A Primer on Keynesian Economics, with Help from JS Mill

Here’s JS Mill contra Say’s Law:

There can never, it is said, be a want of buyers for all commodities; because whoever offers a commodity for sale, desires to obtain a commodity in exchange for it, and is therefore a buyer by the mere fact of his being a seller. The sellers and the buyers, for all commodities taken together, must, by the metaphysical necessity of the case, be an exact equipoise to each other; and if there be more sellers than buyers of one thing, there must e more buyers than sellers for another. This argument is evidently founded on the supposition of a state of barter; and, on that supposition, it is perfectly incontestable. When two persons perform an act of barter, each of them is at once a seller and a buyer. He cannot sell without buying. Unless he chooses to buy some other person’s commodity, he does not sell his own. If, however, we suppose that money is used, there propositions cease to be exactly true. It must be admitted that no person desires money for its own sake […] and that he who sells his commodity, receiving money in exchange, does so with the intention of buying with that same money some other commodity. Interchange by means of money is therefore, as has been often observed, ultimately nothing but barter. But there is this difference – that in the case of barter, the selling and the buying are simultaneously confounded in one operation; you sell what you have, and buy what you want, by one indivisible act, and you cannot do the one without doing the other. Now the effect of the employment of money, and even the utility of it, is, that it enables this one act of interchange to be divided into two separate acts or operations; one of which may be performed now, and the other a year hence, or whenever it shall be most convenient. Although he who sells, really sells only to buy, he needs not buy at the same moment when he sells; and he does not therefore necessarily add to the immediate demand for one commodity when he adds to the supply of another. The buying and selling being now separated, it may very well occur, that there may be, at some given time, a very general inclination to sell with as little delay as possible, accompanied with an equally general inclination to defer all purchases as long as possible.

So I’m saying to myself: Here is John Mill, a “classical economist” par excellence, arguing against Say’s Law – that production creates its own demand – in what appears to be quite a Keynesian fashion.

“So what’s the difference,” I’m asking myself (I’m such a novice), “between Mill’s analysis of the fallacy of Say’s Law and Keynes’s, that Keynes is such a big deal and Mill – well, not so much?”

On reflection, I located the difference (and have italicized it for your convenience). Although he recognized the “disjunct” between buying and selling made possible by the unique nature of money, Mill does not explicitly identify it as a store of value. In arguing that “he who sells really sells only to buy”, Mill shows that his thinking about money is still confined to what economists call “transactions demand for money”, in which people want to hold money only to buy and sell things with it.

Keynes, on the other hand, does not agree that “no person desires money for its own sake”. In fact, his insight that people sell – that is, buy money – for reasons wholly other than to buy more Things That Are Not Money – lies at the very center of Keynes’s whole theory of unemployment and his disagreement with the “classical” economists.

According to Keynes, people can desire money “for its own sake”, rather than for its role as a medium of exchange. People want their wealth in the form of money not just as a lubricant to commerce (Hume’s “oil”), but also as a refuge from the uncertainty inherent in the values of non-liquid assets.

To see this, think about the current recession. Doesn’t everybody sort of wish they had just held on to their money, instead of buying stocks and bonds and houses and CDOs and all sorts of other things whose prices ended up tanking? Of course they do. And that’s why everyone is now “fleeing to safety”, holding their wealth in the form of idle cash deposits, or perhaps ultra-safe bonds.

This “flight to safety” hints at the other, related, key concept of Keynesian economics: uncertainty. Why do people take advantage of money’s function as a “store of value”? Because they have no idea what will happen to the value of anything else (but in times like the present, they have a feeling that the values of everything else will keep dropping).

If your wealth is in the form of houses, you could very well end up sitting on a bunch of houses that you cannot sell, and you can only enjoy one at a time for yourself, so your wealth isn’t very wealth-y. If you had not bought those houses, and just held on to your cash, your wealth would still be wealth-y, because you could turn that money over for stuff you can use. That’s the great thing about money: you can always turn it over.

Mill goes on to argue that a glut, even though it can happen, can never be permanent. This is the other crucial difference between Keynes and the classical economists. Keynes insisted that there is no automatic righting mechanism to lift demand for Things That Are Not Money to a level that would require the employment of everyone able and willing to work.

So these are the 3 core pieces of Keynes’s take-home lesson:

1. Uncertainty (which leads to)
2. the desire to hold wealth in the form of money instead of Things That Are Not Money (made possible by the)
3. absence of an equilibrating mechanism.

This absence of an equilibrating mechanism leads to the need for fiscal policy, such as ARRA.

But that’s another story for another post.

Superfunk

Here’s Mark Thoma opining concerning the “villains” of the present crisis. (He opens by listing candidates: irresponsible borrowers and lenders, benighted economists (incidentally, this is my vote), China, the Fed (I swear to heaven, some people would blame the Fed for their common cold, but that doesn’t mean they’re not to blame), etc. I will have a couple of unimportant things to say afterward:

But even that wasn’t enough to produce a bubble by itself, we have to ask why the checks and balances within the housing sector, both from the market and from regulators, failed to stop the massive flow of money into these assets. The reason is that there were incentive problems all the way through the system. The homeowner gets a non-recourse loan which makes risks mostly one-sided, real estate agents are paid on commission giving them to incentive to maximize the number of houses sold at the highest price they can get, real estate appraisers were in the pocket of the real estate agents (that’s obvious when you buy a house), if they don’t give the values the agents are looking for, their phone stops ringing. The mortgage brokers were being paid, essentially, on commission and they were able to move these loans off their books – sell them as repackaged securities – so as to remove any long-run interest in the outcome of the loans (so they didn’t care what the appraisers said). Their incentive was to sell as many loans as possible with no real concern for quality. Why did people buy these repackaged loans from banks and brokers? Here we come again to the ratings agencies and the poor risk assessment models, the culture within these institutions, moral hazard from implicit or explicit government guarantees, compensation structures, and so on. The incentives at just about every step of the process were to create as many loans as possible with little regard to quality, every check and balance that ought to be in place was missing. The market did not self correct, and regulators clearly fell down on the job, fixing any one of these incentives could have made a big difference by plugging up the pass-through of the excess liquidity from China and the Fed, but the regulators were absent. Whether this is due to incompetence, poorly structured regulatory procedures, or regulatory capture – money talks and nobody wanted to spoil the party – I don’t know for sure. But the regulatory failures were clearly broad based.

Now, a couple of unimportant things, arranged in order of unimportance:

First of all, Mark Thoma needs to learn how to use commas. I love the View (no, not that one), but come on.

Second of all, in regard to incentives, I’ve been thinking lately – and I have a feeling I’m not the first to say this in so many words, but I’m not well enough read in economics to say who my (surely illustrious) predecessors are or in what illustrious tomes they iterated this idea – that economic security, like every other kind of security, is among those public goods, of which Adam Smith wrote so long ago, which need to be provided by the state precisely because there are not sufficient private resources to create it or because there is not sufficient incentive to recruit private resources to its creation. Everyone wants security, but no one is willing to pay the cost of security, because there’s nothing in the way of a return on investment, in the sense that the return on investment would belong to everyone rather than exclusively to the people who paid for it. Given the miserable failure of monetary policy – on full display right now – this is, I believe, a sound argument for fiscal policy. In fact, I think this is the broadest statement of the conclusions of Keynesian economics: the private realm is in a superfunk, and part of being in a superfunk is that you cannot get yourself out of it. Somebody else has to get you out of a superfunk. (In 1907, JP Morgan got the U.S. out of a not-quite-super funk.) Now, while the possibility that Jesus will descend from the clouds and raise economies from the dead cannot be ruled out entirely, it seems that only governments can lift us out of a superfunk right now. In other words, only governments can provide security, because it is a public good.

Of course, there are problems here that fall squarely under the “moral hazard” umbrella. But I think – and I don’t know, I just think – that professional economists, sociologists, political scientists, and anybody else who cares to give it a shot should take this opportunity to rethink the relationship between the public realm, the private realm, and the moral hazard phenomenon. I say this because, as easy and seemingly simple as it seems to rid the world of the moral hazard by minimizing the role of government to the very limit, the cookie does not crumble this way in the real world. In the real world, we have this pattern in which the private realm tells the state “Hands off!” during boom times and then runs to the government for bailouts and “rent” during the thus-far-apparently-inevitable superfunks. So the moral hazard does not disappear when government is minimized, as much because the private realm wants the government ready to hand for morally hazardous purposes as because the government is – well, you know, doing its job and trying to make life secure for everybody.

My question, then, is where is the moral hazard socially located? Is it in an overly involved government, or is it in a private realm that wants its government neither small nor large but just right, i.e., a private realm that wants the government to be, quite frankly, its enabler, its messiah, its defender, its bitch, and out of the way, all at once?

Rethinking (at least a Component of) the American Dream

Richard Florida writing for the Atlantic this month (in my estimation one of the most creative and important pieces of literature to emerge from the global downturn so far):

The housing bubble was the ultimate expression, and perhaps the last gasp, of an economic system some 80 years in the making, and now well past its “sell-by” date. The bubble encouraged massive, unsustainable growth in places where land was cheap and the real-estate economy dominant. It encouraged low-density sprawl, which is ill-fitted to a creative, post-industrial economy. And not least, it created a workforce too often stuck in one place, anchored by houses that cannot be profitably sold, at a time when flexibility and mobility are of great importance.

So how do we move past the bubble, the crash, and an aging, obsolescent model of economic life? What’s the right spatial fix for the economy today, and how do we achieve it?

The solution begins with the removal of homeownership from its long-privileged place at the center of the U.S. economy. Substantial incentives for homeownership (from tax breaks to artificially low mortgage-interest rates) distort demand, encouraging people to buy bigger houses than they otherwise would. That means less spending on medical technology, or software, or alternative energy – the sectors and products that could drive U.S. growth and exports in the coming years. Artificial demand for bigger houses also skews residential patterns, leading to excessive low-density suburban growth. The measures that prop up this demand should be eliminated.

If anything, our government policies should encourage renting, not buying. Homeownership occupies a central place in the American Dream primarily because decades of policy have put it there. A recent study by Grace Wong, an economist at the Wharton Shool of Business, shows that, controlling for income and demographics, homeowners are no happier than renters, nor do they report lower levels of stress or higher levels of self-esteem.

And while homeownership has some social benefits – a higher level of civic engagement is one – it is costly to the economy. The economist Andrew Oswald has demonstrated that in both the United States and Europe, those places with higher homeownership rates also suffer from higher unemployment. Homeownership, Oswald found, is a more important predictor of unemployment than rates of unionization or the generosity of welfare benefits. Too often, it ties people to declining or blighted locations, and forces them into work – if they can find it – that is a poor match for thei interests and abilities.

As homewonwership rates have risen, our scoeity s become less nimble: in the 1950s and 1960s, Americans were nearly twice as likely to move in a given year as they are today. Last year fewer Americans moved, as a percentage of the population, than in any year since the Census Bureau started tracking address changes, in the late 1940s. This sort of creeping rigidity in the labor market is a bad sign for the economy, particularly in a time when businesses, industries, and regions are rising and falling quickly.

[…]

[D]ifferent eras favor different places, along with the industries and lifestyles those places embody. Band-Aids and bailouts cannot change that. Neither auto-company rescue packages nor policies designed to artificially prop up housing prices will position the country for renewed growth, at least not of the sustainable variety. We need to let demand for the key products and lifestyles of the old order fall, and begin building a new economy, based on a new geography.

What will this geography look like? It will likely be sparser in the Midwest and also, ultimately, in those parts of the Southeast that are dependent on manufacturing. Its suburbs will be thinner and its houses, perhaps, smaller. Some of its southwestern cities will grow less quickly. Its great mega-regions will rise farther upward and extend farther outward. It will feature a lower rate of homeownwership, and a more mobile population of renters. In short, it will be a more concentrated geography, one that allows more people to mix more freely and interact more efficiently in a discrete number of dense, innovative mega-reigions and creative cities Serendipitously, it will be a landscape suited to a world in which petroleum is no longer cheap by any measure. But most of all, it will be a landscape that can accommodate and acclerate invention, innovation, and creation […].

Is (Macro)Economics Science?

Dani Rodrick applauds Keynesian warriors DeLong and Krugman, but concludes there’s something wrong with macroeconomics that needs explaining.

A commenter (apparently off a very long and learned speech by Friedrich Hayek) trenchantly observes that “An untold number of economists are at bottom bad philosophers with a false, Marvel Comics understanding of ‘science'”.

Stimulus Shushdown?

Here’s video ofBrad DeLong and Michele Boldrin arguing over the effectiveness of Stimulus.

I felt for DeLong, because it’s very difficult to remain dignified in debate with an overbearing – and rather pompous – clown. I am pretty sure Brad expected a grappling with the issues at hand, but Boldrin was simply not interested. He just did a lot of shoulder-shrugging and shushing.

I also felt for the debate’s auditors, who probably expected edification from an open debate between “experts” but were instead treated to a farcical performance by Boldrin that left DeLong with nothing to sharpen a saw against and therefore unable to edify.

DeLong is right; it was “very strange”. Almost as though Boldrin had no grasp of the most basic economic concepts, such as “unemployment” and “spending”. For instance, he seems not to know (or is pretending not to know) what people do with increases in their income (answer: they spend some and save some) or how (or even that) asset deflation bled into the rest of the economy.

Final note: Boldrin dismissed a very good analogy by DeLong. My mother always told me not to trust anyone who didn’t appreciate a good analogy.

Oh, well. Here’s wishing Brad DeLong worthier opponents in the future.

CBO on Stimulus

Here is the Congressional Budget Office’s estimate of the short-run and long-run effects of the American Recovery and Reinvestment Act of 2009.

Economics as Ideology

From “Financial Crisis and the Systemic Failure of Academic Economics” by Colander, David et al.:

What are the flaws of the new unregulated financial markets which have emerged? As we have already pointed out […], the possibility of systemic risk has not been entirely ignored but it has been defined as lying outside the responsibility of market participants. In this way, moral hazard concerning systemic risk has been a necessary and built-in attribute of the system. The neglect of the systemic partin the “normal mode of operation”, of course, implies that external effects are not taken properly into account and that in tendency, market participants will ignore the influence of their own behavior on the stability of the system. The interesting aspect is more that this was a known and accepted element of operations. Note that the blame should not only fall on market participants but also on the deliberate ignoring of the systemic risk factors or the failure to at least point them out to the public amounts to a sort of academic “moral hazard”.

(italics inserted)

Further:

It seems clear that financial innovations have made the system more fragile. Apparently, the existing linkages within the worldwide, highly connected financial markets have generated the spillovers from the U.S. subprime problem to other layers of the financial system. Many financial innovations had the effect of creating links betwen formerly unconnected players. All in all, the degree of connectivity of the system has probably increased enormously over the last decades. As is well known from network theory in natural sciences, a more highly connected system might be more efficient in coping with certain tasks […] but will often also be more vulnerable to shocks and – systemic failure! The systematic analysis of network vulnerability has been undertaken in the computer science and operations research literature (see e.g. Criado et al., 2005). Such aspects have, however, been largely absent from discussions in financial economics. The introduction of new derivatives was rather seen through the lens of general equilibrium models: more contingent claims help to achieve higher efficiency. Unfortunately, the claimed efficiency gains through derivatives are merely a theoretical implication of a highly stylized model and, therefore, have to count as a hypothesis. SInce there is hardly any supporting empirical evidence (or even analysis of the question), the claimed real-world efficiency gains from derivatives are not justified by true science. While the economic argument in favor of ever new derivatives is more one of persuasion rather than evidence, important negative effects have been neglected. The idea that the system was made less risky with the development of more derivatives led to financial actors taking positions with extreme degrees of leverage and the danger of this has not been emphasized enough.

Ok, there is a great deal being said here, but more important is what is not being said but only implied (or, at the very least, inferred by me). Colander et al. claim that the financial crisis has revealed “a systemic failure of the economics profession”. In practice, though, what does this mean? Do we simply need more sophisticated and supple models that are more reflective of and accountable to the real world that enable more focused manipulation of it policy-wise? Or do the very foundations of economics as a field of study need to be rethought? Although the latter sounds more drastic and terrible, I suspect these options may be indistinct.

There can hardly be any clearer example than this paper and its subject (the financial crisis, its causes, and its relationship – or lack thereof – to mainstream theory) of the political relationship between praxis and theory.

I do not want to go shooting off at the mouth, but I do want to put something on the table here (I am not the first and will not be the last). When we ask why orthodox economics not only cannot explain, but also usually does not bother to acknowledge the reality of, crisis situations, what answers come to mind? How could a field graced with so many brilliant minds have gone centuries with less than a lot of progress in explaining and ameliorating some of the most relevant and obvious objects of its own purported study?

I suggest (what should be evident to many) that orthodox economics never was an objective science through and through. Instead, it has always been primarily a field of political and social rationalization, that is, an ideology. Economists have aimed at explaining economic phenomena, but they have done so within the bounds prescribed by the ultimate goal of justifying economic phenomena, of dressing an otherwise drab status quo in the beautifying garb of genuine science.

From this perspective (which deserves all sorts of profound and detailed qualification for which there is no room here), economics cannot be expected to explain or predict the real world any more than could craniometry.

It seems to me that if Colander et al. are not saying this, then all they’re saying is that economics needs better models and better manners, which is trivial.

Romer on Stimulus

Stimulus has proved polarizing. Here’s Christina Romer in defense.

Korean Peninsula: A God’s-Eye View

The Koreas

Notice the Koreas (smack in the middle). South Korea is all aglow, while North Korea is benighted.

Without resorting to the simple and dogmatic answer that “South Korea is capitalist and North Korea is communist” (though not incorrect, the answer is incomplete), ask yourself, “Why?”

Now you are a geographer! (And an economist, and a political scientist, and a sociologist, and a historian, and a high-school basketball coach – er, wait…)

10 Ways to Make Sure You Are Never Unemployed

Just so no one can ever justly accuse Cosmopolis of not investing – at least a little bit – in human capital, here’s a list of 10 ways to make sure you’re never unemployed (prepared by Career Opportunities News. Ferguson, an imprint of Infobase Publishing, whatever that is):

1. Continue your education. Take at least one course each year to improve your work skills. Your employer may even pick up the tab.

2. Keep Current with New Technology. Make a point to study, and master, the new technology entering your field. Hopefully you’ll end up as the person fellow workers turn to for assistance.

3. Dress for Promotion. Keep up-to-date with changes in fashion, even if it means relegating some of your favorite older items to Saturdays. Being better dressed than the average helps you stand out.

4. Be Sensitive to Diversity Issues. Develop and demonstrate your expertise in working with minorities, people with disabilities, older workers, and both men and women. Rating forms often measure achievements in this area.

5. Pick a Mentor. Develop close working relationships with one or more successful and advancing executives. Support that person and your loyalty may be rewarded.

6. Solicit Feedback. Make sure your work is valued and you are placing the emphasis on what the employer wants. If annual reviews are not held, meet to discuss your progress with your supervisor at least annually.

7. Locate the Right Career Path. Note the kinds of jobs the top people in your organization held on their way up. What career paths did they take and how can you follow them?

8. Become Versatile. Learn as many different jobs in the organization as possible. This will help you avoid being downsized and can be of great assistance when you get promoted.

9. Volunteer. Speak up when opportunities arise to work on special projects. You may learn new skills, make useful contacts, and earn points with your supervisor.

10. Participate in Professional Activities. Become known in your organization and your field by working with employee groups and professional organizations. The more people you know, and who know you, the better off you are.