Robert Lucas Keynesianism had taken some lumps by the early 1970s, but it was still the dominant school in macroeconomics. Then Robert E. Lucas Jr. came along. The longtime University of Chicago economist died Monday at 85. In a famous 1972 article, Lucas made a crucial observation. He noted that virtually every macroeconomic model erroneously assumed, implicitly or explicitly, that government officials who made economic policy could essentially fool people into making irrational decisions. Microeconomics assumed people were rational. Why shouldn’t macroeconomics make the same assumption? For this and other insights he was awarded the 1995 Nobel Prize in Economics. This is from David R. Henderson, “Robert E. Lucas Brought Rationality to Macroeconomics,” Wall Street Journal, May 15, 2023. (May 16 print edition.) I learned yesterday morning from John Cochrane that Bob Lucas died yesterday. I approached my editor at the WSJ and he gave me the green light. This is the quickest article I’ve ever written: just under one hour. I liked the way the editor changed my opening paragraph and my closing paragraph. I still like my title though: “The Accomplishments of a Towering Yet Humble Economist.” My favorite parts are near the end about his insight that development economics is growth economics and his famous quote, which I can quote because it’s out there in the literature: Is there some action a government of India could take that would lead the Indian economy to grow like Indonesia’s or Egypt’s? If so, what,exactly? If not, what is it about the “nature of India” that makes it so? The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them, it is hard to think about anything else. I’ll post the whole thing when 30 days are up. (0 COMMENTS)

You’ve probably heard the phrase, “Don’t let the perfect be the enemy of the good.” What has it meant to you in the past, and might there be a way to apply this caution to the way we approach politics? That’s what this episode is about. It’s fan favorite Mike Munger’s 44th appearance on EconTalk, and one of my favorites yet. The conversation starts with Munger describing his 2008 run for Governor of North Carolina, and the lessons he learned based on constituents’ response to his education platform. (It involved vouchers…) There’s a lot to dig into here as always, so let’s get right to it. We’d like to hear more of what you think related to this episode. Please use the prompts below to share your thoughts in the comments. Or use them to start your own conversation offline. We’re here for it.     1- How does Munger describe the difference between directionalists and destinationists? Which one better characterizes you? Explain. (Bonus: In a recent episode of the Great Antidote podcast at AdamSmithWorks, host Juliette Sellgren and guest Mark Calabria discuss the question, “Should people who care deeply about increasing freedom work for the government?” How would you answer this question, and how do you think this relates to directionalists versus destinationists?)   2- Munger says, “It may be that the reason we can’t have nice things is that my side has constantly–that is the directionalists–have constantly conceded the moral high ground.” What does he mean by that? Which do you think are more effective- consequentialist or moral arguments? Is the distinction between the two any more than just intellectual golf? Explain.   3- Roberts reminds us of Milton Friedman‘s policy proposals in Capitalism and Freedom, now nearly 60 years ago, saying Friedman’s arguments were more pragmatic than moral. How successful were Friedman’s policy prescriptions? What about the minimum wage? Do you agree with Munger that “we” have effectively never tried to argue against a minimum wage on moral grounds? What would a compelling moral argument of this kind look like, and how successful do you think such an argument could be?   4- Russ asserts, “I think, the number of people who believe in the value of liberty for its own sake in the United States is larger than ever as a proportion of the population [today].” To what extent do you agree? Who are all these people on “our side,” and how do they find themselves there? To what extent do principles stands proliferate in politics today? (You might want to read this Kevin Corcoran post at EconLog on anchor versus derivative preferences. Then consider, who are the people whose anchor preference is liberty, and how and where do we find them?)   5- Roberts asks Munger if he’s ever read a book that–written in the last 100 years–made the moral case for capitalism and that was persuasive to an open-minded skeptic? What do you think of the books Roberts and Munger note in this regard? How would you answer that question?         (0 COMMENTS)

University of Rochester economic historian Stanley Engerman died on Thursday, May 11. When I got to Rochester as an assistant professor in 1975, I had already heard of him because of his 1974 book on slavery with Robert Fogel, Time on the Cross. I had first heard about the book not in academic circles–I was a Ph.D. student at UCLA at the time–but from a column on the book in the Wall Street Journal. I would bet it was by my favorite WSJ editor at the time, Lindley H. Clark Jr.. But later in various UCLA seminars his book was discussed. Although I don’t remember the full context, I distinctly remember the late Axel Leijonhufvud disagreeing with someone’s assertion about the Fogel/Engerman findings. Axel said, “The data in that book are shot through with incentives.” Axel’s point, which he took from F/E, was that even with slavery, slave owners often had to give incentives such as extra food in order to get slaves to produce more output. That matters for the story I’m about to tell. Mark Skousen has a nice remembrance of being a research assistant for F/E while they were working on the book in 1971. HT2 Tyler Cowen. I have my own memory of an interaction with Stan. In the spring of 1977 (I think), I was teaching a short course titled “Labor Market Institutions” in the U. of R. Graduate School of Management. There were about 18 to 20 students in the class, 4 of whom were black. The main two books for the class were Thomas Sowell’s Race and Economics and Gary Becker’s The Economics of Discrimination. I used these because the professor who had taught it before me, Ron Schmidt, told me that they had worked well for the course. He was a master teacher and so I followed his lead. (I also added a fair number of articles and a segment on Black Codes from W.E.B. Dubois, Black Reconstruction in America.) Over the break before the class started, I read the books cover to cover. I worked through Becker’s math and liked his book a lot, but I loved  Sowell’s book. I got so excited that I wrote a long letter during the break to a friend in which I quoted some of the highlights from Sowell. In working my way through both books, I realized that one of the themes that emerged was that government at all levels–local, state, and federal–had shafted black people and that the “shafting” had by no means ended with the end of slavery. So in my introduction on the first day of class, I told the students that that was one of the sub-themes and that, in light of that, I wondered why more black people weren’t libertarians. I quickly had 4 students paying attention to everything I said. The second week of class, when we were covering some of the early chapters of Sowell’s book, I took issue with something Sowell wrote about slavery. I don’t remember Sowell’s exact point, but the F/E findings on marginal incentives contradicted it. I got pushback from a lot of the students but especially from all 4 black students. I had the sense that some of them even thought I was downplaying the horror of slavery even though I wasn’t. I could feel the good will in the class slipping away and I wanted to get it back. So I walked across campus to visit Stan in the economics department. We had seen each other in seminars occasionally and he had always been friendly. I told him of my predicament and asked if he would come and give a 30-minute talk on the findings in Time on the Cross that related to the issue the students and I had discussed. Stanley was a very affable guy and so I thought I should warn him. I said that there was a chance that the students would transfer some of their hostility from me to him and that, actually, I was hoping they would. He laughed and said that he would come and give the talk. So he did and it went well. There was some hostility but it gradually dissipated during his talk as he showed his expertise and handled all the questions. I still remember one of his answers. One of the students had asked, “You said you studied the records of plantations that had slaves. How many plantations did you study?” Stanley answered, “80” and, as he saw the dismissive look on the face of the questioner, he added, “Which is 79 more than the number of plantations that most other scholars studied.” I left the U. of R. in 1979 and never kept in touch with Stanley. I wish now that I had written him to thank him again.   (0 COMMENTS)

Economist Tyler Cowen of George Mason University talks with EconTalk’s Russ Roberts about the benefits and dangers of artificial intelligence. Cowen argues that the worriers–those who think that artificial intelligence will destroy mankind–need to make a more convincing case for their concerns. He also believes that the worriers are too willing to reduce freedom and empower […] The post Tyler Cowen on the Risks and Impact of Artificial Intelligence appeared first on Econlib.

I recently attended a Hoover Institution monetary policy conference entitled.”How to get back on track”. But exactly what does it mean to get back on track? That question got me thinking about why I struggle so much when people ask me whether I agree with current Fed monetary policy.  I find the question difficult to answer because there are two distinct senses in which monetary policy can be off track: 1. The current stance of policy can be too easy or too tight.  I.e., the fed funds target might be too low or too high relative to the natural rate. 2. The Fed might have the wrong policy regime.  They might be doing growth rate targeting whereas they ought to be doing level targeting.  That makes policy errors more likely. I find that the average person sees the first question as being more important, whereas for me being “on track” is mostly about the second question.  Thus some of my readers might assume that right now I in some sense “agree with Fed policy”, even though I actually disagree with the policy.  Yes, I don’t see much evidence that the current stance of monetary policy is too easy or too tight, but if the economy ends up in the ditch next year then I’ll probably blame the Fed.  Would that be unfair Monday morning quarterbacking?  I’ll use another sports analogy to try to illustrate my point. Suppose a technical foul were called on the Lakers, and coach Steve Kerr of the Warriors chose Kevin Looney to shoot the technical free throw.  I would severely criticize this decision, as Looney only shoots 60% whereas he could have used Steph Curry (who shoots 90% on free throws.) Now suppose someone asks me to predict the path of Looney’s free throw.  I’ll say that I forecast it to go right through the basket.  Yes, he’s fairly inaccurate, but I have no idea whether he’ll miss left or right or short or long.  Think of a probability distribution with “fat tails”, where the center of the distribution is right on the basket.  He’s not very accurate, but I am not aware of any systematic bias.   Even though I predict Looney’s shot will go toward the basket, I’d still criticize coach Kerr’s decision to use Looney if the shot missed.  Similarly, while the current stance of monetary policy seems OK, the Fed’s “let bygones be bygones” policy regime produces a much less stable monetary policy than would a level targeting approach. People will often point out to me that the financial markets did not predict a big inflation problem in mid-2021.  In that case, is it fair to criticize the Fed for what happened later?  Isn’t that just Monday morning quarterbacking?  I’d say criticism is fair, because they should have had a regime in place where they promised to get back to the NGDP trend line after an overshoot.  That promise would have made the initial overshoot much smaller. Just as I would predict Kevin Looney’s shot to go toward the basket despite his poor skill at shooting, I will usually (not always) predict the future path of NGDP to be roughly where the Fed wants it to be.  And I suspect that the markets have the same view. We don’t have an NGDP futures market, but the markets we do have seem to be implicitly predicting a slowdown in NGDP growth, but no severe recession.  Thus interest rates are expected to fall later this year, but remain above 4%.  A fall in interest rates would only occur if NGDP growth slows, and yet if there were a severe recession then interest rates would fall to well below 4%.  So far, so good. At the conference, St Louis Fed President James Bullard suggested that a soft landing is still very much in play.  He pointed out that unlike in the early 1980s, inflation expectations are close to 2%.  It’s much easier to bring down inflation if the higher rates have not yet become embedded in the public’s expectations.  The Fed still has more credibility than in the early 1980s. I mostly agree with Bullard, but I am a tad less optimistic due to my worry about the policy regime.  Yes, markets seem to be forecasting a fairly good outcome.  But that’s just the midpoint of the distribution—there’s still a worryingly wide range of possible outcomes. We need to switch from a Kevin Looney Fed to a Steph Curry Fed.  We need to shift from flexible inflation targeting to NGDP level targeting, so that when NGDP begins to drift off course there be an immediate move in market interest rates that will nudge the Fed in the right direction. PS.  It is the 30th anniversary of the Taylor Rule, and it was nice to see the conference honor John Taylor for his role in making monetary policy more precise during the late 1900s.  Recessions became less frequent after 1982, which is about the time the Fed began using a more Taylor Rule-type approach to policy.  I see level targeting as the next step. PPS.  Don’t take this post as a criticism of Looney, who is an excellent rebounder. PPPS.  I’m tempted to say that level targeting would make monetary policy almost “Stephertless”, but I won’t. (0 COMMENTS)

It is well known to economists that a rational decision-maker will not include sunk costs in his decisions. Since sunk costs are unrecoverable by definition, they are have nothing to do with decisions made now for the future. Only future costs are recoverable: you simply have not to incur them. Some people do not seem to understand that. In a report on Apple’s imminent and risky launch of “mixed reality” googles, the Wall Street Journal tells us (“Apple Is Breaking Its Own Rules With a New Headset,” May 12, 2023—my underlines): Executives and tech analysts say Apple isn’t waiting longer because it would take too much time to make its ideal version, competitors are already in the market and the company has already devoted a lot of capital and resources into developing the headset. What the company has already spent in development costs should not weigh in whether it launches the product now or later or never. The past development money is sunk and not revoverable whatever decision is made now. Given the direction of the arrow of time, one makes decisions to change the future, not to change the past (except if you work for the Ministry of Truth, but even then you can only change the past as perceived starting from today). Suppose that you have invested $500 dollars in some project that is not producing and unlikely to produce any return, but that investing a supplementary $10 in the project will very likely bring a net profit of $5. The $10 will thus bring a return of 50%, notwithstanding that the accounting return on the total investment will be less than 1% ($5 / $510). Of course, you should invest the $10, except if you are an extreme risk-averter or you know another investment that will bring a return of more than 50% with near certainty. But, when you make the decision now, only the 50% return on $10 will guide your decision, not the return of less than 1%. Indeed, if the return on the $10 were forcasted to be 2% (20¢), a rational decision-maker would probably decline to invest as there are likely better returns available on the market or elsewhere within the company. Cut your loss or, as the saying goes, don’t throw good money after bad money, because losing money, or not making as much as you could, does not reduce costs already sunk. The rule apply to other types of costs and returns too. If you have spent one year creating a Frankenstein monster because (say) you needed a hunting buddy, and you discover that your creature is now likely to kill you instead, it would be bad thinking to factor in the solution “all the time I spent bringing him to life!” That time is gone forever and you won’t get it back. Regrets don’t change the past. Good decisions aim at the future, even if only the immediate future (such as not to be killed by your Frankenstein creature). When Apple releases its product, the company will obviously think that it will profitable even if, as the WSJ reports makes clear, fixes will have to be found and further development to be financed. But the project’s sunk costs at any point in time don’t influence the company’s decision at that moment to continue or not pouring money into it. If any new investment in the project is ever estimated to have no prospect of future satisfactory return, investment will stop whether “a lot” or not of sunk costs have gone into it. Why would the WSJ reporters write the sentence quoted above? I can think of four possibilities. (1) The “executives and tech analysts” consulted by the reporters are a representative sample of all executive and tech analysts, which implies that no executives or tech analysts understand sunk costs. This is very unlikely, for an executive or perhaps even a tech analyst who does not understand that would not stay, or have stayed, long on competitive markets. (2) There are some executives or tech analysts who do understand sunk costs, but the reporters missed them or ignored their opinions. (3) The reporters themselves or their editor don’t clearly understand sunk costs. (4) It is just sloppy writing. I don’t know which one or which one, or which combination, of hypotheses #2, #3, or #4 is true, but whichever it is exposes a failure in providing the information that most of the WSJ readers pay for. It is not because most of the other medias are economically illiterate the WSJ is justified to follow them. In my opinion, this newspaper is one of the very top sources of reliable information in the world—which is why I read it regularly and thus find more occasions to criticize it (while I don’t often read Breitbart, the Chronicle of Higher Education, or the Backwoodsman). But I hope these occasions would be less frequent. (0 COMMENTS)

If you read or watch nothing else about Covid-19 today or this weekend, make sure you watch Margery Smelkinson’s 4-minute testimony. It’s here. (0 COMMENTS)

Back in April, my often co-author and friend Charley Hooper was asked to testify on Zoom in front of a citizens’ commission in Canada that was investigating various responses to Covid-19. Here is the link to the Frontier Centre’s post on his testimony. You can then click on the link there to watch his testimony (or click on this link.) Some highlights follow. 4:00: The mismatch. 5:50: The controversy over ivermectin. 8:20: When various drugs were available to deal with Covid-19. 9:00: History of ivermectin. 10:40: Drugs used for disease A often work with disease B. 11:30: Ivermectin kills lots of viruses. 11:58: Does it work? 12:10: Merck and FDA attack ivermectin. 14:00: FDA claimed that ivermectin is not an anti-viral. 15:00: FDA’s motives: EUA, off-label usage 17:40: Merck’s motives 18:50: Notice the host’s question. 20:30: The TOGETHER trial. 24:00: The other studies, many of which found benefits. 26:00: Host’s question about early treatment. 27:25: A basic principle with treating viruses is to treat early. 28:00: Other drugs not as good and some have serious side effects, such as acute kidney failure and harm to DNA. 29:50: Statistical significance. 31:00: Results versus narrative. “Only” 91.2% sure or 93% sure. 34:00: How ridiculous this would be. 35:30: Conclusion: In pandemic try drugs off the shelf. 39:30: How could this be done better? Get rid of FDA censorship: allow drug companies to make money (a little slim on details here) after patent has expired. 45:30: Repeal efficacy requirement. (0 COMMENTS)

Scott Alexander recently argued that building more housing in a given city causes housing prices to go up in that city. He acknowledged that previous studies had found the opposite relationship, but suggested that he was more impressed by the strong positive correlation between population and prices when there are big changes: Matt Yglesias tries to debunk the claim that building more houses raises local house prices. He presents several studies showing that, at least on the marginal street-by-street level, this isn’t true. I’m nervous disagreeing with him, and his studies seem good. But I find looking for tiny effects on the margin less convincing than looking for gigantic effects at the tails. When you do that, he has to be wrong, right? I also believe that looking at the tails (big changes) is often more revealing than looking at lots of small changes.  But only if you’ve got causality right.  And in this case, Alexander hasn’t necessarily done so. Here’s an analogy.  Suppose you wanted to compare the mainstream view of monetary policy (raising interest rates is deflationary) with the NeoFisherian view (raising interest rates is inflationary.)  So you focused your attention on cases where there were truly massive increases in interest rates–say to 20%, 30% or 50%.  In virtually all of those cases, inflation will be very high when nominal interest rates are very high.  That seems to support the NeoFisherian position.  (I wonder how Alexander feels about this debate.) But this sort of correlation doesn’t address the issue of causation, and thus most economists reject the notion that a high interest rate policy is inflationary, despite the clear correlation.  They see this as an example of “reasoning from a price change”. In my research on market reactions to policy news during the 1930s, I argued that big changes were especially revealing.  But in those sorts of “event studies” the direction of causation is clear—policy news leads to immediate changes in asset prices.   Big changes don’t help if the house price model you are criticizing is also consistent with the stylized fact that bigger cities tend to be more expensive.  That stylized fact would be true even if building more houses reduced house prices at the margin. (0 COMMENTS)

Michael Spence, who shared the 2001 Nobel Prize in economics, is an emeritus professor of economics at Stanford University’s Graduate School of Business. He recently wrote an op/ed titled “In defense of industrial policy.” It is gated at Project Syndicate but appears ungated in the Jordan Times. His case is, at best, flabby. It lacks any empirical evidence and takes as given, without argument or evidence, the idea that many government interventions have benefits that exceed costs. A few highlights: The objective of industrial policies is to alter market outcomes in ways that align them better with a country’s broader economic and social objectives. Free-market purists may bristle, but in the real world many relatively uncontroversial and even widely supported, government interventions shape market outcomes. The first 10 words are correct. But what does he mean by “a country’s broader economic and social objectives?” Does he mean the economic objectives of a president and a Congress? I think so. But why should we give weight to their preferences? Is it the old “we voted for them” argument? But what about the fact that even the majority of registered voters, let alone the majority of U.S. adults, didn’t vote for them? Moreover, given everything we know about the incentives of politicians and about who rises to the top, aren’t their objectives likely to be fairly narrow rather than broad? He says that “Free-market purists may bristle.” That’s probably true. But wouldn’t even many clear-thinking people who aren’t free-market purists bristle also at the ease with which Spence would have government dictate to the rest of us? By focusing on free-market purists, though, a group that he must know is relatively tiny, he manages to avoid actually making an argument. He’s saying, in effect, we can dismiss them because they’re purists. He then writes: For example, public-sector investment in infrastructure, education and the economy’s science and technology base is considered an essential complement to private investment, mitigating risks, increasing returns and bolstering overall economic performance. Other widely accepted interventions that alter market outcomes include antitrust or competition policy, measures to overcome information gaps and asymmetries and regulation to address negative externalities, protect user data and guarantee the safety of everything from airplanes to food. Let’s consider this paragraph bit by bit. Note Spence’s use of the passive voice in his first sentence. Considered by whom? He doesn’t tell us. Probably considered by Spence and certainly by many others. But on what basis do they reach these conclusions? Blank out. Now consider his second sentence. It’s true that the interventions he mentions are widely accepted. But should they be? He seems to take as given that because they’re widely accepted, they’re good ideas. And do we get safer airplanes because government regulates? Maybe. But I can tell you how we get more dangerous airplanes in general aviation than we would likely get with minimal or no regulation. The FAA makes it so costly for a small airplane producer to get permission to sell innovative products, that many possible products don’t exist. So airplane owners hang on to older airplanes for 40 or 50 years. The odds are, given that safety is a normal good and that real income and wealth have increased a lot in the last 50 years, that without costly regulation, many new safer airplanes would exist and send at least a few of the older less-safe airplanes to the garbage dump. But Spence doesn’t consider this possibility. Spence then writes: But these are responses to known market failures. Industrial policies, at least the most divisive ones, go a step further, reshaping the supply side of the economy in pursuit of objectives other than efficiency in the allocation of resources. His first sentence is simply an assertion. He gives no basis for it. His second sentence, though, is correct. Aware that he must deal with the issue of the government picking winners and losers, he writes: The second component, however, has proved divisive. Critics point out that selective public investment in any industry’s productive capacity amounts to picking winners and losers. In their view, governments are not well-equipped to take on this task, not least because vested interests can capture the decision-making process. Though this argument in favor of relying on market outcomes should not be dismissed out of hand, it should be met with some scepticism, not least because it is often rooted in an almost religious commitment to unfettered competition. In fact, industrial policy can be essential to a country’s long-term economic survival, as in the case of defence, particularly in times of war. The first paragraph of the two above is promising. Spence shows that he’s aware of the special interests that could distort the process and lead to bad results. But the second paragraph undercuts that. The argument, he says, “is often rooted in an almost religious commitment to unfettered competition.” For some people who make that argument, that’s probably true. But whether it’s rooted in such a commitment isn’t relevant. The questions is, “Is the argument correct?” But by bringing in the idea that some of the people who disagree with him might be “religious” about their disagreement, he cleverly avoids actually dealing with the argument. Spence then writes: The real question is not whether industrial policy is worth pursuing, but how to do it well. Government capacity is decisive: to act effectively as an investor and major buyer of products and services, the government needs people with talent and experience, receiving compensation to match, and well-designed institutions. Moreover, goals should be precise, limited and clear, and guardrails must be erected to protect against private-sector capture. Industrial policy is not corporate welfare. Isn’t that only one of the real questions? Isn’t another question whether industrial policy is worth pursuing? Is this question irrelevant? Spence seems to think so. Spence asserts that the Defense Advanced Research Projects Agency (DARPA) and the government support of the COVID-19 vaccine are examples of successful industrial policies. That might be true, but he doesn’t give evidence to support his claim. Spence admits that there are industrial policy failures but points out that venture capitalists fail too. He writes: No one expects every investment made by a venture-capital fund to be a home run. Governments should be afforded the same leeway. A decent track record is good enough to make industrial policy pay off for taxpayers. His first sentence is absolutely correct. But the difference between venture capitalists and governments is that venture capitalists are betting their own money while governments are betting our money. That’s a big difference. The very essence of economics is its focus on incentives. The incentives for venture capitalists and government officials are quite different. If the venture capitalists succeed, they might make a lot of money; if they fail, they lose their own money. If government officials succeed, they might get a nice promotion and $10,000 or $20,000 more annually; if they fail, they might not even get demoted. I would have thought that the difference in incentives would be one of the first concerns that would arise in the mind of an accomplished economist. But maybe Spence would say that that’s because I’m religious.   Postscript: Here is the biography of Michael Spence that I wrote in The Concise Encyclopedia of Economics. (0 COMMENTS)