Some folks just imagine conflicts that do not exist

It may make great theater, but terrible science.

In the latest issue (#67) of the real-world economics review, Egmont Kakarot-Handtke presumes to moderate a debate (PDF) between Paul Krugman and Steve Keen (PDF). Sadly, Kakarot-Handtke’s paper lies at that unfortunate intersection of incomprehension and irrelevance. The paper is irrelevant, in that Kakarot-Handtke imagines a debate between loanable-funds and endogenous-money approaches to macroeconomics that to my eye does not exist (at least in this context.) The paper demonstrates incomprehension in that Kakarot-Handtke attributes to the loanable-funds model a non-existent property.

To the latter, we hardly need look beyond the final words Kakarot-Handtke offers:

The structural axiomatic analysis leads to the prediction that Krugman’s loanable funds model will be clearly refuted. It simply does not happen in the actual monetary economy that saving and dissaving of the households is exactly equal.

Here, Kakarot-Handtke appears to tear down a straw man. The textbook loanable funds model is one in which households lend to businesses– directly or indirectly– for investment purposes. If the loanable funds model predicted that households neither saved nor dissaved on net, then there would also be no investment. What Kakarot-Handtke actually argues is that even in a purely consumption-based economy, that households can save or dissave on net if businesses dissave or save, respectively. Surely nothing Krugman has written can make one wonder if he disputes this point.

Nevertheless, Kakarot-Handtke manages to get there. Specifically, Kakarot-Handtke quotes Krugman (twice!) as saying

If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand.

So it is disconcerting to see Kakarot-Handtke then go on to comment

From the quote above it is clear that for Krugman savers and dissavers are not independent. For someone who saves there is someone else who takes the money, courtesy of the intermediation of the banking system, and spends it. Hence there is no effect on the rest of the economy.

(emphasis again added)

Kakarot-Handtke‘s paraphrase is disconcerting for multiple reasons. First, Krugman does not argue that “there is someone else who takes the money.” Rather, he makes a conditional argument– that if someone else takes the money, then this doesn‘t have to represent a net increase in demand. Nothing Krugman wrote implied that he believes saved money must be lent, making Kakarot-Handtke‘s paper a complete non-sequitur.

Further, nothing Krugman wrote implied that he believes that lending necessitated a prior act of household saving. A single offered example need not constitute an exhaustive list of the universe of possibilities. Importantly, this suggests no obvious endorsement of pure loanable funds modeling here, as Kakarot-Handtke insists. Quite to the contrary, Krugman wrote

Keen says that it’s because once you include banks, lending increases the money supply. OK, but why does that matter?

What part of “OK” does Kakarot-Handtke fail to understand? Krugman is not arguing against endogenous money, but rather wondering aloud what the complication adds. I am inclined to wonder as well. Kakarot-Handtke‘s contrived example sheds no light on the subject, arguing only that households may save or dissave.

In fact, Krugman is sympathetic to the idea that debt plays a role in influencing aggregate demand. He writes

In the kind of model Gauti and I use, lending very much can and does increase aggregate demand, so what is the problem?

Krugman goes on to take issue with the notion that lending by definition adds directly to aggregate demand. In truth, much of the problem is that Keen simply makes up his own definition of “aggregate demand” which includes

income plus the change in debt, and that this is expended on both goods and services and purchases of financial claims on existing assets

He then produces the equation \begin{equation} Y\!\left(t\right)+\frac{d}{dt}D\!\left(t\right)=G\!D\!P\!\left(t\right)+N\!AT\!\left(t\right) \end{equation} Yet this construction is catastrophically non-specific. Consider Keen‘s Figure 3, titled “Aggregate demand as income plus change in debt.” The figure shows, however, nominal GDP plus change in debt. Is $Y$ then equal to nominal GDP? In that case, we are left with \begin{equation} \frac{d}{dt}D\!\left(t\right)=N\!AT\!\left(t\right) \end{equation} and find that the “change in debt” is spent entirely on existing assets, and does not add to aggregate demand in the usual sense at all. Clear as mud, that.

Mitchell strikes out again

If Cato’s Daniel J. Mitchell is “particularly impressed” by Sweden’s “genuine fiscal restraint” from 1992-2001, he must love President Obama.

Mitchell shows a graph of total government expenditures in Sweden over the period, noting that “spending grew by an average of 1.9 percent per year” over those nine years. Let’s leave aside the fact that this is in nominal currency– a frequent oversight in Cato’s budget reporting. What I find particularly interesting is that equivalent spending in the United States grew only 0.9 percent per year from 2009-2013. Does that impress Mitchell? I’m guessing not, because spending was especially high in 2009 on account of the bursting of the housing bubble, and resulting unemployment, bailouts, and stimulus. But the story was hardly different in 1992 Sweden– suffering the fallout of a housing bust and banking crisis.

Of course, Sweden went as far as nationalizing banks to deal with the banking crisis and was fully recovered by 1995. So maybe the U.S. should take a lesson from Sweden: nationalize a few banks, get to full employment, and then consider some “fiscal restraint” of its own.

German fiscal policy is not so obviously “onerous”

In Germany last year, households and nonprofits directly consumed 57.4 percent of domestic production. Foreigners (on net) bought another 6.3 percent. Germany invested another 16.7 percent. That comes to 80.5 percent of production. So how can Cato’s Daniel J. Mitchell reasonably claim that “government spending consumes about 44 percent of economic output” as he does in today’s blog post?

The answer is, he cannot. The German government claimed only 19.5 percent of economic output, and even then consumed only 7 percent. The remaining 12.5 percent of economic output– though counted as government expenditure– was in fact consumed by the private sector.

Thus, the domestic private sector eventually claimed almost 93 percent of all economic output.¹ So what did Mitchell really mean? The German government received taxes sufficient to purchase 44 percent of GDP, and spent money sufficient to purchase 44 percent of economic output. That’s fine as far as it goes, but it does not tell us how burdensome the government spending. After all, traders spent $108 trillion on stocks in 2008. Does Mitchell believe that they therefore consumed 175 percent of the economic output of the entire world?

Suppose that government directly confiscated every bit of income produced by the economy, but then returned it dollar-for-dollar to each person. Though the government did nothing, Mitchell claims that government consumed 100 percent of economic output. He may not like that governments take money from some and give to others to spend, and he may not like that governments purchase goods and services and give to others to consume, but he inexcusably exaggerates the amount of output actually consumed by the German government.

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1 claims include the amount saved through net sales to foreigners^↩

Is It Really Time for the Fed to Worry About Inflation?

Ylan Mui at The Washington Post’s Wonkblog had a piece Thursday titled “This is why the Fed should start worrying about inflation again.” The main bit of evidence is a graph attributed to Kevin Logan showing a negative relationship between the unemployment rate and increasing rates of inflation. But this graph actually says far less than Mui says.

Indeed there is a relationship between unemployment and inflation. The Federal Reserve is tasked with balancing inflation and unemployment, and when the Fed fears inflation, it raises interest rates with the intent of slowing the economy and creating unemployment. To some extent, then, the relationship is the Fed’s doing.

Let us put that aside, however, and take the observed relationship at face value. First, it is far from obvious that 6.5 percent unemployment represents a threshold below which inflation is as likely to rise as fall– particularly given the small sample size. In Figure 1, I was unable to reproduce exactly Logan’s figure, but according to data available at the Fed, four of the five years with the highest unemployment rates under 6.5 percent are associated with decreasing inflation.

Figure 1: Unemployment and Changes in Inflation

Source: FRED, series JCXFE and UNRATE and author’s calculations

Rather than cherry picking, we may regress changes in inflation against the unemployment rate. As it turns out, the relationship is statistically weak. The expected change in inflation switches between positive and negative somewhere between 2.5 and 7 percent. Likewise, this suggests that the 50/50 point lies closer to 5 percent than 6.5.

Table 1: Regression results

		(1)	(2)	(3)
$\beta_0$	constant	0.52 (0.37)	0.52 (0.43)	0.52 (0.39)
$\beta_1$	unemployment rate	-0.11 (0.06)#	-0.11 (0.07)	-0.11 (0.06)#
variance/covariance estimator		OLS	jackknife	bootstrap
$-\beta_0/\beta_1$		2.6-7.1	2.9-6.8	3.0-6.7

Standard errors in parenthesis
# Significant at 10% level
Source: FRED, series JCXFE and UNRATE and author’s calculations

In Figure 2, we see the probability that inflation will be higher in 2014 than it was in 2013– assuming various year-round average unemployment rates for 2014. At 6.5 percent unemployment, the probability is closer to one in three than one in two.

Figure 2: Probability of Increased Inflation in 2014

Note: The widest (lightest) confidence band covers 95 percent of outcomes and the most narrow (darkest) band covers 50 percent.
Source: FRED, series JCXFE and UNRATE and author’s calculations

More importantly, increasing inflation is the wrong consideration. The Fed has tolerated inflation below 2.0 percent ever since 2007, and in 2013 core inflation ran only 1.2 percent. If the Fed must target some rate of inflation, it should target a higher rate of inflation. Yet, even if the relationship is meaningful then there is less than a 5 percent chance that 2014 inflation will run even as high as 2.0 percent.

Figure 3: Probability of At Least 2% Inflation in 2014

Note: The widest (lightest) confidence band covers 95 percent of outcomes and the most narrow (darkest) band covers 50 percent.
Source: FRED, series JCXFE and UNRATE and author’s calculations

To the extent that the relationship is both meaningful and a result of Fed activity, then, this suggests that meeting a 2% inflation target would require the Fed to be less hawkish than would be normal for the rate of unemployment. It may yet be some time before the Fed raises interest rates.

(This post originally appeared on the CEPR blog.)

House of Cards and entitlements: embarrassing, but to whom?

UPDATED BELOW

I know I’m late to this little fracas, and I’m not yet caught up on the entire second season, but it is terribly embarrassing that characters in Netflix’s House of Cards would propose raising the retirement age from 65. Now, I understand the original novel was set in the UK. But Netflix’s version is set in the U.S. and in the near present. Were all the writers born before 1938? Because everyone born after 1937 has a Social Security retirement age greater than 65. If you are turning 54 this year, or if you are younger than that, then ever since 1983 your retirement age has been 67. Frank Underwood says the Republicans have wanted this “since Johnson” but Underwood first ran for office in 1986– three years after Republicans got their increase in the retirement age for Social Security.

Now, technically speaking, House of Cards (as far as I have watched) talks only of “entitlements” but connects it to an increase in the age for early retirement, which applies to Social Security but not Medicare. In any case, compared to the typical Medicare recipient, those in their mid-60’s are relatively healthy– while many of those especially unhealthy would be on Medicaid anyway. Consequently, raising the retirement age for Medicare doesn’t even reduce deficits by a noticeable amount. According to the Congressional Budget Office, it would save some $6.7 billion in 2023 (PDF source)– an amount less than 0.03 percent of GDP.

I wonder what the writers had in mind. I’m guessing it’s a slip on the part of the writers. Or– in an age of low employment, wrecked private pensions, and thin household savings– is 70 is just too absurd a proposal for the viewers to swallow? Is this not embarrassing to supposed reformers? Then again, with respect to Matthew Yglesias, maybe the fight over entitlements is not about deficits.

Update: Yup. In the next episode, Underwood specifically mentions Medicare. That makes the CBO report relevant. At least, as relevant as an actual CBO report can be to a fictional show. More importantly, it is not so embarrassing to single out Medicare when talking entitlements. It’s health care costs which are projected to threaten the federal budget– not Social Security. If the United States had health-care costs in line with the rest of the developed world, we would be looking at surpluses, not deficits. But raising the retirement age is no solution.

A note on German austerity

Over at Heritage, Salim Furth talks structural deficits. Sadly, he gets his argument backwards.

The reason Germany did not shrink its structural deficit is that Germany barely had a structural deficit! In 2009, Germany’s structural deficit was just 1 percent of gross domestic product. Greece’s deficit was 19 percent. In fact, across eurozone countries, the change in structural balance from 2009 to 2012 is largely predicted by the size of 2009 deficits—the bigger the deficit, the harder they fell.

That’s a problem for the Keynesian story. According to Krugman’s Keynesian model, government can stimulate aggregate demand by running large deficits in bad times, softening the recession. If government fails in its duty to borrow, the recession will mire on.

[snip]

What did the Germans do that put them in a position for growth right after the recession? Back in 2001, Germany and Greece had the same structural deficit—just above 3 percent. But Germany shrank its deficit from 2004 to 2008 by cutting spending on welfare, unemployment insurance, and pensions.

(source)

Um. Okay. Furth takes data from the latest IMF World Economic Outlook Database. What does the database say about economic growth in these countries over this period? From 2002 to 2009, German output increased 4.7 percent per capita. (That’s only 0.7 percent per year!) By contrast, the Greek economy grew more than three times as fast, per capita (16.3 percent, or 2.2 percent per year.)

So the big-deficit Greeks enjoyed much faster growth than the austere Germans. Now, perhaps Furth might argue the Greek growth was unsustainable on account of all that borrowing, requiring the Greeks to reverse course at the worst possible time. But that hardly represents anything like “a problem for the Keynesian story.”

Economists blithely write “Economists blithely draw…”

Sometimes, I’m going to have to be critical of specific people. Generally, I prefer to be critical of people who disagree with me on policy. Sometimes, a potential ally will make me wince but I let it go. Then there is Steve Keen.

Sometimes, I just don't know what the man could be thinking, driving me to rise to the defense of someone unlikely. Take, for example,

Economists blithely draw diagrams like Figure 23 below to compare monopoly with perfect competition. As shown above, the basis of the comparison is false: given Marshallian assumptions, an industry with many “perfectly competitive” firms will produce the same amount as a monopoly facing identical demand and cost conditions— and both industry structures will lead to a “deadweight loss”. However, in general, small competitive firms would have different cost conditions to a single firm—not only because of economies of scale spread result in lower per unit fixed costs, but also because of the impact of economies of scale on marginal costs.

(PDF source)

Zing! It seems Keen and co-author Russell Standish have Mankiw dead to rights. It appears that Mankiw have made a terrible mistake and did not think about the fact that the marginal cost curve would be different for the industry as a whole. Or so they would have it.

I find this highly unlikely. Their claim that their paper shows that “given Marshallian assumptions, an industry with many ‘perfectly competitive’ firms will produce the same amount as a monopoly” is a matter for another time. For now, it suffices to note that in presenting this figure Mankiw is not referring to “perfect competition” at all. Mankiw leads his discussion saying

We begin by considering what the monopoly firm would do if it were run by a benevolent social planner. The social planner cares not only about the profit earned by the firm’s owners but also about the benefits received by the firm’s consumers. The planner tries to maximize total surplus… the socially efficient quantity is found where the demand curve and the marginal-cost curve intersect. [bold added to original, italics in original]

(source)

The framework for the discussion is monopoly. The discussion concerns the deadweight loss of a profit-maximizing monopoly in contrast to a socially-planned monopoly. In such a context, the monopoly is the industry, so there is no confusion regarding costs. The “efficient quantity” is “efficient” because no monopoly can produce larger total surplus. Mankiw's figure simply does not “compare monopoly with perfect competition” as suggested. Keen and Standish grossly misrepresent Mankiw.