Robert Lucas When I closed the deal to write the Wall Street Journal obit of Robert E. Lucas, I had limited time. I hit a new personal best: I wrote it in just under one hour. That necessarily meant, though, that I couldn’t do as thorough a research job as I do for the October Nobel Prize award, when I have more like 6 hours. So I hadn’t recalled his Nobel speech, or possibly I had never read it. Here’s an excerpt: Your Majesties, Ladies and Gentlemen, As you all know, Alfred Nobel did not choose to establish a prize in Economics. This prize was established in the 1960s, as a memorial, through the generosity of the Bank of Sweden. Generosity and, I would say, wisdom, as the establishment of a Nobel Prize in Economics has had a very beneficial effect on my profession, encouraging us to focus on basic questions and scientific method. It is as if by recognizing Economics as a science, the Bank of Sweden and the Nobel Foundation have helped us to become one, to come close to realizing our scientific potential. Now in 1995 this great honour is given to an economist who maintains that central banks should focus exclusively on the control of inflation, that they must be resolute in resisting the temptation to pursue other objectives, no matter how worthwhile these objectives may be. It would be understandable if people at the Bank of Sweden were now thinking: “Why don’t we tell this man to take his theories to the Bundesbank, and see how many kronor he can get for them over there?” But this is no occasion for ill-feeling. It is not the time to criticize central bankers or anyone else. When Voltaire was dying, in his eighties, a priest in attendance called upon him to renounce the devil. Voltaire considered his advice, but decided not to follow it. “This is no time,” he said, “to be making new enemies”. In this same spirit, I offer my thanks and good wishes to the Bank of Sweden, to the Nobel Committee, and to everyone involved in this wonderful occasion. I lied. This is not an excerpt. This is the whole speech. I can just imagine the twinkle in Bob’s eye as he gives credit to a central bank for helping make economics a science. HT2 Timothy Taylor, aka, The Conversable Economist. (0 COMMENTS)

The recent death of Robert Lucas marks the end of an era. Others have done a nice job describing his immense contributions to the field of macroeconomics. (See, for example, David Henderson and Tyler Cowen.). Here I’ll focus on a few personal observations, as Lucas probably influenced my career more than any other economist. When I was just starting out, I assumed that economics was about ideas—that developing good ideas was the key to success.  Over time, I became increasingly disillusioned with the field.  There seemed to be too much focus on technique and too much weight put on credentials, reputation, connections, etc.  One exception was Robert Lucas, who seemed genuinely interested in figuring out which ideas make the most sense.  Back in the late 1980s, Steve Silver and I wrote a paper on what would now be called “the fallacy of reasoning from a price change”.  The paper was rejected from a prestigious journal for reasons that made no sense.  We pointed this out to the editor, who then sent it out for a second review.  This time it was accepted.  Most editors would have replied to us with a letter saying something like “I see there’s a disagreement with the referee, and we must defer to his/her judgment.”  In this case the editor was Robert Lucas, who actually took the time to evaluate our arguments and saw that we were correct.  He didn’t discount the importance of our paper merely because it didn’t use any techniques more sophisticated than a simple regression. Lucas was also the chair of my dissertation committee.  My research was on currency hoarding and the underground economy, a topic that was completely unrelated to his much more cutting edge work on money and business cycles.  Nonetheless, he was quite supportive of a project that I probably would have had difficulty getting approved by famous economists at almost any other top program.  All of the statistical work was done on a 1970s-era pocket calculator.  He found the ideas to be interesting, and that was enough.  He was an idealistic economist. Looking back on my career, the four economists that most shaped my thinking on macroeconomics were Irving Fisher, Milton Friedman, Bob Lucas and Bennett McCallum.  Lucas was the only one of the four that I took classes from, and without his encouragement it is unlikely that I would have ever made it into academia.   PS.  John Cochrane also found Lucas to be very supportive when he was just starting out.  (0 COMMENTS)

According to a recent CNBC survey, pessimism regarding the American economy is at an all-time high, with 69% of the public having a negative view.  The leading reason is inflation in a weak economy. The latest report this week shows that inflation remains persistently high at near 5%, eroding slower-growing average weekly earnings year-over-year for 25 straight months. The Federal Reserve recently raised its federal funds rate target for the 10th meeting in a row to 5.25%–the highest since August 2007. While these rate hikes were anticipated in light of ongoing inflation, they could have been avoided. But excessive government spending and money printing during the “boom” led to this government-failure bust, the effects of which we’ll feel for months and even years to come. The sluggish economic growth has been rough on Americans, but inflation has been a killer. The survey also noted, “Just 5% say their household income is growing faster than inflation, 26% say it’s keeping pace, and 67% report they are falling behind.” This is devastating lower-income households’ standard of living.  The trend of declining real wages is particularly harmful to low-income Americans. But even the wealthy feel the effects, as more than half of higher-income Americans surveyed report spending less on eating out and entertainment. This has contributed to the anemic annualized economic growth of just 1.1% in the first quarter of 2023 after rising by only 0.9% from the fourth quarter of 2021 to the fourth quarter of 2022.  As prices increase, businesses spend more on production, making it more difficult to raise workers’ wages while remaining profitable. Employees who can’t be paid enough to fund costly goods like childcare and groceries, which have risen by 7.1% over the last year, spend less on other things or fall behind on their bills. Businesses earning less revenue will invest less, and so goes the vicious downward cycle.  Another hit on Americans has been the cost of shelter, which was up 8.1% over the last year even as there are signs that housing prices are cooling across the country. Still, housing prices have been “eclipsing the inflation rate by 150% since 1970.” This means many Americans can’t afford to own a home, and that’s getting further out of reach as mortgage rates have soared.  What’s to be done about inflation threatening Americans’ livelihoods? Legendary economist Milton Friedman had some advice about addressing sky-rocketing inflation that is valuable today.  There is one and only one basic cause of inflation: too high a rate of growth in the quantity of money—too much money chasing the available supply of goods and services,” he argues. “These days, that cause is produced in Washington, proximately, by the Federal Reserve System, which determines what happens to the quantity of money; ultimately, by the political and other pressures impinging on the System, of which the most important are the pressures to create money in order to pay for exploding Federal spending and in order to promote the goal of ‘full employment.’ Despite raising its target interest rate to fight inflation, the Fed has a bloated balance sheet of nearly $9 trillion, which is too high for disinflation to its target of an average 2% rate. When the Fed engages in excessive money printing compared with the supply of goods and services, inflation is the result, as Friedman described.  While it was appropriate for the Fed to raise its target rate, the ongoing increase to its balance sheet is just continuing to distort productive economic activity. And Congress must restrain spending. The national debt is nearly $31.5 trillion, with net interest payments on the debt set to exceed $1 trillion soon.  The government must borrow to finance the deficit when it spends more than it makes, driving up interest rates. Higher interest rates increase the cost of borrowing for businesses, leading to lower investment, which reduces the supply of goods and services. Add in the Fed buying the debt that increases the money supply with less supply of goods and services, resulting in more inflation.  House Republicans passed a debt ceiling bill that would return spending to 2022 levels and limit spending to just 1% growth over the next decade while eliminating other bad policies. Negotiations between the two parties continue, while a June 1 deadline looms. If they don’t reach agreement, it will make the debt issue an ongoing concern as defaulting on the debt nears, further raising interest rates that weaken the economy.  This means we can expect a deeper, longer recession. The Fed and Congress have a duty to stop flawed policies of excessive printing and spending, respectively. High inflation harms Americans, and the Fed and Congress must address this. If they don’t take action soon to address these government failures, the erosion of the American dream will continue. The future of America depends on sound, pro-growth, pro-liberty policies instead that will let people prosper.     Vance Ginn, Ph.D., is founder and president of Ginn Economic Consulting, LLC, chief economist or senior fellow at multiple think tanks across the country, and is host of the “Let People Prosper” podcast. He previously served as the chief economist of the White House’s Office of Management and Budget, 2019-20. Follow him on Twitter @VanceGinn. (0 COMMENTS)

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)