Equilibrium is an extremely important concept in economics, but with a somewhat ambiguous meaning.  Thus macroeconomists might speak of a “disequilibrium” outcome, where nominal shocks distort labor and goods markets due to sticky wages and prices.  But from the perspective of a more complete model of behavior (including price setting), a recession might be viewed as an “equilibrium” outcome. The “natural” or equilibrium interest rate also has multiple meanings, but generally refers to the interest rate that provides for some sort of macroeconomics equilibrium, such as stable prices.  Throughout most of the world, the equilibrium interest rate has been trending lower since the early 1980s.  Until now. . . . A more complete model of the equilibrium interest rate might also account for the political economy of fiscal policy.  Suppose that the natural interest rate falls so low that politicians become tempted to run larger budget deficits.  Eventually, the deficits become so large that the equilibrium interest rate begins rising again. Under recent US administrations, fiscal deficits have become much larger than usual (even before Covid.)  With interest rates so low, there is little to restrain politicians that have a short run focus. During the late 2010s and early 2020s, warnings that the debt might eventually have to be rolled over at much higher interest rates fell on deaf ears.  (I gave that warning several times, but couldn’t find many other pundits who agreed.) This past week, the media is full of reports that British bond yields are soaring in response to Prime Minister Truss’s bold package of tax cuts, which will be financed by borrowing.  There are also rumors that the next Italian government (likely headed by right wing populists) might boost government borrowing. All of this makes me wonder whether ultra-low interest rates are not a stable equilibrium, at least in most places.  I still believe that low rates are a technically feasible equilibrium, but perhaps it is inevitable that politicians in many countries will abuse the privilege of almost costless borrowing—right up to the point where that privilege is removed. One can also apply this argument to other cases.  Perhaps a 2% inflation rate is not politically stable in the long run.  After a long period of low and stable inflation, policymakers begin to (wrongly) assume that the low inflation is “structural”, or inevitable.  They come to believe that they can stimulate the economy without the risk of inflation. Perhaps this even applies to cycles in crime.  During periods when crime rates have fallen to relatively low levels (say the early 1960s or the early 2010s), politicians come to believe we can be a bit softer on criminals.  They reduce the rate of incarceration, which leads to an upward spike in crime.  Eventually, there is another tough on crime phase in the crime cycle. Or perhaps all of this speculation is just the musing of an old guy that just retired, worried about fading into irrelevance.  An aging boomer hoping that his memories of the policy mistakes of the 1960s still have some relevance to younger readers. (0 COMMENTS)

Given how I’ve complained about how bad economists are at naming their ideas, I should probably think twice about attempting to give a name to an idea myself. Still, I feel like tempting fate by badly naming an idea from the work of Elinor Ostrom, which I believe generalizes to even broader applications. The bad name I occasionally use (usually when talking to myself) to describe this phenomenon is “the 5-1 error.” First, a little background. In her fantastic book, Governing the Commons, Elinor Ostrom examines ways of dealing with common pool resource problems. A common pool resource is something which anyone can access, and over which nobody has a well-defined property right. The tragedy of the commons, as described by Garrett Hardin, results in the resource being overused. Think of a pond with a limited fish supply, which can be used by anyone. If I know everyone else can use it, I might want to rush out there now to catch fish before anyone else does. Everyone else has the same idea. Ultimately, the pond becomes totally depleted of fish, and everyone is worse off. Ostrom set out to investigate how people in the real world deal with this challenge. She lays out five different ways this problem can turn out, described as five different games. Summarized, the list goes as follows: Game 1: The standard tragedy of the commons unfolds, and the common pool resource is depleted. Game 2: Central authority is implemented in a way which resembles how regulation works in some textbooks and the minds of some pundits – that is, it effectively achieves its intended aims. The problems are solved, and resources are allocated efficiently. Game 3: Central authority is implemented, but very poorly. So poorly, in fact, that the outcome is even worse than the result of Game 1. Game 4: Yet again, central authority enforces rules over the commons, but its mistakes are kept within a narrow enough band that the outcome is better than 3, though not quite as good as 2. Game 5: The people with direct access to the common pool resource make, monitor, and enforce agreements and contracts among themselves. Over time, these evolve into a unique order to deal with the unique circumstances of that common pool resource. Ostrom’s goal was to better understand how Game 5 works and how it can arise. She did not believe Game 5 is a panacea capable of solving all collective action problems, or that Game 1 is a nonissue. But she did argue that Game 5 was underappreciated. In a key passage, Ostrom notes one reason Game 5 gets overlooked: A further problem for consideration is that games in which enforcers have been arranged for by mutual agreement may be mistaken by analysts and public officials for games in which there have been no agreements about how to cooperate and enforce agreements. In other words, some examples of a ‘Game 5’ may be mistaken for a ‘Game 1.’ These situations may be construed to be ‘informal,’ carrying a presumption that they are not lawful. This goes to fundamental presumptions about the nature of governments as external authorities governing over societies. Game 5 is difficult to see in any specific circumstance, because we don’t know in advance what we’re looking for. We may not notice the evolved institutions, and may even undermine them, because we’re too busy searching for designed institutions. That’s a 5-1 error – at least, that’s what I call it. I also generalize the term beyond common pool resource management and extend it to any area where informal institutions are overlooked by those whose understanding is focused entirely on top down, centralized rules. So, what would be a real-world example of a 5-1 error? In a classic paper called The Fable of the Bees, Steven Cheung identifies one related to externalities. He criticizes the work of J. E. Meade, who argued that beekeeping represents a market failure. Orchard farmers use beehives to pollenate their crops, but at least some bees from one farmer’s hives would travel to and pollinate plants in a neighboring farmer’s crop. Since one farmer can’t feasibly charge another farmer for those pollination services, the market would underprovide for bees. Or so Meade argued. Cheung pointed out that all sorts of bottom-up customs emerged to deal with this (and other) issues: As noted earlier, if a number of similar orchards are located close to one another, one who hires bees to pollinate his own orchard will in some degree benefit his neighbors. Of course, the strategic placing of the hives will reduce the spillover of bees. But in the absence of any social constraint on behavior, each farmer will tend to take advantage of what spillover does occur and to employ fewer hives himself. Of course, contractual arrangements could be made among all farmers in an area to determine collectively the number of hives to be employed by each, but no such effort is observed. Acknowledging the complication, beekeepers and farmers are quick to point out that a social rule, or custom of the orchards, takes the place of explicit contracting: during the pollination period the owner of an orchard either keeps bees himself or hires as many hives per area as are employed in neighboring orchards of the same type. One failing to comply would be rated as a “bad neighbor,” it is said, and could expect a number of inconveniences imposed on him by other orchard owners. This customary matching of hive densities involves the exchange of gifts of the same kind, which apparently entails lower transaction costs than would be incurred under explicit contracting, where farmers would have to negotiate and make money payments to one another for the bee spillover. So Meade is committing a 5-1 error. He was blind to the informal institutions that developed to deal with the issue because he only understood solutions as coming from explicit regulations. Cheung’s final comment on the results of such an error is well worth pondering: I have no grounds for criticizing Meade and other economists who follow the Pigovian tradition for their use of the bee example to illustrate a theoretical point: certainly, resource allocation would in general differ from what is observed if the factors were “unpaid.” My main criticism, rather, concerns their approach to economic inquiry in failing to investigate the real-world situation and in arriving at policy implications out of sheer imagination. As a result, their work contributes little to our understanding of the actual economic system. Kevin Corcoran is a Marine Corps veteran and a consultant in healthcare economics and analytics and holds a Bachelor of Science in Economics from George Mason University. (0 COMMENTS)

Many people’s favorite segments from Atlas Shrugged are mine too. (See here and here.) But there are a lot of shorter segments that I particularly like. Here’s one on child labor (p. 92 of the paperback.) Francisco d’Anconia, at age 12, hides from Mrs. Taggart (Dagne’s mom) the fact that he is working over the summer at Taggart Transcontinental. Mrs. Taggart finally wises up and catches him. Here’s the dialogue: “Francisco,” she [Mrs. Taggart] asked, when she brought him home, “what would your father say about this, if he knew?” “My father would ask whether I was good at the job or not. That’s all he’d want to know.” “Come now, I’m serious.” Franciso was looking at her politely, his courteous manner suggesting centuries of breeding and drawing rooms; but something in his eyes made her feel uncertain about the politeness. “Last winter,” he answered, “I shipped out as a cabin boy on a cargo steamer that carried d’Anconia copper. My father looked for me for three months but that’s all he asked when I came back.” I first read Atlas Shrugged a few days after my 17th birthday and I had had a number of jobs in my early second decade. Not this exciting, of course and not full time. But still, I related. (0 COMMENTS)

Hans Nichols, of Axios.com, writes: Administration officials are deeply concerned by Malpass’ failure to answer this week when asked if climate change was caused by humans. Malpass is David Malpass, currently president of the World Bank. I favor going beyond firing David Malpass; I favor abolishing the World Bank. But I also believe in telling the truth, and that’s a big difference I have with Hans Nichols. You would think, based on Nichols’s statement above, that Malpass was asked whether climate change was caused by humans. He wasn’t. To find out the actual question, I had to go to Valerie Volcovici and Kate Abnett, “World Bank’s Malpass faces calls to resign after climate change doubts,” Reuters, September 22, 2022. Here’s what they write: Malpass appeared at an event hosted by the New York Times at Climate Week in New York City on Tuesday and was asked whether he believes that the “manmade burning of fossil fuels is rapidly and dangerously warming the planet.” Malpass tried at first to dodge the question but later said: “I don’t even know. I’m not a scientist.” You can believe that humans are causing global warming without believing that it is “rapidly and dangerously warming the planet.” Indeed, as Steven Koonin has noted, there’s little basis for this latter belief. (0 COMMENTS)

It’s difficult to imagine how a society of which most members do not believe in individual liberty could become or remain a free society. There must be a tipping point, perhaps far short of the majority, where the mob will seize power or otherwise force its values on the rest of individuals. This is why classical liberals such as James Buchanan or Friedrich Hayek assign much importance to the private morals prevalent in a society—the first by invoking an ethics of reciprocity among natural equals, the second by emphasizing the traditional moral rules in a self-regulating order. Anarcho-capitalists and some more mainstream libertarians such as Gordon Tullock reply that in a free society, it will be in the self-interest of everybody or nearly everybody to engage in, and respect, peaceful cooperation. But let’s focus here on a society with a state whose main function would to maintain a free society against external and internal threats. In America, the laws of 27 states generally prohibit car manufacturers to sell their vehicles directly to the public from company-owned stores, forcing them to use independent dealerships. (Selling online is not forbidden, but many customers apparently like a physical place where they can see the thing and obtain more information.) The situation looks better than half a dozen years ago, when all 50 states had come, over the previous 25 years, to forbid all sales in manufacturers’ stores. It is however doubtful that the state of public opinion has much improved as opposed to becoming infatuated with electric vehicles (EVs). Tesla obtained the privilege of selling cares through its own stores in a few of the restrictive states, but the resistance of independent dealerships and political orthodoxy are now difficult to crack. What is the political orthodoxy justifying these bans? Don Hall, president of the Virginia Automobile Dealers Association, puts it bluntly: When you have one person who controls all the marbles, you get marbles when they want to give it to you. The suggestion is that the state and incumbent rent-seeking businesses control all the marbles. That looks like democracy as the ancient collective liberty as opposed to modern liberty. Another example: An EV startup, Rivian, has failed in its efforts to establish its own stores in Georgia. The Senate President Butch Miller, who is also a Honda dealer, declared, apparently referring to a Rivian lobbyist, Jim Chen (“The Man From Rivian Who Wants to Change How We Buy Cars,” Wall Street Journal, September 17, 2022): Why should 11 million Georgians change the way they’re doing business to accommodate one individual? In a free-enterprise economy, by definition, an entrepreneur is allowed to challenge, through competition and “creative destruction,” what all other businesses do. Even if there were only one Georgian willing to buy a car from a manufacturer willing to sell it directly, the two would be free to trade. Note that if there were only one such Georgian, or a very small number of them, there would be no reason for any car dealer or politician to be worried; they must fear that many consumers would like the alternative they ban. It is not to “accommodate” one individual, even if there were only one, that 11 million Georgians “should” have to change their old ways. In a free society, as opposed to a socialist or fascist one, nobody is forced to change his way. No consumer and no producer can force everyone, let anyone 11 million Georgians, to change their peaceful ways. But in such a society, a firm would certainly be free to offer on its own property to sell a car to any individual willing to buy one. The only “accommodation” to make to any one individual is to recognize that he has the same liberty as any of the 11 million others. It is called consumer sovereignty and free enterprise. We may connect this issue with Gary Gerstle’s book Liberty and Coercion: The Paradox of American Government (Princeton University Press, 2015—see my review in Regulation). Gerstle argued that the American Constitution created a limited central government but allowed the states to be little democratic leviathans. The many examples included slavery and official racism and also sometimes minute regulation of businesses. One hypothesis (which Gerstle, a lover of “good” leviathans, does not envision) is that the American Constitution suffered from the same vice as, albeit to a lesser degree than, the French Constitution. Both the French Declaration of the Rights of Man and the Citizen of 1789 and, even more, that of 1793 tried to marry individual liberty and the sovereignty of the people, an impossible feat. In his book Le Libéralisme (Paris, 1903), where you will find the French text of the two Declarations, Émile Faguet wrote: If the right of the people means its sovereignty, which is exactly what the writers of the [French] Bills of Rights have said, the people has the right, as the sovereign, to suppress individual rights. And this is the conflict. Writing in the same bill of rights both the right of the people and the rights of man, the sovereignty of the people and liberty for example, on an equal basis, amounts to put water and fire together, and ask them to please get along. [My translation] [In the original:] Si le droit du peuple, c’est la souveraineté, ce que précisément ont dit les rédacteurs des Déclarations, le peuple a le droit, en sa souveraineté, de supprimer tous les droits de l’individu. Et voilà le conflit. Mettre dans une même déclaration le droit du peuple et les droits de l’homme, la souveraineté du peuple et la liberté par exemple, à égal titre, c’est y mettre l’eau et le feu et les prier ensuite de vouloir bien s’arranger ensemble. (2 COMMENTS)

In a Republican ad during Ronald Reagan’s 1980 run for president, a Tip O’Neill lookalike was driving alongwhile oblivious to the fact that his car was running out of gas. The Republicans’ intended meaning was that the Democrats were not paying attention to the mess the country was in, a mess that they helped create. But what I took out of it was more literal: the idea that the Democrats’ energy policy, one of the worst parts of Jimmy Carter’s four years, was a disaster that the Democrats refused to admit. (Previous presidents Richard Nixon and Gerald Ford had actually started the bad policies, but that’s another story.) I have the same reaction now as I look at energy policy in Europe. Except that this time, one of the advocates of a destructive energy policy, Britain’s Liz Truss, is claiming the mantle of free market advocate and former prime minister Margaret Thatcher. In setting out her policy, she ignores some very basic economics. And the European Union is making similar mistakes. This is from David R. Henderson, “Europe’s Destructive Energy Policy,” Defining Ideas, September 22, 2022. Another excerpt on just how bad the Truss plan is: Starting in October, Britain’s government will cap overall energy spending by households. Truss announced that households will not have to pay more than $2,875 per year for energy. The government will pay for all energy use beyond that $2,875. Presumably there are many households already at that limit. So consider what would happen if they wanted to use more energy. In a normal market, they would pay more and so would have some incentive to conserve. But Truss is telling them that no matter how much they use, they will pay no more than $2,875. So any additional use will cost them zero. Liz Truss is announcing to Brits that energy use beyond some level is a free good. Expect there to be lots more energy use, although I expect that when she sees that happening, she will crack down on “energy hogs.” Recall that when President Carter chose to keep the Nixon/Ford price controls, he also denounced Americans for excessive usage. At one point, Carter’s fledging Department of Energy even proposed a ban on powerboat use on weekends. As I said of that proposal in a speech in the late 1970s, “In other words, the only time you can use a boat is when you can’t.” Fortunately, that proposal went nowhere. We’ll see what happens in Britain. And Ursula von der Leyen of the European Commission: In making her proposal to tax producers more heavily, European Commission President Ursula von der Leyen stated, “In these times it is wrong to receive extraordinary record profits benefiting from war and on the back of consumers.” She added, “Profits must be shared and channeled to those who need it the most.” Karl Marx could not be reached for a comment. Read the whole thing. (0 COMMENTS)

Alex Tabarrok recently discussed an article that criticizes philosophers for dwelling on the past: Hanno Sauer on why philosophers spend far too much time reading and writing about dead philosophers: Ironically, this post appeared directly after a Tyler Cowen post suggesting that the Quantity Theory of Money is still important.  Almost all of the best work on the QTM is written by dead economists. I am not well informed on philosophy, but one of the biggest problems in economics PhD programs is that the teaching focuses heavily on recent work, and too little attention is paid to macroeconomists that did their work 100 years ago. Students work with a limited set of models, which often reflect a single approach to macroeconomics.  Thus in recent decades, the rental cost of money approach (focused on interest rates) has pushed aside the price of money approach and the quantity of money approach.  Yes, these two alternative approaches have problems, but so does the interest rate approach.  More importantly, they also contain insights that help us to better understand the world, insights that might be missed by those that solely focus on interest rate-oriented models. In my view, a grad program in macro should spend 1/3 of the time teaching the history of economic thought, 1/3 of the time teaching macroeconomic history (i.e. the historical data), and 1/3 of the time teaching modern models of macro.  Perhaps if they had done so in recent decades, then economists would have understood much earlier that a tight money policy by the Fed was driving the US economy into recession in late 2008. I have a book coming out this year (tentatively entitled Alternative Approaches to Monetary Economics), which attempts to address this issue.  In my view, it is not possible to truly understand a field like macro unless you see it from multiple perspectives.  Unfortunately, the wisdom of macroeconomists like Irving Fisher, Ralph Hawtrey and George Warren has been largely forgotten.  Even Milton’s Friedman’s ideas are fading into the past. Here’s Irving Fisher and his son:   (0 COMMENTS)

On a long plane trip, I was reading Henry Kissinger’s Leadership, which is one of the sharpest books ever written by a 99 year old. (Ronald Coase, when he published his magnificent How China Became Capitalist with Ning Wang, was 101!) Still, it is a great achievement and a splendid read regardless of the author’s age. I didn’t expect the following reference to Adam Smith. In the context of describing Richard Nixon’s character, Kissinger describes “two Nixons”. One was “consistently gracious”, thoughtful, developing a relationship with Kissinger that “in its operational character, might have been described as a ‘partnership’ – although true partnership rarely exists when the power is so unequally distributed between the two sides. The president can dismiss his security advisor without procedure or warning and has the authority to impose his preferences … These realities notwithstanding, Nixon never treated me as a subordinate when it came to the issues of national security and foreign policy; rather, he dealt with me as a kind of academic colleague”. There was also another Nixon, “insecure about his image, uncertain of his authority and plagued by a nagging self-doubt”. Of this other “part” of Nixon, who “involved a restless pursuit of approbation”, Kissinger writes that: This other Nixon was accompanied by a version of Adam Smith’s ‘impartial spectator’: that is, a second ‘you’, standing outside yourself, observing and judging your actions. Nixon seemed to me to have been haunted by such critical self-awareness all his life. I confess Leadership is the first Kissinger book I have read. I would be interested in knowing if he references Smith anywhere else. (0 COMMENTS)

Aaron Director was one of the first contributors to the area of law and economics. I defended him here from a scurrilous attack on him by Matt Stoller. If you click on the first link mentioned in the previous sentence, you’ll also see Stoller’s response. When I linked to my EconLog post on Wikipedia on Facebook earlier this week, someone pointed to a good example of Wikipedia’s treatment of free-market types:  Wikipedia’s entry on Aaron Director. Here’s the line that particularly caught my attention: At the University of Chicago, Director completed his transition to conservative corporatist. Check out the whole write-up and see if you think it’s fair. Someone on Facebook suggested that some of the content came from Stoller. That’s plausible.   (0 COMMENTS)

Is economic mobility a dream of the past? In this episode, host Russ Roberts welcomes Harvard’s Raj Chetty, an economist deeply interested in the science of economic opportunity (among other things!). The subject of the conversation is a new study Chetty worked on (and recently published in Nature) which suggests that people with rich friends do better financially than poor people who are only connected to other poor people. The project developed a measure of “social connectedness” that purports to measure community-level (not individual, an important caveat) relationships with the use of Facebook data. Roberts, ever skeptical of empirical research, was surprised by the magnitude of the results Chetty and his colleagues found. Chetty, too, notes the divergence from earlier findings about social mobility in sociology and other disciplines, which have traditionally placed more causal emphasis on factors such as trust or tight-knit community. Chetty and company’s findings don’t simply suggest that you should run out an make rich friends…but it does make Chetty wonder what can be done to bring more economic opportunity to more people. What other factors might be correlated with economic mobility? And if the answer is simple geography, why don’t we see more people moving to the sorts of neighborhoods Chetty and team identify? We’d like to hear what you have to say. What was your biggest takeaway from this episode? Feel free to reply to any of the prompts below; let’s continue the conversation.     1- How do Chetty and his colleagues define “connectedness” and “neighborhood effects,” and how does connectedness’ relate to economic mobility? To what extent does “connectedness” ignore other factors (such as the quality of schools, family structure, and parenting)?   2- Roberts wonders if Chetty’s results are simply a reflection of selection bias issues- that is, ambitious parents will naturally try to move to the most advantageous neighborhoods for their children. How does Chetty respond, and to what extent does he convince you?   3- What are the major policy implications of this study? In other words, how can we create these connections and break down barriers to interaction? Chetty suggests there’s a missed opportunity in terms of how policy couples resources with the kind of social-capital, connection type of intervention his study suggests would be beneficial. How might we change policy accordingly, such that it accounts for social as well as economic support?   4- Do the results of Chetty’s research and his conversation with Russ make you more or less optimistic about the endurance of the “American Dream?” What accounts for your optimism or pessimism?   5- The conversation closes with a discussion on the nature and importance of economic education, a subject dear to our hearts at Econlib. What role should empirical techniques play in economic education? How does Chetty see the relationship between theory and data? What do you think this relationship should be. (Note: for two alternative perspectives, you might consider this article by Nikolai Wenzel and this article by Don Boudreaux.) (0 COMMENTS)