Wither Macroeconomics?

The title is not a typo. Brad DeLong reproduces a list of papers that ten years ago he thought were on the frontier of macroeconomics. Pointer from Mark Thoma. My take on the list is that there is a strong negative correlation between the probability that the ideas are correct and the probability that they are relevant.

Some random thoughts about the state of macroeconomics:

1. Any post that contains a sentence “This chart proves that. . .” doesn’t.

2. Macroeconomists should be much more daunted by measurement issues than they are. I think that we have reasonably good ways of counting the number of people who do paid market work. But that is a far cry from knowing “labor input,” because (a) skills are very heterogeneous and (b) as Garett Jones famously tweeted, most workers are not making widgets but instead are building organizational capital. Output has become increasingly difficult to measure. In the case of goods, quality change has sped up, putting more pressure on statisticians to rely on imputations. And in the case of important services, including education, finance, and medical services, we have almost no conceptual idea for measuring output. We do not know how to factor into our statistics the increased diversity in consumption baskets across individuals. All this casts doubt on our measures of inflation, productivity, and real wages.

3. As of the early 1930s, many economists and commentators thought that the capitalist system had broken down. They saw the decentralized market process as no long working effectively to organize economic activity. See Katznelson, or even better read chapter two of Leuchtenburg’s The FDR years. The biggest intellectual influence at the time was nostalgia for the government planning that took over when the U.S. entered the first World War.

In contrast, Keynes blamed the Depression on what he called a drop in aggregate demand, and Milton Friedman blamed it on a contraction of the money supply. In fact, Keynes and Friedman led the profession down a false path. The pre-Keynesian diagnosis was more apt. I just disagree that central planning was the best solution, although I think it is fair to concede that when you have unemployment rates over 15 percent you are giving central planners a decent shot at doing something right.

4. The Monetary Walrasians (Patinkin and everything that followed) wasted our time. Money does not determine nominal aggregates. It does not determine transactions. The causality runs from the desire to undertake transactions to financial institutions/technology to what people use as money.

5. Money does not determine the price level. Habits determine the price level. Consider the amnesia experiment. If everyone developed amnesia about what money prices were yesterday, then Monetary Walrasianism predicts that today prices would soon find an equilibrium determined by the quantity of money. In fact, my best guess is that people would find money to be worthless in such a setting, and they would resort to barter until a new standard of value emerged.

6. The theory of rational expectations is a waste of time. The simple model of employment fluctuations as arising from errors in aggregate expectations is wrong. And the underlying principle of rational expectations, that everyone as the identical information, is anti-Hayekian, and not in a good way.

In short, almost nothing that gets taught in undergraduate macro is correct. And graduate macro is worse.

My Election Take

1. There is little else to write about today.

2. It was a Seinfeld election. Mitch McConnell said that he did not want to tip his hand before the election by articulating an agenda. Does anyone think he has a hand to tip? The only reason he runs for the Senate is because he loves hanging out there.

3. Conventional wisdom is that, relatively speaking, Democrats have a structural advantage in Presidential elections, because those elections attract more turnout. In other words, they do much better among disengaged voters. One could spin this positively for the Democrats, saying that they get support from the weaker segments of society. One could spin this negatively and say that they rely on a segment of the electorate that is poorly informed and easily bamboozled, which I believe is the case. The counter to that would be that Republicans also rely on a segment of the electorate that is poorly informed and easily bamboozled, which I also believe is the case. I really do not understand why people think that democracy is so great. Its chief advantage is that it provides for peaceful transitions of power. I continue to believe that markets, imperfect as they often are, produce better outcomes than voting.

4. One problem with the Democratic “brand” at the moment is that it is associated with incompetence. How will they remedy that in 2016? Would nominating Cuomo do the trick?

5. Another problem is that in the ethnic/gender wars, the Democrats came off as more strident than the Republicans in 2014. They may have reached the point where their tactics are alienating more voters (many white males and also some white females) than they are attracting. Of course, such tactics may be better suited to a Presidential election with more turnout.

Question from a Commenter

In your three-languages model of politics, it is usually the conservatives using the barbarism-civilization axis, and the progressives using the oppression-oppressed axis.

But given the recent murder of Sotloff by Islamic State terrorists, the vocabulary being used highly progressive sources to describe the event are very conservative sounding. Just today I heard President Obama, Secretary Kerry, reporters and commentators on NPR and C-SPAN have all talked about the event specifically using the words, “uncivilized”, “barbaric”, “savages”, “fiends”, “monstrous”, “beastly”, and so on.

It seems that they are being quite genuine in using these words as their honest appraisals and not paying lip service to the concepts.

So, what do you make of all that?

I have not been following these statements. Do they apply to the act or to the group? If you call an act barbaric without calling a group barbaric, then you are not really using the civilization-barbarism axis. If the progressives are calling ISIS as a whole barbaric, then that would represent a shift toward using conservative’s rhetoric. I have not seen a similar shift in rhetoric on Hamas–I do not know of any progressives who have described Hamas’ tactics as barbaric. I have not seen progressive use the word “barbarism” in describing Rotterham (Indeed, that story has been easy to miss if you only follow liberal media. The Washington Post put in the “religion” section quoted a member of a Muslim youth group as saying that the police “failed us,” so that the story fits the oppressor-oppressed axis). So on the whole–and again, I have not been following the statements on ISIS–I do not get the sense that progressives have undergone a major shift in their outlook.

Repo and the Financial Crisis, a Follow-Up

My former student writes,

I just read the post–thanks. But I now have more questions. Am I slow, or is the repo market really hard to understand?
When you talk about the original intent of repo, I have a few questions:

1) I understood from Metrick in class that the repo market functions as a type of banking system. Dealers take “deposits” and provide securities as collateral; these deposits are returned at some point with interest. Is that different than what you say the repo system used to be, or is that the same?

2) You say that Gorton/Metrick make no distinction with what the repo market used to do, and what it now does. That investment banks used to keep inventory and sell it, but now they have trading and investment portfolios. What does this mean with regard to the repo market? I.e. how does this change what’s happening?

3) Metrick did say that the securitization of real estate was what created new “safe” securities that people with assets they didn’t want to put at risk demanded. Is this the thing you find inherently dangerous? The idea of manufacturing new, relatively “safe”, liquid assets?

Sorry if these questions are stupid–or even embed inaccuracies/misunderstandings. I think I understand the type of transactions that takes place in the repo market, but I’m not at all sure who are the counterparties on opposite sides of the deal, why they want these deals in the first place for such brief periods, and why this market is as large as it is.

Here are my answers: Continue reading

Joel Mokyr on Innovation

He writes,

Many of the most important inventions of the late nineteenth and twentieth centuries are things that we would not want to do without today; yet they had little effect on the national accounts because they were so inexpensive: aspirin, lightbulbs, water chlorination, bicycles, lithium batteries, wheeled suitcases, contact lenses, digital music, and more.

Later,

All the same, I will venture a guess about one feature of the future: technology will go “small.” Twentieth-century technology was primarily about “large” things. …Energy was generated by massive power stations. Materials were produced by gigantic steel mills. Huge airplanes and tall cell towers embodied what the twentieth century could do. But the twenty-first century may be very different. …sorting cells, and sequencing and splicing genes may offer a better path to a better future than building supersonic planes.

Read the whole thing. I think that it may deserve one of David Brooks’ annual awards for magazine pieces.

What I’m Saying

At this event, on Peter Schuck’s book on government failure. Peter Berkowitz liked the book more than I did. Berkowitz, a conservative, was not as troubled as I was by the elitist assumptions embedded in the author’s thinking.

Schuck talks about cultural impediments to better government in the United States. On p. 375, he writes

Of the particular cultural features identified in chapter 4, only four–decentralization, protection of individual rights, acceptance of social and economic inequality, and suspicion of technical expertise and official discretion–seem remotely tractable to policy-driven change.

What he describes as bugs, I would describe as features. In my remarks, I will suggest that the problem is not that the rest of America gives too little authority and autonomy to technical experts. The problem is that technical experts have too exalted a view of their own theories and capabilities.

I am in a bad mood about progressives these days, which is making it difficult for me to be charitable. Maybe it’s the long winter–I slipped and almost injured myself on another patch of global warming yesterday. But I am getting tired of the relentless support for grand social engineering notwithstanding its dismal track record, along with the bitter rhetoric against those of us who happen to disagree.

Wealthy People Making Consumption Loans

Atif Mian and Amir Sufi write,

when the wealthy save in the financial system, some of that saving ends up in the hands of lower wealth households when they get a mortgage or auto loan. But when lower wealth households get financing, it is almost always done through debt contracts. This introduces some potential problems. Debt fuels asset booms when the economy is expanding, and debt contracts force the borrower to bear the losses of a decline in economic activity.

Pointer from Mark Thoma.

So the wealthy lend to the non-wealthy, who use the loans to consume. At some point, this process becomes unsustainable, and bad things happen.

Why don’t the people who manage wealth for the rich folks try to find better investments? According to the secular stagnation story, there are no better investments. However, one can tell an Austrian story in which the consumption loans constitute malinvestment. I would argue that this malinvestment is not caused by the Fed keeping interest rates to low. It is caused by government credit-allocation policies, embedded in various bank regulations.

In a Keynesian story, in which the wealthy have excess saving that cannot find a good use, more government spending is the solution. In the more Austrian story of malinvestment, steering more saving toward government and away from private investment would be part of the problem, not part of the solution.

Liquidity Crisis or Solvency Crisis?

Noah Smith writes,

Back in 2008, as the financial crisis was unfolding, there was a big argument as to whether the crisis was a “liquidity crisis” or a “solvency crisis”. It’s a very important distinction. A “liquidity crisis” is when banks (or similar finance companies) are financially in the black – their assets are greater than their liabilities – but they can’t get the cash to keep paying their bills in the short term. A bank run is the classic example of a liquidity crisis – even if the bank could eventually pay everyone back, it can’t pay them back all at once, so if people get scared and all try to withdraw their money in a rush, they force the bank to collapse. A “solvency crisis”, on the other hand, is when finance companies are actually bankrupt, and no amount of short-term borrowing will change that fact.

This is difficult to unravel. The high officials talked as if it were a liquidity crisis. But one might argue that they acted as if it were a solvency crisis. The Fed could have lent to Citigroup through the discount window. Instead, they injected capital into Citigroup, via TARP.

I think that AIG suffered from a liquidity crisis, because the contractual arrangements in their credit default swaps evidently allowed their counterparties to make “collateral calls” as the underlying securities declined in market value. The way the government dealt with AIG’s liquidity crisis was to give AIG enough money to meet the collateral calls (to Goldman Sachs and others) and essentially taking away capital from AIG, so that AIG had to dismember itself in order to remain a company.

Among the many problems with sorting things out is the problem of valuing brand equity. If you think that Citigroup had brand equity, then they were not in a solvency crisis.

If you think that Freddie and Fannie had brand equity, then they suffered from a liquidity crisis, because once their borrowing costs were held down, they became profitable again.

So I don’t have a crisp answer to Noah’s question, even in hindsight.

Minnesota Macro: The Real Villains

The Krugosphere is hostile to the macroeconomics of the University of Minnesota. I understand that. Krugman has used the term “Dark Age Macroeconomics” to describe what took place between the late 1970s and today. I understand that, too.

But what happened in Minnesota could have stayed in Minnesota. Instead, Stan Fischer and Olivier Blanchard gave MIT’s blessing to DSGE models and vector autoregressions. To me, those two are the real villains.

Had Fischer taken his cues from, say, Clower and Leijonhufvud, rather than from Sidrauski and his ilk, macroeconomists might have spent the last 30 years working on interesting issues and gaining some better understanding of the economy. Instead, they spent the last thirty years diddling with fancy unverifiable equations and pouring a few globs of macro data into the VAR immersion blender.

As the Economy Churns

Mark Perry finds an article by Richard Foster, who wrote,

US corporations in the S&P500 in 1958 remained in the index for an average of 61 years. By 1980, the average tenure of an S&P500 firm was 25 years, and by 2011 that average shortened to 18 years based on seven year rolling averages. In other words, the churn rate of companies in the S&P500 has been accelerating over time

It seems to me that this is just one of many important structural changes that have taken place in the U.S. economy since 1960. It seems very unlikely that the same macroeconomic behavior would be observed today as was observed in past decades when the labor force had different education levels and a different gender mix, when corporate turnover was lower, when we lacked computers for inventory management, when there were restrictions on interstate banking, and so on.