Friday, February 27, 2015

New Keynesian Financial Frictions

Over a year ago, Noah Smith wrote a blog post with an excellent illustration of the first extremely unsuccessful attempted machine gun. The hint was that if at first you don't succeed plausibility might be right around the corner. The post mainly reported a working paper (which has since been revised) by Marco Del Negro, Marc P. Giannoni, and Frank Schorfheide of the New York Fed (pdf warning -- also not light reading). I didn't click the link. I had read a note on the web by Del Negro, Giannoni, and Schorfheide and come to the silly conclusion that they had done something silly. Now 20 months late I finally clicked the link and found the working paper very impressive. As Noah explains
The model they use is a combination of two existing models: 1) the famous and popular Smets-Wouters (2007) New Keynesian model that I discussed in my last post, and 2) the "financial accelerator" model of Bernanke, Gertler, and Gilchrist (1999). They find that this hybrid financial New Keynesian model is able to predict the recession pretty well as of 2008Q
4. Importantly, the forecasts (of the current version) are based on parameter estimates using data available December 2008, so not including 4th quarter 2008 GDP but including the differential between Baa corporate bonds and the Treasury 10 year rate. The model correctly forecasts a deep recession followed by a sluggish recovery. I want to raise a quibble mostly with Smets and Wouters (SW) . In Smets and Wouters (2007) (SW 2007) they assert that they have already considered financial frictions as in Bernanke, Gertler, and Gilchrist (1999)
Finally, the disturbance term [epsilon^b] represents a wedge between the interest rate controlled by the central bank and the return on assets held by the households. A positive shock to this wedge increases the required return on assets and reduces current consumption. At the same time, it also increases the cost of capital and reduces the value of capital and investment, as shown below.3 This shock has similar effects as so-called net-worth shocks in Ben S. Bernanke, Gertler, and Simon Gilchrist (1999) and Christiano, Roberto Motto, and Massimo Rostagno (2003), which explicitly model the external finance premium.
The paragraph explains a FOC for optimal consumption (an Euler equation). It it the real interest rate considered by consumers is the federal funds rate minus the expected inflation rate plus this disturbance term epsilon^b. That would be correct if this were a safe real interest rate. A risk premium which has something to do with risk would not appear in the Euler equation that way. IIRC the risk premium in Bernanke Gertler and Gilchrist doesn't affect consumption at all -- it is the difference between interest charged on loans to firms and interest paid to consumers (consumers get the risk free rate). In fact, consumers do not need to bear the risk of possible bankruptcy of firms. Optimization implies that the Euler equation holds for all assets including Treasury bills or, once they were introduced TIPS. It implies expected return differentials on all assets via the consumption CAPM. The SW 2007 risk premium is also paid by firms as in Bernanke, Gertler, and Gilchrist (1999). But if SW already consider a risk premium motivated by reference to Bernanke, Gertler, and Gilchirst (1999) what do Del Negro, Giannoni, and Schorfheide write about the epsilon^b disturbance in SW 2007 which also appears in their model relabeled simply "b"
The exogenous process [b_t] drives a wedge between the intertemporal ratio of the marginal utility of consumption and the riskless real return [R_t - ��Et[ pi_(t+1)]], and follows an AR(1) process with parameters [rho_ b] and [ sigma_b].
This is in section "2.1.1 The SW Model" the term b_t is justified simply because it appears in SW 2007. No explanation for whey there is such a wedge is given (nor is it easy to imagine one when presenting a model with a non-liquidity constrained representative consumer). In contrast the interest rate paid by firms includes a term which really does correspond to the external finance premium in Bernanke Gertler and Gilchrist (1999). I can't manage the notation with plain ascci it is The expected nominal interest rate paid by firms minus the safe interest rate is equal to b_t plus a constant times the (debt+equity) to equity ratio plus the dispersion of ability across entrepreneurs. Or in other words the differential is equal to a log linear approximation of the external finance premium as modelled in Bernanke Gertler and Gilchrist (1999) plus the disturbance term which Del Negro, Giannoni, and Schorfheide call b and which SW call epsilon^b and which SW justify with a reference to Bernanke, Gertler and Ghilchrist (1999). There is still no explanation of why it appears in the Euler equation. OK I trust no one has read this far [text deleted] update: Mark Thoma did it again. I am no longer confident that no one will read this far. I deleted the rest of of this post because it wasn't polite.

Tuesday, February 24, 2015

Can Someone Help me Balance the Japanese National Income and Product Accounts ?

I was sincerely shocked to read that the Japanese household savings rate was negative. "The savings rate in the year through March was minus 1.3 percent, the first negative reading in data back to 1955" I had always thought of Japanese as high savers (as they used to be). But the reason I was shocked is I can't get the national income and products accounts to balance. By my calculations, total effective demand is about 7% higher than total supply (this is impossible). I get household savings of about -1% of GDP (correspondind to the -1.3% of personal disposable income plus pension distributions) government savings famously -7% of GDP and Japan must have positive net exports mustn't it ? Well actually no. Another shocking fact is that Japan has suddenly shifted from the usual trade surplus to a trade deficit. Why has nobody told me ? However, the deficit is only about 1.5% of GDP. The only remaining category I can think of is corporate saving, which I get at around 6.5% of GDP. How can that be ? I can't find Japanese corporate profits at FRED (the first time it has failed me so no link for you today FRED). In the USA corporate profits net of taxes and depreciation are roughly 7% of GDP. The ratio must be much higher in Japan. Corporate savings would be net profits minus the sum of net investment and dividends paid by corporations. It's almost as if Japanese corporates were investing only to replace depreciated capital and not paying dividends. Or very profitable. Can someone explain to me what is going on ?

Monday, February 23, 2015

Time for a Drum head trial

Uh oh the usually solid front of Political Animals is divided. Current animal Ed Kilgore appreciates the DNC's appreciation of narrative
The one nugget in the DNC report that I found both valuable and amusing is this:
It is strongly believed that the Democratic Party is loosely understood as a long list of policy statements and not as people with a common set of core values (fairness, equality, opportunity). This lack of cohesive narrative impedes the party’s ability to develop and maintain a lifelong dialogue and partnership with voters. The Task Force recommends creating a National Narrative Project to work with party leaders, activists, and messaging and narrative experts to create a strong values-based national narrative that will engage, inspire and motivate voters to identify with and support Democrats.
In contrast animal emeritus brother Benen singled out the narrative nugget for criticism.
While some of the ideas in the document seem to have real merit, including an aggressive emphasis on voter registration, others seem considerably less valuable, such as the “creation of a National Narrative Project to work with party leaders, activists, and messaging and narrative experts to create a strong values-based national narrative.”
I know they share the same values but they really need to sit down and have a talk about narration. I think the judicious judge and moderate moderator of the Political Animal v Political Animal debate really has to be original Political Animal Kevin Drum.

Friday, February 20, 2015

Old Keynesians on Monetary Offset of Fiscal Policy

This is an ultra pointless "someone is wrong on the internet" post. I think I read somewhere the suggestion that Keynesians had to be told by market monetarists that fiscal stimulus can (at least usually) be offset by monetary policy. I think Keynesians have made this point for a while. Here I cut and paste from Samuelson and Solow (1960) "Analytic Aspects of Anti-Inflation Policy" pdf warning also known as the Phillips curve paper.

Wednesday, February 18, 2015

Republicans Worst Idea Ever ?

With the sarcastic hyperbole that won him millions of fans (OK that makes me read everything he writes) Jon Chait declares "Poll Confirms the Republican Immigration Shutdown Plan Is Their Worst Idea Ever". The proof

"Today, CNN has a poll about who to blame in the event of such a shutdown. Fifty-three percent of Americans would blame the Republican Congress, and only 30 percent would blame Obama."

Oddly he claims that 30% is the hard core base crazication factor, when it is well known that it is 27% but I'll spot him 3%.

I think Chait may be right (although the competition is fierce) but that doesn't mean that the DHS shutdown is clearly and by a wide margin the worst idea to which they are currently committed. It doesn't even mean that it is the idea that fares worst by a wide margin in the poll which Chait cites.

There is also the Netanyahu speech.

Josh Marshall (who clearly despises Netanyahu more passionately even than I do) reports with scarcastic delight (and the headline of the week)

"Great Times for Bibi-Boehner Bund!"

click his self link (Josh Marshall is wonderful but TPM links to itself too much)

The CNN/ORC poll found that 63 percent of Americans disagreed with Boehner's decision to extend the invitation without consulting the White House, while 33 percent said it was the right thing to do

Note how I strategically spotted Chait 3% above. Now I want my 3% back so I can claim that 33% = 30% ( to be honest, subtracting the 27% crazification factor, 3% of Alan Keyes resistant US adults would blame Obama and twice as many, a ful 6% think inviting Netanyahu was a good idea).

Continuing with the B-list, I recall that the rarely interesting and otherwise never snarky David Brooks once said that he sometimes wonders if George Bush is a Democratic mole.

There has been some discussion of whether Boehner is in an impossible situtation, incompetent or both. There is another possibility -- that he is a political genius Democratic mole.

Monday, February 16, 2015

Why do Macroeconomists Think We Know Macroeconomics ?

This post is a comment on Noah Smith's brilliant post "Why do non-experts think they know about macroeconomics?" which is, itself, a reply to Scott Sumner's presumably brilliant post (which I haven't read and on which I am not commenting -- for one think I can't find a link in Noah Smith's post).

Noah Smith doesn't have a very high opinion or really existing macroeconomics. However, I think he is a bit too diplomatic. I think I will quote bits of his post and comment.

Sumner argued that macroeconomics uses familiar words (with unfamiliar meanings) so people think they understand it. Like Noah, I agree that this is part of what is going on. I also mostly agree with Noah that

there are some other reasons too: 1. Macroeconomics is relevant to most laypeople. String theory, to use Scott's example, is not. String theory is something you hear Brian Greene or Michio Kaku talk about, and you think "Wow, neato, the Universe is mysterious and funky!", and then you never think about it again. Macroeconomics is something related to our jobs and our investments. It affects us every day. Notice that laypeople do not often hold forth on game theory or decision theory. 2. Macroeconomics has political implications. Many people have political agendas. The "heterodox" people you meet in the blogosphere are almost all just leftists who see mainstream econ as a tool of the neoliberal oppressor, and since macro is by far the most visible branch of econ, they equate "econ" with "macro" and bash it. Or take the "Austrians", whose goal is actually to make econ into a tool of the neoliberal oppressor, for real. Then you have a whole bunch of people who aren't pushing political agendas, but who feel that macroeconomists are pushing agendas, and don't like that. In fact, some macroeconomists are pushing political agendas, though I think it's a clear minority (no, I won't name names). This is also why a lot of laypeople get involved in climate science debates. 3. There is the perception that macroeconomists don't understand their own subject. The Great Recession convinced a lot of people that macroeconomics hasn't solved any of the problems it was created to solve. Contrast that with physics or bio or chem, which have very obviously given us a lot of the awesome stuff that makes our society rich. In addition, you have very public and acrimonious debates between macroeconomists like Krugman, Cochrane, and Sumner. That convinces a lot of people that there is no consensus within macro, which in turn makes them suspect that macroeconomists haven't gotten any answers out of the Universe. If the experts don't understand anything, why can't the amateurs weigh in?
update: I see Mark Thoma found this post (this blog is for stuff I don't want many people to read update: I post stuff which I think is worth reading at -- I do put some effort into those posts end update). I wish to clarify and revise my remarks.

First, ordinary people think they know other technical subjects too. It is easy to get into debates about microeconomics (think pf discussing the incentive effects of welfare or the economic effects of international trade) climate science, food science, and military strategy. Clearly Noah's first two points are valid.

However, I think there is special disrespect for the opinions of macroeconomists. I see two quite different problems. The first (discussed vaguely below and discussed better by Noah) is that there isn't a macroeconomists' consensus on anything. There isn't even a consensus among academics (or for that matter Nobel memorial prize winners) but also wingnut welfare recipient hacks are presented to the public as prominent economists.

I think there is a main stream of contemporary macroeconomics -- New Keynesian DSGE. It matters that the implications of those models are dismissed by real business cycle theorists, austrians, market monetarists, Post-Keynesians, and modern monetary theorists (you can't imagine how much fun I had putting real business cycle theory in that list). But it also definitely matters that new Keynesian DSGE models don't explain patterns which would otherwise be puzzling and don't generate very good forecasts.

end update:

That [Noah's] is an excellent effort. I disagree with two points. First I think macroeconomists with a political agenda are a clear majority (I will name one name -- Robert Waldmann). Second, I don't really think that the Krugman, Cochrane, Sumner debate has a big effect on the opinion the general public has of macroeconomics. The reason is simply that most people don't know who Cochrane and Sumner are ( many times as many people know who Cochrane and Sumner are than know who Robert Waldmann is, but the number is still small). I think that radically different views on everything expressed by Nobel memorial prize winners does have that effect. I note (as a member of the public) that I haven't heard anything from Lucas or Prescott recently.

I realize that I have very little sense of what most people think macroeconomists say. I'm pretty sure that most people think of macroeconomics when they think of economics. I think it is a sign of the strength of the perception that we don't understand our subject that pollsters don't ask people what they think we think.

I hand the microphone back to Noah

Ryan Decker writes in response to my Reason #3 above: When I fire up my web browser I'm not bombarded with confident non-expert opinions about earthquakes, despite seismology's apparent inability to predict them.
True, but seismologists are pretty up front about this, including any seismologist in the press. I think there's a public perception that while seismologists realize their shortcomings, and are therefore probably "on the job" in terms of trying new stuff, macroeconomists might have declared premature victory.
I don't think the modesty of seismologists is the issue. For one thing I don't think that declaring premature victory deprives people of their influence. Prominent pundits and politicians all express extreme confidence that they understand the world. They are influential. I think one clear difference is that seismologists can predict lots of things, just not the thing that we care about for practical reasons. It is hard to doubt that their model of earthquakes is approximately correct. In any case, there is an overwhelming consensus -- when there is an earthquake siesmologists publicly agree about things that happened under the earth.

I think the problem here is that the analogy is much too kind to macroeconomists. It is true that macroeconomists can't predict recessions. It is also true that macroecomists almost all admit this. However, macroeconomists don't agree on the explanation of what happened. Also macroeconomic models have lots of implications which can be confronted with the data. However they don't fit the data as the implications of models of plate tectonics do.

Finally, I think point 2 it is critical. Seismology does not involve ideology (although it has gigantic implications such as get the hell out of Tokyo). Notably lots of non experts have strong opinions about global warming and evolution by natural selection.

A lot of macro people in the press express a lot of certitude about things. John Taylor expresses incredible confidence that the Taylor Rule (with coefficients of exactly 1.5 and 0.5!) is THE best monetary policy rule. Scott Sumner expresses incredible confidence that NGDP targeting is best. Paul Krugman expresses incredible confidence that fiscal stimulus is effective and that austerity is counterproductive. John Cochrane expresses incredible confidence that structural form - removing "sand in the gears" - is the best medicine for an economy in recession. Robert Lucas said that the "central problem of depression prevention has been solved." And so on, and so forth.

I think normal people realize that that certitude is basically never warranted. Yes, those economists often (but not always) have some evidence to back up their claims. But not the kind of evidence that people have in disciplines where data is more abundant, controlled, and replicable.

Here I object to the Ballance. I think there is overwhelming evidence that, when the economy is at the zero lower bound, stimulus is effective and austerity is counterproductive. I think the evidence collected in the 1930 was overwhelming. I think the evidence collected so far in the 21st century is overwhelming. I actuall challenge Noah Smith -- do you really think that Krugman's confidence in claims on those points is "incredible" ? Here's another one -- do you doubt that austerity in economies at the ZLB is counterproductive ?

On the others, Lucas said that long ago (I remember I was in the room) and wasn't widely quoted in the mass media. Again I ask how prominent Sumner and Cochrane are.

update 2: I don't know where to put this but here's some more Krugman fandom. Prominent pundits all express extreme confidence that they understand the world, but none of the others in a small sample of 26 were as successful forecasters as Krugman (pdf warning). Almost everyone must have been put off by his intellectual confidence and his eagerness to say I told you so. However, people who have been keeping track have to notice just how often he claims he told us so and how he always provides links to him telling us so. Noah and Decker agree that a problem for macroeconomists is that we have very little data and no experimental data. I think this is special pleading. Existing macroeconomics is based on the the decision that the 30s are irrelevant and Indonesia is irrelevant and Argentina is irrelevant. We have few data, and we ignore a substantial fraction of them, because they are inconsistent with our models. Even the most standard data set (post WWII US quarterly) doesn't fit the models at all. Yes it is hard to do well without decent data. But it is also hard to do as badly as macroeconomists have without decent data.

And this brings us to

Macroeconomists know more than a lot of people think they do. That doesn't mean they know a lot. And macro discussions in the public sphere tend to focus more on the contentious stuff - the stuff where no one really knows all that much. That's where normal people feel justified jumping in. If you tell them that investment is the most volatile component of GDP, they're not going to argue.
I note again that Noah is no admirer of current macroconomics, but this is pathetic update: not a convincing defence of current macroeconomics which convincing defence is not likely to come from harsh critic of current macroeconomics Noah Smith who wasn't trying to defend existing macroeconomics in that post anyway end update. The discovery is a simple measurement. People can guess that macroeconomists know the coefficient of variation of consumption and investment. People also have good reason not to bow down to the superior insight of someone who has done that calculation. A more interesting question is whether the pattern is convincingly explained by existing models (no) and whether it is easy to explain in many different reasonably convincing ways (yes).

Update: welcome noahpinioners I really really want to extend and revise this paragraph. First, it is important that Noah Smith is a very harsh critic of macroeconomics. In the post to which I link, he mentions that there are non controversial claims in macroeconomics, but one just can't expect him to be the one who comes up with a convincing defence of current macroeconmics. I didn't mean to say that no example of a statement which is accepted by almost all macroeconomists and isn't obvious -- say just a measurement exists. I just mentioned that he (unsurprisingly ) didn't present such a statement. Oh now I am in a bit of trouble, as a commenter might ask me if I, Robert Waldmann, can come up with a non obvious statement accepted by almost all macroeconomists, and especially one not accepted by almost everyone in general. I will try 1. This recession isn't the end of the world. It's mostly cyclical. We are well into a recession so growth is likely to be unusually high averaged over the next 5 years. I think every reccession a lot of people decide that this time its different and we will go into a second great depression. Macroeconomists generally believe in mean reversion. This is, in fact, a measurement with atheoretical VARs implying hump shaped impulse response functions. I don't think it is controversial anymore and it is not obvious. Now maybe it should be controversial as the current troubles seem to have lasted for a long long time. but they haven't lead to total collapse (except in Greece -- massive foreign denominated debt makes things different and macroeconomists know this).

2.Government spending and deficits do not cause low output quickly and in the short run. There is a wide range of guesses of fiscal multipliers but none is well below zero. I think the range is zero (Fama Lucas) to 2.3 (Brad DeLong of course). I think this view is not shared by lots of ordinary people and also by a signficant number of policy makers. Macroeconomists also generally guess that deficits and unproductive government spending probably reduce the trend rate of growth.

I am, if anything, more harshly critical of existing macroeconomics than Noah, but that was a good faith effort. end update.

There are statements which aren't contentious in macroeconomics because almost all macroeconomists assume they are true, when doing academic work, and almost all macroeconomists agree that they are false (but maybe models based on those assumptions might be OK because who knows anything might be). This is not the sort of consensus which wins a field respect.

I think the post is excellent. I would put a lot of stress on point 3. I'd say that, when I think as a citizen and try to guess what policies are effective, I rely on Keynes and ignore the other stuff which was written since 1937 (date of the QJE article not The General Theory). I think I am not so unusual (and I am being paid as a macroeconomist). When I think of pure economic science, I think the same way. This is very unusual, but why ?

Matthew Yglesias's Gaffe

I learn from this wonderfully titled wonderful post "Randomgate is why politicians are so boring" that Obama's gaffe in which he said the attack on the Kosher supermarket in Paris was "random" violence when it was (as the Obama administration has said many times) anti semitic violence was an answer to a question asked by Matt Yglesias in the huge Klein Yglesias Obama interview (which I haven't watched). So Yglesias was right there. He complains that the gaffe he quoted was blown out of proportion. This sort of complaint (more ususally made by the person who uttered the gaffe not the one who reported it without noticing its gaffosity) is generally quite possible the most boring content of serious news. The media have to report the complaint to be fair, but the complaint usually is based on treating "quoted out of context" to mean "quoted." Strangely, Yglesias's post is absolutely brilliant. Read it. Yglesias fans will recognize some of his favorite themes, so the post is not a wildly original addition to the Yglesias literature, but the whole post is a devastating critique of political journalism made by someone right in the eye of the storm.

Saturday, February 14, 2015

Quote of the Day

Robert (not Paul) Waldmann wishes that he and not Paul (not Robert) Waldman had written
And New York City, population 8.4 million, just went ten days without a murder for the first time on record. Which is apparently what happens when you elect a socialist liberal hippie mayor who disrespects the police.

Talk about Wiki

IIRC Wiki means quick in Hawaiian and it sure is. Kate Brown will be sworn in as governor of Oregon on Wednesday and the Wikipedia already includes her on its list of female US state governors. from which I learn that the first states to have female governors were Wyoming, Texas and Alabama. Of course. I also find it odd that, this time last year, four of six female governors were Republicans. Jan Brewer (R Az) retired, so next Wednesday there will be as many Democratic as Republican female governors. Other than the Wikipedia, most news organizations have mainly focused on the fact that Gov. (next Wed.) Brown is openly bisexual.

Monday, February 02, 2015

I Don't Dare click the link

I don't dare click this link but I sure liked the pingback excerpt
Pingback excerpt: […] down. Robert Waldmann, a blogger and remarkable gladiator of a Keynesian team, responded in a post of his own.

2 complaints about Chait

Jon Chait has irritated me in two ways. First he doesn't post often enough. Time after time I surf to and find the same posts I've already read. I think I check for new posts approximately four times per actual new post. Second he has written a second post on political correctness. I have not read this post (this is news). I do not plan to read this post. The point of this post is that if Chait wrote something which I ,the Chait addicted Robert Waldmann, choose not to read, then he has a problem. The pointlessness of this post below. I suspect that I would find the post irritating and boring, so I will just critique the Title "Secret Confessions of the anti-anti-pc movement: in their hearts they know I'm right". In fact, based on the title alone, I suspect that it is based on a false dichotomy (a fallacy more common than any other fallacy or any valid method of reasoning) and, in particular, the claim that any concession that some pc policing has ever been other than optimal implies that in their hearts Chaits critics know he is right to write "While politically less threatening than conservatism (the far right still commands far more power in American life), the p.c. left is actually more philosophically threatening. It is an undemocratic creed." (of course there aren't any anti free speech conservatives burning Dixie Chick records or, oh hell, declaring President Bush above the law and besides who ever said that that torture is undemocratic ?). Again without reading the post, I note that Chait's critics probably agree that the police have sometimes acted other than optimally. That doesn't mean that we want to eliminate the police force. Why do milder criticisms of some of the pc police suggest we agree with Chait ? Now one might ask why I don't complain about the original anti-PC post. I did have some other than favorable thoughts but they were balanced an aspect which I appreciated. I thought the article addressed a deeply boring topic, was too long by a factor of three, and was unconvincing. Among all those words, I found anecdotes but nowhere near solid evidence that political correctitude in the USA had risen declined and risen again. Nor was I convinced that PC excesses are a significant problem. But I looked forward to the epic cyber-mobbing in store. I'm tempted to claim that I roughly guessed its epic scale. What Digby said "The guy deserves a trolling bonus. Nobody does it better." And, in the end, I think one anti-PC hippy bashing post is better than none. Now I know how it feels to be a conservative reading Chait.

Sunday, February 01, 2015

A Question for Those Skeptical about Fiscal Stimulus

There are many opponents of fiscal stimulus that argue that it doesn't work (e.g. Robert Lucas (search for (Laughs.) & Eugene Fama (search for Fama:)). Some argue that nominal aggregate demand affects only the price level. But others argue that fiscal stimulus doesn't affect aggregate demand. My question is what about Argentina.

Argentina has fairly high inflation. Amost no one trusts the official number (11%) and sober serious people are Argentine inflation truthers estimating the rate as about 30%. People with normal dislike of inflation might think ARgentina could use a reduction of aggregate demand. Do fiscal policy skeptics who think Argentina would benefit from lower aggregate demand think that a temporary reduction in Argentine public spending would cause reduced aggregate demand ?

The point of asking oneself about Argentina is that it reverses the relationship between disliking government spending and doubting the effects of fiscal policy on aggregate demand.

If someone who considers himself a fiscal stimulus skeptic realizes that he thinks that austerity is a good anti inflation tool, then he has a puzzle to solve.

I also ask those who believe in expansionary austerity if they think that Argentina should cut aggregate demand and inflationry pressure by raising public spending. If the problem is the over exuberant confidence fairy, then policy should be designed to damage confidence.

update: as usual, I didn't expect anyone to link here. Given the traffic, I have updated two ways. First I have added links to the stimulus skepticism I have in mind. Note the claims to which I link are not qualified by any assertions about monetary policy. Also I added paragraph breaks.

Thursday, January 29, 2015

QOTD Josh Barro

A ‘Rich’ Person Is Someone Who Makes 50 Percent More Than You ... @UpshotNYT NYT - Josh Barro - Jan 29
The first rule of modern tax policy is raise taxes only on the rich. The second rule is that your family isn’t rich, even if you make a lot of money.

Wednesday, January 28, 2015

On Glasner on the Long Run Phillips Curve

David Glasner has another interesting post questioning Milton Friedman's immense status. This time he asserts that the claim that the long run Phillips curve is vertical does not have implications which are useful to policy makers or macro econometricians. I think it is best to just click the link rather than trust my effort to summarize.

I comment

I entirely agree. I think the practical and empirical irrelevance of the long run Phillips curve helps us understand how it came to be believed that old Keynesians (I am thinking Solow, Samuelson and Tobin) contested Friedman's claim. In fact, in everything by them which I have read (which isn't close to everything that that they wrote) they agreed with his argument and conclusion, then went on to say that it didn't offer much guidance to policymakers or econometricians. That is, they made your point (again and again). They are considered to be very smart, but not for making that obvious but important point again and again.

Now the fact that 4 such economists agree should convince me. But I beg to differ with all 4 (see below for qualifications). The argument relies on the assumption that there is a unique equilibrium unemployment rate. It is assumed that cyclical unemployment can't become structural or, in modern jargon, that there is no hysteresis. The existence of a natural rate of unemployment which is also the NAIRU is an article of faith. There isn't much evidence in this continent (Europe) for any such thing. Friedman's obvious and convincing claim is that forecast errors can't have the same sign indefinately. The assertion that deviations of unemployment from the natural rate are all due to forecast errors and nothing else anticipates so called new Keynesian macroeconomics and still dominates the profession. However, it was not argued or defended and has been challenged by decades of European data. Samuelson and Solow discussed this issue in their 1960 AEA talk on the Phillips curve. I'm sure Tobin discussed it a lot. But somehow hysteresis is found when economists look for it then assumed away when they advise policy makers.

The phrase "the long run Phillips curve" has content even without the possible additional words "is vertical" or "slopes down". The phrase asserts that there is no hysteresis. It asserts that forecasts for unemployment and inflation in the distant enough future must lie on a curve -- that the set of equilibria is one dimensional. With extreme enough hysteresis the set of equilibria would be limited only because the unemployment rate must be between 0 and 100%. Such a model would be crazy, but the assertion that the set equilibria is one dimensional is an assumption not a result.

Monday, January 26, 2015

On Coppola on [spoiler alert]

Discussing Syriza, Frances Coppola quotes Keynes who she names only at the end of the column (although she knew and wrote that it would be easy to guess who it was).

Some snippets

Keynes on how to achieve recovery

or public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money. [skip] "Thus as the prime mover in the first stage of the technique of recovery I lay overwhelming emphasis on the increase of national purchasing power resulting from governmental expenditure which is financed by Loans and not by taxing present incomes. Nothing else counts in comparison with this.
I dare to comment on Keynes.

Keynes hadn't arrived at The General Theory (1926) yet, or, at least, he hadn't arrived at Hicks (1937). In the IS-LM model, increased public spending causes increased aggregate demand even if it is financed through increased taxes. Deficit spending has a larger effect, but balanced budget spending increases have a positive multiplier (equal to 1 if the economy is in a liquidity trap).

Coppola explains "What exactly was Keynes criticising in this letter? It was FDR's National Industrial Recovery Programme: "

Coppola on Keynes and Krugman

And I'm sorry, Professor Krugman, but he doesn't have much time for arguments that deliberately raising inflation will magically restore output, either:

there is much less to be said in favour of rising prices, if they are brought about at the expense of rising output. Some debtors may be helped, but the national recovery as a whole will be retarded. Thus rising prices caused by deliberately increasing prime costs or by restricting output have a vastly inferior value to rising prices which are the natural result of an increase in the nation's purchasing power...... ......too much emphasis on the remedial value of a higher price-level as an object in itself may lead to serious misapprehension as to the part which prices can play in the technique of recovery. The stimulation of output by increasing aggregate purchasing power is the right way to get prices up; and not the other way round".
I comment

You are a bit hard on Krugman who would not advocate a National Industrial Recovery Act (I don't know of any economist who thinks it was a good bill). Increased inflation due to promised loose money in the future is quite different.

Also the data from 1933-4 tend provide some support for FDR versus Keynes round one (as the data from 1937-8 overwhelmingly support Keynes v FDR round two). Notably deflation ended and investment levels suggest expected inflation increased sharply. Many (including especially Christina Romer and often Brad DeLong) assert that this must have been due to the US going off the gold standard. But the NIRA aimed to cause this to happen, then it happened. The NIRA involved meddling with the price mechanism (indeed allowing and encouraging anti competitive practices). It is generally detested (also by me). But the few data points of evidence correspond to the hopes of those who enacted it.

On Glasner on Friedman on Phillips

David Glasner has a very interesting post in which he discusses the question of whether David Hume came up with the argument that the long run Phillips curve is vertical or just with the idea that there is a Phillips curve.

In it, he argues that Friedman and Phelps's expectations based critique of the Phillips curve was not original. That sets me off on the usual which is a comment over there and reproduced here.

I very much agree with your claim that Friedman 1968 did not introduce the expectations critique of the Phillips curve. In fact the argument was made repeatedly before Phillips graphed his scatter plot, James Forder wrote a working paper on this

in which the expectations argument is made quite clearly by, among many others, Friedman in 1958, Simons in 1936, Samuelson and Solow 1960 and Hicks in 1967. Simons and Hicks pretty clearly state the view that the long run Phillips curve is vertical.

By the way, while there is overwhelming evidence against an expectations unaugmented Phillips curve, there is not overwhelming evidence that the long run Phillips curve is vertical. If there is downward nominal rigidity, then there can be a sloping long run Phillips curve (Akerlof GA, Dickens WT, Perry GL (1996) The Macroeconomics of Low Inflation [including comments by Gordon and Mankiw]. Brookings Papers on Economic Activity, 1996(1):1-59 [60-76]. Notably, in recent years US inflation and unemployment have fallen on what sure looks like an expectations unaugmented Phillips curve.

There are two separate issues -- is the slope of the long run Phillips curve as low as that of the short run Phillips curve (answer definitely not) and is the long run Phillips curve vertical (this does not follow). Importantly, Friedman argued convincingly that it was impossible to keep unemployment below the NAIRU. It doesn't follow that it is impossible to keep it slightly higher. If there is a range of unemployment over which inflation decelerates to zero, but not below (because of downward nominal rigidity) then unemployment can stay at any point in that range. For example what if with unemployment less than 5% one has accelerating inflation but unemployement must be greater 8% to cause actual deflation. In that case, one can have zero inflation with unemployment at any level between 5% and 8%. Thus far the Phillips curve has a horizontal part. The downward slope comes from having many local labor markets.

In any case, data from the 1970s do not prove that the long run Phillips curve is vertical. Empirical point estimates never had coefficients on lagged inflation adding up to one (unless this was imposed based on Friedman's theoretical argument).

On the other hand, David Hume definitely presented the quantity theory of money. I have no idea if he came up with the permanent income hypothesis.

Friday, January 23, 2015

Reading James Forder

I am actually reading "Macroeconomics and the Phillips Curve" by James Forder. I started in the middle after searching for [Samuelson incomes policy]. I shall go to and honestly pay, although I am currently reading a google book. I decided to read the whole thing and learned something on the first page. It seems that, like the quantity theory of money, the Phillips curve was first discussed by David Hume.
So the great macroeconomic debate of the 60s was Hume vs Hume. It is impressive that his disciple Adam Smith had interesting things to add. Pity so few of their successors did.

Wednesday, January 21, 2015


I typed something sloppily which stimulated Nick Rowe (see his comments here)
Actually I have a challenge. Name a Friedman Solow debate which, with the benefit of hindsight, we agree was won by Friedman. I do not think this is easy to do.
The problem, I think, is the word "we". My challenge was to name a Friedman Solow debate and convince me (Robert Waldmann) that Friedman was right. Rowe interpreted "we" to refer to the main stream of the macroeconomics profession. For that set of people I use the pronoun "they" and I don't agree with them on much.

Of course, no one much cares what I think. However, I do think I have an interesting question. Let's take it as agreed that new Keynesian macroeconomics is basically Friedmanite macroeconomics and both are very different from old Keynesian macroeconomics and real business cycle theory. Now clearly new Keynesian has replaced old Keynesian in the academy and, in that sense, they have won something rather like a debate. However, I think this victory came in one of two ways.

First there was the victory over the straw man of the expectations unaugmented Phillips curve. I think the conventional recollection of that alleged debate is almost entirely fictional. Basically google James Forder Oxford or click here , here, here,here here here. But it really is better to google James Forder Oxford. I haven't read the book, but I have read a lot of his working papers.

I definitely call this one for Samuelson and Solow 1960. Yes the profession (also over here with huge persistent unemployment) believes in the natural rate hypothesis. The profession is crazy.

The permanent income hypothesis is no longer controversial or a hypothesis. It is rejected by the data and no one cares. It is now the permanent income model and it is assserted that although it isn't true it may be useful (the logic is almost that since it isn't exactly true it must be useful). I asked if there is anything useful about the permanent income model. I didn't get a definite yes from any data. here here here here

There is the idea that AD should be managed with monetary policy. I do not do not want to go there. I just note that recent experience doesn't show that good monetary policy solves AD problems. It can be argued that it is because we haven't had good monetary policy. In contrast, there is strong evidence that expansionary fiscal policy (as in China) works, that modestly expansionary fiscal policy (the ARRA in the USA) works moderately and that austerity has terrible consequences. I think the weight of evidence is very strongly against the idea that the best way to manage AD is always monetary policy. I note that part of the Friedman vs Old Keynesian debate was whether liquidity trapping was possible. Friedman argued no. I think the debate should be considered settled (of course I know it isn't considered settled).

Floating exchange rates may beat the alternative, but the idea, which I ascribe to Friedman, that they won't fluctuate widely with associated huge current account surpluses and deficits is now known to be false. Also I vaguely recall reading an Newsweek column by Samuelson about who cares about the current account deficit which we can ban permanently by floating the exchange rate (needless to say, he was wrong, the point is that I think he agreed with Friedman). This is a recollection of something written in the early 70s (when I was in my early teens) which can't be googled.

Rules v discretion in monetary policy. Has anyone noticed that the FOMC is not working according to a rule ? Here I think market monetarists argue that something should be done and would work fine.

Anyway, Rowe and I agree that Friedman dominates mainstream (non RBC) macro. But he seems to think that this is the result of some sort of inquiry which might be construed as scientific. I think it is based on almost universal almost utter contempt for the evidence.

update: I see I have gotten off topic. I should have stuck to the challenge of finding some point where Solow clearly disagreed with Friedman and subsequent data strongly support Friedman. Solow Importantly, I am not discussing Solow's (massive) original contributions -- if Friedman said something first, and Solow agreed, then they didn't debate.

I can think of two debates. One alleged and very famous debate was about the Phillips curve. However, recollections of Solow's position are inconsistent with what he actually wrote. I see two points where Solow disagreed with Friedman. First, in current terminology, Solow argued that inflation expectations were sometimes anchored (sometimes as in not in Latin America in the 60s). Here, current discussion seems to me to follow Solow almost exactly. Second, Solow discussed cyclical unemployment becoming structural. This is now called hysteresis. As far as I know, Friedman didn't consider the issue. It seems to be quite important. Anyway, on the PIH debate, I suggest the reader (if anyone is still reading go to James Forder at Oxford).

On the PIH, Solow dismissed Ricardian equivalence. Friedman didn't use the phrase, but he clearly appealed to the concept. I think the evidence on this point is very clear.

This post is a reply to Rowe comments on an older post. Also in comments to that post, Alan Marin wrote something I was groping towards above

Finally, for now at least, I think that on the crucial Rules vs. Discretion 1970s disagreement between Friedman and the Keynesians, current practice fits neither exactly, but is closer to the Keynesians. Nick Rowe overstated the Friedman "victory" by ignoring the distinction between instruments and targets. Steady inflation is now viewed as a target, but Central Banks are given full discretion over their use of the instrument. This is very different than a Friedmanite rule of a steady increase in the quantity of the monetary base [*]. Central Banks do not even commit to an explicit unvarying Taylor Rule, which would have been closer to a Friedman type of rule. Simiilarly, CB monetary policy does not take Friedman's view that the lags in the effects of policy are so long and variable as to make any response to current events undesirable.
* update: See Nick Rowe in comments again ! The Friedman rule was k% growth of money not of monetary base. This means that during the brief period they tried to follow a Friedman rule, the FOMC had to monitor the money multiplier (IIRC M2 divided by Fed liabilities) and perform open market operations.

Vague Thoughts on Double Taxation of Dividends

Reader beware. This is economics but it isn't my field of expertise. There is a huge literature on the effects of double taxation of dividends which I haven't read.

Dividends are taxed first as corporate income then as personal income of shareholders. In contrast, interest paid by the firm is counted as a cost and subtracted when calculating (and taxing) corporate income. Economists have long argued that this creates inefficiencies. I what I vaguely recall as an actual effect of economic theory on policy, if I understand correctly, Glenn Hubbard convinced George Bush to propose the eventually enacted dividend tax cut of 2003 (see line 9b of your friendly 1040 income which isn't included in the sum of taxable income).

Mike Konczal and Brad DeLong suggested we read a (pdf warning) paper by Danny Yagan which asserts that the tax cut did not have the desired effect (I admit I have read only the abstract).

I am trying to remember the logic of the tax cut. Now of course the tax cut was encouraged by the general view that capital income of all sorts not be taxed. If income is equally distributed already or if one doesn't care about income distribution, this view makes sense. Also even if one cares about income distribution and capital income mostly goes to the rich the optimal tax on capital income goes to zero as time goes to infinity. I wrote a little model in which the tax should be zero after all inequality has been eliminated and as high as can be collected until then (warning PDF which was very kindly and heroically constructed by Sigve Indregard whom I have never met — isn’t the internet wonderful). There is certainly no case for cutting taxes on capital income now leading to accumulated debt causing higher taxes on capital income in the future - the result is that the tax rate should decline over time.

However, there is also the issue of debt vs equity. Here the tax affects decisions to issue and retire shares. At least in the standard model used by macroeconomists a fixed number of firms exist and they maximize the present value of dividends net of taxes. A constant flat tax on dividends doesn't distort their decisions -- it is a tax they have to pay sooner or later. In this model, imagine imposing a 50% dividend tax on firm A but not firm B. The shares of firm A would lose half their value. Nothing else would change. The tax would have no effect on investment or employment.

Obviously the silly simple model leaves almost everything out.

How about initial public offerings ? There aren't any in the standard simple macro model. They are important. The amount raised with an IPO is greater if dividends aren't taxed. This means more low cost internal financing for new firms with good prospects. This means greater financial rewards for entrepreneurs. Now if we cares only about IPOs the tax cut is poorly targetted -- it would better to subsidize IPOs directly. However, one might hope that the 2003 reform caused an increased rate of IPOs. I don't know what happened to the rate of IPOs from 2003 to 2004. I use the Google and find (pdf) "Where Have all the IPOs Gone ?" by Gao Ritter and Zhu. Oooops doesn't seem to have worked.

Going the other way, favoring debt over equity encourages debt financed mergers and leveraged buyouts. This is a distortion. The causal channel is simple -- the tax cut should have caused higher share prices which makes debt financed takeovers more costly. So what happened ? I ask the google again which sends to to the Wikipedia which has an article on LBOs with the section "The third private equity boom and the Golden Age of Private Equity (2003–2007)" oops.

I stress I am not assuming LBOs are bad or that IPOs are good. The assumption is that if something is done to reduce tax liabilities, the tax is causing dead weight losses.

Double taxation of dividends favors debt. This can lead to financial fragility -- one possible benefit of the 2003 tax cut would be reduced bankruptcies -- ooops.

I honestly didn't know what Google just told me. It sure looks as if the aggregate trends are the opposite of those expected by advocates of the 2003 tax cuts.

I am sure no one is convinced by looking at the time series of IPOs LBOs and bankruptcies. There aren't enough data to prove anything. A whole lot of things are going on. However, I don't see a practical alternative. The issues are the creation and destruction of publicly listed corportations. They can't be addressed by looking at a panel of firms.

In any case, I found no evidence at all that the tax cut had the expected effects.

Tuesday, January 20, 2015

On Smith on Rowe on Krugman on Friedman

Nick Rowe wrote a post "There are no Friedmans today, except maybe Friedman himself" which I admit I haven't read.

Rowe declared Milton Friedman the victor of, at least, the macroeconomics debate. Without reading his post, I thought (and commented at Brad Delong's blog) that the battle isn't over and that the other than Friedman forces are currently winning back lost ground. In other words, I agree with Rowe (and an earlier post by DeLong) that Friedman's thought is the main stream of macroeconomics, although it is, oddly, called new Keynesian.

Noah Smith has 5 excellent questions for Nick Rowe. Do read Smith's post (for one thing he has read Rowe's post). My comment

As usual, I think this post is excellent (I guess I should save pixels by leaving that part out).

I definitely agree that mentioning Marxists is a bit odd. Marxist economists were marginal in the 70s. I don't think it makes sense to use the same word for Keynesians and Marxists together at all.

I do not recall widespread support for price controls among mainstream left of center economists. I definitely do recall hearing Robert Solow say that, while he doesn't have any strong ideological fixation on free markets, wage and price controls are just bad policy. Here (and always) I think that claims about what was generally said and written should be ruled out of order unless backed by names and citations. I personally recall hearing what Solow said on the topic in a Kennedy School public debate on what to do about high inflation. Update: Nick Rowe in comments links to Tobin (see next paragraph). My vague recollection of what I heard from economists when I was a biologist does not seem to be reliably intellectual history. I score this one Rowe 1 Waldmann ... hey I was just blogging at my personal blog and I just asked I didn't assert.

Or to put it another way, I am interested in Friedman vs Samuelson, Solow and Tobin.

Actually I have a challenge. Name a Friedman Solow debate which, with the benefit of hindsight, we agree was won by Friedman. I do not think this is easy to do.

I was alive in the 70s although kinda young and not an economist. I remember almost no discussion of wage and price controls after 1973 (when Nixon who was not Galbraith imposed them).

I recall extensive discussion of whether central banks should target interest rates or the money stock. This is a debate which Friedman won, leading to a shift in the late 70s to targetting the money stock, then lost in around 1982. How often do you read about the quantity of money ? How much did it grow in the past year ? Monetarism wasn't just the claim that monetary policy matters, but also the claim that the quantity of money was the key variable, because velocity is stable and predictable. This, the absolutely central aspect of monetarism according to Friedman, seems to have been conveniently forgotten by March 2008 at the latest. Or to put it another way, Friedman and new Keynesians have a lot in common, but also disagree on something Friedman considered extraordinarily important.

Your point 4 is related to your point 1. Rowe defines the left so that universal health insurance and environmental regulation are not leftist. It isn't as if people far to the left of Friedman ranging from Samuelson to Che Guevara are so similar that it is useful to discuss them together. Friedman, however, definitely advocated deregulationa and a sharp reduction of the state which haven't happened. He and Rose Friedman wrote a book called "The Tyranny of the Status Quo" during the Reagan administration. This is not a title for a book written by someone who won the policy debate (you may correctly guess that I haven't read the book).

Finally, you Rowe and I agree that Friedman dominated academic macroeconomics in 2007 with new Keyenesians better labeled Friedmanites. However, there have been some rather shocking new data since then leading to heated debate and making it a very odd time to try to decide who won the debate.