Tyler Cowen can’t heap enough praise on this paper from Raghuram Rajan.
I am loathe to use such language, but at this late date I think it helps to be direct. The paper reads to me like nonsense on stilts. Ostensibly its about the ineffectiveness of attempts to stimulate demand and induce recovery in advanced Western economies.
By my reading it is a litany of complaints about the current political economy of the United States and Western Europe. If this was story about why real wages are stagnant, why there is widespread social unrest, or why the current state of affairs is simply displeasing to Rajan’s aesthetic then we would have something.
As it stands he pens gems like the following:
The status quo ante is not a good place to return to because bloated
finance, residential construction, and government sectors need to shrink,
and workers need to move to more productive work. The way out of the
crisis cannot be still more borrowing and spending, especially if the
spending does not build lasting assets that will help future generations
pay oª the debts that they will be saddled with. Instead, the best short term policy response is to focus on long-term sustainable growth.
There are many things wrong here but I just want to point out a few that are illustrative of what’s wrong with this entire line of thinking.
First, we can argue about government and finance, but there is no evidence that the residential construction sector is bloated. A cursory look at actual production levels would tell you that United States is producing far too few homes. If you don’t trust that then you can look at prices. Rents – the price of the service flow from housing – are rising rapidly against a backdrop of depressed demand and high unemployment.
If you wanted to argue that a structural problem facing the United States is the inability of the residential construction sector to jumpstart itself, that would make sense. However, the idea that a problem facing the US is that it is spending too much capital and labor on residential construction is directly at odds with the facts.
This is important because it provides a window in the virtue vs. vice thinking that pervades this piece and much commentary. Vicious activities like buying houses you cannot afford must be replaced by virtuous ones, presumably such learning to be good electrical engineers.
What’s wrong with this type of thinking is not that it heaps blame upon the guilty, but that it encourages intellectuals to get away with slip-shod mechanics. Virtue and vice are human judgments, not actual forces in the world.
Natural phenomena must have natural explanations. This requires tracing down the effects of impersonal forces. And, perhaps actually taking a glance at housing starts or the issues associated with our vacancy rate measures before making pronouncements about which sectors need to shrink.
Second, Rajan writes that the way out cannot be more borrowing and spending, yet he makes no clear case why. If I may be so bold, I assume what’s going on here is standard ant-grasshopper prejudice. It’s the notion that consuming evermore without preparing for the future is a pernicious human tendency that must be battled at every turn.
Spending of course is not the same as consuming and Rajan pays lip service to that in his “especially if the spending does not build long lasting assets.” Yet, the “especially” is his confession. If the United States had the opportunity to borrow money cheaply in order to invest in highly productive assets this would not be a countervailing consideration that made it “OK” to borrow. It would be the central consideration and the defining feature of profit maximization.
Yet, even in the case that the assets the US wishes to invest in have a low return, its not clear that this makes borrowing a poor decision. If real interest rates are below zero then the return does not have to be great for the borrowing to make sense.
This is compounded by the fact that very little government spending is done on things that people would consider pure consumption. Most tax funded government workers are teachers, firefighters, law enforcement officers and soldiers. We can argue about the marginal products of these workers but all of them are in the business of creating or protecting capital.
If you are concerned about the future its not immediately obvious that these workers are a drag. To be clear, I am not dogmatically defending them. I am pushing back against the notion that “spending” is somehow equivalent to simply throwing wild devil-may-care parties, all the while passing the bill on to our children.
And again, it must be remembered that the real interest rate is not always positive. Even if all we care about is the children, passing wealth on to them is not always free. It is sometimes – and now is such a time – actually costly to do so.
This is just a fact about reality that people need to accept. Storage is not free. Passing goods and services through time is not free. For Jove’s sake people, this is the principle reason that every living thing dies and every built thing ends in ruins. Its not like its some weird confluence of events that should be difficult to internalize. It is the core struggle of our species.
That the combined forces of the industrial revolution, urbanization and the population explosion gave us a reprieve from these forces should not lull you into thinking that this basic issue has vanished into the ether.
Third, and I will be brief here since this has gone on long enough. Rajan says, “the best short term policy response is to focus on long-term sustainable growth.” Again, I hate to be rude but I have to be direct.
Is this some kind of sick joke?
Is there an area in which our policy initiatives have more consistently failed than in producing long term sustainable growth? Do we even have a consensus on how long term growth got started in the first place? Do we have a solid story to explain growth differentials today?
Is there a policy explanation for why the GDP of Northern California is booming out of control while Maine dies a slow death? Lets not even get started with cross-country comparisons where we can gesture in the vague direction of institutions but still know little-to-nothing about how to produce sustainable ones.
Perhaps, Rajan thinks the milder goal of human and physical capital accumulation is what is needed? Yet, this entire piece is arguing against the massive borrowing that is at the heart of such accumulation. Indeed, the largest single type of capital is housing, which Rajan has dismissed. Over half of the production activity of the government sector is education, which Rajan has said is bloated.
If you don’t want more borrowing or more teachers, what do you want? Perhaps efforts to increase TFP or educational effectiveness.
Welcome to the world!
This is what folks have been desperate for my entire life. If we knew how to get it, we would.
To close, none of this addresses the core issue that markets are failing to clear. If the root of our problems was nothing more than poor skills and over-borrowing then we should expect the dollar to fall, the consumption set of Americans to shrink and the competitiveness of US labor to rise.
The US would be at full employment but could not enjoy the bevy of foreign made goods that it does today. Indeed, Americans would be exporting much of their own production. This would be unpleasant for many and we could talk about moving the US towards a higher productivity society.
However, that is not the current situation. While the dollar has fallen and US manufacturing has risen, the balance of trade remains weighted towards imports. Unless this price changes Americans will either spend beyond their means and go deeper into debt or spend below their means and go into recession.
If the consumption and production habits of the US need to change vis-à-vis the world then prices need to change. This should be the core lesson of recessions and indeed, macroeconomics.
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Thursday ~ May 3rd, 2012 at 7:32 am
Kevin Donoghue
“I am loathe to use such language, but at this late date I think it helps to be direct.”
You should do it more often. Sometimes you seem in danger of succumbing to Cowen’s Disease, so it’s good to see that you have a reasonable level of resistance to claptrap.
Thursday ~ May 3rd, 2012 at 8:51 am
BSEconomist
I feel your pain. Every time I see my dad–who like the rest of the republican party has gone the full austrian–I feel compelled to make him understand the real nature of the problem, but its not easy. It just “feels” wrong to him that spending can ever be too low and there’s just no “intuitive” parable like the ant/grasshopper to explain it. I’m left trying to point out that the ant/grasshopper thing is meaningless in context–it’s not an issue of saving like the ant, we’re just letting factories and workers idle, how can that be construed as saving?–but he always comes back to the story that he likes. I’m beginning to think that humans are hard-wired for some of these fallacies.
There has to be a simpler way to get people to understand; Keynesian macro really isn’t that complicated. In the meantime, a whole lot of havoc is being caused by inaction.
Thursday ~ May 3rd, 2012 at 11:02 am
annelidgustator
parable of the babysitting coop
Thursday ~ May 3rd, 2012 at 11:34 am
Th
I have the advantage of having a retired farmer as a dad so I can use his experiences to explain how it works. I remind him he borrowed money to build additional silage and hay storage, cleared land for corn and rented land for alfalfa, bought bigger equipment to handle the additional acreage and expanded his herd commiserate with the new carrying capacity. The additional income even after debt service from the added production moved him from “barely scraping by” category to “successful farmer.”
The austerian alternative solution would have been to send some of us rug-rats to the relatives to live.
Friday ~ May 4th, 2012 at 10:17 am
Mahat Argyll
Actually the austerian alternative solution HAPPENED in the 19th century all over europe. Poor City dwellers in Germany and Austria send their kids to distant relatives and strangers in the country so they could survive. Now what happened was that these children were used as slave labor. They were beaten. There was abuse. No wages. Only food and shelter.
That is the problem of austerian-like thinking. It leads smack back into the STONE AGE. Why? Well…because it is essentially STONE AGE THINKING and not much else. It is the oldest therefore most persistent way of dealing with a crisis: You devour your young. You cannibalize your children.
Saturday ~ May 5th, 2012 at 10:10 am
Barry
“The austerian alternative solution would have been to send some of us rug-rats to the relatives to live.”
More like send you to the factories at age 8. This would feed you, and if you were sorta used up by age 20, well, that’s your fault.
Saturday ~ May 5th, 2012 at 10:17 am
Morgan Warstler
Barry, if that is all you got, you gonna lose….
Sunday ~ May 6th, 2012 at 8:27 am
Th
After thinking a bit more, the better analogy for the austerian approach would be to use the money intended to buy fertilizer for the corn to pay down debt instead. Either way you are reducing future potential and most likely assuring your demise.
Wednesday ~ May 9th, 2012 at 10:31 am
matt
Lets say you have 19 brothers who are all very smart capable people and have reasonable access to your father’s capital. You and your smart capable brothers are entrepreneurs in many different fields, some of them high risk with potential high returns, but you need some starting money. Before your father goes and upgrades all that farming equipment, you would want to make your case for different sorts of investments, that could return higher. In fact, you may want him to just keep his house in order, and allow you and your brothers to start 20 new ventures, some of which will fail, and some of which will be successful.
Doubling down on a failing farm works sometimes, but not others. Is it worth it to shoot future generations in the foot to continue doubling down?
Saturday ~ May 12th, 2012 at 8:15 pm
Nathanael
But, “matt”, that’s merely a question of allocation. Either way you gotta spend more. If you wanna argue about what to spend it on, that’s fine (I think spending on the US military is almost entirely wasted, and we need more trains. What do you think?). But that’s not what the austerians want — they want to NOT spend.
Saturday ~ May 12th, 2012 at 8:13 pm
Nathanael
Henry Ford’s parable: “I pay my workers enough so that they can buy a Ford”. If he hadn’t done so, he wouldn’t have sold many cars.
That’s pretty much the best warning about spending being too low, and it’s a historical example too.
Thursday ~ May 3rd, 2012 at 9:21 am
Wednesday Highlights | Pseudo-Polymath
[…] OK. I get it you didn’t like the paper (linked a few days ago). But, geesh, when criticizing a paper isn’t it bad form to use wrong/bad examples, i.e., house construction is not “bloated” because rents are going up … except why might rents go up? Could there be reasons other than a underultilization of construction resources? Perhaps because people aren’t buying because (with good reason) don’t trust property values to be stable yet? I’m no economist but that argument was just plain dumb. […]
Thursday ~ May 3rd, 2012 at 9:22 am
Stones Cry Out - If they keep silent… » Things Heard: e219v3
[…] OK. I get it you didn’t like the paper (linked a few days ago). But, geesh, when criticizing a paper isn’t it bad form to use wrong/bad examples, i.e., house construction is not “bloated” because rents are going up … except why might rents go up? Could there be reasons other than a underultilization of construction resources? Perhaps because people aren’t buying because (with good reason) don’t trust property values to be stable yet? I’m no economist but that argument was just plain dumb. […]
Thursday ~ May 3rd, 2012 at 10:06 am
Ritwik
But why is the one price in the hands of the government, broadly defined, not changing enough? Why should the Fx market not clear? What on earth prevents the most powerful government/central bank in the world from debasing its currency?
Thursday ~ May 3rd, 2012 at 10:57 am
robertwaldmann
My oh my this is one wonderful post. It is an important and valuable essay and the biggest can of whupass I ever saw. I live in Rome and I’ve never seen ruins like the ruins you made of Rajan’s argument. And he is just about the smartest and most reality based opponent of stimulus.
Anyway, I sure wish I had written this. I think I will retire my stupid Adam Marx jokes.
Thursday ~ May 3rd, 2012 at 8:18 pm
Morgan Warstler
Rajan, like Friedman, (and Sumner) would FULLY SUPPORT my Guaranteed Income (Ebay / Paypal) plan.
If Karl wishes to poo-poo that markets do not clear, than god dammit man, he better stand up and SING how great my plan is.
Did he? No.
SING YOU BASTARD, SING!!!
Karl has the BALLS to say this:
“To close, none of this addresses the core issue that markets are failing to clear. If the root of our problems was nothing more than poor skills and over-borrowing then we should expect the dollar to fall, the consumption set of Americans to shrink and the competitiveness of US labor to rise.
The US would be at full employment but could not enjoy the bevy of foreign made goods that it does today.”
Screw him dude, I FIXED that shit. My numbers add up.
REAL consumption can go up!
The price of good and services can go down!
The importing of foreign made goods can fall!
No more loss of human capital, ever!
And we CAN DO IT ALL IF WE JUST ADMIT that our entrepreneurs MUST be able to pay for labor what it is really worth in a global market, not what we want it to be.
If you are willing to have your labor auctioned, our social compact is that you will receive enough GI to live on…. but that’s it. That’s the ONLY promise we have for you.
You will be watched, judged, tracked, and analyzed by large volume sets of bidders and algorithms all looking for a deal.
None of you are allowed to argue sticky wages are a fact of life, and then refuse to tear down policies that support them.
MINE is the clear path.
Karl can STFU, when he’s got the stones to really argue wherein if he loses he changes his damn policy preferences.
Until then, his pious take down of what are generally basic facts of life stated by Rajan, well its just rhetoric.
Ex: what do you think my system does to a company where they seek and desire mid-term worker stability. They have to PAY MORE for it.
If every mom and dad is pinging the avg. Wal-Mart worker and offering them a more fun, or more interesting, or more personal job, or gasp! one that pays more….
Wal-Mart has to pay more for labor. The market CAN clear, but if in order to do so Karl has to get comfy with excess labor capacity being auctioned to for profit buyers in the local market, well then Karl can stop penning odes and start promoting the only damn plan that makes any god damn sense.
Friday ~ May 4th, 2012 at 4:22 am
reason
Look, I agree with you 100% (I often push this idea elsewhere) but don’t be so rude. I don’t always agree with Karl, but he is one of the good guys.
Friday ~ May 4th, 2012 at 10:34 am
Morgan Warstler
If the problem is so great it demands Karl’s exasperated post, he has no excuse.
I have solved this problem. He may upon multi-hour reflection and far deeper analysis help to achieve minor improvements to my policy agenda, but this is THE solution.
This is off-the-shelf technology. Tens of millions of people know how to buy and sell on Ebay. 99% of the tool sets for serious fraud prevention, reputation scoring, etc. have been done.
Those who wave their hand at my GUARANTEED SOLUTION wave their hands at the last 15 years of Internet take-over of the economy.
This system requires NO real econ-blogger mindset, it is a 21st century Internet solution no more radical than Econ Blogging is itself.
If you fight me doing to the government what the Internet has done to everything else, you are part of the problem.
Econ bloggers can be judged by whether they adopt my policy. It is out there, let them support it in toto.
Saturday ~ May 12th, 2012 at 8:17 pm
Nathanael
Any variant of a “guaranteed living income” policy is a good one…
…except the ones where the requirement is abusive slave-like levels of labor.
Thursday ~ May 3rd, 2012 at 1:49 pm
Lord
Attempting to interpret him in the most favorable manner, I suggest he is leaning against debt toward equity and towards fixing those exchange rates. He is wrong about moving away from these but we do have to move in a different direction with them. Finance has to move towards fair exchange rates and more investment. We have to move away from land price appreciation as a source of income but back to construction. Government must move from free lunches to balanced trade. It’s a stretch, I realize.
Thursday ~ May 3rd, 2012 at 2:26 pm
J.V. Dubois
Oh my, thank you for this blogpost. I thought that I am insane while reading the praise on this pile of crap all over my favorite sources. I was having this sentence in my mind when reading that “Unless this price changes Americans will either spend beyond their means and go deeper into debt or spend below their means and go into recession”
Also am I the only one that finds Rajan’s supply side stories unconvincing? Like the one about untapped market for billions of battery-powered-refrigerators for which hundreds of millions of families in 3rd world countries crave? So facing this utter failure of western ingenuity and engineering to serve these potential customers these poor souls are forced by us evil and lazy westerners to hold mountains of treasury bonds instead. Yes, and I almost forgot – this is somehow bad for us and we should stop issuing more paper debt because …. ?
Thursday ~ May 3rd, 2012 at 4:11 pm
Mayson Lancaster
Karl – I think that “status quo ante” does not mean what you think it means: he is not saying that the residential construction sector is bloated now, but that it was, during the housing bubble. This is arguably true. Also, the finance sector is once again sucking too much profit out of the rest of the economy, arguably.
As far as the rest of his article goes, I find it difficult to disagree with you.
Thursday ~ May 3rd, 2012 at 7:00 pm
Tim
“he is not saying that the residential construction sector is bloated now”
Read it again. That’s exactly what he is saying.
“bloated.. residential construction, ..sectors need to shrink” — Note the present tense
Thursday ~ May 3rd, 2012 at 8:47 pm
curtd59
I don’t think that’s right.
That prices are increasing now (as Karl states) does not mean that rapidly expanding prices prior to the recession were not a misallocation of capital. Or that today’s number of unemployed construction workers are not a reflection of the distortion caused by the earlier overfunding of construction. and that todays unemployed do not contain a surplus. Or that rising prices are not a correction that creates value for homeowners instead of the unemployed who were misallocated by earlier cheap credit.
Karl implicitly favors redistribution from productive to unproductive sectors as if there are no consequences to the misallocation of human capital. He is perfectly honest about it.
It’s that he doesn’t ACCOUNT for that misallocation. It’s not that it doesn’t exist. Karl like Krugman and Delong assumes that this process of misallocation can continue forever without consequences that we cannot eventually accomodate. The opposition (my side of the spectrum) argues that it is possible to enter a position where we are powerless to alter the problem we have put ourselves into.
The truth is that WE DON”T KNOW. Our data collection is not good enough or over a long enough period. So Karl favors erring on the side of short term redistribution, and the conservatives favor erring on the side of long term safety.
The political discord is caused by an political system that prevents secession, and the people on either side cannot choose their futures independently of one another. If we had ‘short time frame’ currency and ‘long time frame’ currency we could let everyone run on their conscience. But in our current state of affairs, we can’t, so the karls of the world prefer to expose the rest of us to risk, instead of the rest of us exposing Karls constituency to short term risk.
“gustus est non verum” And as taste, it is not a matter that can be resolved by argument.
Friday ~ May 4th, 2012 at 2:43 pm
octavian
Agreed…he does use the present tense. Coming from this guy it was not a very persuasive piece (other than to the already persuaded) and was really more of a political tract than anything else. Perhaps that was his intention.
Friday ~ May 4th, 2012 at 3:07 pm
curtd59
That’s nonsense.
If Karl is right, that prices are increasing from extraordinary lows, Rajan can also be correct, in that all the people who WERE in the construction business, and all OTHER related industries that supplied home improvement, furniture, fixtures, electronics and furnishings, lawn care, tree care and anything else homeowners consumed because of distorted prices, but who are now unemployed or underemployed, and particularly those people who have missed the career-change window, were misallocated by the use of expansionary credit. Meanwhile OTHER countries are not misallocating their people.
Karl is perfectly happy with this state of affairs, because it simply means that increased redistribution from the more productive areas of the economy to the less productive is acceptable. While the other side says that redistribution is a net loss, and causes harm to those who the resources are being taken from.
But then Karl is a progressive. That’s how they think about the world. And conservatives, as Haidt states, feel everyone should pull their weight.
Friday ~ May 4th, 2012 at 3:30 pm
Morgan Warstler
“Karl is perfectly happy with this state of affairs, because it simply means that increased redistribution from the more productive areas of the economy to the less productive is acceptable. While the other side says that redistribution is a net loss, and causes harm to those who the resources are being taken from.
But then Karl is a progressive. That’s how they think about the world. And conservatives, as Haidt states, feel everyone should pull their weight.”
This is WHY I say, there is a possible middle ground for Karl, a way to test who he really is and expose him one way or the other… he has to fully support my GU plan.
In my plan, he GETS the re-distribution, BUT it comes with a stiff bill.. he doesn’t get to control the resources of “excess capacity” – instead that labor is put to work:
1. for the benefit of for-profit local bidders.
2. to the harm of public employee unions.
My plan is politically palatable to grown ups of all stripes, and it works PRECISELY because it make Karl’s crowd truly horse trade.
Nothing else out there can both work and carry substantial majority support.
Its a silver bullet baby.
By not making my policy a significant policy focus, Karl is proven an unreasonable man….
Not the guy who wrote the above post.
Friday ~ May 4th, 2012 at 4:25 am
reason
Karl,
has pointed out elsewhere that what WAS bloated was LAND prices. Not the same thing as housing construction. Karl is one of the few economists who point this out. Most of the houses sold where used houses.
Thursday ~ May 3rd, 2012 at 5:27 pm
The Do-Nothing Caucus - NYTimes.com
[…] Karl Smith gets shrill about Raghu Rajan’s latest (pdf), which he calls “nonsense on stilts.” He’s right — and it’s deeply depressing that stuff like this passes for wisdom. […]
Thursday ~ May 3rd, 2012 at 7:02 pm
» The Do-Nothing Caucus New Bullhorn
[…] Karl Smith gets shrill about Raghu Rajan’s latest (pdf), which he calls “nonsense on stilts.” He’s right — and it’s deeply depressing that stuff like this passes for wisdom. […]
Thursday ~ May 3rd, 2012 at 8:34 pm
Raghuram Rajan’s false choice|Politifreak
[…] Smith has more, as does Matthew […]
Thursday ~ May 3rd, 2012 at 10:41 pm
Bo Parker
Wonderful piece. But how to force a price change? What can one little country like the US do in a big global market?
Thursday ~ May 3rd, 2012 at 10:51 pm
teageegeepea
Lots of government spending is on transfers, so the “consumption” label doesn’t seem too far off.
Friday ~ May 4th, 2012 at 4:28 am
reason
??????
What transfers (redistribution) are definitely not is consumption. Are taxes then negative consumption? They just change who gets to do the consumption, not how much is consumed.
This confusion between between the real and the financial is a big problem it seems.
Saturday ~ May 12th, 2012 at 8:19 pm
Nathanael
Transfers are not consumption.
HOWEVER, transfers from rich to poor *always* increase consumption; transfers from poor to rich *always* decrease consumption. Think about it or look up the historical data.
Friday ~ May 4th, 2012 at 3:24 am
Karl Smith vs. Raghu Rajan | FavStocks
[…] Rajan on Lessons from Recession: paper reads to me like nonsense on a stick. Ostensibly its about the ineffectiveness of attempts to stimulate demand and induce recovery in advanced Western economies. By my reading it is a litany of complaints about the current political economy of the United States and Western Europe. If this was story about why real wages are stagnant, why there is widespread social unrest, or why the current state of affairs is simply displeasing to Rajan’s aesthetic then we would have something…. […]
Friday ~ May 4th, 2012 at 3:42 am
Economist's View: Links for 2012-05-04
[…] Rajan on Lessons from Recession – Modeled Behavior […]
Friday ~ May 4th, 2012 at 3:42 am
Links for 2012-05-04 | FavStocks
[…] Rajan on Lessons from Recession – Modeled Behavior […]
Friday ~ May 4th, 2012 at 5:00 am
Demand side VS Supply side « Cettou-Farronato Blog
[…] can find negative reactions on this paper on Model Behavior, Paul Krugman’s blog and a positive reaction on Marginal Revolution. Why have these […]
Friday ~ May 4th, 2012 at 10:34 am
Jack11937
Ok. Here is the view from a venture capitalist.
Your basic argument is that any ‘investment’ must produce a positive return if the interest rate is negative. First, the interest rate will not stay negative forever and the debt incurred will eventually have to be refinanced at a much higher and positive interest rate. Second, you assume that the worst that can happen is that the investment returns zero. In fact, investments can produce ‘returns’ below zero if they deprive us of resources that could in fact be used for a productive investment.
The focus on ‘infrastructure’ investment is a perfect example. Let’s say we borrowed a few trillion dollars and used it to buy enough copper to build telegraph lines to every household in America. I can assure you that would produce a net cost to the economy, not merely a zero return. Railroad investment in the 19th century, or the interstate highway system in the 1950s produced positive returns, but it is not true that any stupid infrastructure investment would do the same. Paying incompetent teachers more to waste the educational window for a generation of American kids is not merely a waste of money; it produces a cost that weighs on the society for generations. Encouraging the middle class to overspend on housing, because Barney and Fannie (and many others) liked the idea, misallocated savings and will cost us dearly.
The real disagreement between us is not over Keynesian economics if we all agree on the assumptions (i.e., deficits do not finance affirmatively counterproductive activity) it is that we do not in fact agree on the assumptions.
As is obvious now in Europe and increasingly in the US, a rent seeking class of public union workers, social activists, and some corrupt industries(e.g. pharmacies in Italy and Greece, the ‘rating agencies’ in the US) , have captured the political apparatus for their own benefit. The welfare state is growing to unsustainable proportions because people think they can simply ‘vote’ for it and someone else will provide the money.
These resources are not being allocated by anything resembling an ‘economy’, but instead by politics and it is obvious that at some point the misallocation will bankrupt all of us. Better to stop it now, when we are scared enough to do so, than fail to do so at some unspecified point in Smith’s and Krugman’s imagined full employment future.
Friday ~ May 4th, 2012 at 2:23 pm
octavian
And the financial industry wouldn’t be a rent seeking class would it now?
Friday ~ May 4th, 2012 at 4:49 pm
Jack11937
I actually mentioned the rating agencies. Some of the financial industry is also to the extent that it corrupts the political establishment and directs subsidies or monopolistic privileges to itself. In fact, if your point is that vast sectors of the economy have become rent seeking, I completely agree. Of course, that strongly supports my point that running vast portions of the economy through the political system, can lead to huge misallocation of resources (rent seeking and stupid bankers included).
Saturday ~ May 12th, 2012 at 8:25 pm
Nathanael
Jack, there’s no way to avoid running huge sectors of the economy through the political system. *There has never been any other alternative* — if you try to make the economy “independent of politics”, a few people get very rich and *make themselves into governments*. This is part of how feudalism started!
The goal should be to keep the economy under the command of a *democratically controlled* government rather than a private, secret, unaccountable government. And our political system is deeply rotten.
Saturday ~ May 12th, 2012 at 9:44 pm
gcallah
Nathanael, feudalism certainly did not start from people “trying to make the economy independent of politics”! There was a collapse of central authority (the Western Roman Empire) and small local authorities filled the gap. That’s how feudalism started (painted with a very broad brush, of course).
Saturday ~ May 12th, 2012 at 8:23 pm
Nathanael
“First, the interest rate will not stay negative forever and the debt incurred will eventually have to be refinanced at a much higher and positive interest rate.”
Wrong, because it’s magical thinking. The interest rate can and will stay negative forever if the economy isn’t brought out of Depression. This is very important to remember.
Any stupid infrastructure investment… will result in a lot of workers with more money to spend on *useful* things. So yeah, frankly, any spending of money which gets it into the hands of the *poor* and therefore *income-constrained* will be inherently valuable. The worst misallocation is to hoard all the wealth in the hands of superrich financiers, who mostly have proven to be spectacularly bad resource allocators.
Krugman agrees with you that resources are being allocated by politics, but he knows better than you who’s allocating them. See the column of May 4th: http://www.nytimes.com/2012/05/04/opinion/krugman-plutocracy-paralysis-perplexity.html?partner=rssnyt&emc=rss
Saturday ~ May 12th, 2012 at 9:47 pm
gcallah
“The interest rate can and will stay negative forever if the economy isn’t brought out of Depression.”
Nonsense. The interest rate is negative because the central bank is holding it negative. If it stopped doing so, it would become non-negative, whether the recession ended or not. And recall that Keynes himself knew that an economy is never going to stay in a recession forever, even without stimulus — he just thought the “long run” was too painful to wait for.
Friday ~ May 4th, 2012 at 10:56 am
John
“The status quo *ante* is not a good place to return to because bloated
finance, residential construction, and government sectors need to shrink,
and workers need to move to more productive work.”
“First, we can argue about government and finance, but there is no evidence that the residential construction sector *is* bloated.”
So, it is your claim that the residential construction sector was not bloated in 2007-2008?
Or do you simply not understand what the phrase “status quo ante” means?
Friday ~ May 4th, 2012 at 11:51 am
TiSch
I think you misrepresent Rajan. His point is not that construction is currently bloated, but that it was bloated prior to the crisis (the status quo ante). Paul Krugman presents data on construction employment that is hard to read because of his choice of vertical scale. Going directly to BLS data shows that a case may be made about a bloated sector until 2007:
http://data.bls.gov/timeseries/CES2000000001?data_tool=XGtable
That’s more than 2million jobs lost.
Rajan clearly outlines why he believes that more borrowing is not the solution, and yes, it is a political economy argument, which you discard right of the bat. A private sector credit expansion prior to the crisis has not lead to more productivity, many conservatives are even more convinced that neither will a public sector credit expansion.
Friday ~ May 4th, 2012 at 2:31 pm
octavian
Krugman’s point I think is that while jobs have been lost in the construction sector they’ve been lost in all sectors and hence the problem is not basically structural. Krugman’s chart shows construction employment shifting up and down by around 20% over the years….we’re currently back at the same level of construction employment of the early 90’s. And I suspect there is a fair degree of regionality about it although I haven’t looked at the numbers.
Friday ~ May 4th, 2012 at 3:13 pm
Matthew Montagu-Pollock
Sigh. Loath and loathe. See the difference here: http://www.dailywritingtips.com/loath-and-loathe/
Friday ~ May 4th, 2012 at 11:16 pm
pat toche
hear hear!!
Saturday ~ May 5th, 2012 at 12:13 am
Poor Raghuram Rajan « Modeled Behavior
[…] has been interpreted by Karl and Paul Krugman to mean that the construction sector is currently in need of shrinking. What it […]
Saturday ~ May 5th, 2012 at 3:00 am
Rajan’s latest paper is "nonsense on stilts" « Economics Info
[…] Source […]
Saturday ~ May 5th, 2012 at 12:31 pm
Lord
I see the same misconceptions offered that because housing construction boomed before, it resulted in mal investment and must bust but this is not necessarily true. Yes, the investment was made under the belief of appreciating prices that were false and will not return any time soon, but that does not mean it was mal investment and it needed to shrink. The expectation of higher prices led to more investment but also kept interest rates above their natural rate. The collapse in prices have led to a similar collapse in interest rates and these lower interest rates establish higher valuations for it. We may not have been able to continue as we did turning appreciation into income, but that does not mean that housing construction was outsize, only that land prices were out of wack. It is difficult for those prices to reset but we have made significant progress over the last several years. If we had a replacement for the income land price appreciation was creating, most likely housing construction would be right back where it was.
Saturday ~ May 5th, 2012 at 10:03 pm
lorenzofromoz
If Rajan is so keen on supply-side reforms, why does he not mention the developed country which has done lots of supply-side reforms and sailed through the GFC and Great Recession with barely a ripple? Because it does not suit the story he wants to tell.
Saturday ~ May 12th, 2012 at 8:27 pm
Nathanael
Love that article. Money quote:
“/…Australian demand (and so income) did not collapse. Which meant debt remained manageable. Why?
The simple answer is: because our central bank is not mad (unlike other central banks). The RBA looks like a standard inflation-targeting central bank. Except it does not have a fixed inflation target, it has an explicit average-over-the-business-cycle target. Which means that, if output falls, the money supply does not have to follow output down. “
Sunday ~ May 6th, 2012 at 10:38 am
gcallah
“The status quo ante is not a good place to return to because bloated
finance, residential construction, and government sectors need to shrink,
and workers need to move to more productive work. ”
This very obviously means that finance, construction and government sectors WERE bloated in the “status quo ante” — before you dump on someone’s paper, try reading it properly.
Tuesday ~ May 8th, 2012 at 6:59 am
Morning Caffeine 5-8-2012 « The Traders Crucible
[…] Rajan on Lessons from Recession « Modeled Behavior […]
Tuesday ~ May 8th, 2012 at 7:00 am
Morning Caffeine 5-8-2012 | Modern Monetary Realism
[…] Rajan on Lessons from Recession « Modeled Behavior […]
Wednesday ~ May 9th, 2012 at 2:31 am
Raghu Rajan polarizes with his essay — Marginal Revolution
[…] David Brooks likes it, and I liked it, but other people are upset or less impressed. Karl Smith flips out. Adam Ozimek points out one misunderstanding of the piece, not the only one I might […]
Friday ~ May 18th, 2012 at 2:41 pm
My take on Rajan’s “True Lessons of the Financial Crisis” « azmytheconomics
[…] lot of economists have made a big deal of Raghuram Rajan’s piece “The True Lessons of the Recession: The West […]
Saturday ~ October 27th, 2012 at 8:02 pm
Demand side VS Supply side « Alpinomics
[…] can find negative reactions on this paper on Model Behavior, Paul Krugman’s blog and a positive reaction on Marginal Revolution. Why have these […]
Tuesday ~ May 7th, 2013 at 6:49 am
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Friday ~ November 22nd, 2013 at 4:07 am
Curt Doolittle
@Karl,
I love it when you attack ‘nonsense-on-stilts’ on purely empirical grounds – meaning purely observationally CAUSAL grounds. And ‘nonsense-on-stilts’, well, that’s your ‘Brand’. And consumers want to buy that brand.
You are the best ratio-scientific public intellectual that we have. And this statement is why:
“Natural phenomena must have natural explanations. This requires tracing down the effects of impersonal forces.” – Karl Smith
Defining the Naturalistic and causal, versus Platonic and correlative. That’s what defines a methodology as scientific versus unscientific. And that’s why you continue to be right. You’re one of the few scientific practitioners in a predominantly platonic profession.
Affections
Curt
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curtd59
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