Thursday, April 30, 2009

Veronique de Rugy on France

The Rule of Law -- Not!

Via the WSJ, here is the view from a "secured (sic) creditor" of Chrysler:
"Like many others I made the mistake of buying what I believed was 'value,'" Mr. Gwin says, adding that investors who bought at the time believed the loans were worth more than their market price. "We did not contemplate having our first liens invalidated by a sitting president," he adds.
As the President intervenes in more and more industries, a key question is how he does it and what he is trying to achieve. Is he trying to reorganize insolvent firms while, as much as possible, preserving the rights of stakeholders as established under existing contracts? Or is he trying to achieve a "fair" outcome as he judges it, regardless of preexisting rules and agreements? I fear it may be the latter, in which case politics may start to trump the rule of law.

Wednesday, April 29, 2009

Chairman John

John Campbell is the new chairman of the Harvard economics department. Congratulations, John, and my condolences as well.

I have long thought that my biggest contribution to Harvard was being part of the team that recruited John to the university. As a coauthor of John early in his career, I knew a few years before the rest of the profession that he is both a great economist and a great human being. I am delighted that the leadership of our department will be in such capable hands over the next few years.

Miron on the Financial Crisis

Tuesday, April 28, 2009

Reis on Macro

Goolsbee versus Obama

The President:

Invoking the Sputnik Era, Obama Vows Record Outlays for Research
The President's adviser:

Does Government R&D Policy Mainly Benefit Scientists and Engineers?

by Austan Goolsbee

Conventional wisdom holds that the social rate of return to R&D significantly exceeds the private rate of return and, therefore, R&D should be subsidized. In the U.S., the government has directly funded a large fraction of total R&D spending. This paper shows that there is a serious problem with such government efforts to increase inventive activity. The majority of R&D spending is actually just salary payments for R&D workers. Their labor supply, however, is quite inelastic so when the government funds R&D, a significant fraction of the increased spending goes directly into higher wages. Using CPS data on wages of scientific personnel, this paper shows that government R&D spending raises wages significantly, particularly for scientists related to defense such as physicists and aeronautical engineers. Because of the higher wages, conventional estimates of the effectiveness of R&D policy may be 30 to 50% too high. The results also imply that by altering the wages of scientists and engineers even for firms not receiving federal support, government funding directly crowds out private inventive activity.

Fed staff goes negative

The FT reports:

Fed study puts ideal interest rate at -5%

The ideal interest rate for the US economy in current conditions would be minus 5 per cent, according to internal analysis prepared for the Federal Reserve's last policy meeting.

The analysis was based on a so-called Taylor-rule approach that estimates an appropriate interest rate based on unemployment and inflation.

A central bank cannot cut interest rates below zero. However, the staff research suggests the Fed should maintain unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5 per cent.

Monday, April 27, 2009

Instantaneous Deflation as a Macro Solution

In the process of making the case that I am a nut, Robert P. Murphy of the Ludwig von Mises Institute examines my column on negative interest rates and offers up a useful observation:

Let's stipulate for the sake of argument that the "equilibrium real interest rate" is negative, and that the nominal interest rate goes all the way down to zero. But oh no! Given the current array of prices and the expected array of prices next year, the implied real interest rate is too high for the market to clear. What to do?

Mankiw's suggestion is that the Fed should credibly promise to dump gobs of new dollars into the economy in twelve months, thus raising the future price "level" and giving people an incentive to unload their dollars today, while they have some purchasing power.

But there is another alternative, and that is for market prices today to fall very steeply until the market clears. The short-term collapse in prices during the present month, say, will then allow for a rapid price inflation back up to "normal" prices a year from now. [Emphasis in the original.]

I think this analysis is correct, under the maintained assumption that prices (including wages) are completely and instantaneously flexible. But if prices are sticky, then the immediate deflation and concurrent increase in expected inflation won't occur painlessly. Instead, it would take a while for the price level to fall, and as we wait, the economy would suffer through a period of depressed economic activity.

According to conventional new Keynesian analysis, sticky prices are the ultimate market imperfection that makes aggregate demand matter. If you deny that prices are sticky and assume they can instantaneously jump downward to new equilibrium levels, many macroeconomic problems become much easier to solve. Indeed, you don't need to solve them at all, as the market would do it.

I wish we lived in the world that Mr Murphy describes, but my reading of the evidence is that we don't.

Symposium Announcement

Alvin Hansen Symposium on Public Policy

Re-Regulating the U.S. Financial Markets:
What Should We Do Once the Recession is Over?

Debate with Randall S. Kroszner, University of Chicago, and Robert J. Shiller, Yale University.

Debate will be followed by comments by Benjamin M. Friedman, Harvard University; Robert C. Pozen, MFS Investment Management; Hal S. Scott, Harvard Law School; and George C. Kaufman, Loyola University Chicago.

Thursday, April 30, 2009, 2:00 PM
Room 105, Emerson Hall
Open to the public

Sunday, April 26, 2009

Voting with Your Feet

The Time of London reports:

TWO OF Britain’s best known entrepreneurs are considering leaving Britain in protest against Alistair Darling’s new 50% tax rate, as leading figures from business and the City line up to warn of a talent exodus.

Hugh Osmond, the pubs to insurance entrepreneur, is thinking about a move to Switzerland. Peter Hargreaves, the £10m-a-year co-founder of Hargreaves Lansdown, the financial adviser, is looking at the Isle of Man or Monaco. More are likely to be follow.

Osmond, whose net worth is estimated at £230m, said: “A lot of people will be off. It’s highly unlikely that I will continue to have the UK as my country of residence. It’s just as easy to work from any close location — Switzerland or wherever.”

Hargreaves, facing an extra £500,000 on his tax bill, warned: “I won’t pay, I’ll leave.”

Robert Pfeiffer, a partner at Compass Advisers, a mergers and acquisitions firm, said that businesses such as his did not need to be based in Britain. “We all love living in London but in the end it becomes an economic decision. The clients don’t care.”

He and his partners were discussing a move to Geneva. “Do we want the hassle of moving? Probably not. But there comes a point economically when it’s hard to justify being here.”

I wonder: Do economists tend to migrate toward low-tax states? I have not noticed much evidence of it, but perhaps they should.

For example, Massachusetts has a top income tax rate of 5.3 percent, while New Jersey has a top rate of 8.97 percent. That difference of 3.67 percent shrinks to about 2.4 percent after taking into account that state taxes are deductible at the federal level, but it is still not trivial. If Paul Krugman and Eric Maskin had stayed at MIT and Harvard, rather than moving to Princeton, they each would have enjoyed about $29,000 more after taxes from winning the Nobel prize.

Saturday, April 25, 2009

Ranking Departments

Friday, April 24, 2009

Congratulations, Emmanuel

On Stock Markets and Roller Coasters

The Economix blog offers up a simulation that alleges to show a ride on a roller coaster "whose track charts the Dow Jones industrial average from October 2007 to March 2009."

But that can't be right. Stock prices are approximately brownian motion, which means they are everywhere continuous but nowhere differentiable. In plainer English, "continuous" means that stock prices an instant from now, or an instant ago, are close to where they are now. But "not differentiable" means that the direction they move over the next instant is not necessarily close to the the direction they were heading over the last instant. A roller coaster with that property would be quite a ride.

The Ideal Financial System

Thursday, April 23, 2009

Which economic system is better?

Rasmussen Reports:

Only 53% of American adults believe capitalism is better than socialism.

The latest Rasmussen Reports national telephone survey found that 20% disagree and say socialism is better. Twenty-seven percent (27%) are not sure which is better....

Republicans - by an 11-to-1 margin - favor capitalism. Democrats are much more closely divided: Just 39% say capitalism is better while 30% prefer socialism.

Buyer Beware

The Wall Street Journal:
Federal Reserve Chairman Ben Bernanke and then-Treasury Department chief Henry Paulson pressured Bank of America Corp. to not discuss its increasingly troubled plan to buy Merrill Lynch & Co. -- a deal that later triggered a government bailout of BofA -- according to testimony by Kenneth Lewis, the bank's chief executive. Mr. Lewis, testifying under oath before New York's attorney general in February, told prosecutors that he believed Messrs. Paulson and Bernanke were instructing him to keep silent about deepening financial difficulties at Merrill, the struggling brokerage giant...."Isn't that something that any shareholder at Bank of America...would want to know?" Mr. Lewis was asked by a representative of New York's attorney general, Andrew Cuomo, according to the transcript. "It wasn't up to me," Mr. Lewis said.
USA Today:
Americans need to sharpen their financial know-how to help them best use their money, especially during the current economic crisis, Federal Reserve Chairman Ben Bernanke said Monday. "As the global economy continues to experience extraordinary turbulence ... the need has never been greater for initiatives that help consumers learn to manage their money wisely," Bernanke said....Improving financial knowledge also can help protect people from scam artists, he said.

Indexing wins again

Yesterday's Wall Street Journal reports:
Investors in actively managed mutual funds for the past five years have reason to wonder what they have been paying for: A new study from Standard & Poor's finds that 70% of large-cap fund managers who use the S&P 500-stock index as a benchmark for comparison have failed to match the performance of the index over that time....The failure of active management is replicated across almost all categories, not only U.S. stock funds but also bond funds and even emerging-markets funds. What's more, those numbers are similar to the previous five-year cycle.
This phenomenon is a perennial favorite of economics professors. It is discussed in my favorite textbook in the chapter on "The Basic Tools of Finance."

Wednesday, April 22, 2009

Great Theater

I am in New York with my wife and two sons, and we just saw the new revival of West Side Story. It's great. (My 10 year old, who has probably never seen a tragedy before, said, "That's a terrible ending." Yet he loved the show and is still singing the songs.)

Bravo, Mr President!

Phil Levy points out:
For the second time in a week, the Obama administration has discarded a major campaign pledge on international economic policy. In its decision last week not to name China a currency manipulator, and now to forswear renegotiation of NAFTA, the administration avoided two potentially costly mistakes.
I am delighted. My biggest fear about international economic policy was that the President might actually follow through on his campaign rhetoric. So this news is a great relief.

More on Negative Interest Rates

Commentary on my negative interest rate piece in the NY Times (and the follow-up here) continues to pour in. To answer the most common queries: Yes, the serial-number-lottery plan was tongue-in-cheek. The goal of mentioning it was to get people thinking about whether, as a matter of first principles, zero is really an unavoidable lower bound for interest rates. And no, I am not the devil incarnate, at least as far as I know. Thank you for asking.

As to the Fed announcing a commitment to a moderate amount of inflation, let me point out that according to many macroeconomic historians, the abandonment of the gold standard was the most useful thing that the federal government did to get the country out of the Great Depression. A commitment to producing a moderate amount of inflation would be the modern equivalent of that act.

I should note that I am not alone among economists in thinking along these lines lately. Several prominent economists have been musing about the possibility of levying a fee on reserves (either total or excess reserves) held by banks. See, for example, Hall and Woodward, Edlin and Jaffee, and Scott Sumner. That fee could be described as a negative interest rate for holdings of reserves. Because this proposal does not affect the return on currency, however, it does not generate the kind of heated reaction my Times piece did.

But for precisely that reason, I am doubtful that this plan by itself would work. If reserves earned a negative return at the margin, banks would have more incentive to lend (which is the motivation for these proposals). But more lending might not be the outcome. Banks could instead discourage deposits by, for example, passing the reserve fee on to depositors. Deposits would then earn a negative return, which would give households an incentive to hold currency rather than bank deposits. Moving the monetary base from excess reserves to currency holdings, however, would yield no macroeconomic benefits. The only thing you would end up stimulating is sales of home safes.

Tuesday, April 21, 2009

President Obama's Fiscal Policy

Federal outlays and revenues as a percentage of GDP.
Source: CBO.

Solow on Posner

Monday, April 20, 2009

The Gains from Trade

Fiscal Responsibility

The Washington Post reports:
President Obama plans to convene his Cabinet for the first time today, and he will order its members to identify a combined $100 million in budget cuts over the next 90 days, according to a senior administration official....Earlier this month, both chambers of Congress passed Obama's $3.5 trillion budget outline for 2010, which includes unprecedented new investments in health care, education and energy. But the huge budget, which contemplates a $1.2 trillion deficit, has drawn the ire of small-government conservatives, who say that such high deficits jeopardize the nation's economic future.
Just to be clear: $100 million represents .003 percent of $3.5 trillion.

To put those numbers in perspective, imagine that the head of a household with annual spending of $100,000 called everyone in the family together to deal with a $34,000 budget shortfall. How much would he or she announce that spending had to be cut? By $3 over the course of the year--approximately the cost of one latte at Starbucks. The other $33,997? We can put that on the family credit card and worry about it next year.

Sunday, April 19, 2009

Observations on Negative Interest Rates

My article on negative interest rates generated more than the usual volume of email, some of it quite heated. While I cannot possibly respond to all of it, let me add a few wonkish comments about the topic, from a variety of perspectives:

1. If r is the real interest rate, then the relative price of consumption tomorrow in terms of consumption today is 1/(1+r). Is there anything in economic theory that requires this relative price to be less than one? Unless consumption goods are costlessly storable, which they aren't, I do not think so. Just as the price of apples can be more or less than the price of pears, the price of consumption tomorrow can be more or less than the price of consumption today. If people are eager to defer consumption, then consumption tomorrow could well be more expensive than consumption today--that is, the equilibrium real interest rate could be negative.

2. Most ec 10 students begin thinking about the interest rate in terms of the supply and demand for loanable funds. That works perfectly here. The recent declines in housing and stock-market wealth have increased Americans' propensity to save. That is, we have increased the supply of loanable funds. There is no reason to presume that the equilibrium interest rate consistent with full employment is necessarily in the upper right quadrant of the Cartesian plane.

3. Higher uncertainty drives up risk premiums. In a Lucas asset pricing model, a higher risk premium could occur in equilibrium with a lower risk-free rate, rather than a higher return on risky capital. As uncertainty increases, the risk-free rate could easily be pushed into the negative region. (If you need convincing on this point, see equation 3.9 in this paper.)

4. The above three points are aimed at establishing that there is nothing particularly radical in the idea of a negative real interest rate from the standpoint of economic theory. But are we really there? That is an empirical question. When I calibrate my favorite version of the Taylor rule using the most recent data, I get a target for the nominal federal funds rate of about negative 1 percent. That means an even more negative target for the real interest rate, as long as expected inflation is still positive. And given the forecasts of inflation and unemployment, we are likely to get further into the negative region in the months to come.

5. If we want to prop up aggregate demand to promote full employment, what is the alternative to monetary policy aimed at producing negative real interest rates? Fiscal policy. Essentially, the private sector is saying it wants to save. Fiscal policy can say, "No you don't. If you try to save, we will dissave on your behalf via budget deficits." That fiscal dissaving would push equilibrium interest rates upward. But is that policy really welfare-improving compared to allowing interest rates to fall into the negative region? If people are feeling poorer and want to save for the future, why should we stop them? Unless we think their additional saving is irrational, it seems best to try to funnel that saving into investment with the appropriate interest rate. And given the available investment opportunities, that interest rate might well be negative.

The New Treasury Plan

A Quick Quiz

Saturday, April 18, 2009

Going Negative

Elmendorf in Ec 10

On Monday, Douglas Elmendorf, the director of the Congressional Budget Office, will give a guest lecture in ec 1o on (no surprise) the U.S. government budget and fiscal policy. The lecture takes place at noon in Sanders Theater in Memorial Hall.

All members of the Harvard community are welcome. If you are not affiliated with Harvard but are a blog reader who wants to attend, please send me an email request. We can accommodate a limited number of guests.

Thursday, April 16, 2009

A Conference for Economics Instructors

If you (like me) teach introductory economics, or are expecting to do so soon, you might be interested in attending this economics conference. It is a one-day meeting I am running at Harvard on Friday, May 8, with the generous support of my publisher (Southwestern, a part of Cengage Learning).
The conference will include some sessions on economics pedagogy from star teachers. It will also include some sessions on recent developments in the economy, including talks from Phill Swagel (who until recently was Assistant Secretary of Treasury for Economic Policy) and Jeff Fuhrer (Executive Vice President and Director of Research of the Boston Federal Reserve). After lunch, participants will have the option to tour Harvard, and the day will end with a party at my home.
Interested? Click through the above link to learn more. (Please note that space is limited. We may not be able to accommodate everyone who expresses interest, and for that, I apologize in advance.) If you have any questions, feel free to contact Brian Joyner at

A Letter to the Pigou Club

From Congressman Bob Inglis:

Dear Pigou Club Members,

A revenue-neutral carbon tax could set up a bi-partisan triple play of this American century. We can clean up the air, create jobs, and enhance our national security.

My Raise Wages, Cut Carbon Act of 2009 cuts payroll taxes and, in equal amount, imposes a tax on carbon dioxide emissions. The tax is border adjustable and is designed to be WTO compliant.

We're conducting a "Virtual Hearing" on the Raise Wages, Cut Carbon Act of 2009 in the hopes of improving the bill before I actually file it. I've kicked off the "hearing" with an opening statement, which you can find here, along with a copy of the bill, a summary, and various white papers addressing different portions of the bill. I'd love for you to look over these materials, and then tell me what you think by posting a YouTube response to my opening statement. You can do that here.

Thank you, and I look forward to benefitting from your expertise and insights!


Bob Inglis
Member of Congress (R-SC4)

Meet the Cassandras

An Occupational Hazard

Does a higher drinking age save lives?

Wednesday, April 15, 2009

Yale Economists on the Financial Crisis

Happy (?) Tax Day

A Lecture from Robert Merton

...on the financial crisis.

From MIT World. Thanks to Arnold Kling for the pointer.

An Event at Brandeis

On Sunday, I will appear at Brandeis University. For those who live in the Boston area and might be interested in attending, here is the official announcement for the event:
Come hear a distinguished panel of experts evaluate the Obama Administration's conduct in three key areas: the economy, foreign policy, and health care.The event will take place Sunday, April 19th at 7:30 p.m. in Hassenfeld Conference Center. Dr. Greg MANKIW, professor of economics at Harvard and former Chairman of President George W. Bush's Council of Economic Advisers, will weigh in on the economy while former Ambassador and current professor international relations at BU Charles DUNBAR will discuss the Administration's foreign policy conduct. Dr. Stuart ALTMAN, former Dean of the Heller School at Brandeis and former Deputy Assistant Secretary for Health Policy, will comment on health care legislation, including the prospects and substance of a viable reform bill. Additionally, Dr. Peniel Joseph, professor of African and Afro-American Studies at Brandeis and a commentator on PBS, will moderate the event and provide historical background on the concept of a president's "100 Day's." Refreshments will be served.

Tuesday, April 14, 2009

Hall and Woodward on Fed Policy

Good Company

A reader writes in:
Found an article about you and John Maynard Keynes in the centerfold of the Barbados Advocate Business Monday. It also mentions the use of your Macro-Economics text for First year economics at our U.W.I. Cave Hill Campus. If you've not yet had the chance you should come visit sometime.
Yes, indeed! I wish all the talks I gave were in venues as enticing as Barbados.

Monday, April 13, 2009

Goodbye, Facebook

I have decided to deactivate my Facebook account.* For the past couple years, I have used the account for the sole purpose of accumulating "friends." Now, Facebook tells me that I have reached my upper limit! So there is little point in keeping the account. Going forward, if you want to be my friend, you will have to come to Harvard Square and meet me face to face.
*As soon as I can figure out how. Right now, Facebook gives me an error message every time I try to deactivate. There appears to be no escape.

Job Opportunity

Thanks to Professor David Cushman of Westminster College for sending this along.

Redefining High School Economics

Many states require some study of economics as part of the high school graduation requirements. A bill being considered by the California legislature would redefine what that means:
Existing law provides that no pupil shall receive a diploma of graduation from high school who, while in grades 9 to 12, inclusive, has not completed a one-semester course in economics. This bill would require 1/2 of that course to focus on personal finance and financial literacy.

A reader writes in:

I am a high school economics teacher, and a board member of the non-profit CCEE (California Council on Economic Education) whose mission it is to support economic education at all levels throughout our state. As you might expect, we (CCEE) are against this legislation. Whereas personal finance is one important application of the core economic principles, it should not replace economic curriculum -- which is what this legislation would result in. We believe that students' understanding of cost/benefit analysis, opportunity cost, how markets works, etc., is more important for the high school class (i.e. it should be the core concepts of an introductory college econ class).

Any thoughts or help? Your voice, especially as a former member of AP test development committee, would be powerful. (And if you're wondering, yes, I do use your textbook, which my students have found incredibly helpful!)

I agree with this teacher that this law would be a step in the wrong direction. The legislation is akin to requiring high school biology teachers to spend half their class time on issues of personal health and nutrition. Personal finance is a useful life skill, but students need a more thorough grounding in other basic economic principles than what can be learned in the other half of a single semester course. They need a framework to think about such as topics as market outcomes, price controls, taxes, international trade, environmental regulation, monetary and fiscal policy, and so on. The goal of high school economics should be to produce not just smarter decision makers at a personal level but better informed voters on election day.

Sunday, April 12, 2009

Unintended Consequences

From The Nation (via Core Econ):

Thanks to an obscure tax provision, the United States government stands to pay out as much as $8 billion this year to the ten largest paper companies. And get this: even though the money comes from a transportation bill whose manifest intent was to reduce dependence on fossil fuel, paper mills are adding diesel fuel to a process that requires none in order to qualify for the tax credit. In other words, we are paying the industry--handsomely--to use more fossil fuel. "Which is," as a Goldman Sachs report archly noted, the "opposite of what lawmakers likely had in mind when the tax credit was established." ...

The origins of the credit are innocent enough.... [The 2005 transportation bill] included a variety of tax credits for alternative fuels such as ethanol and biomass. But it also included a fifty-cent-a-gallon credit for the use of fuel mixtures that combined "alternative fuel" with a "taxable fuel" such as diesel or gasoline....

"You use the toilet every day," said one hedge fund analyst who's been closely following the issue. "Imagine if you could start pouring a little gasoline into the bowl and get fifty cents a gallon every time you flushed."...

Whether or not Congress gets around to turning off the spigot, the episode is a useful reminder of the persistently ingenious ways the private sector can exploit even well-intentioned legislation. Considering that the success of the Treasury's recently announced plan to rescue the financial sector depends, in part, on the private sector not gaming the rules, the black liquor story seems particularly germane.

Happy Easter!

Saturday, April 11, 2009

Another Casualty of the Downturn

Tufts suspends need-blind admissions:
The Office of Undergraduate Admissions reported a 4 percent drop in applications this year....a 13-percent drop in applicants who did not apply for financial aid.

Where do economists come from?

Now is the time of year when many high school students are deciding where to attend college. If you are in this position and are considering a career as an economist, you might find of interest this article on "The Undergraduate Origins of Ph.D. Economists." An excerpt:

Top American Sources of Eventual Economics Ph.D.s
  1. Harvard University
  2. University of California-Berkeley
  3. Cornell University
  4. Stanford University
  5. University of Wisconsin-Madison
  6. University of Michigan
  7. Swarthmore College
  8. Yale University
  9. Princeton University
  10. MIT
Institution Size Normalized Top American Sources of Eventual Economics Ph.D.s
  1. Swarthmore College
  2. Agnes Scott College
  3. Grinnell College
  4. Carleton College
  5. Williams College
  6. Harvard University
  7. Macalester College
  8. Princeton University
  9. Trinity University
  10. MIT

In Praise of Pirates

Who needs help with health insurance?

Friday, April 10, 2009

My Whereabouts

Today I am attending the NBER Macro Annual Conference.

Thursday, April 09, 2009

An Exercise in Game Theory

A great video (via Cheaptalk) to use when teaching the prisoners' dilemma, dominated strategies, Nash equilibrium, etc.

Update: Several readers have emailed me to point out, correctly, that the game in this video differs from a prisoners' dilemma because one strategy is weakly, rather than strictly, dominant. Problem: List all the Nash equilibria. How does the analysis change if I, as a player, am slightly altruistic toward the other player (or slightly vengeful)? What if I think the other player might be slightly altruistic toward me? The situation is wonderful for class discussion.

Siegel on Stock Market Valuation

A couple months ago UPenn economist Jeremy Siegel penned a Wall Street Journal op-ed on stock market valuation and problems in the standardly computed price-earnings ratio. When I first read it, I did not find the arguments were very persuasive. Now, in a new op-ed at Yahoo, Jeremy responds to his critics. This time he comes closer to convincing me that he is on to something. The argument from Bob Shiller, cited by Jeremy in the second article, about stock shares as options makes sense. If you are interested in the issue of stock valuation, click through to the two op-eds and read them in order.

Wednesday, April 08, 2009

What are supply shocks?

In response to the new chapter in my intermediate macro text, NYU economist Dave Backus emails me a great question:


Thanks for this, it's the clearest exposition I've seen. It's my problem, not yours, but I'm still confused about NK models, despite bothering Gertler and Gali regularly with questions. The main issue is supply. Wouldn't most things that shift DAS also shift the long-run value Ybar? One way to put this is the contrast between your Figs 14-5 and 14-6. Why wouldn't an increase in (imported) oil prices work like a drop in TFP? Isn't that the mistake the Fed made in the1970s, trying to resist a shift left in Ybar? Or think of Greenspan's question in the late 1990s about whether the increase in output was also an increase in Ybar-- probably not, looking back, but it was a good question. I may have missed something obvious, but despite your usually lucid exposition, it's not clear why v might shift DAS but not affect Ybar. Is this totally clueless?

Cheers, Dave

Dave raises a question that I, along with much of the new Keynesian literature, have struggled with in recent years: What is the distinction between a shock to potential output (aka the natural level of output) and a shock to the Phillips curve?

Under some sets of assumptions, there is no such distinction. In this case, the Phillips curve equation relates inflation to expected inflation and the output gap (the deviation of output from potential) without any error term. Monetary policy is particularly easy in this situation. Stabilizing inflation will also stabilize output at its natural level. The central bank does not face any tradeoff between stability in inflation and stability in the output gap. Olivier Blanchard and Jordi Gali have called this situation the "divine coincidence."

Many economists, including Blanchard and Gali, doubt that this simple case describes the world. So what is one to do? It is common to tack an additional shock onto the Phillips curve equation, which automatically makes the divine coincidence disappear. But one might wonder where, at a deeper microeconomic level, this shock comes from.

Some new Keynesian modelers build in this shock as a "markup shock." That is, with monopolistic competition, price is a markup over marginal cost. Rather than assuming this markup is constant, it could be time-varying. (Formally, you could have a stochastic elasticity of substitution among the various goods.) In this case, the natural level of output could be defined as the level of output when the markup is at its average level; it would be influenced by productivity, for example, but not the current markup. Inflation would be a function of expected inflation, the output gap, and the markup shock. In this case, because of the markup shock, the central bank faces a tradeoff between stabilizing inflation and stabilizing output at its natural (and welfare-appropriate) level, which does not change in response to the markup. Examples of papers incorporating stochastic markups include Steinsson and my article with Ball and Reis, although there are many others as well.

You might wonder whether the idea of a markup shock makes sense empirically. The fact that OPEC was an oil cartel exercising monopoly power with varying degrees of success is perhaps a good example of time-varying markups. But I would not push this argument too hard.

I suspect that the real answer is that these markup shocks are proxying for something funny going on within the price-adjustment process. I have a couple of things in mind. Blanchard and Gali have tried to build in real wage rigidities and get a kind of endogenous markup shock from that feature of wage adjustment. Alternatively, some years ago Larry Ball and I suggested that shocks to the Phillips curve might result from the interaction between the distribution of relative-price shocks and the price adjustment decision in a menu-cost environment. The result is a kind of transistory markup shock.

The bottom line: Great question. The literature is only beginning to figure out what the answer might be.

Faith-based Economics

Thanks to the reader who sent this in.

Tuesday, April 07, 2009

More on the Treasury Plan

Harvard Presidency as a Part-time Job

One of my Harvard colleagues was struck by a sentence in yesterday's NY Times story about Larry Summers:
Among these insiders are Kenneth D. Brody and Frank P. Brosens, the founding partners of another hedge fund, Taconic Capital Advisors, for whom Mr. Summers did consulting work from 2004 to 2006.
Larry was president of Harvard until June 2006. Is it really possible that Larry did consulting work for a hedge fund during his famously controversial stint as head of Harvard? Or did the NY Times get the facts wrong?

Update: A reader more knowledgeable about the lives of university presidents than I am suggests to me that university presidents often sit on corporate boards and that consulting is no different. Perhaps so, but I am mildly surprised. Given the vast complexity of modern universities like Harvard, I would have expected (and I think I would have preferred) to pay the heads of these institutions enough so that they could focus all of their attention on university issues.

In other words

My supertalented editor Jane Tufts sends me this amusing email:
I was reading an article about Bach's Mass in B Minor and came across this sentence. You can imagine what the previous sentences were like if this is the "In other words" sentence.

"In other words, the work is among those that most openly manifest, in its almost exaggerated monumentality (certainly inappropriate for liturgical use) and its unfathomable many-sidedness, the concord of ideas, the harmony of gestures and the rational pact of alliance that composes every internal contradiction, every external dissension."

Monday, April 06, 2009

The Four Pillars of Sound Policy

Macro 7e

The 7th edition of my intermediate macroeconomics textbook is coming out this summer, ready for fall classes. As well as being updated for current events, including the recent housing bubble and financial crisis, the book has a new chapter, called A Dynamic Model of Aggregate Demand and Aggregate Supply. The model is intended to give the student a basic understanding of modern DSGE models. You can read the page proofs of the new chapter by clicking here. (These page proofs are uncorrected. Don't worry: I will be sure to fix all the typesetting errors before publication.)

If you teach macroeconomics and would like to consider the 7th edition for your course, please contact Scott Guile at

Sunday, April 05, 2009

Parsing the G-20

When world leaders meet, the result is usually a lot of cheap talk. But Keith Hennessey does a nice job demonstrating how the cheap talk has changed with the switch in administration. Be sure to click through the link and read what Keith has to say. Substantively, the change in language is no big deal, but it demonstrates the difference in mind-set between Team Bush and Team Obama.

Picking Winners

Bernanke's Gamble

Cowen on Bailouts

Prehistoric Debate

"Animal Spirits"

Saturday, April 04, 2009

Hoover did it!

UCLA economist Lee Ohanian sends me a paper called "What - or Who - Started the Great Depression?" with the following conclusion:

The defining characteristic of the Great Depression is a substantial and chronic excess supply of labor, with employment well below normal, and real wages in key industrial sectors well above normal. A successful theory of the Depression must explain not only why the labor market failed to clear, but why monetary forces apparently had such large and protracted effects. This paper proposes such a theory, based on President Hoover’s program that offered industrial firms protection from unions in return for paying high wages. Firms deeply feared unions at this time, reflecting a growing union wage premium and a sea change in economic policy, including policies advanced and supported by Hoover, that significantly fostered unionization and enhanced their bargaining power. Consequently, there was an incentive for firms to follow Hoover’s program of paying moderately higher real wages to avoid even higher wages and lower profits that would come from unionization.

I conclude that the Depression is the consequence of government programs and policies, including those of Hoover, that increased labor’s ability to raise wages above their competitive levels. The Depression would have been much less severe in the absence of Hoover’s program. Similarly, given Hoover’s program, the Depression would have been much less severe if monetary policy had responded to keep the price level from falling, which raised real wages. This analysis also provides a theory for why low nominal spending - what some economists refer to as deficient aggregate demand - generated such a large depression in the 1930s, but not in the early 1920s, which was a period of comparable deflation and monetary contraction, but when firms cut nominal wages considerably.

Presidents Hoover and Roosevelt shared similar goals of fostering industrial collusion and increasing real wages and raising labor’s bargaining power. Hoover accomplished these goals during a period of deflation by inducing industry to maintain nominal wages, and by promoting and signing legislation that facilitated union organization and that increased wages above competitive levels, including the Davis-Bacon Act and the Norris-Lagaurdia Act. Roosevelt accomplished these goals with the NIRA and the Wagner Act, both of which raised wages well above competitive levels while increasing industrial collusion.

The 1930s would have been a better economic decade had government policy promoted competition in product and labor markets, rather than adopting policies that extended monopoly in product markets, and that set wages above competitive levels which prevented labor markets from clearing.

I do not have a link to the current draft of the paper, but here is Lee's webpage.

If this analysis makes you start thinking about the macroeconomic effects of card check, you are not alone.

My Whereabouts

I will be talking today at the Harvard Pre-Collegiate Economics Challenge.

Guess who?

"In addition to his $5.2 million in salary and other compensation from D.E. Shaw, [he] received $586,996 in salary from Harvard University."

Answer here.

Friday, April 03, 2009

Boskin on the Obama Budget

Stanford economist Michael Boskin:

The CBO baseline cumulative deficit for the Obama 2010-2019 budget is $9.3 trillion. How much additional deficit and debt does Mr. Obama add relative to a do-nothing budget with none of his programs? Mr. Obama's "debt difference" is $4.829 trillion -- i.e., his tax and spending proposals add $4.829 trillion to the CBO do-nothing baseline deficit. The Obama budget also adds $177 billion to the fiscal year 2009 budget. To this must be added the $195 billion of 2009 legislated add-ons (e.g., the stimulus bill) since Mr. Obama's election that were already incorporated in the CBO baseline and the corresponding $1.267 trillion in add-ons for 2010-2019. This brings Mr. Obama's total additional debt to $6.5 trillion, not his claimed $2 trillion reduction. That was mostly a phantom cut from an imagined 10-year continuation of peak Iraq war spending.

The claim to reduce the deficit by half compares this year's immense (mostly inherited) deficit to the projected fiscal year 2013 deficit, the last of his current term. While it is technically correct that the deficit would be less than half this year's engorged level, a do-nothing budget would reduce it by 84%. Compared to do-nothing, Mr. Obama's deficit is more than two and a half times larger in fiscal year 2013. Just his addition to the budget deficit, $459 billion, is bigger than any deficit in the nation's history. And the 2013 deficit is supposed to be after several years of economic recovery, funds are being returned from the financial bailouts, and we are out of Iraq.

A Ranking of Blogs

An Upside of Downturns?

Surfer Magazine reports:

Fewer Shark Attacks - Thank The Economy

A recent report from the International Shark Attack File at the University of Florida cited the recession as the reason for a decline in shark attacks last year.

“Shark attacks worldwide in 2008 dipped to their lowest level in five years, a sign that Americans may be forgoing vacation trips to the beach,” the report said.

Thursday, April 02, 2009

My Whereabouts

I will be at a Brookings conference over the next two days, watching the presentation of six excellent papers.

Check out in particular the paper by Phill Swagel. It gives an insider's view of the recent debates over financial policy.


From my inbox:

Dear Mr Mankiw,

i'm an italian student, i'm studying law in the university of turin and right now i'm reading your book for an exam of political economy.. and i wanted to thank you because even if my professor almost made me dislike this subject..reading "principles of economics" i'm understanding and loving it.. every page i'm more enthusiastic!

[name withheld]

Econ profs: I am sure none of your students feel this way about your lectures. But, even so, if you aren't using my, and this student's, favorite textbook, maybe it is time for a change. You can get information about the book by clicking here or by emailing

Wednesday, April 01, 2009

Stiglitz on the Geithner Plan

Joe says no go: "the Geithner plan works only if and when the taxpayer loses big time."

Newest Members of Team Obama

My Last Free Post coming soon.

With Harvard having lost so much of its endowment lately, the university has asked me to stop providing this blog free of charge. Starting shortly, therefore, this blog will be available only to Harvard students and alumni and to others who subscribe via the new Harvard-bloggers program. All revenue from this program will be split between building the new Allston campus and providing students hot fudge sundaes on alternate Thursdays and every day during exam periods.

To obtain your subscription to this blog, please click here.

Update: Please, please, please, no more irate emails before you click on the link to check out the price.

Market-based Financial Regulation