One of the problems with working all day and only writing
here at odd moments in the evening, when I have energy and inspiration, is that
I’m always late to every good party. The
Omega point discussion I want to write about is already very old news; it was
on and over weeks ago, which is a few long epochs ago in interweb time. But there were things about the whole
conversation that enchanted me, and others that bothered me, so I might as well
write those things down.
So here it is: a few interweb epochs ago there was an
exchange of bewilderment between Martin
Feldstein and Paul
Krugman. Feldstein was bewildered by
the fact that the Fed’s flood of new money in the last few years has not yet
created the corresponding flood of inflation or even the long run expectation of inflation that he (and many
others) predicted, based on something like a quantity theory of money
(“inflation is too much money chasing too few goods”). And
Krugman was bewildered by the fact that Feldstein was bewildered, since stable
prices when interest rates are at the zero lower bound and the “natural,
full-employment” interest rate would be much lower than zero is what HE
predicted, based on something like the old Keynesian or Hicksian IS-LM
liquidity-trap model.
The contesting bewilderments between these two very
smart economists does raise a question: why does it exist so strongly when both of them based their
predictions and bewilderment on well known, widely taught economic theory? Neither was dealing, I think, with any theory
that the other did not completely understand and, in one way or another, even accept.
Then a few weeks ago Brad
DeLong suggested an answer: what you predict depends on how far into the
future you think the Omega point is, and how strong you think its influence is
on the what is happening now.
The Omega point?? I didn’t recognize that from my Econ 101 text.
I had to look it up. If you feel
up to an excursion into entropy and evolution and cosmology and the nature of time
and God, follow the link to Pierre Teilhard
de Chardin, But for now, let’s just say that the word that DeLong used may
be non-standard in economics, but the idea is strong in the economic
imagination: the point DeLong is talking about is an ideal, theoretical
condition out there in the temporal distance that is pulling at us, tugging us
toward it. It is final result of all
that is happening now, the time when all economic discord and turbulence will
cease, when prices and wages all have adjusted, and the thing that people in
the econ biz call the velocity of money will have stopped gyrating all over the
place, and will have settled wherever it is supposed to be. DeLong even says this directly; he says:
“At that time the
money multiplier will be a reasonable and a reasonably stable value. At that
time the velocity of money will be a reasonable and a reasonably stable value.
… And at that time the price level will be proportional to the monetary base.”
Assuming that nothing else happens to knock us off our
course---no new crises, no earthquakes or tsunamis or plagues, no major wars,
no long-simmering industries suddenly bursting out and changing the world, no fundamental
political changes that bend some cost curve up or down or sideways, no new bubbles
or panics or manias, no out-of-the-blue, irrational desolation or exuberance---assuming
that we are left alone to move where our current Omega point lures us, it is
the point at which we will settle in the end.
It is, finally, the Fabled Economic Long Run.
And DeLong’s post starts by repeating the last phrase of the
famous quote from John Maynard Keynes, in which he states that “in the long run
we are all dead”. Keynes was
complaining, long ago, about economists who constantly refer to the long run
and tell us all to be patient while we get there. Keynes said: “Economists set
themselves too easy, too useless a task, if in tempestuous seasons they can
only tell us, that when the storm is long past, the ocean is flat again.” And
in saying that, Keynes tells us that he thinks that when times are very hard or
very turbulent, whenever, that is, people or politicians might turn to economic
theorists hoping they might at last be of some real use, precisely at those
times something very basic has pushed us far from long run equilibrium, and the
Omega point might at exactly those times have raced far, far ahead of us into
the distant future. In fact (I think he
might be saying) we are in a hard and turbulent time because the Omega point has raced ahead, and because there are barriers of some kind between it and us, and because it will be hard to get to
it. If it were easy to get to and there
were no barriers to keep us from it we would be in it already, and the ocean
would already be flat. At times like
that, he’s saying, the Omega-point-long-run is often so far off that it’s not a
proper subject for economic thought. The
proper thought during a storm at sea is not a daydream about how peaceful it
will be when the storm is over. That may
be tempting, but it’s not useful.
There’s a lot more practical value in thinking about how to survive the
storm with as little damage as possible.
One possible response to that view is
to deny that the long run can really move as far as that into the future, but
DeLong (along with most economists these days, I hope) has seen enough of
reality to know that it does not look like that. Another response, the one DeLong describes in
his post, is this: the Omega point may be far away but it is still very
powerful. It may not even exist anywhere
but in the imagination of economists and economic actors (like bankers or
businessmen or workers or consumers). But the imagined Omega point changes their---our--- current behavior. A whimsical analogy: it may seem serene
sitting on the level sand in the top of an hourglass, but you know how an hourglass works.
If you were sitting there on
that sand you would know that deep beneath you is motion and drift,
and that soon you would feel it, soon you would have to react, soon serenity would
dissolve and you would be pulled through the vortex to the Omega point below. And knowing that, you might react immediately
to prepare, even though the sand you now sit on seems placid.
Of course it’s common, and has been since somewhere around
1950 or so, to see the short run as Keynesian, and the long run as classical,
and where you sit on the spectrum of ideology may depend on, or may determine,
which of those two models you find most immediately useful, and on when you
think the long run will arrive. But
DeLong, I think, was saying it depends also, or also determines, how you think
the short run becomes long. He paints a vivid picture of a “backward
propagation” of behavior that is caused by our awareness of the distant Omega
point, and how that might create a quick, even nearly immediate, economic
response to large rises in the money supply, since current economic actors would
feel in their bones that someday, as the Omega point nears, that increase in
money would create inflationary pressure.
They would feel in their bones that because of how they believe the
economy works there is already motion and drift beneath them, invisible, but
there, and they would begin to prepare for the vortex they know is coming. Because inflation, the Quantity Theory tells
us, is always and everywhere a monetary phenomenon. And because economic actors, even though they
may not understand it on a theoretical level, on a mathematical level, are nevertheless
saturated with a devout faith in the Quantity Theory.
As DeLong says this idea explains why
economists with the same theories might differ in their beliefs even about what
the near future holds:
“…beliefs in 2008 and
2009 that economies’ stays in liquidity traps would be very short…and beliefs
since then that those who believe will not taste death before, but will live to
see exit from the liquidity trap and an outburst of inflation as the Federal
Reserve tries and fails at the impossible task of shrinking its balance sheet
to normal without inflation–all of these beliefs hinged and hinge on a firm and
faithful expectation that this long run is at hand,
or is near, or will soon draw near…
“Back in late 2009 I
thought that the liquidity-trap short run
was likely to be a three-to-five-year phenomenon. It has now been six….The
duration of the short run thus looks to me to be,
this time, not three to five years but more like ten. Or more. The backward-propagation
of the induction-unraveling of the short run
under pressure of the healing rays of the long run
Omega Point is not just not as strong as Marty Feldstein thought, is not just
not as strong as I thought, it is nearly non-existent.”
But to me this does not seem like a
surprise.
I’m not surprised by it partly because
I’m pretty ambivalent about the quantity theory of money even as a long run
concept, but partly also because I’m still back there with Keynes: when the
Omega point is really distant, and the transition to it looks like it’s
difficult and uncertain, it is very probably so far away that we will never get
there at all. At least one thing, a
tsunami or a new industry or a bout of irrational exuberance or depression, one
thing at least will happen to us long before we reach that Omega point, and
whatever it is will create a new storm on our ocean, and will shift the Omega
point to some new position. Something
will turn the hourglass upside down or knock it on its side, or tumble it end
over end down a hill, or break the glass that forms it, or something, and preparing
to whirl through the vortex to an imagined Omega point beneath us will do us no
good when we’re sitting under a torrent of sand dropping on our heads from
above, trying to bury us.
How likely is it that something will
happen to interrupt our trip to the Fabled Economic Long Run? How stable and certain is the Omega point? My own view is that unless the Omega point
really is “at hand, or near, or will soon draw near”, it’s not very certain at
all. And what’s worse, it’s not
uncertain in a way that’s easy to handle: it’s not just subject to some random
variation around a long run expected value.
It’s not stochastic. It’s unknown. We can prepare for it by gaining strengths
that will be useful no matter what the future is. But we can’t rationally forecast it with a
formula.
One example of this that I’ve used
often is the World-Wide Web: in 1989 we could not possibly have predicted the
dot-com bubble of just a few years later, because there was no dot-com start-up
in existence in 1989. The Internet
existed---the capability of sending data between computers. But there was no HTML, no JAVA, no Visual
Basic; there was no such thing as a web app.
There were none of the basic building blocks of modern e-commerce beyond
the existence of the network itself. The
creation of the real World Wide Web changed the way business was done, and left
any prior vision of a long run Omega point that we might have had in 1989 floundering
in the dust.
But that’s a one-time event,
right? Surely that kind of thing doesn’t
happen all the time; surely our longer run expectations are more secure in “ordinary”
times than they were at that point, on the cusp of a transforming technology,
before the first wave of a new and transforming industry. Right?
Let’s go back through a few decades to
see what might have changed the Omega point in each of them. I’ll mention just what comes quickly to my mind,
which means I’ll leave out a vast number of important things that don’t, and I
don’t doubt that you’ll experience some frustration with my lists because I’ll
leave out the very things that you think were most important. So just regard my lists as a start, as
scratch lists, and feel free to add to them.
Imagine yourself not in 1989 but in 1999
trying to look at the long run, the Omega point over the next decade. What would you have forecast?
In the following decade, the 2000s, we had
two new wars sucking away our national wealth, and the horrific events that
preceded those wars. We had a
Presidential election contested up to---and some say decided by---the Supreme
Court. We had the Bush tax cuts early on,
an immense housing bubble through much of the middle of the decade, and then
the largest financial crisis since the great depression. We had the Tea Party, sequesters and fiscal
cliffs. On the up side, the iPhone and
iPad and all of their competitors hit the market, creating an industry that is
still expanding, and after that we not only could order things from abstract
stores without walls, we could do it from our hand held computers (our phones) while
we sat on a park bench. Industry
insiders may have expected each of those things, but most of us did not. YouTube, Facebook and Twitter all were
founded and blossomed; and even industry insiders did not expect those, because
there were no industry insiders in the new industry of social media. SpaceX was founded in 2002. In 2000 the
Federal budget ran a significant surplus…remember
that? Which the CBO projected would continue through the decade and wipe out
the Federal debt. Alan Greenspan, the Ayn Rand acolyte and fiscally
conservative Chairman of the Fed, went before Congress to warn them that the
budget surplus was far too big, that we were paying off the national debt so
fast that it was dangerous to our economic well being, and he then begged Congress
to be more fiscally profligate.
Mid-decade we had Hurricane Katrina that trashed New Orleans; in 2010 we
had an earthquake that devastated Haiti.
In 2004 there was a tsunami that pushed the Indian Ocean well inland
across much of Southeast Asia. Oh…and of
course, a Republican President requested, and Congress enacted, a $700 billion bank bailout, an amount that at
the time seemed almost inconceivably huge, and in quick succession after that we
elected the first black President in US history, and the new President asked
for and received from Congress a $787 billion economic stimulus bill on top of
the bank bailout. He also proposed, and
Congress passed, a national health care bill that drove the Republican party to
such frothy-lipped distraction that it would repeatedly bring the whole country
to the brink of fiscal default by refusing to raise the ceiling on the debt
that the CBO, at the start of the decade, had thought would shrink until it vanished.
How much of that did you predict in
1999?
For the 1990s we’ve already mentioned
the emergence of the World Wide Web and the dot-com bubble. Amazon was founded in 1994. Web TV, Java, Google, and the first Gulf
war. Clinton was impeached by the House,
and then acquitted by the Senate. The
Los Angeles riots in 1992. Did you predict all of that in 1989? Do you want to argue that those things had no
impact on the long run Omega point?
For the 1980s we can point to the
emergence of personal computers as a major industry; it had really started in
the 1970s, but IBM took it to the big time with the first IBM PC in 1981. Those of you who are very young can’t begin
to understand what a radical transformation that was. MS Dos emerged; the Apple Macintosh was
marketed with the famous Super Bowl ad. At
the end of the seventies there was a widespread fear that rapid inflation was
built in to the system in a wage-price spiral, but a deep Fed-induced recession
in the very early years of the 1980s killed inflation expectations by driving
interest rates through the roof. Then we
had “morning again in America” in the middle years, as soon as the Fed allowed
it, and recession again at the end. In
1982 Israel invaded Lebanon. Reagan
fired 13,000 air traffic controllers, which reputedly so damaged the labor
unions in the United States that they have not really recovered since. Again, those of you who are too young to
remember how things were before that event won’t really understand how
transforming that act was, and how much it changed the economy we live in. Congress, with Reagan strong encouragement, reduced
the top tax rate from 70% in 1979 to, for a time, 28% in 1986. Iran-Contra.
Nicaragua. Oliver North sneaking
secret documents out of the OEOB in his secretary’s undergarments, and his
potted plant defending him at Congressional hearings.
Back another decade: what would you
have predicted looking forward from 1969?
The 1970s ended the Vietnam War in somewhat chaotic fashion; President
Richard Nixon was impeached and resigned; in 1973 OPEC imposed an oil embargo
that sacked the US economy in many ways.
A Republican President imposed Wage and Price Controls, an almost
Marxist intrusion of federal fingers into the operations of private markets. Crude oil prices rose from under $2 per
barrel in 1970 to over $36 per barrel in 1980. $36 per barrel may sound cheap
by modern standards, but think what an18-fold increase in the price of oil from
its current level would do to our economy now---from the current roughly $60
per barrel to over $1000 per barrel. Think
about that. Do you think that would have no impact on our long run
expectations? Other seventies events: Apple
computers, Atari computers, Visicalc,
Ethernet and TCP/IP. Floppy
disks, microprocessors, videocassette recorders, LCD screens. Word processors. Pong and the beginning of computer gaming.
Looking forward from 1959? In the sixties: lord---do we really have to
do the sixties??? The riots, the civil
rights movement, the anti-war movement---the Vietnam War itself? The whole suite of New Frontier and Great
Society programs, including Medicare and Medicaid? Leaving
the planet Earth, for the first time in history: we had barely left the
atmosphere at the beginning of the decade, and by the end we had landed men on
the moon. The event itself has not yet
impacted any Omega point, but the process of getting there surely did. The Civil Rights Act, the Voting Rights Act. The assassinations of John Kennedy, Robert
Kennedy, Martin Luther King, Malcolm X, the Birmingham church bombing, Medger
Evers, Chaney, Goodman and Schwerner. Woodstock
and Altemont.
And the fifties: the Interstate Highway
System, the Korean war, the invention of the credit card, radial tires and the
transistor radio, Cobol, Fortran and, of course, the births of Barbie and Mr.
Potato Head. Sputnik and the start of
the space race. The House Un-American
Activities Committee, and McCarthy in the Senate.
Forties: Nazism, Pearl Harbor and all of WWII, the
Marshall Plan, the entire south walking out of the Democratic National
Convention and forming their own separate States Rights Democratic party. The beginning of the Cold War.
Thirties: New Deal, WPA, Great
Depression, Social Security, the dust bowl, Hoover Dam, the Rural
Electrification Administration and the Tennessee Valley Authority, and the
publication of Keynes’ General Theory, which created modern macroeconomics, and
also created a schism in the economic world that we have not yet resolved.
The point of all this is that if the
Omega point is not too far away---if we’re fairly close to long run
equilibrium---then its fire will warm us, and we will all react to it, and do
our best to prepare for it. If it’s
close it’s powerful on its own as our “long run” destination, but also
powerfully affects our short-run behavior, because we really believe in it, we
can feel it. But the farther it is in
the future the less likely it is that we will ever get to whatever Omega point
is pulling at us. It’s still a valid abstraction. It is still the direction that the economic
fundamentals are now moving us, in some sense.
But if the Omega point is a decade away, if too much has to happen to
get us from here to there, then the odds are that a great deal of turbulence
will intervene between now and that long run, and by the time it really could
be at hand, or near, or soon draw near, by that time the Omega point that pulls
at us will not be the one we see now. By
that time the Omega point will have moved to a very different place. And I think most people can see that, and
react as though they can see it. The
distant Omega point does not warm us.
It’s like a fire in another room, or even in another house.
One quick word about the Quantity
Theory and the money supply, and I’ll stop.
There seems to be a great deal of panic in some circles that the Fed has
quadrupled the quantity of base money in the years since 2007. That is the source of Dr. Feldstein’s original
bewilderment and DeLong’s comment about the price level being proportional to
the monetary base when we at last reach the Omega point. But lost in this panic is the fact that the
monetary base is never stationary: it doubles about every 10 years to accommodate
a rising nominal GDP, and has been doing that for many decades. Yes, the base money supply has quadrupled
from its level at the close of 2007, but it’s already been 8 years since then. The Fed will have to be alert, yes, and be
ready to draw that supply down if it becomes necessary. But as time goes on the amount that will have
to be drawn down dwindles. At that time,
the Omega point time that DeLong sees in the future, the Fed’s scramble to
“shrink its balance sheet to normal” may not seem impossible at all. If the Omega point is 12 more years away, the
Fed has already accomplished the task: all it has to do is stop expanding, which,
in fact, it is doing. The base money
supply has held more or less steady for the last year.
Here’s the truth: the ocean is never
ever flat. There are calmer times and
more turbulent times, but it’s never flat.
Even if the general economic models, the Keynesian short run and the
classical long run, all capture real trends in our economic lives, and point to
some economic destination that results from our policy choices, we can’t
believe that ordinary economic actors will rationally treat that long run
single-point destination as inevitable.
In fact, to turn that phrase backwards, we can’t think that it would be
rational for them to think of it as inevitable, particularly when the process
of getting there will take time, and has to leap a few hurdles. Because, to abuse a phrase, the Omega point is
just one damned thing, while real-world economies are one damned thing after
another.
