Zombie economics gets a mulligan: or, how Obamacare caused the Global Financial Crisis

by John Quiggin on February 26, 2010

I’m adding a little section to each of the chapters in my Zombie Economics book called “Reanimation”, about the attempts that are already under way to revive economic ideas killed (at least according to the standard rules of hypothesis refutation) by the global crisis. I wasn’t surprised to find plenty of examples for the efficient markets hypothesis (easy to render immune from any kind of refutation by an appropriate formulation) or for policy ideas that yield big benefits to the rich and powerful, such as privatisation and trickle-down economics. But I was surprised a little while ago to see the crisis described as a transitory blip in the continuing Great Moderation. Still that pales into insignificance compared to this piece by Casey Mulligan of Chicago (h/t commenter Daniel ), in which (I swear this is true!) the crisis is the result of financial markets correctly anticipating the adverse labour market impacts of possible legislation under Obama, such as a health plan that might include means tests.








The crucial point in a good zombie movie is the moment when zombies who seem to have been blasted into the next world by the hero’s shotgun, pull themselves up from the ground and come shambling forward. In the writing of this book, that moment came for me when I read Casey Mulligan’s paper ‘Aggregate Implications of Labor Market Distortions: The Recession of 2008-9 and Beyond


Looking at the way real business cycles theorists have tried to write the Great Depression out of macroeconomic history, presenting instead as a government-induced dislocation of labour markets it was obvious that, sooner or later, something similar would be attempted with the Global Financial Crisis. But, Great Depression revisionism did not take hold until the Depression had faded out of living memory, to the point where hardly any economists who had actually experienced it were still active.


I thought a similar process of fading memory would be required for the GFC. As long as the subprime fiasco, and the chaos of late 2008 remained vivid memories, it would be impossible to deny that this was, indeed, a crisis made in the financial markets.


I underestimated the speed and power of Zombie ideas. As early as Sep 2009, Casey Mulligan was willing to claim that the entire crisis could be explained in terms of labor market interventions. According to Mulligan, financial markets anticipated a variety of measures from the Obama Administration, observing ‘Arguably, the 2008 election was associated with an increase in the power of unions to shape public policy, and thereby the labor market. Congress has considered various legislation that would raise marginal income tax rates, and would present Americans with new health benefits that would be phased out as a function of income.


This is truly impressive. So perspicacious are the financial markets, that even the possibility that Congress might raise taxes, or incorporate a means test in health care legislation that might be passed some time in the future (at the time of writing this in Feb 2010, the bill was still tied up) was sufficient to bring down the entire global financial market. And, even though the McCain-Palin ticket was widely seen as having a good chance (at least before the September 2008), the markets didn’t wait for the election returns to come in. Applying some superstrong version of market efficiency, market participants predicted the election outcome, applied Mulligan’s neoclassical model to the predicted policies of the Obama Administration and (perfectly rationally) panicked.


There is one problem with Mulligan’s neat explanation. Writing in October 2008, when the crisis had already erupted and when Obama’s victory was virtually assured Mulligan had this to say about proposals for economic stimulus


So, if you are not employed by the financial industry (94 percent of you are not), don’t worry. The current unemployment rate of 6.1 percent is not alarming, and we should reconsider whether it is worth it to spend $700 billion to bring it down to 5.9 percent.

This piece, which got the endorsement of his Chicago colleague, Freakonomist Steven Levitt, doesn’t even mention the possibility that a Democratic Congress might raise taxes, or that the health plan that was a central plank of candidate Obama’s platform might include means test. Yet he now claims that these possibilities (still hypothetical as of 2010) caused a massive increase in unemployment, the anticipation of which caused the crash!



H/T Brad DeLong




{ 47 comments }

1

Kieran Healy 02.26.10 at 12:40 am

I hadn’t heard that Giblets’s tenure case had gone through at Chicago. But now I see it must have done. Great news!

It might be worth noting that Chicago’s emblem is a Phoenix, so it’s just the place one would expect dead ideas to arise gloriously out of their own ashes.

2

roger 02.26.10 at 12:45 am

Freakonomics is like a zombie club med. You should trawl through the archives, John. So much! One of my own favorite moments is Levitt’s link to an interview in which Gary Becker, of all people, explained that his whole project in economics is to help poor people – which surely is up there with the supposed statement of the captain in Vietnam, we had to destroy the village in order to save it.

3

Alex 02.26.10 at 12:47 am

Another point worth stressing is the global nature of this crisis. For instance it’s hard to comprehend how exactly Northern Rock saw the looming chaos of radical Marxist Barack Obama all the way back in September 2007.

4

Roger Albin 02.26.10 at 2:23 am

Levitt will be remembered primarily as the subject of one of the better polemics of our time, written by another member of the U of C faculty. For those who haven’t read it:
http://www.realclimate.org/index.php/archives/2009/10/an-open-letter-to-steve-levitt/#more-1488
The Comments section of this post is notable for Levitt’s whining about the exposure of his slipshod arguments.

5

roger 02.26.10 at 2:42 am

It is an interesting thing about the nyt that they are continually fronting libertarians, who form the tiniest percentage of the population – and, to my knowledge, never ever introduce socialist economists into the august column space of the business section – even though Republicans themselves are always telling us that the president elected by a hefty margin is a ‘socialist’. Now, of course, the ballooning of libertarian belief is a well funded thing, and we all know about the Koch foundation, etc. But still, you would think a newspaper based in NY would be cosmopolitan enough to publish the occasional Marxist. Or at least social democrat. We wont see that happen, though. One of the indexes of the corruption wrought by the oligarchy over the past thirty years is the hugely inflated attention paid to libertarians, and the almost non-existent attention paid to socialists, in spite of the fact that socialists form the major parties, and oftne the ruling parties, of many countries across the globe, and libertarians have no power whatsoever.

6

roger 02.26.10 at 2:43 am

I’m not sure why there are strike out marks in that comment. Oh well.

7

Kieran Healy 02.26.10 at 2:57 am

fixed.

8

vivian 02.26.10 at 3:09 am

Which are you tackling for the (mandatory) sequel – vampire ideas in economics or werewolf ideas in economics? The first is a little more obvious but the fad may have peaked by the time it hit the shelves. Plus you could use the subhed “theories that put hair on their chests (or maybe palms)”

9

Phillip Hallam-Baker 02.26.10 at 3:16 am

Why would it matter if the markets crashed because the traders were complete morons who were worried about Obama being elected rather than utter incompetents who were incapable of doing their job of assessing risk?

Either explanation requires us to reject the notion of worshiping at the shrine of the free and perfect market.

It is like the person who keeps a wild tiger in their NYC apartment. No matter what the proximate cause resulted in the tiger eating the neighbor, there is no way to avoid the fact that keeping a big cats in an apartment is a very bad idea.

10

roger 02.26.10 at 4:12 am

Thanks, Kieran.

11

Zamfir 02.26.10 at 8:57 am

But Philip, they were not incompetent. They thought Obama would wreck the world economy, and now that Obama is there, look at the world economy!

You might claim that it was wrecked before Obama, but that’s just efficiency. The markets collected all available knowledge and could collapse the economy much faster.

For comparison, look at communist China where markets are hindered and not working well at all. Their economy still hasn’t collapsed, even though the crisis has already been going for several years.

12

Stuart 02.26.10 at 11:09 am

Personally I would say if global financial markets are so fragile that the possibility of a Democrat victory in the US nearly destroys them, this is an argument for the complete dismantling of existing financial institutions, probably to be replaced by something with far more government intervention/control to keep it stable.

13

Tim Worstall 02.26.10 at 11:44 am

“the efficient markets hypothesis (easy to render immune from any kind of refutation by an appropriate formulation)”

If you cannot refute an idea that is appropriately formulated doesn’t that mean that, since the refutation is not possible, the idea as formulated is correct?

14

Stuart 02.26.10 at 11:52 am

If an idea cannot be refuted in any possible way, that means it is a worthless idea, as it can be true in any future circumstances, and therefore has no predictive power.

15

Tim Worstall 02.26.10 at 12:12 pm

“If an idea cannot be refuted in any possible way, that means it is a worthless idea, as it can be true in any future circumstances, and therefore has no predictive power.”

Eh? Newton was right thus we cannot use Newton’s equations to make predictions about apples falling from trees?

16

Walt 02.26.10 at 12:18 pm

Huh? Newton’s laws are subject to empirical test.

17

Sam C 02.26.10 at 12:35 pm

The argument in 13-16 turns on an equivocation on ‘can be refuted’. Tim Worstall thinks that true ideas can’t be refuted – because they’re true – but the sense in which an idea which can’t be refuted is worthless is: no imaginable observation could in principle show that the idea was false. Newton’s laws can be refuted in this sense (and in fact have been so refuted, by observations of the bending of light during eclipses). Einstein can be refuted in this sense too, even if he’s exactly right: there are imaginable observations which, if made, would show him mistaken.

18

Phillip Hallam-Baker 02.26.10 at 12:41 pm

@Zamfir, what Stuart said.

Even if we take Mulligan’s stupid ‘theory’ as true, it would be an argument for dismantling the financial markets. It does not transfer blame for the crash, it does not even create additional blame. It would not be the fault of the Beetles if the markets had crashed because of the release of the Beetles song Helter-Skelter.

Like many US political statements, it is an absurd statement that is only intended to be believed by the people who listen to Limbaugh or watch Glenn Beck. It can be a very profitable type of theory for the person peddling it. Certain types of politician are always on the lookout for court augurs who can be relied on to provide an ingenious and superficially credible justification for whatever requires explanation.

19

Matt McIrvin 02.26.10 at 1:45 pm

One I just heard, and that I assume we’re going to hear a lot more in months to come, is that the looming European debt crisis is going to provide proof once and for all that an expansive welfare state brings disaster.

20

Kevin Donoghue 02.26.10 at 1:51 pm

Tim Worstall: If you cannot refute an idea that is appropriately formulated doesn’t that mean that, since the refutation is not possible, the idea as formulated is correct?

Suppose my “idea” is this two-equation FX market model.
One-month forward FX rate now = Actual spot rate one month hence + risk premium

Risk premium = Actual spot rate one month hence – One-month forward FX rate now.

Obviously my “idea” is correct in your sense and also vacuous. Some versions of the EMH are really not much better.

21

ejh 02.26.10 at 1:55 pm

One I just heard, and that I assume we’re going to hear a lot more in months to come, is that the looming European debt crisis is going to provide proof once and for all that an expansive welfare state brings disaster.

Indeed. I believe I may have predicted this on one of John Quiggin’s book-related posts previously (and I must be far from alone in having done so).

22

Zamfir 02.26.10 at 2:01 pm

Even if we take Mulligan’s stupid ‘theory’ as true, it would be an argument for dismantling the financial markets.
But these markets have excellent predictive power. They collapse long before the real economy collapses.

We should this feature as a bell-weather. Let’s say we wonder whether the moon supports life.

We take a piece of efficient market, preferably from Wall Street. We send them to the moon. If they perish, we know efficiently that the moon doesn’t support life. If they survive, they’re far away on the moon, so it’s win-win for us.

23

Matt McIrvin 02.26.10 at 2:15 pm

I’ve seen parapsychology resutls in which responses of some sort from a test subject are claimed to correlate to crises in the external world. The correlation in time doesn’t have to be exact because that’s just how psychic powers work. It’s marked as a hit even if the response happens well before the crisis, because, hey, precognition. Apparently this is also how we explain economic fluctuations.

24

alex 02.26.10 at 2:30 pm

It’s ‘bell-wether’; this is important because a ‘wether’ is a castrated ram, and it’s always good to mention castration in the same sentence as Wall Street.

25

Uncle Kvetch 02.26.10 at 2:51 pm

One I just heard, and that I assume we’re going to hear a lot more in months to come, is that the looming European debt crisis is going to provide proof once and for all that an expansive welfare state brings disaster.

I hardly see this as a new development. Conventional wisdom in the US dictates that any bad thing that ever happens anywhere in western Europe provides proof once and for all that an expansive welfare state brings disaster. It’s been the primary narrative in the NY Times’ coverage of Europe for as long as I can remember.

26

HA 02.26.10 at 5:14 pm

I read (briefly) through Mulligan’s paper, and I did not see a claim that anticipation of the policies you mentioned caused real investment to decline. Obviously I don’t think you intentionally misread the paper, and I could easily be wrong. The sentence you quote actually refers to a separate argument, which runs: If I plug labor market distortions into my model, I get results that closely approximate what has actually happened thus far this recession; therefore one can expect added labor market distortions (the policies put in place during the recession) to have a similar effect going forward.

He does claim that a labor market distortion explanation can account for a large part of the recession, and somewhat over half the decline in real investment (though he notes that it declined more sharply, and much earlier, than the model predicts); real investment is reacting, in this story, to effects of existing distortions becoming apparent. The basis for this argument is the degree to which, he claims, that a model incorporating such a distortion fits with the data. It’s perfectly legitimate to argue with this point, but I think we should be careful to state his arguments clearly before we attack them.

(side-note to a comment above: that post on realclimate.org is a particularly egregious example of someone inaccurately describing an argument. The post characterizes the argument: “Mr. Myhrvold claimed, in effect, that it was pointless to try to solve global warming by building solar cells, because they are black and absorb all the solar energy that hits them, but convert only some 12% to electricity while radiating the rest as heat, warming the planet.” And this is wrong; Myhrvold does mention heat radiation from the cells (perhaps wrongly) but for the most part bases his contention on the enormous costs of building solar energy plants–and even then he agrees that, after a few decades, we would see overall better emissions.)

27

Barry 02.26.10 at 5:25 pm

Tim Worstall: “If you cannot refute an idea that is appropriately formulated doesn’t that mean that, since the refutation is not possible, the idea as formulated is correct?”

Kevin Donoghue:
“Suppose my “idea” is this two-equation FX market model.
One-month forward FX rate now = Actual spot rate one month hence + risk premium

Risk premium = Actual spot rate one month hence – One-month forward FX rate now.

Obviously my “idea” is correct in your sense and also vacuous. Some versions of the EMH are really not much better.”

Kevin, now you’re being cruel. Which I like :)

28

fred lapides 02.26.10 at 5:59 pm

I wonder why you bother to note fringe madness and then have commenters debunking it? Sort of like asking rational voters for Obama to prove that Obama is legally a citizen.
Not our need to minister to the insane.

29

Barry 02.26.10 at 7:04 pm

U Chic economics professors are now ‘fringe’?

Well, I can hope.

30

James Wightman 02.26.10 at 7:28 pm

Mini quibble: Barry, multiply RHS of second equation by -1.

31

Barry 02.26.10 at 8:13 pm

James, a minor minor quibble – that would be Kevin :)

32

purpleOnion 02.26.10 at 9:28 pm

We do not have Adam Smith capitalism in America. We do not any type of capitalism in the country. The top economists are those who are able to best justify with the term capitalism what the wealthy and influential are doing in America. Those economists who are able to disguise and obfuscate with the respect of the academic and business community are rewarded with recognition and status. We have an arbitrary financial system that is not based on sound accounting practices and principled economic behavior, but is based on the story the top economists sell to the public. This is one of the reasons that our economy has not recovered. Nobody with any sense of reality wants to continue lending, (OPM,) because foreign nations and institutional investors realize that our system is nothing more than a giant Ponzi scheme and large and smart investors want to have nothing to do with us until the recognize real change taking place. Instead what they see is the same irresponsible criminals running the show and only a complete sucker would continue to lend to a dead beat nation of con men. The jig is up and everyone important to our continued economic growth understands that our entire econmony is based on how long our financial wizards can continue to rip off the majority of Americans. Realizing that this is the current American financial strategy they know that the economy is much too fragile to justify lending. The days of OPM are over and everyone realizes it except those who continue using the same game plan. Our financial gurus and political leaders are committing the ultimate capitalist sin – they are believing their own con game – worse is that they rely on it entirely. Only when they realize that although the world is still populated with abundant suckers, there are also more people who are hip to the game as well will they be able to turn the economy around.

33

John Quiggin 02.26.10 at 10:09 pm

@P H-B #18 I’m pretty sure Zamfir is joking. But then, if I didn’t know better I would assume the same of Mulligan.

34

purpleOnion 02.26.10 at 10:59 pm

The financial market’s members did not panic; they had a temper tantrum. The Bush/Cheney lollipop was pulled out of their mouth.

35

AlanDownunder 02.27.10 at 1:11 am

Mulligan needs to take a Mulligan.

36

Sebastian 02.27.10 at 1:36 am

@roger – about the NYT – I agree that’s a bit of a weird column – with Mulligan, Cowen, and Mankiw they have three right-wing economists writing there – I’m actually not sure Mulligan qualifies as a libertarian, I find him mainly bizarre – I think Cowen is closer to a “real” liberatrian. But on the other hand David Leonhardt’s comments are left of center by US standards, they have Uwe Reinhardt (I’d say probably a social democrat) writing most of the health care posts on Economix and the awesome Nancy Folbres (I think I’d put her as a Socialst, broadly speaking) on a whole range of issues – and although that’s sad, I’d guess that her views are no less on the “fringe” of the spectrum of American public opinion than Mulligans.

37

AaLD 02.27.10 at 5:18 am

It looks to me like Mulligan is simply expanding on Hank Paulson’s claim that “future adminstrations” were partly to blame for the financial crisis.

38

Joshua Holmes 02.27.10 at 6:29 am

I don’t know if this is Zombie Economics so much as just plain stupid.

39

Ted 02.27.10 at 9:00 am

Stuart

There is a difference between a hypothesis being formulated in such a bad way that it cannot be framed in a manner amenable to testing, and YOU failing to refute that hypothesis, even though you have been able to frame that hypothesis in a testable framework.

In other words, the fact that your own ideological inclinations/whimsy/dreams have not been able to withstand the demands of empirical testing a hypothesis, does not mean that the perfectly refutaable hypothesis is in error. It is your own ideology that needs a grease and oil change. ;)

40

Oskar Shapley 02.27.10 at 2:38 pm

It’s pure astrology disguised by some equations.

Whatever happens in the markets, it gets explained as a rational reaction to the past, present, potential future or ex post as perfect prediction of the future.

That’s how Nostradamus’ centuries get fitted to the data.

41

Oskar Shapley 02.27.10 at 2:41 pm

I love Zamfir’s theory of how China is inefficient at going into recessions!

42

James Wimberley 02.28.10 at 12:42 pm

HA in #16: So Myrhvold was misrepresented by Pierrehumbert over solar cells?
Superfreakonomics quoted him thus:

“A lot of the things that people say would be good things probably aren’t,” Myrhvold says. As an example he points to solar power. “The problem with solar cells is that they’re black, because they are designed to absorb light from the sun. But only about 12% gets turned into electricity, and the rest is reradiated as heat — which contributed to global warming.”

Pierrehumbert´s takedown was clearly aimed at Levitt, who is fully responsible for his representation and endorsement of Myhrvold´s bizarre views. The cap fits. I don´t personally care one way or the other whether Levitt was fair to Myhrvold.

43

HA 03.01.10 at 5:31 pm

@ Wimberley:

The problem is that Pierrehumbert’s quotation is misleadingly incomplete. This is the entire quotation from the book:

” “As an example he points to solar power. “The problem with solar cells is that they’re black, because they are designed to absorb light from the sun. But only about 12 percent gets turned into electricity, and the rest is reradiated as heat — which contributes to global warming.

Although a widespread conversion to solar power might seem appealing, the reality is tricky. The energy consumed by building the thousands of new solar plants necessary to replace coal-burning and other power plants would create a huge long-term “warming debt,” as Myhrvold calls it.

“Eventually, we’d have a great carbon-free energy infrastructure, but only after making emissions and global warming worse every year until we’re done building out the solar plants, which could take 30 to 50 years.” “

In other words, while Pierrehumbert characterized Myhrvold’s argument as depending entirely on the amount of thermal radiation produced by solar cells, in fact Myhrvold’s argument is based primarily on the energy costs of building the plants.

By selectively omitting the key part of Myhrvold’s statement, Pierrehumbert managed to falsely describe the argument.

I have no idea whether either one of them is right about the real underlying question, but unless I’m wrong as to what the book actually contains, Pierrehumbert grossly misrepresented Myhrvold’s argument.

44

ajay 03.02.10 at 11:25 am

HA – the problem is that Myrhvold is wrong even in the extended version. He points out, correctly, that constructing lots of solar power stations over the next 30-50 years would be very costly, both in financial and GHG terms.

But what’s the alternative? It certainly isn’t “not building any more fossil fuel power stations and using the ones that already exist”. The lifespan of a fossil fuel station is around 30 years. So in the next 30 years or so, whatever policy choices we make, we will have to replace the entire current generator fleet, plus building enough new capacity to cope with increased demand. The question is “what do we replace it with?” And I don’t know a convincing argument that it will be much more costly in GHG terms to build 15 TW of renewables over the next 30 years than to build 15 TW of fossil fuel stations.

45

Neil C 03.02.10 at 2:00 pm

“For comparison, look at communist China where markets are hindered and not working well at all. Their economy still hasn’t collapsed, even though the crisis has already been going for several years.”

Well, quite. Those Chinese communists are particularly evil for not letting the Chinese economy go into recession, despite the people’s clear preference for being in recession. We, on the other hand, were lucky. Our efficent market gave us a recession, which we must have wanted because it wouldn’t have happened if we didn’t want one.

46

HA 03.02.10 at 2:03 pm

ajay – I like your response, but I don’t have enough information to contribute anything to the underlying issue. While your response IS a good counterargument to Myrhvold’s argument, though, Pierrehumbert’s is not. I admit that I hadn’t even heard of this controversy until I saw the link in these comments, but upon reading Pierrehumbert’s post, and then finding the actual quotation from the book, I was a bit disappointed that Pierrehumbert did not at least acknowledge the mischaracterization. I understand that on reading an item one finds critical of views to which one is emotionally committed, and which one finds incorrect, it can be difficult to state the objectionable argument precisely. I don’t mean to impugn Pierrehumbert personally, and for all I know this is just an example of him making a mistake that we all sometimes make.

Incidentally, I glanced over Mulligan’s paper again yesterday, and I still do not see where he claims that the financial crisis was caused by anticipation of Democratic policies. I could very well be wrong, but I don’t see it. Perhaps our expectation of another zombie movie has led us to see ghosts in unfamiliar homes?

47

purpleOnion 03.03.10 at 2:01 am

A problem with many modern professionals is that too many of them have jumped on the business model bandwagon of mendacity for personal gain. They appear to have learned that intellectual integrity is for suckers. More important is supporting the current paradigm promoted by those who are in power. They label their behavior as being realistic. It is how one survives in a materialistic world. The more talented one is at obfuscation and deceit that support the influentials’ paradigm the greater the success, status and reward he will gain. Honesty, truthfulness, integrity and honor are for suckers; although the appearance of possessing these qualities is essential to one’s usefulness. The use of misleading information is ubiquitous in our culture, and the assumption that anyone who has the opportunity to profit from dishonesty would also do so, excuses the behavior

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