Free exchange

THE Fed appears to have a preferred recovery path. Early in the crisis, the Fed cut rates to near-zero and initiated a policy of security purchases designed to boost the economy. By last 2009 and early 2010, the Fed's messaging switched to discussing exit strategies, signalling that it was comfortable with the trajectory it was forecasting at the time. When actual economic conditions underperformed that trajectory in the summer of 2010, the Fed acted again to move the economy back toward its preferred path.

The Fed's latest economic projections are at right. As you can see, the outlook as somewhat better than it was in November. Growth this year is projected to be much stronger than was previously forecast. The unemployment and inflation forecasts also look better, though not by as much as real GDP growth.

Some analysts will focus on this improvement from November and make guesses about the Fed's commitment to QE2. That's probably not the best way to get a sense of the situation. One would do better to compare current forecasts to those in January of 2010, at which point the Fed was talking about exit.

So, take a look at the range for 2012 unemployment: 7.6% to 8.1%. When the Fed was preparing to tighten, it was forecasting 2012 unemployment of 6.6% to 7.5%, a much stronger labour market than is currently projected. What about inflation? The Fed sees a 2012 core inflation rate of 1.0% to 1.5% as being likely. In January of last year, by contrast, it expected a core inflation rate in 2012 of 1.2% to 1.9%.

So what does this tell us? Well, both measures indicate that the economy is not yet on a path consistent with a move toward Fed tightening. But note, the inflation gap is smaller than the unemployment rate gap. The difference could be due to concern that the natural rate of unemployment has risen, such that inflation pressures in labour markets build earlier than the Fed thought a year ago.

The Fed is going to be watching labour market data very closely to see if the Beveridge curve is showing any signs of a troublesome rise in structural unemployment. Wouldn't it be nice if the Senate would go ahead and approve the Nobel prize-winning economist and Beveridge curve expert nominated to the Fed Board of Governors?

THIS week's interesting economics research:

• Net fiscal stimulus during the Great Recession (Joshua Aizenman and Gurnain Kaur Pasricha)

• Predicting economic market crises using measures of collective panic (Dion Harmon, Marcus de Aguiar, David Chinellato, Dan Braha, Irving Epstein, and Yaneer Bar-Yam)

• The top 20 American Economic Review articles (Kenneth Arrow, Douglas Bernheim, Martin Feldstein, Daniel McFadden, James Poterba, and Robert Solow)

• Why is an elite undergraduate education valuable? (Kevin Lang and Erez Siniver)

• Democracy, property rights, income equality, and corruption (Bin Dong and Benno Torgler)

NOTHING stays the same forever. This week, fresh economic data confirmed what everyone has known since last summer: China surpassed Japan to be the world's second-largest economy sometime in 2010.

What do the figures mean? China is number two in market exchange rates, in American dollars. In terms of purchasing power parity (which takes into the account the differences in prices in different economies), China became second largest many years ago. And in terms of per capita GDP, the Chinese only enjoy one-tenth the national income of the Japanese. It will take a long time for China to catch up in that respect: they number 1.3 billion people, while Japan's population is declining (which could actually boost their well-being by this measure, provided the economy does not shrink). 

Milestone moments like this are artificial. But they serve as good a time as any to remind ourselves of the central message of the I Ching, China's "Book of Changes": all is in motion; nothing remains the same. And Japan surely sped up this day's coming by failing to reform its economy. Now the question is, what will the future look like? 

Based on current trends, China is on track to become the world's largest economy in around 15 years. Japan also looks poised to shed its third-place rank: the economy is largely stagnant and its politics is a mess. 

But before one leaves it at that, it is useful to remember that events rarely flow in predictable ways. Thirty years ago the Japanese economy was widely hailed as being on track to supersede America's, yet it got waylaid for a breathtaking two decades. No one forecast that degree of stagnation—not even The Economist's former editor, Bill Emmott, whose 1989 book "The Sun Also Sets" foretold many of the problems that eventually walloped Japan. 

Today a similar set of historical blinders are worn. It is taken as a given that China's growth is only going to continue going up and up. To be sure, critics talk of bubbles and shocks and rebalancing. Some hedge funds hope to make a packet shorting the country. There are even doomsday whispers of an economic crisis forcing a political crisis that sets the country back dramatically. The Economist regularly sounds these warnings, as when it points out political risk. But together, the criticisms are not taken very seriously, and haven't seemed to dramatically change corporate decisions or the flows of foreign direct investment.

In short, people seem to treat the inevitability of China's economic rise as they did Japan's. But history has the last word—and it is a jokester. Nothing goes up forever. In the long term, China will be number one and Japan will atrophy—that is almost certain. Demographics is destiny, after all. In the medium term, however, it is not so certain. Even Japan has been making huge strides to revitalise its economy. What has changed may change again.

ECONOMISTS at the San Francisco Fed have been working overtime to figure out whether any of America's continuing unemployment problem is structural. Today, writers are linking around this new Economic Letter, by Justin Wiedner and John Williams. Here's the abstract:

Recent labor markets developments, including mismatches in the skills of workers and jobs, extended unemployment benefits, and very high rates of long-term joblessness, may be impeding the return to "normal" unemployment rates of around 5%. An examination of alternative measures of labor market conditions suggests that the "normal" unemployment rate may have risen as much as 1.7 percentage points to about 6.7%, although much of this increase is likely to prove temporary. Even with such an increase, sizable labor market slack is expected to persist for years.

Mr Weidner and Mr Williams run a few regressions on typical labour market relationships to arrive at several different estimates of the new natural rate of unemployment. They conclude that the median increase is "about 6.7%". In January, by contrast, the San Francisco Fed published a working paper by Mary Daly, Bart Hobijn, and Rob Valetta. The authors conduct their own analysis of the labour market and find that:

[T]he natural rate of unemployment has in fact risen over the past several years, by an amount ranging from 0.6 to 1.9 percentage points. This increase implies a current natural rate in the range of 5.6 to 6.9 percent, with our preferred estimate at 6.25 percent. After examining evidence regarding the effects of labor market mismatch, extended unemployment benefits, and productivity growth, we conclude that only a small fraction of the recent increase in the natural rate is likely to persist beyond a five-year forecast horizon.

There are a few things to point out about these studies. The most interesting is the breakdown of the rise in structural unemployment by cause in the latter paper. The authors find that skills mismatch is causing very little of the increase. Rather, unemployment insurance is responsible for most of it, with productivity improvements making up the rest. This determination leads to the conclusion that the rise in the natural rate is temporary. As labour market conditions improve, unemployment benefits will lapse and demand for workers displaced by productivity gains will increase. The "temporary" finding in the first paper cites the analysis in the second.

This result is leading some writers and economists to dismiss the findings as indicating that the problem with labour markets is demand. Certainly the biggest problem with labour markets is demand, but we should tread cautiously. Both studies suggest that there has been some rise in the long-term structural rate of unemployment. This rise would likely be much higher if so many workers had not exited the labour force over the past decade. And the warning in these papers that labour market weakness will persist for some time is not encouraging; the longer workers go without jobs, the less employable they become. As I've said before, it shouldn't be controversial to provide increased support for job retraining programmes. Unfortunately, members of both parties seem anxious to cut such programmes.

A final question is how these analyses will impact the thinking of Federal Reserve officials. The Fed's Economic Letter notes that as of the fourth quarter, the Congressional Budget Office was estimating a natural rate of unemployment of 5.2% with an actual unemployment rate of about 9.6%, for a gap of 4.4%. Now, officials could conceivably be looking at a natural rate of 6.7% with an actual rate of 9.0%, for a gap of 2.3%. To a central banker, that signals a tighter labour market, with less downward pressure on wages, and more of a threat of looming inflation.

I think it would be wrong for the Fed to revise its views too much based on these datapoints, and I think it would be wrong for the Fed to react too quickly to inflation, when and if it emerges. But it also seems clear that members of the FOMC will see what they want to see. Minneapolis Fed President Narayana Kocherlakota is a nominal supporter of QE2, but he is also on record saying that most of current unemployment is structural. These studies are likely to appeal to him. And just this week, Philadelphia Fed President Charles Plosser made comments suggesting that current joblessness has significant structural elements that the Fed can't fix.

These views strike me as woefully off base. I suspect that Ben Bernanke is sceptical of them, as well. But the data points that have come out over the past two months, including those included in the Fed analyses above, have slightly shifted the monetary policy ground to make it harder to maintain an aggressively expansionary pose. And that is cause for concern, particularly for the millions of workers who remain unemployed for cyclical reasons.

TODAY'S recommended economics writing:

• Quarterly report on household debt (New York Fed)

• Wall Street's dead end (New York Times)

• Participation rate update (Calculated Risk)

• The inflation disconnect (macroblog)

• Seattle's foreseeable housing bust (Economix)

THIS morning, hundreds of Washington journalists are fanning out across the city to attend briefings on President Obama's 2012 budget proposal. Many will take detailed notes and ask remarkably specific questions about the tiniest aspects of the plan, which runs to over 200 pages. I suspect they'll have a tougher time than normal maintaining their enthusiasm for the process, however. Rarely has a budget felt more aspirational, and less relevant.

The basic details are interesting to note. The president has budgeted a deficit for fiscal 2012 of $1.1 trillion, or about 7% of GDP. Deficits fall to 3.1% of GDP by the end of the decade, according to the plan, while debt as a share of GDP will rise to 77% over that time frame. Revenues are forecast to increase substantially from fiscal 2011, while outlays decline. Much of the improvement in the budget picture comes from a strengthening economy, despite the fact that the administration's economic forecasts look, to me, to be a little too pessimistic. I would be surprised if real GDP increased just 2.7%, year-on-year, in 2011. Unemployment forecasts also look too dour. On the bright side (for the administration), a pessimistic forecast will increase the scope for good news surprises down the road.

But while the president proposes budgets, Congress passes budget resolutions and appropriations, and the Republican party controls the House of Representative. That means that many of the specific line items in the budget aren't worth the paper they're printed on. Taxation of carried interest? Forget about it. An end to fossil fuel subsidies? Just like last year, it's dead on arrival. Perhaps saddest of all is the president's proposal to reauthorise the nation's transportation funding law, to be paid for with "bipartisan financing for Transportation Trust Fund". The bipartisan financing plan would raise $140 billion through 2016, if it weren't less likely to be found than a yeti riding a unicorn.

The budget is somewhat valuable as a guide to the spending cuts the president may be willing to tolerate. But here, as with the Republican proposals that have trickled out over the past week, early negotiations between the parties are an exercise in furiously ignoring the nature of the country's real fiscal problems. While the parties bicker over funding levels for non-defence, discretionary spending items, the bulk of the budget—and the part that's reponsible for most of the long-term spending growth—is treated like an afterthought.

The situation is thoroughly depressing. Washington seems to have finally gotten itself in the mood to cut deficits. Unfortunately, the cuts that result are likely to be unhelpful, or possibly counterproductive, as leaders slash useful programmes to the bone because they're too scared to talk about reining in health care spending, or cutting wasteful defence programmes, or raising taxes.

It's hard to imagine something worse than a bruising political battle that threatens to shut down the government or throw it into default. But a bruising political battle that threatens to shut down the government or throw it into default without doing a thing about the long-run budget problem would probably do it.

TODAY'S recommended economics writing:

• Medicare, Medicare, Medicare (Matt Yglesias)

• Egypt (Mark Thoma)

• The impact of the printing press (Vox)

• In China, tentative steps toward global currency (New York Times)

LIKE most other government and multilateral agencies, not to mention economists in academia and elsewhere, the IMF entirely failed to see the global crisis coming. This is hardly news, so you might think that yesterday’s internal report into the fund’s performance in the period leading up to the global crisis might have little to offer (unless it tried to whitewash the fund’s failure, which it doesn’t).

Indeed, the report doesn’t offer any particularly startling revelations or novel reasons for why the fund so completely failed to spot any warning signs in its regular surveillance of major economies during 2004-07. But its willingness to provide a list of the (often pretty embarrassing) things the IMF’s reports said in that period still make for pretty interesting—and occasionally, cringe-inducing—reading. Here are some of my favourite bits.

On the American housing market:

In the United States, for example, it did not discuss, until the crisis had already erupted, the deteriorating lending standards for mortgage financing, or adequately assess the risks and impact of a major housing price correction on financial institutions…As late as April 2006, shortly before U.S. housing prices peaked, the WEO and the GFSR explained away the rising share of non-traditional mortgages in the United States thus: “Default rates on residential mortgage loans have been low historically. Together with securitization of the mortgage market, this suggests that the impact of a slowing housing market on the financial sector is likely to be limited.

On the overall message of the fund’s flagship World Economic Outlook:

According to the WEO, the world economic outlook was “among the rosiest” in a decade (April 2004); expected to be “one of its strongest years of growth” unless events take “an awful turn” (September 2004); in the “midst of an extraordinary purple patch” (April 2006); and “strong” (September 2006); all the way up to April 2007 when the report forecast that “world growth will continue to be strong” and opined that global economic risks had declined since September 2006.

Public pronouncements by officials were equally behind the curve:

(A)late as August 2007, Management considered the global economic outlook to be “very favorable.”...Meanwhile,...(in) July 2008...the message was that “risks of a financial tail event have eased.

Even when some of its officials had different ideas, the fund’s management seemed not to be listening. Its then chief economist, Raghuram Rajan, concluded a presentation at the annual Jackson Hole conference of central bankers in 2005 by arguing that “we should be prepared for the low probability but highly costly downturn”. But the IMF now admits that:

Despite the importance of the Economic Counsellor’s position, there was no follow up on Rajan’s analysis and concerns— his views did not influence the IMF’s work program or even the flagship documents issued after the Jackson Hole speech.

In 2006, the fund formed a task force to examine how it could strengthen its financial sector analysis and better integrate this into its annual economic surveillance of individual economies. The report of the task force provided some examples of best practices. Of these, the new report says that “in retrospect, (they) appear completely off the mark”.

Exhibit A: Iceland. The 2006 task force report said that Iceland’s developments from 2003–06 “provide a useful illustration of the importance of a proper analysis of the relationships between financial markets, the financial sector, and the broad economy”. It concluded its discussion of the country by saying, “(I)n Iceland’s case … hedging behavior and generally sound balance sheets and asset-liability management made the financial system relatively robust to the recent shocks.”

Continue reading "The warning signs they missed" >>

JUST a month after the Financial Times compared the Garuda Indonesia IPO to a soaring phoenix, shares have slid 21% on its opening day. This is not entirely surprising. Investors were understandably wary when in October, Garuda declared a loss of $4.4m, then promptly corrected itself, saying it had, in fact, made a profit of five times that amount. The company says it was an honest mistake, which is just as well. To qualify for an offering on the Indonesian exchange, companies must usually post four successive quarters of profit; so a loss might have derailed Garuda's IPO timetable (though this rule was flouted during the recent IPO of Bakrie-sponsored Bumi Mineral Resources).

No matter. The government continues to encourage the sale of shares in state-owned enterprises to address easy liquidity conditions—and also take advantage of them. But this strategy cannot continue forever because the government will run out of companies to sell.

A recent increase in inflation expectations is being caused by supply constraints (for some agricultural products, for instance) and an increase in incomes. The central bank can counteract some of that increase in demand by raising interest rates (to deter local credit growth) or letting the rupiah rise (to lower the price of imports). But both policies have costs. Letting the rupiah rise faster risks hurting an ailing exporting sector pressured by the onslaught of cheap imports under the new ASEAN Free Trade Agreement. Raising interest rates risks curbing an ongoing industrial expansion. (The central bank half-heartedly raised interest rates by 25 basis points last week, but this was just to appease investors who feared the country was falling behind the tightening cycle).

Bank Indonesia, the central bank, has so far opted to hold interest rates and the rupiah steady while imposing capital controls: raising banking reserve requirements, lengthening the tenure of local sovereign-debt holdings, and imposing restrictions on short-term external borrowing by banks. But as inflation picks up, more serious controls (and no doubt more IPOs) will probably be necessary.

MY COLLEAGUES are making my job easy today. At Democracy in America, W.W. notes that despite Republicans' best attempts to see inflation pressures in American data, they simply aren't there. Here at Free exchange, G.I. cites the example of the Asian crisis to explain how a Fed reaction to rising commodity prices would be a mistake. Meanwhile, Buttonwood details the possible extent of the commodity price pressure to come:

Were Chinese oil consumption to reach US per capita levels, its demand would rise ninefold, while Indian consumption would have to go up 23-fold. That would push global oil demand up to 260 million barrels per day, compared with just under 90m barrels a day at present. Clearly, that's not going to happen. But along the way, some combination of much higher prices, a setback to developing nation growth or a switch to alternative fuel sources might be needed; all of which could be very disruptive.

The key factor is that US demand is no longer crucial for setting the global price of all commodities.

America's per capita oil consumption is significantly higher than that in Europe, and so it's unlikely that either India or China would approach those levels, but the point stands; billions of emerging market residents have been consuming resources like members of poor countries and they're increasingly consuming resources like members of industrialised countries. The world will need to adjust, and the price mechanism is the means through which that adjusment will occur.

There is little that developed world central banks can or should do about rising commodity prices. Labour markets are too weak to allow much worker bargaining, and so higher prices are unlikely to lead to a wage-price spiral. The impact of dearer commodities on household budgets is also likely to be contractionary. Consumers must simply adjust their consumption behaviour.

In emerging markets, the central bank decision is more difficult. As members of Economics by invitation note this week, prices in tighter economies will be more likely to pass through to wages, particularly when commodities make up a larger share of household purchases, as they do in poorer countries. Meanwhile, higher food prices could be politically destabilising, which adds an additional consideration to policy.

But the temptation for governments in both rich and emerging countries will be to shield consumers from rising prices, through subsidies and other market interventions. This is likely to do a lot of harm. Fuel subsidies can grow very expensive very quickly amid rising prices. And given real supply constraints, actual changes in behaviour are necessary, and subsidies will deter these shifts.

The days when just one-sixth of the world's population consumed an outsized proportion of available resources were pleasant ones for that lucky one-sixth. The transition to a different distribution will not be easy. But it is inevitable.

FOR those convinced that America is on the verge of becoming Weimar Germany, the high price of oil and gold are exhibits one and two. Often forgotten is the fact that both are traded in global markets and reflect global, not American, demand. Failing to appreciate the distinction can lead to policy mistakes. Just look at 1998.

A financial crisis tipped east Asia into a deep recession in 1997-98, which spread to Russia and then the United States via Long Term Capital Management. To cushion the spillover to America, the Fed first aborted a nascent monetary tightening cycle, then actually cut interest rates. It could do so in part because collapsing Asian demand crushed the price of oil, sending headline inflation below 2%.

We now know that between cheaper oil and the Fed’s rate cuts, the Asian crisis was ultimately a positive for an economy already operating below 5% unemployment. Growth, and with it the stock market, went into overdrive. The result was the Nasdaq bubble.

Today, we have the mirror image. Surging demand in emerging markets that are at or near capacity has driven up commodity prices at a time when America is awash in unused capacity. Buying gold as an inflation hedge makes a lot of sense, if you live in China or India.

Just as the plunge in the price of oil in 1998 did not signal deflationary pressure in America, its rise today does not signal inflationary pressure here, unless it works its way into expectations and wages, of which there’s no sign yet. (The 0.4% rise in hourly wages in January looks weird; for now, I’d discount it.) In fact, it could do the opposite: by draining more American purchasing power to overseas suppliers, higher oil prices leave less money to spend on stuff made in America. (America is a net food exporter so higher food prices are positive for American growth.) If the Fed were to tighten monetary policy today in response to Asia’s inflation problem, it could be the opposite of the mistake it made in 1998, compounding a deflationary shock at a time when the economy is significantly below potential.

IN AN interesting piece at the environmental publication Grist, David Roberts looks at the way in which climate scientists and economists often butt heads over policy recommendations. The scientists, he says, continue to pull in new data on the pace of change and suggest that catastrophe may loom if the world doesn't make drastic cuts to emissions by the middle of the century. Economists, on the other hand, tend to be more optimistic about humanity's ability to weather (pardon) change and adapt. The analyses of an economist like William Nordhaus indicate that climate change will only slightly reduce growth rates over the long run, and so only minimal steps are justified now to mitigate the impact of greenhouse has emissions.

But how does one square such a sanguine take with the apocalyptic findings from those studying the earth's climate? Mr Roberts highlights a couple of factors. One is the economist's assumption that growth will continue, such that future populations will be much richer than we are right now and will therefore be better able to handle the impacts of climate change. Of course, for this to be true, one has to assume that climate change itself won't disrupt growth by too much. And one has to shrug off hypotheses like Tyler Cowen's, which suggest that growth rates have slowed since the 1970s and may continue to underperform the expectations we developed during the 20th century.

But the profession isn't united behind the view that everything will be ok. Mr Roberts goes on:

[Economists] will admit that their models aren't very good at incorporating large short-term shocks. The "long tail" possibilities in climate science -- the low-probability, high-impact stuff like ice shelves collapsing or thermohaline circulation shutting down -- completely borks the models. You start seeing wild, arbitrary swings in model projections based on small adjustments in input assumptions. The models start saying, in essence, "hell if I know!" (Economist Martin Weitzman has done good work on this; Romm has a digestible summary.)

When economists run into the limitations of their models, they tend to heed the Wittgensteinian injunction: Whereof one cannot speak, thereof one must be silent. They don't feel comfortable making policy recommendations without solid modeling to back it up. Giving counsel in the face gigantic, unquantifiable risks starts to feel less like science and more like an exercise in politics or ethics. Heaven forbid.

Let me just add a few thoughts. Economists are by nature conservative, with a small c, in the sense that they're reluctant to endorse big policy shifts without clear evidence of the benefits. And it's difficult to be sure of the trade-offs involved in these recommended policy choices. Modeling the impact of climate change on weather patterns is difficult enough, without then extending that analysis to forecast effects on things like crop yields and water supplies, and thence on to GDP growth rates. Economists want to be careful. They're also concerned that efforts to boost green investments may lead to boondoggles rather than valuable new technologies. If they can't be sure that resources shifted from normal private investments toward government-sponsored alternative technologies will pay off in big drops in emissions, then they'll often opt for what they see as the safe route—normal market economy activity and growth.

Others recommend adopting some policies now as an insurance policy against apocalyptic tail outcomes. That seems sensible, but it's still difficult to know what level of insurance is appropriate to purchase. If you can confidently answer how much the world should pay to avoid apocalypse, then you've gone a long way toward answering how much the world should pay to achieve an optimum level of climate mitigation, and obviously economists haven't gotten to that point yet.

In the face of this uncertainty, many economists nonetheless remain reasonably optimistic, and not entirely without reason. A half century is a very long time. Economies tend to be very flexible over such long time frames. Populations are highly mobile during that kind of window—think about how Detroit has emptied out since 1980. Consumption baskets and technologies can respond well over a five-decade period. I'm probably as confident as anyone that given current temperature projections, measured output won't perform badly at all through 2050, or even through 2100.

But there are a few caveats worth noting. One is that economic resiliency can co-exist quite easily with significant levels of human suffering:

Un-mitigated climate change is going to be like Operation Rolling Thunder. A lot of people are going to die. A lot of people are going to be maimed. A lot of existing physical infrastructure will be destroyed. The extent to which pulverizing Vietnam with high explosives didn’t alter the country’s long-term trajectory is fascinating, but obviously constitutes cold comfort to mothers with dead children or people with no legs. As Kahn notes, the negative impact of climate change will fall disproportionately on the global poor and the elderly. If the entire population of Bangladesh dropped dead tomorrow, per capita GDP would go up. A 20 percent increase in the death rate of Americans over the age of 65 would cause our per capita growth rate to accelerate. It’s important to understand these facts, but it’s strange to think of them as optimistic scenarios...

Another is that unlike economies, political systems can be quite brittle. When you look at historical Jared Diamond collapse scenarios, what you see is that they're hyper-local. A complex society develops within a local environment, and when the local environmental conditions change the society collapses. But in the modern world, even substantial local environmental collapses tend not to lead to societal implosion. If Chinese crops fail, China doesn't end; it imports grain from elsewhere. But the ability to limit the damage of modern crises depends upon the institutions that support a liberal global economy, and institutions aren't always as flexible as economies. The world has this marvelous grain market, but if price increases lead to export-restrictions then that grain market suddenly fails. And if the grain markets fail, the unstable governments kept in place only by their ability to keep local markets provisioned fall. And if the governments fall, the refugees will seek asylum elsewhere, and if that happens then borders will be overwhelmed, and who knows what conflicts may erupt.

In other words, I feel fairly comfortable arguing that a modern economy can handle the stresses of climate change reasonably well; economies are built to handle big change. I feel very nervous about the ability of various political systems to survive temperatures unprecedented in human history. Many political systems rely explicitly on stability to survive, and even those capable of handling climate impacts may struggle to handle the knock-on effects of climate impacts on their more vulnerable neighbours. And as political systems are disrupted, it will become more difficult to sustain growth.

But how exactly does one model that? It's very difficult to say. So should governments do as some climate scientists recommend and begin plowing money into deployment of green power generation? Well, that's not clear either; there are opportunity costs to doing so. This needn't be a recipe for paralysis, however. Economists and climate scientists can certainly agree on many things that should be done: carbon pricing, elimination of fossil fuel subsidies, subsidisation of basic research, and so on. But then one is forced to confront the problem that Washington doesn't appear to be interested in optimal policies.

At this point, environmentalists shift to arguing that the economist's reticence plays an outright pernicious role. Because economists are too conservative to call for ambitious building programmes without more clarity on the trade-offs, it's argued, they convey to policymakers that the situation is not, in fact, that dire. If economists were running around with their hair on fire, Congress might respond.

I'm sceptical. Economists aren't always very successful at getting the policies they want, and when they are, it's often because their prescriptions fit the goals of established interests. That's clearly not the case here. All the same, it seems clear that economists have yet to put together a satisfactory analytical framework for addressing the climate crisis. Well-meaning political leaders need better ways of thinking about how to manage the trade-offs involved, and economists aren't yet providing them. If they can't do better, policy will ultimately either fall short of what's necessary, or run off in other directions unguided by their recommendations.