Monday, May 9, 2011

Watching the economics "profession" self-destruct

Paul Krugman writes about the absurdity of what he calls VSP economics--the droolings of the Very Serious People who have been getting it utterly wrong for the past 35 years.

VSP Economics
Paul Krugman, May 7, 2011, 8:51 PM
Dean Baker and Mark Thoma both wax indignant — and rightly — over a WaPo editorial on economic policy, which says that we must act urgently on unemployment, then rules out any action.
But let me suggest that this editorial is actually a collector’s item. The WaPo is Very Serious Person central — much more so than the Times — and this article encapsulates the essence of VSP economics, 2011 edition. Policy wisdom, as the WaPo describes it, is entirely dictated by fear of things that aren’t happening: fiscal expansion will invite an attack by the invisible bond vigilantes, if you try monetary expansion the inflation monster hiding under your bed will come out and eat you. The problem we actually have — the problem the Post says we dare not let happen — doesn’t seem to matter at all.
Beyond that, think about the economic theory that seems to underlie this article, a theory that is remarkable in its inconsistency.
One way to think about policy in the current environment is to take standard textbook macroeconomics seriously. If you do that, it points to the need for fiscal expansion and whatever monetary expansion you can manage at the zero lower bound.
There is, if you insist, an alternative: you can say that the whole idea that recessions are about aggregate demand is wrong, that we’ve had some kind of structural shock due to malinvestment, and that neither fiscal nor monetary policy can help — in fact, any attempt to mitigate the slump would leave thework of depressions undone. I see this view as wildly inconsistent with the evidence, but at least it’s internally consistent. more

The Old Economic Textbook
Economists and Job Creation
By DEAN BAKER, May 5, 2011
In the wake of the recession brought on by the collapse of the housing bubble many people have called for a new economics. There are certainly grounds for arguing that we need a new economics, but the bigger problem is that economists will not even adhere to the old economics, or at least not when it runs against the accepted thinking in political circles.
This is perhaps most obvious in the response by economists, or lack thereof, to the large U.S. trade deficit. In a system of floating exchange rates, the adjustment to a large and persistent trade deficit is supposed to be a decline in the value of the currency. That is 100 percent economic orthodoxy.
Economists ridicule the people who worry about jobs being lost to imports by telling them that new jobs will be created in other sectors of the economy. There is some logic to this story, but an essential part of the picture is supposed to be a decline in the value of the dollar.
Suppose the United States starts buying $100 billion of imported manufactured goods each year that replace $100 billion worth of goods that had formerly been produced domestically. The story is supposed to be that this means that we have increased the supply of dollars on international currency markets by $100 billion a year, while not increasing the demand at all. With a greater supply of dollars and no change in the demand, the price of the dollar will fall measured in foreign currencies.
A lower-priced dollar makes U.S. exports cheaper for people living in other countries, leading to an increase in exports. A lower-valued dollar also makes imports from other countries more expensive, leading us to import less. If we export more and import less, net exports will rise, creating jobs and moving trade back toward balance. That is the textbook story and the reason that good free traders don't worry when we lose jobs to imports.
However, what happens when the dollar is not allowed to fall? In the last decade many countries, most notably China, have explicitly pegged their currency to the dollar. They do this by buying dollars on international currency markets when their trade surplus (our trade deficit) leads to an excess supply of dollars. In effect, the action of these governments are preventing the normal adjustment process that would bring trade back toward balance and keep the U.S. economy close to full employment.
Without this adjustment process, the "free trade" crew has no real argument. It is entirely plausible that increased imports will lead to higher unemployment since the adjustment mechanism that is supposed to bring the economy back to full employment is not working. This is all straight traditional economics textbook stuff. more

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