Many people have already taken to wearing a green, red, and blue ribbon to symbolize and broadcast their support for this newest American institution.
Strange Bedfellows
| Peter Klein |
One of the interesting aspects of this week’s House vote on the Paulson plan was the coalitions it generated. The Treasury Secretary, the Fed Chair, and leaders of both the Democratic and Republican sides stood hand-in-hand to urge lawmakers to support the bailout. Conservative Republican and liberal Democratic members joined forces to defeat it. What gives? Larry White points to ideology: “Republicans who voted no didn’t like the fact that $700 billion would be taken from taxpayers. . . . Democrats who voted no didn’t like the fact that it would be going to Wall Street.” Maybe, but I prefer Gordon Smith’s suggestion:
Anthony Ha uses the data at MapLight.org (a website dedicated to “illuminating the connection” between money and politics) to tell another familiar political story. Looking at this page, Anthony observes:
Overall, bailout supporters received an average of 54 percent more in campaign contributions from banks and securities than bailout opponents over the last five years. The disparity also held true if you look at individual parties. In fact, the 140 Democrats who voted for the bailout received almost twice as much money from banks and securities as the 95 Democrats who voted against it. (The difference was closer to 50 percent for Republicans.)
Does anybody have data that would permit some quick-and-dirty analysis, say a logistic regression of the House votes as a function of legislator and district characteristics, contributions from the commercial and investment banking industries, and other interest-group variables?
I’m From the Government, and I’m Here to Make You Some Money
| Peter Klein |
I’ve noted before how most commentators on the financial crisis are ignoring political economy. Virtually everyone, with the exception of the good folks at Mises.org, The Beacon, and a few other sites, treats Paulson, Bernanke, bank regulators, members of Congress, and other principals as the benevolent dictators of neoclassical welfare economics. (This is true even of people you’d think might know something about public choice.) But it’s impossible to analyze the current situation without reference to special interests — not only those whose actions are responsible for the current mess, but also those taking advantage of the situation to rewrite the rules and increase their authority.
One example: A particularly foolish (and dangerous) meme working its way through Washington and the surrounding punditocracy is the idea that the Paulson or modified Paulson plan isn’t really a $700 billion bailout. It’s an asset purchase, the argument goes, not a transfer payment; the Treasury buys $700 billion of bad securities, holds them, and sells them later, once market conditions improve. Maybe the Treasury can sell these assets for, say, $500 billion, so the net cost to the taxpayer is only $200 billion. Heck, if prices rise enough, taxpayers may even make money on the deal! (That’s what the junior senator from Missouri said today. Plenty of clever-silly people are saying this kind of thing too.)
The scenario is pure fantasy. Think of it this way. Treasury gets the $700 billion by borrowing (say, from the Chinese) or through increased tax revenue. Suppose the value of these assets really does rise to $500 billion, and the Treasury sells them back to investors. What will the US government do then — return the 500 billion to taxpayers? Does anyone seriously think Congress would cut taxes or offer rebates to give that money back? Not on your life. Congress will simply take that $500 billion and spend it on new programs. The Paulson plan represents an increase in government expenditures of $700 billion, period. Joe and Jane taxpayer will never get a penny of that $700 billion back, no matter what happens to asset prices.
Teaching Economics through Cinema
| Peter Klein |
I wrote something a while back on the entrepreneur in film. Here’s a working paper on the use of cinema in economics education more generally. Gherardo Girardi experiments with movies in the clasroom and reports the results, summarized by this (perhaps unintentionally) droll remark: “The results from the student surveys show that the students strongly wish to see the proposed module introduced.” No kidding.
Girardi’s recommendions include some surprises along with familiar items:
- Death of a Salesman (Arthur Miller, 1949, US) – Choice of profession, sense of self worth based on economic performance;
- Grapes of Wrath (John Steinbeck, 1939, US) – Property rights, migration, trade unions;
- Oliver Twist (Charles Dickens, 1838, UK) – Economics of crime, economics of charities;
- Rogue Trader (James Dearden, 1999, US) / Wall Street (Oliver Stone, 1987, US; C) – Psychology of financial markets, business ethics;
- Balkanizateur (Sotiris Goritsas, 1998, Greece; C) – Efficiency of capital markets;
- La Terra Trema (Luchino Visconti, 1948, Italy) – Poverty and the risks of entrepreneurship;
- St. Francis (Michele Soavi, 2002, Italy) / Francis, God’s Jester (Rossellini, 1950, Italy) – Choice between wealth and poverty
- Mother India (Mehboob Khan, 1957, India; C) – Rural financial markets in poor countries;
- Pride and Prejudice (Jane Austin, 1813, UK) – Dowries, economics of inheritance;
- Ashani Sanket (a.k.a. Distant Thunder, Satyajit Ray, 1973, India) – Economics of famines;
- Robin Hood (author unknown, 1973 Walt Disney production recommended) – Morality of stealing from the rich/the state
See also From ABBA to Zeppelin, Led: Using Music to Teach Economics.
Karl’s Revenge
| Peter Klein |
I closed my first post on the bailout mess with “Capitalism, requiescat in pace.” Here’s Martin Masse with the details. (Thanks to Mark Thornton.)
Paulson, Bernanke, Congress: We Need Your Help!
| Peter Klein |
With our economy in crisis, the US Government is scrambling to rescue our banks by purchasing their “distressed assets”, i.e., assets that no one else wants to buy from them. We figured that instead of protesting this plan, we’d give regular Americans the same opportunity to sell their bad assets to the government. We need your help and you need the Government’s help!
Use the form below to submit bad assets you’d like the government to take off your hands. And remember, when estimating the value of your 1997 limited edition Hanson single CD “MMMbop”, it’s not what you can sell these items for that matters, it’s what you think they are worth. The fact that you think they are worth more than anyone will buy them for is what makes them bad assets.
Here’s the link (via Sean Corrigan, and please excuse the language). Remember, if people can’t get rid of their bad assets, they will have to cut back their spending, hurting local businesses, which will then be unable to spend, hurting other businesses, and so on, generating a “consumption crunch” that will cause the next Great Depression. Please, somebody, break some windows!
Best of “On the Economy”
| Peter Klein |
Tom Keane’s greatest (interview) hits, featuring Nassim Taleb, Bill Gross, Robert Lord Skidelsky, Mohamed El-Erian, Eugene Fama, Peter Peterson, James MacGregor Burns, Peter Bernstein, Allan Meltzer, Martin Feldstein, James Poterba, Peter Fisher, David Malpass, Milton Friedman, Thomas Schelling, Myron Scholes, William Sharpe, Edmund Phelps, Gary Becker, Robert Mundell, Robert Solow, Amartya Sen, Robert Lucas, Kenneth Arrow, and Paul Samuelson.
A Critique of Modern Law and Economics Research
| Peter Klein |
From Eric Engle. How can I not link to a paper with “Theoretical Puffery” in the title? (Thanks to Mark Thornton for the pointer.)
Law and Economics: Theoretical Puffery, Exaggerated Claims and Counterfactual Models
Eric Engle
Universität Bremen; Harvard University – Berkman Center for Internet & SocietySeptember 15, 2008
Economic analyses of law predominate in the United States because they can claim to be objective and scientific thus verifiable and the basis of predictions and reproducible experiments. However, several of the claims of economic analysis of law go too far and are entirely unrealistic. This explains why economic analysis of law has not been taken up outside of the U.S. to the extent it has in the U.S. This article points out the unrealistic presumptions within law and economics theory (homo economicus and efficient markets, mostly) and the unrealistic claims of law and economics (that the law is and should be a mirror of the economy). Economic analysis of law cannot and should not serve as a general basis of legal decision making. However, as a special theory applicable as a method for determining certain issues economic methods can well inform legal decision making helping judges to shape justice correctly. This article exposes the competing schools within law and economics and presents a defensible version of economic methodology applied within legal discourse.
Nationalization of US Credit Markets: Where Is the Analysis?
| Peter Klein |
Over and over during the last week we’ve been told that unless Congress, the Treasury, and the Fed take “bold action,” credit markets will freeze, equity values will plummet, small businesses and homeowners will be wiped out, and, ultimately, the entire economy will crash. Such pronouncements are issued boldly, with a sort of Gnostic certainty, a little sadness for dramatic effect, and only minor caveats and qualifications.
And yet, details are never provided. The analysis is conducted entirely at a superficial, almost literary, level. “If the government doesn’t act then banks will be afraid to lend, and people can’t get credit to buy a house or expand their business, and the economy will tank.” Unless we rescue these particular financial institution, in other words, a massive contagion effect will swamp the entire economy. But how do we know this? We don’t. First, we don’t even know if there is a “credit crunch.” Nobody has bothered to provide any empirical evidence. Second, even if credit markets are tight, does it matter? Any predictions about the long-term effects are, of course, purely speculative. Sure, borrowers like cheap and easy credit and tighter credit markets will leave some borrowers worse off. But what are the magnitudes? What are the likely effects on the economy as a whole? (Possibly zero.) What are the possible scenarios, what is the likelihood of each, and how large are the expected effects? Where is the cost-benefit analysis? After all, the seizure of Fannie and Freddie, the takeovers of AIG and WaMu, the modified Paulson plan — the effective nationalization of the US financial sector, in other words — ain’t exactly costless. There are direct costs, of course, to be borne by taxpayers, but the possible long-term effects brought about by increased moral hazard, regime and policy uncertainty, and the like are enormous. Even on purely utilitarian grounds, the arguments offered so far are tissue-paper thin.
Perhaps the dopiest remark I heard today was from Jamie Galbraith on the Diane Rehm show. “I’m a risk-averse person, and the risk of doing nothing is too great.” Huh? Um, shouldn’t a risk-averse person compare the risk of doing nothing with, well, the risk of doing something? Jamie, are the provisions of the bill making its way through Congress this morning risk free?
Government Funding and the Economic Organization of Scienctific Research
| Peter Klein |
A prominent climate scientist, Richard Lindzen of MIT, argues that the politicization of climate science over the last decade is but a symptom of a larger, more general problem caused by government science funding: namely an emphasis on demonstrable results that satisfy the public and have “practical” implications, rather than the pursuit of scientific truth (via Sean Corrigan).
For a variety of inter-related cultural, organizational, and political reasons, progress in climate science and the actual solution of scientific problems in this field have moved at a much slower rate than would normally be possible. Not all these factors are unique to climate science, but the heavy influence of politics has served to amplify the role of the other factors. By cultural factors, I primarily refer to the change in the scientific paradigm from a dialectic opposition between theory and observation to an emphasis on simulation and observational programs. The latter serves to almost eliminate the dialectical focus of the former. Whereas the former had the potential for convergence, the latter is much less effective. The institutional factor has many components. One is the inordinate growth of administration in universities and the consequent increase in importance of grant overhead. This leads to an emphasis on large programs that never end. Another is the hierarchical nature of formal scientific organizations whereby a small executive council can speak on behalf of thousands of scientists as well as govern the distribution of ‘carrots and sticks’ whereby reputations are made and broken. The above factors are all amplified by the need for government funding. When an issue becomes a vital part of a political agenda, as is the case with climate, then the politically desired position becomes a goal rather than a consequence of scientific research. This paper will deal with the origin of the cultural changes and with specific examples of the operation and interaction of these factors. In particular, we will show how political bodies act to control scientific institutions, how scientists adjust both data and even theory to accommodate politically correct positions, and how opposition to these positions is disposed of.
The paper is well worth reading by social scientists and organization theorists. Business-school faculty will recognize the parallels with the call for “relevance” in management education (see the links in Teppo’s recent post). And there are important connections to the arts and humanities; recent scholarship, for example, challenges the notion that public funding produces better art (painting, music, literature, drama) than patronage or commercial funding (Cantor, Cowen, Scherer). Some readers may respond, with Pilate, “What is truth?” Somebody has to pay the bills, in other words, and that party will want something in return. (more…)
Mankiw: Defer to the Philosopher-Kings
| Peter Klein |
One of the most disappointing economist responses to the proposed bailout is Greg Mankiw’s. While not exactly endorsing the Paulson-Bernanke plan itself, Greg supports the process through which it emerged. His argument, essentially, is this: Paulson and Bernanke are very smart and have access to better information than the rest of us, so we should stop complaining and go along with whatever they propose.
I find this stunningly naive, for four reasons:
1. It ignores differences in theoretical frameworks or models. No doubt Karl Marx, John Maynard Keynes, Oskar Lange, Paul Samuelson, and Joseph Stiglitz were or are highly intelligent people. Do we have to accept all their policy conclusions? Surely intelligent specialists can come to different conclusions not only because they have access to different information (the Friedmanite view), but because they have different understandings of how the world works. (This is especially true when long-run, rule-utilitarian consequences are at stake.)
2. It ignores the distinction between theoretical and applied economics. Even if people agree on theoretical questions, they may disagree on the application of theory to specific historical situations, which is a matter of judgment, not intelligence.
3. It ignores private interests. Paulson and Bernanke are not disinterested, Platonic philosopher-kings pursing the common good. Presumably they are pursuing private interests, just like every other political actor. Has Greg never heard of public choice?
4. It ignores concerns other than economic efficiency. Economists, like everyone else, have normative opinions. Some may oppose the bailout not on utilitarian grounds, but because they think giving taxpayer dollars to failing enterprises is immoral, regardless of possible contagion effects.
GM-Fisher: Yet More
| Peter Klein |
The debate over the acquisition of Fisher Body by General Motors, like the Energizer bunny, keeps going, and going, and going. . . . The new issue of Industrial and Corporate Change has two more papers, “Lawyers Asleep at the Wheel? The GM–Fisher Body Contract” by Victor Goldberg and “The Enforceability of the GM–Fisher Body Contract: Comment on Goldberg” by Ben Klein. Here are the abstracts:
Goldberg: In the analysis of vertical integration by contract versus ownership, one event has dominated the discussion — General Motors’ (GM) merger with Fisher Body in 1926. The debates have all been premised on the assumption that the 10-year contract between the parties signed in 1919 was a legally enforceable agreement. However, it was not. Because Fisher’s promise was illusory the contract lacked consideration. This note suggests that GM’s counsel must have known this. It raises a significant question in transactional engineering: what is the function of an agreement that is not legally enforceable?
Klein: Goldberg unconvincingly claims that the General Motors (GM)–Fisher Body contract was in fact legally unenforceable. But even if Goldberg’s contract law conclusion were correct, it is economically irrelevant. It is clear from the actions of Fisher and GM and from the testimonial and other contemporaneous evidence that both transactors considered the contract legally binding and behaved accordingly. Therefore, proper economic analysis of the Fisher–GM case should continue to assume contract enforceability, and the economic determinants of organizational structure illustrated by the case remain fully valid.
Advice For Junior Faculty
| Peter Klein |
Last Friday the Chronicle of High Ed published the first in a series of articles giving strategic advice for pre-tenure faculty. In “A Call for Clarity” Cathy Trower and Anne Gallagher identify four common pitfalls facing early-career professors:
- Vague and inconsistent tenure guidelines
- Lack of constructive feedback
- A culture of “don’t ask, don’t tell”
- Divergence between policy and practice
In response they suggest that universities adopt formal written policies, offer tenure workshops, and provide clear interpretation of tenure rules. Good advice. (Thanks to Fabio Chaddad for the pointer.)
A New Hope
| Peter Klein |
Finally, encouraging signs of resistance to the Paulson-Bernanke Corporate Welfare Act of 2008. Naturally, the commentators at our favorite sites at our favorite sites listed in the “Links” section below and to the right have been been against the bailouts from the beginning, but now mainstream scholars and analysts are getting into the act. I don’t mean complaints from members of Congress or The Candidates that the recent and proposed bailouts don’t go far enough (e.g., homeowners should get bailed out too) or that the Paulson-Bernanke proposal doesn’t include enough new regulations. Rather, I’m talking about sensible analysis by prominent, mainstream economists and other experts explaining that a market economy in which profits are private while losses are socialized is, well, not a market economy at all but a socialist or corporate-fascist state. See, for example, statements by Luigi Zingales, John Cochrane, and Richard Epstein, among others. Maybe the Empire can be defeated after all. (Apologies to Seth MacFarlane for modding his image.)
Update: Casey Mulligan is also quite good.
Request for Urgent Confidential Business Relationship
| Peter Klein |
Perhaps you found this in your inbox today. But, really, is it any sillier than the real thing?
From: Minister of the Treasury Paulson
Subject: REQUEST FOR URGENT CONFIDENTIAL BUSINESS RELATIONSHIPDear American:
I need to ask you to support an urgent secret business relationship with a transfer of funds of great magnitude.
I am Ministry of the Treasury of the Republic of America. My country has had crisis that has caused the need for large transfer of funds of 800 billion dollars US. If you would assist me in this transfer, it would be most profitable to you.
I am working with Mr. Phil Gram, lobbyist for UBS, who will be my replacement as Ministry of the Treasury in January. As a Senator, you may know him as the leader of the American banking deregulation movement in the 1990s. This transactin is 100% safe.
This is a matter of great urgency. We need a blank check. We need the funds as quickly as possible. We cannot directly transfer these funds in the names of our close friends because we are constantly under surveillance. My family lawyer advised me that I should look for a reliable and trustworthy person who will act as a next of kin so the funds can be transferred.
Please reply with all of your bank account, IRA and college fund account numbers and those of your children and grandchildren to wallstreetbailout@treasury.gov so that we may transfer your commission for this transaction. After I receive that information, I will respond with detailed information about safeguards that will be used to protect the funds.
Yours Faithfully Minister of Treasury Paulson
Of course, the word “deregulation” above should be “change in regulation.”
See also: All Your Banks Are Belong to US (via Anthony).
Online Managerial Economics Seminar with Luke Froeb
| Peter Klein |
Luke Froeb, co-author (with Brian McCann) of the excellent MBA text Managerial Economics: A Problem-Solving Approach and co-blogger at Management R&D is conducting an online seminar this Wednesday, “Teaching MBA Students How to Solve Problems Using Economics.” (I can’t bring myself to use the word “webinar.”) All you need to participate is an internet connection and a phone. It’s free but you have to register.
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