10/21/10 7:47 PMMartin Wolf Understands Economics... - Grasping Reality with Both Hands

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Grasping Reality with Both HandsThe Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, Reality-Based, and Even-HandedDepartment of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 7080467; delong@econ.berkeley.edu.

Economics 210aWeblog ArchivesDeLong Hot on GoogleDeLong Hot on Google BlogsearchSeptember 27, 2010

Martin Wolf Understands Economics...

...as John Cochrane does not.

John Cochrane complains about being accurately quoted by Paul Krugman:

John Cochrane of the University of Chicago, who wrote that Krugman was sliminga growing enemies list: "Don't argue with them, swift-boat them. Find someembarrassing quote from an old interview. Well, good luck, Paul. Let's just notpretend this has anything to do with economics..."

John Cochrane's problem is not one embarrassing quote. It is that he keeps saying,over and over again, things that are wrong on a basic level, that reduce the level of thedebate, and spread ignorance.

For example, Mike Sandifer:

Speaking of ignorance, I saw John Cochrane on Bloomberg a couple of weeksago... at the 3:23 mark, he said that fiscal stimulus was ineffective because a dollarof spending is a dollar that had to come from someone else. Correct me if I’mwrong, but isn’t this an obvious fallacy? The stimulus is being financed with deficitspending, with government debt being bought by at least some of that money thatmay otherwise be on the sidelines. The link to the video:http://www.youtube.com/watch?v=HO4E1bs4CbE

Now comes Martin Wolf to--patiently--argue with John Cochrane and his ilk:

We can only cut debt by borrowing: “You can’t cut debt by borrowing.” How oftenhave you read or heard this comment from “austerians” (a nice variant on“Austrians”), who complain about the huge fiscal deficits that have followed thefinancial crisis?

The obvious response is: so what? Shifting debt from people who cannot support

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it to those who can - the population at large, both now and in future - seems tomake a great deal of sense if the alternative is an economic collapse that leads to aloss of output and investment now and so of income in the long term. Indeed,under the latter alternative, even the fiscal deficits may end up little, if any,smaller if one tries to slash them, as the UK could be about to discover.

Before leaping to that conclusion, however, let us approach the issue of de-leveraging - or debt reduction - analytically....

Since the financial balances of the household, corporate, government and foreignsectors must sum to zero, a rise in the surplus of the household sector must beoffset by an offsetting move in other sectors. During a post-crisis recession, thesurplus of the corporate sector always rises... because managements slashinvestment.... [N]on-financial corporate sectors were running substantial financialsurpluses in the high-income countries before the crisis and are running stillbigger surpluses now.... [S]urplus countries do not want to make the adjustmentsneeded to allow the US, UK and other former deficit countries run huge currentaccount surpluses at full employment levels of income.... When one has eliminatedeverything else, it turns out that the only sector both able and likely to offset alarge move of the household sector towards financial surplus in a post-crisis slumpis the government. Indeed, that is exactly what has happened.

My conclusion, then, is... the only way that the private sector can de-leverage,when large economies are in a post-crisis recession, is for the government toleverage. The economy, as a whole, cannot de-leverage in any other way, otherthan via accelerated mass bankruptcy, which would certainly deepen therecession.... The recommended alternative of slashing the fiscal deficit while theprivate sector tries to slash its debt suffers from a fallacy of composition: it isimpossible for all sectors of the economy to spend less than income at the sametime...

Brad DeLong on September 27, 2010 at 06:22 PM in Economics, Economics: FiscalPolicy, Economics: Macro | Permalink

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Don the libertarian Democrat said...Martin Wolf is about as good as it gets in this crisis. It's not even a fair contest.

Reply September 27, 2010 at 07:07 PM

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Richard said...I keep waiting for someone to ask John Cochrane: "Prof. Cochrane, do you realize theUS isn't on the gold standard any more"?

Mind you, I had Cochrane for a class, and he taught me some neat things about factormodeling, but I do wonder, why the hell is a finance guy trying to tell a macro guy thathe doesn't understand macro; and why does he keep thinking that we're still on thegold standard?

Reply September 27, 2010 at 07:19 PMRob in FL said...Why are the right wing economists taking Dr. Krugman's professional criticism sopersonally? They have taken to slinging personal insults more and more frequently,rather than respond to the deficiencies in their work. They are revealing themselves tobeing a bunch of hacks, rather than educators and researchers.

Reply September 27, 2010 at 07:22 PMOmega Centauri said..." it is impossible for all sectors of the economy to spend less than income at the sametime..."I really like that. I've been trying to argue against austerity, by talking about demand. Ithink Martin states it in a much more understandable fashion. But sane economicpolicy I think is a lost cause, we are an emotion driven morality tale species, and willdismiss all cogent arguments that refute the austerity cure as mere sophistry. As aspecies, our total economic learning from 1937 to 2010 sums to precisely zero.

Reply September 27, 2010 at 07:50 PMDrDick said in reply to Rob in FL..."They are revealing themselves to being a bunch of hacks"

Ding! I think you have answered your own question.

Reply September 27, 2010 at 08:11 PMhoward said in reply to DrDick...i try not to post just to say "second," but given that i was prepared to respond to rob infl virtually word-for-word the way that drdick did, i can only say "second."

but my initial reason for wanting to post was to ask the prof: you know this clown, atleast professionally. what's your explanation? is he just not very smart? or does heknow one thing? or is it simply something in the econ department water cooler?

Reply September 27, 2010 at 10:11 PMToo Much Fed said...Martin Wolf DOES NOT Understand Economics...

"The obvious response is: so what? Shifting debt from people who cannot support it tothose who can - the population at large, both now and in future - seems to make agreat deal of sense if the alternative is an economic collapse that leads to a loss ofoutput and investment now and so of income in the long term."

TOTALLY unfair to the people who understood there was too much debt and should bebenefiting.

I suggest a shift of debt to Martin Wolf so all his income goes to the interest payments.Let's see how he likes that.

Reply September 27, 2010 at 11:27 PMToo Much Fed said...

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Martin Wolf DOES NOT Understand Economics...

"My conclusion, then, is... the only way that the private sector can de-leverage, whenlarge economies are in a post-crisis recession, is for the government to leverage."

False. Does not understand the difference between a deficit with currency and a deficitwith debt.

"The economy, as a whole, cannot de-leverage in any other way, other than viaaccelerated mass bankruptcy, which would certainly deepen the recession...."

False. Does not understand the difference between a deficit with currency and a deficitwith debt. Does not understand how debt levels rose without producing price inflation.

"it is impossible for all sectors of the economy to spend less than income at the sametime..."

Needs to look into wealth/income inequality.

Reply September 27, 2010 at 11:36 PMToo Much Fed said...Martin Wolf DOES NOT Understand Economics...

"My conclusion, then, is... the only way that the private sector can de-leverage, whenlarge economies are in a post-crisis recession, is for the government to leverage. Theeconomy, as a whole, cannot de-leverage in any other way, other than via acceleratedmass bankruptcy, which would certainly deepen the recession.... The recommendedalternative of slashing the fiscal deficit while the private sector tries to slash its debtsuffers from a fallacy of composition: it is impossible for all sectors of the economy tospend less than income at the same time..."

Does not understand how a mishandled aggregate supply shock can later appear to bean aggregate demand shock.

Reply September 27, 2010 at 11:40 PMToo Much Fed said...Rob in FL said: "They are revealing themselves to being a bunch of hacks, rather thaneducators and researchers."

Make it political hacks instead of actual economists.

Make it both the right wing (private debt) and left wing (gov't debt).

Stop listening to both "wings".

Reply September 27, 2010 at 11:45 PMMin said in reply to Too Much Fed...Too Much Fed: "TOTALLY unfair to the people who understood there was too muchdebt and should be benefiting."

The thing is, we are all in this together, as Red Green says. :) Not that we should nottry to have fair policies, but if we expect the people as a whole to shed debt and gettheir houses in order, the gov't must run high deficits. If people who were prudent andfrugal feel unfairly treated by that, they can take solace in the fact that they will bebetter off if everyone is better, in absolute terms if not relative terms. We are facing aonce in a lifetime crisis, and we need to pull together.

Reply September 28, 2010 at 12:50 AMfresno dan said..."Since the financial balances of the household, corporate, government and foreignsectors must sum to zero..."

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I have never understood this phrase - it makes it seem like there can never be truelosses.

If we reduce the economy to say 3 people, and there is a total of 100$ of value in thatsociety, (and this represents the value of all the houses, a total of 3 houses and 30% ofthe sum "GDP" of the society) and I burn down all three houses, has not the sum of thevalue of the society been reduced by 30%? Say I owned the houses outright - am I trulynot poorer than I was before?

Reply September 28, 2010 at 03:00 AMHerman said...The problem, I think, with John Cochrane is that he has of late become the object ofmuch ridicule. He does not understand why, and so finds it convenient to blameKrugman. The reason people have been ridiculing Cochrane is because he has been repeatedlyspouting nonsense, and being a man of deep and unshakable faith, seems completelylacking in critical ability.

Try googling for "mind boggling nonsense".http://www.google.com/search?q="mind+boggling+nonsense"

Reply September 28, 2010 at 03:02 AMRPLong said...DeLong, you can't possibly believe that first Sandifer quote, can you? Stimulusspending does come from someone else. Perhaps what's throwing you off is the factthat there is an intertemporal substitution issue going on. Regardless of present value,stealing from me in the future is equally as abhorrent as stealing from me today.

Sometimes it pays to appreciate the subtleties of opposing opinions, rather than justmake them look ridiculous.

Reply September 28, 2010 at 04:36 AMAnon said in reply to RPLong...But that's not what Sandifer is saying (it's a very short quote, please read morecarefully). He's replying to the claim that stimulus spending is -ineffective- because it'scoming from somewhere else, i.e that it crowds out private spending. His reply isadequate.

Reply September 28, 2010 at 04:58 AMRyan said...Anon, I recognize what you and Sandifer are getting at but continue to disagree. Couldit be that I actually understood Sandifer's point, DeLong's point, Cochrane's point, andstill believe that stimulus spending ultimately doesn't work because it's merely anintertemporal shift?

[No, it could not.

It is not "merely" an intertemporal shift. That is the point. If you think that anintertemporal shift of demand is stimulus not working, than you don't understandSandifer's point at all.]

It's okay if you disagree with me (or Cochrane), but it's disingenuous to imply that Ican't read a quote accurately or that Cochrane says things that aren't true. That's mypoint.

Reply September 28, 2010 at 05:29 AMMichael Gauss said in reply to fresno dan ...

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Agreed. If my house burns down today whose financial balance goes up?

Reply September 28, 2010 at 05:54 AMogmb said...If posting an embarrassing old quote counts as sliming, then I'm happy to slime John"Bantam Cock" Cochrane once again...

"Most of all, caveat emptor -- these are a matters for buyers and sellers, not regulators.Nobody else gets hurt if you buy a lousy mortgage pool. The government does not needto write a new rule every time someone buys a rotten tomato. Investors will demandthe right transparency, complexity, and risk-sharing or monitoring of mortgage pools.That is, unless they get bailed out and learn to count on that instead! The history of themortgage market is a grand story of bringing credit to people who need it, upon theremoval of layer after layer well-intended but counterproductive "protective"regulation." -- John Cochrane, 2007

Reply September 28, 2010 at 06:35 AMRichard said...BTW, the best commentary in this discussion is here:http://freakonomics.blogs.nytimes.com/2009/02/05/economics-cage-match-delongkrugman-vs-cochranefama/

Specifically, by Kevin H:I haven’t read beyond Cochrane’s ‘3 Fallacies’ but I already know he’s wrong about allof them:

1. “Jobs created by stimulus spending are offset by jobs lost from the decline in privatespending.” Ok, but with the big exception that this offset can be delayed in time. Heeven makes that argument in #3 but fails to apply it back to #1. The basic idea wouldbe to move the job losses to an economy which can sustain them with little impact ongrowth. The error he makes is to assume that jobs and the economy have a linearrelationship. A few jobs added in a bad economy have a lot more impact than a fewjobs lost in a good economy.

2. “The economy overall does not care if you buy a car, or if you lend money to acompany that buys a forklift.” Nope, the economy sometimes does care very much. Ifyou have a well capatalized economy (like ours), there are plenty of forklifts to goaround. Factories to make every conceivable device are ready to rehire workers themoment they think that there will be a market for their products. There is a complexinteraction between market and producer that Cochrane is dismissing. Economies are a‘weakest link’ type phenomenon. You can only have as many goods sold as theminimum of the total amount you can produce or the total amount you are willing tobuy (supply-demand curves only add a very little elasticity to that basic cap). Rightnow we can produce more than we are willing to buy, so encouraging our willingness tobuy is the only way to increase overall economic activity.

3. Cochrane almost hits it with his thirst fallacy: “The classic arguments for fiscalstimulus presume that the government can systematically fool people.” It seems to methat this is close to the truth, if a bit overly negative. The fact is that people have had afundamental psychological shift. When everyone is optimistic, there is an economicboost, and likewise, when everyone behaves in a pessimistic fashion, there is aneconomic hit. This is again because of the ‘weakest link’ type phenomenon ineconomics. It doesn’t just matter what people can buy, or can do, they must alsobelieve it is the right thing to do. The underlying weaknesses in the economy are badenough, but pessimism turns bad into disaster. Therefore, simply making people less

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pessimistic can have a positive impact on the economy.

— Kevin H

Reply September 28, 2010 at 08:07 AMRichard said...More:

Fama and Cochrane miss a large point. They somehow assume that the people pickingup the gov’t debt, and thereby not using the same money in the private market, woulduse this money in the private sector if not for the stimulus. But much of this moneywill come by accumulating debt from outside sources (although this scares people, Idon’t think it’s so bad). And this money will not be invested currently in the privatesector because the financial sector is paralyzed and private sector is consumed byuncertainty. This is the point of large government stimulus packages during times likethese. It assumes that the market has been somewhat paralyzed and needs a shock toright the markets. The debt is delayed and, of course, eventually needs to be payedback, but hopefully during a time of growth and financial stability, when a small shortterm rise in taxes combined with budget decreases can work to lower debt withoutsignificantly hurting the economy.

— Jon

Reply September 28, 2010 at 08:10 AMRichard said...To add to Jon's point, Cochrane seems to assume that all actors are rational and profit-maximizing, but we know that some of the biggest actors in the arena right now arsovereign entities (like China), and if he's going to state that China is seeking profit-maximization in its investments, then he is more out of touch with reality than Ithought. For their own power/political purposes (or just flat-out investinginexperience), they would rather lend to the US government right now rather than it'sconsumers & corporates, yet Cochrane seems unwilling to acknowledge reality as it israther than reality as it fits his models.

Reply September 28, 2010 at 08:16 AMRyan said in reply to Ryan...I never said anything about an intertemporal shift of demand. I was talking about anintertemporal shift of spending...

[What we have hear is a failure to communicate: everyone else here, including me, uses"demand" and "spending" as synonyms. Drawing unexplained distinctions is nothelpful.]

Reply September 28, 2010 at 09:13 AMMin said in reply to fresno dan ...fresno dan: "I burn down all three houses, has not the sum of the value of the societybeen reduced by 30%?"

Certainly there has been a loss in real terms. But burning down the houses is not afinancial transaction, and it is the financial balances that sum to zero. Say that thehouses were insured, and the insurance companies pay off. The amount of insurancethat is received is a plus to the home owners, but a negative to the insurancecompanies. Add them together, and the result is zero. :)

Reply September 28, 2010 at 10:53 AMMin said in reply to Richard...

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Kevin H: "Cochrane almost hits it with his thirst fallacy: “The classic arguments forfiscal stimulus presume that the government can systematically fool people.”

It is not necessary to fool people to effect a shift between equilibria.

Reply September 28, 2010 at 11:14 AMMin said in reply to Richard..."The debt is delayed and, of course, eventually needs to be payed {sic} back" -- Jon

Gov't debt has been continually rolled over since Jackson paid it off in the 1830s. OC,specific bonds have been paid off, but, in a sense, we have never fully paid for the CivilWar. Gov't debt never has to be fully paid off, and doing so would take a lot of moneyout of the economy.

Reply September 28, 2010 at 11:20 AMBarry said in reply to Rob in FL..."Why are the right wing economists taking Dr. Krugman's professional criticism sopersonally? "

Because they're used to getting their way, and having their 'lessers' bow down to them.Remember that Chicago law professor several days ago, who couldn't stand having hisstatements dissected and shown to be some combination of lies, BS and ignorance?

What I'd like to see is the rest of eoconomics realize their chance is here, and storm theBastille of Chicago (and George Mason, Aggie, UCLA, Stanford/Hoover, etc.).

Reply September 29, 2010 at 08:34 AMToo Much Fed said...Min said: "Too Much Fed: "TOTALLY unfair to the people who understood there wastoo much debt and should be benefiting."

The thing is, we are all in this together, as Red Green says. :) Not that we should nottry to have fair policies, but if we expect the people as a whole to shed debt and gettheir houses in order, the gov't must run high deficits. If people who were prudent andfrugal feel unfairly treated by that, they can take solace in the fact that they will bebetter off if everyone is better, in absolute terms if not relative terms. We are facing aonce in a lifetime crisis, and we need to pull together."

No, we are not in this together. We have the very few experiencing positive realearnings growth (maybe even extremely positive) with everyone else experiencingnegative real earnings growth.

Reply September 29, 2010 at 09:27 AMToo Much Fed said...Ryan said: "I never said anything about an intertemporal shift of demand. I was talkingabout an intertemporal shift of spending...

[What we have hear is a failure to communicate: everyone else here, including me, uses"demand" and "spending" as synonyms. Drawing unexplained distinctions is nothelpful.]"

Is there a difference between an intertemporal shift of demand and an intertemporalshift of spending? Please explain.

Reply September 29, 2010 at 09:34 AMToo Much Fed said...Min said in reply to Richard...

"'The debt is delayed and, of course, eventually needs to be payed {sic} back' -- Jon

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Gov't debt has been continually rolled over since Jackson paid it off in the 1830s. OC,specific bonds have been paid off, but, in a sense, we have never fully paid for the CivilWar. Gov't debt never has to be fully paid off, and doing so would take a lot of moneyout of the economy."

I see two problems with this.

1) Someone has to make the interest payments thru taxes

2) The people who own the gov't debt will want a certain return (whether financial ORsome other). Since the federal budget is not set up to pay back the gov't debt atmaturity, there is a rollover risk. Plus, the owners of the gov't debt could sell it. Eitherone or both could raise interest rates. It seems to me for some reason that the U.S.gov't is willingly interest rate constrained.

Reply September 29, 2010 at 09:52 AMfresno dan said...

I would ask, what if the houses were not insured?I don't have a house to live in, and neither do the two other residents of "Fresno" -maybe accounting says everything remains in "balance", but being without a house is adecrease in living standard I would think. I would hope the accounting accounts forreality.

But it makes me wonder - the burned down houses are real, and if accounted for, it isobvious everybody is worse off.

So what if I take a big pile of money and burn it up? Its just paper, and shouldn'tquantitative easing, or printing dollars take us back to where we were? If say 6 trilliondollars in home value goes up in smoke, and the Federal Reserve prints up 6 trilliondollars, shouldn't everything "balance?" And should this balance be what we strive for,or be a measure of what we are seeking?But somehow, in this accounting of finance, people who had houses, but no longer do,who had jobs, but no longer do, who had health insurance, but no longer do, seems notto be accounted for. Of course, there is unemployment "insurance", and renting (andthat's the same as paying a mortgage for a house? - money for a domicile - samething?) and "cobra" for health insurance, right? So according to financial accounting,everything balances? And if you do get a job cleaning sewers, for half the pay, than thewater district has more money for something else - everything balances...hmmmm, thesewer thing makes me think, food in one end, sh*t out the other...balance...butsomehow, I'd rather be in imbalance, and eat only food.

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10/21/10 7:47 PMMartin Wolf Understands Economics... - Grasping Reality with Both Hands

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