Bernanke vs. Warren-Vitter

He writes,

The problem is what economists call the stigma of borrowing from the central bank. Imagine a financial institution that is facing a run but has good assets usable as collateral for a central bank loan. If all goes well, it will borrow, replacing the funding lost to the run; when the panic subsides, it can repay. However, if the financial institution believes that its borrowing from the central bank will become publicly known, it will be concerned about the inferences that its private-sector counterparties will draw. It may worry, for example, that its providers of funding will conclude that the firm is in danger of failing, and, consequently, that they will pull their funding even more quickly. Then borrowing from the central bank will be self-defeating, and firms facing runs will do all they can to avoid it. This is the stigma problem, and it affects everyone, not just the potential borrower. If financial institutions and other market participants are unwilling to borrow from the central bank, then the central bank will be unable to put into the system the liquidity necessary to stop the panic. Instead of borrowing, financial firms will hoard cash, cut back credit, refuse to make markets, and dump assets for what they can get, forcing down asset prices and putting financial pressure on other firms. The whole economy will feel the effects, not just the financial sector.

Pointer from Mark Thoma.

In effect, Bernanke is saying that you have to make firms that get into trouble want to be bailed out. If you make bailouts too painful for them, then “financial firms will hoard cash, cut back credit, refuse to make markets, and dump assets.”

I am not impressed by his reasoning. What he calls “stigma” is not a bug of the Bagehot principle. It is a feature.

Paul Romer’s Case for Ad Hominem

He writes,

The only way I can see to protect scientific discourse is to limit entry into the discussions of science. But this MUST NOT BE DONE on the basis of beliefs about what is true. It must instead be based on a demonstrated commitment to the norms of science. As part of this process of defending science, exclusion by shunning, plays an essential role. People who show, by publishing even one Willie Horton paper, that they are not committed to those norms, have to be excluded. So too must the people who promote and encourage Willie Horton papers. In science, “It was my PAC, not me” should not be an acceptable defense.

Pointer from Mark Thoma.

Later, he criticizes positions taken by Milton Friedman and George Stigler against the idea of monopolistic competition. On the narrow issue of whether economists should use the model of monopolistic competition, I am entirely on Romer’s side. I tell my AP econ students that we spend most of our time on the nearly-irrelevant models of perfect competition and monopoly, when in the real world we almost always find monopolistic competition or oligopoly.

But I do not agree with Romer’s larger point. What would it mean to shun Milton Friedman because in Romer’s judgement Friedman’s opposition to the theory of monopolistic competition was politically motivated? Would we discard the permanent income hypothesis, the Friedman-Savage utility function, and the Monetary History of the United States?

As I understand Romer, he is arguing that the scientific norms in economics are so delicate that we must shun economists who fail to maintain certain standards. I look at it differently.

I believe that politics pervades the economics profession. Paul Samuelson’s textbook was a political document, and his claim to scientific neutrality was an exercise in (self-) deception. There is no economist so pure as to be free of bias.

It is not desirable to throw out the ideas of biased economists (indeed, if I am correct, that would mean throwing out all ideas in economics). Instead, the ideas ought to be debated as ideas, without regard to who proposed them. If you think that monopolistic competition matters in growth theory, then you should be able to make that case. You can do very well by pointing out the flaws in other people’s work. But attacking their motives adds nothing to the discussion. To say otherwise is to suggest that all economic discourse should consist of asymmetric insight (claiming to understand your opponents better than they understand themselves). Is that really what Paul Romer wants–to turn economics journals into Paul Krugman columns? If so, then Romer should be shunned.

On Macro and Methods

This may or may not relate to the issue of “mathiness” raised by Paul Romer, recently cited by by Joshua Gans and by Mark Thoma. It is from an essay I am working on:

Keynesianism treats the economy as a single business producing one output, called GDP. This modeling strategy focuses all attention on the problem of choosing how much to produce. It assumes away the problem of choosing among outputs or the problem of choosing from among many possible production methods or supply-chain configurations.

This single output, GDP, is produced by a single technique, called the aggregate production function. Thus, the Keynesian modeling strategy ignores the existence of multiple alternative patterns of specialization. Keynesians act as if there were exactly one pattern of specialization in the economy. There is no need to choose among alternative patterns, to discard outmoded patterns, or to discover new patterns.

In the Keynesian framework, jobs are only lost when there is a drop in demand. In the PSST framework, and in the real world, jobs are constantly being destroyed, for a variety of reasons.

Economic progress consists of re-arranging production of output to be more efficient. It is an always-ongoing process that necessarily destroys jobs. A new consumer product makes other products obsolete, or at least less desirable. A new invention or managerial innovation makes it possible to produce the same output with fewer workers. A new configuration of trade uses labor more efficiently…

In the Keynesian story, all unemployment looks like the temporary layoffs that used to occur in automobiles and steel when firms accumulated excess inventories. Once inventory balance was restored, workers were recalled to the same jobs.

In the PSST story, all unemployment looks like structural unemployment. That is, workers who lose jobs will not find that those jobs return in several months, or ever. Instead, displaced workers will have to be employed by different firms, often in different industries.

In the Keynesian story, the process of economic adjustment to a shock consists of arriving at the correct relationships between the money supply and the aggregate price level and between the price level and the aggregate wage. In the PSST story, the process of economic adjustment to a shock requires entrepreneurs to discover new arrangements of tasks that add sufficient value to generate sustainable profits. As with all entrepreneurial effort, this is a trial-and-error process. Some new businesses will fail, generating no sustainable employment. Only a few will be so successful that they create large numbers of new jobs. Sorting out this process will take time.

From the perspective of someone who finds that the PSST story fits well with economic thinking, the Keynesian modeling strategy seems contrived and misguided. By aggregating the economy into a single business, Keynesianism necessarily shoves the phenomenon of structural adjustment and the ferment of entrepreneurial trial and error into the background. Keynesians regard this as a useful simplification. Instead, Keynesianism is more like Hamlet without the Prince.

On Hypocrisy

Robert Trivers writes,

Recently something brand new has emerged about Steve that is astonishing. In his own empirical work attacking others for biased data analysis in the service of political ideology—it is he who is guilty of the same bias in service of political ideology. What is worse—and more shocking—is that Steve’s errors are very extensive and the bias very serious. A careful reanalysis of one case shows that his target is unblemished while his own attack is biased in all the ways Gould attributes to his victim.

Pointer from Jason Collins.

Paul Krugman writes,

what you should really look for, in a world that keeps throwing nasty surprises at us, is intellectual integrity: the willingness to face facts even if they’re at odds with one’s preconceptions, the willingness to admit mistakes and change course.

Pointer from Mark Thoma.

Is it a rule of thumb that if you accuse other people of committing an intellectual sin, then you yourself are committing it?

Larry White on Free Banking History

His final sentence:

Central banks primarily arose, directly or indirectly, from legislation that created privileges to promote the fiscal interests of the state or the rent-seeking interests of privileged bankers, not from market forces.

Pointer from Mark Thoma (!).

I think that one could write essentially the same sentence to explain quantitative easing.

Hayek and Business Management

Chris Dillow writes,

If extensive knowledge is possible, then bosses might be able to manage big companies well. If not, then centrally planned companies will be inefficient. Sure, perhaps competition will eventually weed out egregious incompetence, but market forces might not grind so finely as to eliminate all inefficiency

Pointer from Mark Thoma.

I cannot emphasize enough how much I agree with this. Because I spent 15 years in business, I got an opportunity to see large organizations close up. I saw that in a large business, the top management cannot keep track of more than about three major initiatives at a time. I saw that compensation systems have to be frequently overhauled, because employees learn to game any system that stays in place for more than a couple of years. I saw the “suits vs. geeks” divide, as specialists in information technology or financial modeling had difficulty communicating with executives who had only general knowledge.

The notion of large, efficient organization is an oxymoron. If you think that large corporations have overwhelming advantages, then you have explained why IBM still dominates the computer industry, while Microsoft and Apple never really got amounted to much of anything. I like to say that if you are afraid of large corporations then you have never worked for one.

Of course, large corporations do exist. That is because as clumsy as they are, they can still be less clumsy than the alternative, which is to break a corporation into a network of contractually related divisions. Nobel Laureate Oliver Williamson tried to address the issue of when to expect a market and when to expect a hierarchy. His answers do not really speak to me, but I do not claim to have better ones.

I do think that government often tilts the scale in favor of large organizations. The high fixed cost of regulatory compliance is one factor. Government has been a key customer in industries like aerospace, information technology, and finance, and the fixed costs of selling to government are very high, because of all of the hoops that you have to jump through.

Ken Rogoff on the State of the Economy

He writes,

The steady decline of real interest rates is certainly a puzzle, but there are a host of factors. First, we do not actually observe the true economic real interest rate; that would require a utility-based price index that is extremely difficult to construct in a world of rapid change in both the kinds of goods we consume and the way we consume them. My guess is that the true real interest rate is higher, and perhaps this bias is larger than usual. Correspondingly, true economic inflation is probably considerably lower than even the low measured values that central banks are struggling to raise.

Read the whole thing. It is part of an interesting symposium on secular stagnation. Pointer from Mark Thoma.

Rogoff also supports the hypothesis of financial crowding out.

Whether by accident or design, banking and financial market regulation has hugely favoured low-risk borrowers (governments and cash-heavy corporates), knocking out other potential borrowers who might have competed up rates. Many of those who can borrow face higher collateral requirements. The elevated credit surface is partly due to inherent riskiness and slow growth in the post-Crisis economy, but policy has also played a large role. Many governments, particularly in Europe, have rammed down the throats of pension funds, banks, and insurance companies. Financial repression of this type not only effectively taxes middle-income savers and pensioners (who receive low rates of return on their savings) but also potential borrowers (especially middle-class consumers and small businesses), which these institutions might have financed to a greater extent if they were not required to be so overweight in government debt.

Do Unit Roots Ruin the Concept of Potential GDP?

Roger Farmer re-litigates an old controversy about macroeconomic data, concluding

What do we learn from this? Much the same as we learn from the fact that unemployment has a unit root. Just as unemployment can remain persistently high, so GDP can remain persistently below trend. There is no evidence that the economy is self-correcting.

Pointer from Mark Thoma. My comments:

1. Although unemployment has a unit root, Ed Leamer finds that there is some persistence to changes in payroll employment. See his textbook. You might also Google Kling-Leamer-momentum-employment.

2. Unit roots in macro data cause a huge problem. If you don’t correct for them, you get spurious correlation. If you do correct for them, you tend to get noise. That is one reason I call macroeconometrics The Science of Hubris.

3. In stock market returns, econometricians have been able to identify long-term mean reversion even though the short run is a random walk. Can something similar be done with GDP data?

4. If real GDP truly is nonstationary, then how can we rescue the concept of potential GDP? If you think of the economy as ultimately self-correcting, then what it corrects to is potential GDP. If the economy is not self-correcting, then the concept of potential GDP can have no objective basis.

I come to this issue with a desire not to praise the concept of potential GDP, but to bury it. From a PSST perspective, there is no such thing as potential GDP. The patterns of specialization and trade that are sustainable now are the patterns that are sustainable now. There were other patterns that were sustainable in the past, and entrepreneurs will discover still other patterns sustainable in the future, but right now we cannot describe those alternative patterns as potential. Right now those alternative patterns are either not sustainable or yet to be discovered.

Exit, Voice, and Technocracy

Tim Harford writes,

several economists suggested structures that would put decision making at arm’s length from politicians, delegating it to technocrats with the expertise and incentives to do what is right for Britain.

He reports on interviews he had with several mainstream economists. Pointer from Mark Thoma.

What this tells you is that mainstream economists distrust voice (the political process), as I do. However, for mainstream economists, the preferred alternative is fantasy despotism, with technocrats in the role of despots. For me, the preferred alternative is exit, with people given more opportunities to choose among different governing bodies. See the widely-unread Unchecked and Unbalanced.

What Isn’t Wrong with Macro?

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.