Here is Narayana Kocherlakota's explanation for his dissent with respect to the most recent FOMC decision. As I mentioned in the comment section of my previous post, Kocherlakota actually has some New Keynesian (NK) leanings, and his dissent is entirely consistent with an NK view of the world. In this view, a Taylor rule dictates monetary policy. In Taylor-rule land, only the current state of the world, defined by the current inflation rate and the current unemployment rate, matters (though some Taylor rules have anticipated inflation on the right-hand side). On those terms, the current state actually looks better than the state in November 2010. Inflation is higher and unemployment is lower, which should dictate a less accommodative policy, not a more accommodative one.
Thus, if we buy NK, Kocherlakota's dissent makes sense. However, this guy, for example, seems to think that Kocherlakota is ridiculously hawkish and callous toward the unemployed. Seems he just wants to enforce New Keynesian consistency though.
I live in non-NK land (or willing-to-be-convinced-but-still-unconvinced-NK-land), so if Kocherlakota's dissent makes sense to me, and it can make sense in NK-land, it must be good, right?
Friday, August 12, 2011
Wednesday, August 10, 2011
The FOMC: There is good commitment, and there is...
Yesterday's FOMC statement came with some unexpected news, but in retrospect I think we should have seen it coming. Here is the key change in policy:
A key problem here, of course, is that not everyone is on board, and the dissenting group - Fisher, Kocherlakota, Plosser - includes two of the most capable economists on the committee. Outside of Dudley, the New York Fed President, only one of the voting regional Fed Presidents, Evans (Chicago), voted in favor of the policy change. I think the dissenters are on the right side of this issue.
Given the current operating regime the Fed is in, with very large quantity of excess reserves in the financial system, and the interest rate on reserves (IROR) determining short-term nominal interest rates, the experience is not there, nor is there agreement on what theory to apply, for the Fed to understand well what it is doing. It is also very difficult for people trying to understand what the Fed understands, to know what is going on. In this context, how can the FOMC be so certain of itself as to commit two years in advance?
Further, it seems the outcome the Fed would hope for is one where inflation increases, the interest rate on reserves increases commensurately, and the Fed proceeds to sell off assets so as to normalize the state of its balance sheet, with zero exess reserves. Committing to IROR = 0.25 for two years risks two outcomes that seem equally bad (if we believe that 2% inflation is optimal). One is the too-high-inflation outcome: People anticipate high inflation, reserves start to look much less desirable, and the high inflation is self-fulfilling. The other is too-low-inflation: People anticipate low inflation, the reserves look more desirable, and low inflation is self-fulfilling. The first scenario is something that I have been worried about. The second scenario was a concern of Jim Bullard, and Narayana Kocherlakota. I think both are possibilities, i.e. there are multiple equilibria.
Fed officials like to talk about "anchoring expectations." In this circumstance, the kind of FOMC statement that would anchor expectations would be something like: "We anticipate raising the fed funds rate target (actually the IROR target, but what the heck) as observed and anticipated inflation warrants. Currently, we think we are on a path on which inflation will increase."
The Committee currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.Thus, the key change is applying a date to the "extended period" language that has been in the statement since late 2008. "Likely to warrant" is about as clear a commitment as I think will ever come from the FOMC. Compare this to what was in the November 2010 statement where QE2 was laid out:
...the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.That program was executed exactly as planned. There was some language in there to hedge against wild unforeseen circumstances, but once the FOMC gets this specific it has to stick to its guns or risk destroying its credibility.
A key problem here, of course, is that not everyone is on board, and the dissenting group - Fisher, Kocherlakota, Plosser - includes two of the most capable economists on the committee. Outside of Dudley, the New York Fed President, only one of the voting regional Fed Presidents, Evans (Chicago), voted in favor of the policy change. I think the dissenters are on the right side of this issue.
Given the current operating regime the Fed is in, with very large quantity of excess reserves in the financial system, and the interest rate on reserves (IROR) determining short-term nominal interest rates, the experience is not there, nor is there agreement on what theory to apply, for the Fed to understand well what it is doing. It is also very difficult for people trying to understand what the Fed understands, to know what is going on. In this context, how can the FOMC be so certain of itself as to commit two years in advance?
Further, it seems the outcome the Fed would hope for is one where inflation increases, the interest rate on reserves increases commensurately, and the Fed proceeds to sell off assets so as to normalize the state of its balance sheet, with zero exess reserves. Committing to IROR = 0.25 for two years risks two outcomes that seem equally bad (if we believe that 2% inflation is optimal). One is the too-high-inflation outcome: People anticipate high inflation, reserves start to look much less desirable, and the high inflation is self-fulfilling. The other is too-low-inflation: People anticipate low inflation, the reserves look more desirable, and low inflation is self-fulfilling. The first scenario is something that I have been worried about. The second scenario was a concern of Jim Bullard, and Narayana Kocherlakota. I think both are possibilities, i.e. there are multiple equilibria.
Fed officials like to talk about "anchoring expectations." In this circumstance, the kind of FOMC statement that would anchor expectations would be something like: "We anticipate raising the fed funds rate target (actually the IROR target, but what the heck) as observed and anticipated inflation warrants. Currently, we think we are on a path on which inflation will increase."
Sunday, August 7, 2011
Pre-FOMC: A Guide to What's on the Table This Week
The upcoming FOMC meeting this week is a critical one, and an important test for Ben Bernanke. In terms of something we can agree the Fed should be concerned with - inflation - here is what is going on. The figure shows the cpi, the core cpi (cpix in the figure) the pce deflator, and core pce deflator (pcex in the figure). I've taken January 2005 as a base period here. This is obviously arbitrary, but that choice is instructive in this context. The figure also shows a 2% trend path, which represents the Fed's quasi-explicit target. I'm not defending the 2% inflation target, and I don't think the Fed can defend it either, relative to 0%, 1%, 3%, or 4%, for example.
In June, the headline cpi was 3.1% above the 2% trend, the pce 1.6% above, the core cpi 0.4% below, and the core pce 0.6% below. Now, if the FOMC wanted to be consistent with previous FOMC statments and public minutes, and if it were looking only at that picture, there would be grounds for tightening. While core price indexes are a little below where they should be, an increase in the relative price of food and energy has persisted since 2005, and there is no good reason to expect that relative price shift to go away. As I noted here, the FOMC is on record as being focused on headline inflation, and rightly so.
Of course, the FOMC is not looking just at that picture. Indeed, unless you have been living in an isolation tank for the last several weeks, you know that all hell appears to be breaking loose. The Fed is bound by law to speak to its dual mandate, and I think there is little dispute about the role of a central bank in promoting financial stability.
On the real side, the last quarterly GDP numbers were weak, and there is nothing very promising in the monthly data. Things could be worse, but residential construction is still in the toilet, with no pickup in housing starts; consumption expenditure is weak; employment is growing but at a slow pace; the employment/population ratio is also still in the toilet.
In financial markets real and nominal yields on US government debt have recently dropped significantly. Stock prices are falling. Sovereign debt problems in Europe are going unsolved. Our federal government's inability to develop a coherent fiscal plan has the potential to get us into trouble.
How do we make sense out of this, and what should the Fed be doing about it? First, suppose that the turmoil in financial markets is only temporary, but nevertheless forecasts indicate that real growth (absent Fed action) will continue to be more sluggish than we had expected. Should the Fed be doing something? No, there is nothing it can do. The interest rate on reserves has been at 0.25% since fall 2008, and the "extended period" language could be in the FOMC statement until eternity. The Fed could do QE3, but QE2 was irrelevant, so another round would have no effect either. Even if you thought quantitative easing worked as the Fed claims, long-maturity Treasury yields are already low. The problem is not that safe long bond yields are too high.
On the financial front, the big story is uncertainty. One story you hear is that firms are not investing because they are uncertain about future government behavior. While we appear to have a weak executive branch and a goofy legislative branch, I think the uncertainty people are concerned with is rooted in debt problems - in this case sovereign debt. Europe's sovereign debt problems have the potential to produce calamity on the order of what we saw in fall 2008. Mitigating that is our previous experience, and the fact that policymakers have had more time to figure out where the vulnerabilities lie.
A key problem is that low US Treasury yields reflect a scarcity of safe assets in the world. US debt, in spite of our recent fiscal fracas and S&P downgrade, is still viewed as a safe haven. I mentioned above that inflation, if anything, is currently too high in the US, but a continuation of the current financial conditions, or a worsening of the situation in Europe, would ultimately lead to a downward price level adjustment in the US, due to the increase in demand for the liabilities of our consolidated government. Effectively, there is a liquidity problem, but it is not one that can be solved through standard open market operations - this is not a currency shortage (as for example in the Great Depression) but a shortage of consolidated-government debt (i.e. the net debt of the central bank and federal government combined).
What to do about the liquidity shortage? The Fed can of course use conventional discount window lending, but currently the liquidity problem is mainly in Europe, not in the US. There is another tool, though, which is the Fed's swap facilities with foreign central banks. These played an important role during the financial crisis, were discontinued, and then renewed again in May 2010. As far as I can tell, these swap lines are still open, but are currently not being used, and I don't know why. Maybe someone has information on this.
In any event, I'm very curious to see what comes out of this FOMC meeting. Reassuring words? Something big? There is certainly a lot at stake, including the credibility of the institution.
In June, the headline cpi was 3.1% above the 2% trend, the pce 1.6% above, the core cpi 0.4% below, and the core pce 0.6% below. Now, if the FOMC wanted to be consistent with previous FOMC statments and public minutes, and if it were looking only at that picture, there would be grounds for tightening. While core price indexes are a little below where they should be, an increase in the relative price of food and energy has persisted since 2005, and there is no good reason to expect that relative price shift to go away. As I noted here, the FOMC is on record as being focused on headline inflation, and rightly so.Of course, the FOMC is not looking just at that picture. Indeed, unless you have been living in an isolation tank for the last several weeks, you know that all hell appears to be breaking loose. The Fed is bound by law to speak to its dual mandate, and I think there is little dispute about the role of a central bank in promoting financial stability.
On the real side, the last quarterly GDP numbers were weak, and there is nothing very promising in the monthly data. Things could be worse, but residential construction is still in the toilet, with no pickup in housing starts; consumption expenditure is weak; employment is growing but at a slow pace; the employment/population ratio is also still in the toilet.
In financial markets real and nominal yields on US government debt have recently dropped significantly. Stock prices are falling. Sovereign debt problems in Europe are going unsolved. Our federal government's inability to develop a coherent fiscal plan has the potential to get us into trouble.
How do we make sense out of this, and what should the Fed be doing about it? First, suppose that the turmoil in financial markets is only temporary, but nevertheless forecasts indicate that real growth (absent Fed action) will continue to be more sluggish than we had expected. Should the Fed be doing something? No, there is nothing it can do. The interest rate on reserves has been at 0.25% since fall 2008, and the "extended period" language could be in the FOMC statement until eternity. The Fed could do QE3, but QE2 was irrelevant, so another round would have no effect either. Even if you thought quantitative easing worked as the Fed claims, long-maturity Treasury yields are already low. The problem is not that safe long bond yields are too high.
On the financial front, the big story is uncertainty. One story you hear is that firms are not investing because they are uncertain about future government behavior. While we appear to have a weak executive branch and a goofy legislative branch, I think the uncertainty people are concerned with is rooted in debt problems - in this case sovereign debt. Europe's sovereign debt problems have the potential to produce calamity on the order of what we saw in fall 2008. Mitigating that is our previous experience, and the fact that policymakers have had more time to figure out where the vulnerabilities lie.
A key problem is that low US Treasury yields reflect a scarcity of safe assets in the world. US debt, in spite of our recent fiscal fracas and S&P downgrade, is still viewed as a safe haven. I mentioned above that inflation, if anything, is currently too high in the US, but a continuation of the current financial conditions, or a worsening of the situation in Europe, would ultimately lead to a downward price level adjustment in the US, due to the increase in demand for the liabilities of our consolidated government. Effectively, there is a liquidity problem, but it is not one that can be solved through standard open market operations - this is not a currency shortage (as for example in the Great Depression) but a shortage of consolidated-government debt (i.e. the net debt of the central bank and federal government combined).
What to do about the liquidity shortage? The Fed can of course use conventional discount window lending, but currently the liquidity problem is mainly in Europe, not in the US. There is another tool, though, which is the Fed's swap facilities with foreign central banks. These played an important role during the financial crisis, were discontinued, and then renewed again in May 2010. As far as I can tell, these swap lines are still open, but are currently not being used, and I don't know why. Maybe someone has information on this.
In any event, I'm very curious to see what comes out of this FOMC meeting. Reassuring words? Something big? There is certainly a lot at stake, including the credibility of the institution.
Saturday, August 6, 2011
Repy to Krugman Part II
A few more words on the fracas associated with this, before we move on to the serious problems facing the world. I was mulling over Krugman's comments, in particular this one:
Now, prominence actually might be bad. I could have a prominent zit on the end of my nose, in which case I'm just hoping it will go away quickly. Prominence can also be good. Ed Prescott is a prominent person in the profession in part because of the students he has trained, and the students that were trained by the students of students, etc. On that dimension, Prescott is prominent, Krugman not so much.
Lady Gaga is prominent. A few weeks ago I actually shared an airplane with this person, on the way back from Sydney. The security guy at the Sydney airport clued us into this fact, though he seemed to be somewhat embarrassed by what she had on. Lady Gaga then left my mind, until we landed in LA. My wife and I were walking the 20 miles to US immigration, and there she was. Conservatively dressed, this time (for Lady Gaga), but with 5-inch heels and a funny hat. Not sure how she walked the 20 miles without breaking an ankle. Now, you might think being prominent in the sense of Lady Gaga would be a bad thing (for her) in an airport, but she actually seemed to be quite into it. Even the walk to immigration was a performance, and she seemed to like the attention.
Now, Lady-Gaga-prominence is a particular kind of prominence. Many people know her name, but most of us could not say much about her music or what ideas are floating around in her head. Krugman has some Lady-Gaga-prominence, but of course there's more depth to it than that. People who know who he is are aware of the ideas in his head, and he has followers. We can say that he is influential. But what of that influence? People can be prominent and propagate bad ideas, as Krugman does on a regular basis. John Quiggin is apparently prominent - he has written many words, and there is obviously a market for that stuff. On the basis of my reading of "Zombie Economics," I would argue that he is also propagating bad ideas. So much for prominence.
Now, here's the core of Krugman's idea here:
Krugman is badly confused. The ideas of some of "those guys" are in fact in the core of some of the work that he is so proud of. His liquidity trap paper uses a cash-in-advance construct, popularized by Lucas. His paper with Eggertsson is a direct descendant of Kydland and Prescott (1982), by way of Rotemberg and Woodford.
This kind of criticism is just misguided flailing-about, and it certainly can't accomplish anything useful.
It’s funny in this case, because Quiggin is in fact a prominent economist, Williamson not so much.So, it seems that, in Krugman's mind, prominence is a good thing, I have not so much of this thing, and therefore I must be some kind of lesser being, who should not be so uppity.
Now, prominence actually might be bad. I could have a prominent zit on the end of my nose, in which case I'm just hoping it will go away quickly. Prominence can also be good. Ed Prescott is a prominent person in the profession in part because of the students he has trained, and the students that were trained by the students of students, etc. On that dimension, Prescott is prominent, Krugman not so much.
Lady Gaga is prominent. A few weeks ago I actually shared an airplane with this person, on the way back from Sydney. The security guy at the Sydney airport clued us into this fact, though he seemed to be somewhat embarrassed by what she had on. Lady Gaga then left my mind, until we landed in LA. My wife and I were walking the 20 miles to US immigration, and there she was. Conservatively dressed, this time (for Lady Gaga), but with 5-inch heels and a funny hat. Not sure how she walked the 20 miles without breaking an ankle. Now, you might think being prominent in the sense of Lady Gaga would be a bad thing (for her) in an airport, but she actually seemed to be quite into it. Even the walk to immigration was a performance, and she seemed to like the attention.
Now, Lady-Gaga-prominence is a particular kind of prominence. Many people know her name, but most of us could not say much about her music or what ideas are floating around in her head. Krugman has some Lady-Gaga-prominence, but of course there's more depth to it than that. People who know who he is are aware of the ideas in his head, and he has followers. We can say that he is influential. But what of that influence? People can be prominent and propagate bad ideas, as Krugman does on a regular basis. John Quiggin is apparently prominent - he has written many words, and there is obviously a market for that stuff. On the basis of my reading of "Zombie Economics," I would argue that he is also propagating bad ideas. So much for prominence.
Now, here's the core of Krugman's idea here:
...if you look at how many freshwater macroeconomists have responded to Keynesian arguments in this crisis, you find over and over again that they resort to assertions of privilege — basically, I am a famous macroeconomic expert and you aren’t — rather than really addressing the issues...But in any case, this is never an appropriate way to argue — least of all at a time like this, when events have strongly suggested that a lot of work in economics these past few decades, very much including the work on which these guys’ reputations are based, was on the wrong track.The problem with this, as with Quiggin's book, is that it is so vague and general as to be vacuous. There was "a lot of work," done by "these guys." It was on the "wrong track." "These guys" are apparently "freshwater economists," but guys like that are very hard to identify these days. 1970s ideas have evolved to the point where the labels "fresh" and "salt" don't apply to anyone in particular.
Krugman is badly confused. The ideas of some of "those guys" are in fact in the core of some of the work that he is so proud of. His liquidity trap paper uses a cash-in-advance construct, popularized by Lucas. His paper with Eggertsson is a direct descendant of Kydland and Prescott (1982), by way of Rotemberg and Woodford.
This kind of criticism is just misguided flailing-about, and it certainly can't accomplish anything useful.
Friday, August 5, 2011
Reply to Paul Krugman and other Rabble-Rousers
Well, the blogosphere is a strange place, full of funny people. Sometimes people ignore me. Sometimes I hit a nerve and an organized mob goes to work. I wrote this, John Quiggin replied with this, and Paul Krugman felt the need to stand up for his comrade with this.
Like everything I've done in this blog, I've learned from this. People have come back with interesting comments, and we've worked through some ideas. I learned something about some work that exists out there, and about some interesting people.
Krugman seems to think that I'm somehow "pulling rank" on John Quiggin. Well, the story of my life is being misunderstood, so I'm accustomed to this. In my original post, I'm just giving you a factual account of how I happened to be reading Quiggin's book. If I tell you that, previous to getting the book in the mail, I had never heard of John Quiggin, that's certainly not his fault, nor does that mean that I think the guy is a dope, or that I'm somehow better than he is. Holy crap! Who am I anyway? I have not worked at any institution (save perhaps the Minneapolis Fed) that anyone would rank in the top 20 in the world. I typically work on things that people find somewhat esoteric and cultish. I grew up in small-town Ontario and was educated in public schools. My parents were well-educated, but basically lived hand-to-mouth.
Quiggin is a very interesting case. He has a strong technical background, and has an enormous number of citations for a paper published in 1982 that seems to have been written when he was an undergraduate. That paper is in decision theory, which I find hard, and he has published other work in that vein. The man writes, and has written, an enormous amount. His keyboard must be on fire.
The bone I have to pick is with his damn book. There are some theorists that see modern macroeconomics and like it. It fits together like things they already know, the language is similar, and one can see how standard economics can be put to work to understand aggregate phenomena. Quiggin is not like that though. If you read Zombie Economics and this paper, with names redacted, you would not know it was the same person, as Zombie Economics reads like fringe economics (Austrians, Post-Keynesians, etc.). In fringe economics, the game is dismissing things you know little about, and offering little that is actually constructive.
Quiggin and Krugman indeed have a lot in common. They are smart people, with demonstrated success in particular branches of economics, but with little or no knowledge of what makes modern macroeconomics tick. In part, they seem to think that modern macro is a tool of right wing conservatives and therefore needs to be destroyed. Let me assure you that modern macro is not inherently a tool of any particular ideology. It just forces you to work harder to find the appropriate role for government. But the result is better policy.
Like everything I've done in this blog, I've learned from this. People have come back with interesting comments, and we've worked through some ideas. I learned something about some work that exists out there, and about some interesting people.
Krugman seems to think that I'm somehow "pulling rank" on John Quiggin. Well, the story of my life is being misunderstood, so I'm accustomed to this. In my original post, I'm just giving you a factual account of how I happened to be reading Quiggin's book. If I tell you that, previous to getting the book in the mail, I had never heard of John Quiggin, that's certainly not his fault, nor does that mean that I think the guy is a dope, or that I'm somehow better than he is. Holy crap! Who am I anyway? I have not worked at any institution (save perhaps the Minneapolis Fed) that anyone would rank in the top 20 in the world. I typically work on things that people find somewhat esoteric and cultish. I grew up in small-town Ontario and was educated in public schools. My parents were well-educated, but basically lived hand-to-mouth.
Quiggin is a very interesting case. He has a strong technical background, and has an enormous number of citations for a paper published in 1982 that seems to have been written when he was an undergraduate. That paper is in decision theory, which I find hard, and he has published other work in that vein. The man writes, and has written, an enormous amount. His keyboard must be on fire.
The bone I have to pick is with his damn book. There are some theorists that see modern macroeconomics and like it. It fits together like things they already know, the language is similar, and one can see how standard economics can be put to work to understand aggregate phenomena. Quiggin is not like that though. If you read Zombie Economics and this paper, with names redacted, you would not know it was the same person, as Zombie Economics reads like fringe economics (Austrians, Post-Keynesians, etc.). In fringe economics, the game is dismissing things you know little about, and offering little that is actually constructive.
Quiggin and Krugman indeed have a lot in common. They are smart people, with demonstrated success in particular branches of economics, but with little or no knowledge of what makes modern macroeconomics tick. In part, they seem to think that modern macro is a tool of right wing conservatives and therefore needs to be destroyed. Let me assure you that modern macro is not inherently a tool of any particular ideology. It just forces you to work harder to find the appropriate role for government. But the result is better policy.
Wednesday, August 3, 2011
The Great Divide is Between Thoma's View of Reality and Reality
I saw this piece by Mark Thoma a while back, yawned, and went on to something else. When I got back from vacation, in the course of catching up and following links to my posts, I discovered that there is actually a reference to one of my posts hiding in there (more on that later), so I thought it was worthwhile to rebut his nonsense.
We'll skip the bad analogy at the beginning of the piece. Mark's point is essentially a standard one. Academics are out of touch with the "real world" and basically spend their time staring out the window thinking deep thoughts for their own entertainment.
Apparently, as we keep hearing from the usual rabble-rousers, academics failed to predict the financial crisis, so what are they good for anyway? Further,
What's at the root of the problem?
There is no great divide between academics and practitioners in economics. When I go to conferences and go out to give seminars I meet people working in many different fields in economics. Plenty of them move around among institutions where people think about policy and advise policy makers, institutions where the main job is doing frontier research and educating students, and consulting work. Go to any business school and you will find loads of applied economics that people find useful not only as an organizing tool to make sense of the world but for making money. In business schools applied economics sometimes is called finance, accounting, or marketing.
One of the great successes in economics is auction theory. This started off in a quite abstract, mathematical fashion, and ultimately expanded into empirical work in the hands of people like Robert Porter, Ken Hendricks, and Harry Paarsch, for example. Auction theory has been used successfully in the design of auctions of bandwidth and oil leases, and there are currently economists working for Yahoo and Google who use their knowledge of auctions to contribute in important ways to making those companies profitable.
Closer to home, there are plenty of high-level academics who are willing to get their hands dirty at regional Federal Reserve Banks and at the Board of Governors in Washington. In this respect, there is far more interaction between academics and the Federal Reserve System than was the case 10, 20, or 30 years ago, thanks in part to the pathbreaking work done by people like John Kareken, Art Rolnick, Tom Sargent, Gary Stern, and Neil Wallace at the Federal Reserve Bank of Minneapolis in the 1970s.
Now, here's where Thoma mentions me:
We'll skip the bad analogy at the beginning of the piece. Mark's point is essentially a standard one. Academics are out of touch with the "real world" and basically spend their time staring out the window thinking deep thoughts for their own entertainment.
Apparently, as we keep hearing from the usual rabble-rousers, academics failed to predict the financial crisis, so what are they good for anyway? Further,
...a few practitioners saw the housing bubble coming.Who were those people anyway? They must have made a killing! Did they predict the turning point in housing prices in 2006? Did they predict that prices would fall from their peak by about 35% (or whatever)? What exactly is a bubble anyway? Do those practitioners have a good definition of this phenomenon? What do they think caused it? Do they know when the housing market will turn around if they are so smart?
What's at the root of the problem?
Economics has lost the connection between the practitioners and the academics. This may have something to do with the desire among economists to become more of a science – a heavy focus on theory and math is the result.So, we would do much better if we did not use the tools that Newton, Pontryagin, Bertsekas, Arrow, Debreu, Samuelson, Solow, Nash, Harsanyi, Selten, Hurwicz, Maskin, Myerson, etc., gave us. Then we could better communicate with those in the trenches and the world would be a better place.
There is no great divide between academics and practitioners in economics. When I go to conferences and go out to give seminars I meet people working in many different fields in economics. Plenty of them move around among institutions where people think about policy and advise policy makers, institutions where the main job is doing frontier research and educating students, and consulting work. Go to any business school and you will find loads of applied economics that people find useful not only as an organizing tool to make sense of the world but for making money. In business schools applied economics sometimes is called finance, accounting, or marketing.
One of the great successes in economics is auction theory. This started off in a quite abstract, mathematical fashion, and ultimately expanded into empirical work in the hands of people like Robert Porter, Ken Hendricks, and Harry Paarsch, for example. Auction theory has been used successfully in the design of auctions of bandwidth and oil leases, and there are currently economists working for Yahoo and Google who use their knowledge of auctions to contribute in important ways to making those companies profitable.
Closer to home, there are plenty of high-level academics who are willing to get their hands dirty at regional Federal Reserve Banks and at the Board of Governors in Washington. In this respect, there is far more interaction between academics and the Federal Reserve System than was the case 10, 20, or 30 years ago, thanks in part to the pathbreaking work done by people like John Kareken, Art Rolnick, Tom Sargent, Gary Stern, and Neil Wallace at the Federal Reserve Bank of Minneapolis in the 1970s.
Now, here's where Thoma mentions me:
Academic economists do evaluate policy proposals theoretically and empirically, and they do provide forecasts of the economy. But forecasting in particular is not the main focus of their efforts, , and they’ve all but ignored – even looked down their noses upon – forecasters and practitioners in the government and business communities. They are often viewed as data grubbers who use old-fashioned models and techniques, and are thus unworthy of attention from high-minded academics.Notice what he's up to. Mark fancies himself as a very high-minded and fair individual who would never stoop to name calling, but he's essentially calling me an arrogant twit. If you go back and read my post, you'll see that it was a response to some interview comments by Larry Meyer that included this:
My views would be considered outrageous in the academic community, but I feel very strongly about them. Those models [modern macro models] are a diversion. They haven’t been helpful at all at understanding anything that would be relevant to a monetary policymaker or fiscal policymaker. So we’d better come back to, and begin with as our base, these classic macro-econometric models.Meyer essentially disparages post-1980 modern macroeconomics as a waste of time, and I thought that deserved a response. The gulf there is not a problem for modern macro, it's a problem for Meyer, who has not taken the time and trouble to understand what macroeconomists are doing and how he can make use of it. Why Mark Thoma can't see that is beyond me.
John Quiggin
[For an expanded (and published) update on this post, see this.]
John Quiggin is an Australian economist who some of you might be familiar with as the author of "Zombie Economics: How Dead Ideas Still Walk Among Us." Currently he is having a bit of a dustup with the Australian wing of the Rupert Murdoch empire.
I knew absolutely nothing about John Quiggin, until someone asked me to write a short review of Zombie Economics for the Journal of Economic Literature. The timing was good, as I was about to leave for Australia to give a plenary talk at the Australian Conference of Economists in Canberra in July. I could read the book on the plane (though a trip from St. Louis to Chicago would actually be sufficient) and might actually come across the man himself, or news of him, at the conference.
By the time I got to Canberra, I had read Zombie Economics, and had written a draft of my review which panned the damn thing (more on that later). I was a little lost at the conference as none of the Australian economists I know showed up, but Pete Klenow was there, and I sat down at dinner with Max Corden, who is one of the most engaging people I have run into in my life. Between courses at dinner, various awards were presented, and at one point we got to an the annual award of Distinguished Fellow of the Economic Society of Australia. Previous recipients included my dinner companion Max Corden, Trevor Swan (he of the "Solow-Swan model"), and Murray Kemp. Who did the 2011 award go to? John Quiggin.
What is Quiggin's claim to fame? His early work is an odd mix of agricultural economics and decision theory, but he seems to have distinguished himself mainly in public policy. He writes regularly in the mainstream media, writes a blog, and Zombie Economics appears to have sold well.
Now, what is Quiggin up to in Zombie Economics? Roughly, Quiggin is the Australian farm team in the Krugman/Thoma/DeLong league. Quiggin argues that there are five key "zombie ideas" that have been used by conservative economists for ideological purposes. The financial crisis has showed us that, without question, these ideas are wrong. Nevertheless the ideas, like zombies, continue to walk. If you read the book, you'll see why it could sell well in airports. However, I would recommend Life by Keith Richards (which is the last book I bought in an airport) over Zombie Economics any day. Keith is much more interesting, and the economics is better.
So, what are the zombie ideas? They are:
1. The Great Moderation.
2. The Efficient Markets Hypothesis.
3. Dynamic Stochastic General Equilibrium
4. Trickle-down economics
5. Privatization
The Great Moderation: Quiggin is a little confused on this one, as the Great Moderation simply characterizes a set of properties of US aggregate time series. From about 1985-2007, inflation was lower and less variable, and real GDP was less variable about trend than had been the case previously. Quiggin is certainly correct, though, in finding fault with those (Ben Bernanke included) who wanted to argue that the Great Moderation was due to a regime change in economic policy. If policy was so great, it should have done a better job over the last four years.
The Efficient Markets Hypothesis: For Quiggin this is "the idea that prices generated by financial markets represent the best possible estimate of the value of any investment." Here, Quiggin is badly confused, but maybe the finance practitioners are not helping him out much. Market efficiency is simply an assumption of rationality. As such it has no implications. If it has no implications, it can't be wrong.
Dynamic Stochastic General Equilibrium: Quiggin claims that this is "the idea that macroeconomic analysis should not concern itself with economic aggregates like trade balances or debt levels, but should be rigorously derived from macroeconomic models of individual behavior." I can hear you snorting with laughter. Why is "but" in that sentence? Like the "efficient markets hypothesis," DSGE has no implications, and therefore can't be wrong. Indeed DSGE encompasses essentially all of modern macroeconomics. Which of our models is not dynamic, with uncertainty (and therefore stochastic), and with some equilibrium concept. Indeed, many of them incorporate trade balances and public and private debt. Granted, some of our models were not so helpful in making sense of the financial crisis. But others were, and some of the models that were not helpful could be (and are being) modified so that they are.
Trickle-down economics: This one puzzled me. For the previous three zombie ideas, Quiggin is confused, but I could see where the confusion might come from. However, while the words "trickle-down economics" are familiar to me, I have a hard time associating that idea with the mainstream ideas of any academic economists. On some level, it seems obvious that economic growth benefits all residents of a country. Whatever my skill set, I would rather ply my trade in the United States than in Malawi. While there may exist serious barriers to economic mobility in the United States that we should be addressing, the financial crisis does not somehow point out some serious deficiencies in how economists think about the income and wealth distributions.
Privatization: Here, Quiggin offers a litany of government privatization efforts gone awry. If I wanted to, I could take this evidence as supporting the hypothesis that government is really bad - so bad that it can even screw up privatization.
So, the heart of economic thought is a set of zombie ideas that should die a miserable death. But to be replaced by what? Quiggin is pretty vague about this. He thinks that "heuristics and unconsidered assumptions inevitably play a crucial role," and that economics should focus "more on realism, less on rigor." Eureka. We need some sloppy, realistic, heuristic models with unconsidered assumptions.
It's unfortunate that some of the people who write so much about economics for the general public spend so little time reading about what economists actually do, and attempting to understand it. No wonder people are confused.
John Quiggin is an Australian economist who some of you might be familiar with as the author of "Zombie Economics: How Dead Ideas Still Walk Among Us." Currently he is having a bit of a dustup with the Australian wing of the Rupert Murdoch empire.
I knew absolutely nothing about John Quiggin, until someone asked me to write a short review of Zombie Economics for the Journal of Economic Literature. The timing was good, as I was about to leave for Australia to give a plenary talk at the Australian Conference of Economists in Canberra in July. I could read the book on the plane (though a trip from St. Louis to Chicago would actually be sufficient) and might actually come across the man himself, or news of him, at the conference.
By the time I got to Canberra, I had read Zombie Economics, and had written a draft of my review which panned the damn thing (more on that later). I was a little lost at the conference as none of the Australian economists I know showed up, but Pete Klenow was there, and I sat down at dinner with Max Corden, who is one of the most engaging people I have run into in my life. Between courses at dinner, various awards were presented, and at one point we got to an the annual award of Distinguished Fellow of the Economic Society of Australia. Previous recipients included my dinner companion Max Corden, Trevor Swan (he of the "Solow-Swan model"), and Murray Kemp. Who did the 2011 award go to? John Quiggin.
What is Quiggin's claim to fame? His early work is an odd mix of agricultural economics and decision theory, but he seems to have distinguished himself mainly in public policy. He writes regularly in the mainstream media, writes a blog, and Zombie Economics appears to have sold well.
Now, what is Quiggin up to in Zombie Economics? Roughly, Quiggin is the Australian farm team in the Krugman/Thoma/DeLong league. Quiggin argues that there are five key "zombie ideas" that have been used by conservative economists for ideological purposes. The financial crisis has showed us that, without question, these ideas are wrong. Nevertheless the ideas, like zombies, continue to walk. If you read the book, you'll see why it could sell well in airports. However, I would recommend Life by Keith Richards (which is the last book I bought in an airport) over Zombie Economics any day. Keith is much more interesting, and the economics is better.
So, what are the zombie ideas? They are:
1. The Great Moderation.
2. The Efficient Markets Hypothesis.
3. Dynamic Stochastic General Equilibrium
4. Trickle-down economics
5. Privatization
The Great Moderation: Quiggin is a little confused on this one, as the Great Moderation simply characterizes a set of properties of US aggregate time series. From about 1985-2007, inflation was lower and less variable, and real GDP was less variable about trend than had been the case previously. Quiggin is certainly correct, though, in finding fault with those (Ben Bernanke included) who wanted to argue that the Great Moderation was due to a regime change in economic policy. If policy was so great, it should have done a better job over the last four years.
The Efficient Markets Hypothesis: For Quiggin this is "the idea that prices generated by financial markets represent the best possible estimate of the value of any investment." Here, Quiggin is badly confused, but maybe the finance practitioners are not helping him out much. Market efficiency is simply an assumption of rationality. As such it has no implications. If it has no implications, it can't be wrong.
Dynamic Stochastic General Equilibrium: Quiggin claims that this is "the idea that macroeconomic analysis should not concern itself with economic aggregates like trade balances or debt levels, but should be rigorously derived from macroeconomic models of individual behavior." I can hear you snorting with laughter. Why is "but" in that sentence? Like the "efficient markets hypothesis," DSGE has no implications, and therefore can't be wrong. Indeed DSGE encompasses essentially all of modern macroeconomics. Which of our models is not dynamic, with uncertainty (and therefore stochastic), and with some equilibrium concept. Indeed, many of them incorporate trade balances and public and private debt. Granted, some of our models were not so helpful in making sense of the financial crisis. But others were, and some of the models that were not helpful could be (and are being) modified so that they are.
Trickle-down economics: This one puzzled me. For the previous three zombie ideas, Quiggin is confused, but I could see where the confusion might come from. However, while the words "trickle-down economics" are familiar to me, I have a hard time associating that idea with the mainstream ideas of any academic economists. On some level, it seems obvious that economic growth benefits all residents of a country. Whatever my skill set, I would rather ply my trade in the United States than in Malawi. While there may exist serious barriers to economic mobility in the United States that we should be addressing, the financial crisis does not somehow point out some serious deficiencies in how economists think about the income and wealth distributions.
Privatization: Here, Quiggin offers a litany of government privatization efforts gone awry. If I wanted to, I could take this evidence as supporting the hypothesis that government is really bad - so bad that it can even screw up privatization.
So, the heart of economic thought is a set of zombie ideas that should die a miserable death. But to be replaced by what? Quiggin is pretty vague about this. He thinks that "heuristics and unconsidered assumptions inevitably play a crucial role," and that economics should focus "more on realism, less on rigor." Eureka. We need some sloppy, realistic, heuristic models with unconsidered assumptions.
It's unfortunate that some of the people who write so much about economics for the general public spend so little time reading about what economists actually do, and attempting to understand it. No wonder people are confused.
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