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John Cochrane on the Failure of Macroeconomics

The state of modern macroeconomics is not good; John Cochrane, professor of finance at the University of Chicago, senior fellow of the Hoover Institution, and adjunct scholar of the Cato Institute, writing in Thursday’s Wall Street Journal, thinks macroeconomics is a failure. Perhaps so, but he has trouble explaining why.

The problem that Cochrane is chiefly focused on is slow growth.

Output per capita fell almost 10 percentage points below trend in the 2008 recession. It has since grown at less than 1.5%, and lost more ground relative to trend. Cumulative losses are many trillions of dollars, and growing. And the latest GDP report disappoints again, declining in the first quarter.

Sclerotic growth trumps every other economic problem. Without strong growth, our children and grandchildren will not see the great rise in health and living standards that we enjoy relative to our parents and grandparents. Without growth, our government’s already questionable ability to pay for health care, retirement and its debt evaporate. Without growth, the lot of the unfortunate will not improve. Without growth, U.S. military strength and our influence abroad must fade.

Macroeconomists offer two possible explanations for slow growth: a) too little demand — correctable through monetary or fiscal stimulus — and b) structural rigidities and impediments to growth, for which stimulus is no remedy. Cochrane is not a fan of the demand explanation.

The “demand” side initially cited New Keynesian macroeconomic models. In this view, the economy requires a sharply negative real (after inflation) rate of interest. But inflation is only 2%, and the Federal Reserve cannot lower interest rates below zero. Thus the current negative 2% real rate is too high, inducing people to save too much and spend too little.

New Keynesian models have also produced attractively magical policy predictions. Government spending, even if financed by taxes, and even if completely wasted, raises GDP. Larry Summers and Berkeley’s Brad DeLong write of a multiplier so large that spending generates enough taxes to pay for itself. Paul Krugman writes that even the “broken windows fallacy ceases to be a fallacy,” because replacing windows “can stimulate spending and raise employment.”

If you look hard at New-Keynesian models, however, this diagnosis and these policy predictions are fragile. There are many ways to generate the models’ predictions for GDP, employment and inflation from their underlying assumptions about how people behave. Some predict outsize multipliers and revive the broken-window fallacy. Others generate normal policy predictions—small multipliers and costly broken windows. None produces our steady low-inflation slump as a “demand” failure.

Cochrane’s characterization of what’s wrong with New Keynesian models is remarkably superficial. Slow growth, according to the New Keynesian model, is caused by the real interest rate being insufficiently negative, with the nominal rate at zero and inflation at (less than) 2%. So what is the problem? True, the nominal rate can’t go below zero, but where is it written that the upper bound on inflation is (or must be) 2%? Cochrane doesn’t say. Not only doesn’t he say, he doesn’t even seem interested. It might be that something really terrible would happen if the rate of inflation rose about 2%, but if so, Cochrane or somebody needs to explain why terrible calamities did not befall us during all those comparatively glorious bygone years when the rate of inflation consistently exceeded 2% while real economic growth was at least a percentage point higher than it is now. Perhaps, like Fischer Black, Cochrane believes that the rate of inflation has nothing to do with monetary or fiscal policy. But that is certainly not the standard interpretation of the New Keynesian model that he is using as the archetype for modern demand-management macroeconomic theories. And if Cochrane does believe that the rate of inflation is not determined by either monetary policy or fiscal policy, he ought to come out and say so.

Cochrane thinks that persistent low inflation and low growth together pose a problem for New Keynesian theories. Indeed it does, but it doesn’t seem that a radical revision of New Keynesian theory would be required to cope with that state of affairs. Cochrane thinks otherwise.

These problems [i.e., a steady low-inflation slump, aka "secular stagnation"] are recognized, and now academics such as Brown University’s Gauti Eggertsson and Neil Mehrotra are busy tweaking the models to address them. Good. But models that someone might get to work in the future are not ready to drive trillions of dollars of public expenditure.

In other words, unless the economic model has already been worked out before a particular economic problem arises, no economic policy conclusions may be deduced from that economic model. May I call  this Cochrane’s rule?

Cochrane the proceeds to accuse those who look to traditional Keynesian ideas of rejecting science.

The reaction in policy circles to these problems is instead a full-on retreat, not just from the admirable rigor of New Keynesian modeling, but from the attempt to make economics scientific at all.

Messrs. DeLong and Summers and Johns Hopkins’s Laurence Ball capture this feeling well, writing in a recent paper that “the appropriate new thinking is largely old thinking: traditional Keynesian ideas of the 1930s to 1960s.” That is, from before the 1960s when Keynesian thinking was quantified, fed into computers and checked against data; and before the 1970s, when that check failed, and other economists built new and more coherent models. Paul Krugman likewise rails against “generations of economists” who are “viewing the world through a haze of equations.”

Well, maybe they’re right. Social sciences can go off the rails for 50 years. I think Keynesian economics did just that. But if economics is as ephemeral as philosophy or literature, then it cannot don the mantle of scientific expertise to demand trillions of public expenditure.

This is political rhetoric wrapped in a cloak of scientific objectivity. We don’t have the luxury of knowing in advance what the consequences of our actions will be. The United States has spent trillions of dollars on all kinds of stuff over the past dozen years or so. A lot of it has not worked out well at all. So it is altogether fitting and proper for us to be skeptical about whether we will get our money’s worth for whatever the government proposes to spend on our behalf. But Cochrane’s implicit demand that money only be spent if there is some sort of scientific certainty that the money will be well spent can never be met. However, as Larry Summers has pointed out, there are certainly many worthwhile infrastructure projects that could be undertaken, so the risk of committing the “broken windows fallacy” is small. With the government able to borrow at negative real interest rates, the present value of funding such projects is almost certainly positive. So one wonders what is the scientific basis for not funding those projects?

Cochrane compares macroeconomics to climate science:

The climate policy establishment also wants to spend trillions of dollars, and cites scientific literature, imperfect and contentious as that literature may be. Imagine how much less persuasive they would be if they instead denied published climate science since 1975 and bemoaned climate models’ “haze of equations”; if they told us to go back to the complex writings of a weather guru from the 1930s Dustbowl, as they interpret his writings. That’s the current argument for fiscal stimulus.

Cochrane writes as if there were some important scientific breakthrough made by modern macroeconomics — “the new and more coherent models,” either the New Keynesian version of New Classical macroeconomics or Real Business Cycle Theory — that rendered traditional Keynesian economics obsolete or outdated. I have never been a devote of Keynesian economics, but the fact is that modern macroeconomics has achieved its ascendancy in academic circles almost entirely by way of a misguided methodological preference for axiomatized intertemporal optimization models for which a unique equilibrium solution can be found by imposing the empirically risible assumption of rational expectations. These models, whether in their New Keynesian or Real Business Cycle versions, do not generate better empirical predictions than the old fashioned Keynesian models, and, as Noah Smith has usefully pointed out, these models have been consistently rejected by private forecasters in favor of the traditional Keynesian models. It is only the dominant clique of ivory-tower intellectuals that cultivate and nurture these models. The notion that such models are entitled to any special authority or scientific status is based on nothing but the exaggerated self-esteem that is characteristic of almost every intellectual clique, particularly dominant ones.

Having rejected inadequate demand as a cause of slow growth, Cochrane, relying on no model and no evidence, makes a pitch for uncertainty as the source of slow growth.

Where, instead, are the problems? John Taylor, Stanford’s Nick Bloom and Chicago Booth’s Steve Davis see the uncertainty induced by seat-of-the-pants policy at fault. Who wants to hire, lend or invest when the next stroke of the presidential pen or Justice Department witch hunt can undo all the hard work? Ed Prescott emphasizes large distorting taxes and intrusive regulations. The University of Chicago’s Casey Mulligan deconstructs the unintended disincentives of social programs. And so forth. These problems did not cause the recession. But they are worse now, and they can impede recovery and retard growth.

Where, one wonders, is the science on which this sort of seat-of-the-pants speculation is based? Is there any evidence, for example, that the tax burden on businesses or individuals is greater now than it was let us say in 1983-85 when, under President Reagan, the economy, despite annual tax increases partially reversing the 1981 cuts enacted in Reagan’s first year, began recovering rapidly from the 1981-82 recession?

The Enchanted James Grant Expounds Eloquently on the Esthetics of the Gold Standard

One of the leading financial journalists of our time, James Grant is obviously a very smart, very well read, commentator on contemporary business and finance. He also has published several highly regarded historical studies, and according to the biographical tag on his review of a new book on the monetary role of gold in the weekend Wall Street Journal, he will soon publish a new historical study of the dearly beloved 1920-21 depression, a study that will certainly be worth reading, if not entirely worth believing. Grant reviewed a new book, War and Gold, by Kwasi Kwarteng, which provides a historical account of the role of gold in monetary affairs and in wartime finance since the 16th century. Despite his admiration for Kwarteng’s work, Grant betrays more than a little annoyance and exasperation with Kwarteng’s failure to appreciate what a many-splendored thing gold really is, deploring the impartial attitude to gold taken by Kwarteng.

Exasperatingly, the author, a University of Cambridge Ph. D. in history and a British parliamentarian, refuses to render historical judgment. He doesn’t exactly decry the world’s descent into “too big to fail” banking, occult-style central banking and tiny, government-issued interest rates. Neither does he precisely support those offenses against wholesome finance. He is neither for the dematerialized, non-gold dollar nor against it. He is a monetary Hamlet.

He does, at least, ask: “Why gold?” I would answer: “Because it’s money, or used to be money, and will likely one day become money again.” The value of gold is inherent, not conferred by governments. Its supply tends to grow by 1% to 2% a year, in line with growth in world population. It is nice to look at and self-evidently valuable.

Evidently, Mr. Grant’s enchantment with gold has led him into incoherence. Is gold money or isn’t it? Obviously not — at least not if you believe that definitions ought to correspond to reality rather than to Platonic ideal forms. Sensing that his grip on reality may be questionable, he tries to have it both ways. If gold isn’t money now, it likely will become money again — “one day.” For sure, gold used to be money, but so did cowerie shells, cattle, and at least a dozen other substances. How does that create any presumption that gold is likely to become money again?

Then we read: “The value of gold is inherent.” OMG! And this from a self-proclaimed Austrian! Has he ever heard of the “subjective theory of value?” Mr. Grant, meet Ludwig von Mises.

Value is not intrinsic, it is not in things. It is within us. (Human Action p. 96)

If value “is not in things,” how can anything be “self-evidently valuable?”

Grant, in his emotional attachment to gold, feels obligated to defend the metal against any charge that it may have been responsible for human suffering.

Shelley wrote lines of poetry to protest the deflation that attended Britain’s return to the gold standard after the Napoleonic wars. Mr. Kwarteng quotes them: “Let the Ghost of Gold / Take from Toil a thousandfold / More than e’er its substance could / In the tyrannies of old.” The author seems to agree with the poet.

Grant responds to this unfair slur against gold:

I myself hold the gold standard blameless. The source of the postwar depression was rather the decision of the British government to return to the level of prices and wages that prevailed before the war, a decision it enforced through monetary means (that is, by reimposing the prewar exchange rate). It was an error that Britain repeated after World War I.

This is a remarkable and fanciful defense, suggesting that the British government actually had a specific target level of prices and wages in mind when it restored the pound to its prewar gold parity. In fact, the idea of a price level was not yet even understood by most economists, let alone by the British government. Restoring the pound to its prewar parity was considered a matter of financial rectitude and honor, not a matter of economic fine-tuning. Nor was the choice of the prewar parity the only reason for the ruinous deflation that followed the postwar resumption of gold payments. The replacement of paper pounds with gold pounds implied a significant increase in the total demand for gold by the world’s leading economic power, which implied an increase in the total world demand for gold, and an increase in its value relative to other commodities, in other words deflation. David Ricardo foresaw the deflationary consequences of the resumption of gold payments, and tried to mitigate those consequences with his Proposals for an Economical and Secure Currency, designed to limit the increase in the monetary demand for gold. The real error after World War I, as Hawtrey and Cassel both pointed out in 1919, was that the resumption of an international gold standard after gold had been effectively demonetized during World War I would lead to an enormous increase in the monetary demand for gold, causing a worldwide deflationary collapse. After the Napoleonic wars, the gold standard was still a peculiarly British institution, the rest of the world then operating on a silver standard.

Grant makes further extravagant and unsupported claims on behalf of the gold standard:

The classical gold standard, in service roughly from 1815 to 1914, was certainly imperfect. What it did deliver was long-term price stability. What the politics of the gold-standard era delivered was modest levels of government borrowing.

The choice of 1815 as the start of the gold standard era is quite arbitrary, 1815 being the year that Britain defeated Napoleonic France, thereby setting the stage for the restoration of the golden pound at its prewar parity. But the very fact that 1815 marked the beginning of the restoration of the prewar gold parity with sterling shows that for Britain the gold standard began much earlier, actually 1717 when Isaac Newton, then master of the mint, established the gold parity at a level that overvalued gold, thereby driving silver out of circulation. So, if the gold standard somehow ensures that government borrowing levels are modest, one would think that borrowing by the British government would have been modest from 1717 to 1797 when the gold standard was suspended. But the chart below showing British government debt as a percentage of GDP from 1692 to 2010 shows that British government debt rose rapidly over most of the 18th century.

uk_national_debtGrant suggests that bad behavior by banks is mainly the result of abandonment of the gold standard.

Progress is the rule, the Whig theory of history teaches, but the old Whigs never met the new bankers. Ordinary people live longer and Olympians run faster than they did a century ago, but no such improvement is evident in our monetary and banking affairs. On the contrary, the dollar commands but 1/1,300th of an ounce of gold today, as compared with the 1/20th of an ounce on the eve of World War I. As for banking, the dismal record of 2007-09 would seem inexplicable to the financial leaders of the Model T era. One of these ancients, Comptroller of the Currency John Skelton Williams, predicted in 1920 that bank failures would soon be unimaginable. In 2008, it was solvency you almost couldn’t imagine.

Once again, the claims that Mr. Grant makes on behalf of the gold standard simply do not correspond to reality. The chart below shows the annual number of bank failures in every years since 1920.

bank_failures

Somehow, Mr. Grant somehow seems to have overlooked what happened between 1929 and 1932. John Skelton Williams obviously didn’t know what was going to happen in the following decade. Certainly no shame in that. I am guessing that Mr. Grant does know what happened; he just seems too bedazzled by the beauty of the gold standard to care.

Further Thoughts on Capital and Inequality

In a recent post, I criticized, perhaps without adequate understanding, some of Thomas Piketty’s arguments about capital in his best-selling book. My main criticism is that Piketty’s argument that. under capitalism, there is an inherent tendency toward increasing inequality, ignores the heterogeneity of capital and the tendency for new capital embodying new knowledge, new techniques, and new technologies to render older capital obsolete. Contrary to the simple model of accumulation on which Piketty relies, the accumulation of capital is not a smooth process; it is a very uneven process, generating very high returns to some owners of capital, but also imposing substantial losses on other owners of capital. The only way to avoid the risk of owning suddenly obsolescent capital is to own the market portfolio. But I conjecture that few, if any, great fortunes have been amassed by investing in the market portfolio, and (I further conjecture) great fortunes, once amassed, are usually not liquidated and reinvested in the market portfolio, but continue to be weighted heavily in fairly narrow portfolios of assets from which those great fortunes grew. Great fortunes, aside from being dissipated by deliberate capital consumption, also tend to be eroded by the loss of value through obsolescence, a process that can only be avoided by extreme diversification of holdings or by the exercise of entrepreneurial skill, a skill rarely bequeathed from generation to generation.

Applying this insight, Larry Summers pointed out in his review of Piketty’s book that the rate of turnover in the Forbes list of the 400 wealthiest individuals between 1982 and 2012 was much higher than the turnover predicted by Piketty’s simple accumulation model. Commenting on my post (in which I referred to Summers’s review), Kevin Donoghue objected that Piketty had criticized the Forbes 400 as a measure of wealth in his book, so that Piketty would not necessarily accept Summers’ criticism based on the Forbes 400. Well, as an alternative, let’s have a look at the S&P 500. I just found this study of the rate of turnover in the 500 firms making up the S&P 500, showing that the rate of turnover in the composition of the S&P 500 has been increased greatly over the past 50 years. See the chart below copied from that study showing that the average length of time for firms on the S&P 500 was over 60 years in 1958, but by 2011 had fallen to less than 20 years. The pace of creative destruction seems to be accelerating

S&P500_turnover

From the same study here’s another chart showing the companies that were deleted from the index between 2001 and 2011 and those that were added.

S&P500_churn

But I would also add a cautionary note that, because the population of individuals and publicly held business firms is growing, comparing the composition of a fixed number (400) of wealthiest individuals or (500) most successful corporations over time may overstate the increase over time in the rate of turnover, any group of fixed numerical size becoming a smaller percentage of the population over time. Even with that caveat, however, what this tells me is that there is a lot of variability in the value of capital assets. Wealth grows, but it grows unevenly. Capital is accumulated, but it is also lost.

Does the process of capital accumulation necessarily lead to increasing inequality of wealth and income? Perhaps, but I don’t think that the answer is necessarily determined by the relationship between the real rate of interest and the rate of growth in GDP.

Many people have suggested that an important cause of rising inequality has been the increasing importance of winner-take-all markets in which a few top performers seem to be compensated at very much higher rates than other, only slightly less gifted, performers. This sort of inequality is reflected in widening gaps between the highest and lowest paid participants in a given occupation. In some cases at least, the differences between the highest and lowest paid don’t seem to correspond to the differences in skill, though admittedly skill is often difficult to measure.

This concentration of rewards is especially characteristic of competitive sports, winners gaining much larger rewards than losers. However, because the winner’s return comes, at least in part, at the expense of the loser, the private gain to winning exceeds the social gain. That’s why all organized professional sports engage in some form of revenue sharing and impose limits on spending on players. Without such measures, competitive sports would not be viable, because the private return to improve quality exceeds the collective return from improved quality. There are, of course, times when a superstar like Babe Ruth or Michael Jordan can actually increase the return to losers, but that seems to be the exception.

To what extent other sorts of winner-take-all markets share this intrinsic inefficiency is not immediately clear to me, but it does not seem implausible to think that there is an incentive to overinvest in skills that increase the expected return to participants in winner-take-all markets. If so, the source of inequality may also be a source of inefficiency.

Now We Know: Ethanol Caused the 2008 Financial Crisis and the Little Depression

In the latest issue of the Journal of Economic Perspectives, now freely available here, Brian Wright, an economist at the University of California, Berkeley, has a great article, summarizing his research (with various co-authors including, H Bobenrieth, H. Bobenrieth, and R. A. Juan) into the behavior of commodity markets, especially for wheat, rice and corn. Seemingly anomalous price movements in those markets – especially the sharp increase in prices since 2004 — have defied explanation. But Wright et al. have now shown that the anomalies can be explained by taking into account both the role of grain storage and the substitutability between these staples as caloric sources. With their improved modeling techniques, Wright and his co-authors have shown that the seemingly unexplained and sustained increase in world grain prices after 2005 “are best explained by the new policies causing a sustained surge in demand for biofuels.” Here is the abstract of Wright’s article.

In the last half-decade, sharp jumps in the prices of wheat, rice, and corn, which furnish about two-thirds of the calorie requirements of mankind, have attracted worldwide attention. These price jumps in grains have also revealed the chaotic state of economic analysis of agricultural commodity markets. Economists and scientists have engaged in a blame game, apportioning percentages of responsibility for the price spikes to bewildering lists of factors, which include a surge in meat consumption, idiosyncratic regional droughts and fires, speculative bubbles, a new “financialization” of grain markets, the slowdown of global agricultural research spending, jumps in costs of energy, and more. Several observers have claimed to identify a “perfect storm” in the grain markets in 2007/2008, a confluence of some of the factors listed above. In fact, the price jumps since 2005 are best explained by the new policies causing a sustained surge in demand for biofuels. The rises in food prices since 2004 have generated huge wealth transfers to global landholders, agricultural input suppliers, and biofuels producers. The losers have been net consumers of food, including large numbers of the world’s poorest peoples. The cause of this large global redistribution was no perfect storm. Far from being a natural catastrophe, it was the result of new policies to allow and require increased use of grain and oilseed for production of biofuels. Leading this trend were the wealthy countries, initially misinformed about the true global environmental and distributional implications.

This conclusion, standing alone, is a devastating indictment of the biofuels policies of the last decade that have immiserated much of the developing world and many of the poorest in the developed world for the benefit of a small group of wealthy landowners and biofuels rent seekers. But the research of Wright et al. shows definitively that the runup in commodities prices after 2005 was driven by a concerted policy of intervention in commodities markets, with the fervent support of many faux free-market conservatives serving the interests of big donors, aimed at substituting biofuels for fossil fuels by mandating the use of biofuels like ethanol.

What does this have to do with the financial crisis of 2008? Simple. As Scott Sumner, Robert Hetzel, and a number of others (see, e.g., here) have documented, the Federal Open Market Committee, after reducing its Fed Funds target rates to 2% in March 2008 in the early stages of the downturn that started in December 2007, refused for seven months to further reduce the Fed Funds target because the Fed, disregarding or unaware of a rapidly worsening contraction in output and employment in the third quarter of 2008. Why did the Fed ignore or overlook a rapidly worsening economy for most of 2008 — even for three full weeks after the Lehman debacle? Because the Fed was focused like a laser on rapidly rising commodities prices, fearing that inflation expectations were about to become unanchored – even as inflation expectations were collapsing in the summer of 2008. But now, thanks to Wright et al., we know that rising commodities prices had nothing to do with monetary policy, but were caused by an ethanol mandate that enjoyed the bipartisan support of the Bush administration, Congressional Democrats and Congressional Republicans. Ah the joy of bipartisanship.

Barro and Krugman Yet Again on Regular Economics vs. Keynesian Economics

A lot of people have been getting all worked up about Paul Krugman’s acerbic takedown of Robert Barro for suggesting in a Wall Street Journal op-ed in 2011 that increased government spending would not stimulate the economy. Barro’s target was a claim by Agriculture Secretary Tom Vilsack that every additional dollar spent on food stamps would actually result in a net increase of $1.84 in total spending. This statement so annoyed Barro that, in a fit of pique, he wrote the following.

Keynesian economics argues that incentives and other forces in regular economics are overwhelmed, at least in recessions, by effects involving “aggregate demand.” Recipients of food stamps use their transfers to consume more. Compared to this urge, the negative effects on consumption and investment by taxpayers are viewed as weaker in magnitude, particularly when the transfers are deficit-financed.

Thus, the aggregate demand for goods rises, and businesses respond by selling more goods and then by raising production and employment. The additional wage and profit income leads to further expansions of demand and, hence, to more production and employment. As per Mr. Vilsack, the administration believes that the cumulative effect is a multiplier around two.

If valid, this result would be truly miraculous. The recipients of food stamps get, say, $1 billion but they are not the only ones who benefit. Another $1 billion appears that can make the rest of society better off. Unlike the trade-off in regular economics, that extra $1 billion is the ultimate free lunch.

How can it be right? Where was the market failure that allowed the government to improve things just by borrowing money and giving it to people? Keynes, in his “General Theory” (1936), was not so good at explaining why this worked, and subsequent generations of Keynesian economists (including my own youthful efforts) have not been more successful.

Sorry to brag, but it was actually none other than moi that (via Mark Thoma) brought this little gem to Krugman’s attention. In what is still my third most visited blog post, I expressed incredulity that Barro could ask where Is the market failure about a situation in which unemployment suddenly rises to more than double its pre-recession level. I also pointed out that Barro had himself previously acknowledged in a Wall Street Journal op-ed that monetary expansion could alleviate a cyclical increase in unemployment. If monetary policy (printing money on worthless pieces of paper) can miraculously reduce unemployment, why is out of the question that government spending could also reduce unemployment, especially when it is possible to view government spending as a means of transferring cash from people with unlimited demand for money to those unwilling to increase their holdings of cash? So, given Barro’s own explicit statement that monetary policy could be stimulative, it seemed odd for him to suggest, without clarification, that it would be a miracle if fiscal policy were effective.

Apparently, Krugman felt compelled to revisit this argument of Barro’s because of the recent controversy about extending unemployment insurance, an issue to which Barro made only passing reference in his 2011 piece. Krugman again ridiculed the idea that just because regular economics says that a policy will have adverse effects under “normal” conditions, the policy must be wrongheaded even in a recession.

But if you follow right-wing talk — by which I mean not Rush Limbaugh but the Wall Street Journal and famous economists like Robert Barro — you see the notion that aid to the unemployed can create jobs dismissed as self-evidently absurd. You think that you can reduce unemployment by paying people not to work? Hahahaha!

Quite aside from the fact that this ridicule is dead wrong, and has had a malign effect on policy, think about what it represents: it amounts to casually trashing one of the most important discoveries economists have ever made, one of my profession’s main claims to be useful to humanity.

Krugman was subsequently accused of bad faith in making this argument because he, like other Keynesians, has acknowledged that unemployment insurance tends to increase the unemployment rate. Therefore, his critics argue, it was hypocritical of Krugman to criticize Barro and the Wall Street Journal for making precisely the same argument that he himself has made. Well, you can perhaps accuse Krugman of being a bit artful in his argument by not acknowledging explicitly that a full policy assessment might in fact legitimately place some limit on UI benefits, but Krugman’s main point is obviously not to assert that “regular economics” is necessarily wrong, just that Barro and the Wall Street Journal are refusing to acknowledge that countercyclical policy of some type could ever, under any circumstances, be effective. Or, to put it another way, Krugman could (and did) easily agree that increasing UI will increases the natural rate of unemployment, but, in a recession, actual unemployment is above the natural rate, and UI can cause the actual rate to fall even as it causes the natural rate to rise.

Now Barro might respond that all he was really saying in his 2011 piece was that the existence of a government spending multiplier significantly greater than zero is not supported by the empirical evidenc. But there are two problems with that response. First, it would still not resolve the theoretical inconsistency in Barro’s argument that monetary policy does have magical properties in a recession with his position that fiscal policy has no such magical powers. Second, and perhaps less obviously, the empirical evidence on which Barro relies does not necessarily distinguish between periods of severe recession or depression and periods when the economy is close to full employment. If so, the empirical estimates of government spending multipliers are subject to the Lucas critique. Parameter estimates may not be stable over time, because those parameters may change depending on the cyclical phase of the economy. The multiplier at the trough of a deep business cycle may be much greater than the multiplier at close to full employment. The empirical estimates for the multiplier cited by Barro make no real allowance for different cyclical phases in estimating the multiplier.

PS Scott Sumner also comes away from reading Barro’s 2011 piece perplexed by what Barro is really saying and why, and does an excellent job of trying in vain to find some coherent conceptual framework within which to understand Barro. The problem is that there is none. That’s why Barro deserves the rough treatment he got from Krugman.

My Paper on Hawtrey’s Good and Bad Trade

I have just posted my paper “Hawtrey’s Good and Bad Trade: A Centenary Retrospective” based on a series of blog posts this fall on SSRN. Here is a link to download the paper.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2369028

Comments on the paper will be gratefully accepted either as comments to this post or via email at uneasymoney@hotmail.com

OMG!

I just read this review/essay (“Lead Poisoning: The Ignored Scandal”) by Helen Epstein of the book Lead Wars: The Political Science and the Fate of America’s Children by Gerald Markowitz and David Rosner, in the March 21, 2013 issue of the New York Review of Books.. The story it tells is so outrageous – and on so many different levels — that it makes you want to cry, and to cry out in horror and disgust. And lest you think that it is an old story, think again.

In 1990, Leslie Hanes, another young black single woman, moved into an apartment that was supposed to have been fully stripped of lead paint years earlier. In 1992, she gave birth to a daughter, Denisa, and in the spring of the following year, she too joined the toddler lead study.3 The day before Hanes signed the consent form, the contractor found that her apartment was not in fact lead-free. The remaining lead paint was removed, but by the following September Denisa’s blood lead level had more than tripled and was now six times higher than that currently considered safe by the Centers for Disease Control.

Denisa’s mother was not informed of the blood test result for another three months, by which time it was nearly Christmas. The research assistant who told her about it wished her happy holidays and advised her to wash her front steps more carefully and to keep eighteen-month-old Denisa from putting her hands in her mouth. When Denisa eventually entered school, she had trouble keeping up and had to repeat second grade. This came as a surprise to her mother, a former high school honors student. As Hanes told The Washington Post‘s Manuel Roig-Franzia in 2001, sometimes Denisa came home crying because she thought she was stupid. “No, baby, you’re not stupid,” Leslie told her. “We just have to work harder.”

The effects of putting children at high risk of lead poisoning are tragic and appalling.

Long before the Baltimore toddler study was even conceived, millions of children had their growth and intelligence stunted by lead-contaminated consumer products—and some five million preschool children are still at risk today. One expert even estimated that America’s failure to address the lead paint problem early on may well have cost the American population, on average, five IQ points—enough to double the number of retarded children and halve the number of gifted children in the country. Not only would our nation have been more intelligent had its leaders banned lead paint early on, it might have been safer too, since lead is known to cause impulsivity and aggression. Blood lead levels in adolescent criminals tend to be several times higher than those of noncriminal adolescents, and there is a strong geographical correlation between crime rates and lead exposure in US cities.

In 2000, the two mothers sued the Johns Hopkins–affiliated Kennedy Krieger Institute, which employed the scientists. The mothers’ cases were thrown out by a lower court, but after an appeals court remanded the case to be heard, the mothers reached an undisclosed settlement with the institute. The ninety-six-page appeals court judgment compared the Baltimore lead study to the notorious Tuskegee experiment, in which hundreds of black men with syphilis were denied treatment with penicillin for decades so that US Public Health Service researchers could study the course of the disease.

The toxic effects of lead poisoning were known long ago

The problem began in the early twentieth century when a spate of lead-poisoning cases in children occurred across the United States. The symptoms—vomiting, convulsions, bleeding gums, palsied limbs, and muscle pain so severe “as not to permit of the weight of bed-clothing,” as one doctor described it—were recognizable at once because they resembled the symptoms of factory workers poisoned in the course of enameling bathtubs or preparing paint and gasoline additives. One Dupont factory was even nicknamed “the House of the Butterflies” because so many workers had hallucinations of insects flying around. Many victims had to be taken away in straitjackets; some died.

By the 1920s, it was known that one common cause of childhood lead poisoning was the consumption of lead paint chips. Lead paint was popular in American homes because its brightness appealed to the national passion for hygiene and modernism, but the chips taste sweet, and it could be difficult to keep small children away from them. Because of its well-known dangers, many other countries banned interior lead paint during the 1920s and 1930s, including Belgium, France, Austria, Tunisia, Greece, Czechoslovakia, Poland, Sweden, Spain, and Yugoslavia.

In 1922, the League of Nations proposed a worldwide lead paint ban, but at the time, the US was the largest lead producer in the world, and consumed 170,000 tons of white lead paint each year. The Lead Industries Association had grown into a powerful political force, and the pro-business, America-first Harding administration vetoed the ban. Products containing lead continued to be marketed to American families well into the 1970s, and by midcentury lead was everywhere: in plumbing and lighting fixtures, painted toys and cribs, the foil on candy wrappers, and even cake decorations. Because most cars ran on leaded gasoline, its concentration in the air was also increasing, especially in cities.

Lead paint was the most insidious danger of all because it can cause brain damage even if it isn’t peeling. Lead dust drifts off walls, year after year, even if you paint over it. It’s also almost impossible to get rid of. Removal of lead paint with electric sanders and torches creates clouds of dust that may rain down on the floor for months afterward, and many children have been poisoned during the process of lead paint removal itself. Even cleaning lead-painted walls with a rag can create enough dust to poison a child. Gut renovating the entire house solves the problem, but this too may contaminate the air around the house for months.

The sheer magnitude and duration of those effects is mind-boggling, and the suffering has not ended.

There is no way of knowing how many children were harmed over the past century by America’s decision not to ban lead from consumer products early on, but the number is somewhere in the millions. The most accurate national survey of lead poisoning was probably the 1976–1980 National Health and Nutrition Examination Survey, which found that 4 percent of all children under six—roughly 780,000—had blood lead concentrations exceeding thirty micrograms per deciliter, which was then thought to be the limit of safety.

Black children, the survey found, were six times more likely to have elevated lead than whites. The number of children with lead levels over five micrograms per deciliter—or for that matter over one or two—was obviously much higher, but there’s no way of knowing how high it was. The 1985 leaded gasoline ban and the gradual renovation of slum housing have since reduced the number of poisoned children, so that today, the CDC estimates that some 500,000 children who are between one and five years old have lead levels over five micrograms per deciliter.

As the scale and horror of the lead paint problem came to light, the lead companies played down the bad news. When popular magazines like Ladies’ Home Journal began publicizing the dangers of lead poisoning in the 1930s and 1940s, lead and paint manufacturers placed cartoons in National Geographic and The Saturday Evening Post celebrating the joy that lead paint brought into children’s lives. Advertisements for Dutch Boy paint—which contained enough lead in one coat of a two-by-two-inch square to kill a child—depicted their tow-headed mascot painting toys with Father Christmas smiling over his shoulder.

See below

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The companies also hired a public relations firm to influence stories in The Wall Street Journal and other conservative news outlets, which characterized Needleman as part of a leftist plot to increase government spending on housing and other social programs. So, just as the tobacco industry deliberately obfuscated the dangers of cigarettes until skyrocketing smoking-related Medicaid costs finally led state governments to sue the companies, and just as oil company–backed scientists now downplay the dangers of greenhouse gases, the lead industry also lied to Americans for decades, and the government did nothing to stop it.

During the 1980s, government officials finally agreed that the lead paint crisis was real, but they were conflicted about how to deal with it. In 1990, the Department of Health and Human Services developed a plan to remove lead from the nation’s homes over fifteen years at a cost of $33 billion—a large sum, but half the estimated cost of doing nothing, which would incur a greater need for special education programs, Medicaid and welfare payments for brain-damaged and disabled lead-poisoning victims, and other expenses. But the plan was opposed by the lead industry, realtors, landlords, insurance companies, and even some private pediatricians who objected to the extra bother of screening children. The plan was soon shelved, and instead, the EPA, looking for a cheaper way around the problem, commissioned the Baltimore toddler study.

Since then, the US government has spent less than $2 billion on lead abatement. This money has supported a number of exemplary state and nonprofit programs that work in inner cities, but it’s a tiny fraction of what’s needed, and about twenty times less than US spending on the global AIDS crisis since 2004 alone. It’s worth asking why both Republican and Democratic administrations appear to have cared so little about this threat to America’s children.

And the horror continues

Lead-poisoning prevention once had its partisans too, but they were marginal and rapidly stifled. During the 1960s, the Black Panthers and the Puerto Rican activist group the Young Lords set up community health clinics and carried out screening programs for tuberculosis and sickle cell anemia as well as lead poisoning. The historian Alondra Nelson’s excellent Body and Soul: The Black Panther Party and the Fight Against Medical Discrimination (2011) describes how these groups maintained that new civil rights laws and Great Society programs alone would never meet the needs of the poor unless the poor themselves had a voice in shaping them. The Panthers espoused violence and called for a separate black country. They certainly weren’t right about everything, but when it came to lead poisoning, they probably were.

By the early 1980s, the movements to achieve social justice led by Martin Luther King Jr., Malcolm X, and the Black Panthers had largely subsided, and with them, grassroots advocacy for the health of poor black children. Some scientists continued to raise the alarm about lead poisoning, including Herbert Needleman, Jane Lin-Fu of the US Children’s Bureau, Philip Landrigan of Mount Sinai Hospital in New York, and Ellen Silbergeld, the editor of the journal Environmental Research, but they lacked a strong social movement to take up their findings and fight for children at risk. Although there were some desultory campaigns against lead poisoning, neither the powerful women’s health movement nor environmental groups took up the issue in a sustained manner. The Obama administration has invested no more in this problem than George W. Bush’s did. Lead poisoning isn’t even on the CDC’s priority list of “winnable public health battles.”


About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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