Worthwhile Canadian Initiative

New Keynesian countercyclical fiscal policy isn't what you probably think it is

If it weren't for the Zero Lower Bound on nominal interest rates, there would be no macroeconomic role for fiscal policy in New Keynesian models. Monetary policy alone could and therefore should be used to hit the macroeconomic target, because this leaves fiscal policy free to try to hit its many microeconomic targets as best it can. (There are perfectly good microeconomic reasons why fiscal policy should be countercyclical, but that's another story.)

But if a big drop in demand causes the natural rate of interest to fall too low, relative to the inflation target, the ZLB maybe be a binding constraint on monetary policy in New Keynesian models, because the central bank cannot drop the actual real rate of interest down to the natural rate. So you might want a countercyclical fiscal policy, that raises the natural rate when private demand is low and the natural rate is low, and lowers the natural rate when private demand is high and the natural rate is high, to keep the economy away from the ZLB. Let's assume you do.

What would you need to do to government spending in a New Keynesian model to raise or lower the natural rate of interest, and to mitigate those fluctuations in the natural rate? The answer is not what you probably think it is.

Explaining the Health Spending Slowdown

Canadian Institute for Health Information numbers show that there is a moderation in health expenditure growth underway.  From a growth rate of 6.1 percent in 2010, the CIHI estimates growth in total nominal health spending of 3.9 percent in 2011 and 3.4 percent in 2012.  Over the same period, the health expenditure to GDP ratio in Canada is estimated to go from 11.9 to 11.6 percent.  The growth rate for total nominal public health spending is going from 5.6 percent in 2010 to 2.0 percent in 2012.  Even private health spending is being marked by the slowdown with the growth rate going from 7.3 percent in 2010 to 4.6 percent in 2012.

Words and wartime austerity

Words matter. You can't have an intelligent discussion about fiscal policy if you use loaded and misleading words to describe fiscal policy.

Cancelling or postponing a government investment project might be a wise decision. Or it might be a foolish decision. But it is not "austerity".

Implementing or preponing a government investment project might be a wise decision. Or it might be a foolish decision. But it is not "profligacy".

Real economists talk about "tightening" or "loosening" fiscal policy. They don't talk about "austerity" or "profligacy". Not when they are talking among themselves. Or they shouldn't. They don't even talk about "fiscal stimulus", which is another loaded question-begging word.

"Austerity" and "profligacy" are perfectly good words to describe the consumption decisions of a household. But they are bad words to describe the consumption and investment and taxation decisions of a government. Because public finance is not like household finance.

Economists are supposed to understand the difference. So they shouldn't use words that obfuscate the difference.

There is one important exception, where economists should talk about "austerity". And it's an exception that proves the rule.

It would be perfectly correct for economists to say that the UK government in the Second World War had a policy of "austerity". Because the purpose of that policy was to drive down household consumption as low as it could reasonably go. So it would free up as many resources as possible for the war. Yet at the same time the government ran very large deficits. Fiscal policy was extremely "loose". "Austerity" does not mean "tight fiscal policy".

(They implemented austerity by a mixture of: rationing consumer goods; persuading people to save by buying war bonds; and directly controlling the supply-side, so that firms that used to produce consumer goods were told they had to produce weapons instead.)

The lunch problem

When I first joined Carleton, just three out of thirty professors in the economics department were female. Then one retired, one moved to Montreal, and I was the only female professor around on a regular basis. 

For the most part, I didn't mind. If I was the kind of person who objected to being in a male-dominated profession, I wouldn't have gone into economics in the first place. But the absence of women meant I had to socialize with male colleagues, or not socialize at all. I had to work out what kinds of interactions with my male colleagues were socially or otherwise acceptable. It wasn't obvious, at first, where to draw the line.

Did finance really matter?

If we used cows as money, we would probably teach our students courses on "Money and Milk Yields". If an outbreak of foot and mouth disease had caused a recession, macroeconomists would feel they needed to pay much more attention to veterinarians.

Milk yields matter. Foot and mouth disease is a problem. But these are fundamentally microeconomic problems. There is no inherent connection between milk yields and money, or foot and mouth disease and recessions. There is only a connection if our monetary practices make a connection where there needn't be one.

We use paper, ink, and electrons as money. Since those are all quite plentiful, we are free to make whatever connections we like with our money. We can target the price of cows, if we like. So money would be paper cows. And if we did that, we would still teach courses on money and milk yields, and worry about recessions caused by foot and mouth disease. But we don't have to do that. We could target something else instead.

It is presumably not a coincidence that a global financial crisis coincided with the beginning of a global recession. There was a connection between money and finance. But does there have to be that connection? Or was it simply a contingent fact based on our particular monetary practices?

Fiscal Death Watchlist

I found Nick Rowe’s post Is Japan Already Dead quite inspiring so I decided to dig up the most current IMF World Economic Outlook Database for numbers on net debt to GDP ratios.  Japan – which may already be dead – has a net debt to GDP ratio in 2012 of 134 percent.  An estimate of the net debt to GDP ratio does not exist for all countries but for those for which data is available, I offer the following fun ranking: the fiscal dead, the fiscal zombie (walking dead) and the fiscal living.

Men, women, and law school tuition

Law school is a human capital investment, worth making (roughly speaking) if the benefits are higher than the costs.

Male lawyers earn, on average, more than female lawyers (e.g. here). But that does not mean they get a higher return on their legal education. The pay-off to going to law school is the increase in earnings relative to the next best alternative. If the next best alternative is serving ice-cream, then law school may still be a worthwhile investment, even if it does not guarantee a six figure salary.

Is Japan already dead?

No, I don't think it is. But I think "Is Japan already dead?" is a much better question to ask than "Will the increased interest rates from economic recovery kill Japan?"

This is just a supplement to three posts: by me; by Noah Smith; and by Paul Krugman. (This also harks back to Livio's post and my earlier post). I think I've finally figured out a way to articulate something I couldn't explain very well before.

Why don't schools teach typing?

My niece wants to take a typing class. She watches her mother's hands whiz across the keyboard, rattling off 80 or 90 words per minute. She wants to be able to write quickly and effortlessly too. But her school doesn't teach typing. The question is: why not?

Learning how to touch-type is a classic example of a human capital investment. It requires hours of practice, but there is a big productivity pay-off. When typing becomes a purely automatic process, when there is no need to ever even glance at the keyboard or think about which key to use, the writer is free to concentrate on writing - something called cognitive automaticity. A person who can type quickly can get things done rapidly and efficiently. I can answer emails, write memos or accomplish other routine tasks faster than most economists, because I can type quickly. Moreover, learning good posture at the keyboard has health benefits, because it reduces the risk of repetitive strain injury.

So why isn't typing taught in school? Why doesn't every student graduate from high school knowing the the best way to use a keyboard? Why do schools no longer offer the kind of intensive training in typing that is needed to become a highly proficient typist, working consistently at 80 word per minute or more? I don't know, but I have theories.

A theory of the price level is a theory of inflation, but not vice versa

Because of calculus.

Suppose you start with a theory of the price level P(t). Differentiate that theory with respect to time and you get a theory of the inflation rate Pdot(t). If P(t) jumps at some time, which it might in some cases, inflation is infinite at those times, but that's interesting to know.

Suppose you start with a theory of the inflation rate Pdot(t). Integrate that theory with respect to time, and you don't get a theory of the price level. First because you don't have a theory of the constant of integration. Second, because if the price level jumps, your theory will only tell you that it jumps and won't tell you how high it jumps.

If Canada used American racial categories...

The US Census Bureau counts people by race: white, black, Asian, and so on. Statistics Canada counts people by "visible minority status" - we don't like to mention words like "race" or "white" up here.

The other day I found myself wondering - if Canada used American racial categories, how would the demographics of the two countries compare? 

The usefulness of AS-AD, an example

Here is a model I saw recently. Except I am the one who has used the AS-AD framework to illustrate that model.

The AD curve is drawn under the assumption that the central bank holds the nominal interest rate fixed.

According to that model:

If wages are sticky (so we are on the SRAS) a decrease in AD (the leftward shift from the red to the pink AD curve) will cause a fall in output and employment. OK.

But if wages are perfectly flexible (so we are on the LRAS) the same decrease in AD will cause an increase in inflation.

The author notes that this result is "counterintuitive", and says that more research is needed into the question of wage-determination.

Anyone familiar with the AS-AD framework would immediately see the problem and start asking questions about the stability of the equilibrium under flexible wages, and would recognise that you usually get counterintuitive comparative statics results if the equilibrium is unstable.

The model is here (HT Mark Thoma).

Here we go again. God this is depressing.

This is why we must continue to teach AS-AD and make sure that nobody gets out of an economics PhD program without seeing it and understanding it.

Otherwise they might end up running US monetary policy, and pulling the levers the wrong way.

On the percentage of Canada covered by water (totally off topic)

Sorry. This is about maths and stats, with a possible application to physical geography. Nothing to do with economics (well, it might have an application to business cycles, but I'm not ready to go there yet).

Maybe the geographers have already figured this one out long ago (I couldn't find it on Google, but I was probably asking the wrong question).

This question has been stuck in my brain for months. I can't answer it. I can't even ask the question properly. And it's really bugging me that I can't ask it and answer it properly. But I think it can be asked properly, so someone could solve it with basic math and stats.

Wikipedia tells me that 9% of Canada is covered by water. I thought it would be higher.

In defence of the AS-AD framework

I disagree with Peter Dorman (HT Mark Thoma). I have used the AS-AD framework many times in my blog posts (and I don't remember anyone ever snickering at me for doing so) because I find it useful. Paul Krugman offers a partial defence of AS-AD, with the following caveat:

"So there is a place for AS-AD, although it’s an awkward one, and the transition to IS curve plus Taylor rule plus Phillips curve, which is the model you really want to use for America right now, is a moment that fills me with dread every time we take it on in a new edition."

I understand that dread. I know where he's coming from. But I have decided we need to face it down. Because it's a false dread.

Fiscal Equity, Taxes and GTHA Transit

Federal Finance Minister Jim Flaherty has shot down Ontario Premier Kathleen Wynne’s proposal that the 34 billion dollar Metrolinx Greater Toronto and Hamilton Area (GTHA) transit expansion plan could be funded by a special regional increase in the provincial portion of the HST.  For this to happen, Ottawa would have to agree to Ontario’s request to put a special deal in place to allow for a regional increase in the HST.  Flaherty has stated that the agreement between Ottawa and Ontario does not allow for regional variation in the HST and will not accept a proposed regional sales tax increase.  This is a pretty interesting issue.  Of course, one can debate whether a consumption or income tax increase is the best way to fund transit or whether there should be a general tax rate increase at all to fund a transit plan given that the increase goes into general revenue.  The additional money could end up not only funding transit, but also a lot of other things.  However, there are more interesting aspects to this issue. 

Friends for Myles: Social networks and tax compliance

One reason why people pay their taxes is that they’re afraid of being caught, and fined, if they cheat.

In the simplest possible model of tax evasion, people only comply with the tax code if the benefits of evasion – the savings in taxes paid -  are less than the costs – the probability of getting caught times the penalty if caught.

The major problem with this simple model (and more sophisticated variants of it) is that it doesn’t fit the facts. Far fewer people evade taxes than one might expect, given that the probability of audit is fairly low (not that IRS, CRA or any other revenue agency will reveal the actual number), and the penalties for small-scale avoidance are not all that high.

Why doesn’t the simple model work? One hypothesis is that people pay taxes because they believe others are paying taxes: they contribute because it’s fair. Another hypothesis is that people are really lousy at estimating the probability getting audited.

Monopolistic Competition vs the Plucking Model

I like macroeconomics with monopolistic competition rather than perfect competition. It helps me make sense of the world. (Most modern macro models assume monopolistic competition.)

I like Milton Friedman's "Plucking Model". It seems to work well empirically.

But the two seem to me to be in conflict. I can't consistently believe both.

How can we spot a boom?

Suppose I had perfect knowledge about the economy. So I knew exactly what the right monetary policy would be to keep the economy growing along some sustainable path. And I knew exactly what that sustainable path would look like.

I would then be able to tell the difference between:

1. Monetary policy is too loose, and the economy is in an unsustainable boom. Maybe the boom can be prolonged for a bit, by making monetary policy even looser. But eventually the boom must end, and ouput and employment will fall. Maybe they will even fall temporarily below the sustainable path, because adjustment is difficult. Either way, the end of a boom will look like a recession.

2. Monetary policy is not too loose, and the economy is growing along the sustainable path. Then monetary policy suddenly becomes too tight, and output and employment drop below the sustainable path. The economy is in recession.

Bike share programs: good feelings, bad economics?

My local mall does not provide short-term bicycle rentals. It also does not sell roast-lamb-and-mint flavour potato chips, or jeans in a size 32 inch waist/36 inch leg.

I would like to be able to purchase all three of these goods and services. For the last two items on the list, the intuition of the average person is the same as the intuition of the average professional economist: quit whining and deal with it. Most Canadian firms do not produce obscure potato chips flavours or clothes in unusual sizes because consumers aren't willing to pay enough for those items to cover the firms' costs. The benefits consumers enjoy from these goods and services are less than the costs of providing them, so it's not efficient to provide the good or service.

Yet when it comes to short-term bicycle rentals, people often reach a completely different conclusion: government should intervene to create a bike sharing program. All the world class cities have them: Washington, London, Paris, Beijing, New York, and Toronto.

Visible minorities: Distinctly Canadian

As far as I know, Canada is the only country that divides its population into "visible minorities" and "non-visible minorities." In this post, I describe how, and why, Canada counts people this way.

A person's visible minority status is ascertained by asking:

"Is this person....White, South Asian (e.g., East Indian, Pakistani, Sri Lankan, etc.), Chinese, Black, Filipino, Latin American, Arab, Southeast Asian (e.g., Vietnamese, Cambodian, Malaysian, Laotian, etc.), West Asian (e.g., Iranian, Afghan, etc.), Korean, Japanese, Other - Specify" (Source: National Household Survey): 

Respondents may choose more than one option, or provide a write-in answer. The responses are coded as follows:

• white = not visible minority
• white and  West Asian, Arab, or Latin American = not visible minority
• West Asian, Arab or Latin American (as a single response) = visible minority
• any other response = visible minority

Note that there is no "Aboriginal" option. No one claiming Aboriginal ancestry is asked to respond to the survey question. Aboriginal Canadians are not "visible minorities" according to the official, statistical definition.