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September 16, 2009

Economist's View - 5 new articles

Who Has All the Answers?

Justin Fox:

Hyman Minsky didn't have all the answers, by Justin Fox: Economist Hyman Minsky, who never got much attention while he was alive, has become one of the big celebrities of this financial crisis. In Sunday's Boston Globe, Stephen Mihm has the best account of Minsky's life and significance that I've seen so far. A sample:
Today most economists, it's safe to say, are probably reading Minsky for the first time, trying to fit his unconventional insights into the theoretical scaffolding of their profession. If Minsky were alive today, he would no doubt applaud this belated acknowledgment, even if it has come at a terrible cost. As he once wryly observed, "There is nothing wrong with macroeconomics that another depression [won't] cure."
But did Minsky really have much to add beyond the crucial insight that financial systems are inherently unstable? His former student Eric Falkenstein, responding on his blog to Mihm's article, isn't so sure:
I was Minsky's TA while a senior at Washington University in St.Louis in 1987, and took a couple of his advanced classes, which regardless of the official name, were all just classes in Minskyism. He was a maverick, but perhaps a bit too much, being a little too dismissive of others, as he hated the traditional Samuelson/Solow Keynesians as much as the Friedmanite Monetarists. He always thought a market collapse was just around the corner. The S&P was 250 when I took his course, it went to 1500 in 2007 and then back to 735 in 2009. Does that prove he was right all along? ...
The problem ... is that his top-down theory is rejected by the data. Aggregate leverage ratios do not closely correspond to business cycles. If Minsky took microeconomics more seriously he could have made his theory more relevant, by noting that crises tend to occur in specific subsets in the economy: in 1990, hotels and Commercial real estate, in 2001, high tech, in 2008, mortgages. The mistake is not one made in aggregate, but in different sectors each recession. By noting these areas, but not the aggregate economy, had too much leverage, and depended on expected future increases in collateral value, he might have been more successful proselytizing his colleagues. But he was a traditional Keynesian, who liked to look at aggregate equations, like Profits=Investment + Deficits + Net Imports.
I think the broader point here is that there is no one Theory That Explains Everything in economics. Neoclassical economics certainly doesn't explain everything. Neither does Minskyism. Nor Austrian business cycle theory. Nor complexity theory. It seems like the best approach would be an eclectic one that takes lots of different economic models into account. But eclecticism doesn't get you far in academia.

There is no grand, unifying theoretical structure in economics. We do not have one model that rules them all. Instead, what we have are models that are good at answering some questions - the ones they were built to answer - and not so good at answering others.

If I want to think about inflation in the very long run, the classical model and the quantity theory is a very good guide. But the model is not very good at looking at the short-run. For questions about how output and other variables move over the business cycle and for advice on what to do about it, I find the Keynesian model in its modern form (i.e. the New Keynesian model) to be much more informative than other models that are presently available (as to how far this kind of "eclecticism" will get you in academia, I'll just note that this is exactly the advice Mishkin gives in his textbook on monetary theory and policy).

But the New Keynesian model has its limits. It was built to capture "ordinary" business cycles driven by price rigidities of the sort that can be captured by the Calvo model model of price rigidity. The standard versions of this model do not explain how financial collapse of the type we just witnessed come about, hence they have little to say about what to do about them (which makes me suspicious of the results touted by people using multipliers derived from DSGE models based upon ordinary price rigidities). For these types of disturbances, we need some other type of model, but it is not clear what model is needed. There is no generally accepted model of financial catastrophe that captures the variety of financial market failures we have seen in the past.

But what model do we use? Do we go back to old Keynes, to the 1978 model that Robert Gordon likes, do we take some of the variations of the New Keynesian model that include effects such as financial accelerators and try to enhance those, is that the right direction to proceed? Are the Austrians right? Do we focus on Minsky? Or do we need a model that we haven't discovered yet?

We don't know, and until we do, I will continue to use the model I think gives the best answer to the question being asked. The reason that many of us looked backward for a model to help us understand the present crisis is that none of the current models were capable of explaining what we were going through. The models were largely constructed to analyze policy is the context of a Great Moderation, i.e. within a fairly stable environment. They had little to say about financial meltdown. My first reaction was to ask if the New Keynesian model had any derivative forms that would allow us to gain insight into the crisis and what to do about it and, while there were some attempts in that direction, the work was somewhat isolated and had not gone through the type of thorough analysis needed to develop robust policy prescriptions. There was something to learn from these models, but they really weren't up to the task of delivering specific answers. That may come, but we aren't there yet.

So, if nothing in the present is adequate, you begin to look to the past. The Keynesian model was constructed to look at exactly the kinds of questions we needed to answer, and as long as you are aware of the limitations of this framework - the ones that modern theory has discovered - it does provide you with a means of thinking about how economies operate when they are running at less than full employment. This model had already worried about fiscal policy at the zero interest rate bound, it had already thought about Says law, the paradox of thrift, monetary versus fiscal policy, changing interest and investment elasticities ina crisis, etc., etc., etc. We were in the middle of a crisis and didn't have time to wait for new theory to be developed, we needed answers, answers that the elegant models that had been constructed over the last few decades simply could not provide. The Keyneisan model did provide answers. We knew the answers had limitations - we were aware of the theoretical developments in modern macro and what they implied about the old Keynesian model - but it also provided guidance at a time when guidance was needed, and it did so within a theoretical structure that was built to be useful at times like we were facing. I wish we had better answers, but we didn't, so we did the best we could, and the best we could involved at least asking what the Keynesian model would tell us, and then asking if that advice has any relevance today. Sometimes if didn't, but that was no reason to ignore the answers when it did.

What's Wrong with Macroeconomics?

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

Added 9/15:


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

"The Tobin Tax Lives Again"

Dani Rodrik thinks he must be dreaming:

The Tobin Tax Lives Again, by Dani Rodrik, Commentary, Project Syndicate: Something happened in late August that I never thought I would see in my lifetime. A leading policymaker in the Anglo-American empire of finance actually came out in support of a Tobin tax - a global tax on financial transactions.
The official in question was Adair Turner, the head of the United Kingdom Financial Services Authority, the country's chief financial regulator. Turner, voicing his concerns about the size of the financial sector and its frequently obscene levels of compensation, said he thought a global tax on financial transactions might help curb both.
Such a statement would have been unthinkable in the years before the sub-prime mortgage meltdown. Now, however, it is an indication of how much things have changed. ...
The idea has since become a cause-célèbre for a wide range of non-governmental organizations and advocacy groups that see in it the double virtue of cutting finance down to size and raising a big chunk of revenue for favored causes - foreign aid, vaccines, green technologies, you name it. It has also been endorsed by some French (predictably!) and other continental European leaders. But, until Turner mentioned the idea, you would not have been able to identify a single major policymaker from the United States of America or the United Kingdom ... with anything nice to say about it.
The beauty of a Tobin tax is that it would discourage short-term speculation without having much adverse effect on long-term international investment decisions. Consider, for example, a tax of 0.25 percent applied to all cross-border financial transactions. Such a tax would instantaneously kill the intra-day trading that takes place in pursuit of profit margins much smaller than this, as well as the longer-term trades designed to exploit minute differentials across markets.
Economic activity of this kind is of doubtful social value, yet it eats up real resources in terms of human talent, computing power, and debt. So we should not mourn the demise of such trading practices. Meanwhile, investors with longer time horizons going after significant returns would not be much deterred by the tax. So capital would still move in the right direction over the longer term. ...
Moreover, it is undeniable that such a tax would raise a great deal of money. Revenue estimates for a small tax on international currency transactions run into hundreds of billions of dollars per year. The receipts would be even greater if the base is extended, as was implied by Turner, to all global financial transactions. Whatever the precise amount, it is safe to say that the numbers in question are huge...
What the Tobin tax does not do is help with longer-term misalignments in financial markets. Such a tax would not have prevented the US-China trade imbalance. Neither would it have stopped the global saving glut from turning into a ticking time bomb for the world economy. It would not have protected European and other nations from becoming awash in toxic mortgage assets exported from the US. And it would not dissuade governments intent on pursuing unsustainable monetary and fiscal policies financed by external borrowing.
For all of these problems we will need other macroeconomic and financial remedies. But a Tobin tax is a good place to start if we want to send a strong message about the social value of the casino known as global finance.

More here.

links for 2009-09-14

"Financial Rescue and Reform"


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