Category Archives: PSST and Macro

A Book I Will Not Review

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Because I contributed a chapter. The book is the Routledge Handbook of Major Events in Economic History, edited by Randall E. Parker and Robert Whaples. The handbook tends to be U.S.-centric, with some surprising exceptions, such as a brief, fascinating chapter on World War I. The chapters are predominantly about events in the twentieth century. The book is priced out of your range, unless you are a library.

My chapter is called The 1970’s: The decade the Phillips Curve died. My main point is that except for the 1970’s, the Phillips Curve has performed really well. However, because of the 1970’s, macroeconomics went through great contortions from which it has not recovered.

This is not to say that we should go back to the macroeconomic consensus as it existed in 1970 (although that is where I see Paul Krugman coming out). But I do not think that the macroeconomic consensus as it existed in 2007 was any better. Hence PSST.

There is another chapter on the 1970’s by Robert Hetzel, which covers much of the same ground as my chapter. And he got to use graphs, which makes me jealous (my chapter would have worked better with graphs).

He and I would differ in our interpretation of the 1980-1983 period. Hetzel writes,

The Volcker-Greenspan FOMCs succeeded in controlling inflation without the need to engineer periodic bouts of high unemployment.

But we had the highest spike in the unemployment rate since the Great Depression–higher than the peak unemployment rate in 2009.

Is the Demand for Skill Falling?

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Paul Beaudry, David A. Green, and Benjamin M. Sand have a paper with an intriguing abstract, which says in part,

Many researchers have documented a strong, ongoing increase in the demand for skills in the decades leading up to 2000. In this paper, we document a decline in that demand in the years since 2000, even as the supply of high education workers continues to grow. We go on to show that, in response to this demand reversal, high-skilled workers have moved down the occupational ladder and have begun to perform jobs traditionally performed by lower-skilled workers. This de-skilling process, in turn, results in high-skilled workers pushing low-skilled workers even further down the occupational ladder and, to some degree, out of the labor force all together.

If true, this would upset nearly everyone’s narrative apple cart, including mine.

Macro Without Theory

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Garett Jones writes about sticky-wage Keynesian economics.

there’s no failure of “effective demand” for final goods in a sticky-wage Keynesian world. The reason there’s so little output during a recession according to sticky-wage Keynesians is because high wages make output too expensive to produce.

I think that Keynesians have good reason to resist being boxed into a particular microfoundations model, or theory. I think they are better off just asserting that more spending leads to more output, and responding to the question of “why” with hand-waving. To me, Keynesian economics is nothing more and nothing less than the view that spending creates jobs and jobs create spending. The attempt to articulate microfoundations has never added value.

Incidentally, the Scott Sumner view is that nominal GDP creates jobs, which might appear to be close to the Keynesian view. However, Sumner argues that the central bank controls nominal GDP, which means that fiscal policy only affects the mix between private-sector and public-sector spending.

The Keynesian counter-argument is that the central bank is constrained in some way. Again, I think they are better off just asserting this rather than relying on some specific explanation, such as low nominal interest rates. First, there are powerful arguments that low nominal interest rates are not a constraint. Second, I do not think that Keynesians want to tie themselves down to a view that says that fiscal stimulus is completely unnecessary when interest rates are above zero.

For those of you not already familiar with my own views of macro, see the papers listed here.

Russ Roberts and Edward Leamer

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I love this video, but that is because I agree so much with Leamer.

One thing I would point out about his charts is that he uses trend lines and implies that mean reversion is the norm. That is, for most of the postwar period, if you had a recession that took GDP below trend, you would then have above-trend growth. An alternative hypothesis is that real GDP follows a random walk with drift. That would mean that it always tends to grow at 3 percent, regardless of its recent behavior. The last three recession seem to follow such a model.

In the late 1980s, some folks, notably Charles Nelson and Charles Plosser, argued strenuously against mean reversion and in favor of the random walk with drift. Note that this is back when Leamer describes output and employment as mean-reverting. I wonder if what happens as data get revised over long periods of time is that random walks get turned into mean-reverting trends.

Note Tyler Cowen’s comment on the latest employment report:

we are recovering OK from the AD crisis, but the structural problems in the labor market are getting worse. It’s becoming increasingly clear those structural problems were there all along and also that they are a big part of the real story. On the AD side, mean-reversion really is taking hold, as it should and as is predicted by most of the best neo-Keynesian models.

Some Perspective on Budget Cuts and Austerity

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Employment, in thousands:

Category 2000 2006 2012
Private sector employment 111,101 114,155 111,820
Government employment 20,790 21,975 21,915

Source: FRED graph, establishment survey. Private sector employment increased less than 1 percent from 2000 to 2012, while government employment (Federal, state, and local) increased more than 5 percent.

Spending, millions of dollars:

Category 2006 Q4 2012 Q4
Total GDP 13584.2 15851.2
Government Expenditures 4325.9 5704.9

Source: FRED graph, national income accounts. Government spending (again, including state and local government) is up 32 percent since 2006.

In my view, these facts can provide some perspective on the issue of spending cuts and austerity. Draw your own conclusions.

As an aside, two documents that usually come out in February were not available when this was written (on March 6th, scheduled for posting March 8th). One is the President’s Budget. The other is the Economic Report of the President. I wonder if they are being planned for release at “news graveyard” time, which is late afternoon on a Friday.

Hall of Shame Forecasters

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I am pleased to see that Nouriel Roubini makes this list. He is famous for predicting the Great Recession. But if you always predict bad things, then you are certain to be correct when they happen–and equally certain to be incorrect the rest of the time.

Pointer from Scott Sumner.

For what it’s worth, I increased my exposure to the market late in 2008 and early 2009. But these days I am happy to have a very low-beta portfolio, in which my participation in the ups and downs of the market is small. For every 10 percentage points the stock market goes up, my portfolio gains about 2 percentage points. I am more weighted toward real estate and commodities (oil, not gold), as befits my fear that the next decade might unleash considerable inflation.

One phenomenon I am not bearish about is the sequester. My guess is that its adverse effects on the economy will not be visible to the naked eye, which will observe a rebounding economy. The sequester’s adverse effects can only be seen through the lens of a Keynesian macroeconomic model. Such models always include government spending multipliers of about 1.5 (or 1.57). However, a forecaster might have been better served by assuming a negative multiplier.

[UPDATE: The employment figures for February were relatively positive. Even if you take a conventionally Keynesian view of aggregate demand, you should be quite bullish. Whatever negative impacts of “austerity” have been more than offset by the positive surprises in the stock market and home prices.]

Where Wages Are Stickiest

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From the National Employment Law Project:

Industry dynamics are playing an important role in shaping the unbalanced recovery. We find that three lowwage industries (food services, retail, and employment services) added 1.7 million jobs over the past two years, fully 43 percent of net employment growth. At the same time, better-paying industries (like construction; manufacturing; finance, insurance and real estate; and information) did not grow, or did not grow enough to make up for recession losses. Other better-paying industries (like professional and technical services) saw solid growth, but not in their mid-wage occupations. And steep cuts in state and local government have hit mid- and higher-wage occupations the hardest.

Pointer from Tyler Cowen (also Mark Thoma).

Focus on the last sentence. What if pay for all government workers–federal, state and local–had been reduced by 5 percent at the start of the recession? How many jobs would have been saved?

In general, I think that we mis-frame the government budget issue when we talk about taxes vs. program cuts. Instead, we should be talking about taxes vs. reductions in compensation for government workers. It is not at all clear to me that we need to reduce incomes in the private sector in order to maintain incomes in the public sector.

The Financial Cycle

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Claudio Borio writes,

Financial liberalisation weakens financing constraints, supporting the full self-reinforcing interplay between perceptions of value and risk, risk attitudes and funding conditions. A monetary policy regime narrowly focused on controlling near-term inflation removes the need to tighten policy when financial booms take hold against the backdrop of low and stable inflation. And major positive supply side developments, such as those associated with the globalisation of the real side of the economy, provide plenty of fuel for financial booms: they raise growth potential and hence the scope for credit and asset price booms while at the same time putting downward pressure on inflation, thereby constraining the room for monetary policy tightening.

Pointer from Timothy Taylor.

Borio’s writing is a bit too colorful for my tastes. He uses exclamations! In a working paper!

Still, read the paper. There may be something to the idea that financial sector expansions and contractions are a phenomenon outside of the conventional macroeconomic model. I am quite sympathetic to that point of view.

Profile of Stanley Fischer

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Written by Dylan Mathews, who plumps for Fischer to be the next Fed Chairman.

If Bernanke halved the value of the dollar relative to, say, the Chinese yuan, that would dramatically increase U.S. exports and probably economic growth, too, but it would also wreak havoc with the global financial system. Every dollar-denominated asset in the world, including all manner of bonds, would plummet in value.

It’s less risky for small countries. There aren’t massive piles of shekels lying around in other countries the way there are with dollars and euros, and Fischer took advantage of that fact. On May 30, 2008, a dollar was worth about 3.2 shekels. On March 6, 2009, it was worth 4.2 shekels. In less than a year, Fischer had reduced the value of the shekel by about 25 percent — a massive devaluation.

It worked. Exports soared, and 2008’s trade deficit of $2 billion became 2009’s trade surplus of $5 billion. While other countries fell deeper into recession, Israel brushed its shoulders off.

1. Early in his tenure as head of the Israeli central bank, Fischer simply kept the nominal interest rate in Israel identical to that of the United States. According to the theory of his colleague and textbook co-author Rudi Dornbusch, this would stabilize the exchange rate between the shekel and the dollar. It seemed to work out that way.

2. The quoted passages show that Israel was able to beat the liquidity trap. They suggest that the U.S. also could have beaten the liquidity trap, but doing so would “wreak havoc with the global financial system.” I doubt the “wreak havoc” part. The article does not say whether Fischer believes it, but I suspect that he does–otherwise he would have advised Bernanke to follow a looser policy, and Bernanke probably would have listened.

3. To the extent that the Israeli policy worked, it scores a point for the model of aggregate demand and a point against PSST. If you think in terms of patterns of sustainable specialization and trade, you would not expect a rapid, massive shift toward tradable goods to be something that an economy can handle easily.

4. Fischer was my professor for monetary economics, and his was one of the three signatures on my dissertation. He was a nice man and an impressive teacher, but I did not care for his course, which I thought was just typical MIT mathematical masturbation.

5. I think that Fischer’s influence on the economics profession was large and detrimental. A ridiculously high proportion of macroeconomics professors are descendants in some way of Fischer. He was their thesis adviser, or their adviser’s adviser, or their adviser’s adviser’s adviser, etc. The net result is a macroeconomics discipline dominated by mathematical technique, with relatively little thought about the real workings of the economy or whether measured national statistics actually correspond to theoretical macroeconomic variables.

Cowen on Cochrane on Macro

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Tyler Cowen writes,

I get nervous when I read Keynesians claiming that the real rate of return is negative these days. Is civilization moving backwards? (And if so, don’t we really have a budgetary problem?) I prefer instead to think about segmented rates of return and wonder why that has come about, and if so how we actually measure opportunity costs for projects. If the risk premium on private projects is quite high, motivating a rush to T-Bills, is then the risk premium on government projects high or low? Does “the chance that the government repays my loan,” as measured by bond rates, equal “actual comovement consumption risk of the government project itself”? I see those two variables confused all the time.

He refers to a long post by John Cochrane on New Keynesianism vs. Old Keynesianism. Trying to avoid the math, I think of old Keynesianism, new Keynesianism, and real business cycle theory in terms of their answers to two questions:

1. Is there market clearing in the aggregate labor and product markets?

2. Do consumers base decisions on permanent income (rather than one year’s income)?

The real business cycle theory answers “yes” to both. Old Keynesians answer “no” to both. New Keynesians answer “no” to (1) and “yes” to (2).

Cochrane writes,

Now, a spontaneous outbreak of thrift, to the point of valuing the future a lot more than the present, seems a bit of a strained diagnosis for the fundamental trouble of the US economy.

I think that the (New) Keynesian view is that the outbreak of thrift is due to the collapse of house prices. People who had bought homes see a decline in permanent income, so they try to spend less and save more. This saving, rather than being channeled into capital investment, gets put into the mattress. To answer Tyler’s question, there is a huge mismatch between what consumers want to hold in order to assure future consumption (riskless assets) and the risky projects that are available to entrepreneurs. This lowers the demand for aggregate output and, with sticky wages and prices, this leads to low output and high unemployment.

To me, this is a just-so story for the current recession. If we are going to tell just-so stories, I prefer a PSST story. A lot of patterns of trade that were not really sustainable in 2006 became blatantly unsustainable in 2008 and 2009. Construction employment is a tiny part of that. A lot of it is jobs in firms that were not well suited to the Internet era, from labor-wasting manufacturing firms to retailers like Borders Books.

Circling back to Tyler’s question, perhaps the bailouts had the ironic effect of making investment seem much riskier. As Holman Jenkins points out,

In the Chrysler and General Motors GM -0.60% bankruptcies, government played the role of “debtor-in-possession” financier, then behaved as no DIP financier would, using its leverage to do favors for an important Democratic constituency group, the United Auto Workers, at the expense of debt holders.

The regulator of Fannie Mae FNMA +1.79% and Freddie Mac FMCC +2.11% trumpeted them as solvent and well-capitalized amid the crisis, then gave their boards immunity from shareholder lawsuit in the government takeover that followed a short time later, wiping out their shareholders.

Not directly related to the financial crisis but coming in the same moment of untrammeled government discretion was the BP oil spill. The White House dictated a $20 billion compensation program, funded by BP shareholders, without benefit of any legal process at all.

A big increase in the uncertainty of property rights should raise the risk premium on private-sector projects, making government debt relatively low risk.