Ah. Noah Smith goes reading in the fresh waters, and finds that people there are still claiming that there was a dramatic improvement in growth once Reagan/Friedman came along.

I’ve written about this many times, e.g. here. The great era of US economic growth was the postwar generation; even during the good years of the 90s we didn’t achieve comparable growth, and overall, the post-Reagan era was marked by slower growth than the equivalent period of time pre-Reagan. And I haven’t even gotten into the income distribution thing.

All of which makes me wonder: what goes on in these peoples’ minds? Do they never even think of actually looking at the numbers, because they know that Reagan ushered in a great boom? Inquiring minds (which they obviously don’t have) want to know.

Via Mark Thoma, Noah Smith* has a terrific piece on how to argue with economists. All the points are good, but I’d like to focus on Principle 4, “Argument by accounting identity almost never works.”

What he’s referring to, I assume, is arguments like “since savings equals investment, fiscal stimulus can’t affect overall spending”, or “since the current account balance is equal to the difference between domestic saving and domestic investment, exchange rates can’t affect trade”. The first argument is, more or less, Say’s Law and/or the Treasury view. The second argument is what John Williamson called the doctrine of immaculate transfer.

Why are such arguments so misleading? Noah doesn’t fully explain, so let me put in a further word. As I see it, economic explanations pretty much always have to involve micromotives and macrobehavior (the title of a book by Tom Schelling). That is, when we tell economic stories, they normally involve describing how the actions of individuals, driven by individual motives (and maybe, though not necessarily, by rational self-interest), add up to interesting behavior at the aggregate level.

And the key point is that individuals in general neither know nor care about aggregate accounting identities. Take the doctrine of immaculate transfer: if you want to claim that a rise in savings translates directly into a fall in the trade deficit, without any depreciation of the currency, you have to tell me how that rise in savings induces domestic consumers to buy fewer foreign goods, or foreign consumers to buy more domestic goods. Don’t tell me about how the identity must hold, tell me about the mechanism that induces the individual decisions that make it hold.

And once you do that, you realize that something else has to be happening — a slump in the economy, a depreciation of the real exchange rate, it depends on the circumstances, but it can’t be immaculate, with nothing moving to enforce the identity.

When it comes to confusions about the macro implications of S=I, again the question is how the identity gets reflected in individual motives — is it via the interest rate, via changes in GDP, or what?

Accounting identities are important; in fact, they’re the law. But they should inform your stories about how people behave, not act as a substitute for behavioral analysis.

*On his home page, Noah says he is named Smith like everyone else. No, not among economists. Many years ago I ran a small NBER conference that happened to include two Itos from Japan and two Parks from Korea; the conference director (Kirsten Foss) and I had a discussion about whether, as a courtesy, all the Americans should adopt the same name, and if so what name. We agreed that the generic name for an American economist was “Stein.”

Barry Ritholtz sends us to a San Francisco Fed paper from last summer that makes a point on which many people seem confused: despite globalization and all that, the bulk of a consumer dollar spent in America falls on American-produced goods and services.

The reason this matters — or at least one reason it matters — is for discussion of austerity, stimulus, and all that. I often get comments along the lines of “Well, maybe stimulus worked back in the old days, but now it just means spending more on stuff from China”. In reality, that’s nowhere near true.

Why? For one thing, most consumer spending is on services, few of which are really tradable. For another, even if the thing you buy in WalMart says “Made in China”, the price includes a lot of US value-added in the form of transportation and retailing costs.

Here’s the paper’s estimates of the share of personal consumption expenditure (PCE) spent on imports in general and imports from China:

So we’re still a country where about 85 cents of your consumer dollar is spent at home, one way or another. And this means, among other things, that the rules of macroeconomics haven’t changed nearly as much as people imagine.

Well, I read Scott Sumner’s claim that Simon Wren-Lewis and I are making basic errors, and at first I couldn’t figure out at all what his problem is. Then it struck me: he doesn’t understand that Wren-Lewis and I were doing comparative statics.

What do I mean by that? I thought this was part of every economist’s training, but maybe not any more. Anyway, there are a variety of problems in economics — by no means only in macro — where you want to understand how some kind of shock will affect some equilibrating variable. You want to know, say, how an excise tax will affect the price of coffee, or how an international transfer will affect the terms of trade, or how a change in the savings rate will affect GDP.

How do you do this? It’s often helpful to do the analysis in two stages. First, you ask how some desired quantities would change holding the equilibrating variable constant; then you ask how that variable has to change to restore equilibrium. So, for example, if I ask how an excise tax will affect the price of coffee, I start by asking how that tax would affect the excess supply of coffee — the difference between the quantity of coffee demanded and the quantity supplied — holding the price constant; then I ask how much the price of coffee has to fall to eliminate that excess supply.

Notice that in that first step I am not forgetting that in the end the quantity of coffee demanded must equal the quantity supplied; I’m reasoning in the subjunctive, asking how the quantities would shift if it the price were temporarily held constant.

So what are people like Wren-Lewis and me doing when we ask how savings or investment would change from some given shock? We’re not forgetting that in the end savings must equal investment; we’re just doing the first step in a comparative statics exercise. Suppose that I want to ask how, say, a fall in housing wealth affects the economy. First I ask how much this would increase savings, holding GDP constant; then I ask how much GDP has to fall to restore the equality between savings and investment. The picture — which is something everyone used to learn in Econ 101 — looks like this:

Here the savings curve shifts up from S1 to S2; the upward shift of the curve at a given level of GDP is what Wren-Lewis and I mean by the “increase in savings”. In the end, of course, savings must equal investment, which is why GDP must fall from Y1 to Y2. But Wren-Lewis and I haven’t forgotten that S=I; we’re just using the perfectly ordinary method and language of comparative statics.

And Sumner thinks we have made some kind of basic error, and ties himself into knots trying to set us straight. It’s really very sad.

The Times has a piece today showing, correctly, that the top 1 percent of the income distribution is a fairly diverse group. But what that mainly reflects is the fact that the slogan “we are the 99 percent” sets the cut too low. A large part of the rising share of the top 1 — about 60 percent, according to the Piketty-Saez data — is actually attributable to the top 0.1 percent. And that’s not a diverse group at all, according to Heim et al (pdf):

If you add together nonfinance executives, “financial professions”, real estate, and lawyers, you’ve got more than 70 percent of the total; plus some of the other categories are probably essentially business executives too. Basically, the top 0.1 percent is the corporate suits, with a few token sports and film stars thrown in.

Real wealth in America isn’t nuanced at all.

Alan Krueger, the chairman of the Council of Economic Advisers — who is not only a colleague of mine at Princeton, but gets a lot of my mail and vice versa — gave a very informative speech on inequality last week that should have received more press than it did. Much of it was stuff that inequality mavens already know, but he had one striking result that was what I suspected but hadn’t seen demonstrated: a clear negative relationship between inequality at a point in time and intergenerational social mobility.

Below is what he dubs the Great Gatsby Curve. On the horizontal axis is the Gini coefficient, a measure of inequality. On the vertical axis is the intergenerational elasticity of income — how much a 1 percent rise in your father’s income affects your expected income; the higher this number, the lower is social mobility.

As he shows, America is both especially unequal and has especially low mobility. But he also argues that because we are even more unequal now than we were a generation ago, we should expect even less social mobility going forward.

Very illuminating — and disturbing.

William Cohan has an interesting take on Mitt Romney, which is completely distinct from the policy and left/right issues. According to Cohan, who did deals with Bain during the Romney years, the company specialized in dirty tricks.

Specifically, Bain would make the high bid for a company being offered for sale — then, after the other bidders had been sent away, would start finding things to complain about, and haggle the price down. This was, I gather, a major sin, since believe it or not Wall Street wheeling and dealing requires a high level of trust in one’s personal word.

This isn’t a policy issue; it’s the kind of thing I usually try to stay away from, the supposedly character-revealing nature of someone’s personal history. But as these things go, it’s especially interesting. Would you buy a used company — or a used ideology — from this guy?

Just a heads up — I’ll be on both Fareed Zakaria (talking with Ken Rogoff) and This Week (from New York! Yay!) tomorrow.

Apologists for rising inequality often argue that since most Americans’ income has risen despite rising inequality, there’s no reason to complain about inequality other than envy. So it’s worth remembering that we used to expect economic growth to deliver large increases in real income, not just a bit of a rise that’s accomplished in large part through longer working hours; and that a major reason so many have seen such small gains is that a large part of growth has been siphoned off to the very high end.

Lane Kenworthy had a nice chart illustrating both points, comparing median family income with real GDP per family (for those worried about the fine points, it was nominal GDP divided by the CPI, avoiding some technical issues):

You see the contrast: a doubling of family incomes in the post war generation compared with maybe 20 percent since, and family incomes growing in line with GDP before, lagging far behind since, with the difference basically being the rising share of the 1 percent.

This is real stuff, not some trivial envy-driven concern. But we must be very, very quiet about it, right?

S&P’s downgrade of a bunch of European sovereigns was no surprise. What was somewhat surprising — and which went unmentioned in almost all the news stories I’ve read — was why S&P has gotten so pessimistic. From their FAQs:

We also believe that the agreement [the latest euro rescue plan] is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the EMU’s core and the so-called “periphery”. As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues.

And today we read about the response:

German chancellor Angela Merkel has called on eurozone governments speedily to implement tough new fiscal rules after Standard & Poor’s downgraded the credit ratings of France and Austria and seven other second-tier sovereigns.

Still barreling down the road to nowhere.

A bit of a break from the usual — for some reason I’ve been on a Mozart kick the past few days.

I was deeply radicalized by the 2000 election. At first I couldn’t believe that then-candidate George W. Bush was saying so many clearly, provably false things; then I couldn’t believe that nobody in the news media was willing to point out the lies. (At the time, the Times actually told me that I couldn’t use the l-word either). That was when I formulated my “views differ on shape of planet” motto.

Now, however, Mitt Romney seems determined to rehabilitate Bush’s reputation, by running a campaign so dishonest that it makes Bush look like a model of truth-telling.

I mean, is there anything at all in Romney’s stump speech that’s true? It’s all based on attacking Obama for apologizing for America, which he didn’t, on making deep cuts in defense, which he also didn’t, and on being a radical redistributionist who wants equality of outcomes, which he isn’t. When the issue turns to jobs, Romney makes false assertions both about Obama’s record and about his own. I can’t find a single true assertion anywhere.

And he keeps finding new frontiers of falsehood. The good people at CBPP find him asserting, with regard to programs aiding low-income Americans, that

What unfortunately happens is with all the multiplicity of federal programs, you have massive overhead, with government bureaucrats in Washington administering all these programs, very little of the money that’s actually needed by those that really need help, those that can’t care for themselves, actually reaches them.

which is utterly, totally untrue. Administrative costs are actually quite small, and between 91 and 99 percent of spending, depending on the program, does in fact go to beneficiaries.

At this rate, Romney will soon start lying about his own name. Oh, wait.

Hahahaheehee! The Fed transcripts from 2006 show a lot of laughter and an incredible amount of complacency, with people mainly worried about inflation rather than the coming recession.

Brad DeLong digs up a contemporaneous column of mine in which I knew better; here’s more from Mark Thoma.

In truth, I did not foresee the scale of the catastrophe; I was thinking mainly of the direct impact of a housing bust on investment spending, with only a nod to possible effects on consumer demand, and no sense at all of how fragile the financial system was. But I was a lot closer to understanding the real risks than, apparently, anyone at the Fed.

Two puzzling things: first, the housing bubble was the clearest thing I’ve ever seen in my professional life. How could they ignore even the possibility of a severe bust?

Second, some of the same people you read in these transcripts dismissing risks to the real economy and worrying wrongly about inflation are still making policy pronouncements, in which they … dismiss risks to the real economy and worry wrongly about inflation.

The latest on Hungary from my Princeton colleague Kim Lane Scheppele, below the fold.

Read more…

Like a lot of people, I was fairly startled by Mitt Romney’s new defense of his work at Bain: it was just like the auto bailout!

“In the general election, I’ll be pointing out that the president took the reins of General Motors and Chrysler, closed factories, closed dealerships, laid off thousands and thousands of workers. He did it to try to save the business,” Romney said on “CBS This Morning.” “We … had, on occasion, to do things that are tough to try to save a business.”

The first thought is, didn’t Romney write an op-ed titled Let Detroit Go Bankrupt? Yes, he did. But the title was misleading. What he actually called for was a “managed bankruptcy”, with government support — not too different from what actually happened.

So can Romney claim that he was for this successful policy all along? No, he can’t — because when the actual policy was proposed, he trashed it:

What is proposed is even worse than bankruptcy–it would make GM the living dead.

So what the story of Romney and the auto bailout actually shows is something we already knew from health care: he’s a smart guy who is also a moral coward. His original proposal for the auto industry, like his health reform, bore considerable resemblance to what Obama actually did. But when the deed took place, Romney — rather than having the courage to say that the president was actually doing something reasonable — joined the rest of his party in whining and denouncing the plan.

And now he wants to claim credit for the very policy he trashed when it hung in the balance.