Category Archives: Mark Thoma is Indispensable

Three opinions about monetary policy

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1. Tyler Cowen cites a paper by three economists which argues that the lower bound for the interest rate does not matter. Cowen comments, “this evidence is the (current) final word, and I hope it will be heeded as such.”

2. Mark Thoma links to an article by Blanchard and Summers saying that the most important new development in macroeconomics is the significance of the lower bound for the interest rate.

3. My own view is that the lower bound is not significant, but that is because the impact of monetary policy is over-rated even above the lower bound. As an aside, I disapprove when macroeconomists talk of “the” interest rate, as if there were only one. Or, equivalently, when they use the term “interest rates” to imply that if you know one, you know them all.

My view is that the central bank is just another bank. It can no more hit an inflation target than Citibank can. If the government wants to really print money sufficiently to get people to notice, it has to use something like Modern Ponzi Theory.

I know that mine is an outlier view. Everyone else pays great heed to the Fed. If I am correct, then some day what everyone else claims to “know” about the importance of the central bank will eventually be understood to belong in the same category as astrology or 18th-century medical theory.

Why humans can still play chess

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Ken Rogoff writes,

At one time, it did seem that computers would sound the death knell for chess, not to mention all human mind games. That was certainly my guess in the late 1970s, when the rise of computers was one of the main reasons I gave for retiring from competitive chess.

Pointer from Mark Thoma.

Tic-tac-toe is not much of a game. It has been solved, and the solution is easy to remember.

I believe that computers have solved the game of Othello, and with best play by both sides, White should win, 33-31. But humans still play in Othello tournaments.

The reason is that the “solution” to Othello is impossible to remember. There are many, many variations that lead to the optimal score. More important, there are many openings where if you have memorized the continuations and your opponent has not, you can get an outstanding result.

Another way to put this is that a computer has sufficient memory to put every playable variation into its “opening book.” The only positions that a computer will not recognize from memory will be ones where it is way ahead.

Humans do not have that much memory. You can take a human out of his opening book and force him to think, without putting yourself in a hopeless position.

I suspect that a similar solution to chess is attainable. Suppose that you turned a computer loose playing against itself millions of times, a la Alpha Go, and you discarded all of the variations where one side falls hopelessly behind, until you end up with the solution to chess. My guess is that this would consist of tens of thousands of variations that end in a draw. A computer can store all of these variations, along with refutations of plausible alternatives.

If you play against such a computer, you must either follow a line that the computer has memorized, leading to a draw, or pick a line that loses easily. Same as in tic-tac-toe.

If I am correct about Othello, a championship match involving computers would just result in a lot of 33-31 wins for white that the computers have already memorized. If I am correct about chess, then such a match would just result in a lot of draws that the computers have already memorized. No new lines would emerge.

But humans could still play the game, because they don’t have that much memory. As an aside, when he was pursuing the goal of achieving grandmaster status, Rogoff told me that he had 30,000 entire chess games in what he called “active memory,” with more in storage. Wow!

Paul Volcker talks his book

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He writes,

No price index can capture, down to a tenth or a quarter of a percent, the real change in consumer prices. The variety of goods and services, the shifts in demand, the subtle changes in pricing and quality are too complex to calculate precisely from month to month or year to year.

Pointer from Mark Thoma. The book is co-authhored by Christine Harper, which sort of reminds me of those “as told to” sports autobiographies.

Anyway, Volcker is arguing against trying to use monetary policy to try to fine-tune the inflation rate.

I think of people as acting on the basis of habit. The expect prices tomorrow to be about where they are today. This really helps in making the countless calculations about what to buy, which job to take, which business to start, expand, or fold, etc. To get people to believe differently and to change their way of calculating takes a lot of effort. When Mr. Volcker became Fed chairman, the U.S. government had managed this trick, creating a regime where everyone felt that they had to factor general inflation into their decisions. Getting back to a low-inflation regime was not an easy process.

Another habit people have is treating government bonds as net wealth. That is, when the government borrows $100 from X to give money to Y, Y thinks he is better off by $100 and X thinks he now has a $100 bond. Neither X nor Y puts the obligation to re-pay that $100 on his personal balance sheet.

But that habit changes when something makes the X’s start to wonder whether the government is really going to pay them back, or if it is only going to pay them back in inflation-ruined currency. Then things start to get ugly.

The point is that models of simple, continuous, linear behavior do not apply to fiscal and monetary policy. Instead, there are phase changes. We shift from a regime of predictably stable overall prices to high inflation. There is not much in between those two regimes. We shift from a regime where government debt is treated as risk-free from one in which it is treated as highly risky. There is not much in between those two regimes, either.

Dean Baker on the Great Recession

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He writes,

Prices of non-residential structures increased by roughly 50 percent between 2004 and 2008 (see Figure 5 here). This run-up in prices was associated with an increase in investment in non-residential structures from 2.5 percent of GDP in 2004 to 4.0 percent of GDP in 2008 (see Figure 4).

This bubble burst following the collapse of Lehman, with prices falling back to their pre-bubble level. Investment in non-residential structures fell back to 2.5 percent in GDP. This drop explains the overwhelming majority of the fall in non-residential investment in 2009. There was only a modest decline in the other categories of non-residential investment.

Again, the collapse of Lehman hastened this decline, but the end of this bubble was inevitable. In this respect, it is worth noting investment in non-residential structures is pretty much the same share of GDP today as it was at the trough of the Great Recession, supporting the view that the issue was levels were extraordinarily high before the downturn, rather than being extraordinarily low in the downturn itself.

Pointer from Mark Thoma.

I pass this along not because I am inclined to agree with it or any other aggregate-demand story, but because:

1. Explaining the depth of the recession is hard. It is easy to point to the financial crisis and do hand-waving, but as Baker points out, the actual chain of causation is not so clear.

2. Baker is someone who does not succumb to mood affiliation. His views, correct or not, are arrived at independently.

3. I had forgotten about the bubble in commercial real estate.

4. I expect to see an insightful response from Kevin Erdmann.

John Ioannidis on Economics

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Self-recommending. But here is an excerpt.

Most empirical data do not come from experiments but from non-experimental sources such as surveys and routinely collected information. Along with Chris Doucouliagos and Tom Stanley, my research center examined 6,700 empirical studies encompassing 159 topics. We found that there is probably substantial bias in much of this literature. For example, the value of a statistical life, which measures how much people are willing to pay to reduce their risk of death, appears to have been exaggerated by a factor of eight. On average, the strength of the results may have been exaggerated by a factor of two. In a third of the studies, by a factor of four.

But overall, he is more upbeat than I am on economics as a science.

Pointer from Mark Thoma.

Corporate tax cuts, math, and intellectual swindles

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John Cochrane writes,

Each dollar (per worker) of static tax losses raises wages by [more than one dollar] It’s always greater than one… A number greater than one does not mean you’re a moron, incapable of addition, a stooge of the corporate class, etc.

This is also a lovely little example for people who decry math in economics. At a verbal level, who knows? It seems plausible that a $1 tax cut could never raise wages by more than $1. Your head swims. A few lines of algebra later, and the argument is clear. You could never do this verbally.

For the other side of the controversy, see Mark Thoma.

Let me swindle you with the following example.

1. We have the GDP factory, with two workers, A and B.

2. Each worker faces a different tax rate on wages.

3. The pre-tax wage of worker A is fixed. It cannot change.

4. (a) Each worker stays fully employed. (b) That means that the ratio of the marginal product of worker A to the marginal product of worker B must remain constant.* (c) That means that the ratio of the after-tax wage of worker A to the after-tax wage of worker B must remain constant.

*That ratio is completely determined by the production function, which is given, and by the quantities used of the two workers, which are fixed at full employment.

OK, now we cut the tax rate for worker A. What happens to the pre-tax wage of worker B?

At the fixed pre-tax wage of worker A, the after-tax wage for worker A goes up. Because of 4(c), that means that the after-tax wage of worker B must go up. The only way that can happen is if the pre-tax wage of worker B goes up. And to get worker B’s after-tax wage to go up by, say $1, you have to raise worker B’s pre-tax wage by more than $1. So worker B gets a big raise.

Substitute “capital” for worker A, “the interest rate” for worker A’s wage, and the corporate income tax for worker A’s tax rate, and I think you have the story that everyone is talking about.

But this is a swindle. We have fixed both the quantity and price of worker A. Taking worker A to be capital, the fixed supply is plausible because you think “how can we instantly adjust the supply of capital?” The wage, er, interest rate is fixed because, well, we know that the world interest rate is given, right?

But it cannot be right. A fixed wage suggests a perfectly elastic supply. A fixed quantity suggests a perfectly inelastic supply. There is a contradiction between 3 and 4(a).

The larger issue is that the simple model of a GDP factory with two factors of production and full employment is just silly. And even though other models add enough complexity to require computers to solve, they are also just silly.

There are many types of capital, which is what creates all of the lobbying and infighting over corporate taxes to begin with. There are also many types of labor, which substitute for and complement with the various types of capital in different ways. Adjustment takes time, and not all types of capital and labor are continuously employed. Over time, there is innovation, some of which is exogenous and some of which is in response to the tax change. The supply of each type of capital and each type of labor is neither perfectly elastic nor perfectly inelastic (and certainly not both!).

The moral of the story, in my view, is that forecasting the impact of economic policy is not a science. We know that, but then people demand a forecast, and they turn to a CBO “score” as if it were the final word on the subject. I have a forthcoming essay on the mis-use of CBO scores.

Heterodox introductory economics

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Samuel Bowles and Wendy Carlin write,

The Economy takes on board the fundamental innovations of Hayek and Nash used in contemporary economics research. But concerns about climate and other market failures as well as economic instability provide reasons to doubt Hayek’s argument that governments should limit their activities to enforcing property rights and other rules that permit markets to function.

Pointer from Mark Thoma. They refer to this free textbook. I can see that I disagree with a lot of it. For example, The Economy says,

Through most of their history, humans have regarded natural resources as freely available in unlimited quantities

This seems wrong to me. Prior to the invention of agriculture, humans had to take into account the limited availability of resources. If nothing else, when hunter-gatherers exhaust a food supply in an area, they have to move or face starvation.

Instead, I would emphasize that the price-and-profit system encourages humans to use our ingenuity to reduce our dependence on scarce resources. This natural tendency toward conservation in a capitalist economy is one of the most important concepts for economists to teach. Thus, the environmental lesson in their book is nearly the opposite of mine in Specialization and Trade.

Still, there are many ways in which their textbook strikes me as a constructive improvement over the textbooks in the Samuelson tradition. I am very sympathetic to their effort to bring more heterodox views into introductory teaching.

A notewriter on public choice

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He or she writes,

Unlike providing pure public goods or setting generally applicable laws, the more widely accepted function of the state, the direct provision of goods and services can impact on people’s personal wealth and satisfaction in much more pressing ways. . .

. . .producers previously used to competing, albeit imperfectly, under an open market regime, will now set their eyes very carefully on the people tasked with commissioning their services: the public officials. Rather than competing for customers directly, in this new higher-stakes game, they will have to aggressively lobby officials for public contracts or employment. The result is that the same behaviour in the same sector of the economy that produces relatively efficient outcomes under market rules, produces inefficient, even predatory outcomes under democratic rules.

Pointer from Mark Thoma.

The really pure public choice view is that in the market and in politics, the same human motives are operating. They just operate under different institutional rules in each case. The less doctrinaire view would say that social norms also may differ between the market realm and the political realm. In theory, it is possible for the norms of political behavior to attenuate the tendency toward inefficient and predatory outcomes. How well this works in practice is certainly debatable.

Occupation and Gender

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Justin Fox writes,

If you are one of those who believe that men are congenitally disposed to prefer working with things and women to prefer working with people, these numbers offer some support for your position.

Some support? If you go to his post, you will find that every single one of the top male occupations involves things, and the top 9 female occupations involve people. This has to be one of the most powerful separations in all of social research.

Pointer from Mark Thoma.

From Prosperity to Poverty

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Ricardo Hausmann writes,

Income poverty increased from 48% in 2014 to 82% in 2016, according to a survey conducted by Venezuela’s three most prestigious universities. The same study found that 74% of Venezuelans involuntarily lost an average of 8.6 kilos (19 pounds) in weight. The Venezuelan Health Observatory reports a ten-fold increase in in-patient mortality and a 100-fold increase in the death of newborns in hospitals in 2016.

Pointer from Tyler Cowen.

Justin Fox blames the resource curse.
Pointer from Mark Thoma. I think that Fox, like too many economists, wants to look at material factors and ignore the role of ideas. Venezuela is cursed more by socialism than by oil.