Category Archive for: Economics [Return to Main]

Tuesday, August 04, 2015

'Sarcasm and Science'

On the road again, so just a couple of quick posts. This is Paul Krugman:

Sarcasm and Science: Paul Romer continues his discussion of the wrong turn of freshwater economics, responding in part to my own entry, and makes a surprising suggestion — that Lucas and his followers were driven into their adversarial style by Robert Solow’s sarcasm...
Now, it’s true that people can get remarkably bent out of shape at the suggestion that they’re being silly and foolish. ...
But Romer’s account of the great wrong turn still sounds much too contingent to me...
At least as I perceived it then — and remember, I was a grad student as much of this was going on — there were two other big factors.
First, there was a political component. Equilibrium business cycle theory denied that fiscal or monetary policy could play a useful role in managing the economy, and this was a very appealing conclusion on one side of the political spectrum. This surely was a big reason the freshwater school immediately declared total victory over Keynes well before its approach had been properly vetted, and why it could not back down when the vetting actually took place and the doctrine was found wanting.
Second — and this may be less apparent to non-economists — there was the toolkit factor. Lucas-type models introduced a new set of modeling and mathematical tools — tools that required a significant investment of time and effort to learn, but which, once learned, let you impress everyone with your technical proficiency. For those who had made that investment, there was a real incentive to insist that models using those tools, and only models using those tools, were the way to go in all future research. ...
And of course at this point all of these factors have been greatly reinforced by the law of diminishing disciples: Lucas’s intellectual grandchildren are utterly unable to consider the possibility that they might be on the wrong track.

'The US Financial Sector in the Long-Run: Where are the Economies of Scale?'

 And one more  before heading out the door. From Tim Taylor:

The US Financial Sector in the Long-Run: Where are the Economies of Scale?: A larger financial sector is clearly correlated with economic development, in the sense that high-income countries around the world have on average larger markets for banks, credit cards, stock and bond markets, and so on compared with lower-income countries. But there are also concerns that the financial sector in high-income countries can grow in ways that end up creating economic instability (as I've discussed herehere, and here). Thomas Philippon provides some basic evidence on the growth of the US financial sector over the past 130 years in "Has the US Finance Industry Become Less Efficient? On the Theory and Measurement of Financial Intermediation," publishes in the April 2015 issue of the American Economic Review (105:4, pp. 1408–1438). The AER is not freely available online, but many readers can obtain access through a library subscription.

There are a couple of ways to think about the size of a country's financial sector relative to its economy. One can add up the size of certain financial markets--the market value of bank loans, stocks, bonds, and the like--and divide by GDP. Or one can add up the economic value added by the financial sector. For example, instead of adding up the bank loans, you add up the value of banking services provided. Similarly, instead of adding up the value of the stock market, you add up the value of the services provided by stockbrokers and investment manager.

Here's a figure from Philippon showing both measures of finance as a share of the US economy over the long run since 1886.

The orange line measured on the right axis is "intermediated assets," which measures the size of the financial sector as the sum of all debt and equity issued by nonfinancial firms, together with the sum of all household debt, and some other smaller categories. Back in the late 19th century, the US financial sector was roughly equal in size to GDP. By just before the Great Depression, it had risen to almost three times GDP, before sinking back to about 1.5 times GDP. More recently, you can see the financial sector spiking with the boom in real estate markets and stock markets in the mid-2000s at more than 4 times GDP, before dropping slightly. The overall trend is clearly up, but it's also clearly a bumpy ride.

The green line shows "finance income," which can be understood as a measure of the value added by firms in the financial sector. For the uninitiated, "value added" has a specific meaning to economists. Basically, it is calculated by taking the total revenue of a firm and subtracting the cost of all goods and services purchased from other firms--for example, subtracting costs of supplies purchased or machinery. In the figure, most of the "value-added" that measures  "finance income" includes all wages and salaries paid by a firm, along with any profits earned.

An intriguing pattern emerges here: finance income tracks intermediated assets fairly closely. In other words, the amount paid to the financial sector is more-or-less a fixed proportion of total financial assets. It's not obvious why this should be so. For example, imagine that because of a rise in housing prices, the total mortgage debt of households rises substantially over time, or because of rising stock prices over several decades, the total value of the stock market is up. Especially in an economy where information technology is making rapid strides, it's not clear why incomes in the financial sector should be rising at the same pace. Does a bank need to incur twice the costs if it issues a mortgage for $500,000 as compared to when it issues a mortgage for $250,000? Does an investment adviser need to incur twice the costs when giving advice on a retirement account of $1 million as when giving advice on a retirement account of $500,000? Shouldn't there be some economies of scale in financial services?

Philippon isn't the first to raise this question: for example, Burton Malkiel has asked why there aren't economies of scale in asset management fees here. But Philippon provides evidence that, for whatever reason, a lack of economies of scale has been widespread and long-lasting in the US financial sector.

Full disclosure: The AER is published by the American Economic Association, which is also the publisher of the Journal of Economic Perspectives, where I have worked as Managing Editor since 1986.

Fed Watch: Gearing Up For Employment Day

Tim Duy:

Gearing Up For Employment Day, by Tim Duy: The big event this week is the employment report. Fed watchers will eagerly dive into the data, looking for signs that the labor market made "some" further improvement. "Some" improvement appears to be an important hurdle to clear before the Fed will raise interest rates. How much "some" is necessary? I suspect it's like pornography - you will know it when you see it.
Incoming data continues a pattern general mediocrity. Today we received the June income and spending report, which one could have largely backed out of the second quarter GDP numbers. Real incomes edged up 0.2% while real spending was flat. Spending softened compared to last year, not unlike the pattern of 2004:

PCEa080315

Recall that it was in July of 2004 that the Fed initiated the previous tightening cycle. Note also that one aspect of consumer spending, auto sales, showed no signs of softening in July.
Inflation remains below target, but arguably not far below target: 

PCE080315

While on a year-over-year basis, core-PCE remains well below target, recent reading are more solid. On an annualized basis, core-PCE rose 1.79% in June, within the range that I suspect most policymakers believe is consistent with their mandate (you can't hit exactly 2% all the time). The Fed will see these numbers as supporting their view that the 2014 inflation drop was driven by largely temporary factors.  
Manufacturing numbers remain on the soft side:

ISM080315

Stronger dollar, lower commodity prices, and softer global demand took the wind out of that sector, to be sure. Note that a sharp decline in ISM numbers from mid-2004 through mid-2005 did not deter the Fed from continuing its rate hike campaign.
Coming on the heels of last week's disastrous employment cost report, Friday's measure of wages will be closely watched. The tentative signs of wage growth acceleration we had been seeing in the ECI were quickly wiped out in the second quarter:

ECI080315

How will the Fed view this data? Tough call at this point. Digging into the data may lead them to conclude that this report was more smoke than fire.  Millan Mulraine via across the curve:

...I wanted to make a few observations on the ECI report following our conversation with the BLS. The key findings reinforce our earlier view that this anomalous performance in both wages and benefits has been driven by one-off factors that should unwind. As such, we believe that this report does not reflect a germane deterioration in underlying inflation dynamics, and will have little bearing on the Fed’s deliberation on policy.

1. The sharp deceleration in the growth rate of the wages and salaries component (which accounts for about 70% of total compensation) was driven by a sharp falloff in incentive pay this quarter versus Q1. This accounted in the sharp drop in the growth rate of private industry wages (on an NSA basis) from 0.8% q/q in Q1 to 0.2% q/q in Q2. Excluding commission sale incentives, wages and salaries were unchanged at a solid 0.6% q/q pace in both quarters.

2. Benefits were also affected by special factors, and the key driver was the redefinition to retirement benefits in Q2, perhaps caused by the underfunding of some retirement pension plans. The 0.8% q/q drop in unionized workers benefits was a big part of this. Here is a link of various stories highlighting this fact earlier this year...

 The Fed may also find solace in the Atlanta Fed Wage Growth Tracker:

Atlanta-fed_individual-wage-growth-3

Of course, maybe they don't need faster wage growth at all, as Jon Hilsenrath at the Wall Street Journal reminds us:

Given her [Fed Chair Janet Yellen] stance, Friday’s employment cost report doesn’t look like a deal breaker for the Fed in its long-running debate about when to raise short-term interest rates. Wages appear to be stagnant but not clearly weakening, which is what she set out as her threshold for not acting. Still, it creates new doubts for officials and doesn’t help them build the confidence they’re hoping to build that the job market is nearing full employment and inflation rising toward 2%.

At least one Fed official is on record saying he couldn't care less about the ECI report. That is St. Louis Federal Reserve President James Bullard, via the Wall Street Journal:

“We are in good shape” for increasing the Fed’s currently near-zero short-term rate target at the Sept. 16-17 central bank gathering, Mr. Bullard said in an interview with The Wall Street Journal. He said officials needed to see how growth data released Thursday shaped up before clearing the way to act. 
Mr. Bullard shrugged off a report Friday showing surprising tepid wage gains, saying he isn’t that worried about that situation right now.

That said, I think that most Fed officials would be more comfortable ignoring the ECI report if they see some hard evidence in the next two labor reports that wage growth really is strengthening.

Bottom Line: My general sense is that the data is falling in line in such a way that the Fed can justify a rate hike in September. Not sure I would describe the situation as being in "good shape" as Bullard does, but I see where they can find room in the data, especially if their logic is to go early so they can go slower. A 200k+ nonfarm payroll gain, a tick down in unemployment, and some wage growth would support that case. September is a hard call, however, because I doubt that the next six weeks of data will give them a clear, consistent story free of any warts or boils. If they ultimately need perfect data to move forward, then they will again take a pass on September. Perfect data will simply be hard to come by, I suspect, in a world where 2% growth is the new 4%.

Links for 08-04-15

Monday, August 03, 2015

'Are All Tax Increases a Bad Thing?'

I have time for one more... This is John Whitehead at Environmental Economics:

Are all tax increases a bad thing?: Not necessarily. And yet, Greg Mankiw:

As long-time readers of this blog know, I have long advocated greater use of Pigovian taxes, such as taxes on carbon emissions. Such taxes can correct incentives by aligning private and social costs, and the revenue from such taxes can be used to reduce other, distortionary taxes.

Skeptics of Pigovian taxes on the right sometimes argue that such taxes are good in principle but in practice the left will co-opt them and, rather than using the revenue to reduce other taxes, will use it to fund ever larger government.

Sadly, that point of view is getting some support in Washington state.  The headline above from The Seattle Times reads 'Green' alliance opposes petition to tax carbon.  Why the opposition?  Because the ballot measure is revenue-neutral. Some environmentalists want to use the revenue from the proposed carbon tax to increase spending instead.

I believe that a carbon tax could someday win bipartisan support.  But before it does so, those on the left will need to convince those on the right that the tax would be a tax shift, not a tax increase.  The carbon tax needs to be evaluated on its own merits and should not be a stalking horse for a broader, big-government agenda.

The standard textbook treatment of a Pigouvian tax is agnostic on what happens to the revenue. It could be used efficiently to finance other projects..., reduce distortionary taxes or reduce government debt...

Mankiw's last paragraph strays far from the economics and is one-sided in its condemnation of those on the political left. A bipartison paragraph would read more like this:

I believe that a carbon tax could someday win bipartisan support.  But before it does so, those on the left will need to convince those on the right that the tax would be a tax shift, not a tax increase.  And those on the right will need to convince those on the left that the tax is not trojan horse for a tax cut for the rich. The carbon tax needs to be evaluated on its own merits. and should not be a stalking horse for a broader, big-government agenda.

The carbon tax needs to be evaluated on its own merits. Period. ...

I know of no empirical evidence to suggest that there is only one efficient use for Pigouvian tax revenue. 

'Is Deficit Fetishism Innate or Contextual?'

A quick one before hitting the road. Is deficit fetishism bullshit? This is from Simon Wren-Lewis:

Is deficit fetishism innate or contextual?: In a couple of interesting posts, Jonathan Hopkin and Ben Rosamond, political scientists from the LSE and Copenhagen respectively, talk about ‘political bullshit’. They use ‘bullshit’ as a technical term due to Princeton philosopher Harry Frankfurt. Unlike lying, bullshit tells false stories that pay no heed to the truth. Their appeal is more to common sense, or what Tyler Cowen calls common sense morality. At a primitive level it is the stuff of political sound bites, but at a slightly more detailed level it is the language of what Krugman ironically calls ‘Very Serious People’.
The implication which can then be drawn is that because bullshit does not reside in the “court of truth”, trying to combat it with facts, knowledge or expertise may have limited effectiveness. The conditions under which this might be true, and the extent to which information technology impacts on this, are fascinating issues...
In the case of fiscal policy, deficit fetishism as bullshit involves appeals to ‘common sense’ by invoking simple analogies with households, often coupled with an element of morality - it is responsible to pay down debts. The point in calling it bullshit (in this technical sense) is that attempts to counter it by appeals to facts or knowledge (e.g. the government is not like a household, as every economist knows) may have limited effectiveness. Instead it might be better to fight bullshit with bullshit...
I want to ask whether deficit fetishism will always be powerful bullshit, or whether its force is a symptom of a particular time, and what is more a time that may by now have passed. ...
At first sight deficit fetishism seems to be innate...

Paul Krugman: America’s Un-Greek Tragedies in Puerto Rico and Appalachia

Austerity for Puerto Rico would be a "terrible idea":

America’s Un-Greek Tragedies in Puerto Rico and Appalachia, by Paul Krugman, Commentary, NY Times: On Friday the government of Puerto Rico announced that it was about to miss a bond payment. It claimed that for technical legal reasons this wouldn’t be a default, but that’s a distinction without a difference.
So is Puerto Rico America’s Greece? No, it isn’t, and it’s important to understand why.
Puerto Rico’s fiscal crisis is basically the byproduct of a severe economic downturn. The commonwealth’s government was slow to adjust to the worsening fundamentals, papering over the problem with borrowing. And now it has hit the wall. ... But ... while the island’s economy has declined sharply, its population, while hurting, hasn’t suffered anything like the catastrophes we see in Europe. ... Why have the human consequences of economic troubles been muted?
The main answer is that Puerto Rico is part of the U.S. fiscal union. When its economy faltered, its payments to Washington fell, but its receipts from Washington — Social Security, Medicare, Medicaid, and more — actually rose. So Puerto Rico automatically received aid on a scale beyond anything conceivable in Europe.
Is Puerto Rico’s status as part of the U.S. all good? A recent report ... argues that its economy is hurt by sharing the U.S. minimum wage, which raises costs, and also by federal benefits that encourage adults to drop out of the work force. ...
But the evidence that minimum wages or social benefits are really a problem is, as one careful if older study put it, “surprisingly fragile.” Notably, Puerto Rico’s low rate of labor force participation probably has more to do with outmigration than with welfare: when job opportunities dry up, young, able-bodied workers move elsewhere, while the least employable stay in place. ...
There is, of course, the problem of maintaining public services for those who remain. ... What this tells us ... is that even for a part of the United States, too much austerity can be self-defeating. It would, in particular, be a terrible idea to give the hedge funds that have scooped up much of Puerto Rico’s debt what they want — basically to destroy the island’s education system in the name of fiscal responsibility.
Overall, however, the Puerto Rican story is one of bad times that fall well short of utter disaster. And the saving grace in this situation is big government — a federal system that provides a crucial safety net for American citizens in times of need, wherever they happen to live.

'The Revolt Against the Ruling Class'

Robert Reich:

The Revolt Against the Ruling Class: “He can’t possibly win the nomination,” is the phrase heard most often when Washington insiders mention either Donald Trump or Bernie Sanders.
Yet as enthusiasm for the bombastic billionaire and the socialist senior continues to build within each party, the political establishment is mystified.
They don’t understand that the biggest political phenomenon in America today is a revolt against the “ruling class” of insiders that have dominated Washington for more than three decades.
In two very different ways, Trump and Sanders are agents of this revolt. I’ll explain the two ways in a moment.  
Don’t confuse this for the public’s typical attraction to candidates posing as political outsiders who’ll clean up the mess, even when they’re really insiders who contributed to the mess.
What’s new is the degree of anger now focused on those who have had power over our economic and political system since the start of the 1980s.
 ...
Yet despite the growing revolt against the ruling class, it seems likely that the nominees in 2016 will be Jeb Bush and Hillary Clinton. After all, the ruling class still controls America.
But the revolt against the ruling class won’t end with the 2016 election, regardless. 
Which means the ruling class will have to change the way it rules America. Or it won’t rule too much longer.

Links for 08-03-15

Sunday, August 02, 2015

'Freshwater’s Wrong Turn'

Paul Krugman follows up on Paul Romer's latest attack on "mathiness":

Freshwater’s Wrong Turn (Wonkish): Paul Romer has been writing a series of posts on the problem he calls “mathiness”, in which economists write down fairly hard-to-understand mathematical models accompanied by verbal claims that don’t actually match what’s going on in the math. Most recently, he has been recounting the pushback he’s getting from freshwater macro types, who seem him as allying himself with evil people like me — whereas he sees them as having turned away from science toward a legalistic, adversarial form of pleading.
You can guess where I stand on this. But in his latest, he notes some of the freshwater types appealing to their glorious past, claiming that Robert Lucas in particular has a record of intellectual transparency that should insulate him from criticism now. PR replies that Lucas once was like that, but no longer, and asks what happened.
Well, I’m pretty sure I know the answer. ...

It's hard to do an extract capturing all the points, so you'll likely want to read the full post, but in summary:

So what happened to freshwater, I’d argue, is that a movement that started by doing interesting work was corrupted by its early hubris; the braggadocio and trash-talking of the 1970s left its leaders unable to confront their intellectual problems, and sent them off on the path Paul now finds so troubling.

Recent tweets, email, etc. in response to posts I've done on mathiness reinforce just how unwilling many are to confront their tribalism. In the past, I've blamed the problems in macro on, in part, the sociology within the profession (leading to a less than scientific approach to problems as each side plays the advocacy game) and nothing that has happened lately has altered that view.

'The Myth of Mobility'

In case you somehow missed that socioeconomic mobility is low in the US relative to many other countries, this is Anne Kim at Washington Monthly:

The Myth of Mobility: ... Surveys find that nearly two-thirds of Americans believe it’s “still possible to start out poor in this country, work hard and become rich,” while also discounting the value of family background and connections in achieving success. In a 2014 survey by the Pew Research Center, just 18 percent of Americans said “belonging to a wealthy family” was “very important” for getting ahead.
But a mounting pile of evidence is beginning to show that family background is, in fact, determinative. ...
“[C]hildren raised in low-income families will probably have very low incomes as adults, while children raised in high-income families can anticipate very high incomes as adults,” write co-authors Pablo Mitnik and David Grusky of the Stanford University Center on Poverty and Inequality in a report published by the Pew Charitable Trusts and the Russell Sage Foundation.
In particular, the study finds, children raised in wealthy households can expect to enjoy incomes that are at least 200 percent larger than the expected incomes of children raised in low-income households and 75 percent larger than the incomes of children from the middle class.
As a result of the persistence of these advantages - and disadvantages - from generation to generation, Mitnik and Grusky conclude: “[T]he United States is very immobile.” ...

And remember:

Our findings suggest that wealth transmission is not primarily because children from wealthier families are inherently more talented or more able...

Links for 08-02-15

Saturday, August 01, 2015

'Lehman Brothers Once Again...'

Brad DeLong:

Lehman Brothers Once Again…: Ah. The debate continues:

David Zaring: Did The Fed Fail To Save Lehman Brothers Because It Legally Couldn’t?: “The Fed’s lawyers said, after the fact, that no, they didn’t have the legal power to bail out Lehman…

…Peter says yes they did, Philip says no, and I’m with Peter on this one...

I have two points to make here…

My first point is one that is obvious to an economic historian. But I do not see picked up by the lawyers. It is that central banks are government-chartered corporations rather than government agencies precisely to give them additional freedom of action. Corporations can and do do things that are ultra vires. Governments then either sanction them, or decide not to.

During British financial crises of the nineteenth century, the Bank of England repeatedly violated the terms of its 1844 charter restricting its powers to print bank notes. The Chancellor the Exchequer would then not take any steps in response to sanction it. Such a policy–of writing a charter for the central bank with the expectation that in an emergency the Bank would do whatever was needed to stabilize the economy in spite of the limitations placed on it by its charter, was clearly envisioned by the author of the 1844 charter, then Prime Minister Robert Peel, who expected to see the Governor of the Bank of England take responsibility for doing what was needed...

Peel saw a choice: either (i) give the Bank of England explicit powers (and so run the risk that financiers, expecting that those powers would be used, would exploit moral hazard and so produce irrational exuberance, extravagant overleverage, and repeated frequent financial crises), or (ii) forbid the Bank of England from acting and rely on financial statesmen in the future to take actions ultra vires under the principle that in the end salus populi suprema lex. Peel chose (ii). To him and his peers, the risks that granting explicit powers would enable moral hazard appeared greater than the risks that when a crisis should come the makers of monetary policy would not understand their proper role. And the Federal Reserve banks have inherited their non-agency but corporation legal structure from the Bank of England.

My second point is that Bernanke, Geithner, and their company at the head of the Federal Reserve in 2008 really, really, really want their decision not to have rescued Lehman in the fall of 2008 to have been a judgment call that went wrong.

They really do not want to have let a situation develop in which there is a systemically-important financial institution that they cannot support. Should any systemically-important financial institution ever approach a state in which the central bank could not support it in an emergency, the most elementary principles of central banking command that such an institution be resolved or shut down immediately.

To fail to do so is complete and total central banking malpractice.

Privatization

Chris Dillow on the privatization of government services:

Creating markets: ... My point here is a simple one. Whether effective markets and private ownership can be created depends upon particular institutional and technical conditions.
This is, of course, a variant on Coase's famous point (pdf) - that there are costs to market transacting. These costs must be weighed against the costs of other forms of economic organisation - be it the firm or state control.
This applies to issues much nearer home. Whether public sector services should be privatized depends upon precise institutional detail: is it possible to write contracts which ensure a high quality of service without excessive rent-seeking? In Coasean terms, is the cost of market transacting lower than the cost of in-house production?
The answer will vary from service to service and place to place. .... It all depends upon subtle details.

I wrote about this a bit in 2007 in "Markets are Not Magic":

To listen to some commentators is to believe that markets are the solution to all of our problems. Health care not working? Bring in the private sector. Need to rebuild a war-torn country? Send in the private contractors. Emergency relief after earthquakes, hurricanes, and tornadoes? Wal-Mart with a contract is the answer. ...
Markets don't work just because we get out of the way. When government contracts are moved to the private sector without ensuring the proper incentives are in place, there will be problems - waste, inefficiency, higher prices than needed, etc. There is nothing special about markets that guarantees that managers or owners of companies will have an incentive to use public funds in a way that maximizes the public rather than their own personal interests. It is only when market incentives direct choices to coincide with the public interest that the two sets of interests are aligned.
If there is no competition, or insufficient competition in the provision of government services by private sector firms, there is no reason to expect the market to deliver an efficient outcome, an outcome free of waste and inefficiency. Why would we think that giving a private sector firm a monopoly in the provision of a public service would yield an efficient outcome? If the projects are of sufficient scale, or require specialized knowledge so that only one or a few private sector firms are large enough or specialized enough to do the job, why would we expect an ideal outcome just because the private sector is involved? If cronyism limits the participants in the marketplace, why would we expect an outcome that maximizes the public interest?
There is nothing inherent in markets that guarantees a desirable outcome. A market can be a monopoly, a market can be perfectly competitive, a market can be lots of things. Markets with bad incentives produce bad outcomes, markets with good incentives do better. ...
For government goods and services, when incentives consistent with a competitive outcome are present, we should get government out of the way and privatize, and there are lots of circumstances where this will be appropriate. There is no reason at all for the government to produce its own pencils and pens, buying them from the private sector is more efficient so long as the bids are competitive.
When competitive conditions are not met but can be regulated, the regulations should be put in place and the private sector left to do its thing... There's no reason for government to do anything except ensure that the incentives to motivate competitive behavior are in place and enforced.
But rampant privatization based upon some misguided notion that markets are always best, privatization that does not proceed by first ensuring that market incentives are consistent with the public interest, doesn't do us any good. ...

'Microfoundations 2.0?'

Daniel Little:

Microfoundations 2.0?: The idea that hypotheses about social structures and forces require microfoundations has been around for at least 40 years. Maarten Janssen’s New Palgrave essay on microfoundations documents the history of the concept in economics; link. E. Roy Weintraub was among the first to emphasize the term within economics, with his 1979 Microfoundations: The Compatibility of Microeconomics and Macroeconomics. During the early 1980s the contributors to analytical Marxism used the idea to attempt to give greater grip to some of Marx's key explanations (falling rate of profit, industrial reserve army, tendency towards crisis). Several such strategies are represented in John Roemer's Analytical Marxism. My own The Scientific Marx (1986) and Varieties of Social Explanation (1991) took up the topic in detail and relied on it as a basic tenet of social research strategy. The concept is strongly compatible with Jon Elster's approach to social explanation in Nuts and Bolts for the Social Sciences (1989), though the term itself does not appear in this book or in the 2007 revised edition.

Here is Janssen's description in the New Palgrave of the idea of microfoundations in economics:

The quest to understand microfoundations is an effort to understand aggregate economic phenomena in terms of the behavior of individual economic entities and their interactions. These interactions can involve both market and non-market interactions.
In The Scientific Marx the idea was formulated along these lines:
Marxist social scientists have recently argued, however, that macro-explanations stand in need of microfoundations; detailed accounts of the pathways by which macro-level social patterns come about. (1986: 127)

The requirement of microfoundations is both metaphysical -- our statements about the social world need to admit of microfoundations -- and methodological -- it suggests a research strategy along the lines of Coleman's boat (link). This is a strategy of disaggregation, a "dissecting" strategy, and a non-threatening strategy of reduction. (I am thinking here of the very sensible ideas about the scientific status of reduction advanced in William Wimsatt's "Reductive Explanation: A Functional Account"; link).

The emphasis on the need for microfoundations is a very logical implication of the position of "ontological individualism" -- the idea that social entities and powers depend upon facts about individual actors in social interactions and nothing else. (My own version of this idea is the notion of methodological localism; link.) It is unsupportable to postulate disembodied social entities, powers, or properties for which we cannot imagine an individual-level substrate. So it is natural to infer that claims about social entities need to be accompanied in some fashion by an account of how they are embodied at the individual level; and this is a call for microfoundations. (As noted in an earlier post, Brian Epstein has mounted a very challenging argument against ontological individualism; link.)
Another reason that the microfoundations idea is appealing is that it is a very natural way of formulating a core scientific question about the social world: "How does it work?" To provide microfoundations for a high-level social process or structure (for example, the falling rate of profit), we are looking for a set of mechanisms at the level of a set of actors within a set of social arrangements that result in the observed social-level fact. A call for microfoundations is a call for mechanisms at a lower level, answering the question, "How does this process work?"

In fact, the demand for microfoundations appears to be analogous to the question, why is glass transparent? We want to know what it is about the substrate at the individual level that constitutes the macro-fact of glass transmitting light. Organization type A is prone to normal accidents. What is it about the circumstances and actions of individuals in A-organizations that increases the likelihood of normal accidents?

One reason why the microfoundations concept was specifically appealing in application to Marx's social theories in the 1970s was the fact that great advances were being made in the field of collective action theory. Then-current interpretations of Marx's theories were couched at a highly structural level; but it seemed clear that it was necessary to identify the processes through which class interest, class conflict, ideologies, or states emerged in concrete terms at the individual level. (This is one reason I found E. P. Thompson's The Making of the English Working Class (1966) so enlightening.) Advances in game theory (assurance games, prisoners' dilemmas), Mancur Olson's demonstration of the gap between group interest and individual interest in The Logic of Collective Action: Public Goods and the Theory of Groups (1965), Thomas Schelling's brilliant unpacking of puzzling collective behavior onto underlying individual behavior in Micromotives and Macrobehavior (1978), Russell Hardin's further exposition of collective action problems in Collective Action (1982), and Robert Axelrod's discovery of the underlying individual behaviors that produce cooperation in The Evolution of Cooperation (1984) provided social scientists with new tools for reconstructing complex collective phenomena based on simple assumptions about individual actors. These were very concrete analytical resources that promised help further explanations of complex social behavior. They provided a degree of confidence that important sociological questions could be addressed using a microfoundations framework.

There are several important recent challenges to aspects of the microfoundations approach, however.

So what are the recent challenges? First, there is the idea that social properties are sometimes emergent in a strong sense: not derivable from facts about the components. This would seem to imply that microfoundations are not possible for such properties.

Second, there is the idea that some meso entities have stable causal properties that do not require explicit microfoundations in order to be scientifically useful. (An example would be Perrow's claim that certain forms of organizations are more conducive to normal accidents than others.) If we take this idea very seriously, then perhaps microfoundations are not crucial in such theories.

Third, there is the idea that meso entities may sometimes exert downward causation: they may influence events in the substrate which in turn influence other meso states, implying that there will be some meso-level outcomes for which there cannot be microfoundations exclusively located at the substrate level.

All of this implies that we need to take a fresh look at the theory of microfoundations. Is there a role for this concept in a research metaphysics in which only a very weak version of ontological individualism is postulated; where we give some degree of autonomy to meso-level causes; where we countenance either a weak or strong claim of emergence; and where we admit of full downward causation from some meso-level structures to patterns of individual behavior?

In once sense my own thinking about microfoundations has already incorporated some of these concerns; I've arrived at "microfoundations 1.1" in my own formulations. In particular, I have put aside the idea that explanations must incorporate microfoundations and instead embraced the weaker requirement of availability of microfoundations (link). Essentially I relaxed the requirement to stipulate only that we must be confident that microfoundations exist, without actually producing them. And I've relied on the idea of "relative explanatory autonomy" to excuse the sociologist from the need to reproduce the microfoundations underlying the claim he or she advances (link).

But is this enough? There are weaker positions that could serve to replace the MF thesis. For now, the question is this: does the concept of microfoundations continue to do important work in the meta-theory of the social sciences?

I've talked about this many times, e.g., but it's worth making this point about aggregating from individual agents to macroeconomic aggregates once again (it deals, for one, with the emergent properties objection above -- it's the reason representative agent models are used, it seems to avoid the aggregation issue). This is from Kevin Hoover:

... Exact aggregation requires that utility functions be identical and homothetic … Translated into behavioral terms, it requires that every agent subject to aggregation have the same preferences (you must share the same taste for chocolate with Warren Buffett) and those preferences must be the same except for a scale factor (Warren Buffet with an income of $10 billion per year must consume one million times as much chocolate as Warren Buffet with an income of $10,000 per year). This is not the world that we live in. The Sonnenschein-Mantel-Debreu theorem shows theoretically that, in an idealized general-equilibrium model in which each individual agent has a regularly specified preference function, aggregate excess demand functions inherit only a few of the regularity properties of the underlying individual excess demand functions: continuity, homogeneity of degree zero (i.e., the independence of demand from simple rescalings of all prices), Walras’s law (i.e., the sum of the value of all excess demands is zero), and that demand rises as price falls (i.e., that demand curves ceteris paribus income effects are downward sloping) … These regularity conditions are very weak and put so few restrictions on aggregate relationships that the theorem is sometimes called “the anything goes theorem.”
The importance of the theorem for the representative-agent model is that it cuts off any facile analogy between even empirically well-established individual preferences and preferences that might be assigned to a representative agent to rationalize observed aggregate demand. The theorem establishes that, even in the most favorable case, there is a conceptual chasm between the microeconomic analysis and the macroeconomic analysis. The reasoning of the representative-agent modelers would be analogous to a physicist attempting to model the macro- behavior of a gas by treating it as single, room-size molecule. The theorem demonstrates that there is no warrant for the notion that the behavior of the aggregate is just the behavior of the individual writ large: the interactions among the individual agents, even in the most idealized model, shapes in an exceedingly complex way the behavior of the aggregate economy. Not only does the representative-agent model fail to provide an analysis of those interactions, but it seems likely that that they will defy an analysis that insists on starting with the individual, and it is certain that no one knows at this point how to begin to provide an empirically relevant analysis on that basis.

Links for 08-01-15

Friday, July 31, 2015

'There May be a Complex Market Living in Your Gut '

I found this amusing:

There may be a complex market living in your gut: Conventional theories used by economists for the past 150 years to explain how societies buy, sell, and trade goods and services may be able to unlock mysteries about the behavior of microbial life on earth, according to a study by researchers from Claremont Graduate University, Boston University, and Columbia University.
The findings, published July 29 in the open access journal PLOS ONE, provide new insight into the behavior of the planet's oldest and tiniest life forms, and also create a new framework for examining larger questions about biological evolution and productivity.
Joshua Tasoff, an economics professor at Claremont Graduate University, conducted the study with Michael Mee of the Department of Biomedical Engineering at Boston University and Harris Wang of the Department of Systems Biology at Columbia University. ...
Although microbes are ubiquitous, they interact with each other in complicated ways that are not well understood. A large fraction of microbial life exists in complex communities where the exchange of molecules and proteins is vital for their survival. They trade these essential resources to promote their own growth in ways that are similar to countries that exchange goods in modern economic markets.
Inspired by these similarities, Tasoff, Mee, and Wang applied the general equilibrium theory of economics, which explains the exchange of resources in complex economies, to understand the trade of resources in microbial communities. ...
The results confirmed the team's predictions. As trade increased, the bacterial communities grew faster. And while all of the microbes benefited from trade, the more a bacteria strain exported, the slower it grew relative to the importing bacteria strain.
"That means that species face a tradeoff between growing their communities faster versus increasing their own population relative to that of a trading partner," Tasoff said.
The findings open the door for the application of other economic concepts that could improve our understanding of microbial and other biological communities, Tasoff said.

Paul Romer: Freshwater Feedback on Mathiness

More from Paul Romer:

Freshwater Feedback Part 1: “Everybody does it”: You can boil my claim about mathiness down to two assertions:

1. Economist N did X.
2. X is wrong because it undermines the scientific method.

#1 is a positive assertion, a statement about “what is …”#2 is a normative assertion, a statement about “what ought …” As you would expect from an economist, the normative assertion in #2 is based on what I thought would be a shared premise: that the scientific method is a better way to determine what is true about economic activity than any alternative method, and that knowing what is true is valuable.

In conversations with economists who are sympathetic to the freshwater economists I singled out for criticism in my AEA paper on mathiness, it has become clear that freshwater economists do not share this premise. What I did not anticipate was their assertion that economists do not follow the scientific method, so it is not realistic or relevant to make normative statements of the form “we ought to behave like scientists.”

In a series of three posts that summarize what I have learned since publishing that paper, I will try to stick to positive assertions, that is assertions about the facts, concerning this difference between the premises that freshwater economists take for granted and the premises that I and other economists take for granted.

In my conversations, the freshwater sympathizers generally have not disagreed with my characterization of the facts in assertion #1–that specific freshwater economists did X. In their response, two themes recur:

a) Yes, but everybody does X; that is how the adversarial method works.
b) By selectively expressing disapproval of this behavior by the freshwater economists that you name, you, Paul, are doing something wrong because you are helping “those guys.”

In the rest of this post, I’ll address response a). In a subsequent post, I’ll address response b). Then in a third post, I’ll observe that in my AEA paper, I also criticized a paper by Piketty and Zucman, who are not freshwater economists. The response I heard back from them was very different from the response from the freshwater economists. In short, Piketty and Zucman disagreed with my statement that they did X, but they did not dispute my assertion that X would be wrong because it would be a violation of the scientific method.

Together, the evidence I summarize in these three posts suggests that freshwater economists differ sharply from other economists. This evidence strengthens my belief that the fundamental divide here is between the norms of political discourse and the norms of scientific discourse. Lawyers and politicians both engage in a version of the adversarial method, but they differ in another crucial way. In the suggestive terminology introduced by Jon Haidt in his book The Righteous Mind, lawyers are selfish, but politicians are groupish. What is distinctive about the freshwater economists is that their groupishness depends on a narrow definition of group that sharply separates them from all other economists. One unfortunate result of this narrow groupishness may be that the freshwater economists do not know the facts about how most economists actually behave. ...[continue]...

Pictures of Austerity

Brendan Mochoruk and Louise Sheiner of the Brookings Institution say that Fiscal Headwinds are Abating:

Tight fiscal policy by local, state, and federal governments held down economic growth for more than four years, but that restraint finally appears to be over...

This is a pretty good summary of the charts:

Fiscal policy is no longer a source of contraction for the economy, but neither is it a source of strength.

But in my view the statement "neither is it a source of strength" understates how poorly fiscal policy has been managed. The strong headwinds never should have been there to begin with, and we have yet to feel the wind at our backs:

Fiscalimpact1

Monthly-employment-change

State-spending

Monthly-federal-emplyment

'U.S. Paychecks Grow at Record-Slow Pace'

Martin Feldstein says that when it comes to income inequality, you're all a bunch of whiners:

...we should not lose sight of how well middle-income families have actually done over the past few decades. Unfortunately, the political debate is distorted by misleading statistics that grossly understate these gains..., the US middle class has been doing much better than the statistical pessimists assert. ...

So it's yet another another round of "inequality has not grown as much as Democrats claim." Thought we had gotten beyond that. Today's news:

U.S. wages and benefits grew in the spring at the slowest pace in 33 years, stark evidence that stronger hiring isn't lifting paychecks much for most Americans. The slowdown also likely reflects a sharp drop-off in bonus and incentive pay for some workers.
The employment cost index rose just 0.2 percent in the April-June quarter after a 0.7 increase in the first quarter, the Labor Department said Friday. The index tracks wages, salaries and benefits. Wages and salaries alone also rose 0.2 percent.
Both measures recorded the smallest quarterly gains since the second quarter of 1982.
Salaries and benefits for private sector workers were unchanged, the weakest showing since the government began tracking the data in 1980. ...
The employment cost index figures now match the sluggish pace of growth reported in the average hourly pay data that's part of the monthly jobs report. ...

Video: NBER Feldstein Lecture by Alan Krueger on Labor Force Participation

Paul Krugman: China’s Naked Emperors

What can we learn from the response of the Chinese government to the problems in China's stock market?:

China’s Naked Emperors, by Paul Krugman, Commentary, NY Times: ... We’ve seen ... strange goings-on in China’s stock market. In and of itself, the price of Chinese equities shouldn’t matter all that much. But the authorities have chosen to put their credibility on the line by trying to control that market — and are in the process of demonstrating that, China’s remarkable success over the past 25 years notwithstanding, the nation’s rulers have no idea what they’re doing. ...
China is at the end of an era — the era of superfast growth... Meanwhile, China’s leaders appear to be terrified — probably for political reasons — by the prospect of even a brief recession. ... China’s response has been an all-out effort to prop up stock prices. Large shareholders have been blocked from selling; state-run institutions have been told to buy shares; many companies with falling prices have been allowed to suspend trading. ...
What do Chinese authorities think they’re doing?
In part, they may be worried about financial fallout. It seems that a number of players in China borrowed large sums with stocks as security, so that the market’s plunge could lead to defaults. This is especially troubling because China has a huge “shadow banking” sector that is essentially unregulated and could easily experience a wave of bank runs.
But it also looks as if the Chinese government, having encouraged citizens to buy stocks, now feels that it must defend stock prices to preserve its reputation. And what it’s ending up doing, of course, is shredding that reputation at record speed.
Indeed, every time you think the authorities have done everything possible to destroy their credibility, they top themselves. Lately state-run media have been assigning blame for the stock plunge to, you guessed it, a foreign conspiracy against China, which is even less plausible than you may think: China has long maintained controls that effectively shut foreigners out of its stock market, and it’s hard to sell off assets you were never allowed to own in the first place.
So what have we just learned? China’s incredible growth wasn’t a mirage, and its economy remains a productive powerhouse. The problems of transition to lower growth are obviously major, but we’ve known that for a while. The big news here isn’t about the Chinese economy; it’s about China’s leaders. Forget everything you’ve heard about their brilliance and foresightedness. Judging by their current flailing, they have no clue what they’re doing.

Links for 07-31-15

Thursday, July 30, 2015

Fed Watch: GDP Report

Tim Duy:

GDP Report, by Tim Duy: The second quarter GDP report, while not a blockbuster by any measure, will nudge the Fed further in the direction of a September rate hike. At first blush this might seem preposterous - 2.3% growth is nothing to write home about in comparison to history. But history is deceiving in this case. It remains important to keep in mind that 2% is the new 4%.
Year-over-year growth rates continue to hover around 2.5%:

GDP073015

While the 2.3% quarterly rate of the second quarter was below consensus forecasts, the first quarter figure was revised up from -0.2% to 0.6%. That said, the annual revisions from 2012-2014 disappointed. Average annual growth from 2011 to 2014 dropped from a previsouly reported 2.3% to 2.0%. Sad, very sad.
That was still enough growth, however, to sustain fairly solid job growth and sharp declines in the unemployment rate, suggesting that potential output growth is indeed fairly anemic. The Fed staff appear to agree; see their very low potential growth numbers in the accidentally released forecasts (and for more on the implications of those forecasts, see Gavin Davies). Note also the low end of the range of potential growth estimates from FOMC meeting participants is 1.8%. Furthermore, San Francisco Federal Reserve President John Williams wants the Fed to guide the economy to a 2.0% growth rate in 2016. Hence 2.3% growth when the economy is operating near full-employment is sufficient for many policymakers to pull the trigger on the first rate hike.
A second implication of the revisions is that they provide no relief for those pondering low productivity growth. Indeed, it is quite the opposite, and they suggest downward revisions to productivity. Low productivity plus low labor force growth equals low potential output growth. 2% is the new 4%. And don't expect that all the data will fall into the same nice, consistent patterns we typically see in a business cycle. Some indicators will point up, others down, leading to many erroneous calls that a recession is soon upon us.  
As an aside, solid research and development spending gives hope that productivity growth will accelerate:

GDPa073015

We can only wait and see.
The inflation numbers also point to a September hike. Recall that the Fed is waiting until they are reasonably confident that inflation is heading back to target. Headline and core PCE rebounded to 2.15% and 1.81% annual growth rates in the first quarter, respectively, adding weight to the Fed's conviction that the inflation weakness of the first half was indeed transitory. To be sure, these gains have yet to translate into higher year-over-year numbers. But a forward looking Fed will expect they will head higher.
Separately, the forward-looking indicator of initial unemployment claims continues to hover at very low levels:

CLAIMS073015

A reminder that layoffs are few and far between as we head into next week's employment report for July.
Bottom Line: An unspectacular recovery, but sufficient to keep the Fed on track for raising rates this year. The case for September further strengthens.

'Dentists and Skin in the Game'

Paul Krugman:

Dentists and Skin in the Game: Wonkblog has a post inspired by the dentist who paid a lot of money to shoot Cecil the lion, asking why he — and dentists in general — make so much money. Interesting stuff; I’ve never really thought about the economics of dental care.

But once you do focus on that issue, it turns out to have an important implication — namely, that the ruling theory behind conservative notions of health reform is completely wrong.

For many years conservatives have insisted that the problem with health costs is that we don’t treat health care like an ordinary consumer good; people have insurance, which means that they don’t have “skin in the game” that gives them an incentive to watch costs. So what we need is “consumer-driven” health care, in which insurers no longer pay for routine expenses like visits to the doctor’s office, and in which everyone shops around for the best deals. ...

As it turns out, many fewer people have dental insurance than have general medical insurance; even where there is insurance, it typically leaves a lot of skin in the game. But dental costs have risen just as fast as overall health spending...

Links for 07-30-15

Wednesday, July 29, 2015

Fed Watch: FOMC Recap

Tim Duy:

FOMC Recap, by Tim Duy: The July FOMC meeting yielded the widely expected outcome of no policy change. Very little change in the statement either - pulling out any useful information is about as easy as reading tea leaves or chicken bones. But that won't stop me from trying! On net, I would count it was somewhat more hawkish as the Fed gears up to hike rates later this year. By no means, however, did the statement make any definitive signal about September. The Fed continues to hold true to its promise to make the next move about the data. The era of handholding fades further into memory.
The first paragraph contained nearly all of the changes in the statement. Using the Wall Street Journal's handy-dandy Fed tracker:

FOMCa072915

In my opinion, this represents a not trivial upgrade of their thoughts on the labor market. Job growth is "solid," unemployment continues to decline, and a much more forceful conclusion on underemployment. No longer has underutilization diminished by a wishy-washy "somewhat." It now conclusively "has" diminished. Hence, it seems like the Fed is closer to declaring victory over one impediment to hiking rates - Fed Chair Janet Yellen's concerns about the high degree of underemployment.
I tend to regard the exclusion of the "energy prices appear to have stabilized" as the elimination of an artifact from the June statement. Energy prices are not in free-fall as the were at the end of last year, and have instead been tracking within a range since the beginning of the year. Hence the Fed can later repeat the inflation forecast as:
"...the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of earlier declines in energy and import prices dissipate."
Some may interpret it as a more dovish signal in light of the recent declines in oil prices. I am wary of that interpretation.
The only other change to the statement was in the third paragraph:

FOMCb072915

The addition of the determiner "some" fits nicely with the changes to the first paragraph. The labor market has now shown sufficient improvement such that the bar to a rate hike is actually quite low. Essentially, meeting participants believe the economy is closing in on full employment. And that in and of itself will raise their confidence on the inflation outlook.
There was some early chatter regarding the continued description of the risks to the outlook as "nearly" balanced. This was taken as dovish. Had they said the balance is weighted toward inflation, however, the Fed would have essentially been promising a rate hike in September, and they have been very clear they do not want to make such a promise. So the failure to change the balance of risks should not be that surprising. In that vein, I suspect that when they do hike, they will say something like "with today's action, the risks to the outlook remain balanced" such that they leave no signal regarding the timing or the magnitude of the next move.
Bottom Line:  All else equal, the next two labor reports will factor strongly into the Fed's decision in September. A continuation of recent labor trends is likely sufficient to induce them to pull the trigger. Further signs of stronger wage growth would make a September move a certainty.

FOMC Press Release

Not much to say about this, policy is unchanged, and not as much guidance on what to expect going forward as some expected (i.e., to get people ready for a rate increase in September):

Press Release, Release Date: July 29, 2015: Information received since the Federal Open Market Committee met in June indicates that economic activity has been expanding moderately in recent months. Growth in household spending has been moderate and the housing sector has shown additional improvement; however, business fixed investment and net exports stayed soft. The labor market continued to improve, with solid job gains and declining unemployment. On balance, a range of labor market indicators suggests that underutilization of labor resources has diminished since early this year. Inflation continued to run below the Committee's longer-run objective, partly reflecting earlier declines in energy prices and decreasing prices of non-energy imports. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations have remained stable.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced. Inflation is anticipated to remain near its recent low level in the near term, but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of earlier declines in energy and import prices dissipate. The Committee continues to monitor inflation developments closely.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.
The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee's holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Jeffrey M. Lacker; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams.

'Using Math to Obfuscate — Observations from Finance

More from Paul Romer on "mathiness" -- this time the use of math in finance to obfuscate communication with regulators:

Using Math to Obfuscate — Observations from Finance: The usual narrative suggests that the new mathematical tools of modern finance were like the wings that Daedalus gave Icarus. The people who put these tools to work soared too high and crashed.
In two posts, here and here, Tim Johnson notes that two government investigations (one in the UK, the other in the US) tell a different tale. People in finance used math to hide what they were doing.
One of the premises I used to take for granted was that an argument presented using math would be more precise than the corresponding argument presented using words. Under this model, words from natural language are more flexible than math. They let us refer to concepts we do not yet fully understand. They are like rough prototypes. Then as our understanding grows, we use math to give words more precise definitions and meanings. ...
I assumed that because I was trying to use math to reason more precisely and to communicate more clearly, everyone would use it the same way. I knew that math, like words, could be used to confuse a reader, but I assumed that all of us who used math operated in a reputational equilibrium where obfuscating would be costly. I expected that in this equilibrium, we would see only the use of math to clarify and lend precision.
Unfortunately, I was wrong even about the equilibrium in the academic world, where mathiness is in fact used to obfuscate. In the world of for-profit finance, the return to obfuscation in communication with regulators is much higher, so there is every reason to expect that mathiness would be used liberally, particularly in mandated disclosures. ...
We should expect that there will be mistakes in math, just as there are mistakes in computer code. We should also expect some inaccuracies in the verbal claims about what the math says. A small number of errors of either type should not be a cause for alarm, particularly if the math is presented transparently so that readers can check the math itself and check whether it aligns with the words. In contrast, either opaque math or ambiguous verbal statements about the math should be grounds for suspicion. ...
Mathiness–exposition characterized by a systematic divergence between what the words say and what the math implies–should be rejected outright.

'Spare Tire? Stock Markets, Banking Crises, and Economic Recoveries'

From Ross Levine, Chen Lin, and Wensi Xie at Vox EU:

Spare tire? Stock markets, banking crises, and economic recoveries: Do stock markets act as a ‘spare tire’ during banking crises, providing an alternative corporate financing channel and mitigating the economic severity of crises when the banking system goes flat?

In 1999, Alan Greenspan, then Chairman of the Federal Reserve System, argued that stock markets could mitigate the negative effects of banking crises, including more fragile businesses and greater unemployment. Using the analogy of a spare tire, he conjectured that banking crises in Japan and East Asia would have been less severe if those countries had built the necessary legal infrastructure so that their stock markets could have provided financing to corporations when their banking systems could not. If firms can substitute equity issuances for bank loans during banking crises, then banking crises will have less harmful effects on the public.

But researchers have not evaluated the spare tire view. Although official entities and others discuss the spare tire argument (e.g. US Financial Crisis Inquiry Commission 2011, Wessel 2009), we are unaware of systematic assessments of the testable implications emerging from Greenspan’s view of how financial markets can ease the effects of systemic banking failures.

In a recent paper, we provide the first assessment of the spare tire view... The findings are consistent with the three predictions of the spare tire view. ... The estimated economic effects are large...

'Second-best Macroeconomics'

Paul Krugman wonders if he has been advocating for the right type of policies:

Second-best Macroeconomics: The ... economic problems facing both the United States and Europe have been quite straightforward and comprehensible. ... So no worries: just hit the big macroeconomic That Was Easy button, and soon the troubles will be over.
Except that all the natural answers to our problems have been ruled out politically. Austerians not only block the use of fiscal policy, they drive it in the wrong direction; a rise in the inflation target is impossible given both central-banker prejudices and the power of the goldbug right. Exchange rate adjustment is blocked by the disappearance of European national currencies, plus extreme fear over technical difficulties in reintroducing them.
As a result, we’re stuck with highly problematic second-best policies like quantitative easing and internal devaluation. ... In case you don’t know, “second best” ... comes from a classic 1956 paper by Lipsey and Lancaster, which showed that policies which might seem to distort markets may nonetheless help the economy if markets are already distorted by other factors. ...
The problems with second best as a policy rationale are familiar. For one thing, it’s always better to address existing distortions directly, if you can — second best policies generally have undesirable side effects... There’s also a political economy concern,... in a complicated world you can come up with a second best rationale for practically anything. ...
But here we are, with anything resembling first-best macroeconomic policy ruled out by political prejudice, and the distortions we’re trying to correct are huge — one global depression can ruin your whole day. So we have quantitative easing, which is of uncertain effectiveness, probably distorts financial markets at least a bit, and gets trashed all the time by people stressing its real or presumed faults; someone like me is then put in the position of having to defend a policy I would never have chosen if there seemed to be a viable alternative. ...
Which makes me ask myself the question: Do people like me spend too much time being limited by what is presumed to be politically practical? Should we devote more time to trying to widen the range of options, to pointing out that we really would be much better off if we threw off the fetters of conventional deficit fears, the 2 percent inflation target, and the extremely ill-advised euro project?

Links for 07-29-15

Tuesday, July 28, 2015

The Politics of Economics and ‘Very Serious People’

New column:

The Politics of Economics and ‘Very Serious People’: The latest debate in the economics blogosphere is about the true meaning of the term “Very Serious People,” a term of derision initially used to describe some supporters of the Iraq war. It was later broadened to describe people who advocate for the tough position on any issue – budget cuts and entitlement reform to ease debt worries, increases in interest rates to prevent inflation, and so on – despite evidence contrary to their policy proposals.
Very Serious People often embrace unpopular policies; they adopt the tough and serious route they believe is needed to ensure the US remains on solid footing, and they ridicule the opposition as softies unwilling to accept that there is no easy way to overcome our economic problems. Gain requires pain, but we should note that the tough policies Very Serious People embrace usually impose the pain on other people -- often the poor and disadvantaged. When they are asked to step up and pay more taxes to reduce the deficit, for example, their tune generally changes.
Henry Farrell, an Associate Professor of Political Science at George Washington University says, “Being a Very Serious Person is about occupying a structural position that tends to reinforce, rather than counter, one’s innate biases and prejudices.” I’m not sure that fully captures the desire to appear tough and disciplined, to be seen as the one willing to say what needs to be done no matter how hard it is, but it did lead me to think about the degree to which I, and other economists, are influenced by our political leanings. To what extent do our politics determine our economics? ...

'Should Central Bankers Stick to Talking about Monetary Policy?'

Simon Wren-Lewis on whether "central bankers need to keep quiet about policy matters that are not within their remit":

Should central bankers stick to talking about monetary policy?: Few disagree that the recent remarks on corporate governance and investment made by Andy Haldane (Chief Economist at the Bank of England) are interesting, and that if they start a debate on short-termism that would be a good thing. As Will Hutton notes, Hillary Clinton has been saying similar things in the US. The problem Tony Yates has (and which Duncan Weldon, the interviewer, alluded to in his follow-up question) is that this is not obviously part of the monetary policy remit.
Haldane gave an answer to that, which Tony correctly points out is somewhat strained. ...
I have in the past said very similar things to Tony...
However I am beginning to have second thoughts about my own and Tony’s views on this. First, it all seems a bit British in tone. Tony worked at the Bank, and I have been involved with both the Bank and Treasury on and off, so we are both steeped in a British culture of secrecy. I do not think either of us are suggesting that senior Bank officials should never give advice to politicians, so what are the virtues of keeping this private? In trying to analyse how policy was made in 2010, it is useful to have a pretty good idea of what advice the Bank’s governor gave politicians because of what he said in public, rather than having to guess. ...
It is often said that central bankers need to keep quiet about policy matters that are not within their remit as part of an implicit quid pro quo with politicians, so that politicians will refrain from making public their views about monetary policy. Putting aside the fact that the ECB never got this memo, I wonder whether this is just a fiction so that politicians can inhibit central bankers from saying things politicians might find awkward (like fiscal austerity is making our life difficult). In a country like the UK with a well established independent central bank, it is not that clear what the central bank is getting out of this quid pro quo. And if it stops someone with the wide ranging vision of Haldane from raising issues just because they could be deemed political, you have to wonder whether this mutual public inhibition serves the social good.

The danger is that the Fed will become politicized as a result of taking sides on hotly debated political/policy questions. This is from a post in February of 2007:

...Should the Federal Reserve Chair talk only about matters directly related to monetary policy, or is it okay to discuss broader issues such as inequality, minimum wages, and Social Security without making the direct connection to monetary policy evident?...:

Willem Buiter: Martin's Column "Why America will need some elements of a welfare state", refers extensively to a recent speech by Ben Bernanke...

I believe it is a serious mistake for central bankers to express public views on politically contentious issues outside their mandates. The mistake is no less serious for being made so commonly by central bankers all over the world.

Central bank Governors have a lengthy and unfortunate track record of holding forth in public on matters that are outside the domains of their mandate (in the case of the Fed, monetary policy and financial stability)... With the exception of the Governors of the Bank of England and the Reserve Bank of New Zealand, every Governor on the block appears to want to share his or her views on necessary or desirable fiscal, structural and social reforms. Examples are social security reform and the minimum wage, subjects on which Alan Greenspan liked to pontificate when he was Chairman of the Board of Governors of the Federal Reserve System. Jean-Claude Trichet cannot open his mouth without some exhortation for fiscal restraint or structural reform rolling out. In the case of Chairman Bernanke's speech, equality of opportunity, income distribution, teenage pregnancy and welfare dependency are clearly not part of the (admittedly broad) three-headed mandate of the Fed: maximum employment, stable prices and moderate long-term interest rates. ...

When the Head of a central bank becomes a participant, often a partisan participant, in public policy debates on matters beyond the central bank's mandate..., the institution of the central bank itself is politicised and put at risk of becoming a partisan-political football. This puts at risk the central bank's operational independence in the management of monetary policy and in securing financial stability.

Central bankers, Mr. Bernanke included, should 'stick to their knitting' (if I may borrow Alan Blinder's phrase). Being the head of an institution with the national and global visibility of the Fed or the ECB gives one an unparalleled platform for addressing whatever one considers the great issues of the time. The temptation to climb that unique pulpit must be near-irresistible. Nevertheless, unless the text for the sermon concerns monetary policy or financial stability, that temptation is to be resisted in the interest of the institutional integrity and independence of the central bank.

As I've said before, I agree.

Fiscal policy has a clear connection to monetary policy through the government budget constraint, and there are also times -- e.g. recently -- when monetary policy needs the help of fiscal policy (if the Fed is forced to shoulder the entire burden, it can bring other risks). So I have no problem with the Fed chair raising fiscal policy issues (as Bernanke did, though not forcefully enough perhaps). I have a bit more trouble when the topic is inequality (e.g. Yellen's big speech on this -- and the subsequent reaction from the right). It's harder to see how that is connected to the Fed's policy mandate, and with Republicans already out to take away as much of the Fed's powers as they can, it was a bad time to tick them off.

Maybe this is too cautious. Perhaps Federal Reserve officials should feel free to address whatever topic they'd like. But the Fed's independence was instrumental during the Great Recession -- without it, monetary policy would have been as terrible as fiscal policy and things would have been much worse -- and I'd rather not take any risks.

Is Content Aggregation Harmful?

This is from the NBER (Project Syndicate, are you listening?):

Content Aggregation by Platforms: The Case of the News Media, by Lesley Chiou and Catherine Tucker, NBER Working Paper No. 21404, July 2015: ... In recent years, the digitization of content has led to the prominence of platforms as aggregators of content in many economically important industries, including media and Internet-based industries (Evans and Schmalensee, 2012).
These new platforms consolidate content from multiple sources into one place, thereby lowering the transactions costs of obtaining content and introducing new information to consumers. ... For these reasons, platforms have attracted considerable legal and policy attention. ...
Our results indicate that ... the traffic effect is large, as aggregators may guide users to new content. We do not find evidence of a scanning effect...
Our empirical distinction between a scanning effect where the aggregator substitutes for original content and a traffic effect where the aggregator is complementary, is useful for analyzing the potential policy implications of such business models. The fact we find evidence of a "traffic effect" even with a relatively large amount of content on an aggregator, is perhaps evidence that the "fair use" exemptions often relied on by such sites are less potentially damaging to the original copyright holder than often thought.

On the comment that the benefits outweigh the harm "even with a relatively large amount of content on an aggregator," when I post an entire article, as I did yesterday with this Vox EU piece, a surprisingly high percentage of you still click through to the original.

With video, at least in most cases, there is code available to put the video on your site. You play it and it has ads, branding, etc. I've always thought (or maybe hoped) content providers should do the same thing. Provide an embed button that allows me to duplicate an article -- it would come with ads, links to other content on their site, etc. -- on my site. Reads of the article would go way up (not from just my site, I mean if they allowed everyone to do this), and it would increase the number of people who see ads associated with their content (so they could charge more).

'Are We Overestimating Inflation (Again?)'

Cecchetti & Schoenholtz:

Are we overestimating inflation (again?): Twenty years ago, a group of experts – the “Boskin Commission” – concluded that the U.S. consumer price index (CPI) systematically overstated inflation by 0.8 to 1.6 percentage points each year. Taking these findings to heart, the Bureau of Labor Statistics (BLS) got to work reducing this bias, so that by the mid-2000s, experts felt it had fallen by as much as half a percentage point.
We bring this up because there is a concern that as a consequence of the way in which we measure information technology (IT), health care, digital content and the like, the degree to which conventional indices overestimate inflation may have risen. ...
When indices like the consumer price index (CPI) or the personal consumption expenditure price index (PCE) persistently overstate inflation, there are important consequences. So long as the upward bias is constant, central bankers can (and do) modify their inflation targets. Yet, these price indexes also are used to adjust entitlement benefits without correcting for any persistent bias. And, they can have an important impact on public discourse. In particular, upward bias means that the median real wage may have risen substantially over past decades, in contrast to reported stagnation.
If the overstatement of inflation has increased during the past decade, this also has profound consequences. For one thing, the reported slowdown in annual productivity growth – from something like 2½% in the decade prior to the crisis to about 1% today – could be more apparent than real. For another, true inflation may be even further below the Federal Reserve’s long-run objective of 2% on the PCE than current readings imply.
There is good reason to think that the price mismeasurement problem has gotten worse, but quantifying that deterioration is another thing. The impact on inflation may turn out to be small – perhaps an extra ¼% annually – leaving it well within the range of uncertainty that the Boskin Commission highlighted 20 years ago. ...

After presenting their analysis, they end with:

So, what’s the bottom line? We have little doubt that inflation has been overstated for decades. That means that the rise of U.S. real output, real income, productivity, and living standards has been understated materially over the long run. In recent years, IT price mismeasurement probably has worsened this growth and productivity bias significantly. But the potential impact of IT mismeasurement on measures of consumer price inflation – which has been the source of much discussion – is small compared to what a worsening bias in health care prices would imply.

[There is a large controversy surrounding the Boskin report that I am ignoring.]

Links for 07-28-15

Monday, July 27, 2015

Paul Krugman: Zombies Against Medicare

Despite what you might hear from conservatives, Medicare is "eminently sustainable":

Zombies Against Medicare, by Paul Krugman, Commentary, NY Times: Medicare turns 50 this week, and it has been a very good half-century. Before the program went into effect, Ronald Reagan warned that it would destroy American freedom; it didn’t, as far as anyone can tell. What it did do was provide a huge improvement in financial security for seniors and their families, and in many cases it has literally been a lifesaver as well.
But the right has never abandoned its dream of killing the program. So it’s really no surprise that Jeb Bush recently declared that while he wants to let those already on Medicare keep their benefits, “We need to figure out a way to phase out this program for others.” ...
The ... reason conservatives want to do away with Medicare has always been political: It’s the very idea of the government providing a universal safety net that they hate, and they hate it even more when such programs are successful. But ... they usually shy away from making their real case...
What Medicare’s would-be killers usually argue, instead, is that the program as we know it is unaffordable — that we must destroy the system in order to save it... And the new system they usually advocate is ... vouchers that can be applied to the purchase of private insurance.
The underlying premise here is that Medicare as we know it is incapable of controlling costs, that only the only way to keep health care affordable going forward is to rely on the magic of privatization.
Now, this was always a dubious claim. .... In fact, Medicare costs per beneficiary have consistently grown more slowly than private insurance premiums... Indeed, Medicare spending keeps coming in ever further below expectations...
Right now is, in other words, a very odd time to be going on about the impossibility of preserving Medicare, a program whose finances will be strained by an aging population but no longer look disastrous. One can only guess that Mr. Bush is unaware of all this, that he’s living inside the conservative information bubble, whose impervious shield blocks all positive news about health reform.
Meanwhile, what the rest of us need to know is that Medicare at 50 still looks very good. It needs to keep working on costs, it will need some additional resources, but it looks eminently sustainable. The only real threat it faces is that of attack by right-wing zombies.

'Poor Little Rich Kids? The Determinants of the Intergenerational Transmission of Wealth'

Genes are not as important as people think:

Poor Little Rich Kids? The Determinants of the Intergenerational Transmission of Wealth, by Sandra E. Black, Paul J. Devereux, Petter Lundborg, and Kaveh Majlesi, NBER Working Paper No. 21409 Issued in July 2015: Wealth is highly correlated between parents and their children; however, little is known about the extent to which these relationships are genetic or determined by environmental factors. We use administrative data on the net wealth of a large sample of Swedish adoptees merged with similar information for their biological and adoptive parents. Comparing the relationship between the wealth of adopted and biological parents and that of the adopted child, we find that, even prior to any inheritance, there is a substantial role for environment and a much smaller role for genetics. We also examine the role played by bequests and find that, when they are taken into account, the role of adoptive parental wealth becomes much stronger. Our findings suggest that wealth transmission is not primarily because children from wealthier families are inherently more talented or more able but that, even in relatively egalitarian Sweden, wealth begets wealth.

[Open link]

'Debt Miracle: Why the Country that Borrowed the Most Industrialized First'

"When we consider the dangers of debt in today’s world, we should keep an eye on its potential benefits as well.":

Debt miracle: Why the country that borrowed the most industrialized first, by Jaume Ventura and Hans-Joachim Voth, Vox EU: Towering debts, rapidly rising taxes, constant and expensive wars, a debt burden surpassing 200% of GDP. What are the chances that a country with such characteristics would grow rapidly? Almost anyone would probably say ‘none’.
And yet, these are exactly the conditions under which the Industrial Revolution took place in Britain. Britain’s government debt went from 5% of GDP in 1700 to over 200% in 1820, it fought a war in one year out of three (most of them for little or no economic gain), and taxes increased rapidly but not enough to keep pace with the rise in spending.
Figure 1 shows how war drove up spending and led to massive debt accumulation – the shaded grey areas indicate wars, and they are responsible for almost all of the rise in debt. Over the same period, Britain moved a large part of its population out of agriculture and into industry and services – out of the countryside and into cities. Population grew rapidly, and industrial output surged (Crafts 1985). As a result, Britain became the first country to break free from the shackles of the Malthusian regime.

Figure 1. Debt accumulation and government expenditure in the UK, 1690-1860

Vothjuly15fig1

Until now, scholars mostly thought of the effect of government borrowing on growth as either neutral or negative. One prominent view held that investment in private industry would have been higher had Britain fought and borrowed less (Williamson 1984). Another argument is that private savings decisions undid the potentially negative effects of massive borrowing – because debt eventually has to be repaid, private agents anticipated rising taxes in the future and neutralized the effects of debt accumulation (Barro 1990).
The revolution that wasn’t
In a recent paper, we argue that Britain’s borrowing binge was actually good for growth (Ventura and Voth 2015). To understand why massive debt accumulation may have accelerated the Industrial Revolution, we first consider what should have happened in an economy where entrepreneurs suddenly start to exploit a new technology with high returns. Typically, we would expect capital to chase these investment opportunities – anyone with money should have tried to put their savings into new cotton factories, iron foundries and ceramics manufacturers. Where they didn’t have the expertise to invest directly, banks and stock companies should have recycled funds to direct savings to where returns where highest.
This is not what happened. Financial intermediation was woefully inadequate – it failed to send the money where it should have gone. As one prominent historian of the British Industrial Revolution argued:
“the reservoirs of savings were full enough, but conduits to connect them with the wheels of industry were few and meagre … surprisingly little of [Britain’s] wealth found its way into the new industrial enterprises ….” (Postan 1935).
There were many reasons for this, but deliberate financial repression by the government was one of them. Usury limits, the Bubble Act, the Six Partner Rule that limited the size of banks – all of them were designed to stifle private intermediation, in part so as to facilitate access to funds for the government (Temin and Voth 2013).
Without effective intermediation, new sectors had to self-finance – rates of return stayed high because so little fresh capital entered to chase the sky-high returns. Allen calculated that the profit rate for capital rose from 10% in the 1770s to over 20% by the 1830s – capital’s share of national income more than doubled (Allen 2009).
Why debt helped
The inefficiency of private intermediation is crucial for debt to play a beneficial role. By issuing bonds on a massive scale, the government effectively pioneered a way – unintentionally – to put money in the pockets of entrepreneurs in the new sectors.
How did it do that? Before the availability of government debt, Britain’s rich and mighty – the nobility – overwhelmingly invested in land and land improvements. Status was closely tied to land, but improving it was not a profitable enterprise. Many forms of investment yielded a return of 2% of less. No wonder that noblemen were disenchanted with landed investment: By the 1750s, the first nobles were switching massively out of land and into government debt. The Prime Minister Sir Robert Peel advised: “every landowner ought to have as much property (as his estate) in consols or other securities…” (Habbakuk 1994). Many nobles obliged, shifting into an asset with a superior risk-return profile. As Lord Monson put it: “What an infernal bore is landed property. No certain income can be reckoned upon. I hope your future wife will have consols. . . ” (Thompson 1963).
The shift from investing in liming, marling, draining, and enclosure into government debt liberated resources – labor that could no longer be profitably employed in the countryside had to look for employment elsewhere. Because so much of English agricultural labor was provided by wage laborers, the switch to government debt pushed workers off the land. Unsurprisingly, wages failed to keep pace with output; real wages, adjusted for urban disamenities, probably fell over the period 1750-1830. What made life miserable for the workers, as eloquently described by Engels amongst others, was a boon to the capitalists. Their profit rates continued to rise as capital received an ever-larger share of the pie – while the share of national income going to labor and land contracted. Higher profits spelled more investment in new industries, and Britain’s industrial growth accelerated.
By putting debt at the center of our interpretation of the Industrial Revolution, we can provide a unified explanation for a number of features that have so far seemed puzzling. Growth was relatively slow, especially in the beginning (Crafts 1985) – but technological change was probably quite rapid (Temin 1997). Government borrowing slowed capital formation on impact – but structural change was rapid over the period as a whole. Rates of return were high in industry, but little capital chased these returns. Wages failed to keep up with productivity despite the rapid move out of the countryside and into the cities. By emphasizing how government debt issuance ‘healed’ the negative consequences of financial frictions, we can jointly explain rapid structural change and slow growth; rapid technological change and poor wage growth; massive government borrowing and the first take-off into sustained growth.
Good-bye to Downton
The issuance of government debt also accelerated social change – the rise of the capitalists and the decline of nobility. Without it, rates of profit in industry would have been less, and the decline and fall of the nobility as a dominant economic force would have taken much longer.
The solution that would have ensured the fastest growth – a much better financial system – would have preserved England’s social hierarchy entirely. Financial investment from the nobility would have flowed into new sectors via banks and the stock market, allowing the top 1% to earn high returns. The rise of the capitalists would have been long-delayed or been avoided altogether.
The bigger picture
How much of the situation in industrializing England has any relevance for the world as it is now? Is this a tale from a distant island and period of which we know little – to paraphrase Chamberlain – or does it hold lessons for the present? Financial frictions are still very prominent even in the most developed countries today; changing the profitability of revolutionary sectors should have first-order effects on the long-run rate of growth. The issuance of government debt may still crowd out investment that is, overall, inefficient.
These efficiency-enhancing effects of government debt may be all the more important in developing countries. There, the added benefits of debt that we did not discuss – such as providing a safe store of value, and a certain source of liquidity (Holmstrom and Tirole 1998) – may tilt the overall scoresheet even more in favor of government borrowing. None of this is to say that debts may not become excessive (Reinhart and Rogoff 2009) – but when we consider the dangers of debt, we should keep an eye on its potential benefits as well.
References
Allen, R (2009), “Engel’s pause: A pessimist’s guide to the British Industrial Revolution”, Explorations in Economic History 46 (2): 418–35.
Barro, R J (1987), “Government spending, interest rates, prices, and budget deficits in the United Kingdom, 1701–1918”, Journal of Monetary Economics 20 (2): 221–47.
Crafts, N F R (1985), British Economic Growth during the Industrial Revolution, Oxford: Oxford University Press.
Habakkuk, H J (1994), Marriage, Debt, and the Estates System: English Landownership, 1650-1950, Clarendon Press.
Holmstrom, B R, and J Tirole (1998), “Private and Public Supply of Liquidity”, Journal of Political Economy 106(1): 1-40.
Postan, M M (1935), “Recent trends in the accumulation of capital”, The Economic History Review 6 (1): 1–12.
Temin, P (1997), "Two views of the British industrial revolution", The Journal of Economic History 57(1): 63-82.
Temin, P and H-J Voth (2013), Prometheus Shackled: Goldsmith Banks and England’s Financial Revolution After 1700, Oxford University Press.
Thompson, F M L (1963), “English landed society in the nineteenth century”, English Landed Society in the Nineteenth Century.
Reinhart, C M, and K Rogoff (2009), This Time is Different, Princeton University Press.
Williamson, J G (1984), "Why was British growth so slow during the industrial revolution?" The Journal of Economic History 44(3): 687-712.
Ventura, J and H-J Voth (2015), “Debt into growth: How government borrowing accelerated the Industrial Revolution”, CEPR DP No. 10652.

Links for 07-27-15

Sunday, July 26, 2015

'The F Story about the Great Inflation'

Simon Wren-Lewis:

The F story about the Great Inflation: Here F could stand for folk. The story that is often told by economists to their students goes as follows. After Phillips discovered his curve, which relates inflation to unemployment, Samuelson and Solow in 1960 suggested this implied a trade-off that policymakers could use. They could permanently have a bit less unemployment at the cost of a bit more inflation. Policymakers took up that option, but then could not understand why inflation didn’t just go up a bit, but kept on going up and up. Along came Milton Friedman to the rescue, who in a 1968 presidential address argued that inflation also depended on inflation expectations, which meant the long run Phillips curve was vertical and there was no permanent inflation unemployment trade-off. Policymakers then saw the light, and the steady rise in inflation seen in the 1960s and 1970s came to an end.
This is a neat little story, particularly if you like the idea that all great macroeconomic disasters stem from errors in mainstream macroeconomics. However even a half awake student should spot one small difficulty with this tale. Why did it take over 10 years for Friedman’s wisdom to be adopted by policymakers, while Samuelson and Solow’s alleged mistake seems to have been adopted quickly? Even if you think that the inflation problem only really started in the 1970s that imparts a 10 year lag into the knowledge transmission mechanism, which is a little strange.
However none of that matters, because this folk story is simply untrue. There has been some discussion of this in blogs (by Robert Waldmann in particular - see Mark Thoma here), and the best source on this is another F: James Forder. There are papers (e.g. here), but the most comprehensive source is now his book, which presents an exhaustive study of this folk story. It is, he argues, untrue in every respect. Not only did Samuelson and Solow not argue that there was a permanent inflation unemployment trade-off that policymakers could exploit, policymakers never believed there was such a trade-off. So how did this folk story arise? Quite simply from another F: Friedman himself, in his Nobel Prize lecture in 1977.
Forder discusses much else in his book, including the extent to which Friedman’s 1968 emphasis on the importance of expectations was particularly original (it wasn’t). He also describes how and why he thinks Friedman’s story became so embedded that it became folklore....

Links for 07-26-15

Saturday, July 25, 2015

'The Rise in Obesity'

From Vox EU (and in today's links), can economic factors explain the rise in obesity?:

Changing economic factors and the rise in obesity: The dramatic increase in obesity has raised the question of whether economic incentives can explain this trend. ...
Of the 27 economic factors, two stand out as having the largest effects. First is the increase in restaurants per capita, which explains 12%, 14%, and 23% of the increases in BMI, obesity, and severe obesity, respectively. Increased availability of restaurant food would likely encourage substitution away from home-cooked meals to relatively unhealthy restaurant meals. Furthermore, fast food is not the lone culprit. When we split the restaurant variable into fast-food and full-service restaurants, we find similar effects for each type.
The second major contributor is the increase in superstores and warehouse clubs per capita, which accounts for 17%, 16%, and 24% of the growth in body mass index, obesity, and severe obesity. The superstore variable combines Walmart Supercenters with the warehouse club chains Costco, Sam’s Club, and BJ’s Wholesale Club. A possible explanation for the impact of these stores on obesity is that they sell food at discounts of around 20% relative to traditional grocers. Alternatively, buying food in bulk at warehouse clubs could contribute to overeating. However, when decomposing the superstore variable, Walmart Supercenters are found to have roughly the same effect as warehouse clubs. Since Walmart Supercenters sell food in traditional package sizes, this reduces the likelihood that bulk buying is a primary explanation.
This analysis suggests that variables related to the costs of eating – particularly Supercenter/warehouse club expansion and increasing numbers of restaurants – are leading drivers of the rise in obesity occurring since the early 1980s. However, the source of these effects remains somewhat uncertain. One possibility, previously discussed, is that they lower food prices, particularly for energy-dense food products and restaurant meals, so that the utility-maximising level of weight has increased. An alternative is that the expansion of Supercenters/warehouse clubs and restaurants has reduced time costs because of the greater availability of such foods. When combined with time-inconsistent preferences (i.e. the inability to follow through on previously made plans) this could lead to weight gains beyond utility-maximising levels. Consistent with this, we find that Supercenter/warehouse club densities are correlated with increases in weight loss attempts, which may reflect eating mistakes.
While restaurants, Supercenters, and warehouse clubs appear to have contributed substantially to the rise in obesity, this does not necessarily mean that they are bad for society. The increased availability and affordability of food brought about by these businesses undoubtedly have substantial benefits for consumers. However, such progress comes at a cost. Future research should investigate the reasons why restaurants and superstores contribute to obesity with the aim of helping policymakers develop appropriately targeted solutions.

'The Old Man and the CPI'

Paul Krugman:

The Old Man and the CPI: I don’t watch financial news, but CNBC was on in the gym, so I was treated to a long ad from Ron Paul, who wants you to buy his video explaining the coming crisis brought on by loose money. And I found myself thinking about the remarkable fact that there really are people who will buy that video.
After all, Ron Paul has been making the same prediction year after year — in fact, he’s been making this prediction at least since 1981! — and has been wrong year after year. It’s hard to think of a doctrine that has been as thoroughly refuted by events as goldbug economics. ...
The basic mindset of the kind of people who pay Ron Paul for his economic advice is pretty clear: they’ve made some money over the course of their lives, they believe that all of it reflects their own virtue, and they think they know from that experience what it takes to create wealth. They hear that the Fed is printing money, and it sounds to them like a violation of both the laws of economics and morality — and they surely think of it as a plot to take away their completely earned gains and give them to Those People (hence the whiteness issue).
You can try as hard as you like to tell such people that monetary policy is mainly a technical problem, that the Fed isn’t giving money away, and that predictions of runaway inflation have been utterly wrong; it will make no difference. You can point out that they would have done a much better job of investing if they had listened to the MIT gang; sorry, we’re just not their kind of people.
I’d say it’s sad, but I find it hard to feel much sympathy for the marks of this particular scam. Then again, that’s probably why they will never, ever listen to what I have to say.

There are also silverbugs:

LBJ signed the 1965 act,... the president noted, “our coinage of dimes, and quarters, and half dollars, and dollars have contained 90% silver.” Not any more: The new dimes and quarters would “contain no silver.” Instead they would be “composites, with faces of the same alloy used in our 5-cent piece that is bonded to a core of pure copper.” The new half dollar would have 80% silver on the outside and 19% silver inside.

... The value of the dollar started sinking after the 1965 coinage act, and by 1980 the dollar—so long valued at 0.77 ounces of silver—plunged to 0.02 ounces of silver. Today it is valued at 0.06 ounces of silver.
The pre-1965 silver coins have mostly disappeared from circulation. Misers who try to spend silver or gold coins they have hoarded are subject to a capital-gains tax. Monetary purists, incidentally, prefer to speak of “spending” gold and silver, rather than “selling” it, because gold and silver are the true constitutional money.
The U.S. Constitution prohibits states from coining money themselves or making anything but gold or silver coins legal tender. ...
A ... radical approach would be the Free Competition in Currency Act, originally the brainchild of Ron Paul, the former Texas congressman, and offered again in the last Congress by Rep. Paul Broun (R., Ga.). It adopts the idea of the late Nobel laureate Friedrich Hayek. This measure would end the legal tender laws, halt capital-gains taxation on gold and silver, and permit private coinage.

One important characteristic of a medium of exchange is that its supply can be controlled in way that allows shocks to the supply and demand for the medium of exchange to be offset. Otherwise, the value will potentially vary quite a bit over time. (E.g. the price of silver went from around $10 near the end of 1972 to over $100 at the beginning of 1980, followed by a large fall back to around $10 at the beginning of 1990. In 2001 it fell to around $6, then spiked to around $50 by 2011, then fell again to around $15 today, and all indications are that it will fall further.) Such large variations in purchasing power of the medium of exchange are highly undesirable -- this is what the gold and silver bugs object to, periods of rapid inflation and deflation (in addition to the variation in purchasing power, it creates considerably uncertainty about the future -- what will be the value of the medium of exchange when loans are repaid? -- and harms future investment).

One way to control the supply is to have it be essentially fixed, as with bitcoin, but that is not sufficient. As we've seen with bitcoin, variations in demand can have a huge impact on value. Similarly for precious metals. Supply can change with mining, etc., but it changes slowly, and variations in demand can lead to wildly fluctuating values. The solution is to have some central authority -- let's call if "the Fed" -- with the ability to alter the supply of the commodity quickly so as to keep the price stable.

So the choice is to have a medium of exchange whose value can vary significantly, suddenly and unexpectedly, or have a central authority intervene to stabilize the price (by stockpiling or selling the medium of exchange to offset shocks to the supply and demand for the commodity). The point is that if changes in the value of a medium of exchange is the concern, as it appears to be, then switching to a commodity money does not solve the problem of needing a central authority to keep the value stable.

Survey of Long-Term Interest Rates

The conclusion of a long White House report on long-term interest rates:

Image1

Image2

V. Conclusion Many factors play roles in the determination of long - term interest rates, including the rate of productivity growth, beliefs about future risks, consumer preferences , demographic shifts , and the stance s of monetary and fiscal policy. As markets have become globally integrated, conditions in foreign markets are increasingly important for U . S . long - term interest rates. Over the past two decades, long - term interest rates have been falling worldwide. An explanation for why they are so low — and whether those low levels will persist — i s one of the most difficult questions facing macroeconomists today.
 Interest rates are jointly determined by the supply of saving and the demand for investment. While it is difficult to make strong predictions, this report argues that there are a number of reasons to think that the global saving supply curve has shifted outward , a development that would help to keep equilibrium interest rates low . As with any price in the economy, a low price is beneficial to some and has negative ramifications for others. Low long - term interest rates make it cheaper for governments to finance their debt burdens. By reducing the cost of borrowing, lower long - term interest rates create more fiscal sp ace for government programs, including infrastructure investment, reducing the cost of expansionary fiscal policy. Lower long - term interest rates should also reduce the cost of borrowing by the private sector, encouraging investments that can enhance growth in the future. However, if rates are low because of subdued expectations about future growth, investment is unlikely to be robust .
For savers, lower equilibrium long - term interest rates would affect the return to savings, the cost of borrowing for homeownership, and lifecycle decisions about when to retire and the time pattern of consumption.
Finally, lower long - term interest rates could have important implications for monetary policy, particularly regarding the zero lower bound for short - term interest rates and specific policy tools. Market participants , in turn, may take these factors into effect when making economic forecasts or planning consumption and investment.
Ultimately, interest rates reflect fundamental macroeconomic conditions and there is no “optimal” rate of interest. The goal of policy should not be to target a particular rate, but to support long - run growth, maintain price stability, and strengthen the resilience of financial markets .

Links for 07-25-15

Friday, July 24, 2015

'Raise the Gas Tax Already'

James Surowiecki:

Raise the Gas Tax Already: Senate Majority Leader Mitch McConnell is a conservative Republican. Senator Barbara Boxer is a liberal Democrat. So the fact that they’ve worked together to come up with a plan to fund highway spending for the next three years might seem like a good thing, a rare moment of bipartisanship in a Congress riven by ideological hostility. And, in fact, you could see the thousand-page bill they’ve produced as, in the words of the Times, “real progress,” except for one thing: their complicated, jury-rigged plan is only necessary because of the continued refusal by Congress to embrace the obvious, economically sensible solution to highway funding, namely raising the gas tax. ...
The fundamental problem, of course, is that raising taxes, no matter how economically sensible those taxes might be, is anathema to a huge swath of the Republican Party. ... Opposition to higher income taxes has some theoretical justification: higher marginal rates discourage people from working more and investing. ... But no such argument exists against the gas tax: all it does, in essence, is ask drivers to pay for the roads they use. It’s not even fair to say that keeping this tax at its current level is a check on big government, since most federal highway spending now goes toward rebuilding and repairing roads—maintenance that even conservatives recognize we must do.
Highway revenue has to be raised somehow. Congress should show some political spine, discard the Rube Goldberg funding schemes, and stop treating all taxes as bad ones.

As noted in the article, there are also, of course, environmental benefits from an increase in gas taxes.

'What Is Wrong with the West’s Economies?'

This is from Edmund Phelps. It was kind of hard to highlight the main points in brief extracts, so you may want to take a look at the full article:

What Is Wrong with the West’s Economies?: What is wrong with the economies of the West—and with economics? ...
Many of us in Western Europe and America feel that our economies are far from just...
With little or no effective policy initiative giving a lift to the less advantaged, the jarring market forces of the past four decades—mainly the slowdowns in productivity that have spread over the West and, of course, globalization, which has moved much low-wage manufacturing to Asia—have proceeded, unopposed, to drag down both employment and wage rates at the low end. The setback has cost the less advantaged not only a loss of income but also a loss of what economists call inclusion—access to jobs offering work and pay that provide self-respect. And inclusion was already lacking to begin with. ...
How might Western nations gain—or regain—widespread prospering and flourishing? Taking concrete actions will not help much without fresh thinking: people must first grasp that standard economics is not a guide to flourishing—it is a tool only for efficiency. Widespread flourishing in a nation requires an economy energized by its own homegrown innovation from the grassroots on up. For such innovation a nation must possess the dynamism to imagine and create the new—economic freedoms are not sufficient. And dynamism needs to be nourished with strong human values.
Of the concrete steps that would help to widen flourishing, a reform of education stands out. The problem here is not a perceived mismatch between skills taught and skills in demand. ... The problem is that young people are not taught to see the economy as a place where participants may imagine new things, where entrepreneurs may want to build them and investors may venture to back some of them. It is essential to educate young people to this image of the economy.
It will also be essential that high schools and colleges expose students to the human values expressed in the masterpieces of Western literature, so that young people will want to seek economies offering imaginative and creative careers. Education systems must put students in touch with the humanities in order to fuel the human desire to conceive the new and perchance to achieve innovations. This reorientation of general education will have to be supported by a similar reorientation of economic education.
We will all have to turn from the classical fixation on wealth accumulation and efficiency to a modern economics that places imagination and creativity at the center of economic life.

I'm skeptical that this is the answer to our inequality/job satisfaction problems.

'The Housing Market Still Isn’t Rational'

For the fans of Robert Shiller:

The Housing Market Still Isn’t Rational: Home prices have been climbing. They have risen 27 percent nationally since 2012, even more in places like San Francisco. But why worry? If you accept the efficient markets theory — and believe that real estate is an efficient market — then these prices are based on “new information,” even if you don’t know what that information is.
The problem with this kind of thinking is that the efficient markets theory is at best a half-truth, as a voluminous literature on market anomalies shows. What’s more, even that half-truth is grounded mainly in the stock market, which attracts professional investors who sometimes do make the market behave efficiently.
The housing market is another matter. It is far less rational than even the often irrational stock market...[explains why]...
The bottom line is that there is no reason to assume that the real estate market is even close to efficient. You may want to buy a house if you love it and can afford it. But remember that you cannot safely rely on “comparable sales” to judge that the price is fair. The market isn’t efficient enough for that.