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Excellent economics extended essays



Here are three links to pieces I've read and learned from:

Excerpt:
Three laws guide this bogus analysis of groups. First, define the group by the outcome you are trying to explain. Second, invoke a stereotype and exaggerate it. Third, endow the group with innate permanent properties, akin to racial characteristics. Together, these errors establish a kind of collective guilt, blaming an entire ill-defined group for the failings of its individuals, even if the offenders are a tiny minority. This is both divisive and false -- and all the more toxic because of its flavor of intellectual propriety.
Another excerpt:
Ayaan Hirsi Ali wrote a memoir in 2006 -- "Infidel" -- that was roughly the Muslim equivalent of "Hillbilly Elegy". I respect Ali for her intelligence and courage, but question her group analysis. She defines "genuine" or "devout" Muslims by whether they support terrorism: "Every devout Muslim who aspired to practice genuine Islam -- the Muslim Brotherhood Islam, the Islam of the Medina Quran schools -- even if they didn't actively support the [9/11] attacks, they must at least have approved of them. It was about belief."
HT@Tyler Cowen (I think it's Tyler: I've seen it posted in multiple places.)

2. Andrea O'Sullivan on the Russian hacks. The best piece I've seen yet.
Excerpt:
Obviously, it is crucial that America maintain a fair electoral process--flawed though "democracy" may be--and the prospect of a foreign power deliberately sabotaging this can strike a primal fear in Americans' hearts. Yet this kind of mass anxiety can also be opportunistically stoked by government operatives to further their own agendas, as history has demonstrated time and again. Responsible Americans must therefore approach claims made by unnamed intelligence officials--and the muddying media spin on them--with clear eyes and cool heads. And we must demand that these extraordinary claims be backed by appropriate evidence, lest we allow ourselves to be lead into another CIA-driven foreign fiasco.
3. Excellent story on Hans Rosling. I highly recommend taking the test of your knowledge that's in the piece. My results were humbling, but in a good way; the world is doing even better than I had thought.

An excerpt on Castro:
Take an outbreak in Cuba that Rosling investigated in 1992. The Cuban embassy in Sweden had asked him to find out whether toxic cassava could have caused roughly 40,000 people to experience visual blurring and severe numbness in their legs. On his first morning in Havana, Rosling met local epidemiologists in a conference room. "Then, two men walk in with guns, and in comes Fidel Castro," he recalls. "My first surprise was that he was so kind, like Father Christmas. He didn't have the attitude you might expect from a dictator."

With Castro's approval, Rosling travelled to the heart of the outbreak, in the western province of Pinar del Río. It turned out that there was no link with cassava. Rather, adults stricken with the disorder all suffered from protein deficiency. The government was rationing meat, and adults had sacrificed their portion to nourish children, pregnant women and the elderly.

Reporting back to Castro, Rosling couched his conclusions carefully: "I know your neighbours want to force their economic system on you, which I don't like, but the system needs to change because this planned economy has brought this disease to people." After his presentation, Rosling went to the toilet. A Cuban epidemiologist approached him to thank him. He and his colleagues had come to the same conclusion several months earlier, but they were removed from the investigation for criticizing communism. Corroboration of their work from Rosling and other independent researchers supported the policy changes that stemmed the outbreak.
What's not said: did Castro do anything to allow Cubans more access to meat? Deregulate the economy, say, so that people could invest and hire? In an otherwise good story, this failure to close the loop is a big flaw.

Another excerpt:
Rosling's charm appeals to those frustrated by the persistence of myths about the world. Looming large is an idea popularized by Paul Ehrlich, an entomologist at Stanford University in California, who warned in 1968 that the world was heading towards mass starvation owing to overpopulation. Melinda Gates says that after a drink or two, people often tell her that they think the Gates Foundation may be contributing to overpopulation and environmental collapse by saving children's lives with interventions such as vaccines. She is thrilled when Rosling smoothly uses data to show how the reverse is true: as rates of child survival have increased over time, family size has shrunk. She has joined him as a speaker at several high-level events. "I've watched people have this 'aha' moment when Hans speaks," she says. "He breaks these myths in such a gentle way. I adore him."
And a passage that affirms my own strategy as an academic:
But among his fellow scientists, Rosling is less popular. His accolades do not include conventional academic milestones, such as massive grants or a stream of publications in top-tier journals. And rather than generating data, Rosling has spent the past two decades communicating data gathered by others. He relays facts that he thinks many academics have been too slow to appreciate and argues that researchers are ignorant about the state of health and wealth around the world. That's dangerous. "Campuses are full of siloed people who do advocacy about things they don't understand," he says.
HT@Tyler Cowen.

In the past, I've argued that tight money caused the Great Recession. But what caused the tight money? One answer is too much weight placed on inflation targeting, combined with a backward-looking approach to inflation. Consumer price inflation was quite high during the first half of 2008, due to rising oil prices and a weak dollar.

An excellent paper presented by Robert Hetzel at the recent Mercatus/Cato Monetary Rules Conference suggests another possible reason why the Fed erred in 2008:

The FOMC had started lowering the funds rate from its cyclical peak of 5.25 percent at its September 2007 meeting out of concern that a disruption to the flow of credit to mortgage markets would weaken growth. Following its lean-against-the-wind procedures, it lowered the funds rate to 2 percent at its April 2008 meeting. However, at that meeting, the FOMC signaled an end to the easing cycle.

One reason for this signaling was that economy appeared to stabilize in 2008Q2. Temporary factors made it appear that the economy was reviving. A decline in net exports boosted GDP. The enormous boost to disposable income provided by the Bush tax cuts temporarily halted the decline in real personal consumption expenditures that had begun in December 2007 (Hetzel 2012, 213).13 Most important, the FOMC became concerned about the persistent overshoot in its inflation target and also about depreciation of the dollar. Its communication delivered the message that the easing cycle was over so that the next move in the funds rate was likely to be upward.1
In footnote 13, Hetzel explains the tax cut in more detail:

The following figures are for annualized growth rates of monthly real PCE:

12/2007 - 2/2008: -1.9%
3/2008 - 5/2008: 1.7%
6/2008 - 9/2008: -3.8%
10/2008 - 12/2008: -4.5%

There is a pause to these negative growth rates in the months of March, April, and May. That pause came from the boost to income from the Bush tax cut, which President Bush signed into law on February 12, 2008. The actual rebates arrived in the month of May, but households anticipated their arrival.
The following graph shows how the tax cut impacted disposable income:

It's worth noting that Bush's 2008 tax cut was an almost ideal example of fiscal stimulus. It did not involve wasteful bridges to nowhere; it was a pure lump sum transfer to households. It was far better timed than usual, occurring before mainstream economists or the Fed even forecast a recession. (Notably, it was far better timed that the 2009 fiscal stimulus.) Kudos to Bush. And yet it failed to accomplish its goal--preventing a recession. Indeed the recession became very severe just a few months later. Why?

One possible culprit is the financial crisis that occurred in the fall of 2008. But on closer examination, the economy worsened significantly during the summer of 2008. Indeed I've argued that the economic decline that occurred in the second half of 2008 had the effect of dramatically lowering asset prices, and pushing highly leveraged investment banks like Lehman into bankruptcy. But why was the economy so weak in the summer of 2008? Perhaps the answer is tight money.

Europe and the US had pretty similar monetary policies during 2008, and pretty similar recessions. So let's compare the two cases:

The blue line is the eurozone. Notice that NGDP growth remained robust up through the first quarter of 2008. Then the eurozone went into recession. (This is nominal GDP, not real, so even a flat line is recessionary.) The US (red line) went into recession in the first quarter of 2008, but then had a reprieve in the second quarter---perhaps due to fiscal stimulus. After that, both regions had a deep recession in late 2008 and early 2009.

Hetzel considers the failure to cut interest rates between April and October of 2008 to be an effective tightening of monetary policy, and I agree. As noted earlier, one reason for the tightening might have been high inflation. Another might have been that the fiscal stimulus gave the Fed a sort of "head fake". At a time of high inflation, the strong consumption numbers during the spring of 2008 convinced the Fed that it had done enough to prevent recession. If you read Bernanke's memoir you sense a sort of "eye of the hurricane" moment in the spring, when it seemed to the Fed that they had weathered the subprime mortgage crisis, and that the economy was holding up OK due to the Fed's bold action when Bear Stearns failed, as well as the aggressive rate cuts of early 2008.

But of course this was a false dawn. The Fed's refusal to ease monetary policy during the late spring and summer of 2008 caused NGDP to start falling during the summer months. This is because the housing/banking distress had caused the Wicksellian equilibrium rate to fall sharply during 2008. Here are some estimates of the equilibrium rate from Vasco Curdia :

BTW, the slight increase in Q3 NGDP is misleading, as the level in September was considerably lower than in July, based on monthly estimates of Macroeconomics Advisers. This graph shows that monthly nominal consumption started falling sharply in September, but even the June to August period is weaker than it looks, as that slight decline occurred against a backdrop of rapid inflation (Hetzel used real consumption data):

I still think the high inflation rates were the main reason why the Fed erred in mid-2008, but the fiscal stimulus almost certainly was a contributing factor. The fiscal boost lasted only a few months, but it left us with a monetary policy that was far too tight for the needs of the economy. It's quite possible that the Fed's overreaction to the spring 2008 fiscal stimulus actually made the recession worse than otherwise.

Monetary offset can be less than 100% or more than 100%. I still think the assumption of 100% monetary offset of fiscal policy is the baseline assumption we should work with, until proven otherwise.

A new paper in Public Choice shows that President Richard Nixon understood the costs of wage and price controls, but implemented them to secure his re-election in 1972. Here is the abstract:

In late July, 1971, Nixon reiterated his adamant opposition to wage and price controls calling them a scheme to socialize America. Yet, less than a month later, in a stunning reversal, he imposed the first and only peacetime wage and price controls in U.S. history. The Nixon tapes, personal tape recordings made during the presidency of Richard Nixon, provide a unique body of evidence to investigate the motivations for Nixon's stunning reversal. We uncover and report in this paper evidence that Nixon manipulated his New Economic Policy to help secure his reelection victory in 1972. He became convinced that wage and price controls were necessary to grab the headlines away from the defeatist abandonment of the Bretton Woods Agreement and the closing of the U.S. gold window. Nixon understood the impact of his wage and price controls, but chose to trade off longer term economic costs to the economy for his own short-term political gain.

The paper reproduces evidence from the Nixon tapes that reveal the private conversations and motivations behind the implementation of the NEP. Here are a few choice quotes from President Nixon and Treasury Secretary John Connally:

Nixon [February 22, 1971]: ''Here's my concern about the freeze. There is strong support for a wage board and wage-price controls and particularly from sources like Arthur Burns. The difficulty with wage-price controls and a wage board as you well know is that the God damned things will not work. They didn't work even at the end of World War II. They will never work in peacetime.''

Nixon: ''I know the reasons, you do it [wage and price controls] for cosmetic reasons good God! But this is too early for cosmetic reasons.''

Nixon [July 24, 1971] refers to a program proposed by Connally and states that he wants to emphasize ''making America competitive again.''

Connally [July 27, 1971]: ''There is a risk in imposing wage and price controls. No question about it. But there's a risk if you don't.''

Connally [August 12, 1971]: ''To the average person in this country this wage and price freeze--to him means you mean business. You're gonna stop this inflation. You're gonna try to get control of this economy. If you take all of these actions. you're not going to have anybody. left out to be critical of you.''

A few minutes later Nixon agrees to accelerate the [NEP] program.

While Nixon was initially reluctant to accept the wage and price freeze, he soon turned into an enthusiastic supporter: ''As a matter of fact, I'd like the freeze on right through the election.'' He worried that the goal of a 2-3 % inflation rate by the end of 1972 would not be achieved, but the design for the program was such that Nixon could plausibly deny responsibility for any failure.

The paper clearly shows that it was political motives of re-election that drove Nixon's decision to implement policy that was known to be extremely costly to the economy. File this one under the explanatory power of public choice. Self-interest is often a powerful motive for political actors (for more, see Bruce Bueno do Mesquita's EconTalk on a revisionist perspective of US presidencies).

An ungated version of the paper is available here.

I've long been deeply suspicious of contrarian research that purports to show that the minimum wage doesn't decrease low-skilled employment. But Don Boudreaux explains my suspicion far better than I could :
Has any science ever devoted so much time, effort, and cleverness to elaborate attempts to determine whether or not a central and indisputably correct tenet of that science - a tenet used without question to predict outcomes in general - fails to work as an accurate predictor for one very specific, small slice of reality as has been devoted by economics over the past two decades to determine whether or not the law of demand works to accurately predict the effects of minimum wages on the quantity demanded of low-skilled labor?

I'm pretty sure that the answer to my question is 'no.'

I judge from the furious debate over the effects of minimum wages on the quantity demanded of low-skilled labor that were there to exist powerful political and ideological forces that stand to benefit if the general public believes that small orange rocks dropped into swimming pools cause no increases in the water levels of swimming pools, there would be no shortage of physicists who conduct and publish studies allegedly offering evidence that, indeed, the dropping of small orange rocks into swimming pools does not tend to raise the water levels of swimming pools (and, indeed, might even lower pools water levels!).

And so it is with minimum-wage legislation. The strong political and ideological interests on the pro-minimum-wage side keep alive the debate over whether or not raising employers' costs of employing low-skilled workers causes employers to further economize on the amounts of low-skilled labor that they hire. There is no furious empirical debate among scholars over whether or not, say, raising an excise tax on oranges would, ceteris paribus. cause fewer oranges to be bought and sold. There is no furious empirical debate among scholars over whether or not, say, an increase in the tuition charged to attend college would, ceteris paribus. discourage some people from enrolling in college. There is no furious empirical debate among scholars over whether or not, say, imposing a poll tax would, ceteris paribus. discourage some people from voting.

Yet because powerful political and ideological interests have a stake in the market for low-skilled workers being immune from the normal operation of the law of demand, a furious debate rages over whether or not employers forced to pay more for labor do or don't further economize on labor.

One picayune criticism of Don's analogy: Comparing the minimum wage to "small orange rocks" leads casual readers to the specious inference that we have trouble detecting the minimum wage's disemployment effect because it, too, is small. Don's should have simply spoken of "orange rocks" - then explained that we might trouble detecting even sizable disemployment effects because of confounding factors. Don is naturally well-aware of this point. He even extends his orange rock analogy by identifying confounding "factors such as rainfall and evaporation, swimmers jumping into and out of pools, and the condition of each of the many pools' drainage and filtering systems." But I wish he'd driven it home a little more aggressively.

Last point: If I were an immigration skeptic, I'd be sorely tempted to use Don's words to debunk the mainstream view that immigration has minimal effect on native wages :

Has any science ever devoted so much time, effort, and cleverness to elaborate attempts to determine whether or not a central and indisputably correct tenet of that science - a tenet used without question to predict outcomes in general - fails to work as an accurate predictor for one very specific, small slice of reality as has been devoted by economics over the past two decades to determine whether or not the law of supply works to accurately predict the effects of immigration on the wages of native laborers?
The key difference: The Law of Comparative Advantage specifically predicts an ambiguous net effect of immigration on native wages, because specialization and trade raises labor productivity and therefore labor demand. You can't credibly say the same about the minimum wage.

Both old monetarists and market monetarists like to describe recessions in terms of a "shortage of money", caused by either a drop in the money supply or an increase in money demand. In this view, the focus is on money as a medium of exchange.

I've always been uncomfortable with that framing, as I don't think the term 'shortage' accurately describes the problem. Rent controls and prices controls on gasoline lead to huge queuing problems. In contrast, there are usually no lines at ATMs, even at the worst points of a recession. Interest rates adjust until money supply equals money demand. In my view, it's more useful to think of the problem as an increase in the value of money. My focus is on money as a medium of account.

I don't want to overstate these differences, as we both believe the problem is caused by either a decrease in money supply or and increase in money demand, and we both believe that the effects are higher unemployment, and monopolistically competitive firms having more difficulty finding customers at their current (sticky) prices. (Most firms are monopolistically competitive---having some pricing power, but also facing competition from similar firms.)

I thought of this difference when reading about India's recent demonetization of 500 and 1000 rupee notes (about $7.50 and $15 in value), which form the bulk of the currency stock in India:

The Reserve Bank of India (RBI), the central bank, has been unable to print money anywhere near fast enough to replace the $207bn in 500- and 1,000-rupee notes that were outlawed overnight on November 8th. Unless India's four existing money presses can be speeded up, or bills quickly imported, experts reckon it could take five or six months before the money removed from circulation is fully replaced.

According to J.P. Morgan, an investment bank, Indians were making do at the end of November with a little more than a quarter of the cash that had been in circulation at the beginning of the month--and this in a country where cash represented 98% of all transactions by volume and 68% by value. The RBI has in effect been forced to ration new cash, most in the form of 2,000-rupee notes that are, owing to the lack of 1,000s and 500s, exceedingly difficult to break for change.
FWIW, I do not think it will take 5 or 6 months to replace the money (these early official estimates are usually too pessimistic in this sort of situation.). But even if it takes 3 or 4 months, it's big problem for the Indian economy:

Small wonder that Fitch, a ratings agency, on November 29th cut its forecast for India's GDP growth for the year to March 2017 from 7.4% to 6.9%. That is in line with most financial institutions' trimmed estimates, although some economists think the damage could be even worse. "There will be no or negative growth for the next two quarters," predicts one Delhi economist who prefers anonymity. "Consumer spending was the one thing really driving this economy, and now we are looking at a negative wealth-effect where people feel poorer and spend less." In my view, this is the sort of monetary shock that is correctly described as a "shortage" of money. In some ways it's even worse than an ordinary garden-variety recession. At least Americans were able to get cash in 2009. But in other respects it less severe, as it's expected to be a temporary monetary shock. It would not surprise me at all if the Indian economy almost immediately returned to full employment after the cash shortage ended. In contrast, employment often takes years to recover from severe monetary shocks that raise the value of the medium of account. (RGDP in India may take a bit longer to recover, for various reasons.)

I think of the Indian crisis as the combination of two shocks, a very mild "medium of account shock" and a very severe "medium of exchange shock". The medium of account shock is mild because it's expected to last for just a few months.

So then why did this shock take about 5% off the Indian stock market? Perhaps because there is a tail risk that this will backfire politically, and weaken the Modi government:

Perhaps more embarrassingly for Mr Modi's government, there are few signs that its harsh economic medicine is achieving the declared goal of flushing out vast hoards of undeclared wealth or "black" money. Officials had predicted that perhaps 20% of the pre-ban cash would not be deposited in banks, for fear of disclosure to the taxman. Yet within three weeks of the "demonetisation"--well before the deadline to dispose of old bills, December 30th--about two-thirds of the money had already found its way into "white" channels.

In another country, such a fiasco would spell disaster for the government in power. Particularly so, one would think, for a party that sailed into office on promises to boost growth, provide jobs and encourage investment. Mr Modi's opponents have blasted his policy as obtuse, destructive and downright criminal; some insinuate that his Bharatiya Janata Party (BJP) was tipped off about the ban. Opposition parties have held rallies and marches across the country and brought India's parliament to a standstill with demands for a vote on the ban, and for Mr Modi himself to debate its merits, to no avail so far.
Like the recent Brexit vote, this is a sort of natural experiment, from which we may learn a bit more about business cycles. It will be interesting to watch if and how the current Indian slowdown differs from more conventional tight money recessions. One difference already seems apparent; the action seems to have depreciated the rupee in foreign exchange markets :

The Indian government's decision to scrap high denomination notes in order to crack down on counterfeiting and money laundering has had the unintentional effect of weakening the Rupee.

On the GBP/INR price chart there is a clear spike on November 9 and 10 after the Indian government surprised markets by announcing out of the blue that it was excluding 500 and 1000 Rupee notes from legal tender.

PS. Larry White has an excellent post on this issue, discussing lots of the side effects produced by this policy experiment.

In my comment sections I see a lot of speculation about the rising stock market, and what it's telling us about the policies of the next administration. I'm on record as strongly favoring the use of market indicators to evaluate the effect of policies. But before doing so, a few caveats:

1. It's easier to use market indicators where you have a real time response to a discrete policy move---such as an unexpected increase or decrease in the fed funds target. Markets respond within seconds.

2. It's important to keep in mind that stock prices can at best tell us something about the likely economic impact of a new administration, not it's overall impact. Thus if an administration increases the risk of nuclear war from 0.4% to 0.8%, that's a really bad thing, but it won't significantly impact prices, partly because the probability is so low, and partly because even money may be worthless after a nuclear war.

The same is true if a new President emboldens the Russians to slaughter 1000s of Syrians, or if they reduce civil liberties, or stop trying to address global warming, or harass illegal immigrants, or 100 other policies that some might object to for non-stock market reasons. Lots of bad things don't impact the stock market.

3. There are policies that might help the stock market without necessarily helping the economy, such as reducing bank regulation, or sharply cutting corporate income tax rates.

Having said all that, I do think that a corporate tax reform that reduces rates to 20% and closes loopholes would help the economy. Even better if they put debt and equity on a level playing field. (Debt is currently taxed more lightly than equity, which is sort of bizarre given that debt crises such as 2007-09 seem to hurt the economy much more than equity crashes like 1987 and 2001.)

I also think that reducing regulations on business is generally a good thing, with the possible exception of environmental regulations, where there are clear externality concerns. In addition, there is evidence beyond the equity markets that growth expectations are rising. For instance, long-term real interest rates have risen in recent weeks, as has the US dollar. Unfortunately even those facts allow for two alternative interpretations, either fiscal stimulus or faster supply-driven growth. Because I believe the Fed would offset the demand-side impact of fiscal stimulus, I lean toward the supply-side argument. But it's obviously still a debatable point.

To summarize, I strongly favor using market indicators as tests of the likely impact of policy. But always be aware that it's hard to get a "clean" test of any theory, as there are usually multiple possible interpretations. The best tests occur where there are repeated, discrete, policy announcements that occur at a point in time, such as fed funds rate announcements. And even there, you need to compare the announced value to the predicted value in the futures market.

One final point. You need to be intellectually consistent. The stock market nearly tripled under President Obama. I doubt even his supporters would give him all of the credit for that, indeed he's been hard at work trying to redistribute wealth from the rich to the poor. But that means that if a tripling of the market may or may not reflect Obamanomics, it's pretty hard to be certain that a less than 10% increase reflects Trumponomics. It may, but we'll know more when the actual policies are announced, and we see how the stock market responds.

PS. The EMH tells us that the Obama bull market cannot be written off as a mere "rebound" from its depressed 2009 levels.

PPS. I encourage commenters to avoid getting off track with my non-economic problems cited above. I don't know enough about Aleppo to argue the case; my point was that you could imagine some non-economic issues than are nonetheless important. You could replace Aleppo with abortion, pot legalization, kidney sales, or many other issues that involve difficult ethical judgments. There's more to life that stock prices.

Tyler Cowen has a good article on which stock indices to use for which questions.

Abundant adoption and twin studies find minimal long-run nurture effects. In plain language: The family that raises you has little effect on your adult outcomes. A key caveat. though, is that almost all of these studies come from the First World. Does growing up elsewhere durably stunt personal development? Existing evidence is largely silent.

While reading the National Academy of Sciences all-new report on The Economic and Fiscal Consequences of Immigration . though, I finally encountered some relevant data - though unfortunately, it only allows us to measure the effect of growing up in the U.S. versus anywhere else.

Background: To estimate an immigrant's long-run fiscal effect, you must also estimate how successful his descendants will be. The NAS explains its method:
In order to forecast taxes and benefits for an average immigrant and descendants, it is necessary to first forecast the ultimate educational attainment for young immigrants and the future educational attainment of the offspring of immigrants. The panel predicted the education of offspring as a function of parental education using regression analysis based on CPS samples 15 years apart. Adult child education is regressed on parental education by birth region, with separate equations for native-born children versus foreign-born children. This generates equations that are used to predict a child's ultimate educational attainment.
Big finding: Children of immigrants have markedly greater educational success than you would expect given their foreign-born parent's education. While children always tend to resemble their parents, the resemblance is stronger when both child and parent are native-born. Estimates for children of natives:

The most striking achievement gaps: Less than 20% of children of native-born high school dropouts go beyond high school, but almost 40% of children of foreign-born high school dropouts pass this milestone. Similarly, about half of children of native-born high school grads surpass their parents' attainment - versus over two-thirds of children of immigrant high school grads.

What does this teach us about the power of nurture? For the sake of argument, assume that everyone born in the United States enjoys the same educational environment, so genes (and luck) explain all remaining disparities.* Then we can use immigrants' children's success to measure the stunting effect of growing up outside the United States! Intuitively: If a native and an immigrant's children perform equally well, we should infer that their parents had equal genetic potential.

For convenience, let's code the five educational categories as continuous variables: less than high school =1, high school graduate =2, some college =3, bachelor's degree =4, more than bachelor's =5. Then here is children's average educational attainment E. conditional on their parents':


Now we're ready to calculate the nurture effects of national origin. There's no harm at the tip top: Non-Americans with advanced degrees look intrinsically no abler than Americans with advanced degrees. As you move down the educational ladder, however, environmental deprivation goes from moderate (-.20 steps for college grads) to serious (-.57 steps for high school grads, -.67 for less than high school). And if you think that American-born children of immigrant parents are also somewhat deprived, their parents' estimated environmental deprivation is even worse.

Main doubt: The NAS correlates success for individual parents and their kids. In principle, then, kids of immigrants could have one native-born parent - and kids of native-born parents could have one immigrant parent. Ideally, we'd compare kids of two immigrant parents to kids of two native parents. Given the strong correlation in spousal education. though, this probably understates immigrants' deprivation. Genetically speaking, an immigrant who marries an equally-educated native is "marrying down."

The implications for immigration are debatable. So are the implications for education. But the implications for nurture effects are clear. If you grew up in a relatively deprived American home, adoption and twin research imply that your educational success would have barely changed. If you grew up in an absolutely deprived non- American home, however, your educational success would have been markedly worse - masking your underlying genetic potential. The broader but still provisional lesson: Nurture matters after all. Behavioral geneticists have struggled to detect nurture effects because of range restriction - not because there's nothing to detect.

* Whether or not you buy this assumption, it still sets a lower bound on nurture effects. Keep reading.

Nick Rowe and I have fairly similar views on what's right and what's wrong with Neo-Fisherism. Recall that Neo-Fisherism is the view that shifting to a policy of higher nominal interest rates will lead to higher inflation, especially if the policy persists for an extended period of time.

There's a grain of truth in this claim, but at the same time the policy implications are trickier than the Neo-Fisherians seem to assume. This reflects the age-old distinction between one time level shifts in the money supply, and permanent shifts in the growth rate of the money supply. A one-time increase in M reduces interest rates, whereas an increase in the money supply growth rate increases inflation, and hence nominal interest rates. But here's the problem, every permanent increase in the growth rate of money begins with what looks like a one-time increase. And the fact that prices are sticky makes this all even harder to sort out. So how do you identify easy and tight money?

Nick Rowe has a very clever post that beautifully lays out what's going on here. He uses the money supply, so I thought it would be interesting to translate his claims into exchange rate language, which is the approach I've used in analyzing Neo-Fisherism. Here's Nick:

They key question to ask is this: when the. central bank announces an increase in the. interest rate that it pays on. money (call it Rm), what does it announce about the growth rate of the stock of. money? [You need to read Nick's entire post to understand why I added the ellipses.] Here's my translation into forex language: The key question is when the Bank of Japan announces an increase in the foreign exchange value of the yen, what does it announce about changes in the expected future appreciation of the yen in forex markets? Now let's go back to Nick's post: If the central bank announces that Rm increases by 1%, and at the same time announces that money growth increases by 1%, then we get Neo-Fisherian results. The inflation rate increase by 1%, but the opportunity cost of holding money is unchanged (the increased Rm and increased inflation cancel out), so there is no initial jump up or down in the price level.

But if the central bank announces that Rm increases by 1%, and at the same time announces that money growth will not change, then we get an initial drop in the price level, because the opportunity cost of holding money has fallen so the demand for money has increased, but there is no subsequent change in the inflation rate.
And my translation into forex language:

If the BOJ announces that the spot exchange rate is unchanged, and at the same time announces that the expected depreciation of the yen increases by 1%, then we get Neo-Fisherian results. The inflation rate increase by 1%, but the opportunity cost of holding money is unchanged (the increased Rm and increased inflation cancel out), so there is no initial jump up or down in the price level.

But if the BOJ announces that the yen suddenly appreciates by 1%, and at the same time announces that the future appreciation of the yen does not change, then we get an initial drop in the price level, but there is no subsequent change in the inflation rate.
You might object that prices are sticky and hence PPP does not hold in the short run. But Nick's example faces the exact same complication:
If we assumed prices are sticky rather than perfectly flexible, that initial drop in the price level would take a few years of deflation to work itself out.
Nick claims that the key mistake made by both New Keynesians and Neo-Fisherians is that they look at interest rates and ignore the money supply:

It's not enough to ask what happens if the central bank changes the deposit rate of interest. We must also ask what the central bank does with the money supply. And the New Keynesians (Neo-Wicksellians) are to blame by deleting that second question, by deleting money from their model. It's very useful to also look at the money supply, but not essential. What is essential is that you look beyond interest rates, to a monetary measure that gives an unambiguous reading on the distinction between level shifts and growth rates shifts. The money supply does this, but so do exchange rates, or the price of gold (in the 1930s).

In one sense Nick's money supply approach is superior to my forex approach. It's more general in that it applies to both closed and open economies. Obviously the exchange rate approach only applies to open economies. But there are an almost infinite number of similar ways of measuring the "price of money", which do apply to closed economy models. Thus you could replace the spot exchange rate with the one-year forward NGDP futures price, and the expected appreciation in the exchange rate with the expected depreciation over time in the one-year forward NGDP futures price. That applies equally well to a closed economy model. And I would argue that it is superior to the money supply, as it incorporates the effects of both money supply and money demand shocks.

What actually happened in the Great Recession? Why wasn't there a deflationary spiral when central banks were constrained by the ZLB? The answer is simple: the price level (and real output too, if prices are sticky) did not spiral down to zero because central banks did not let the money supply spiral down to zero. In fact, they did the opposite. They did "QE" (aka Open Market Operations). Empirical puzzle solved. I agree, but I'm not sure this will satisfy Cochrane. He might argue that changes in QE didn't seem to impact the price level, and hence that QE was ineffective. So price stability remains a mystery.

I'd reply that there was little correlation between the amount of QE and the inflation rate for standard "thermostat" reasons. If policy were effective you'd expect to see no correlation.

Cochrane might reply that this excuse is too clever, and that I'd need evidence.

I'd reply that the evidence is in the asset markets, which responded to news of QE as if it were effective.

And that final point is my principle objection to modern macro (New Keynesian and Neo-Fisherian.) There is too little interest in the response of asset prices to policy shocks, and what that tells us about the structure of the economy. These real time prices tell us a lot, if you only bother to look.

Rex Tillerson, the former Exxon CEO whom Donald Trump has picked for Secretary of State, has made a lot of comments and taken a lot of positions in favor of free trade. That's not unusual for a Secretary of State. When I was at the Council of Economic Advisers under Martin Feldstein, I read pretty much every memo written by pretty much every senior economist. (The "Weekly Reader" contained all the memos.) The Council was virtually always (I can't think of an exception) on the side of free trade or at least on the side of the freest trade they thought they could get. The senior economist for trade, Geoffrey O. Carliner (see here at p. 153) was regularly writing memos about interagency meetings he was attending on trade issues. Over 80%--and it might have been over 90%--of the time, the State Department was one of the CEA's closest allies. (Also good on free trade were the Treasury Department and the Office of Management and Budget.)

But there is one area on which the State Department has been very bad on trade and that is when it supports sanctions on countries whose governments conduct policies that the U.S. government doesn't like.

Rex Tillerman appears to have a consistent opponent of such sanctions. My antiwarcolleague Justin Raimondo writes :
Exxon is one of the principal supporters of USA Engage, a business lobby that has for years argued against Iranian and Iraqi sanctions, and that believes in "positively engaging other societies through diplomacy, multilateral cooperation, the presence of American organizations," and that "the best practices of American companies and humanitarian exchanges better advances U.S. objectives than punitive unilateral economic sanctions."
That's refreshing.

Of course, we don't know whether he opposes sanctions on principle or simply because they were bad for his company. For evidence that he takes positions based on self-interest rather than principle, see this .

We shall see. We will also see how well or badly Tillerson controls the worst instincts of his putative deputy. John Bolton.

Historian Ralph Raico passed away yesterday. David has already shared some memories. let me share mine too. I met Ralph first when I was 18. A sweet, grumpy man, he was a very serious scholar and a magnificent teacher.
I first met Ralph when he visited Italy, on the invitation of my mentors and friends Marco Bassani and Carlo Lottieri, to take part in an ambitious two day conference on classical liberalism (the proceedings, which include his speech, are available here ). Marco then drove Ralph, and Hans Hoppe, who was likewise participating in the conference, to Lake Como, where I lived with my family. We had dinner together. I don't quite remember when and why this happened, but I have a clear recollection of Ralph familiarising with my dog, Obi-Wan Kenobi (Ralph didn't particularly approve of the name). Ever since, whenever I bumped into Ralph, I always had to answer his questions on my mother's health, and Obi's too.

I had the pleasure of being in touch with Ralph from time to time, to hear his stories on the early years of the postwar libertarian movement, and, most importantly, to listen to his lectures.

The story of Raico and his pal George Reisman meeting Ludwig von Mises for the first time is particularly amusing.
In the words of Guido Hulsmann ,
Raico and Reisman were both fifteen years old. They had been reading The Freeman for a year or two and had also read some of Mises's books. Inspired, they had established the "Cobden Club," an organization of right-wing students to fight the good fight. One day they decided to pay their hero a visit and came up with the ruse of presenting themselves as salesmen.
Apparently, Raico and Reisman (fifteen year old guys who had read Human Action already!) knocked at his door and asked the great man if he wanted a subscription to Freeman, thinking that he would warm up to their youth and commitment. Mises replied that he already had a subscription and shot the door. Later a proper meeting was arranged for the two wonder boys by FEE .

Ralph later translated Mises's Liberalism into English. When he was a PhD student under Hayek at the Committee on Social Thought in Chicago, he edited the New Individualist Review. In that short lived, yet impressive journal, many important articles were housed: from George Stigler's The Intellectual and the Marketplace to Ronald Hamowy's perceptive critique of Hayek's Constitution of Liberty and a piece by Bruno Leoni on "consumer sovereignty". In its preface to the Liberty Fund reprint, Milton Friedman commented that the New Individualist Review "sets an intellectual standard that has not yet, I believe, been matched by any of the more recent publications in the same philosophical tradition".

Friedman also noted that the journal was highly indebted to two events, one local and one national. The local one was the fact that Hayek moved to Chicago, to work at the Committee on Social Thought. The national one was the Vietnam War.
Conspicuously, the journal published a special issue on the draft, which included essays by Milton Friedman and Walter Oi, and reconnected the opposition to the draft to the great libertarian anti-militarist tradition.Opposition to imperialism was at the root of Ralph's commitment to classical liberalism, very much in the tradition of Richard Cobden.

Ralph Raico has written quite a few essays (some are available here ), though not as many as all who knew him wished he wrote, and a book on German liberalism. He was a splendid lecturer. I remember listening to him rehearsing the lecture that became also this article on Keynes. I couldn't find a recording online. The text, however, may suffice to provide you with a glimpse of Ralph Raico's scholarship, passion, and profound commitment to individual liberty.

The Fed has a mandate to stabilize prices and provide for high employment. The Fed interprets that mandate as calling for 2% PCE inflation and an unemployment rate close to the natural rate. Tim Duy points out that the unemployment rate has recently fallen below the Fed's estimate of the natural rate:

On one hand, the unemployment rate plunged 0.3 percentage points in November to 4.6 percent.

This is below the range of the longer-run central tendency (4.7 - 5.0 percent), sufficient to prompt a preemptive rate hike in December without dissent.
For most of the past 8 years, the unemployment rate has been above the natural rate. How should policy change as inflation falls below this benchmark?

Here's it's easiest to start with the case where we have a simple inflation target---2% inflation, regardless of what's going on in the economy. Under that regime the policy choice is simple---always aim for 2% inflation. Now let's add a second goal, unemployment close to the natural rate. In that case, you still aim for 2% inflation when unemployment is at the natural rate. But when unemployment is high you adopt a bit more expansionary monetary policy than would be called for by a strict 2% inflation target, and vice versa. This means the Fed should aim for slightly above 2% inflation during high unemployment years, such as 2008-15, and slightly below 2% inflation when unemployment is below the natural rate---like right now, or during the housing bubble.

Is this the Fed's actual policy? No. As far as I can tell, the Fed aims at something closer to the exact opposite---below 2% inflation during periods of high unemployment, and above 2% inflation during booms. On the face of it, this seems to violate the dual mandate. But since neither Congress nor the economics profession seems to notice this problem, there is no pressure to fix the policy. One reason I favor NGDPLT is that it would force the Fed to move toward a policy that it theoretically has already adopted, but in practice does not adhere to. A policy that is consistent with the Fed's legally mandated policy goals.

PS. Don't assume the takeaway from this post is about what the Fed should do today. The Fed's problems run far deeper than today's decision, which is relatively unimportant. Rather the Fed does not have the correct regime in place to deal with a turn in the business cycle. As long as we continue in this expansion, monetary policy will probably be roughly OK, and not a major concern for the economy. Our problems lie elsewhere. The problem is procyclical inflation.

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