What is the core for?

Suddenly I have so much to say about the core CPI, in response to the latest attacks by Barry Ritholtz and Daniel Gross. I've already said most of it in comments to a post by Brad DeLong (also note kharris' insightful comments) and one to the original Barry Ritholtz post. I may reproduce some of them in future posts here, but my last (thus far) comment (from the DeLong post) is probably what needs to be said first:

There are really 3 separate questions here:

(1) What is the best measure of retrospective changes in purchasing power?

(2) What is the best indicator of the general trend in prices (with respect to what can expected in the immediate future)?

(3) What is the best target for monetary policy?

For the first question, obviously the full index is better than the core, and nobody denies that.

For the second question, there is room for debate, but if the only choices are the core and the full index (to measure inflation for a specific period of a year or less), I would still choose the core. (If you let me smooth the inflation rate with, say, an exponential smoother, I might prefer the full index.)

For the third question, I think there is little room for reasonable debate: the core is better. When food and energy prices go up relative to other prices, the optimal policy rule would accommodate those increases so as to allow other prices to remain stable. The increase in the general inflation rate does little harm; the alternative of deflation in the non-core component would do considerable harm.

Messrs. Ritholtz and Gross, and their supporters in this commentary, are finessing the issue by not distinguishing among these three purposes.

The answer to the third question only works if people know roughly what to expect in advance. If people expect the Fed to control the overall inflation rate but the Fed only attempts to control the core, the outcome will not be good when the two start to diverge. People who attack the core index are contributing to the likelihood of such a bad outcome, as well as to the likelihood of the other bad outcome in which the Fed actually does control the full inflation rate even in situations where it shouldn't.

Keynes (quoted by DeLong) on Liquidationism

Brad DeLong digs up a nice quote from Keynes, which makes a point similar to what I was trying to argue here, here, and here. I can't claim that the recent US housing boom was either quite as benign or quite as productive as the investment boom of the late 1920s, but the same general principle applies. The behavior of investors in the late 1920s appeared quite reckless in immediate retrospect, but they obviously did more good than harm (or at least, the great harm that resulted indirectly was only because of subsequent bad policies). And we do now, of course, have to be concerned about the risk of inflation, which was not (or shouldn't have been) an issue in the early 1930s. But the idea that speculators have to be severely and broadly punished by the monetary authority for taking excessive risks -- that idea, I contend along with Keynes, is foolish. It is very hard to distinguish which speculative actions were ex ante prudent and/or valuable and which were excessive. It is (as the Fed now clearly realizes) not the job of the central bank to make such judgments after the fact (or, except in its regulatory role, before the fact). The mandate is for high employment and reasonable price stability, and it is not desirable that the mandate should be broadened to include assuring the right incentives for speculators.

Why Jane Galt is Still Wrong

I'm willing to bet a fairly hefty sum of money that almost none of the lefty bloggers who linked to it originally will link to my attempts to rectify their misunderstanding.

So writes Jane Galt. I don’t think I’m one of those she had in mind, since I didn’t deal directly with Ms. Galt’s arguments in my earlier posts (and I wouldn’t willingly accept the term “lefty,” though it’s possible that the shoe fits, or that it appears to fit). Nonetheless, I can’t resist the challenge.

Her words again:

…my metaphor was aimed at a specific kind of redistribution: that which is less interested in making the poor better off, than in making the rich worse off, so that they don't make the rest of us look bad. Or as Brad Delong said:

Surely public policy should weigh the spite-generated utility the rich gain from their conspicuous consumption as worth less than nothing?

And in that case, the wealth hierarchy is precisely equivalent to the beauty hierarchy, morally speaking: it is a zero sum game in which a lucky few feel better only when the others feel worse. So to my mind, anything that applies to the enjoyment of wealth by the lucky few applies equally well to the enjoyment of endowments like beauty, athleticism, and intelligence. I am unable to construct a moral argument for cutting down the tall poppies of the income distribution that doesn't apply equally well to conspicuous flaunting of one's pulchritude, physical prowess, or brains.

But how is it that she misses the critical point? To wit: the creation of conspicuous wealth, by its very nature, uses up resources that could be used for other purposes. Indeed, wealth might be defined as the ability to command resources, and therefore, the more resources that are used to produce conspicuous wealth, the more effective it is. By contrast, the process of flaunting one’s pulchritude, etc., while it may use up some resources, is not inherently resource-intensive. And certainly, such endowments, to the extent that they are truly endowments, don’t require resources to create.

The beauty hierarchy is, as Ms. Galt states, a zero-sum game (roughly), but – because of the resources used up – the wealth hierarchy could very well be a negative-sum game. Using up resources is fine as long as the full social benefit of the product exceeds the cost of the resources. But with conspicuous consumption that is not necessarily the case. Because there are negative externalities – namely the unhappiness (mistakenly labeled as envy) generated among inferiors – associated with that consumption, there is no mechanism to insure that the social benefit from the resources used is at least as great as the cost.

Of course there are counterarguments. For example, as Ms. Galt points out, there are also positive externalities associated with the pursuit of wealth. But those positive externalities have had their day in court. It is not at all fair to brush aside the negative externalities that may be associated with the pursuit of wealth (even if they are more difficult to measure).

Enough with the Envy and Spite Rhetoric

(See my last post, and its many links, for background.)

The terms “envy” and “spite,” it now occurs to me, not only frame the debate in an unpleasant light: they are also fundamentally inaccurate characterizations of the issue involved. Envy and spite are emotions directed at people: “I am envious of Peter”; “I am spiteful toward Paul”. These emotions imply hostility, which in fact has nothing to do with the argument that people derive utility from relative wealth. Thus Tyler Cowen Alex Tabarrok can complain that he doesn’t like being envied, but here he is talking about the actual emotion of envy (with all the attendant hostility), not about the property of certain utility functions that has been labeled as “envy.”

To say that I get utility from my relative wealth is not to say that I have any particular feeling about those against whom I compare myself. The word “envy” (and similarly the word “spite”) exaggerates the degree of other-regard that is present. The “others” in this case are not concrete people about whom I have feelings, but abstract reference points against which I compare myself. It’s not that the poor are envious of the rich; it’s that the poor feel bad about themselves when they compare themselves to the rich (or more likely to a social average in which the rich are only one element). Similarly, it’s not that the rich are spiteful toward the poor, it’s that they feel good about themselves when they compare themselves to the poor (or to the social average).

I doubt that Tyler Cowen Alex Tabarrok really gets significant disutility from being part of such an abstract reference point, but if he does, he seriously needs to chill. And his comparison of envy to homophobia is also “fruit of the poison tree,” since it derives from the original misuse of the word “envy.” The hatred that homophobes feel toward homosexuals is entirely other-regarding. Very much in contrast to relative wealth feelings, it has nothing (except at a deep psychological level) to do with what the homophobe feels about himself. Homosexuals have a legitimate complaint about being the objects of actual hate, rather than imagined envy.

In fact, when Brad DeLong brought the word “spite” into this discussion, he was conceding a point that he never should have conceded. The phrase “politics of envy” is used, by those who oppose redistribution, to frame the debate in emotional terms. The phrase may perhaps be a reasonably accurate characterization of the politics. To get people excited about redistribution – to get them to vote on that basis – you may have to make them emotional, literally “envious.” Rational arguments about their underlying preferences probably won’t do the trick. But Greg Mankiw let the term “envy” slip from the political argument into the economic one, where it becomes quite misleading. That, in my opinion, was a mistake that needs to be corrected before the discussion can proceed.

UPDATE: Oops, I referenced the wrong Marginal Revolution blogger (for this post).

Inequality, Spite, and the Game of Love

The debate du jour in the economic blogosphere seems to be about relative wealth – whether it affects welfare and whether public policy should take this possible effect into account. We have the usual dramatis personae, with Brad DeLong and Greg Mankiw in the leading roles, Jane Galt as the female lead, a cameo appearance by Chris Dillow, and Mark Thoma in the role of messenger (and let’s not forget Tyler Cowen…and now Gabriel Mihalache...and...and...and...never mind, I'm going to have to post this before I read every single blog). Most of the discussion concerns “envy” and “spite” – the supposed emotions of the poor and rich, respectively, which mediate the welfare effect of relative wealth.

I have a couple of points to bring up. First, from a utilitarian point of view, it doesn’t help Brad’s case that he points particularly to the spiteful rich rather than the envious poor. If the rich get pleasure from knowing they are better off than the poor, that, by itself, is a good reason to keep the income distribution unequal. Why not give the rich that extra pleasure of being relatively, rather than just absolutely, rich? The only utilitarian reason is that it (ostensibly) harms the poor, which is to say, in the terms of the discussion, that the poor are envious. Yes, I do understand that Brad is countering Greg’s comment about “making envy a basis for public policy,” but it seems to me that Greg's whole line of thought brings us into the realm of emotional, rather than rational, policy analysis. Greg casts redistribution in an unpleasant light by using the word “envy,” and instead of trying to cast it in a pleasanter light (“people like being equal”), Brad reflects back the bad light by using the word “spite.” In any case, it’s all mood music.

But I wonder why everyone (except Chris Dillow) thinks that the effect of relative wealth is merely subjective. As Chris points out, there are objective ways in which consumption by the rich may hurt the not-so-rich. I wonder why nobody has brought up what seems to me to be the obvious example: sexual competition. (For example, suppose you like tall redheads and you’re into spanking….OK, never mind.) I think particularly of competition among men, although arguments can also be made about competition among women. (My example also assumes, without loss of generality, that the men are heterosexual. And, oh, yes, back in the 80s I used to believe that stuff about men and women being roughly equal, so it didn’t matter who was chasing whom…but the 80s ended back in 1989, if I recall.)

In the area of beauty, evolution somehow seems to have failed the human male (well, most human males, anyhow: men are no plums, but they do contain the occasional Pitt). So men tend to compete for the attention of women not (like peacocks) on the basis of their natural endowment but on the basis of other things, which are often expensive. If I own a BMW and you buy a Jaguar, it hurts me objectively, because all the chicks that used to ride in my BMW will want to ride in your Jaguar instead. (In reality, it’s probably just as well that I drive a Saturn; my wife wouldn’t be too happy if I used the car to go cruising for chicks.) There’s no envy or spite involved here: just men who are competing rationally and women who like men with fancy cars. Although the competition has some benefit for the women involved, it’s easy to see that there’s also a deadweight loss. It’s a multi-player prisoner’s dilemma, and there is no mechanism to produce a cooperative solution.

UPDATE: Steve Waldman brings up another, much more important (but less sexy!) area in which objective competition causes relative wealth to have an impact: politics.

UPDATE2: I missed Alex Tabarrok’s important post, which might sort of provide a justification for Brad’s focus on spite. Also this other one by Gabriel Mihalache.

J. Bradford DeLete

One of the privileges of having my own blog is that I get to re-post the comments that Brad DeLong deletes. As everyone knows, he is quite trigger-happy with that delete button. Well, I can kind of understand: his threads would go on for miles of drivel if he let every Tom, Dick, and Harry post comments. But moi...? For my latest, first some background:

1. Brad attacks a political reporter for making light of Hillary Clinton’s “wonkish” energy proposals. The media should cater instead to careful and concerned readers who really care about her speech.

2. Brad attacks another reporter for not stating prominently enough that global warming skeptics are liars, lunatics, and charlatans. The media should cater to careless and sloppy readers, who will be more influenced by the skeptics’ statements than by the author’s unambiguous but subtle challenges.

3. More of the above: the post on which I commented.

So…

Will the real Brad DeLong please stand up? Is it the one who believes readers are dumb and casual and need to be spoon-fed the truth about global warming? Or is it the one who believes readers are subtle and sophisticated and need to be given more substantive details about Hillary Clinton’s energy proposals?

Oops, I forgot: It’s the one who deletes posts from those who find problems with what he says. I suppose one might be able to avoid this fate by stating the criticisms in unusually diplomatic language, instead of trying to be witty. But isn’t Brad himself the one who is always attacking reporters for being too diplomatic in their criticisms?

My latest comment agrees with something he said, though, so I’m guessing it won’t be deleted. (To be fair, I did make some mildly hostile comments on the first post cited above, and Brad didn’t delete them either. I guess it’s hard to predict.)

X or not X

Which of the following is closer to truth?

(1) The 2003 tax cut stimulated spending and thereby helped strengthen the current recovery.

(2) The 2003 tax cut did not stimulate spending and therefore is not contributing to the low national savings rate.

I tend to go with (1), but I’m willing to look at evidence for (2). What troubles me, though, is that most Democrats – including people like Paul Krugman and Brad DeLong, who should know better – seem to think the answer is “none of the above.” I happen to be a Democrat myself, but I also support the Party of Logic and Arithmetic, which somehow seems to be opposed by both major parties (not to mention most occasional third parties) most of the time. Either people spent the tax cut or they saved it, or perhaps they spent half of it and saved the other half, but you can’t say, “For purposes of calculating the short-run macroeconomic impact, they saved the tax cut, but for purposes of calculating the growth and balance of payments implications, they spent it.”

I’d like to suggest that, if you want to make the case for the Democrats, you’re better off with (1). Yes, you do have to acknowledge that the Bush administration did something that was not 100% stupid or 100% evil. But in return, you get to make a logically coherent case that they did something maybe 50% stupid or 50% evil, depending on how you look at it. After all, most economists consider the low national savings rate to be a big problem.

On the other hand, if you want to make the case for the Republicans, you’re better off with (2). Yes, you have to give up the argument that the tax cut saved the country from ruin. But in return you get – well, a free lunch. If the tax cut didn’t affect the overall savings rate, then young people will inherit the same savings, so there is no intergenerational transfer. Taxpayers overall are a little better off. If you’re a risk-averse taxpayer, you’re right where you started: just buy a Treasury bond and make your future tax payments with the proceeds. If you’re a less risk-averse taxpayer, you get to take advantage of the government’s credit rating and invest the money in something more profitable. So all these macro effects add up to a slight benefit, and the micro effect – less distortionary taxation, leading to a more efficient economy – is just gravy.

Of course, the Democrats could counter that this tax cut went to the rich, while the compensating future tax receipts (or benefit cuts) might come from the middle class (or the poor). But that argument only works if you expect the Republicans to stay in power. And frankly, personally, Democrat though I am, I would not be terribly unhappy to see the revenue made up with, say, a value added tax. I do like progressive taxes, but my feeling is, since people with nothing at all pay no taxes at all, any tax is progressive in the most critical income range.