Trudeau's legacy was tolerance (official bilingualism, getting the government "out of the bedrooms of the nation"), toughness (controversially, he invoked the War Measures Act, suspending civil liberties in response to violent acts - including kidnapping and murder - by a radical wing of Quebec separatists), and constitutional reform. He was fiercely principled, and not afraid to speak his mind, to the point of apparently telling an opposition member to "f*** off" during question period in the House of Commons (though whether Trudeau said this, mouthed it, or thought it, is subject to debate). Trudeau is not the type who could be elected to anything in the United States. In particular, his preference for a flower (rather than a large flag pin) on his lapel would not go over well.
Now, here's where I come in. In 1975 I was an undergraduate at Queen's University, Kingston, Ontario. I was a math major, and most of what I knew was math, statistics, natural sciences, and computer science. I couldn't see myself (just) proving theorems for the rest of my life, or being an actuary, and someone suggested I take economics. I ended up in an Introduction to Economics class taught by Neil Bruce. This was a full-year course, using Dick Lipsey's book. The first half was micro, taught by Neil.
One day, late in the fall of 1975, Neil Bruce walked into class, and announced that he wasn't going to teach the lesson he had planned. He told us that he and his colleagues had watched Trudeau on the television the evening before, they had discussed Trudeau's new policy initiative, and he (Neil) was going to spend the next 90 minutes talking about it. That policy initiative was the Anti-Inflation Board (AIB), a government agency that was to spend the next 3 years overseeing collective wage agreements and price-setting in Canada. One story behind the AIB is that Trudeau was influenced by another Canadian, John Kenneth Galbraith, at that time a professor at Harvard. Trudeau apparently didn't buy Milton Friedman's notion that "inflation is always and everywhere a monetary phenomenon," but instead went with Galbraith, whose ideas on inflation control seemed to have been shaped by his service with the Office of Price Administration during World War II. The solution to high inflation? Legislate it out of existence.
Neil Bruce had been busy teaching us the standard basics of microeconomics. By then we had covered price theory, consumer and firm behavior, and the effects of taxes and subsidies, etc. Neil could show us, using some basic tools, how the AIB would introduce distortions and would misallocate resources, and we could add that welfare loss to the waste from the creation of a new government bureaucracy. There were three important lessons here. (i) Smart and well-intentioned politicians (in this case, one I admired, Pierre Trudeau) could be misled by smart and well-intentioned, but nevertheless misguided, economists. (ii) The Ivy League is capable of harboring bad ideas. (iii) A guy (Neil Bruce) who received his PhD from the University of Chicago Economics Department, which some people thought was full of right-wing bad guys (and the bad-guy image hasn't gone away), was making more sense than the Prime Minister and the economist from Harvard.
Now, for a person with an urge to fix what is wrong with the world, a course in microeconomics might be quite discouraging. Mostly (and this of course depends very much on how it is taught), conventional micro is a series of exercises in how governments can screw things up. Rent controls end up hurting the people they were intended to help. Various subsidies, inappropriate taxation, tariffs, and quotas reduce welfare in general and cut down on the gains from exchange. If we want to fix things, this will involve undoing stuff, and that stuff may be the pet projects of our well-intentioned but misguided friends, who will only give us grief. There are, however, ways out for good-deed-doers. There are externalities (positive and negative), market failures, and monopoly power. Working out how to fix the externalities, complete the markets, or regulate the monopolies requires work, though. It may be the case that one can fix the externality through a clever market mechanism - cap and trade for pollution for example. However, the government may actually be no better at supplying some item the private market fails to provide or monopoly power might actually not be so bad - it may actually promote innovation. The answers are not clear at the outset. One has to weigh alternatives, and carefully measure the costs and benefits of government intervention.
However, there may be a refuge for the good-deed-doer in that other branch of economics - macroeconomics. There is a large body of work - Keynesian economics - that tells us that intervention is the name of the game, and it looks easy. According to Keynesians, the government can, and should, act to make things better. Doing nothing in a recession, when unemployment is high and real GDP is low, would be cruel as well as inefficient. That is what I was taught in the macro portion of my Intro course. At the time, it didn't occur to me that what I learned in the fall semester should have something to do with what I learned in the spring.
I have had plenty of opportunities to talk to Keynesians and learn from them over the years. Mark Gertler, for example, has strong Keynesian leanings, and I learned a lot from in him in graduate school. However, both Mark and I were learning a lot from someone else - Rao Aiyagari, who had been a Neil Wallace student at Minnesota and, in 1981, had the complete tool basket together, i.e. everything we now know as modern macro. Rao, and the writings of Lucas, Wallace, Sargent, and Prescott, made sense to me, and I caught the Minnesota bug.
There seems to be a view among some people that interest in Minnesota macro is all about the aesthetics of mathematics. I certainly think that a functional equation is an object of beauty. I also think that the average North American has a bad attitude toward mathematics. Indeed, some people seem quite proud, rather than ashamed, of the fact that they don't know it. Mathematics is a language that, in some circumstances, is simply an efficient tool for getting the job done. I could be like Adam Smith, and write it in words, or I could be like Bob Lucas and write down an economic model and analyze it using some mathematics. I can walk 8 miles from the University to the Fed (and maybe get lost on the way), or I can get there on the train.
There are many things about the recent financial crisis that have surprised me. One of those surprises was the wide support for Keynesian-style fiscal programs, in particular the American Recovery and Reinvestment Act of 2009 (or stimulus package). Why did I think that policymakers might at least stop and think before jumping into something like that? First, New Keynesians, led by Mike Woodford, with their renewed popularity in central banks and among academics, were primarily interested in monetary policy. I took this as some sign that they had recognized that Milton Friedman was right in his analysis of policy lags. Even if fiscal policy works as Lipsey said it did in his book, the legislative process is too cumbersome, the effects are so uncertain, and the lags are so long that you just should not bother. Further, there seemed to be something different going on here. By calling this a "financial crisis," we were recognizing that the key forces at work were financial. It wouldn't seem that the economics of sticky wages and prices would have much to say about that, so why would we be following some simple Keynesian policy prescription?
Now, Christina Romer, in her farewell speech is quite unrepentant. She argues that the stimulus package worked, and her interpretation of what is going on in the economy would have fit right into the second semester of my 1975-76 Intro to Economics course. Indeed, Christina could have showed up in class and said the following, and everyone would have understood her:
The … United States still faces a substantial shortfall of aggregate demand. GDP by most estimates is still about 6 percent below trend. This shortfall in demand, rather than structural changes in the composition of our output or a mismatch between worker skills and jobs, is the fundamental cause of our continued high unemployment….
This represents the extreme end of Keynesian economics. She seems pretty sure about this. GDP is not where it should be. She knows where it should be, and she knows how to get us there. Y = C + I + G + NX. We don't have enough Y because of too little C, I, and NX, so we just replace that with some more G. Easy. As Brad DeLong says here, "the government's money is as good as anyone else's."
New Keynesian Economics is less extreme, in that it makes a clear assumption about what the friction is in the economy - typically the distortions from sticky prices, in an otherwise-standard modern macro model. In a Woodford model, we're at least recognizing that what we think of as the efficient level of GDP can fluctuate - it's a moving target, and we're going to be uncertain about what it is in real time. You can quarrel (as I do, and others as well) about how New Keynesian models are put together, and whether they fit the empirical evidence, but at least there is something recognizable here as economics.
Unfortunately, what Romer says in the quote above, and what DeLong says here in the debate with my friend Boldrin, is mostly bilge. Let me explain. Why does an increase in spending by the government on goods and services matter in basic Keynesian models? Expenditure on goods and services is income for consumers; when consumers get more income, they spend more; that is also income for consumers, so they spend more, etc. That's the multiplier. This is a wonderful thing - it's essentially a free lunch. For every $1 the government spends we get more than $1 in GDP. How much more? Here, Christina claims we get about $1.60 more, and she argues that that's probably a lower bound. This is great! Followed to it's logical conclusion, of course, this should make us want an infinite-sized government so that we can all be infinitely rich. Keynesians aren't that stupid of course. Typically the argument would be that this only applies when there is "resource slack" in the economy. Like now.
Now, what is left out of the typical textbook Keynesian analysis or, put another way, what implicit assumptions are they making?
No Ricardian equivalence. Ricardian equivalence is the notion that forward-looking consumers take account of the implications of current government policy for future taxation. Suppose the government increases spending on goods and services today. It must finance this by increasing taxes, or by borrowing. If it borrows, it is going to have to increase taxes in the future to pay off the debt. What difference does the financing make to me as a consumer? Either way I'm stuck with the tax bill - it's just deferred if the government borrows to finance its higher deficit. Now, a Keynesian would then say that there are two problems here. One is that credit markets are not perfect. Indeed, if some consumers are credit constrained, Ricardian equivalence does not work. But if the problem is in credit markets, why not address that directly? Government intervention by way of spending directly on goods and services seems rather roundabout. A second Keynesian response might be that consumers are not as sophisticated as Ricardian equivalence requires them to be. Who has the knowledge to see through the government's behavior and understand the future tax implications of current policies? The answer to this is that it is never good to fool people. By saying people are too stupid to get it, we are just saying that we can make them do something that is not in their interest - spending more today when they should be saving.
There are resources lying around that can be put to use to produce the goods and services the government wants to buy. If the government wants to build a bridge, this requires labor, materials, and capital equipment. If the government wants to fight a war, that also requires labor, materials, and capital equipment. Typically, we would think of these inputs to production as having an opportunity cost, which is what we could have done with them in the best available alternative. In the most basic kind of Keynesian model, the opportunity cost of government spending is zero - it's literally a free lunch. The notion is that, with a 9.6% unemployment rate, for example, and given the quantity of existing empty buildings and idle machinery, we just take all the idle resources we have and put them to work. Of course it's not that simple. Do the unemployed workers have the skills that the government needs to produce things that are actually useful for society? Are the unemployed workers living in the places where these government goods and services are going to be useful? What if the increased government spending actually uses labor skills that are in high demand, and soaks up resources that would actually be more useful in the private sector? What if the government's intervention actually slows down the adjustment that needs to take place in the economy, i.e. moving jobs and resources across industries and from one geographical location to another? In the excerpts here, from Christina Romer's farewell speech, she is quite proud of the speed with which the stimulus package was passed and implemented. Do you think that much thought went into how that money was spent, or that anyone attempted to seriously answer questions like the ones I just asked?
When I do a class in intermediate macroeconomics, the first thing we do is to see how far we can go with conventional microeconomic tools in understanding how the macroeconomy works. Basically, this is the analog of what Neil Bruce was doing in our micro intro class - he was using conventional micro tools to think about a policy that was addressed to a macro issue - inflation. This past spring, as fiscal policy was very much on the agenda, one exercise my class did was to think about all the ways that government spending could matter, without bringing sticky wages and prices onto the table. This is essentially extending what I do in Chapter 5 of my book. There, I start with a basic case, which is government purchases as pure waste. This is a good model for spending on a war. The spending (hopefully) is for a good purpose, but the benefits will not be reflected in the National Income Accounts. Standard microeconomics tells you that GDP will in fact increase as a result. Under the assumption that consumption and leisure are normal goods, consumers will work harder to support the larger government, as higher taxes have caused their after-tax incomes to fall. The multiplier, however, is less than 1, since consumption decreases. Consumption is crowded out by the larger government. The opportunity cost of government spending here is lost leisure and consumption. One can now think about many other types of government purchases. There are government-provided goods and services, for example those associated with National Parks, that provide consumers with direct benefits. There are items like roads and bridges that make private sector production (e.g. trucking) more profitable. For some of these types of spending (e.g. government-provided goods and services are perfect substitutes for private goods and services), the multiplier can be zero. In other cases (complementarities), we can get substantial multipliers. This boils down to the issue of whether the government is more efficient than the private sector at providing particular goods and services, or particular kinds of capital inputs. We have a whole field of economics that deals with this: public economics. Actually, that's Neil Bruce's department.
Now, this analysis does not say much in particular about the cyclical nature of government intervention. In general, this type of analysis is concerned with the long run. What do we want the government to do? How large should it be? We can, however, make the case that, if we have some project we think it would be socially advantageous for the government to undertake, the opportunity cost of doing it in a recession is lower. Recently, some forces in my school district convinced me that a new middle school was needed. Some other forces wanted to argue that this wasn't the time to do it, as we are in a recession. My answer to that was that this is indeed exactly the right time. The school could be built quickly and at low cost, and I was pleased to vote in favor of floating a school bond at a low interest rate. However, I did not notice arguments like that being used in favor of the stimulus package. This appeared to be a set of new initiatives that we would otherwise not have been contemplating.
Is there some case for a fiscal policy initiative that we could construct based on the particulars of the financial crisis? If we think that a key source of our recent problems is a temporary increase in credit market frictions, one approach might be a pure Ricardian one. When there are credit-constrained economic agents, a temporary tax cut for everyone, with a promise to pay off the resulting debt with higher future taxes, is effectively a large government credit program. It does not require any new government bureaucracy, and just works through the existing income tax mechanism. Those who are credit constrained spend the tax cut as if they were getting a loan, and work harder or consume less in the future so as to pay the higher future taxes, as if they were paying off the loan. Those who are not credit-constrained save the tax cut so as to pay their future taxes. There are no long-run implications for the government budget. Why didn't we just do that?
By now, we are well past the financial crisis. The financial system is not entirely out of the woods, but we're well beyond the need for emergency measures. However, the recovery has been weaker than expected, and there is some shouting, particular from you-know-who that we need to do more, and "more" appears to mean more spending by the federal government on goods and services. Krugman does not seem to be particular about the specific goods and services that comprise this extra spending. Here's Krugman:
As I pointed out in February 2009, the Congressional Budget Office was predicting a $2.9 trillion hole in the economy over the next two years; an $800 billion program, partly consisting of tax cuts that would have happened anyway, just wasn’t up to the task of filling that hole.Interpretation: Krugman knows, and he's using the CBO for support, what the "right" or efficient level of GDP is, and he's telling us how to get there. It's easy - like filling a hole. And who wants a hole anyway?
What I was taught in Intro to Economics was that the role of an economist in society is to give advice. I think this was in Dick Lipsey's introduction, where he talks about positive and normative economics. Learning and practicing economics can be a purely intellectual and selfish exercise. We want to understand how the world works, and having that knowledge makes us feel better, and perhaps more in control. However (and some people I know disagree with me here), we also want to make the world a better place. Now, that's a delicate thing. Economists like to think about efficiency, but there are few, if any, practical policy interventions that imply Pareto improvements - making everyone better off. Someone always loses. What we can do however, is to analyze the effects of particular policies, and then give a rundown of who wins and loses. Alternatively, if you give me a particular objective, I should be able to design a policy that accomplishes the objective efficiently.
What does Paul Krugman want? He may want money and power, but that's not saying much. The quest for that stuff seems universal. What he says he wants, given the current circumstances, is for fewer people to be unemployed and more people to be employed. Why does he want that? It appears that he is concerned with equity. For him, it is criminal that some people are doing well and won't help out the unemployed, who are in dire straits.
What Krugman appears to be arguing for is insurance. Some people who are unemployed today never expected to be, and some of the currently employed (maybe me) will be unemployed in the future. Bad stuff happens to everyone, the private market for some reason does not insure us against all these bad events, and we accept that there is a role for government in providing insurance. Lucas, in his 1987 book Models of Business Cycles conducts a thought experiment, where he asks what the representative consumer would pay to get rid of business cycle risk, and the answer is "not much." Of course, we knew that had to be wrong on some level, as business cycle risk is borne disproportionately by the poor and less-educated. But why would you insure these people by having the government employ them during recessions? If we think our unemployment insurance system is badly designed, as I think we can argue it is, why not fix that?
Krugman has good intentions, as did John Kenneth Galbraith. However, just as Galbraith was selling a flawed policy to Pierre Trudeau, Krugman is selling snake oil to the American public. And man, he is selling it in a nasty way. The second Bush administration included people who were masters of deception, and the art of pandering to fear and ignorance. Krugman acts like someone who has studied those methods and put them into practice, and this does not serve anyone well.
The Republican party does not seem to have much to offer us. They seem to be about further pandering to fear and ignorance, with no constructive economic ideas. The Democrats do better on the fear and ignorance front, though there could be many improvements. On economic policy, there is clearly room for either political party to push forward an agenda of sound fiscal policy, driven by careful economic research and good economic principles. In Canada, a Liberal government (those characters would be far to the left of the Democratic Party, remember) actually turned deficits in the neighborhood of 8% of GDP into surpluses in the mid-to-late 1990s. If Krugman wanted to, he could lead a revolution in the Democratic party that would give the party a fiscally-responsible image. But that would mean talking sense for a change.