100 Best Blogs for Econ Students

100 Best Blogs for Econ Students

Delicious hotlist

6 Blogs That Will Help You Understand Economics

6 Blogs That Will Help You Understand Economics

MakeUseOf.com

One of the most common questions of the last few years has been "how did we get into this mess?" Understanding why the global economic problems occurred, and what issues are currently relevant, isn't easy. TV pundits and politicians have their opinions, but they're often contradictory, resulting in further confusion.
But worry not, layman economists! Although economics is complex, it doesn't necessarily need to be out of your grasp. There are numerous blogs across the Internet that provide interesting, timely information and argument about the economy of both today and tomorrow. More importantly, the econ blogs out there are written in a language you can actually understand.

Calculated Risk

If you're looking for the latest information about current economic conditions in the United States and, to a lesser extent, the world, Calculated Risk is the place to be. This blog can be a little bit daunting at first because of the volume of information that it delivers and the initially obscure nature of the graphs and post titles.
Dive into the posts themselves, however, and you'll find that Calculated Risk does a pretty good job of summarizing what's important and leaving out what isn't. The blog also does regular round-ups that point out the most important news of the last week and the most important upcoming announcements.
Calculated Risk doesn't delve much into economic history or theory, but it's an amazing blog for people who want to learn about what's happening right now. They also have really awesome graphs!

Carpe Diem

Staffed by Mark Perry, a professor of economics at the University of Michigan, Carpe Diem is a centrist current economics blog that tends to skew towards covering "weird" or "unique" topics – one series of posts argues that increasing voter turnout would not have any major effect on the outcomes of elections, for example. Whatever the topic, however, Mark does a good job of providing clear posts that don't fall into using too much economic mumble-jumbo.
Carpe Diem is also one of the few blogs that has been posting positive economic news on a fairly regular basis. If you're a glass-half-full kind of person you'll probably enjoy this blog.

China Financial Markets

There is no question that China is an important part of the global economy, but the economics of the country in which a sixth of the world's population resides isn't usually explored by western media outlets. China Financial Markets fills that gap.
While published in a blog format, China Financial Markets is more like a single-article online magazine. New posts occur only about once a week, but they're incredibly long and very detailed – I'd say the average post is between 1,000 and 2,000 words. This is probably the hardest blog listed here to understand, and at least part of that difficulty is due to the fact that the posts may touch on people, objects and locations you've never heard of before. It's an incredibly insightful blog, however, and well worth your time.

Freakonomics

This pop-econ blog is, like the book of the same name, focused on strange and unusual economic outcomes that occur throughout the world. The blog features posts from the authors of Freaknomics, but includes occasional posts from other contributors as well.
You won't find much serious economic talk on this blog, but what you will find are engaging posts about economics that are easy to read and easy to understand. If you're very new to reading about economics, and you're not ready to jump into the heavier stuff just yet, reading Freakonomics for awhile can get you into the right state of mind – and the fact that this blog isn't serious business doesn't mean you won't learn anything.

The Big Picture

If you take Calculated Risk's tendency to post cool graphs, add a dash of political opinion, and smother the whole thing with some in-depth economic analysis, what do you get? The Big Picture.
Created by Barry Ritholz (the author of Bailout Nation), a financial journalist and money manager, The Big Picture provides timely posts about current economic events and laces them with engaging, well written commentary. Although the author of this blog has Wall Street ties, this is not a blog built to sell the author's services or trumpet Wall Street's successes while neglecting its failures. Instead, The Big Picture acts as a watchdog – many of the blog's posts are about how poor behavior on the part of Wall Street is having negative economic consequences.

The Conscience of a Liberal

There are few economists who are controversial as Paul Krugman, the Noble Prize winning professor who, as the title of his blog suggests, stands defiantly on the political left. What really makes Krugman's blog stand out from the crowd, however, is the ease with which he makes his economic arguments accessible. Although he occasionally falls into deeply academic talk, his posts are for the most part laid out in layman's terms. They address specific points, as well, which makes it easier for economic newbies to follow what's being discussed.
The Conscience of a Liberal is a bit of a pessimistic blog (at least at the moment) so be warned that you may come away deeply afraid that you and everyone you know will lose their jobs and never be able to find another one, ever. There is a reason why the New Yorker once ran a comic depicting Krugman as a street preacher foretelling the end of days.

Conclusion

Reading these blogs won't necessarily turn you into an economics professor overnight. These blogs will, however, give you a much better perspective on current events. So what are you waiting for? Start learning, real good!

---

Hey Facebookers, make sure to check out MakeUseOf page on Facebook. Over 24,000 fans already!

---

Similar MakeUseOf Articles

• Xoom – An Alternative Method To Withdraw Funds From PayPal To A Local Bank (19 comments)
• Use Memoriser to Memorize Information Fast During Work Day (8 comments)
• Use BudgetSketch To Make A Household Budget That Works (30 comments)
• UpDown Online Stock Market Trading Simulator Lets You Play Without Losing Money (14 comments)
• The Five Best Educational YouTube Channels (16 comments)
• The Best Free Online Grammar Resources (24 comments)
• Teach & Learn On The Nuvvo Online Learning Community (7 comments)
• TAS – Free Easy To Use Financial Accounting Software (22 comments)
• SimpleD Budget – Free Budget Tracker Software (Windows) (16 comments)
• ProProfs Toolset – Easy Educational Tools for Teachers and Tutors (10 comments)

Burton Malkiel on Investing | FiveBooks | The Browser

Five good books on investment.
http://thebrowser.com/interviews/burton-malkiel-on-investing

200 Countries and 200 Years in 4 Minutes

200 Countries and 200 Years in 4 Minutes

Greg Mankiw's Blog

ONE: The app every American should own

ONE: The app every American should own

TUAW

My brother and I frequently discuss the fact that, though many Americans are passionate about a wide variety of issues affecting our country, few seem to actually take the time to do anything about it. And who can blame them? Many Americans are so overworked, underpaid, and in fear of how they'll make their mortgage payment or health insurance premium next month that they may not have time to attend a political rally or contact their representative on a certain issue? Well, now there's an app that makes it easier for the average Joe to take political action and promote change -- all from his iPhone.
ONE Campaign is essentially a call-to-action app. It lists a number of political issues or advocacy movements and gives you instant access to proven projects that are working to combat the issues (like vaccines for children, for example). You can then enlist your Twitter or Facebook friends to help spread the word and join movements that are important to you. But the best thing about the app is that it gives you instant tools so you can actually take political action. With a few taps you can call your Congressman or sign a petition to support your cause. The app knows who your Congressional leaders are based on the zip code you enter. So many political action apps are solely news-focused. They tell us the bad things that are happening and leave us angry or distressed. The ONE app allows us to take productive action on an issue as easily as we download a song. ONE Campaign is a free download.

ONE: The app every American should own originally appeared on TUAW - The Unofficial Apple Weblog on Sat, 04 Jun 2011 08:00:00 EST. Please see our terms for use of feeds.

Source | Permalink | Email this | Comments

Strong Dollar = Strong Economy ?

Strong Dollar = Strong Economy ?

Greg Mankiw's Blog

An excellent column from Christy Romer.

Google Plays the Yield Curve

Google Plays the Yield Curve

Greg Mankiw's Blog

Click on graphic to enlarge.

I was fascinated a story in today's Wall Street Journal.  Apparently, Google is sitting on $37 billion in cash, but nonetheless decided to sell $3 billion worth of bonds.  Why?  To take advantage of low interest rates.

It is like reverse maturity transformation.  The banking system borrows short and lends long.  Google is borrowing long and lending short.  (Or maybe I should call it reverse quantitative easing, as Google is also doing exactly the opposite of what the Fed has been doing.)

Does this make sense for Google?  I have no idea, and I am ready to concede that those guys are a lot smarter (and financially successful) than I am.  But there is reason to be skeptical. 

The chart above shows the spread between the ten-year Treasury bond and the three-month Treasury bill.  The yield spread is now high by historical standards.  The empirical literature on the expectations theory of the term structure (in which I have sometimes played) suggests that this is a good time to borrow short and lend long--the opposite of what Google is doing.

Maybe this time is different, and past empirical regularities will not hold going forward.  But ponder this question: If you had a friend with a paid-up house, would you suggest that he now take out a long-term mortgage in order to deposit the proceeds in a money-market fund?  If not, does it make sense for Google to be doing much the same thing?

Updates:

1. A smart reader sends in the following plausible explanation:

While it's true that Google has $37 billion in cash and equivalents, almost all of that $37 billion is in non-U.S. accounts (an artifact of funneling most of their profits through low-tax Ireland). They cannot spend that $37 billion in the U.S. without incurring a tax rate of 35 percent; thus, the borrowing is to finance spending in the U.S. (as opposed to abroad). All the big tech companies do the same thing (Microsoft was in the news for the same thing some 6 months ago).  Thus, Google is not trying to play the yield curve so much as intertemporally arbitrage the U.S. tax code. By not repatriating the $37 billion now, they are betting that the U.S. corporate tax rate on repatriated foreign profits will be appreciably lower in the future than it is now.

2. On the other hand, another loyal reader points me toward this source, which says:

The firm doesn't have the same issue with overseas cash that many of its large-cap technology peers do. Of Google's $37 billion in cash, only about $17 billion is sitting outside the U.S. Microsoft, by contrast, has no net cash remaining in the U.S., while nearly 90% of Cisco's cash is sitting outside of the country.

Sent with Reeder

Answering the bunnies

Answering the bunnies

Econbrowser

A cartoon has been making the rounds (e.g., Forbes, Zero Hedge, and Real Clear Politics) in which cartoon characters (bunnies maybe? or perhaps some other life form) ask questions about quantitative easing. I would have provided slightly different answers than did the didactic character in the cartoon, so I thought it might be fun to interject myself as a third character in the bunnies' conversation.
The cartoon begins with a discussion of quantitative easing.

Bunny: What does that mean?
JDH: It means that the Fed is going to buy some more long-term Treasury securities. The idea is that by buying a large amount, the effect will be to increase the price of those bonds, which would make the interest rates on those and other bonds lower. Lower interest rates might help make more loans available to small businesses and create better opportunities for households to refinance. By depreciating the dollar, the move may also encourage U.S. exports and discourage U.S. imports.
Bunny: Why do they call it the quantitative easing? Why don't they just call it printing money?
JDH: Actually no money is going to be printed. The Fed will pay for these purchases by crediting accounts that banks have with the Fed. Although it is true that banks could ask to withdraw these funds in the form of green currency, they currently are showing no interest in doing so. And before banks did start to want to withdraw these funds as money, the Fed plans to sell the assets off to bring the reserves back in. There is no plan now or in the future to "print a ton of money".

The bunnies then go on to note correctly that one of the goals of quantitative easing is to prevent deflation.

Bunny: Isn't [deflation] good? Doesn't that mean people can buy more of the stuff?
JDH: It would if your nominal income stayed the same. But that's exactly the problem. In episodes of deflation, people's wages go down, and many lose their jobs and can't find new ones. A decrease in the price of what we buy sounds good to us, but a decrease in the price of what we sell (namely, a decrease in our salary) does not. The experience of countries in which wages and prices are falling has been very painful, and the Fed wants to avoid this.
Bunny: But aren't food, gas, health care, and tuition prices higher than a year ago?
JDH: Yes, though items such as clothes and furniture are lower. But if we wait until deflation is established more broadly before acting, measures like the ones the Fed just announced would likely be less effective.
Bunny: Aren't bond prices higher than a year ago?
JDH: Bond prices don't enter into consumer's budgets. In fact, the higher bond prices are one indicator that deflation is a greater risk today than it was a year ago.
Bunny: Has the Fed ever been right about anything?
JDH: A study by Christina and David Romer published in the American Economic Review in 2000 found that Federal Reserve forecasts of inflation were significantly better than those generated by the Blue Chip survey of economic forecasters, the Survey of Professional Forecasters, or Data Resources, Inc. A study by Jon Faust and Jonathan Wright published in the Journal of Business and Economic Statistics in 2009 found the Fed's forecasts of inflation were significantly better than those generated by a battery of state-of-the-art time-series forecasting techniques.

The bunnies then get into a discussion of the mechanics of bond purchases by the Fed.

Bunny: If the Ben Bernank wants to buy the Treasury bonds with the American people's money, he does not buy them from the Treasury, he buys them from the Goldman Sachs?
JDH: Goldman Sachs is one of 16 different dealers from which the Federal Reserve Bank of New York solicits competitive bids. That's the way it's been done for a century, and it would be illegal for the Fed to do as the bunnies propose. From U.S. Monetary Policy and Financial Markets, 1998, Chapter 7:

The Federal Reserve makes all additions to its portfolio through purchases of securities that are already outstanding. The Federal Reserve Act [of 1913] does not give the [Federal Reserve] System the authority to purchase new Treasury issues for cash. Over the years, a variety of provisions had permitted the Treasury to borrow limited amounts directly from the Federal Reserve. Options for such loans existed until 1935. Temporary provisions for direct loans were reintroduced in 1942 and renewed with varying restrictions a number of times thereafter. Authority for any kind of direct loans to the Treasury lapsed in 1981 and has not been renewed.

The reason that the Fed has always been required to buy bonds from private dealers rather than the U.S. Treasury is that the process of money creation needs to be institutionally separated from the process of financing the public debt. In fact, the potential blurring of those boundaries is one of the most important legitimate criticisms of quantitative easing.

And here is the original cartoon, in which you'll see that the bunnies' own answers are much funnier than mine.

Sent with Reeder

Assessing Fantasy Scenarios

Assessing Fantasy Scenarios

Econbrowser

With the EGTRRA/JGTRRA extensions and proposals for tax reform and debt reduction flying left and right, I think it behooves us to review what the theoretical (well, actually undergraduate textbook) literature and the empirical assessments suggest will be the impact of tax rate changes. I want to devote special attention to the hypothesis that there will be large dis-incentive effects on high income households should their tax rates go up, with correspondingly large negative ramifications for overall economic activity.
Tax rate reductions can affect the macroeconomy in many different ways. In what is typically characterized as the Keynesian approach, the tax rate reduction increases disposable income, and hence consumption. In what is typically characterized as the supply side approach, the tax rate reduction induces an increase in labor supply.
The former effect induces an outward shift of the aggregate demand curve, while the latter shifts out the long run aggregate supply curve (since potential output depends upon the labor stock employed).

Figure 1: Shift in aggregate demand curve due to reduced tax rate, or shift in potential GDP.
Now, in typical macroeconomic modeling (in what is sometimes called the Neoclassical synthesis), both effects are included. Which effect dominates? This is an empirical issue (Interestingly, this was the topic of the first economics paper I wrote in college, during the era of Arthur Laffer and Jude Wanniski; I guess economic policy is like fashion -- some things, like platform shoes, keep on coming back).
Theory
To highlight the reason why this is an empirical issue, first consider the impact of a tax reduction on the after tax wage rate, and hence the labor-leisure tradeoff. Let IC₁ be the original indifference curve, X the maximum number of hours of leisure, and Y income.

Figure 2: Impact of (after-tax) wage rate increase. Source http://www.knowledgerush.com/kr/encyclopedia/Labor_market/
The original equilibrium point is A, with X_A hours of leisure, Y_A income. A tax rate decrease raises the after tax wage rate, making the relative price line steeper. The new equilibrium is at B. Now leisure falls to X_B, as income rises to Y_B. Leisure is a normal good in this example. Notice that the income and substitution effects are then offsetting (X_A to X_C is the income effect, X_C to X_B is the substitution effect). Notice that the indifference curves could be drawn so that in fact leisure increased in response to the tax rate decrease. In such instances, the labor supply curve would be backward bending. Only if leisure is an inferior good (i.e., one prefers less leisure as income rises, which seems like an unappealing assumption) can one rule out the backward bending supply curve over the entire range of wage rates. (More undergrad-level notes here, and here).
Empirics
Since theory does not provide guidance on the real-world effect, we have to appeal to data. There are numerous studies addressing this question (see a meta analysis here). I'm going to refer to the numbers the Congressional Budget Office uses in its microsimulation model, here; I show Table 2 from the paper below.

Source: CBO, "The Effect of Tax Changes on Labor Supply in CBO's Microsimulation Tax Model," Background Paper (April 2007).
The table can be read as follows:

Income elasticity measures the percentage change in total hours worked that would result from a 1 percent increase in after-tax income, holding the after-tax wage rate constant. Substitution elasticity measures the percentage change in hours worked from a 1 percent increase in the after-tax wage rate, holding the worker's utility constant. The total wage elasticity is the sum of the two elasticities; it measures the percentage change in hours worked that would result from 1 percent increases in both after-tax income and the after-tax wage rate.

I think it's of interest that if one is worried about the incentive effects on the top four deciles (top two quintiles), these elasticities suggest that the anxiety is misplaced. The elasticity for these two quintiles is 0.028; that is a tax rate increase that decreases after tax wages by 1 percent would decrease labor supply by these individuals by 0.028 percent(!). Notice that the elasticity is much higher for secondary earners.
Overall, the CBO concluded in the 2007 report (Table 3) that only about 4% of the static revenue loss associated with extending the EGTRRA/JGTRRA and implementing an AMT fix would be offset by the increased tax revenue associated with people working longer hours due to supply side effects.
Policy Implications
What this tells me is that in crafting tax increases, one should pay attention to incentives, but one shouldn't overstress the importance of supply side effects. And in particular, those incentive effects seem particularly small for high income earners. There is a separate question of whether a higher tax rate would disproportionately impact the consumption of high income households, which account for a large share of overall US consumption (as opposed to raising taxes on lower-income liquidity constrained households, which arguably have a higher marginal propensity to consume). To me, that makes more sense, from an analytical perspective, than fixating on the supply side effect.
Postscript: These are static effects in the CBO study. For discussion of dynamic effects, see this post.

Sent with Reeder

A QE2 Ditty

A QE2 Ditty

Greg Mankiw's Blog

Reader Dave Stehman sends in the following:

It's Called Quantitative Easing

I heard it in the headlines
It's news all over town
We might be double dippin'
Green shoots have all turned brown

It's a balance sheet recession
With a housing overhang
But they've got a brand new program
And it will start you with a bang

And it's called, quantitative easing
They say results are always pleasing.
When liquidity all starts freezing
Just warm things up with quantitative easing

I will say it straight and simple
It's clear, just like a bell
There's some long term bonds to buy
There's some short term bonds to sell

Don't talk about the good times
Don't ask me where they went
Just move your inflation target
On up to three point five per cent

And it's called, quantitative easing
This ain't no joke, it ain't no teasing
When the GDP starts wheezing
Treat with a shot of quantitative easing

Good and magic things will happen
It might take a week or three
Unemployment plunging downward
Recovery shaped just like a V

You'll see Nobels at the Treasury
There'll be rock stars at the Fed
It'll take hair off of Krugman's face
Put it on top of Ken Rogoff's head

And it's called, quantitative easin'
This ain't no scam, so don't call no policeman
When the engine of commerce starts seizin'
Just add a quart or quantitative easin'

Show no mercy to the critics
Don't let no one stop your nerve
You can mock Ricardian Equivalence
You can laugh at the Laffer Curve

Tell that guy at the Minneapolis Fed
To shut up, or you'll break his legs
And if the Bond Vigilantes don't like it?
Well, they can go suck eggs

And it's called quantitative easin'
You know I say this for a reason
When the economy just sits there squeezing
Loosen things up with quantitative easing

Top 5 World News Websites Guaranteed Free From Censorship

Top 5 World News Websites Guaranteed Free From Censorship

MakeUseOf.com

My name is Ryan Dube and I am a corporate news media addict. There…I said it. I love the glitzy commercials, the shiny well-funded world news websites with lots of widgets and cool gadgets to feed my mobile phone and my PC with piles of important news headlines, like who won the Oscars last night or how President Obama's wonderful budget impact my taxes.
You know – the sort of stuff that you gaze over while you're sipping on your morning coffee, content that all is right in the world, and that the Western World is the center of the Universe and always in the right. In this article, I'm going to share 5 world news websites that completely shatter that unrealistic view of the world.

Last year I was discussing world military events with a friend from the UK. He made a comment about U.S. and U.K. military action in Iraq that I hadn't heard about. I was flummoxed. Up to that point, I was an avid reader of all of the corporate news media giants – CNN, Fox News, and CBS. I trusted those news organizations to deliver the most important news in the world to my doorstep.
He forwarded me the link from an Independent UK news organization. I read the story, and grew angrier with every sentence – not because of the content but because I hadn't heard about it. I went back and sifted through my favorite media sites, and eventually found the news story, but it was buried under mountains of other headlines deemed far more important – things like Britney Spear's emotional breakdown. That experience lit a fire under me – never again would I subject myself to the biased headlines of corporate media.

Independent News – The Way News Used to Be

There was a time – and old-school journalists remember it well – when journalism as a career meant being so passionate about getting the truth in front of the public eye, that one would resort to extremes of self-sacrifice. As world governments, dictators and entire armies sought to pin entire populations down under oppressive regimes – the valiant journalist served as a citizen spy, going where even many CIA operatives failed to go, and reporting back their stories to the entire world.
True journalism broke the back of oppression – it exposed deceit and corruption to the light of day. But today…well, today we have stories about the latest movies out over the weekend, and updates about the Toyota Recall. The media itself is now a bastion of corporate corruption.
However, we have hope in the form of Independent media. There are still organizations that believe in those founding ideals of journalism – there are still journalists that hold true to the principles that keep democratic societies informed about the atrocities and corruption taking place throughout the world. This list of unbiased world news websites is my nod of support and admiration for those organizations, my own small contribution to the destruction of that bloated creature known as Corporate Media.

I'm starting with the UK-based The Independent because it was the news source that my friend forwarded to me years ago. I do believe private funding supports the organization, but from my personal use of the site for news stories, I've noticed that they cover many world news stories which many other corporate owned entities avoid. You may find Hollywood gossip-style stories here and there, but nowhere near as bad as U.S. based media sources.

I think my favorite source for unbiased, hard-hitting stories is the world news website TheRealNews. This news program is a flagship show of the Independent World Television (IWT). They accept no advertising (even The Independent can't say that), and their mission statement is inspiring for any young journalist just entering into the news industry. From TheRealNews about page:
"The movements for the rights of working people, women, children, immigrants, indigenous people, for freedom of religion and conscience, for moral and spiritual values and for peace and against racism are news. The health of our planet will be a story, day after day."
Now, doesn't that just make you want to stand up and take your hat off? This is an organization that truly understands and adheres to the founding principles of journalism.

The Independent Media Center just has guerrilla journalism written all over it. I picture brave journalists from all corners of the world, interviewing victims in war-torn countries and other centers of violence simply to get their stories out to the world. The IMC, as it is affectionately called, hosts news blogs from independent journalists throughout the world, including Iraq, Iran, Israel and Palestine just to name a few. Want the real scoop on world news? You know that you'll get the real story here.

World News is sort of an aggregate of many world news websites, including the likes of Al Jazeera, BBC News, The Guardian and The Times of India. While individual news sources may not be totally unbiased or completely free of censorship, you can rest assured that if you're getting all of your news from World News, then you know that you'll be betting all sides of the story.

I know I said The Real News is my favorite independent news source, AlterNet is actually my other favorite. Founded in 1998, AlterNet led the way for all future journalists seeking to break from from the scourge of Corporate Media. The articles there cover significant issues, and it also highlights stories from other independent news sources.

The site's mission statement is just as inspiring:

"AlterNet's aim is to inspire action and advocacy on the environment, human rights and civil liberties, social justice, media, health care issues, and more."

When the world seems crazy and confusing and you just don't know where to turn anymore to get the truth, websites like AlterNet offer you a refuge. It gives you a place that you can return to and know that you're not being fed propaganda or political party lines. Independent news is the real stuff, and these are the world news websites where you can get it.

Do you know of any other excellent Independent news sites? Share your favorites with other readers in the comments section below.

Did you like the post? Please do share your thoughts in the comments section!
New on Twitter ? Now you can follow MakeUseOf on Twitter too.

Related posts

• (7)Breaking News – Personalize Your Own Online Newspaper with NewsCred
• (20)5 Great Multi-Source News Websites
• (27)5 English Foreign Newspapers That You Should Read
• (15)Ways to Stay on Top of The News
• (17)Use Stacks To Save Websites For Later Reading [Mac]

Sent with Reeder

Best,

Wei

How Did Economists Get It So Wrong? - NYTimes.com

How Did Economists Get It So Wrong? - NYTimes.com

Delicious hotlist

How I Became A Keynesian | The New Republic

How I Became A Keynesian | The New Republic

The Last Temptation of Risk

by Barry Eichengreen

04.30.2009

From the May/June 2009 issue of The National Interest.



THE GREAT Credit Crisis has cast into doubt much of what we thought we knew about economics. We thought that monetary policy had tamed the business cycle. We thought that because changes in central-bank policies had delivered low and stable inflation, the volatility of the pre-1985 years had been consigned to the dustbin of history; they had given way to the quaintly dubbed “Great Moderation.” We thought that financial institutions and markets had come to be self-regulating—that investors could be left largely if not wholly to their own devices. Above all we thought that we had learned how to prevent the kind of financial calamity that struck the world in 1929.

We now know that much of what we thought was true was not. The Great Moderation was an illusion. Monetary policies focusing on low inflation to the exclusion of other considerations (not least excesses in financial markets) can allow dangerous vulnerabilities to build up. Relying on institutional investors to self-regulate is the economic equivalent of letting children decide their own diets. As a result we are now in for an economic and financial downturn that will rival the Great Depression before it is over.

The question is how we could have been so misguided. One interpretation, understandably popular given our current plight, is that the basic economic theory informing the actions of central bankers and regulators was fatally flawed. The only course left is to throw it out and start over. But another view, considerably closer to the truth, is that the problem lay not so much with the poverty of the underlying theory as with selective reading of it—a selective reading shaped by the social milieu. That social milieu encouraged financial decision makers to cherry-pick the theories that supported excessive risk taking. It discouraged whistle-blowing, not just by risk-management officers in large financial institutions, but also by the economists whose scholarship provided intellectual justification for the financial institutions’ decisions. The consequence was that scholarship that warned of potential disaster was ignored. And the result was global economic calamity on a scale not seen for four generations.



SO WHERE were the intellectual agenda setters when the crisis was building? Why did they fail to see this train wreck coming? More than that, why did they consort actively with the financial sector in setting the stage for the collapse?

For economists in business schools the answer is straightforward. Business schools see themselves as suppliers of inputs to business. Just as General Motors provides its suppliers with specifications for the cold-rolled sheet it needs for fabricating auto bodies, J. P. Morgan makes clear the kind of financial engineers it requires, and business schools deem to provide. In the wake of the 1987 stock-market crash, Morgan’s chairman, Dennis Weatherstone, started calling for a daily “4:15 Report” summarizing how much his firm would lose if tomorrow turned out to be a bad day. His counterparts at other firms then adopted the practice. Soon after, business schools jumped to supply graduates to write those reports. Value at Risk, as that number and the process for calculating it came to be known, quickly gained a place in the business-school curriculum.

The desire for up-to-date information on the risks of doing business was admirable. Less admirable was the belief that those risks could be reduced to a single number which could then be estimated on the basis of a set of mathematical equations fitted to a few data points. Much as former–GM CEO Alfred Sloan once sought to transform automobile production from a craft to an engineering problem, Weatherstone and his colleagues encouraged the belief that risk and return could be reduced to a set of equations specified by an MBA and solved by a machine.

Getting the machine to spit out a headline number for Value at Risk was straightforward. But deciding what to put into the model was another matter. The art of gauging Value at Risk required imagining the severity of the shocks to which the portfolio might be subjected. It required knowing what new variables to add in response to financial innovation and unfolding events. Doing this right required a thoughtful and creative practitioner. Value at Risk, like dynamite, can be a powerful tool when in the right hands. Placed in the wrong hands—well, you know.

These simple models should have been regarded as no more than starting points for serious thinking. Instead, those responsible for making key decisions, institutional investors and their regulators alike, took them literally. This reflected the seductive appeal of elegant theory. Reducing risk to a single number encouraged the belief that it could be mastered. It also made it easier to leave early for that weekend in the Hamptons.

Now, of course, we know that the gulf between assumption and reality was too wide to be bridged. These models were worse than unrealistic. They were weapons of economic mass destruction.

For some years those who relied on these artificial constructs were not caught out. Episodes of high volatility, like the 1987 stock-market crash, still loomed large in the data set to which the model was fit. They served to highlight the potential for big shocks and cautioned against aggressive investment strategies. Since financial innovation was gradual, models estimated on historical data remained reasonable representations of the balance of risks.



WITH TIME, however, memories of the 1987 crash faded. In the data used by the financial engineers, the crash became only one observation among many generated in the course of the Great Moderation. There were echoes, like the all-but-failure of the hedge fund Long-Term Capital Management in 1998. (Over four months the company lost $4.6 billion and had to be saved through a bailout orchestrated by the Federal Reserve Bank of New York.) But these warning signs were muffled by comparison. This encouraged the misplaced belief that the same central-bank policies that had reduced the volatility of inflation had magically, perhaps through transference, also reduced the volatility of financial markets. It encouraged the belief that mastery of the remaining risk made more aggressive investment strategies permissible. It made it possible, for example, to employ more leverage—to make use of more borrowed money—without putting more value at risk.

Meanwhile, deregulation was on the march. Memories of the 1930s disaster that had prompted the adoption of restrictions like the Glass-Steagall Act, which separated commercial and investment banking, faded with the passage of time. This tilted the political balance toward those who, for ideological reasons, favored permissive regulation. Meanwhile, financial institutions, in principle prohibited from pursuing certain lines of business, found ways around those restrictions, encouraging the view that strict regulation was futile. With the elimination of regulatory ceilings on the interest rates that could be paid to depositors, commercial banks had to compete for funding by offering higher rates, which in turn pressured them to adopt riskier lending and investment policies in order to pay the bill. With the entry of low-cost brokerages and the elimination of fixed commissions on stock trades, broker-dealers like Bear Stearns, which had previously earned a comfy living off of such commissions, now felt compelled to enter riskier lines of business.

But where the accelerating pace of change should have prompted more caution, the routinization of risk management encouraged precisely the opposite. The idea that risk management had been reduced to a mere engineering problem seduced business in general, and financial businesses in particular, into believing that it was safe to use more leverage and to invest in more volatile assets.

Of course, risk officers could have pointed out that the models had been fit to data for a period of unprecedented low volatility. They could have pointed out that models designed to predict losses on securities backed by residential mortgages were estimated on data only for years when housing prices were rising and foreclosures were essentially unknown. They could have emphasized the high degree of uncertainty surrounding their estimates. But they knew on which side their bread was buttered. Senior management strongly preferred to take on additional risk, since if the dice came up seven they stood to receive megabonuses, whereas if they rolled snake eyes the worst they could expect was a golden parachute. If an investment strategy that promised high returns today threatened to jeopardize the viability of the enterprise tomorrow, then this was someone else’s problem. For a junior risk officer to warn the members of the investment committee that they were taking undue risk would have dimmed his chances of promotion. And so on up the ladder.



WHY CORPORATE risk officers did not sound the alarm bells is thus clear enough. But where were the business-school professors while these events were unfolding? Answer: they were writing textbooks about Value at Risk. (Truth in advertising requires me to acknowledge that the leading such book is by a professor at the University of California.) Business schools are rated by business publications and compete for students on the basis of their record of placing graduates. With banks hiring graduates educated in Value at Risk, business schools had an obvious incentive to supply the same.

But what of doctoral programs in economics (like the one in which I teach)? The top PhD-granting departments only rarely send their graduates to positions in banking or business—most go on to other universities. But their faculties do not object to the occasional high-paying consulting gig. They don’t mind serving as the entertainment at beachside and ski-slope retreats hosted by investment banks for their important clients.

Generous speaker’s fees were thus available to those prepared to drink the Kool-Aid. Not everyone indulged. But there was nonetheless a subconscious tendency to embrace the arguments of one’s more “successful” colleagues in a discipline where money, in this case earned through speaking engagements and consultancies, is the common denominator of success.

Those who predicted the housing slump eventually became famous, of course. Princeton University Press now takes out space ads in general-interest publications prominently displaying the sober visage of Yale University economics professor Robert Shiller, the maven of the housing crash. Not every academic scribbler can expect this kind of attention from his publisher. But such fame comes only after the fact. The more housing prices rose and the longer predictions of their decline looked to be wrong, the lonelier the intellectual nonconformists became. Sociologists may be more familiar than economists with the psychic costs of nonconformity. But because there is a strong external demand for economists’ services, they may experience even-stronger economic incentives than their colleagues in other disciplines to conform to the industry-held view. They can thus incur even-greater costs—economic and also psychic—from falling out of step.



WHY BELABOR these points? Because it was not that economic theory had nothing to say about the kinds of structural weaknesses and conflicts of interest that paved the way to our current catastrophe. In fact, large swaths of modern economic theory focus squarely on the kind of generic problems that created our current mess. The problem was not an inability to imagine that conflicts of interest, self-dealing and herd behavior could arise, but a peculiar failure to apply those insights to the real world.

Take for example agency theory, whose point of departure is the observation that shareholders find it difficult to monitor managers, who have an incentive to make decisions that translate into large end-of-current-year bonuses but not necessarily into the long-term health of the enterprise. Risk taking that produces handsome returns today but ends in bankruptcy tomorrow may be perfectly congenial to CEOs who receive generous bonuses and severance packages but not to shareholders who end up holding worthless paper. This work had long pointed to compensation practices in the financial sector as encouraging short-termism and excessive risk taking and heightening conflicts of interest. The failure to heed such warnings is all the more striking given that agency theory is hardly an obscure corner of economics. A Nobel Prize for work on this topic was awarded to Leonid Hurwicz, Eric Maskin and Roger Myerson in 2007. (So much for the idea that it is only the financial engineers who are recognized by the Nobel Committee.)

Then there is information economics. It is a fact of life that borrowers know more than lenders about their willingness and capacity to repay. Who could know better what motivation lurks in the mind of the borrower and what opportunities he truly possesses? Taking this observation as its starting point, research in information economics has long emphasized the existence of adverse selection in financial markets—when interest rates rise, only borrowers with high-risk projects offering some chance of generating the high returns needed to service and repay loans will be willing to borrow. Indeed, if higher interest rates mean riskier borrowers, there may be no interest rate high enough to compensate the lender for the risk that the borrower may default. In that case lending and borrowing may collapse.

These models also show how borrowers have an incentive to take on more risk when using other people’s money or if they expect to be bailed out when things go wrong. In the wake of recent financial rescues, the name for this problem, “moral hazard,” will be familiar to even the casual newspaper reader. Again this is hardly an obscure corner of economics: George Akerlof, Michael Spence and Joseph Stiglitz were awarded the Nobel Prize for their work on it in 2001. Here again the potential problems of an inadequately regulated financial system would have been quite clear had anyone bothered to look.

Finally there is behavioral economics and its applications, including behavioral finance. Behavioral economics focuses on how cognition, emotion, and other psychological and social factors affect economic and financial decision making. Behavioral economists depart from the simpleminded benchmark that all investors take optimal decisions on the basis of all available information. Instead they acknowledge that decision making is not easy. They acknowledge that many decisions are taken using rules of thumb, which are often formed on the basis of social convention. They analyze how, to pick an example not entirely at random, decision making can be affected by the psychic costs of nonconformity.

It is easy to see how this small step in the direction of realism can transform one’s view of financial markets. It can explain herd behavior, where everyone follows the crowd, giving rise to bubbles, panics and crashes. Economists have succeeded in building elegant mathematical models of decision making under these conditions and in showing how such behavior can give rise to extreme instability. It should not be a surprise that people like the aforementioned George Akerlof and Robert Shiller are among the leaders in this field.

Moreover, what is true of investors can also be true of regulators, for whom information is similarly costly to acquire and who will similarly be tempted to follow convention—even when that convention allows excessive risk taking by the regulated. Indeed, these theories suggest that the attitudes of regulators may be infected not merely by the practices and attitudes of their fellow regulators, but also by those of the regulated. Economists now even have a name for this particular version of the intellectual fox-in-the-henhouse syndrome: cognitive regulatory capture.

And what is true of investors and regulators, introspection suggests, can also be true of academics. When it is costly to acquire and assimilate information about how reality diverges from the assumptions underlying popular economic models, it will be tempting to ignore those divergences. When convention within the discipline is to assume efficient markets, there will be psychic costs if one attempts to buck the trend. Scholars, in other words, are no more immune than regulators to the problem of cognitive capture.

What got us into this mess, in other words, were not the limits of scholarly imagination. It was not the failure or inability of economists to model conflicts of interest, incentives to take excessive risk and information problems that can give rise to bubbles, panics and crises. It was not that economists failed to recognize the role of social and psychological factors in decision making or that they lacked the tools needed to draw out the implications. In fact, these observations and others had been imaginatively elaborated by contributors to the literatures on agency theory, information economics and behavioral finance. Rather, the problem was a partial and blinkered reading of that literature. The consumers of economic theory, not surprisingly, tended to pick and choose those elements of that rich literature that best supported their self-serving actions. Equally reprehensibly, the producers of that theory, benefiting in ways both pecuniary and psychic, showed disturbingly little tendency to object. It is in this light that we must understand how it was that the vast majority of the economics profession remained so blissfully silent and indeed unaware of the risk of financial disaster.



WITH THE pressure of social conformity being so powerful, are we economists doomed to repeat past mistakes? Will we forever follow the latest intellectual fad and fashion, swinging wildly—much like investors whose behavior we seek to model—from irrational exuberance to excessive despair about the operation of markets? Isn’t our outlook simply too erratic and advice therefore too unreliable to be trusted as a guide for policy?

Maybe so. But amid the pervading sense of gloom and doom, there is at least one reason for hope. The last ten years have seen a quiet revolution in the practice of economics. For years theorists held the intellectual high ground. With their mastery of sophisticated mathematics, they were the high-prestige members of the profession. The methods of empirical economists seeking to analyze real data were rudimentary by comparison. As recently as the 1970s, doing a statistical analysis meant entering data on punch cards, submitting them at the university computing center, going out for dinner and returning some hours later to see if the program had successfully run. (I speak from experience.) The typical empirical analysis in economics utilized a few dozen, or at most a few hundred, observations transcribed by hand. It is not surprising that the theoretically inclined looked down, fondly if a bit condescendingly, on their more empirically oriented colleagues or that the theorists ruled the intellectual roost.

But the IT revolution has altered the lay of the intellectual land. Now every graduate student has a laptop computer with more memory than that decades-old university computing center. And she knows what to do with it. Just like the typical twelve-year-old knows more than her parents about how to download data from the internet, for graduate students in economics, unlike their instructors, importing data from cyberspace is second nature. They can grab data on grocery-store spending generated by the club cards issued by supermarket chains and combine it with information on temperature by zip code to see how the weather affects sales of beer. Their next step, of course, is to download securities prices from Bloomberg and see how blue skies and rain affect the behavior of financial markets. Finding that stock markets are more likely to rise on sunny days is not exactly reassuring for believers in the efficient-markets hypothesis.

The data sets used in empirical economics today are enormous, with observations running into the millions. Some of this work is admittedly self-indulgent, with researchers seeking to top one another in applying the largest data set to the smallest problem. But now it is on the empirical side where the capacity to do high-quality research is expanding most dramatically, be the topic beer sales or asset pricing. And, revealingly, it is now empirically oriented graduate students who are the hot property when top doctoral programs seek to hire new faculty.

Not surprisingly, the best students have responded. The top young economists are, increasingly, empirically oriented. They are concerned not with theoretical flights of fancy but with the facts on the ground. To the extent that their work is rooted concretely in observation of the real world, it is less likely to sway with the latest fad and fashion. Or so one hopes.

The late twentieth century was the heyday of deductive economics. Talented and facile theorists set the intellectual agenda. Their very facility enabled them to build models with virtually any implication, which meant that policy makers could pick and choose at their convenience. Theory turned out to be too malleable, in other words, to provide reliable guidance for policy.

In contrast, the twenty-first century will be the age of inductive economics, when empiricists hold sway and advice is grounded in concrete observation of markets and their inhabitants. Work in economics, including the abstract model building in which theorists engage, will be guided more powerfully by this real-world observation. It is about time.

Should this reassure us that we can avoid another crisis? Alas, there is no such certainty. The only way of being certain that one will not fall down the stairs is to not get out of bed. But at least economists, having observed the history of accidents, will no longer recommend removing the handrail.



Barry Eichengreen is the George C. Pardee and Helen N. Pardee Professor of Economics and Political Science at the University of California, Berkeley.

How did Paul Krugman get it so wrong?

How did Paul Krugman get it so Wrong?

John H. Cochrane*

Many friends and colleagues have asked me what I think of Paul Krugman’s New York Times Magazine article, “How did Economists get it so wrong?”

Most of all, it’s sad. Imagine this weren’t economics for a moment. Imagine this were a respected scientist turned popular writer, who says, most basically, that everything everyone has done in his field since the mid 1960s is a complete waste of time. Everything that fills its academic journals, is taught in its PhD programs, presented at its conferences, summarized in its graduate textbooks, and rewarded with the accolades a profession can bestow, including multiple Nobel prizes, is totally wrong. Instead, he calls for a return to the eternal verities of a rather convoluted book written in the 1930s, as taught to our author in his undergraduate introductory courses. If a scientist, he might be a global-warming skeptic, an AIDS-HIV disbeliever, a creationist, a stalwart that maybe continents don’t move after all.

It gets worse. Krugman hints at dark conspiracies, claiming “dissenters are marginalized.” Most of the article is just a calumnious personal attack on an ever-growing enemies list, which now includes “new Keyenesians” such as Olivier Blanchard and Greg Mankiw. Rather than source professional writing, he plays gotcha with out-of-context second-hand quotes from media interviews. He makes stuff up, boldly putting words in people’s mouths that run contrary to their written opinions. Even this isn’t enough: he adds cartoons to try to make his “enemies” look silly, and puts them in false and embarrassing situations. He accuses us of adopting ideas for pay, selling out for “sabbaticals at the Hoover institution” and fat “Wall street paychecks.” It sounds a bit paranoid.

It’s annoying to the victims, but we’re big boys and girls. It’s a disservice to New York Times readers. They depend on Krugman to read real academic literature and digest it, and they get this attack instead. And it’s ineffective. Any astute reader knows that personal attacks and innuendo mean the author has run out of ideas.

That’s the biggest and saddest news of this piece: Paul Krugman has no interesting ideas whatsoever about what caused our current financial and economic problems, what policies might have prevented it, or what might help us in the future, and he has no contact with people who do. “Irrationality” and advice to spend like a drunken sailor are pretty superficial compared to all the fascinating things economists are writing about it these days.

How sad.

That’s what I think, but I don’t expect you the reader to be convinced by my opinion or my reference to professional consensus. Maybe he is right. Occasionally sciences, especially social sciences, do take a wrong turn for a decade or two. I thought Keynesian economics was such a wrong turn. So let’s take a quick look at the ideas.

Krugman’s attack has two goals. First, he thinks financial markets are “inefficient,” fundamentally due to “irrational” investors, and thus prey to excessive volatility which needs government control. Second, he likes the huge “fiscal stimulus” provided by multi-trillion dollar deficits.



Efficiency.

It’s fun to say we didn’t see the crisis coming, but the central empirical prediction of the efficient markets hypothesis is precisely that nobody can tell where markets are going – neither benevolent government bureaucrats, nor crafty hedge-fund managers, nor ivory-tower academics. This is probably the best-tested proposition in all the social sciences. Krugman knows this, so all he can do is huff and puff about his dislike for a theory whose central prediction is that nobody can be a reliable soothsayer.

Krugman writes as if the volatility of stock prices alone disproves market efficiency, and efficient marketers just ignored it all these years. This is a canard that Paul knows better than to pass on, no matter how rhetorically convenient. (I can overlook his mixing up the CAPM and Black-Scholes model, but not this.) There is nothing about “efficiency” that promises “stability.” “Stable” growth would in fact be a major violation of efficiency. Efficient markets did not need to wait for “the memory of 1929 … gradually receding,” nor did we fail to read the newspapers in 1987. Data from the great depression has been included in practically all the tests. In fact, the great “equity premium puzzle” is that if efficient, stock markets don’t seem risky enough to deter more people from investing! Gene Fama’s PhD thesis was on “fat tails” in stock returns.

It is true and very well documented that asset prices move more than reasonable expectations of future cashflows. This might be because people are prey to bursts of irrational optimism and pessimism. It might also be because people’s willingness to take on risk varies over time, and is lower in bad economic times. As Gene Fama pointed out in 1970, these are observationally equivalent explanations. Unless you are willing to elaborate your theory to the point that it can quantitatively describe how much and when risk premiums, or waves of “optimism” and “pessimism,” can vary, you know nothing. No theory is particularly good at that right now.

Crying “bubble” is empty unless you have an operational procedure for identifying bubbles, distinguishing them from rationally low risk premiums, and not crying wolf too many years in a row. Krugman rightly praises Robert Shiller for his warnings over many years that house prices might fall. But advice that we should listen to Shiller, because he got the last one right, is no more useful than previous advice from many quarters to listen to Greenspan because he got several ones right. Following the last mystic oracle until he gets one wrong, then casting him to the wolves, is not a good long-term strategy for identifying bubbles. Krugman likes Shiller because he advocates behavioral ideas, but that’s no help either. People who call themselves behavioral have just as wide a divergence of opinion as those who don’t. Are markets irrationally exuberant or irrationally depressed? It’s hard to tell.

This difficulty is no surprise. It’s the central prediction of free-market economics, as crystallized by Hayek, that no academic, bureaucrat or regulator will ever be able to fully explain market price movements. Nobody knows what “fundamental” value is. If anyone could tell what the price of tomatoes should be, let alone the price of Microsoft stock, communism would have worked.

More deeply, the economist’s job is not to “explain” market fluctuations after the fact, to give a pleasant story on the evening news about why markets went up or down. Markets up? “A wave of positive sentiment.” Markets went down? “Irrational pessimism.” ( “The risk premium must have increased” is just as empty.) Our ancestors could do that. Really, is that an improvement on “Zeus had a fight with Apollo?” Good serious behavioral economists know this, and they are circumspect in their explanatory claims so far.

But this argument takes us away from the main point. The case for free markets never was that markets are perfect. The case for free markets is that government control of markets, especially asset markets, has always been much worse.

Krugman at bottom is arguing that the government should massively intervene in financial markets, and take charge of the allocation of capital. He can’t quite come out and say this, but he does say “Keynes considered it a very bad idea to let such markets…dictate important business decisions,” and “finance economists believed that we should put the capital development of the nation in the hands of what Keynes had called a `casino.’” Well, if markets can’t be trusted to allocate capital, we don’t have to connect too many dots to imagine who Paul has in mind.

To reach this conclusion, you need evidence, experience, or any realistic hope that the alternative will be better. Remember, the SEC couldn’t even find Bernie Madoff when he was handed to them on a silver platter. Think of the great job Fannie, Freddie, and Congress did in the mortgage market. Is this system going to regulate Citigroup, guide financial markets to the right price, replace the stock market, and tell our society which new products are worth investment? As David Wessel’s excellent In Fed We Trust makes perfectly clear, government regulators failed just as abysmally as private investors and economists to see the storm coming. And not from any lack of smarts.

In fact, the behavioral view gives us a new and stronger argument against regulation and control. Regulators are just as human and irrational as market participants. If bankers are, in Krugman’s words, “idiots,” then so must be the typical treasury secretary, fed chairman, and regulatory staff. They act alone or in committees, where behavioral biases are much better documented than in market settings. They are still easily captured by industries, and face politically distorted incentives.

Careful behavioralists know this, and do not quickly run from “the market got it wrong” to “the government can put it all right.” Even my most behavioral colleagues Richard Thaler and Cass Sunstein in their book “Nudge” go only so far as a light libertarian paternalism, suggesting good default options on our 401(k) accounts. (And even here they’re not very clear on how the Federal Nudging Agency is going to steer clear of industry capture.) They don’t even think of jumping from irrational markets, which they believe in deeply, to Federal control of stock and house prices and allocation of capital.



Stimulus

Most of all, Krugman likes fiscal stimulus. In this quest, he accuses us and the rest of the economics profession of “mistaking beauty for truth.” He’s not clear on what the “beauty” is that we all fell in love with, and why one should shun it, for good reason. The first siren of beauty is simple logical consistency. Paul’s Keynesian economics requires that people make logically inconsistent plans to consume more, invest more, and pay more taxes with the same income. The second siren is plausible assumptions about how people behave. Keynesian economics requires that the government is able to systematically fool people again and again. It presumes that people don’t think about the future in making decisions today. Logical consistency and plausible foundations are indeed “beautiful” but to me they are also basic preconditions for “truth.”

In economics, stimulus spending ran aground on Robert Barro’s Ricardian equivalence theorem. This theorem says that debt-financed spending can’t have any effect because people, seeing the higher future taxes that must pay off the debt, will simply save more. They will buy the new government debt and leave all spending decisions unaltered. Is this theorem true? It’s a logical connection from a set of “if” to a set of “therefore.” Not even Paul can object to the connection.

Therefore, we have to examine the “ifs.” And those ifs are, as usual, obviously not true. For example, the theorem presumes lump-sum taxes, not proportional income taxes. Alas, when you take this into account we are all made poorer by deficit spending, so the multiplier is most likely negative. The theorem (like most Keynesian economics) ignores the composition of output; but surely spending money on roads rather than cars can affect the overall level.

Economists have spent a generation tossing and turning the Ricardian equivalence theorem, and assessing the likely effects of fiscal stimulus in its light, generalizing the “ifs” and figuring out the likely “therefores.” This is exactly the right way to do things. The impact of Ricardian equivalence is not that this simple abstract benchmark is literally true. The impact is that in its wake, if you want to understand the effects of government spending, you have to specify why it is false. Doing so does not lead you anywhere near old-fashioned Keynesian economics. It leads you to consider distorting taxes, how much people care about their children, how many people would like to borrow more to finance today’s consumption and so on. And when you find “market failures” that might justify a multiplier, optimal-policy analysis suggests fixing the market failures, not their exploitation by fiscal multiplier. Most “New Keynesian” analyses that add frictions don’t produce big multipliers.

This is how real thinking about stimulus actually proceeds. Nobody ever “asserted that an increase in government spending cannot, under any circumstances, increase employment.” This is unsupportable by any serious review of professional writings, and Krugman knows it. (My own are perfectly clear on lots of possibilities for an answer that is not zero.) But thinking through this sort of thing and explaining it is much harder than just tarring your enemies with out-of-context quotes, ethical innuendo, or silly cartoons.

In fact, I propose that Krugman himself doesn’t really believe the Keynesian logic for that stimulus. I doubt he would follow that logic to its inevitable conclusions. Stimulus must have some other attraction to him.

If you believe the Keynesian argument for stimulus, you should think Bernie Madoff is a hero. He took money from people who were saving it, and gave it to people who most assuredly were going to spend it. Each dollar so transferred, in Krugman’s world, generates an additional dollar and a half of national income. The analogy is even closer. Madoff didn’t just take money from his savers, he essentially borrowed it from them, giving them phony accounts with promises of great profits to come. This looks a lot like government debt.

If you believe the Keynesian argument for stimulus, you don’t care how the money is spent. All this puffery about “infrastructure,” monitoring, wise investment, jobs “created” and so on is pointless. Keynes thought the government should pay people to dig ditches and fill them up.

If you believe in Keynesian stimulus, you don’t even care if the government spending money is stolen. Actually, that would be better. Thieves have notoriously high propensities to consume.



The crash.

Krugman’s article is supposedly about how the crash and recession changed our thinking, and what economics has to say about it. The most amazing news in the whole article is that Paul Krugman has absolutely no idea about what caused the crash, what policies might have prevented it, and what policies we should adopt going forward. He seems completely unaware of the large body of work by economists who actually do know something about the banking and financial system, and have been thinking about it productively for a generation.

Here’s all he has to say: “Irrationality” caused markets to go up and then down. “Spending” then declined, for unclear reasons, possibly “irrational” as well. The sum total of his policy recommendations is for the Federal Government to spend like a drunken sailor after the fact.

Paul, there was a financial crisis, a classic near-run on banks. The centerpiece of our crash was not the relatively free stock or real estate markets, it was the highly regulated commercial banks. A generation of economists has thought really hard about these kinds of events. Look up Diamond, Rajan, Gorton, Kashyap, Stein, and so on. They’ve thought about why there is so much short term debt, why banks run, how deposit insurance and credit guarantees help, and how they give incentives for excessive risk taking.

If we want to think about events and policies, this seems like more than a minor detail. The hard and central policy debate over the last year was how to manage this financial crisis. Now it is how to set up the incentives of banks and other financial institutions so this mess doesn’t happen again. There’s lots of good and subtle economics here that New York Times readers might like to know about. What does Krugman have to say? Zero.

Krugman doesn’t even have anything to say about the Fed. Ben Bernanke did a lot more last year than set the funds rate to zero and then go off on vacation and wait for fiscal policy to do its magic. Leaving aside the string of bailouts, the Fed started term lending to securities dealers. Then, rather than buy treasuries in exchange for reserves, it essentially sold treasuries in exchange for private debt. Though the funds rate was near zero, the Fed noticed huge commercial paper and securitized debt spreads, and intervened in those markets. There is no “the” interest rate anymore, the Fed is attempting to manage them all. Recently the Fed has started buying massive quantities of mortgage-backed securities and long-term treasury debt.

Monetary policy now has little to do with “money” vs. “bonds” with all the latter lumped together. Monetary policy has become wide-ranging financial policy. Does any of this work? What are the dangers? Can the Fed stay independent in this new role? These are the questions of our time. What does Krugman have to say? Nothing.

Krugman is trying to say that a cabal of obvious crackpots bedazzled all of macroeconomics with the beauty of their mathematics, to the point of inducing policy paralysis. Alas, that won’t stick. The sad fact is that few in Washington pay the slightest attention to modern macroeconomic research, in particular anything with a serious intertemporal dimension. Paul’s simple Keynesianism has dominated policy analysis for decades and continues to do so. From the CEA to the Fed to the OMB and CBO, everyone just adds up consumer, investment and government “demand” to forecast output and uses simple Phillips curves to think about inflation. If a failure of ideas caused bad policy, it’s a simpleminded Keynesianism that failed.



The future of economics.

How should economics change? Krugman argues for three incompatible changes.

First, he argues for a future of economics that “recognizes flaws and frictions,” and incorporates alternative assumptions about behavior, especially towards risk-taking. To which I say, “Hello, Paul, where have you been for the last 30 years?” Macroeconomists have not spent 30 years admiring the eternal verities of Kydland and Prescott’s 1982 paper. Pretty much all we have been doing for 30 years is introducing flaws, frictions and new behaviors, especially new models of attitudes to risk, and comparing the resulting models, quantitatively, to data. The long literature on financial crises and banking which Krugman does not mention has also been doing exactly the same.

Second, Krugman argues that “a more or less Keynesian view is the only plausible game in town,” and “Keynesian economics remains the best framework we have for making sense of recessions and depressions.” One thing is pretty clear by now, that when economics incorporates flaws and frictions, the result will not be to rehabilitate an 80-year-old book. As Paul bemoans, the “new Keynesians” who did just what he asks, putting Keynes inspired price-stickiness into logically coherent models, ended up with something that looked a lot more like monetarism. (Actually, though this is the consensus, my own work finds that new-Keynesian economics ended up with something much different and more radical than monetarism.) A science that moves forward almost never ends up back where it started. Einstein revises Newton, but does not send you back to Aristotle. At best you can play the fun game of hunting for inspirational quotes, but that doesn’t mean that you could have known the same thing by just reading Keynes once more.

Third, and most surprising, is Krugman’s Luddite attack on mathematics; “economists as a group, mistook beauty, clad in impressive-looking mathematics, for truth.” Models are “gussied up with fancy equations.” I’m old enough to remember when Krugman was young, working out the interactions of game theory and increasing returns in international trade for which he won the Nobel Prize, and the old guard tut-tutted “nice recreational mathematics, but not real-world at all.” He once wrote eloquently about how only math keeps your ideas straight in economics. How quickly time passes.

Again, what is the alternative? Does Krugman really think we can make progress on his – and my – agenda for economic and financial research -- understanding frictions, imperfect markets, complex human behavior, institutional rigidities – by reverting to a literary style of exposition, and abandoning the attempt to compare theories quantitatively against data? Against the worldwide tide of quantification in all fields of human endeavor (read “Moneyball”) is there any real hope that this will work in economics?

No, the problem is that we don’t have enough math. Math in economics serves to keep the logic straight, to make sure that the “then” really does follow the “if,” which it so frequently does not if you just write prose. The challenge is how hard it is to write down explicit artificial economies with these ingredients, actually solve them, in order to see what makes them tick. Frictions are just bloody hard with the mathematical tools we have now.



The insults.

The level of personal attack in this article, and fudging of the facts to achieve it, is simply amazing.

As one little example (ok, I’m a bit sensitive), take my quotation about carpenters in Nevada. I didn’t write this. It’s a quote, taken out of context, from a bloomberg.com article, written by a reporter who I spent about 10 hours with patiently trying to explain some basics, and who also turned out only to be on a hunt for embarrassing quotes. (It’s the last time I’ll do that!) I was trying to explain how sectoral shifts contribute to unemployment. Krugman follows it by a lie -- I never asserted that “it take mass unemployment across the whole nation to get carpenters to move out of Nevada.” You can’t even dredge up a quote for that monstrosity.

What’s the point? I don’t think Paul disagrees that sectoral shifts result in some unemployment, so the quote actually makes sense as economics. The only point is to make me, personally, seem heartless -- a pure, personal, calumnious attack, having nothing to do with economics.

Bob Lucas has written extensively on Keynesian and monetarist economics, sensibly and even-handedly. Krugman chooses to quote a joke, made back in 1980 at a lunch talk to some business school alumni. Really, this is on the level of the picture of Barack Obama with Bill Ayres that Sean Hannity likes to show on Fox News.

It goes on. Krugman asserts that I and others “believe” “that an increase in government spending cannot, under any circumstances, increase employment,” or that we “argued that price fluctuations and shocks to demand actually had nothing to do with the business cycle.” These are just gross distortions, unsupported by any documentation, let alone professional writing. And Krugman knows better. All economic models are simplified to exhibit one point; we all understand the real world is more complicated; and his job is supposed to be to explain that to lay readers. It would be no different than if someone were to look up Paul’s early work which assumed away transport costs and claim “Paul Krugman believes ocean shipping is free, how stupid” in the Wall Street Journal.

The idea that any of us do what we do because we’re paid off by fancy Wall Street salaries or cushy sabbaticals at Hoover is just ridiculous. (If Krugman knew anything about hedge funds he’d know that believing in efficient markets disqualifies you for employment. Nobody wants a guy who thinks you can’t make any money trading!) Given Krugman’s speaking fees, it’s a surprising first stone for him to cast.

Apparently, salacious prose, innuendo, calumny, and selective quotation from media aren’t enough: Krugman added cartoons to try to make opponents look silly. The Lucas-Blanchard-Bernanke conspiratorial cocktail party celebrating the end of recessions is a silly fiction. So is their despondent gloom on reading “recession” in the paper. Nobody at a conference looks like Dr. Pangloss with wild hair and a suit from the 1800s. (OK, Randy Wright has the hair, but not the suit.) Keynes did not reappear at the NBER to be booed as an “outsider.” Why are you allowed to make things up in pictures that wouldn’t pass even the Times’ weak fact-checking in words?

M of all, Paul isn’t doing his job. He’s supposed to read, explain, and criticize things economists write, and real professional writing, not interviews, opeds and blog posts. At a minimum, this style leads to the unavoidable conclusion that Krugman isn’t reading real economics anymore.



How did Krugman get it so wrong?

So what is Krugman up to? Why become a denier, a skeptic, an apologist for 70 year old ideas, replete with well-known logical fallacies, a pariah? Why publish an essentially personal attack on an ever-growing enemies list that now includes practically every professional economist? Why publish an incoherent vision for the future of economics?

The only explanation that makes sense to me is that Krugman isn’t trying to be an economist, he is trying to be a partisan, political opinion writer. This is not an insult. I read George Will, Charles Krauthnammer and Frank Rich with equal pleasure even when I disagree with them. Krugman wants to be Rush Limbaugh of the Left.

Alas, to Krugman, as to far too many ex-economists in partisan debates, economics is not a quest for understanding. It is a set of debating points to argue for policies that one has adopted for partisan political purposes. “Stimulus” is just marketing to sell Congressmen and voters on a package of government spending priorities that you want for political reasons. It’s not a proposition to be explained, understood, taken seriously to its logical limits, or reflective of market failures that should be addressed directly.

Why argue for a nonsensical future for economics? Well, again, if you don’t regard economics as a science, a discipline that ought to result in quantitative matches to data, a discipline that requires crystal-clear logical connections between the “if” and the “then,” if the point of economics is merely to provide marketing and propaganda for politically-motivated policy, then his writing does make sense. It makes sense to appeal to some future economics – not yet worked out, even verbally – to disdain quantification and comparison to data, and to appeal to the authority of ancient books as interpreted you, their lone remaining apostle.

Most of all, this is the only reason I can come up with to understand why Krugman wants to write personal attacks on those who disagree with him. I like it when people disagree with me, and take time to read my work and criticize it. At worst I learn how to position it better. At best, I discover I was wrong and learn something. I send a polite thank you note.

Krugman wants people to swallow his arguments whole from his authority, without demanding logic, or evidence. Those who disagree with him, alas, are pretty smart and have pretty good arguments if you bother to read them. So, he tries to discredit them with personal attacks.

This is the political sphere, not the intellectual one. Don’t argue with them, swift-boat them. Find some embarrassing quote from an old interview. Well, good luck, Paul. Let’s just not pretend this has anything to do with economics, or actual truth about how the world works or could be made a better place.



*University of Chicago Booth School of Business. Many colleagues and friends helped, but I don’t want to name them for obvious reasons. Krugman fans: Please don’t bother emailing me to tell me what a jerk I am. I will update this occasionally, so please pass on the link rather than the document, http://faculty.chicagobooth.edu/john.cochrane/research/Papers/#news.