Quote of the Day: On the New Keynesian Liquidity Trap: Every law of economics seems to change sign at the zero bound

New-Keynesian models produce some stunning predictions of what happens in a "liquidity trap" when interest rates are stuck at zero.  They predict a deep recession. They predict that promises work: "forward guidance," and commitments to keep interest rates low for long periods, with no current action, stimulate the current level of consumption.  Fully-expected future inflation is a good thing. Growth is bad. Deliberate destruction of output, capital, and productivity raise GDP. Throw away the bulldozers, let them use shovels. Or, better, spoons. Hurricanes are good. Government spending, even if financed by current taxation, and even if completely wasted, of the digging ditches and filling them up type, can have huge output multipliers.

Even more puzzling, new-Keynesian models predict that all of this gets worse as prices become more flexible.  Thus, although price stickiness is the central friction keeping the economy from achieving its optimal output, policies that reduce price stickiness would make matters worse.

In short, every law of economics seems to change sign at the zero bound. If gravity itself changed sign and we all started floating away, it would be no less surprising.

From University of Chicago Professor John H. Cochrane at his blog: The Grumpy Economist

Quote of the Day: Business Advise: Get Lawyers and Lobbyists

If you run a business, get a lot of lawyers and lobbysists. He who writes the regulations will make a lot of money. He who does not will lose.  Make sure you make the right political contributions and don't say anything critical of those in power. You will need a discretionary waiver of something, and these rules are so huge and so vague, the regulators can do what they want with you. Don't be the one to get "crucified" (EPA). We live in the crony-capitalist system that Luigi Zingales describes so well. Live with it. Political freedom requires economic freedom, taught us Milton Friedman. You don't have the latter, don't expect the former.

This snarky but relevant and realistic advice is from University of Chicago Professor John H. Cochrane who writes that there won’t be much legislation due to a divided Congress, but that big or major changes will emanate from a labyrinth of executive orders and from the “metastatic expansion of regulation, let by ACA, Dodd-Frank, and EPA” which he explains in detail here

Quote of the Day: Economic Numbers Cannot Stand Without the Logic that Produces Them

Economic models aren’t engineering models. If you ask several aeronautical engineers to project how adding flaps affects an airplane’s takeoff speed, their models will be complex, but they will come up with about the same, and reliable, answers. You don’t need to know why.

But good economic models are quantitative parables, not authoritative black boxes. They only are trustworthy if they illustrate clearly understandable and explicitly stated pathways…

But economic numbers cannot stand without the logic that produces them. Clarity and transparency are far more important to a good quantitative parable than the illusion of authoritative precision.

This is from professor John H. Cochrane of the University of Chicago at the Bloomberg discussing the unrealistic Keynesian based assumptions and projections made by the CBO on the “Fiscal Cliff”.