A low volume, high quality source from the demand side perspective.The podcast is produced weekly. A transcript is posted on the day of.

Thursday, October 31, 2013

Transcript: Alan Greenspan and why it was not my fault, plus Martin Wolf


Heaven forbid that Robert Shiller, Nouriel Roubini, Steve Keen, Dean Baker and others should be thought of as worthy of note. To be worthy, of course, you had to adhere to the economics that was wrong. Heaven forbid we should ask those who got it right what they saw. A detective story? How will Alan Greenspan resurrect his career.
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John Maynard Keynes knew uncertainty. Maybe he is not of note either. But by rational long-term self-interest, Greenspan means perfect foresight, or at least an image of the future that corresponds to his view.


Some have said Alan Greenspan is a bad man, and that may be true. But we blame him too much. Yes, his understanding of the economy is based primarily on the fantasy world of Ayn Rand. Today they are primarily concerned with why it was not his fault. But he was chosen for who he was, feted for his sponsorship of bankers can do no wrong, and it is entirely understandable that he clings to his views. Without them, he has no personal capital. But he was chosen.

Greenspan began as a political schmoozer. He schmoozed his way to the top, with his Ayn Rand-ism and telling people what they wanted to hear. Ford's chief economist. Likely author of the Whip Inflation Now button. Reagan saw somebody who would not regulate. Instant replacement for Paul Volcker. Once at the top he operated with little understanding of how things worked and a big understanding of lots of liquidity making markets happy. The Greenspan put.

He communicated, if you can call it that, in obfuscational double-speak and kept his finger on the interest rate button. Higher for inflation -- or what he feared would be inflation -- lower for sluggish growth. Didn't matter where the inflation came from, didn't matter where the sluggishness came from. The dot.com boom busted open the New Economy, so back down went the interest rates. It is worth noting that the economy did best during his tenure when he did the least. Also worth noting that although he makes much of increases in productivity and productivity in general, citing the run-up from the mid-1990's, he understands it as poorly as others. The low unemployment of that period produced the higher productivity, as we've shown, not the other way around.

But our listeners likely can fill in their own commentary.

Botched plays? Many of them. Raising rates into the spike in oil prices triggered the bust of 2000, the bursting of the dot.com bubble that rose on margin speculators.


Oops, not his fault.

His staff's.

Greenspan's long-term view at the time of the Bush tax cuts was that the US was in danger of running out of Treasury debt, and tax reductions rather than spending increases ought to be the way to avoid the danger of zero debt growth. (see excerpt, January 2001 Senate testimony online)

Indeed, in almost any credible baseline scenario, short of a major and prolonged economic contraction, the full benefits of debt reduction are now achieved before the end of this decade--a prospect that did not seem likely only a year or even six months ago.

The most recent data significantly raise the probability that sufficient resources will be available to undertake both debt reduction and surplus-lowering policy initiatives. Accordingly, the tradeoff faced earlier appears no longer an issue. The emerging key fiscal policy need is to address the implications of maintaining surpluses beyond the point at which publicly held debt is effectively eliminated.

The time has come, in my judgement, to consider a budgetary strategy that is consistent with a preemptive smoothing of the glide path to zero federal debt or, more realistically, to the level of federal debt that is an effective irreducible minimum. Certainly, we should make sure that social security surpluses are large enough to meet our long-term needs and seriously consider explicit mechanisms that will help ensure that outcome. Special care must be taken not to conclude that wraps on fiscal discipline are no longer necessary. At the same time, we must avoid a situation in which we come upon the level of irreducible debt so abruptly that the only alternative to the accumulation of private assets would be a sharp reduction in taxes and/or an increase in expenditures, because these actions might occur at a time when sizable economic stimulus would be inappropriate. In other words, budget policy should strive to limit potential disruptions by making the on-budget surplus economically inconsequential when the debt is effectively paid off.

In general, as I have testified previously, if long-term fiscal stability is the criterion, it is far better, in my judgment, that the surpluses be lowered by tax reductions than by spending increases. The flurry of increases in outlays that occurred near the conclusion of last fall's budget deliberations is troubling because it makes the previous year's lack of discipline less likely to have been an aberration.

So. Greenspan is an easy target. The lesson to be learned is not that there are bad economists who rise to the pinnacle of power, but that they are the front men for a financial elite that still calls the tune and that tune is not a good one for the real economy. Ben Bernanke is another person chosen for his preference to protect banks, as evidenced in his academic work. Didn't work. Not going to work. Can't work.

Martin Wolf is not so easy a target. Wolf has been a severe critic of austerity, has slammed the Tea Party and other government minimalists, and we've quoted him favorably more than once.


Five to seven years to get through a deleveraging. Well, maybe. We'll artue more another time. At a minimum, this is more serious than the previous experiences.

"The plight of the middle class and rising inequality" and "long-term growth stuck at a low level" are mentioned consecutively, but not connected, as they should be.

Wolf wants us to accept the return of the privileged class as a natural, if not particularly welcome, byproduct of the flow of things.

The "reduction in household debt" is a statistic skewed by aggregation. Never mind that the equity associated with that debt was completely wiped out. That is, debt may be lower, but middle class household wealth is in the subbasement.

"The housing market has corrected." Meaning stabilized at a much lower level. Though once again a housing recovery is known more by rumor than fact. The Fed's enormous efforts under Bernanke to revive housing, including its purchase of mortgage backed securities in the billions every month, has met with some modest success. Demand Side sees further down to go.

"The energy boom as an economic plus" is a long-term disaster to the environment. We are stealing from the future and calling it growth.

"Innovation." Yes. The US has innovation. It's too bad the economic incentives are not aligned to make that innovation meet the real and emergent needs. They are enormous.

"Survived a fiscal tightening?" Some have prospered. Many have not survived. The average is still breathing the fresh air, but that average is four big guys standing on the rest of us. Infrastructure and education are crumbling. That is the present. The future cannot be built on that.

The sequester is met with remarkable resilience. Big new growth on the horizon. Not real growth without much more radical changes in policies.

We'll see.

Friday, October 25, 2013

Transcript: Technology and Growth, the Business Cycle, Minsky and Keynes

Today on the podcast, whither the business cycle? Whither growth? Can part of the strength in the stock market be explained by rich people having to spend their money somewhere? And the best part, some Hyman Minsky on John Maynard Keynes.
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We are not at all amused that technology is the mainstream explanation for growth. To call it a canard is perhaps too harsh, but technology is an aspect of growth, not the cause. No doubt it is the mainstream explanation. Exogenous technology shocks promote new waves of productivity or new categories of products. But answer me, Is this not another aspect of the fantasy that the economy is a machine? Somehow with the right parts the thing will work to its optimum, and we can safely ignore the questions of equality, income distribution, and so forth.

In fact, it is the human capital, the institutions and the public goods available which produce technological advances and the wherewithal to absorb and integrate them efficiently. Not unlike fertile soil and appropriate nurturing produce good crops. The schools and the availability of education, the public sponsored R&D, often in the US through the Defense Department, but also through public universities, the so-called research universities), the legal and political framework -- yes, including capitalism -- these are the roots of growth. Technology is a part of that growth.

Technology doesn't fall from the sky, and it is not produced by incentives to profit. Enough of the literature shows that the implementation of new ideas is the wheelhouse of private enterprise, not the foundational breakthroughs.

That comes up with a recent look at Romer and Jones by Lars Syll at Real World Economic Review.

Of the three state variables that we endogenize, ideas have been the hardest to bring into the applied general equilibrium structure. The difficulty arises because of the defining characteristic of an idea, that it is a pure non-rival good. A given idea is not scarce in the same way that land or capital or other objects are scarce; instead, an idea can be used by any number of people simultaneously without congestion or depletion.

Because they are non-rival goods, ideas force two distinct changes in our thinking about growth, changes that are sometimes conflated but are logically distinct. Ideas introduce scale effects. They also change the feasible and optimal economic institutions. The institutional implications have attracted more attention but the scale effects are more important for understanding the big sweep of human history.

The distinction between rival and non-rival goods is easy to blur at the aggregate level but inescapable in any microeconomic setting. Picture, for example, a house that is under construction. The land on which it sits, capital in the form of a measuring tape, and the human capital of the carpenter are all rival goods. They can be used to build this house but not simultaneously any other. Contrast this with the Pythagorean Theorem, which the carpenter uses implicitly by constructing a triangle with sides in the proportions of 3, 4 and 5. This idea is non-rival. Every carpenter in the world can use it at the same time to create a right angle.

Of course, human capital and ideas are tightly linked in production and use. Just as capital produces output and forgone output can be used to produce capital, human capital produces ideas and ideas are used in the educational process to produce human capital. Yet ideas and human capital are fundamentally distinct. At the micro level, human capital in our triangle example literally consists of new connections between neurons in a carpenter’s head, a rival good. The 3-4-5 triangle is the non-rival idea. At the macro level, one cannot state the assertion that skill-biased technical change is increasing the demand for education without distinguishing between ideas and human capital

Jones and Romer have a bit of a clue here, but it is not complete, or totally accurate.

It possible, I suppose, for the idea to transcend the human base which holds it, but htere is nothing so common as a bad idea. The clash of ideas in politics, and the slowness with which some ideas are adopted while others take over overnight, demonstrates that the population that is the cultural medium for the idea is more important than the idea itself.

A bit tangential to where we started, but it is connected.

Rival goods here are the private goods of our treatment in Demand Side, the book, (check out DemandSideBooks.com). Human capital is well explained. Omitted from this excerpt are public goods. Private goods are rival goods. Non-rival goods here are not the public goods of Demand Side the book. The roads and schools and legal framework shared by all provide the opportunity for the idea. You don't get ideas or technology advancing in Africa.

Have to leave that there.

Maybe a parting shot -- an educational system such as we had in the fifties, sixties and into the seventies, eighties and nineties created a meritocracy, where the bright and motivated could flourish. The GI Bill. Free and cheap four-year schools. Jobs doing things that were worth doing. Now, with the best and brightest priced out, we are getting second rate talent, people whose parents can pay, and they are occupying key positions. So we are getting second rate results

Elsewhere in the article, Jones and Romer remember six stylized facts from Nicholas Kaldor, another non-winner of the Sveriges Riksbank Prize for Economics Sciences in Memory of Alfred Nobel. Then they remember a few of their own. What is missing from them all are public goods and the Commons. We are trudging along in a world of factories and factory labor, a world of the Nineteenth Century, long after the rise of Big Government, and we are ignoring Big Government. The explosion of population and the expansion of prosperity and the rise of Big Government happened simultaneously. The public goods that arrived with Big Government are a proximate explanation for expansion and prosperity in a period of population boom.

Growth in mainstream economics, as we've argued, ignores the Commons. Much growth in the early and mid part of the last century was bringing non-monetized activity into the market. List your services here. Much other growth is technology stealing from the environmental property of the planet. Stealing somebody's TV set and selling it is not economic growth, but stealing the atmosphere and the ocean and the habitability of the planet is counted as growth. One of the most often mentioned bonanzas for American growth these days is shale gas, fracked oil. We can pump it up out of the ground and convert it into poison for the atmosphere and count it as growth, but to do something that is actually sustainable, that is quite too expensive.

Now, before we run out of time, Hyman Minsky and the business cycle. We should say John Maynard Keynes, Hyman Minsky and the business cycle. We've been re-reading Minsky's best book, according to some, which is John Maynard Keynes -- not a biography, a development of thought.

A note on the stock market to get us warmed up. The only healthy sign in the current economy is the buoyant stock market, financial markets. We have long argued that this is the result of the QE's, with the Fed taking on a trillion dollars a year in debt securities, pushing money into risk -- so-called risk, although we have yet to see the Fed allow any actual experience of risk in the feathers of the markets. But income disparity is also a driver of buoyancy. It is not that corporate securities are so much better now, nor that the prospects for business are rosy. Instead, it is the QE's and the demand from the well-to-do. Yes, corporations are showing profits, but it is coming from unhealthy sources -- refinancing debt at low interest rates, squeezing the workers and cutting costs.

Minsky put it simply, and if I could find it here I would quote it directly. Paraphrased, it is that the rich divide their spending between consumption and investment quote-unquote in financial assets. Since even lavish consumption is a smaller proportion of their incomes than for workers, who may spend all their income on consumption, the demand for financial assets goes up.

Now, on to Minsky and Keynes, and the question of the business cycle.

Quoting from Minsky:
Keynes's theory of investment and finance ... is an alternative to today's conventional wisdom, which holds that the valuable insights of The General Theory have been incorporated into the neoclassical synthesis. [But] the neoclassical synthesis leads to propositions that the normal path of a market economy can be characterized as one of full-employment growth.... The alternative [Keynesian] interpretation leads to propositions that the normal path of a capitalist economy is cyclical; ...

In the alternative interpretation, the core of Keynes's system consists of an analysis of capitalist finance in the context of uncertainty, and of how capitalist finance affects the valuation of items in the stock of capital assets and thus affects the pace of investment. This core of Keynesian economics is fundamentally inconsistent with the static-production-function and invariant-preference-system constructs which are the basis of the neoclassical synthesis. Keynes and the neoclassical view blend only if one or the other is distorted. In the neoclassical synthesis, Keynes has been distorted.

In Keynes's theory, investment is the proximate tune caller for aggregate demand. ... In portfolio terms, the production of an increment to the capital stock is equivalent to the creation of an addition to the stock of financial assets. However, where the production of an addition to the stock of ordinary financial assets does not generate a significant demand for labor or increase productive capacity, investment requires the employment of labor and increases productive capacity. In addition, investment must be financed. This implies that investment leaves behind a residue of proper financial instruments.

.. 131-132

then p. 126

The combined effect of the short-run stabilizing properties of consumption expenditures, the stabilizing properties of government expenditures and tax schedules, the influence of those monetary assets which are not the debt of any unit, and the central bank acting as a lender of last resort will bring a debt-deflation and its accompanying income decline to a halt. However, because a debt-deflation process has both an immediate and a lingering effect upon investment and desired debt positions, it will lead to a period of persistent unemployment. A relatively low-income, high-unemployment, stagnant recession to uncertain depth and duration will follow a debt-deflation process.

Minsky completed Keynes

The theory that business cycles and fluctuations are a function of external shocks -- sometimes positive t3echnology improvements, sometimes untoward events j-- is the conventional paradigm. But it is obtuse, to say the least. At least as obtuse as the phobia of government debt. Perhaps not as obtuse as the ignoring of climate change. But obtuse.

Thursday, October 17, 2013

Transcript: Riksbank Prize, Minsky, Keen

The Nobel Prize was awarded this week.

I had no problem with Robert Shiller. He could see the bubble. Heck, he predicted the dot.com bust. And pointed out the housing bubble years in advance. As important to me, he provided the apt metaphor for the economy, or at least seconded my preference. Metaphors are essential. People understand complex issues by use of the metaphor. Once a metaphor is accepted, the rest of a person's understanding follows "intuitively." The economy is viewed by most people through the metaphor of a business or household. Everybody balances their books, goes out and earns or rents for their money. If everyone -- including the government -- plays by the same rules, then everyone is happy. The problem arises when somebody overspends or borrows imprudently.
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The apt metaphor is the family farm. For the economy to work well, everyone needs to be employed doing useful things. If the fields are too wet to plow or plant, there is fence to fix and barns to raise. There are roads to grade or drain tile to be installed. Planning is important. Anticipating the weather. Prudence is important. You don't just open the doors in the morning and let everyone out and fend for themselves. All able hands employed makes for the most vigorous enterprise. Full employment is the only route to prosperity. Shiller raised this metaphor in a couple of his New York Times pieces.

No, I had no problem with Robert Shiller.

I had a problem with Eugene Fama

So did Peter Radford

At Real World Economic Review, under the title

The Fama Quasi-Nobel: posthumous award for EMH?
from Peter Radford

They’re kidding, right?

Nope. They mean it.

What’s really weird is that he splits the award with Robert Shiller and some guy called Hansen who is an econometrician and thus unintelligible and largely irrelevant to sensible discussion of the economy.

There are a few ways to deal with this.

Take One:

Fama was the guy who created the Efficient Markets Hypothesis (EMH). ... [T]his theory tells us that there is nothing an investor can do to outfox the market. [A]ll the information that is out there is incorporated in prices. Thus all those ads telling us about past performance and about clever investment strategies are simple hoaxes. The market is what it is, and neither you nor I can outwit it unless by dumb luck.

This interpretation of EMH means it is a ... solid, relevant and good piece of work. The problem is that it is built on ... the same quicksand as its companion theories that posit rational behavior. And because it can be reduced to ... “the market is what it is,” it has little value to anyone other than obscure finance theorists. ...

In a nutshell EMH is another example of the hermetically sealed reality-resistant thinking that dominates modern economics: ... only quirks or rotten stuff sit outside the pristine and pure wondrous working of the marketplace. Which is why theorists like Fama are so ideologically hell bent against anything that appears to intrude into their precious markets. Especially governments.

Take Two:

... [Robert] Shiller [on the other hand] has devoted much of his professional career to pointing out that people are a bit less – perhaps a lot less – than rational. At least in the meaning Fama has for rational.

... Shiller achieved notoriety for his study of real estate prices and noting the rise of the bubble that so famously burst a few years back.

Bubbles would suggest that markets are somewhat less than rational and are inclined to significant overshooting, undershooting, and other total misinterpretations of information. This is hardly efficient. Indeed, a quick look at Shiller’s work seems to imply that he has debunked EMH pretty well. Don’t forget that according to EMH a house priced $100 one day and $1,000,000 the next is entirely within the realm of rational experience. The difference simply reflects different information. ...

So the quasi-Nobel prize committee is backing both sides of a very important argument. One that has huge implications for ... bank regulation. Do we regulate banks because they are likely to get swept away by Shiller-like exuberance? Or do we leave well alone because [banks] are embedded in the smooth rational workings of the financial market place a la Fama?

Take Three:

This is what I call the “Krugman cop-out”.

[Paul Krugman's] argument is that, even though Shiller seems to have undone Fama, and even though the work of the two seems to be in contradiction, the award to Fama is still worthy. After all someone had to dig the hole Shiller’s work subsequently filled up. Krugman is taking the old academic high road .... Perhaps he’s mindful that his work could also be debunked one day, and so he has closed ranks.

Take Four:

My view is that the quasi-Nobel committee was on the brink of giving Fama the prize back in the mid 2000′s, but was stopped dead in its tracks by the crisis, the bursting of the bubble, and the disarray this meant for the Fama camp. The committee had to wait for the dust to settle and for Fama’s defenders to rally 'round. They also had to allow the [audience] of anyone interested in the prize to lose sight of EMH amongst all the post-crisis confusion and exposure of economics generally. Then they had to get someone else to steal the headlines so that few outsiders would notice -- Shiller is a terrific choice.

In many ways the award is akin to posthumous recognition. It is a reward for hard work done in the service of a now debunked theory.

EMH still has its supporters, of course. They are that hardy band of rationalists who still dominate much of the economics landscape and who strenuously fight to keep reality at bay. Most of them appear to live in Chicago,

... says Peter Radford

Mark Thoma had the thought:

Are Rationality and the Efficient Markets Hypothesis Useful?

Just a quick note on the efficient markets hypothesis, rationality, and all that. [These are] important contributions not because they are accurate descriptions of the world (though they may come close in some cases), but rather because they give us an important benchmark to measure departures from an ideal world. It's somewhat like studying the effects of gravity in an idealized system with no wind, ... in a vacuum ... as a first step. If people say, "Yes, but it's always windy here," then we can account for those effects .... Same for the efficient markets hypothesis and rationality. If people say, in effect, "but it's always windy here" -- those models miss important behavioral effects ... -- then the models need to be amended appropriately (though, like dropping heavy weights short distances in the wind, some markets may act close enough to idealized conditions ...). We have not done enough to amend models to account for departures from the ideal, but that doesn't mean the ideal models aren't useful benchmarks.

Nice try. Fama's world is hypothetical. It is like studying the effects of gravity without mass. It might be an entertaining diversion, like a crossword puzzle, but it is basically meaningless.

Merign Knibbe left this, also at RWER

Inefficient financial markets and an irrational economist: example

The mortgage market has become the most important financial market. Is it efficient in the Fama sense? [That is, is it] characterized by competing, intelligent, well-educated, rational people who ... can change their assets/loans portfolio [in response to the latest information]? [Who even] know that their house and their mortgage are part of their entire assets/loans portfolio? Maybe not.

The Wall Street Journal had something interesting to say for a change

Nobel Laureates Shiller and Fama: The Oddest of Bedfellows

It’s hard to imagine an odder pair of intellectual bedfellows than Eugene Fama and Robert Shiller, who along with Lars Peter Hansen were today awarded the Nobel prize in economics.

Mr. Fama is considered by some to be the founder of modern finance for his work in developing the so-called efficient market hypothesis, the notion that prices always capture an equilibrium that incorporates all available information. In Mr. Fama’s world, where investors act rationally, there is no room for things like “momentum trading” or “chasing prices higher.” In fact, in 2010, in the wake of the devastating crisis that followed the massive run-up in real estate prices, he told the New Yorker’s John Cassidy, “I don’t even know what a bubble means.”

By contrast, the titles of behavioral economist Mr. Shiller’s popular books tell you all need to know about [how] he feels about assumptions that investors are always rational. His best-selling 2000 book “Irrational Exuberance” was ... about the forces that create market bubbles. It predicted the bursting of the tech bubble in 2001....[Its] 2005 edition identified the bubble-like behavior in U.S. real estate that would later lead to the crisis of 2008. In 2009, he published “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism,” which he wrote with George Akerlof, another Nobel laureate and the husband of Federal Reserve Chair nominee Janet Yellen. As its subtitle suggests, it’s a work that inevitably touches on how the economy is often affected by the ways in which human beings can act irrationally.

Both men have had significant influence on the formation of investment strategies and pricing models. But in the post-crisis world, it’s perhaps fair to say that Mr. Shiller is looking more in touch with our current understanding of how markets work.

That was a gentle way to end: "more in touch with our current understanding of how markets work."

The proposition that all of the information is included in the market is valid, I suppose, if you define information as views, panic, euphoria, greed, spin, and the rest of human thought and feeling and attempts to manipulate. With information so defined, Fama may have a point. But if information is defined simply as reliable data and coherent interpretations, then he is clearly wrong.

Fama's 2012 interview with the New Yorker magazine in which he denied the existence of bubbles and said flatly that the recession preceded the housing collapse offers sufficient evidence that he inhabits la-la land and is more concerned with protecting his intellectual property than coming to grips with reality. That interview is included at the end of today's transcript.

But Fama IS consistent and persistent, and so is the Riksbank. Radford called it a QUASI Nobel, as in fake. It sprang up in 1969, long after the start date of the other Nobels -- 1895, an invention of the Sveriges Riksbank. The actual name of the prize is "The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel." If as we've said, economics science is to science what FoxNews is to news, this award comes from the staff and management of the counterpart to FoxNews. By awarding the prize to Fama, the Riksbank carries on the tradition of Black and Sholes and Friedman and Lucas and two-thirds of the other recipients with pretty theories that were wrong, some of them absurd.

I once met Douglass North who shared the prize one year long ago. I read his work. It was okay, I thought at the time. A bit trivial, perhaps. But he was an economic historian, very underrepresented among laureates. Since then I have come to appreciate Professor North. At least he was not demonstrably wrong.

Then if you think of the people who did not receive the Nobel, you see what a disgrace it is. At the top of the list: John Kenneth Galbraith. You're only eligible if you're alive, so John Maynard Keynes was never eligible, having died in 1946. Galbraith, however, lived a long and fruitful life. Served during World War II and was responsible in large part for the absence of black markets and inflation then. Later served under Kennedy. Wrote dozens of excellent books. His never receiving this prize, when it is given to the bankers' butlers, is the capstone to the proof that the prize is not relevant.

The most absurd applications of the efficient market nonsense arise when the theory strays from financial markets and tries to say something about efficient allocation of capital. The financial markets are a casino and perhaps you can't beat the house, though there are many examples of people who have. But to say markets have efficiently organized things is to ignore the welfare of billions, to accept the extravagance of trivialities and the paucity of essentials, to embrace the fever to burn through the planets environment and the indifference toward the millennia ahead and the people who could have lived here, to applaud an ambivalence about full employment and support the determination to make banks profitable. These are all market-determined. The market is controlled by, as Galbraith showed, the dominant corporations in each sector. Finance is no different. The government is the hand of the big players in most markets.

Perhaps James K. Galbraith, John Kenneth's son and intellectual heir, will someday be honored as a token to reality.

Another economist I follow closely who likely will never receive the Riksbank Prize is Australian Steve Keen, the world's most important interpreter of another non-Prize winner, Hyman Minsky.

As part of my economics activity, I have occasion to listen to accounts of Keen's personal travels. I was taken aback a couple of months ago when he announced a trip to Ecuador. Must be desperate, I thought. Completely wrong.

Ecuador under Correa, a PhD economist, has engaged the brightest young people available and set them to devising an enlightened egalitarian capitalism. A coup from the hereditary oligarchs looms over every day. The task is to neutralize them while convincing the emerging capitalists that the new way is better for everybody. Steve's accounts of the vigor and commitment of these people reminded me of the accounts of the New Deal, when Franklin Roosevelt and the motivated minds of a generation came together to solve the Great Depression.

Keen was there, working with the government and teaching through FLACSO, the Latin American School of Social Sciences. As I understood it, FLACSO operates throughout Latin America. Steve is hopeful of getting a substantial grant for the development of Minsky, his revolutionary dynamic modeling software. It's the best thing I've heard in many a moon.

A crash course Keen prepared for his FLACSO students in disequilibrium economics is linked to on the podcast.

Crash course in disequilibrium economics


Next time, maybe a bit of Minsky and Keynes.


Eugene Fama on the Housing Bubble...

Interview with Eugene Fama: The New Yorker:

John Cassidy: I met Eugene Fama in his office at the Booth School of Business. I began by pointing out that the efficient markets hypothesis, which he promulgated in the nineteen-sixties and nineteen-seventies, had come in for a lot of criticism since the financial crisis began in 1987, and I asked Fama how he thought the theory, which says prices of financial assets accurately reflect all of the available information about economic fundamentals, had fared.

Eugene Fama: I think it did quite well in this episode. Stock prices typically decline prior to and in a state of recession. This was a particularly severe recession. Prices started to decline in advance of when people recognized that it was a recession and then continued to decline. There was nothing unusual about that. That was exactly what you would expect if markets were efficient.

John Cassidy: Many people would argue that, in this case, the inefficiency was primarily in the credit markets, not the stock market—that there was a credit bubble that inflated and ultimately burst.

Eugene Fama: I don’t even know what that means. People who get credit have to get it from somewhere. Does a credit bubble mean that people save too much during that period? I don’t know what a credit bubble means. I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning.

John Cassidy: I guess most people would define a bubble as an extended period during which asset prices depart quite significantly from economic fundamentals.

Eugene Fama: That’s what I would think it is, but that means that somebody must have made a lot of money betting on that, if you could identify it. It’s easy to say prices went down, it must have been a bubble, after the fact. I think most bubbles are twenty-twenty hindsight. Now after the fact you always find people who said before the fact that prices are too high. People are always saying that prices are too high. When they turn out to be right, we anoint them. When they turn out to be wrong, we ignore them. They are typically right and wrong about half the time.

John Cassidy: Are you saying that bubbles can’t exist?

Eugene Fama: They have to be predictable phenomena. I don’t think any of this was particularly predictable.

John Cassidy: Is it not true that in the credit markets people were getting loans, especially home loans, which they shouldn’t have been getting?

Eugene Fama: That was government policy; that was not a failure of the market. The government decided that it wanted to expand home ownership. Fannie Mae and Freddie Mac were instructed to buy lower grade mortgages.

John Cassidy: But Fannie and Freddie’s purchases of subprime mortgages were pretty small compared to the market as a whole, perhaps twenty or thirty per cent.

Eugene Fama: (Laughs) Well, what does it take?

John Cassidy: Wasn’t the subprime mortgage bond business overwhelmingly a private sector phenomenon involving Wall Street firms, other U.S. financial firms, and European banks?

Eugene Fama: Well, (it’s easy) to say after the fact that things were wrong. But at the time those buying them didn’t think they were wrong. It isn’t as if they were na├»ve investors, or anything. They were all the big institutions—not just in the United States, but around the world. What they got wrong, and I don’t know how they could have got it right, was that there was a decline in house prices around the world, not just in the U.S. You can blame subprime mortgages, but if you want to explain the decline in real estate prices you have to explain why they declined in places that didn’t have subprime mortgages. It was a global phenomenon. Now, it took subprime down with it, but it took a lot of stuff down with it.

John Cassidy: So what is your explanation of what happened?

Eugene Fama: What happened is we went through a big recession, people couldn’t make their mortgage payments, and, of course, the ones with the riskiest mortgages were the most likely not to be able to do it. As a consequence, we had a so-called credit crisis. It wasn’t really a credit crisis. It was an economic crisis.

John Cassidy: But surely the start of the credit crisis predated the recession?

Eugene Fama: I don’t think so. How could it? People don’t walk away from their homes unless they can’t make the payments. That’s an indication that we are in a recession.

John Cassidy: So you are saying the recession predated August 2007, when the subprime bond market froze up?

Eugene Fama: Yeah. It had to, to be showing up among people who had mortgages. Nobody who’s doing mortgage research—we have lots of them here—disagrees with that.

John Cassidy: So what caused the recession if it wasn’t the financial crisis?

Eugene Fama: (Laughs) That’s where economics has always broken down. We don’t know what causes recessions. Now, I’m not a macroeconomist so I don’t feel bad about that. (Laughs again.) We’ve never known. Debates go on to this day about what caused the Great Depression. Economics is not very good at explaining swings in economic activity.

John Cassidy: Let me get this straight, because I don’t want to misrepresent you. Your view is that in 2007 there was an economic recession coming on, for whatever reason, which was then reflected in the financial system in the form of lower asset prices?

Eugene Fama: Yeah. What was really unusual was the worldwide fall in real estate prices.

John Cassidy: So, you get a recession, for whatever reason, that leads to a worldwide fall in house prices, and that leads to a financial collapse...

Eugene Fama: Of the mortgage market… What’s the reality now? Everybody talks about a credit crisis. The variance of stock returns for the market as a whole went up to, like, sixty per cent a year—the Vix measure of volatility was running at about sixty per cent. What that implies is not a credit market crisis. It would be stupid for anybody to give credit in those circumstances, because the probability that any borrower is going to be gone within a year is pretty high. In an efficient market, you would expect that debt would shorten up. Any new debt would be very short-term until that volatility went down.

John Cassidy: But what is driving that volatility?

Eugene Fama: (Laughs) Again, its economic activity—the part we don’t understand. So the fact we don’t understand it means there’s a lot of uncertainty about how bad it really is. That creates all kinds of volatility in financial prices, and bonds are no longer a viable form of financing.

John Cassidy: And all that is consistent with market efficiency?

Eugene Fama: Yes. It is exactly how you would expect the market to work.

John Cassidy: Taking a somewhat broader view, the usual defense of financial markets is that they facilitate investment, facilitate growth, help to allocate resources to their most productive uses, and so on. In this instance, it appears that the market produced an enormous amount of investment in real estate, much of which wasn’t warranted...

Eugene Fama: After the fact...There was enormous investment across the board: it wasn’t just housing. Corporate investment was very high. All forms of investment were very high. What you are really saying is that somewhere in the world people were saving a lot—the Chinese, for example. They were providing capital to the rest of the world. The U.S. was consuming capital like it was going out of sight.

John Cassidy: Sure, but the traditional Chicago view has been that the financial markets do a good job of allocating that capital. In this case it, they didn’t—or so it appears.

Eugene Fama: (Pauses) A lot of mortgages went bad. A lot of corporate debt went bad. A lot of debt of all sorts went bad. I don’t see how this is a special case. This is a problem created by a general decline in asset prices. Whenever you get a recession, it turns out that you invested too much before that. But that was unpredictable at the time.

John Cassidy: There were some people out there saying this was an unsustainable bubble…

Eugene Fama: Right. For example, (Robert) Shiller was saying that since 1996.

John Cassidy: Yes, but he also said in 2004 and 2005 that this was a housing bubble.

Eugene Fama: O.K., right. Here’s a question to turn it around. Can you have a bubble in all asset markets at the same time? Does that make any sense at all? Maybe it does in somebody’s view of the world, but I have a real problem with that. Maybe you can convince me there can be bubbles in individual securities. It’s a tougher story to tell me there’s a bubble in a whole sector of the market, if there isn’t something artificial going on. When you start telling me there’s a bubble in all markets, I don’t even know what that means. Now we are talking about saving equals investment. You are basically telling me people are saving too much, and I don’t know what to make of that.

John Cassidy: In the past, I think you have been quoted as saying that you don’t even believe in the possibility of bubbles.

Eugene Fama: I never said that. I want people to use the term in a consistent way. For example, I didn’t renew my subscription to The Economist because they use the world bubble three times on every page. Any time prices went up and down—I guess that is what they call a bubble. People have become entirely sloppy. People have jumped on the bandwagon of blaming financial markets. I can tell a story very easily in which the financial markets were a casualty of the recession, not a cause of it.

John Cassidy: That’s your view, correct?

Eugene Fama: Yeah.

Thursday, October 10, 2013

Transcript: Debt Ceiling Options and Demand Side Redux

This is the 600th episode of the Demand Side Podcast. To mark the occasion we will remember the Demand Side view and if we have time, we'll relay a piece on the personality disorders of the rich. But first, to fill in your understanding of this debt ceiling debacle coming up, and the President's legal options, some material from the Columbia Law Review. This was pursuant to the last debt ceiling debacle, in the summer of 2011, and was published in October 2012 under the title
Listen to this episode


[sorry no link]

Now this is not about the chaos that might ensue whatever the president decides in the financial markets, which are an interlinking web of often very short-term arrangements, where an interest rate spike as might and probably will occur in uncertain conditions. This is about the options, and as the authors make immediately clear, the president has no options that are constitutional. Ignoring the debt ceiling is probably the least unconstitutional.

Authors are:

Neil H. Buchanan, Professor of Law, The George Washington University Law School, and Senior
Fellow at the Taxation Law and Policy Research Institute, Monash University.


Michael C. Dorf, Professor of Law, Cornell University Law School.
The federal statute known as the “debt ceiling” limits total borrowing
by the United States. Congress has repeatedly raised the ceiling to
authorize necessary borrowing, but a political standoff in 2011 nearly
made it impossible to borrow funds to meet obligations that Congress had
affirmed earlier that very year. Some commentators urged President
Obama to ignore the debt ceiling, while others responded that such
borrowing would violate the separation of powers and therefore that the
president should refuse to spend appropriated funds.

This Article analyzes the choice the president nearly faced in
summer 2011, and which he or a successor may yet face, as a “trilemma”
offering three unconstitutional options: ignore the debt ceiling
and unilaterally issue new bonds, thus usurping Congress’s borrowing
power; unilaterally raise taxes, thus usurping Congress’s taxing power;
or unilaterally cut spending, thus usurping Congress’s spending power.
We argue that the president should choose the “least unconstitutional”
course—here, ignoring the debt ceiling. We argue further, though more
tentatively, that if the bond markets would render such debt inadequate
to close the gap, the president should unilaterally increase taxes rather
than cut spending. We then use the debt ceiling impasse to develop
general criteria for political actors to choose among unconstitutional options.

We emphasize three principles derived from a famous speech by
President Lincoln: 1) minimize the unconstitutional assumption of
power; 2) minimize sub-constitutional harm; and 3) preserve, to the extent
possible, the ability of other actors to undo or remedy constitutional


In the spring of 2011, federal officials announced that, at some point
later in the year, the federal government would be unable to meet all of
its obligations unless the federal debt ceiling was raised. There was no
economic problem. Interest rates on U.S. Treasury bills were close to
zero percent, and the government could readily issue new debt to cover
its expenses, if only Congress would go through the formal process of
raising the debt ceiling to conform with the budget that it itself had then
only recently approved. There was a political problem, however.

Expressing concern about long-term fiscal deficits, Republicans in
Congress—especially those allied with the Tea Party movement—insisted
on a dollar of current spending cuts for every dollar increase in the debt
ceiling. Even as Keynesian economists warned of the dangers of premature
austerity, Democrats, including President Barack Obama, accepted
the Republican view that deficit reduction was imperative, but they insisted
that increased tax revenues had to be part of the formula for
achieving that goal. A standoff ensued.

As the day of reckoning approached with no deal in place, some observers
advanced a creative solution. Section 4 of the Fourteenth
Amendment, they noted, forbids the questioning of “[t]he validity of the
public debt of the United States,” and therefore, they argued, the debt
ceiling is unconstitutional insofar as it forbids the federal government
from honoring its existing financial commitments. Accordingly, these
observers contended that in the event that Congress and the President
failed to reach an agreement, the President would be authorized, or
perhaps even constitutionally obligated, to simply ignore the debt ceiling.
This proposed gambit was quickly dubbed the “nuclear option,”
and it garnered support from some prominent politicians, including
former President Bill Clinton.

The nuclear option had its own problems, however. For one thing, it
could backfire. As a hedge against the possibility that the government
would later default on debt issued by a president acting without congressional
authorization, bond purchasers might demand very high rates of
interest for the “radioactive” bonds, thus destabilizing rather than calming
financial markets. But even if the president’s unilateral authorization
of new debt would pacify the markets, it would apparently avoid a
violation of Section 4 of the Fourteenth Amendment only by violating
the separation of powers. After all, Article I of the United States
Constitution gives to Congress, not the president, the power “to borrow
Money on the credit of the United States.”

Thus, Treasury Secretary Timothy Geithner quickly announced that
the Administration would not rely on the Section 4 nuclear option. Perhaps
that was simply a ploy to increase pressure on Congress to strike a
deal. If so, it worked, because at the eleventh hour Congress did indeed
pass legislation raising the debt ceiling and punting to a newly created
bipartisan congressional “super-committee” the question of how to
achieve the deficit reduction that was also mandated by the legislation.

And we know how that turned out. The Sequester.

In principle this is not a default, as in an insolvency. As is obvious to anybody, a government that can print the medium of its debt cannot default. This is a choice by the government not to pay, if it comes to that.

The president could in theory engage with the Fed to buy additional Treasury securities and add them to the Fed's already enormous balance sheet. This would be tantamount to actually printing money, and except for the accounting of it, would be very much like the avenue prescribed by the MMTers. Central banks buying their government's debts has not had a good history, but it is do-able, and is actually being done right now.

Now to the Demand Side Perspective
in honor of our 600th episode, depending on how you count them.

The business cycle, of expansion, peak, recession, trough, recovery is a function of investment. This is the Keynesian view of John Maynard Keynes, as in the General Theory and the so-called Response to Viner in the Quarterly Journal of Economics that was Keynes' most significant defense of the General Theory.

Investment produces growth through the multiplier effect, where multiples of the initial investment are created in real economic activity -- in employment and incomes -- as determined by the propensity to consume.

Also, we note, investment goods typically involve higher wages than mundane consumption goods.

Business investment is affected by: (1) the interest rate, (2) prospective return on the investment, and (3) uncertainty.

The government can employ people in non-consumption industries, and create the value from which borrowing is paid off. It can produce high-value investment goods -- infrastructure, physical and social, and high-level wages.

Government is not beset by uncertainty over potential profits. Thus the condition of uncertainty which sometimes paralyzes private investment does not need to apply. Government's profits are embedded in the economy: better roads, education, infrastructure that is targeted toward adaptation to climate change, all produce incomes, savings, value to business and households.

The basic condition of stagnation and decline is one without investment, where all workers are engaged in the consumption goods industries. Since it does not take all workers to meet all demand -- as it fall short by the amount of savings, savings being the portion not consumed -- wages sag, prospective profits decline, what investment there is declines.

Leon Keyserling, chief economist to Harry Truman, identified this the need for investment to absorb desired savings.

Some version of this model is accepted by all economists with any success at forecasting or even describing what has happened. Of course, a large minority of economists are completely at sea, still holding on to a conviction that the economy will adjust naturally if the government will get out of the way, that no policy is good policy, and that employment and production return to equilibrium by themselves. Equilibrium analysis for some reason has not been laughed out of town.

The focus for the so-called Keynesians of this day has indeed been on investment, spurring it through ever lower interest rates and ever more generous tax benefits to business. We call them "so-called Keynesians" when one of Keynes' closest collaborators Joan Robinson referred to them with the gentle title of "bastard Keynesians." The Keynesians of the private investment only, interest rate rules all, tax cuts as stimulus school were not fathered by John Maynard. They do not have the genes of uncertainty, money, or debt deflation, nor the all-important primacy of demand. It is a kind of Keynesianism for business.

The zero lower bound school led by Paul Krugman and Ben Bernanke imagines there is an interest rate, even if it is negative, which will spur recovery. Both acknowledge the need for fiscal action, but here it is imagined at least by some that tax cuts are as good as investment.

Yes, Keynes spent a lot of ink on the link between the interest rate and the prospective return on investment. But he also pointed to the primacy of uncertainty, and he referred to the financial markets as a casino -- not the avenue to recovery.

Uncertainty can be understood not as a risk assessment, but as what weight do you give your risk assessment. In bad times, entrepreneurs will not pull the trigger on projects with the same probability of success that in good times will get the go-ahead. The same information is given less weight in times of high uncertainty.

The interest rate and the tax benefits are exploited by business to the extent they can be, but do not affect real investment to any great degree. See now that corporations are making record profits, but they do not invest.

Government can act in times of uncertainty. They don't when they are captured by the corporations and by the crackpots.

Rich People Just Care Less
The Great Divide
The Great Divide is a series about inequality.

Turning a blind eye. Giving someone the cold shoulder. Looking down on people. Seeing right through them.

These metaphors for condescending or dismissive behavior are more than just descriptive. They suggest, to a surprisingly accurate extent, the social distance between those with greater power and those with less — a distance that goes beyond the realm of interpersonal interactions and may exacerbate the soaring inequality in the United States.

A growing body of recent research shows that people with the most social power pay scant attention to those with little such power. This tuning out has been observed, for instance, with strangers in a mere five-minute get-acquainted session, where the more powerful person shows fewer signals of paying attention, like nodding or laughing. Higher-status people are also more likely to express disregard, through facial expressions, and are more likely to take over the conversation and interrupt or look past the other speaker.

Bringing the micropolitics of interpersonal attention to the understanding of social power, researchers are suggesting, has implications for public policy.

Of course, in any society, social power is relative; any of us may be higher or lower in a given interaction, and the research shows the effect still prevails. Though the more powerful pay less attention to us than we do to them, in other situations we are relatively higher on the totem pole of status — and we, too, tend to pay less attention to those a rung or two down.

A prerequisite to empathy is simply paying attention to the person in pain. In 2008, social psychologists from the University of Amsterdam and the University of California, Berkeley, studied pairs of strangers telling one another about difficulties they had been through, like a divorce or death of a loved one. The researchers found that the differential expressed itself in the playing down of suffering. The more powerful were less compassionate toward the hardships described by the less powerful.

Dacher Keltner, a professor of psychology at Berkeley, and Michael W. Kraus, an assistant professor of psychology at the University of Illinois, Urbana-Champaign, have done much of the research on social power and the attention deficit.

Mr. Keltner suggests that, in general, we focus the most on those we value most. While the wealthy can hire help, those with few material assets are more likely to value their social assets: like the neighbor who will keep an eye on your child from the time she gets home from school until the time you get home from work. The financial difference ends up creating a behavioral difference. Poor people are better attuned to interpersonal relations — with those of the same strata, and the more powerful — than the rich are, because they have to be.

While Mr. Keltner’s research finds that the poor, compared with the wealthy, have keenly attuned interpersonal attention in all directions, in general, those with the most power in society seem to pay particularly little attention to those with the least power. To be sure, high-status people do attend to those of equal rank — but not as well as those low of status do.

This has profound implications for societal behavior and government policy. Tuning in to the needs and feelings of another person is a prerequisite to empathy, which in turn can lead to understanding, concern and, if the circumstances are right, compassionate action.

In politics, readily dismissing inconvenient people can easily extend to dismissing inconvenient truths about them. The insistence by some House Republicans in Congress on cutting financing for food stamps and impeding the implementation of Obamacare, which would allow patients, including those with pre-existing health conditions, to obtain and pay for insurance coverage, may stem in part from the empathy gap. As political scientists have noted, redistricting and gerrymandering have led to the creation of more and more safe districts, in which elected officials don’t even have to encounter many voters from the rival party, much less empathize with them.

Social distance makes it all the easier to focus on small differences between groups and to put a negative spin on the ways of others and a positive spin on our own.

Freud called this “the narcissism of minor differences,” a theme repeated by Vamik D. Volkan, an emeritus professor of psychiatry at the University of Virginia, who was born in Cyprus to Turkish parents. Dr. Volkan remembers hearing as a small boy awful things about the hated Greek Cypriots — who, he points out, actually share many similarities with Turkish Cypriots. Yet for decades their modest-size island has been politically divided, which exacerbates the problem by letting prejudicial myths flourish.

In contrast, extensive interpersonal contact counteracts biases by letting people from hostile groups get to know one another as individuals and even friends. Thomas F. Pettigrew, a research professor of social psychology at the University of California, Santa Cruz, analyzed more than 500 studies on intergroup contact. Mr. Pettigrew, who was born in Virginia in 1931 and lived there until going to Harvard for graduate school, told me in an e-mail that it was the “the rampant racism in the Virginia of my childhood” that led him to study prejudice.

In his research, he found that even in areas where ethnic groups were in conflict and viewed one another through lenses of negative stereotypes, individuals who had close friends within the other group exhibited little or no such prejudice. They seemed to realize the many ways those demonized “others” were “just like me.” Whether such friendly social contact would overcome the divide between those with more and less social and economic power was not studied, but I suspect it would help.

Since the 1970s, the gap between the rich and everyone else has skyrocketed. Income inequality is at its highest level in a century. This widening gulf between the haves and have-less troubles me, but not for the obvious reasons. Apart from the financial inequities, I fear the expansion of an entirely different gap, caused by the inability to see oneself in a less advantaged person’s shoes. Reducing the economic gap may be impossible without also addressing the gap in empathy.

Daniel Goleman, a psychologist, is the author of “Emotional Intelligence” and, most recently, “Focus: The Hidden Driver of Excellence.”

• The reason the Republicans shutdown the government is an attempt by "conservative" groups to "defund Obamacare". From the NY Times: A Federal Budget Crisis Months in the Planning
Shortly after President Obama started his second term, a loose-knit coalition of conservative activists led by former Attorney General Edwin Meese III gathered in the capital to plot strategy. ...

Out of that session, held one morning in a location the members insist on keeping secret, came a little-noticed “blueprint to defunding Obamacare,” signed by Mr. Meese and leaders of more than three dozen conservative groups.

It articulated a take-no-prisoners legislative strategy that had long percolated in conservative circles: that Republicans could derail the health care overhaul if conservative lawmakers were willing to push fellow Republicans — including their cautious leaders — into cutting off financing for the entire federal government.

“We felt very strongly at the start of this year that the House needed to use the power of the purse,” said one coalition member ...

Last week the country witnessed the fallout from that strategy: a standoff that has shuttered much of the federal bureaucracy and unsettled the nation.
• This is a radical approach to public policy and it is Not Gonna Happen.

• All of the furloughed federal workers will be paid in full for lost pay during the shutdown. The House passed this bill on Saturday by a 407-0 vote. So workers will be paid for not working.

• Most defense workers have been recalled. From the NY Times: Hagel Recalls Most Defense Department Workers
Defense Secretary Chuck Hagel made a surprise announcement on Saturday that he would recall next week almost all of the 400,000 civilian employees of the Defense Department who had been sent home when the government shut down.

Mr. Hagel said the decision that “most D.O.D. civilians” would now be exempted from furloughs came after Pentagon and Justice Department lawyers interpreted a budget law passed just before the shutdown to include a larger number of workers.
• Congress will pay-the-bills (aka raise the "debt ceiling"). This is not negotiable. Treasury believes they will be low on funds by October 17th.

• Monday, October 14th is Columbus Day (A Federal holiday), and the week of October 14th through October 18th is a "Constituent Work Week" (aka recess). The current schedule is to the have no votes after 3 PM ET on Friday October 11th, so Congress can leave Washington Friday night. It is very unlikely that Congress will leave town that week without agreeing to "pay the bills".

• The bottom line is: 1) the shutdown was caused by groups making non-negotiable demands, 2) the shutdown will be expensive, and my guess is 3) the shutdown will probably end before Congress goes on recess.

A Federal Budget Crisis Months in the Planning

Michael Stravato for The New York Times
"You are here because now is the single best time we have to defund Obamacare. This is a fight we can win." SENATOR TED CRUZ, speaking in August to a Heritage Action gathering in Dallas
Published: October 5, 2013

WASHINGTON — Shortly after President Obama started his second term, a loose-knit coalition of conservative activists led by former Attorney General Edwin Meese III gathered in the capital to plot strategy. Their push to repeal Mr. Obama’s health care law was going nowhere, and they desperately needed a new plan.

Out of that session, held one morning in a location the members insist on keeping secret, came a little-noticed “blueprint to defunding Obamacare,” signed by Mr. Meese and leaders of more than three dozen conservative groups.

It articulated a take-no-prisoners legislative strategy that had long percolated in conservative circles: that Republicans could derail the health care overhaul if conservative lawmakers were willing to push fellow Republicans — including their cautious leaders — into cutting off financing for the entire federal government.

“We felt very strongly at the start of this year that the House needed to use the power of the purse,” said one coalition member, Michael A. Needham, who runs Heritage Action for America, the political arm of the Heritage Foundation. “At least at Heritage Action, we felt very strongly from the start that this was a fight that we were going to pick.”

Last week the country witnessed the fallout from that strategy: a standoff that has shuttered much of the federal bureaucracy and unsettled the nation.

To many Americans, the shutdown came out of nowhere. But interviews with a wide array of conservatives show that the confrontation that precipitated the crisis was the outgrowth of a long-running effort to undo the law, the Affordable Care Act, since its passage in 2010 — waged by a galaxy of conservative groups with more money, organized tactics and interconnections than is commonly known.

With polls showing Americans deeply divided over the law, conservatives believe that the public is behind them. Although the law’s opponents say that shutting down the government was not their objective, the activists anticipated that a shutdown could occur — and worked with members of the Tea Party caucus in Congress who were excited about drawing a red line against a law they despise.

A defunding “tool kit” created in early September included talking points for the question, “What happens when you shut down the government and you are blamed for it?” The suggested answer was the one House Republicans give today: “We are simply calling to fund the entire government except for the Affordable Care Act/Obamacare.”

The current budget brinkmanship is just the latest development in a well-financed, broad-based assault on the health law, Mr. Obama’s signature legislative initiative. Groups like Tea Party Patriots, Americans for Prosperity and FreedomWorks are all immersed in the fight, as is Club for Growth, a business-backed nonprofit organization. Some, like Generation Opportunity and Young Americans for Liberty, both aimed at young adults, are upstarts. Heritage Action is new, too, founded in 2010 to advance the policy prescriptions of its sister group, the Heritage Foundation.

The billionaire Koch brothers, Charles and David, have been deeply involved with financing the overall effort. A group linked to the Kochs, Freedom Partners Chamber of Commerce, disbursed more than $200 million last year to nonprofit organizations involved in the fight. Included was $5 million to Generation Opportunity, which created a buzz last month with an Internet advertisement showing a menacing Uncle Sam figure popping up between a woman’s legs during a gynecological exam.

The groups have also sought to pressure vulnerable Republican members of Congress with scorecards keeping track of their health care votes; have burned faux “Obamacare cards” on college campuses; and have distributed scripts for phone calls to Congressional offices, sample letters to editors and Twitter and Facebook offerings for followers to present as their own.

One sample Twitter offering — “Obamacare is a train wreck” — is a common refrain for Speaker John A. Boehner.

As the defunding movement picked up steam among outside advocates, Republicans who sounded tepid became targets. The Senate Conservatives Fund, a political action committee dedicated to “electing true conservatives,” ran radio advertisements against three Republican incumbents.

Heritage Action ran critical Internet advertisements in the districts of 100 Republican lawmakers who had failed to sign a letter by a North Carolina freshman, Representative Mark Meadows, urging Mr. Boehner to take up the defunding cause.

“They’ve been hugely influential,” said David Wasserman, who tracks House races for the nonpartisan Cook Political Report. “When else in our history has a freshman member of Congress from North Carolina been able to round up a gang of 80 that’s essentially ground the government to a halt?”

On Capitol Hill, the advocates found willing partners in Tea Party conservatives, who have repeatedly threatened to shut down the government if they do not get their way on spending issues. This time they said they were so alarmed by the health law that they were willing to risk a shutdown over it. (“This is exactly what the public wants,” Representative Michele Bachmann of Minnesota, founder of the House Tea Party Caucus, said on the eve of the shutdown.)

Despite Mrs. Bachmann’s comments, not all of the groups have been on board with the defunding campaign. Some, like the Koch-financed Americans for Prosperity, which spent $5.5 million on health care television advertisements over the past three months, are more focused on sowing public doubts about the law. But all have a common goal, which is to cripple a measure that Senator Ted Cruz, a Texas Republican and leader of the defunding effort, has likened to a horror movie.
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“We view this as a long-term effort,” said Tim Phillips, the president of Americans for Prosperity. He said his group expected to spend “tens of millions” of dollars on a “multifront effort” that includes working to prevent states from expanding Medicaid under the law. The group’s goal is not to defund the law.

“We want to see this law repealed,” Mr. Phillips said.

A Familiar Tactic

The crowd was raucous at the Hilton Anatole, just north of downtown Dallas, when Mr. Needham’s group, Heritage Action, arrived on a Tuesday in August for the second stop on a nine-city “Defund Obamacare Town Hall Tour.” Nearly 1,000 people turned out to hear two stars of the Tea Party movement: Mr. Cruz, and Jim DeMint, a former South Carolina senator who runs the Heritage Foundation.

“You’re here because now is the single best time we have to defund Obamacare,” declared Mr. Cruz, who would go on to rail against the law on the Senate floor in September with a monologue that ran for 21 hours. “This is a fight we can win.”

Although Mr. Cruz is new to the Senate, the tactic of defunding in Washington is not. For years, Congress has banned the use of certain federal money to pay for abortions, except in the case of incest and rape, by attaching the so-called Hyde Amendment to spending bills.

After the health law passed in 2010, Todd Tiahrt, then a Republican congressman from Kansas, proposed defunding bits and pieces of it. He said he spoke to Mr. Boehner’s staff about the idea while the Supreme Court, which upheld the central provision, was weighing the law’s constitutionality.

“There just wasn’t the appetite for it at the time,” Mr. Tiahrt said in an interview. “They thought, we don’t need to worry about it because the Supreme Court will strike it down.”

But the idea of using the appropriations process to defund an entire federal program, particularly one as far-reaching as the health care overhaul, raised the stakes considerably. In an interview, Mr. DeMint, who left the Senate to join the Heritage Foundation in January, said he had been thinking about it since the law’s passage, in part because Republican leaders were not more aggressive.

“They’ve been through a series of C.R.s and debt limits,” Mr. DeMint said, referring to continuing resolutions on spending, “and all the time there was discussion of ‘O.K., we’re not going to fight the Obamacare fight, we’ll do it next time.’ The conservatives who ran in 2010 promising to repeal it kept hearing, ‘This is not the right time to fight this battle.’ ”

Mr. DeMint is hardly alone in his distaste for the health law, or his willingness to do something about it. In the three years since Mr. Obama signed the health measure, Tea Party-inspired groups have mobilized, aided by a financing network that continues to grow, both in its complexity and the sheer amount of money that flows through it.

A review of tax records, campaign finance reports and corporate filings shows that hundreds of millions of dollars have been raised and spent since 2012 by organizations, many of them loosely connected, leading opposition to the measure.

One of the biggest sources of conservative money is Freedom Partners, a tax-exempt “business league” that claims more than 200 members, each of whom pays at least $100,000 in dues. The group’s board is headed by a longtime executive of Koch Industries, the conglomerate run by the Koch brothers, who were among the original financiers of the Tea Party movement. The Kochs declined to comment.

While Freedom Partners has financed organizations that are pushing to defund the law, like Heritage Action and Tea Party Patriots, Freedom Partners has not advocated that. A spokesman for the group, James Davis, said it was more focused on “educating Americans around the country on the negative impacts of Obamacare.”

The largest recipient of Freedom Partners cash — about $115 million — was the Center to Protect Patient Rights, according to the groups’ latest tax filings. Run by a political consultant with ties to the Kochs and listing an Arizona post office box for its address, the center appears to be little more than a clearinghouse for donations to still more groups, including American Commitment and the 60 Plus Association, both ardent foes of the health care law.

American Commitment and 60 Plus were among a handful of groups calling themselves the “Repeal Coalition” that sent a letter in August urging Republican leaders in the House and the Senate to insist “at a minimum” in a one-year delay of carrying out the health care law as part of any budget deal. Another group, the Conservative 50 Plus Alliance, delivered a defunding petition with 68,700 signatures to the Senate.

House Republican Efforts to Repeal or Weaken the Health Care Law

The Cost of the Shutdown by the Numbers

News Analysis: The Benefits of Intransigence (October 6, 2013)
Related in Opinion

Paul Krugman: The Boehner Bunglers (October 7, 2013)
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In the fight to shape public opinion, conservatives face well-organized liberal foes. Enroll America, a nonprofit group allied with the Obama White House, is waging a campaign to persuade millions of the uninsured to buy coverage. The law’s supporters are also getting huge assistance from the insurance industry, which is expected to spend $1 billion on advertising to help sell its plans on the exchanges.

“It is David versus Goliath,” said Mr. Phillips of Americans for Prosperity.

But conservatives are finding that with relatively small advertising buys, they can make a splash. Generation Opportunity, the youth-oriented outfit behind the “Creepy Uncle Sam” ads, is spending $750,000 on that effort, aimed at dissuading young people — a cohort critical to the success of the health care overhaul — from signing up for insurance under the new law.

The group receives substantial backing from Freedom Partners and appears ready to expand. Recently, Generation Opportunity moved into spacious new offices in Arlington, Va., where exposed ductwork, Ikea chairs and a Ping-Pong table give off the feel of a Silicon Valley start-up.

Its executive director, Evan Feinberg, a 29-year-old former Capitol Hill aide and onetime instructor for a leadership institute founded by Charles Koch, said there would be more Uncle Sam ads, coupled with college campus visits, this fall. Two other groups, FreedomWorks, with its “Burn Your Obamacare Card” protests, and Young Americans for Liberty, are also running campus events.

“A lot of folks have asked us, ‘Are we trying to sabotage the law?’ ” Mr. Feinberg said in an interview last week. His answer echoes the Freedom Partners philosophy: “Our goal is to educate and empower young people.”

Critical Timing

But many on the Republican right wanted to do more.

Mr. Meese’s low-profile coalition, the Conservative Action Project, which seeks to find common ground among leaders of an array of fiscally and socially conservative groups, was looking ahead to last Tuesday, when the new online health insurance marketplaces, called exchanges, were set to open. If the law took full effect as planned, many conservatives feared, it would be nearly impossible to repeal — even if a Republican president were elected in 2016.

“I think people realized that with the imminent beginning of Obamacare, that this was a critical time to make every effort to stop something,” Mr. Meese said in an interview. (He has since stepped down as the coalition’s chairman and has been succeeded by David McIntosh, a former congressman from Indiana.)

The defunding idea, Mr. Meese said, was “a logical strategy.” The idea drew broad support. Fiscal conservatives like Chris Chocola, the president of the Club for Growth, signed on to the blueprint. So did social and religious conservatives, like the Rev. Lou Sheldon of the Traditional Values Coalition.

The document set a target date: March 27, when a continuing resolution allowing the government to function was to expire. Its message was direct: “Conservatives should not approve a C.R. unless it defunds Obamacare.”

But the March date came and went without a defunding struggle. In the Senate, Mr. Cruz and Senator Mike Lee, a Utah Republican, talked up the defunding idea, but it went nowhere in the Democratic-controlled chamber. In the House, Mr. Boehner wanted to concentrate instead on locking in the across-the-board budget cuts known as sequestration, and Tea Party lawmakers followed his lead. Outside advocates were unhappy but held their fire.

“We didn’t cause any trouble,” Mr. Chocola said.

Yet by summer, with an August recess looming and another temporary spending bill expiring at the end of September, the groups were done waiting.

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“I remember talking to reporters at the end of July, and they said, ‘This didn’t go anywhere,’ ” Mr. Needham recalled. “What all of us felt at the time was, this was never going to be a strategy that was going to win inside the Beltway. It was going to be a strategy where, during August, people would go home and hear from their constituents, saying: ‘You pledged to do everything you could to stop Obamacare. Will you defund it?’ ”

House Republican Efforts to Repeal or Weaken the Health Care Law

The Cost of the Shutdown by the Numbers

News Analysis: The Benefits of Intransigence (October 6, 2013)
Related in Opinion

Paul Krugman: The Boehner Bunglers (October 7, 2013)
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Heritage Action, which has trained 6,000 people it calls sentinels around the country, sent them to open meetings and other events to confront their elected representatives. Its “Defund Obamacare Town Hall Tour,” which began in Fayetteville, Ark., on Aug. 19 and ended 10 days later in Wilmington, Del., drew hundreds at every stop.

The Senate Conservatives Fund, led by Mr. DeMint when he was in the Senate, put up a Web site in July called dontfundobamacare.com and ran television ads featuring Mr. Cruz and Mr. Lee urging people to tell their representatives not to fund the law.

When Senator Richard M. Burr, a North Carolina Republican, told a reporter that defunding the law was “the dumbest idea I’ve ever heard,” the fund bought a radio ad to attack him. Two other Republican senators up for re-election in 2014, Lamar Alexander of Tennessee and Lindsey Graham of South Carolina, were also targeted. Both face Tea Party challengers.

In Washington, Tea Party Patriots, which created the defunding tool kit, set up a Web site, exemptamerica.com, to promote a rally last month showcasing many of the Republicans in Congress whom Democrats — and a number of fellow Republicans — say are most responsible for the shutdown.

While conservatives believe that the public will back them on defunding, a recent poll by the Kaiser Family Foundation found that a majority — 57 percent — disapproves of cutting off funding as a way to stop the law.

Last week, with the health care exchanges open for business and a number of prominent Republicans complaining that the “Defund Obamacare” strategy was politically damaging and pointless, Mr. Needham of Heritage Action said he felt good about what the groups had accomplished.

“It really was a groundswell,” he said, “that changed Washington from the outside in.”