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Tuesday, July 01, 2014
I will assume that unemployment is a function of actual inflation minus expected inflation. I will also assume that people are smart enough that no policy will cause them to make forecast errors of the same sign period after period after period.
Friedman's conclusion follows if there is the additional assumption that expected inflation is a constant plus a linear function of lagged inflation. In this case, unless the coefficients sum to one and the constant is zero, it is possible to cause a constant non zero forecast error. It can't be that people are dumb enough to stick with a constant plus a linear function with coefficients that sum to anything but one if that rule is exploited to make surprise inflation always always positive.
However, I know of no one who ever wrote that such a simple model of expectations is the truth. Rather some people including Cagan, Friedman, Tobin, and Solow asserted that something like that is a useful approximation at some times in some places. Many authors expressed belief in a more complicated story in which inflation expecttions are anchored if inflation is low and variable but not anchored if inflation is high and/or steady.
I think such expectations can be modelled either as a result of boundedly rational learning with hypothesis testing or ration Bayesian updating. I will try to do so (famous last words of this post which sensible readers will read).
The monetary authority will, in fact, stick to a simple rule (but agents do *not* know that the rule never changes). It can target inflation and is tempted to trick firms into supplying more than they would under perfect foresight by setting actual inflation higher than expected inflation. I will assume that perfect inflation forecasting causes unemployment to be 5%. This is the non accelerating inflation rate of unemployment. Unemployment is linear in the inflation expectations error so the long term average unemployment is equal to the long term average expectations error.
The simple rule may be stochastic with targets based on coins flipped and dice rolled etc in secret. The monetary authority wants low unemployment and low inflation.
The question is can the long term average unemployment rate be lower than 5%
First bounded rationality with hypothesis testing. The bounded rationality is forecasting with a simple rule which might included parameters estimated by OLS on old data of. In the very simplest rule expected inflation is 2% no matter what. The hypothesis testing part is it is assumed that forecasting rules are ordered from a firwt rule to a second etc. When agents use rule n they also test the null that rule n gives optimal forecasts against the alternative that rule n+1 gives better forecasts. The switch to rule n+1 if the null is rejected a the 5% level (as always this can be any level and as always I choose 5% because everyone does). I will assume that rules are also ordered so if rule n gives persistent underestimates of future inflation, rule n+1 gives higher forecasts.
Forecasting rule 1 is forecast inflation equals 2%. Rule 2 is forecast inflation is equal to a constant estimated by OLS. Rule 3 is forecast inflation is equal to an estimated constant plus an estimated coefficient times lagged inflation. Rule 4 is a regression on two lags of inflation. the series of rules goes on to infinity always adding more and more parameters to be estimated, and includes the actual inflation rule (the monetary policy rule for this silly model).
Friedmans story about accelerating inflation at 3% unemployment works in this model. Rule 2 is flexible enough for his example. If inflation is higher than forecast inflation by a constant, the estimated constant term in the regression grows without bound.
A key necessary assumption is that agents never accumulate more than a finite amount of data about the Monetary authority. A sensible way of putting this is that learning about the Fed Open Market Committee restarts each time a new Fed chairman is appointed. To make things not too easy for myself, I assume that once agents pass from rule 1 to rule 2 they stick with it using all data to estimate parameters. The data used to test the current rule against the next one are only those accumulated with the current chairman. I will assume Chairmen are replaced at known fixed intervals of say 100 periods of time.
Fed open market committe members know all this. They can set inflation so the 2% forecast rule is never rejected against the estimated constant. The optimal strategy will be mixed, that is they will randomize inflation so it isn't too easy to learn what the best estimated constant is. I will assume they set inflation equal to a constant plus a mean zero white noise disturbance term (to be clear the expected value of the random term conditional on lagged information is always zero)
Clearly FOMCs can achieve set inflation to be 2.000001% plus a mean 0 variance 1 constant term without getting caught before the chairman's term expires. This means that the long run average unemployment rate can be less than the NAIRU. This means that there is a long run tradeoff between average unemployment and average inflation.
update: we have a winner so the offer immediately below has expired.
if anyone has read this far, please tell me in comments and I will praise you to the sky in a new post]
Friedman's argument can be true, unemployment can depend only on expectation errors and there can be a long run inflation unemployment tradeoff. There is a big difference between trying to achieve constant unemployment lower than the NAIRU and trying to achieve average unemployment lower than the NAIRU. Friedman also implicitly assumed that the monetary authority never changes and is known to never change.
Basically his implicit assumption is either the Fed can set unemployment to any constant or there is a natural rate. This doesn't follow for many many reasons. I just described one.
OK I talked about Bayesian learning. This post is already way too long. The idea about Bayesian is we start with a prior with a huge mass at inflation is 2% plus a mean zero disturbance term. Then there are positive prior probabilities on a huge variety of other models. However all of the other models have time varying coefficients which follow random walks. This means that the forecast conditional on belief in model N depends on parameters estimated with exponentially weighted lagged data. This means that given the 2.0000001% plus noise rule, the ratio of the likelihood for those models to the likelihood with the 2% plus noise model doesn't growth without bound. This means that the posterior keeps a huge mass on 2% and there is a long run tradeoff between long run average unemployment and long run average inflation.
I disagree 0.1% with Wren-Lewis (I object to his use of the word "need") and about 0.01% with Kling who suggests a claim about what was necessary without quite making it.
Now I cut and paste an over long comment with which I polluted Kling's comment thread. I do not recommend reading the same old same old. I seriously considered posting this to my hard drive (but not my trash can -- I'm a word horder).
Thanks for the link. I think that you and Wren-Lewis agree 100%.
The 0.1% is that I think Friedman's story (in which backward looking expectations were pretty explicit) is sufficient to explain stagflation in the USA in the 1970 but not necessary. I think the pre-Friedman and contra Friedman Keynesians could fit the facts too.
[this "comment" has become much too long for a comments thread. The rest is over here]
My now old tired argument is that a model in which expected inflation is a constant plus 0.5 times lagged inflation fits the 1970s US data fine, but implies a long term inflation unemployment tradeoff and does not imply acceleration.
The model is obviously not the truth and not just because all models are false by definition. We can be sure it isn't a true claim about expectations by introspection, that is a thought experiment. No one can believe that after a thousand years of exactly 10% inflation year after year, expected future inflation will be 5%. I know of no evidence that anyone ever believed any such thing (although I'm sure someone somewhere did, because tinfoil hats).
It was obvious to prominent Keynesians (I am thinking of Solow and Tobin) that the one lag autoregressive expectations model wasn't the truth. It is also obvious that in around 1970 and 1971, they thought something like it was an approximation useful to US policy makers. This view seems to me to be supported by US aggregate data through 1980 (and through 2014). I think that Friedman's position is that Keynesians should not be allowed to use friedman's methodology of positive economics and their claim that an equation was useful there and then must be interpreted as a claim that it is a universal truth. If that was his view, he was much more generoust to Solow Samuelson and Tobin than well to get personal I ever was in the 20th century (and at least the first 10 years of the 21st). I believed that they believed in a Phillips curve with no expectations term at all. I was clearly totally wrong.
As I note from time to time to time to time, it was standard to include price inflation in estimates of the Phillips relation from say Phillips's second paper on the topic on. There was a debate which can be translated into contemporary econospeak as "in around 1970, Solow believed that US inflation expectations (unlike Latin American inflation expectations) were anchored."
This doesn't mean that he predicted that they would remain anchored. Like Keynes, he clearly and definitely said that the relationship between inflation and real variables was not stable and that they decoupled given high inflation.
Solow's position was very explicitly that inflation expectations are sometimes anchored and sometimes not. So high or steady inflation is eventually reflected one for one in expectations, but low and variable inflation isn't (so the average forecast error can increase in the average inflation rate). I think that this is very devinitely the view currently expressed by, among others, Ben Bernanke, Janet Yellen and Narayana Kocherlakota. I also think it is consistent with the evidence. In any case, it is the current view of many top status economists, who remember the 1970s as we do, and is the standard view among monetary policy makers.
For example, I just noticed this
In this Economic Letter, we focus on two simple extensions that are potentially important to the current inflation outlook.note especially "Cogley, Timothy, Giorgio E. Primiceri, and Thomas J. Sargent. 2010. “Inflation-Gap Persistence in the U.S.” American Economic Journal: Macroeconomics 2(1), pp. 43–69 (which I haven't read).
The first extension incorporates anchored inflation expectations with the constraint that long-run inflation eventually returns to the Fed’s inflation target of 2% (see Williams 2006, Stock and Watson 2010, and Cogley, Primiceri, and Sargent 2010).
The semi new point I would like to make here is that Solow's position is entirely consistent with the argument Friedmans AEA presidential address. Friedman discussed only the case of a FOMC which set a very low unemployment target (3% IIRC). If one accepts his assertion that this would lead to accelerating inflation (as I do) nothing much follows. It doesn't follow that the Fed can't stabilize. It doesn't follow that the Fed can't cause long term average unemployment to be lower or higher (within limits).
It is an example which makes it clear that belief in an expectations unaugmented Phillips curve is unreasonable. Almost nobody ever believed in an expectations unaugmented Phillips curve. Samuelson and Solow definitely did not. Hicks made an argument almost identical to Friedman's in 1967. http://www.economics.ox.ac.uk/materials/working_papers/paper399.pdf
I think the key event was the spread of the strange belief that Samuelson, Solow et al believed in an expectations unaugmented Phillips curve. It was believed by, well for example, Robert Waldmann that looking at the data they saw a pattern and just decided to assume it was a structural relationship. I think that this strange delusion (about what Samuelson and Solow thought) was extremely influential exactly because they were famously brilliant economists. Also they and especially Samuelson were top figures in the formalization of economic theory, so a perceived error by Samuelson due to insufficient respect for theory was shocking. The take home lesson was that you better not trust data without formal theory -- that looking at data and thinking in English could lead very smart people to think very stupid things.
I don't know exactly when or how the strange delusion about old Keynsians began. It is certainly expressed in Friedman's Nobel lecture (in which he doesn't name his straw Keynesians).
Tnis all means I agree with Krugman about the role of Friedman Phelps and stagflation in causing the rational expectations revolution. However I also think that incorrect beliefs about what people who disagreed with Friedman said were crucial too.
Sunday, June 29, 2014
A glossary: I'm not sure the participants are using terms exactly the same way. I will explain how I use them.
1. New Classical to me refers both to models based on the Lucas supply function and to real business cycle models. I think Mark Thoma used the phrase to refer only to the Lucas Supply function which explains why he says new classical models have been abandoned.
2. Stagflation: I think this generally refers to high inflation and high unemployment at the same time. Importantly, I don't think the word implies inflation which will remain high forever and ever so long as unemployment remains normal or low (at or below the NAIRU).
3. Stable Phillips curve: To correspond to the meaning of curve, this should mean the claim that inflation is best modelled as a function of unemployment plus a disturbance term (that is with no effect working through expected inflation)
4. The natural rate hypothesis is a claim that the long run Phillips curve is vertical at a natural rate of unemployment (which depends on labor market institutions)
Simon Wren-Lewis argues that stagflation could easily be reconciled with the old Keynesian approach (and notes that it was) so the change must have been caused by something else. He believes the cause was economists' attraction to rational constrained maximization.
There is a much simpler reading. Just as the original Keynesian revolution was caused by massive empirical failure (the Great Depression), the New Classical revolution was caused by the Keynesian failure of the 1970s: stagflation. [skip] I just do not think that is right. Stagflation is very easily explained: you just need an ‘accelerationist’ Phillips curve (i.e. where the coefficient on expected inflation is one), plus a period in which monetary policymakers systematically underestimate the natural rate of unemployment. You do not need rational expectations, or any of the other innovations introduced by New Classical economists. No doubt the inflation of the 1970s made the macroeconomic status quo unattractive. But I do not think the basic appeal of New Classical ideas lay in their better predictive ability. The attraction of rational expectations was not that it explained actual expectations data better than some form of adaptive scheme. Instead it just seemed more consistent with the general idea of rationality that economists used all the time. Ricardian Equivalence was not successful because the data revealed that tax cuts had no impact on consumption - in fact study after study have shown that tax cuts do have a significant impact on consumption. Stagflation did not kill IS-LM. In fact, because empirical validity was so central to the methodology of macroeconomics at the time, it adapted to stagflation very quickly.I agree (except for the word "need" see below).
Mark Thoma agrees with Simon Wren-Lewis.
Paul Krugman wrote
I remember the 70s quite well, and stagflation did indeed play a role in the rise of new classical macro, albeit in a subtler way than the caricature that it proved Keynes wrong, or something like that. What mattered instead was the fact that stagflation had in effect been predicted by Friedman and Phelps; and the way they made that prediction was by taking a step in the direction of microfoundations. [skip] What this did was to give immense prestige to the notion that you could use the assumption of rationality to make better predictions than you could using historical experience alone.I agree with this too except for the part about "What mattered"
Noah Smith agrees with Krugman.
I am sure that Krugman recalls the 70s correctly (I arrived later but have similar recollections). However, I do not think that the perceptions in the late 70s about what Paleo Keynesians said in the 60s were accurate. Roughly I have seen no evidence that any prominent economist wrote anything which was proven false by the occurance of stagflation. Here, as often, I am retailing the research on recent history of thought by James Forder
I do not believe that any prominent Keynesian ever presented a model which was inconsistent with stagflation. It is widely believed that at some point Keynesians believed in a stable Phillips curve. This belief is not based on any primary sources.
I think that the immense prestige is based on an extraordinarily successful strategy of setting up and knocking down a straw man.
I think it is useful to see how the Old Keynesians responded to Lucas's supply function paper. I strongly recommend reading as a statement of the old Keynesian orthodoxy http://cowles.econ.yale.edu/P/cd/d03a/d0315.pdf. This is prominent old Keynesian James Tobin summarizing a conference which happens to have included roughly the first presentation of the Lucas supply function outside of Chicago (except, as noted by Tobin in 1971, for the clear description in "The General Theory of Employment Interest and Money"). I note that Tobin agreed that Friedman was definitely right that eventually expected inflation would rise one for one with a permanent increase in inflation.
Second I think that a non accelerationist expectations augmented Phillips curve in which a permanent increase in lnflation of 1% causes an increase in expected inflation of 0.5% is consistent with stagflation (as I defined it above). An accelerationist Phillips curve is sufficient but not necessary. Let's say crazy monetary policy causes 30% inflation one year and 15% expected inflation the next year. According to the non accelerationist expectations augmented Phillips curve, enormous unemployment would be required to get actual inflation down to 10%. One might argue that actual data through the 70s refuted the 0.5 times lagged inflation model, but it just isn't true that any combination of high inflation and high unemployment refutes it. I know of no hint of any evidence that anyone ever believed that such a model is the truth and, in particular, was not convinced by the argument that a permanent increase in inflation must eventually cause a one for one increase in expected inflation. Simple models like the 0.5 model were estimated and used to forecast, because people thought they were false but useful -- reasonable approximations given the range of policies actually being considered -- that is because people used Friedman's methodology of positive economics.
Importantly the 0.5 model implies a downward sloping long run Phillips curve. It is also the sort of model which old Keynesians used in the 1960s.
Finally, it is consistent with the data through the 1970s. My estimate of that parameter using data through 1980q1 is
. reg ldwinf infcpi linfcpi unem if qtr<1980 ldwinf | Coef. Std. Err. t infcpi | .4888773 .0642374 7.61 linfcpi | .0698199 .0748645 0.93 unem | -.1724548 .1291306 -1.34 _cons | .0518619 .0063418 8.18
This is roughly similar to estimates reported by 1971 (though not with my few variables from FRED). Ldwinf is the growth rate "Business Sector: Compensation Per Hour" over the following year, infcpi is CPI inflation over the preceding year, linfcpi is CPI inflation the year before that and unem is the standard unemployment rate. I used quarterly data so overlapping year long periods.
The controversy between Friedman and the Paleo Keynesians was whether the sum of coefficients on lagged inflation is one or less. Data from the 1970s do not answer this question.
The standard definition of "stagflation" is a combination of high inflation and high unemployment. This can occur in a 1960s era Keynesian model. Only after the fact did people (notably including Friedman who knew otherwise) come up with the idea that Paleo Keynesians didn't model expected inflation or assume that the Phillips curve shifts up at all with expected inflation.
Also 1960s era Keynesians agreed that Friedman was right about the long run -- that eventually an permanent increase in inflation would not cause inflation higher than expected inflation.
In 1971 Tobin agreed that this must be true. However, the US data from the 70s which allegedly proved Friedman right and someone else wrong doesn't prove that it is true.
Friday, June 27, 2014
Monday, June 23, 2014
Sunday, June 22, 2014
Saturday, June 21, 2014
The op-ed contains nothing even approaching a specific suggestion for what , other than to say that defeating terrorists “will require a strategy — not a fantasy. It will require sustained difficult military, intelligence and diplomatic efforts — not empty misleading rhetoric."@robertwaldmann was attempting absurdly self referential tweets when I found Greg Sargent @ThePlumLineGS noting the influence of his co-blogger.
Wednesday, June 18, 2014
Sunday, June 15, 2014
Monday, June 09, 2014
Friday, June 06, 2014
Latest Gallup Numbers Confirm 10-12 Million Newly Insured Under Obamacare [skip] you're probably up to 12-13 million who are newly insured under Obamacare.I comment. April 2 you forecast 10 million newly insured by December 31 2013 well below the CBO's original forecast. I said hooey. I think you were, in part, relying on Gallup estimates for the first quarter (the 15.6 in your graph) and very conservatively extrapolating.
I guessed the original CBO guess would be about right (bewared of Doug). Now you agree. Your calculations from then say 12 million adults (your guess was 2 million under 26ers were already covered due the ACA in 2013). Clearly the number of children newly covered when their parents get medicaid or private is well over a million. Your 10 million by Dec 31 guess is no longer operative. I told you so
Also this isn't what we get from the ACA in 2014. Medicaid signups continue. The Medicaid rolls increased by about 1 million in April. Almost all of this must be due to the ACA (one would expect less than 100,000 due to population growth etc).
I admit I was wrong (link above). I thought the CBO guess (13 million in 2014) would turn out to be about right. Clearly it was an underestimate. Counting under 26ers and children the number is clearly well over 13 million now. Also it is growing quickly (by almost a million last month).
Worth the price ? Hmm Surtax -- fine by me. Cut back the Medicair advantage boondoggle very fine by me, tax Cadillac insurance very fine by me, Medicair advisory panel uh not just advisory excellent. The costs seem to be excellent reforms all by themselves.
Of course the real cost was keeping the Senate busy during the few months of a filibuster proof majority. Also the 2010 elections. I'd say well worth the political cost, but that's not obvious.
update: Just here. Drum is anchored. He said 10 million and he is reluctant to admit he was wrong. So a Gallup estimate of 10 million adults since 2013 (in addition to the 2 million by 2013) becomes 10-12 million in his headline. That doesn't work. His old calculations (no new relevant data) say 12 million adults plus millions of children. After reviewing the Gallup numbers, he gets to "you're probably up to 12-13 million who are newly insured under Obamacare." The "10-" in the title is absulultey not justified by the text of the post.
Monday, June 02, 2014
b>that decision must ultimately be made by the government. No doubt the government will usually be overprotective of its secrets, and so the process of decision-making — whatever it turns out to be — should openly tilt in favor of publication with minimal delay. But ultimately you can’t square this circle. Someone gets to decide, and that someone cannot be Glenn Greenwald.I was unusually prolix in a comment.
I believe the bolded passage is an example of a fallacy which is more common than any other fallacy or any valid method of reasoning -- the false dichotomy. Kinsley asks if elected officials should have authority to keep things secret backed by the threat of prison. The alternatives he offers are prosecute Greenwald for espionage or eliminate all restrictions on revealing government secrets.
Thus Kinsley tries to sneak in the assumption that there is no middle way -- that it is, for example, impossible to threaten to prosecute people with security clearance for revealing secrets learned using that clearance without also threatening to prosecute journalists who report those secrets. I have just described the Obama administration's current policy (although the espionage act is so vague that the non prosecution of Greenwald and well most Washington reporters is an act of prosecutorial discretion - Obama administration policy which the next administration is free to change).
So our Democratically elected officials decide to keep secrets with a system of classification and security clearances. Currently Snowden would be prosecuted if in the USA while prosecution of Greenwald is not even under consideration (unless Eric Holder lied).
Kinsley could go further. The Guardian online has a wide circulation, but the Snowden effect is vastly amplified by all the other journals (including say mother jones at this blog) which repeated Greenwald's assertions. If Greenwald is guilty for reporting facts which were already out of the control of the US government, why so are you. Kinsley's logic is that there is no difference between Snowden, Greenwald, Drum, or, I'm sure, Kinsley.
Or heads up. I'm pretty sure that Greenwald, Drum,Kinsley and a good half of the US public could be prosecuted under the Espionage Act. It might be time to amend it a bit no ?
I think this is a fair excerpt with elisions
"whoever, for the purpose of obtaining information respecting the national defence with intent or reason to believe that the information to be obtained is to be used ... to the advantage of any foreign nation ... obtains, ... any sdocument, writing or note of anything connected with the national defence
"(d) whoever, lawfully or unlawfully having possession of ...any document ...relating to the national defence, wilfully communicates or transmits or attempts to communicate or transmit the same and fails to deliver it on demand to the officer or employee of the United States entitled to receive it;
shall be punished by a fine of not more than $10,000, or by imprisonment for not more than two years, or both."
The elided text consists of clauses or phrases separated from the quoted text by conjunctions such as "or". If you obtain any document respecting the national defence with an aim to help humanity (including foreigners) you are criminally liable.
Note there is no requirement that the documents related to the national defence be classified. If, say, you tell foreign policy makers the US military budget as published in the Federal Register for the sole purpose of helping them forecast US aggregate demand and optimizing their macroeconomic policy, then "shall be punished by a fine of not more than $10,000, or by imprisonment for not more than two years, or both."
I'm not a lawyer. I note that the text is perfectly clear. I trust that it has been interpreted to be the law Congress should have written. I think this is done through the absolutely essential judicial principle of lying about plain English if reading what was clearly written has bad enough consequences. But I have no doubt that, under current US law, you, Kinsley and I are felons.