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April 14, 2015

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Secular Stagnation: The Long View

Posted: 14 Apr 2015 12:24 AM PDT

From the NBER Digest:

Secular Stagnation: The Long View, by Matt Nesvisky: Growth economists are divided on whether the U.S. is facing a period of "secular stagnation" - an extended period of slow economic growth in the coming decades. In "Secular Stagnation: The Long View" (NBER Working Paper No. 20836), Barry Eichengreen considers four factors that could contribute to a persistent period of below-potential output and slow growth: a rise in saving due to the global integration of emerging markets, a decline in the rate of population growth, an absence of attractive investment opportunities, and a drop in the relative price of investment goods. He concludes that a decline in the relative price of investment goods is the most likely contributor to an excess of saving over investment.

With regard to long-term future growth rates, a key point of debate is how to interpret, and project forward, the "Third Industrial Revolution": the computer age and the new economy it has created. Some argue that the economic impact of digital technology has largely run its course, while others maintain that we have yet to experience the full effect of computerization. In this context, Eichengreen looks at the economic consequences of the age of steam and of the age of electrification. His analysis identifies two dimensions of the economic impact: "range of applicability" and "range of adaptation."
Range of applicability refers to the number of sectors or activities to which the key innovations can be applied. Use of the steam engine of the first industrial revolution for many years was limited to the textile industry and railways, which accounted for only a relatively small fraction of economic activity. Electrification in the second industrial revolution, says Eichengreen, had a larger impact on output and productivity growth because it affected a host of manufacturing industries, many individual households, and a wide range of activities within decades of its development.
The "computer revolution" of the second half of the 20th century had a relatively limited impact on overall economic growth, Eichengreen writes, because computerization had deeply transformative effects on only a limited set of industries, including finance, wholesale and retail trade, and the production of computers themselves. This perspective suggests that the implications for output and productivity of the next wave of innovations will depend greatly on their range of applicability. Innovations such as new tools (quantum computers), materials (graphene), processes (genetic modification), robotics, and enhanced interactivity of digital devices all promise a broad range of applications.
Range of adaptation refers to how comprehensively economic activity must be reorganized before positive impacts on output and productivity occur. Eichengreen reasons that the greater the required range of adaptation, the higher the likelihood that growth may slow in the short run, as costly investments in adaptation must be made and existing technology must be disrupted.
Yet the slow productivity growth in the United States in recent years may have positive implications for the future, he writes. Many connected activities and sectors - health care, education, industrial research, and finance - are being disrupted by the latest technologies. But once a broad range of adaptations is complete, productivity growth should accelerate, he reasons. "This is not a prediction," Eichengreen concludes, "but a suggestion to look to the range of adaptation required in response to the current wave of innovations when seeking to interpret our slow rate of productivity growth and when pondering our future."

Links for 04-14-15

Posted: 14 Apr 2015 12:06 AM PDT

In Defense of Modern Macroeconomic Theory

Posted: 13 Apr 2015 07:13 AM PDT

A small part of a much longer post from David Andolfatto (followed by some comments of my own):

In defense of modern macro theory: The 2008 financial crisis was a traumatic event. Like all social trauma, it invoked a variety of emotional responses, including the natural (if unbecoming) human desire to find someone or something to blame. Some of the blame has been directed at segments of the economic profession. It is the nature of some of these criticisms that I'd like to talk about today. ...
The dynamic general equilibrium (DGE) approach is the dominant methodology in macro today. I think this is so because of its power to organize thinking in a logically consistent manner, its ability to generate reasonable conditional forecasts, as well as its great flexibility--a property that permits economists of all political persuasions to make use of the apparatus. ...

The point I want to make here is not that the DGE approach is the only way to go. I am not saying this at all. In fact, I personally believe in the coexistence of many different methodologies. The science of economics is not settled, after all. The point I am trying to make is that the DGE approach is not insensible (despite the claims of many critics who, I think, are sometimes driven by non-scientific concerns). ...

Once again (lest I be misunderstood, which I'm afraid seems unavoidable these days) I am not claiming that DGE is the be-all and end-all of macroeconomic theory. There is still a lot we do not know and I think it would be a good thing to draw on the insights offered by alternative approaches. I do not, however, buy into the accusation that there "too much math" in modern theory. Math is just a language. Most people do not understand this language and so they have a natural distrust of arguments written in it. .... Before criticizing, either learn the language or appeal to reliable translations...

As for the teaching of macroeconomics, if the crisis has led more professors to pay more attention to financial market frictions, then this is a welcome development. I also fall in the camp that stresses the desirability of teaching more economic history and placing greater emphasis on matching theory with data. ... Thus, one could reasonably expect a curriculum to be modified to include more history, history of thought, heterodox approaches, etc. But this is a far cry from calling for the abandonment of DGE theory. Do not blame the tools for how they were (or were not) used.

I've said a lot of what David says about modern macroeconomic models at one time or another in the past, for example it's not the tools of macroeconomics, it's how they are used. But I do think he leaves out one important factor, the need to ask the right question (and why we didn't prior to the crisis). This is from August, 2009:

In The Economist, Robert Lucas responds to recent criticism of macroeconomics ("In Defense of the Dismal Science"). Here's my entry at Free Exchange in response to his essay:

Lucas roundtable: Ask the right questions, by Mark Thoma: In his essay, Robert Lucas defends macroeconomics against the charge that it is "valueless, even harmful", and that the tools economists use are "spectacularly useless".

I agree that the analytical tools economists use are not the problem. We cannot fully understand how the economy works without employing models of some sort, and we cannot build coherent models without using analytic tools such as mathematics. Some of these tools are very complex, but there is nothing wrong with sophistication so long as sophistication itself does not become the main goal, and sophistication is not used as a barrier to entry into the theorist's club rather than an analytical device to understand the world.

But all the tools in the world are useless if we lack the imagination needed to build the right models. We ... have to ask the right questions before we can build the right models.

The problem wasn't the tools that macroeconomists use, it was the questions that we asked. The major debates in macroeconomics had nothing to do with the possibility of bubbles causing a financial system meltdown. That's not to say that there weren't models here and there that touched upon these questions, but the main focus of macroeconomic research was elsewhere. ...

The interesting question to me, then, is why we failed to ask the right questions. ...

Why did we, for the most part, fail to ask the right questions? Was it lack of imagination, was it the sociology within the profession, the concentration of power over what research gets highlighted, the inadequacy of the tools we brought to the problem, the fact that nobody will ever be able to predict these types of events, or something else?

It wasn't the tools, and it wasn't lack of imagination. As Brad DeLong points out, the voices were there—he points to Michael Mussa for one—but those voices were not heard. Nobody listened even though some people did see it coming. So I am more inclined to cite the sociology within the profession or the concentration of power as the main factors that caused us to dismiss these voices. ...

I don't know for sure the extent to which the ability of a small number of people in the field to control the academic discourse led to a concentration of power that stood in the way of alternative lines of investigation, or the extent to which the ideology that markets prices always tend to move toward their long-run equilibrium values caused us to ignore voices that foresaw the developing bubble and coming crisis. But something caused most of us to ask the wrong questions, and to dismiss the people who got it right, and I think one of our first orders of business is to understand how and why that happened.

Here's an interesting quote from Thomas Sargent along the same lines:

The criticism of real business cycle models and their close cousins, the so-called New Keynesian models, is misdirected and reflects a misunderstanding of the purpose for which those models were devised.6 These models were designed to describe aggregate economic fluctuations during normal times when markets can bring borrowers and lenders together in orderly ways, not during financial crises and market breakdowns.

Which to me is another way of saying we didn't foresee the need to ask questions (and build models) that would be useful in a financial crisis -- we were focused on models that would explain "normal times" (which is connected to the fact that we thought the Great Moderation would continue due to arrogance on behalf of economists leading to the belief that modern policy tools, particularly from the Fed, would prevent major meltdowns, financial or otherwise). That is happening now, so we'll be much more prepared if history repeats itself, but I have to wonder what other questions we should be asking, but aren't.

Let me add one more thing (a few excerpts from a post in 2010) about the sociology within economics:

I want to follow up on the post highlighting attempts to attack the messengers -- attempts to discredit Brad DeLong and Paul Krugman on macroeconomic policy in particular -- rather than engage academically with the message they are delivering (Krugman's response). ...
One of the objections often raised is that Krugman and DeLong are not, strictly speaking, macroeconomists. But if Krugman, DeLong, and others are expressing the theoretical and empirical results concerning macroeconomic policy accurately, does it really matter if we can strictly classify them as macroeconomists? Why is that important except as an attempt to discredit the message they are delivering? ... Attacking people rather than discussing ideas avoids even engaging on the issues. And when it comes to the ideas -- here I am talking most about fiscal policy -- as I've already noted in the previous post, the types of policies Krugman, DeLong, and others have advocated (and I should include myself as well) can be fully supported using modern macroeconomic models. ...
So, in answer to those who objected to my defending modern macro, you are partly right. I do think the tools and techniques macroeconomists use have value, and that the standard macro model in use today represents progress. But I also think the standard macro model used for policy analysis, the New Keynesian model, is unsatisfactory in many ways and I'm not sure it can be fixed. Maybe it can, but that's not at all clear to me. In any case, in my opinion the people who have strong, knee-jerk reactions whenever someone challenges the standard model in use today are the ones standing in the way of progress. It's fine to respond academically, a contest between the old and the new is exactly what we need to have, but the debate needs to be over ideas rather than an attack on the people issuing the challenges.

'The Mythic Quest for Early Warnings'

Posted: 13 Apr 2015 06:30 AM PDT

Cecchetti & Schoenholtz:

The mythic quest for early warnings: Economists and policymakers are on a quest. They are looking for the elixir that will protect their economies from financial crises. Their strategy is to find an indicator that provides an early warning of collapse, and then respond with preventative measures.
We think the approach of waiting for warnings is seriously flawed. The necessary information may never be in our grasp. And even if it were, our ability to respond rapidly and effectively is far from clear. Rather than treating the symptoms of illness after they start to develop, we believe the better strategy is early immunization: the more resilient the financial system, the less reliance we will have on faulty or nonexistent warnings.
To back up a bit, there are now an abundance of indices designed to measure financial system stress. ... [reviews work on scores of indicators] These findings are compelling. They tell us that forecasting systemic stress is extremely difficult and that ordinary financial market indicators efficiently summarize what information there is. ...
We do not mean to strike too harsh a tone. Having accurate measures of where we stand is extremely useful. ...
Will researchers eventually develop measures that tell us not just where we stand, but where we are going? Is the quest for early warning indicators destined to succeed? It's possible that with more detailed data on what is going on in both financial institutions and financial markets that we will be able to anticipate big risks on the horizon. We hope so, but shouldn't plan on it: there are important grounds for skepticism. ...
Where does this leave us?  Our answer is that we have yet another reason to be skeptical of time-varying, discretionary regulatory policy. In an earlier post, we noted that the combination of high information requirements, long transmission lags and significant political resistance made it unlikely time-varying capital requirements will be effective in reducing financial vulnerabilities. Our conclusion then, which we reiterate now, is that the solution is to build a financial system that is safe and resilient all of the time, since we really never know what is coming. That means a regulatory system based on economic function, not legal form, with sufficient capital buffers to guard against all but the very worst possibilities.
In the end, a financial system that relies on an early warning indicator of imminent financial collapse seems destined to fail.

I don't think we should stop trying to find indicators that would be useful to regulators (and neither do they), just because we haven't found them yet doesn't mean no such indicators exist -- they may. But I fully agree that regulation should be based upon the state of the art, and presently we haven't found reliable indicators of forthcoming problems in financial markets.

Paul Krugman: It Takes a Party

Posted: 13 Apr 2015 05:37 AM PDT

In the upcoming presidential elections, political parties matter more than the particular candidates:

It Takes a Party, by Paul Krugman, Commentary, NY Times: So Hillary Clinton is officially running, to nobody's surprise. And you know what's coming: endless attempts to psychoanalyze the candidate,... endless thumb-sucking about her "positioning" on this or that issue.
Please pay no attention..., there has never been a time ... when the alleged personal traits of candidates mattered less. As we head into 2016, each party is quite unified on major policy issues — and these unified positions are very far from each other. ...
For example, any Democrat would, if elected, seek to maintain the basic U.S. social insurance programs — Social Security, Medicare, and Medicaid..., while also preserving and extending the Affordable Care Act. Any Republican would seek to destroy Obamacare, make deep cuts in Medicaid, and probably try to convert Medicare into a voucher system.
Any Democrat would retain the tax hikes on high-income Americans..., and possibly seek more. Any Republican would try to cut taxes on the wealthy ... while slashing programs that aid low-income families.
Any Democrat would try to preserve the 2010 financial reform... Any Republican would seek to roll it back...
And any Democrat would try to move forward on climate policy, through executive action if necessary, while any Republican ... would block efforts to limit greenhouse gas emissions.
How did the parties get this far apart? Political scientists suggest that it has a lot to do with income inequality. As the wealthy grow richer..., their policy preferences have moved to the right — and they have pulled the Republican Party ever further in their direction. Meanwhile, the influence of big money on Democrats has at least eroded a bit, now that Wall Street, furious over regulations and modest tax hikes, has deserted the party en masse. The result is a level of political polarization not seen since the Civil War. ...
As you can probably tell, I'm dreading the next 18 months, which will be full of sound bites and fury, signifying nothing. O.K., I guess we might learn a few things — Where will Ms. Clinton come out on ... the Trans-Pacific Partnership? ... — but the differences between the parties are so clear and dramatic that it's hard to see how anyone who has been paying attention could be undecided even now, or be induced to change his or her mind between now and the election.
One thing is for sure: American voters will be getting a real choice. May the best party win.

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