Homo economicus or homo paleas?

Or at least that's how Google translate renders "straw man."

Dick Thaler is in the news, with a long review of his book in the Wall Street Journal  and a thoughtful opinion piece in the New York Times, earning plaudits from Greg Mankiw no less.

The pieces are nice reference points to think about just where psychological economics is. (That's a better adjective than "behavioral" since we are all students of behavior.)

Bottom line: People do a lot of nutty things. But when you raise the price of tomatoes, they buy fewer tomatoes, just as if utility maximizers had walked into the grocery store.

Homo paleas

Dick spends the first half of his precious space in the New York Times and much of the WSJ review complaining about homo economicus, the dispassionate rational maximizer of economic theory.

Unit roots in English and Pictures

After my unit roots redux post, a few people have asked for a nontechnical explanation of what this is all about.

Suppose there is an unexpected movement in any of the data we look at -- inflation, unemployment, GDP, prices, etc.  Now, how does this "shock" affect our best estimate of where this variable will be in the future? The graph shows three possibilities.

Bachmann, Berg and Sims on inflation as stimulus

Rüdiger Bachmann, Tim Berg, and Eric Sims have an interesting article, "Inflation Expectations and Readiness to Spend: Cross-Sectional Evidence" in the American Economic Journal: Economic Policy.

Many macroeconomists have advocated deliberate, expected inflation to "stimulate" the economy while interest rates are stuck at the lower bound. The idea is that higher expected inflation amounts to a lower real interest rate. This lower rate encourages people to spend today rather than to save, which, the story goes, will raise today's level of output and employment.

As usual in macroeconomics, measuring this effect is hard. There are few zero-bound observations, fewer still with substantial variation in expected inflation.  And as always in macro it's hard to tell causation from correlation, supply from demand, because from despite of any small inflation-output correlation we see.

This paper is an interesting part of the movement that uses microeconomic observations to illuminate such macroeconomic questions, and also a very interesting use of survey data. Bachman, Berg, and Sims look at survey data from the University of Michigan. This survey asks about spending plans and inflation expectations. Thus, looking across people at a given moment in time, Bachman, Berg, and Sims ask whether people who think there is going to be a lot more inflation are also people who are planning to spend a lot more. (Whether more "spending" causes more GDP is separate question.)

The answer is... No. Not at all. There is just no correlation between people's expectations of inflation and their plans to spend money.

In a sense that's not too surprising. The intertemporal substitution relation -- expected consumption growth = elasticity times expected real interest rate -- has been very unreliable in macro and micro data for decades. That hasn't stopped it from being the center of much macroeconomics and the article of faith in policy prescriptions for stimulus. But fresh reminders of its instability are welcome.

At first blush, this just seems great. Finally, micro data are illuminating macro questions.

Unemployment insurance and unemployment

"The Impact of Unemployment Benefit Extensions on Employment: The 2014 Employment Miracle" by Marcus Hagedorn, Iourii Manovskii and Kurt Mitman is making waves. NBER working paper here. Kurt Mitman's webpage has an ungated version of the paper, and a summary of some of the controversy. It's part of a pair, with "Unemployment Benefits and Unemployment in the Great
Recession: The Role of Macro Effects" also including Fatih Karahan.

A critical review by Mike Konczal at the Roosevelt Institute blog, and a more positive review by Patrick Brennan at National Review Online are both interesting. Both are thoughtful reviews that get at facts and methods. Maybe the tone of the economics blogoshpere is improving too. Bob Hall's comments and response on the earlier paper are also worth reading. This is a bit deja-vu from the observation that North Carolina experienced a large drop in unemployment when it cut benefits. My post here, WSJ coverage, and I think there are some papers which google isn't finding fast enough at the moment.

The basic issue: I think it's widely accepted, if sometimes grudgingly, that unemployment insurance increases unemployment. If you pay for anything, you get more of it. People with unemployment insurance can hold out for better jobs, put off moving or other painful adjustments, and so on. The earlier paper points out that there are important general equilibrium effects as well. We should talk about how UI affects labor markets, not just job search.

Quick disclaimer. Let's not jump to "good" and "bad."  Searching too hard and taking awful jobs in the middle of a depression might not be optimal. Pareto-optimal risk sharing with moral hazard looks a lot like unemployment insurance.  Perhaps that disclaimer can settle down the tone of the debate.

But the question remains. How much?  How much does unemployment insurance increase unemployment? And the related macro question, just why did unemployment in the US suddenly drop coincident with sequester and the end of 99 week unemployment benefits?

Cancel currency?

Ken Rogoff has  an interesting NBER Working paper "Costs and Benefits to Phasing Out Paper Currency."

Ken would like to get rid of paper currency in favor of all electronic transactions. I'm a big fan of low-cost electronic transactions using interest-paying electronic money. But I'm not ready to give up cash. 

Ken has two basic points: The zero bound, and tax evasion / illegal economy. 

Loggerheads

Government Debt Management at the Zero Lower Bound is a very nice and interesting paper by Robin Greenwood, Sam Hanson, Josh Rudolph, and Larry Summers.

Figure 1. Comparing Quantitative Easing and Treasury Maturity Extension, 2007–2014 ...the cumulative change in 10-year equivalents (scaled as a percentage of GDP) associated with the respective balance sheet policies undertaken by the Federal Reserve and the Treasury. Positive values increase the interest rate risk placed in public hands (Treasury policies), while negative values decrease it (typically Fed QE, but also Treasury maturity shortening in 2008–2009).

First point, what the Fed taketh away, the Treasury giveth. (Hence the title of this post). The Fed bought lots of long-term debt, with the idea that this would raise the price, lower the interest rate on the long-term debt, and thus stimulate the economy.

At the same time, however, the Treasury was selling lots of long-term debt. Interest rates are very low, and debts are high, so it's a great time to lock in low-rate financing. Homeowners and businesses are doing the same thing.

McCloskey on Piketty and Friends

Deirdre McCloskey has written an  excellent essay reviewing Thomas Piketty’s Capital in the Twenty-First Century.

As an economic historian and historian of economic ideas, McCloskey can place the arguments into the framework of centuries-old ideas (and fallacies) as few others can. She has read philosophy and "social ethics." She can even knowledgeably review the literary references.

Her central point: "trade-based betterment," (she wisely avoids "capitalism" to emphasize that  the focus on "capital" is about a hundred years out of date) has raised living standards by factors of 30 or more -- much more if you think about health, freedom, lifespan, tavel, etc. unavailable at any price in 1800;  it has led to much greater equality in many things that count, such as consumption, health and so on; and stands to do so again if we do not kill the goose that laid these golden eggs.  From late in the review,

Redistribution, although assuaging bourgeois guilt, has not been the chief sustenance of the poor....If all profits in the American economy were forthwith handed over to the workers, the workers ... would be 20 percent or so better off, right now....

But such

one-time redistributions are two orders of magnitude smaller in helping the poor than the 2,900 percent Enrichment from greater productivity since 1800. Historically speaking 25 percent is to be compared with a rise in real wages 1800 to the present by a factor of 10 or 30, which is to say 900 or 2,900 percent. 

As a too-long post on a far-too-long review of a enormously-too-long book, I'll pass on some particularly good bits with comment.

On the long history of fashionable worrying:

Frameworks for Central Banking in the Next Century

The special issue of the JEDC containing papers from the conference "Frameworks for Central Banking in the Next Century" is available until Jan 18 online for free. My "monetary policy with interest on reserves" is here.  Alas, Elsevier doesn't allow me to post a pdf and only allows free access until Jan 18, so if you want pdfs grab them now. 

The lineup is pretty impressive. Of those I have read, I highly recommend Sargent, Prescott, Ohanian, Ferguson and Plosser to blog readers. In particular, if you thought Friedman was always and everywhere MV=PY and 4%, read Sargent.

The lineup:

Behavioral Political Economy

I was interested to read "Behavioral Political Economy: A Survey" by Jan Schnellenbach and Christian Schubert. (HT marginal revolution's irresistible links.)

Context: I have long been puzzled at the high correlation between behavioral economics and interventionism.

People do dumb things, in somewhat predictable ways. It follows that super-rational aliens or divine guidance could make better choices for people than they often make for themselves. But how does it follow that the bureaucracy of the United States Federal Government can coerce better choices for people than they can make for themselves?

For if psychology teaches us anything, it is that people in groups do even dumber things than people do as individuals -- groupthink, social pressure, politics, and so on -- and that people do even dumber things when they are insulated from competition than when their decisions are subject to ruthless competition.

So on logical grounds, I would have thought that behavioral economists would be libertarians. Where are the behavioral Stigler, Buchanan, Tullock, etc.?  The case for free markets never was that markets are perfect. It has always been that  government meddling is  worse. And behavioral economics -- the application of psychology to economics -- seems like a great tool for understanding why governments do so badly. It might also inform us how they might work better; why some branches of government and some governments work better than others.

This nice paper got my attention, since the paper says that's starting to happen.

...Assuming cognitive biases to be present in the market, but not in politics, behavioral economists often call for government to intervene in a “benevolent” way. Recently, however, political economists have started to apply behavioral economics insights to the study of political processes, thereby re-establishing a unified methodology. This paper surveys the current state of the emerging field of “Behavioral Political Economy”

I came away horribly disappointed. Not with the paper, but with the state of the literature that the authors ably summarize.

Guilds

The Syndics of the Drapers' Guild by Rembrandt, 1662.

I enjoyed Sheilagh Ogilvie's The Economics of Guilds in the latest Journal of Economic Perspectives. Bottom line:

..the behavior of guilds can best be understood as being aimed at securing rents for guild members; guilds then transferred a share of these rents to political elites in return for granting and enforcing the legal privileges that enabled guilds to engage in rent extraction. 

The paper nicely works through all the standard pro-guild and pro-regulation arguments. If you just replace "Guild" with "regulatory agency" it sounds pretty fresh.

Did guilds provide contract enforcement, security in weak states, property right protections not otherwise available? No.

Across the Great Divide

Across the Great Divide: New Perspectives on the Financial Crisis is published. This is the book form of the joint Brookings-Hoover conference on the financial crisis, organized by Martin Baily and John Taylor.  The link allows you to download the whole thing as pdf for free, or buy the book.

There will be a webcast book event on Wed Nov 5, from the Hoover Institution's Washington D. C. offices, also available after the fact at that link.

My "Toward a Run-Free Financial System" is in it, in published form, also available on my webpage.

Larry Summers' Low Equilibrium Real Rates,  Financial Crisis, and Secular Stagnation is an interesting read in his evolving case for "secular stagnation," which I'm sure will get a lot of attention.

But lots of the other papers are really interesting as well.

Previous posts on this interesting conference here and on the Summers speech here.

The rest of the table of contents:

Introduction
By Martin Neil Baily and John B. Taylor

Heretics

Low inflation is back in the news.  The Wall Street Journal covers the latest decline in European inflation. Peter Schiff has a nice article explaining that inflation is not such a great thing, unless of course you're a government that wants to pay back debt with cheap money. I dipped into this heresy in an earlier post, explaining that maybe zero rates and slight deflation just represent the arrival of Milton Friedman's optimal quantity of money.

But this news also brings to mind some thoughts on the second heresy -- maybe we have the sign wrong, and we're getting low inflation or deflation because interest rates are pegged at zero, and maybe the way to raise inflation (if you want to) is for the Fed to raise interest rates, and leave them there. (Earlier posts on this question  here and here)

Back in 2010, Narayana Kocherlakota explained the basic idea

Long-run monetary neutrality is an uncontroversial, simple, but nonetheless profound proposition. In particular, it implies that if the FOMC maintains the fed funds rate at its current level of 0-25 basis points for too long, both anticipated and actual inflation have to become negative. Why? It’s simple arithmetic. Let’s say that the real rate of return on safe investments is 1 percent and we need to add an amount of anticipated inflation that will result in a fed funds rate of 0.25 percent. The only way to get that is to add a negative number—in this case, –0.75 percent.

To sum up, over the long run, a low fed funds rate must lead to consistent, but low, levels of deflation.”

It's really simple. One of the most fundamental relations in economics is the Fisher equation, nominal interest rate = real interest rate plus expected inflation. Real interest rates can be affected by monetary policy in the short run. But not forever. So if the Fed raises the nominal interest rate and leaves it there, expected inflation should eventually rise to meed that nominal rate.

Why and how we care about inequality

Note: These are remarks I gave in a concluding panel at the Conference on Inequality in Memory of Gary Becker, Hoover Institution, September 26 2014. The conference program here, and John Taylor's summary here, where you can see the great papers I allude to. I'll probably rework this to a more general essay, so I reserve the right to recycle some points later.

Why and How We Care About Inequality

Wrapping up a wonderful conference about facts, our panel is supposed to talk about “solutions” to the “problem” of inequality.

We have before us one “solution,” the demand from the left for confiscatory income and wealth taxation, and a substantial enlargement of the control of economic activity by the State.

Note I don’t say “redistribution” though some academics dream about it. We all know there isn’t enough money, especially to address real global poverty, and the sad fact is that government checks don’t cure poverty. President Obama was refreshingly clear, calling for confiscatory taxation even if it raised no income. “Off with their heads” solves inequality, in a French-Revolution sort of way, and not by using the hair to make wigs for the poor. The agenda includes a big expansion of spending on government programs, minimum wages, “living wages,” government control of wages, especially by minutely divided groups, CEO pay regulation, unions, “regulation” of banks, central direction of all finance, and so on. The logic is inescapable. To “solve inequality,” don’t just take money from the rich. Stop people, and especially the “wrong” people, from getting rich in the first place.

In this context, I think it is a mistake to accept the premise that inequality, per se, is a “problem” needing to be “solved,” and to craft “alternative solutions.”

Just why is inequality, per se, a problem?

Suppose a sack of money blows in the room. Some of you get $100, some get $10. Are we collectively better off? If you think “inequality” is a problem, no. We should decline the gift. We should, in fact, take something from people who got nothing, to keep the lucky ones from their $100. This is a hard case to make.

One sensible response is to acknowledge that inequality, by itself, is not a problem. Inequality is a symptom of other problems. I think this is exactly the constructive tone that this conference has taken.

But there are lots of different kinds of inequality, and an enormous variety of different mechanisms at work. Lumping them all together, and attacking the symptom, “inequality,” without attacking the problems is a mistake. It’s like saying “fever is a problem. So medicine shall consist of reducing fevers.”

IOR caused the recession!

Apparently saying something nice about the Fed last week stepped over some bright line somewhere.
Lois Woodhill, writing at Forbes.com, wrote one of the most unintentionally hilarious rebukes here.

Source: Louis Woodhill at Forbes.com

The above chart

...shows what happened the last time the Fed raised the IOR rate [to 0.25%] (remember, it was zero for 95 years). 

The plunge in velocity overwhelmed the Fed’s frantic money creation during the period immediately after it started paying IOR.  NGDP tanked, taking RGDP and employment with it. 

Look, something caused the economic collapse of 2008-2009.  Given the evidence, IOR looks a lot like a man caught at a murder scene with a smoking gun in his hand.

Interesting.  Interest on reserves caused the recession!

S&P economists and inequality

Neil Irwin at the New York Times writes interesting coverage of a report titled "How Increasing Income Inequality Is Dampening U.S. Economic Growth, And Possible Ways To Change The Tide" by S&P economists.

The article starts with interesting comments about business economists

...you have to know a little bit about the many tribes within the world of economics. There are the academic economists...many labor in the halls of academia for decades writing carefully vetted articles for academic journals that are rigorous as can be but are read by, to a first approximation, no one. 

Ouch!

Macro debates, the oped

This is a a Wall Street Journal Op-Ed, on supply vs, demand in understanding slow growth. WSJ asks that I don't re-post the oped for a month; a month has passed so here it is for those of you who don't subscribe to WSJ.

The underlying paper is The New Keynesian Liquidity Trap, for those wanting more substance to some of the claims about New Keynesian models.

They didn't want the graph, but I think it illustrates the point well.

The Op-Ed, [with a few cuts restored and one typo fixed]:

Output per capita fell almost 10 percentage points below trend in the 2008 recession. It has since grown at less than 1.5%, and lost more ground relative to trend. Cumulative losses are many trillions of dollars, and growing. And the latest GDP report disappoints again, declining in the first quarter.

Sclerotic growth trumps every other economic problem. Without strong growth, our children and grandchildren will not see the great rise in health and living standards that we enjoy relative to our parents and grandparents. Without growth, our government's already questionable ability to pay for health care, retirement and its debt evaporate. Without growth, the lot of the unfortunate will not improve. Without growth, U.S. military strength and our influence abroad must fade.

Lucas and Sargent Revisited

The economics blogosphere has a big discussion going on over Bob Lucas and Tom Sargent's classic "After Keynesian Macroeconomics." You can start at Simon Wren-Lewis, Mark Thoma here and here and work back through the links.

A few thoughts here, as it bears on my WSJ oped from last week and my last post on EFG and how we do macro.

1. Views of Keynesian economics

Re-reading this paper, you will be struck about how much Lucas and Sargent praise Keynesian models, which you'd think it is their purpose to destroy.

They called the Keynesian revolution a "remarkable intellectual event." they continued

Summer Institute

I just got back from the NBER Summer Institute. The Economic Fluctuations and Growth meeting organized by Larry Christiano and Chad Jones sparks some thoughts on where macro is and where we're going. (I also attended the monetary economics and asset pricing meetings, which were excellent and thought provoking too, but one can only blog so much.)

Review:

Summers on Stagnation

Larry Summers has published a very interesting speech, U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound. I heard a version of the same thoughts last October, at the joint Brookings-Hoover conference "The U.S. Financial System—Five Years After the Crisis."

I was struck then, as I am now, at how much consensus there is among macroeconomists. Yes, you heard it here. And Larry expresses it elegantly, as you might expect. While the press talks about recovery, macroeconomists look at output growth and employment and it still looks pretty dismal.

Revolving Door

Source: Lucca, Seru and Trebbi

David Lucca, Amit Seru and Francesco Trebbi have an interesting working paper, "The Revolving Door and Worker Flows in Banking Regulation." (NBER working paper here, ungated ssrn link here.

They construct

"a unique dataset of career paths of more than 35,000 former and current regulators across all regulators of commercial banks and thrifts -- the Federal Reserve Banks (Fed), the Federal Depository Insurance Corporation (FDIC), the Office of Comptroller and Currency (OCC), the Office of Thrift Supervision (OTS), and state banking regulators -- that have posted their curricula vitae (CVs) on a major professional networking website." 

I found Figure 4, above, pretty interesting. 10% of people in this sample move from regulator to industry or back again each year. And this flow has doubled since the financial crisis and regulatory expansion.