Fiscal stimulus vs. quantitative easing

I've been puzzled by many things surrounding the rancorous macroeconomic debate.  One has been the relatively subdued debate on the optimal balance between fiscal stimulus and unconventional monetary policy (aka, quantitative easing).  Long ago I expected a modern revival of Keynes vs. Friedman monetarist debate.  There was some discussion but it has seemed subdued relative to what I would have expected.  My impression was that this didn't happen because it seems most conservatives don't like either fiscal policy or aggressive monetary policy (yet another puzzle).  I also thought that, maybe, the liberal-moderate wing of economists preferred fiscal stimulus because they thought the size of government was probably a little too small anyway.

But now I think the truth is we know little about quantitative easing and this makes economists of all stripes nervous.  And what little is known isn't especially encouraging.  In any case, I like the fact that Krugman has responded to those asking for more discussion on the subject:

Does unconventional monetary policy solve the zero bound problem?

Some comments on my post on the true cost of fiscal stimulus argue that the zero lower bound aka liquidity trap isn’t really binding, because the Fed is using other measures to expand the economy. A few commenters imply that I haven’t been paying attention.

Well, yes I’m aware that BB is doing a bunch of unconventional stuff. But the available — albeit thin — evidence is that it takes a huge expansion of the Fed’s balance sheet to accomplish as much as would be achieved by a quite modest cut in the Fed funds rate. And the Fed isn’t willing to expand its balance sheet to the $10 trillion or so it would take to be as expansionary as it “should” be given, say, a Taylor rule.

Which means that the zero bound is still binding, which means that right now we’re very much still in liquidity trap territory.

Jim Hamilton also seems to think there is a limit to what the Fed can do.  I really respect Jim Hamilton's views because he focuses squarely on the facts and it is impossible for me to tell whether he leans left or right politically--two things I like a lot in economists.

Costs of cap and trade, a few links

I'm not super current on the details of the Waxman-Markey bill.  But here are a few must read links:

CBO analysis of costs (CBO is reasonably objective, in my view)
Heritage foundation analysis (what you can always expect from Heritage)
EPA analysis
Review of McKinsey research
Krugman:  It's easy being green
Krugman: Pigou, Glenn Beck, and the false case against cap-and-trade
Krugman: The textbook economics of cap-and-trade
A series of nice posts by Robert Stavins

Something I really need to understand better:  how emissions permits allocated to electricity companies are passed through to consumers in the form of lower electricity prices.  This doesn't seem to get all the incentives right.  I really wish (hope?) they somehow impose multi-tiered pricing wherein the marginal price increases sharply with level of use.  This could keep the burden low while providing strong incentives for energy efficiency.  

Implications of Climate Change on Food Crops

Last week Food Technology Magazine asked me to do a little write up for their blog. If you've read my earlier posts about my work with Wolfram Schlenker on potential climate change impacts on crop yields, there isn't much new here.  But since I'm swamped and don't have time to post anything else right now, here it is:

In a recent study, Wolfram Schlenker and I set out to develop a better statistical model linking weather and U.S. crop yields for corn, soybeans, and cotton—the largest three crops in the U.S. in production value. Corn and soybeans are of particular interest because they are really important for global food prices and the U.S. contributes about 40% of the world’s production of these crops, and a much larger share of world exports for these crops. The goal was to find the causal links between observed climate and yields so that we might predict how yields will change as the climate changes.
The novelty of our work is that it carefully accounts for variation in temperatures over time and space. This contrasts with earlier studies that compare yields to average weather outcomes, like average temperature. The problem with averages is that they dilute nonlinearities—effects of the extremes—that are clearly important for crop growth and yield.

Findings
Our major new finding is that extreme heat is critical to yield outcomes. A key measure of extreme heat is given by how much temperatures exceed about 29°C (84°F) during the growing season. The threshold varies somewhat by crop—29°C (84°F) for corn, 30°C (86°F) for soybeans, and 32°C (90°F) for cotton. Below the threshold, warmer temperatures are more beneficial for yields; damages stemming from temperatures much above the threshold can be staggeringly large.
Another important finding is that the non-linear relationship between weather and yields across time in a fixed location is nearly an identical match to the non-linear relationship found when comparing weather distributions and yields across locations with different climates. This indicates farmers in southern areas have been unable to adapt to their warmer climates.
When we use the estimated relationship to predict yield outcomes under projected climate change scenarios, we find that between 2070 and 2099 nationwide average yields on corn, soybeans, and cotton are projected to fall 30–46% under the slowest Hadley III warming scenario and 63–82% under the fastest Hadley III warming scenario. Predicted declines are substantial even in the more immediate future (2020–2049).

Implications
What are the implications of these dramatic findings? Well, it’s hard to tell. The results should provide good motivation for seed companies and plant scientists to develop more heat tolerant plants. Some think CO₂ fertilization will offset a large portion of losses from climate change. But it also seems clear that farmers will want to change the kinds of crops they grow and possibly their planting dates. It’s also possible gains in cooler parts of the world will offset losses in the U.S. The extent to which new areas become arable will determine how crop prices will change. To me, the inescapable conclusion is that the magnitude of climate changes currently anticipated will cause the face of agriculture worldwide to change dramatically. And to some extent this is true regardless of whether or not we markedly reduce CO₂ emissions in the near future.

A proposed new definition of macroeconomics

Krugman on Skidelsky's proposed definition of macro:

[M]acroeconomics should be defined as the field that studies those areas of economic life in which irreducible uncertainty, uncertainty that cannot be tamed with statistics, dominates.

Krugman gives the impression that he disagrees with this definition.  I hope he disagrees.  Sheesh.  This definition could apply to almost any field of economics.

Although an increasing number of economists are becoming wedded to the idea that the only kind of empiricism that should be done in economics involves randomized controlled experiments or nearly ideal natural experiments, for which uncertainty can more-or-less be statistically quantified in an objective manner (Heckman might disagree), this is still the minority.  While I appreciate experiments and natural experiments, I find other kinds of modeling and empiricism valuable, and so do, I suspect, most economists of all stripes.

Still, this looks like an interesting book.  Let's see if it's on Kindle...

Toxic waters

The New York Times is doing a nice series on water pollution.  In my circles the problems with agricultural waste have been well known for a long time.  See, for example, these reports from USDA-ERS from a few years back [1, 2, 3]. It's become more of a concern as the livestock industry has rapidly become more concentrated.  With lots of animals in a small area it effectively creates a pretty serious sewage problem.  North Carolina was on the front lines of the rapidly concentrating hog industry so these problems have been around here for awhile.  The Times seems to focus on dairy, which has become concentrated more recently.  My understanding (I haven't looked at the data) is that Idaho--the focus of one of the Times videos--is getting more dairy because their regulations are less strict.

Anyway, it's nice to see some national attention given to this problem.  My impression is that most do not realize how important agriculture is for water quality.

There are zillion epidemiological and economic studies looking at air pollution but I've seen much less on water.  Actually, the only person I know that is attempting to use quasi-experimental methods now fashionable in empirical economics is  Stacy Sneeringer (ungated copies of her papers can be found here). Stacy is visiting USDA-ERS and I just spoke with her last week.  The challenges include complicated geology and thin and poor water quality data.  Still, for aspiring number crunchers, there's plenty of room for more research on this topic.

Fine scale weather data for the continguous United States

My coauthor Wolfram Schlenker and I are making our fine-scale weather data publicly available for all who want to use it.  These are the data we used in our PNAS study of crop yields.

The raw data files give daily minimum and maximum temperatures and total precipitation on a 2.5x2.5 mile grid for the contiguous United States from 1950-2005. The data set is massive (60GB as zipped files, approximately 300GB unzipped).  We had hoped to post all the data on a website but it's just too big.  Instead, we have put the data onto 8 DVDs and we are happy to ship them to you.  Just send one of us an email.

A website documenting the raw data and how to use them is located here.  The site includes STATA computer code that can be used to transform the raw temperature data into degree day measures with bounds of your own choosing.

We hope many find these data useful.

About the Great Marcoeconomic Debate

The increasingly snarky debate between so-called saltwater and freshwater macroeconomists seems to be drawing the irk of some of my colleagues walking the halls of my institution.   The public airing of our dirty laundry seems to make some uncomfortable.

For context, here's my earlier short post and a great compilation of the Great Debate by Mark Thoma.

I sympathize with my colleagues, but feel differently.  I actually find it all fun and interesting, even if the snark is too thick.  (Maybe this is easier for me to stomach as a non-macro specialist.)  In the long run we'll remember the substance as much as the snark, and the substance will stick.  Airing dirty laundry is good for the profession because it provides full transparency.  With full transparency and the lightning-quick back-and-forth of the internet, no longer will it be possible for economics students to be indoctrinated into any particular school of thought without easily checking out what the other side has to say.  Reclusiveness is bad for science and, if nothing else, the public food fight kills reclusiveness.  So bring it on!

A few of my random thoughts about all of this:

1) In some ways the "failure" of macroeconomics has been exaggerated.  I  believe most macroeconomists are nonideological and much of the macroeconomic consensus remains intact.  The great majority still believe, I think, that monetary policy should be the main tool used to combat business cycles when we are not at the zero lower bound of interest rates.  And since we don't hit the zero-rate lower bound very often, most are mostly on the same page. To a large extent, Friedman's monetarist position stands.

2) There would seem to be more disagreement about what to do if interest rates fall to zero.  But the quality of that debate hasn't been as good as it should have been.  Part of the problem is that the freshwater side seems to be ignoring the zero-rate dichotomy (what to do at the zero lower bound).

3) I still don't think conservative economists have made enough or clear enough arguments about alternatives to fiscal policy at the zero lower bound.  I think (though I'm not a macro guy) that monetarist alternatives are still on the table, they're just really strange alternatives.  Krugman and other saltwater folks are kinda ignoring these alternatives and they're not being called on it, or at least not very effectively.

4) There have been more wild and unsubstantiated claims coming from the right as compared to the left (e.g., Casey Mulligan's argument about spontaneous laziness causing recessions--okay he didn't say it exactly like that, but what he said is pretty close and equally and obviously ridiculous; Cochrane's overly dismissive view of Keynesian ideas as "fairy tales"; multiple claims that fiscal stimulus exaggerates the size of recessions in light of substantial theory and evidence to the contrary; Posner's bad math and false claims of ethical breaches by Romer; and so on...).  The full-fledged rational-exptations-to-the-hilt, no-sticky-prices, true believers need to face up to reality.

5) I don't think Krugman is being shrill (well, maybe a little) or political to call these guys (in 4) on their unsubstantiated (and clearly political) extremism.  While Krugman has some pretty strong political views, he does a pretty good job laying out a strong intellectual basis for his position and navigating back and forth between theory and evidence.  In contrast, the other side is ignoring compelling theory and compelling evidence that strongly contradicts their positions.  And then they accuse Krugman of political hackery?  Uhm, who's the teapot calling the kettle black?

6) Following up from (3), there must be some good intellectual counterpoints to the stimulus-loving saltwater front and they should be made.  But politically conservative economists aren't making those arguments, or at least they aren't making them very well.  Ken Rogoff may be an exception, but he just doesn't seem to be drawing the wide attention of other conservative economists.  It seems to me Greg Mankiw is the one to do it.  But his posts are just too thin and oblique.  I think reality-based conservatives need to be making better monetarist arguments--inflation targeting and all that.  Maybe they don't want to offend their more extreme Ron Paul (Austrian?) followers who overly fear inflation and long for a return to the gold standard.  I'm speculating; I don't know.  Vigorous debate is good.  But substance so far has been unduly one-sided because, for some unknown reason, the other side isn't being very clear or convincing. For example, John Taylor seems to contradict his own Taylor Rule.  I think his Rule is currently screaming for the printing presses yet he seems to claim the Fed is being too loose with money.  I just don't get it.

7) I actually thought Krugman's piece was pretty balanced.  He's not simply embracing Keynesianism.  He's also saying where Keynesians and New Keynesians fall short, and that we need to bring behavioral economics into the mix and connect macro with finace.  These seem like an inescapable truths to me.  Facts are something we need to contend with.  To some conservative economists it seems the thought of bringing psychology into economics is tantamount to giving in to liberals and socialists.  I don't see that at all.  Indeed, the Austrians would seem to embrace behavioral aspects of economic behavior.

8) Like I said earlier, I think the bubbleheads (Shiller, Krugman, many others...) don't seem to be paying enough attention to the fact that asset prices appear more rational at the height of bubbles than they do during normal times or recessions.  It would seem irrational pessimism rather than irrational exuberance is the more pervasive problem.  I think that paints things in a somewhat different light than typical bubble rhetoric.  It certainly helps us to understand why many economists didn't expect such a sharp downfall (mea culpa). They call it the equity premium puzzle in finance.  Anyway, this, I think, is a key area where behavioral economics, finance and macroeconomics need to link up.  But since I'm not a macro guy I'm certainly not the one to try doing it.

Update (9/18): I agree with the comments about inflation targeting and apparent internal political conflict among conservative economists about such a position.  But that's a poor excuse for the better scholars of that crowd.  As far as I can tell, the only viable position for conservatives is to say the Fed, despite its aggressive efforts, still did too little too late.  Here is what appears like a serious attempt at this position by Scott Sumner that will be presented at Cato and Jim Hamilton's response to it.  I'm not in a position to judge the merits.

Update (9/20): Taking the snark up another notch, here's David Levine and response by Brad Delong.

Okay, I'm really beginning to see how the snark gets in the way of substance.  The problem is the opposite side latches on to some exaggerated snark and not the surrounding substance.  Each side then reacts by responding only to the exaggerated snark coupled with a little new substance.  So the more snarky things become, both the snark and substance spiral, but there's little focused debate on substance.

So, starting with Krugman's piece, his exaggerated and snarky title really hurt the egos of the predominantly freshwater folks who have done a lot of interesting and useful stuff.  It's just questionable whether those interesting and useful things inform our recent and current macro situation. So these folks who have done some useful, interesting (and often very mathematical) things are understandably offended by Krugman.  He really should have thrown a bone.  Then his broader points (which were pretty good ones, I think) might have elicited more constructive debate.

Then the snark externality just gets larger with each iteration.  So it goes...

Sigh... the pluses and minuses of the internet era...  I still think its benefits far outweigh the costs.

This more recent post by Krugman is rather pointed but I think a lot more constructive in tone.  It matches what I recall learning in graduate school in the late 1990s.  The standard justification given for rational expectations approaches was that, especially with the apparent taming of business cycles, departures from full-rationality was just small stuff.  They had a point, until...

Mark Thoma points us to Famine

I really need read this book. Mark Thoma: "Could it Happen Again"

I've been reading a book called Famine, and they were far more common in the past than I realized. It notes that, historically, societies have been able to deal with one year of bad harvest. It's not costless, and sometimes markets or governments do not deliver the food where it is needed, but there is generally enough food in reserve to augment the poor harvest sufficiently to avoid widespread hunger (this was no accident historically, governments kept food in reserve to smooth variations is supply). But when there are poor harvests two years in a row, whether it be from natural disasters such as weather problems or human caused problems such as war, then the problems become severe. No matter how well markets or governments work, there aren't generally enough supplies in reserve to withstand two consecutive years of substantially reduced harvests.

This book, together with the financial crisis, make me wonder just how insulated modern societies are from these kinds of problems. Could the world withstand two consecutive years of food shortage? I suppose we believe, as we believed with the economy, that modern institutions and technology insulate us from such problems, it can't happen in our advanced societies. But what would happen if an unexpected volcano's emissions blocked sunlight for two harvests, or if some fungus or bacteria suddenly appears wiping out grain supplies worldwide for several years? How bad would conditions be, and how bad would fights between nations get if there truly was a worldwide food shortage?

My guess is that we are closer to the edge than we like to believe.

Based on the stylized facts I know, I believe large-scale famine could very easily happen again.  All we need is a little more demand growth from rapidly advancing countries like China and India, a little bad luck with the weather, and continued stagnation and bad governance in the some of the poorest countries.  Put it all together and, well, it seems both scary and plausible.

I really don't get tire tarriffs

Brad delong is right.  

I'm really confused by this move.  But then political economy continues to baffle me.  Maybe this is intended to buy a vote or two in the senate for the health care bill?  I could imagine that such a policy might buy a blue dog vote or two, and that could make a difference.

But on its own merits, this is a really bad idea.

Norman Borlaug--man responsible for the Green Revolution--dies at 95

What an amazing life.  I cannot think of another individual who has done more for humankind.  To say he saved a billion people could be an understatement.  Yet few even know who the guy was.  Maybe that will change now that he has died.

http://www.timesonline.co.uk/tol/news/world/asia/article6832878.ece


http://www.thelibertypapers.org/2009/09/13/norman-borlaug-the-man-who-saved-a-billion-people/

Michael Pollan says health care reform will pit insurance companies against agribusiness (in a good way)

To budding agricultural economists looking for interesting questions to dig into, read Michael Pollan. This piece in the New York Times touches on some interesting economics:

No one disputes that the $2.3 trillion we devote to the health care industry is often spent unwisely, but the fact that the United States spends twice as much per person as most European countries on health care can be substantially explained, as a study released last month says, by our being fatter....

...One recent study estimated that 30 percent of the increase in health care spending over the past 20 years could be attributed to the soaring rate of obesity, a condition that now accounts for nearly a tenth of all spending on health care...

...As things stand, the health care industry finds it more profitable to treat chronic diseases than to prevent them. There’s more money in amputating the limbs of diabetics than in counseling them on diet and exercise...

...As for the insurers, you would think preventing chronic diseases would be good business, but, at least under the current rules, it’s much better business simply to keep patients at risk for chronic disease out of your pool of customers...

But these rules may well be about to change — and, when it comes to reforming the American diet and food system, that step alone could be a game changer. Even under the weaker versions of health care reform now on offer, health insurers would be required to take everyone at the same rates, provide a standard level of coverage and keep people on their rolls regardless of their health. Terms like “pre-existing conditions” and “underwriting” would vanish from the health insurance rulebook — and, when they do, the relationship between the health insurance industry and the food industry will undergo a sea change.

The moment these new rules take effect, health insurance companies will promptly discover they have a powerful interest in reducing rates of obesity and chronic diseases linked to diet....Insurers will quickly figure out that every case of Type 2 diabetes they can prevent adds $400,000 to their bottom line. Suddenly, every can of soda or Happy Meal or chicken nugget on a school lunch menu will look like a threat to future profits.

AGRIBUSINESS dominates the agriculture committees of Congress, and has swatted away most efforts at reform. But what happens when the health insurance industry realizes that our system of farm subsidies makes junk food cheap, and fresh produce dear, and thus contributes to obesity and Type 2 diabetes? It will promptly get involved in the fight over the farm bill — which is to say, the industry will begin buying seats on those agriculture committees and demanding that the next bill be written with the interests of the public health more firmly in mind...

Pollan has a really interesting point here. While I think Pollan may be overstating the influence of agribusiness and agricultural policy on the cheap prices of unhealthy foods (something I've mentioned before [1, 2, 3]), this really could be a game changer.

Here's how I see it:

Most of the health care bills primarily target the problem of adverse selection: keeping insurance companies from cherry picking the lowest health risks, leaving those with real problems uninsured.

Fixing the adverse selection problem might exacerbate the moral hazard problem: If everyone is insured for the same price no matter what, it provides less incentive for people to take care of themselves and prevent health problems from happening in the first place. This is (I think) what makes serious Republicans go a little crazy.

Now, here the issue is more complex than most moral hazard problems because we need to put aside the idea that everyone is perfectly rational. I rather imagine that, holding all else the same, insuring everyone isn't going to make people much fatter than they already are. People really don't enjoy being fat or sick. It's that people can't help themselves.

But with mandatory pooling insurance companies may have a stronger incentive to aid prevention. And this may really work given people probably want to lose weight and be healthier anyhow. Here I can imagine insurance companies teaming with behavioral economists and psychologists to devise ways to help people eat healthier, exercise, and lose weight.

An interesting feature of this perspective is that it provides a reasonable argument against a single payer system or a large public-sector option. Private insurance companies will surely have a stronger incentive to help people be healthier than the government will. To some extent USDA is captured by agribusiness interests and would have a much more difficult time than insurance companies in implementing creative mechanisms to help people live healthier lives. It's hard to imagine how much of this will actually take place, but it is a compelling argument.

One reason for skepticism: so far insurance companies seem to have been rather unsuccessful at policing doctors from administering unnecessary care (see this excellent article). If they can't control moral hazard by doctors how will they control it for individuals? The hope, I think, is that the problem with individuals is more behavioral. People want to lose weight and be healthy; doctors don't want less money.

Note to self about climate change impacts and income inequality

Brad Delong's finger exercise could be tweaked to examine the effects of climate-change-induced reduction in agricultural productivity.

For the representative individual in the U.S. or any developed nation, the decline in agricultural productivity would be a very small deal since agricultural commodities are a very tiny share of aggregate consumption.

For the representative individual in a countries where people live on $2 a day or less and spend most of their income on agricultural commodities, it would be a very big deal.

So we need to tweak Delong's finger exercise so there are two kinds of individuals with different expenditure shares on commodities and one price. The expenditure share would be a couple orders of magnitude larger for the poor individual and demand would be more elastic, due to a larger income effect. The overall wealth impact would surely be huge for the poor individual and tiny for the rich individual.

Obama's health care speech

Obama's health care speech to a joint session of congress was as impressive on substance as it was on delivery. Even if you disagree with some specific proposals, he nailed the economics.

Is this what they call egregious moderation? Apparently to Joe Wilson.

Then there was a bizarre "fact check" in the Washington Post today in response to Obama's statement beginning: "The only thing this plan would eliminate is the hundreds of billions of dollars in waste and fraud, as well as unwarranted subsidies in Medicare...."

Supposed fact checker Lori Montgomery of the Washington Post begins by writing "This is, at best, wishful thinking." Okay. But if so, then why does she finish with "Many health-care experts view this as a promising route to cutting costs without harming care to the millions of senior citizens who rely on health care."

Thanks for clearing up the facts Lori Montgomery.

(This was in the printed version of the W.P.--sorry I couldn't find a link.)

The state of macroeconomics: It's about irrational pessimisim

Paul Krugman gives us a fabulous review of macroeconomics and current ideological debate within the field.

He also nails the cruxes of where current macroeconomics, of both Keynesian and neoclassical stripes, falls short. One problem is that current theories lack a fundamental cause for crises and ensuing recessions. Another is that current theories ignore the central role of financial market failures. The answer, he suggests, is fundamentally psychological or behavioral. To get our models right we'll need to make them less elegant. He presents a clear and compelling case.

My main criticism with Krugman's review, and more generally with his writings on business cycles, is that he doesn't acknowledge or emphasize that asset prices (stocks, houses, etc) appear most rational--in the textbook economic sense--just before the "bubble" is about to pop. During normal or more depressed times, asset prices appear too low as compared to textbook theory.

Too many overlook this essential puzzle. It seems irrational pessimism rather than irrational exuberance is the greater psychological challenge. Irrational pessimism also seems better suited the baby-sitting-coop story and Keynesian models in general.

Update: John Cochrane responds to Paul Krugman. I think maybe he should have sat on it a few days before posting.

Also, as I state in the comments, I understand that within the Keynesian (and Friedman) models recessions are caused by liquidity preference--an unexplained shift in the demand for money. But what causes liquidity preference? In a word, fear. And given history and the generally limited duration of recessions, seemingly irrational pessimism about the long-run return of less liquid assets. The asset pricing literature calls it the equity premium puzzle (i.e., too much risk aversion).

Why not call it irrational pessimism? Anyway, since the equity premium is generally too high rather than too low it seems to me that irrational pessimism as opposed to irrational exuberance is the more pervasive behavioral problem. No?

Another Update: Nick Rowe and Brad Delong explain why Cochrane probably should have sat and thought about his response to Krugman for a few days before posting.

Yet Another Update: Paul Krugman gets a little pithy (he's probably right, but this probably doesn't help freshwater folks to become less insulated) and Brad Delong further disembowels Cochrane's specific arguments. 

Yet Another:  Mark Thoma provides a whole list...

Would you believe Cochrane got his PhD at Berkeley and (I think) took his first graduate macro course from George Akerlof?  I can attest that at Berkeley graduate students get healthy exposure to both freshwater and saltwater macro.  Is that so in Chicago and Minnesota? I don't know.

Both sides are a little heavy on snark.  But the facts do sit much more heavily on the saltwater side of things. Cochrane's refusal to acknowledge and wrestle honestly with these facts hurts his position badly (i.m.h.o. as a non-macro guy).  At least Nick Rowe is aiming at a more scholarly debate.

Maybe in the long run the snark will help attract more attention and thought to an important debate.  As Krugman spells out in his article, even the Keynesian (saltwater) side of things has a lot holes that need filling.  And it's clear there needs to be more integration of finance and macro.