An Oversight in Krugman's End This Depression Now

I started reading Paul Krugman's new book, End This Depression Now!, and felt compelled to point out one problematic remark from the first chapter. In chapter 1 he writes, 

"Clearly what we're interested in is involuntary unemployment. People who aren't working because they have chosen not to work, or at least not to work in the market economy- retirees who are glad to be retired, those who have decided to be full-time housewives or househusbands- don't count. Neither do the disabled, whose inability to work is unfortunate, but not driven by economic issues."

The problem is the last sentence. In fact, for people with disabilities, unemployment may be even more sensitive to economic issues than for others. People with disabilities may be the first to be fired when the economy makes a turn for the worse and the last to be hired when things begin to improve. The employment gap between men and women with and without work- related disabilities has increased over the past 20 years, reaching its largest ever recorded in 2009. Many people with disabilities are willing and able to work with sufficient accommodation. Often a small and relatively inexpensive change is all it takes. Since Krugman supports government spending and investment projects to End This Depression, why not target some of it towards workplace inclusion? Entrepreneurship and virtual or otherwise nontraditional work situations may also be viable--and productive-- options. These issues are all topics of a report of the National Council on Disability called "The Power of Digital Inclusion: Technology's Impact on Employment and Opportunities for People with Disabilities." I worked on the report while at the Center for Advanced Communication Policy at Georgia Tech.

Long-term unemployment, Krugman writes, is "deeply demoralizing for workers," and "the blow to dignity and self-respect can be devastating." Krugman's book is poignantly dedicated "to the unemployed, who deserve better." What an unfortunate carelessness to exclude the disabled even in the first few pages! 

One translation of an often cited Bible verse is "He who does not work, shall not eat" (II Thessalonians 3:10). Another translation of what Paul wrote to the early Christians is "He who is not willing to work, should not eat." Nowadays there is a distinction, but back then the translations would be equivalent. Involuntary unemployment was not a common part of the human experience. In pre-industrial society, farmers farmed and fishermen fished and servants served. But it was not the case that the "labor market" "failed to clear," leaving people involuntarily unemployed.

In fact, the rare biblical cases of involuntary unemployment mostly involve people with disabilities-- blind, deaf, lame, or lepers. They do not work, but Paul and the apostles do not argue that they shouldn't eat. Rather they spread Jesus' message of charity and compassion. This is the Christian attitude toward involuntary unemployment, not an attitude of "let them starve." Jesus' interactions with the lepers teach that they have human dignity, in an era when it was widely believed that disability was a punishment for sin.

When medicine, technology, and social understanding evolved enough to make it possible for people with disabilities to work, Christian teaching promoted this. Krugman cites Ben Bernanke and some happiness studies as his source that work lends dignity to human life, but this message was spelled out emphatically in 1981 in Pope John Paul II's "Laborem Exercens" ("On Human Work"). Laborem Exercens includes a section on disability.

Recently, national communities and international organizations have turned their attention to another question connected with work, one full of implications: the question of disabled people. They too are fully human subjects with corresponding innate, sacred and inviolable rights, and, in spite of the limitations and sufferings affecting their bodies and faculties, they point up more clearly the dignity and greatness of man. Since disabled people are subjects with all their rights, they should be helped to participate in the life of society in all its aspects and at all the levels accessible to their capacities. The disabled person is one of us and participates fully in the same humanity that we possess. It would be radically unworthy of man, and a denial of our common humanity, to admit to the life of the community, and thus admit to work, only those who are fully functional. To do so would be to practise a serious form of discrimination, that of the strong and healthy against the weak and sick...  The various bodies involved in the world of labour, both the direct and the indirect employer, should therefore by means of effective and appropriate measures foster the right of disabled people to professional training and work, so that they can be given a productive activity suited to them. Many practical problems arise at this point, as well as legal and economic ones; but the community, that is to say, the public authorities, associations and intermediate groups, business enterprises and the disabled themselves should pool their ideas and resources so as to attain this goal that must not be shirked: that disabled people may be offered work according to their capabilities, for this is demanded by their dignity as persons and as subjects of work. Each community will be able to set up suitable structures for finding or creating jobs for such people both in the usual public or private enterprises, by offering them ordinary or suitably adapted jobs... Careful attention must be devoted to the physical and psychological working conditions of disabled people-as for all workers-to their just remuneration, to the possibility of their promotion, and to the elimination of various obstacles...

This was in 1981! (And the rest of the document is equally far ahead of its time). Over 20 years ago, the Church proclaimed that unemployment of the disabled is involuntary unemployment and contrary to human dignity. Now Paul Krugman, who may or may not have a larger readership than the Pope, is finally proclaiming that involuntary unemployment is contrary to human dignity, but has to add the unfortunate aside: the disabled don't count.

Unsecured Consumer Credit with Risk of Default

Here are my slides for a presentation I'm giving tomorrow on a paper by Chatterjee, Corbae, Nakajima, and Rios-Rull called "A Quantitative Theory of Unsecured Consumer Credit with Risk of Default" (Econometrica, November 2007). It is a very technical paper that incorporates the main characteristics of U.S. consumer bankruptcy law into a general equilibrium model.

The paper represents a relatively recent trend of taking household balance sheets seriously in macroeconomics. Macro models commonly abstract away from household debt, assumed that since one person's assets are another person's liabilities, in the aggregate it washes out. But as Chatterjee et al.'s paper and others by Mian and Eggertsson and Krugman show, the distribution of household debt matters a lot, especially when thinking about the effectiveness (or lack thereof) of various types of fiscal, monetary, and other policies in a recession.

The Economics of Structured Finance

For anyone interested in the financial crisis, I thought I'd try to summarize a paper I just read for my Empirical Macroeconomics and Finance course. The paper is called "The Economics of Structured Finance," by Coval, Jurek, and Stafford, 2009, in the Journal of Economic Perspectives, Volume 23, Number 1.

Structured finance is the pooling of economic assets and subsequent issuance of a prioritized capital structure of claims, called tranches, against these collateral pools. The prototypical example of a structured finance security is a collateralized debt obligation (CDO).

A reason that the practice of structuring securities arose was to allow the tranches to be rated by the credit rating agencies so that they could be comparable with single-name securities or corporate bonds. Securities involve a complex mix of risks. Adding the prioritization structure creates “safe” assets at the high priority senior tranches. Senior tranches only absorb losses after the junior claims have been exhausted, which allows senior tranches to obtain credit ratings in excess of the average rating for the whole collateral pool.

For example, consider two bonds, both with default probability p. Both pay $0 in case of default and $1 otherwise. You could pool them into a $2 fund, and then form a junior and senior tranche. The junior tranche pays $1 if both bonds avoid default and $0 if either bond defaults. The senior pays $1 if neither bond defaults or if only one out of two bonds defaults; it pays $0 if both bonds default.

The recent financial crisis involved the discovery that the “safe” manufactured tranches were actually far riskier than advertised. Even AAA rated securities defaulted with reasonable likelihood. When this was finally realized, in late 2007 and 2008, investors stopped buying structured finance products. How did the credit rating agencies get it so wrong?

Notice that in the example above, the risk of default for the senior tranche depends on the correlation between bond defaults. If the bond default probabilities are uncorrelated, then the senior tranche defaults with probability p²

Next, the authors look at the relation of structured finance to subprime. Government- sponsored agencies such as Fannie Mae, Freddie Mac, and Ginnie Mae were chartered to purchase mortgages originated by local banks that satisfy certain size and credit quality requirements. They repackage these conforming mortgages into mortgage-backed securities to be resold in capital markets with the implicit guarantee of the U.S. government. Mortgages that fall below the credit standard (“subprime”) were packaged into “private-label” mortgage-backed securities, which in turn were resecuritized into structured finance CDOs. So there were two levels of structuring, and a lot more correlations to worry about, which were not properly accounted for. The ratings also didn't take into account systemic risk, which structured finance was particularly susceptible to. Typically, securities that are correlated with the market as a whole should offer higher expected returns, since it is less valuable to have an asset that will pay well when times are good and pay poorly when times are bad, than vice versa. The systemic risk of the structured finance products was underestimated.

The authors don't place all the blame on the credit rating agencies. They partly blame some perverse incentives, and also a regulatory guideline saying that banks holding AAA-rated securities were required to hold only half as much capital as was required to support other investment-grade securities.This distorted the demand for AAA-rated securities, and fueled a lot of the effort to create an imprudently large volume of structured financial products.

After the Crisis

An interesting reading to kick off the semester warns of "the dangers of presuming a precision and degree of knowledge we do not have." The article, by Ricardo Caballero, is called "Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome," and appeared in the Fall 2010 Journal of Economic Perspectives.

Caballero, who is an MIT professor, writes that "On the methodological front, macroeconomic research has been in 'fine-tuning' mode within the local-maximum of the dynamic stochastic general equilibrium world, when we should be in 'broad-exploration' mode."

Basically, the general approach to macroeconomics these days is to begin with a stochastic neoclassical growth model-- a basic model of households and firms that everyone learns at the beginning of grad school-- and tack on some special effects, like money, monopolistic competition, or nominal rigidities. The problem is that "by some strange herding process the core of macroeconomics seems to transform things that may have been useful modeling short-cuts into a part of a new and artificial 'reality,' and now suddenly everyone uses the same language, which in the next iteration gets confused with, and eventually replaces, reality.
Along the way, this process of make-believe substitution raises our presumption of
knowledge about the workings of a complex economy."

We try to make incremental improvements to the model, adding a parameter here and there, but actually bring it further and further from reality by compounding absurd assumptions. "In realistic, real-time settings, both economic agents and researchers have a very limited understanding of the mechanisms at work. This is an order-of-magnitude less knowledge than our core macroeconomic models currently assume, and hence it is highly likely that the optimal approximation paradigm is quite different from current workhorses, both for academic and policy work. In trying to add a degree of complexity to the current core models, by
bringing in aspects of the periphery, we are simultaneously making the rationality
assumptions behind that core approach less plausible."

Caballero makes a distinction between uncertainty and Knightian uncertainty. The latter involves risk that cannot be measured and hence cannot be hedged--things you'd never think of thinking of. This is the kind of uncertainty that is involved in most crises and panics. In one sense, it is very discouraging that novelty and surprise is such a big part of financial crises, for then, how can we ever hope to model or understand them? On the other hand, there are nevertheless some insights: widespread confusion triggers panics which trigger demand for broad insurance (and a role for government). Macroeconomists need to embrace complexity and recognize that human reaction to the truly unknown is fundamentally different
from reaction to the risks associated with a known situation and environment.

Last semester, I took a course in Psychology and Economics with Matthew Rabin. The types of models we studied there captured things like belief-based or reference-dependent preferences, ego utility, social preferences, and framing and bracketing effects. All of these tweaks to the standard models are made for the sake of increased realism, but still, they are just tweaks. Usually they involve adding a nice Greek letter to the model. The standard model is a special case for which the Greek parameter is 0 or 1. Agents are allowed to have particular types of risk preferences, but the risks can always be measured, and in fact the models almost always impose rational expectations. Rational inattention is allowed, but Knightian uncertainty is not; agents are perfect Bayesian updaters with well-defined Bayesian priors. In this sense, as Professor Rabin describes in the syllabus, the course is "purposely, pointedly, persistently, proudly and ponderously mainstream."

Caballero says we need to go further from the mainstream and into areas like complex-systems theory and robust-control theory. In doing so we may need to "relax the artificial micro-foundation constraints imposed just for the sake of being able to generate 'structural' general equilibrium simulations."

This semester, I have one course that teaches precisely the methodology that Caballero so harshly criticizes. It's a theory-intensive course in macroeconomics, and the main textbook is Recursive Methods in Economic Dynamics by Stokey and Lucas. I'm excited to balance this course with a new course called Empirical Methods in Macroeconomics and Finance taught by Professor Atif Mian. This course will focus on new ways to integrate finance and macro. We will also get to learn about some new data sets and work at developing research ideas. Yet another complementary course will be Professor Barry Eichengreen's European Economic History course. Theory, empirics, and history sounds like a balanced mental diet for this semester.

To Debt

Politicians may come and go, but debt is forever. In tribute to today's debt ceiling bill, here is a selection of poetry by the Roman epigrammatic poet Martial (40-104 AD). He was born in Bilbilis, Spain and after 64 A.D. he lived in Rome.

A Bargain

His cloak is brand-new, the best Tyrian hue,
He has got a good bargain I know.
‘Was it cheap?’ do you say? Well, of course, he won't pay,
And what is ten thousand— to owe?

To Gaius

I chanced to ask a loan—a hundred merely;
E'en as a gift that should not task severely
A wealthy friend, and so I asked him, knowing
His pockets bulge with cash to overflowing.
‘Go to the Bar,’ says he, ‘get rich by pleading’—
'Tis cash, not counsel, Gaius, that I'm needing.


A Rich Creditor

You dun me for ten pounds I owe, and on the petty grounds
That some one else has failed, and so you lose two hundred pounds,
But why exact from me the dues unpaid by other men?
For if two hundred you can lose, why, you can lose the ten.


To Afer

‘One thousand pounds Coranus owes to me,
Mancinus two, and Titius owes three,
Albinus owes just twice as much, and then
Sabinus and Serranus each owe ten;
My flats and farms give thirty thousand clear,
My Parma sheep bring sixty in each year’—
That's how you talk, and every day's the same;
I know it better than I know my name.
Unpaid I can no more your tales endure;
They bring a nausea only cash can cure.


The Proof of Friendship

You say you're my friend, but you never will lend
E'en a trifle: it's always ‘No, No’!
Your coffers are brimming, your Nile-fields are swimming
With plenty, while I hungry go.
When winter draws nigh do you ever supply
Me with gown, or a fat present make?
No proof can I find of your friendship but wind:
And that in my face you will break.


True Kindness

You gave him back his bond, but why
Should you suppose you gave thereby
The money that was due?
He owed the hundred pounds before?
To please him lend him twenty more—
And keep the I O U.

Debt Be Not Proud

Debt be not proud, though some have called thee
Mighty and dreadfull, for, thou art not soe,
For, those, whom thou think'st, thou dost overthrow,
Fault not, poore debt, nor canst thou bury mee.
From triplet A's, we'll never slip to bee,
Much pleasure, from thy issue, much more must flow,
And soonest our accounts of thee doe grow.
Issue forth bonds, and proceed treasurie.
Thou art slave to Fate, Chance, kings, and desperate men,
And dost with parties, warre, and lobbying dwell,
And stimulus can make us spend as well,
And better spend than starve; why swell'st thou then?
No tax increases, but let spending grow:
Ceiling shall bind no more; debt, thou shalt owe.

Based on the 17th Century poem Death Be Not Proud (or Divine Sonnet X) by John Donne

Debt Ceiling Blame Game

Who will bear the blame for the debt ceiling mess?

MSN has already put out an "unscientific poll" of self-selected readers of MSN Money. I have another metric (also quickly designed, less than perfect scientific rigor, but informative and interesting). I looked at Google search volume data. For whom did people search when they searched for the debt ceiling? Who was most strongly associated with the debt ceiling situation?

Searches containing the words debt ceiling and Obama were far more common than searches containing the words debt ceiling and Congress, Reid, Boehner, Senate, or House. (See the graph at the bottom of the post.) Obama is most strongly associated with the debt ceiling and the second runner up is the House. Over the month of July, Obama debt ceiling searches were over three times as common as House debt ceiling searches.

President Obama's party may be more in the clear, however. In July, people were about 2.5 times more likely to search for debt ceiling and Republicans or conservatives than for debt ceiling and liberals or Democrats.

Now, association does not necessarily imply blame, but these findings are qualitatively similar to the findings of the MSN poll which did specifically ask about blame. The Google results seem to provide some confirmation to the often-repeated political wisdom that the public sees the President as ultimately responsible for the economy.

Papal Economic Teachings

A papal encyclical is written by the Pope to address some issue of priority. Encyclicals offer critique and counsel, pointing out problems and suggesting solutions. They tend to be quite scholarly in tone and extensively researched and thought out. The Industrial Revolution prompted the first of many economics-related encyclicals. Here are some of the main ones in chronological order:

Rerum Novarum (On the Condition of Labor) 1891, Pope Leo XIII – Addresses the plight of workers in the wake of the Industrial Revolution, touching on socialism, unbridled capitalism, a living wage, workers’ rights, support for unions, and a rejection of class struggle.

Quadragesimo Anno (On the Reconstruction of the Social Order) 1931, Pope Pius XI – Written during Great Depression, offers an update on the state of labor and industrialization, and strong critiques of communism, unrestrained capitalism, class conflict, and inequalities. Pope Pius denounces the concentration of wealth and economic power.

Mater et Magistra (Christianity and Social Progress) 1961, Pope John XXIII – Notes power of science and technology to improve the human condition, but also to limit human freedoms. Calls on governments to safeguard human rights and expresses concerns for the growing gap between rich and poor nations, for the plight of farmers and rural areas, and for the arms race.

Pacem in Terris (Peace on Earth) 1963, Pope John XXIII – In response to the Cold War, the encyclical outlines necessary conditions for lasting world peace, looking at respect for human rights and disarmament.

Populorum Progressio (On the Development of Peoples) 1967, Pope Paul VI – Examines the economy on a global level, and addresses the rights of workers to decent work, just wages, and to form and join unions. Pope Paul VI calls development the new name for peace, criticizes unjust economic structures that lead to inequality, and supports new international and social relationships.

Laborem Exercens (On Human Work) 1981, Pope John Paul II – Emphasizes the dignity of work and the rights of workers, and the priority of labor over capital. Also addresses disabled workers, emigration, materialism, and the spirituality of work.

Sollicitudo Rei Socialis (On Social Concern) 1987, Pope John Paul II – Critiques East‐West blocs and other “structures of sin” that compromise the progress of poor nations, and calls for solidarity between rich and poor nations.

Centesimus Annus (The Hundredth Year) 1991, Pope John Paul II – Focuses on the moral dimensions of economic life, the advantages and limitations of the market, the role of business, and the responsibilities and limitations of government.

Deus Caritas Est (God is Love) 2005, Pope Benedict XVI – Pope Benedict locates love of the poor at the center of Catholic life.

Caritas In Veritate (Charity in Truth) 2009, Pope Benedict XVI – Deals with the ethics of contemporary economics; poverty and development; global solidarity; charity, justice and the common good; rights and duties; and care for creation. Here are some excerpts:

“On the part of rich countries there is excessive zeal for protecting knowledge through an unduly rigid assertion of the right to intellectual property, especially in the field of health care. At the same time, in some poor countries, cultural models and social norms of behaviour persist which hinder the process of development.” (22)

“The mobility of labour, associated with a climate of deregulation, is an important phenomenon with certain positive aspects, because it can stimulate wealth production and cultural exchange. Nevertheless, uncertainty over working conditions caused by mobility and deregulation, when it becomes endemic, tends to create new forms of psychological instability, giving rise to difficulty in forging coherent life-plans, including that of marriage. This leads to situations of human decline, to say nothing of the waste of social resources. In comparison with the casualties of industrial society in the past, unemployment today provokes new forms of economic marginalization, and the current crisis can only make this situation worse. Being out of work or dependent on public or private assistance for a prolonged period undermines the freedom and creativity of the person and his family and social relationships, causing great psychological and spiritual suffering. I would like to remind everyone, especially governments engaged in boosting the world's economic and social assets, that the primary capital to be safeguarded and valued is man, the human person in his or her integrity …. (25)

“Economic activity cannot solve all social problems through the simple application of commercial logic. This needs to be directed towards the pursuit of the common good, for which the political community in particular must also take responsibility. Therefore, it must be borne in mind that grave imbalances are produced when economic action, conceived merely as an engine for wealth creation, is detached from political action, conceived as a means for pursuing justice through redistribution” (36).

Drawing from these and other teachings, the U.S. Catholic Bishops have put together a ten-part Framework for Economic Life as "principles for reflection, criteria for judgement and directions for action." The ten principles are all pretty short and not very Catholic-specific. The first, for example, is "The economy exists for the person, not the person for the economy." The third is "A fundamental moral measure of any economy is how the poor and vulnerable are faring." I imagine that most people would accept at least some of the statements, and that they could have wide interpretations. I'll reflect and maybe blog on them in the coming weeks.

Shakira Teaches Economics

Everything you need to know about economics can be found in Shakira lyrics...

On scarcity and insatiability:
You can have it all, anything you want you can make it yours. Anything you want in the world, anything you want in the world. Nothing to big or small, anything you want you can make it yours. Anything you want in the world, anything you want in the world.
(Give It Up To Me)

On capitalism:
Refugees run the seas 'cause we own our own boats.
(Hips Don't Lie)

On macroeconomics:
Did it again love, I got it all wrong, but it felt so right, I can't believe it.
And all the mistakes that went on for too long, wish there was a way I could delete it.
(Did It Again)

On contract theory:
I might steal your clothes and wear them if they fit me
Never made agreements just like a gypsy
And I won't back down 'cause life's already bit me.
(Gypsy)

On recessions:
Todo en un desorden infernal
Que se iba a convertir en un desempleado mas
De la tasa que anualmente esta creciendo sin parar
(Everything in infernal disorder, unemployment growing each year without stopping)
(Octavo Dia)

On private property:
For you I'd give up all I own and move to a communist country.
(Don't Bother)

On monetary policy:
Mientras tanto este mundo gira y gira
Sin poderlo detener
Y aqui abajo unos cuantos nos manejan
Como fichas de ajedrez
(Meanwhile the world turns and turns with no way to stop it.
And here below a few manage us like chess pieces.)
(Octavo Dia)

On gift-exchange economies:
Te regalo mis silencios. Te regalo mi nariz.
Yo te doy hasta mis huesos, pero quedate aqui.
(I give you my silences. I give you my nose. I even give you my bones, so long as you stay here.)
(Tu)

On forecasting:
Un dia despues de la tormenta, cuando menos piensas sale el sol.
Cuando menos piensas sale el sol.
(One day after the storm, when you least expect it, the sun comes out.
When you least expect it, the sun comes out.)
(Sale el Sol)

On labor and leisure:
El octavo dia Dios despues de tanto trabajar
Para liberar tensiones luego ya de revisar
Dijo todo esta muy bien es hora de descansar
Y se fue a dar un paseo por el espacio sideral.
(On the eighth day, God, after much work
To release tensions
Said everything is very well this is the hour to rest
And he went for a walk in outer space)
(Octavo Dia)

On depreciation:
The ring you gave to her will lose its shine.
(Don't Bother)

On risk aversion:
And I say, hey you, you're no fool
If you say no, ain't it just the way life goes
People fear what they don't know
Come along for the ride, oh, yeah
(Gypsy)

On globalization:
Rock it out and rock it in from Dublin to Babylon.
Jump it out and jump it in from Kingston to Providence land.
(Un Poco de Amor)

On history:
Cada dia que pasa es uno mas parecido a ayer.
(Each day is another one like yesterday).
(Inevitable)

On time inconsistent preferences:
Tu mordiste la manzana y renunciaste al paraíso
y condenaste a una serpiente siendo tu el que así lo quiso.
Por milenios y milenios permaneciste desnudo
y te enfrentaste a dinosaurios bajo un techo y sin escudo.
Y ahora estas aquí queriendo ser feliz,
cuando no te importo un pepino tu destino.
(You bit the apple and renounced paradise
and condemned a serpent just because you were the one that wanted it that way.
For thousands of years you remained naked
And you faced dinosaurs under a roof and without a shield.
And now you’re here wanting to be happy
when your destiny was worthless to you.)
(Pies Descalzos Suenos Blancos)

On consumer theory:
No puede ser nada normal acabar eligiendo tan mal
Se siente tan bien todo lo que hace mal
Y contigo nunca es suficiente

http://lyricstranslate.com.

(It can't be normal to keep choosing so poorly. Everything that feels good is bad for you.
And with you nothing is ever enough.)
(Lo Hecho Está Hecho)

On Behavioral Economics (I):
Loca loca loca, la loca, la loca!

On behavioral economics (II):
My will and self-restraint
Have come to fail now, fail now
See, I'm doing what I can, but I can't so you know
That's a bit too hard to explain

On behavioral economics (III):
I can't help it baby, Ahh fool, I'm a fool, I'm a fool!

On economists:
You were so full of yourselves. But damn were you cute as well.
(Did It Again)