When minimum wages are increased, one consequence we might see follow is reduced employment. I say might see, rather than will definitely see, because employers can adjust on multiple margins. Instead of reducing employment, they may reduce hours, benefits, perks, or just put less effort into providing a pleasant working environment. But consumers can adjust to the impact of minimum wages in a variety of ways as well. California’s recent minimum wage increase shows an example of this.  After the minimum wage of fast food workers in California was increased to $20 an hour, fast food establishments increased prices to offset this increase in costs. But this wage increase only applied to fast food workers, not restaurant workers more generally. This means that dine-in establishments do not have to pay their workers this minimum wage – including the workers at various restaurants owned by California Governor Gavin Newsom. Restaurants like Governor Newsom’s that feature “a $37 pasta dish and a $67 steak dinner on the menu” don’t “qualify as fast food, so [are] not required to pay the $20 minimum wage.”  As a result, these dining establishments have not been subject to a large spike in labor costs and have not had to sharply increase their prices. And this has changed the way Californians are eating out, as was described in this story. That article says the minimum wage increase “certainly marked a major win for the roughly 500,000 fast food workers in the state,” but it immediately goes on to note that these restaurants “now seem to be taking a hit when it comes to customer traffic” due to price increases, which makes the “major win” seem a little less than certain. And this decline is a new phenomenon – because “before the new law went into effect, fast food consumer traffic in the state was trending slightly higher than the national average.” But the decline in fast food traffic isn’t entirely the result of people simply choosing to eat out less. Instead, people are making different choices about where to go out to eat. Now we see that “more expensive casual dining chains like Olive Garden and Chili’s have actually gotten a bump in traffic among California consumers since April. While it’s true that they don’t fall under the fast food category, and so aren’t required to meet the $20 minimum wage for workers across the board, their prices are still considerably higher than those of their quick-service counterparts.” So why would places that serve more expensive food be seeing their traffic increase, while the still-less-expensive fast food establishments see their traffic decline? The answer is that even though the price of dine-in chains hasn’t fallen in absolute terms, it has still fallen in relative terms compared to fast food. Fast food and dine-in restaurants differ in terms of price, quality, and convenience. But with fast-food establishments being forced to increase their prices in the face of increased labor costs, the gap in price between fast food and dine-in establishments has gotten smaller without any change in the other two dimensions. As a result, people are seeing what it would cost them to get a basic combo at McDonalds and thinking “Well, if I’m going to have to pay this much just to get some McDonalds, I may as well pay just a little bit more and go to Chili’s instead.” As a result of this labor market intervention, Californians face higher food costs, and there has been a shift in favor of restaurants that are both more expensive in absolute terms for the consumer but also pay their employees less than the fast food minimum wage. This seems like very nearly the opposite outcome that the advocates of such a law would have wanted. As Don Boudreaux likes to say, who’d have thunk it? (0 COMMENTS)

  Often when I advocate abolishing a particular regulation, I’m accused of thinking that my proposal is a panacea. Usually, that’s false: I point out that it would move things in the right direction but that it’s not close to being a panacea. I’m guessing that for most policies he advocates, Bryan Caplan has the same reaction I have. But he makes the case that housing deregulation is indeed a panacea. He argues strongly, with data, that deregulation would reduce the cost of housing, and thereby reduce poverty, reduce income inequality, reduce traffic congestion, restore the geographic mobility that we older people experienced in the 1970s when we were younger, provide construction jobs, and even reverse the decline of fertility. A conservative estimate, states Caplan, again backing it up with data in the footnotes, is that housing deregulation would reduce the cost of housing by approximately 50 percent. Because housing costs are about 20 percent of the average American household’s budget, the cost of living would be 90 percent of what it is now, which means that the standard of living would increase by 11 percent (100 divided by 90 = 1.11.) The effects of deregulation would be bigger for lower-income people, notes Caplan. The reason is simple: lower-income people spend a bigger share of their income on housing. That means also that deregulation would reduce income inequality. This is from David R. Henderson, “Build, Baby, Build,” Defining Ideas, June 20, 2024. It’s my review of Bryan Caplan’s book of the same name. Read the whole thing. (0 COMMENTS)

The upcoming legislative election in France (on June 30 and, for the second round, July 7) tells us much about politics. It also suggests some comparisons between American and French politics. The parties of the left vying for a majority in the National Assembly have built a populist coalition, the New Popular Front (Nouveau Front Populaire) or NPF, which temporarily unites in the pursuit of power both left and extreme-left parties, including the Communist Party. In each circumscription, NPF is running a single candidate of the left. The extreme-right National Rally (Ralliement National) or NR, and the more center-right Republicans (Les Républicains or LR) have agreed on a similar coalition. Renaissance, the center-right party of the current president, Emmanuel Macron, is running candidates in a loose alliance with a few small parties. “Extreme” is a matter of degrees. Many Americans do not realize that the typical Democrat in America would be called center-right in France. A detached analyst would be hard-pressed to find a difference between, say, Barack Obama and Emmanuel Macron. The political extremes are less extreme in America than in France, but that may have started to change a few years ago. In the current French election campaign, it has been observed that the only program elements on which all parties of the NPF really agree is to increase taxes and transfers- that is, to redistribute more money and benefits in kind to favored political clientèles. The redistribution is basically to the poor and the modest middle-class, at the cost of “the rich” or, in fact, the less rich. It is a general political phenomenon that, whether on the left or on the right, those who want to re-engineer society have problems agreeing among themselves about what sort of utopia they want. Interestingly, the program of the far right is as populist as the far left and targets the same clientele with similar goodies such as more “social” expenditures, also financed by the “rich,” and some price controls. The far right does add its dada of less immigration and more protectionism. The left adds “ecological planning” and a higher minimum wage. As Anthony de Jasay would say, in line with public choice theory, a political party that wants to get elected pursues the votes of the poorest 50%+1 of the voters with the promise to loot on their behalf the richest 49%. More generally, and whatever the reasons why the rationally ignorant voters support one party or another, the essence of politics or how politics works consists in harming some individuals in order to benefit others. At least, this is politics as we know it. Mr. Macron’s “center-right” is just more prudent than the extremes, if only because it has already boosted the annual budget deficit to 5% of GDP. Besides the general workings of politics, a major political similarity between France and America—after the Enlightenment, since America had a very short history before—is that most citizens in each place think that freedom (“liberté”) has been born and dwells in their own country. In reality, liberty has been battered in both places, often in the very name of its defense, by their respective glorified political authorities, only earlier and more decisively in France than in America. In America, the worst is yet to come; over the long French history, it has come many times. Marianne is a fictitious attractive woman who has historically symbolized the French Republic. Her image or bust has taken different aspects over time–recently, those of French actresses such as Brigitte Bardot. The featured image of this post reproduces the current Marianne logo of the French state. Some may think that Marianne is a sexist symbol, but it certainly illustrates how efficient the French government has been in government propaganda and imagery for fueling national pride and obedience. Classical liberals and libertarians are rightly suspicious of state glorification. The imminent French legislative election (like the forthcoming American presidential one) illustrates how escaping the plague of politics is as difficult as it is required. How to stop governments from competing to discriminate against some citizens in order to favor others? Nobel laureate economist James Buchanan and the school of constitutional political economy he inspired have proposed subjecting politics to unanimously chosen rules at a superior “stage,” the constitutional stage. At that abstract stage, politics is tantamount to mutually beneficial exchange, while it is discrimination and exploitation in the realm of day-to-day politics. (See my Econlib review of James Buchanan and Geoffrey’s book The Reason of Rules.) Anthony de Jasay, another economist and political philosopher worth consulting on these matters, proposed a more radical solution: abolish politics; that is, completely substitute individual choices for collective choices. (De Jasay’s book The State and his Against Politics are good entry doors to this radical theory; the links are to my Econlib reviews.) The pessimists will opine that either ideal is a long shot. I would counter that considering something along those lines is required for the future of individual liberty and prosperity. (0 COMMENTS)

Janan Ganesh is probably my favorite news commentator.  In a recent column, he pushes back at the widespread belief that the global rise of the hard right is a reaction to neoliberalism: Rightwing populism is ascendant in France, which might be the least economically liberal country in the rich world. Government spending there accounts for well over half of national output. The component that goes on social protection — cash benefits and so on — is likewise OECD-topping. On the other side of the Alps, the Italian state is not far behind on either overall or social spending. The hard right is not just successful there. It is the power in the land. Meanwhile, in Australia, where the government is smaller, the mainstream political parties are holding up. The centre-left governs. Ganesh also discusses the view that the loss of manufacturing jobs is the problem.  He points out that the extreme right has recently gained a lot of ground in Germany, where manufacturing is a far higher share of GDP than in other western countries.  He then adds: And if that is odd, consider next door Austria, which might be the most confounding case study in the west. It has one of the highest levels of public spending and a manufacturing sector almost as large as Germany’s and a rampant hard right. Ganesh then raises some interesting questions regarding the politics of neoliberalism in the US: What possessed the Democrats to think America wanted or needed a statist economic transformation? The slogan “Build Back Better” implies a widespread unhappiness with the pre-Covid world that didn’t exist. On the eve of the pandemic, economic confidence was at an high not seen since the millennium. There is much more of interest.  Read the whole thing. PS.  He doesn’t discuss the developing world, but the shift of politics to the right in India and China also fits his hypothesis.  It seems rather far-fetched to view the rise of Modi and Xi as a reaction to “neoliberalism” in India and China. (0 COMMENTS)

As a Financial Times headline says, “AI in Finance Is Like ‘Moving from Typewriters to Word Processors’” (June 16, 2024). But, I think, not much further, despite all the excitement (see “Ray Kurzweil on How AI Will Transform the Physical World,” The Economist, June 17, 2024). At least, doubts are warranted regarding the “generative” form of AI. (IBM defines generative AI as referring to “deep-learning models that can generate high-quality text, images, and other content based on the data they were trained on.”) The conversational and grammatical capacities of an AI bot like ChatGPT are impressive. This bot writes better and appears to be a better conversationist than what must be a significant proportion of human beings. I am told that he (or she, except that the thing has no sex and I am anyway using the neutral “he”) efficiently performs tasks of identification and classification of objects and that he does simple coding. It’s a very sophisticated program. But he crucially depends on his humongous database, in which he makes zillions of comparisons with brute electronic force. I have had occasions to check that his analytical and artistic capacities are limited. Sometimes, they are astonishingly limited. Very recently, I spent a couple of hours with the latest version of DALL-E (the artistic side of ChatGPT) trying to have him understand correctly the following request: Generate an image of a strong individual (a woman) who walks in the opposite direction of a crowd led by a king. He just could not understand. I had to elaborate, reformulate, and re-explain many times, like in this modified instruction: Generate an image of a strong and individualist individual (a woman) who walks in the opposite direction of a nondescript crowd led by a king. The woman is in the foreground and walks proudly from west to east. The crowd led by the king is in the close background and walks from east to west. They are going in opposite directions. The camera is south. (By “close background,” I meant “near background.” Nobody is perfect.) DALL-E was able to repeat my directives when I tested him, but he could not see the glaring errors of his visual representations, as if he did not understand. He produced many images where the woman on the one hand, and the king and his followers on the other hand, walked in the same direction. The first image below provides an intriguing example of this basic misunderstanding. When the bot finally drew an image where the woman and the king walked in opposite directions (reproduced as the second image below), the king’s followers had disappeared! A toddler learning to dry recognizes his errors better when they are explained to him. I said of DALL-E “as if he could not understand,” and that is indeed the problem: the machine, actually a piece of code and a big database, simply does not understand. What he does is impressive compared to what computer programs could do until now, but this not thinking or understanding–intelligence as we know it. It is very advanced computation. But ChatGPT does not know that he is thinking, which means that he is not thinking and cannot understand. He just repeats patterns that he finds in his database. It looks like analogical thinking but without the thinking. Thinking implies analogies, but analogies don’t imply thinking. It is thus not surprising that DALL-E did not suspect the possible individualist interpretation of my instruction, which I did not spell out: a sovereign individual declined to follow the crowd loyal to the king. A computer program is not an individual and does not understand what it means to be one. As suggested by the featured image of this post (also drawn by DALL-E after much prodding, and reproduced below), AI cannot, and I suspect will never be able to, understand Descartes’s Cogito ergo sum (I think, therefore I am). And this is not because he cannot find Latin in his databases. Nowhere in his database could DALL-E find a robot with a cactus on his head. The other Dali, Salvator, could have easily imagined that. Of course, nobody can forecast the future and how AI will develop. Prudence and humility are required. Advances in computation will likely produce what we would now consider miracles. But from what we know about thinking and understanding, we can safely infer that electronic devices, as useful as they are, will likely never be intelligent. What’s missing in “artificial intelligence” is the intelligence. ****************************** DALL-E’s wrong illustration of a simple request from P. Lemieux Another wrong interpretation by DALL-E of a simple request   Self-portrait of DALL-E, under the influence of your humble blogger   (0 COMMENTS)

  The Wall Street Journal reported in April that the Justice Department would conduct a “criminal investigation into consulting firm McKinsey related to its past role in advising some of the nation’s largest opioid manufacturers on how to boost sales.” According to the WSJ report, “McKinsey consultants advised the company [Purdue] on how to increase sales of its flagship drug, including suggesting that Purdue’s sales team make more calls to healthcare providers it knew wrote high volumes of OxyContin prescriptions and spend less time on doctors who prescribed the opioid medication the least, the records showed.” Oxy Imagine that. McKinsey allegedly tried to help Purdue tailor its sales efforts to doctors who already prescribed oral opioid drugs. There’s nothing mysterious or nefarious about this. It is standard and economically rational. To do otherwise would be inefficient and wasteful. Some consultants do this sort of work virtually every day. The small consulting company, Objective Insights, Inc. (co-owned by one of the authors) has performed it a handful of times. This is from David R. Henderson and Charles L. Hooper, “Is Promoting to Customers a Crime?” American Institute for Economic Research, June 18, 2024. Read the whole thing, which is not long. (0 COMMENTS)

In his book Word and Object, W. V. Quine describes the problems that arise when one is attempting to translate an entirely unfamiliar language. Among the ideas he raises in his discussion is that when attempting to translate what someone is saying, one should employ the principle of charity, by which Quine meant we should assume “assertions startlingly false of the face of them are likely to turn on hidden differences of languages.” If your translation implies your interlocutor has said something patently absurd, you should assume that something has been lost in translation rather than assume you’re speaking with a fool. And Quine points out that this isn’t limited to translating from unknown languages – the same problem can arise “in the domestic case” as a result of “linguistic divergence.” I try, however imperfectly, to apply this idea when talking to other people. And recently, I wondered if such a “linguistic divergence” might, if properly accounted for, help me form a more charitable understanding of how some people talk about rights.  The view in question has been described by Michael Huemer as the Legalist View of rights. (Of note, in that paper Huemer is talking specifically about property rights, but the same view is often taken about rights more generally.) As Huemer puts it, in the Legalist View,  Property rights are in every aspect and detail dependent on government-created laws. (N.B., property rights are not only legal but also moral rights; this is why theft is not just illegal but unethical. The Legalist View is not merely that certain legal rights are dependent on laws, but that the relevant moral rights are dependent on laws.) This is a line of thought I’ve heard in various forms over the years. Its proponents will often say “Rights exist only to the extent that they are established by a society and/or enforced by the state. To speak of something that has no social enforcement behind it as a ‘right’ is a confusion. If it’s not upheld and enforced by a state or by society, then it’s not a right.”  Now, this line of thought has always struck me as, in Quine’s words, startlingly false on the face of it, because it has rather absurd implications. For example, I take it as given that slavery represented the greatest institutionalization of human rights violations in history. But on the “rights only exist when enforced by a state” view, slavery wasn’t a rights violation at all. If rights only exist if a state (or sufficiently strong social conventions) recognize and enforce them, then it simply follows that whenever and wherever slavery is enforced by the state and considered generally acceptable by citizens, no enslaved person experiences any violation of their rights – because genuinely they have none. On this view, the infamous Dredd Scott decision declaring that African Americans “had no rights which the white man was bound to respect” wasn’t a grave error – it was an unambiguously factual statement (at least at the time). If your theory says slavery doesn’t violate anyone’s rights as long as society approves of it and the state enforces it, you need a better theory.  Or so it always seemed to me. But I now wonder if, perhaps, there is a hidden difference of languages, or a linguistic divergence, that might cast this in a different light. I recently recalled a back and forth from the comment section on this blog on the nature of rights from a few years back (yes, I can remember things like this but can’t usually remember when my sibling’s birthdays are!). One commentator defended a legalistic view of rights, saying that if one believes “rights exist and can be ‘negated’ even when the social context clearly doesn’t recognize those rights, then I won’t agree with that bit of the argument. There are many rights that I think societies should create and protect; but they don’t exist before the society goes and does that.”  But I realized from something else the commenter said that maybe his view might be salvageable. Also discussed in that post was the Loving v Virginia case that overturned bans on interracial marriage. On the legalistic view defended by this commenter, one would have to say that such laws, before they were struck down, didn’t violate anyone’s rights. And this commenter accepted that implication – although he also added his belief that “the Lovings *should have had* the right to marry.” Nonetheless, before the court rulings were issued, they had no such right.  So here’s my suggestion that might bridge the gap. This commenter affirmed that he believed the Lovings should have had the right to get married. This in turn entails that it was wrong for the state to prevent them from getting married. Well, saying “it’s wrong for the state to prevent people from X” is, to people like me, simply what it means to say people have a right to X. If I say “people have a right to free speech,” I’m saying that it’s wrong for the state to forcibly silence people from speaking. It’s a prescriptive claim, which in turn allows us to evaluate what kinds of laws are appropriate or inappropriate. On this view, laws and conventions can be rights violations. By this other definition of rights, saying “people have a right to free speech” is a descriptive claim, and as such it may be true or false depending on the laws and conventions in any given society. Thus, on this view, laws and conventions cannot violate rights, because “rights” simply means “whatever is recognized and enforced by laws and conventions.”  Consider, then, when this commenter also said “There are many rights that I think societies should create and protect; but they don’t exist before the society goes and does that.” This is affirming the view that there is something out there, existing prior to and independently of social enforcement, and that particular something ought to be protected and recognized. To the extent that society or the state should protect these things but does not do so, that is a failing and should be corrected. To people like me, that prior thing is what we speak of when we talk about rights, and what we mean when we say rights exist prior to and independently of being formally recognized and enforced by the state or social conventions. This commenter and I both agree that there is something existing prior to state policy and social conventions that prescribes what such policy and conventions should be. It’s just that I call this prior existing something “rights”, and he does not.   As a further example, here’s another thought experiment Huemer offers in the previously cited paper, where I toss in an additional caveat: Suppose you are exploring a remote wilderness region outside the jurisdiction of any government, when you come upon a clearing containing a rude hut. The hut appears to have been built by a hermit, who is its only inhabitant. Since property rights depend entirely upon governmental laws [or social conventions – KC], and none are in force here, you determine that the hermit does not own the hut. Over his vociferous protestations, you decide to spend the night in the hut, eat some of the food that the hermit has grown and gathered, and then paint the hut lime green. You don’t need to do any of these things; you just do them for fun. In this thought experiment, the hermit is not under the jurisdiction of any government, nor are there any reigning social conventions. Still, it seems obvious that you would be doing something wrong to the hermit if you carried out these acts. And I think almost everyone who accepts the legalist view of rights, if pressed, would acknowledge that it would be wrong to do these things to the hermit. Well, the wrongness of those actions is, to people like me, simply what it means to say the hermit has property rights here and that you’ve violated them. If you agree that it would be wrong to do these things to the hermit, then you agree with the substance of what people like me mean when we say the hermit has rights even in the absence of the state and social enforcement, even if you would describe the situation with a different vocabulary.  My point in this post is not to argue that one definition of “rights” is the objectively correct one, or that one is pragmatically superior to the other. (I may come back to that point in a future post, but let’s table it for now.) My point is simply that it’s possible much of the disagreement about whether rights exist prior to or independently of the state may simply be turning on a linguistic divergence over what the word “rights” is meant to designate.   (0 COMMENTS)

An important statistic in international trade economics is the “terms of Trade.”  The terms of trade is the ratio between export prices and import prices.  In other words, the terms of trade is a relative price telling us how many imports we can buy per dollar of exports.  A country’s terms of trade improves (gets larger) when export prices rise relative to import prices; people can now purchase more imports from abroad while giving up fewer exports.  Conversely, a country’s terms of trade decreases (gets smaller) when the price of imports rises relative to the price of exports; people have to pay more in exports to import the same value of imports. For example, let’s say we have two countries: Whitebreak and Faltera.  Whitebreak exports wheat and imports artwork (and vice versa for Faltera).  Wheat sells for $1 and artwork sells for $1.  The terms of trade in this initial state is 1.  Now let’s say the price of wheat doubles to $2.  Whitebreak’s terms of trade improves to 2 ($2 for wheat / $1 for art).  Selling the same amount of wheat can now buy 2 pieces of art.  Whitebreak’s terms of trade has improved. Conversely, Faltera now must give up two pieces of art to buy the same amount of wheat. The terms of trade have improved for Whitebreak, but are the residents of Whitebreak made better off?  It may be tempting to say, “Yes!  They can buy more with the same amount of resources.  Of course they are better off!”  As readers of the title of this piece have likely already deduced, that answer is incorrect.  Why prices changed tells us more about whether or not the people of Whitebreak are better off.  As Scott Sumner would say, never reason from a price change. There are two reasons why the price of a good can change: an change in demand for that good or a change in supply.  If demand increases and the price of wheat rises, the people of Whitebreak are made better off: the quantity of wheat consumed in the world increases and the economic surplus generated in the wheat market increases.  Further, since Falterans are buying more, they are selling more art to Whitebreak, so Whitebreakian residents enjoy more decorations for their homes.  In this case, the terms of trade increase correlates with Whitebreak being better off.  Note that the Falterans also are better off even though their terms of trade have fallen because they increase the consumption of the goods they want. But let us say that, rather than an increase in demand for Whitebreakian wheat, there is a blight that decimates the crop.  This decrease in supply would cause the price of wheat to rise.  Again, this increase in price for wheat would improve Whitebreak’s terms of trade with Faltera, but in this case the people of Whitebreak are certainly made worse off: they have less wheat to consume (and, consequently, less wheat to trade for art).  Their economic wellbeing deteriorates.  In this case, the terms of trade improvement does not signal improvement in the living standards of Whitebreakians. In real life, both the price of exports and the price of imports are constantly changing.  Since the terms of trade is a ratio, it can also change depending on the percentage changes of prices.  For example, let’s say there is a recession and the prices for both Whitebreak wheat and Faltera art fall due to declining demand.  Art is a luxury good, so the decline will likely be more substantial for artwork rather than wheat.  If, say, wheat prices fall 3% but art prices fall 20%, the terms of trade will improve.  Again, this improvement is misleading regarding the wellbeing of Whitebreakians and Falterans. Understanding this limitation to the terms of trade, or any statistic, is important for discussing trade policy.  Judging a policy’s success or failure by a single (or even a basket of) metrics can lead to incorrect reasoning if one does not understand the underlying data influencing the metric. None of this is to say we need to abandon terms of trade.  It is a useful statistic.  But just like any statistic, we must be cautious in its use and interpretation.  Ultimately, the answer to whether a terms of trade improvement (or deterioration) is a good thing or a bad thing is: “it depends.”   Jon Murphy is an assistant professor of economics at Nicholls State University. (0 COMMENTS)

Many of my contrarian opinions derive from my focus on a single macroeconomic variable—NGDP. Consider the recent period of high inflation. Almost all economists believe the inflation was caused by a mix of supply and demand side shocks. In contrast, I believe the high inflation was all demand-side, with supply shocks playing no role at all, at least over the 2019-24 period as a whole.Consider some data from the past 4 1/4 years:Under 4% NGDP targeting, NGDP should have risen by 18.1% between 2019:Q4 and 2024:Q1. Actual increase was 29.0%.Under 2% PCE inflation targeting, prices should have risen by 8.8% between January 2020 and April 2024. Actual increase was 17.8%.Note that NGDP rising by an excessive 11% led to 9% above target inflation. That means supply shocks explain none of the total cumulative excess inflation.  Yes, supply shocks clearly played a role during certain months back in 2022.  But those negative shocks were offset by positive supply shocks during other months. The economy’s supply side has been strong—real GDP has risen more rapidly than expected, mostly due to immigration.  Indeed, given the rate of NGDP growth, we are lucky that inflation was not even a bit higher.  A positive supply shock (a surge in immigration) held inflation to a level slightly below what one would have predicted based on NGDP growth alone. My contrarian views on the role of monetary policy in the recent inflation mirror some similarly heterodox views of the Great Recession.  I argued that the Great Recession was caused by a tight money policy in 2008.  Extremely few economists agree with me.  When I argue that the Great Recession was caused by a big fall in NGDP, people accuse me of engaging in a tautology.  In their view, a big fall in NGDP is a recession.  They confuse nominal and real GDP.   The past 4 1/4 years clearly demonstrate that real and nominal GDP are not identical—a big NGDP overshoot showed up as excess inflation, not very fast RGDP growth.  So much for the “tautology” theory. Another complaint is that while falling NGDP was a problem back in 2008, there was nothing the Fed could have done about it because we were stuck at the zero lower bound.  But we were not at the zero lower bound in 2008–the Fed was doing normal conventional monetary policy.  Indeed in October 2008 they instituted IOR to keep interest rates from falling, i.e., to prevent the economy from overheating. Why do my views diverge so sharply from those of my colleagues?  I see several factors. 1. If you didn’t expect an inflation surge, it’s natural to look for some sort of unexpected factor to explain the result.  Supply shocks are a handy excuse, especially given that for a brief period they were contributing to higher than normal inflation.  But this is motivated reasoning.  Economists often overlook the fact that the economy is also continually hit by positive supply shocks, such as the surge in immigration, or the repairing of supply lines after the disruption of Covid abated.  They correctly saw negative supply shocks during certain months, but failed to see that for the past 4 1/4 years as a whole the supply situation has been excellent.  2. Most economists are relatively supportive of the Fed’s monetary policy stance.  Thus when NGDP deviates dramatically from the 4% growth path, they are reluctant to blame monetary policy.  That would be almost like blaming the economics profession for the policy disaster.  It is much more satisfying to look for explanations that involve mysterious “exogenous shocks”. 3. The stance of monetary policy is often very different from how it appears when looking at indicators such as interest rates.  Rates were falling in 2008 even as money was getting tighter.  Rates rose dramatically in 2022 even as monetary policy remained quite expansionary (albeit arguably slightly less so than in 2021.)  If you misjudge the stance of monetary policy, you are far more likely to misdiagnose the cause of recession or high inflation.  This mistake is especially likely to occur when an exogenous factor (such as a housing slump) causes a big change in the natural interest rate, making the Fed’s policy rate a highly inaccurate indicator of the actual stance of policy. My focus on nominal GDP also explains why I am not impressed by unconditional forecasts.  I notice that lots of people that were right about the inflation of the early 2020s were wrong about the effects of the previous QE programs under Bernanke.  (And vice versa.)  I am far more impressed by conditional forecasts.   What do you think would happen if the Fed allows 29% NGDP growth in the 4 1/4 years after 2019:Q4?  That’s the sort of question we should be thinking about. While NGDP is a useful indicator, inflation and interest rates are not.  If you tell me that inflation is rising, I don’t know what that means for the economy without knowing whether the increase was due to supply or demand shocks.  If you tell me that interest rates are going to be lower, it means nothing unless I know whether the fall in rates is due to easy money or a weak economy. Only NGDP gives an unambiguous indication of the current state of the economy.  It doesn’t tell us everything we need to know, especially in the long run.  But over the short to medium run, no other variable comes close as a way of understanding current macroeconomic conditions. There are times when economists are tempted to ignore the signals being sent by NGDP.  Don’t do that!  Back on June 28, 2021, Jason Furman was being interviewed by David Beckworth.  Here’s Furman: So I have some sympathy for nominal GDP targeting. . . . If we were following it now, we would already have lifted off interest rates. And we’re going to, with extreme likelihood, overshoot the nominal GDP target we were on. So under your [Beckworth’s] framework, you’d have to make up for that with a sustained period of lower than trend on nominal GDP growth. I don’t mean that to pick on you, this experience has destroyed anyone’s plans that they wrote down before. It’s such a weird period. But to me, that says, “I’d like the Fed, if the unemployment rate a year from now is still 5.5%, I’d like the Fed to take that into account, regardless of what’s happening to nominal GDP or prices as an independent problem and issue that they need to take into account.” So I think that anything has to have a dual mandate, but do you look at nominal GDP and the like, instead of inflation? Maybe. Ouch!  June 2021 is when NGDP was just returning to the pre-Covid trend line.  In retrospect, it was the perfect time to tighten policy to prevent an NGDP overshoot.  To his credit, Furman correctly surmised that tightening would be required to prevent an NGDP overshoot, but for other reasons he thought that was an unwise idea.  He thought NGDP was sending a misleading signal, that we should have looked at the unemployment rate (which actually is an unreliable indicator.) With the benefit of hindsight, we can clearly see that the NGDP signal was exactly right and Furman was wrong.  It was time to tighten.   Ignore NGDP at your own risk. (0 COMMENTS)

Economics students are often taught that government should intervene when there is market failure. But what about government failure? Should we expect government intervention to outperform market outcomes? Listen as Duke University economist Michael Munger explores the history of how economists have thought about this dilemma and possible ways to find a third or even […] The post Does Market Failure Justify Government Intervention? (with Michael Munger) appeared first on Econlib.