Alan Krueger, Assistant Secretary of the Treasury for Economic Affairs, suggested in a speech in October a useful metaphor to distinguish different kinds of economic indicators. Some indicators are like the gauges on the dashboard of the car — industrial production, unemployment, inflation and so on.  They give the latest bits of information on the business cycle outlook, for businesspeople , government policy-makers, economic forecasters, and anyone else who wishes to follow such developments at high frequency. Many of these numbers are typically collected on a monthly basis. Other statistics are like the results of 10,000 mile checkups – the poverty rate, infant mortality, life expectancy, carbon emissions, natural resource depletion, the crime rate, traffic congestion, leisure surveys, and other measures of inequality, health, the environment and the quality of life.  They are needed to supplement market-measured output in order to get a comprehensive feel for welfare and the longer term sustainability of the economy. This second category of statistics is more often collected on an annual basis.

GDP is the single indicator that gets the most attention. Lately much of that attention has been very critical. In late September, the most recent in a long line of critics weighed in. This group was weighty indeed: the Commission on the Measurement of Economic Performance and Social Progress was created by President Sarkozy, chaired by Joseph Stiglitz, chair-advised by Amartya Sen, and coordinated by Jean-Paul Fitoussi, with Nobel-Prize winners abound. The Commission apparently believes that we have been focusing too much on market-measures output “By their reckoning, much of the contemporary economic disaster owes to the misbegotten assumption that policy makers simply had to focus on nurturing growth, trusting that this would maximize prosperity for all. “What you measure affects what you do,” Mr. Stiglitz said…”If you don’t measure the right thing you don’t do the right thing.” (New York Times, Sept. 23, 2009.)

I certainly agree that the non-market variables are important, both in the sense that they should be measured well and in the sense that policy-makers should put some priority on them as objectives. But I question whether the measurement issue and the objective issue are as closely linked as many would have it. I especially question any claims that the role of GDP should be in practice be replaced with a concept that factors in these other measures of environment, inequality, health etc. GDP is a comprehensive measure of market output, and is available quarterly, and belongs on the dashboard. The other variables are typically available only annually, and there is no way to know how to aggregate them into a single number, let alone to aggregate them together with the standard economic measures. By all means, take the 10,000 mile checkups seriously. But don’t remove GDP from the dashboard.

I am not sure I see the claim that the reason for the myriad errors our national policy makers have made in recent years is the measurement problem (notwithstanding the Bush Administration’s notorious downgrading of science). We have perfectly good tools for helping to make decisions about environmental regulation, for example, in the form of cost benefit analysis. GDP measurement issues simply have nothing to do with that. Perhaps you believe that a Republican Administration may want to pressure the EPA to count some genuine environmental damages at zero or suppress the evidence entirely; perhaps you believe that a Democratic Administration may want to count some genuine economic costs at zero or abandon cost benefit analysis entirely. Yes, that would have a big effect on the policy decision. But what does any of it have to do with GDP?

In the same newspaper reporting Joe’s comments, I read a report about a development that has received mysteriously little attention: according to numbers from the Energy Information Agency, greenhouse gas emissions fell sharply in 2008 (by more than 2 ½ %), are falling even more in 2009 (about 6%), and in the next few years are almost certain to remain easily below the levels of 2005.   (See the chart below.)  The oil price spike in 2008 deserves some credit. Some might wish to try to give some credit to policy too. But there can be no doubt that the main reason for the sharp fall in emissions is the recession. A simple statistic for the unitiated: although CO2 emissions in an average year rise by 0.8%, they fell that much in both 1991 and 2001, the last two recession years, in addition to the much larger drop in the much larger recent recession. That is not a coincidence.

How should one weigh a 9 percent fall in emissions against a 3.8% fall in real GDP (from the 2007Q4 peak to the 2009Q2 apparent-trough)? I strongly suspect that a majority of Americans, no matter how well-informed, would think that the output loss far more than outweighs the climate benefit. A minority, in favor of very drastic action on climate change, might implicitly choose the other way. (I myself am in favor of pretty serious action, but not in favor of policies that impose huge economic costs, either because they are too drastic or are designed in an inefficient way. And of course engineering a recession would be a very inefficient way to do it.) Are Joe Stiglitz and Amartya Sen among those who think we are better off on balance? I have no idea. To ask the question is to help illuminate why attempts to sum everything up into a single number, such as “Green GDP,” fail.

Incidentally, if Joe does think that the estimated 9 percent fall in emissions outweighs the 4% loss in GDP, then he doesn’t think that our current situation constitutes a “contemporary economic disaster.” It would then logically follow that any policy decisions that got us into this situation were good (whether or not attributable to incomplete on false information about banking activity or inequality or anything else)!

So9urce: US EIA

The Queen of England during the summer asked economists why no one had predicted the credit crunch and recession.   Paul Krugman points out that, inasmuch as economists can almost never predict the timing of recessions (and don’t claim to be able to), the real questions are worse.  The real questions are, rather how macroeconomists (most) could have gotten it so wrong as to believe that:
(i) a severe recession was not even looming ahead as a potential danger, and
(ii) a breakdown of many of the world’s most liquid financial markets, in New York and London, was impossible to imagine.

To anyone wondering about these questions, I recommend Krugman’s essay in the New York Times Sunday magazine, September 6:  “How Did Economists Get it So Wrong?” .
I think his diagnosis of the state of macroeconomic theory for the last 30 years has it right. 

I would only add that he is modest in skipping over one point:  during Japan’s lost decade of growth in the 1990s Paul himself forcefully drew from the Japanese experience the implication that a severe economic breakdown was, after all, possible in a modern industrialized economy – a breakdown that both was reminiscent of the Great Depression and was outside the ken of modern macroeconomic theory.   But macroeconomics went on as before.   (Likewise with the stock market correction of 1987, the LTCM crisis of 1998, and the dotcom bust of 2000-01.   I do think, however, that our field did a better job with the emerging market crises of 1994-2001, in part because it was considered permissible to argue that financial markets in this case were highly imperfect.)

The list of scholarly economists who in my view deserve kudos for getting important parts of the crisis right ahead of time also includes, among others:

• Robert Shiller – for declaring most visibly that the housing boom was a bubble,
• Ned Gramlich — for pointing out most assiduously that families were being persuaded to take out mortgages that weren’t good for them,
• Ragu Rajan — for diagnosing most accurately the problems of excessive leverage in the financial system,
• Claudio Borio and Bill White at the BIS — for seeing most presciently the dangers of a monetary policy that ignored asset bubbles, and
• Nouriel Roubini – for warning most fortissimo how serious a future meltdown was likely to be.

Returning to Krugman’s NYT article, even the caricature drawings are good…  except that I have never seen Olivier Blanchard in a double-breasted suit.    But Robert Lucas definitely merits a place there as a leader of the orthodoxy:   When given one page in a recent  Economist essay to defend “freshwater” economic theorists regarding the crisis, he actually thought it was a useful rebuttal to point out that critics are repeating arguments they have made before.  And he also thought it was useful to explain:  “The term “efficient” as used here means that individuals use information in their own private interest. It has nothing to do with socially desirable pricing; people often confuse the two.”  — As if it is not the latter question that the public is wondering about.

(For other economists’ reactions to the Krugman piece, see the National Journal site.)

 [Any reader wishing to make comments on this post is referred to the RGE version.]

The Yale Book of Quotations provides a useful service: It tabulates well-known sound-bites, but tries to get the exact quote and citation right, which is rare.    (P.T. Barnum in fact never said “There is a sucker born every minute.”    Richard Nixon never said “But it would be wrong.” Etc.)  The editor also compiles an annual list of Top Ten Quotes of the Year.   In the second week of December he released the list for 2008.  Number 1, for example, is “I can see Russia from my house” (carefully attributed to the Tina Fey parody rather than precisely what Sarah Palin originally said).

The good news is that the title line in my blogpost of July 17 was chosen as one of the top ten quotes of 2008 (tied for tenth place, it is true).    The sentence is: “If there are no atheists in foxholes, there are no libertarians in financial crises.”     The bad news is that the quote was attributed to Paul Krugman, who had used it subsequently on the Bill Maher Show.   I had originally written it in 2007 as the first line of an article in a Cato Journal issue devoted to financial crises.  Among the others who picked up on the line after my blogpost were Ben Bernanke,  Mark Shields, Bloomberg,  WSJ.com, Brad deLong, and Tom Keene – generally with attribution, when the format permitted.

The list of Top Ten Quotations of 2008 went out over AP on December 15 as it was, and appeared in lots of newspaper stories and TV broadcasts.  Krugman immediately set the record straight on his blog, as I knew he would.   AP sent out a correction on December 22.    It should be obvious that this is not a scandal of any sort and that Krugman is just as quotable as he ever was.
  

But there are some other, more interesting, aspects.

One is an illustration of how tough is the world in which highly visible columnists like Krugman live.   There are lots of Krugman-haters out there.  Of course the phenomenon originates in the fact that he consistently has been liberal and anti-Bush (not precisely the same thing).  But the antipathy goes very deep.    The Yale/AP list was originally called to my attention by one Joel West.   I told him I was indebted to him for pointing out the misattribution.   But I also told him that I was sure that there had been no desire on Paul’s part to steal my line:  TV shows like Bill Maher don’t customarily allow their guests to display footnotes.     But Mr.West must be one of the Krugman-haters, because his subsequent blogpost accused Krugman of dishonesty.   As had another Krugman-hating blogpost before that.   These people are eager for ammunition against someone of a different ideological persuasion and are not sufficiently discriminating about what they use.

Ironically, of the other two soundbites that share tenth place on the Yale/AP list with the atheists-libertarians quote, one is something else attributed to Krugman (“Cash for trash”), and the third is from the all-time champion Krugman-hater, Donald Luskin.   Luskin earned the Top Ten honor when quoted as saying “Anyone who says we’re in a recession, or heading into one — especially the worst one since the Great Depression — is making up his own private definition of “`recession’”  in the Washington Post, September 14.    This was of course after a huge fraction of economic commentators and the public had already decided that the country was probably in recession, as now turns out indeed to have been the case.   (I myself took a bit of grief on various blogs both for saying the “R word” too early and also for saying it too late.  But I have also gotten credit.)

The atheists-and-libertarians line itself has also drawn some grief from some atheists and libertarians, on various blogsites.   I don’t mean to put these two philosophies together (although that would be an interesting essay question on some exam).  Nor is it the case that either group is objecting to being associated with the other.   But both have pointed out that the statement is not literally true.   They are entirely correct:  There are plenty of atheists in the military;  and there are plenty of libertarians in a financial crisis.  But of course the statement did not literally mean there are no atheists in foxholes or libertarians in financial crises.  The claims are, rather, that on average:  (i) soldiers under fire tend suddenly to grow more religious in outlook, and (ii) policy-makers facing a financial crisis tend suddenly to grow more interventionist in outlook.    But, yes, there really are conscientious atheists in foxholes.   They are a minority, but a substantial one.   And yes there really are thoughtful libertarians in financial crises.  Again a minority, but not to be dismissed.   If anything, I admire the intellectual consistency of those who have thought through their views well enough ahead of time that they do not change them under pressure from events that, even if calamitous, were predictable. 

I wish to add my heart-felt approval to many others, regarding the awarding of the Nobel Prize in Economics to Paul Krugman.  For those readers of the New York Times who can only think of him as a columnist, let me assure you that long before he ever wrote a newspaper opinion piece, Krugman had become the leading international economist of my generation.  I leave it to others to explain the trade theory research that earned the ultimate accolade.  I will only say that (together with Elhanan Helpman) Krugman took traditional trade theory – which ever since David Ricardo had assumed perfect competition, constant returns to scale, and unchanging technology – and made it more realistic by assuming imperfect competition, increasing returns to scale, and endogenous technology.  

Paul was my classmate in graduate school at MIT in the mid-1970s.    In 1974 I departed my idyllic undergraduate institution for life in the big city (academically speaking).  My college mentor had given me some final words of advice:  not to waste much time worrying about how a position near the top of my undergraduate class would translate to the MIT Economics Department, where all the students had been at the top of their class.  He said,  “My impression is that within a few months of starting the graduate program, the students sort out for themselves who is the top student, the second student, and so on, and then they don’t worry about it from then on.”    As it turned out, it only took two weeks for us to figure out that Paul was the star of the class.   This was clear, not so much from grades on problem sets, but from the intense discussion among classmates that is the core of a good graduate program.

When it came time to write a class skit at the annual MIT Christmas party, we did a parody of the Wizard of Oz.   There was no question who should play the Wizard, who was a parody of Paul Samuelson: our own Paul.    Here are some of his lines, from 34 years ago:

“Though I made a lot of money

No one thought my jokes were funny

‘Til I won the Nobel Prize…”

“So you see you can be winners

even though you are just beginners

When you win your Nobel Prize.”

Congratulations, Paul.   We always knew you would do it !

I propose that the Congressional leadership re-introduce the Trouble Asset Relief Program accompanied by a major new policy: a small tax on securities market transactions. This will accomplish the political goal of aiming a silver bullet into the heart of the (understandable) popular outrage that blocked passage of the TARP bill on Monday. It will simultaneously accomplish the fiscal goal of raising revenue in the future. This is revenue that the federal government would have sorely needed even before the bailout arose and will need even more if the taxpayer is to be protected against the risk of heavily subsidizing the financial sector.

A tax on securities market transactions might sound like a wild populist policy that would damage the functioning of the economy. But in fact it is probably more sensible than such populist measures as banning short sales, which has already been tried (to no avail).

Proposals for financial transactions taxes have a distinguished pedigree, going back at least as far as Keynes.  Best-known is the Tobin tax proposal, by Nobel Prize winner James Tobin, which was specifically aimed at volatility in foreign exchange markets. More relevant to what I am proposing are two articles by the pre-Treasury Larry Summers: “A Few Good Taxes” and “When Financial Markets Work Too Well: A Cautious Case for a Securities Transactions Tax” (1989).   Add to the list of proponents another Nobel Prize Winner, Joe Stiglitz.

There is extensive experience with securities transaction taxes (STTs), especially in other countries.  There have also been quite a few studies of their effects. Often the motivation for such proposals is to reduce short-term speculative turnover:   a tax of 0.1% means nothing to a long-term investor, but is a strong disincentive to those traders who hold their positions for only minutes or hours.  The idea is that reducing short-term speculation will reduce volatility.  On the other hand, defenders of unfettered financial markets often argue that such a tax will reduce liquidity and thus hurt the customers who depend on the market.

The general historical experience seems to be that there is no discernible effect on volatility (though a couple of studies find effects on volatility, either upward  or downward).   In other words, the tax might not help the functioning of the financial markets — the original motivation – but neither does it hurt, according to a majority of the studies.  In some cases the volume of trading within the country is affected.  But what the tax does does usually do is raise money for the Treasury.  

The UK long had a securities transactions tax, known as a stamp duty, which was set at 0.5% in 1986.  Sweden introduced a 0.5 per cent tax on the purchase and sale of equities in 1984 — prompting some financial trading to move offshore – and kept it until 1991.  (Froot and Campbell, studied these two examples in a 1994 book that I edited.   The Swedish case is particularly relevant to the current US context because the popular motivation there was to “take down a peg” high-earning speculators.)    Japan, Korea, Taiwan and Hong Kong have a long history with securities transactions taxes, and India introduced one in 2004; in these cases there were not significant reductions in either price volatility or market turnover.  Other countries that have had financial turnover taxes of at least 0.1% include Australia, Austria, Denmark, Finland, France, Germany, Malaysia, and Singapore.  (Germany abolished its turnover tax in 1991, and Japan in 1999.)   In addition there are other countries that impose smaller fees.

Even the United States had a STT until 1965, and to this day imposes an SEC fee of .0033%.  Thus we have already lost our virginity !

An important potential drawback, if the US were to impose a more substantial transactions tax alone, is that it might drive financial business offshore.   There is an answer to this point.  As noted, many countries already have taxes on financial transactions. Furthermore, lots would love to cooperate with the United States in an international program to harmonize such taxes internationally. This is precisely the sort of project in which many abroad have long asked Americans to participate, but which we have not hitherto wanted to do.

The level and longevity of the tax might be adjusted to achieve the goal of Section 134 of the TARP bill: that the taxpayer recoup the costs of the bailout. A 2004 study by the Congressional Research Service reported that an 0.5% tax on stock transfers could raise $65 billion a year.  Others have produced higher revenue estimates.   A tax extended to bonds and derivatives (especially derivatives!) would of course raise more.   Remember that one does not compare this annual revenue to the $700 billion headline cost of the bailout.  Rather, one compares the present discounted value of the annual flow of revenue to however much of TARP’s $700 billion is left over after the government (we hope) collects something on the troubled loans and also recoups something on warrants obtained from the participating banks.

The tax might on the margin contribute to a shrinking of the size of the financial sector; but this shrinking needs to happen anyway, as Ken Rogoff has pointed out. And most important politically, it would give expression in a non-damaging way to the blood lust that the public feels toward Wall Street, a venting that needs to take place if the bailout bill is going to be approved.

[To any readers who wish to post comments:  I suggest you go to the RGE version of this post.]