Category Archives: PSST and Macro

My Problem with Search Theories of Unemployment

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Nick Rowe steps into a debate.

The better the job you want to get, the longer you expect to search (or wait) before you get it. ..

Now suppose the economy enters a recession. The trade-off worsens … You choose a new point. You will probably choose a point as drawn, expecting to search or wait longer and get a worse quality job.

He illustrates with a nice diagram.

It’s a neat theory, and I like it better than models that do not use job search. But I don’t really buy it.

From a PSST perspective, the searching that is important is the search for new patterns of sustainable specialization and trade. It’s not like a marriage market in which a suitable match exists and you just have to find it.

Paul Krugman Sentences I Might Have Written

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I certainly agree with this:

the professional economists who either play important roles in making policy or appear to have influence on the discussion got their Ph.Ds from MIT in the second half of the 1970s. An incomplete list, with dates of degree:

Ben Bernanke 1979
Olivier Blanchard 1977
Mario Draghi 1976
Paul Krugman 1977
Maurice Obstfeld 1979
Kenneth Rogoff 1980

Larry Summers was at Harvard during the same period, but he was an MIT undergrad and very much part of that intellectual circle. Also, just about everyone on the list studied with Stan Fischer, who remains very much in the middle of policy-making.

Note that we are talking about macroeconomic policy. But some important microeconomic policy makers came out of that period as well. Carl Shapiro comes quickly to mind.

Of course, Krugman has other sentences that I could not have written.

Analytically, empirically, the MIT style has had an astonishing triumph.

As you know, I think that macroeconomic data can be twisted to “prove” any theory. You can look at reasonable, credible blog posts by Scott Sumner or Tyler Cowen pointing out many discrepancies between recent macroeconomic performance and the Krugman-style Keynesian analysis. Empirical macroeconomics seems to me to boil down to a pure exercise in confirmation bias.

As you also know, I have a less exalted view of MIT’s approach to economics and of Stan Fischer’s role as the Genghis Khan of macro. See, my recent post on academic hiring networks, my memoirs of a would-be macroeconomist, or my recent essay on camping-trip economics. Read that essay next to Krugman’s post.

Kevin Erdmann Revisits the Housing Boom

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He writes,

the commonly repeated anecdotes of janitors and checkout clerks being
handed $300,000 mortgages on a hope and a prayer do not appear to be representative. On net, all the new mortgages went to families with incomes around $45,000 and higher.

And elsewhere he writes,

growth in homeownership came from high income households and that households didn’t increase their debt payment/income ratios or their relative consumption of housing during the boom. The evidence against the standard narrative is even more stark when we look at dollar levels, because, despite frequent implications to the contrary, low income households don’t tend to take on nearly as much debt as high income households.

Consider two ratios:

1. Debt-to-income.

2. Debt-to-equity.

Many narratives of the financial crisis focus on debt-to-income ratios. The oppressor-oppressed narrative is that greedy lenders imposed inappropriately high debt-to-income ratios on innocent borrowers, who then could not meet their mortgage payments. The civilization-barbarism narratives stress the use of houses as ATMs and the forced expansion of lending toward irresponsible borrowers.

It seems to me that Erdmann is suggesting that debt-to-income ratios did not got out of line, or perhaps they only got out of line for high-income borrowers. He may be right, although I would suggest looking at the Home Mortgage Disclosure Act (HMDA) data and not just the survey of consumer finances.

Ever since Bob Van Order explained the mortgage default option to me almost 30 years ago, I have viewed debt-to-equity as more important than debt-to-income. If we define sup-prime lending in terms of debt-to-income, then I am inclined not to attach much significance to the proportion of sub-prime loans. To me, the dangerous loans are the ones with low down payments. There is some overlap between those and loans with high debt-to-income ratios, but not enough overlap to equate the two.

Let’s take Erdmann’s analysis of debt and income as accurate. I see no reason to change my preferred narrative of mortgage lending and the housing boom. That is, there was a surge in lending with low down payments. I am pretty confident that the HMDA data support this. In addition, there was a surge of lending for non-owner-occupied homes (speculators).

Think of owner-occupants with low down payments and non-owner-occupants as the speculative component in the housing market. My narrative is that the speculative component soared during the housing boom. These speculators did very well until house prices started to level off late in 2006. Then what had been a virtuous cycle on the way up turned into a vicious cycle on the way down, and the speculative buyers got hammered.

Getting from that to a recession is the more difficult part for me, because I do not allow myself to use the words “aggregate demand.” Instead, to explain the recession I have to make a case that many patterns of specialization and trade became unsustainable, or were finally perceived as unsustainable, while new sustainable patterns were difficult to discover. I might argue that the surge in government economic intervention exacerbated the difficulty of discovering new patterns of sustainable specialization and trade. TARP and the stimulus were largely efforts at redistribution, and that gave people a bigger incentive to focus on grabbing some of the loot than on developing a sustainable new business. Of course, Keynesians will tell you that the problem is that the surge in government intervention should have been bigger and lasted longer.

Four Forces Watch: Larry and the Robots

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Mike Konczal writes,

There’s been a small, but influential, hysteria surrounding the idea is that a huge wave of automation, technology and skills have lead to a massive structural change in the economy since 2010.

He goes on to say that Larry Summers has demolished this notion, by pointing out that we have not seen rapid productivity growth over this period.

This looks suspiciously like a straw man to me. I am about as big a believer as there is in the significance of structural change, but I do not see a “huge wave of automation” that has taken place over the past five years.

My thoughts:

1. What I do see are the four forces: the New Commanding Heights (demand for physical goods tapering off while demand for health care and education rises); demographic dispersion–what Charles Murray calls Coming Apart; factor-price equalization (American workers confronting stiffer foreign competition); and Moore’s Law (improvements in computers and communication).

2. These four forces have been operating for decades, and there was nothing peculiar about the 2010-2014 period. The New Commanding Heights force has been operating for more than 50 years. The demographic dispersion force got started about 50 years ago, but for the first 25 years or so the impact was small. Instead, the most notable demographic change from 1965 to 1990 was the increase in female labor force participation. Factor-price equalization had to await liberalization of the economies of China and India, which did not really get started until the 1980s and even then took a while to have an impact. Moore’s Law was articulated in the 1960s, but as recently as the late 1980s Robert Solow’s quip that we see computers everywhere but in the productivity statistics seemed apt.

3. The four forces cause the economy to move in the direction depicted in Neal Stephenson’s The Diamond Age. In that novel, we see Thetes, who work very little and live inexpensively (think of a consumption basket dominated by big-screen TVs). And we see Vickies, who work creatively and hard in order to consume unnecessary luxury services (think of high-tuition education, high-end precautionary medical care, and exotic vacations).

4. Larry Summers looks at the last twenty years and sees a “secular stagnation” in aggregate demand, interrupted by the dotcom bubble and then the housing bubble. Instead, I look at the last 15 years and see The Diamond Age starting to become reality. The housing bubble gave Thetes the impression of being wealthier than they really were, and when it popped they had to adjust to reality. (Although one could argue that, illusions aside, they did not lose home equity, because they did not have any in the first place.) The process of adjusting to reality can take time–look at Greece.

5. Consider the statement, “If we had more aggregate demand, then more non-high-skilled people would have jobs and wages would be higher.”

I do not believe that statement, Instead, I believe that nothing short of direct intervention in labor markets (government make-work jobs and wage subsidies, or you could hope for an impact from changes in means-tested programs that reduce implicit marginal tax rates) will change macroeconomic outcomes. But as long as jobs and wages are lower than what Summers/Krugman/Sumner think they should be, there is no way to falsify the statement that “if we had more aggregate demand….” The alleged lack of jobs and wages can be viewed from their perspective as proof that there is insufficient aggregate demand. There is no measure of “sufficient aggregate demand” that exists independently from the desired result of a larger wage bill. Indeed, Sumner would say that the wage bill is a measure of aggregate demand that can be targeted by the Fed.

Macroeconomics and Expertise

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As part of a general blog conversation, Noah Smith writes,

Scott Sumner expresses incredible confidence that NGDP targeting is best. Paul Krugman expresses incredible confidence that fiscal stimulus is effective and that austerity is counterproductive. John Cochrane expresses incredible confidence that structural form – removing “sand in the gears” – is the best medicine for an economy in recession. Robert Lucas said that the “central problem of depression prevention has been solved.” And so on, and so forth.

I think normal people realize that that certitude is basically never warranted. Yes, those economists often (but not always) have some evidence to back up their claims. But not the kind of evidence that people have in disciplines where data is more abundant, controlled, and replicable.

Pointer from Mark Thoma. I disagree that this is how normal people think. I believe that the main problem with non-expert opinion in macroeconomics is that normal people can be just as dogmatic in their macro views as self-proclaimed experts.

I would amend the last paragraph to substitute “thoughtful economists” for “normal people.” With that amendment, the quoted passage would have my vote.

Sentences I Might Have Written

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Instead, they were written by Richard E. Wagner and Vipin P. Veetil.

Our analysis suggests that the decline in the velocity of money is a consequence–not a cause–of real problems. To turn Leland Yeager’s (1997) dictum on its head: when output shutters, the veil flutters. Injecting money into the economy–however it may be done–cannot help economic actors coordinate their plans. Money is not a substitute for information. We differ from both those who assume velocity of money is stable and those who don’t, for both the stability and instability in the velocity of money is a reflection of human action at the micro-level. All problems and solutions must be sought and found at the micro-level. A macroeconomics that begins with the velocity of money, irrespective of whether it treats velocity as stable or unstable, assumes away all that is of economic significance.

Actually, the paper is filled with sentences I might have written. Another excerpt:

Aggregate variables like GDP are not account entries that belong to action-taking entities. Instead, they are aggregations over interactions among the plans of many entities. The data of accounting do not account for the actions of economic entities. Counting is not creating.

The interesting question is what will happen if the Fed tries to stabilize nominal gross domestic product. As the authors point out, at the ground level, all the Fed is doing is swapping money for securities. Those swaps will benefit some people and hurt others. From a PSST perspective, this will create different patterns of specialization and trade from what would emerge otherwise. Presumably these new plans will be less sustainable than the plans that would have occurred without Fed intervention. In that sense, even if NGDP is stabilized, the economy is made worse off.

Facts do not change Minds

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Scott Sumner tries,

Here we have not only the economy reacting to the Great Austerity Experiment better than predicted by the CBO, but even far better than predicted if there were no austerity.

Does this ring a bell? Do you remember the Great Stimulus Experiment of 2009? The time that the unemployment rate didn’t just rise much more than expected in response to the stimulus, it rose far more than expected under the alternative scenario of no stimulus!

Do you think that Jared Bernstein is going to change his mind because of these facts? I don’t.

Granted, I don’t think that anyone should completely change their mind based on macroeconomic observations. There is too much causal density to take any empirical evidence as definitive. But by the same token, no one is entitled to hold a view of macroeconomics without a scintilla of doubt. I wish that more commentators were willing to allow that there is a significant probability that they are wrong when it comes to macro.

How to Fix Economic Education

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In this essay, I argue that it is badly broken.

Unfortunately, the conventional misrepresentation takes seriously the economics of a camping trip. There are resources to be allocated, including the time that campers have available to pitch a tent, light a fire, cook a meal, and so forth. And there are goods to be allocated, including sleeping bags, food, and water. Thus, from the conventional standpoint, there is nothing wrong with using the camping trip as a metaphor for the economy.

Read the whole thing.

The Technocrat’s Creed

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He writes,

The near-global stagnation witnessed in 2014 is man-made. It is the result of politics and policies in several major economies — politics and policies that choked off demand. In the absence of demand, investment and jobs will fail to materialize. It is that simple.

Pointer from Mark Thoma.

Several years ago, I noticed

Stiglitz always writes as the omniscient observer. He knows exactly what should have been done

The creed of the technocrat, particularly as believed by Stiglitz might be something like this:

I am infallible. I can solve any problem. Given the authority, I can optimize any situation. When bad outcomes occur, these invariably come from policies that deviate from what I know to be optimal. The only thing that stands between reality and economic nirvana is opposition to me, which comes from economists who are too blind to see the correct ideas or from politicians who are too evil to implement them.

When it comes to other mainstream economists, Stiglitz is capable of spotting weaknesses in their point of view. He can be quite insightful in that regard. But if he has ever admitted being wrong himself, or even in doubt, I have not seen it.

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.