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August 20, 2014

Latest Posts from Economist's View

Latest Posts from Economist's View


'What Does the Fed Have to do with Social Security? Plenty'

Posted: 20 Aug 2014 04:46 AM PDT

Dean Baker:

What does the Fed have to do with Social Security? Plenty: Most of the people who closely follow the Federal Reserve Board's decisions on monetary policy are investors trying to get a jump on any moves that will affect financial markets. Very few of the people involved in the debate over the future of Social Security pay much attention to the Fed. That's unfortunate because the connections are much more direct than is generally recognized. ...

Have Blog, Will Travel

Posted: 20 Aug 2014 04:23 AM PDT

I am here today:

5th Lindau Meeting on Economic Sciences
19-23 August 2014, Lindau, Germany
Lindau Meeting of the Laureates of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel
The 5th Lindau Meeting on Economic Sciences will provide an open exchange of economic expertise and inspire cross-cultural and inter-generational encounters among economists from all over the world. From 19 to 23 August, the participating 18 Nobel Laureates and 460 young scientists will have plenty of opportunity for an intensive exchange of ideas.
The meeting will open on 20 August with a keynote address by the German Chancellor Angela Merkel, and will also feature "a panoramic view on the situation and prospects in Latin America" by Mario Vargas Llosa, the 2010 Nobel Laureate in Literature. The scientific programme will address central fields of the discipline, ranging from econometrics, game theory, and neo-classical growth theory to mechanism design and systemic risk measurement. The overarching question "How useful is economics – how is economics useful?" will also be subject of the meeting's closing panel debate on Mainau Island on Saturday, 23 August.
Programme
The scientific programme of the 5th Lindau Meeting on Economic Sciences will comprise lectures and panel discussions (accessible for all registered meeting participants and guests), as well as discussion sessions and master classes (both accessible only for participating Nobel Laureates and young scientists).
A detailed version of the programme including all lecture titles of the participating laureates with links to their abstracts is available in the Lindau Mediatheque. Please find a PDF version of the printed programme here. To get an overview of the meeting schedule you can also download the programme structure.
Participating Laureates
18 Laureates will attend the 5th Lindau Meeting on Economic Sciences. Among 17 economists there will also be Mario Vargas Llosa, Nobel Laureate in Literature in 2010, participating in the meeting. Please find further information on the Laureates' profiles including their CVs in the Lindau Mediatheque.
Robert Aumann
Peter DiamondLars Peter Hansen
Finn Kydland
Eric Maskin
Daniel McFadden
Robert C. Merton
James Mirrlees
Roger Myerson
Edmund Phelps
Edward Prescott
Alvin Roth 
Reinhard Selten
William Sharpe
Christopher Sims
Vernon Smith
Joseph Stiglitz
Mario Vargas Llosa

Today's Program:

Wednesday, 20 August
8.30 Plenary Lecture Inselhalle Lars Peter Hansen Uncertainty and Valuation
 09.00 Plenary Lecture Inselhalle Alvin E. Roth Repugnant Markets and Prohibited Transactions
09.30 Plenary Lecture Inselhalle Edmund S. Phelps Bringing Dynamism, Homegrown Innovation and Human Flourishing into Economics
10.00 Coffee Break
10.30 Plenary Lecture Inselhalle Christopher A. Sims Inflation, Fear of Inflation, and Public Debt
11.00 Plenary Lecture Inselhalle Vernon L. Smith Rethinking Market Experiments in the Shadow of Recessions: The Good and the Sometimes Ugly; Propositions on Recessions
14.00 Opening Ceremony Inselhalle Opening Ceremony
Angela Merkel Chancellor of the Federal Republic of Germany Master of Ceremony
16.00 Discussion Lars Peter Hansen Discussion with young scientists
16.00 Discussion Edmund S. Phelps Discussion with young scientists
16.00 Alvin E. Roth Discussion with young scientists
16.00 Discussion Christopher A. Sims Discussion with young scientists
 16.00 Discussion Vernon L. Smith Discussion with young scientists
17.30 Break
20.00 Social Function Inselhalle Get-Together

Links for 8-20-14

Posted: 20 Aug 2014 03:33 AM PDT

'Very Confused About Cyclical Recovery'

Posted: 19 Aug 2014 01:42 PM PDT

Brad DeLong tries to make sense of the labor market:

Over at Equitable Growth: In Which I Make Myself Very Confused About Cyclical Recovery: Will somebody please tell me that I have made a gross arithmetic error in what is below, and can be much more optimistic? ...
I really do not understand the triumphalism of the very sharp Steve Braun et al. from the CEA...
So the labor market is, they say, 5/6 of the way back to normal--the current unemployment rate of 6.2% is 3.8%-points down from the peak of 10.0%, and has only 0.8%-point left to go before it hits a pre-crisis NAIRU of 5.4%. When it does, we will attain a "cyclically normal" labor market with a participation rate at 63.4%, 0.5%-points higher than today's 62.9%, and an associated employment-to-population ratio of 60.0%.
By that metric, we have done 3/4 of the work of cyclical recovery: from a 5.5%-point gap between employment and participation at the trough to a 3.9%-point gap now and a 3.4%-point gap at NAIRU. We will have made 1.7%-points back from the trough on the employment-to-population ratio when cyclical recovery is complete. The permanent damage to employment from the Great Recession Lesser Depression appears to be less than 0.9%-points of participation because there are also ongoing "cohort effects unrelated to aging" that reduce participation.
Let me stress that this is not senior and not-so-senior White House officials under pressure from political operatives putting as positive a spin on things as they can without actually losing their... No: what I mean to say is this: this is what the CEA's Steven Braun, John Coglianese, Jason Furman, Betsey Stevenson, and Jim Stock actually believe is true about the world--that the labor market is recovering successfully and strongly from the disaster of 2008-9.
But I look at 25-54. The employment rate is down from 79.9% in 2007 to 76.6% in July 2014--3.3%-points less, compared to 4.0%-point a fall from 63% to 59% over the entire population. The participation rate is down from 80.8% in July 2014 compared to 83.1% for 2007--2.3%-points, compared to the 3.1%-point fall from 66.0% to 62.9% over the entire population.
A normal NAIRU spread would put the 25-54 employment-to-population ratio at 78.7%, 2.5%-points below the 81.2% cyclically-adjusted 25-54 participation ratio. When cyclical recovery is complete, we would then expect to make back 3.7%-points back from the trough on the 25-54 employment-to-population ratio. So far we have made back only 1.0%-point.
So which is it? Has hysteresis done 1.8%-points of damage to 25-54 employment or 0.9%-points to total employment? Have we done 3/4 of the work of recovery relative to the proper labor force-trend share benchmark? Or have we done only 1/3 of the work of recovery?
The 25-54 data and the economy-wide aging trend-adjusted data used by the CEA appear to be telling us very different things both about the cyclical state of the labor market and about the damage done by hysteresis. How to reconcile? Which is right?

'Irrational Exuberance Meets Secular Stagnation'

Posted: 19 Aug 2014 01:42 PM PDT

Antonio Fatás:

Irrational exuberance meets secular stagnation: Robert Shiller warns us in the New York Times about the potential risks of high stock market valuations in the US. According to Shiller "the United States stock market looks very expensive right now". Brad DeLong and Dean Baker disagree with Shiller and argue that stock prices might look higher than historical averages but this could be ok given other changes in the economic environment. ... But there are ... reasons why the historical average might not be relevant...

The Agent-Based Method

Posted: 19 Aug 2014 06:26 AM PDT

Rajiv Sethi:

The Agent-Based Method: It's nice to see some attention being paid to agent-based computational models on economics blogs, but Chris House has managed to misrepresent the methodology so completely that his post is likely to do more harm than good. 

In comparing the agent-based method to the more standard dynamic stochastic general equilibrium (DSGE) approach, House begins as follows:

Probably the most important distinguishing feature is that, in an ABM, the interactions are governed by rules of behavior that the modeler simply encodes directly into the system individuals who populate the environment.

So far so good, although I would not have used the qualifier "simply", since encoded rules can be highly complex. For instance, an ABM that seeks to describe the trading process in an asset market may have multiple participant types (liquidity, information, and high-frequency traders for instance) and some of these may be using extremely sophisticated strategies.

How does this approach compare with DSGE models? House argues that the key difference lies in assumptions about rationality and self-interest:

People who write down DSGE models don't do that. Instead, they make assumptions on what people want. They also place assumptions on the constraints people face. Based on the combination of goals and constraints, the behavior is derived. The reason that economists set up their theories this way – by making assumptions about goals and then drawing conclusions about behavior – is that they are following in the central tradition of all of economics, namely that allocations and decisions and choices are guided by self-interest. This goes all the way back to Adam Smith and it's the organizing philosophy of all economics. Decisions and actions in such an environment are all made with an eye towards achieving some goal or some objective. For consumers this is typically utility maximization – a purely subjective assessment of well-being.  For firms, the objective is typically profit maximization. This is exactly where rationality enters into economics. Rationality means that the "agents" that inhabit an economic system make choices based on their own preferences.

This, to say the least, is grossly misleading. The rules encoded in an ABM could easily specify what individuals want and then proceed from there. For instance, we could start from the premise that our high-frequency traders want to maximize profits. They can only do this by submitting orders of various types, the consequences of which will depend on the orders placed by others. Each agent can have a highly sophisticated strategy that maps historical data, including the current order book, into new orders. The strategy can be sensitive to beliefs about the stream of income that will be derived from ownership of the asset over a given horizon, and may also be sensitive to beliefs about the strategies in use by others. Agents can be as sophisticated and forward-looking in their pursuit of self-interest in an ABM as you care to make them; they can even be set up to make choices based on solutions to dynamic programming problems, provided that these are based on private beliefs about the future that change endogenously over time. 

What you cannot have in an ABM is the assumption that, from the outset, individual plans are mutually consistent. That is, you cannot simply assume that the economy is tracing out an equilibrium path. The agent-based approach is at heart a model of disequilibrium dynamics, in which the mutual consistency of plans, if it arises at all, has to do so endogenously through a clearly specified adjustment process. This is the key difference between the ABM and DSGE approaches, and it's right there in the acronym of the latter.

A typical (though not universal) feature of agent-based models is an evolutionary process, that allows successful strategies to proliferate over time at the expense of less successful ones. Since success itself is frequency dependent---the payoffs to a strategy depend on the prevailing distribution of strategies in the population---we have strong feedback between behavior and environment. Returning to the example of trading, an arbitrage-based strategy may be highly profitable when rare but much less so when prevalent. This rich feedback between environment and behavior, with the distribution of strategies determining the environment faced by each, and the payoffs to each strategy determining changes in their composition, is a fundamental feature of agent-based models. In failing to understand this, House makes claims that are close to being the opposite of the truth: 

Ironically, eliminating rational behavior also eliminates an important source of feedback – namely the feedback from the environment to behavior.  This type of two-way feedback is prevalent in economics and it's why equilibria of economic models are often the solutions to fixed-point mappings. Agents make choices based on the features of the economy.  The features of the economy in turn depend on the choices of the agents. This gives us a circularity which needs to be resolved in standard models. This circularity is cut in the ABMs however since the choice functions do not depend on the environment. This is somewhat ironic since many of the critics of economics stress such feedback loops as important mechanisms.

It is absolutely true that dynamics in agent-based models do not require the computation of fixed points, but this is a strength rather than a weakness, and has nothing to do with the absence of feedback effects. These effects arise dynamically in calendar time, not through some mystical process by which coordination is instantaneously achieved and continuously maintained. 

It's worth thinking about how the learning literature in macroeconomics, dating back to Marcet and Sargent and substantially advanced by Evans and Honkapohja fits into this schema. Such learning models drop the assumption that beliefs continuously satisfy mutual consistency, and therefore take a small step towards the ABM approach. But it really is a small step, since a great deal of coordination continues to be assumed. For instance, in the canonical learning model, there is a parameter about which learning occurs, and the system is self-referential in that beliefs about the parameter determine its realized value. This allows for the possibility that individuals may hold incorrect beliefs, but limits quite severely---and more importantly, exogenously---the structure of such errors. This is done for understandable reasons of tractability, and allows for analytical solutions and convergence results to be obtained. But there is way too much coordination in beliefs across individuals assumed for this to be considered part of the ABM family.

The title of House's post asks (in response to an earlier piece by Mark Buchanan) whether agent-based models really are the future of the discipline. I have argued previously that they are enormously promising, but face one major methodological obstacle that needs to be overcome. This is the problem of quality control: unlike papers in empirical fields (where causal identification is paramount) or in theory (where robustness is key) there is no set of criteria, widely agreed upon, that can allow a referee to determine whether a given set of simulation results provides a deep and generalizable insight into the workings of the economy. One of the most celebrated agent-based models in economics---the Schelling segregation model---is also among the very earliest. Effective and acclaimed recent exemplars are in short supply, though there is certainly research effort at the highest levels pointed in this direction. The claim that such models can displace the equilibrium approach entirely is much too grandiose, but they should be able to find ample space alongside more orthodox approaches in time. 

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The example of interacting trading strategies in this post wasn't pulled out of thin air; market ecology has been a recurrent theme on this blog. In ongoing work with Yeon-Koo Che and Jinwoo Kim, I am exploring the interaction of trading strategies in asset markets, with the goal of addressing some questions about the impact on volatility and welfare of high-frequency trading. We have found the agent-based approach very useful in thinking about these questions, and I'll present some preliminary results at a session on the methodology at the Rethinking Economics conference in New York next month. The event is free and open to the public but seating is limited and registration required. 

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