November 10, 2008, 4:38 pm

Stimulus math (wonkish)

I wrote this morning’s column partly because I had a hunch that the Obama people might be thinking too small on stimulus. Now I have more than a hunch – I’ve heard an unreliable rumor! So let’s talk about stimulus math, as I see it.

Actually, before I get to the math, some concepts. Nearly every forecast now says that, in the absence of strong policy action, real GDP will fall far below potential output in the near future. In normal times, that would be a reason to cut interest rates. But interest rates can’t be cut in any meaningful sense. Fiscal policy is the only game in town.

Wait, there’s more. Ben Bernanke can’t push on a string – but he can pull, if necessary. Suppose fiscal policy ends up being too expansionary, so that real GDP “wants” to come in 2 percent above potential. In that case the Fed can tighten a bit, and no harm is done. But if fiscal policy is too contractionary, and real GDP comes in below potential, there’s no potential monetary offset. That means that fiscal policy should take risks in the direction of boldness.

So what kinds of numbers are we talking about? GDP next year will be about $15 trillion, so 1% of GDP is $150 billion. The natural rate of unemployment is, say, 5% — maybe lower. Given Okun’s law, every excess point of unemployment above 5 means a 2% output gap.

Right now, we’re at 6.5% unemployment and a 3% output gap – but those numbers are heading higher fast. Goldman predicts 8.5% unemployment, meaning a 7% output gap. That sounds reasonable to me.

So we need a fiscal stimulus big enough to close a 7% output gap. Remember, if the stimulus is too big, it does much less harm than if it’s too small. What’s the multiplier? Better, we hope, than on the early-2008 package. But you’d be hard pressed to argue for an overall multiplier as high as 2.

When I put all this together, I conclude that the stimulus package should be at least 4% of GDP, or $600 billion.

That’s twice what the unreliable rumor says. So if there’s any truth to the rumor, my advice to the powers that be (or more accurately will be in a couple of months) is to think hard – you really, really don’t want to lowball this.

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November 10, 2008, 4:38 pm

Stimulus math (wonkish)

I wrote this morning’s column partly because I had a hunch that the Obama people might be thinking too small on stimulus. Now I have more than a hunch – I’ve heard an unreliable rumor! So let’s talk about stimulus math, as I see it.

Actually, before I get to the math, some concepts. Nearly every forecast now says that, in the absence of strong policy action, real GDP will fall far below potential output in the near future. In normal times, that would be a reason to cut interest rates. But interest rates can’t be cut in any meaningful sense. Fiscal policy is the only game in town.

Wait, there’s more. Ben Bernanke can’t push on a string – but he can pull, if necessary. Suppose fiscal policy ends up being too expansionary, so that real GDP “wants” to come in 2 percent above potential. In that case the Fed can tighten a bit, and no harm is done. But if fiscal policy is too contractionary, and real GDP comes in below potential, there’s no potential monetary offset. That means that fiscal policy should take risks in the direction of boldness.

So what kinds of numbers are we talking about? GDP next year will be about $15 trillion, so 1% of GDP is $150 billion. The natural rate of unemployment is, say, 5% — maybe lower. Given Okun’s law, every excess point of unemployment above 5 means a 2% output gap.

Right now, we’re at 6.5% unemployment and a 3% output gap – but those numbers are heading higher fast. Goldman predicts 8.5% unemployment, meaning a 7% output gap. That sounds reasonable to me.

So we need a fiscal stimulus big enough to close a 7% output gap. Remember, if the stimulus is too big, it does much less harm than if it’s too small. What’s the multiplier? Better, we hope, than on the early-2008 package. But you’d be hard pressed to argue for an overall multiplier as high as 2.

When I put all this together, I conclude that the stimulus package should be at least 4% of GDP, or $600 billion.

That’s twice what the unreliable rumor says. So if there’s any truth to the rumor, my advice to the powers that be (or more accurately will be in a couple of months) is to think hard – you really, really don’t want to lowball this.

http://krugman.blogs.nytimes.com/2008/11/15/macro-policy-in-a-liquidity-trap-wonkish/#more-1037

http://krugman.blogs.nytimes.com/2008/11/10/stimulus-math-wonkish/

November 28, 2008, 1:13 pm

Too much of a good thing …

Is only prudent. As far as I know, nobody has written up the case for a fiscal expansion larger than our best estimate of what’s needed to close the looming output gap. So I thought it might be useful to write the obvious down.

In the figure below, I’ve drawn a series of “IS curves” — each showing how the level of real GDP depends on the Fed’s target interest rate. Currently, the economy looks like IS1: even at a zero interest rate, output will be far short of full employment. Fiscal expansion should shift the curve right — but it might either be too little (IS2) or too much (IS3).

The key point is this: if fiscal expansion is too little, that’s the end of the story. If it’s too much, the Fed can head off inflation by raising rates. So there’s an asymmetry.

In reality, we can’t be sure how much bang we’ll get for the buck. What the asymmetry means is that we should err on the side of too much.

Go big!

 

http://krugman.blogs.nytimes.com/2008/11/28/too-much-of-a-good-thing/

 

 

November 28, 2008, 1:47 pm

Was the Great Depression a monetary phenomenon?

Sins of omission?

Has anyone else noticed that the current crisis sheds light on one of the great controversies of economic history?

A central theme of Keynes’s General Theory was the impotence of monetary policy in depression-type conditions. But Milton Friedman and Anna Schwartz, in their magisterial monetary history of the United States, claimed that the Fed could have prevented the Great Depression — a claim that in later, popular writings, including those of Friedman himself, was transmuted into the claim that the Fed caused the Depression.

Now, what the Fed really controlled was the monetary base — currency plus bank reserves. As the figure shows, the base actually rose during the great slump, which is why it’s hard to make the case that the Fed caused the Depression. But arguably the Depression could have been prevented if the Fed had done more — if it had expanded the monetary base faster and done more to rescue banks in trouble.

So here we are, facing a new crisis reminiscent of the 1930s. And this time the Fed has been spectacularly aggressive about expanding the monetary base:

Ben goes for broke

And guess what — it doesn’t seem to be workiing.

I think the thesis of the Monetary History has just taken a hit.

http://krugman.blogs.nytimes.com/2008/11/28/was-the-great-depression-a-monetary-phenomenon/

November 15, 2008, 8:00 am

Macro policy in a liquidity trap (wonkish)

That’s the title of a new report from Jan Hatzius et al at Goldman Sachs (not available online). The Goldman guys, like me, come up with scary figures about the size of the gap in demand that needs to be filled — figures that suggest the need for a fiscal stimulus that’s enormous by historical standards. Their approach is different, and probably better than mine; I’ll get to that in a bit. But I want to talk conceptual stuff for a moment.

It’s a curious thing that even now, when we are clearly in a liquidity trap, we still have a lot of economists denying that such a thing is possible. The argument seems to go like this: creating inflation is easy — birds do it, bees do it, Zimbabwe does it. So it can’t really be a problem for competent countries like Japan or the United States.

This misses a key point that I and others tried to make for Japan in the 90s and are trying to make again now: creating inflation is easy if you’re an irresponsible country. It may not be easy at all if you aren’t.

A decade ago, when I tried to make sense of Japan’s predicament, I used a simple, unrealistic model to ask what we really know about the relationship between the money supply and the price level. We normally say that an increase in the money supply, other things equal, leads to an equal proportional increase in the price level: double M and you double the CPI. But that’s not actually right. What a model with all the i’s dotted and t’s crossed actually says is that the CPI doubles if you double the current money supply and all future expected money supplies.

And how do you do that? No matter how much Japan increases the monetary base now, expectations of future money supplies won’t move if people believe that the Bank of Japan will move to stabilize the price level as soon as the economy recovers. And once you realize that central banks may not be able to move expectations about future money supplies, it becomes a real possibility that the economy will be in a liquidity trap: if interest rates are near zero, money printed now just gets hoarded, and monetary policy has no traction on the real economy.

Zimbabwe wouldn’t have this problem: people believe that any money it prints will stay in circulation. But the likes of Japan, or the United States, print money for policy purposes, not to pay their bills. And that, perversely, is what makes them vulnerable to a liquidity trap. Back in 1998 I argued that the Bank of Japan needed to find a way to “credibly promise to be irresponsible.” That didn’t go down too well, but it was what sober, careful economic analysis prescribed.

Or as I said in the linked paper,

The whole subject of the liquidity trap has a sort of Alice-through-the-looking-glass quality. Virtues like saving, or a central bank known to be strongly committed to price stability, become vices; to get out of the trap a country must loosen its belt, persuade its citizens to forget about the future, and convince the private sector that the government and central bank aren’t as serious and austere as they seem.

OK, so now back to Hatzius et al. They emphasize the role of the disruption of credit markets in pushing us into a liquidity trap. They then turn to an estimate of likely changes in the “private sector balance” — the difference between private sector saving and private sector investment. And it’s stunning:

The GS house price forecast combined with current equity prices and credit spreads implies a rise in the private sector balance from +1% of GDP in the second quarter of 2008 to +10% in the fourth quarter of 2009— - a rise of 9 percentage points, or 6 points at an annual rate.

What’s the answer? Huge fiscal stimulus, to fill the hole. More aggressive GSE lending. Maybe a “pre-commitment” by the Fed to keep rates low for an extended period — that’s a more genteel version of my “credibly promise to be irresponsible.” And maybe large-scale purchases of risky assets.

The main thing to realize is that for the time being we really are in an alternative universe, in which nothing would be more dangerous than an attempt by policy makers to play it safe.

http://krugman.blogs.nytimes.com/2008/11/15/macro-policy-in-a-liquidity-trap-wonkish/#more-1037

November 15, 2008, 6:08 pm

Brad Setser is scaring me

Brad’s blog is the go-to place for all balance-of-payments-related data analysis. Now he has a post up about US exports. Why is this important? Exports have been the one good thing about the US economic situation; in fact, the reason the economy didn’t fall off a cliff immediately when the housing bubble burst was that, for a while, export growth took up the slack.

But Brad says that the export boom is over — in fact, it now looks like an export slump. Like he says, ut-oh.

http://krugman.blogs.nytimes.com/2008/11/15/brad-setser-is-scaring-me/

 

 http://krugman.blogs.nytimes.com/2008/11/29/the-keynesian-moment/

November 29, 2008, 12:03 pm

The Keynesian moment

Greg has this exactly right:

IF you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than a half-century ago, his diagnosis of recessions and depressions remains the foundation of modern macroeconomics. His insights go a long way toward explaining the challenges we now confront.

I think it’s worth saying a bit more about why, exactly, we’re in such a Keynesian moment.

If Keynes receded in our consciousness over the past few decades, it wasn’t mainly because of uninformed criticisms from the right; it was because central bankers seemed to have everything under control. Uncle Alan and his counterparts, by controlling the money supply, could do the job of stabilizing the economy, and Keynesian fiscal policy seemed irrelevant.

Now, Keynes understood the role of monetary policy quite well, and believed that it had been effective in the past. What he argued, however, was that there were situations in which monetary policy could do no more — and that the world economy he lived in was facing such a situation:

To-day and presumably for the future the schedule of the marginal efficiency of capital is, for a variety of reasons, much lower than it was in the nineteenth century. The acuteness and the peculiarity of our contemporary problem arises, therefore, out of the possibility that the average rate of interest which will allow a reasonable average level of employment is one so unacceptable to wealth-owners that it cannot be readily established merely by manipulating the quantity of money. So long as a tolerable level of employment could be attained on the average of one or two or three decades merely by assuring an adequate supply of money in terms of wage-units, even the nineteenth century could find a way. If this was our only problem now—if a sufficient degree of devaluation is all we need—we, to-day, would certainly find a way.

Archaic language, but he was describing a situation very much like the one we face now.

To be sure, Keynes failed to foresee the postwar rise of the “marginal efficiency of capital” — the way that economic growth combined with inflation would create an environment in which interest rates were high enough in normal times that monetary policy was effective at fighting slumps. Hence the long era in which Keynes didn’t seem all that relevant. But his analysis remained as valid as ever, under the right conditions. Those conditions reappeared first in Japan during the 90s; now they’re everywhere.

And in the long run, it turns out, Keynes is anything but dead. http://www.nytimes.com/2008/11/30/business/economy/30view.html?partner=permalink&exprod=permalink

Economic View

What Would Keynes Have Done?

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By

N. GREGORY MANKIW

Published: November 28, 2008

IF you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than a half-century ago, his diagnosis of recessions and depressions remains the foundation of modern macroeconomics. His insights go a long way toward explaining the challenges we now confront.

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David G. Klein

 

According to Keynes, the root cause of economic downturns is insufficient aggregate demand. When the total demand for goods and services declines, businesses throughout the economy see their sales fall off. Lower sales induce firms to cut back production and to lay off workers. Rising unemployment and declining profits further depress demand, leading to a feedback loop with a very unhappy ending.

The situation reverses, Keynesian theory says, only when some event or policy increases aggregate demand. The problem right now is that it is hard to see where that demand might come from.

The economy’s output of goods and services is traditionally divided into four components: consumption, investment, net exports and government purchases. Any expansion in demand has to come from one of these four. But in each case, strong forces are working to keep spending down.

CONSUMPTION The Conference Board reports that consumer confidence is near its record low. It is easy to understand why consumers are so scared. House values have declined, 401(k) balances have shrunk and unemployment is up. For many people, the sense of economic uncertainty is greater than they’ve ever experienced. When it comes to discretionary purchases, like a new home, a car, or a washing machine, wait-and-see is the most rational course.

A bit more saving is not entirely unwelcome. Many economists have long lamented the United States saving rate, which is low by international and historical standards.

For the overall economy, however, a recession is not the best time for households to start saving. Keynesian theory suggests a “paradox of thrift.” If all households try to save more, a short-run result could be lower aggregate demand and thus lower national income. Reduced incomes, in turn, could prevent households from reaching their new saving goals.

INVESTMENT In normal times, a fall in consumption could be met by an increase in investment, which includes spending by businesses on plant and equipment and by households on new homes. But several factors are keeping investment spending at bay.

The most obvious is the state of the housing market. Over the past three years, residential investment has fallen 42 percent. With house prices continuing to decline, increased building of new homes is not likely to be a source of robust demand over the next few years.

Business investment has lately been stronger than residential investment, but it is unlikely to pick up the slack in the near future. With the stock market down, interest rates on corporate bonds up and the banking system teetering on the edge, financing new business projects will not be easy.

NET EXPORTS Not long ago, it looked as if the rest of the world would save the United States economy from a deep downturn. From March 2004 to March 2008, the dollar fell 19 percent against an average of other major currencies. By increasing the price of foreign goods in the United States and reducing the price of American goods abroad, this depreciation discouraged imports and bolstered exports. Over the last three years, real net exports have increased by about $250 billion.

In the coming months, however, the situation may well go into reverse. As the United States financial crisis has spread to the rest of the world, fast-moving international capital has been looking for a safe haven. Ironically, that haven is the United States. Since March, the dollar has appreciated 19 percent, a move that will put a crimp in the export boom.

GOVERNMENT PURCHASES That leaves the government as the demander of last resort. Calls for increased infrastructure spending fit well with Keynesian theory. In principle, every dollar spent by the government could cause national income to increase by more than a dollar if it leads to a more vibrant economy and stimulates spending by consumers and companies. By all reports, that is precisely the plan that the incoming Obama administration has in mind.

The fly in the ointment — or perhaps it is more an elephant — is the long-term fiscal picture. Increased government spending may be a good short-run fix, but it would add to the budget deficit. The baby boomers are now starting to retire and claim Social Security and Medicare benefits. Any increase in the national debt will make fulfilling those unfunded promises harder in coming years.

Keynesian economists often dismiss these long-run concerns when the economy has short-run problems. “In the long run we are all dead,” Keynes famously quipped.

The longer-term problem we now face, however, may be more serious than any that Keynes ever envisioned. Passing a larger national debt to the next generation may look attractive to those without children. (Keynes himself was childless.) But the rest of us cannot feel much comfort knowing that, in the long run, when we are dead, our children and grandchildren will be dealing with our fiscal legacy.

So what is to be done? Many economists still hope the Federal Reserve will save the day.

In normal times, the Fed can bolster aggregate demand by reducing interest rates. Lower interest rates encourage households and companies to borrow and spend. They also bolster equity values and, by encouraging international capital to look elsewhere, reduce the value of the dollar in foreign-exchange markets. Spending on consumption, investment and net exports all increase.

But these are not normal times. The Fed has already cut the federal funds rate to 1 percent, close to its lower bound of zero. Some fear that our central bank is almost out of ammunition.

Fortunately, the Fed has a few secret weapons. It can set a target for longer-term interest rates. It can commit itself to keeping interest rates low for a sustained period. Most important, it can try to manage expectations and assure markets that it will do whatever it takes to avoid prolonged deflation. The Fed’s decision last week to start buying mortgage debt shows its willingness to act creatively.

It is hard to say how successful monetary and fiscal policy will be in avoiding a deep downturn. But as events unfold, you can be sure that policymakers in the Fed and Treasury will be looking at them through a Keynesian lens.

In 1936, Keynes wrote, “Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slave of some defunct economist.” In 2008, no defunct economist is more prominent than Keynes himself.

N. Gregory Mankiw is a professor of economics at Harvard. He was an adviser to President Bush and advised Mitt Romney in his campaign for the Republican presidential nomination.

November 24, 2008,

Citigroup

Mark Thoma has the rundown of informed reactions. A bailout was necessary — but this bailout is an outrage: a lousy deal for the taxpayers, no accountability for management, and just to make things perfect, quite possibly inadequate, so that Citi will be back for more.

Amazing how much damage the lame ducks can do in the time remaining.

http://krugman.blogs.nytimes.com/2008/11/24/citigroup/?scp=6&sq=krugman&st=cse

Face value

Listen to the music

Nov 20th 2008
From The Economist print edition

Can Judy McGrath keep MTV Networks up with the beat of the internet era?

mtv networks

JUDY MCGRATH believes that “change has to be in everyone’s DNA, personally and professionally.” As the chief executive of MTV Networks, a division of Viacom, an American media group, she was still sad to see one of MTV’s longest-running programmes, “Total Request Live”, come to an end this week. The ten-year-old television show, which played music videos, was an MTV staple. But in recent years the show began to seem outdated, given that viewers could easily find the same videos online. On November 16th Ms McGrath joined celebrities and MTV staff at the firm’s Times Square studio for the show’s nostalgic finale—a three-hour long tribute, in effect, to MTV’s old way of doing things. Ms McGrath’s job is to make sure that MTV continues to find new ways of doing things.

The company where she has spent her career is no stranger to change. MTV Networks oversees 150 television channels, including MTV, Comedy Central and Nickelodeon, and 390 websites. The firm began in 1981 as a channel that screened music videos and has since evolved into one of America’s most powerful media companies. It has emerged as the standard-bearer for popular culture. It continues to show music videos, but these days MTV Networks also offers comedy, reality television, children’s programmes, cartoons, online virtual worlds and video games.

Ms McGrath grew up in Scranton, Pennsylvania, in a family that loved jazz, and she aspired to write about music for Rolling Stone magazine. After graduating from college she moved to New York in 1978 and got a job at Mademoiselle, a now-defunct women’s magazine. She started off typing recipes, even though she couldn’t cook. After making a mistake in one of the recipes and receiving complaints from bewildered readers, she switched to writing about fashion and parties.

Her experience working for women’s magazines brought her closer to music, but never to Rolling Stone. Via several female colleagues at Condé Nast, to whom she refers as the “old girl network”, she heard about a small, innovative start-up that had just launched, called MTV. At the time it consisted of a single cable channel available only in New Jersey. Ms McGrath knew nothing about television, but she found the concept “artful and fascinating, and it was also irresistible”. Bob Pittman, MTV’s founder, was impressed by her creativity and sensed her “capacity to create and let it go”, he says, which he thought would be essential to keep the company innovative and fresh. He hired her as a copywriter, and she began her ascent through the ranks of the company. During her “long, slow crawl to the top”, as she puts it, Ms McGrath focused on attracting talent and helping to select creative programming. Having come of age in the 1970s, she also urged MTV to take on more social campaigns, such as “Choose or Lose”, which encouraged young people to vote.

Since becoming chief executive in 2004, Ms McGrath has pushed the company to grow in new ways. She has focused on international expansion, raising the number of countries that receive MTV’s television programming to 162. (Programmes are broadcast in 33 languages.) She has also tried to diversify MTV’s sources of revenue. Under her leadership, the company has paid more attention to designing and selling consumer products, such as toys and clothing, which tie into its shows. And she recognised the growth potential of video games. In 2006 MTV Networks bought Harmonix, a maker of such games; the partnership yielded “Rock Band”, a hit to the tune of 7m copies. Another acquisition, of Atom Entertainment, brought AddictingGames.com, a “casual gaming” website, under MTV Networks’ umbrella.

MTV knows its mainly young audience well, but it is also battling to keep their attention. The people to whom MTV has always appealed are the same people who now spend their time on MySpace and Facebook and watch free video-clips on YouTube. Ms McGrath describes MTV Networks’ main audience as the “on-demand generation”—young people who are used to getting the content they want, whenever they want it. In the past few years MTV Networks has had to compete with the internet’s copious offerings in order to keep viewers loyal and retain advertisers. The company has expanded its digital offerings considerably over the years, but will MTV be able to change quickly enough to fit its customers’ tastes and online habits?

The long and winding road

Ms McGrath knows that she needs to wage a war on two fronts: one for viewers, another for advertisers. On the advertising front, she admits that “a big part of our future is working differently with advertisers and distributors and maximising interesting ways to involve them.” This may mean being more flexible when it comes to control over content on the web. In 2007 MTV’s parent company, Viacom, sued Google (the owner of YouTube) for $1 billion for copyright infringement, complaining that it was profiting from Viacom’s content, uploaded by YouTube users. Yet this month MTV Networks struck an innovative deal with MySpace, which also allows its users to upload video clips. Technology provided by Auditude will identify clips on MySpace belonging to MTV Networks and overlay advertising on them; MySpace and MTV will split the resulting revenue. This may signal that MTV is becoming more creative in its dealings with its online rivals.

“I think the major strategy is that you have to be open and flexible, and probably change it every day,” says Ms McGrath. Now she must decide how much change to pursue in the future. She plans to expand more into digital content, seek further international growth and continue to develop new products. Next year MTV Networks will release a new “Rock Band”-style game, featuring music by the Beatles. This shows that MTV is not about to abandon its roots—the promotion of music through new media. But as the cancellation of “Total Request Live” demonstrates, Ms McGrath is not afraid to ring the changes.

http://www.economist.com/people/displaystory.cfm?story_id=12633125

Professor Krugman, you always complain your timing is not perfect.

This time it was.

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http://freakonomics.blogs.nytimes.com/2008/11/25/bush-congratulates-krugman/?scp=3&sq=krugman&st=cse

November 25, 2008, 3:11 pm

Bush Congratulates Krugman

By Justin Wolfers

Yesterday, President Bush invited the most recent round of Nobel laureates to the White House to accept his congratulations.

And yes, this included his trenchant critic and economics prize-winner, Paul Krugman.

Photo from Economist.com

This photo posted on Economist.com (from Agence France-Presse) makes me wish I were better at reading body language.

I’m going to shamelessly rip off The New Yorker’s cartoon caption contest and ask readers to submit their preferred caption. The best caption wins one of those prized pieces of Freakonomics schwag.

Mull this one over during Thanksgiving dinner, and I’ll return with the contest winner next week.

(Hat tip: Free Exchange) http://freakonomics.blogs.nytimes.com/2008/11/25/bush-congratulates-krugman/?scp=3&sq=krugman&st=cse

Daily chart

Nobel prize

The youngster gets it

Oct 14th 2008
From Economist.com

The Nobel prize for economics is given to Paul Krugman

IT WAS widely expected that Paul Krugman, who won the the 2008 Nobel prize for economics on Monday October 13th, would claim the award one day. In 1991 he had received the John Bates Clark medal for the best young economist, which is widely seen as a stepping stone to a Nobel award. What is more of a surprise is that he was honoured rather sooner in his life than many other winners. Like most Nobel laureates in economics, Mr Krugman was recognised for research undertaken early in his career—in this case for his pioneering work on modelling trade between countries whose firms grow more profitable the bigger they become. At 55, he is only four years older than the youngest ever winner, Kenneth Arrow, who was 51 when he won in 1972. But he is a fresh-faced youngster in comparison with Leonid Hurwicz, one of last year’s winners, who was 90 when he shared the prize.

AP

 http://www.economist.com/daily/chartgallery/displaystory.cfm?story_id=12411202

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Economics focus

Bold strokes

Oct 16th 2008
From The Economist print edition

A strong economic stylist wins the Nobel prize

Illustration by Jac Depczyk

WHEN Paul Krugman won the Nobel prize in economics on October 13th, the news was greeted with nostalgia as well as congratulation by some of his fellow economists. Since 1999 Mr Krugman has written a twice-weekly column for the New York Times, in which he has devoted himself to attacking the Bush administration and all of its works. The nostalgists feel these jeremiads have distracted him from the cutting-edge research that secured his reputation. The polemicist, they feel, has buried the theorist.

And yet the old Krugman is still recognisable in the new. Indeed, the arts of the columnist are not so far removed from Mr Krugman’s style as an economist. In his most celebrated academic papers, Mr Krugman paints with bold strokes, striving to render his insights as starkly as possible. Like a good columnist, he cuts to the quick of a problem, stripping it of clutter and encumbering nuance. The result is a revealing caricature: what economists call “models”.

Mr Krugman won the prize for his models of international trade and economic geography. Both belong to the same grand project he confidently launched just a year after earning his doctorate: “Before my 25th birthday,” he has written, “I basically knew what I was going to do with my professional life.” In 1978 he realised that a model of “monopolistic competition”, published a year earlier by Avinash Dixit and Joseph Stiglitz, could help him introduce economies of scale into trade theory and beyond.

Economies of scale had long posed awkward problems for theorists. If bigger firms face lower costs, then in principle one firm should supply the entire market, thereby enjoying the lowest costs of all. But in the Dixit-Stiglitz model, this monopolising logic is offset by a countervailing force: consumers’ taste for variety. People prefer to spread their custom over different versions of the same good. The market is therefore carved up among competing firms, each offering a product bearing its own distinctive stamp. The model is highly stylised. Nonetheless it gave Mr Krugman, as he put it, “a tool to open cleanly what had previously been regarded as a can of worms”.

Mr Krugman used this tool to save economics from an abiding empirical embarrassment. According to one of the discipline’s founding doctrines, countries gain from specialisation and exchange, concentrating on what they do best and importing the rest. The theory explains why the Portuguese might sell wine in exchange for English cloth. But it cannot explain why similar countries, blessed with similar ratios of capital, labour and land, should so vigorously trade similar goods back and forth. This is not a small blind spot. According to the World Trade Organisation, 52% of Germany’s exports to France are things France also produces and exports to Germany. But the Dixit-Stiglitz model, with its subtly differentiated firms competing for variety-loving consumers, lent itself to explaining why Germans might import Renaults, even as the French imported Volkswagens.

Mr Krugman’s model showed that when trade barriers fall, firms gain access to bigger markets, allowing them to expand production and reap economies of scale. But openness also exposes them to competition from rival foreign firms, paring their margins. Some firms may go out of business. But between the domestic survivors and the foreign entrants, consumers still have more goods to choose from. Thus the gains from trade arise not from specialisation, but from scale economies, fiercer competition and the cornucopia of choice that globalisation provides.

Scale economies also allowed Mr Krugman to give economics for the first time a sense of space. In a 1991 article, he notes that night-time satellite photos of Europe reveal the distinctive contours of economic activity: bright lights cluster around metropolitan centres, shining particularly brightly around the triangle of Brussels, Amsterdam and Dortmund.

Before Mr Krugman, economists found these images difficult to square with the rest of their body of theory. They were accustomed to assuming that firms face constant returns to scale. But if that were true, then every peasant could build a small smelter or assembly line in his backyard. There would be no need for an economy to divide into a farm belt and an industrial belt.

Geography lessons

In Mr Krugman’s model, by contrast, big factories benefit from lower costs of production. Manufacturing firms might therefore cluster near to a large market, leaving behind a sparsely populated hinterland, in order to make the most of scale economies and minimise the cost of transporting goods to their customers.

Earlier theorists had instead assumed that firms herd together to benefit from some kind of “spillover”. Perhaps firms pick up tricks of the trade and other know-how from their neighbours. However plausible, these explanations were nonetheless unsatisfying. Because economists could not measure spillovers or delimit their scope (“How far does a technological spillover spill?” Mr Krugman wondered), they could invoke them to explain just about anything.

Mr Krugman’s models instead identified a less elusive benefit of proximity. He pointed out that a firm’s decision to locate in a district is a gift to other firms in the area, because in attracting new workers it also brings new customers. Unlike a technological spillover, this gift would in principle leave a paper trail, showing up in local firms’ sales figures.

In neither contribution did Mr Krugman claim great originality for his ideas or great realism. His achievement was to formalise insights that many people had previously had informally. Ideas that had fluttered in and out of people’s grasp for decades, he pinned down like a butterfly on display. Sometimes a good economist, like a good columnist, succeeds not by making a point before everyone else, but by making it better than anyone else.

 

 http://www.economist.com/finance/displaystory.cfm?story_id=12429411

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14:55 GMT +00:00

Hilarity ensues

Posted by:

Economist.com | WASHINGTON, DC

Categories:

Flotsam and jetsam

SO, PERHAPS you recall that economist Paul Krugman recently won the Nobel Prize? Well, new Nobelists are afforded the honour of a meeting with the president, and at right, you can see Mr Krugman enjoying his day in the Oval Office. Why is this hilarious? Because Mr Krugman has a part-time job as a New York Times opinion columnist, a platform he’s used to relentlessly skewer the Bush administration in the harshest of langauge for a decade now.

This is none of that inside-the-Beltway, knowing criticism, of the sort that can pass between men who will later share a drink at a Washington bar. It’s a blistering, white hot rage. Not for nothing did pundits on the right call Mr Krugman’s award an overtly political thing (conveniently, or ignorantly, misunderstanding his economic contributions).

But for all Mr Krugman’s frustrations, he now gets to waltz into the White House to be congratulated on his Nobel by his chief antagonist, who now leaves the presidency in disgrace, his party in tatters.

So, like, what do you think they talked about?

(Photo credit: AFP)

http://www.economist.com/blogs/freeexchange/2008/11/hilarity_ensues.cfm

Flawless Timing:

http://www.economist.com/blogs/freeexchange/krugman1125.jpg

 

 

 

 

Op-Ed Contributor

What They Hate About Mumbai

By SUKETU MEHTA

Published: November 28, 2008

MY bleeding city. My poor great bleeding heart of a city. Why do they go after Mumbai? There’s something about this island-state that appalls religious extremists, Hindus and Muslims alike. Perhaps because Mumbai stands for lucre, profane dreams and an indiscriminate openness.

Mumbai is all about dhandha, or transaction. From the street food vendor squatting on a sidewalk, fiercely guarding his little business, to the tycoons and their dreams of acquiring Hollywood, this city understands money and has no guilt about the getting and spending of it. I once asked a Muslim man living in a shack without indoor plumbing what kept him in the city. “Mumbai is a golden songbird,” he said. It flies quick and sly, and you’ll have to work hard to catch it, but if you do, a fabulous fortune will open up for you. The executives who congregated in the Taj Mahal hotel were chasing this golden songbird. The terrorists want to kill the songbird.

Just as cinema is a mass dream of the audience, Mumbai is a mass dream of the peoples of South Asia. Bollywood movies are the most popular form of entertainment across the subcontinent. Through them, every Pakistani and Bangladeshi is familiar with the wedding-cake architecture of the Taj and the arc of the Gateway of India, symbols of the city that gives the industry its name. It is no wonder that one of the first things the Taliban did upon entering Kabul was to shut down the Bollywood video rental stores. The Taliban also banned, wouldn’t you know it, the keeping of songbirds.

Bollywood dream-makers are shaken. “I am ashamed to say this,” Amitabh Bachchan, superstar of a hundred action movies, wrote on his blog. “As the events of the terror attack unfolded in front of me, I did something for the first time and one that I had hoped never ever to be in a situation to do. Before retiring for the night, I pulled out my licensed .32 revolver, loaded it and put it under my pillow.”

Mumbai is a “soft target,” the terrorism analysts say. Anybody can walk into the hotels, the hospitals, the train stations, and start spraying with a machine gun. Where are the metal detectors, the random bag checks? In Mumbai, it’s impossible to control the crowd. In other cities, if there’s an explosion, people run away from it. In Mumbai, people run toward it — to help. Greater Mumbai takes in a million new residents a year. This is the problem, say the nativists. The city is just too hospitable. You let them in, and they break your heart.

In the Bombay I grew up in, your religion was a personal eccentricity, like a hairstyle. In my school, you were denominated by which cricketer or Bollywood star you worshiped, not which prophet. In today’s Mumbai, things have changed. Hindu and Muslim demagogues want the mobs to come out again in the streets, and slaughter one another in the name of God. They want India and Pakistan to go to war. They want Indian Muslims to be expelled. They want India to get out of Kashmir. They want mosques torn down. They want temples bombed.

And now it looks as if the latest terrorists were our neighbors, young men dressed not in Afghan tunics but in blue jeans and designer T-shirts. Being South Asian, they would have grown up watching the painted lady that is Mumbai in the movies: a city of flashy cars and flashier women. A pleasure-loving city, a sensual city. Everything that preachers of every religion thunder against. It is, as a monk of the pacifist Jain religion explained to me, “paap-ni-bhoomi”: the sinful land.

In 1993, Hindu mobs burned people alive in the streets — for the crime of being Muslim in Mumbai. Now these young Muslim men murdered people in front of their families — for the crime of visiting Mumbai. They attacked the luxury businessmen’s hotels. They attacked the open-air Cafe Leopold, where backpackers of the world refresh themselves with cheap beer out of three-foot-high towers before heading out into India. Their drunken revelry, their shameless flirting, must have offended the righteous believers in the jihad. They attacked the train station everyone calls V.T., the terminus for runaways and dreamers from all across India. And in the attack on the Chabad house, for the first time ever, it became dangerous to be Jewish in India.

The terrorists’ message was clear: Stay away from Mumbai or you will get killed. Cricket matches with visiting English and Australian teams have been shelved. Japanese and Western companies have closed their Mumbai offices and prohibited their employees from visiting the city. Tour groups are canceling long-planned trips.

But the best answer to the terrorists is to dream bigger, make even more money, and visit Mumbai more than ever. Dream of making a good home for all Mumbaikars, not just the denizens of $500-a-night hotel rooms. Dream not just of Bollywood stars like Aishwarya Rai or Shah Rukh Khan, but of clean running water, humane mass transit, better toilets, a responsive government. Make a killing not in God’s name but in the stock market, and then turn up the forbidden music and dance; work hard and party harder.

If the rest of the world wants to help, it should run toward the explosion. It should fly to Mumbai, and spend money. Where else are you going to be safe? New York? London? Madrid?

So I’m booking flights to Mumbai. I’m going to go get a beer at the Leopold, stroll over to the Taj for samosas at the Sea Lounge, and watch a Bollywood movie at the Metro. Stimulus doesn’t have to be just economic.

Suketu Mehta, a professor of journalism at New York University, is the author of “Maximum City: Bombay Lost and Found.”

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