Friday, February 21, 2014

Book Review: Arnold Kling's Macroeconomics Book

Psst! The Wizard is powerless!

So claims Arnold Kling in his deeply subversive little book formally entitled Memoirs of a Would-be Macroeconomist, but known in Mr. Kling's blog simply as "my macroeconomics book."

He should know, of course. He worked for the Fed from 1980 to 1986 during the reign of Paul Volcker. He was a worker bee in a very busy office, collecting data, analyzing reports, coding FORTRAN, and doing other things staff economists do. He was close enough to the Wizard to know what was going on, and yet apparently had no position of any power. It's what I'd call the perfect fly-on-the-wall appointment.

So with all that effort, the Wizard stood behind his curtain, tweaking the carefully calibrated dials, turning knobs, pulling on levers and pushing buttons. The monetary machinery creaked and groaned, serviced by the army of economists including Mr. Kling, who oiled it for greater transparency and efficiency. Yet still, despite their best efforts, great clouds of irrational obfuscation issued forth.

Mr. Volcker is widely credited for ending the inflation of the 1970s, but Mr. Kling doesn't give him much credit. He writes
I might argue that it was not Volcker who made the difference [in inflation]. ...What I am suggesting is that the high inflation of the late 1970s may have been self-correcting. It resulted in weakness in the stock market and in housing, which then created severe recessions--remember, the unemployment rate climbed over 10 percent in the second half of 1982. Yes, most economists say that was due to monetary tightening, but I am suggesting that it was due to financial dynamics that were playing out regardless of what the Fed was doing.
Contrary to mainstream thinking, Mr. Kling argues that (short of the full Zimbabwe), inflation is not very susceptible to either monetary or fiscal policy. Expectations control inflation more than most economists acknowledge--as the money supply is increased, the market automatically corrects by reducing the velocity, and vice versa.  Mr. Kling's opinion is that QE, tapering, and Fed-speak are mostly if not entirely irrelevant.

That differentiates him from the folks (charlatans?) over at ZeroHedge or Occupy, who believe that the Fed is actively malign. But powerlessness implies an inability to do evil as much as good. Besides, Mr. Kling has a great deal of respect for his former bosses--he credits them with good intentions, and even for a few good deeds. In his list of economists who have led "interesting lives," (that he himself might like to have lived) Mr. Bernanke comes in for special praise, but mostly for his research rather than his chairmanship.

Mr. Kling's alternative to standard macroeconomics is something called patterns of sustainable specialization and trade (PSST). He describes it nicely in his book. For a more scholarly account you can download a pdf here. I will summarize it in two sentences:
Entrepreneurs, mostly by trial and error, will look for ways to maximize value from existing resources. In response to change, new economic patterns will evolve over time that optimize the consumer surplus.
As Mr. Kling generally rejects mathematical models as unrealistically simple, mainstream economists obviously dislike his view. He's basically telling them that they've wasted their professional lives for the past thirty years.

There is a view that is more charitable to the mainstreamers. One can accuse PSST of being untestable and unhelpful. In discarding econometric models, Mr. Kling essentially throws up his hands in despair and asks us to abandon all hope of messing constructively with the economy. This is a rather depressing conclusion that people of good will prefer to reject.

But I think PSST allows for some predictions. In particular, I think it renders the two recent books by Tyler Cowen (the world's most overrated economist?) wrong. In The Great Stagnation Mr. Cowen argues that technological change has come to a (temporary) halt, and we've already consumed the benefits from electrification, the IC engine, etc. Thus economic growth is in decline, and this accounts for the declining wages, unemployment, etc.

But this doesn't square with PSST. Absent technological change, the economy should be stagnant. That means that the optimal patterns of specialization and trade would already be in place, with consumer surplus maximized. Thus, rather than there being unused resources, all resources would be used to maximum extent. Of course the "boom" wouldn't really exist--consumer surplus would never grow. Indeed, it might gradually shrink, and despite the full employment we would all be getting steadily poorer. (Think of it as an economy with no additional labor-saving devices.)

That doesn't describe our current economy. Instead of stagnation we have crisis. That means there is rapid change occurring that renders existing patterns non-optimal. I think that change is fairly obviously technological, so the great stagnation theory is wrong.

Mr. Cowen's second book, Average is Over, contradicts the stagnation thesis, arguing that rapid technological change in the form of computer automation will put huge numbers of people out of work. He suggests that, despite marvelous new technology, up to 80% of us will be in absolute terms poorer than we are today. (You can't win with this guy--technology or no, we're all gonna get poorer no matter what.) But PSST says this can't be true, at least not in the long term. Entrepreneurs are not going to leave 80% of human capital sitting on the table collecting no return--that is clearly not an optimal pattern. So while almost everybody agrees that in the short term new technology will be highly disruptive, in the longer term new patterns will evolve that utilize the existing human resources. New technology will eventually show up as added consumer surplus.

My claim is that Mr. Kling's book is subversive. Of course it undermines mainstream economics. It also diminishes the Austrians, Austerians, NGDP, DSGE, neo-Keynsians, and the doomsters over at ZeroHedge. I like PSST because I think it correctly predicts that new technology will make us richer. I've argued along similar lines in my post here.

The second way Mr. Kling is subversive is his status in the profession--he has none. He occupies no faculty chair, nor has he ever served as a policy maker in government. Following his fly-on-the-wall stint at the Fed, he held a similar position at Freddie Mac. He then went on to start an Internet company, which made him financially independent. I understand that his day job now is teaching high school, undoubtedly done as a labor of love. (Lucky students!) The title of his memoir gives it away: Memoirs of a Would-be Macroeconomist.

Third, Mr. Kling writes a professional memoir rather than a scholarly article. That makes it much more interesting to read, and it also lets him draw on his extensive and relevant experience. But this is not the typical way that academic research proceeds. Rather than just the in-crowd, Mr. Kling is addressing readers like me--interested laymen curious about economics. (I'm a rank amateur, with no formal economics education whatsoever.) Of course I prefer that approach, but apparently the cognoscenti do not. The book has not been widely reviewed. I don't believe the book is mentioned on Tyler Cowen's blog at all. This is discouraging.

Finally, and related to the third point, Mr. Kling obeys Trotsky's First Law, which states that the value of a scholarly article is inversely proportional to the height of the paywall, that judged not just by the subscription fee, but also the time and effort required to read it. Mr. Kling accordingly values his work very highly--it is an enjoyable (if not always easy) read, only 120 pages long, and is available for FREE.

Psst! I think Mr. Kling has written a very important book. Pass it along.

Further Reading:

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