Monday, October 11, 2010

Clarifying Economic Principles: Monetary, Free Trade, and Unemployment

I consider it one of our important duties to try to simplify and clarify the lessons of economics for people to understand. I came across this philosophy well expressed last week on Thought du Jour:

Every intellectual has a very special responsibility. He has the privilege and the opportunity of studying. In return, he owes it to his fellow men (or “to society”) to represent the results of his study as simply, clearly and modestly as he can. The worst thing that intellectuals can do – the cardinal sin – is to try to set themselves up as great prophets vis-à-vis their fellow men and to impress them with puzzling philosophies. Anyone who cannot speak simply and clearly should say nothing and continue to work until he can do so.

Karl Popper, “Against Big Words”, In a search of a better world: lectures and essays from thirty years (Routledge, London, 1994), p.83.
Here then are a few simplifications: the limits of what computers can tell us about the effectiveness monetary policy, the political economy of selling free trade, and the difference between "voluntary" and "involuntary" employment.

Sumner on the limits of what you can find with Granger causality empirics:
"Just to be clear, I am not one of those monetarists who argues that you should expect to find a correlation between current movements in M, however defined, and future movements in AD. Indeed if you did find this sort of correlation, it would suggest extraordinary incompetence on the part of the Fed. If they are inflation targeting, there should be no correlation between M and P. And yet M would still be causing P."
Why? Suppose the Fed saw that people expected inflation to be 3% instead of 2%. In response, they tighten monetary policy (whether through interest rate increases, selling assets, or strongly worded hints it matters not). As a result, people's expectations shift back to 2%. P continues growing at 2% as it had despite the shift in M. A longer discussion about the importance of realizing that the Fed moves last and can support or undo any fiscal operation Congress might choose is here - pretty long but there are several good stops for intuition along the way.

Now you run this through a computer. The computer says "M changed, P didn't --> no correlation." But the reason P was 2% instead of 3% was the change in M. M causes P, but the computer would never tell you that.

Yglesias tries to clarify the issue of free trade by comparing unfree trade with regressive sales taxes. Consider it the political economy of selling free trade (emphasis his own):
The disparities are staggering. In his research, Gresser found that the tariff rate on a cashmere sweater is 4 percent; the rate for one made of much cheaper acrylic is 32 percent. A silk brassiere has a tariff rate of less than 3 percent, but the rate on a polyester one is ... 17 percent. The tariff rate on a snakeskin handbag is just over 5 percent but climbs to 16 percent for one made of canvas. Similar variations occur when it comes to household goods. Drinking glasses that cost more than $5 each have a tariff of 3 percent, while those that cost less than 30 cents each have a rate of 28.5 percent. A silk pillowcase has a rate of 4.5 percent; this goes up to nearly 15 percent for one made of polyester.
More generally, we’re pulling in about $10 billion a year in federal sales taxes on imported clothing, primarily drawn from non-luxury items. That’s a sharply regressive tax and I’m certain that if a politician stood up and said “what this country needs is a sales tax on non-fancy clothing” everyone would consider that insane. But nobody wants to hear about free trade.

More wonkishly, Yglesias explains the difference between "voluntary" and "involuntary" employment and how Keynes meant something probably no other person would think of by the term. This is useful primarily for translating Keynes into a modern understanding, so I'll just refer you to the link if you are interested.

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