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    February 2011

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    Maxine's Essays

    • 21st Century Regress
      Sometimes it seems like the world is going to hell and there's absolutely nothing a girl economist can do about it.
    • What Exactly Are We Crowding Out?
      The current economic downturn isn't a random draw of a black ball from an urn containing white balls and black balls. There's no sampling distribution. Very specific policies and actions landed us here. Now we must decide not only what policies need to be put in place to prevent it happening again, but also what policies would best drive us out of the ditch faster and sustainably.
    • I Wish It Were Only Butter
      We should be giving up some butter if we must. We should not give up education or health investment (or infrastructure or the environment (hello, BP). They may be the only legacies of any value that we pass on to our children and grandchildren.
    • Rational Health Investment?
      The obvious "market solution" is to improve the long run return on investments in health among the disadvantaged through meaningful and effective publicly funded education. The obvious short run "market solution" is to reduce the costs of investment and the shadow price of health for the disadvantaged by providing health insurance cover and reduced out-of-pocket costs.
    • The Socrates Parameter
      To the extent that our limbic systems respond to such engineering by over-riding the judgment of our frontal lobe and to the extent that our frontal lobe is deprived of the information it requires to make a rationally self-interested judgment, we are not only pigs and fools, we are slaves.
    • The Economic Rewards of Virtue
      If individual virtue tempers our "piggy" desires and conditions our choices to something that is both individually and socially better, then the economic rewards of virtue as embodied in and promoted by societal norms and institutions are far greater than we have ever suspected. As economists, we would do well to recognize this when we teach U max.
    • The Market for Morals
      Markets then are places where more is exchanged than goods and services, labor and product, credit, and interest. They are places where we also develop the personal virtues of temperance and prudence and the social virtues of benevolence and justice. When they function well, they produce trust, loyalty, and sympathy among those who trade there.
    • Post-Modern Applied Economics: It’s the Error Term, Stupid
      Maxine believes it’s time to refocus attention and discussion on the error term. It is often where much of the action is in our models. It is where unexpectedly catastrophic events dwell resulting in fat tails. It is where our animal spirits manifest and cause us to do the right thing or the wrong thing or the thing everyone else is doing rather than the self-interested, fully-informed rational thing. It is where God and miracles and chance dwell.
    • Intergenerational Win-Win: Health Insurance, Education, Environment, Infrastructure
      So when we’re talking about fiscal stimulus packages and we’re borrowing from our grandchildren to finance them, we should be thinking about how to use stimulus monies to create value for those grandchildren AND stimulate our economy.
    • Short-term Private Payoffs, Long-term Social Costs
      The real health reform discussion, the one we should be having, is “What must we do to create a health system that is both efficient and fair?” The answer will almost certainly include relegating the private sector to markets where market forces or regulation are effective at aligning short-term private incentives and goals with long-term societal interests. If such markets are scarce or non-existent in health, then the private health sector will be of limited value.
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    Krugman:"When you’re doing micro, you assume rational individuals and rapidly clearing markets; when you’re doing macro, frictions and ad hoc behavioral assumptions are essential."

    I've done micro, and assumed nothing of the sort. Actual markets are dominated by individuals behaving strategically and lots of markets do not clear. Economists, who study them, know this. Didn't the macro people get the memo? (Phelps had something to say about this, a long time ago. Alan Blinder wrote a book asking about prices and price formation. what happens to this stuff?)

    I know what Krugman says is true about how NK macro is done, because I've skimmed Michael Woodford, but why isn't Woodford embarassed? Is it only because he can feel superior to the unreality of RBC and NC?

    Krugman praises the Fed "monasteries" in a back-handed way, but I don't see why. Minneapolis, Atlanta, St. Louis -- their research departments look like hobbyshops run by right-wing crackpots to me, and they fund and burnish the reputation of academics all the time.

    Income distribution and (social) insurance might have something to do with economic performance. One might suspect that full-employment and shared growth is incompatible with a sufficient degree of concentration of wealth and income, but this is a topic macro-economics never wants to touch. Krugman and DeLong pass for the Left in the Economics, and they won't touch it.

    Krugman admitted he was shocked to discover that Presidents and policy mattered to income distribution. DeLong, when confronted with Piketty and Saez data said he couldn't "find" the mechanisms responsible, and, of course, was shocked and surprised by a trend of more than 20 years duration.

    I don't think economists on the right are all that reluctant to express their normative views. On the contrary.

    But, economists, left and center, are unaccountably reluctant to admit that the economy is a political struggle over income and wealth. With that kind of wilful ignorance in place, it shouldn't be surprising that, instead of a parable on on-going class warfare, understandable by the oppressed masses, Brad DeLong gives the world an impenetrable phrase, such as, "nominal income determination" and wonderment that, with banksters robbing us blind, that we are not more aware that we are all in this leaky macroeconomic lifeboat together.

    I like Brad DeLong, but how the heck did a guy with the ideology of an Eisenhower Republican get to represent the Economics Left?

    Below I'll print the comments I left on the Krugman post. But they are by no means exhaustive. For example, I agree that the field is much too enamored with the idea of the invisible hand, and it's largely controlled by such people -- they force others to tow the line because they control publication in the top journals which is almost all of what money, position, and other rewards are based on in academia. I also agree that assumptions like perfect rationality, no frictions, perfect information -- and expertise -- and self discipline, etc. are best discarded in some micro analysis too, not just macro; micro shouldn't ignore these things either.

    I'd also add this theory: people who are win at all cost, and with a history of winning, are more likely to be libertarians, and more likely to be workaholics from childhood, so such people tend to be successful in economics, especially today with how publication has come to depend so much on mechanics rather than high level intelligence. Someone who has little high level intelligence can get tenure at Chicago just by working 100 hours a week from age 5 at things that are time consuming and mechanical but not that hard to understand. Thus, libertarians are in positions of control in academic economics much more than their representation in the general population.

    Now, here are my original comments:

    The Krugman post, "The Instability of Moderation" is very important, and excellent even by Krugman's standards. I consider it an instant classic. My comments:

    1) "It’s a deeply reasonable approach – but it’s also intellectually unstable. For it requires some strategic inconsistency in how you think about the economy. When you’re doing micro, you assume rational individuals and rapidly clearing markets; when you’re doing macro, frictions and ad hoc behavioral assumptions are essential."

    There's really, at a fundamental root level, no inconsistency here. It is, in fact, consistent with the high level intelligent principle that you make the assumptions that are sensible for the given particular situation and purpose, not necessarily one size fits all, and then you interpret the implications to reality intelligently not necessarily literally, or near literally.

    2) "the law of diminishing disciples"

    Great phrase, and I think there's a lot of truth to this. The disciples that follow the originator are often far more mechanical, black and white, simple-minded, and inflexible. This is really true of Adam Smith, who would be stunned to see how he's mischaracterized today.

    3) "Even as the real business cycle people took over the professional journals, to the point where it became very hard to publish models in which monetary policy, let alone fiscal policy, matters..."

    You have something similar in Finance. I wonder if the internet can have a strong effect in decreasing the control of information dissemination, reward, and punishment these people have in academia.

    4) "This is Minskyism: the long period of relative stability led to greater risk-taking, greater leverage, and, finally, a huge deleveraging shock."

    There's also another kind of Minskyism that I think might be important: You have a crisis, like the Great Depression, so active monetary and fiscal policy gets used because things get so desperate and conservative economics so obviously and painfully doesn't work. Then, the use of active monetary and fiscal policy results in a great moderation for decades, and the depression or other crisis gets forgotten. So people now start to think active monetary and fiscal policy isn't needed – look how great the market works! Of course, it's worked so well because of the government intervention, but they deny that, and they ignore history, or ignore the inconvenient parts of history, or come up with bogus interpretations. So they gain credibility and power, and start dismantling regulation, and stopping fiscal and monetary stimulus, until we have another crisis bad enough to disprove their theories. Then, we again get active government policy resulting in a great moderation with outstanding equal widespread growth..., and the cycle continues.

    On the positive side, I think after enough strong cycles most people will really start to learn and we'll discard extreme freshwater economics and conservative ideology, but it's taken a great deal of suffering and loss and sadly will take more to learn.

    Ok, so how does "concentrated, unfettered wealth and power" come into being? Was it the market or government that saved Goldman Sachs, Citi, BOA etc.? Was it the market or big government that allowed them to become too big to fail? Why are they seeing record profits today while over 150 smaller banks have been liquidated this year alone? The lesson for small banks is clear - the best way to avoid market forces is to become big enough so that the government will protect you from market forces.

    It's not surprising that the concentrated wealth frequently occurs in highly-regulated industries. Does that occur because of markets or because of regulatory capture? The old adage that big business, big government and big labor all enjoy and incestuous relationship is truer than ever.

    The problem especially with Krugman, is the naive belief that titans like the big banks can be regulated.

    Andy: "so how does 'concentrated, unfettered wealth and power' come into being? Was it the market or government that saved Goldman Sachs . . .?

    There's an economics parable for you, and it wouldn't be hard to find similar from John Cochrane or Robert Barro.

    Krugman would say, in reply, "what's your model?", not "what's my narrative?" How's that working out?

    One major thing that strikes me about economics is that I cannot find (in my admittedly spotty reading) any account of the hierarchies that are a constant feature of human societies. The hierarchies that shape attitudes, rewards and outcomes. Even Smith glosses over this. Consider the passage quoted by Kennedy, that landlords

    "are led by an invisible hand to make nearly the
    same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among its inhabitants..."

    "Nearly the same distribution of the necessaries of life"??? Did Smith really think that landlords had much the same access to necessaries as cottagers? Or was he reflecting a view that the chain of social hierarchy was inevitable, natural and constant?

    You can make more sense of the current situation if you ask about relative social position, power and ability to secure rents than if you talk about debt or demand as if it does not matter whose debt and whose demand.

    I'll add that if there is any serious economic work that addresses these issues I would be glad to know of it.

    "Why are they seeing record profits today while over 150 smaller banks have been liquidated this year alone? "

    Yes, thats why. (Because the market share that was taken by the 150 smaller banks - and Merryl Lynch - is up for grabs.)

    P.S. I don't really believe that concentration is a direct result of too big to fail. More failures, would have just meant even more concentration. Niches are occupied by small companies, but every downturn blows some of them away, and economies of scale win out in the end.

    It is important to understand how voters and non-economists translate this stuff. Here are some of what I believe are the actual translations and a few potential problems.
    Capitalism: Money talks. I have money so I get to have what I want.
    Golden Rule: Them that has the gold makes the rules. Ok, well many have more gold but we all want the same stuff so those who have less gold should shut up.
    Free Enterprise: I get to do what I want to make money. Since this is a sacred duty YOU pay the externalities.This is necessary because you have to purchase freedom from the lenders.
    Invisible Hand: The best thing I an do for you is exactly what I want to do. Interfering with me is anti growth and you should be made anathma, cursed and probably water boarded.I think much of the war on terror is based on Muslim nations relatively small purchasing power and TSA/Homeland Sec stuff is really to ensure the airline industry.
    "Following your bliss" and human potential my arse! Back to your cubical buckeroo or you will be replaced by your neighbors Aunt Betsie.
    85% of jobs have been routinized and dumbed down. Your "presence" in your job is not needed just your function. Outside finance personality is not required, and usually not even there.

    A final question: If there is rational self interest why is there a marketing and advertising industry ? I think perhaps marketing execs are the true real time economists.

    "First, at a minimum economists had better learn to speak and write in parables so that the working classes can understand macroeconomic policy as readily as they understand gas station lines and and as well as they misunderstand payroll taxes, marginal tax rates, and estate taxes."

    That's pretty condescending. FYI, I used to work as a carpenter before I got my degree in Aeronautical engineering, the lunchtime conversations of blue collar workers are at least as erudite and grounded in facts as those of most economists I have spoken to.

    But on that subject, didn't Uncle Milton achieve this with his 12 part unparalleled/unchallenged series "Freedom to Loose"


    My question was rhetorical. I agree concentration is not the result of "too big to fail" - rather it's the opposite - over-concentration is why we have too big to fail. My complaint is that the big banks never should have become as big as they did. Absent that, they should have been broken up as part of the bailout. Instead we've institutionalized too big to fail.

    And of course I agree that size brings economies of scale. However, size also brings the ability to unduly influence government policy through regulatory capture and other means. The benefits of large firms must be balanced against their increased ability to use their size in order to obtain government protection and competitive advantage.

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