Archive for the ‘Krugman’s Blog’ Category

Krugman’s blog, 11/22/14

November 23, 2014

There was one post yesterday, “The Wisdom of Peter Schiff:”

No, seriously. Well, sort of. Danny Vinik sends us to the latest from Schiff, who made a big splash in 2008-2009 predicting runaway inflation if not hyperinflation; he was a favorite of Glenn Beck’s.

And in his new piece Schiff lays out the analytical issue very clearly:

Mainstream economists (who hold sway in government, the corporate world, and academia) argued that as long as the labor market remained slack, inflation would not catch fire. My fellow Austrian economists and I loudly voiced the minority viewpoint that money printing is always inflationary-in fact, that it is the very definition of inflation.

The truth is that high levels of unemployment are historically correlated with higher inflation and low levels of unemployment with lower inflation. That is because an economy that more fully utilizes labor resources is more productive. More production brings down prices. In contrast, an economy that does not fully employ its citizens is less productive, and its government is more prone to pursue misguided inflationary policies to stimulate the economy.

OK, leave aside the business about defining money-printing as inflation; guys, nobody cares. But what Schiff says very clearly is that according to his worldview, rolling the printing presses should cause inflation (by the normal definition) even in a depressed economy, and that high unemployment should in fact make inflation higher, not lower.

He has that exactly right: the central dispute is between those who see depressions as the result of inadequate demand, implying that inflation will fall and that printing money does nothing unless it boosts employment, and those who see depressions as the result of maladapation of resources or something — anyway, something on the supply side — who predict that running the printing presses will lead to runaway inflation.

How could you test those rival views? Why, how about having a huge slump, to which central banks respond with aggressive monetary expansion? And that is, of course, the test we’ve just run. And everywhere you look, inflation is low, verging on deflation.

So we’ve just run the Schiff test — and his brand of economics, by his own criteria, loses with flying colors. And that goes for just about all anti-Keynesian doctrines: we ran as close to a clean experiment as you’re ever going to get, and the answer is no.

Now, just about everyone on that side insists that it’s not true, that sinister bureaucrats are smuggling away the inflation evidence and burying it in Area 51. That tells you a lot about who we’re dealing with. But at least Schiff states the issue clearly before refusing to admit error.

Krugman’s blog, 11/21/14

November 22, 2014

There were three posts yesterday.  The first was “Me, Myself, and Abe:”

Bloomberg tells the story; it didn’t seem that dramatic to me. But who plays me in the miniseries?

A sort of related story, about bearded economists trying to set policymakers straight: Lars Svensson and the Riksbank, in the FT.

Update: For those asking how to address me in Japan, it’s “Kuruguman-sensei.”

The second post yesterday was “Inequality and Crises: Scandinavian Skepticism:”

In early December I’m supposed to talk at a Columbia conference on inequality and its consequences, and one issue I’ll have to address is the ongoing question of whether rising inequality makes countries more vulnerable to financial crises, makes it harder to recover from such crises, or in some other way degrades performance.

I’ve been wary of this line of argument, in part because it appeals so much to my general leanings: inequality worries me a lot, and it would be great if it was bad on the macro side too. So I bend over backwards not to buy into that proposition too easily.

And I continue to be skeptical, in part because there have been some pretty bad crises with lousy recoveries in countries that don’t have a lot of inequality. Consider, in particular, the post-1990 Swedish slump, brought on by runaway deregulated banks and a real estate bubble (sound familiar), taking place in a society with very low inequality. How did that compare with the US experience after 2007? Actually, they were very close:

Real GDP per capita in two crisesReal GDP per capita in two crises

 

I’ve included the LIS estimates of inequality as measured by the Gini coefficient for the relevant period; Sweden in the early 1990s had very low inequality, but nonetheless basically ran a dress rehearsal for the Great Recession and aftermath.

Just one piece of evidence. But I’m still having trouble with this one.

As usual, he ended the week with music.  The last post yesterday was “Friday Night Music: Jessica Hernandez and the Deltas:”

I have no idea who recommended this, and I normally wouldn’t have thought it was my style, but there’s no arguing with sheer unadulterated joyousness:

 

Krugman’s blog 11/20/14

November 21, 2014

There was one post yesterday, “Structural Deformity:”

Shinzo Abe is doing the right thing, seeking to delay the next rise in consumption taxes; this is good economic policy, and also a fairly new experience for me — I met with a national leader, made a case for the right policy, and he’s actually doing it! (Of course, there were many other people making the same case.)

But there’s a lot of skepticism, which on the whole is justified: Abe is trying to accomplish something very difficult, and it’s by no means clear whether the instruments he’s deploying are sufficient.

Still, there’s one type of criticism that I really, really hate, for Japan and elsewhere — and I hate it especially because it’s one of those things that is so completely accepted by Very Serious People that they don’t even realize that they’re spouting a dubious hypothesis rather than speaking The Truth. I refer to the claim that Japan doesn’t need a demand boost, it needs structural reform (TM).

What are we talking about here? Traditionally, structural reform was offered as an answer to the problem of stagflation. If your economy starts to overheat, with accelerating inflation, despite quite high unemployment, then the argument was that this was due to labor market rigidities — basically a euphemism for a system in which it’s hard to fire people or slash their wages — and that to allow better performance you needed to make the labor market more flexible, i.e., more brutal.

OK, this argument makes a fair bit of sense, although even when the problem is stagflation it’s less ironclad than conventional wisdom would have you believe; there’s always been reason to believe that much “structural” unemployment is actually the result of hysteresis, of the lasting damage done by prolonged recessions. Still, at least this was a coherent argument.

But Japan isn’t suffering from stagflation; neither is Europe. They are, instead, suffering from low inflation or deflation, and persistent shortfalls in demand despite zero interest rates. Why, exactly, is structural reform supposed to help cure this problem?

Indeed, the kind of structural reform people have mostly talked about in the past — making labor markets more flexible, so that it’s easier to cut wages — would, if anything, deepen the slumps. Why? The paradox of flexibility: falling wages and prices increase the real burden of debt, depressing demand further.

In fact, if you think about it, there’s a definite snake-oil feel to calls for structural reform, which is touted as a universal elixir — it cures inflation, but it cures deflation too! Also back pain and bad breath.

Now, there might be some kinds of structural reform that would do Japan some good. For example, changes in land use or building height regulations that made more infill possible in Japanese cities could spur investment, and help increase demand. But the point is that the blanket call for “structural reform” as the answer is intellectually lazy, and destructive. Not only would much of what we call structural reform hurt rather than help; declaring that the problem is structural causes policymakers to take their eye off the ball, since what Japan needs right now, more than anything else, is to escape from deflation any way it can.

Krugman’s blog, 11/19/14

November 20, 2014

There were two posts yesterday.  The first was “Fiscal Responsibility Claims Another Victim:”

A few more thoughts on Japan.

The bad growth news shows, pretty clearly, that the consumption tax hike was a big mistake. It also shows, by the way, how weak the market monetarist argument — which is that fiscal policy doesn’t matter, because central banks can always achieve the nominal GDP they want — really is; do you seriously want to contend that Kuroda likes what he sees, that he isn’t trying as hard as he can to boost Japan out of deflation?

Beyond that, the Japanese story is another example of the damage wrought by the rhetoric of fiscal responsibility in a depressed economy.

Leave on one side the expansionary austerity nonsense. Even among relatively sensible people, you often encounter calls for a strategy that couples loose fiscal policy, maybe even stimulus, in the short run with measures to address long-run sustainability. So, let’s spend on public works now while also addressing entitlement and/or tax reform to stabilize the budget picture over the next few decades. This sounds reasonable; in a better world it actually would be reasonable. But in this world it ends up producing very bad results.

Why? In practice, political systems (and politicians) have limited ability to focus. If you give them a mixed message about stimulus now but long-run cuts, the urgency of the stimulus part gets lost, and in fact the practical result is generally austerity even in depression.

So it was with Japan. The IMF advised Japan to go ahead with consumption tax hikes, while also endorsing monetary and fiscal stimulus. But as I’ve pointed out already, putting fiscal sustainability up near the front of a report on a country engaged in a very difficult attempt to escape deflation undermined the message, and led to a tax hike that was not effectively offset.

One way to say this is that when people come out with a message along the lines of “We must address fiscal sustainability while supporting short-term recovery,” the message that actually comes across is more like

So why blur things this way? The usual answer is still that unless you address the long-term issues, you might have a loss of confidence that undermines recovery. This is, however, unlikely — both because the fiscal consequences of a delay are small and because losing confidence would actually be a good thing in this situation.

I have to admit that the Fund’s role here somewhat surprises me. The IMF is in general making a lot of sense on macro issues these days, and is well aware of the dangers of deflation. So I had hoped it would be more sensitive to the risks of responsibility rhetoric in this case.

But anyway, another lesson from Japan — the country that has offered many useful lessons to the West, none of which our policymakers have been willing to learn.

Yesterday’s second post was “Misteaks:”

I’ve made a few. Here’s me talking with Business Insider about the big ones and what I learned.

Krugman’s blog, 11/18/14

November 19, 2014

There was one post yesterday, “The Structure of Obamacare:”

The big revelation of this week has been how many political pundits have spent six years of the Obama administration opining furiously about the administration’s signature policy without making the slightest effort to understand how it works. They’re amazed and in denial at the suggestion that it has the same structure as Romneycare, which has been obvious and explicit all along; they are shocked, shocked to learn that it uses the mandate as an alternative to taxing and spending, which has always been completely obvious and open.

Let me expand on the second point, by referring to my own publicly available class notes from 2012. To explain Obamacare, I started with a schematic representation of how single-payer health care works:

Then I showed a schematic of ObamaRomneycare — it calls it that right on the slide — and showed that to a first approximation it delivered the same results, but with a much smaller amount of money flowing through the federal budget:

So the community rating/mandate/subsidy system is in effect a way of simulating single payer, but with lower headline taxing and spending.

It’s important to be clear what this does NOT mean — it doesn’t mean that there is a huge hidden burden on the public. For the most part, people buying health insurance would have bought it anyway. Under single-payer, they would have stopped doing that, and paid taxes instead; under the ACA, they continue to pay premiums but don’t pay the extra taxes. There’s no secret extra cost.

So, why was Obamacare set up this way? It’s mainly about politics, but nothing that should shock you. Partly it was about getting buy-in from the insurance industry; a switch to single payer would have destroyed a powerful industry, and realistically that wasn’t going to happen. Partly it was about leaving most people unaffected: employment-based coverage, which was the great bulk of private insurance, remained pretty much as it was. This made sense: even if single-payer would have been better than what people already had, it would have been very hard to sell them on such a big change. And yes, avoiding a huge increase in on-budget spending was a consideration, but not central.

The main point was to make the plan incremental, supplementing the existing structure rather than creating massive changes. And all of this was completely upfront; I know I wrote about it many times.

Look, I understand why the hired guns of the right have to act ignorant and profess outrage. But I really am shocked at centrists who apparently thought they could opine on the politics of health reform, year after year, without taking a hour or two to learn how the darn thing was supposed to work.

Krugman’s blog, 11/17/14

November 18, 2014

There were two posts yesterday.  The first was “Contractionary Policies Are Contractionary:”

Terrible numbers from Japan. Probably the drop was overstated — I don’t have any special knowledge here, but other indicators didn’t look quite this bad. But still, no question that the ill-considered sales tax hike of the spring is still doing major damage.

Fairly clear now that Abe won’t go through with round two, which is good news.

So contractionary policy is contractionary. I could have told you that, and in fact have told you that again and again. But some people still don’t get the message. In Germany, the Bundesbank president opposes expansionary monetary policy because it might reduce the pressure for fiscal austerity:

“Such purchases might create new incentives to run up debt, besides adding to the reform fatigue in a number of countries,” he cautioned.

Translation: if EB purchases of debt keep interest rates down (as the implied promise to do “whatever it takes” has already been doing), deeply depressed economies might not feel the need to keep slashing spending to eliminate budget deficits.

That’s actually quite an awesome concern to express at this moment. European recovery has stalled, largely thanks to fiscal contraction; inflation is far below target, and outright deflation looms; and the political basis for the European project is coming apart at the seams. And Weidmann worries that monetary expansion might make life too easy for debtors.

But as Wolfgang Munchau says in a terrific column today,

German economists roughly fall into two groups: those that have not read Keynes, and those that have not understood Keynes.

Wish I’d written that! Although it’s not so much Keynes as the whole notion that inadequate demand can ever be a problem that they don’t get. Munchau tells us something I didn’t know, that Ludwig Erhard “once tried to explain the Great Depression in terms of cartels.” In the German economics mindset, there is only microeconomic distortion; macro problems, even in the middle of Europe’s second Great Depression, don’t exist.

How does this end? We have to keep pounding on the issues, and I’m reasonably sure that Draghi and co get it. But with the largest player on the European scene living in a fantasy world, the best guess has to be that nothing much is done until there is complete political crisis, with anti-European nationalists taking over one or more major nations.

Yesterday’s second post was “A Pundit Explains What’s Wrong With Washington:”

Or, actually, demonstrates by example what’s wrong with Washington.

Matt Yglesias finds Ron Fournier saying this about health reform:

On health care, we needed a market-driven plan that decreases the percentage of uninsured Americans without convoluting the U.S. health care system. Just such a plan sprang out of conservative think tanks and was tested by a GOP governor in Massachusetts, Mitt Romney.

Instead of a bipartisan agreement to bring that plan to scale, we got more partisan warfare. The GOP resisted, Obama surrendered his mantle of bipartisanship, and Democrats muscled through a one-sided law that has never been popular with a majority of the public.

The mind reels. How is it possible for anyone who has been following politics and, presumably, policy for the past six years not to know that Obamacare is, in all important respects, identical to Romneycare? It has the same three key provisions — nondiscrimination by insurers, a mandate for individuals, and subsidies to make the mandate workable. It was developed by the same people. I and many others have frequently referred to ObamaRomneycare.

Well, I’ve know for years that many political pundits don’t think that understanding policy is part of their job. But this is still extreme. And I’m sorry to go after an individual here — but for God’s sake, don’t you have to know something about the actual content of a policy you critique?

And what’s actually going on here is worse than ignorance. It’s pretty clear that we’re watching a rule of thumb according to which if Republicans are against a proposal, that means it must be leftist and extreme, and the burden on the White House is to find a way to make the GOP happy. Needless to say, this rewards obstructionism — there is literally nothing Obama can do to convince some (many) pundits that he’s making a good faith effort, because they don’t pay any attention to what he does, only to the Republican reaction.

Awesome.

Krugman’s blog, 11/16/14

November 17, 2014

There was one post yesterday, “Japan Through the Looking Glass:”

There are indications that Shinzo Abe may indeed do the right thing and postpone the planned rise in Japan’s consumption tax. Let’s hope so. But many people are still treating this as an agonizing choice. For example, Gavyn Davies frames it as a choice between recovery and fiscal sustainability, although he sort of acknowledges that this may be a false dilemma.

Several points here.

First, unless Japan breaks out of deflation, and the artificially high real interest rates this causes, there is no way to achieve fiscal sustainability. Success for Abenomics is as crucial for fiscal matters as everything else.

Second, everyone acknowledges that the impact of a delayed sales tax increase on Japan’s debt would be trivial — less than one percent of GDP. So why is this supposed to be something to worry about? Supposedly, Japan would lose credibility.

Actually, that’s unlikely — I see no prospect that Japan will put off the tax hike forever. But even if it were true, this is credibility Japan wants to lose.

After all, suppose investors conclude that Japan will never raise taxes enough to service its debt. What would they think would happen instead? Not default — Japan doesn’t have to default, because its debts are in its own currency. No, what they might fear is monetization: Japan will print lots of yen to cover deficits. And this will lead to inflation. So a loss of fiscal credibility would lead to expectations of future inflation, which is a problem for Abe’s efforts to, um, get people to expect inflation rather than deflation, because … what?

Long ago I argued that what Japan needed was a credible promise to be irresponsible. And deficits that must be monetized are one way to make that happen (as they were in the 1930s, when Japan had a very successful comeback from the Great Depression, aside from that invading China thing.)

As I and other people like Paul McCulley have tried to explain many times, the liquidity trap puts you on the other side of the looking glass; virtue is vice, prudence is folly, central bank independence is a bad thing and the threat of monetized deficits is to be welcomed, not feared.

As it happens, I don’t think this stuff will come into play in Japan, where the Ministry of Finance’s deficit obsession ensures that tax hikes will at best be delayed, not canceled. But the whole premise of those who fear the consequences of delay misses the point.

Krugman’s blog, 11/15/14

November 16, 2014

There were two posts yesterday.  The first was “The Unwisdom of Crowding Out (Wonkish):”

I am, to my own surprise, not too happy with the defense of Keynes by Peter Temin and David Vines in VoxEU. Peter and David are of course right that Keynes has a lot to teach us, and are also right that the anti-Keynesians aren’t just making really bad arguments; they’re making the very same really bad arguments Keynes refuted 80 years ago.

But the Temin-Vines piece seems to conflate several different bad arguments under the heading of “Ricardian equivalence”, and in so doing understates the badness.

The anti-Keynesian proposition is that government spending to boost a depressed economy will fail, because it will lead to an equal or greater fall in private spending — it will crowd out investment and maybe consumption, and therefore accomplish nothing except a shift in who spends. But why do the AKs claim this will happen? I actually see five arguments out there — two (including the actual Ricardian equivalence argument) completely and embarrassingly wrong on logical grounds, three more that aren’t logical nonsense but fly in the face of the evidence.

Here they are:

First, there’s the Say’s Law argument: because spending must equal income, any increase in government spending must be matched by a fall in private spending. “This is just accounting,” declared John Cochrane. No, it isn’t — and it was the remarkable fact that prominent economists were saying things like this, as if none of the debates of the 1930s had happened, that led me to proclaim a Dark Age of macroeconomics.

Second, there’s the misuse of Ricardian Equivalence. It’s important to understand that we’re not debating about whether Ricardian equivalence is right; even if it were (it isn’t), what the anti-Keynesians were saying was wrong, as I tried to explain a number of times. It’s crucial, I’d argue, to realize that what the people invoking Ricardo were saying was wrong even in terms of their own model. If you don’t get that, you don’t appreciate the depths to which all too many economists sank.

Third, there’s the standard textbook crowding out story, in which increased government spending in the face of a fixed money supply, or maybe a nominal income target, causes interest rates to rise and private investment to fall. The money supply argument doesn’t work when we’re at the zero lower bound, which is after all why we’re talking about fiscal policy in the first place; but there is a school of thought that insists that the Fed and the ECB and the BoJ could achieve full employment if only they wanted to. I disagree, and I think this is mostly wishful thinking, but at least it’s not the kind of raw nonsense involved in arguments #1 and #2.

Fourth, there’s the claim that we’re at full employment, or maybe always at full employment, that demand-side economics is wrong, so any government use of resources must divert them from other uses. I think this is empirically silly for the US and Europe in recent years, but again it’s not the kind of raw nonsense of the first two arguments.

Finally, there’s the confidence fairy: demand-side economics is valid, but business hates big government so much that any attempt to use fiscal policy will backfire. Oh, kay.

My point is that you do a disservice to the debate by calling all of these things Ricardian equivalence; and the nature of that disservice is that you end up making the really, really bad arguments sound more respectable than they are. We do not want to lose sight of the fact that many influential people, including economists with impressive CVs, responded to macroeconomic crisis with crude logical fallacies that reflected not just sloppy thinking but ignorance of history.

Yesterday’s second post was “Suzanne Vega Saturday (Personal):”

Notes:

1. Gerry Leonard, who plays guitar on tour and produced her new album, is incredible.

2. If you saw Suzanne Vega years ago, as I did, and wondered if she’s still as good in live performance, she isn’t — she’s better. She seems to have grown into her stage presence, and now shows wonderful energy and rapport with the audience.

3. You forget how good a guitarist she is. Some of the most amazing passages were instrumental, with Vega and Leonard playing off each other or engaged in dense counterpoint.

4. Has there ever been another widely heard song, let alone a massive hit, written in blank verse?

5. Ironbound! Apparently by audience request; it turns out I’m not the only fan who loves that song.

6. The food in Joe’s Pub was very good — and my friends and I shared a bottle of Malbec, which I never did manage during my whirlwind trip to Argentina.

7. I didn’t intend to be a groupie and go backstage, but her manager recognized me. And luckily I was wearing black; for those of my station in life, all other colors lie.

Krugman’s blog, 11/14/14

November 15, 2014

There were two posts yesterday.  The first was “Inflation Truth, Really:”

I’m in Argentina for the day — literally (stuff came up, forcing me to make this a very quick visit; sorry, no time for media interviews or anything not already booked). And I thought it might be worth telling people something they may not know about the history of MIT’s Billion Prices Project.

If you’ve been following the sad story of America’s inflation truthers, you know that a variety of people — angry billionaires like Paul Singer, wannabe economic pundits like Niall Ferguson, etc. — have claimed in recent years that official US statistics vastly understate inflation. There are multiple ways to show that this is nonsense, but one of the easiest is to point to the Billion Prices data, collected independently from online prices, and note that while it doesn’t track the official CPI exactly — the basket of goods sold online doesn’t exactly match the coverage of the CPI — there is not a large, persistent discrepancy:

 

But does this mean that we can always trust governments? Of course not. The US Bureau of Labor Statistics is in fact squeaky clean, and if you know anything about how it works you realize would be impossible to put it under severe political pressure without that fact being obvious. But that isn’t going to be true in all times and places.

In fact, the BPP owes its origins to questions about Argentine inflation numbers. InflacionVerdadera.com was created in 2007 as an alternative to dubious official statistics, and this in turn led to the BPP and its offspring PriceStats. And PriceStats continues to produce independent Argentine inflation estimates; their number is in orange, the official number in blue:

 

Argentina really does seem to have much higher inflation than the government admits.

What’s going on? Basically, Argentina — having benefited hugely from heterodox policies after the collapse of its currency board in 2001 — kept being heterodox too long, and is now experiencing classic developing-country problems, with a persistent budget deficit that it is monetizing because it lacks access to capital markets, leading to persistent inflation and balance of payments problems.

And if anyone starts yelling that I’m being inconsistent in saying that deficit spending and money-printing are a problem in Argentina, because those are the same policies I want in the US, the answer is, yes, they are — because the US is in a liquidity trap, suffering from persistent lack of demand, while Argentina is overheated.

I may have more to say about Argentina, and maybe also about the talk I’m giving shortly before heading to the airport, tomorrow.

The second post yesterday was “Friday Night Music: Suzanne Vega, I Never Wear White:”

I know, it’s early afternoon, but I’m on the road, and probably won’t have a later chance. Sorry, all her Joe’s Pub shows this weekend are sold out:

It’s so great to hear her doing new music.

 

Krugman’s blog, 11/13/14

November 14, 2014

There were four posts yesterday.  The first was “People Should Take My Advice:”

So says William Pesek:

Even as Japan’s economy struggles to shake off an April sales-tax increase, lawmakers are mulling another. In a meeting with Prime Minister Shinzo Abe last week, Krugman warned the move could be the death-knell of “Abenomics,” no matter how many yen the Bank of Japan prints. And he’s absolutely right. Raising taxes on households again would further crimp spending and doom any chance of reaching the 2 percent inflation target the government has set for itself.

And strange to say, I agree with this view.

Seriously: I understand that Japan’s long-run fiscal position is problematic, but I don’t think fears of an imminent fiscal crisis make sense — and on the other side, it’s now or never on breaking out of the deflation trap, which is crucial even for the fiscal future. Now is no time to lose momentum on Abenomics.

Yesterday’s second post was “Networks and Economic History:”

Via FT Alphaville, Climateer Investing discusses transportation networks in the industrial revolution, Metcalfe’s Law, and all that. Fun stuff; and I remembered an old piece of mine (from 1998, I think) that manages to combine Metcalfe with Zipf, and might be worth resurrecting. So here it is, in full (not that it’s very long):

NETWORKS AND INCREASING RETURNS: A CAUTIONARY TALE
I just read a terrific little book by Tom Standage, The Victorian Internet, a history of the rise of the telegraph. The story is, just as he claims, a great metaphor for the rise of the Internet; indeed, it is a stunningly close parallel in many respects. Standage uses the story in part to caution against the naive view that the Internet will eliminate nationalism, foster world peace, or promote a new golden age of culture. But the story also offers a more mundane cautionary lesson, suggesting that we should be skeptical about some of the enthusiastic claims about the rules under which the “new economy” works.

One of the key propositions of the “new economy” view is the idea that networks are inherently a source of very strong increasing returns; enthusiasts like Kevin Kelly like to invoke “Metcalfe’s Law”, which says that the usefulness of a network is proportional to the square of the number of people it connects, because that is the number of possible directions of communication. If you think that something like Metcalfe’s Law actually applies, it has dramatic implications for economic dynamics. It suggests, for example, that networks are hard to get started, even when the technology is there, because it isn’t worth investing in a connection unless enough other people are already connected. But once a network passes the tipping point at which connecting starts to happen, it should experience explosive growth, because each successive connection will be more valuable than the one before.

A telegraph example actually demonstrates the force of this argument quite nicely. Imagine a nation consisting of a number of equal-sized cities, each with 100 people. (Numbers are chosen for expository convenience, not realism!) If someone builds a telegraph line connecting two of the cities, it will make 10,000 two-way communications possible (from each of the inhabitants of one city to each of the inhabitants of the other). But when a third city is added to the network, this adds 20,000 possible communications, because the new city can communicate with the 200 people already in the network. And the fourth connection adds 30,000 possible links.

It’s easy to see that in this case investors might be doubtful about the potential business on a single telegraph line; only once several lines had already been built would the economics of building still more become favorable, and then they would become ever more favorable.

The history of the telegraph, however, doesn’t actually look that way. There was explosive growth, all right: the U.S. telegraphic network expanded 600-fold between 1846 and 1852. But the pause between when the technology was ready and the commercial applications began was negligible: as soon as an experimental line between Baltimore and Washington was up and running, investors were up and running too.

Why didn’t investors hesitate? For one obvious reason: cities were not all the same size, and they could start by building lines connecting the biggest cities. A line between New York and Philadelphia already connected a large number of potential customers. And conversely, later lines did not necessarily add more potential communications than the existing ones: they connected to a bigger existing base, but they ran to smaller cities. In short, the inequality of city sizes meant that the network was not all that subject to increasing returns after all.

Of course, this all depends on the distribution of city sizes; but we know something about that. Somewhat mysteriously (see my book The Self-Organizing Economy) the size distribution of cities in the United States has long been quite well described by the “rank-size rule”: the second city has half the population of the first, the third 1/3 the population, and so on. So imagine a country whose biggest city has 120 people, the next 60, the third 40, and so on. And now ask how many possible communications are added when each city enters the network, assuming – as is reasonable – that cities enter in size order.

Well, the connection between the two biggest cities will create 7200 (120 × 60) possible communications. Adding the third city to the network will add another 7200 (180 × 40). Then the network starts to run into diminishing returns: the next connection adds 6600 possible communications, the one after that 6000, and so on. The size of the base to link to keeps getting bigger, but the size of the next city keeps getting smaller, and the latter effect dominates.

The point is not that networks necessarily face diminishing rather than increasing returns; rather it is that increasing returns are by no means guaranteed. Against Metcalfe’s Law must be set DeLong’s Law (after Berkeley’s Brad DeLong, who has made this point several times): in building a network, you tend to do the most valuable connections first. Is the net effect increasing or diminishing returns? It can go either way.

Increasing returns are, of course, more fun to think about – but that is itself a reason for caution. “New economy” types have a tendency to tell great stories, both about the economy and about themselves. Alas, the fact that a story is entertaining doesn’t mean that it is true.

The third post yesterday was “Why the One Percent Hates Obama:”

A peculiar aspect of the Obama years has been the disconnect between the rage of Obama’s enemies and the yawns of his sort-of allies. The right denounces financial reform as a vast government takeover — and lobbies fiercely against it — while the left dismisses reform as symbols without substance. The right accuses Obama of being a socialist stealing the money of hard-working billionaires, while the left dismisses him as having done nothing to address inequality.

On all these issues, the truth is that Obama has done far more than he gets credit for — not everything you’d want, to be sure, or even most of what should be done, but enough so that the right has reason to be furious.

The latest case in point: taxes on the one percent. I keep hearing that Obama has done nothing to make the one percent pay more; the Congressional Budget Office does not agree:

According to CBO, the effective tax rate on the one percent — reflecting the end of the Bush tax cuts at the top end, plus additional taxes associated with Obamacare — is now back to pre-Reagan levels. You could argue that we should have raised taxes at the top much more, to lean against the widening of market inequality, and I would agree. But it’s still a much bigger change than I think anyone on the left seems to realize.

The last post yesterday was “Rage of the Traders:”

Sometimes the absurdity of what passes for economic wisdom surpasses even my highly adapted expectations. I really, truly expected that even Wall Street would consider PeterPaul Singer’s hyperinflation in the Hamptons rant embarrassing, and try to pretend that it never happened. But no; apparently it’s being passed around eagerly by traders and big shots who think it’s the greatest thing since sliced foie gras.

So what’s this about? Jesse Eisinger at ProPublica tries to make a case for the rage of the hedgies; Eisinger argues that while it’s foolish to claim that the inflation books are cooked, the government and the Fed have created a fake sense of financial health, so the overall perception that it’s some kind of illusion is right.

Sorry, but I don’t buy that.

For one thing, if you want to claim that the stress tests were all fake and the banks were truly insolvent, shouldn’t we have seen a reckoning by now? I’d say that in retrospect it’s clear that many assets really were temporarily underpriced thanks to the market panic, and that once the panic subsided the big banks were revealed to be in better shape than many people (including me) believed.

Beyond that, Eisinger is imputing a reasonable analysis to the likes of Singer based on no evidence I can see. I’d suggest that when Singer talks about a debased currency and fake economic growth, that’s because he really believes that we have a debased currency and fake growth, not as a metaphor for some other kind of economic deception.

And where is that perception coming from? I still think that Brad DeLong’s analysis has it right. What we’re looking at here are traders who looked at historical correlations — while disdaining macroeconomics — and concluded that low interest rates would surely rise back to historical norms. When those rates did no such thing, they looked at the Fed’s intervention — and to them it looked like a big trader distorting markets, London Whale-style, by making huge bets that would surely go bad. So they sat back and waited for the collapse.

And the collapse keeps not happening, because the Fed is not a rogue trader and historical norms for interest rates aren’t relevant in a persistently depressed, deleveraging economy. But rather than acknowledge that they were wrong, let alone that, er, Keynesian macroeconomics has something to teach them, these guys lash out: It’s all fake!

Oh, and really rich people often have no idea when they look ridiculous. After all, who in their entourage is going to tell them?


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