Showing posts with label Talks. Show all posts
Showing posts with label Talks. Show all posts
Thursday, July 28, 2016
Macro-Finance
A new essay "Macro-Finance," based on a talk I gave at the University of Melbourne this Spring. I survey many current frameworks including habits, long run risks, idiosyncratic risks, heterogenous preferences, rare disasters, probability mistakes, and debt or institutional finance. I show how all these approaches produce quite similar results and mechanisms: the market's ability to bear risk varies over time, with business cycles. I speculate with some simple models that time-varying risk premiums can produce a theory of risk-averse recessions, produced by varying risk aversion and precautionary saving, rather than Keynesian flow constraints or new-Keynesian intertemporal substitution.
Wednesday, May 25, 2016
Equity financed banking video
Video of my talk at the Minneapolis Fed's "Ending Too Big to Fail" symposium. A link to the video (youtube) in case you don't see the above embedded version. The event webpage, with links to the other talks and the agenda. Summary: AM: Dodd Frank is a big failure, we need a big fix. PM: We'll get it to work with little fixes here and there. I posted the text of my talk earlier.
Monday, March 21, 2016
The Habit Habit
The Habit Habit. This is an essay expanding slightly on a talk I gave at the University of Melbourne's excellent "Finance Down Under" conference. The slides
(Note: This post uses mathjax for equations and has embedded graphs. Some places that pick up the post don't show these elements. If you can't see them or links come back to the original. Two shift-refreshes seem to cure Safari showing "math processing error".)
Habit past: I start with a quick review of the habit model. I highlight some successes as well as areas where the model needs improvement, that I think would be productive to address.
Habit present: I survey of many current parallel approaches including long run risks, idiosyncratic risks, heterogenous preferences, rare disasters, probability mistakes -- both behavioral and from ambiguity aversion -- and debt or institutional finance. I stress how all these approaches produce quite similar results and mechanisms. They all introduce a business-cycle state variable into the discount factor, so they all give rise to more risk aversion in bad times. The habit model, though less popular than some alternatives, is at least still a contender, and more parsimonious in many ways,
Habits future: I speculate with some simple models that time-varying risk premiums as captured by the habit model can produce a theory of risk-averse recessions, produced by varying risk aversion and precautionary saving, as an alternative to Keynesian flow constraints or new Keynesian intertemporal substitution. People stopped consuming and investing in 2008 because they were scared to death, not because they wanted less consumption today in return for more consumption tomorrow.
Throughout, the essay focuses on challenges for future research, in many cases that seem like low hanging fruit. PhD students seeking advice on thesis topics: I'll tell you to read this. It also may be useful to colleagues as a teaching note on macro-asset pricing models. (Note, the parallel sections of my coursera class "Asset Pricing" cover some of the same material.)
I'll tempt you with one little exercise taken from late in the essay.
A representative consumer with a fixed habit \(x\) lives in a permanent income economy, with endowment \(e_0\) at time 0 and random endowment \(e_1\) at time 1. With a discount factor \(\beta=R^f=1\), the problem is
\[ \max\frac{(c_{0}-x)^{1-\gamma}}{1-\gamma}+E\left[ \frac {(c_{1}-x)^{1-\gamma}}{1-\gamma}\right] \] \[ c_{1} = e_{0}-c_{0} +e_{1} \] \[ e_{1} =\left\{ e_{h},e_{l}\right\} \; pr(e_{l})=\pi. \] The solution results from the first order condition \[ \left( c_{0}-x\right) ^{-\gamma}=E\left[ (c_{1}-x)^{-\gamma}\right] \] i.e., \[ \left( c_{0}-x\right) ^{-\gamma}=\pi(e_{0}-c_{0}+e_{l}-x)^{-\gamma}% +(1-\pi)(e_{0}-c_{0}+e_{h}-x)^{-\gamma}% \] I solve this equation numerically for \(c_{0}\).
The first picture shows consumption \(c_0\) as a function of first period endowment \(e_0\) for \(e_{h}=2\), \(e_{l}=0.9\), \(x=1\), \(\gamma=2\) and \(\pi=1/100\).
The case that one state is a rare disaster is not special. In a general case, the consumer starts to focus more and more on the worst-possible state as risk aversion rises. Therefore, the model with any other distribution and the same worst-possible state looks much like this one.
Watch the blue \(c_0\) line first. Starting from the right, when first-period endowment \(e_{0}\) is abundant, the consumer follows standard permanent income advice. The slope of the line connecting initial endowment \(e_{0}\) to consumption \(c_{0}\) is about 1/2, as the consumer splits his large endowment \(e_{0}\) between period 0 and the single additional period 1.
As endowment \(e_{0}\) declines, however, this behavior changes. For very low endowments \(e_{0}\approx 1\) relative to the nearly certain better future \(e_{h}=2\), the permanent income consumer would borrow to finance consumption in period 0. The habit consumer reduces consumption instead. As endowment \(e_{0}\) declines towards \(x=1\), the marginal propensity to consume becomes nearly one. The consumer reduces consumption one for one with income.
The next graph presents marginal utility times probability, \(u^{\prime}(c_{0})=(c_{0}-x)^{-\gamma}\), and \(\pi_{i}u^{\prime}(c_{i})=\pi _{i}(c_{i}-x)^{-\gamma},i=h,l\). By the first order condition, the former is equal to the sum of the latter two. \ But which state of the world is the more important consideration? When consumption is abundant in both periods on the right side of the graph, marginal utility \(u^{\prime}(c_{0})\) is almost entirely equated to marginal utility in the 99 times more likely good state \((1-\pi)u^{\prime}(c_{h})\). So, the consumer basically ignores the bad state and acts like a perfect foresight or permanent-income intertemporal-substitution consumer, considering consumption today vs. consumption in the good state.
In bad times, however, on the left side of the graph, if the consumer thinks about leaving very little for the future, or even borrowing, consumption in the unlikely bad state approaches the habit. Now the marginal utility of the bad state starts to skyrocket compared to that of the good state. The consumer must leave some positive amount saved so that the bad state does not turn disastrous -- even though he has a 99% chance of doubling his income in the next period (\(e_{h}=2\), \(e_{0}=1\)). Marginal utility at time 0, \(u^{\prime }(c_{0})\) now tracks \(\pi_{l}u^{\prime}(c_{l})\) almost perfectly.
In these graphs, then, we see behavior that motivates and is captured by many different kinds of models:
1. Consumption moves more with income in bad times.
This behavior is familiar from buffer-stock models, in which agents wish to smooth intertemporally, but can't borrow when wealth is low....
2. In bad times, consumers start to pay inordinate attention to rare bad states of nature.
This behavior is similar to time-varying rare disaster probability models, behavioral models, or to minimax ambiguity aversion models. At low values of consumption, the consumer's entire behavior \(c_{0}\) is driven by the tradeoff between consumption today \(c_{0}\) and consumption in a state \(c_{l}\) that has a 1/100 probability of occurrence, ignoring the state with 99/100 probability.
This little habit model also gives a natural account of endogenous time-varying attention to rare events.
The point is not to argue that habit models persuasively dominate the others. The point is just that there seems to be a range of behavior that theorists intuit, and that many models capture.
When consumption falls close to habit, risk aversion rises, stock prices fall, so by Q theory investment falls. We nearly have a multiplier-accelerator, due to rising risk aversion in bad times: Consumption falls with mpc approaching one, and investment falls as well. The paper gives some hints about how that might work in a real model.
(Note: This post uses mathjax for equations and has embedded graphs. Some places that pick up the post don't show these elements. If you can't see them or links come back to the original. Two shift-refreshes seem to cure Safari showing "math processing error".)
Habit past: I start with a quick review of the habit model. I highlight some successes as well as areas where the model needs improvement, that I think would be productive to address.
Habit present: I survey of many current parallel approaches including long run risks, idiosyncratic risks, heterogenous preferences, rare disasters, probability mistakes -- both behavioral and from ambiguity aversion -- and debt or institutional finance. I stress how all these approaches produce quite similar results and mechanisms. They all introduce a business-cycle state variable into the discount factor, so they all give rise to more risk aversion in bad times. The habit model, though less popular than some alternatives, is at least still a contender, and more parsimonious in many ways,
Habits future: I speculate with some simple models that time-varying risk premiums as captured by the habit model can produce a theory of risk-averse recessions, produced by varying risk aversion and precautionary saving, as an alternative to Keynesian flow constraints or new Keynesian intertemporal substitution. People stopped consuming and investing in 2008 because they were scared to death, not because they wanted less consumption today in return for more consumption tomorrow.
Throughout, the essay focuses on challenges for future research, in many cases that seem like low hanging fruit. PhD students seeking advice on thesis topics: I'll tell you to read this. It also may be useful to colleagues as a teaching note on macro-asset pricing models. (Note, the parallel sections of my coursera class "Asset Pricing" cover some of the same material.)
I'll tempt you with one little exercise taken from late in the essay.
A representative consumer with a fixed habit \(x\) lives in a permanent income economy, with endowment \(e_0\) at time 0 and random endowment \(e_1\) at time 1. With a discount factor \(\beta=R^f=1\), the problem is
\[ \max\frac{(c_{0}-x)^{1-\gamma}}{1-\gamma}+E\left[ \frac {(c_{1}-x)^{1-\gamma}}{1-\gamma}\right] \] \[ c_{1} = e_{0}-c_{0} +e_{1} \] \[ e_{1} =\left\{ e_{h},e_{l}\right\} \; pr(e_{l})=\pi. \] The solution results from the first order condition \[ \left( c_{0}-x\right) ^{-\gamma}=E\left[ (c_{1}-x)^{-\gamma}\right] \] i.e., \[ \left( c_{0}-x\right) ^{-\gamma}=\pi(e_{0}-c_{0}+e_{l}-x)^{-\gamma}% +(1-\pi)(e_{0}-c_{0}+e_{h}-x)^{-\gamma}% \] I solve this equation numerically for \(c_{0}\).
The first picture shows consumption \(c_0\) as a function of first period endowment \(e_0\) for \(e_{h}=2\), \(e_{l}=0.9\), \(x=1\), \(\gamma=2\) and \(\pi=1/100\).
The case that one state is a rare disaster is not special. In a general case, the consumer starts to focus more and more on the worst-possible state as risk aversion rises. Therefore, the model with any other distribution and the same worst-possible state looks much like this one.
Watch the blue \(c_0\) line first. Starting from the right, when first-period endowment \(e_{0}\) is abundant, the consumer follows standard permanent income advice. The slope of the line connecting initial endowment \(e_{0}\) to consumption \(c_{0}\) is about 1/2, as the consumer splits his large endowment \(e_{0}\) between period 0 and the single additional period 1.
As endowment \(e_{0}\) declines, however, this behavior changes. For very low endowments \(e_{0}\approx 1\) relative to the nearly certain better future \(e_{h}=2\), the permanent income consumer would borrow to finance consumption in period 0. The habit consumer reduces consumption instead. As endowment \(e_{0}\) declines towards \(x=1\), the marginal propensity to consume becomes nearly one. The consumer reduces consumption one for one with income.
The next graph presents marginal utility times probability, \(u^{\prime}(c_{0})=(c_{0}-x)^{-\gamma}\), and \(\pi_{i}u^{\prime}(c_{i})=\pi _{i}(c_{i}-x)^{-\gamma},i=h,l\). By the first order condition, the former is equal to the sum of the latter two. \ But which state of the world is the more important consideration? When consumption is abundant in both periods on the right side of the graph, marginal utility \(u^{\prime}(c_{0})\) is almost entirely equated to marginal utility in the 99 times more likely good state \((1-\pi)u^{\prime}(c_{h})\). So, the consumer basically ignores the bad state and acts like a perfect foresight or permanent-income intertemporal-substitution consumer, considering consumption today vs. consumption in the good state.
In bad times, however, on the left side of the graph, if the consumer thinks about leaving very little for the future, or even borrowing, consumption in the unlikely bad state approaches the habit. Now the marginal utility of the bad state starts to skyrocket compared to that of the good state. The consumer must leave some positive amount saved so that the bad state does not turn disastrous -- even though he has a 99% chance of doubling his income in the next period (\(e_{h}=2\), \(e_{0}=1\)). Marginal utility at time 0, \(u^{\prime }(c_{0})\) now tracks \(\pi_{l}u^{\prime}(c_{l})\) almost perfectly.
In these graphs, then, we see behavior that motivates and is captured by many different kinds of models:
1. Consumption moves more with income in bad times.
This behavior is familiar from buffer-stock models, in which agents wish to smooth intertemporally, but can't borrow when wealth is low....
2. In bad times, consumers start to pay inordinate attention to rare bad states of nature.
This behavior is similar to time-varying rare disaster probability models, behavioral models, or to minimax ambiguity aversion models. At low values of consumption, the consumer's entire behavior \(c_{0}\) is driven by the tradeoff between consumption today \(c_{0}\) and consumption in a state \(c_{l}\) that has a 1/100 probability of occurrence, ignoring the state with 99/100 probability.
This little habit model also gives a natural account of endogenous time-varying attention to rare events.
The point is not to argue that habit models persuasively dominate the others. The point is just that there seems to be a range of behavior that theorists intuit, and that many models capture.
When consumption falls close to habit, risk aversion rises, stock prices fall, so by Q theory investment falls. We nearly have a multiplier-accelerator, due to rising risk aversion in bad times: Consumption falls with mpc approaching one, and investment falls as well. The paper gives some hints about how that might work in a real model.
Monday, September 29, 2014
Why and how we care about inequality
Note: These are remarks I gave in a concluding panel at the Conference on Inequality in Memory of Gary Becker, Hoover Institution, September 26 2014. The conference program here, and John Taylor's summary here, where you can see the great papers I allude to. I'll probably rework this to a more general essay, so I reserve the right to recycle some points later.
Why and How We Care About Inequality
Wrapping up a wonderful conference about facts, our panel is supposed to talk about “solutions” to the “problem” of inequality.
We have before us one “solution,” the demand from the left for confiscatory income and wealth taxation, and a substantial enlargement of the control of economic activity by the State.
Note I don’t say “redistribution” though some academics dream about it. We all know there isn’t enough money, especially to address real global poverty, and the sad fact is that government checks don’t cure poverty. President Obama was refreshingly clear, calling for confiscatory taxation even if it raised no income. “Off with their heads” solves inequality, in a French-Revolution sort of way, and not by using the hair to make wigs for the poor. The agenda includes a big expansion of spending on government programs, minimum wages, “living wages,” government control of wages, especially by minutely divided groups, CEO pay regulation, unions, “regulation” of banks, central direction of all finance, and so on. The logic is inescapable. To “solve inequality,” don’t just take money from the rich. Stop people, and especially the “wrong” people, from getting rich in the first place.
In this context, I think it is a mistake to accept the premise that inequality, per se, is a “problem” needing to be “solved,” and to craft “alternative solutions.”
Just why is inequality, per se, a problem?
Suppose a sack of money blows in the room. Some of you get $100, some get $10. Are we collectively better off? If you think “inequality” is a problem, no. We should decline the gift. We should, in fact, take something from people who got nothing, to keep the lucky ones from their $100. This is a hard case to make.
One sensible response is to acknowledge that inequality, by itself, is not a problem. Inequality is a symptom of other problems. I think this is exactly the constructive tone that this conference has taken.
But there are lots of different kinds of inequality, and an enormous variety of different mechanisms at work. Lumping them all together, and attacking the symptom, “inequality,” without attacking the problems is a mistake. It’s like saying “fever is a problem. So medicine shall consist of reducing fevers.”
Yes, the reported, pre-tax income and wealth of the top 1% in the U.S. and many other countries has grown. We have an interesting debate whether this is “good” or “market” inequality – Steve Jobs starts a company that invents the iphone, takes home 1/10 of 1% of the welfare (consumer surplus) the iphone created, and lives in a nice house and flies in a private jet – or “bad,” “rent-seeking” inequality, cronyism, exploiting favors from the government. Josh Rauh made a good case for “market.” It’s interesting how we even use different language. Emmanuel Saez spoke of how much income the 1% “get,” and Josh how much the 1% “earn.”
In middle incomes, as Kevin Murphy told us, the “returns to skill” have increased. This has nothing to do with top-end cronyism. As Kevin so nicely reminds us, wages go up when demand for skill goes up and supply does not. He locates the supply restriction in awful public schools, taken over by teacher’s unions. Limits on high –skill immigration also restrict supply and drive up the skill premium. There’s a problem we know how to fix. Confiscatory taxation isn’t going to help!
More “education” is one obvious “solution.” But we need to be careful here, and not too quickly join the chorus asking that our industry be further subsidized. The returns to education chosen and worked hard for are not necessarily replicated in education subsidized or forced. Free tuition for all majors draws people into art history too. Forgiving student loans for people who go to non-profits or government work, or a large increase in wealth and income taxation, remove the market signal to study computer programming rather than art history, which raises the skill premium even more. Saudi Arabia spends a lot on “education” in Madrases around the world. In a Becker memorial conference remember three rules: Supply matters, not just demand; don’t redistribute income by distorting prices; and human capital investments respond to incentives. (By the way, I’m all for art history. Just don’t pretend that the measured economic returns to education will apply.)
America has a real problem on the lower income end, epitomized by Charles’ Murray’s “Fishtown.” A segment of America is stuck in widespread single motherhood, leading to terrible early-child experiences, awful education, substance abuse, and criminality. 70% of male black high school dropouts will end up in prison, hence essentially unemployable and poor marriage prospects. Less than half are even looking for legal work.
This is a social and economic disaster. And it has nothing to do with whether hedge fund managers fly private or commercial. It is immune to floods of Government cash, and, as Casey Mulligan reminded us, Government programs are arguably as much of the problem as the solution. So are drug laws, as much of the earlier discussion reminded us.
Around the world, about a billion people still live on $2 a day, have no electricity, drinking water, or even latrines. If you care about “inequality,” minimum wage earners in the US should be paying Piketty taxes.
These cases all represent completely different problems. Where there are problems, we should fix them, but to fix them, not to “reduce inequality.”
Kinds of inequality
More puzzling, why are critics on the left so focused on the 1% in the US, when by many measures we live in an era of great leveling?
Earnings inequality between men and women has narrowed drastically, as Kevin Murphy reminded us. Inequality across countries, and thus across people around the globe, has also been shrinking dramatically even as income inequality within advanced countries has risen. One billion Chinese were rescued from totalitarian misery, and a billion Indians sort-of-rescued from British-style license-Raj socialism. These are wonderful events for human progress as well as, incidentally, for global inequality. Sure, these countries have many political and economic problems left, but the “its’ all getting worse” story just aint’ so. China and India did not start growing by confiscatory taxation of income and wealth, and increasing state intervention in markets. Exactly the opposite. And the parts of the world left or falling behind – parts of the Middle East, Latin Amirica (think Venezuela), parts of Africa – have just nothing to do with the private-jet purchases of US hedge fund billionaires.
“Inequality” is about more than income or wealth, reported to tax authorities. Consumption is much flatter than income. Rich people mostly give away or reinvest their wealth. It’s hard to see just how this is a problem.
Political, social, cultural inequality, inequality of lifespan, of health, of social status, even of schooling are all much flatter than they used to be (Nick Eberstat recently summarized these in a nice Wall Street Journal Oped.) Mark Zuckerberg wears a hoody, not a top hat.
Look at Versailles. Nobody, not even Bill Gates, lives like Marie Antoinette. And nobody in the US lives like her peasants. In 1960, Mao Tse-Tung waved his hand and 20 millions died. In 1935, Joseph Stalin did the same. Neither reported a lot of income to tax authorities for economists to measure “inequality.” It is preposterous to claim that, even the citizens of Ferguson Mo., with all their problems and injustices, are less equal now than they were in 1950. Or 1850.
Why does it matter at all to a vegetable picker in Fresno, or an unemployed teenager on the south side of Chicago, whether 10 or 100 hedge fund managers in Greenwich have private jets? How do they even know how many hedge fund managers fly private? They have hard lives, and a lot of problems. But just what problem does top 1% inequality really represent to them?
I’ve been reading Piketty, Saez, Krugman, Stiglitz, the New York Times editorial pages to find the answers. They all recognize that inequality per se is not a persuasive problem, so they must convince us that inequality causes some other social or economic ill.
Here’s one. Standard and Poors economists wrote a recent summary report on inequality, (earlier post here) perhaps as penance for downgrading the US debt, and wrote
If this argument held any water, wouldn’t banning “Keeping up with the Kardashians” be far more effective? (Or, better, rap music videos!) If the problem is truly overspending by low income Americans, can we not think of more directed solutions? For example, might we not want to remove the enormous taxation of savings that they face through social programs?
Another example. The S&P report moved on to a new story: Inequality is a problem because rich people save too much of their money, and poor people don’t. So, by transferring money from rich to poor, we can increase overall consumption and escape “secular stagnation.”
I see. Now the problem is too much saving, not too much consumption. We need to forcibly transfer wealth from the rich to the poor in order to overcome our deep problem of national thriftiness.
I may be bludgeoning the obvious, but let’s point out just a few ways this is incoherent. If Keynesian “spending” and “aggregate demand” are the problems behind low long-run growth rates – and that’s a big if - standard Keynesian answers are a lot easier solutions than confiscatory wealth taxation and redistribution. Which is why standard Keynesians argued for monetary and fiscal policies, not confiscatory anti-inequality taxation, until the latter became politically popular.
In a series of recent blog posts, (see coverage here) Paul Krugman offers evidence that people vastly underestimate how wealthy the rich are, bemoans how they live separate lives -- my fry cook has, in fact, no idea of their lifestyle -- and argues for confiscatory taxation to eliminate the "externality" of their excessive consumption. Well, I'm glad logical consistency isn't holding back these arguments.
The most common argument is that we have to reduce income inequality to avoid political instability. If we don’t redistribute the wealth, the poor will rise up and take it. As a cause-and effect claim about human affairs, this is dubious amateur political science, one that would look especially amateurish to the political scientists and historians at this Hoover Institution on War, Revolution and Peace. Maybe the poor should rise up and overthrow the rich, but they never have. Inequality was pretty bad on Thomas Jefferson’s farm. But he started a revolution, not his slaves.
These are just three examples, and I won’t go on since time is short. But there are some interesting patterns. The answer is always the same – confiscatory wealth taxation and expansion of the state. The question, the “problem” this answer is supposed to solve keeps changing. When an actual economic problem is adduced – excessive spending by the poor, inadequate spending by the rich, political instability -- they don’t advocate the problem’s natural solution. These “problems” are being thought up afterwards to justify the desired answer. And amazing, novel and undocumented cause-and-effect assertions about public policy are dreamed up and passed around like internet cat videos.
Politics and Money
But these are serious people. Let’s recognize this is all the balderdash and distraction that it seems, and that we are circling around the elephant in the room. Let’s try to find the core issue that they are really talking about. Let’s find a common ground, a resolvable difference, so we can stop talking past each other.
In the end, most of these authors are pretty clear the real problem they see: money and politics. They worry that too much money is corrupting politics, and they want to take away the money to purify the politics.
That explains the obsessive focus on the income and wealth of the top 1%. Consumption may be flatter, but income and wealth buy political connections. And all of our concern about the status of the poor, the returns to skill, awful education, the effects of widespread incarceration, all this is irrelevant to the money and politics nexus.
Now, the critique of an increasingly rent-seeking society echoes from both the left and the libertarians. Rent-seeking is a big problem. Cronyism is a big problem. Stigler finds a lot to agree with in Stiglitz. As do Friedman, Buchanan, and so forth.
But now comes the most astounding lack of logic of all. If the central problem is rent-seeking, abuse of the power of the state, to deliver economic goods to the wealthy and politically powerful, how in the world is more government the answer?
If we increase the statutory maximum Federal income tax rate 70% , on top of state and local taxes, estate taxes, payroll taxes, corporate taxes, sales taxes and on and on -- at a Becker conference, always add up all the taxes, not just the one you want to raise and pretend the others are zero -– will that not simply dramatically increase the demand for tax lawyers, lobbyists and loopholes?
If you believe cronyism is the problem, why is the first item on your agenda not to repeal the Dodd Frank act and Obamacare, surely two of the biggest invitations to cronyism of our lifetimes? And move on to the rotten energy section of the corporate tax code.
They don’t, and here I think lies the important and resolvable difference. Stiglitz wrote that “wealth is a main determinant of power.” Stigler might answer, no, power is a main determinant of wealth. To Stiglitz, if the state grabs all the wealth, even if that wealth is fairly won, then the state can ignore rent-seeking and benevolently exercise its power on behalf of the common man. Stigler would say that government power inevitably invites rent-seeking. His solution to cronyism is to limit the government’s ability to hand out goodies in the first place. We want a simple, transparent, fair, flat and low tax system.
Here is where I think Josh Rauh’s masterful collection of data that the upper 1% in the U.S. are making their money fairly, falls flat to left ears. They think even fairly gotten money will pervert politics.
Now we have boiled the argument down to a simple question of cause and effect. They believe that raising tax rates and a large increase in state direction of economic activity will reduce rent-seeking and cronyism. I assert the opposite, which is the rather traditional conclusion of the vast literature on public choice as well as obvious experience. If I were trying to be polite, I might say it’s an interesting new theory to be debated and investigated. But I’m not, and it isn’t. It is the cream on the cake of amateur ad-hoc assertions of cause-and-effect relationships in human affairs, changing the sign of everything we know.
As we look around the world, cronyism, rent-seeking, using the power of the state to deliver riches to yourself and privilege to your family is a huge problem, not just driving inequality, but driving most of poverty, lack of growth, and human misery throughout the world. But Egypt, say, does not suffer because it is not good enough at grabbing wealth, stifling markets and blocking the rise of entrepreneurs. Quite the opposite.
Politics and the agenda.
But let’s go with their argument. At least now the argument makes sense, in a way hat limiting envy-induced spendthrifery does not. But looked at in the light of day, the argument is truly scary. They are saying that the government must confiscate individual wealth so that individual wealth cannot influence politics in directions they don’t like. Koch brothers, no. Public employee unions, yes.
We finally agree on a cause-and-effect proposition. Yes, expanding the power of the state to direct economic activity and strip people of wealth is well-proven way to cement the power of the state and quash dissent.
So now you see why I rebel at the presumption that “inequality” is a problem, and why I rebel at the task of articulating an alternative “solution.” “Inequality” has become a meaningless buzzword, or code word for “on our team,” like “sustainability,” or “social justice.” Should we discuss “free-market solutions” to address “social justice?”
“Inequality” has become a code word for endless, thoughtless, and counterproductive intrusions into economic activity. Minimum wages, stronger teachers unions, even prison guard unions, are all advocated on the grounds of “providing middle class jobs” to “reduce inequality,” though they do the opposite. Mayor Bill de Blasio has already reduced it to farce: As reported in the New York times, the latest energy efficiency standards for fancy New York high rises are bing put in place. Why? To cool the planet by a billionth of a degree? To stem the rise of the oceans by a nanometer? No, first on the list… to reduce inequality. Poor people pay more of their incomes in heating bills, you see.
Finally, why is “inequality” so strongly on the political agenda right now? Here I am not referring to academics. Kevin has been studying the skill premium for 30 years. Emmanuel likewise has devoted his career to important measurement questions, and will do so whether or not the New York Times editorial page cheers. All of economics has been studying various poverty traps for a generation, as represented well by the other authors at this conference. Why is there a big political debate just now? Why is the Administration and its allies in the punditry, such as Paul Krugman and Joe Stiglitz, all a-twitter about “inequality?” Why are otherwise generally sensible institutions like the IMF, the S&P, and even the IPCC jumping on the “inequality” bandwagon?
That answer seems pretty clear. Because they don’t want to talk about Obamacare, Dodd-Frank, bailouts, debt, the stimulus, the rotten cronyism of energy policy, denial of education to poor and minorities, the abject failure of their policies to help poor and middle class people, and especially sclerotic growth. Restarting a centuries-old fight about “inequality” and “tax the rich,” class envy resurrected from a Huey Long speech in the 1930s, is like throwing a puppy into a third grade math class that isn’t going well. You know you will make it to the bell.
That observation, together with the obvious incoherence of ideas the political inequality writers bring us leads me to a happy thought that this too will pass, and once a new set of talking points emerges we can go on to something else.
But if that is our circumstance, clearly we should not fall for the trap. Don’t surrender the agenda. State our own agenda. We care about prosperity. We care about fixing the real, serious, economic problems our country faces and especially that people on the bottom of society face. Globally, we care about the billion on $2 a day, that no amount of tax and transfer will help.
The “solutions,” the secrets of prosperity, are simple and old-fashioned: property rights, rule of law, honest government, economic and political freedom. A decent government, yes, providing decent roads, schools, and laws necessary for the common good. Confiscatory taxation and extensive government direction of economic activity are simply not on the list.
Why and How We Care About Inequality
Wrapping up a wonderful conference about facts, our panel is supposed to talk about “solutions” to the “problem” of inequality.
We have before us one “solution,” the demand from the left for confiscatory income and wealth taxation, and a substantial enlargement of the control of economic activity by the State.
Note I don’t say “redistribution” though some academics dream about it. We all know there isn’t enough money, especially to address real global poverty, and the sad fact is that government checks don’t cure poverty. President Obama was refreshingly clear, calling for confiscatory taxation even if it raised no income. “Off with their heads” solves inequality, in a French-Revolution sort of way, and not by using the hair to make wigs for the poor. The agenda includes a big expansion of spending on government programs, minimum wages, “living wages,” government control of wages, especially by minutely divided groups, CEO pay regulation, unions, “regulation” of banks, central direction of all finance, and so on. The logic is inescapable. To “solve inequality,” don’t just take money from the rich. Stop people, and especially the “wrong” people, from getting rich in the first place.
In this context, I think it is a mistake to accept the premise that inequality, per se, is a “problem” needing to be “solved,” and to craft “alternative solutions.”
Just why is inequality, per se, a problem?
Suppose a sack of money blows in the room. Some of you get $100, some get $10. Are we collectively better off? If you think “inequality” is a problem, no. We should decline the gift. We should, in fact, take something from people who got nothing, to keep the lucky ones from their $100. This is a hard case to make.
One sensible response is to acknowledge that inequality, by itself, is not a problem. Inequality is a symptom of other problems. I think this is exactly the constructive tone that this conference has taken.
But there are lots of different kinds of inequality, and an enormous variety of different mechanisms at work. Lumping them all together, and attacking the symptom, “inequality,” without attacking the problems is a mistake. It’s like saying “fever is a problem. So medicine shall consist of reducing fevers.”
Yes, the reported, pre-tax income and wealth of the top 1% in the U.S. and many other countries has grown. We have an interesting debate whether this is “good” or “market” inequality – Steve Jobs starts a company that invents the iphone, takes home 1/10 of 1% of the welfare (consumer surplus) the iphone created, and lives in a nice house and flies in a private jet – or “bad,” “rent-seeking” inequality, cronyism, exploiting favors from the government. Josh Rauh made a good case for “market.” It’s interesting how we even use different language. Emmanuel Saez spoke of how much income the 1% “get,” and Josh how much the 1% “earn.”
In middle incomes, as Kevin Murphy told us, the “returns to skill” have increased. This has nothing to do with top-end cronyism. As Kevin so nicely reminds us, wages go up when demand for skill goes up and supply does not. He locates the supply restriction in awful public schools, taken over by teacher’s unions. Limits on high –skill immigration also restrict supply and drive up the skill premium. There’s a problem we know how to fix. Confiscatory taxation isn’t going to help!
More “education” is one obvious “solution.” But we need to be careful here, and not too quickly join the chorus asking that our industry be further subsidized. The returns to education chosen and worked hard for are not necessarily replicated in education subsidized or forced. Free tuition for all majors draws people into art history too. Forgiving student loans for people who go to non-profits or government work, or a large increase in wealth and income taxation, remove the market signal to study computer programming rather than art history, which raises the skill premium even more. Saudi Arabia spends a lot on “education” in Madrases around the world. In a Becker memorial conference remember three rules: Supply matters, not just demand; don’t redistribute income by distorting prices; and human capital investments respond to incentives. (By the way, I’m all for art history. Just don’t pretend that the measured economic returns to education will apply.)
America has a real problem on the lower income end, epitomized by Charles’ Murray’s “Fishtown.” A segment of America is stuck in widespread single motherhood, leading to terrible early-child experiences, awful education, substance abuse, and criminality. 70% of male black high school dropouts will end up in prison, hence essentially unemployable and poor marriage prospects. Less than half are even looking for legal work.
This is a social and economic disaster. And it has nothing to do with whether hedge fund managers fly private or commercial. It is immune to floods of Government cash, and, as Casey Mulligan reminded us, Government programs are arguably as much of the problem as the solution. So are drug laws, as much of the earlier discussion reminded us.
Around the world, about a billion people still live on $2 a day, have no electricity, drinking water, or even latrines. If you care about “inequality,” minimum wage earners in the US should be paying Piketty taxes.
These cases all represent completely different problems. Where there are problems, we should fix them, but to fix them, not to “reduce inequality.”
Kinds of inequality
More puzzling, why are critics on the left so focused on the 1% in the US, when by many measures we live in an era of great leveling?
Earnings inequality between men and women has narrowed drastically, as Kevin Murphy reminded us. Inequality across countries, and thus across people around the globe, has also been shrinking dramatically even as income inequality within advanced countries has risen. One billion Chinese were rescued from totalitarian misery, and a billion Indians sort-of-rescued from British-style license-Raj socialism. These are wonderful events for human progress as well as, incidentally, for global inequality. Sure, these countries have many political and economic problems left, but the “its’ all getting worse” story just aint’ so. China and India did not start growing by confiscatory taxation of income and wealth, and increasing state intervention in markets. Exactly the opposite. And the parts of the world left or falling behind – parts of the Middle East, Latin Amirica (think Venezuela), parts of Africa – have just nothing to do with the private-jet purchases of US hedge fund billionaires.
“Inequality” is about more than income or wealth, reported to tax authorities. Consumption is much flatter than income. Rich people mostly give away or reinvest their wealth. It’s hard to see just how this is a problem.
Political, social, cultural inequality, inequality of lifespan, of health, of social status, even of schooling are all much flatter than they used to be (Nick Eberstat recently summarized these in a nice Wall Street Journal Oped.) Mark Zuckerberg wears a hoody, not a top hat.
Look at Versailles. Nobody, not even Bill Gates, lives like Marie Antoinette. And nobody in the US lives like her peasants. In 1960, Mao Tse-Tung waved his hand and 20 millions died. In 1935, Joseph Stalin did the same. Neither reported a lot of income to tax authorities for economists to measure “inequality.” It is preposterous to claim that, even the citizens of Ferguson Mo., with all their problems and injustices, are less equal now than they were in 1950. Or 1850.
Why does it matter at all to a vegetable picker in Fresno, or an unemployed teenager on the south side of Chicago, whether 10 or 100 hedge fund managers in Greenwich have private jets? How do they even know how many hedge fund managers fly private? They have hard lives, and a lot of problems. But just what problem does top 1% inequality really represent to them?
I’ve been reading Piketty, Saez, Krugman, Stiglitz, the New York Times editorial pages to find the answers. They all recognize that inequality per se is not a persuasive problem, so they must convince us that inequality causes some other social or economic ill.
Here’s one. Standard and Poors economists wrote a recent summary report on inequality, (earlier post here) perhaps as penance for downgrading the US debt, and wrote
As income inequality increased before the crisis, less affluent households took on more and more debt to keep up--or, in this case, catch up--with the Joneses....In Vanity Fair, Joe Stiglitz wrote similarly that inequality is a problem because it causes
a well-documented lifestyle effect—people outside the top 1 percent increasingly live beyond their means….trickle-down behaviorismAha! Our vegetable picker in Fresno hears that the number of hedge fund managers in Greenwich with private jets has doubled. So, he goes out and buys a pickup truck he can’t afford. Therefore, Stiglitz is telling us, we must quash inequality with confiscatory wealth taxation… in order to encourage thrift in the lower classes?
If this argument held any water, wouldn’t banning “Keeping up with the Kardashians” be far more effective? (Or, better, rap music videos!) If the problem is truly overspending by low income Americans, can we not think of more directed solutions? For example, might we not want to remove the enormous taxation of savings that they face through social programs?
Another example. The S&P report moved on to a new story: Inequality is a problem because rich people save too much of their money, and poor people don’t. So, by transferring money from rich to poor, we can increase overall consumption and escape “secular stagnation.”
I see. Now the problem is too much saving, not too much consumption. We need to forcibly transfer wealth from the rich to the poor in order to overcome our deep problem of national thriftiness.
I may be bludgeoning the obvious, but let’s point out just a few ways this is incoherent. If Keynesian “spending” and “aggregate demand” are the problems behind low long-run growth rates – and that’s a big if - standard Keynesian answers are a lot easier solutions than confiscatory wealth taxation and redistribution. Which is why standard Keynesians argued for monetary and fiscal policies, not confiscatory anti-inequality taxation, until the latter became politically popular.
In a series of recent blog posts, (see coverage here) Paul Krugman offers evidence that people vastly underestimate how wealthy the rich are, bemoans how they live separate lives -- my fry cook has, in fact, no idea of their lifestyle -- and argues for confiscatory taxation to eliminate the "externality" of their excessive consumption. Well, I'm glad logical consistency isn't holding back these arguments.
The most common argument is that we have to reduce income inequality to avoid political instability. If we don’t redistribute the wealth, the poor will rise up and take it. As a cause-and effect claim about human affairs, this is dubious amateur political science, one that would look especially amateurish to the political scientists and historians at this Hoover Institution on War, Revolution and Peace. Maybe the poor should rise up and overthrow the rich, but they never have. Inequality was pretty bad on Thomas Jefferson’s farm. But he started a revolution, not his slaves.
These are just three examples, and I won’t go on since time is short. But there are some interesting patterns. The answer is always the same – confiscatory wealth taxation and expansion of the state. The question, the “problem” this answer is supposed to solve keeps changing. When an actual economic problem is adduced – excessive spending by the poor, inadequate spending by the rich, political instability -- they don’t advocate the problem’s natural solution. These “problems” are being thought up afterwards to justify the desired answer. And amazing, novel and undocumented cause-and-effect assertions about public policy are dreamed up and passed around like internet cat videos.
Politics and Money
But these are serious people. Let’s recognize this is all the balderdash and distraction that it seems, and that we are circling around the elephant in the room. Let’s try to find the core issue that they are really talking about. Let’s find a common ground, a resolvable difference, so we can stop talking past each other.
In the end, most of these authors are pretty clear the real problem they see: money and politics. They worry that too much money is corrupting politics, and they want to take away the money to purify the politics.
That explains the obsessive focus on the income and wealth of the top 1%. Consumption may be flatter, but income and wealth buy political connections. And all of our concern about the status of the poor, the returns to skill, awful education, the effects of widespread incarceration, all this is irrelevant to the money and politics nexus.
Now, the critique of an increasingly rent-seeking society echoes from both the left and the libertarians. Rent-seeking is a big problem. Cronyism is a big problem. Stigler finds a lot to agree with in Stiglitz. As do Friedman, Buchanan, and so forth.
But now comes the most astounding lack of logic of all. If the central problem is rent-seeking, abuse of the power of the state, to deliver economic goods to the wealthy and politically powerful, how in the world is more government the answer?
If we increase the statutory maximum Federal income tax rate 70% , on top of state and local taxes, estate taxes, payroll taxes, corporate taxes, sales taxes and on and on -- at a Becker conference, always add up all the taxes, not just the one you want to raise and pretend the others are zero -– will that not simply dramatically increase the demand for tax lawyers, lobbyists and loopholes?
If you believe cronyism is the problem, why is the first item on your agenda not to repeal the Dodd Frank act and Obamacare, surely two of the biggest invitations to cronyism of our lifetimes? And move on to the rotten energy section of the corporate tax code.
They don’t, and here I think lies the important and resolvable difference. Stiglitz wrote that “wealth is a main determinant of power.” Stigler might answer, no, power is a main determinant of wealth. To Stiglitz, if the state grabs all the wealth, even if that wealth is fairly won, then the state can ignore rent-seeking and benevolently exercise its power on behalf of the common man. Stigler would say that government power inevitably invites rent-seeking. His solution to cronyism is to limit the government’s ability to hand out goodies in the first place. We want a simple, transparent, fair, flat and low tax system.
Here is where I think Josh Rauh’s masterful collection of data that the upper 1% in the U.S. are making their money fairly, falls flat to left ears. They think even fairly gotten money will pervert politics.
Now we have boiled the argument down to a simple question of cause and effect. They believe that raising tax rates and a large increase in state direction of economic activity will reduce rent-seeking and cronyism. I assert the opposite, which is the rather traditional conclusion of the vast literature on public choice as well as obvious experience. If I were trying to be polite, I might say it’s an interesting new theory to be debated and investigated. But I’m not, and it isn’t. It is the cream on the cake of amateur ad-hoc assertions of cause-and-effect relationships in human affairs, changing the sign of everything we know.
As we look around the world, cronyism, rent-seeking, using the power of the state to deliver riches to yourself and privilege to your family is a huge problem, not just driving inequality, but driving most of poverty, lack of growth, and human misery throughout the world. But Egypt, say, does not suffer because it is not good enough at grabbing wealth, stifling markets and blocking the rise of entrepreneurs. Quite the opposite.
Politics and the agenda.
But let’s go with their argument. At least now the argument makes sense, in a way hat limiting envy-induced spendthrifery does not. But looked at in the light of day, the argument is truly scary. They are saying that the government must confiscate individual wealth so that individual wealth cannot influence politics in directions they don’t like. Koch brothers, no. Public employee unions, yes.
We finally agree on a cause-and-effect proposition. Yes, expanding the power of the state to direct economic activity and strip people of wealth is well-proven way to cement the power of the state and quash dissent.
So now you see why I rebel at the presumption that “inequality” is a problem, and why I rebel at the task of articulating an alternative “solution.” “Inequality” has become a meaningless buzzword, or code word for “on our team,” like “sustainability,” or “social justice.” Should we discuss “free-market solutions” to address “social justice?”
“Inequality” has become a code word for endless, thoughtless, and counterproductive intrusions into economic activity. Minimum wages, stronger teachers unions, even prison guard unions, are all advocated on the grounds of “providing middle class jobs” to “reduce inequality,” though they do the opposite. Mayor Bill de Blasio has already reduced it to farce: As reported in the New York times, the latest energy efficiency standards for fancy New York high rises are bing put in place. Why? To cool the planet by a billionth of a degree? To stem the rise of the oceans by a nanometer? No, first on the list… to reduce inequality. Poor people pay more of their incomes in heating bills, you see.
Finally, why is “inequality” so strongly on the political agenda right now? Here I am not referring to academics. Kevin has been studying the skill premium for 30 years. Emmanuel likewise has devoted his career to important measurement questions, and will do so whether or not the New York Times editorial page cheers. All of economics has been studying various poverty traps for a generation, as represented well by the other authors at this conference. Why is there a big political debate just now? Why is the Administration and its allies in the punditry, such as Paul Krugman and Joe Stiglitz, all a-twitter about “inequality?” Why are otherwise generally sensible institutions like the IMF, the S&P, and even the IPCC jumping on the “inequality” bandwagon?
That answer seems pretty clear. Because they don’t want to talk about Obamacare, Dodd-Frank, bailouts, debt, the stimulus, the rotten cronyism of energy policy, denial of education to poor and minorities, the abject failure of their policies to help poor and middle class people, and especially sclerotic growth. Restarting a centuries-old fight about “inequality” and “tax the rich,” class envy resurrected from a Huey Long speech in the 1930s, is like throwing a puppy into a third grade math class that isn’t going well. You know you will make it to the bell.
That observation, together with the obvious incoherence of ideas the political inequality writers bring us leads me to a happy thought that this too will pass, and once a new set of talking points emerges we can go on to something else.
But if that is our circumstance, clearly we should not fall for the trap. Don’t surrender the agenda. State our own agenda. We care about prosperity. We care about fixing the real, serious, economic problems our country faces and especially that people on the bottom of society face. Globally, we care about the billion on $2 a day, that no amount of tax and transfer will help.
The “solutions,” the secrets of prosperity, are simple and old-fashioned: property rights, rule of law, honest government, economic and political freedom. A decent government, yes, providing decent roads, schools, and laws necessary for the common good. Confiscatory taxation and extensive government direction of economic activity are simply not on the list.
Sunday, July 13, 2014
Summer Institute
I just got back from the NBER Summer Institute. The Economic Fluctuations and Growth meeting organized by Larry Christiano and Chad Jones sparks some thoughts on where macro is and where we're going. (I also attended the monetary economics and asset pricing meetings, which were excellent and thought provoking too, but one can only blog so much.)
Review:
There were two papers on macro theory. Fist, the conference started with Gauti Eggertsson and Neil Mehrotra's "A Model of Secular Stagnation," which I discussed, slides here.
I think it's an important paper. The standard simple New-Keynesian model has a lot of trouble to produce a steady slump with positive inflation. So if you want "secular stagnation," you need a new model. I also have a lot of trouble with the "negative natural rate." It tends to be a deus-ex-machina, output is lower than I'd like so the natural rate must be negative. It would be much more convincing if we could separately measure the natural rate, but that too needs a model. This paper provides a model whose steady states resemble old fashioned static Keynesian relations, not the dynamic new-Keynesian ones, and a model where one could think about separately measuring the negative natural rate.
"Important" doesn't mean "right" or "conclusive." This model rules out storage, has no money, and hobbles the rate of return on capital, all of which tend to put bounds of zero or above on long-term real interest rates. More thoughts on the slides, which I may write up at more length some day. (Olivier Blanchard discussed the same paper on Friday, bringing in data from around the world. If he posts his slides I'll update.)
Second, Paul Beaudry presented his paper with Dana Galizia, Franck Portier, titled "Reconciling Hayek's and Keynes' Views of Recessions," which Ivan Werning discussed. It was a rather complex model trying to capture overaccumulation and liquidation.
There were two empirical papers. Simon Gilchrist, presented his paper with Raphael Schoenle, Jae Sim, Egon Zakrajsek, "Inflation Dynamics During the Financial Crisis," discussed by Mark Bils. Companies short of cash in the financial crisis raised prices; companies with a lot of cash lowered them. Clean dynamic model, clean data, a nice bit of the micro data analysis going on in macro these days.
Sarah Zubairy presented her paper with Valerie Ramey, "Government Spending Multipliers in Good Times and in Bad: Evidence from U.S. Historical Data," discussed by Yuriy Gorodnichenko. As Valerie has done before, they regress output on military spending shocks to estimate multipliers. Here the question is whether the effects are larger when there is higher unemployment or a low interest rate, with a bunch of small but important methodological improvements. The conclusion is no, and multipliers a bit below one throughout, but much methodological discussion on how one interprets the facts.
There were two "Growth" papers. First, Roland Benabou presented "Forbidden Fruits: The Political Economy of Science, Religion and Growth" with Davide Ticchi and Andrea Vindigni. The basic idea is that religion blocks or adapts to new ideas, going back centuries. History, going back a thousand years, regressions of patents on religiosity, all building to a big model, with section titles like "Inequality, Religion and the Politics of Science."
Paul Romer "discussed" the paper, i.e. gave a long and thoughtful speech, covering religion, social norms, neuroeconoimcs (Southerners faced with a slight insult have big spikes in cortisol levels compared to Northerners), the shocking rate of incarceration in the US, words vs. equations in economics, and lots more.
Last but certainly not least, Ufuk Akcigit presented "Young, Restless and Creative: Openness to Disruption and Creative Innovations" with Daron Acemoglu and Murat Alp Celik, discussed by Sam Kortum, The basic idea is that companies with young CEOs are more likely to make radical innovations rather than incremental ones. A complex model precedes regressions of patent citations on CEO age.
Thoughts:
Just how we do economics was a big theme running through all the discussion. Words vs. equations; models and empirical work; and what kinds of things we look at and what kind of work people are doing.
Most of the theory papers had some "motivating" facts. Most of the facts papers and more or less motivating theory. Not one paper wrote down a model, estimated or calibrated its parameters, and compared that model to data. (Gilchrist came pretty close, but more the exception that proves the rule.) This isn't a complaint, really, it's just where we are. The kinds of things people want to investigate are just too hard to write down models rich enough to take to the data.
This point came up again and again. Sam gently chided Ufuk at al for presenting 24 pages of complex model all to "motivate" some regressions. He suggested that the model should be used to guide and constrain regressions, and to give a more structural interpretation to the parameters. Pat Kehoe, asking a question, complained that it's awfully hard to measure a fiscal multiplier with no guidance of which model for its possible operation. He pointed out that any model restricts how many variables together should respond to a fiscal expansion. For example the static Keynesian model says consumption should rise. The real business cycle model gives a multiplier through impoverishing people, which has joint predictions across consumption, labor, etc. Likewise I complained that in wars, the assumption that everything else is on average equal -- made when regressing output on fiscal shocks -- seems a bit stretched.
Similarly, both of the macro theory papers stopped well short of serious confrontation with data. We didn't see anything like the standard fully specified models of the Larry Christiano type, compared to, say, impulse-response functions. The models are so stylized you can't begin to quantify them. (I got off cheap shot pointing out that secular stagnation required deflation in the model. Since we do not have deflation, case closed. It's a cheap shot because I think the model could be easily modified to have stagnation with low positive inflation.) This too is not really a criticism. I've been working with simpler and simpler models, as I find it hard to keep the intuition and quantitative parable aspect alive as models get more complex. You have to walk before you can run. But questions like, how could Ed Prescott and Ellen McGrattan go off and measure the natural rate, are not yet answered.
A similar issue came up in the paper I discussed for Asset Pricing, Aytek Malkhozov, Philippe Mueller, Andrea Vedolin, and Gyuri Venter "Mortgage Risk and the Yield Curve," slides here. It developed a really nice arbitrage-free model with supply effects. And then used the model only to "motivate" regressions of returns on a measure of duration. Though the regression coefficient is tied to structural model parameters, the authors never made that link at all. Well, the model was perhaps too simple to do that. And, everyone else seems to be writing papers the same way. It's not a criticism, here, but an observation on our emerging culture.
Math vs. literature is a similar theme to atheoretical regressions/models as parables vs. estimates and tests. In my 30 years as an economist, our field has become much more literary and less quantitative. In part that reflects a different emphasis. It's really hard to build towards maximum likelyhood tests of effects of religion on the adoption of new ideas. Paul Romer commented on this at length, with "models vs. words" on his slides. In his view, math is a useful language because it removes much of the value-laden elements of language and forces logic to be out in the open. He linked language to us vs. them, social norms, morality, and those pesky cortisol levels. (I'm doing my best to recall a speech, so forgive me Paul if I don't get it all right.) He pointed to my use of "paleo-Keynesian" to describe the static models from the 1960s, guessing nobody would remember anything else from my discussion. When I complained that Paul Krugman invented the term, he pointed out (correctly) that such borrowing just made its use more rhetorically effective. There go the cortisol levels. I'm not sure in the end though whether Paul was approving or bemoaning the shift back towards literature in economic analysis. Certainly his vision for the future of growth theory, centered on values, social norms, biology, and so forth, does not lend itself easily to quantification.
The use of ancient quotations came up several times. I complained a bit about Eggertsson and Mehrotra's long efforts to tie their work to quotes from verbal speculations of Keynes, Alvin Hansen, Paul Krugman and Larry Summers. Their rhetorical device is, "aha, these equations finally explain what some sage of 80 years ago or Important Person today really meant." Ivan Werning really complained about this in Paul Beaudry's presentation. What does this complex piece of well worked out "21st century economics" have to do with long ago muddy debates between Keynes and Hayek? It stands on its own, or it doesn't. (In his view, it did, so why belittle it?)
Yes. Physics does not write papers about "the Newton-Aristotle debate." Our papers should stand on their own too. They are right or wrong if they are logically coherent and describe the data, not if they fulfill the vague speculations of some sage, dead or alive. It's especially unhelpful to try to make this connection, I think, because the models differ quite sharply from the speculations of the sage. Alvin Hansen certainly did not think that a Taylor interest rate rule with a phi parameter greater than one was a central culprit in "secular stagnation." I haven't checked against the speech, but I doubt he thought that inflation would completely cure the problem in the first place.
Sure, history of thought is important; tying ideas to their historical predecessors is important; recognizing the centuries of thinking on money and business cycles is important. But let's stand up for our own generation; we do not exist simply to finally put equations in the mouths of ancient economists.
But, tying it all up, perhaps I'm just being an old fogey. Adam Smith wrote mostly words. Marx like Keynes wrote big complicated books that people spent a century writing about "this is what they really meant." Maybe models are at best quantitative parables. Maybe economics is destined to return to this kind of literary philosophy, not quantified science.
Curious too what was missing. All the macro was decidedly Keynesian. General equilibrium with distortions, anything other than trend on "supply" was noticeable by its absence. So was the discussion. But maybe that's my fault for going to the NBER and not the Minnesota Macro meetings.
A last thought. Economic Fluctuations merged with Growth in the mid 1990s. At the time there was a great confluence of method as well as interest. Growth theorists were studying growth with Bellman equations, dynamic general equilibrium models of innovation and transmission of ideas, thinking about where productivity shocks came from. Macroeconomists were using Bellman equations, and studying dynamic general equilibrium models with stochastic technology, along with various frictions and other propagation mechanisms.
That confluence has now diverged. I enjoyed spending an hour or two thinking about how religion has blocked or adapted to ideas over the centuries, and Paul's view on social norms or neuroeconomics. But I don't really have any expertise to contribute to that debate. Questions like whether young CEOs head more innovative companies, or whether, like deans, what matters is the age of the faculty are a little closer to home, since I spend a lot of time consuming corporate finance. But the average sticky-price macro type does not. Likewise, when Daron Acemoglu, who seems to know everything about everything, has to preface his comments on macro papers with repeated disclaimers of lack of expertise, it's clear that the two fields really have gone their separate ways. Perhaps it's time to merge fluctuations with finance, where we seem to be talking about the same issues and using the same methods, and growth to merge with institutions and political or social economics.
Review:
There were two papers on macro theory. Fist, the conference started with Gauti Eggertsson and Neil Mehrotra's "A Model of Secular Stagnation," which I discussed, slides here.
I think it's an important paper. The standard simple New-Keynesian model has a lot of trouble to produce a steady slump with positive inflation. So if you want "secular stagnation," you need a new model. I also have a lot of trouble with the "negative natural rate." It tends to be a deus-ex-machina, output is lower than I'd like so the natural rate must be negative. It would be much more convincing if we could separately measure the natural rate, but that too needs a model. This paper provides a model whose steady states resemble old fashioned static Keynesian relations, not the dynamic new-Keynesian ones, and a model where one could think about separately measuring the negative natural rate.
"Important" doesn't mean "right" or "conclusive." This model rules out storage, has no money, and hobbles the rate of return on capital, all of which tend to put bounds of zero or above on long-term real interest rates. More thoughts on the slides, which I may write up at more length some day. (Olivier Blanchard discussed the same paper on Friday, bringing in data from around the world. If he posts his slides I'll update.)
Second, Paul Beaudry presented his paper with Dana Galizia, Franck Portier, titled "Reconciling Hayek's and Keynes' Views of Recessions," which Ivan Werning discussed. It was a rather complex model trying to capture overaccumulation and liquidation.
There were two empirical papers. Simon Gilchrist, presented his paper with Raphael Schoenle, Jae Sim, Egon Zakrajsek, "Inflation Dynamics During the Financial Crisis," discussed by Mark Bils. Companies short of cash in the financial crisis raised prices; companies with a lot of cash lowered them. Clean dynamic model, clean data, a nice bit of the micro data analysis going on in macro these days.
Sarah Zubairy presented her paper with Valerie Ramey, "Government Spending Multipliers in Good Times and in Bad: Evidence from U.S. Historical Data," discussed by Yuriy Gorodnichenko. As Valerie has done before, they regress output on military spending shocks to estimate multipliers. Here the question is whether the effects are larger when there is higher unemployment or a low interest rate, with a bunch of small but important methodological improvements. The conclusion is no, and multipliers a bit below one throughout, but much methodological discussion on how one interprets the facts.
There were two "Growth" papers. First, Roland Benabou presented "Forbidden Fruits: The Political Economy of Science, Religion and Growth" with Davide Ticchi and Andrea Vindigni. The basic idea is that religion blocks or adapts to new ideas, going back centuries. History, going back a thousand years, regressions of patents on religiosity, all building to a big model, with section titles like "Inequality, Religion and the Politics of Science."
Paul Romer "discussed" the paper, i.e. gave a long and thoughtful speech, covering religion, social norms, neuroeconoimcs (Southerners faced with a slight insult have big spikes in cortisol levels compared to Northerners), the shocking rate of incarceration in the US, words vs. equations in economics, and lots more.
Last but certainly not least, Ufuk Akcigit presented "Young, Restless and Creative: Openness to Disruption and Creative Innovations" with Daron Acemoglu and Murat Alp Celik, discussed by Sam Kortum, The basic idea is that companies with young CEOs are more likely to make radical innovations rather than incremental ones. A complex model precedes regressions of patent citations on CEO age.
Thoughts:
Just how we do economics was a big theme running through all the discussion. Words vs. equations; models and empirical work; and what kinds of things we look at and what kind of work people are doing.
Most of the theory papers had some "motivating" facts. Most of the facts papers and more or less motivating theory. Not one paper wrote down a model, estimated or calibrated its parameters, and compared that model to data. (Gilchrist came pretty close, but more the exception that proves the rule.) This isn't a complaint, really, it's just where we are. The kinds of things people want to investigate are just too hard to write down models rich enough to take to the data.
This point came up again and again. Sam gently chided Ufuk at al for presenting 24 pages of complex model all to "motivate" some regressions. He suggested that the model should be used to guide and constrain regressions, and to give a more structural interpretation to the parameters. Pat Kehoe, asking a question, complained that it's awfully hard to measure a fiscal multiplier with no guidance of which model for its possible operation. He pointed out that any model restricts how many variables together should respond to a fiscal expansion. For example the static Keynesian model says consumption should rise. The real business cycle model gives a multiplier through impoverishing people, which has joint predictions across consumption, labor, etc. Likewise I complained that in wars, the assumption that everything else is on average equal -- made when regressing output on fiscal shocks -- seems a bit stretched.
Similarly, both of the macro theory papers stopped well short of serious confrontation with data. We didn't see anything like the standard fully specified models of the Larry Christiano type, compared to, say, impulse-response functions. The models are so stylized you can't begin to quantify them. (I got off cheap shot pointing out that secular stagnation required deflation in the model. Since we do not have deflation, case closed. It's a cheap shot because I think the model could be easily modified to have stagnation with low positive inflation.) This too is not really a criticism. I've been working with simpler and simpler models, as I find it hard to keep the intuition and quantitative parable aspect alive as models get more complex. You have to walk before you can run. But questions like, how could Ed Prescott and Ellen McGrattan go off and measure the natural rate, are not yet answered.
A similar issue came up in the paper I discussed for Asset Pricing, Aytek Malkhozov, Philippe Mueller, Andrea Vedolin, and Gyuri Venter "Mortgage Risk and the Yield Curve," slides here. It developed a really nice arbitrage-free model with supply effects. And then used the model only to "motivate" regressions of returns on a measure of duration. Though the regression coefficient is tied to structural model parameters, the authors never made that link at all. Well, the model was perhaps too simple to do that. And, everyone else seems to be writing papers the same way. It's not a criticism, here, but an observation on our emerging culture.
Math vs. literature is a similar theme to atheoretical regressions/models as parables vs. estimates and tests. In my 30 years as an economist, our field has become much more literary and less quantitative. In part that reflects a different emphasis. It's really hard to build towards maximum likelyhood tests of effects of religion on the adoption of new ideas. Paul Romer commented on this at length, with "models vs. words" on his slides. In his view, math is a useful language because it removes much of the value-laden elements of language and forces logic to be out in the open. He linked language to us vs. them, social norms, morality, and those pesky cortisol levels. (I'm doing my best to recall a speech, so forgive me Paul if I don't get it all right.) He pointed to my use of "paleo-Keynesian" to describe the static models from the 1960s, guessing nobody would remember anything else from my discussion. When I complained that Paul Krugman invented the term, he pointed out (correctly) that such borrowing just made its use more rhetorically effective. There go the cortisol levels. I'm not sure in the end though whether Paul was approving or bemoaning the shift back towards literature in economic analysis. Certainly his vision for the future of growth theory, centered on values, social norms, biology, and so forth, does not lend itself easily to quantification.
The use of ancient quotations came up several times. I complained a bit about Eggertsson and Mehrotra's long efforts to tie their work to quotes from verbal speculations of Keynes, Alvin Hansen, Paul Krugman and Larry Summers. Their rhetorical device is, "aha, these equations finally explain what some sage of 80 years ago or Important Person today really meant." Ivan Werning really complained about this in Paul Beaudry's presentation. What does this complex piece of well worked out "21st century economics" have to do with long ago muddy debates between Keynes and Hayek? It stands on its own, or it doesn't. (In his view, it did, so why belittle it?)
Yes. Physics does not write papers about "the Newton-Aristotle debate." Our papers should stand on their own too. They are right or wrong if they are logically coherent and describe the data, not if they fulfill the vague speculations of some sage, dead or alive. It's especially unhelpful to try to make this connection, I think, because the models differ quite sharply from the speculations of the sage. Alvin Hansen certainly did not think that a Taylor interest rate rule with a phi parameter greater than one was a central culprit in "secular stagnation." I haven't checked against the speech, but I doubt he thought that inflation would completely cure the problem in the first place.
Sure, history of thought is important; tying ideas to their historical predecessors is important; recognizing the centuries of thinking on money and business cycles is important. But let's stand up for our own generation; we do not exist simply to finally put equations in the mouths of ancient economists.
But, tying it all up, perhaps I'm just being an old fogey. Adam Smith wrote mostly words. Marx like Keynes wrote big complicated books that people spent a century writing about "this is what they really meant." Maybe models are at best quantitative parables. Maybe economics is destined to return to this kind of literary philosophy, not quantified science.
Curious too what was missing. All the macro was decidedly Keynesian. General equilibrium with distortions, anything other than trend on "supply" was noticeable by its absence. So was the discussion. But maybe that's my fault for going to the NBER and not the Minnesota Macro meetings.
A last thought. Economic Fluctuations merged with Growth in the mid 1990s. At the time there was a great confluence of method as well as interest. Growth theorists were studying growth with Bellman equations, dynamic general equilibrium models of innovation and transmission of ideas, thinking about where productivity shocks came from. Macroeconomists were using Bellman equations, and studying dynamic general equilibrium models with stochastic technology, along with various frictions and other propagation mechanisms.
That confluence has now diverged. I enjoyed spending an hour or two thinking about how religion has blocked or adapted to ideas over the centuries, and Paul's view on social norms or neuroeconomics. But I don't really have any expertise to contribute to that debate. Questions like whether young CEOs head more innovative companies, or whether, like deans, what matters is the age of the faculty are a little closer to home, since I spend a lot of time consuming corporate finance. But the average sticky-price macro type does not. Likewise, when Daron Acemoglu, who seems to know everything about everything, has to preface his comments on macro papers with repeated disclaimers of lack of expertise, it's clear that the two fields really have gone their separate ways. Perhaps it's time to merge fluctuations with finance, where we seem to be talking about the same issues and using the same methods, and growth to merge with institutions and political or social economics.
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