What is an Economist? Tyler Cowen's Version

In a recent interview that Tyler Cowen did with the Economist, there is a segment where he talks about the econ blogosphere. Specifically, he discusses how the blogosphere and the internet is changing the very definition of what it means to be an economist:

If you look at someone like Interfluidity, known to his mother as Steve Randy Waldman, he is not credentialed the way that Paul Krugman is, but he is a brilliant guy. I think of him as much of an economist or more than any economist. I think partly, the notion of who or what is an economist is breaking down. Take Matt Yglesias, Matt is a philosophy undergraduate major at Harvard. Matt is a way better economist than most economists. It is as if being an economist is this new thing. It’s not just about researching an area for a few years and publishing a paper, it’s about knowing how to twiddle the dials on the internet and learn from this collective thing called the blogosphere, your twitter feed, or other sources that are out there and Matt is awesome at that, and in a funny way is one of the world’s best economists.

It is somewhat surprising to hear an academic economist acknowledge that people who are not formally schooled in economics can be better economists than people who have their PhDs. As someone who is planning on getting an MA in economics and working in the private sector, it is refreshing to hear that you don't have to have a doctorate to make a difference in the field.

I'll be on the lookout for other interesting answers to the question "What is an economist?" and I'll be posting them here. I expect a wide variety of descriptions, including some less than favorable portrayals of the "dismal scientists." If you have your own description of what an economist is (or isn't), share it in the comments section below.

Guest Post: Making Sense of the Balanced Budget Amendment

The guest post below is by Andrew Hanson, who blogs regularly over at Amateur Philosophy (you can also follow him on Twitter here.) Andrew is up to date on the DC pulse, and he is a wealth of knowledge about current policy developments. He always brings interesting points to the table, and best of all, he thinks like an economist! I'm thrilled that Andrew has taken the time to write today's guest post on the balanced budget amendment.

 

Greetings, Zackonomics readers! I'm Andrew Hanson. I'm a fellow 2009 Teach For America alumnus, and I blog at Amateur Philosophy on philosophy, economics, and public policy. Zack and I struggled together while teaching algebra to a quite memorable group of eighth graders. 

One of the most interesting aspects of the past five years is how hard-won economic knowledge seems to have been lost by many in the public policy realm, and zombie ideas have again gained influence. Many of these ideas are associated with the Tea Party Movement, which became particularly influential in the 2010 congressional elections. However, they've also gained influence in other conservative and libertarian circles as well. There are many examples. The so-called "Gold Buggers" have called for a return to the gold standard. The Hangover Theory has returned, suggesting that recessions are the punishment we deserve for unwarranted excesses and malinvestment during the boom. Inflation hawks have been crying out in fear of hyperinflation because of the Federal Reserve's decision to "print" more money. The most recent zombie idea is that the federal government is a family that needs to "tighten its belt" when times are tough. The Balanced Budget Amendment, a proposal that would amend the constitution to mandate that the federal government keeps the budget balanced on an annual basis. 

Let's focus on the Balanced Budget Amendment, why it's bad economics and bad policy. First, there is a long-term federal budget problem that can only be resolved by cutting health care costs and the Medicare entitlement. But balancing the budget this year and every year after that wouldn't help solve that problem; it would make it worse.  To understand why, we have to first think about why the federal government might want to run budget deficits in general. The primary reason the U.S. economy isn't growing is that there isn't enough demand for goods, services, and investments to take advantage of our productive capacity. Factories and workers are sitting idle when they could be engaging in productive activities. 

Economists know that recessions are accompanied by a fall in aggregate demand, and though it cannot prevent recessions completely, the federal government can make output and employment less volatile by adopting "automatic stabilizers", changes in fiscal policy that stimulate aggregate demand without policymakers signing any new laws or measures. The tax system, for example, collects less in taxes when output falls because taxes are tied to the level of economic activity: income, earnings, and profits. Government spending, such as unemployment insurance, can also act as an automatic stabilizer. As unemployment rises, the government spends more on unemployment insurance to make up for the lost spending in the economy. More automatic stabilizers, such as tying the payroll tax to the level of unemployment are being proposed now as well. 

A Balanced Budget Amendment would require the government to raise taxes and cut spending during a recession, which would further depress aggregate demand, and make the recession longer and far more painful. Instead, the federal government should try to balance the budget over the course of the business cycle, but even that may be asking too much. The federal government never needs to balance its budget completely; it just needs to keep the federal debt as a percentage of GDP at a reasonable level. Kenneth Rogoff and Carmen Reinhardt, economists at Harvard, have detailed exactly what levels are crisis and what countries can afford in their book "This Time It's Different". Their basic conclusion is that anything over 90% of GDP is quite dangerous, while a government could run the federal debt at 50% of GDP basically forever.

The Paradox of Thrift

It is hard to disagree with the fact that individual thrift is a good thing. However, collective thrift can be a bad thing, as we are seeing right now. Economists call this the paradox of thrift, and the idea is credited to John Maynard Keynes. In the following discussion of this paradox, it is important to distinguish between the short-run and the long-run.

In the short-run, sudden increases in the aggregate savings rate can be harmful to economic growth. We saw this happen during the Great Recession, and it is still and issue right now. According to the BEA, the personal savings rate was 5.4% of disposable income in June of this year. From 2005 to 2007, the savings rate averaged between 1.6% and 2.2% of disposable income (depending on the measure used.) When the savings rate more than doubles in a short period of time, it will be felt throughout the economy.

Data from http://www.bea.gov/national/nipaweb/Nipa-Frb.asp?Freq=Qtr

The pre-recession savings rate turned out to be unsustainable as many people had nothing to fall back on. Since the financial crisis and the related bursting of the housing bubble, consumers have held onto more of their money out of both fear and necessity. The sudden increase in the savings rate that occurred in 2008 is akin to a shock to aggregate demand. A shock to AD decreases national income, which in turn decreases savings despite the increase in the marginal propensity to save. Economist Paul McCulley of Pimco described the paradox like this:

If we all individually cut our spending in an attempt to increase individual savings, then our collective savings will paradoxically fall because one person's spending is another's income--the fountain from which savings flow.

This is an excellent description of the paradox of thrift in the short-run. Essentially, the paradox of thrift says that saving more of your money can be good for the individual, but if we all decide to do it at the same time, it can actually be worse for all of us than if we did nothing at all. This reminds me of game theory's famous prisoner's dilemma. Now, let's shift our view to the long-run.

In the long-run, collective thrift (i.e. a higher marginal propensity to save) is a usually a good thing, which is consistent with most people's intuition. To borrow Paul McCulley's lingo, savings are the fountain from which investment flows, assuming people aren't simply hoarding money.

So, what can we do about the the paradox that we face? My conclusion is that policymakers should encourage consumers to avoid having extremely low savings rates during economic expansions. Yes, low savings rates can stimulate growth in the short-term since more money is being quickly funneled back into the economy via consumption. However, low savings rates are counter-productive in the long-run. We still live in a world with business cycles, and when recessions rear their ugly heads, individuals and households need a financial buffer. When someone loses a job, past savings can be shifted to cover bills and living expenses if needed. In addition to individuals having this essential buffer, higher collective savings over the long-run are good for the economy since savings is the mechanism for investment. Policymakers can help over the long-run by limiting uncertainty and maintaining trust, so that savings are invested productively.

While the paradox of thrift does have some valid criticisms (here and here), it is an interesting concept that has important implications for our economy.

Graduate School

I am officially a graduate student in economics! Just over one week ago, I started my Master's degree in Applied Economics. The two tracks that I am deciding between are "Data Analytics" or "Applied Micro and Policy". I would love to do both of them, but the program is only three semesters long, so my capacity is limited.

Unfortunately, I have not been posting to the blog much lately due to the fact that I have been in the process of relocating to a new city for my graduate program. However, my goal is to post at least 3 to 4 times per week by the end of the the year, and writing that here will hopefully be an effective commitment device!

Now, I should get back to studying for my three-week Math Econ course. The Cobb-Douglas production function, Taylor's Theorem, and Hessian matrices await!

Look for posts soon... and don't forget to follow me on Twitter as an easy way to get updates for this blog.