Monday, February 17, 2014

In Box

It is a delight of being an economist how many fascinating papers come through the in box. It is a deep frustration that I don't have the time to read them all.  Here are a few on my in-box today, courtesy of NBER, SSRN, and AEA email lists. Disclaimer: I've only read the abstracts so far. (If you can't get NBER working papers, Google usually finds ungated versions on authors' webpage or ssrn.)

1. The Demise of U.S. Economic Growth: Restatement, Rebuttal, and Reflections by Robert J. Gordon.

The United States achieved a 2.0 percent average annual growth rate of real GDP per capita between 1891 and 2007. This paper predicts that growth in the 25 to 40 years after 2007 will be much slower, particularly for the great majority of the population. Future growth will be 1.3 percent per annum for labor productivity in the total economy, 0.9 percent for output per capita, 0.4 percent for real income per capita of the bottom 99 percent of the income distribution, and 0.2 percent for the real disposable income of that group.

The primary cause of this growth slowdown is a set of four headwinds, all of them widely recognized and uncontroversial. Demographic shifts will reduce hours worked per capita, due not just to the retirement of the baby boom generation but also as a result of an exit from the labor force both of youth and prime-age adults. Educational attainment, a central driver of growth over the past century, stagnates at a plateau as the U.S. sinks lower in the world league tables of high school and college completion rates. Inequality continues to increase, resulting in real income growth for the bottom 99 percent of the income distribution that is fully half a point per year below the average growth of all incomes. A projected long-term increase in the ratio of debt to GDP at all levels of government will inevitably lead to more rapid growth in tax revenues and/or slower growth in transfer payments at some point within the next several decades.

There is no need to forecast any slowdown in the pace of future innovation for this gloomy forecast to come true, because that slowdown already occurred four decades ago. In the eight decades before 1972 labor productivity grew at an average rate 0.8 percent per year faster than in the four decades since 1972. While no forecast of a future slowdown of innovation is needed, skepticism is offered here, particularly about the techno-optimists who currently believe that we are at a point of inflection leading to faster technological change. The paper offers several historical examples showing that the future of technology can be forecast 50 or even 100 years in advance and assesses widely discussed innovations anticipated to occur over the next few decades, including medical research, small robots, 3-D printing, big data, driverless vehicles, and oil-gas fracking.
Ouch, I hope he's wrong. "Exit from the labor force both of youth and prime-age adults" sounds like a self-inflicted wound, as does "educational attainment,... the U.S. sinks lower in the world league..''

I'm still a techno-optimist. In my mind, Gutenberg sparked the scientific revolution. Knowledge is costly, and if you cannot communicate it there is no reason to get it. Communication costs just dropped to essentially zero. Hold on to your hats, unless self-inflicted wounds kill the golden goose.

2. An Optimizing Neuroeconomic Model of Discrete Choice by Michael Woodford
A model is proposed in which stochastic choice results from noise in cognitive processing rather than random variation in preferences. The mental process used to make a choice is nonetheless optimal, subject to a constraint on available information-processing capacity that is partially motivated by neurophysiological evidence. The optimal information-constrained model is found to offer a better fit to experimental data on choice frequencies and reaction times than either a purely mechanical process model of choice (the drift-diffusion model) or an optimizing model with fewer constraints on feasible choice processes (the rational inattention model).
Wow. It has long struck me that what is sometimes called "irrationality" or "psychology" is just a good set of rules of thumb for dealing with an information-rich environment. And that our standard model of information -- here is a pack of cards, we both know you picked one, I don't know which one you picked -- is just not up to the task. But I'm not a good enough mathematician or theorist to write down a useful model of information overload. I can't wait to see what Mike, a master theorist,  has come up with here.

3. High Discounts and High Unemployment by Robert E. Hall
In recessions, the stock market falls more than in proportion to corporate profi t. The discount rate implicit in the stock market rises. All types of investment fall, including employers' investment in job creation. According to the leading view of unemployment -- the Diamond-Mortensen-Pissarides model -- when the incentive for job creation falls, the labor market slackens and unemployment rises. Employers recover their investments in job creation by collecting a share of the surplus from the employment relationship. The value of that flow falls when the discount rate rises. Thus high discount rates imply high unemployment. This paper does not explain why the discount rate rises so much in recessions. Rather, it shows that the rise in unemployment makes perfect economic sense in an economy where the stock market falls substantially in recessions because the discount rises.
Well, I think I have a good model of why discount rates rise in recessions -- "By force of habit." For some time now, it's been on my back burner to unite that mechanism, or similar mechanisms from asset pricing that deliver high risk premiums in recessions, with a production side in order to generate a full business cycle model. That model will be driven by risk premiums, not by the riskless interest rate, a fundamental change in macroeconomics. It seems like Bob has a good part of that worked out!

4. Gorton, Gary, and Guillermo OrdoƱez. 2014. "Collateral Crises." American Economic Review, 104(2): 343-78.
Short-term collateralized debt, private money, is efficient if agents are willing to lend without producing costly information about the collateral backing the debt. When the economy relies on such informationally insensitive debt, firms with low quality collateral can borrow, generating a credit boom and an increase in output. Financial fragility is endogenous; it builds up over time as information about counterparties decays. A crisis occurs when a (possibly small) shock causes agents to suddenly have incentives to produce information, leading to a decline in output. A social planner would produce more information than private agents but would not always want to eliminate fragility.
I have been a big fan of Gary's view, with various coauthors, that we suffered a "systemic run" when previously "informationally insensitive" securities -- nobody pays much attention to annual reports when entering a repo contract -- suddenly become "informationally sensitive," hence subject to asymmetric information-induced illiquidity. I can't wait to read through the detailed published version.

It's snowing hard in Chicago, and it would be great to curl up by a fire place, read these papers and write detailed blog posts on each one. Alas,  it's time to get back to my day job.


  1. Wow, a good day for reading papers. All of those sound fascinating.

  2. Reading papers is your day job! Maybe even blogging :) I've also been a big fan of Gorton's view, especially his explanation of the similarities of the recent financial crisis to bank runs of the 19th century. I'd love to have you write on this further perhaps discussing some of Gorton's suggestions to avoid another crisis.

  3. I figure if we get strong enough growth, that will start drawing some people who have dropped out of the labor force back into it - and technology will help to make them productive. Technology has usually helped to make relatively low-skilled workers more productive through the past 250 years.

    1. "Technology has usually helped to make relatively low-skilled workers more productive"

      Sure but the process has tended to be fairly brutal in the short term - witness the forces that moved most of our ancestors from farming to urban life, that was at least as much push as pull.

  4. I just finished reading Gorton's "Slapped by the Invisible Hand" today, which was very good. I printed off the above paper to read next. (along with the Hall one)

  5. Please keep making posts like these John. They're very useful for students.

  6. I'm confused by the informationally insensitive argument in paper 4, if I'm thinking about tranched CMOs, etc.

    Are they saying the different levels of tranches don't matter ? as in people before the shock are buying them without looking at the tranches, or possibly buying "bad" securities as complimentary goods to the better tranches they do care about?

    seems like the finance industry could save a lot of time and money by not working out those numbers in that case. even if all they currently do is verify the rating agency numbers.

    1. They are saying they are informationally insensitive from a repo / collateral perspective. In a repo contract I lend to Lehman and accept collateral in case they can't pay me back. As long as I know Lehman is solvent and will pay me back, I don't care much about the collateral they give me (which I only receive if they default). As soon as I start worrying that Lehman may be insolvent, I realize there's a chance they may default and I will have to take the collateral instead of being paid back. Then I have an incentive to learn about the collateral or "produce information" about it. The collateral is now "informationally sensitive" and so is the repo. Repo goes from being basically money to being risky.

    2. More importantly, you have no need to worry about Lehman's profits as long as they are solid enough to be away from bankruptcy. Lehman debt is "information insensitive" far from bankruptcy. That's the point of debt, really. But as it gets closer to bankruptcy, the value of Lehman debt depends more on its fortunes, so lending requires lots more information.

    3. If Lehman's paper is being purchased by wealthy investors, pension funds or charitable endowments then failure by Lehman will not bring down the system. If instead, Lehman's paper is being purchased by other "banks" who in turn borrow on the strength of that paper then we have a systemically fragile system prone to collapse at any moment. Constructing fragile, failure prone, interbank lending arrangements is a deliberate choice made by the bankers and lawyers involved - it is an example of the "picking up nickels in front of a steam roller" dynamic.

    4. Absalon,

      It is an example of the perfect crime. Joe, Nick, Amy, and George are all questioned in regards to a homicide. The murder weapon is found and a set of prints from all four are found on the weapon. Joe claims that Nick pulled the trigger. Nick claims that Amy did it. Amy claims that George did it. And George claims that Joe did it.

    5. Frank - It is not a crime to build fragile failure prone interbank lending arrangements. It would be professional negligence for the lawyers to do so if they are not warning the client about the fragile nature of the agreement. If the effect of the agreements is hidden in the annual report or leads to misleading financial statements then there could be a crime. If the original agreement was drafted with the knowledge that it would be used to publish misleading financial statements then the lawyer could be guilt of a crime (And in your example of Joe, Nick, Amy and George it sounds like they might all be accomplices and the law might not care who actually pulled the trigger.)

  7. Dr. Cochrane,

    You have mentioned implementing a “systemic externality fee” in a previous post. The details are very complicated and interesting. I hope to see more of this in the future.


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