Brad DeLong Makes an Omission

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He writes,

So what do economists have to say when they speak as public intellectuals in the public square? As I see it, economists have five things to teach at the “micro” level–of how individuals act, and of their well-being as they try to make their way in the world. These are: the deep roots of markets in human psychology and society, the extroardinary [sic] power of markets as decentralized mechanisms for getting large groups of humans to work broadly together rather than at cross-purposes, the ways in which markets can powerfully reinforce and amplify the harm done by domination and oppression, the manifold other ways in which the market can go wrong because it is somewhat paradoxically so effective, and how the market needs the state to underpin and manage it on the “micro” level.

Pointer from Mark Thoma.

The phrase “the ways in which markets can powerfully reinforce and amplify the harm done by domination and oppression” locates Brad on the three-axis model, doesn’t it? You can read his post and see whether his examples prove his point. I tend to think not, but I do not want to focus my post on this issue.

What is absolutely missing in Brad’s list is any mention of public choice. Thus, we are left to take the enchanted view of the state as the cure for all of the market’s problems. Is he saying that economists are not qualified to speak about the flaws in government processes? Or is he saying that even though we know something about incentive problems and institutional weaknesses of government, we should shut up about it?

If Brad were to employ this gambit in a debate on economic philosophy, I think he would be dead out of the opening, as a chess player would put it.

The 2014 Nobel Laureates Fama, Hansen, and Shiller

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What they have in common is the “second moment.” In statistics, the first moment of a distribution is the mean, a measure of central tendency. The second moment is the variance, or spread. Politically, their views have a high second moment. If they are asked policy questions during interviews, the differences should be wide.

Shiller is known for looking at “variance bounds” for asset prices. Previously, economists had tested the efficient market hypothesis by looking at mean returns on stocks or bonds. Shiller suggested comparing the variance of stock prices with the variance of discounted dividends. Thus, the second moment. He found that the variance of stock prices was much higher than that of discounted dividends, and this led him to view stock markets as inefficient. This in turn made him a major figure in behavioral finance.

Fama was the original advocate for efficient markets. However, he was an empiricist. He verified an important implication of Shiller’s work: if stock prices vary too much, stock returns should exhibit long-run “mean reversion.” Basically, when the ratio of stock prices to a smoothed path of dividends is high, you should sell. Conversely, when the ratio is low, you should buy. Mean reversion also says something about the properties of the second moment.

Finally, Hansen is the developer of the “generalized method-of-moments” estimator. This is a technique that is most useful if you have a theory that has implications for more than one moment of the distribution. For example, Shiller’s work shows that the efficient markets hypothesis has implications for both the first and second moment (mean and variance) of stock market returns.

Although Tyler and Alex are posting about this Nobel, I think that John Cochrane is likely to offer the best coverage. As of now, Cochrane has written two posts about Fama.

In one post, Cochrane writes,

“efficient markets” became the organizing principle for 30 years of empirical work in financial economics. That empirical work taught us much about the world, and in turn affected the world deeply.

In another post, Cochrane quotes himself

empirical finance is no longer really devoted to “debating efficient markets,” any more than modern biology debates evolution. We have moved on to other things. I think of most current research as exploring the amazing variety and subtle economics of risk premiums – focusing on the “joint hypothesis” rather than the “informational efficiency” part of Gene’s 1970 essay.

Cochrane’s point that efficient market theory is to finance what evolution is to ecology is worth pondering. I do not think that all economists would agree. Would Shiller?

Some personal notes about Shiller, who I encountered a few times early in my career.

1. His variance-bounds idea was simultaneously discovered by Stephen LeRoy and Dick Porter of the Fed. The reference for their work is 1981, “The Present-value Relation: Tests Based on Implied Variance Bound,”’ Econometrica, Vol. 49, May, pp. 555-574. Some of the initial follow-up work on the topic cited LeRoy and Porter along with Shiller, but over time their contribution has been largely forgotten.

2. When Shiller’s Journal of Political Economy paper appeared (eventually his American Economic Review paper became more famous), I sent in a criticism. I argued that his variance bound was based on actual, realized dividends (or short-term interest rates, because I think that the JPE paper was on long-term bond prices) and that in fact ex ante forecasted dividends did not have such a bound. Remember, this was about 1980, and his test was showing inefficiency of bond prices because short-term interest rates in the 1970s were far, far higher than would have been implied by long-term bond prices in the late 1960s. I thought that was a swindle.

He had the JPE reject my criticism on the grounds that all I was doing was arguing that the distribution of dividends (or short-term interest rates) is unstable, and that if you use a long enough data series, that takes care of such instability. I did not agree with his view, and I still don’t, but there was nothing I could do about it.

3. When I was at Freddie Mac, we wanted to use the Case-Shiller-Weiss repeat-sales house price index as a check against fraudulent appraisals. (The index measures house price inflation in an area by looking at the prices recorded when the same house is sold in two different years.) I contacted Shiller, who referred me to Weiss. Weiss was arrogant and unpleasant during negotiations, and we gave up and decided to create our own index using the same methodology and our loan database. Weiss was so difficult, that we actually had an easier time co-operating with Fannie on pooling our data, even though they had much more data at the time because they bought more loans than we did. Eventually, our regulator took over the process of maintaining our repeat-sales price index.

4. Here is my review of Shiller’s book on the sub-prime crisis. Here is my review of Animal Spirits, which Shiller co-wrote with George Akerlof.

Finally, note that Russ Roberts had podcasts with Fama on finance and Shiller on housing.

Wither the World’s Manufacturing Employment?

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Dani Rodrik writes,

Consider China. In view of its status as the world’s manufacturing powerhouse, it is surprising to discover that manufacturing’s share of employment is not only low, but seems to have been declining for some time. While Chinese statistics are problematic, it appears that manufacturing employment peaked at around 15% in the mid-1990’s, generally remaining below that level since.

Pointer from Tyler Cowen.

Rodrik’s main point is that newly-developing countries, like China and Brazil, seem to have maxed out on their manufacturing employment without reaching the levels of income achieved by earlier industrializers, such as South Korea. He is concerned that this means poor growth prospects in the newer developing countries.

When the US, Britain, Germany, and Sweden began to deindustrialize, their per capita incomes had reached $9,000-11,000 (at 1990 prices). In developing countries, by contrast, manufacturing has begun to shrink while per capita incomes have been a fraction of that level: Brazil’s deindustrialization began at $5,000, China’s at $3,000, and India’s at $2,000.

By the way, the title of my post is not a typo.

To think about this, start with the idea that employment increases in sectors where demand grows faster than productivity, and employment declines in sectors where productivity grows faster than demand. That is not a very deep theory–it is arithmetic.

In rich countries, the share of goods in consumption has been declining for decades. The best hope for manufacturing growth in the newer developing countries is that their own consumers will want to accumulate physical stuff, the way we did in the middle decades of the twentieth century.

However, households in China today are not going to want what households in the U.S. wanted fifty years ago. Analog television? Stereos? Landline phones? Cars that don’t last more than a few years?

Maybe no country today has to go through a phase in which 1/4 of its labor force works in manufacturing. Middle-class households around the world can get the stuff they want without devoting so much labor to that sector.

It may be that the cost of the manufactured goods that a middle-class household wants nowadays is so low that Brazil, China, and India are already middle class in that respect. Our own middle-class incomes are much higher, but we fritter that away on cost-ineffective health care and education.

I think that this is an important point about the nature of inequality, both in the U.S. and in the world. A higher proportion of people can afford food. A higher proportion of people can afford useful goods, ranging from refrigerators to cell phones. However, a lower proportion of people can afford elite schools and unsubsidizedinsulation from having to pay directly for health care.

This is not your grandfather’s inequality. It may be better or worse, but it is different.

Consumer Spending and the Stimulus

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Jonathan A. Parker, et al, find a strong effect.

on average households spent about 12-30% of their stimulus payments, depending on the specification, on non-durable consumption goods and services (as defined in the CE survey) during the three-month period in which the payments were received. This response is statistically and economically significant. Although our findings do not depend on any particular theoretical model, the response is inconsistent with both Ricardian equivalence, which implies no spending response, and with the canonical life-cycle/permanent income hypothesis (LCPIH), which implies that households should consume at most the annuitized value of a transitory increase in income like that induced by the one-time stimulus payments. We also find a significant effect on the purchase of durable goods and related services, primarily the purchase of vehicles, bringing the average response of total consumption expenditures to about 50-90% of the payments during the three-month period of receipt.

Their approach uses cross-section analysis, with differences across households in the timing of receipt of stimulus payments as the identification strategy.

IMF Official Joins the Daft

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The WSJ blog reports,

A senior official at the International Monetary Fund said Wednesday that it will be difficult for the Bank of Japan to meet its 2% inflation goal within its two-year time horizon, noting that inflation expectations aren’t growing significantly.

Those of us who are daft™ believe that inflation is only a monetary phenomenon if the monetary authorities do some really spectacular helicopter drops. Ordinary buying and selling of securities will not do it. To be fair, the official, Naoyuki Shinohara, seems to think that central bank purchases of stocks or real estate investment trusts could do the trick, so he may not be completely daft™.

The Voice of Authority

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Either Google “Charlie Rose Stanley Fischer” or try this link.

I am particularly interested in Fischer’s view that (a) the financial crisis had the potential to cause another Great Depression and (b) that the policy responses of the United States worked quite well and (c) fiscal expansion was needed, because monetary policy could not do enough. He does not offer a list of evidence on these points. Instead, he says, in effect, that experts agree on these points. Some possibilities:

1. There is a lot of evidence, but in an oral interview he could not give footnotes.

2. Fischer’s circle is an echo chamber that takes these views, without much need for evidence.

3. Fischer formulated an opinion early on in the crisis, and he has seen no need to change his views, because hypotheses about the financial crisis are untestable (we cannot undertake controlled experiments in macro).

I am particularly curious about (1), and where one could find the list of observations that supports the view that we were headed toward another Great Depression without the bank bailouts and fiscal stimulus.

Is Age the Key Variable?

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The Guardian reports,

in England, adults aged 55 to 65 perform better than 16- to 24-year-olds at foundation levels of literacy and numeracy.

Pointer from Tyler Cowen. Several of his commenters raise the issue that seemed obvious to me: how much of this reflects the higher number of immigrants in the younger cohort?

Remember that the null hypothesis is that schooling practices do not matter. That would imply that the problem of the younger generation is not that schools in England have gotten worse.

Brink Lindsey on Growth Prospects

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He writes,

In the 21st century…all growth components have fallen off simultaneously

The number of hours worked per person has been falling secularly. Years of schooling per worker has grown slowly. Capital per worker is growing slowly. And the residual, or “total factor productivity,” has also grown slowly.

On the human capital issue, Alex Tabarrok points to a NYT story, which says

In the United States, young adults in particular fare poorly compared with their international competitors of the same ages — not just in math and technology, but also in literacy.

More surprisingly, even middle-aged Americans — who, on paper, are among the best-educated people of their generation anywhere in the world — are barely better than middle of the pack in skills.

My view is that growth will depend on luck in terms of discoveries. One possibility would be discovering a cure for obesity/diabetes. Another possibility would be discovering drugs that improve the ability of young people to learn, by increasing conscientiousness, cognitive ability, or both. Another possibility would be a discovery that makes solar power really inexpensive. Another possibility would be the development of very high skill at manipulating DNA, so that we can “grow a table,” in Rodney Brooks’ phrase.

I am not counting on any of these things happening. I am just saying that you need something really big in order to affect TFP growth.

As Brink points out, public policy could be changed in order to promote growth. However, I think we are less likely to have good luck on the policy front than on the discovery front. I think that policy has a lot of inertia.

The New Keynesian Model: Who Believes It?

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John Cochrane has been going after the New Keynesian model. The other day, he linked to a paper by Bill Dupor and Rong Li. They argue that the stimulus did not increase expected inflation, which is a channel by which fiscal policy is supposed to create an expansion in the New Keynesian model.

My question is whether anyone really believes the New Keynesian model. I know that for twenty years, it’s what every graduate student was taught. I know that everyone thinks that writing down a dynamic optimization problem counts as microfoundations.

But when it comes to interpreting the stimulus, my sense is that most economists revert to the old Keynesian model. If they believed the New Keynesian model, I think they would be using the language of intertemporal substitution and expectations more frequently. Instead, what I keep reading is more along the lines of spending creates jobs and jobs create spending.

What, Me Worry?

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This year’s “edge” question is what we should be worried about. So far, my favorite is David Berreby.

out of the 9 billion people expected when the Earth’s population peaks in 2050, the World Health Organization expects 2 billion—more than one person in five—to suffer from dementia. Is any society ready for this? Is any really talking about how to be ready?

One might hope that we would have a cure by then. But in general, the demographics of the future look…strange. Rodney Brooks thinks we will need a lot of robots to

take up the slack doing the thankless and hard grunt work necessary for elder care, e.g., lifting people into and out of bed, cleaning up the messes that occur, etc., so that the younger humans can spend their time providing the social interaction and personal face time that we old people are all going to crave.

Of course, if someone had asked me, I would have said that I worry about fiscal imbalances.