Saturday, May 29, 2010

Krugman Blog

I may write on this thing called a blog, but I spend little time reading the blogs of other people. I basically read conventional media, often in conventional form. I like to sit for a while in the morning with the actual newspaper and drink my coffee.

Now, being curious, I took a look at Krugman's blog, to see how he does it. The guy writes a lot. He'll have at least one, and maybe two posts per day. They are short thoughts, with typically a strong opinion stated. Of course, I'm not opposed to strong opinions - I certainly have a few of those myself. However, let's take one of these blog posts apart to see how it works. For May 26, here, Krugman has a post called "Reasons to Despair." Certainly a dramatic title - sounds like a Thomas Hardy novel. Here's the first paragraph:
For some reason today’s papers made me feel especially grim about the prospects for economic recovery — not the economic news so much as what one sees about the mindset of policy makers.
So, we are in despair because the policy makers are doing something wrong, or we think they are about to do something wrong. What is it? Next paragraph:
Here’s where we are: growing GDP, but mass unemployment still the law of the land, with only tiny progress so far. What can be done?
Yes, GDP certainly is growing - it's been doing so for three quarters now. The rest is loaded language. Krugman likes the term "mass unemployment." Obviously he thinks the unemployment rate is too high, but relative to what? Does he have some insight as to what an optimal unemployment rate might be at this time? Note that he does not point out that employment is growing, and the unemployment rate did not fall last time around because of an influx of workers into the labor force. There are more people searching because they think the their prospects look a lot better. Let's see what he thinks we should do about the mass unemployment.
Well, we could have more fiscal stimulus — but Congress is balking even at the idea of extending aid for the ever-growing ranks of the long-term unemployed. Fiscal responsibility, you see — hey, and let’s make sure estate taxes stay low!
Even if you were a diehard Keynesian, this is strange talk when you have a recovery well underway - everyone knows that employment lags output, and the unemployment rate takes a long time to fall in a recovery. Our unemployment benefits could certainly be more generous though. As Kartik Athreya would say: "insure people, not firms." Here's what's next:
We could get tough with China, which continues its currency manipulation and, in the face of a world of grossly inadequate demand, is actually tightening monetary policy to avoid an overheating economy — when basic textbook economics says that it should be appreciating its currency instead, which would not only rebalance China’s economy but help the rest of the world. So given China’s outrageous behavior, Geithner went to China, got nothing .. and pronounced himself very pleased.
I did not realize Krugman was a China basher. How unseemly. I'm not sure what textbook Krugman was reading, but it wasn't mine (I know, shameless advertising). I thought notions that a country could somehow "manipulate" it's exchange rate to its advantage, or that economic policy was about "balancing" something were long ago relegated to the garbage dump, but apparently not. On we go:
We could do more through monetary policy. Macro theory suggests that the theoretically right answer, if you can do it, is to get central banks to commit to a higher inflation target. But the Fed and the Bank of Japan say no, because … well, that’s not what central bankers do.
What macro theory? The right answer to what? I don't know what Krugman wants the Fed to be doing. Krugman is a liquidity trap guy, so how does he think we get more inflation from the central bank in the current state of the world? The Fed could reduce the interest rate on reserves to zero, but that won't get us much more inflation. I don't know about the Bank of Japan, but it's hard to characterize the Fed as under the control of a bunch of inflation hawks - Bernanke is decidedly dovish on inflation, for example. And finally:
It’s depressing: shibboleths and conventional wisdom are blocking all routes out of this slump. And I worry that policy makers will just sit there, for years and years, all the while congratulating themselves on the soundness of their policies.
I have seen "shibboleth" before, but I looked it up to make sure I knew what it meant. This is actually a cool word. The strange thing here is that Krugman wants to characterize himself as the outsider, despairing that his obvious truths are falling on the deaf ears of the insiders. But Krugman is the insider. His views are in fact those of the majority of policymakers who have any power in this country. I would not characterize those policymakers as sitting on their thumbs congratulating themselves though. They are actually working hard to figure this thing out.

56 comments:

  1. Who are you? You sound like a moron.
    Anon out.

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  2. I suspect that an unemployment rate that hovers around 10% is not optimal; when, what is it, 40% of the unemployed are unemployed for 27+ weeks, that doesn't sound optimal to me either. When all of the jobs created in the last decade go poof, that seems to qualify as mass unemployment. I don't think I'm being unreasonable.

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  3. From the second anonymous to the first: look at Williamson's textbook and take back that silly moron charge.

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  4. One needn't be a moron to sound like one. And, to be sure, writing an economics textbook is neither sufficient nor necessary to not being a moron, either. I accept your apology.

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  5. Sounds like an Andolfatto collaborator. You want to talk about strong opinions? Why don't you dig up anything written by Milton Friedman. That's strong opinion. Not science.

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  6. Good breakdown of Paul Krugman's argument style. The "basic textbook economics" thing has come up before when he debated a WSJ writer. When Krugman says "basic textbook economics", he is referring to his own textbooks even if the particular topic doesn't appear in most other textbooks.

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  7. ...Krugman has a post called "Reasons to Despair." Certainly a dramatic title - sounds like a Thomas Hardy novel.

    My guess is that Krugman had in mind the Ian Dury song, "Reasons to be Cheerful" which many of his readers will have heard. Then again, he seems to take a certain delight in pop-culture references which his readers are quite likely to miss. He entitled one of his Lionel Robbins lectures at the LSE "The Night They Re-Read Minsky".

    As for Krugman's economics, quite a lot of it is available in conventional book form, some of it pitched at a level suitable for lay readers. I'm sure quite a lot of it would strike you as "unseemly", as indeed are Ian Dury's lyrics.

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  8. right on about krugman.

    he obviously, but bizarrely, cares more about his own fame -- hence the drama -- than actual correct policy.

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  9. This is interesting. In reply to your comments:

    1. You know who I am obviously. I guess you mean I am nobody important, while Krugman is very important. Yes, I am a moron, and a nobody.
    2. GDP is growing like it typically does, but the unemployment rate is very high. Further, the drop in employment relative to GDP was unusually large during this recession, i.e. average labor productivity behaved quite differently in this recession. What's going on? I think a lot of this has to do with the change in the sectoral composition of output. For example, coming out of the recession, the growth is not going to come from the housing sector or auto manufacturing in Michigan. There is sectoral reallocation of labor going on - across industries and geographically. That give you a high unemployment rate as the adjustment takes place. There's nothing much the government can do about it but provide public education and generous unemployment benefits.
    3. Yes, Andolfatto and I know each other well. I was on his dissertation committee, we are both former residents of the Great White North, and we are both on the payroll of the St. Louis Federal Reserve Bank. It's not like we agree on everything, though. Sometimes I think he is a moron.
    4. Thanks for the Ian Dury reference.
    5. On the last comment: No, I think you are wrong. Krugman has plenty of fame and money, and he doesn't need or want any more of that. I think he believes he understands the world and wants to make it a better place.

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  10. As regards this:

    I thought notions that a country could somehow "manipulate" it's exchange rate to its advantage, or that economic policy was about "balancing" something were long ago relegated to the garbage dump, but apparently not.

    Certainly Krugman disagrees with you (and many others) there and he doesn’t confine himself to blog posts in making his case. At least he does if you belive in what John Williamson (no relation I presume?) calls the doctrine of immaculate transfer. (But maybe you don’t. I’m not familiar with your work, or indeed any of modern macro beyond the stuff which gets mentioned on blogs such as those of Paul Krugman, Mark Thoma and Brad DeLong. That’s quite enough to fill up my spare reading-time.) In any case, simply calling Krugman a China-basher, with unseemly ideas which belong in the garbage dump, really doesn’t contribute anything. It’s no better than calling him a poopy-head.

    Krugman is a liquidity trap guy, so how does he think we get more inflation from the central bank in the current state of the world?

    Well, if the current state includes the conventions which central banks follow, then we can’t. But Krugman pointed out in 1998 that if a central bank can credibly commit to keeping interest rates low in the future despite higher inflation, it can pull the economy out of a liquidity trap. You’ve read that paper I’m sure. Scott Sumner nags him incessantly about this; unlike you he wants Krugman to push harder for expansionary monetary policy. Woodford and Eggertson (and others I’m sure) have published papers in recent years making similar points. Again, I’m sure you know those papers better than I do. Anyway I think that would be his answer to your question, what macro theory? Of course there’s lots of other macro theory out there but Krugman has never pretended to take freshwater models (for example) at all seriously. He has explained why he rejects that stuff. He hasn’t been so forthcoming about why he rejects other schools such as the Post-Keynesians – I suspect he would echo Robert Solow’s comment that a lot of that stuff is semi-incoherent.

    If you can make even a passably good case that he’s wrong you’ll have a fine blog here. Krugman has lots of critics in the blogosphere, but none really capable of giving him a match.

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  11. Is this post disingenuous or obtuse -- or some toxic mix of both? The attitude and style of the post reminds me of why there were basically no US-born students in my econ PhD program studying Macro -- it is full of a bunch of obtuse mathematical silliness and little material with relationship to the actual world. (The non-US students studied it because it was required for the central bank employment waiting for them back home, but none them believed that any of it was useful (at best it was considered interesting math challenges)).

    So, to answer: "So, we are in despair because the policy makers are doing something wrong, or we think they are about to do something wrong. What is it?" Krugman despairs at unemployment remaining well above prior established NAIRU levels and decreasing at a very slow rate; yet many at the various Fed banks are more concerned about inflation despite long-run treasury yields at historic lows; and despite operating so far away from the PPC, Congress fails to implement effective and sufficiently large stimulus. i.e., PK despairs at this incorrect policy response (see Keynes, JM; or "lost decade" in Japan).

    Next: "unemployment too high" -> yes, compared to NAIRU, compared to where we were a very short time ago. (I guess jumping from 5% to 10% quickly then very slowly returning doesn't seem like a problem if you have tenure.)

    Next: "Even if you were a diehard Keynesian, this is strange talk when you have a recovery well underway - everyone knows that employment lags output, and the unemployment rate takes a long time to fall in a recovery." First derivative is small in this case, small by historic norms. Unemployment is falling at too slow a rate, there is a labor force under utilization gap that will take a long time at this rate to close (2-4 years?). In PK's opinion, this is inefficient.

    Next: "I thought notions that a country could somehow "manipulate" it's exchange rate to its advantage, or that economic policy was about "balancing" something were long ago relegated to the garbage dump, but apparently not." Sad. No, "not". At zero lower bound, China's excess demand for treasuries coveys no corresponding interest rate decrease to the US. (See Beggar Thy Neighbor on wikipedia if you need a refresher.) So their buildup hurts us. This is elementary, undergrad stuff. Just sad.

    Next: "What macro theory? The right answer to what? I don't know what Krugman wants the Fed to be doing. Krugman is a liquidity trap guy, so how does he think we get more inflation from the central bank in the current state of the world?" FOMC setting an inflation target of, say, min 4% for some sufficiently long period. Putting it as a stated policy and in the notes. In other words, change expectations by jettisoning that silly policy that most everyone really believes that the Fed really believes: price stability is the only mandate. The market believes that the Fed bank governors as a whole cares much more about price stability than unemployment/output optimization (if at all). Because of a bunch of silly 70s and later models that seemed to say that the Phillips Curve doesn't exist, inflation expectations are perfectly and instantly understood by our wonderful representation agent in all his wage negotiations, blah blah blah.

    Next: "But Krugman is the insider. His views are in fact those of the majority of policymakers who have any power in this country." Really...? http://www.ft.com/cms/s/0/932eafe6-69c1-11df-8432-00144feab49a.html

    My apologies for the acerbic tone, but Macro is indeed in a dark age. Colander warned about this a long time ago. Sad. http://delong.typepad.com/sdj/2010/05/a-missing-macroeconomic-playbook.html

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  12. Yes, it is hard to articulate everything I want to in a blog post. I was trying to stay away from the "poopy-head" style of argument, but without complete success apparently. Economic science is done much more carefully, and that's my day job. See here:

    http://artsci.wustl.edu/~swilliam/

    I am actually quite optimistic about the state of macroeconomics. When Krugman, or the last commenter, write about "freshwater macro," what they appear to be talking about is macro circa 1978. There are plenty of tools developed in the last thirty years that can be brought to bear (are are being brought to bear) to understand our predicament and what to do about it. In the departments I have worked in, the PhD students are intensely interested in macro, and many of them have gone on to do quite well for themselves in the economics departments and central banks of the world.

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  13. I think Krugman's main criticism of "freshwater macro" isn't that it is totally wrong and bad and hasn't done any good work since Milton Friedman, his criticism is that those schools are largely unaware of the work being done on the coasts. I don't know nearly enough about how economics is taught around the US to know if that is true, but his argument is that a grad student at Princeton is exposed to both schools, whereas a grad student at, say, Minnesota pretty much just gets the "freshwater" side of things.

    Which raises the question of what the schools are. I don't think he sees "saltwater" and "freshwater" as being two distinct schools of thought as much as they are two nebulous and ill-defined collections of scholars, theories, and papers. The criticism is that the freshwater people haven't paid enough attention to the saltwater people, and as a result are incapable of communicating with them on certain issues. The criticism is not that they have rejected some saltwater theory synthesis. So, for example, Krugman says the fed should be doing more and someone not familiar with his past writings says, "aren't you a liquidity trap guy, what more could they do?" People who do know more about his past papers and current policy positions think, "oh, he wants the fed to credibly commit to low interest rates over a long term." Krugman's point is that a freshwater economist should be familiar with his papers and policy positions, just as he is familiar with the papers and ideas coming out of the middle of the country. Basically his argument is that "freshwater" schools have a teaching culture which has ignored half the economics profession over the last few decades, that that has bread scholars who are unfamiliar with what half the profession has been doing over the last few decades, and that that is just obviously stupid and bad.

    Again, that could be totally unfair, you are in a better position to judge if what he is saying is right than I am. I just want to make sure you understand what he is saying.

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  14. One of the concerns raised in blog comments about current DSGE models in what we could call the "Andolfatto fiscal policy firestorm posting" is the lack of serious modeling of government. For instance, in Prof Williamson's text, it is just something that wastes resources and shifts the PPF inward. Yet recent work, such as Easterly (Was the Wealth of Nations determined in 10000 BC) suggests government plays a crucial role in economic development. There was also some work by Aschauer back in the 80s about the role of infrastructure. No extant DSGE model can really be taken seriously in the analysis of fiscal policy until models are developed that take government seriously. Markets and government are surely both complements and substitutes. I know there is an extensive politico-economic literature by the likes of Tabellini, Alesina et al but this too doesn't really "get" government except as a convenient device to play lots of game theory.
    I also note that Prof Williamson nowhere mentions in his intermediate text that the whole book may be chimerical because of the lack of existence of any such animal as an aggregate production function. Perhaps that would be too jarring for tender undergraduate minds...
    paul e.

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  15. Anonymous #2 back again.
    (1) You didn't respond to my comment on mass unemployment. There are millions of unemployed Americans; there are millions more unemployed since the recession started in Dec of 2007. The fact that there is slow growth
    doesn't make the unemployment any less problematic. The number now is 5 unemployed
    for every job opening; this is betyter than 6 but styill nothing to write home about. What's so hard about calling this as your eye's see it: mass unemployment. But then you have to think hard about how our models allow this to take place.
    (2) Being linked to by Mark Thoma is a good thing! I have now discovered your blog and will check you out now and then. It also meant that rude people came to your site and for that...I wish people would say what they want without name calling.
    (3) I respect your text but I don't believe in it. I use Mankiw.

    malcolm

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  16. " Krugman likes the term "mass unemployment." Obviously he thinks the unemployment rate is too high, but relative to what? Does he have some insight as to what an optimal unemployment rate might be at this time? Note that he does not point out that employment is growing, and the unemployment rate did not fall last time around because of an influx of workers into the labor force. There are more people searching because they think the their prospects look a lot better. Let's see what he thinks we should do about the mass unemployment."

    Ok, first off, I don't think "mass unemployment" is a misuse of language or misleading. This is very unusually high unemployment by the standards of the last 100 years, and Krugman believes, I think rightly so, that it's much higher than it would be if we had had smarter economic policy. It's just not a misuse. It is "mass" relative to his benchmarks, one of which is the pain and suffering and another of which is history.

    "Does he have some insight as to what an optimal unemployment rate might be at this time?"

    Yeah. He does have a Nobel Prize in economics, and if you'd look at his work you'd see he's studied situations like this intensely for decades.

    "Note that he does not point out that employment is growing"

    He has mentioned this in other blog posts, if you follow his blog. It's hard to mention everything in just one blog post. It's not a 30 page article. And he's also noted that at the rate it's growing it would take many years to reach what he considers in the neighborhood of the lowest sustainable and practical unemployment rate, and there's no need to suffer for that long when we can speed things up greatly. As Keynes said, "In the long run we're all dead.".

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  17. "Even if you were a diehard Keynesian, this is strange talk when you have a recovery well underway - everyone knows that employment lags output"

    Again, if you read other Krugman posts you'd see he points out that output is growing, but slower than at similar points in other recoveries.

    And again, his whole point is that output growth and employment growth both are positive, but could be far more positive with smart stimului, both fiscal and monetary. At the current rate of recovery we'd suffer many years with far lower output and employment than we could have had with smart fiscal and monetary stimuli.

    It's like if you have pnemonia, and you're recovering naturally. Sure in a few months of laying in bed and not being able to work you'd fully recover, but you might be financially ruined by then. It's just stupid to suffer unnecessarily far longer than if you just took the pennicillan. Take the pennicillan so you recover in a fraction of the time and don't bankrupt your family.

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  18. "I thought notions that a country could somehow "manipulate" it's exchange rate to its advantage, or that economic policy was about "balancing" something were long ago relegated to the garbage dump, but apparently not."

    Just not true. Many esteemed economists think there can be exceptions. In fact, there's a whole literature on optimal currency areas with the implicit idea that an advantage is you have the power in your zone to manipulate your exchange rate. It especially can be an issue in a worldwide demeand glut at the zero lower bound.

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  19. "What macro theory? The right answer to what? I don't know what Krugman wants the Fed to be doing. Krugman is a liquidity trap guy, so how does he think we get more inflation from the central bank in the current state of the world? The Fed could reduce the interest rate on reserves to zero, but that won't get us much more inflation."

    Ok first off, "What macro theory?". This is the Dark Ages of economics Krugman talks about. Theory that's taught at schools like Harvard, Berkely, and Princeton, just not at freshwater schools like Chicago. This is why you thought that exchange rate manipulation in some cases being advantageous was on the garbage heap of economic history.

    Second off, Krugman answers this in a post one day earlier:

    You either have to buy lots of long-term assets — we’re talking multiple trillions here — or credibly commit not just the current FOMC, but future FOMCs, to pursuing higher inflation targets.

    at: http://krugman.blogs.nytimes.com/2010/05/25/inflation-deflation-japan/

    Very short term interest rates are near zero, but the Fed can buy longer term bonds as much as it wants, pushing interest rates as low as it wants. It could push the typical 30 year fixed mortgage rate to zero if it wanted. A $150,000 house would have a monthly payment in the 500's! Or 60 year mortgages could be bought to zero interest by the Fed; then the payment on our $150,000 house is $250/month! Clearly the Fed could create inflation if it really wanted to.

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  20. Another one of the legions of economists suffering with Krugman envy.

    Check out Scott Sumner's blog. He spends his life trying to be noticed by Krugman.

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  21. This blog business could get rather time-consuming. I'll answer some of your queries, but I won't have time for much detail here. Thanks for the comments. This is very informative.

    1. I think what bothered most macroeconomists about Krugman's piece in the New York Times Magazine was that he was speaking to the general public in an authoritative way about the state of macroeconomics, with a Nobel Prize to back him up, but from our perspective he just seemed out-of-it. Things like this are damaging to the profession. It's hard enough as it is to gain respect for what we do without being sabotaged by our own. Krugman characterized "freshwater economists" as people who sit in their cocoons, ignore the saltwaters, and have nothing to say about policy. I don't think this was true even in 1978. What I would characterize as "Minnesota Macro" is incredibly diverse, and has spread all over the world. There are people who we might once have considered Minnesota Macros who are practicing New Keynesians - people like Larry Christiano and Bob King. Some departments, for example NYU, have a mix of Minnesota Macros and New Keynesians, and they seem to get along fine. My background is not Minnesota - I was educated at Wisconsin, and the people I worked with most were Rao Aiyagari and Mark Gertler. Rao was a very open-minded scholar, and Mark has gained prominence as a New Keynesian, but works both sides of the fence. People like Mark and Nobu Kiyotaki are basically first-rate economists who have contributed in a big way to modern macro, sometimes by doing Keynesian economics.

    2. I certainly don't envy Paul Krugman. I'm perfectly happy being me.

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  22. Krugman is also worried about big downside risks to future real growth (see his comparisons to Japan). He also thinks that significant part of current unemployment is cyclical and could be solved with higher current AD.
    From the old monetarist perspective broad monetary aggregates are not performing well - that means Krugman's fears may be justified. What is the new monetarist perspective - are we going to get a faster growth in M2 or are you hoping for an uptick in velocity?

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  23. Some other replies to your comments:

    1. Good point about the government. I'm certainly not a government minimalist. I grew up in Canada, and I'm quite content to have a broad array of social insurance, including government-run health care. Indeed, I think it's efficient. But I think the foundations for Keynesian economics are too weak to take it seriously. The case for countercyclical government spending is dubious - except that the government might want to undertake large capital projects during a recession when the costs are low.

    2. This is where I think Krugman is wrong - low employment and high unemployment is in good part due to sectoral adjustment. You don't want to think of the current recession as being some aggregate "financial shock." The financial propagation is obviously important, but there is a key sectoral element to the underlying shock that makes this recession look so different.

    3. A New Monetarist does not pay much attention to M2, M1, or velocity. I'm interested in thinking about the central bank as another financial intermediary (with some special powers) and how it relates to the other financial intermediaries in the system. You can't summarize what is important in some monetary aggregate, for example.

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  24. "Krugman characterized "freshwater economists" as people who sit in their cocoons, ignore the saltwaters"

    Maybe a lot aren't, but some prominant ones seem to be by the things they say, like repeating the "Treasury View".

    For example, have you heard some of the wildly unrealistic things Casey Mulligan of Chicago has said on his blog?

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  25. "The case for countercyclical government spending is dubious"

    What about World War II? How can you explain such a fast stark plunge in unemployment other than the concurrent giant increase in government buying?

    Also, have you read Krugman's article, Baby-Sitting the Economy, at:

    http://www.slate.com/id/1937

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  26. PK: ".... basic textbook economics says that it should be appreciating its currency instead, which would not only rebalance China’s economy but help the rest of the world....."

    You: "I thought notions that a country could somehow "manipulate" it's exchange rate to its advantage, ..."

    As Krugman himself has not only said repeatedly (as a New Trade Theorist), but actually alludes to in the very paragraph you quote: "... not only rebalance China’s economy ....", i.e., in the sense reflecting real free trade.

    "On we go ...."

    Far too fast. Why not slow down and actually read what PK's written on various topics before going off half-cocked? I've been reading him for years, and I have to say, many of his critics write things about him that make me wonder what economist they are talking about.

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  27. "... low employment and high unemployment is in good part due to sectoral adjustment."

    Specifically? I suppose you'd say it was mainly those construction workers who don't have any construction jobs.

    Not sure that one holds much water, though:

    http://www.econbrowser.com/archives/2009/12/how_important_i_1.html

    If there are 15 million unemployed, construction might be only one out of 10.

    Manufacturing was harder hit in this recession than construction, but is now rebounding much faster. That would make sense given that (1) the U.S. is still the biggest manufacturing exporter in the world, (2) that the dollar has sunk significantly, and (3) demand is increasing elsewhere in the world. That's not "sectoral adjustment". That's just factories revving back up again.

    There might be something to this "sectoral adjustment" idea, but basically, it doesn't look much more plausible than Casey Mulligan's supposition that a lot of people just don't feel very much like working these days.

    Don't just wave your hands and say it might mostly be sectoral. Get specific. Isn't that how economists build their cases? From actual data? That's what I'm used to from reading economists, like, well, Paul Krugman, for example. (Not that you'd know -- you don't read him much, by your own admission.)

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  28. "Krugman characterized "freshwater economists" as people who sit in their cocoons, ignore the saltwaters.... "

    Isn't it a tad disingenuous to characterize Krugman's remarks as some vulgar regional prejudice when it's always been clear that the terms refer to schools of thought that happened to correlate somewhat geographically? Are there not "freshwater economists" at Stanford, and "saltwater economists" at Chicago?

    The characterization has always been tongue-in-cheek. Robert Hall, who apparently coined the fresh-/salt-water dichotomy, wrote: "To take a few examples: Sargent corresponds to distilled water, Lucas to Lake Michigan, Feldstein to the Charles River above the dam, Modigliani to the Charles below the dam, and Okun to the Salton Sea."

    That said, it does seem that people like Barro, Cochrane, Lucas, etc., often opine publicly as if nobody in macroeconomics had ever seriously challenged the "policy ineffectiveness proposition" that was so much in vogue in the late 70s. If I'm not mistaken, some of them back then went so far as to say that there'd be no serious repercussions for the economy in raising interest rates to kill inflation. As it happened, repercussions were so dramatic that we've only recently reached similar unemployment rates; in Chile, it got so bad in 1983 that the Chicago Boys were fired, and "emergency employment" was hiked up to 30% of the workforce -- far higher than FDR have ever gone with the WPA. But how embarrassing to have to admit that they ended up making a Keynesian of Pinochet. No, no, no,let's pretend it didn't happen.

    If you want to accuse people of taking the fresh/salt distinction so seriously as to be utterly blinkered (or to appear blinkered, at any rate) to what the other side has said, I don't think you'd put Krugman at the top of the list, exactly.

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  29. "What about World War II? How can you explain such a fast stark plunge in unemployment other than the concurrent giant increase in government buying?"

    Um, any number of reasons, surely. Perhaps a change from a capitalist economy to what was in effect a government-run economy? Where the entire population supported the change and so didn't try to muck things up (via strikes or capital flight)?

    Any arguments from WWII to the present economy seem to me highly dubious.

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  30. "Perhaps a change from a capitalist economy to what was in effect a government-run economy?"

    I guess that would mean the U.S. stopped being a capitalist country starting late in 1941. But I'm only judging by this:

    http://granitegrok.com/pix/TaxesAsPercentOfGDP.gif

    Strangely, this period of non-capitalism from 1941 to the present day includes some of the periods of greatest economic growth and living standards improvement in American history. Also very hard to understand: from the end of WW II to around 1990, this supposedly socialist order in America was engaged in something called the Cold War, opposed to other socialist countries, in defense what my elders called "the free enterprise system".

    Note also that even at its peak in WW II period, the ratio of federal revenue to GDP never reached 20%, and that this has remained roughly the same (14%-18%) over that whole period.

    "Any arguments from WWII to the present economy seem to me highly dubious."

    Any very significant differences between the WWII period and the present economy strike me as pretty negligible if your goal is debunking Keynesian stimulus.

    Sure, there was a war on, skewing production toward that -- military expenditure as a share of GDP almost touched 40% at one point.

    http://symonsez.files.wordpress.com/2010/01/us-military-spending.jpg

    And to the extent that there was rationing, it skewed consumption away from rationed goods. But it did create jobs, and promote investment and spending, in the domestic, non-military-related economy. But real GDP per capita bumped up to an unprecedented level, and even during the slump of the immediate postwar period, never really settled back.

    http://www.asymptosis.com/wp-content/uploads/2007/12/gdp_per_cap_chart_1799_on.gif

    In short, the bulk of the economy in WW II was still non-military, and it apparently did benefit by WW II spending.

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  31. Hey yo! Great post! It did help me a lot in my research. Thanks for the information.

    Tagged: bank reviews

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  32. "Strangely, this period of non-capitalism from 1941 to the present day includes some of the periods of greatest economic growth and living standards improvement in American history. "

    No one said that the period of non-capitalism continued after WWII, that's you.

    "Also very hard to understand: from the end of WW II to around 1990..." So now you switch to the end of WWII. Of course, during WWII, the US had no problem partnering with the Soviets. But, unlike you, I wouldn't infer anything from that. Socialist countries can fight and be enemies with socialist countries; capitalist countries can fight and be enemies with capitalist countries.

    "Note also that even at its peak in WW II period, the ratio of federal revenue to GDP never reached 20%,..." 20%, that doesn't sound much. Until we read: "military expenditure as a share of GDP almost touched 40% at one point." And that's just military expenditure.

    Anyway, I don't really care about labels. If it bites your back to call the US economy during WWII, non-capitalist and government-run, then let's call it capitalist. But it's not a type of capitalism that could be repeated today. If the government started ordering people around to the same extent that it did during WWII, people wouldn't take it, and they would try to muck it up - not paying their taxes, striking, working less, getting their money out of the country.

    "Any very significant differences between the WWII period and the present economy strike me as pretty negligible if your goal is debunking Keynesian stimulus."

    My goal isn't "debunking" Keynesian stimulus. I haven't put a horse in this race. You, on the other hand, apparently have. And if you think that the difference between the present economy and the WWII economy is negligible, well then, there's not much more that can be said to continue this discussion. And if the *best* justification for Keynesian stimulus is WWII (or, as I sometimes read, Nazi Germany), then Keynesian stimulus has real problems. Not - to repeat - that I'm saying it does have real problems, just that it better have better justification elsewhere.

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  33. Dear Stephen,

    It's interesting. I came hear from MR. I was all ready to start responding to your comments, but the other replies have done a good job. I'd just like to make the point that the beauty of the blogosphere is that all these novices know exactly what PK is talking about. They understand his arguments even the somewhat technical aspects and are engaging in the debate. You could become a part of that argument, but I hope you will take other thinkers more seriously and "get in the game" so speak.

    I was in a Ph.D. program at Texas for two years. My professors were a lot like you, they don't really understand what people are saying. They don't know the arguments, but as a blogger, we learn the arguments as they develop over time, so we know the detail behind this PK post. We understand it, and it's not way out there stuff. Here is a link of Ben Bernanke addressing Olivier Blanchard's call for a 4% inflation target. And of course, quantitative easing has gotten lots of attention, since Japan in the 90s that was reignited today (here's an easy paper Bernanke wrote in '04). What can the fed do? The short answer is print money and buy t-bills, but there are lots of other ideas out there.

    Frankly, you should know this stuff. Maybe you know more than you letting on, but these are serious people. It's easy to turn your nose up at Krugman cause he's not a macro guy, but can you so easily dismiss Bernanke and Blanchard? Going to school at Texas, a lot of what PK says really hits home. I mean in this post you even show how you just aren't with it. You aren't in the debate.

    I took 3 macro classes at Texas. I learned lots of dynamic programming and computational macro like Krusell/Smith and Aiyagari. We had GE models trying to map the wealth dist. or the risk premium. We read lots of Prescott did lots of RBC stuff, what else? oh solving Stationary Rational Expectations Equilibrium was as close as we got to anything monetary related. In only one model in all three classes did monetary policy have an effect, and it was an inflation tax model. I never read a Woodford paper or anything like it. (I think some of my teachers hadn't either)

    I think the tools of the saltwater schools have value probably more than PK does, but I think even he would concede that they have some. What I think he is bemused about is that my professors actually act like they believe their models. Ed Prescott doesn't think monetary policy can have a real effect on the economy. I've seen him say as much. After a talk by Lucas, he said I don't see how any of this can have a real effect. They couldn't really even converse.

    As far as I know, the saltwater schools basically aren't represented on the blogosphere. And I would love for them to get in the game. Maybe you could even start that. It probably still won't even represent my profs, because UT didn't even have any monetary classes and our young prof advanced macro prof. who came straight form Rochester told us "I don't know anything about monetary policy." He hadn't learned any at Rochester.

    I was in a Ph.D. program for 2 years, took 3 macro classes, and didn't learn one argument for why the fed should exist. You should know that for people like me, PK's criticisms really hit home.

    I'm probably telling you what I wish I had told my professors. I want economics to be better, and I want economists to be better. Good luck blogging. I hope you get in the game. If you produce quality work, your ideas can reach a wide audience.

    Charlie

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  34. Excellent blog. Don't give up on it. I generally agree with Krugman but it's a breath of fresh air to read a lucid freshwater guy take the other side.

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  35. This reminds me of arguments I had with Deirdre (and Don too) McCloskey at the University of Iowa. There was no making any headway, as her (or his) answer would ultimately be that "if you understood, you would agree with me." I think I have dipped into the Krugman archive enough to understand how he thinks about macro. It's basically a conventional Econ 101, IS-LM, AD-AS view of the world, with a bit of Mike Woodford thrown in. I actually put a lot of effort into understanding Woodford, and have written extensively about that (see my Wash U department web page for that). I read "Interest and Prices" and have seen plenty of New Keynesian papers, including Mike's recent stuff. What I'm trying to do here is something the monetary theorists I talk to (Neil Wallace for example) have shied away from, which is putting New Monetarist ideas into a language that most economists should be able to understand. As New Monetarists we think we have a lot to offer. We think the real business cycle theorists, the New Keynesians, and the Old Monetarists, have been falling down on the job, and that we can ultimately do things better.

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  36. "As New Monetarists we think we have a lot to offer. We think the real business cycle theorists, the New Keynesians, and the Old Monetarists, have been falling down on the job, and that we can ultimately do things better."

    Ok, let's see what you've got.

    But I'd still like to hear how you explain the giant sudden plunge in unemployment with World War II if as you've said, "The case for countercyclical government spending is dubious".

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  37. Yes, a war is a great thing for increasing employment. The people who lived through that time seem to agree that having that boom in GDP was great. Good jobs too - getting your head blown off, freezing your toes off in the winter in France, etc. There is nothing Keynesian about WWII - it's all about crowding out. No evidence of a multiplier working, since private consumption dipped, with the help of various rationing programs. Not much of any private capital accumulation going on.

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  38. Ah, there it is whispered again: "Keynesians like war!" *Sigh*.

    OK, explain this: it's 1937, employment growth has been brisk, FDR decides to become fiscally conservative, and the economy tanks -- with employment dropping faster than in 192-33. They have to invent a new word for it, because they are still in the Depression. So they call it a Recession.

    "There is nothing Keynesian about WWII --"

    Keynes himself moaned that it seemed "politically impossible for a capitalistic democracy to organize expenditure on such a scale necessary to make the grand experiment which would prove my case - except in war conditions." (The New Republic, July 29, 1940, p.158)

    Did he ever say that the American economy during WW II was a disappointing experimental result? If somebody was going to say there was nothing Keynesian about WW II, wouldn't it be Keynes?

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  39. "What I'm trying to do here is something the monetary theorists I talk to (Neil Wallace for example) have shied away from, which is putting New Monetarist ideas into a language that most economists should be able to understand. As New Monetarists we think we have a lot to offer."

    Or, as certain McCloskey's might have it: if we understood you, we'd agree?

    Economics, what a field. Sounds like it's tough all over.

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  40. "This reminds me of arguments I had with Deirdre (and Don too) McCloskey at the University of Iowa. There was no making any headway, as her (or his) answer would ultimately be that "if you understood, you would agree with me." I think I have dipped into the Krugman archive enough to understand how he thinks about macro."

    I think you don't realize how out of touch the following statements make you sound.

    "I thought notions that a country could somehow "manipulate" it's exchange rate to its advantage, or that economic policy was about "balancing" something were long ago relegated to the garbage dump, but apparently not."

    "What macro theory? The right answer to what? I don't know what Krugman wants the Fed to be doing. Krugman is a liquidity trap guy, so how does he think we get more inflation from the central bank in the current state of the world?"

    It's not that people necessarily think that if you understood the arguments, you'd agree. It's that people are blown away that you don't understand the arguments, when a bunch of novice econ blog followers do.

    Here is a post about the first quote.

    I find the second quote just embarrassing. I just don't know how you can be a monetary macro guy and not know about quantitative easing. And not at all be part of the debate that the fed should be printing money buying longer term bonds and focusing on raising the rate of inflation to get lower real interest rates. I mean, I was reading about this as an undergrad in the context of Japan. It's not that everybody smart and informed agree, but they all understand. Here's a recent post to get you started. But there is a lot more, contributed by a lot of different people.

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  41. Michael, you do your case no good with your inexplicable replies: "Ah, there it is whispered again: "Keynesians like war!"

    Richard Serlin is the one who brought up WWII (and apparently you concur that it's a good example). So it's not SW who first mentioned war. And there is *nothing*, absolutely nothing in his reply @ 2:46, which can be interpreted as his saying that Keynsians like war. Not even remotely. If you cannot sustain a discussion without making replies that are completely off the point and ridiculous, then one can only assume that reasoned argument doesn't matter to you.

    And my apologies to CW for interjecting myself.

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  42. Obviously we want to stimulate the economy with government spending on alternative energy, infrastructure, basic scientific and medical projects, education, etc. rather than war. But if the government spent World War II money buying those things, why do you think the effect of unemployment plunging (and the workforce expanded substantially with women entering en masse) wouldn't be the same?

    Whatever crowding out occurred in WWII, it still wasn't enough to stop a huge net increase in jobs.

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  43. Honest questions here, Mr. Serlin, just trying to understand:

    1/ All your spending proposals are investments. Does that mean you think that spending WWII money on digging ditches and filling them back in, would not reduce unemployment, or not reduce it as much? Or would crowd out worse? Or has some other bad effect?

    2/ Could you make concrete what you mean by WWII money? How much and for how many years? I guess you think the US government would be able to borrow those sums. At what point do you think the government *couldn't* borrow? You'd agree, I guess, that borrowing 10 times GDP in one year is impossible. (Do you?) Where do *you* start getting worried?

    3/ Spending money on alternative energy probably means buying lots of Chinese and German equipment. Do you agree? Do you think it's ok? Or would you try to restrict this spending on American goods?

    4/ Spending WWII money on infrastructure etc. means ramping up production and then ramping it down. I guess you think that the costs of this kind of resource management are minimal or can be disregarded or we have worse problems to think about. Is that correct?

    5/ Do you think that, to spend WWII kind of money, the average living standards of Americans would need to come down? After all, that's what happened in WWII (with rationing, etc.)

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  44. Good discussion. My two cents again:

    1. Believe me, folks, I understand the models your arguments are based on, and your general worldview. This is like coming into a room where a group of people has been carrying on a discussion for some time. These people have arrived at some conclusions that they all agree on. At first I have no idea what these people are up to, but I ask someone next to me what is going on. He or she gives my the quick synopsis. It's all very clear now. I look at the people in the room, who I have known for a long time. I know a lot about how they think, and I can see how they arrived at these conclusions, but I don't agree with the conclusions. Indeed, I think that if we go where these people want to go, that we'll all be worse off as a result. My job now is to try to change their minds. In the short run, though, I'm not going to be Mr. Popularity. In fact, some of these people are going to bark at me for being late to the meeting.

    2. The unemployment rate should not be your welfare measure. The war example is a good one. Take the Viet Nam War, for example, which hopefully we can all agree was a waste of resources. We can also probably agree that the increase in G from the Viet Nam War increased employment, reduced the unemployment rate, and increased GDP. A good thing, right. Obviously not. We would rather that the US had not fought the Viet Nam War. Ex post, it is clear we would all be better off. The war example is extreme, but the point is that you care about what the G is. The fact that more G gives you more GDP, more employment, or less unemployment, should not necessarily make you want more of it.

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  45. Stephen,

    If your starting to feel up to speed, you could have a good series of posts just breaking up this post into more serious responses. You might want to use some of the links I posted, where PK spells the arguments out in detail. Then respond with your positions in separate posts. Almost everyone in the blogosphere has been calling for more QE (buying longer term t-bills), that includes Krugman, Mankiw, Cowen, Sumner, Delong and Thoma, at least. It'd be interesting to hear your perspective.

    I think there are at least three ideas in this post you could write on.

    1. What does SW think about Aggregate Demand? It seems you have a sectoral adjustment possibly with not perfectly substitutable skills or maybe a time to search model in your head. Do you really think that can account for 10% unemployment?

    2. How does China's currency policy affect the US? Why would China selling dollar reserves and allowing the currency to appreciate not have a stimulus affect?

    3. Quantitative Easing: what should the fed be doing now? Specifically, should the be buying t-bills and targeting higher inflation rates?

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  46. Charlie,

    Thanks. I'll get to 1 and 2 at some point. However, here is something I wrote about the last employment report:

    http://newmonetarism.blogspot.com/2010/05/april-employment-numbers.html

    #3 I have addressed earlier. Read these for example:

    http://newmonetarism.blogspot.com/2010/05/fomc-minutes.html
    http://newmonetarism.blogspot.com/2010/05/ecb-and-inflation-control.html
    http://newmonetarism.blogspot.com/2010/05/fed-independence.html
    http://newmonetarism.blogspot.com/2010/04/fomc-statement-april-28.html
    http://newmonetarism.blogspot.com/2010/04/feds-balance-sheet.html
    http://newmonetarism.blogspot.com/2010/04/money-multiplier.html

    I'm also interested in financial regulation and banking. You can look through my blog archive for things on that.

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  47. Replying to "a"s questions:

    1) It's just a lot better to employ the unemployed on high social return projects of the kind that the pure free market will grossly underprovide or inefficiently provide due to long established in economics market problems like externalities, asymmetric information, inability/impracticality to patent, giant economies of scale/monopoly problems, difficulty of price discrimination leading to underprovision, keeping secret of zero marginal cost idea/information goods, etc.

    These things create far more total societal utilis than digging and filling in ditches.

    2) I just mean a lot of money, enough when combined with smart monetary policy to pull us out of the recession or depression. Then, when the cycle is at or above non-accelerating-inflation-rate-of-unemployment (NAIRU), we can raise taxes to more than pay for this spending, or cut some of it back.

    But I think the spending on government investment should greatly increased permanently, not just cyclically, precisely because it is so underprovided by the pure free market due to the long established in economics market problems I've mentioned. We should just increase taxes (predominantly on the wealthy; the argument that they'll work less is countered with the income effect and substitution effects, the backward bending labor supply curve, and the empirical evidence) to cover it. We should shift our production a lot more long term and permanently to investment and away from consumption, especially zero sum game (or close to) positional/context/prestige heavy consumption. Positional/context/prestige externalities are a colossal source of little addressed inefficiency in our economy. For more on this I suggest this Washington Post Op-Ed from Cornell economist Robert H. Frank:

    http://www.robert-h-frank.com/PDFs/WP.1.24.99.pdf

    and this American Economic Review article:

    http://www.aeaweb.org/articles.php?doi=10.1257/000282805774670392

    3) Some of the spending would stimulate foreign economies, but a lot wouldn't. The benefit to foreign economies would give us more moral authority to ask them to stimulate their economies (and not push down their currencies so much) to reciprocate. And anyway, if some of the government investment spending leaks to other countries, we can just do more of it to make up for it. We're not going to run out of good high return investments, and the recession is projected to last years, so there's time to get these projects up and running.

    4) I don't think ramp down is a big problem. It can be done gradually and monetary policy can pick up any slack. Plus, I wouldn't ramp down. I'd permanently shift away from consumption and towards high return investment (especially in basic science and medicine and making college more easily affordable, so students go more, and study more and flip burgers less). I'd just raise taxes to more than cover it as the economy recovered.

    5) Standards of living would go up, a lot over the long run, with the increased spending on high return investments of the kind the pure free market will grossly underprovide like alternative energy, education, basic scientific and medical research, infrastructure, etc.

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  48. Ok Professor Williamson, so you admit, then, that fiscal stimulus can increase GDP and employment (and greatly):

    "We can also probably agree that the increase in G [government spending] from the Viet Nam War increased employment, reduced the unemployment rate, and increased GDP."

    Great, it's important that we've established that.

    But next you say that the increase was for something undesirable, the production of war. This is clearly arguable for the Viet Nam War (but not for U.S. expenditures in World War II. If all of the non-axis countries said they weren't going to use their militaries to defend themselves I wouldn't be here today, as the Nazis would have exterminated all of the Jews in the world).

    I agree that the composition of GDP matters greatly. For years I've said not all ten trillion dollars in GDP are the same. This is especially due to the sadly neglected but nonetheless colossal positional/context/prestige externalities (see these articles from Cornell economist Robert Frank for more: http://www.robert-h-frank.com/PDFs/WP.1.24.99.pdf , http://www.aeaweb.org/articles.php?doi=10.1257/000282805774670392 ). The more GDP consists of what Frank calls non-positional goods, or inconspicuous consumption, and high return investment goods, the more total societal utils it will lead to over the long run.

    Certainly I'd rather see people unemployed than employed in pursuing a war of pure aggression. But I don't see anything wrong, and a lot right, in seeing people, rather than unemployed, employed in advancing their educations, building high return and badly needed infrastructure, providing the resources for basic scientific and medical projects, building solar plants, the smart grid, retrofitting buildings and other alternative energy projects, especially since such high return projects will be grossly underprovided, or inefficiently provided, by the pure free market due to long established in economics market problems like externalities, asymmetric information, giant economies of scale/natural monopoly, etc.

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  49. Hi Richard,

    Excellent. Now we're getting somewhere. Except for the stuff about Bob Frank (he's interesting, thinks outside the box, but can be a little wacky sometimes) we're pretty much in agreement I think. We have to make judicious choices about what goes into G, based on all the factors you mention. It's not a simple problem. If the world worked like the Keynesian cross, we would have infinite G and be infinitely well off. Unfortunately our resources are finite and the government has to ultimately pay off its debt.

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  50. Agreed, but I think Frank's point is good, and very important, that in a wealthy economy positional/context/prestige externalities are very large. A lot of what's in our GDP provides more positional/context/prestige pleasure/utility than intrinsic pleasure/utility.

    Position/context/prestige shouldn't be eliminated; it can be a nice and useful thing in moderation and used intelligently. But if through smart taxation you can get just about the same pleasure from a Corvette as a Ferrari costing ten times as much, because the Corvette is just as rare and exclusive, then you get virtually the same pleasure for a tenth the cost (I don't think there's much difference in intrinsic pleasure between a Corvette and a Ferrari driven on public streets). And, the other 9/10th's can go towards non-positional goods like cancer research that can save your, or your children's, lives, research to find a way to eat as much as you want without getting fat, better public health, safety, and recreation, and on and on. You just lower the cost of obtaining a given level of prestige (or position, or good seemingness), i.e., $50,000 Corvette as prestigious and good seeming as a $500,000 Ferrari was. You don't eliminate prestige and good seemingness as a pleasure and incentive. You just efficiently make it less costly to obtain.

    And yes, exaggerated example, but tax policy changes could make something like a Corvette as exclusive, prestigious, and good seeming as a Porsche is now, or a 5,000 square foot home as exclusive, prestigious, and good seeming as a 15,000 square foot one is now, etc.

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  51. In addition to the articles I cited, Frank has a book which goes into the research supporting this in depth, "Luxury Fever".

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  52. Thanks Richard for your answers.

    1/ I agree. It seems to me the implication is that it's important to consider the rate of return of government spending.

    2/ "we can raise taxes to more than pay for this spending..." That indeed would be my prefered outcome. But, given the cyclicality of politics and the fact that the choices about how to pay for the debt are left for the future, isn't there a strong probability that the Republicans will get back in and choose to cut Social Security and health rather than raise taxes? It seems to me to be a big roll of the dice, and it seems to me that the biggest stimulus-pushers have very little confidence in the wisdom of Congress today but quite a lot of confidence in its wisdom in the future.

    "We should shift our production a lot more long term and permanently to investment and away from consumption..." I'd agree with that. I just don't think most Americans would agree with that.

    3/ "The benefit to foreign economies would give us more moral authority to ask them to stimulate their economies (and not push down their currencies so much) to reciprocate." You have more confidence in moral authority than I!

    4/ "Plus, I wouldn't ramp down." If you're going to spend WWII kind of money, you have to ramp down, I think. I just don't think it's possible to continue spending that kind of money indefinitely.

    5/ "Standards of living would go up, a lot over the long run..." I'd agree they would. And in the long run - okay, I won't repeat the joke. But in the short run, American living standards would go down, right? Sharply even. I just don't see the American people accepting that bargain, mostly because of "a bird in the hand" rule. Accepting pain now for a better time in the future only works when there is a huge crisis; we haven't had that size of a crisis yet.

    Anyway, much appreciate your taking the time to give me such detailed answers. I think I am on your wavelength in terms of what is theoretically best; I guess I am just more pessimistic about the practical problems.

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  53. Charlie Clarke is quite arrogant for someone who failed out of a PhD program.

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  54. Serlin pretends to know quite a bit about macro for someone whose graduate education came from Arizona, which he hasn't finished. There isn't a single macro person there.

    Arrogance is easy. Science is hard. Try doing science.

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  55. A very good post and an excellent blog. I am now a follower. Thanks, Steve @ http://www.study-aids.co.uk

    Dissertations | Essays

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  56. Mass unemployment should at all times be accompanied by being prepared financially.

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