The Economics of George Orwell

Diane Coyle has a nice review of Richard Thaler's new book,  Misbehaving. Diane's review is, for the most part, appropriately laudatory. But she does voice a concern that I share. Here is Diane...

"Behavioural economics is now one of the most popular areas of the subject, ... but the new embrace by economists makes me uneasy. This is not just because of the well-known debate about paternalism (as discussed by Gilles St Paul in The Tyranny of Utility or Julian LeGrand and Bill New in Government Paternalism: Nanny State or helpful Friend?) It is because the sight of economists delighting in a new tool to engineer society is alarming –"

I agree. Here is a quote from my review of Akerlof and Shiller's 2009 book Animal Spirits, another piece that draws on behavioural economics to engage in social engineering. 

Akerlof and Shiller want to replace rational choice with behavioural economics. And here is what they mean by that...

“Behavioural economists assert that what makes individuals truly happy can be different from what they in fact choose to do. In Akerlof and Shiller’s words, ‘...capitalism...does not automatically produce what people really need; it produces what they think they need...’ (p. 26).”

To a classical liberal like me, this is a scary proposition since it gives a licence to someone else, someone who knows my true preferences, to act on my behalf. Is this the government or the church? Both institutions have claimed that right in the past, with disturbing outcomes. The idea that the government knows my preference better than I do is a little too  Orwellian for me. 

I went on to criticize Akerlof and Shiller for tearing down too much of classical theory and failing to replace it with a credible alternative. You can read my full review here. 

In my view, we can understand all of the failures of classical macroeconomics without giving up on rational choice. Heres what I said in 2009

I personally find it much more credible to believe that markets may sometimes misallocate resources and that this misallocation is directed by self-fulfilling crises of confidence. There is an existing agenda (part of neo- classical economics) that integrates psychology with economics by constructing economic models in which market fundamentals do not uniquely determine outcomes. In these models, it is the self-fulfilling beliefs of market participants that fill the gap. In my view, this idea of a self-fulfilling belief is a more appropriate candidate for what one should mean by animal spirits than the ... alternative meanings proposed by the authors. This narrower established definition is already widely used by a large existing body of researchers.

Here is a link to a survey paper that discusses this alternative approach.

Multiple Equilibria and Financial Crises

In May of this year, Jess Benhabib and I organized a conference at the Federal Reserve Bank of San Francisco with much help from Kevin Lansing at the Fed. Many thanks Kevin!

Kevin has just sent me a link to a website put together by the Fed with links to all of the papers, including slides of presenters and discussants plus a video of Karl Shell's dinner talk on the history of sunspots. The conference was sponsored by the NBER, UCLA and NYU. Many thanks to all who helped make this possible. 

Running a Surplus in Normal Times is Keynesian

In a recent letter to The Guardian, a coterie of mainly English academics has criticized George Osborne's Mansion House speech in which he proposed to run a budget surplus in normal times. 

Mansion House

According to the letter writers, 

The chancellor’s plans, announced in his Mansion House speech, for permanent budget surpluses [my italics] are nothing more than an attempt to outmanoeuvre his opponents (Report, 10 June). They have no basis in economics. Osborne’s proposals are not fit for the complexity of a modern 21st-century economy and, as such, they risk a liquidity crisis that could also trigger banking problems, a fall in GDP, a crash, or all three.

I have searched for details on the Osborne plan, but they are sketchy. There is no mention in the speech of 'permanent budget surpluses'. Instead, the Chancellor proposes that the Treasury should run surpluses in 'normal times'. He suggests that the Office for Budget Responsibility, should define what 'normal' means. The OBR may not be the best independent body to fulfill this role, but I can certainly see a role for some independent body to recommend when it makes sense to run a current account deficit.

As far as I can see, Chancellor Osborne is proposing to relinquish political control of the fiscal reins in much the same way that Gordon Brown relinquished control of the monetary reins when the Bank of England gained independence in 1997. There is a clear temptation for elected governments to spend in response to electoral cycles and some kind of independent body that keeps that temptation in check is, in my view, a good idea.

Sensible fiscal policy demands that a government should be prepared to run deficits in recessions, but that during normal times, expenditures on non-capital items should be in surplus. Interpreted in this way, the Chancellor's proposal is one that is very much in line with Keynesian economics. 

Keynes' views on fiscal policy are summarized in Volume 27 of his collected works, to which I do not have immediate access. The following is a second-hand quote from the article by Brown-Collier and Collier, "What Keynes Really Said about Deficit Spending", published in the Journal of Post-Keynesian Economics.

Keynes distinguishes public investment, which he wants to be chosen on a cost-benefit basis, from current expenditure, which should not be financed from deficit spending.

Lets not judge the Osborne plan before it is fleshed out in more detail. Running a surplus in normal times is, after all, an essentially Keynesian proposition.  

How to Fix the Banks: Revisited

The bankers are angry. They feel the regulations designed to prevent another meltdown are cramping their style. Their bonuses are down. I agree. Red tape is not the way to save the banking system.

The banks engaged in a freewheeling orgy of unregulated risk taking for two decades. And when the world crashed: they expected, and received, bailouts. But we don't need to bash the banks to save the system.

As a society, we do not have a stake in saving HSBC. We do not have a stake in saving Barclays, or RSBC, or Lehmann Brothers, or Bank of America. But we do have a stake in saving the banking system. Here is a link to a piece I wrote in 2009 on how to do that.

GDP: A Brief But Affectionate Review

For a neo-paleo-Keynesian like me, the first week of an undergraduate macroeconomics lecture is taken up with accounting: Tedious but necessary. What is GDP? How is it different from GNP? National Income? How do we measure it? Does it matter? I've always struggled with outside readings to fill this material out and make it interesting. Now I have one. Diane Coyle has written a timely and very readable little tome about her love affair with national income accounting. It's very short, and you will be able to gobble it down in an afternoon. I did, while whiling away a few hours on a flight.

Why? You say! How could this be interesting? It's interesting because it has a lot to say about the current controversy over productivity. Unemployment is almost back to normal in the UK and the USA. But Real GDP is lagging well behind trend. How could this be?

We have been drinking the index-number cool-aid for so long that we have forgotten how difficult and ambiguous it is to construct a measure of aggregate product in a world where more than 60% of GDP is intangible: as Diane would say, it is weightless.

It is tempting to give up entirely on measuring real GDP and implicitly on economic growth. One might argue that we should be far more concerned about resource utilization than about the number we attach to an increasingly diverse bundle of differentiated commodities. Unemployment matters. What we produce, in a modern market oriented economy, arguably, matters less.

If we are interested primarily in resource utilization, the stuff of business cycles, there is an alternative to standard measures of real GDP. We can divide nominal GDP by a wage index, instead of a price index. Labor has a least a semblance of homogeneity and aggregating the time input of doctors with that of burger flippers is surely easier that adding plum puddings to computer chips. I showed how to do this, in a recent book, by using national income accounting data to estimate the money wage: My wage index data is available here.

I do not want to suggest that we should stop trying to measure growth. Economic progress is an important idea as 1.5 billion Chinese can attest to. If we must be metaphorical bean counters, and there are few alternatives to counting progress, there is no alternative but to bite the bullet and produce the best measures of an aggregate price index that we can. But as Diane reminds us, small revisions to our measurement methods can cause very large revisions of our estimates. Let's not be too concerned when our index numbers temporarily misbehave.