DSGE Models Are Not Micro-founded

Mark Thoma quotes George Evans,

First, because it is a carefully developed, micro-founded model incorporating price frictions, the NK model makes it possible to incorporate in a disciplined way the various additional sectors, distortions, adjustment costs, and parametric detail found in many NK/DSGE models.

No! There is no specialization and trade in these models. You can call such a model “micro-founded” all you want. It isn’t. These empty modeling exercises do not deserve to be called micro-founded. They do not even deserve to be called economics.

Is This Socialism?

Chris Dillow writes,

Markets, therefore, have a big place in socialism – not least because, as Adam Smith said, they are a means whereby people provide for others without caring. (The best counter-argument to this I’ve seen comes from Matthijs Krul).

This principle has another implication. Socialism should be achieved by evolution, by creating stepping stones – small institutional tweaks that create the potential for bigger ones. For example, small acts of empowering people – such as worker directors or patients’ groups – might create a demand for greater power.

Pointer from Mark Thoma. What Dillow appears to want strikes me as a form of capitalism that is tweaked to make competition less intense among low-skilled workers and more intense among employers. I can heartily endorse the thrust of what he is proposing as much better than what we have currently.

The Future of Mainstream Macro?

According to Olivier Blanchard,

I suspect that even DSGE modelers will agree that current DSGE models are flawed. But DSGE models can fulfill an important need in macroeconomics, that of offering a core structure around which to build and organize discussions. To do that, however, they have to build more on the rest of macroeconomics and agree to share the scene with other types of general equilibrium models.

Pointer from Mark Thoma.

Actually, he does not even mention what I believe is the main flaw with this approach to macroeconomics. As I point out in Specialization and Trade, that flaw is the failure to include specialization at all. Instead, there is one type of worker producing one type of good. This is obviously unwise once you consider it, but once you consider it you are no longer a respectable macroeconomist.

Expensive Cities and Labor Immobility

Peter Ganong and Daniel Shoag write,

Though lawyers still earn much more in the New York area in both nominal terms and net of housing costs, janitors now earn less in the New York area after housing costs than they do in the Deep South. This sharp difference arises because for lawyers in the New York area, housing costs are equal to 21 percent of their income, while housing costs are equal to 52 percent of income for New York area janitors. While it may still be “worth it” for skilled workers to move to productive places like New York, for unskilled workers New York’s high housing prices offset the nominal wage gains.

Once again, land-use regulation is accused of being a major culprit. And along those lines, discussing Tokyo, Alex Tabarrok writes,

Rising housing prices are not an inevitable consequence of growth and fixed land supply–high and rising housing prices are the result of policy choices to restrict land development.

However, note that in a post devoid of politics or vitriol, Paul Krugman writes,

In today’s world, core headquarters functions – the stuff done by top executives and highly paid experts – can be unbundled from the more mundane operations of a company. These high-end functions are also the ones that benefit most from the agglomeration economies of a big city; not to mention the amenities such a city offers to people whose salaries are enough to let them afford decent housing despite high prices.

Meanwhile, it’s no longer necessary to have all the back-office operations in the same place, requiring that a lot of less-well-paid workers deal with high rents even as they suffer on the long subway ride in from Queens.

Pointer from Mark Thoma.

The point is that with modern communications technology, the upper echelons no longer have to be close to all of their mid-level staff.

This particular form of unbundling may or may not be the major factor. However, I think that patterns of specialization have shifted in ways that allow the affluent to invade some major cities and drive out the less-affluent. My view is that, as with colleges, affluent residents are a powerful attraction to other affluent residents, so that you head toward an outcome in which there is competition for “admission” to the high-end cities. For a variety of reasons, including differences in tastes, many of the less-affluent do not enter this competition.

Dietrich Vollrath on Brad DeLong’s Manufacturing Puzzle

Vollrath writes,

everything makes sense if ϵI=0.77. That is, if the income elasticity of demand for manufactured goods is a little less than one. An elasticity less than one means that if your income goes up by 10%, your expenditure on manufactured goods rises by less than 10%. It goes up, but not by a similar percent. This income elasticity less than one acts a lot like the “demand shift” that DeLong dismisses in his first scenario. If you like, I’ve just given a very specific form to that demand shift.

Which is point (3) in my post on the puzzle.

Pointer from Mark Thoma.

Zoning After 100 Years

Justin Fox writes,

Fischel has a long list of explanations for this intensification of zoning that I won’t go into here, other than to mention the one that drives me the craziest — the dressing-up of self-interested economic arguments in the language of environmentalism and morality.

Pointer from Mark Thoma.

My thoughts:

1. In urban areas, there are important spillover effects from development. Your new building might block my view, create noise or congestion, and so on. In theory, this would be resolved in a Coasian manner–either you compensate me for the harm that you do or I compensate you for not allowing you to build. But in practice the mechanisms for Coasian bargaining do not exist. Hence, these spillovers are dealt with by the political process.

2. Land-use regulation is a major source of political power. If the teachers’ unions ultimately determine who can and cannot be elected in Montgomery County, Maryland, then the ability to fund a campaign comes from developers. The developers are effectively bribing the county council to get their projects approved.

3. I am not sure what the free-market equilibrium looks like for major cities. Perhaps there would be a bit more high-rise apartments built and somewhat less upward pressure on prices and rents. But do not be so sure that the effect would be large.

4. Economists and pundits look at the higher incomes in San Francisco and New York relative to small-town Ohio and see missed opportunities caused by zoning restrictions. I think that these observers under-estimate the differences in lifestyle preferences.

Brad DeLong’s Manufacturing Demand Puzzle

He writes,

If the income elasticity of demand for “manufactured goods” were one and the price elasticity of demand were zero, then we would have expected the decline in relative price to 40% of its initial value to be associated with stability in relative quantities, and for the nominal share of manufactures in GDP to fall on the same track as the price–as it has.

…For our demand for manufactured goods to have a price elasticity of zero seems to me to make little sense: Manufactured stuff is useful. When the price of manufactures drops relative to the price of other stuff, we ought to buy more manufactures

Pointer from Mark Thoma. DeLong is looking at the changes in reported price of manufactured goods relative to the rest of GDP and the reported nominal quantities over the past 70 years. A few of my thoughts:

1. We did increase our purchase of manufactured goods over the past 70 years, but we imported more and exported less. The price of foreign manufactures (including the cost of shipping them here) fell by more than did our cost of producing them. I doubt that this resolves the entire puzzle, but it must resolve some of it.

2. My guess is that the same sort of arithmetic applies to food. That is, the relative price of food has fallen, and the nominal share of food production in GDP has fallen by about the same amount. Even though food also is useful.

3. Robert Fogel told us that the income elasticity of food and manufactured goods is 0.6, not one.

Paulson, Bernanke, and Lehman, continued

James B. Stewart writes,

One of the more intriguing questions Professor Ball tackles is why Mr. Paulson, rather than Mr. Bernanke, appears to have been the primary decision maker, when sole authority to lend to an institution in distress rests with the Fed. The answer, he suggests, is to be found more in psychology than data.

“By many accounts, Paulson was a highly assertive person who often told others what to do, and Bernanke was not,” Professor Ball writes. “Based on these traits, we would expect Paulson to take charge in a crisis.”

Pointer from Mark Thoma.

Stewart, who did his own reporting on the events, supports Professor Ball’s view. My reading of Paulson is that he is a high-testosterone guy. My reading of Bernanke is that he isn’t. I have always viewed Paulson as the great villain of the financial crisis response. I do not believe that any of the bailouts were justified, and I view him as the driver of the bailouts.

Suppose you take a Bagehot view, which is that in a crisis the central bank should lend freely, on good collateral, at a penalty rate. In the case of Bear Stearns, my recollection is that the Fed took on crummy collateral. Ball claims that Lehman had good collateral that the Fed could have lent against.

The Great Regulation

Guy Rolnik writes,

Looking at both intangible investments and political activities to explain the 20% rise in Tobin’s q in the U.S. since 1970, a new working paper by James Bessen from Boston University concludes that activity associated with increased Federal regulation is the most important explanatory factor, especially after 2000. In fact, spending on R&D and other intangibles has fallen relative to conventional assets since 2000.

Noting that operating margins for these firms have also risen since 1990 by over 2% in aggregate, Bessen’s study also found that variables associated with regulation and corporate campaign contributions account for about half of this increase.

Pointer from Mark Thoma. The article is a long interview with Bessen, interesting throughout. For example,

In 2011 a new patent law passed, the Leahy-Smith America Invents Act. This patent law was essentially negotiated between a small number of large pharma companies and a small number of large tech companies.

…all of a sudden you have a whole lot of small businesses in every state in the country who are now upset about getting sued for patent infringement over these very ridiculous claims.

Once again, I wonder how much of the trend toward industry consolidation and loss of dynamism in the past twenty years is due to regulation and rent-seeking.

The Book Sounds Interesting

Erwin Dekker writes,

The rise of fascism posed an even greater threat to the values of the liberal bourgeois, and at the same time it demonstrated that socialism might not be inevitable after all. One of my book’s major themes is the transformation from the resigned, and at times fatalistic, study of the transformation of the older generation, to the more activist and combatant attitude of the younger generation. Friedrich Hayek, Karl Popper, Peter Drucker as well as important intellectual currents in Vienna start to oppose, and defend the Habsburg civilization from its enemies.

I have seen many references to the article on Facebook and on blogs, including Mark Thoma’s link.

The book seems like it might be interesting, but the publishers are evidently worried that people might buy it, so they are charging a price that should deter that from happening.