Macroeconomic foundations made of sand

28 Feb, 2015 at 15:57 | Posted in Economics | Comments Off on Macroeconomic foundations made of sand

Olivier Blanchard, the IMF’s chief economist, recently wrote:

“We in the field did think of the economy as roughly linear, constantly subject to different shocks, constantly fluctuating, but naturally returning to its steady state over time. Instead of talking about fluctuations, we increasingly used the term “business cycle.” Even when we later developed techniques to deal with nonlinearities, this generally benign view of fluctuations remained dominant.”

o-OSTRICH-IN-THE-SAND-facebookThe models that macroeconomic practitioners developed reflected this essentially linear view. Blanchard went on to observe that although macroeconomists did not ignore the possibility of extreme tail risk events, they regarded them as a thing of the past in developed countries … If you get the policy settings right, linear models will work.

Except that they won’t. And that is because these models are not realistic views of how the economy actually works. Representative agents aren’t actually representative of anyone. Rational expectations are driven as much by emotion as logic …

Leaving banks out of economic models, or – worse – modelling their money-creating function incorrectly, made it impossible for mainstream economists to understand the significance of the build-up of credit that led to the financial crisis. The warnings came principally from people outside mainstream economics, particularly the followers of Hyman Minsky. After the crisis, Minsky’s “financial instability hypothesis”, long consigned to a dusty shelf in a dark cupboard, suddenly became hot news. Unsurprisingly, since we had just lived through something that looked very like a “Minsky moment”.

Clearly, the exclusion of the financial industry from models of the macroeconomy was a major omission. Equally clearly, the fact that most macroeconomists did not, and to a large extent still do not, understand the mechanisms by which money is created and circulated in the modern monetary economy, is a big, big problem. Central banks are now “adding” the financial sector to existing DSGE models: but this does not begin to address the essential non-linearity of a monetary economy whose heart is a financial system that is not occasionally but NORMALLY far from equilibrium. Until macroeconomists understand this, their models will remain inadequate …

Some of the most influential people in macroeconomics have spent their lives developing theories and models that have been shown to be at best inadequate and at worst dangerously wrong. Olivier Blanchard’s call for policymakers to set policy in such a way that linear models will still work should be seen for what it is – the desperate cry of an aging economist who discovers that the foundations upon which he has built his career are made of sand. He is far from alone.

Frances Coppola

Lördagsmorgon i P2 — ljuset i det musikaliska mörkret

28 Feb, 2015 at 15:31 | Posted in Varia | Comments Off on Lördagsmorgon i P2 — ljuset i det musikaliska mörkret

radioI dessa tider — när ljudrummet dränks i den kommersiella radions tyckmyckentrutade ordbajseri och fullständigt intetsägande melodifestivalskval — har man ju nästan gett upp.

Men det finns ljus i mörkret! I radions P2 går varje lördagmorgon ett vederkvickelsens och den seriösa musikens Lördagsmorgon i P2.

Så passa på och börja dagen med en musikalisk örontvätt och rensa hörselgångarna från kvarvarande musikslagg. Här kan man till exempel lyssna på musik av Vassilis Tsabropoulos, John Tavener, Gustav Mahler och Arvo Pärt. Att i tre timmar få lyssna till sådan musik ger sinnet ro och får hoppet att återvända. Tack public-service-radio!

Och tack Eva Sjöstrand. Att i tre timmar få lyssna till underbar musik och en programledare som har något att säga och inte bara låter foderluckan glappa hela tiden — vilken lisa för själen!
 

Molins fontän

28 Feb, 2015 at 10:11 | Posted in Varia | 4 Comments

 

Tillägnad alla gamla radikala vänner och kollegor som numera glatt traskar patrull och omfamnar allt de en gång i tiden hade modet att våga kritisera och ifrågasätta …

Milton Friedman’s anti-feminist feminism

27 Feb, 2015 at 14:58 | Posted in Economics, Politics & Society | 2 Comments

 

‘How I became a Keynesian’

26 Feb, 2015 at 18:06 | Posted in Economics | 3 Comments

Until [2008], when the banking industry came crashing down and depression loomed for the first time in my lifetime, I had never thought to read The General Theory of Employment, Interest, and Money, despite my interest in economics … I had heard that it was a very difficult book and that the book had been refuted by Milton Friedman, though he admired Keynes’s earlier work on monetarism. I would not have been surprised by, or inclined to challenge, the claim made in 1992 by Gregory Mankiw, a prominent macroeconomist at Harvard, that “after fifty years of additional progress in economic science, The General Theory is an outdated book. . . . We are in a much better position than Keynes was to figure out how the economy works.”

adaWe have learned since [2008] that the present generation of economists has not figured out how the economy works …

Baffled by the profession’s disarray, I decided I had better read The General Theory. Having done so, I have concluded that, despite its antiquity, it is the best guide we have to the crisis …

It is an especially difficult read for present-day academic economists, because it is based on a conception of economics remote from theirs. This is what made the book seem “outdated” to Mankiw — and has made it, indeed, a largely unread classic … The dominant conception of economics today, and one that has guided my own academic work in the economics of law, is that economics is the study of rational choice … Keynes wanted to be realistic about decision-making rather than explore how far an economist could get by assuming that people really do base decisions on some approximation to cost-benefit analysis …

Economists may have forgotten The General Theory and moved on, but economics has not outgrown it, or the informal mode of argument that it exemplifies, which can illuminate nooks and crannies that are closed to mathematics. Keynes’s masterpiece is many things, but “outdated” it is not.

Richard Posner

On prices and profits

25 Feb, 2015 at 19:10 | Posted in Economics | Comments Off on On prices and profits

a twistMuch recent discussion about potential price inflation seems to take as a given that it would be sparked by a pickup of wage growth. But looking at data from the non-financial corporate sector–which accounts for well more than half of all private-sector economic activity and for which rich data are available–what’s really striking about price growth since the end of the Great Recession is how much of it has been driven by risingprofits, not rising labor costs. In fact, labor costs have been essentially flat between the end of the Great Recession and the first quarter of 2014. Profits earned per unit sold, on the other hand, have been rising at an average annual growth rate of nearly 9% since the recovery’s beginning. To the degree that there is any inflationary pressure in the U.S. economy over that time, it is surely not coming from labor costs.

Josh Bivens

On knowledge and education

23 Feb, 2015 at 21:27 | Posted in Economics, Politics & Society | Comments Off on On knowledge and education

Education is a friend of mine. And it should be available and affordable for all. But … people insisting that educational failings are at the root of still-weak job creation, stagnating wages and rising inequality. This sounds serious and thoughtful. But it’s actually a view very much at odds with the evidence, not to mention a way to hide from the real, unavoidably partisan debate.

The education-centric story of our problems runs like this: We live in a period of unprecedented technological change, and too many American workers lack the skills to cope with that change. This “skills gap” is holding back growth, because businesses can’t find the workers they need. It also feeds inequality, as wages soar for workers with the right skills… So what we need is more and better education … It’s repeated so widely that many people probably assume it’s unquestionably true. But it isn’t … there’s no evidence that a skills gap is holding back employment.

Paul Krugman


Although Krugman doesn’t name him explicitly, Harvard economist and George Bush advisor Greg Mankiw is one of those mainstream economists who has been appealing to the education variable to explain the rising inequality we have seen for the last 30 years in both the US and elsewhere in Western societies. Mankiw writes:

Even if the income gains are in the top 1 percent, why does that imply that the right story is not about education?

If indeed a year of schooling guaranteed you precisely a 10 percent increase in earnings, then there is no way increasing education by a few years could move you from the middle class to the top 1 percent.

But it may be better to think of the return to education as stochastic. Education not only increases the average income a person will earn, but it also changes the entire distribution of possible life outcomes. It does not guarantee that a person will end up in the top 1 percent, but it increases the likelihood. I have not seen any data on this, but I am willing to bet that the top 1 percent are more educated than the average American; while their education did not ensure their economic success, it played a role.

To me this is nothing but really one big evasive attempt at trying to explain away a very disturbing structural shift that has taken place in our societies. And change that has very little to do with stochastic returns to education. Those were in place also 30 or 40 years ago. At that time they meant that perhaps a CEO earned 10-12 times what “ordinary” people earns. Today it means that they perhaps earn 100-200 times  what “ordinary” people earns.

A question of education? No way! It is a question of  income and wealth increasingly being concentrated in the hands of a very small and privileged elite, greed and a lost sense of a common project of building a sustainable society.

 

Fiscal debt — what we should be aiming for

23 Feb, 2015 at 15:08 | Posted in Economics, Politics & Society | Comments Off on Fiscal debt — what we should be aiming for

 

Lynn Parramore: Do you think there are lessons in what has happened in the Eurozone for students of economics and the way the subject is taught?

Mario Seccareccia: Yes, indeed. Ever since the establishment of the modern nation-state in the late eighteenth and nineteenth centuries, the creation of the euro was perhaps the first significant experiment in modern times in which there was an attempt to separate money from the state, that is, to denationalize currency, as some right-wing ideologues and founders of modern neoliberalism, such as Friedrich von Hayek, had defended. What the Eurozone crisis teaches is that this perception of how the monetary system works is quite wrong, because, in times of crisis, the democratic state must be able to spend money in order to meet its obligations to its citizens. The denationalization or “supra-nationalization” of money with the establishment that happened in the Eurozone took away from elected national governments the capacity to meaningfully manage their economies. Unless governments in the Eurozone are able to renegotiate a significant control and access money from their own central banks, the system will be continually plagued with crisis and will probably collapse in the longer term.

Lynn Parramore

Voyage to Avalon

22 Feb, 2015 at 17:19 | Posted in Varia | Comments Off on Voyage to Avalon

 

Game of chicken

21 Feb, 2015 at 15:24 | Posted in Economics | Comments Off on Game of chicken

 

Wynne Godley on the euro project

21 Feb, 2015 at 13:07 | Posted in Economics, Politics & Society | 1 Comment

If a government stops having its own currency, it doesn’t just give up “control over monetary policy” as normally understood; its spending powers also become constrained in an entirely new way. If a government does not have its own central bank on which it can draw cheques freely, its expenditures can be financed only by borrowing in the open market in competition with businesses, and this may prove excessively expensive or even impossible, particularly under “conditions of extreme emergency.”

greece-feb12-bank__3197265k

If Europe is not to have a full-scale budget of its own under the new arrangements it will still have, by default, a fiscal stance of its own made up of the individual budgets of component states. The danger, then, is that the budgetary restraint to which governments are individually committed will impart a disinflationary bias that locks Europe as a whole into a depression it is powerless to lift.

Wynne Godley

(h/t Edward Fullbrook & Stephanie Kelton)

Greece — the perfect example of debt deflation

20 Feb, 2015 at 10:22 | Posted in Economics, Politics & Society | 1 Comment

 

irvingDeflationary policies are deflationary. To a large extent the deflation is caused by tight monetary and fiscal policies pursued by ECB. With a very defensive fiscal policy and a targeted inflation rate set at a very low level, real inflation has during the last couple of years been negative. Another consequence of the austere fiscal and monetary policies is that overall unemployment is stuck at an enormously high level.

This is deeply worrying.

So here’s a suggestion for reading …

Zoltan Pozsnar and Paul McCulley have written an absolutely splendid essay on what a liquidity trap means and why mainstream neoclassical economics has nothing to offer in way of solving the problems that it brings along – and why it is so important to get hold of the insights that Fisher, Keynes, and Minsky have given us on debt-deflation processes and liquidity traps:

A liquidity trap is a circumstance in which the private sector is deleveraging in the wake of enduring negative animal spirits caused by the bursting of joint asset price and credit bubbles that leave privatesector balance sheets severely damaged. In a liquidity trap the animal spirits of the private sector cannot be revived by a reduction in short-term interest rates because there is no demand for credit. This effectively means that conventional monetary policy does not work in a liquidity trap …

Deleveraging can be rational for an individual household. It can be rational for an individual corporation. It can be rational for an individual country. However, in the aggregate it begets the paradox of thrift1: what is rational at the microeconomic level is irrational at the community, or macroeconomic, level.

This is not to say that the private sector should not deleverage. It has to. It is a part of the economy’s healing process and a necessary first step toward a self-sustaining economic recovery.

However, deleveraging is a beast of a burden that capitalism cannot bear alone. At the macro level, deleveraging must be a managed process: for the private sector to deleverage without causing a depression, the public sector has to move in the opposite direction and re-lever by effectively viewing the balance sheets of the monetary and fiscal authorities as a consolidated whole.

Fiscal austerity does not work in a liquidity trap and makes as much sense as putting an anorexic on a diet. Yet, “diets” are the very prescriptions that fiscal austerians have imposed (or plan to impose) in the U.S., U.K. and Eurozone. Austerians fail to realize, however, that everyone cannot save at the same time and that in liquidity traps, the paradox of thrift and depression are fellow travelers that are functionally intertwined.

Historically, austerity has only worked when accompanied by monetary easing – where wealth effects and stronger private demand for credit helped offset the effects of fiscal austerity – and/or a weaker currency – which helped steal others’ demand.

In a liquidity trap, however, austerity cannot work because monetary policy is neither functioning correctly nor able offset lost demand, and weak currencies work only at a time of strong global demand and only for individual countries, not for several major countries at one time. Imposing austerity without potential offsets and at a time of weak global aggregate demand is deflationary, which makes deleveraging much harder, balance sheet repair much slower and recovery much less likely to achieve. In a liquidity trap, governments have no logical option but to borrow and to invest.

How could governments borrow more if government debt is also a problem everywhere? Would it not be irresponsible to increase borrowing at a time of record government debt levels? Fiscal austerians are quick to invoke age-old textbook orthodoxies: (1) that additional borrowing will be too much for future generations to handle, citing the law of Ricardian equivalence; (2) that increased borrowing will crowd out private sector borrowing and will most likely delay the economic recovery; and (3) that bond investors will stop buying and send yields higher.

However, in the topsy-turvy world of liquidity traps, these textbook orthodoxies do not apply, and acting irresponsibly relative to orthodoxy by increasing borrowing will do more good than harm. Austerians argue that reducing deficits and putting nations’ fiscal houses in order will help growth through confidence. However, Ricardian equivalence does not work in reverse! It is not confidence, but Godley’s tyranny of arithmetic that matters: someone simply has to borrow and invest to fill missing demand.

Crowding out, overheating and rising interest rates are also not likely to be a problem as there is no competition for funds from the private sector. For evidence, look no further than the impact of government borrowing on long-term interest rates in the U.S. during the Great Depression, or more recently, Japan …

Held back by concerns borne of these orthodoxies, however, governments are not spending with passionate purpose. They are victims of intellectual paralysis borne of inertia of dogma that, in the present circumstances, do not apply. As a result, their acting responsibly relative to orthodoxy and going forth with austerity may drag economies down the vortex of deflation and depression.

The importance of fiscal expansion and the impotence of conventional monetary policy measures in a liquidity trap have profound implications for the conduct of central banks. This is because in a liquidity trap, the fat tail risk of inflation is replaced by the fat tail risk of deflation. In turn, the fatness of the deflation tail is a function of the government’s willingness and ability to pump-prime, i.e. to borrow and spend.

The truth about relativity

19 Feb, 2015 at 15:39 | Posted in Economics | 1 Comment

What if you are single, and hope to appeal to as many attractive potential dating partners as possible at an upcoming singles event? My advice would be to bring a friend who has your basic physical characteristics (similar coloring, body type, facial features), but is slightly less attractive (—you). predictablyWhy? Because the folks you want to attract will have ahard time evaluating you with no comparables around. However, if you are compared with a “-you,” the decoy friend will do a lot to make you look better, not just in comparison with the decoy but also in general, and in comparison with all the other people around. It may sound irrational (and I can’t guarantee this), but the chances are good that you will get some extra attention.

Of course, don’t just stop at looks. If great conversation will win the day, be sure to pick a friend for the singles event who can’t match your smooth delivery and rapier wit. By comparison, you’ll sound great.

Now that you know this secret, be careful: when a similar but better-looking friend of the same sex asks you to accompany him or her for a night out, you might wonder whether you have been invited along for your company or merely as a decoy.

Great book that ought to be on every economist’s reading list.

Even a genius has to work hard

19 Feb, 2015 at 10:14 | Posted in Education & School | 1 Comment

Several years later I developed a broader theory of what separates the two general classes of learners—helpless versus mastery-oriented. I realized that these different types of students not only explain their failures differently, but they also hold different “theories” of intelligence. The helpless ones believe that intelligence is a fixed trait: you have only a certain amount, and that’s that. I call this a “fixed mind-set.” Mistakes crack their self-confidence because they attribute errors to a lack of ability, which they feel powerless to change. They avoid challenges because challenges make mistakes more likely and looking smart less so … Such children shun effort in the belief that having to work hard means they are dumb.

Your-Inner-GeniusThe mastery-oriented children, on the other hand, think intelligence is malleable and can be developed through education and hard work. They want to learn above all else. After all, if you believe that you can expand your intellectual skills, you want to do just that …

We validated these expectations in a study published in early 2007 … As we had predicted, the students with a growth mind-set felt that learning was a more important goal in school than getting good grades. In addition, they held hard work in high regard, believing that the more you labored at something, the better you would become at it. They understood that even geniuses have to work hard for their great accomplishments. Confronted by a setback such as a disappointing test grade, students with a growth mind-set said they would study harder or try a different strategy for mastering the material.

The students who held a fixed mind-set, however, were concerned about looking smart with less regard for learning. They had negative views of effort, believing that having to work hard at something was a sign of low ability …

EinstinePeople may well differ in intelligence, talent and ability. And yet research is converging on the conclusion that great accomplishment, and even what we call genius, is typically the result of years of passion and dedication and not something that flows naturally from a gift. Mozart, Edison, Curie, Darwin and Cézanne were not simply born with talent; they cultivated it through tremendous and sustained effort. Similarly, hard work and discipline contribute more to school achievement than IQ does.

Carol S. Dweck

Extremely important and far-reaching research indeed.

Being diagnosed a “gifted child” sure is a confidence boost. But it’s not always the blessing people so often assume. It can also blind you to the fact that even if you’re smart, there are other people who are also smart. People you can learn from them. Learning that makes brain neurons grow new connections. For some of us that insight — unfortunately — comes late in life.

Lucas’ bridge and the Ricardian equivalence fairy-tale

18 Feb, 2015 at 19:03 | Posted in Economics | 1 Comment

Imagine a Nobel Prize winner in physics, who in public debate makes elementary errors that would embarrass a good undergraduate. Now imagine other academic colleagues, from one of the best faculties in the world, making the same errors. It could not happen. However that is exactly what has happened in macro over the last few years.

Where is my evidence for such an outlandish claim? Well here is Nobel prize winner Robert Lucas:

Bridge_to_nowhere“But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder — the guys who work on the bridge — then it’s just a wash.  It has no first-starter effect.  There’s no reason to expect any stimulation.  And, in some sense, there’s nothing to apply a multiplier to.  (Laughs.)  You apply a multiplier to the bridge builders, then you’ve got to apply the same multiplier with a minus sign to the people you taxed to build the bridge.”

And here  is John Cochrane, also a professor at Chicago, and someone who has made important academic contributions to macroeconomic thinking:

“Before we spend a trillion dollars or so, it’s important to understand how it’s supposed to work.  Spending supported by taxes pretty obviously won’t work:  If the government taxes A by $1 and gives the money to B, B can spend $1 more. But A spends $1 less and we are not collectively any better off.”

Both make the same simple error. If you spend X at time t to build a bridge, aggregate demand increases by X at time t. If you raise taxes by X at time t, consumers will smooth this effect over time, so their spending at time t will fall by much less than X. Put the two together and aggregate demand rises.

The more interesting question for me is why the errors were made … I want to suggest two answers. The first is familiarity with models. I cannot imagine anyone who teaches New Keynesian economics, or who talked to people who teach New Keynesian economics, making this mistake … The second difference between physics and macro that could lead to more mistakes in the latter is ideology … When you are arguing out of ideological conviction, there is a danger that rhetoric will trump rigour … The problem too many macroeconomists have with fiscal stimulus lies not in opposing schools of thought, or the validity of particular theories, or the size of particular parameters, but instead with the fact that it represents intervention by the state designed to improve the working of the market economy. They have an ideological problem with countercyclical fiscal policy. But the central bank is part of the state, and it intervenes to improve how the economy works, so this ideological view would also mean that you played down the role of monetary policy in macroeconomics. So ideology may also help explain a lack of familiarity with the models central banks use to think about monetary policy. In short, an ideological view that distorts economic thinking can lead to mistakes.

Simon Wren-Lewis

In case your not yet persuaded, here’s another blog post describing what goes wrong  when people like Robert Lucas and those with similar views apply their models based on Ricardian equivalence:

[T]hink about what happens when a family buys a house with a 30-year mortgage.

Suppose that the family takes out a $100,000 home loan (I know, it’s hard to find houses that cheap, but I just want a round number). If the house is newly built, that’s $100,000 of spending that takes place in the economy. But the family has also taken on debt, and will presumably spend less because it knows that it has to pay off that debt.

But the debt won’t be paid off all at once — and there’s no reason to expect the family to cut its spending right now by $100,000. Its annual mortgage payment will be something like $6,000, so maybe you would expect a fall in spending by $6000; that offsets only a small fraction of the debt-financed purchase.

Now notice that this family is very much like the representative household in a Ricardian equivalence economy, reacting to a deficit financed infrastructure project like Lucas’s bridge; in this case the household really does know that today’s spending will reduce its future disposable income. And even so, its reaction involves very little offset to the initial spending.

How could anyone who thought about this for even a minute — let alone someone with an economics training — get this wrong? And yet as far as I can tell almost everyone on the freshwater side of this divide did get it wrong, and has yet to acknowledge the error.

Paul Krugman

Indeed — how can anyone get this wrong and make such ridiculously simple errors when arguing about fiscal stimulus?

Fiscal policy is not irrelevant. Ricardian equivalence is.

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