Category Archives: PSST and Macro

Relate this to Tobin’s q

Posted on by

Justin Fox reported,

>Ocean Tomo calculates intangible assets simply “by subtracting the tangible book value from the market capitalization of a given company or index,” so the rise in intangibles since the 1970s is in part just a reflection of rising stock market valuations. But that’s not all it is: the cyclically adjusted price-earnings ratio on the Standard & Poor’s 500 Index has risen about 2 1/2 times since 1975, while the intangibles increase has been almost fivefold.

Tobin’s q is the ratio of the stock price to the replacement cost of capital. I am tempted to write:

q = P/K = (P/E)(E/K), where P is the stock price, E is earnings, and K is capital.

As Fox points out, a fair amount of the rise in q since the late 1970s comes from a higher P/E ratio. But I gather that if you think of K as tangible capital, then E/K also has soared.

Fox’s piece was mentioned in Scott Sumner’s discussion of what I called the fifth force. But Robin Hanson got me to take a look.

I would note that intangibles in the economy include not just firm-specific intangibles but also general intangibles that lead to better patterns of specialization and trade. Institutional improvements in India and China, as well as lower transportation and communication costs, come to mind.

Tyler Cowen has much more, including a hypothesis that accounting issues are involved.

The Banking Crisis and the Real Economy

Posted on by

How important was the financial crisis as a causal factor in the economic slump? Apparently, Brad DeLong and Dean Baker disagree. Baker wrote,

The $8 trillion in equity created by the housing bubble made homeowners feel wealthier. They consumed based on this wealth, believing that it would be there for them to draw on for their children’s education, their own retirement or for other needs.

When the bubble burst, homeowners cut back their consumption since this wealth no longer existed. However contrary to what you often read in the paper, consumption is not currently low, it is actually quite high when compared with any time except the years of the stock and housing bubbles.

DeLong replies,

in the absence of the financial crisis, the Federal Reserve’s lowering interest rates as consumption spending fell in response to the decline in home equity would have pushed down the value of the dollar and made further hikes in business investment a profitable proposition and so directed the additional household savings thus generated into even stronger booms in exports and business investment: in the absence of the financial crisis, what was in store for the U.S. was not a long, deep depression but, rather, a shallow recession plus a pronounced sectoral rotation.

Pointer from Mark Thoma. Conventional economics did not have a story of how stress in the financial sector could cause problems in the real economy. Even now, that view comes across as a just-so story. Baker argues that one does not need such a story, but DeLong says that we do need it.

I would note that if the financial crisis did not matter, then the bailouts, including interest payments on reserves, were simply transfers to bank shareholders. The more conventional view is that the bailouts prevented a horrible depression. So, the way I see it, the conventional view went from saying that the financial sector is nothing special to saying that you need to invoke specialness of the financial sector to explain how bad the recession was (Baker argues the opposite) and, moreover, the recession would have been even worse without the bailouts.

From a PSST perspective, I think that one must allow that it is possible that credit plays a big role in sustaining patterns of trade, and there may be something special about the financial sector. However, my own inclination is to see the financial sector as of 2007 as overgrown and to view the bailouts as making no contribution to the process of creating new patterns of specialization and trade.

Another Thiel Theme: Short Globalization

Posted on by

In his conversation with Tyler Cowen, this theme was not as pervasive as contrarianism, but I found it more interesting and more provocative. Thiel’s view is that globalization has peaked. Therefore, companies and cities that are tied closely to globalization will decline relative to companies and cities that are less outward looking. So Texas will do better than Virginia, because Texas is focused on its own domestic production, while Virginia’s strength (I would say this only about Northern Virginia, by the way) is its military and diplomatic connections overseas.

Think about the notion “globalization has peaked” from a PSST perspective. Economic activity consists of patterns of sustainable specialization and trade. Globalization means that new patterns are being created across countries more rapidly than within countries. What would drive that differential, and what would slow it down?

Think of the benefit of a new pattern coming from comparative advantage and specialization. The cost is the fixed cost of setting up the pattern. Compared with setting up a local pattern, setting up an international pattern will tend to have higher fixed cost but with a larger subsequent benefit.

One possibility is that the cost of setting international patterns fell as China and India allowed their economic institutions to conform more readily to U.S. standards. However, over time, as China and India climb their way into the middle class, international comparative advantage is being reduced. There was an infamous paper by Samuelson that envisioned such a scenario. (It was perhaps his last academic publication, and it was not well received, because he seemed to disparage free trade.)

Another possibility is that the “low-hanging fruit” of reasonably low fixed cost international setups has been picked. Manufacturing and call centers can be moved offshore at moderate cost. With the New Commanding Heights industries of education and health care, it is much more difficult.

Another possibility is that globalization has not peaked.

A Possible Project for Me

Posted on by

I was thinking of doing a whole bunch of relatively short videos on PSST. The thought process that led me to this was:

1. The Weintraub volume on MIT economics showed how Samuelson shaped the direction of economics, in part with his textbook. I think of his textbook as “seeing like a state” in terms of economics. I think of PSST as the opposite view–very bottom-up.

2. I think one could write a decent textbook that focuses on PSST rather than on the production-and-distribution story that is the focus of neoclassical economics.

3. But nowadays, a textbook is not my medium of choice. The bigger closer library is the Internet, and YouTube in particular.

4. On YouTube, short, punchy pieces work better than long lectures. The challenge for me would be to break my ideas into bite-sized bits and still keep track of them–show the links among them, avoid duplication etc.

Anyway, I think of this as having about a 15 percent chance of going anywhere (it depends on whether I can remain convinced that it is a good idea). The next step would be to put together a draft outline.

Bernanke, the Savings Glut, and Stagnation

Posted on by

You probably already read this.

Secular stagnation works through reduced domestic investment and consumption, the global savings glut through weaker exports and a larger trade deficit. However, there are important differences as well. As I’ve mentioned, the savings glut hypothesis takes a global perspective while the secular stagnation approach is usually applied to individual countries or regions. A second difference is that stagnationists tend to attribute weakness in capital investment to fundamental factors, like slow population growth, the low capital needs of many new industries, and the declining relative price of capital. In contrast, with a few exceptions, the savings glut hypothesis attributes the excess of desired saving over desired investment to government policy decisions, such as the concerted efforts of the Asian EMEs to reduce borrowing and build international reserves after the Asian financial crisis of the late 1990s.

I find Bernanke, both in this post and in preceding ones, more persuasive than Larry Summers.

Genghis Khan on Structural Change in Finance

Posted on by

Stanley Fischer said,

To conclude, the U.S. financial system has changed a great deal over the past several decades. One of the most important changes has been the rapid growth of the nonbank sector. Many reforms have been adopted for both banks and nonbank financial institutions. But regulation is a cat and mouse game. Regulators need to respond to existing regulatory gaps and to keep pace with further changes. We hope we will succeed in doing so. But we know that we will never be able to identify in advance all the threats to stability that are out there, and that it is therefore all the more critical to maintain and strengthen the robustness of our financial institutions, and of the financial system as a whole.

Read the whole thing. Pointer from Mark Thoma.

Both theoretical and empirical work in macroeconomics tends to ignore structural changes of this kind. On the empirical side, think of econometrics. There are three classes of factors at work in macroeconomics data. One is short-term noise, such as a cash-for-clunkers program adding to auto sales one quarter and subtracting from them the next. Another is cyclical drivers–the sorts of things that your theory suggests as causal factors in macroeconomic fluctuations. Finally, there are structural changes, such as the changes in financial markets that Fischer is talking about.

I do not think that it is possible to sift through these three factors without using judgment. Just dumping the data into your econometrics software is an exercise in garbage-in, garbage-out.

Keen vs. Krugman

Posted on by

The controversy flared three years ago. The issue is whether banks are special because they can create deposits “out of thin air.” The formative exposure that I had to this issue–and I would bet that the same goes for Krugman–is James Tobin’s Widow’s Cruse paper.

I am now reading a draft of a book that talks about this issue. The author argues vehemently that those of us aligned with Tobin or other mainstream economists fail to appreciate what makes banks special.

I could argue either side of this issue. As you know, I like to say that the nonfinancial sector wants to have a balance sheet with long-term risky liabilities (newly-planted fruit trees) and short-term risk-free assets (money). The financial sector accommodates this by doing the reverse.

The kicker is that financial institutions are owned by people, also. When a bank finances a fruit orchard, what it does is carve the returns of the fruit orchard into two tranches: a debt tranche (deposits at the bank) and an equity tranche (shares of the bank). This carve-up adds value in part because the debt tranche because its relative price is relatively stable and transparent.

First, let me argue against what I see to be the position taken by the author of the draft book that I am reading. He comes across to me to be claiming that banks break the identity between saving and investment. I would express what it seems to me to be saying as something like

S + L = I

where S is saving, I is investment, and L is the banks creating loans at the stroke of a pen. I am not buying that at all. Banks may be able to create loans and deposit balances at the stroke of a pen, but they cannot create real goods at a stroke of a pen.

Banks can do things that indirectly stimulate the production of real goods. But the chain of events has to be something like

1. Banks loosen lending
2. Businesses invest more
3. Saving goes up (not necessarily the rate of saving, but total saving)

The Keynesian explanation for (3) would be that income has gone up. My explanation might be more along the lines that banks have made the risk of the fruit orchard, as perceived by savers, go down. The banks may do this through better diversification of fruit investments, by obtaining and exploiting information that enables them to avoid bad fruit trees, or just by public-relations moves that encourage depositors to be trusting, perhaps too much so. As a result, people are happier about using fruit trees to enhance future consumption opportunities, so that saving and investment go up.

Now let me take the other side. A lot of economic activity in a modern economy depends on credit. Business investment, housing investment, and some consumer spending are dependent on credit. In a mainstream AS-AD macro, a contraction in the supply of credit is going to reduce spending and economic activity. Or, from a PSST perspective, a credit contraction will disrupt those patterns of specialization and trade that require credit to operate.

So, I am willing to go along with the author in attaching importance to credit conditions. However, I am not willing to go so far as to attach special significance to the particular mechanism by which banks create credit.

Housing Finance and Recessions

Posted on by

Oscar Jorda and others write,

The rapid increase in credit-to-GDP ratios since the mid-1980s was just the final phase of a long historical process. The run-up started at the end of World War II and was shaped by a long boom in mortgage lending. One of the startling revelations has been the outsize role that mortgage lending has played in shaping the pace of recoveries, whether in financial crises or not, a factor that has been underappreciated until now.

Pointer from Mark Thoma.

When I read this, I wanted to shout “Underappreciated by who?” Maybe by the macroeconomists who were trained by Stan Fischer, Thomas Sargent, and their progeny. But until Genghis Khan pillaged macro, every macroeconomist knew that housing and mortgage credit rationing were major economic forces in the United States. Until the late 1980s, the process generating recessions consisted of interest rates rising, mortgage lenders losing deposits (because of interest rate ceilings), home buyers losing access to credit, and housing collapsing. And every macro economist knew this.

And even if you are too young to know any old-fashioned macro, you could read Ed Leamer. I would suggest that the authors of this essay try searching for Leamer Housing is the business cycle.

What this essay teaches shows to be underappreciated is Google.

Note that there is more to the essay, which Timothy Taylor found worthwhile.

Genghis Khan Lays Waste to John Taylor

Posted on by


Stanley Fischer said,

a simple rule of that sort will, by necessity, leave out many factors that appropriately influence monetary policy, such as financial developments, temporary divergences in relationships between different measures of economic activity or inflation, and the like. A simple rule can provide the starting point for the decisions made by the FOMC, but in reaching their interest rate decision, members of the Committee will always have to use their judgment to identify the special circumstances confronting the economy, and how to react to them.

Pointer from Mark Thoma.

Trade, Employment and Wages

Posted on by

Derek M. Scissors writes,

If trade deficits have caused job loss for decades, millions of jobs on some counts, we should see a clear and sustained relationship between trade and unemployment. We don’t.

Right away, I can think of two reasons not to find a relationship.

1. As with many macroeconomic variables, there is causal density. Many factors affect the trade balance, and many factors affect unemployment. In standard international macro, anything that strengthens domestic demand will cause employment to rise along with the trade deficit.

2. Deviations from full employment are temporary (they last for several years, but not forever), at least according to many economic theories. In the long run, the primary effect of globalization should be on the wage rates of various workers, not on the employment rates. And indeed a recent paper by Ebenstein and others claims to find such effects