Monthly Archives: April 2015

What Isn’t Wrong with Macro?

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David Andolfatto is in a very different place than I am. He writes,

what part of the above manifesto do you not like? The idea that people respond to incentives? Fine, go ahead and toss that assumption away. What do you replace it with? People behave like robots? Fine, go ahead and build your theory. What else? Are you going to argue against having to describe the exact nature of government policy? Do you want to do away with consistency requirements, like the respect for resource feasibility. Sure, go ahead.

Pointer from Mark Thoma. Elsewhere, Mark points to interesting comments by Noah Smith.

Some of the parts of mainstream macro that I do not like:

1) that there is a single representative agent who is the consumer and owner of the one firm.

2) that this representative agent never has to use trial and error to figure out what might be a profitable business, much less what might be a profitable pattern of trade involving many businesses.

3) that this representative agent cannot hold more than one expectation about the future. Instead, there is the very anti-Hayekian notion of “rational expectations” which assumes away local information.

4) that “money” and “the price level” are objective, precisely determinate quantities, rather than part of a consensual hallucination.

5) that you can wave your hands and talk about “financial friction” in models in which financial intermediaries are redundant.

And those are just off the top of my head.

The Crowding-Out of Financial Intermediation

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Timothy Taylor points to an IMF report, which says,

The investment slump in the advanced economies has been broad based. Though the contraction has been sharpest in the private residential (housing) sector, nonresidential (business) investment—which is a much larger share of total investment—accounts for the bulk (more than two-thirds) of the slump

I have an argument that this represents crowding out, caused by increased government deficits. However, this is not textbook crowding out, in which the government increases the demand for savings, raising interest rates and reducing investments.

Instead, it is crowding out of financial intermediation. Recall that my view of financial intermediation is that the public wants to issue risky, long-term liabilities and hold safe, short-term assets. Financial intermediaries accommodate this by doing the opposite.

When the government incurs large deficits, it issues safe, short-term liabilities. This crowds out private financial intermediation, because much of the demand for safe, short-term liabilities is satisfied by government debt. Think of the public holding a $100 balance sheet. Without government deficits, financial intermediaries might hold $100 in risky, long-term investments and issue $100 in safe, short-term securities. Instead, with $100 in government bonds issued to financed deficits, the public’s demand for safe, short-term securities can be satisfied with zero investment. Financial intermediation goes away altogether, or just consists of intermediaries who issue safe securities backed by government bonds.

Regulators and the Socialist Calculation Problem

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My latest essay is on Engineering the Financial Crisis, by Jeffrey Friedman and Wladimir Kraus. I think that their book demonstrates that regulation falls victim to the socialist calculation problem.

Centralizing risk assessment through regulatory risk weights and rating agency designations has several weaknesses. Local knowledge, such as detailed understanding of individual mortgages, is overlooked. At a macro level, regulators’ judgment of housing market prospects were no better than those of leading market participants. Moreover, regulators imposed a uniformity of risk judgment, rather than allowing different assessments to emerge in the market.

Does More Government Debt Reduce Interest Rates?

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This is a random idea that is almost surely wrong. And if it is wrong, it will be wrong in a way that seems obviously stupid. So don’t expect me to stick with it.

Without blaming Nick Rowe, I started thinking about this when he wrote,

By “secular stagnation” I mean “declining equilibrium real interest rates”.

Most explanations of secular stagnation say it is caused by a rising desire to save and/or a falling investment demand. Call this the “Saving/Investment Hypothesis”.

But there are lots of different real interest rates. For example, the real interest rate on Bank of Canada currency is around minus 2%. (That currency pays 0% nominal interest, and the Bank of Canada targets 2% inflation). But people are willing to hold currency, despite that, because it is very liquid. But all assets differ in their liquidity. More liquid assets will have a lower real yield than less liquid assets. And if an asset becomes more liquid over time, its real yield will fall over time.

What if there is a sharp rise in the supply of government debt? The standard view is that this tends to raise interest rates, as debt absorbs more savings.

The alternative view I am putting out there is that government debt offers liquidity (in the limiting case, think of it as a very close substitute for money). If the supply of liquidity goes up, then there is less demand for banks to manufacture liquidity out of risky assets. The public wants fewer deposits backed by loans on fruit trees and instead is happy to hold mutual funds containing government bonds.

The result is fewer fruit trees planted. We would observe a decline in interest rates on low-risk assets and an increase in interest rates (or a loss of credit availability altogether) for risky investment projects.

Think of this as government debt crowding out private investment, even though the interest rate on safe assets, particularly government debt itself, can remain low and perhaps even fall as the crowding out gets larger. Again, this is probably wrong.

The Lost Art of Political Dialogue

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Adam Garfinkle writes.

Second, disagreements were understood as natural and healthy; disputes civilly aired were believed to reveal the better way forward. Dialogic discourse rather than dictatorial narratives held pride of place. Socrates, not Plato’s philosopher-king, prevailed.

Third, defeat in political contests came to be seen as inherently provisional and temporary; there is always the next election. That realization, in turn, conduces to compromise and conciliation, other means of rendering politics something other than a continuously zero-sum proposition.

I strongly recommend reading the whole thing.

It is possible for people who disagree about politics to conduct a dialogue in order to clarify the nature of the disagreement. However, that notion has been discarded. Instead, the objective is to get the other guy to shut up. This intellectually inferior and divisive approach pervades the culture on campus and on line.

‘Scott Alexander’ on the Growth Mindset

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He writes,

if you’re not familiar with it, growth mindset is the belief that people who believe ability doesn’t matter and only effort determines success are more resilient, skillful, hard-working, perseverant in the face of failure, and better-in-a-bunch-of-other-ways than people who emphasize the importance of ability. Therefore, we can make everyone better off by telling them ability doesn’t matter and only hard work does…

A rare point of agreement between hard biodeterminists and hard socialists is that telling kids that they’re failing because they just don’t have the right work ethic is a crappy thing to do. It’s usually false and it will make them feel terrible. Behavioral genetics studies show pretty clearly that at least 50% of success at academics and sports is genetic; various sociologists have put a lot of work into proving that your position in a biased society covers a pretty big portion of the remainder. If somebody who was born with the dice stacked against them works very hard, then they might find themselves at A2 above. To deny this in favor of a “everything is about how hard you work” is to offend the sensibilities of sensible people on the left and right alike.

Read the whole thing. I found it difficult to excerpt.

The view that I hold, which is not based on any studies and is just my opinion, is that effort matters a lot, but that the propensity to undertake effort is more genetic than environmental.

In a school setting, my sense is that you get good effort and results if you happen to have a cohort of students who compete to impress one another in terms of classroom accomplishments and who encourage one another to do their best. (Imagine having a Michael Jordan in the class, pushing everyone on his “team” to be better.) If there is a way for a teacher to influence that, to create such an atmosphere where otherwise it would not exist, I would like to know the secret. My guess is that setting up teams and having competitive games is a way to trick students for a day or two, but I don’t think it creates the overall mentality that I have in mind.

Reputation Systems as Regulators

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Tyler Cowen and Alex Tabarrok write,

In recent times, information technology has made it easier to observe a seller’s reputation and to contribute to the formation of a seller’s reputation at low cost. Yelp, Angie’s List, and Amazon Reviews all make it easy for past buyers to report their observations on seller quality and for future buyers to observe a seller’s accumulated reputation.

This might mean that we need less regulation. Other possibilities:

1. We have always had the means to use reputation systems as an alternative to regulation. But regulation is the preferred outcome of the political system, perhaps for bootleggers and baptists’ reasons. The advent of better information and technology actually does not change the relative economic and political advantages of regulation.

2. One issue with reputation systems is that there is an ongoing temptation to game them. Consider “search engine optimization” or “social media marketing.” Surely there are folks out there offering to get your business top rankings on Yelp. Given that gaming will work at least sometimes, is an unregulated equilibrium necessarily the best?

3. It becomes harder for new entrants to break into a market governed by reputation than one governed by regulation. Obtaining a license from a regulatory agency might be easier than obtaining visibility in a rating system.

An Intriguing Sentence to Summarize Marx’s Ideal

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From Peter Lawler,

Happiness is the unobsessive life of the hobbyist who doesn’t have to work for a living.

Lawler claims that this is Marx’s ultimate vision, and not surprisingly Lawler says that it has some merit, although he thinks that in the end it fails as a philosophy. The post is mostly about a claim by Lawler that not having children undermines serenity. But Lawler should do more to flesh out his ideas.

Timothy Taylor on Batteries

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He writes,

For electric cars to be truly cost-competitive with gas-fueled vehicles, battery costs need to drop dramatically. The rule-of-thumb has been that the cost of the battery pack in an electrical car needs to drop to $150 per kilowatt/hour or less. A few years back, it was standard to read that battery packs in electric cars were costing $700 per kilowatt/hour or more. Given the historically slow pace of progress in battery technology, it looked as if achieving these costs savings might be three or four decades away.

…the market leaders for electric cars have already reached a cost of $300 per kilowatt-hour–that is, they aren’t just writing with another set of predictions for how batteries will improve, but arguing that they have already improved.

…On this trajectory, nonsubsidized electric vehicle would be commercially viable in about a decade.

I have my doubts that batteries will improve at a high rate going forward. I suspect that energy efficiency will improve at least as quickly. That means that in relative terms, all-electric cars will gain little, if anything, on gasoline-powered cars.

[UPDATE: A reader writes,

In March 2013 Bjorn Lomborg wrote a piece for the WSJ suggesting that electric cars have “a dirty little secret”: these cars are much more energy intensive to produce, especially because of the mining of lithium for the batteries. As a result, there are no environmental gains from such cars until they’ve been driven about 80,000 miles. So the real effect of the subsidies to get people to buy such vehicles is to allow upper income people to feel good about themselves. That’s a laudable goal for a government program, isn’t it?

This is a general problem with trying to be a “green” consumer. When X costs less than Y, the market is telling you that X uses fewer resources. When you think that X uses too much of a particular (seen) resource and you buy Y instead, then you use more of another (unseen) resource.

QE in Germany, 1937?

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Hitler’s plans to revitalize the German economy by spending on infrastructure and rearmament were financed by issuing off-balance-sheet paper claims to suppliers–which in theory were redeemed by reichsmarks but in practice were allowed to mount up. The practice was potentially highly inflationary, but in the short term it worked wonders. Unemployment fell from six million to less than one million by 1937. Germany’s economy outperformed all others in recovery from the Depression.

That is from When Globalization Fails, by James MacDonald, reviewed here. I think Tyler would like this book.

I think of QE as analagous. QE finances deficit spending with off-balance-sheet “paper” (bank reserves) which in theory are money but in practice are allowed to mount up in banks without acting as money–yet.