06 Jan 2010

NYU’s Divergent Offspring: An Experiment in Austrian vs. Mainstream Economics

All Posts No Comments

Von Pepe sent me this WSJ survey of economists about the economy in 2010. Michael Feroli of J.P. Morgan Chase predicted: ““We’ll have above-trend growth, low inflation, and the fed on hold through 2010.”

This is interesting because Mike was the only other American in my cohort in NYU’s PhD program. It was Mike who came up with the great line–as we were studying for a math exam in which the Turks and Japanese were sure to beat us–that after the qualifiers at the end of the year, there would be some ethnic cleansing. (I.e. we were goners.)

Well somehow our American can-do attitude got us both through the program. In all seriousness, Mike was/is a really sharp guy, and a big free market economist to boot. It’s just that he was more of a Chicago School free market guy, as opposed to the quaint Austrians with their verbal analysis.

So it will be interesting to see which of our predictions pans out for 2010. In contrast to Mike, I am expecting below-trend growth (in fact I expect what will be called a “double dip” and possibly an outright crash) and surging (price) inflation. I think by “on hold” Mike means that the Fed won’t raise rates. On this point I’m not sure what will happen. I agree that the Fed will continue its interventions, especially through buying assets and throwing them onto its balance sheet. But if, say, 10-year Treasurys are yielding 5+ percent by March, the Fed is going to be hard pressed to keep its interest rate targets the same.

06 Jan 2010

Free Advice for My Fellow Bloggers

All Posts No Comments

Bryan Caplan is getting a lot of links and commentary for his suggestions of books his colleagues should write. After the burning jealousy of all this attention subsided, I realized that I too should offer such a list. So here are books or long essays that I think various people should write in the new year:

* Stephan Kinsella: Name-Calling Never Works: Tales From the Courtroom and the Blogosphere.

* Steve Landsburg: “More War Is Safer War: An Optimal Pigovian Tax on Diplomacy.”

* Robert Wenzel: To All the Financial Analysts I’ve Loved Before. (We also would have accepted Living With Paranoid Schizophrenia.)

* Gene Callahan: “In Defense of Benedict Arnold.”

* Jeff Tucker: “How I Started With Nothing But Racists and Cranks and Managed to Create the Best-Read Economics Blog in the World.”

* Silas Barta: How to Make Friends and Influence Bloggers.

* Tyler Cowen: “Necessary and Sufficient Conditions for Me to Revise My Prior Probability of Central Bankers Being Evil.”

* Arnold Kling: “Why Obama’s Economic Team Should Stop Being So Niggardly With Tax Cuts.” (Yikes! Calm down people, does this make it okay?)

06 Jan 2010

Senator Dodd Likely to Drop Out; Free Advice for Peter Schiff Campaign

All Posts No Comments

CNBC reports:

Leading Democratic Senator Christopher J. Dodd, chairman of the Banking Committee, will announce Wednesday that he is retiring, NBC News has learned.

It is likely that once Dodd announces his decision, Connecticut Attorney General Richard Blumenthal told CNBC he will run for Dodd’s former Senate seat, but Blumenthal stopped short of formally announcing his candidacy.

Blumenthal said he would have supported Dodd had he opted to run again, but he declined to say whether he had spoken to officials at the White House.

Dodd plans to continue heading efforts to pass financial regulatory reform legislation this year despite his announced retirement from the Senate a source close to Dodd said Wednesday. “He will see it through,” said the source, who asked not to be identified.

Over the years, the Connecticut senator has raised millions of dollars from employees of Wall Street firms.

I just skimmed this story, but I didn’t see it mention any of the “appearances of impropriety” surrounding Dodd. (NPR wasn’t afraid to “go there” in their story, gee whiz.)

I don’t know what the odds are of Peter Schiff getting the Republican nomination, but I do think Dodd’s campaign staff didn’t like that particular scenario. Regardless of the Democratic nominee, if Schiff is in the final race I think he should spend 75% of his funds just running clips from his TV appearances* calling the bubble. He doesn’t even need to campaign on a platform, just look at the camera and say, “Never again. Not on my watch.”

* BTW I watched a few seconds of that YouTube link to make sure it was a decent one, and you will fall out of your chair in the first few moments when some analyst bites Schiff’s head off for doubting that the US in 2006 was experiencing phenomenal productivity growth. You won’t believe the example she uses, when she is actually offended at his pessimism. Check it out.

05 Jan 2010

When Murphy Debates McKitrick, the Temperature Rises

All Posts No Comments

OK the post title was awful, I admit it. On my MasterResource post criticizing Ross McKitrick’s proposal to tie a carbon tax to observed temperature changes, McKitrick posted the following comment:

Hello Bob and others,

I’d like to respond to some of the points made here. The main concern I have in reading your posting is that you seem to have some ideal alternative in mind, in which perfect information for all time now and in the future is available to decision-makers, and there is no difficulty overcoming the obstacles to forming a coalition to implement it. So if you are going to criticize my proposal in comparison to an ideal alternative, I hope that in a follow-up post you will tell us what the ideal is. So far all the alternatives I have seen being seriously discussed are much worse, except for the strategy of doing nothing. However, my tax idea strikes me as a near approximation to doing nothing since the tax rate would start low and gradually taper off from there. That’s my expectation: others would expect the tax to start low and rise.

Your first objection is that we can’t say for sure what the present value of the marginal damages of a tonne of CO2 is. So? All we can ever do is work with estimates. Without some working estimate of the marginal damages you have no rationale for any emissions policy, whether price or cap-based. At least with my proposal, the direction of change over time has a higher chance of being correct than other instruments that do not build in learning mechanisms (i.e. everything else). Bear in mind that if you require perfect information then there is no possibility of setting any policy correctly.

In other words you are criticising my policy because in order to implement it requires picking an initial dollar value, and the choice is inherently uncertain. But that applies to any policy option. Given the uncertainty, my proposal lowers the expected costs of making a mistaken commitment, compared to any alternatives I know of.

To implement any policy, either an emissions tax, tradable permits (worse) or command regulations (worst), involves picking an explicit or implicit dollar value of the marginal damages. One of the worst aspects of regulations like the ethanol mandate and appliance efficiency rules is that they appear not to place a price on emissions control, when in fact they do. It just happens to be buried in the costs of regulation, and often comes out to thousands of times higher per tonne of actual abatement achieved than we would think is a reasonable emissions tax level.

You are also concerned about price volatility since the “Earth’s temperature” bounces around a lot. I have always suggested that the tax be smoothed out using a simple moving average, between 12 and 36 months, so that the change in the tax is primarily driven by a sustained trend not by weather variability. By applying a simple smoother it is not hard to ensure that the tax variations remain reasonable, especially in comparison to the cap and trade case where a vertical supply curve and a nearly-vertical demand curve interact. (That’s why Europe’s ETS system has such explosive price variability and always will, as will a cap and trade system implemented in any industrialized economy.) Having some variability is not a problem–we cope with energy price fluctuations all the time. In this case a certain amount of variabiltiy has a theoretical justification (marginal warming, if it is damaging at all, is more damaging at times when there has already been a spike in natural warming).

Your third objection is to suppose, what if the IPCC is correct, but natural forces mask warming for a while, then we delay the correct policy response. Once again you are imagining an alternative world in which we have perfect information. If the IPCC is correct, and we know them to be correct, then people will anticipate the future tax increase and plan accordingly. If the IPCC is correct but we do not know them to be correct (or believe them to be incorrect), then no one is in a position to make the right choice. At least under my proposal, policy will eventually update as new information becomes available. Every other policy proposal is impervious to new information. We have a choice between policies that assimilate new information as it becomes available, versus policies that never assimilated new information. We do not have the option of policies that assimilate information before it becomes available.

Note that in the above, I edited out a lot of his comment, since he was addressing other people and not just me. I replied:

Ross (if I may),

Obviously it’s hard to be precise in a blog post, but I think you are misunderstanding my problems. When you ask me for a rival policy that responds to new information and is superior to yours, I can glibly reply: Sure, let’s have a carbon tax calibrated to the best-estimate of the social cost of carbon. And then as we get new information (including new temperature readings), we update the SCC using Bayes Law and adjust the tax accordingly. That is literally the theoretically best policy, given our uncertainty.

Now why don’t we do that? It’s because we all can’t *agree* on what the SCC actually is. There are people who think it’s really high, like Joe Romm, and that we should be taxing the heck out of emissions right now. Then there are people like Richard Lindzen, who thinks the IPCC estimate of climate sensitivity is too high, and (I presume) the “optimal carbon tax” should be a lot lower than what most other experts would say.

So what I was doing in my post wasn’t so much saying, “Whoa, McKitrick’s plan backfires because the IPCC might be right!” Rather, what I was saying is that I don’t believe there is actually a wide overlap where both sides in the debate could agree to a McKitrick tax.

For example, to get Rob Bradley to sign off on the tax, the initial rate has to be low. So in principle, if tropospheric temperatures stayed flat for the next two years (or even fell), then we would have a very low carbon tax for 2 years in a row.

Knowing that possibility, someone like Joe Romm would insist that this low initial tax rate would have to go up by a factor of 20 or something at the first blip in global temperature. If we didn’t concede that to him, then Romm would never sign on to the policy, because there would be (in his mind) an unacceptably high probability of catastrophe.

Do you see where I’m going with this? Because of the natural variability in temperatures, I don’t see how you actually could get honest people who have wildly different estimates of the SCC to agree to a McKitrick-style tax. Thus, I don’t think you are necessarily “smoking the other side out” if they balk at your proposal, since you’re asking *them* to sacrifice their view on the front end.

Maybe that’s a good way to frame my point: We could just as well propose a Murphy temperature tax, in which we start out with a $100 / ton tax on carbon. But then for every 1% the tropospheric temperature falls behind the IPCC suite of models’ forecasts (given the observed emissions and updating the forecasts all along), we knock down the Murphy tax accordingly. So we can “smoke out” the skeptics and see if they actually think the IPCC models are overpredicting temperature rises, or if (on the contrary) the people criticizing Waxman-Markey etc. are really just philosophically opposed to government intervention.

Does that help clarify my point?

If I were famous, blogs across the geeconosphere would go nuts: “Murphy proposes $100 / ton carbon tax!!”

05 Jan 2010

"A Savvy Bond Man Bets on Rising Inflation"

All Posts No Comments

John Cochran (not the Chicago guy, the Vienna guy) sent me this wonderful WSJ article from Dec. 26 profiling Bill Tedford. For longtime readers, just look at how many of Tedford’s points are the same things I’ve been harping on:

Bill Tedford is encouraging investors to bet against remarks by Federal Reserve Chairman Ben Bernanke, who told a group of Washington-area business leaders this month that “inflation could move lower from here.”

For more than 20 years, Mr. Tedford has run a benchmark-beating bond portfolio for Little Rock, Ark.,-based Stephens Inc. And though Mr. Bernanke sees slack in the economy that could push inflation down, Mr. Tedford says inflation already is evident in the consumer-price index and will lurch higher in 2010 and 2011.

He and Stephens have begun encouraging clients to invest more money in timber, oil and gas, agricultural commodities and industrial and precious metals—historically good places to be amid rising inflation.

“The alarming part,” Mr. Tedford says, “is the possibility that inflation could explode beyond the numbers we’re looking at.”

Across the country these days debate rages about whether U.S. fiscal policy has primed the country for a bout of inflation—and just how bad any inflation might be. Count Mr. Tedford among the group of inflation bugs who worry that all the dollars now sloshing around the economy can only have an inflationary outcome.

For 20 years Mr. Tedford has managed a portfolio now amounting to about $1.25 billion, including $800 million in government bonds. During that time, his audited performance has topped the benchmark Barclays U.S. Intermediate Government Bond Index in the one-, three-, five-, 10-, 15- and 20-year periods. In the 12 months ended Sept. 30, his 8.87% return outpaced the index by more than 2.6 percentage points.

Because his focus is riskless U.S. government debt, Mr. Tedford’s only concern is federal economic policy and the outlook for inflation. And these days, the model he has relied on for two decades insists that inflation is bubbling to the surface.

The key data point in Mr. Tedford’s model: the monetary base, basically money circulating through the public or reserves banks on deposit with the Federal Reserve. Over long sweeps of time, he says, inflation closely tracks increases in the monetary base that exceed economic growth.

For instance, he notes, in the 40 years to 2007 the U.S. monetary base grew at 7.08% a year. Gross domestic product, meanwhile, grew at 3.04%. The resulting surplus monetary-base growth of 4.04% closely matches CPI and the personal-consumption-expenditures price index, another measure of overall inflation.

In the wake of the U.S.-inspired global financial crisis, the nation’s monetary base has ballooned to more than $2 trillion at the end of November from less than $850 million in August 2008, before the crisis began, according to Federal Reserve data. Even subtracting the more than $1 trillion in excess reserves, the nation’s monetary base has grown by more than 11% in the past 15 months, “one of the highest changes I’ve ever measured.” Mr. Tedford says.

U.S. GDP during that period shrank by about 2%.

“The weight of that sharply increased monetary base points to significant inflation in 2010 and into 2011,” he says.

His model “anticipates that trailing 12-month CPI goes positive by the end of this year, up to 3% or 4% by the end of 2010, and then toward 5% or 6% by mid-2011.” And if some of the excess reserves start leaking into the banking system, as Mr. Tedford thinks is happening, “inflation could go much higher.”

Already, Mr. Tedford says, inflation is apparent. While the unadjusted year-over-year CPI reading for October showed prices sank by 0.2%, the year-to-date change since January indicates prices are up more than 2.3%.

For two years Mr. Tedford’s bond portfolio trailed its benchmark by as much as 1.2 percentage points—”a very painful period for us,” he says. “The model was right about inflation, but the interaction between inflation and interest rates didn’t follow the norms.”

Nevertheless, he says the model “has been extraordinarily accurate in the last 20 years [and] is responsible for our track record against the benchmark.”

I’m too busy/lazy right now to capture and reproduce the WSJ chart, but you should click on the link and check it out. It is nostalgic for me because when I worked at Laffer Associates we used a similar metric. (And yes, go ahead and put stuff about Peter Schiff in the comments if you must, I’m still saying I learned a lot about monetary theory while there.)

Among other things, I loved this article because it shows the limits of the efficient markets hypothesis. There is nothing wrong about me thinking that my model is better than “the market’s model,” because there’s no such thing as the market’s model. The market price is that which balances the competing forecasts and risk tolerances of everyone who wants to put money on the line.

05 Jan 2010

A Critique of Ross McKitrick’s Proposal to Tax Temperature

All Posts No Comments

At MasterResource today I critique economist Ross McKitrick’s proposal to tie CO2 taxes to global temperatures. (His idea is that if manmade global warming is really serious, then the tax will rise accordingly. But if it turns out the critics of the IPCC are right, then the tax will automatically stay modest.) Here’s the finale:

Ross McKitrick’s proposal to tie CO2 taxes to observed temperature trends is an interesting attempt to break out of the modelling log-jam, but ultimately I don’t think it will work. Even putting aside the serious theoretical difficulties in properly calibrating the tax, we could never trust the politicians to keep their word once they had enacted it.

05 Jan 2010

Say What You Will About Monarchies, At Least They Understood Free Trade

All Posts 1 Comment

I am working on a book project with Bill Peterson on democracy. He sent me a copy of Hans Hoppe’s Democracy: The God That Failed, which somehow I never managed to read up until now. I have seen so many of Hoppe’s lectures at the Mises Institute that I figured I already knew what was in the book.

Well I was totally wrong. So far I have only read the first essay, but it blew me away. When I get caught up with my other work I will write a review for Mises.org. (And no, I haven’t hit the famously controversial parts yet, so I can’t yet say whether people are blowing that out of proportion.)

Among his other points, Hoppe argues that hereditary monarchies have a much greater incentive to enact productive long-term policies because they can pass the estates on to their children. In contrast, the people running a democratic government at any given time, only have a few years in which to suck out as many resources as possible.

For something completely different, I am writing up a quick description of mercantilism. I was explaining that it was the dominant philosophy guiding governments from the 16th – 18th centuries, until the ideas of Adam Smith and other British classical economists overturned it. Then I was going to add that in modern times, we have seen the rebirth of mercantilist ideas, because even though 99% of economists endorse free trade, the general public doesn’t.

Does anyone see a connection here? I don’t know enough history to be able to say one way or the other, but per Hoppe, is it just possible that the European monarchies implemented mercantilist policies when they genuinely believed they promoted national prosperity, but then when David Hume et al. proved them wrong, they switched to free trade? But with the rise of democracy, it doesn’t matter what the rulers actually know to be the correct long-term policies–they have to enrich a few special interests as quickly as possible, before they leave office?

04 Jan 2010

Samuelson Et Al. Goofed on Soviet Union Because of Their Models, Not Their Politics

All Posts 4 Comments

Alex Tabarrok has an interesting post today on how the mainstream textbook authors were far too generous in their predictions about Soviet GNP back in the day:

First, an even more off-course analysis [than in Samuelson's textbook] can also be found in another mega-selling textbook, McConnell’s Economics (still a huge seller today). Like Samuelson, McConnell estimated Soviet GNP as half that of the United States in 1963 but he showed that the Soviets were investing a much larger share of GNP and thus growing at rates “two to three times” higher than the U.S. Indeed, through at least ten (!) editions, the Soviets continued to grow faster than the U.S. and yet in McConnell’s 1990 edition Soviet GNP was still half that of the United States!

A second case of being blinded by “liberal” ideology? If so, Levy and Peart throw another curve-ball because the very liberal even “leftist” texts of the time, notably those by Lorie Tarshis and Robert Heilbroner did not make the Samuelson-McConnell mistake.

Tarshis and Heilbroner were more liberal than Samuelson and McConnell but offered a more nuanced, descriptive and tentative account of the Soviet economy. Why? Levy and Peart argue that they were saved from error not by skepticism about the Soviet Union per se but rather by skepticism about the power of simple economic theories to fully describe the world in the absence of rich institutional detail.

To make their predictions, Samuelson and McConnell relied heavily on the production possibilities frontier (PPF), the idea that the fundamental tradeoff for any society was between “guns and butter.” Thus, in the 1948 edition Samuelson wrote:

The Russians having no unemployment before the war, were already on their Production-possibilities curve. They had no choice but to substitute war goods for civilian production-with consequent privation.

Note that Samuelson assumes all countries and economic systems are efficient (the Russians are “on” the curve) only the choice of guns versus butter differs. When the war ended, the fundamental tradeoff became one between investment and consumption and since the Soviets invested a greater share of GNP they would naturally consume less but grow faster. Moreover, since the Soviet’s had solved the unemployment problem they were, if anything, more efficient than the U.S. (here we see the Keynesian influence).