A Behavioral new-Keynesian Model

Here are comments on Xavier Gabaix' "A Behavioral new-Keynesian model." Xavier presented at the October 21 NBER Economic Fluctuations and growth meeting, and I was the discussant. Slides here

Short summary: It's a really important paper. I think it's too important to be true.

Gabaix' irrationality fixes the pathologies of the standard model by making a stable model unstable, and hence locally determinate. Gabaix' irrationality parameter M in [0,1] can thus substitute for the usual Taylor principle that interest rates move more than one for one with inflation.

Levinson on growth

I disagree rather profoundly with crucial parts of Marc Levison's essay "Why the Economy Doesn't Roar Anymore" in the Saturday Wall Street Journal.

Yes, growth is slow. Yes, the ultimate source of growth is productivity. But no, sclerotic productivity is not "just being ordinary." No, our economy is not generating as much productivity growth as is possible, so just get used to it. No, productivity does not fall randomly from the sky no matter what politicians do.

Mark starts well, with a nice and vivid review of the post WWII growth "miracles."

He stumbles a bit at the 1973 Yom Kippur war and oil embargo

"Politicians everywhere responded by putting energy high on their agendas. In the U.S., the crusade for “energy independence” led to energy efficiency standards, the creation of the Strategic Petroleum Reserve, large government investments in solar power and nuclear fusion, and price deregulation. [JC: ?? The 1970s had price controls, not deregulation!] But it wasn’t the price of gasoline that brought the long run of global prosperity to an end. It just diverted attention from a more fundamental problem: Productivity growth had slowed sharply."

"The consequences of the productivity bust were severe.."

More good descriptions of eurosclerosis follow. But you see him veer off course, as  he sees little connection between the litany of ham-handed responses to the oil shock and the decline in productivity.

Five Books to Change Liberals' Minds

"Five Books to Change Liberals' Minds" is the title of a remarkable post by Cass Sunstein.

It can be easy and tempting, especially during a presidential campaign, to listen only to opinions that mirror and fortify one's own. That’s not ideal, because it eliminates learning and makes it impossible for people to understand what they dismiss as “the other side.”

If you think that Barack Obama has been a terrific president (as I do) and that Hillary Clinton would be an excellent successor (as I also do), then you might want to consider the following books, to help you to understand why so many of your fellow citizens disagree with you:

“Seeing Like A State: How Certain Schemes to Improve the Human Conditions Have Failed,” by James Scott.....

and  closes

Having read these books, you might continue to believe that progressives are more often right than wrong, and that in general, the U.S. would be better off in the hands of Democrats than Republicans. But you’ll have a much better understanding of the counterarguments -- and on an issue or two, and maybe more, you’ll probably end up joining those on what you once saw as “the other side.”

Most public intellectual commentary these days takes a tone of parochial demonization -- the hilarious "how Paul Krugman made Donald Trump possible" is good to ponder. When such people even consider views the other side, it's  bulveristic speculation -- did bad childhoods make them evil, or are they bought? The next sentence usually bemoans polarization. This piece by Sunstein is a breath of fresh air.

Those who listen buy themselves an ear.  I usually find I disagree with Sunstein about most things (though his attempt to rein in regulation from inside the Administration is both praiseworthy and instructive in its failure). But knowing that his opinions come from such consideration, they carry more weight. It's more effective than upping low Krugmanian insult to high Bergeracian disdain.

I'm sure many of my blog readers could suggest additional books for Mr. Sunstein -- Friedman, Sowell, Murray, and so on. That's not the point. When grandma sends you books about how to clean your room, you never read them. If you want to send suggestions, send good liberal and progressive books that lovers of freedom should read.

Volume and Information

This is a little essay on the puzzle of volume, disguised as comments on a paper by Fernando Alvarez and Andy Atkeson, presented at the Becker-Friedman Institute Conference in Honor of Robert E. Lucas Jr. (The rest of the conference is really interesting too, but I likely will not have time to blog a summary.) 

Like many others, I have been very influenced by Bob, and I owe him a lot personally as well. Bob pretty much handed me the basic idea for a "Random walk in GNP" on a silver platter. Bob's review of a report to the OECD, which he might rather forget, inspired the Grumpy Economist many years later. Bob is a straight-arrow icon for how academics should conduct themselves. 

On Volume:  (also pdf here) 

Volume and Information. Comments on “Random Risk Aversion and Liquidity: a Model of Asset Pricing and Trade Volumes” by Fernando Alvarez and Andy Atkeson 

John H. Cochrane

October 7 2016 

This is a great economics paper in the Bob Lucas tradition: Preferences, technology, equilibrium, predictions, facts, welfare calculations, full stop.

However, it’s not yet a great finance paper. It’s missing the motivation, vision, methodological speculation, calls for future research — in short, all the BS — that Bob tells you to leave out. I’ll follow my comparative advantage, then, to help to fill this yawning gap.

Volume is The Great Unsolved Problem of Financial Economics. In our canonical models — such as Bob’s classic consumption-based model — trading volume is essentially zero.

The reason is beautifully set out in Nancy Stokey and Paul Milgrom’s no-trade theorem, which I call the Groucho Marx theorem: don’t belong to any club that will have you as a member. If someone offers to sell you something, he knows something you don’t.

More deeply, all trading — any deviation of portfolios from the value-weighted market index — is zero sum. Informed traders do not make money from us passive investors, they make money from other traders.

It is not a puzzle that informed traders trade and make money. The deep puzzle is why the uninformed trade, when they could do better by indexing.

A first step to progressive consumption taxes

What's an easy way to get going on progressive income taxes? Simply remove all limits on contributions to and withdrawals from IRAs. (I thank my Hoover colleague Michael Bernstam for this clever idea, and the Hoover coffee room for bumping us into each other.)

Background: Once people see that a consumption tax, in place of income tax, corporate tax, estate tax, etc. is much simpler and more economically efficient, the natural question is "what about progressivity?" The answer is that there are lots of ways to make a consumption tax progressive.

Trump Taxes

As I see it, important points about the Trump tax affair are not yet reflected in media coverage. 1) This affair reflects the intrinsic difficulties of an income tax. A consumption tax can be more progressive -- Mr. Trump would have likely have paid a lot more. 2) Raising personal income tax rates and especially capital gains and estate tax rates will do little to raise tax payments from the likes of Mr. Trump. No taxable income = no tax at any rate. It will likely have the opposite effect, making more lawyer, accountant, and lobbyist time worthwhile.

The main issue, really, is not what taxes Mr. Trump did or did not pay after the big loss. The big issue is what taxes he did or did not pay beforehand.