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September 14, 2009

Economist's View - 10 new articles

"For All Obama's Talk of Overhaul, the US has Failed to Wind in Wall Street"

Joseph Stiglitz is not impressed with the administration's response to the financial crisis:

For all Obama's talk of overhaul, the US has failed to wind in Wall Street, by Joseph Stiglitz, Comment is Free: What went wrong? Have the right lessons been learned? Could it happen again? The anniversary of the Lehman Brothers' bankruptcy and the freezing of the credit markets that followed is an occasion for reflection. I fear that our collective response has been mistaken and inadequate – that we may just have made matters worse.
The financial sector would like us to believe that if only the Federal Reserve and the Treasury had leapt to the rescue of Lehmans all would have been fine. Sheer nonsense. Lehmans was not a cause but a consequence: a consequence of flawed lending practices, and of inadequate oversight by regulators.
Financial markets had lent on the basis of a bubble – a bubble in large part of their making. They had incentive structures that encouraged excessive risk-taking and shortsighted behavior. And that was no accident. It was the fruit of vigorous lobbying, which strived equally hard to prevent regulation of changes in the financial structure, new products like credit default swaps – which, while supposedly designed to manage risk, actually created it – and ingenious devices to exploit poor and uninformed borrowers and investors. The sector may not have made good economic investments, but its political investments paid off handsomely.
Lehmans was allowed to fail, we were told at the time, because its failure did not pose systemic risk. The systemic consequences its failure entailed, of course, were used as an excuse for the massive bailouts for the banks. Thus the Lehmans example became at best a scare tactic; at worst it became an excuse, a tool, to extract as much as possible for the banks and the bankers that brought the world to the brink of economic ruin.
Had more thought gone into how to deal with Lehmans, the Treasury and Fed might have realized that it played an important role in the shadow banking system, and that it was important to protect the integrity of the shadow system which had come to play such an important role in the US and global financial payments system. But many of Lehmans' activities had no systemic importance. The administration could have found a path between the false dichotomy of abandonment or bailout. That would have protected the payments system, providing the minimum amount of taxpayer money. Shareholders and long-term bondholders would have been wiped out before any public money had to be put in.
Bailing out the US banks need not have meant bailing out the bankers, their shareholders, and bondholders. We could have kept the banks as ongoing institutions, even if we had played by the ordinary rules of capitalism which say that when a firm can't meet its obligations to creditors, the shareholders lose everything.
Unquestionably we should not have allowed banks to become so big and so intertwined that their failure would cause a crisis. But the Obama administration has created a new concept: institutions too big to be resolved, too big for capital markets to provide the necessary discipline. The perverse incentives for excessive risk-taking at taxpayers' expense are even worse with the too-big-to-be-resolved banks than they are at the too-big-to-fail institutions. We have signed a blank check on the public purse. We have not circumscribed their gambling – indeed, they have access to funds from the Fed at close to zero interest rates, and it appears that "trading profits" have (besides "accounting" changes) become the major source of returns.
Last night Barack Obama defended his administration's response to the financial crisis, but the reality is that a year on from Lehmans' collapse, it has failed to take adequate steps to restrict institutions' size, their risk-taking, and their interconnectedness. Indeed, it has allowed the big banks to become even bigger – just as it has failed to stem the flow of profligate executive bonuses. Obama's call on Wall Street yesterday to support "the most ambitious overhaul of the financial system since the Great Depression" is welcome – but the devil, as ever, will be in the detail.
There remain many institutions willing and able to engage in gambling, trading and speculation. There is no justification for this to be done by institutions underwritten by the public. The implicit guarantee distorts the market, providing them a competitive advantage and giving rise to a dynamic of ever-increasing size and concentration. Only their own managerial competence, demonstrated amply by a few institutions, provides a check on the whole process.
The Lehmans episode demonstrates that incompetence has a price. That there would be serious problems in our financial institutions was apparent since early 2007, with the bursting of the bubble. Self-deception led those who had allowed the bubble to develop, who had looked the other way as bad lending practices became routine, to think that the problems were niche or temporary. But after the fall of Bear Stearns, with rumors that Lehmans was next, the Fed and the Treasury should have done a serious job of figuring out how to manage an orderly shutdown of a large, complex institution; and if they determined that they lacked adequate legal authority, they should have requested it.
They appear, remarkably, to have been repeatedly caught off-guard. They claim in the exigency of the moment they were doing the best they could. There was no time for thought. And that explains how they veered from one solution to another: after saying that they did not want to bail out Lehmans because of a concern about moral hazard, they extended the government's safety net further than it had ever been. Bear Stearns extended it to investment banks, and AIG to all financial institutions. Perhaps they were doing the best they could at the time; but that is no excuse for not having anticipated the problems and been better prepared.
Lehman Brothers was a symptom of a dysfunctional financial system and regulatory failure. It should have taught us that preventing problems is easier, and certainly less costly, than dealing with them when they become virtually intractable.
I also think the administration should have moved faster "to restrict institutions' size, their risk-taking, and their interconnectedness," but I haven't completely given up hope that they will get this done. But I doubt it will go as far as I'd like.

Could It Happen Again?

I've been reading a book called Famine, and they were far more common in the past than I realized. It notes that, historically, societies have been able to deal with one year of bad harvest. It's not costless, and sometimes markets or governments do not deliver the food where it is needed, but there is generally enough food in reserve to augment the poor harvest sufficiently to avoid widespread hunger (this was no accident historically, governments kept food in reserve to smooth variations is supply). But when there are poor harvests two years in a row, whether it be from natural disasters such as weather problems or human caused problems such as war, then the problems become severe. No matter how well markets or governments work, there aren't generally enough supplies in reserve to withstand two consecutive years of substantially reduced harvests.

This book, together with the financial crisis, make me wonder just how insulated modern societies are from these kinds of problems. Could the world withstand two consecutive years of food shortage? I suppose we believe, as we believed with the economy, that modern institutions and technology insulate us from such problems, it can't happen in our advanced societies. But what would happen if an unexpected volcano's emissions blocked sunlight for two harvests, or if some fungus or bacteria suddenly appears wiping out grain supplies worldwide for several years? How bad would conditions be, and how bad would fights between nations get if there truly was a worldwide food shortage?

My guess is that we are closer to the edge than we like to believe.

What's Wrong with Macroeconomics?

Some recent contributions to "what's wrong with macroeconomics?":


[This list is incomplete, so please add any I've missed in comments.]

"Freshwater Rage"

Paul Krugman responds to the response to his criticism of macroeconomics:

Freshwater rage, by Paul Krugman: I'm still on the road, with only sporadic internet access. So I've missed out on much of the outpouring of rage over my magazine article. I gather, though, that the usual suspects are utterly outraged at my suggestion that freshwater macro has spent several decades heading down the wrong path. They're smart! They work hard, using hard math! How dare I say such a thing?
And all of this, of course, without a hint of irony.
For when freshwater macro took over a good part of the field, its leaders gleefully dismissed all the work Keynesian economists had done over the previous few decades, often with sneers and sniggers.
And that same adolescent quality was evident in the reactions to the Obama administration's attempts to deal with the crisis — as Brad DeLong points out, people like Robert Lucas and John Cochrane (not to mention Richard Posner, who isn't a macroeconomist but gets his take from his colleagues) didn't say that when serious scholars like Christina Romer based policy recommendations on Keynesian economics, they were wrong; the freshwater crowd declared that anyone with Keynesian views was, by definition, either a fool or intellectually dishonest.
So the freshwater outrage over finding their own point of view criticized is, you might think, a classic case of people who can dish it out but can't take it.
But it's actually even worse than that.
When freshwater macro came in, there was an active purge of competing views: students were not exposed, at all, to any alternatives. People like Prescott boasted that Keynes was never mentioned in their graduate programs. And what has become clear in the recent debate — for example, in the assertion that Ricardian equivalence rules out any effect from government spending changes, which is just wrong — is that the freshwater side not only turned Keynes into an unperson, but systematically ignored the work being done in the New Keynesian vein. Nobody who had read, say, Obstfeld and Rogoff would have been as clueless about the logic of temporary fiscal expansion as these guys have been. Freshwater macro became totally insular.
And hence the most surprising thing in the debate over fiscal stimulus: the raw ignorance that has characterized so many of the freshwater comments. Above all, we've seen the phenomenon of well-known economists "rediscovering" Say's Law and the Treasury view (the view that government cannot affect the overall level of demand), not because they've transcended the Keynesian refutation of these views, but because they were unaware that there had ever been such a debate.
It's a sad story. And the even sadder thing is that it's very unlikely that anything will change: freshwater macro will get even more insular, and its devotees will wonder why nobody in the real world of policy and action pays any attention to what they say.
I am not quite as pessimistic about the prospects for change, but many people have their life's work wrapped up in a particular brand of model and they will defend that work aggressively, so I do agree that it's likely to come in spite of rather than because of the old guard.

"Economics and Its Discontents"

David Warsh says economics has served us well in dealing with the aftermath of the crisis and that, while macroeconomics has problems, "The last thing we needs is a civil war in economics":

Economics and Its Discontents, by David Warsh: In the aftermath of the worst scare since the 1930s, economists have identified a new culprit to share the blame for the subsequent mess – themselves, or rather those among their tribe with whom they disagree. No longer are greedy Wall Street bankers, feckless regulators and a blasé Federal Reserve Board the only suspects. The economics profession has joined them in the dock.
"How Did Economists Get It So Wrong?" asked Paul Krugman last week in The New York Times Magazine. "The Financial Crisis and the Systemic Failure of the Economics Profession, " wrote David Colander, Alan Kirman and several others in Critical Review.
"The Other-Worldly Philosophers," offered the headline of thoughtful examination in The Economist two months ago. On its cover, a textbook – "Modern Economic Theory" – melted into a puddle. The editorial began, "Of all the bubbles that have been pricked, few have burst more spectacularly than the reputation of economics itself."
Is that really true? Or is the hubbub another case of what Sigmund Freud, in Civilization and Its Discontents, termed "the narcissism of small differences" – the tendency to exaggerate the dissimilarities of those who resemble us in an effort to buttress our own self-regard?
Since the controversy is mainly a renewal of hostilities among the New Classical and New Keynesian schools that flared fiercely in the 1970s and '80s, supplanting the antagonisms among Monetarists and Old Keynesians before settling down to an uneasy backseat truce the '90s and '00s (dubbed, if you can believe it, "the new neoclassical synthesis"), there is some reason to suspect that psychopathology is the real problem
The fireworks, as usual, have been provided by Krugman, New York Times columnist, Princeton professor and winner of last year's economics Nobel Prize.
Forty years ago, he wrote, economics had divided into two great factions, purists and pragmatists, meaning New Classicals and New Keynesians (or freshwater and saltwater economists, in Robert Hall's memorable phrase, which characterized the neighborhoods of the universities in which the various parties tended to work).
The purists, led by Robert Lucas, Thomas Sargent and Edward Prescott, favored ingeniously-constructed mathematical models, disparaged Keynes, doubted that business cycles can be cured by policy (other than steady monetary growth and credible policy actions to control inflation).
The pragmatists, including Olivier Blanchard, David Romer and N. Gregory Mankiw, inherited from Keynes the belief that market failure is at the center of the business cycle, and built their own style of mathematical models to relate that failure to individual behavior in setting wages and prices. They remained convinced that policy could combat recessions.
Lulled by the success of central bankers Paul Volcker and Alan Greenspan – the quarter-century of steady growth and low inflation over which they presided has been dubbed "the Great Moderation" — the pragmatists gradually abandoned the Old Keynesian faith in activist fiscal policy (although they continued to argue among themselves over whether the smooth sailing stemmed from good monetary policy or from a series of positive developments in the economy itself).
Gradually, even the pragmatists traded their customary wariness for triumphal confidence that monetary policy alone was adequate to tame the business cycle – until last year, when the housing bubble and its counterpart sub-prime crisis gave way to panic when a large investment bank, Lehman Brothers, was allowed to fail. That development, a year ago, took almost all macroeconomists completely by surprise, purists and pragmatists alike.
"Neither side was prepared to cope with an economy that had gone off the rails despite the Federal Reserve Board's best efforts," wrote Krugman, though he acknowledged, far down in his article, that policy makers seem to have muddled through. ("Cross your fingers," he wrote.) For economics itself, he concluded, there was nothing for it now except to admit that, "after several revolutions and counter revolutions, Keynesian economics remains the best framework we have for making sense of recessions and depressions." The article was accompanied by a series of even more forceful cartoons.
A more temperate version of the same story was offered by Robert J. Gordon, of Northwestern University, earlier this summer at the International Colloquium on History of Thought in Sao Paulo, Brazil. For those interested in the history of the freshwater-saltwater controversy, his account makes fascinating reading.
Gordon offers to relinquish the "Keynesian" adjective to describe the present-day pragmatist (or saltwater tradition) in recognition that this nomenclature was tainted in the '70s, in large part due to the success of New Classical purists to link it to the failed Phillips Curve, with its one-way tradeoff between unemployment and inflation. Instead, he proposes to substitute "1978-era macro" to describe the pragmatist point of view. A new generation of models, developed to describe supply-side responses to the OPEC shocks as well as traditional demand-side effects, was introduced in two path-breaking intermediate texts that appeared that year, one by Rudiger Dornbush and Stanley Fischer, both of the Massachusetts Institute of Technology, the other by Gordon himself. They contain virtually all the tools necessary to understand the crisis of 2008, he says.
The reasoning is more delicate than Krugman's article; the survey of the relevant work more even-handed and generous. And he traces some important similarities between the bubbles of 1927-29 and 2003-06. But in the end, Gordon makes the same point as Krugman: to understand what happened in the US during the 2007-09 worldwide crisis, "we are best served by applying 1978-era macro and forgetting most of the modern macro that has developed since." He concludes, "Empirical success and common sense have triumphed over the endless search for deep microfoundations in a world in which macroeconomic interactions triumph over individual choice." He means that wage earners don't choose to leave their jobs and firms to shut their plants in a recession, in order to enjoy more free time (the caricature implied by purists' models); instead they are the victims of the coordination failures that occur when financial crashes spill over to the demand for products, and from there to layoffs and unemployment.
That is almost certainly true. But neither is it the whole story. The search for microfoundations may not have turned up much to brag about in the investigation of recessions and unemployment, but it has paid off handsomely in other fields, such as monetary theory and the economics of growth. It may yet tell us something worth knowing about public finance, and even produce a good strong model of the relationship of banking and finance to the real economy. (Almost everyone agrees that's what's needed now.) There is no reason to think that the purists should abandon their quest.
But then there is no reason to turn to them for policy advice. For once, there is strong evidence that, with the pragmatists, we're in good hands. Consider, for example, the performance of the Israeli economy, where arch-pragmatist Stanley Fischer is head of the central bank. A veteran of the Asian and Russian financial crises – during which he was deputy managing director of the International Monetary Fund – Fischer was quick to act when the global economy abruptly stalled last year. He slashed interest rates and conducted a modest competitive devaluation. Now Israel's export-driven economy is expected to grow by 3.3 percent next year. A single country, yes, but significant as was the performance of the Swedish economy (on similar grounds) in the early 1930s.
More to the point is the current situation in the United States, where another arch- pragmatist, Ben Bernanke, has assumed control, and where the economy apparently is beginning to grow again. Unemployment is still rising; job growth next year is expected to be painfully slow: the recession will go into the record books as the worst since World War II. The seven major economies of Europe are growing again, according to the Organization for Economic Cooperation and Development, as are those of China, India and Russia. On the evidence so far, it is Robert Lucas, not Paul Krugman, who has been more nearly correct: the central problem of depression-prevention apparently has been solved.
By no means is it time to sound the All Clear. But broadly speaking, economics has served us well in understanding and managing the crisis — microeconomics in understanding the myriad mismatched incentives that produced it; battle-tested pagmatic macroeconomics in managing it, so far. Taking the saltwater/freshwater battle back to the pubic won't help. Freud wrote Civilization and its Discontents in part to explain the persistence of ethnic strife. Never mind the narcissism of small differences. The last thing we needs is a civil war in economics' equivalent of the Balkan states, the fractious province of Macro.

"Is Modern Macro or 1978-era Macro More Relevant to the Understanding of the Current Economic Crisis?"

Robert Gordon argues that "modern macro neglects the basic sources of both impulses and propagation mechanisms of business cycles," and that we should return to "1978-era macroeconomics." Here's the introduction to his paper:

Is Modern Macro or 1978-era Macro More Relevant to the Understanding of the Current Economic Crisis?, by Robert Gordon: 1. Introduction For more than three decades since 1978 hundreds of U. S. macroeconomists have developed what is often called the "modern macroeconomics" of business cycle fluctuations.[1] Until recently, there was evident self-satisfaction that macroeconomic truth had been discovered, that old errors had been buried, and that a long period of warfare between new classicals and new Keynesians had ended as a consensus had emerged based on Dynamic Stochastic General Equilibrium (DSGE) models that combined new-classical market clearing with the new-Keynesian contribution of sticky prices.[2]
Along the way numerous modern macroeconomists concluded that the U. S. "Great Moderation" of macroeconomic volatility in the 1984-2007 period (as compared to higher volatility in the earlier 1947-84 postwar interval) was a side benefit of modern analysis. However since 2007 the world economy has entered a crisis of sub-prime mortgage defaults, excessive leveraging followed by deleveraging, output and employment meltdowns, and an enormous destruction of wealth. The Great Moderation is dead. Neither the proponents of modern macro nor the adherents of Keynesian ideas anticipated the crisis in advance. But even the most avid supporters of the modern macro camp have thus far failed to provide any intellectual links with their preferred explanations of business cycle downturns based on technology retardation, changes in preferences, or tightness in monetary policy.
This paper is not an endorsement of 1936-era Keynesian thought, but rather revives an alternative intellectual paradigm called "1978-era macroeconomics."
This incorporates all the rich underpinnings of Keynesian demand-side economics added in the postwar era by Baumol, Eisner, Friedman, Jorgenson, Modigliani, and Tobin and many others to the micro foundations of the economy's demand side. The 1978-era version of aggregate demand shocks in the fact of incomplete price adjustment has no trouble in tracing the links between yet another financial bubble in 2003-06 (as in 1927-1929 and 1997-1999) and the resulting massive downdraft on economic activity in a disequilibrium where markets fail to clear. Among the elements of 1978-era demand-side macro that are often neglected today are the dependence of current consumption on current income and wealth, and the accelerator theory of investment which makes investment depend on the rate of change of real output and income.
But 1978-era macro does not include the other intellectual baggage of the term "Keynesian economics", which has been forever tainted by association (in Lucas-Sargent 1978 and elsewhere) with the discredited 1960s-era Phillips Curve and its implication of an exploitable inflation-unemployment tradeoff. Instead this paper revives the supply-side invented in the mid-1970s that recognizes the co-existence of flexible auction-market prices for commodities like oil and sticky prices for the remaining non-oil economy. Adverse supply shocks coming not just from oil prices but also, as in the early 1970s from auction-market price shocks in food and exchange rates, boosted the expenditure share of commodities and forced nominal spending on non-shocked products to contract. Without flexible wages, a decline in real non-shocked output had to occur and did, leaving policymakers with the dilemma that any attempt to control inflation would create a recession, while any attempt to stabilize real GDP would lead to faster inflation.
As combined in 1978-era theories, empirical work, and pioneering intermediate macro textbooks, this merger of demand and supply resulted in a well-articulated dynamic aggregate demand-supply model that has stood the test of time in explaining both the multiplicity of links between the financial and real economies, as well as why inflation and unemployment can be both negatively and positively correlated. The achievement of 1978-era macro was to retain the best of Keynesian demand-side economics while dropping the negatively sloped inflation-unemployment tradeoff with its neglect of supply shocks. 1978-era macro recognizes that the correlation between inflation and unemployment can be either negative or positive, just as microeconomics has long predicted that the correlation between the price and quantity of wheat can be either negative or positive depending on the size of the shocks to demand and supply.
To understand the domestic macroeconomic environment of the 2007-09 worldwide crisis, we are best served by applying 1978-era macro. The adjective "business cycle" in front of the phrase "modern macro" represents an important qualification to the scope of this paper. Much of modern macro escapes its critical overview, including such broad areas of modern macro progress as growth theory, search and matching models of unemployment, theories of why prices and wages are only partial flexible, and attempts to use modern versions of production functions and factor input measurement to develop empirical counterparts to longstanding 1978-era macro constructs such as potential GDP growth and the GDP gap.[3]
The world economic crisis started in the United States, and an understanding of its causes, possible prevention, and policy responses is most easily developed in the context of a hypothetically closed American economy. The economics literature of the last 50 years is dominated by American economists arguing over alternative theories of the domestic sources of American business cycles. Any suggestion in this paper that American business cycle macroeconomics has been going backwards in the past few decades does not extend to our colleagues who have greatly deepened our understanding of international imbalances and exchange rate adjustment.
The failings of modern American business fluctuations macro were evident long before the start of the world crisis in 2007. Yet so dominant have been the modern macroeconomists in the teaching of graduate economics education that few economists under the age of 45 are even aware that there is another macro that was well developed by 1978 and provides a more suitable intellectual framework for dealing with the current crisis. Even a distinguished senior economist, Olivier J. Blanchard (2008), recently joined in the orgy of self-congratulation by writing a survey paper on the state of macro which concluded "the state of macroeconomics is good." His sanguine paper was released as a NBER Working Paper only one month before the failure of Lehman Brothers in September, 2008, began the worldwide downward economic spiral.
The development of this paper by coincidence coincides with the recent cover of The Economist (July 18, 2009), which depicts a wax-like book titled Modern Economic Theory, shown melting into a puddle like the Wicked Witch of the West in the 1939 movie The Wizard of Oz.
The Economist derides the economics profession for (1) helping to cause the crisis, (2) failing to spot it, and (3) having no idea how to fix it. Our theme is different; there is no accusation here that economists of one school of thought or another "caused the crisis." Some did see it coming but almost none forecast the amplification of shocks that is its unique trait. Many have helped to fix it, starting with Chairman Bernanke of the Fed, perhaps the leading American academic expert on the Great Depression. Indeed, Bernanke in his own work and collaboration with Mark Gertler (1989) has made important contributions to macroeconomics but has steered clear of linking them to the market-clearing environment of DSGE models that are the subject of this paper.
The malaise of modern macroeconomics has recently been the subject of strikingly vitriolic accusations. The Economist (p. 70) quotes Paul Krugman's LSE Lionel Robbins Lecture of 10 June 2009 as stating "most macroeconomics of the past 30 years was spectacularly useless at best, and positively harmful at worst." More recently Krugman (2009) has amplified this criticism in a long and overly argumentative denunciation of modern macroeconomics. In notably similar language that might have inspired Krugman, Buiter (2009) wrote three months earlier that "the typical graduate macroeconomics. . . training received at Anglo-American universities during the past 30 years or so may have set back by decades serious investigations of aggregate economic behaviour and economic policy-relevant understanding. It was a privately and socially costly waste of time and other resources."
This paper takes a more temperate view of what is wrong with modern macro. It looks back into the pre-crisis (pre-2007) intellectual history of macroeconomic theory and argues that modern macro neglects the basic sources of both impulses and propagation mechanisms of business cycles. The basic problem is that modern macro consists of too much micro and not enough macro. Focus on individual preferences and production functions misses the essence of macro fluctuations -- the coordination failures and macro externalities that convert interactions among individual choices into constraints that prevent workers from optimizing hours of work and firms from optimizing sales, production, and utilization. Also modern business-cycle macro has too narrow a view of the range of aggregate demand shocks that in the presence of sticky prices constrain the choices of workers and firms. Shocks that have little or nothing to do with technology, preferences, or monetary policy can interact and impose constraints on individual choices.
How does the contrast between domestic American "modern macro" and the alternative 1978 version illuminate the current world crisis? Modern business-cycle macroeconomics has little to say about the origins of the Great Depression of the 1930s and concludes that it must have resulted from a massive negative technology shock, a monumental bout of forgetfulness.[4] In contrast 1978-era macro understands the Great Depression as the joint result of wealth, consumption, investment, and monetary policy shocks in the context of regulatory failure. No 1978-era macroeconomists predicted in advance the full sweep of the 2007-09 meltdown, but they were led by their studies of the Great Depression and postwar business cycles to regard as fundamental drivers of business cycles a wide variety of demand shocks, including the coordination failures evident in the financial and housing bubbles.
The paper begins in Part 2 with an account of the worldwide crisis, where the main novelty is a set of observations about similarities and differences between 2003-09 and 1927-32. Then in Part 3 the elements of 1978-era macroeconomics are established and are contrasted in Part 4 with the hybrid but inconsistent edifice built by modern macroeconomists in the form of Dynamic Stochastic General Equilbrium (DSGE) models.
1. The "modern macro of business cycle fluctuations" describes the set of models and strategies that have dominated graduate school and academic-conference business-cycle macroeconomics since the late 1970s. Developers of modern macro rarely use that phrase since they take for granted that all macro is "modern," while critics like Solow (2008) feel obliged to define "modern macro" as what they are criticizing.
2. The self-satisfaction of modern macro is often demonstrated by Blanchard's (2008) much-cited conclusion that "the state of macro is good." More on Blanchard below. A more measured and scholarly paper arrives at the same verdict as summarized in the title of Woodford (2009), "Convergence in Macroeconomics: Elements of a New Synthesis." Woodford among others conclude that New Classical and New Keynesian macro have converging on DSGE with price stickiness as a consensus model.
3. There is no need here to provide citations of the forms of modern macro that escape criticism here. The large literature on new endogenous growth theory is well known; search and matching models were developed by Diamond, Mortensen, and Pissarides and their followers, and the large "New Keynesian" literature on the micro foundations of wage and price adjustment was fully surveyed by Gordon (1990) among others. A recent source that brings together the modern production function approach to the measurement of potential real GDP and the GDP gap is Anderson (2009).
4. There are a welcome set of exceptions, as always. The work of Bernanke (1983) and Bernanke-Gertler (1989) are notable examples of post-1978 attempts to link the financial collapse of the Great Depression with the real economy, although neither did so with the full apparatus of modern DSGE models. Eggertson-Woodford (2004) come closer to an attempt to merge modern macro with the zero lowerbound characteristic of nominal interest rates in the late 1930s and the 2008-09 period. Ongoing work by my colleagues Christiano and Eichenbaum (2009) on fiscal policy multipliers in the presence of a zero lower bound represent further progress in this direction.

Fed Watch: Quick Note on Confidence

Should the latest numbers on consumer confidence improve your confidence in the economy? Here's Tim Duy:

Quick Note on Confidence, by Tim Duy: As Calculated Risk noted, the commentary on the August Consumer Sentiment number from the University of Michigan ran along the generally positive tone echoed by the Wall Street Journal:
Main Street is beginning to feel some relief, though, according to the Reuters/University of Michigan preliminary reading of consumer sentiment for September, released Friday.
The index rose to 70.2 in September from to 65.7 in August, the first increase since June. Consumers felt better about current conditions, and about the future.
Looking at a charts, it is tough to see much of a rebound in August; the bounce happened in April, and the index has been moving sideways since:
Still, even moving sideways is better than falling, and it is telling you something about the path of spending, suggesting that consumers are moving toward spending just about what they did last year:
That we are headed to zero year-over-year growth in spending should not come as a surprise. The calendar is now working in the favor of the data as we move past the big declines in spending registered last summer:
When does confidence start pulling higher? For that, we need the job market to improve at a more rapid pace, thereby reversing this pattern of private wage and salary growth:
Beyond that, your forecast for aggregate spending is largely base on your view of a.) jobless recovery or not, b.) the direction of saving rates, and c.) the accessibility of credit in the post-bubble era. Note that the latter alone suggests persistent downward pressure on spending. Returning to the rates of spending growth (and, by association, the confidence numbers) of the pre-Great Recession period looks to be unlikely.
In short, the August "rebound" in confidence isn't much of a rebound - the rebound happened in April. That said, slowing "improving" labor market conditions argue for a continuing gains in confidence in the months ahead, but I would expect the gains will continue to come slowly.


William Easterly has a question:

Afghanistan, William Easterly: Maybe I have a biased selection, but it seems like every sensible economist, political scientist, development worker, and journalist that I know thinks our current course in Afghanistan can have only one outcome -- disaster. Disaster for Americans, for our NATO allies, AND for Afghans.
Why is nobody listening?

"Gender, Risk, and Competition"

Are differences in risk aversion and competitiveness between men and women due to cultural pressures rather than innate tendencies?:

Gender, risk, and competition, by Alison Booth, Vox EU: It is well known that women are under-represented in high-paying jobs and top-level management positions. Recent work in experimental economics, largely examining college-age men and women attending coeducational universities, has examined to what degree this underrepresentation may be due to innate differences between men and women. Experimental studies have shown that women are less willing than men to take risks or to enter a competitive environment such as a tournament (see for example Niederle and Vesterlund, 2007).
Gender differences in risk aversion and competition, it is sometimes argued, may help explain some of the observed gender disparities in labour force achievement. For example, if remuneration in high-paying jobs is tied to bonuses based on a company's performance and if women are more risk-averse than men, fewer women may choose to take high-paying jobs because of the uncertainty.
Might culture matter?
Are women naturally more risk-averse or less inclined to enter a competitive situation? Or are they trained to be that way? Why women and men might have different preferences or risk attitudes has been discussed but not tested by economists. Broadly speaking, those differences may be due to nurture, nature, or some combination of the two. For instance, boys are pushed to take risks and act competitively when participating in sports, and girls are often encouraged to remain cautious. Thus, the choices made by men could be due to the nurturing received from parents or peers. Similarly, the disinclination of women to take risks or act competitively could be the result of parental or peer pressure not to do so.
An interesting study by Gneezy, Leonard, and List (2008) explored the role of culture in determining gender differences in competitive behaviour. They investigated two distinct societies, the Maasai tribe of Tanzania and the Khasi tribe in India. The former is patriarchal while the latter is matrilineal. In the patriarchal society, women were found to be less competitive than men, a result consistent with studies using data from Western cultures. But in the matrilineal society, women were more competitive than men. Indeed, the Khasi women were found to be as competitive as Maasai men. The authors interpret this as evidence that culture has an influence.
Environmental factors
What other environments could affect competitive and risk-taking behaviour? Educational psychologists argue that the gendered aspect of individuals' behaviour is brought into play by the gender of others with whom they interact, and that there may be more pressure for girls to maintain their gender identity in schools where boys are present than for boys when girls are present. In a coeducational environment, girls are more explicitly confronted with adolescent subculture (such as personal attractiveness to members of the opposite sex) than they are in a single-sex environment. This may lead them to conform to society's expectations of how girls should behave to avoid social rejection. If competitive behaviour or risk avoidance is viewed as being a part of female gender identity while risk-seeking is a part of male gender identity, then a coeducational school environment might lead girls to make less competitive and risky choices than boys.
Experimental evidence on environmental influences
To investigate the role that nurturing might play in shaping risk and competitive attitudes, we used UK students from years 10 and 11 of state-funded single-sex or coeducational schools as experimental subjects (Booth and Nolen 2009a, 2009b). The students had been in that environment since completing primary school, and their average age was just under 15 years. Our goal was to examine the effect of two potential types of nurturing – educational environment and randomly assigned experimental peer-groups. The former represents long-run nurturing experiences, while the latter captures short-run environmental effects.
The students were taken by bus from their respective schools to the University of Essex for the experiments. They came from eight schools in the counties of Essex and Suffolk. Four of the schools were single-sex. In Suffolk County, there are no publicly funded single-sex schools. In Essex County, the old single-sex "grammar" schools remain, owing to a (convenient for our purposes) quirk of political history. On arrival, students from each school were randomly assigned into 65 groups of four. Groups were of three types – all-girls, all-boys, or mixed. Mixed groups had at least one student of each gender and the modal group comprised two boys and two girls. The composition of each group – the appropriate mix of single-sex schools, coeducational schools and gender – was determined beforehand. Thus only the assignment of the 260 girls and boys from a particular school to a group was random. The school mix was two coeducational schools from Suffolk (103 students), two coeducational schools from Essex (45 students), two all-girl schools from Essex (66 students), and two all-boy schools from Essex (46 students). All students were paid a show-up fee as well as any winnings from the experiments. A survey was administered immediately after the experiment, to obtain background information to facilitate robustness checks.
We gave subjects in the controlled experiment an opportunity to choose the risky outcome – a real-stakes gamble with a higher expected monetary value than the alternative outcome with a certain payoff – and in which the sensitivity of observed risk choices to environmental factors could be explored. The task was carefully constructed so that subjects with a coefficient of relative risk aversion greater than a particular level would choose the real-stakes gamble; otherwise they would choose the certain amount. Their choice was either to receive £5 with certainty or to flip a coin and get £11 if the coin comes up heads or get £2 if the coin comes up tails.
We hypothesized that women and men may differ in their propensity to choose a risky outcome for several reasons – innate preferences or because their innate preferences are modified by pressure to conform to gender-stereotypes. Single-sex environments are likely to modify students' risk-taking preferences in economically important ways. Our specific conjectures were that girls from single-sex schools are less risk averse than girls from coed schools, and that girls in same-gender groups are less risk averse than girls in coed groups. We also conjectured that girls in same-gender environments (single-sex schooling or same-gender experimental groups) are no less risk-averse than boys.
We found that girls from single-sex schools were as likely to take a risk by gambling their £5 in the hopes of winning £11 as boys (from either coed or single sex schools) and were more likely to take a risk than coed girls. Moreover, gender differences in preferences for risk-taking were sensitive to the gender mix of the experimental group, with girls being more likely to choose to take a risk when assigned to an all-girl group. This suggests that observed gender differences in behaviour under uncertainty found in previous studies might reflect social learning rather than inherent gender traits.
Competitive behaviour
Competitive behaviourwas measured by allowing students to choose between payment via a tournament (winner-takes-all) or by piece rate. Subjects were advised that their payment would depend on which option they chose if this round was randomly selected for payment. Students' tasks involved solving paper mazes, as is common in this literature.
Using the data generated from this experiment, we found that girls from single-sex schools were significantly more likely to choose to enter the tournament than coeducational girls, ceteris paribus. Being randomly assigned to an all-girls group made the girl more likely to enter the tournament. We also compared girls' behaviour with that of boys from single-sex and coeducational schools – girls from single-sex schools behaved more like boys. These findings were robust to a number of sensitivity checks.
What might explain these findings?
While our research should not be interpreted as saying that we should all immediately enrol our daughters in single-sex schools, it does provide food for thought. Educational studies have shown that there may be more pressure for girls to maintain their gender identity in schools where boys are present than for boys when girls are present. In a coeducational environment, adolescent girls are more explicitly confronted with adolescent subculture (such as personal attractiveness to members of the opposite sex) than they are in a single-sex environment. This may lead them to conform to boys' expectations of how girls should behave to avoid social rejection. If risk avoidance is viewed as being a part of female gender identity while risk seeking is a part of male gender identity, then being in a coeducational school environment might lead girls to make safer choices than boys.
What role for policy?
These results matter, not least because of the underrepresentation of women in high-paying jobs and top management positions. While gender differences in risk aversion or competition could explain some of the observed disparities in labour force achievement, these gender differences are not necessarily innate, as shown by our experiments and those of Gneezy et al. (2008). Women may be trained to be so by their environment. Appropriate policy action might be directed not only to removing discrimination on the demand-side but also towards developing female confidence in risk-taking on the supply-side.
Booth, Alison L. and Patrick Nolen (2009a). "Gender Differences in Risk Behaviour: Does Nurture Matter?" CEPR Discussion Paper No. 7198, March.
Booth, Alison L. and Patrick Nolen (2009b). "Choosing to Compete: How Different Are Girls and Boys?" CEPR Discussion Paper No. 7214, March.
Gneezy, Uri, Kenneth Leonard, and John List. (2008). "Gender Differences in Competition: Evidence from a Matrilineal and a Patriarchal Society". Forthcoming in Econometrica.
Niederle, Muriel and Lise Vesterlund (2007). "Do women shy away from competition? Do men compete too much?" Quarterly Journal of Economics 122 (3); 1067-1101.
This article may be reproduced with appropriate attribution.

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