Monthly Archives: January 2015

Ignoring Hotelling, Ignoring Standard Macroeconomics

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Rabah Arezki and Olivier Blanchard write,

Futures markets suggest that oil prices will rebound but will remain below the level of recent years.

Pointer from Mark Thoma.

Futures markets are bound to tell you that oil prices will remain near current levels, with a tendency to rise. If not, there is an arbitrage opportunity. If futures prices were far below spot prices, then producers would pump lots of oil and holders of inventories would try to sell every drop as soon as possible, until current prices fell. If futures prices were far above spot prices, then producers would cap wells and holders of inventories would fill every storage tank to the brim, until current prices rose.

I find the Hotelling model of resource pricing persuasive. In that model, the futures price and the spot price do not contain independent information. The relationship between the two is governed by storage cost and the rate of interest.

Then there is this:

central banks’ forward guidance is crucial to anchor medium-term inflation expectations in the face of falling oil prices.

This statement confused me on many levels.

1. The drop in oil prices that is already behind us would not seem to cause a downward shift in medium-term inflation expectations. The quoted phrase seems to equate the future with the past and levels with rates of change.

2. Elsewhere in the article, the authors point out that for oil importing countries, a drop in oil prices will boost aggregate demand. Well, from a conventional macroeconomic standpoint, that is the end of the story. There is no reason at all for monetary authorities to think that all of a sudden they need to counter the deflationary impact of an increase in aggregate demand. That is an oxymoron.

The Returns to College Going Forward

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Nick Bunker writes,

Intuitively, then, increasing the supply of educated workers should reduce inequality as it would increase wages among a broader supply of more educated workers. But that assumes the demand for educated workers will continue to rise. Problem is, recent research finds that the demand for skilled labor appears to be on the decline.

Pointer from Mark Thoma.

Let us think about the “race between education and technology” idea. The Goldin-Katz story is that the high school movement helped produce a work force that could earn decent incomes in the industrial era. This is a nice just-so story, but note that in the late 19th and early 20th centuries the just-so story was that industrialization was reducing the demand for skills, replacing the craftsman with the assembly-line worker.

But let us suppose that more education is needed to enable the typical worker to keep pace with changes in technology. That is, suppose we buy that there is a race between education and technology. In that case, I am pretty sure that education has to lose that race.

Change in technology is being led by Moore’s Law. The core components of computers get twice as good every couple of years. Maybe that is slowing down a bit. But even so, it is much faster than the rate of improvement in steam engines in the 19th century or electric motors in the 20th century.

As an indicator of faster technological change, look at how much more quickly smart phones achieved mass adoption in comparison with personal computers.

As an indicator of how hard it is for humans to keep up, look at computers and chess. Twenty years ago, the world’s biggest computer could not have beaten the human world champion. Now, you could to it with a laptop. Maybe even a smart phone.

The metaphor of a “race” suggests that the two participants are capable of moving at the same speed. But if you compare Moore’s Law with the highest feasible rate at which me might increase educational attainment, you realize that the two speeds are hopelessly different. Either we come up with some radical, paradigm-shifting way of improving human learning capacity (genetic engineeering? implants? Diamond Age primers?) or the machines are certain to win.

Nassim Taleb Quote Bleg

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I remember Taleb saying something to the effect that risk in financial markets is like a lion (or tiger?) hunting, in that it will find the weakest prey. Can anyone find such a quote? I have tried basic Google searches and searches through my blogs, but without success.

Peter Wallison and the N-word

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He says,

By 2008, before the financial crisis, there were 55 million mortgages in the US. Of these, 31 million were subprime or otherwise risky. And of this 31 million, 76 % were on the books of government agencies, primarily Fannie and Freddie. This shows where the demand for these mortgages actually came from, and it wasn’t the private sector. When the great housing bubble (also created by the government policies) began to deflate in 2007 and 2008, these weak mortgages defaulted in unprecedented numbers, causing the insolvency of Fannie and Freddie, the weakening of banks and other financial institutions, and ultimately the financial crisis.

Remember what the Washington Post Style section proclaimed on January 1st. Narrative is out. Facts are in.

Of course, in addition to the Freddie and Fannie securities, there were lots of private-sector securities backed by risky mortgages. My contention is that this boom was fueled by risk-based capital rules, which stated that once these loans were packaged into securities, divided into tranches, and blessed by rating agencies as AAA, banks could earn three times the return on such mortgages as could be earned by originating and holding an old-fashioned, low-risk mortgage.

Reset Your Clock to 2003

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The WSJ reports,

Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said Tuesday rock-bottom borrowing costs in the bond market are not a positive vote on the economic outlook.

My reaction:

1. This is another echo of 2003-2004, when Fed officials were equally puzzled by low long-term rates. I was even more puzzled than they were back then, and I am even more puzzled than they are now.

2. The conventional wisdom is that the bond markets watch the Fed, because the Fed has magical control over everything. To me, it seems more realistic to have the Fed watching the bond markets for clues about the economy. The Fed is actually powerless to alter the consensual hallucination.

3. I remember when Tyler Cowen described blog readers as like followers of a TV show or comic strip. They have cumulative knowledge of your blog, so that you can refer implicitly to what you have written previously, and they enjoy little inside jokes. Twitter has changed that. Now I have a lot of one-off readers, who leave comments that show that they know absolutely nothing of my previous writing. They have no context for my thinking on macroeconomics, and so they just decide that I am an ignoramus. I have gotten advice from people to make my blog post headlines more Twitter-friendly. In fact, I am reconsidering whether I want to get any traffic at all from Twitter. In the long run, I think I will like what I write more if I ignore the one-off reader population.

Something’s Rotten in Happiness Research

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From a book review:

Those sky-high happiness surveys, it turns out, are mostly bunk. Asking people “Are you happy?” means different things in different cultures. In Japan, for instance, answering “yes” seems like boasting, Booth points out. Whereas in Denmark, it’s considered “shameful to be unhappy,” newspaper editor Anne Knudsen says in the book.

When you ask me to report my happiness, what do I report?

1. How I feel compared to one minute ago.
2. How I feel compared to yesterday.
3. How I have been feeling on average this week with how I remember feeling some time in the past.
4. How I feel about my life as a whole compared to other people’s livs.
5. How I think other people think I am feeling.
6. How I think other people expect me to feel.

…

The one thing I know about my happiness is that it is reduced when people produce charts that are derived from data that lacks reliability. It is hard to get less reliable than a survey that asks a question that does not have a precise interpretation.

How do you say ‘Have a Nice Day’ in Japanese?

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John Mauldin writes,

If interest rates were to rise by a mere 2%, it would take anywhere from 80 to 100% of all Japanese tax
revenues simply to pay the interest on the Godzillaesque Japanese debt.

If you read Mauldin, you should do so over a period of time, to get a sense of his biases, which are strong.

However, his views are consistent with my emphasis on the notion that governments and banks are subject to multiple equilibria, and that when leverage is high, the movement from one equilibrium to another can be sudden and catastrophic.

Pete Boettke on Ideology and Economics

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He writes,

Market fundamentalism is far from the mainstream of economic thought. The mainstream folks consider their work non-ideological and merely technical because they all share the same tacit presuppositions of political economy. It would be healthy if they looked through a different window, and spent some time reading those Nobel economists I mentioned above, or the Nobel worthy economists I mentioned as well.

Read the whole thing. I had a hard time choosing an excerpt. It also could use more fleshing out, in my view.

What Boettke is wrestling with is an asymmetry between mainstream economics and those of us with a free market bent.

Here is how I would describe the asymmetry. I think that the free-market types understand the main arguments of mainstream economists, but I think that mainstream economists only seem to deal with a straw-man version of free-market economics. Keep in mind, however, the Law of Asymmetric Insight: when two people disagree, each one tends to think that he understands his opponent better than the opponent understands himself.

I think that we on the free-market side understand behavioral economics. We understand asymmetric information. We understand market failure. Thus, we differ from the straw-man version of us that mainstream economists dismiss.

On the other hand, mainstream economists appear to me not to appreciate the two most important arguments that we have. One is the socialist calculation argument. My sense is that mainstream economists either do not believe that the socialist calculation problem is real, or they believe that it only applies to socialist dictatorships. In fact, any government program to spend, tax, or regulate will encounter the socialist calculation problem. That is, government planners face a fundamental information problem themselves. Knowledge is dispersed. What planners do not know is important, and indeed it can be more important than what they claim to know about market failure.

The second argument is the public choice argument. This is often over-simplified as “government officials act based on self-interest.” The deeper issue, which Boettke mentions in his post, is that markets and government should be looked at in parallel as institutions. The market process has certain strengths and weaknesses. Government has other strengths and weaknesses. The mainstream approach simply assumes away all weaknesses of the political process. Once an economist identifies a market failure and a policy to treat it, the next step if to play fantasy despot and recommend the policy.

Finally, I have to say that this is not mere abstract philosophy. The socialist calculation problem is real. It affects financial regulators, who in the period leading up to the financial crisis used crude “risk buckets” to alter the incentives of banks. That approach was woefully information-poor, and it created huge incentives for banks to do exactly what they did with risky mortgages. See Not What They Had in Mind. The socialist calculation problem affects every agency of the government, from the FCC to the FDA to the panel of experts who is supposed to determine which medical procedures to allow.

The institutional weaknesses of government are real. Read Peter Schuck’s book. You can get the flavor of it from his talk and my comments.

Wither Macroeconomics?

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The title is not a typo. Brad DeLong reproduces a list of papers that ten years ago he thought were on the frontier of macroeconomics. Pointer from Mark Thoma. My take on the list is that there is a strong negative correlation between the probability that the ideas are correct and the probability that they are relevant.

Some random thoughts about the state of macroeconomics:

1. Any post that contains a sentence “This chart proves that. . .” doesn’t.

2. Macroeconomists should be much more daunted by measurement issues than they are. I think that we have reasonably good ways of counting the number of people who do paid market work. But that is a far cry from knowing “labor input,” because (a) skills are very heterogeneous and (b) as Garett Jones famously tweeted, most workers are not making widgets but instead are building organizational capital. Output has become increasingly difficult to measure. In the case of goods, quality change has sped up, putting more pressure on statisticians to rely on imputations. And in the case of important services, including education, finance, and medical services, we have almost no conceptual idea for measuring output. We do not know how to factor into our statistics the increased diversity in consumption baskets across individuals. All this casts doubt on our measures of inflation, productivity, and real wages.

3. As of the early 1930s, many economists and commentators thought that the capitalist system had broken down. They saw the decentralized market process as no long working effectively to organize economic activity. See Katznelson, or even better read chapter two of Leuchtenburg’s The FDR years. The biggest intellectual influence at the time was nostalgia for the government planning that took over when the U.S. entered the first World War.

In contrast, Keynes blamed the Depression on what he called a drop in aggregate demand, and Milton Friedman blamed it on a contraction of the money supply. In fact, Keynes and Friedman led the profession down a false path. The pre-Keynesian diagnosis was more apt. I just disagree that central planning was the best solution, although I think it is fair to concede that when you have unemployment rates over 15 percent you are giving central planners a decent shot at doing something right.

4. The Monetary Walrasians (Patinkin and everything that followed) wasted our time. Money does not determine nominal aggregates. It does not determine transactions. The causality runs from the desire to undertake transactions to financial institutions/technology to what people use as money.

5. Money does not determine the price level. Habits determine the price level. Consider the amnesia experiment. If everyone developed amnesia about what money prices were yesterday, then Monetary Walrasianism predicts that today prices would soon find an equilibrium determined by the quantity of money. In fact, my best guess is that people would find money to be worthless in such a setting, and they would resort to barter until a new standard of value emerged.

6. The theory of rational expectations is a waste of time. The simple model of employment fluctuations as arising from errors in aggregate expectations is wrong. And the underlying principle of rational expectations, that everyone as the identical information, is anti-Hayekian, and not in a good way.

In short, almost nothing that gets taught in undergraduate macro is correct. And graduate macro is worse.

Community College: What is the Right Price?

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Reihan Salam writes,

Texas A&M economist Jonathan Meer kindly pointed me to their recent work on net prices — that is, net tuition and fees after grant aid — for students attending public institutions, including community colleges. It turns out that in 2011–12, “net tuition and fees at public two–year colleges ranged from $0 for students in the lower half of the income distribution to $2,051 for the highest-income group.” That is, net tuition and fees were $0 for students from households earning $60,000 or less while it was $2,051 for students from households earning over $106,000. While I don’t doubt that many households in the $106,000-plus range will welcome not having to pay for their children’s community college education, I’m hard-pressed to see why this initiative will have a “huge” impact, given that we’re presumably most concerned about improving community college access for students from disadvantaged backgrounds.

My comments:

1. Just based on my gut feeling, I think that the vast majority of students attending community college do not have favorable outcomes. (But note this study,pointed to by Tyler Cowen.

Attending a community college increased the probability of earning a bachelors degree within eight years of high school graduation by 23 percentage points for students who would not have attended any college in the absence of reduced tuition.

My guess is that it does not replicate.)

I am not even sure that students in the lower tier of four-year colleges have favorable outcomes. Instead, the true cost, including what the students pay out of pocket plus subsidies plus opportunity cost, exceeds the benefit for many who attend college. In contrast, President Obama seems to endorse the fairy-dust model of college, where you can sprinkle it on anyone to produce affluence.

He said a high school diploma is no longer enough for American workers to compete in the global economy and that a college degree is “the surest ticket to the middle class.”

He describes the U.S. as a place where college is limited to “a privileged few.” I think a more realistic assessment would conclude that the U.S. errs on the side of sending too many young people to college, not too few.

2. At community colleges, most of the favorable outcomes are middle-class students who, if community college were not available, would find some other path to success. (Possibly related: Philip Greenspun writes,

Amanda Pallais of Harvard presented “Leveling Up: Early Results from a Randomized Evaluation of Post-Secondary Aid”, a paper on the Susan Thompson Buff ett Foundation scholarship for lower income Nebraskans who have a high-school GPA of at least 2.5 and maintain a college GPA of at least 2.0. It turns out that people who are going to attend college and graduate will do so even without this grant and people who were marginally attached to academic will become only slightly more attached. The cost of keeping one student in college for an additional semester is $40,000 of foundation funds.

Pointer from Tyler Cowen.

3. For the students that you want community college to help, I think that the case for community college is sort of like the case for last-ditch cancer therapy. Every once in a while it works, and you want to give people hope. But looking at the overall costs and benefits involved, the money is not well spent.

4. Rather than expand community colleges, I suspect the best approach would be to contract them by making them more selective. Try to find the students who are most likely to benefit, and concentrate on those. Robert Lerman, who is far from an anti-opportunity meanie, suggests apprenticeships.

5. If I were President Obama, of course, I would champion universal “free” community college. Worst case, my proposal becomes law. A lot of money gets wasted, but it’s not my money. Best case, the Republicans vote it down and I call them anti-opportunity meanies.