I have a new article in Economic Affairs, which discusses the prospects for monetarism in the 21st century. Unfortunately, the journal was not able to use my graphs, therefore I’d like to discuss one omitted graph that illustrates an interesting trait of macroeconomics—it’s lack of fixed principles.  There is a tendency of macroeconomists to shift with the intellectual fashions of the day. In the paper, I discussed three general approaches to monetary economics.   1.  Old Keynesianism:  Money supply data uninformative and monetary policy is often ineffective. 2.  New Keynesian:  Money supply data is uninformative and monetary policy is highly effective. 3.  Monetarism:  Money supply data is informative and monetary policy is highly effective. Old Keynesianism is popular when inflation is so low that nominal interest rates fall close to zero.  In that environment, one often sees large increases in the monetary base coinciding with very low inflation (left portion of the graph).  This leads many to assume that monetary policy is ineffective at the zero lower bound.  Monetarism is least popular during these periods.  Keynes’s General Theory was actually a special theory for an economy with near zero inflation expectations. New Keynesianism is most popular when inflation is at moderate levels and fairly stable, say from 1983 to 2007.  During these periods, there is little correlation between money growth and inflation, mostly because inflation is quite stable.  It’s not that money doesn’t matter, rather it’s an example of what Milton Friedman called the thermostat problem.  If you skillfully adjust a thermostat to keep the temperature at a constant 72 degrees, it looks like the thermostat is not influencing the temperature.  New Keynesians do regard monetary policy as still being highly effective, but they focus on interest rates, not the money supply. Monetarism is most popular during periods of high and unstable inflation, such as the 1970s.  During those periods, there is usually a close correlation between long run money growth rates and inflation (right portion of the graph).  In contrast, interest rates become an unreliable indicator of the stance of monetary policy due to the Fisher effect. Personably, I view it as a major embarrassment that macroeconomists shift between these models according to the inflation trends of the moment—like teenagers changing their style of dress each fall.    We need a monetary model that fits any macroeconomic environment.  My preference is market monetarism, where NGDP futures are both the indicator and instrument of monetary policy.  Where monetary policy is always effective and fiscal stabilization policy is never needed. I am currently working on a book that will make the case for a truly “general theory”, a monetary theory that explains monetary policy in both Japan and Zimbabwe. (0 COMMENTS)

Regular EconLog reader Kevin Corcoran sent me an interesting writeup on finding economic ideas in fiction. I edited it slightly. Here it is: Occasionally, when watching a show or movie, I’ll notice scenes that nicely illustrate ideas in economics. My ability to spot and describe such moments is, no doubt, one of the reasons I’m so popular at parties. [DRH note: ha ha.] Recently, one came to mind that made me think of Bryan Caplan’s concept of rational irrationality. The show is called House, M.D., and its titular character is Dr. Gregory House, a doctor who is brilliant at diagnosing difficult cases but is also arrogant, anti-social, and addicted to pain pills due to a half-crippled leg. There was an ongoing story for several episodes in the second season where House had been temporarily removed as department head while being investigated for his various antics. One of his subordinates, Dr. Foreman, was put in charge during the investigation period. Dr. Foreman was presented as generally the smartest doctor (other than House) on the team, and the one who was most willing to butt heads with and push back against House. In the episode A Failure to Communicate, the other doctors noticed that Foreman, even though he was now technically in charge, was suddenly pushing back less against House, and seemed less sure of himself making decisions. That led to this bit of dialogue between him and Dr. Chase: Foreman: You got a point to make? Or did you just feel like giving a long unnecessary explanation for something medically irrelevant? Chase: What happened to the Foreman who always has an answer? The guy who practically wears a sign saying, “I’m as good as House, but I’m nicer”. Foreman: I never said that. Chase: I guess it’s safe to be confident when House is there to overrule you. Now that it’s all on you… Foreman: (Pauses, smiles) It’s different. Yeah. This scene captures the essence of how rational irrationality begins. Foreman, of course, cares about the outcomes – he wants to get the diagnosis right. But he also knows that his voice is less than decisive when it comes to choosing a course of action. And that background knowledge led him, without even realizing before this point, to express his ideas with greater confidence than he could fully justify. Now that his choices are authoritative, he suddenly becomes less sure about how right he is, and more concerned if he’s missed something or might be wrong. As with all good fiction, this is a totally believable bit of writing. Nobody who watches this episode will think “The way Foreman is acting is so unrealistic.” We all can see how that kind of behavior makes sense, and how we’d almost certainly do the same thing if we were in a similar position. Rational irrationality extends this idea. As voters, people have far less reason to second guess themselves than Foreman ever did. Even before he was temporarily in charge of the team, Foreman’s voice still had some effect and some influence, and that provided him with additional incentives to get things right. But in all but the smallest elections, voters don’t come anywhere close to having that kind of influence on the outcome, and the incentive to exert intellectual discipline to be sure you have things right doesn’t have enough force to overpower ideological commitments, tribal loyalties, partisan expression, and so on. There’s not much point in second-guessing your decisions when nothing will be different because of your making a different decision. As a result, voters’ behavior is almost entirely driven by knee jerk reactions they have no reason to reevaluate. That’s one of several examples of my finding nuggets of economic thought in fiction. Kevin and I think it would be fun for EconLog readers to mention instances where they also have seen the ideas of economics in fiction. Have at it. (0 COMMENTS)

Does government intervention create its own externalities (or “neighborhood effects”)? Many economists think so and the question appears especially important in the current storm of dirigisme. Sixty years ago, Milton Friedman defended the idea in his influential book Capitalism and Freedom. A mainstream neoclassical economist and moderate classical liberal, Friedman wrote (p. 32): Our principles offer no hard and fast line how far it is appropriate to use government to accomplish jointly what is difficult or impossible for us to accomplish separately through strictly voluntary exchange. In any particular case of proposed intervention, we must make up a balance sheet, listing separately the advantages and disadvantages. Our principles tell us what items to put on one side and what items on the other and they give us some basis for attaching importance to the different items. In particular, we shall always want to enter on the liability side of any proposed government intervention, its neighborhood effects in threatening freedom, and give this effect considerable weight. Just how much weight to give to it, as to other items, depends upon the circumstances. If, for example, existing government intervention is minor, we shall attach a smaller weight to the negative effects of additional government intervention. This is an important reason why many earlier liberals, like Henry Simons, writing at t time when government was small by today’s standards, were willing to have government undertake activities that today’s liberals would not accept now that government has become so overgrown. Technically, externalities are usually modelled as non-intentional effects of activities carried on for other purposes. Otherwise, everything that imposes indirect costs or benefits on somebody would be an externality; pretty much all activities would fall in that category. It seems to follow that the typical government intervention should not count as a positive or negative externality, because it is explicitly designed to create benefits for some groups and impose corresponding costs on others. However, if it also has  indirect consequences on everybody’s liberty, it can be considered as creating freedom externalities, as Friedman suggests. (In this perspective, a government intervention whose purpose is to increase government power and to decrease individual liberty would not generate freedom externalities, but only direct freedom costs.) Does growing government intervention, besides increasing freedom externalities, also increase their rate of increase, as the Friedman criterion above seems to say? For any individual, the cost of a given intervention in terms of his own individual liberty will conceivably be larger the higher is the starting level of government intervention and power. One reason would be that, at higher thresholds of power, the more likely an additional intervention will combine with existing controls to give irresistible power to government and seriously undermine the liberty of the subject (or “citizen”). If government surveillance is widespread, for example, the more likely a new public morality or lifestyle law can be used to harass unpopular minorities. Another reason is simply that, as individual liberty decreases, the more an individual will find the remainder valuable. Note how in other to avoid the serious problem of cost-benefit analysis—which is that no scientific basis exists for weighing the benefits of some individuals against the costs imposed on other—we should formulate the problem of freedom externalities à la James Buchanan: each individual estimates his own cost and benefit from a given intervention and can  be presumed to consent to it only if, for him,  the latter is larger than the former. The only assumption made here is that, everything else equal, no individual wants to be more oppressed; oppression is a cost, not a beneficial or neutral condition. If some individuals like to be slaves for the mere pleasure of servitude, freedom externalities are not unambiguously positive or negative. The problem then becomes more complicated. Considering only negative freedom externalities, Friedman’s warning is valid: the higher the level of government intervention, the larger are the negative freedom externalities of any new proposed intervention. I suggest that it is not easy today to find any new government intervention—or at least any “net” intervention—that would survive the Friedman criterion. (0 COMMENTS)

Capitalism makes people compete for scarce resources. People compete for scarce resources because scarce resources are, well…, scarce.  Free markets enable people to compete for resources peacefully. Prior to capitalism, people dealt with scarcity largely through conquest, and enslavement. Free trade has eliminated any excuse for conquest. As Adam Smith observed in The Wealth of Nations, trading with people in other nations to obtain goods is far less costly than trying to conquer and contain them. People produce more when they benefit from their production than they do at the point of a bayonet. Smith also argued that free labor is far more cost effective than is slavery. Again, people produce more when they benefit by their production than they do under threat of punishment.   Capitalism is based on greed, extreme competition, predatory behaviour and nearly zero empathy. Capitalism is based on the idea that people should be free and that they should own themselves and the product of their labor. People under any economic system try to improve their own material well-being and that of their families and loved ones. Is that “greed” or is it simply being responsible? By and large, individuals try to improve their conditions within the rules established by society. Under a free market, people trade goods and services with others. An entrepreneur with no empathy for her customers is unlikely to understand what goods and services her customers want and will not stay in business long. In a socialist country, to the extent to which people give according to their ability and receive according to their need, people tend to demonstrate minimum ability and maximum need. More likely, though, goods flow from the politically weak to the politically strong.  As a result, predators rise to the top.   Capitalism doesn’t care about those who are poor, sick, or disabled. Capitalism is not a living being. Only people can care about others, and they can care about others in whatever economic system they are in. Under a free market system, people benefit by helping others.  Entrepreneurs can profit only by providing goods and services that people want and for which they are willing and able to trade the fruits of their labor.   In a Capitalist system money is required for education and healthcare. The provision of education, healthcare, food, clothing, and housing requires resources, and someone must pay for, or otherwise provide, those resources. Money is a proxy for those resources and it facilitates their exchange. In a free market, the people benefitting from services like education and healthcare pay for them.  In socialist societies, or in welfare states, others must bear the cost. Economist Milton Friedman observed that there are only four ways to spend money: The best way to ensure that money is spent wisely (that is, to get the most value for the least expenditure), is to let people spend their own money for their own benefit. Richard Fulmer worked as a mechanical engineer and a systems analyst in industry. He is now retired and does free-lance writing. He has published some thirty articles and book reviews in free market magazines and blogs. With Robert L. Bradley Jr., Richard wrote the book, Energy: The Master Resource. (0 COMMENTS)

Some members of the American Economics Association have recently written to the AEA to ask that it move its 2023 meetings away from New Orleans and its 2024 meetings away from Texas. Their stated reason is that Louisiana and Texas have laws that heavily restrict abortion. They write: These restrictions on healthcare place an undue, differential burden on young women in the economics profession, who are forced to balance the risk of needing medical care unavailable in Louisiana with their professional obligation to attend the Annual Meetings. My Hoover colleague John Cochrane discusses the issues quite thoroughly. Their petition to the AEA got me thinking about something else. Would these petitioners also advocate not having the AEA conference in Canada? Here’s a quote from a June 25 article at Time.com: On average, women wait one to two weeks for an abortion in Canada and as long as five weeks for later-term abortion care, according to Action Canada. So if the meetings were held in Canada, the young women they worry about would have an even harder time getting an abortion in Canada. Here’s another quote from the same story: “Even though we have the fully enshrined right to this service, that doesn’t mean that it’s widely available,” said Kelly Bowden, director of Policy, Advocacy and Government Relations at Action Canada for Sexual Health & Rights. This quote beautifully states the essence of single-payer: you have a right to health care, but that doesn’t mean you’ll get it. As I once put it in a radio interview in which I was discussing Canada’s Medicare system: Canada’s Medicare doesn’t guarantee that you’ll get medical care; it guarantees simply that you’ll be able to line up for medical care. Now there is a silver lining, from the same article, that the petitioners to the AEA could point to: Most of the clinics that have capacity are in Toronto and Montreal, said Joyce Arthur, executive director of the Abortion Rights Coalition of Canada. But it’s much harder to find clinics in Canada’s western provinces, meaning women in states such as North Dakota and South Dakota — which could soon have new restrictions — will have difficulty finding services. She said it also could promote a system where Canadian practitioners prefer Americans who pay in cash. (italics added.) “We want to help Americans but it’s difficult because we want to take care of Canadians first,” Arthur said. “It could result in a two-tiered system.” So maybe the petitioners would not object to having the AEA meet in Canada because there is relatively free market in medical care in Canada for those who are not Canadian residents. I’ve heard stranger things than economists advocating free markets.   (0 COMMENTS)

Is there a pro-freedom progressivism? I’m not certain, but Matthew Yglesias sure seems to think so. In the past hour, he has tweeted the following: 1.  Criticism of a “Really outrageous attack on free speech” by law enforcement in Arizona. 2. Argued “Let’s make it easier to get permits to build houses”   An hour earlier he made the pitch more overtly political, “Own Ron DeSantis by making it easier to build houses in California.“ 3.  Argued “Let’s make clean energy deployment easier“ 4.  Argued “Let’s increase the supply of doctors and other medical professionals” by weakening the AMA cartel. 5.  Five hours ago he suggested that “freedom” was the best way to sell the pro-choice argument: As I’ve said many times, there’s no such thing as public opinion.  It depends how you frame the question.  I.e., the question creates the opinion. 6.  Six hours ago, he tweeted, “YIMBY is about freedom, not apartment buildings.” 7.  Twenty hours ago he tweeted on vaccines and nuclear power.  In both areas he has written more extensive essays, sometimes advocating the removal of regulatory barriers that slow the development of vaccines and prevent the construction of (low carbon) nuclear power plants. Matt Yglesias is certainly not a libertarian.  But he’s also not a typical progressive.  Rather he advocates something called “popularism”, which is roughly the achievement of progressive goals via popular means (and in some cases compromises.)  This differs from “populism”, which often aims at non-progressive policy goals such as trade barriers, immigration barriers, and the weakening of criminal justice protections.  In Yglesias’s view, unpopular “woke” excesses actually end up hurting the progressive cause. I find it interesting that Yglesias often sees the “freedom” message as a way of making public policies more palatable.  He spends part of the year in Texas, and seems to have a pretty good grasp of how middle Americans think, especially when compared to the typical coastal progressive. PS.  If I were pro-life, I’d be infuriated by this misleading and manipulative video.  But as Yglesias correctly suggests, it is probably quite effective. PPS. Warning:  If progressives keep using the freedom message because it works, they might eventually find themselves beginning to believe in freedom.  Handle with care!  🙂 (0 COMMENTS)

Have we made our lives too comfortable? Can we imagine living without the many services we pay for, the apps that assist us, or the algorithms that reduce our physical efforts while saving us precious time? Journalist Michael Easter argues in his book, The Comfort Crisis: Embrace Discomfort To Reclaim Your Wild, Happy, Healthy Self, that moving out of our physical and mental comfort zones is not only good for us but might improve our health and mental well-being. In this episode, he and EconTalk host Russ Roberts discuss the merits of boredom, listening to our surroundings, death, and “this thing called misogi”. Dive in, and tell us about your past and anticipated novel experiences; we’d love to hear from you.       1- The theme of rites of passage is rich in ancient and modern literature and film. What do you think of the practicality of choosing a physically challenging, psychologically tough misogi (禊) experience that has only 50% odds for success?   2- If too little or too much mental and physical stimulation can have lasting negative effects, how much risk should we choose to take? What stimulating event or activity would cross you to the other side of the U-shaped curve Easter describes and that Roberts believes he is now scaling?   3- To what extent does Easter sufficiently explain why he contends that monumental intellectual accomplishments don’t achieve the same or similar life-changing outcomes as tremendous physical wins?   4- Door Dash, Amazon Next-Day Delivery, Venmo, Lyft, Google Maps, (name your favorites). How do these innovations assist our propensity toward routine and lack of focus on the present? What does your cost/benefit analysis reveal about your value for increasing daily conveniences?   5- Humans used to run down prey in the heat for miles, and then carry heavy weight over long distances. Is it a good or a bad thing that the majority of us have let these skills stultify? Do you agree or disagree with Easter that we should also seek to learn where else we might be “falling short” in our lives? Explain.   (0 COMMENTS)

An Economist article on government subsidization of child care (day care) is full of economic lessons, although not necessarily or exactly those that the magazine draws (“British Child Care Is Expensive: Making It More Affordable Would Help Some Mothers Into Paid Work,” June 30, 2022). The magazine correctly suggests that a statement by the outgoing British prime minister, Boris Johnson, is questionable: better access to child care, said the politician, “would have a massive benefit for the economy.” We can be more radical: the statement is meaningless if the benefit is not net of cost or if, by “the economy,” Johnson did not mean all UK citizens or residents. In any event, better access to baby food or diapers or clothing or large apartments would have the same effect. It is true that the venerable magazine and often offers refreshing perspectives and, at least, sets the problem correctly: In an ideal world, the government would not have to worry about any of this. Based on their preferences and potential earnings, parents would make a rational judgment over whether to outsource child care or keep it in-house; it might make sense for them to borrow to cover short-term costs, for instance. The sentence that follows, however, is not sufficiently informed by the economic way of looking at things: The question for policymakers is how much parental behaviour does reflect actual preferences and how much it is driven by constraints. … In a free society, “constraints” are made of other people’s preferences and their equal liberty of choice. For example, most consumers are not willing to pay more for goods and services that use the less regular labor of women who choose to have ten children. The magazine also writes: But there is also plenty of evidence that constraints are an issue. Three in five non-working mothers say that they would prefer to work, given the right child care. Of course. Most good things have costs, that is, constraints.  Many non-working people would prefer to work given the right salary. Many would prefer to read more books or to go to the gym more frequently if it required less time or money. Many would shop at Whole Foods if it were not so expensive. Many would prefer to live in Los Angeles if they could get both the benefits of the city and none of its costs. And so forth. The real question, alluded to by The Economist but a bit too impressionistically, is whether these choices are made by individuals given their preferences and constraints, or by government giving its own choices and constraints. A sentence that shortly follows helps identify the error of imagining an ideal government world: Cheaper child care could help growth, in other words, but policies would need to be well-designed to target genuinely constrained parents and to stop costs spiralling out of control. The first clause would be true only if we defined “economic” growth as the growth of the production of the goods and services that the government prefers its flock to consume—more child services as opposed to fewer concerts or less beer, for example. The important second clause assumes that, to paraphrase the doubts expressed by the Economist about the preferences of rational parents, governmental behavior rationally reflect the preferences of everybody in the economy—which public choice economics has shown is the mother of all heroic assumption-s–instead of embedding bureaucratic and political interests and constraints. To avoid being what James Buchanan called normative eunuchs, we may consider another factor: personal responsibility, which is inseparable from the ethical belief in equal and sovereign individuals. In this perspective, each individual adult (or voluntary family grouping) must make his own trade-off between, on the one hand, the joy and learning benefits of having and rearing children and, on the other hand, the opportunities that must thereby be forgone. Time and other resources are limited. And how did our forebears, who were poorer than us, do it? Anyone today who is willing to be, net of child care, as poor as our forebears were could raise as many children as they did with as little help from Big Brother as they had. This remains true despite changes in relative prices between their time and ours; for example, housing and domestic servants have become much more expensive relatively to domestic appliances and robots, which have become much cheaper (they previously had an infinite cost). (0 COMMENTS)

At first glance, this post may seem a rather pessimistic take. When people ask me what’s going to happen to the economy, they do not wish to be told that it’s hard to forecast macro variables.  Nonetheless, I see this as a hopeful post. Writing it has actually made me more optimistic about forecasting. Before explaining my theory, let me review two analogous but clearly different theories, the Efficient Markets Hypothesis (EMH) and the Lucas Critique: The EMH says that’s it’s hard to predict asset prices, because current asset prices already reflect the expected impact of publicly available information.  Thus knowing that Tesla car sales are rising fast and that governments are pushing green energy doesn’t help me predict the rate of return from investing in Tesla stock.  The market has already priced in this information.  The Lucas Critique says that when policymakers try to take advantage of the historical relationship between the policy instrument and a policy goal variable, the relationship will shift, and become unstable.  Thus if you notice that there is a positive relationship between the money supply and employment levels under a gold standard, and then artificially increase the money supply in order to create jobs, the relationship will tend to break down.  Workers will begin demanding higher wages in anticipation of higher future inflation. Neither of these theories precludes the ability of me or anyone else to forecast macro variables.  I’m not a policymaker, and thus the Lucas Critique does not apply to me.  And the EMH doesn’t preclude the possibility of being able to predict rising inflation or recession in 2023, as those forecasts might already be embedded in asset prices.  Nonetheless, these two well-known theories are somewhat analogous to the hypothesis that I’m about to offer, which is built on three assumptions: 1. Much of what we are asked to predict represents policy failures.  Not all predictions; it is certainly possible to predict a healthy economy.  But the predictions that people value most are policy failures, such as a surge in inflation or the timing of the next deep recession. 2.  We often forecast by looking at past patterns in the data.  We say, “The last time X happened, the economy experienced Y.”  Importantly, “X” is almost always public information. 3. Policymakers are generally trying to prevent policy failures, and rely on public information. Each time a major airliner crashes, investigators retrieve the black box and try to figure out the cause.  If a component has failed, they may ask airlines to replace that component with something more reliable.  If it was pilot error, they may inform pilots of what went wrong and how to respond to the situation more effectively next time.  As a result, it’s really hard to predict what will cause the next major airplane crash. Much of macro forecasting consists of little more than economists observing something like: “In the past, I notice that macro shock X was often followed by policy failure Y.”  If policymakers never learned from their mistakes, then this would be a useful method of forecasting the macroeconomy.  But policymakers do learn from their mistakes.  They don’t learn as quickly and as effectively as I would like, but they do learn.  And that learning (combined with the subsequent adjustment in policymaking) makes macro forecasting much more difficult than otherwise.  Indeed, this point holds even if policymakers learn the wrong lesson—say by overreacting where in the past they under-reacted.  Any adjustment in policy based on learning makes forecasting much more difficult than otherwise.  In my view (and here’s the optimistic part of the post), this gives us two useful avenues for forecasting. 1. Not all bad outcomes reflect future policy mistakes.  Some bad outcomes might end up being a lesser of evils, given previous policy mistakes that had already occurred.  For instance, as the Great Inflation was getting underway (due to excessive monetary stimulus), the Fed briefly adopted a tight money policy during late 1966 and early 1967, which slowed NGDP growth to about 5%.  Fearing a recession, they then backed off from that policy and NGDP growth surged and averaged over 10% over the next 14 years.  In retrospect, they should have continued with the monetary restraint (say 5% NGDP growth) even if it resulted in a mild recession during 1967.  The alternative (the Great Inflation) was much worse. Today, the Fed needs to slow NGDP growth down to no more than 4%, perhaps a bit less.  Doing so increases the risk of recession, but it is still worth doing.  That fact is what allows so many people today to confidently forecast a recession, whereas it is much harder to forecast recessions during periods when the economy is in equilibrium with low inflation and high employment, and any recession would represent a policy error.  Thus bad outcomes can be forecast when they represent optimal policy—the lesser of evils in addressing an already bad situation. 2.  Another way of forecasting bad outcomes is to look for evidence that policymakers have not learned the right lessons.  In 2020 and 2021, Bob Hetzel looked at the rhetoric coming out of the Jay Powell Fed and noticed disturbing parallels with policy that produced the Great Inflation.  The Fed did learn some useful lessons from the mistakes made during the Great Recession of 2007-09, but overreacted because it ignored the lessons of the 1960s and 1970s.    To summarize, any attempt to forecast bad macro outcomes involves a combination of two types of analysis.  First, ascertaining when bad outcomes are almost inevitable, because they represent the lesser of evils (often due to previous policy mistakes.)  Second, trying to figure out what sort of mistakes a given set of policymakers is likely to make. But we also shouldn’t ignore the pessimistic side of this analysis.  History almost never plays out in the same way twice as policymakers are always learning from past mistakes, even where they learn the wrong lessons or only a portion of the true story.  As we try to forecast the timing of bad outcomes for the economy, Jay Powell is trying to make us fail.  And he has very powerful tools at his disposal. No amount of progress in the science of macroeconomics can solve this problem, because it’s essentially an arms race between forecasters and the Fed.   (0 COMMENTS)