Robert's Stochastic thoughts: 8/1/15

Thursday, August 20, 2015

Begging for even more attention from Paul Romer

I have recently been delighted to find comments on this blog from someone named Paul who seems to be Paul Romer himself. He seems to have taken the time to answer my "Question for Paul Romer" even after writing "Solow's Choice" which makes the answer very clear. In that post, he suggests that, in 1978 Solow should have written a simple, applied general equilibrium (SAGE) model with downwarnd nominal rigidity instead of mocking Lucas and Sargent. I just remembered that I have written (but not type set sorry) a SAGE model with downward nominal rigidity -- it's behavior is strange with secular stagnation and sunspots and stuff. I wonder if it is worth a look Also, given the success of my question for Paul Romer, I have two similar ones What about Thomas Sargent ? Does he display Feynman integrity ? I sometimes think he does and sometimes think he's just discovered a spectacularly successful rhetoric of false modesty. Brad DeLong named Alan Blinder as a model of intellectual integrity (sorry can't find the link). Does Alan Blinder display Feynman integrity ?

Tuesday, August 18, 2015

Romer, DeLong and Krugman on Solow and Lucas

I can't resist typing this post. I am very sure it is not worth reading (that's why it's here not at http://angrybearblog.com)

Paul Romer, Paul Krugman and Brad DeLong are having a polite inside baseball discussion of what went wrong with Macro in the 70s and early 80s. I agree with all three that it is probably time to move on to how to fix macroeconomics in the 2010s. Also civility is good. In particular, I think it would be useful to the reality based community to make sure Paul Romer feels welcome (I note that I get paid largely for trying to explain Paul Romer to students). However, I feel free to be as rude as I want to be on this blog. I don't share Romer's beliefs about the history of thought including his beliefs about the very recent thoughts of Paul Krugman and Brad DeLong.

I am to comment Romer's post brilliantly entitled "Solow's Choice".

update 2: Paul Romer himself was kind enough to answer my question for Paul Romer in a comment on that post ! I am thrilled.

Robert,

Re your question, I hope that my posts about Solow's remarks in 1978 answer your question. But to be specific, I think that Solow did depart from the role of the scientist by using debating tactics to dismiss the critique by Lucas and Sargent. And I suppose he did not live up to Feynman's mandate in the sense that he does not acknowledge the problems that the big simulation models suffered from. But so did Lucas and Sargent, I suppose, by pushing the policy ineffectiveness result prematurely. Feynman integrity sets a pretty high bar.

Paul

end update 2

update: Romer has uploaded the conference volume here so you can read Solow's chapter as I just did.

end update:

Before wasting the time of the reader (if any) I state my conclusions.

1) I think that Solow made the right choice. It is true that academic macroeconomists (including those at MIT) almost all disagreed. I think subsequent events show that Solow was right.

2) I think that Brad DeLong absolutely agrees with Solow. I don't know much about much, but I know a lot about the thought of Brad DeLong. I think Romer's guesses about DeLong's beliefs are incorrect.

3) Romer makes guesses about Solow's motivation. I make different guesses (knowing much less).

Romer wrote

In the summer of 1978, Lucas and Sargent were making three claims:
(a) Existing multi-equation macro simulation models were not identified. That is, these models summarized correlations in the data but did not yield reliable statements of the form “if the government does X, this will cause Y to happen.”
(b) It was time to use SAGE models to address such fundamental questions about economic fluctuations as why changes in the supply of money influence economic activity; and
(c) SAGE models will imply that an active monetary policy cannot stabilize economic fluctuations.
Solow thought that Lucas and Sargent were wrong about the policy ineffectiveness claim (c). DeLong, Krugman, and I all agree. In the 2013 introduction to his collected papers, Lucas uses some asides about the Great Depression and the Great Recession to admit that now even he agrees. Claim (c) is what DeLong and Krugman have in mind when they say that Solow was right and Lucas was wrong.

Romer agrees with (b) but doesn't explain why he thinks that macroeconomic models must be SAGE models. I don't know if he considers the assumption that the economy is in general equilibrium a falsifiable hypothesis or not. I think if he thinks it is, he must consider the possibility that it shall be falsified (he wrote that theories must bow to facts). If it isn't, I don't see what is gained by assuming it. I think that GE implies the assumption of rationality. this is certainly true of the DSGE model presented by Arrow and Debreu 1954 and it is also assumed in all contemporary applied DSGE models of which I am aware. But this is an assumption which we can be sure is false and which is defended because it might be useful. I have never understood how anyone can argue that one must assume something because it might be useful. Lucas certainly insisted on the assumption of rational expectations. Solow certainly thought that it was a very bad idea to make that assumption (as did Friedman).

Personally, I think that the new Keynesian SAGE program has been sterile and that it was a mistake to start on it back in the 1970s.

I am quite sure that DeLong thinks Solow was right in rejecting (b). I am not expert on much, but I am quite expert on the thought of Brad DeLong. In 1983 he said that he was going to do fields exams in economic history and econometrics and not macroeconomics because he thought that macroeconomics had headed down a blind alley which it wouldn't leave for decades. I think subsequent events suggest he was right. Importantly, he knew about early new Keynesian work at MIT. He didn't like the rational expectations hypothesis (he is quite famous as a critic of it). Also more recently he wrote

But then Mike Woodford and company lost sight of the goal. Yes, New Keynesian models with more or less arbitrary micro foundations are useful for rebutting claims that all is for the best macro economically in this best of all possible macroeconomic worlds. But models with micro foundations are not of use in understanding the real economy unless you have the micro foundations right. And if you have the micro foundations wrong, all you have done is impose restrictions on yourself that prevent you from accurately fitting reality.
Thus your standard New Keynesian model will use Calvo pricing and model the current inflation rate as tightly coupled to the present value of expected future output gaps. Is this a requirement anyone really wants to put on the model intended to help us understand the world that actually exists out there? Thus your standard New Keynesian model will calculate The expected path of consumption as the solution to some Euler equation plus an intertemporal budget constraint, with current wealth and the projected real interest rate path as the only factors that matter. This is fine if you want to demonstrate that remodel can produce macroeconomic pathologies. But is it a not-stupid thing to do if you want your model to fit reality?

Krugman recently wrote

I’m actually mainly with Waldmann on this one, although Wren-Lewis’s analysis is nonetheless very useful. For the point he makes about the implications even of perfectly well-informed and rational consumers was and as far as I know still is totally misunderstood by freshwater economists [skip]
But aside from exposing the intellectual decline and fall of the Chicago School, is this the way we should go about modeling such things? Well, yes, sometimes, because rigorous intertemporal thinking, even if empirically ungrounded, can be useful to focus one’s thoughts. But as a way to think about the reality of spending decisions, no. Ordinary households — and that’s who makes consumption decisions — have no idea what the government is spending, whether it is temporary or permanent, whatever.

This is absolutely a critique (indeed a contemptuous dismissal) of claim (b) and not at all a comment on claim (c) .

I note that Wren Lewis agrees

I think it is clear that DeLong rejects the SAGE program and not just the policy ineffectiveness proposition. I don't claim to completely understand Krugman's view, but it seems to me to be very different from Lucas's and quite different from Romer's

Romer guesses that Solow dismissed Lucas and Sargent because he was worried that policy makers would take the policy ineffectiveness proposition seriously. I must stress that this is just a guess. Solow might have just had the impression that Lucas's approach was crazy. I my experience, most people do have that reaction.

Romer criticizes Solow for not writing down a model where fear of worker's anger prevents employers from cutting wages. In particular, he asks for a SAGE model with downward nominal wage rigidity. Solow did re-introduce the idea of efficiency wages and explicitly motivated the assumption that wages affect productivity through morale. I think Romer criticized Solow for failing to do what, in fact, Solow did (or perhaps for failing to work out a model during a conference).

Journal of Macroeconomics Volume 1, Issue 1, Winter 1979, Pages 79-82

Another possible source of wage stickiness

Abstract

A number of hypotheses have been advanced to explain wage stickiness. This article explores another reason why wage stickiness might be in an employer's interest: the relationship between productivity and the wage rate. If the wage enters the short-run production function, a cost-minimizing firm will leave its wage offer unchanged, no matter how its output varies, if and only if the wage enters the production function in a labor-augmenting way.

A free pdf is available here

In the text of the paper, Solow explicitly refers to morale

Romer's problem might be that Solow didn't put his model of wage stickiness in a SAGE model but cited Malinvaud instead. Note the article is published in 1979 a very brief delay after 1978. Solow did send it to a low ranking journal (it wasn't rejected by a higher ranking journal -- decades later Solow had not ever had a manuscript rejected).

really pointless stuff after the jump

AIPAC gall is amazing

Here members of AIPAC (often for attribution) assert that it is improper for Barack Obama to criticize AIPAC. It is very important that they don't just contest the (obviously accurate) criticisms, but argue that criticizing them is something he must never ever do. The amazing thing is that it is clear that they wanted this article to be published (I think it is clear that they contacted The Times). In the USA there is a powerful bunch of people who think that they must not be criticized, are willing to say so, and don't imagine that their denunciation of lese AIPAC will anger anyone who can cause them any problems -- that is they assume that they are so powerful that they can be as arrogant as they want. I think that no country with any self esteme would allow any group to treat it that way. The quotes directly that it is unacceptable for a President to (implicitly) criticize AIPAC (without naming it).

“It’s somewhat dangerous, because there’s a kind of a dog whistle here that some people are going to hear as ‘it’s time to go after people,’ and not just rhetorically,” said David Makovsky

That is criticism (without naming people or groups) is an incitement to violence. Or what else can "not just rhetorically" mean. Makovsky directly said that it is unacceptable to criticize AIPAC (what other interpretation is there ?). and

Words have consequences, especially when it’s authority figures saying them, and it’s not their intent, perhaps, but we know from history that they become manipulated,” said Malcolm Hoenlein, executive vice chairman of the Conference of Presidents of Major American Jewish Organizations, repeating a concern he had raised directly with Mr. Obama during the closed-door session. “Of all political leaders,” Mr. Hoenlein added, “he certainly should be the most sensitive to this.”

How can this be interpreted as other than the claim that it is not acceptable for Obama to participate in a debate about his policy by saying that criticisms of his policy are inaccurate ? The cheek the gall the arrogance faccia di bronzo prepotente haughty and you know the word I am not willing to type in this context.

Living in the Real World

I think it is almost possible that the Editorial Board of the Washington Post may have decided to stop ignoring reality. To me the editorial entitled "Only a handful of GOP candidates are living in the real world" is news. My general impression is that the WaPo unsigned editorials have been well right of center for decades with a strong focus on how it would be good to invade Iraq and cut Social Security. I might have just missed other reality based editorials, but I don't recall such a frank assertion that the GOP has gone nuts. To be sure, the editorial is a compromise; it is a polemic written by a committee. They looked hard for traces of Republican sanity. Given their influence inside the beltway, I think it would actually make a difference if they continued to frankly note Republican craziness. To be more specific, I think they influence spineless moderate Democrats who won't get to the left of the WaPo editorial board.

Wednesday, August 05, 2015

What Wouldn't be a Dynamic-Stochastic General-Equilibrium model?

In Which I Try to Answer a Question asked by Larry Summers as a Joke

The LSE held a discussion on Reconstructing Macroeconomics. Brad DeLong posted a transcript , the video is here.

Larry Summers opened with a joke

Larry Summers: You know I was tempted to blast off at Dynamic-Stochastic General-Equilibrium models. That is, actually, my inclination. But on the other hand it occurred to me to ask the question: "What wouldn't be a Dynamic-Stochastic General-Equilibrium model?" That would be a Static-Certain Partial-Equilibrium model. It is hard to see how that represent any kind of an improvement. So I can't be against DSGE on principle.

I have a sense of humor, but I am going to suppress it and pretend to take the joking answer literally. I note that the diametric opposite of a Dynamic-Stochastic General-Equilibrium model would be a Static-Certain Partial-Disequilibrium model. Even in jest, even Summers has trouble separating the concepts of model and equilibrium -- which in context means Nash equilibrium. Also the joke is a joke, a Dynamic-stochastic-partial equilibrium model is not a Dynamic-Stochastic General-Equilibrium model. It is also easy to answer the question, because there are models older than any DSGE model -- Summers can propose we go back to using those models. For one thing, he clearly does use those models (as do DeLong and Krugman). They weren't equilibrium models. Bernanke and Blanchard (who have made huge contributions to Reconstructing Macroeconomics) assume in their answers that they are required to start with a standard new Keynesian DSGE model and modify it to reconcile it with reality. Blanchard said

Suppose you are writing two textbooks, one undergrad, one grad. In the undergraduate textbook, it seems to me that when teaching the IS-LM, [skip]
At the graduate level, we now have this explosion of DSGE models which put one friction and another into the model. Again, targeting pedagogy, it seems to me that there are two mechanisms which are central. The first is leverage, which starting with Ben [Bernanke's] work and earlier work we have, I think we know how to deal with it. The second is liquidity. And I think there we are much less far along the way. Again, I am hoping that someday we will put it together and have a simple way of thinking about leverage and a simple way of thinking about liquidity. These two things will come into our New Keynesian model, and we will be able to tell a simple story. We are at the stage at which the DSGE models have much too much in them to be fully understood.

Blanchard is not joking. He takes it as a given that the IS-LM model is for undergraduates and that graduate teaching and research should be based on new Keynesian DSGE models. He also notes a problem -- current DSGE models do not clarify thought, because we don't understand what is going on in the computer as it simulates them. He neglects another problem -- DSGE models are based on extremely strong assumptions (including rational expectations but also including say the assumption that there is no housing sector or inventories) which we are all sure aren't literally true. The only defense of the approach is that we should think about simple things which we understand which might give us insights into the much more complex real world. I find it hard to accept the assumption that macroeconmics must be based on incomprehensible models which fundamentally rely on assumptions we are sure are false in ways which seem to have been critically important and which yield, at best, mediocre forecasts.

I'd like to see a debate where Summers (or Krugman or DeLong) argues for the resolution "Old Keynesian models from the 60s and 70s are a more promising starting point for macroeconomic research than New Keynesian DSGE models". Someone would have to argue contra. Oddly, I find it extremely difficult to think of (and impossible to find) anyone willing to do this. I can't recall hearing or reading a defense of the NK DSGE approach. It is just assumed that this is what macroeconomics is and must be, but I honestly can't recall an argument for why it should be (hmmm am I too young to be senile?).

Starting this post, I had planned to argue for the resolution, but this is getting long and I want to type about how we got where we are. Senile or not, I am too young to remember, Old-Keynes had been abandoned already when I arrived in economics in 1985. But this is a blog.

A question for Paul Romer

Professor Romer, do you think that Robert Solow has Feynman integrity ?

I do.

I quote and question "Lucas and his colleagues interpreted the hostile reaction they received from such economists as Robert Solow to mean that they were facing implacable, unreasoning resistance from such departments as MIT."

Whatever Lucas thought, I wonder if Romer thinks that Solows resistance was "unreasoning". He used humor as did Stigner (and Lucas) but does that mean he felt "Stigler Conviction".

Now it is certainly possible for someone to dismiss the rational expectations hypothesis and without serious thought as soon as he hears what it is and to consistently consider it absurd from then on (I am an example). I heard of the concept of Nash equilibrium when I was 17 and immediately thought that some related idea might be useful, but the hypothesis that actual play is in Nash equilibrium is clearly false.

Since then, I have never doubted that the Nash equilibirum hypothesis is fundamentally wrong. I am a methodological individualist, so I have no time at all for the idea that it is useful to characterize the set of Nash equilibria, because an outcome being a Equilibrium tells us anything about how likely it is.

Update: Paul who seems to be Paul Romer himself kindly took the time to answer my question. The answer is no as indeed I guessed from his post "Solow's choice"

Robert, Re your question, I hope that my posts about Solow's remarks in 1978 answer your question. But to be specific, I think that Solow did depart from the role of the scientist by using debating tactics to dismiss the critique by Lucas and Sargent. And I suppose he did not live up to Feynman's mandate in the sense that he does not acknowledge the problems that the big simulation models suffered from. But so did Lucas and Sargent, I suppose, by pushing the policy ineffectiveness result prematurely. Feynman integrity sets a pretty high bar.
Paul

Monday, August 03, 2015

When did the Freshwater School Adopt the "Adversarial Method"

Paul Romer and Paul Krugman write that Lucas, Prescott et al had great intellectual integrity back in the 70s but then turned to sophistry. I think there is a very eminent eyewitness account of the shift.

I think a very interesting contribution to this discussion is an interview of Sargent by Evans and Honkapohja.

"my recollection is that Bob Lucas and Ed Prescott were initially very enthusiastic about rational expectations econometrics. After all, it simply involved imposing on ourselves the same high standards we had criticized the Keynesians for failing to live up to. But after about five years of doing likelihood ratio tests of rational expectations models, I recall both Bob Lucas and Ed Prescott telling me that those tests were rejecting too many good models. The idea of calibration is to ignore some of the probabilistic implications of your model, but to retain others. Somehow, calibration was intended as a balanced to professing that your model, though not correct, is still worthy as a vehicle for quantitative policy analysis."

http://bit.ly/1OYDdwH

So they took the wrong turn after about five years. I note two things -- Sargent said this soon after being awarded the Nobel memorial prize.

The other is that the Lucas critique is a critique of exactly what Lucas did after "about five years". assuming that a model is useful as a vehicle for quantitative policy analysis by looking only at the fit of the variables policy makers care about. http://bit.ly/1OYDK1R

Human Capital Spillovers

Paul Romer proposes that economists try to think like physicists. I think he means the same thing Sargent means when he talks about taking models seriously.

I am going to treat his post as a challenge. Romer wrote

1) There is a crucial distinction between human capital (stored in neurons), and codified information (stored in some external form, such as printed text or bits on a hard drive.) 2) Anything stored in neurons is a rival good. 3) A person’s human capital is fully excludable as long as people have legal control over their own bodies. So there are no human capital “spillovers” and no human capital “externalities.”

His discussion goes on, but I want to challenge the third claim.

For one thing, I think the post is, for the purposes of growth theory, just like a human capital spillover. I learned from the post. I didn't pay for it (nore did Romer expect any payment). The fact that something is excludeable doesn't mean that others are, in fact, excluded. People voluntarily share knowledge as Romer did in his post including the claim that there are no human capital spillovers.

I agree with Romer that ESP doesn't exist, so we can't steal knowledge from each other's brains. We don't learn just by being around someone who knows something. But I think there are human capital spillovers and externalities.

The reason is that we can learn by watching someone use their human capital (I really mean watch with our eyes).

This is a very inefficient way to learn. It is much more efficient for the knowledgeable person to explain things, sometimes it is necessary for the learner to attempt a task and be critiqued by the teacher or coach. But "no" is a strong word.

Someone who wants to prevent this can use knowledge only in private and prevent others from watching (as someone can lock up a document). But someone who is indifferent about the knowledge of others will use skills when being watched and the others will learn (slightly) more than nothing.

Human capital is invisible when it just sits there, but more than exactly none of it can be inferred by watching someone use it.

I think there are much more important processes which aren't true spillovers but which can be usefully modeled as if they were spillovers.

1) altruism. In standard models agents are selfish but actual people aren't. People teach other people without demanding payment or negotiating. The effect on the spread of information is like a spillover. Pretending it just happens while using standard utility functions is an almost harmless shortcut.

2) Gift exchange. People can have a norm or custom that they teach each other (so long as it isn't too hard). This is an exchange not a spillover. However, I think in the real world there is a lot of this going on without cash payment, negotiation or checking how much each is teaching and how much each is learning. The macro effects are similar to those of a spillover and quite different from purchasing of education. This is not a spillover, but modeling it as a spillover is a more useful approximation than modeling it as a market exchange.

3) people with complementary skills work together in teams. In the process, with the sole aim of getting the task done, they explain what they are doing. This is learning and teaching by doing. The fact that both end up learning from the others is a by product of the effort to perform a task together.

4) some people enjoy teaching. I had a lot of knowledge pretty much forced on me by people I knew in college. This is a case of how you can get models to do anything by playing with utility functions. But it is reality. Consider blogging. Some people do it without expecting any reward. Romer is very clear that he expects costs not benefits from his posts on mathiness. This is not at all like market exchange of education services. The post on how human capital doesn't spill over is a human capital spillover.

5) When learning it is best to expose ones imperfect knowledge to criticism. One kind of non spillover teaching is the lecture where someone knowledgeable talks and learners listen. Another is the presentation with criticism, the problem set with correction etc where someone who is learning talks or writes and someone knowlegeable comments critiques and corrects. In the real world, the roles are not always clear. If I think I understand something but am not sure, it is useful to me to try to explain it to a critical listener who doesn't know about it already. Who is the teacher and who is the student? This isn't a spillover (we are both expending effort) but it is better modeled as a spillover than as a market exchange.

So I think there are minor unimportant human capital spillovers and also extremely important social interactions which spread knowledge which aren't spillovers but which have similar implications for the spread of knowledge and economic growth and all that, while they don't have anything like the same implications as the purchase of teaching services with tuition.

So I think models with human capital spillovers are useful even if actual human capital spillovers are unimportant.

Robert's Stochastic thoughts