Category Archives: PSST and Macro

December’s Medium-High Employment Growth

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My comments on the latest employment report:

1. Pay no attention to the household survey. That is true in any month. The household survey on a monthly basis contains much noise. The establishment survey is nearly all signal. The establishment survey shows gains of 250,000 jobs per month for the past several months.

2. Employment has a lot of momentum. A few years ago, I wrote,

I have 603 observations of three-month averages followed by one-month values.

327 have medium job growth in the three-month period followed by medium job growth in the next month.
112 have low job growth followed by low job growth
63 have medium followed by low
45 have medium followed by high
33 have low followed by medium
14 have high followed by medium
8 have high followed by high
1 has low followed by high (December 1970, looks fluky)
0 have high followed by low

3. My definition of “high” job growth is 350,000 per month. Medium is 50,000 to 350,000. So what we are experiencing is growth on the high end of medium.

4. What to make of the low increase in earnings–1.7 percent year over year? From the perspective of mid-1970s macro, you say that slow wage growth increased labor demand, raising employment. From the perspective of pre-1970s macro, you say. . .Whaa??? Another data point that lies off the Phillips Curve. If you take a PSST perspective, you say that you did not expect to see a Phillips Curve, anyway.

The Great Depression as a Coordination Failure

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In Fear Itself, Ira Katznelson shows how many intellectuals yearned for a planned economy, but without the ugly police-state repression of Fascist Italy or Communist Russia. As you know, I sense that Katznelson himself seems to still yearn for government oversight of the economy. In fact, Katznelson quote explicitly expresses disappointment that planning was superceded by what he called the “fiscal policy” approach (meaning Keynesian economics). Of course, I think that central planning is not the answer.

Katznelson disparages the Keynesians (and the monetarists) who came up with the aggregate-demand theory of the Depression. He clearly prefers the pre-Keynesian theory that the Depression was a breakdown of the capitalist system.

Here’s the thing. I agree with Katznelson.

The PSST story would look at the Depression as a coordination failure. The market price system, which is supposed to serve as a decentralized planning apparatus, screwed up. Old patterns of specialization and trade became unsustainable, and for a long time the market could not figure out new, sustainable ones.

The modern macroeconomic view is that the Depression was caused by a shortfall in aggregate demand, as opposed to a breakdown of the capitalist system. Instead, I prefer the pre-Keynesian diagnosis, although I do not believe that government officials could have done better by taking over more of the planning. To the extent that they attempted central planning through the NRA and various other New Deal initiatives, the results were certainly not good.

Chris Dillow on Complexity Economics

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No, it’s not another review of Colander and Kupers (but I wonder what he would think of it). He writes,

One feature of complexity economics is that recessions can be caused not merely by shocks but rather by interactions between companies. Tens of thousands of firms fail every year. Mostly, these failures don’t have macroeconomic significance. But sometimes – as with the Fukushima nuclear power plant or Lehman Brothers – they do. Why the difference? A big part of the answer lies in networks. If a firm is a hub in a tight network, its collapse will cause a fall in output elsewhere. If, however, the network is loose, this will not happen; the loss of the firm is not so critical. Daron Acemoglu has formalized this in an important paper, and there are some good surveys of network economics in the latest JEP.

Read the whole thing. Pointer from Mark Thoma. My thoughts:

1. From a PSST perspective, the importance of a highly-connected firm makes sense. The more connected a firm is, the more patterns of specialization and trade depend on that firm. Also, this may help to explain why shocks in the economy do not average out. A shock that suddenly destroys a highly-connected firm is not going to simultaneously create an equal a highly-connected firm somewhere else. My guess is that dense networks of connection are both difficult to create and difficult to destroy, but they can be destroyed more rapidly than they can be created.

2. Note that complexity economics attracts some attention from heterodox economists on both the left and the right.

3. Dillow thinks that complexity economics deserves more attention. I agree that one reason it tends to be overlooked is that it does not provide the clarity of prediction and tidyness of results that is sought by mainstream economists.

4. Mainstream economists and complexity economists would agree that the world is complex and that models are simplifications. Mainstream economists emphasize the virtues of simple models, while heterodox economists emphasize the vices.

We are Re-living 2003

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Describing the latest Fed pronouncement, David Andolfatto writes,

how new are these buzzwords? They’re not new at all. Consider this from the December 09, 2003 FOMC statement

I have said before that the economy resembles 2003. Output has recovered more strongly than employment. Long-term bond rates are puzzlingly low. House prices have been rising (quite rapidly near us in suburban Maryland). Policy makers are trying to loosen mortgage credit.

UPDATE: See also Mark Thoma/Tim Duy.

John Cochrane Walks Back, and Now I am Grumpy

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He writes,

Now, if you read FOMC minutes, Fed speeches, or talk to people at the Fed about policy, you will see that this intertemporal, expectation-focused approach resulting from the revolutions of the 1970s permiates [sic] the policy-making process. For example, “forward guidance” is the rage. It only takes one beer for the conversation to quickly acknowledge that QE likely worked as much by signaling low interest rates for a long time than it did by exploiting some sort of permanent price-pressure in Treasury markets.

Consider two questions:

1. Why does employment fluctuate?

2. How does the Fed affect financial markets?

If you want to use the term “intertemporal, expectation-focused approach” to talk about (1), I am not convinced. I think that this dubious idea took hold because economists were writing down models of a GDP factory, abstracting from the question of which goods to produce. The only meaningful choice left was intertemporal–do you run the GDP factory faster now or next year? This is a case in which an overarching theory was dictated by a simplistic modeling strategy.

If you want to use the term “intertemporal, expectation-focused approach” to talk about (2), you have a strong case. I believe in at least the weak form of the efficient markets hypothesis. When you incorporate that into your thinking, then you have to think of the Fed either as affecting markets with surprises or with rules. As Cochrane points out, this leads to a discussion of rules.

However, there is another consideration, which is that perhaps in financial markets the Fed is throwing small pebbles into a big pond. Maybe in the grand scheme of things, monetary policy does not do much to change long-term interest rates, stock prices, and other important market rates. Yes, I know that many investors believe that Fed policy matters, and there is this whole industry of trying to “read” the Fed, and it is possible that the Fed can influence the readers in some way–but again, markets are overall weakly efficient.

What I keep coming back to is my view that the Fed’s regulatory policies have big effects on credit allocation. Tell banks that they can multiply the interest rate on regulator-designated low-risk assets by three to get their regulation-adjusted rate of return, and by golly banks will load up on regulator-designated low-risk assets. But I am doubtful that its monetary policies do anything.

Hurricane Katrina and World War II

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Tatyana Deryugina, Laura Kawano, and Steven Levitt write,

Four years later, Hurricane Katrina victims are less likely to be unemployed.

…If moving costs (either financial or psychological) are high, then people will rationally forego higher earnings available elsewhere unless the expected benefit of moving is large enough to outweigh the fixed cost. The forced relocation caused by
the hurricane required displaced residents to pay the moving costs, leading to higher wages (although potentially lower utility levels).

Pointer from Tyler Cowen.

The PSST interpretation would be that forced relocation helps the economy more quickly find patterns of sustainable specialization and trade. That is my interpretation of the role that the second world war played in getting the United States out of the Great Depression. Millions of men were uprooted, and many of them chose to relocate to locations with better opportunities. When my late father attended a reunion of Soldan High School in St. Louis, he was stunned by the distance that many of his former classmates had traveled, both geographically and economically, from their home town. He reflected that this never would have happened without the war.

Standard macro would predict (and did predict) a major recession following the war. So might PSST, given the challenge of transition from wartime to peacetime. However, the fact that many returning servicemen actually thought about where they wanted to live after the war helped make the transition work. The paper on Hurricane Katrina suggests a similar effect.

Macroeconomics is Infinitely Confirmable

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John Cochrane writes,

Keynsesians, and Krugman especially, said the sequester would cause a new recession and even air traffic control snafus. Instead, the sequester, though sharply reducing government spending, along with the end of 99 week unemployment insurance, coincided with increased growth and a big surprise decline in unemployment.

Sometimes, I think that there are macroeconomists (Krugman is not the only one) for whom there is no path of economic variables that could ever contradict their point of view. They remind me of the climate scientists who tell us that Buffalo’s Snowvember came from global warming.

Macroeconomics is infinitely confirmable because of its high causal density and lack of controlled experiments. The macroeconomist has enough interpretative degrees of freedom to twist any pattern of economic activity to fit his or her priors.

In theory, you could ask macroeconomists to place bets on their predictions. However, that, too, would run afoul of causal density. If you make unconditional predictions, then an oil shock or other event could make you right or wrong more or less by accident. And the conditional forecasting space gets very complicated very quickly.

The Unlimited Wealth Gains from Transfer Payments

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Gary Burtless writes,

For middle-income families, tax cuts and higher government benefits erased almost 90% of the market income losses caused by the recession. For Americans with lower incomes the combination of tax cuts and more generous benefits offset virtually all the market income losses. Millions of laid off workers were clearly made worse off by the recession. But income replacement through the permanent tax and transfer system plus temporary measures to boost families’ spendable incomes achieved their intended goal. For poor and moderate-income families, wage and capital income losses caused by the recession were largely or wholly offset by tax cuts and benefit increases.

Pointer from Mark Thoma.

When someone’s analysis is contrary to what one believes, the overwhelming temptation is to nit-pick the methodology. I try to restrain myself, but in this case I cannot.

What Burtless demonstrates is that the government wrote checks. Did anyone ever question that?

What some of us questioned was the macroeconomic impact of those checks. If you believe that government can manufacture wealth by writing checks, then a zillion dollar combination of tax cuts and transfer payments would make the American people a zillion dollars better off. Seeing that this is absurd, one might want to go back and think more carefully about the macroeconomic analysis.

I am not saying that macroeconomic analysis definitely proves that the stimulus failed. But I fail to detect in Burtless’ piece any contribution to the discussion.

Theories of Unemployment

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Stuart Armstrong writes,

The employment market is a market, with the salary being the price. Why doesn’t this market clear? Why doesn’t the price (salary) simply adjust, and then everyone gets a job? It seemed profoundly mysterious that this didn’t happen.

Pointer from “Scott Alexander.”

I commend Armstrong for posing the issue and thinking through it. Everyone who studies economics needs to puzzle it out. However, my viewpoint differs from his.

To me, you have to distinguish real wages from nominal wages. For just a moment, I will play the macro game of treating the economy as a giant GDP factory with identical workers, so I will speak of “the” real wage and “the” nominal wage.

The simplest macro theory of unemployment is that it is due to money illusion. The real wage needs to be lower in order to clear the labor market, but workers will not accept lower nominal wages. Meanwhile, the price level is determined by something else (the money supply, say), so you can be stuck at the wrong real wage. The Keynesian/monetarist cure for this is a higher price level, at which workers are willing to accept the lower real wage that they would not accept previously. It’s the most coherent way to tell the macro story, but it is not very popular. Scott Sumner likes it. I think Bryan Caplan likes it. I think most modern Keynesian macro folks consider it to be too simple.

The theory of unemployment that Robert Solow taught when I was at MIT was from Edmund Malinvaud’s book, The Theory of Unemployment Reconsidered. It did not rely on money illusion. Instead, both wages and prices were sticky. If they both happened to be too high relative to another nominal variable (again, the money supply is a standard candidate), then the demand for goods will be low, and this will reduce the demand for labor. This was called a general disequilibrium model, because it shows how problems in one market can spill over into another market. So, in 2008 there is excess supply in the construction market, and as workers are laid off there they reduce their demand for consumer durable goods, and so you get layoffs there, and so on.

General disequilibrium never really caught on as a story. Instead economists went for the sort of stuff that Stan Fischer and Olivier Blanchard were pushing, which was representative-agent intertemporal optimization with some ad hoc rigidities thrown in. And if you do not know what that means, just suffice to say that Solow and I hated it then and hate it now, while Paul Krugman likes it when it’s used to support Keynesian policies. When it’s used to oppose Keynesian policies, he calls it Dark Age Macro.

The stickiness of “the” price and “the” wage are ad hoc rigidities in the Malinvaud model. To get from there to what I currently believe, you need to incorporate all sorts of other adjustment problems or coordination failures. Imagine the economy being run by a central planner. What does the central planner want to do with those laid-off construction workers, or with the 19-year-olds who took a few courses at community college and then dropped out, or with the 57-year old manufacturing worker whose job was just taken by a robot or by a factory worker in Vietnam?

Substitute for the central planner the set of all entrepreneurs in the economy. Well, it turns out that the entrepreneurs are, collectively, almost as bereft of ideas as the central planner. Meanwhile, the unemployed folks are not so desperate that they go around offering to wash dishes or empty bed pans or do yard work for $5 an hour. Instead, they subsist on savings and handouts from various sources until the set of entrepreneurs figures out something useful for them to do. That is what Tyler Cowen and I started calling the recalculation problem five years ago. It is what I mean when I say that the entrepreneurs have to discover new patterns of sustainable specialization and trade.

In the Malinvaud model, if you could “unstick” wages and prices, you would get out of general disequilibrium. In PSST, it’s probably better to keep prices and wages where they are, so that the existing sustainable patterns of specialization and trade don’t get lost. In order to raise employment, entrepreneurs will have to discover new patterns, and that is a time-consuming, trial-and-error process. Monkeying around with the money supply or the government deficit is not necessarily going to make the process go any faster.