John Quiggin on Zombie Economics
Nov 1 2010

John Quiggin of Crooked Timber and the author of Zombie Economics talks with EconTalk host Russ Roberts about ideas in economics that should stay dead and buried. Quiggin argues that many economic theories such as the Great Moderation, the efficient markets hypothesis and others have been discredited by recent events and should be relegated to the graveyard. Roberts challenges some of Quiggin's claims and wonders whether proposed alternatives might do even worse than the policies Quiggin is criticizing. Much of the conversation focuses on the role of government in the financial sector and how that might be improved going forward.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Robert Kennedy
Nov 1 2010 at 9:22am

This is the kind of episode of Econtalk that I really like. The guest has a different point of view than Russ and there is an intelligent and non-dogmatic back & forth between 2 smart people.

I think the observations about Australia are interesting and worth exploring further. Different economies have had different experiences in terms of the financial crisis and studying those differences would seem to be fruitful.

I was struck that Russ did not challenge Mr. Quiggin much on the impacts of bad regulations. Mr. Quiggin seems to imply that regulating the banks more would inherently produce good results when most of us here believe that emerges from most central planning is regulations with unintended consequences that are often worse than no or less regulation.

Shawn Reed
Nov 1 2010 at 10:32am

Robert…as a seminary professor of mine used to tell us: “You can’t say everything when you say anything, because if you try to say everything, you won’t say anything, because you’ll be saying everything else.”

[Typo fixed–Econlib Ed.]

Jason Clemens
Nov 1 2010 at 12:56pm

I found the Quiggan interview frustrating in that he was quite selective in the evidence he chose to include / exclude. For instance, his international comparison of countries that used stimulus vs. those that didn’t or that utilized smaller stimulus included only Iceland and Ireland. He ignored countries like Germany, Canada, and the U.K. He also ignored evidence on banking and the effects of artificial separation between different players a la Glass-Steagall. It would have been nice for Professor Roberts to have pushed him a little harder.

Richard W. Fulmer
Nov 1 2010 at 1:29pm

Dr. Quiggin argues that governments are unlikely to stop bailing out large financial institutions and, therefore, governments should regulate those same institutions. This conclusion only makes sense if it can be assumed that governments will regulate wisely. The regulations that encouraged mortgage companies to make loans to people who could not pay them back and the recent Dodd-Frank bill suggest that this is a very bad assumption.

Nov 1 2010 at 1:44pm

Good podcast, and nice to hear some considerate discussion from the other side–Krugman need not apply…

It is truly baffling to me though that anyone could look over the last 30-40y and label it as an experiment in the “minimum state.”

Lee Kelly
Nov 1 2010 at 1:54pm

Quiggin agrees that implicit guarantees subsidise risk-taking and that they contributed significantly to the financial crisis of 2008. When asked why he supports accommodating, rather than ending, bailouts with reregulation, Quiggin explains that the financial crisis of 2008 would have been far worse without the bailouts.

However, this is the wrong counterfactual to consider by Quiggin’s own assumptions. Without the implicit guarantee of bailouts the financial crisis of 2008 would not have occurred (or at least been far less severe). The correct counterfactual for considering a world without bailouts would diverge from reality sometime in the 1980s.

Nov 1 2010 at 1:55pm

Ur podcast is part of what makes monday my fave day…thanks a ton!

luv crookedtimber blog

luv u russ, but ur Hyper skepticism on LEH failure is…well “hyper”…all traders will tell u LEH changed everything- so will historical data on market and economic activity (market: volatility, volume, credit spreads, etc / economic: manufacture output, employment, consumer activity, etc) that LEH precipitated the crisis.

The only qualifier is that the entire system was fragile, so looking back it’s only a question of: if LEH was saved, then who would’ve been next? (ie which jenga piece would’ve caused the entire, shabby tower to collapse?)

I notice the complete absence of fannie and Freddie as major culprits in the crisis…this makes a lot of sense bc only financial entities w/ the “too big too fail” (TBTF) structure took the risks that ruined them (and the system).

Securitization…this is a good thing. The problem was/is the incentives for generating the securities (ie the “no skin in the game” problem for originators) compounded with the TBTF guarantee….and lack of due diligence from end investors.

Iceland (other non-stimulus using countries) is great evidence for stimulus effectiveness…not to mention the work of jan hatzius at goldman sachs (and all the other professional, private market economists).

I would LUV for a podcast (or series of them) that discusses inequality/mobility vs growth or whatever…by far one of the most challenging economic questions.

This is from the economist (a critique of krugman’s “conscience of a liberal”)

krugman responds to the “inequality” criticisms of the economist

luv u!

Shawn Reed
Nov 1 2010 at 2:02pm

Should Dr. Quiggin come here to read these comments, I just wanted to thank him for being one of the fewer guests with markedly opposing views who was willing to come onto the show. Though I disagree with his prescription (public choice being the dominant reason for that), I appreciated simply hearing it, and the model of respectful-while-clear disagreement between the host and guest. That’s just good for me as a human to emulate.

Nov 1 2010 at 2:24pm

@jason clemens…

GER, UK and CAN r rife with what we would call “stimulus”…

germany has “stealth” stimulus in the form of wage sharing (ie the govt pays corps not to lay off people) and a far more extensive social safety for big things like education and healthcare (2 of the biggest expenses for any household) and re-education/training programs.

canada is a commodity powerhouse and also has stealth safety nets. also, canada never had the financial crisis. they just watched it happen, so stimulus wasnt a big thing.

UK…this is trickier

Giuseppe Paleologo
Nov 1 2010 at 3:04pm

I also enjoyed the conversation. I like it when different economic views are presented, and Roberts is as his best in this setting. Even though this economic discussion is light-years ahead of what you will find anywhere else on the internet, I have some minor quibbles. I believe Russ was too easy on Quiggin, particularly on two topics that dear to me:

EFFICIENT MARKET HYPOTHESIS: as it happens, I have read only the Efficient Market Hypothesis chapter of Quiggin’s book, as it’s the only one I felt I could competently judge. I found it wanting. It seems that Quiggins is a) lacking a precise understanding of the EMH; b) overloading the EMH with meanings and predictions it doesn’t have; c) misrepresenting the proper interpretation of its true advocates, Fama above all.

That chapter should have been titled: “a critique of the mistaken interpretation of some advocates of the EMH, written by someone who doesn’t understand it either.” Someone has to finally write a long article explaining why Quiggin or Fox are not even wrong with respect to the EMH.

INEQUALITY: Quiggin is advocating Krugman’s view (who in turns takes it from Larry Bartels) that policy drives inequality rather than increasing returns driven by technology and globalization. Moreover he defines inequality measurement cross-sectionally instead of accounting for increased income inequality within one individual’s life, the impact of immigration on cross-sectional measurements, and many, many other issues that make measurement of inequality very subtle.
And finally, he suggests (without engaging in a full discussion) that Brin’s wealth is an unjust desert because it was a marginal improvement upon an invention that had been developed “by universities” (that’s not true, but is not important here). This too is an unoriginal argument that comes for Alperovitz and Daly and it is thoroughly refutable (Will Wilkinson literally demolished Daly in a bloggingheads episode on this subject).

Overall, the discussion of inequality is really an open-ended one. But Quiggin’s critique of the EMH was enough to convince me that his book was not worth buying.

Krzysztof Ostaszewski
Nov 1 2010 at 3:25pm

This is what John Quiggin said in the podcast: “It is impossible for government to take a neutral stance in response to a stock market crash.” I believe these are exact words, although his accent made some things fuzzy for me.

What exactly if not neutral was the government stance in response to the stock market crash on October 19, 1987? The biggest stock market crash ever. In fact, the Clinton Administration initially took a neutral stance in response to a mini panic in the U.S. markets after the Asian Crisis in 1997, and the result was also very good for the economy (one could argue that this was due to being busy with impeachment, and not their ideological stance, but it is what they did that affected the outcome). It was only the Russian crisis and LCTM situation that caused them to become busy bodies and set up the dot-com bubble and bust.

His idea is that we can’t control what politicians do so we just must accept bad policies. I remember that theory very well from my childhood in communist Poland. Except that in Poland we refused to accept it, and after decades of peaceful resistance guess what: the politicians actually were changed, and the policies were changed. What a crock! — Free people, living in a free country are assumed to be completely unable to control their politicians, just keep quiet and take it, because these politicians are not serving the people, they are actually omnipotent, super powerful creatures, and can do whatever they want. If not for this, then what exactly do we need freedom for?

Well, we sometimes had different politicians in the U.S. This is what President Ronald Reagan said in a press conference after the October 19, 1987 market crash, when harassed by all worked up journalists: “Ladies and gentlemen, markets fluctuate.” In fact, I believe Robert Rubin said about same thing in 1997. Yes, it is possible for government to take a neutral stance in response to a stock market crash. And that is the correct response. So some people lost money in the stock market. Some other people made money in their short positions. Markets fluctuate. Free, grownup people can deal with it.

Nov 1 2010 at 4:31pm

@Krzysztof Ostaszewski:

1987 crash…govt was not neutral, if we consider the fed reserve as a govt body:

“In an effort to restrain the declines in financial markets and to prevent any spillovers to the real economy, the Federal Reserve acted to provide liquidity to the financial system and did so in a public manner that was aimed at supporting market confidence. One of the most prominent actions of the Federal Reserve was to issue a statement on Tuesday morning (as noted above) indicating that it would support market liquidity. This statement was referred to by one market participant as “the most calming thing that was said [Tuesday]” (Murray 1987b), and likely contributed to the rebound that morning.”

that document gives specifics on the liquidity actions…

LTCM was almost the same in that the fed reserve put its credibility on the line when it publicly called all interested parties to maiden lane and forced them to resolve the problem (ie everyone takes a hit b4 markets open the next trading day).

@Giuseppe Paleologo:

EMH…what do u think about george soros’ “reflexivity” principle (from alchemy of finance, 1987)?

Nov 1 2010 at 9:14pm

Another take on Australia’s stimulus:

Giuseppe Paleologo
Nov 1 2010 at 9:15pm

@xian I have no specific opinion on reflexivity because I don’t know much about it. From a distance, it looks like adaptive expectations, which in the limit (or equilibrium) approaches rational expectations.

Nov 1 2010 at 11:41pm

Real zombie economics ideas: Keynesianism, inflation measurement, Hayek’s “scientism,” and empiricism in general.

In fact, one could call economics in general a zombie field, seeing how as a profession/academic area it almost exclusively destroys value in society! (Night of the Living Fed …)

Sadly, the record of history is crystal clear that economics is little more than a parlor trick used in tricking free but gullible people to give up their liberty. This is basically the argument of those in the Quiggin camp: “Ooh something scary happened … mumbo jumbo mumbo jumbo … better let Big Brother take care of ya!”

However, it is a very efficient tool for that task. In the past, men had to fight wars to enslave each other. Now we just cite an obscure paper on QE. All hail PAX ECONOMICA!

Nov 2 2010 at 1:29am

I often struggle to listen to an entire EconTalk podcast because they are usually dominated by market fundamentalism so it was really refreshing to hear a balanced conversation. It’s much more pleasurable to hear both sides of an argument. When I only hear extreme free market liberalism I turn off.

Russ – please get more guests on who don’t agree with you on everything.

Billy P B
Nov 2 2010 at 2:59am

Russ, I wish you knew you were in Australia, I would’ve bought you a beer! Are you surprised to learn that we don’t actually drink Fosters down here? Cheers.

Nov 2 2010 at 7:57am

The early discussion of the bailouts and their inevitability or not reminded me of a fact that I think needs more attention. It was not the failure of Lehman that caused the panic, in my opinion, it was the consequent failure of the Reserve money fund and the runs on Wachovia and prior to that the run on Wamu that paniced the Feds. I am no Keyenesian but the paradox of thrift is a good way of describing this phenomenon. Philosophically I despise the idea of deposit insurance but it is surprising to me that we seem not to have studied the phenomenon of wiping out so much savings that occured in the Depression and avoiding that fact has to be a good thing. Are Wall St’s lobbyists really the only reason this has not been the focus of policy making?

Nov 2 2010 at 8:00am

Great show! Such a rich discussion!

R.I.P. Benoit Mandelbrot, who paved the way for our understanding that many of the phenomena (economics, biology, physics even) that we study in such superb analytical detail are the emergent hydra heads of processes whose outcomes are unknowable until they are completed, and whose end states are dependent on initial conditions in ways we have a hard time predicting.

Australia had a small stimulus, then a bailout, then a large stimulus. It imposed new restrictions on capital flows and resisted raising taxes, but didn’t get rid of Too Big To Fail. The US had a small stimulus, then a bailout, then a large stimulus. It imposed new restrictions on capital flows and resisted raising taxes, but didn’t get rid of Too Big To Fail.

The outcomes look very different. If we accept that Australia is doing better, it could be due to things that are ineffable or hard to quantify: better timing of government interventions, the details of the banking changes, the lower complexity of Australia’s situation, etc. It could also be that the US had pumped so much more wealth towards the financial sector that the collapse on Wall Street left a much bigger hole to fill. Whether by luck or by superior long-term planning, Australia had retained the ability to exploit its deposits of the kind of stuff that was still finding buyers in a worldwide recession, and that certainly played a role.

I love the idea of a show where you take a long, hard look at the CPI. How about a long discussion with a government economist, an analyst from a bond shop, and an academic specialist?

Also, and because they are a piece of the puzzle that I haven’t heard much about yet: I would love an episode with somebody who studies pension funds, from Calpers right on down to the NJ union of carpenters. They move funds on a massive scale, but I have never heard a good analysis of how their needs tied into the current mess: how is that industry structured, what are the incentives, what do we know about the state of their finances?

Mark Crankshaw
Nov 2 2010 at 1:05pm

It seems that most of the ideas proffered by Mr. Quiggin are themselves Zombie ideas– the same old stale Keynesian blather sprinkled with the same old leftist fantasies that all we need is a little redistribution and wise government oversight and all of our problems will soon be solved. Total bullocks…

It appears that, being a statist, Quiggin holds the unstated premise shared by all of his fellow statists, from communists to “liberals”: the government is an institution that carefully considers societal problems and then politically devises fair, efficient and rational means by which to solve those problems. In this view, the government is fully accountable to its subjects, and with great love and kindness, it showers its wondrous beneficence upon us all. If you buy this loopy fantasy world premise, only then do the views set forth by Quiggin make any sense.

I ,for one, do not buy it. In the real world the government is a parasitic institution that diverts a massive amount of wealth from its host (the tax-paying producers) into the pockets of the most politically powerful and organized groups. The political process, far from the arena of careful consideration, is almost exclusively the arena of rent-seekers, lobbyists and demagogues seeking to viciously exploit policy (especially regulatory policy) for political or financial gain for the few at the expense of the many. The political process is conducive almost exclusively to unfair, inefficient, and irrational decisions for whatever problem/issue is at hand. The last few years of political activity should dispel any notion that the political process is accountable to the electorate (if the proceeding 200 years had not done so already). The exclusive purpose of all government spending and legislation in Western democracies is to keep our elected officials fat, dumb, and re-elected. All the better to keep the ruling elite that these elected officials truly serve permanently entrenched in wealth, privilege and power.

One of the most draw-dropping of the many justifications for increasing the wealth, privilege and power of our ruling elites that Quiggin offers is that when the government meddles in the market for political gain, the government should be rewarded with additional power to manipulate the market for political gain. According to Quiggin, the parasitic government is to be rewarded (by increased regulatory power) when it makes incredibly stupid anti-market policy (such as “too big to fail”). Does he not realize that there arises a perverse incentive for politicians to enact even worse anti-market policies in the future so they can increase regulatory power in a vicious cycle? Moral hazard, anyone? And what will our “wise” leaders do with this increased power and oversight? Why, the same thing they have always done: use it as a cudgel to extort more money from their victims, or play favorites with big political donors or other politically favored groups, and intentionally cause some other “market failures” so they can be rewarded once again. Does Quiggin not know that there exist many politically powerful groups which seek to replace competitive markets with non-competitive political fiat? That these groups seek to replace resource allocation by the market, where production is directed by millions of consumers, with resource allocation directed by a few politicians, lobbyists, and political pressure groups? I suspect he does, but like most statists, he is simply not in favor of the truly democratic allocation of resources by consumers (the likes of you and me), he simply prefers the powerful few (which he is or imagines to be) to do the allocating. No doubt the pickings are a lot fatter for academics when resources are allocated by political fiat rather than the free choice of the tax-paying public…

Even worse, he trots out the old lame income studies that purport to show that (surprise, surprise) the allocation of income is getting dangerously out of hand—and there needs to be re-distribution and quick! That is, the amount of money directed by political fiat should increase (benefitting the likes of Quiggin), and the amount of money directed by the market should consequently decrease (so much for the rest of us). But of course…

One would have to be incredibly naïve to believe that these “income studies” are ever conducted by those who really had no policy objective in mind, who coolly and dispassionately examined the facts, and are forced by the overwhelming nature of the data to an objective conclusion. Maybe it works that way in fantasy land, but not in the real world. On the contrary, these “studies” are merely a transparent and clumsy pretext to advocating an increased level of taxation on the “rich” (and they seek to rob the “rich” for the same reason that bank robbers rob banks—that’s where the money is) and re-distributing resources to political pet projects (like, what do you know, higher education). The very design of the “study” leads directly to the conclusion sought by the re-distributionist-to-be.
Let’s, for the sake of argument, concede the re-distributer’s contention, that those other than the top are falling behind. What Keynesians like Quiggin advocate is simply taking bits of green paper (fiat currency) from some and simply giving those bits of paper to others. Typical of the Keynesian view, there is little thought to production. It would seem to me that, to make life better for most, it would best to increase the production of the necessities of life (shelter, food, clothing). If the production of those necessities stays constant (or worse, due to increased taxation, actually falls) then the greater amount of money chasing those necessities that results from re-distributionist policies will make the price of those items increase. That’s not exactly in the best interest of those who spend the largest percentage of their income on necessities.

On the other hand, rather than bolting directly to income distribution, could there be any political barriers to the production of shelter, food, and clothing? Shouldn’t we remove unnecessary or harmful political barriers rather than simply enrich the political class willy-nilly? Perversely, our government has been attempting desperately to keep housing prices ever higher. What is the impact of that policy on the affordability of shelter? Our government sets tariffs on imported food, sets artificially high prices on staple foods, and devotes an entire agency (the Department of Agriculture) whose only purpose is to ensure that market prices do not prevail and that consumers of food pay more than they would otherwise. What is the impact of the policy on the affordability of food? Our government sets tariffs on imported clothing. What is the impact of the policy on the affordability of clothing?

Rather than simply giving the government more money with which to buy our votes and enrich the powerful—why not reconsider the massive amounts of uneconomic government spending? Do we need 150 military bases all around the world? Do we really need all those soldiers, bombs, and weapons of destruction? Do we need all the do-nothing make-work government bureaucracies? Social security checks to wealthy seniors? Our wasteful drug policy? Subsidies to the so-called arts? And on and on and on? I know what a hardship it is for our government to scrape by on the $4,000,000,000,000-plus dollars they extort from us every year, but to believe that the problem of poverty (or any other problem) is a matter of deficient taxation when there is a Mount Everest of government directed un-economic waste that could be better put to use elsewhere appears to me evidence of a poverty of imagination…

Nov 2 2010 at 3:29pm

I find it interesting how dogmatic some of the commentary is. The podcast was good a constructive discussion. Why is it necessary to insist on absolutes. Maybe stimulus works if the underlying conditions are correct. Maybe quantatative easing works given the right conditions. My grandfather used to say a poor workman blames his tools. Maybe one tool works for one place and another works for another.

We should find the common ground and build on it and not be so fixated on who is right. Maybe both sides are right and wrong. Liquidity doesn’t seem to be working in the US why is that?

Lots of interesting questions to work on.

Nov 2 2010 at 11:14pm

The USA is too big and democratic (as opposed to authoritarian)to ever respond to a crisis quickly enough with appropriate fiscal stimulus.

Australia is small enough to respond quickly.

This is how I see it from Australia.

On the issue of inequality the USA (& Australia also) are “high immigration” nations. High immigration is bound to “skew” the numbers when it comes to inequality.

Nov 3 2010 at 4:41am

As an Australian it was a surprise to hear a compatriot being interviewed on Econtalk. I’ve often tuned out of Econtalk discussions when the topic has been too ‘American’, as a lot of your country’s current problems are not impacting us.

My own take, as an Aussie, on the difference between the two economies is that Australia has China to thank for buying our mineral resources and seeing us through the GFC. And we also have a highly regulated banking sector that hasn’t been allowed to follow US banks down foolish pathes.

Have Americans yet realised that their economy is one of the most dysfunctional in the developed world? And, more importantly, when will they start looking at other countries to see what they are doing right, and respond accordingly?

Telling an Australian economist that he is, fundamentally, wrong, on structural questions, while the Australian economy continues to grow, after avoiding a recession, might make you feel patrotic, but in the long run it isn’t going to do you any favours.

Nov 3 2010 at 6:27am

Just a few additions to the Australian situation.

ANZ and NAB did have some exposure to US mortgages, in the order of $100 million or so. ANZ also marketed some CDO garbage to retail investors in New Zealand (through their ING brand) which although marketed as super-safe, resulted in losses. After action by retail customers ANZ was forced into the situation of reimbursing some of the losses.

The interesting aspect playing out in Aus. now is that because the banks came through the financial crisis relatively unscathed they are now looking to expand into asia. Now the banks know they’ll receive taxpayer guarantees what are their incentives for the results and expansion risks. Some feel we have seen this movie before.

John Thurow
Nov 3 2010 at 8:46am

My main problem with all of this is that Government policies are based on or are supposed to be based on economic theory. If macro economics is bankrupt and can’t support any of its hypothesis or theories what justification does any government agency have with creating policies which interfere with individual economic liberty? Wouldn’t the prudent course be to not act if you don’t know especially since abiding by constitutional constraints in the long run is the better course even if it means not implementing some great idea that will solve all economic problems?

I think the idea that the “stimulus” worked in Australia doesn’t stand up to any scrutiny. What is the baseline and how do you know the economy wouldn’t be better without it? There are other countries that took a more modest course whose economies are doing well and others that didn’t do anything that aren’t improving. It would be interesting to sort through all the laws, policies, culture and other difference factors between countries to see if there are other factors affecting the outcome before reaching such a conclusion. We have an experiment of some sorts between the states (less so now that Federal Law mandates everything). But even so, what states are doing better than other states? Does their policies toward liberty and upholding the law have anything to do with their success?

Mark Crankshaw
Nov 3 2010 at 10:39am

@ Outsider

Maybe quantatative easing works given the right conditions.

And maybe drunken teens who recklessly handle dynamite might not get blown up. This issue, in my view, is not a remote academic debate where a wrong decision will have little effect on people like me. It is precisely because Keynesian policies have the potential to go spectacularly wrong that I have deep concerns. Even when Keynesian policies do not fail, the “benefits” to Keynesian policies are primarily captured by some groups (government, debtors, those who get the “stimulus” first) at the direct expense of others (those to whom debt is owed, those on fixed income, those with savings, those who never get the “stimulus”). Who speaks for those groups harmed by these policies? Even Keynes admitted his policies were a stealth means of re-distributing wealth and lowering wages for workers.

As for common ground– what common ground is there between a pick-pocket and his victim? When a pick-pocket gets caught, no doubt he’ll say: “We should find the common ground and build on it and not be so fixated on who is right. Maybe both sides are right and wrong”. Quantitative easing is just pick-pocketing on a massive scale– maybe that works– but for whom?

@ Andrew

Have Americans yet realised that their economy is one of the most dysfunctional in the developed world?

I agree. However, our dysfunctional economy is a direct result of our deeply dysfunctional political system. While Australia may have escaped the carnage, and perhaps that was due to reasonable policy decisions– that does not imply those decisions will work everywhere. Policies that may work well in Australia may be detrimental when applied in the US precisely because of political system is so dysfunctional. Maybe those in positions of power in Australia are well-meaning, competent, and free from corruption. You can rest assured that those in position of power in the US are not…

Nov 3 2010 at 4:20pm

Have Americans yet realised that their economy is one of the most dysfunctional in the developed world? And, more importantly, when will they start looking at other countries to see what they are doing right, and respond accordingly?

Hmmmmm. Last time I checked the Federal Reserve Flow of Funds report the aggregated US household net worth stood at +$53 trillion, or about $175k per person (see table B.100). Per capita GDP is almost $46,000. That doesn’t sound too dysfunction to me.

I think that the obsession with the recent “crisis” has further distorted our perception of financial reality. The housing bubble clearly wasn’t good, but one has to add up the pluses and the minuses to make any sense out of the state of the economy.

Ralph Buchanan
Nov 3 2010 at 8:36pm

Great Podcast!
You guys are walking the same fence of the limits of knowledge but from opposite sides. Faced with the unknown (where is the “mal” in the malinvestment originating) you propose different management strategies: markets vs. government intervention.
That’s probably the best scenario for a rational discussion of policy you’ll find – agree on the problem but agree to disagree on the solution. Usually those discussions end in name-calling.

The market is usually the most efficient, sometimes bungling, but that’s because of perverse incentives provided by the government managers who are using aggregates to make policy. The two views always exist in parallel.

Seems the best you can hope for is an occasional intersection of the macro and micro levels such as the supply-side era.

Demand deficiency is never the problem: people always want stuff, but the right stuff has to be available at the appropriate price.
Government spending will only produce the wrong stuff, or the appropriate stuff at an inappropriate price, and therefore, misleading incentives.
Furthermore, the government (influence peddling and rent-seeking in tow) and its bureaucratic inertia picking winners/losers will only further skew the market and worsen or prolong problems.

The explanation of the Australian survival of the financial crisis (they were protected anyway, and besides they were in too much debt to invest in what turned out to be a bad investment) doesn’t say much for the Keynesian doctrine and its viability for managing the economy.

Thanks for bringing up the panel explanation – the fallacy of assuming the income data represent real people frozen in a subclass is one of the most persistent falsehoods used to club market proponents in popular media.

With all this limits of knowledge and fallacious data discussion, any chance at a Thomas Sowell interview? Or how about the guys from Government Size and Implications for Economic Growth (Bergh & Henrekson)?

Simon Cranshaw
Nov 4 2010 at 6:16am

I got the impression that for Quiggin the rise in incomes of the top 1% reflected some unfair concentration of “wealth” in that 1%. He seemed ot say these people had just been lucky and it would only be fair to redistribute a lot of their wealth. I have two points against this. For one thing I don’t think being rich means to have a lifestyle so different from others. A billionaire is subject to similar health risks as an average worker. They see the same internet. Although income numbers have diverged, haven’t the lifestyles of rich and poor converged? The second point is the effect of allowing extreme wealth is not so much in that it gives large resource rewards. It is in that it allocates investment power. Billionaires can build large experimental businesses. Quiggin may question whether people “deserve” their wealth but I think this is the wrong question. To take wealth away Sergey Brin and similar others will just slow the development of innovative businesses.

Nov 4 2010 at 1:46pm

To Mark C

I think you missed my point. The debate is around what to do and my point was that different things might work in different circumstances in different countries and that we should not have a preconcieved notion of what works and what doesn’t as the evidence for and against all alternatives is inconclusive at best.
Both sides of the debate trot out counter examples so maybe we should distrust them all.

I am not advocating that QE is a good thing.

My point is that in the right conditions it may be an appropriate response.

I am not a keynsian I think the economy manages us we don’t manage it.

I also tink that the monetarists have also proven incapable.

Maybe we should do a Hayek and have no plan and just wait for things to sort themselves out.

I don’t think this is politically very realistic since everyone seems to assume that the economy is managed by the government.

Nov 4 2010 at 5:22pm

“Economics isn’t a progress science”

An engineer or scientist can design a test for an object to verify expected outcomes. These tests might be ran 10, 100, 1,000,000 times with repeatable results. A test procedure can enable others to run the same test and observe the results. Through these tests we can state: “99.9999% of the time you press the breaks they will engage and your car will stop” or “99.9999% of the time you press the “s” key, an “s” will be displayed on the screen.” If you change any initial condition, or modify the input, there is no guarantee that the output will be the same. The tests must be repeated to ensure expected behavior.

It is this type of certainty that defines science vs faith, engineering from philosophy, certainty from theory.

The challenge in Economics is that we simply don’t have the ability to run the exact same test repeatedly. We can compare abstractions to abstractions and try to backfit explanations, but cannot predict with certainty the future results of an action. It strikes me more like chaos theory (weather patterns for example) than gravity. It’s trying to predict the path of a rock rolled down a mountain.

I believe Economics can progress – but the progression will be less definite, less measurable. It means Economic theory is not a trendline with yearly 5% improvements in accuracy, but more of a organic mass that is continuously being fed new and different ideas.

It is for this reason I completely disagree with Quiggin on his opinion that the stimulus “worked”. How did it work? On what measures? What would have been the outcome had it not been spent? What if it was 1/2 as big? Or 2x the size? We can’t answer those questions with any real certainty.

All we can say is a factual timeline of: “This amount of resources was distributed by a central authority in a particular way, and here is what happened overall during this timeframe for reasons we can’t state with certainty”. There are simply too many variables.

I also disagree that you can compare Australia’s economy to that of the United States and expect that a “2% of GDP” stimulus would have similar results. From an Engineer’s perspective it is laughable, the systems are completely different. It’s like modeling a Nuclear power plant and a Hydro plant in terms of their overall capacity, then expecting them to operate the same way during a drought. It’s crazy.

You can make up aggregate, abstract representations and compare percentages of A to B, but to do so ignores the fundamental building blocks of the system. For many years the US market gave signals to both purchasers and builders that housing was an appropriate area to invest their time and money. It should be no surprise that if the mechanisms that drive demand change, there will be an effect on the current investment in capacity. My hypothesis is that Australia’s production capacity was not over leveraged with respect to the global market or hasn’t yet seen a dramatic change in demand and thus has not required a significant resource reallocation (market correction). This was likely due to good fortune and not any central planning (aka the fortunate CEO theory).

Nov 4 2010 at 8:36pm

Thank you Mr. Roberts for the podcast. I know I get more than I pay for when I download it and your efforts (Rich Goyette too) are appreciated.

Two other comments:

1). It was a nice change of pace to get a glass of sweet confirmation bias koolaid in my flavor for a change.

2). Does the comments section of EconTalk have an in-house orthopedist who can offer advice for treating the knee after a particularly violent jerk?

Nov 4 2010 at 10:28pm

Given the disagreements on the Bush Tax cuts, are tax cuts now zombie economics?

Mike Laursen
Nov 5 2010 at 12:02am

re: “I got the impression that for Quiggin the rise in incomes of the top 1% reflected some unfair concentration of “wealth” in that 1%.”

I’m not an Economist, just an Econtalk listener trying to learn a bit about Economics. I have a question about how these studies calculate wealth and I hope you can answer it in layman’s terms.

A lot of the wealth of the more wealthy people is held in stocks. When trying to estimate the worth of those stock holdings, do these studies do a simple calculation such as multiplying stock price by number of shares held?

Normally, only a relatively small volume of a company’s stock is bought or sold on the market. Why do we assume that the price that the stock sells at at this limited volume is the same price it would sell at if, say, a billionaire were to try to liquidate all of his stock holdings at once?

Or asking a different way, why is market capitalization considered a significant or accurate measure of a company’s value? Seems to me like it vastly overestimates the worth.

Howard Roark
Nov 5 2010 at 7:36pm

Russ –

Another interesting podcast. Thank you!

Have you ever considered a slightly different format, one where instead of playing the role of interviewer, you invite a 2nd guest with an opposing view and then play the role of debate moderator? I would have loved the hear Thomas Sowell respond to John Quiggin on the topic of income inequality. Sowell devotes an entire chapter in his book, “Economic Facts and Fallacies” to debunking much of the “liberal – progressive” complaints of social in-justice with regard to this issue. This includes not only the common problem of looking at mere statistical categories of income as snapshots in time (rather than tracking individuals over their entire lifetimes), but also examining other factors like household size (which is shrinking) and the number of hours worked (income when measured on the basis of $ earned per actual hr. worked shrinks the gap). Sowell also discusses the “zero-sum” fallacy which seems to be at the heart of “liberal – progressive” politics. If a “rich” man earns more, that doesn’t necessarily mean the rest of us earn less. Wealth is not a fixed pie, and a society cannot multiple its wealth by dividing it.

With regard to “trickle-down” economics, Sowell has noted elsewhere that this can be demonstrated simply by looking at any business’s income statement. Who gets paid first and last? Do suppliers get paid before employees? Yes. Do employees get paid before shareholders? Yes. Therefore, the so-called “rich” owners of the business, the men and women who have assumed all the risks, are the last ones to get paid.

Getting off the topic of pure economics, when it comes to public policy, one must also consider other factors like law and morality. Have you considered pushing these boundaries a bit more in your interviews? I always enjoy hearing your discussions with Richard Epstein, because he is so astute on the topics of Constitutional law and economics. Few people (if any) can bridge this nexus better than him. For example, I would have liked to hear some comments on the Constitutionality of the Wall Street bail-outs. Whether it is a good idea or not economically speaking is irrelevant, if the federal government did not have the enumerated power (per Article I, Section 8) required to pass TARP.

With regard to the issue of morality as it pertains to the income gap, let me say this: I own my life! (Corrolary: You own your life.) Therefore, I own my mind, body, time, talent, and energy; and thus, the fruits of my labor. If I please my fellow man by offering him a product or service at a quality / price point which he values at less than his maximum willingness to pay (i.e., generating for him a consumer surplus), and at the same time, at a quality / price point less than my competitors, do I not deserve to keep my producer’s surplus? If I don’t own my life, then who does? Does “society” (whatever that means) own my life? Does the government? I am the only person who has ever occupied my physical body and the only one who ever will. Self-ownership is the ultimate natural law / private property right; see “The Philosophy of Liberty” at –

If so-called “liberal – progressives” believe it is okay to use the coercive power of the state to “redistribute” (i.e., steal) income from one American in order to give it to another American under the pretense of reducing the so-called “income gap,” are they not advocating legalized plunder? As Frederic Bastiat pointed out in The Law (1850): “The war against illegal plunder has been fought since the beginning of the world. But how is… legal plunder to be identified? Quite simply. See if the law takes from some persons what belongs to them, and gives it to other persons to whom it does not belong. See if the law benefits one citizen at the expense of another by doing what the citizen himself cannot do without committing a crime. Then abolish this law without delay… If such a law is not abolished immediately it will spread, multiply, and develop into a system.”

Thus, even if we can prove that the income gap is growing, does that mean it is morally permissible for the government to intervene? And if so, wouldn’t the cure be worse than the disease (e.g., distortion of incentives, government tyranny, etc.)? As they used to say in the waning days of the Soviet Union – “Comrades, we don’t have any bread to eat. But don’t worry about that, because at least we get to share our poverty equally.”

Besides, isn’t it a good thing that we have a large income gap between say, the dope-smoking high school drop-out who delivers pizzas for a living, vs. the man who busted his a– going to medical school – followed by a very difficult and stressful residency program – in order to practice brain surgery?

And if “liberal – progressives” don’t like what a “rich” man earns, don’t they have the freedom to vote with their wallets by boycotting his products and services? For example, if I think Tiger Woods makes too much money playing golf, I can simply change the channel and watch something else.

If we forget about economic efficiency for a moment, the problem with the federal government’s bail-outs and so-called, “stimulus” spending over the past few years is that I (and many others) have been forced against our free-will to buy the home we prudently chose not to buy, to buy the GM / Chrysler car we never wanted to own or drive, and to pay to have solar panels installed on our neighbor’s roof. How can this be justified morally, not to mention legally per the Constitution?

The answer is: It can’t!

Nov 6 2010 at 10:22am

Ad Panel data and following people’s income – beware of the ‘regression to the mean’ statistics artifact!!! It is totally expected that if you take the ‘Bottom X%’, that it would be always different people – and because you cannot anywhere but up, those people will just be better off…

John Berg
Nov 6 2010 at 2:39pm

I see by the date of Howard Roark’s message that he had use of the 2010 US Election results. Certainly many voters in the US agree with him. I was pleased with Roark’s connecting the election results with the US shock at watching, nonplussed, President Obama’s attack on the US Constitution. Apparently 75 years have gone by since anyone has pointed out the importance of Federalism to the exceptional nature of the USA. “US Federalism,” a better name for this quality than “State’s Rights” which now as the connotation of “Jim Crow,” represents the contract made by the States in forming the Federal Government. That contract has significant economic value and should suggest examination of the US Constitution to learn how the genius of it’s intricate structure helps make us exceptional and how President Obama’s Progressiveism is a threat to it.

John Berg

Donald Sivori
Nov 8 2010 at 6:02pm


According to Mr. Quiggin Australia didn’t have much of a housing bubble and no housing bust. House prices stayed high. The financial system didn’t seem to get into the sort of risky mortgage backed securities. Export demand was fairly healthy the last five years. Why would they have a recession at all? Is it possible that fiscal stimulus did nothing at all? Is it possible the the mind recession they experienced, that came after Australia applied fiscal stimulus, was caused by the stimulus attempt?

Krzysztof Ostaszewski
Nov 8 2010 at 9:45pm

The only thing Federal Reserve did in 1987 was to announce that liquidity will be provided. There were no changes in interest rates, no behind the scenes secret bailouts, etc. if you think that response was excessive, please tell me how — it was minimal in comparison to what Federal Reserve has been doing since 1998. And the Federal Government did not even for a moment consider a stock market crash to be a catastrophic event in 1987, even though John Kenneth Galbraith was on television pronouncing the death of American Capitalism.

In 1987, the Federal Reserve did not try to say they would cure the economy. They merely provided liquidity. If we had similar response in 2008, I am willing to bet a bottle of Chiroubles Beaujolais that we would now have lower unemployment rate than Germany. Can’t decide this bet, I know, but I would suggest that we have a good look at policies of Germany since Chancellor Merkel did not have to form a Grand Coalition to run a government, and compare them with the U.S. policies, and then compare the unemployment rates in the two countries.

Nov 10 2010 at 4:23pm

Krzysztof Ostaszewski,

I think the main fallacy with comparing 1987 to the current (or other) situations is that you are making the false equivalency between the stock market and the economy. It’s true that the Dow Jones, S&P, and Nasdaq are related to investor confidence, investment, and the economy. It is also true that every time there is a large stock market drop or climb people make broad predictions about its implications for the economy. In reality it is simply one especial volatile, highly visible, indicator of economic health. 1987 was not preceded by the sharp decline in home prices, massive defaults, collapse of large interconnected institutions, etc. etc. etc. Most explanations for the 1987 crash revolve around theories such as program trading, speculative attacks, disputes over exchange rates, etc., NOT large scale illiquidity and possible insolvency.

Nov 10 2010 at 5:51pm

Krzysztof Ostaszewski,

Not that I would guess you find his opinion very compelling but here is a rebuttal using some fancy charts that tries to debate the “German austerity” claim.

Jet J
Nov 15 2010 at 8:01am

Great podcast Russ,

The alternative views makes for extremely interesting listening and really does more for educating your audience than any other sytle of podcast as contrasting views can be placed and the listener can decide.

As far as the debate on more regulation goes, coming from Australia I completely agree with John and it always puzzles me, when Russ and others say that government regulation is a problem.

If there was sufficient government regulation there wouldn’t be the mess there is… incetives are all wrong for the bankers and gov. regulation is needed otherwise you get what we have had whereby bankers run wild and take excessive risks because they’re allowed to.

Nov 15 2010 at 11:25am

Krzysztof Ostaszewski,

One more comment (if you’re still around :). What about the situation in Ireland? Ireland made great economic strides by greatly liberalizing its market over the last ~15-20 years. Unfortunately, partly because of the liberalization, developed a housing bubble and was involved in much of the banking problems that have effected much of the world recently.

Unlike the majority of countries in crises they were very early on the “austerity” band wagon, never really trying a stimulus and instead “tightening its belt.”

How has that worked out for Ireland? Not too well in my opinion as, unlike most other nations in the crises, is STILL experiencing largely negative GDP growth… although that might FINALLY be changing.

Ryan Edwards
Nov 17 2010 at 10:31pm

@ Andrew’s ‘My own take, as an Aussie, on the difference between the two economies is that Australia has China to thank for buying our mineral resources and seeing us through the GFC. And we also have a highly regulated banking sector that hasn’t been allowed to follow US banks down foolish pathes.’

@John Thurow’s ‘I think the idea that the “stimulus” worked in Australia doesn’t stand up to any scrutiny. What is the baseline and how do you know the economy wouldn’t be better without it?’

Statistically, after controlling for the business cycles, Chinese stimulus has had no positive effect on output growth during the last decade. It actually has a slightly negative, slightly lagged and very significant effect. This implies resource dependence is not doing us any favors (Dutch disease maybe?) and the stellar performance must be accounted for some other way. Maybe the stimulus does stand up to scrutiny, maybe it doesnt. Those countries who used big and targeted stimuli like Australia systematically performed better, with obvious exceptions. I have seen IMF reports go into some detail on this but more generally, the surveys of the fiscal literature tend to conclude that in this age it tends to have Keynesian effects. Anyway, the only point I wanted to make was that in the short-term and the long-term the Australian resources sector gets far more credit than it is due given the real evidence here and abroad.

topology of the mind
Nov 19 2010 at 1:33pm

Not exactly what you were talking about at minute 25, but I read this result in graduate school and I’m surprised that it hasn’t gotten a wider audience:

Janet Yellen and George Akerlof proved in the 1980’s that individual irrationality does not get smoothed out in the macro picture.

  • Can small deviations from rationality make significant differences to economic equilibria? – The American Economic Review, 1985

It just falls out of the envelope theorem. ε² deviations at the individual level result in ε deviations at the macro level.

To address directly what you were talking about — whether individually efficient stock prices add up to a totally efficient market — that’s the role of arbitrageurs! I’m thinking of cross-asset, cross-market stat arb’s specifically.

I think where this breaks down is the “Born rule” if you will. Projections of the future form a probability distribution but the future itself is just one draw from that distribution.

topology of the mind
Nov 19 2010 at 1:35pm

@Robert: Seconded. Great guest, loved the contrast.

topology of the mind
Nov 19 2010 at 1:37pm

@Outsider: Listeners drawn to the show are typically libertarians and not as smart as Russ!

Glenn Donovan
Nov 21 2010 at 10:06pm

Well, I have a different take utterly than many of the commenters. First, I loved this show – so maybe I’m not that different – it was a very reasoned discussion, thoughtful and substantive. But I’m sorry, I really felt like Russ let Quiggin off the hook for his unwillingness to address his own contradictions. Here are just a few:

1. Australia – Have the laws of physics been repealed there? Because, last time I checked, every dollar of ‘stimulus’ is just a dollar that would have had more velocity if left in in its owner’s hands in the first place. Fyi, Quiggin admits that the real estate bubble just hasn’t burst there yet, due to fortuitous banking decisions which limited international exposure, so really, what’s the example I’m supposed to bowled over by again, smashing any resistance I might have to flaccid orgies of debt?

2. The entire premise is of Quiggin’s ‘pragmatism’ is, well we’re stuck with government intervention, so lets make the best of it. And then to suggest that the so called ‘great moderation’ represented a quiescent period of regulatory action is just silly. Do either of you work in banking/securities/insurance? Do you have any idea how much regulations have grown there in the past 40 yrs? Whether you count lines of statutes or costs of compliance – these numbers have skyrocketed in the past 40 yrs. But the real problem is the main point. Quiggin seems to believe we can stumble along as we are without hollowing out the U.S. economy, as though regulation and intervention in financial services were not in fact a root cause of the magnitude and severity of our recent ‘crisis’. To me, this is a fundamental evasion of the truth about our regulatory failures and the unintended consequences of govt intervention.

3. The entire idea that the philosophical problem of whether markets are efficient or rational or not as a reason to give government a license to exercise statist policies starts from a false, consequentialist assumption. Get this – I’m free, and I wouldn’t give up being free even if some economist proved that statism worked better. Period, dot, end of sentence. Orders emerge, some of them are good, others maybe not so much, but I’d rather compete in that freeforall than confront the glazed and stupefying look of the typical civil servant or be subject to the vagaries of executive and legislative power plays.

While I didn’t expect Russ to be rude, I do think he conceded far too much. I was particularly thrilled when he took him on over income inequality. The average statist looks at this data and fails to consider not only income mobility, but also behavior over time. Guess what, in a free society, some people will be better at accumulating capital than others. Even more to the point, wealthier individuals have more income invest to earn themselves even more income and wealth. They also manage their financial affairs more prudently. They’re also more educated, much more likely to own businesses, and don’t watch 60 hours of TV per week. In fact, gasp, their parents might have sent them to the best schools and taught them to be ambitious and responsible and diligent – and voila, they make more money than those whose idea of a good time is going to the bar or working merely 8 hrs a day. This might explain the diverging lines better than, Quiggin’s explanation which was that most wealth accumulated in our society is ill-gotten. I mean, that’s what he said, and really, you have to wonder if he’s ever run a business or worked in a major corporation, because the only place people are getting free rides is where the govt is intervening. He should go work in a Silicon Valley startup for a year and them come back and make that statement about the source of wealth creation.

Quiggin is actually a purveyor of “BlackWhite” speak (see Orwell’s Newspeak in 1984). He uses dulcet tones and strikes an intellectual pose, but only uses that to peddle a continuation of state intervention in the housing market and financial services sector – despite the now incontrovertible evidence that such interventions only really benefit the powerbrokers and their clients in our crony capitalist economy (Public Choice). It’s perfectly clear and one doesn’t need a Ph.D. to understand it. So pardon me if his deferential tone doesn’t win me over, he’s a proponent of the status quo and to that I say – “you’ve got to be kidding me!”.

My two cents, keep it coming, I love the podcast.

Nov 28 2010 at 3:41pm

quiggin recently delivered a lecture at the LSE

available here on podcast

Zombie Economics: How Dead Ideas Still Walk among Us

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Podcast Episode Highlights
0:36Intro. [Recording date: October 28, 2010. October 29 in Queensland.] Ideas in economics you argue are wrong but keep coming back like Zombies, hard to kill. Start with the first one, the Great Moderation. What was the idea behind it and why do you think it's dead? Label given to the period starting in the mid-1980s and going through the mild recessions in the United States around 1990, dot-com bubble and bust. Economy looked a lot less volatile than it had been in the past. Claim was that this wasn't just a lucky draw from the dice; this was the product of the kind of deregulated financial system and the approach to monetary policy based on adjusting interest rates in line with the Taylor rule that had been adopted at this time. View was economy was on more stable footing. That kind of claim wasn't new. Was made in the 1920s when we first discovered monetary policy in some sense, and more strongly again in 1950s and 1960s when monetary and fiscal policy seemed to be able to stabilize the economy. Idea encouraged the view that we should worry about developments in asset markets and things like that; looking at the real economy seemed to be more stable. Led us to imbalances. Idea that "this time is different" has a timeless appeal; we want to believe that. John Taylor, podcast, argues that the reason the Great Moderation ended was that we simply followed bad monetary policy; we could have sustained it; the recessions of 1990s and 2001 were relatively mild by historical standards, and this last bust was the result of a failure to follow the policies that led to the Great Moderation. What's your response to that? Don't see it that way; see the dot-com bubble and bust as a kind of rehearsal for the kind of bubble and bust we had in 2008 and since; willingness of Greenspan in particular to bail out financial institutions and encourage them to believe they would be bailed out while not restricting their financial innovation. Think that was really evident in 2000 in the lead up to the dot-com bubble and bust, huge growth in the financial sector backed up by the so-called Greenspan put that really is the problem here.
4:38Confused by that answer. That's Taylor's criticism. Taylor's criticism is that Greenspan's interest rate policies in the aftermath of the dot com bubble--the Greenspan put, the willingness of Greenspan to ease the losses. Are you as critical as John Taylor is of Greenspan's policy? Distinguishing, think the difficulty in the framing of these questions: if you only have the one instrument of interest rates you have to use it both to manage the real economy and to work its influence on the financial sector. The problem was that although the dotcom recession was relatively mild, the recovery was very weak. In terms of fiscal policy, there was a case for stimulative policy, but we had the problem that this was building up in financial markets. My conclusion is we need measures directly to regulate financial markets. We need to focus on that rather than trying to use interest rates for all purposes. Issue of deregulation or re-regulation. One of the central issues that developed economies have to struggle with right now. You make the argument that--another Zombie idea of sorts--market liberalism generally, idea sometimes called the Washington consensus, that free markets are the right way to create growth, prosperity, to develop, and you are critical of that idea. Would replace some of the policies of the 1980s and 1990s with a stronger regulatory environment. Make the case for that and talk about why it's necessary. I'd focus particularly on the financial sector--deregulation of the financial sector was the characteristic feature of the post-1970s period of market liberalism. Various other things in product markets, but the really striking difference was this huge growth in the financial sector and a belief that regulation had to be light-handed so we didn't discourage financial innovation. My view is that is almost entirely wrong-headed thinking. We can't allow the financial system to collapse and in turn the majority of financial innovation unless it is tightly controlled is going to be arbitraging against those regulations. If when the financial system fails, everybody gets bailed out, all financial sectors will take risks. Everyone wants to bet on that happening. Only way to stop that is to regulate a range of activities that can be undertaken.
8:10You and I are on opposite poles of the regulatory spectrum, yet I totally agree with half to two-thirds of that story. Let's see where we disagree and adjudicate the dispute. Agree with that once you have in place the idea that a bailout is likely or inevitable, which has been the case in the United States and in other parts of the world--in the United States it goes back to at least 1984 with the bailout of Continental Illinois and proceeds through a whole series of events where the signature nature of these bailouts are the bailout of creditors--the people who in a market system should be monitoring risk taking; yet if they know they are not going to be bailed out, don't behave correctly. Fundamental question is: why wouldn't you simply be in favor of no bailouts? We've never tried market liberalism, so why do you think we should go in a different direction whatsoever? Precipitating event was the failure of the Federal Reserve to come up with some spine and say we never guarantee; we are not part of that agreement; we are going to let them go under. Discovered in a matter of days that letting Lehman go under would take entire system with them. AIG, Goldman Sachs. Looking at things like money markets, the extent of the shock was such that in my view the alternative to a bailout was even worse than a bailout itself. Idea that we can let things fail to some extent was tried in the Great Depression and the 19th century. Can't say we haven't tried this. Of course, we've never had a pure system of market liberalism but equally my remaining Communist friends tell me we've never had pure Communism. No doubt both are correct. At some point you have to say this is as close as we are likely to get, and the contradictions only get worse. Bailing out or not making it clear who will and who won't be bailed out, characteristic of the period since the 1970s, always ends up failing. Interesting issue. May have been true--no way to figure it out. May have been true that Lehman Brothers was the precipitating event and had the government continued to let firms fail it would have been catastrophic. Hard to know. But certainly that was the result of past mistakes, and regime change is hard to impose. Hard to say: Well, from now on we really mean it. Let's take your point as correct, that given the past decisions that have been made it's impossible to make a credible promise that you will let firms fail. What's to be done, given the central role of financial markets in the modern economy and in the business cycle, at least the one we're in right now--the downturn. Looking at the long-run story, I am a fan of a [?] version of narrow banking. What do you mean by that? Reimposition of something like Glass-Steagall--that is, a separation between banks that take deposits from the general public and make loans, and investment banking. Cast-iron guarantee of the banks in the first category, combined with the most credible promise you can make not to rescue banks in the second category. Only way you can make that second promise credible is to say you can have no significant financial dealings across that boundary. Can't have joint ownership, can't have large-scale extension of credit and securitization crossing the boundary between a regulate-and-guarantee banking sector and an investment banking sector. That I think is the way in which we can potentially achieve that kind of credible guarantee. We do in a sense have that kind of guarantee with respect to the stock market. That is, if you lose your money in the stock market, you are more or less guaranteed that the government isn't going to say: That's terrible; we'll bail you out. Stock market is very big to fail. So it's not so much too big to fail, but too interconnected to fail that's the problem. Always worth remembering that the 2001 recession, which was preceded by a sharp drop in the value of technology stocks, had a very mild effect. The people who had invested in those stocks lost their money--some of them did, some of them made a lot of money. They didn't expect to be bailed out. Real problem is the interconnectedness, and then the ability to use leverage--borrowed money--to finance your risky bets. As long as you have a permissive attitude toward financial innovation, say you can introduce whatever financial innovation or instruments you like. In a situation where you've got a government guarantor for part of that system, the incentive is always to find new ways of getting more leverage, taking more risks--because some part of the losing bets will be laid off on the public.
15:10Narrow banking idea. A number of people have come out in favor of it. Some dispute the claim that the repeal of Glass Steagall was central, but fundamental idea--forget the challenge of implementation for the moment, might be more difficult than it sounds--is if the government is going to guarantee something it should probably guarantee the deposits of the investor who is putting a large part of their nest-egg into this bank; but certainly the professional investor, speculator and taking risk--they get the up-side so it's only fair that they get the down-side as well. Seems like an appealing idea. What is stopping it? Crucial problem: United States bailed out Long-Term Capital Management (LTCM), which was regulated on the premise. 1998. Precisely that these were deregulated firms, story was these are professional investors, limited to wealthy people investing their own money; we don't have to watch what they are doing. But what they allowed was LTCM to borrow from institutions that hadn't been guaranteed, so they weren't gambling with their own money, but in effect with the deposits of you and I. That connection is crucial. The repeal of Glass Steagall in 1999 made official something that had in practice been the case for several decades before that. Don't want to point to that legislative act as the crucial point. It's more that we moved from a system governed by the spirit of Glass Steagall to one of integrated banking where the whole system is interconnected. Russ's suggestion: it's the political power of Wall Street that really would be the major impediment to this kind of regulation. They could make some kind of argument that it's important that different parts of their institutions can talk to each other. Claim made that it's more efficient. Seems kind of a stretch. Reason we are not going to move in that direction is that Wall Street likes living off you and me and we ought to be fighting that. We've seen how the very modest regulation that went through was vigorously resisted and watered down as far as it could be. Saw resentment of having bonuses cut even when they were taking government money. AIG: view that that wasn't our problem and we shouldn't have to have any obligation. These are the guys that are always right, taken collectively, and therefore we mustn't do anything to interfere with their doing their job.
19:07Efficient markets. Trained at U. of Chicago; some of those zombie-peddlers in your book. Irony is--fascinating as we think about these issues, challenge is, I'm sympathetic to those ideas still. They are zombie-like; they are still alive in my brain; people still defend them. The reason I defend them, is I look, as you say: it's true there is an ideological view that says markets are always right, markets always price things correctly, etc. But if you press Eugene Fama and others who put forth these ideas, they'd say: But of course we didn't for that to be the case if government was going to bail out losers! What's compelling about your argument--the part I accept--is what do we do now? We're in a world where government does do that. How should that affect our perception of financial markets? Agree; even if individual losers aren't bailed out, impossible for government to take a neutral stance in response to something like a stock market crash. Something has to happen. What would it mean for governments not to respond to it? Tax revenues fall, unemployment rises, and so forth. We are in this world where, when the whole market gets way out of whack, the kind of reasoning that leads to the efficient market hypothesis doesn't stand up very well. Whereas Samuelson and I and others would say, if the market says GM is worth more than Ford, it's probably right. Certain parallelism in your book: you are also critical of theories of macroeconomics that look for micro foundations or over-emphasize them; you can argue that the efficient market hypothesis is sort of a similar phenomenon. You have the idea that--look at the value of a particular stock, the current price is probably your best bet, but you might struggle to make the case that the entire market is processing all its information correctly. Similarly, individual decisions could be rational, or at least somewhat sensible, but you can have problems at the macro level despite that. Is that a fair summary? That's very much my view. Something we haven't yet got a handle on. Limits of rationality and things like bounded awareness. I'm interested in the sense of--less interested in the gross violations of rationality that we see like hyperbolic discounting and so forth, and more interested in the point that even if we are highly sophisticated people we can't possibly encompass all possibilities; and therefore we have to have situations where thinking collectively we think about some possibilities and necessarily ignore some others. If something suddenly forces those other possibilities to our attention, we can have a very sudden shift--animal spirits of the market from one kind of equilibrium to another. Those are ideas that have been around for a while and never fully worked out in a rigorous way. Rigorous thing is a real constraint for academic research, at least in the modern era. Sympathetic to some ideas that are not necessarily rigorous in a mathematical way but still you can learn something from them. Stick with the efficient market hypothesis: A lot of people argue, you would be one of them, that the bubble that popped in 2007-2008 in the housing market, or in the financial market using housing as an asset, totally eliminates the possibility that the efficient markets hypothesis should be taken seriously at the overall market as a whole. Yet people who defended it, argued it wasn't clear it was really a bubble or when the bubble would pop, that information isn't widely understood. Let's say I accept your view; I'm somewhat agnostic on this. I am sympathetic to the efficient markets view, little bit of a zombie idea for me; but let's say I agree with you that sometimes markets get out of control. What do we do about it? In many ways the dotcom bubble was a clearer test case. Housing is a complicated asset. With the dotcom bubble you had situations where the kind of valuations that were prevailing. Not a pot of gold. It was alleged, plausibly, that the procurement division of GM was worth more than GM itself. Strange things. That was a situation where all of the provisions could be put to the test and failed. There were people who tried to bet against it. Question of what we do about them: going right back to when I was first learning economics, right at the end of the Keynesian era--the view then inherited from the Great Depression was that financial markets are really important but like fire, they are a good servant and a dangerous master. Need to take an attitude, in particular in regard to financial innovation, to say if you want to innovate, come along, explain how this innovation is going to work, demonstrate that it isn't going to undermine the effectiveness of the regulations or that you can find regulations that will counter that; try and keep the size of the financial sector in proportion to its sensible role in the economy. I don't think that the financial sector accounting for 40-50% of corporate profits can possibly be of the right size.
26:21The challenge, though, is what regulatory environment would help that happen. You'd have to show your innovations are productive--sort of like an FDA (Food and Drug Administration)--here in the United States approves pharmaceuticals, have to prove efficacy, lack of side effects. Interesting idea, but in practice hard to do. Sort of in an example of that, securitization market, which I view as a poison, a toxic, yet so many political spectators say: We just have to recreate it because it's so valuable. My view is: where is the evidence that it was so valuable? It certainly was valuable for Wall Street. Where is the evidence that it channeled productive funds into productive uses? I don't see it. People are used to it. Evidence is that lots of stuff that was going on in mortgage markets suppressed when you go to this kind of securitization. Credit default swaps--if you are a large actor and you are betting on some other large actor to fail, which is what a credit default swap is, possibility you could act in the market in a way to improve the chances of that happening. Writ large. Like insurance where I get to bet your house will burn down. Worry about me sneaking around with gasoline at night. Fascinates me that even though I disagree with things in your book, fundamentally the part I accept, those of us who are market oriented have to deal with that we did say things like: Securitization is innovative, it added a lot of funds to the housing market; and those of us who are defenders of markets often said that's good. In the market, if the market produced it, it has value. We neglected the fact that part of the reason it emerged so successfully was because of a guarantee, either literal in the case of Fannie and Freddie or semi-literal in the case of LTCM and other institutions. The challenge, where we disagree fundamentally, is the implementation of something other than hands off. Extremely difficult to specify how a regulatory regime would work that would avoid the problems of public choice and special interest manipulation that underlie the problem already. I'm drawn to try to get people to get out of the bailout mode rather than try to create a regulatory regime that would work. I suspect that the right kind of regulatory proposal would produce some common ground. Not so much suppress financial innovation but say if you want to make a financial innovation, just don't come near our banks and ask them to finance you. Do it on your own nickel. Treasury to say you'll never get a penny from us if you don't succeed. Can only do that if we have a clear dividing wall between the institutions. In good times, the ones on the far side of the wall will be making money and the ones on the protected side of the wall are going to be complaining. That is part of the dynamic that brought down, using Glass Steagall as a symbol. Interesting point earlier: we don't expect those kinds of bailouts in other parts of the economy. Though recently in the auto industry here in the United States we've done some of that. But if you go back to the dotcom example, someone who invested in a disastrously failed dotcom and came to the government with their hand out and said we've got to keep it going would be laughed at. That's what makes that sector vibrant. The financial sector is, I think, the central challenge going forward. My view is the mixed economy is here to stay; governments are going to play a significant role in the economy. Challenge from my perspective is to try to stop the temptation to get government into things where it doesn't belong. The more expansive a view you have of what government should be doing, the more important it is.
32:15You have a lengthy and ambitious discussion of how the economics profession for the last 30-40 years has looked at business cycle theory. Go through a whole bunch of different, one could call them "fads." Different theories of macroeconomics and recessions. Summarize. Where do you think we stand today, whether you are on the left or the right, whether you believe in the Great Moderation or not, it's pretty clear that the economics profession was taken by surprise by the current mess. There are individuals who have claimed to have foreseen it; maybe they were a broken clock; a lot of people were predicting catastrophe for a long time. Broken clock is right twice a day. Some points about imbalances. Where do we stand? In theoretical terms, edifice of beauty. We had the challenge, old-style Keynesian models, big aggregates in there, seemed to work reasonably well until the first stagflation period. Then the argument was the kind of Lucas critique: these kinds of reduced form relationships will only work as long as the structure is the same. Fully specified market foundations. First versions of that gave very strong conclusions: business cycles only possible if governments brought them about. Keynesians responding to that challenge by building more sophisticated versions of those models which allowed for some kind of business-cycle-like phenomena. Seemed to do okay during the Great Moderation, to produce the kinds of stuff you'd see in the Great Moderation. Doesn't give any story at all about the Great Depression; we'll come back to that later. Have these models, but they start with general equilibrium and can't really get far from general equilibrium by their nature. Always difficult to predict crises, but certainly people who took a more traditional view and said whenever any of the big aggregates get way out of whack with their historical values, something bad is going to happen--that's at the level of anybody who predicted the crisis. Probably have to admit that we can't model things with the kind of precision; have to back up, more pragmatic approach, a lot of indicators roughly on track. Big question right at the moment: supposing things do fall in a heap, as they do from time to time--what shall we do about it? Fundamental question of what caused the Great Depression or what caused this particular crisis that we're in--obviously you'd like to predict it in advance. Let's put that aside--too demanding a task. There are people who believe we'll figure it out some day. If we figure it out, we can prevent it. That's a theory. But ex post, after the fact, if we look back on it, we can't agree as economists on these issues. That to me suggests a great deal of pessimism about advances. Talk to Robert Skidelsky, different project, Keynes's biographer, and he said: Economics isn't a progressive science. He meant it doesn't make progress. We don't really add to our knowledge. Are you that pessimistic? Fair criticism? Not quite that pessimism. But in terms of the last 30 years, we keep on doing the same thing. Start with general equilibrium, add a twist to it, derive some interesting phenomena, but the next paper doesn't take that and add more things. It goes back to general equilibrium and adds something else. Keep on essentially writing the same paper. There is a non-progressiveness in the kind of approach we are using that is inherent, difficulty of meeting the demands for rigor that are there. The other point is that we have had these big cycles, roughly four of them, classicals believed we'd return to full employment until the Great Depression and Keynes; and then we believed economics is progressive; now we have Keynesian theory and we all know how the economy works. Now we are back to a more sophisticated but still essentially similar view of the classicals or a compromise between the classicals and Keynesians. Probably a bit of an advance there. Current crisis, still better than what happened in the Great Depression in some ways. Near-classical synthesis that emerged was some sort of progress, but at best six steps forward and two steps back. Famous Bernanke quote where he apologizes to Milton Friedman and says: We'll never make that same mistake again that we made back in the Great Depression and let the money supply collapse. It was really a punctuation mark about the Great Moderation, saying: We learned about that; we won't make that same mistake again. And yet, the best spin I think you can put on the story you just told is that: If we hadn't done all those bailouts, unemployment would have gone to 20% or 25% or 15% or something horrific; could have been a lot worse--but that's really hard to know. That's the problem. Not clear we didn't make a different kind of mistake this time. Could look at the countries that couldn't do a bailout--Iceland--either couldn't do it, or having done the bailout couldn't do any fiscal stimulus because they were out of money. Those countries have done badly. As opposed to bailouts, which I think were more or less specific to this crisis, I think the evidence that fiscal stimulus has worked is pretty strong. Seems to me reasonably convincing. Left over from the Depression and the Chinese and Japanese era is: Can we get a once-off stimulus that will push us back onto the right path, or do we need to keep on having more and more fiscal stimulus, having more and more debt? We have only had one round of stimulus; have to hope that that was enough.
41:37One listener, Paul Sebastian, sent me an email with an article you wrote summarizing your book, Foreign Policy, perhaps tongue in cheek: surprised Keynesianism wasn't one of your zombie ideas. Obviously you are more sympathetic to the Keynesian model. Would challenge that with your remark about the stimulus. Hard to know whether the recent round of stimulus made any difference. How would we settle this dispute? Two ways: econometrics, which doesn't settle anything very much; the other is the power of the episode. Coming from Australia it's sort of we had plenty of warning of the crisis, had a big stimulus, and almost no recession. Australians at least are not uniformly but certainly pretty generally convinced that fiscal stimulus worked here to prevent the crisis. Chinese fiscal stimulus and its impact on demand. These instances pretty striking cases. Zombie idea can be from both sides. Tell us a little bit about Australia. A little background on the pre-crisis state of the economy--what was the nature of the housing market in Australia? Did you go through the same situation as the United States? More detail about the nature of the fiscal stimulus, that was large. Housing market: Australia housing prices still high. Could characterize as a bubble, but it's lasted a long time and didn't collapse during the crisis. Didn't have that impact. In general, the economy has been remarkably strong in the most recent five years or so because of export demand from China for minerals and things like that. So, we started in a pretty strong position. We didn't have an explicit guarantee of bank deposits. Previously relied on this sort of nod and a wink that your money is safe. That wasn't going to last. First was to guarantee bank deposits. Also guarantee our banks' borrowings from overseas, charged something for that so it wasn't totally a bailout. That sort of kept the direct financial impact from striking home. Concerned with export demand, and Australian losses on investment. In Christmas of 2008 there was a straightforward cash handout--everybody got not a huge amount of money but it was something similar to what Bush had about that time. Then there was a much bigger stimulus that came in January of 2009. Some of the projects that they spent money on have done well and some pretty badly. Only one quarter of negative growth. Once the stimulus kicked in, pretty rapid recovery. How high did unemployment get at its peak? Peaked just about 6%. Now 5.1%. Now back to where we were before the crisis. Some opportunity for financial experiment there; hard to distinguish between external issues, Chinese demand, the nature of your banking system. Other than the deposit issue, are there any other features of the Australian banking system that are very different from the American one? Much more concentrated: four big banks that really run the show. In the wake of the crisis--there had been pressure to liberalize mergers among those banks, had the Four Pillars policy, major banks aren't allowed to merge with each other. View in the wake of the crisis was that the banks were a cozy oligopoly turned out well because it meant that they didn't have to push as hard for high-risk profits as elsewhere. Weren't as exposed. Now, on the one hand moves to reform the oligopoly, letting them merge with each other, encouraging foreign entry off the political agenda as having too much risk associated with them; on the other hand, all the obvious problems of having an oligopolistic banking sector. Odd coalition of people saying we need to look at some kind of reform of the financial sector. Government's position is everything is perfectly fine and leave it as it is. Strange--not persuaded by the argument that if you are an oligopoly you won't be tempted by the opportunity to make a killing. Interesting that they didn't invest in these global assets that destroyed so many other banks around the world. Two points that were made. More perhaps that they didn't have any short-term pressure--in a takeover, big difference between being the acquirer and being the target. Even if your strategy isn't profit maximizing in the long run, might want to go after high risk things in order that you are the one who emerges as the buyer rather than the target. Other point, really paradoxical, is that Australia is a deficit country, so one of the reasons we didn't invest very much overseas is that business is borrowing, not lending; net borrowing position; gross aggregate investment isn't that great.
50:19Last part of the book, trickle-down economics--you point out that many times the names are given by their enemies, not by their friends. What do you see as the central distributional issue in modern economies? What role do you think ideology like supply-side ideology play in helping or hurting that? Clearly we are seeing a huge increase in concentration of income and wealth at the top of the income distribution, in the United States; seems to be a trend in most of the English-speaking countries, and then more in recent trends elsewhere. Draw a couple of conclusions from that. One, ideology really does matter. Hard to believe that this reflects differences in the underlying forces. Really does seem as if both subtleties as well as the gross forces like those of the tax system, as well as attitudes of people as to what is reasonable and what is to be expected--that these things seem to play a role. We have seen this big increase. I've been more and more convinced by the argument that it really is concentrated in not just the top 10% of the income distribution, but the top 1% and even smaller. Then the question is: Are there positive externalities flowing to everybody else? I would say the evidence is not. We've got a good market experiment out of the 30 years or so of market liberalism that we can more or less say that for lots of people, the clock has stopped at this point. We really don't see the kind of improvements in welfare for people certainly outside the top 20% of the income distribution. Those people did a lot worse than they did in the post-Keynesian 30 years from say 1945-1975. Push back; disagree with the empirical evidence for it. When you look at pictures of the various deciles you picture in your book about this--the top 10, the bottom deciles or quartiles or quintiles, a lot of them are done that way--it leads to the impression that people aren't getting ahead and all the gains are going to the top. But if you look at panel data, it's not true. Those pictures are misleading. The people at the bottom do much better at the end of the 10, 20, and 30 year periods; and what appears to be stagnation at the bottom and all the gains going to the top are statistical artifacts from an enormous increase in the divorce rate starting in the 1970s, change in the way households were constructed--so when you went to measure households you got a distorted view. Enormous changes in the United States in immigration, so you have a lot of people coming in at the bottom. If you follow the same people, they don't stagnate. I'm not going to suggest that the gains at the top are part of the gains that go to the bottom. But I think the picture that there is a lack of social mobility in the United States is very unclear. You have to first--you always get a different picture from panel data than aggregate data. I was being told that back in the 1970s. Panel data--this is where you follow the same people over time rather than looking at slices of cross-sections at different points in time. People's income tends to rise from youth to middle age. Your way can get a different picture from looking at panel data to looking at the cross section picture. Household data has a problem that household structures have changed and things like that. But that was true also in the early period. Very little evidence to suggest that social mobility is declining or increasing. Book: A lot of doing international comparisons. Americans think they have a great deal of social mobility, and that simply isn't true. If you get the same people, somebody born in the bottom quintile in the United States is much more likely to end up there than somebody born in other countries. Partly reflects the fact that the distance between those quintiles is so great in the United States. You might say the bottom quintile is rising, so there is relative inequality versus absolute standard of living. If everybody is doing better, there is not much mobility: you are still in the bottom quintile or second quintile--but your life could be better. But we don't see on the standard measures, and even after we adjust for household size, much improvement happening in the bottom quintile. Look at the poverty line--the United States has an absolute poverty line. In essence, consumption basket back in 1963. The proportion of people below that poverty line hasn't changed very much. It fell pretty dramatically from the 1950s but since the 1970s it hasn't fallen very much. Since then, now, after you do adjustments for quality and so forth, you can get some action there. You point out in the book, sometimes the price index is flawed. If you look at the last decade, most of those things have now been put into the calculation, so the Consumer Price Index (CPI), is pretty well hedonically adjusted; most of the kind of calculations have been made. Yet there are a high proportion of Americans below that poverty line now. Skeptical; it's an issue to come back to in future podcasts. One of the challenges of the way the CPI is constructed in the United States: very difficult time dealing with housing.
57:53Let's put aside our disagreement about the bottom portion of the distribution and look at the top. Want to find a place where we agree. We both agree that the top 10% or 20% have done very well; we both agree that there are parts of that improvement that weren't very well earned and had no social productivity, such as the financial sector. But surely there are parts that have been productive for everybody. Often think of Google; Sergey Brin became a billionaire, and that's good. Most of us benefit from Google. Do you think we understand much about that income distribution change; understand the standard solutions, say different tax structure? Lot of invariance in distribution to a lot of changes in the tax structure. What might we do to make things better? Good question. We don't really understand it. If you look at the literature, the official answer was it's technology. But what they really meant was wasn't: We've gone out and identified technological changes that produces greater inequality. What they mean is: We've looked at imports and at this and at that, and none of them seem to work well as explanations, but we've got an increase in technology, so that's what it is. Obviously Google is a great thing and has made Brin rich, but the correlation between what people put in to these sorts of things and what they got out is very [?]. Built the Internet really with the universities. Stuff of interest to us; the universities got almost nothing out of it. Wasn't central planning point of view, wasn't somebody's idea that universities should work on this. Was because we had slack in the system and we could do it and didn't have to worry about getting paid. If we recognize that there really is a big element of luck in the correlation between social utility and what you put in is actually quite small, that might push us back in the direction of saying that we shouldn't be encouraging and welcoming those huge disparities in wealth, most of which--in some cases, good people get the money and that's good, but most of the time, people are actually on the take and it's financial maneuvers of little social value. What we haven't talked about is that venture capitalists, a market that emerges when there is great financial wealth, individuals putting bets down on emerging new companies, that that market is a high upside, low downside market. Works pretty well. Still a lot of failures, but that's what you'd expect. One answer is to encourage a little more of that. Part of the story. End hard to see. Securitization and derivatives not betting on a good proposal. Could potentially get better outcomes out of the financial sector.
1:02:31Going forward. You want to see a larger role for government than I do. Give us some guidelines for where the government ought to go in the next century. First--people on the left, things like climate change: We need to understand the power of markets and welcome markets. Role for government is not to be second-guessing markets all the time. As far as possible, employ market processes where they can be. The kind of model, push all the way in one way or the other--balance requires we understand the strength of markets. But after 30 years when we've largely tried to explain away, we have to recognize that having a large government is likely to produce a more stable outcome than the kind of minimum state idea.