Some would say the current state of macro is in disarray as it is having a great deal of trouble explaining the current economic situation. But I don't think disarray is so much occuring as is intense competition. Right now there are a ton of competing views trying to explain the siuation. Krugman, Kling, and Sumner seem to me to be the big three right now. Here's Kling on the current state of macro and the competing views:
I am prepared to offer pushback against the Sumner-Hetzel viewpoint. However, it really deserves the status of the "null hypothesis." In a more reasonable world, everyone would be starting from the presumption that Sumner and Hetzel are correct. Those of us arguing folk-Minskyism and telling the Recalculation Story should be the ones fighting an uphill battle to bring our ideas into the policy debates. That this is not the case, and that SC is now on the fringe, is one of the most remarkable stories of this whole macroeconomic episode.
Showing posts with label Macroeconomics. Show all posts
Showing posts with label Macroeconomics. Show all posts
Cochrane vs. Krugman
A couple of months old, but John Cochrane takes Paul Krugman to task in this essay.
(HT: The Big Questions)
(HT: The Big Questions)
It's Complicated
Interesting piece by economist Axel Leijonhufvud on macro, where we are, how to explain how we got here and the uncertainty of the future. Here as some nice paragraphs:
We have known about the endogenous instability of fractional reserve banking for some 200 years. It is Hyman Minsky's contribution to have explained that this financial instability extends beyond just the commercial banking system. Minsky argued that a long period without crises – such as the late “Great Moderation” – would lead to an increased willingness to assume risk and thus cause the system to become financially fragile. And the fragile system will sooner or later crash.
and...
Twin dangers looming ahead are Japanese-style stagnation on the one hand and Latin-American-style high inflation on the other. In more normal times, we would regard these prospects as both unlikely and very far apart on a spectrum of eventualities. High levels of public debt, large unfunded liabilities, and large current deficits mean that they are not at all far apart in the current situation. The apparent political difficulties in decisively remedying the public finances are likely to mean that this is not just a temporary predicament. The navigable channel between Scylla and Charybdis has become quite narrow.
and The Big Question...
High leverage has been the big culprit in the current disaster. To reduce the risk of another crash, we must curb leverage. But governments do not want the financial sector to deleverage now because the requisite falling asset prices and curtailed credit would deepen the recession. The question, of course, is: If not now, when?
(HT: EconLog)
We have known about the endogenous instability of fractional reserve banking for some 200 years. It is Hyman Minsky's contribution to have explained that this financial instability extends beyond just the commercial banking system. Minsky argued that a long period without crises – such as the late “Great Moderation” – would lead to an increased willingness to assume risk and thus cause the system to become financially fragile. And the fragile system will sooner or later crash.
and...
Twin dangers looming ahead are Japanese-style stagnation on the one hand and Latin-American-style high inflation on the other. In more normal times, we would regard these prospects as both unlikely and very far apart on a spectrum of eventualities. High levels of public debt, large unfunded liabilities, and large current deficits mean that they are not at all far apart in the current situation. The apparent political difficulties in decisively remedying the public finances are likely to mean that this is not just a temporary predicament. The navigable channel between Scylla and Charybdis has become quite narrow.
and The Big Question...
High leverage has been the big culprit in the current disaster. To reduce the risk of another crash, we must curb leverage. But governments do not want the financial sector to deleverage now because the requisite falling asset prices and curtailed credit would deepen the recession. The question, of course, is: If not now, when?
(HT: EconLog)
Roger Koppl and the Future of Macro
Roger Koppl has a new paper coming out on where he thinks macro is headed (the link is only a manuscript). Here's his short post at ThinkMarkets summing up his thoughts. A snippet:
I say the “New Interventionist Economics” will be characterized by five features:
Bubbles
Radical Uncertainty
Animal Spirits
Complexity Dynamics
Extra-Market Control
The comments on his post are also worth reading.
I say the “New Interventionist Economics” will be characterized by five features:
Bubbles
Radical Uncertainty
Animal Spirits
Complexity Dynamics
Extra-Market Control
The comments on his post are also worth reading.
Kling on Traditional Keynesianism in 2009 (and some other stuff)
Arnold Kling on Keynesian policies and the 21st century American economy. His concluding paragraphs:
The way I see it, the complexity of today's economy means that old-fashioned Keynesian policies will not restore full employment. Pump-priming and stimulus policies are a good fit for a manufacturing economy with homogeneous labor affected by temporary layoffs. They are not such a good fit for a post-industrial economy with an educated labor force facing permanent structural changes.
The way I see it, the complexity of today's economy means that old-fashioned Keynesian policies will not restore full employment. Pump-priming and stimulus policies are a good fit for a manufacturing economy with homogeneous labor affected by temporary layoffs. They are not such a good fit for a post-industrial economy with an educated labor force facing permanent structural changes.
Over the next ten years, some sectors of the economy on long-term downward trends will continue to shrink. Sectors that became bloated in recent years, notably mortgage finance, will eventually settle back to lower, sustainable levels. Much of the new strength in the economy will come from underlying long-term forces. New workers will be absorbed by businesses that have not yet been launched in industries that we have not even imagined. For this restructuring, what I like to call The Great Recalculation, Keynesian stimulus will be irrelevant.
This is definitely an oversimplification, but I think what Kling is more or less saying is this: If you owned a house today built in the 1930's that had continually been renovated so it was currently modernized, and suddenly it was devastated by a storm, why would you use 1930's technology, design and materials to repair it?
Also, here is an excellent overview by Kling on the history of monetary and fiscal policy since the 1930's and the effects different economic theories had on those policies.
Paul De Grauwe on the State of Macro
Via Taking Hayek Seriously, here is a link to Paul De Grauwe's new paper "Top Down versus Bottom Up Macroeconomics". The introduction to De Grauwe's paper:
In order to understand the nature of different macroeconomic models it is useful to make a distinction between top-down and bottom-up systems. In its most general definition a top-down system is one in which one or more agents fully understand the system. These agents are capable of representing the whole system in a blueprint that they can store in their mind. Depending on their position in the system they can use this blueprint to take over the command, or they can use it to optimize their own private welfare. These are systems in which there is a one to one mapping of the information embedded in the system and the information contained in the brain of one (or more) individuals. An example of such a top-down system is a building that can be represented by a blueprint and is fully understood by the architect.
Bottom-up systems are very different in nature. These are systems in which no individual understands the whole picture. Each individual understands only a very small part of the whole. These systems function as a result of the application of simple rules by the individuals populating the system. Most living systems follow this bottom-up logic (see the beautiful description of the growth of the embryo by Dawkins(2009)). The market system is also a bottom-up system. The best description made of this bottom-up system is still the one made by Hayek(1945). Hayek argued that no individual exists who is capable of understanding the full complexity of a market system. Instead individuals only understand small bits of the total information.
The main function of markets consists in aggregating this diverse information. If there were individuals capable of understanding the whole picture, we would not need markets. This was in fact Hayek’s criticism of the “socialist” economists who took the view that the central planner understood the whole picture, and would therefore be able to compute the whole set of optimal prices, making the market system superfluous.
My contention is that the rational expectations models are the intellectual heirs of these central planning models. Not in the sense that individuals in these rational expectations models aim at planning the whole, but in the sense that, as the central planner, they understand the whole picture. These individuals use this superior information to obtain the “optimum optimorum” for their own private welfare. In this sense they are top-down models.
In this paper I will contrast the rational expectations top-down model with a bottomup macroeconomic model. This will be a model in which agents have cognitive limitations and do not understand the whole picture (the underlying model). Instead they only understand small bits and pieces of the whole model and use simple rules to guide their behavior. I will introduce rationality in the model through a selection mechanism in which agents evaluate the performance of the rule they are following and decide to switch or to stick to the rule depending on how well the rule performs relative to other rules.
Mankiw vs Krugman
Greg Mankiw defends himself against (seemingly unjust) charges made by Paul Krugman.
Every Keynesian style defense I've read on the stimulus package, including the White House, confuses modeling with reality. Krugman, the central figure of this group, consistently determines the assumptions he makes about the economy are 100% true and infallible. This is an unbelievably arrogant and dishonest thing for someone as intelligent and influencial as Krugman to do. Mankiw writes:
I do not object to claims such as:
A: "Based on our models of the economy, we believe there would be X million fewer jobs today without the stimulus."
But it is absurd to suggest that you can say:
B: "We have measured how many jobs the stimulus has saved or created, and the number is X."
Economists are capable of making statements such as A, but it is beyond our ken to make statements such as B. Statement B is, of course, much stronger than statement A, as it purports to be based on data rather than on models. Unfortunately, we are hearing statements like B much too often from administration officials. A good example is here, where can you "learn" that 110,185.36 jobs have been created or saved in California alone.
Krugman is disguising politics as economics, and his pedigree is allowing him to get away with it. This is bad news for the discipline of economics.
UPDATE: Mario Rizzo weighs in over at Think Markets.
Every Keynesian style defense I've read on the stimulus package, including the White House, confuses modeling with reality. Krugman, the central figure of this group, consistently determines the assumptions he makes about the economy are 100% true and infallible. This is an unbelievably arrogant and dishonest thing for someone as intelligent and influencial as Krugman to do. Mankiw writes:
I do not object to claims such as:
A: "Based on our models of the economy, we believe there would be X million fewer jobs today without the stimulus."
But it is absurd to suggest that you can say:
B: "We have measured how many jobs the stimulus has saved or created, and the number is X."
Economists are capable of making statements such as A, but it is beyond our ken to make statements such as B. Statement B is, of course, much stronger than statement A, as it purports to be based on data rather than on models. Unfortunately, we are hearing statements like B much too often from administration officials. A good example is here, where can you "learn" that 110,185.36 jobs have been created or saved in California alone.
Krugman is disguising politics as economics, and his pedigree is allowing him to get away with it. This is bad news for the discipline of economics.
UPDATE: Mario Rizzo weighs in over at Think Markets.
Kling on the Stimulus Package and Macro
Arnold Kling, my go-to-guy anything macro-related, offers some thoughts on the stimulus package:
It would appear that the great claim to fame of the stimulus is that it kept state and local governments from having to reduce spending. If you combine that with wage stickiness at the state and local level (that is, if you believe that they would cut jobs rather than cut pay for government workers), then the stimulus saved jobs. From a Recalculation perspective, one might ask whether those are the jobs that you would want to save.
Here's an essay by Kling on why he lost faith in traditional macro. Some key snippets:
There are no controlled experiments in macroeconomics. We would like to observe what would happen to employment and output in the United States in 2010 under different stimulus proposals. Ideally, we could construct alternative universes with the exact same initial conditions and try different policies. In practice, this is not possible.
When researchers attempt macroeconometrics, they are attempting to turn different time periods into controlled experiments. In effect, we take the situation in 1980 and 2005 and identify the factors that cause them to be different. We are interested in the effects of particular factors, notably fiscal and monetary policy. This method is valid only if we have properly controlled for other factors. The way I see it, controlling for other factors is impossible, because structural change is too important, too multi-faceted, and too pervasive for any statistical methodology to overcome.
***
Because of the need to impose strong priors, the structural approach is nothing but a roundabout way of communicating the way you believe the economy works. The estimated equations are not being used to discover relationships. Instead, the equations are being used by the econometrician to communicate to others the econometrician's beliefs about how the economy ought to work. To a first approximation, using structural estimates is no different from creating a simulation model out of thin air by making up the parameters.
His concluding paragraph:
We badly want macroeconometrics to work. If it did, we could resolve bitter theoretical disputes with evidence. We could achieve better forecasting and control of the economy. Unfortunately, the world is not set up to enable macroeconometrics to work. Instead, all macroeconometric models are basically simulation models that use data for calibration purposes. People judge these models based on their priors for how the economy works. Imposing priors related to rational expectations does not change the fact that macroeconometrics provides no empirical information to anyone except those who happen to share all of the priors of the model-builder.
It would appear that the great claim to fame of the stimulus is that it kept state and local governments from having to reduce spending. If you combine that with wage stickiness at the state and local level (that is, if you believe that they would cut jobs rather than cut pay for government workers), then the stimulus saved jobs. From a Recalculation perspective, one might ask whether those are the jobs that you would want to save.
Here's an essay by Kling on why he lost faith in traditional macro. Some key snippets:
There are no controlled experiments in macroeconomics. We would like to observe what would happen to employment and output in the United States in 2010 under different stimulus proposals. Ideally, we could construct alternative universes with the exact same initial conditions and try different policies. In practice, this is not possible.
When researchers attempt macroeconometrics, they are attempting to turn different time periods into controlled experiments. In effect, we take the situation in 1980 and 2005 and identify the factors that cause them to be different. We are interested in the effects of particular factors, notably fiscal and monetary policy. This method is valid only if we have properly controlled for other factors. The way I see it, controlling for other factors is impossible, because structural change is too important, too multi-faceted, and too pervasive for any statistical methodology to overcome.
***
Because of the need to impose strong priors, the structural approach is nothing but a roundabout way of communicating the way you believe the economy works. The estimated equations are not being used to discover relationships. Instead, the equations are being used by the econometrician to communicate to others the econometrician's beliefs about how the economy ought to work. To a first approximation, using structural estimates is no different from creating a simulation model out of thin air by making up the parameters.
His concluding paragraph:
We badly want macroeconometrics to work. If it did, we could resolve bitter theoretical disputes with evidence. We could achieve better forecasting and control of the economy. Unfortunately, the world is not set up to enable macroeconometrics to work. Instead, all macroeconometric models are basically simulation models that use data for calibration purposes. People judge these models based on their priors for how the economy works. Imposing priors related to rational expectations does not change the fact that macroeconometrics provides no empirical information to anyone except those who happen to share all of the priors of the model-builder.
GDP and The Descendents of Keynes
Veronique de Rugy cuts through the nonsense of the recent GDP numbers. A snippet:
the way the GDP accounts for government spending is totally biased: It assumes that if the government is spending $200,000 on a contractor to repave a road in the middle of nowhere that it will create $200,000 of genuine economic value. By contrast, GDP measures are tougher on private-sector spending. As my George Mason university colleague Garett Jones explained to me recently “So if Exxon Mobil pays an engineer $200,000 per year, that only shows up in GDP if the engineer finds an extra $200,000 of oil to sell, or builds a new machine that sells for $200,000, something like that. So our GDP measures of “government spending” are awful–and when the government is in a race to spend money as quickly as possible, these measures are going to be even worse than usual.”
Mario Rizzo does an even better job examining the whole of the White House's and Congress' spending strategies. His concluding paragraph:
In sum, at least 2.5 percentage points of the 3.5 percent increase are suspect on their own terms. And then there are the future costs to bear. As long as the stimulus-spending persists the “stuff index” (GDP) will look okay. And as long as the costs are hidden either in the future or in some other way, the politics will look fine for the stimulators.
Keynesian types want to spend as much as quickly as possible because they believe Depression 2.0 will arrive if we don't. Supply siders want the market to reallocate resources on its own to achieve equilibrium. The Keynesian argument is markets are driven by fear and greed, as Rob has pointed out a few times, and will spiral into oblivion without proper government intervention. The consequences of spending nor the creation of value/utility related to said spending do not matter to the Keynesian (though he may claim they do). Supply siders believe a reallocation would be long, tough and painful for many, but ultimately more appropriate and healthier than attempting to manipulate the economy on a grand scale.
GDP is a wonderful tool for the neo-Keynesian to frame and promote his story. But when you seperate the recipe from the final product, I don't think there is a whole lot to trust or like.
the way the GDP accounts for government spending is totally biased: It assumes that if the government is spending $200,000 on a contractor to repave a road in the middle of nowhere that it will create $200,000 of genuine economic value. By contrast, GDP measures are tougher on private-sector spending. As my George Mason university colleague Garett Jones explained to me recently “So if Exxon Mobil pays an engineer $200,000 per year, that only shows up in GDP if the engineer finds an extra $200,000 of oil to sell, or builds a new machine that sells for $200,000, something like that. So our GDP measures of “government spending” are awful–and when the government is in a race to spend money as quickly as possible, these measures are going to be even worse than usual.”
Mario Rizzo does an even better job examining the whole of the White House's and Congress' spending strategies. His concluding paragraph:
In sum, at least 2.5 percentage points of the 3.5 percent increase are suspect on their own terms. And then there are the future costs to bear. As long as the stimulus-spending persists the “stuff index” (GDP) will look okay. And as long as the costs are hidden either in the future or in some other way, the politics will look fine for the stimulators.
Keynesian types want to spend as much as quickly as possible because they believe Depression 2.0 will arrive if we don't. Supply siders want the market to reallocate resources on its own to achieve equilibrium. The Keynesian argument is markets are driven by fear and greed, as Rob has pointed out a few times, and will spiral into oblivion without proper government intervention. The consequences of spending nor the creation of value/utility related to said spending do not matter to the Keynesian (though he may claim they do). Supply siders believe a reallocation would be long, tough and painful for many, but ultimately more appropriate and healthier than attempting to manipulate the economy on a grand scale.
GDP is a wonderful tool for the neo-Keynesian to frame and promote his story. But when you seperate the recipe from the final product, I don't think there is a whole lot to trust or like.
GDP Shortcomings
Via MR, Michael Mandel's article this week in BusinessWeek is a must read. The opening paragraphs:
the official [GDP] statistics are not designed to pick up cutbacks in "intangible investments" such as business spending on research and development, product design, and worker training. There's ample evidence to suggest that companies, to reduce costs and boost short-term profits, are slashing this kind of spending, which is essential for innovation. Without investment in intangibles, the U.S. can't compete in a knowledge-based global economy. Yet you won't see that plunge reflected in the GDP and productivity statistics, which are still too focused on more traditional sectors, such as motor vehicles and construction.
In effect, government statisticians are trying to track a 21st century bust with 20th century tools. Not only is that distorting the critical data that investors, policymakers, and corporate executives use to evaluate the economy, but it might also be creating a false sense of relief as Americans battle a brutal recession.
If increasing GDP is the ultimate goal, but measuring the ultimate goal is structurally flawed, how are policy makers expected to accomplish the ultimate goal in a beneficial and efficient manner?
More on the current state of macro in a bit.
the official [GDP] statistics are not designed to pick up cutbacks in "intangible investments" such as business spending on research and development, product design, and worker training. There's ample evidence to suggest that companies, to reduce costs and boost short-term profits, are slashing this kind of spending, which is essential for innovation. Without investment in intangibles, the U.S. can't compete in a knowledge-based global economy. Yet you won't see that plunge reflected in the GDP and productivity statistics, which are still too focused on more traditional sectors, such as motor vehicles and construction.
In effect, government statisticians are trying to track a 21st century bust with 20th century tools. Not only is that distorting the critical data that investors, policymakers, and corporate executives use to evaluate the economy, but it might also be creating a false sense of relief as Americans battle a brutal recession.
If increasing GDP is the ultimate goal, but measuring the ultimate goal is structurally flawed, how are policy makers expected to accomplish the ultimate goal in a beneficial and efficient manner?
More on the current state of macro in a bit.
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