On the State of Macroeconomics

In a paper, Ricardo Reis defends macroeconomics against various critiques. He concludes:

I have argued that while there is much that is wrong with macroeconomics today, most critiques of the state of macroeconomics are off target. Current macroeconomic research is not mindless DSGE modeling filled with ridiculous assumptions and oblivious of data. Rather, young macroeconomists are doing vibrant, varied, and exciting work, getting jobs, and being published. Macroeconomics informs economic policy only moderately and not more nor all that differently than other fields in economics. Monetary policy has benefitted significantly from this advice in keeping inflation under control and preventing a new Great Depression. Macroeconomic forecasts perform poorly in absolute terms and given the size of the challenge probably always will. But relative to the level of aggregation, the time horizon, and the amount of funding, they are not so obviously worst than those in other fields. What is most wrong with macroeconomics today is perhaps that there is too little discussion of which models to teach and too little investment in graduate-level textbooks.

Models Make Economics A Science

In the Journal of Economic Literature, Ariel Rubinstein discusses Dani Rodrik’s “superb” book “Economics Rules.” The article nicely articulates what economics and specifically, economic modeling is about. Some quotes (emphasis my own) …

… on the nature of economics:

[A] quote … by John Maynard Keynes to Roy Harrod in 1938: “It seems to me that economics is a branch of logic, a way of thinking”; “Economics is a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world.”

[Rodrik] … declares: “Models make economics a science” … He rejects … the … common justification given by economists for calling economics a science: “It’s a science because we work with the scientific method: we build hypotheses and then test them. When a theory fails the test, we discard it and either replace it or come up with an improved version.” Dani’s response: “This is a nice story, but it bears little relationship to what economists do in practice …”

… on models, forecasts, and tests:

A good model is, for me, a good story about an interaction between human beings …

A story is not a tool for making predictions. At best, it can help us realize that a particular outcome is possible or that some element might be critical in obtaining a particular result. … Personally, I don’t have any urge to predict anything. I dread the moment (which will hopefully never arrive) when academics, and therefore also governments and corporations, will be able to predict human behavior with any accuracy.

A story is not meant to be “useful” in the sense that most people use the word. I view economics as useful in the sense that Chekhov’s stories are useful—it inspires new ideas and clarifies situations and concepts. … [Rodrik] is aware … “Mischief occurs when economists begin to treat a model as the model. Then the narrative takes on a life of its own and becomes dislodged from the setting that produced it. It turns into an all-purpose explanation that obscures alternative, and potentially more useful, story lines”.

A story is not testable. But when we read a story, we ask ourselves whether it has any connection to reality. In doing so, we are essentially trying to assess whether the basic scenario of the story is a reasonable one, rather than whether the end of the story rings true. … Similarly, … testing an economic model should be focused on its assumptions, rather than its predictions. On this point, I am in agreement with Economics Rules: “. . . what matters to the empirical relevance of a model is the realism of its critical assumptions”.

… on facts:

The big “problem” with interpreting data collected from experiments, whether in the field or in the lab, is that the researchers themselves are subject to the profession’s incentive system. The standard statistical tests capture some aspects of randomness in the results, but not the uncertainty regarding such things as the purity of the experiment, the procedure used to collect the data, the reliability of the researchers, and the differences in how the experiment was perceived between the researcher and the subjects. These problems, whether they are the result of intentional sleight of hand or the natural tendency of researchers to ignore inconvenient data, make me somewhat skeptical about “economic facts.”

Who Voted for Brexit?

In a CEPR Discussion Paper, Sascha Becker, Thiemo Fetzer, and Dennis Novy argue that education and income mainly explain voting outcomes. In the abstract of their paper, the authors write:

We find that exposure to the EU in terms of immigration and trade provides relatively little explanatory power for the referendum vote. Instead, … fundamental characteristics of the voting population were key drivers of the Vote Leave share, in particular their education profiles, their historical dependence on manufacturing employment as well as low income and high unemployment. … within cities, we find that areas with deprivation in terms of education, income and employment were more likely to vote Leave.

Does the Swiss Agricultural Sector Add Value?

In December 2016, the Swiss Federal Council concluded that in international comparison, government support for the Swiss agricultural sector is very high. But critics point out that the government report might understate the social cost of government support. In a separate study the lobby group `Vision Landwirtschaft’ had presented estimates according to which the Swiss agricultural sector adds negative value, on the order of 1 billion CHF per year.

NZZ reports by Désirée Föry: February 9, 2017 and April 2, 2017.

Citigroup Advises Against the `Fiscal Theory of the Price Level’

In a recent Citigroup Global Economics View Research report, Willem Buiter discusses “Bad and Good ‘Fiscal Theories of the Price Level’.” Quoting my own work on the Fiscal Theory, Buiter warns that policy makers start to pay attention to the theory:

It does not often happen that a rather obscure technical bit of economic theory
merits an audience wider than the small band of academics who spend their waking
hours pondering such matters because that is the kind of thing they do. This note
addresses one of those occasions. The obscure economic theory in question is the
so-called fiscal theory of the price level (FTPL) …

The destruction of the logic of the FTPL by Buiter and Niepelt ought to have been
the end of the FTPL – their arguments were never refuted. … Recently, some of the originators of the original FTPL have tried to resurrect it …

 

 

Macroeconomic Effects of Bank Solvency vs. Liquidity

In a CEPR discussion paper, Òscar Jordà, Björn Richter, Moritz Schularick, and Alan M. Taylor suggest that higher bank capital ratios help stabilize the financial system ex post but not ex ante, and that illiquidity breeds fragility.

Abstract of their paper:

Higher capital ratios are unlikely to prevent a financial crisis. This is empirically true both for the entire history of advanced economies between 1870 and 2013 and for the post-WW2 period, and holds both within and between countries. We reach this startling conclusion using newly collected data on the liability side of banks’ balance sheets in 17 countries. A solvency indicator, the capital ratio has no value as a crisis predictor; but we find that liquidity indicators such as the loan-to-deposit ratio and the share of non-deposit funding do signal financial fragility, although they add little predictive power relative to that of credit growth on the asset side of the balance sheet. However, higher capital buffers have social benefits in terms of macro-stability: recoveries from financial crisis recessions are much quicker with higher bank capital.

`Brussels’ to Disrupt European Banking

The Economist reports that forthcoming European payments regulation has the potential to disrupt the industry.

Provided the customer has given explicit consent, banks will be forced to share customer-account information with licensed financial-services providers.

… payment services … could become more integrated into the internet-browsing experience …

With access to account data … fintech firms could offer customers budgeting advice, or guide them towards higher-interest savings accounts or cheaper mortgages. Those with limited credit histories may find it easier to borrow, too, since richer transaction data should mean more sophisticated credit checks.

Portfolio Adjustments in Money Market Mutual Funds

On the Liberty Street Economics blog, Catherine Chen, Marco Cipriani, Gabriele La Spada, Philip Mulder, and Neha Shah discuss last year’s regulatory changes regarding money market mutual funds:

First, institutional prime and muni funds—but not retail or government funds—must now compute their net asset values (NAVs) using market-based factors, thereby abandoning the fixed NAV that had been a hallmark of the MMF industry. Second, all prime and muni funds must adopt a system of gates and fees on redemptions, which can be imposed under certain stress scenarios.

Investors adjusted their portfolios in response to these changes:

… investors’ shift from prime and muni funds to government—and, in particular, agency—funds means that a large segment of the industry still operates under a stable NAV (and therefore is, in principle, vulnerable to runs). … Since the new regulations have resulted in a very large shift of assets into relatively safe government funds, the SEC’s reforms have made runs on MMFs less likely and the industry itself more resilient.

John Cochrane and Janet Yellen

On his blog, John Cochrane discusses the possibility of an alternative monetary policy regime in which the Fed tightly controls expected inflation. He states, repeatedly, that given our current understanding of the matter he would refrain from implementing such a regime if he became Fed chair (rather than stating that he would not currently advise to move in that direction). Given that Janet Yellen is expected to retire next year and John Cochrane is mentioned as a possible successor, I find the statement remarkable.

Bitcoin Unlimited

On Bloomberg, Yuji Nakamura and Lulu Yilun Chen report about conflicting views in the Bitcoin community on how to address capacity limits in the blockchain.

Bitcoin Unlimited is essentially a software upgrade to the blockchain. Years ago, bitcoin’s early developers imposed a cap on the amount of data it could process. While that slowed down the network, it was seen as a necessary safety measure against potential attackers who could overload the system. Now, Unlimited supporters say the blockchain is robust enough that it doesn’t need any limit at all.

While most agree the blockchain is stronger, critics … say that removing the data cap is a risky move which will leave bitcoin vulnerable to governments and global banks. Without a limit, large organizations would use their resources to out-muscle smaller miners and effectively take control of the blockchain and bitcoin itself.

Julian Baggini’s “Freedom Regained: The Possibility of Free Will”

In his book, Julian Baggini points out that materialism, not determinism, undermines the notion of free will. He accepts that man is subject to the laws of nature but simultaneously seems to argue for a holistic model of man and human choice. He concludes that the concept of free will is consistent with predetermined causes; with unconscious choice; and that it does not require that a choice could have been different.

Discussion in The Guardian.

Douglas Adams’ “The Hitch Hiker’s Guide to the Galaxy”

In Douglas Adams’ book (volume one in the trilogy of four) we learn, among other things:

  • Towels are particularly useful for interstellar travelers on a shoestring.
  • It’s not clear whether humans conduct experiments on mice or vice versa.
  • The answer to Life, Universe, and Everything is “forty-two” as Deep Thought found after an extended period (seven and a half million years) of number crunching.
  • But what is the question? To find out, an even more powerful computer was built: The Earth. “Deep Thought designed the Earth, we built it and you lived on it.”
  • Unfortunately, the Vogons destroyed the planet just five minutes before the program was completed. The badly timed intervention was communicated as follows: “This is Prostetnic Vogon Jeltz of the Galactic Hyperspace Planning Council. As you will no doubt be aware, the plans for development of the outlying regions of the Galaxy require the building of a hyperspatial express route through your star system, and regrettably your planet is one of those scheduled for demolition. The process will take slightly less than two of your Earth minutes. Thank you.” And after some moments: “There’s no point acting all surprised about it. All the planning charts and demolition orders have been on display in your local planning department in Alpha Centauri for fifty of your Earth years, so you’ve had plenty of time to lodge any formal complaint and it’s far too late to start making a fuss about it now.”
  • Another artificial planet may be under construction. It might feature fjords as in Norway (on the original Earth), but this time in Africa.

See here or here for quotes from the book(s).

Stable Long-Run Money Demand

On VoxEU, Luca Benati, Robert Lucas, Juan Pablo Nicolini, and Warren Weber argue that long-run money demand in many countries is rather stable.

… using a specific, narrow monetary aggregate, M1, we study a dataset comprising 32 countries since the mid-19th century (Benati et al. 2016). The main finding of this large-scale investigation is that, contrary to conventional wisdom, in most cases statistical tests do identify with high confidence a long-run equilibrium relationship between either M1 velocity and a short-term interest rate, or M1, GDP, and a short rate – that is, a long-run money demand.

On the Performance of Swiss Portfolio Managers

In the NZZ, Michael Schaefer reports on a study about the performance of Swiss portfolio managers in 2016.

  • The median portfolio returns in all investment strategies except those not investing in stocks fell short of the corresponding benchmark returns.
  • Only a fifth of the portfolios generated returns in excess of their benchmark.
  • These numbers do not yet account for management fees.
  • No portfolio manager generated high returns across all strategies.
  • But some managers consistently generate high returns in certain strategies.

America’s Miserable 21st Century

In Commentary, Nicholas Eberstadt recounts how low employment, deteriorating health, and declining social mobility in the United States foreshadow a “Miserable 21st Century.”

  • Between 2000 and 2016, the work rate for Americans aged 20 or older fell by almost 5 percentage points, to 60 percent.
  • In the “prime working age” group, it fell by almost 4 percentage points.
  • While work rates for men had been falling for much longer, a similar decline for prime age women set in in 2000.
  • Death rates for white men and women aged 45–54 rose slightly since 2000; they increased sharply for the subset with high school or lower education.
  • In 2016, life expectancy at birth in the US fell for the first time in decades.
  • By 2013, more Americans died from drug overdoses than from either traffic fatalities or guns.
  • Alan Krueger’s research suggests that about 50% of prime working-age male labor-force dropouts take pain medication on a daily basis.
  • This group spends its time watching TV, movies, or playing video games, and many take drugs.
  • The “welfare state” (Medicaid) helps the unemployed pay for their drugs.
  • In 2013, roughly 20% of civilian men aged 25–55, and roughly 50% of non-working prime-age people were Medicaid beneficiaries.
  • Roughly 60% of the non-working prime-age male non-Hispanic population collected disability benefits.
  • While the U.S. has a higher incarceration rate than almost any other country, only few of the Americans ever convicted are incarcerated. “Maybe 90 percent of all sentenced felons today are out of confinement,” due to release, probation, or parole, adding to a stock of roughly 20 million people.
  • Geographical mobility and job churning are in decline.
  • Chances of surpassing one’s parents’ real income are lower than ever before in postwar America.

Stability vs. Equality?

In The Great Leveler, Walter Scheidel argues that over thousands of years, only mass violence and catastrophes have triggered significant reductions in inequality.

From the book’s introduction:

For thousands of years, civilization did not lend itself to peaceful equalization. … stability favored economic inequality. This was as true of Pharaonic Egypt as it was of Victorian England, as true of the Roman Empire as of the United States. … Four different kinds of violent ruptures have flattened inequality: mass mobilization warfare, transformative revolution, state failure, and lethal pandemics.

… there is no compelling empirical evidence to support the view that modern economic development, as such, narrows inequalities. There is no repertoire of benign means of compression that has ever achieved results that are even remotely comparable to those produced by the Four Horsemen.