Category Archives: PSST and Macro

The self-quarantine decision: my thought process

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Even though we have no symptoms and no reason to believe we have been infected, my wife and I are going to try to do everything reasonable to reduce outside contact for a while. Call it “social distancing” or self-quarantining.

This means giving up discretionary trips to the grocery store or other shopping. It means giving up going to dance sessions (that is a big sacrifice, as far as I am concerned). It means not having social meals with others. It means not going to visit our children and grandchildren (an even bigger sacrifice).

My thought process is this:

1. I would rather be in front of an exponential curve than behind it.

When I started my Internet business in April of 1994, most people had not heard of the World Wide Web, and many of those who had heard of it took a “wait and see” attitude about whether it would work out as a business environment. It only became clear that the Web was a business platform more than a year later. But by that time, it was harder to ride the curve.

A lot of people, including government leaders in most countries, are going with a “wait and see” approach before reacting to the virus. They are certainly not getting ahead of the curve. In a few weeks, the self-quarantine decision we are taking may be imposed on everyone. Meanwhile, we hope to reduce our chance of contracting the virus and becoming spreaders.

2. In an uncertain situation, I like to compare the upside and the downside. When the upside of doing something is high and the downside is low, go for it. When it’s the opposite, avoid it.

So think about the upside and the downside of going about our normal business instead of self-quarantining. The upside would be that for the next few weeks I get to dance more and spend more time with friends and family. The downside is that I contract the virus and spread it. I think that the downside, even though it is unlikely, is worse, especially becoming a spreader.

3. How long will we self-quarantine? Either we’ll get something like an “all-clear” signal in a few weeks, or, if my worst fears are correct, there will be government-imposed measures that are as strong or stronger than what we are taking.

4. If I were in government, I would, in addition to making an all-out effort to test people with pneumonia symptoms, be making a large effort to test a sample of asymptomatic people. And re-test people in that sample every few days. From a statistical perspective, random testing strikes me as necessary in order to get a reliable picture of the epidemic. I would not trust an “all-clear” signal that was not backed by evidence from random testing.

Note that this post is not about the current Administration, so please self-quarantine your political comments and take them elsewhere.

UPDATE: John Cochrane recommends an essay by Tomas Pueyo. The message is to respect the exponential curve.

Macroeconomics and the virus crisis, II

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Before I get to that, Matt Ridley writes,

There are already several different strains of the virus, one of which, the L strain, looks to be more lethal than others.

What? Whoa!! Somebody needs to shout this from the rooftops. It suggests that there is no such thing as the death rate, even controlling for other factors. To me, it may suggests that we should be testing for this specific “L strain.”

Also, if there is more than one strain, does immunity to one strain not necessarily confer immunity to another? So you could get “it’ (i.e., one of them) again?

Now on to some other economists, who mostly make sense.

1. Alan Blinder writes,

If most Americans who wanted a test could get one, and if people who tested positive stayed home and sought medical attention, fear of going out wouldn’t disappear, but it would dissipate. Think of it as a super-effective form of fiscal stimulus. Test kits are ridiculously cheap compared with the GDP and job losses they might forestall.

2. Tyler Cowen writes,

Do you want to give people cash if they will just go out and spend it on entertainment or in large, crowded stores? Is that what you are hoping they will do? To what extent do we want the “transmitting sectors” to be contracting right now? Does it do much good to send consumers money they will spend on Amazon or pizza deliveries, two sectors that may do fine or even prosper during the tough times?

I do not think we should bail out shale oil producers or cruise lines. Presumably we wish to support businesses with an income gap for coronavirus reasons, but what exactly should we do? I am puzzled by the degree of certainty people seem to exhibit about this issue.

3. Timothy Taylor tells us about a quickly-published booklet edited by Richard Baldwin and Beatrice Weder di Mauro. Taylor quotes Baldwin and Eiichi Tomiura writing

the supply-chain disruptions that are likely to be caused by COVID-19 could lead to a push to repatriate supply chains. Since they [sic] supply chains were internationalised to improve productivity, their undoing would do the opposite.

I intend to download the booklet and read it. Meanwhile, I recommend Taylor’s entire post.

The booklet evidently includes some quantitative estimates of the GDP cost of the virus crisis. I am quite sure that the models used to produce those estimates are worthless. There is no way for them to estimate the cost of shifting to less-efficient supply chains. More important, nobody has a model of how leveraged financial institutions interact with the economy. Consider a cruise line that owes debt service payments on its ships or an airline that owes debt service payments on its planes. If they cannot service their debts and they have to declare bankruptcy, it is hard to calculate the effect of that on GDP. It is even harder to calculate the effect hits when the banks with the outstanding loans have to deal with the effect on their balance sheets.

Macroeconomics and the virus crisis

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Tyler Cowen writes,

First, consider the relatively optimistic view: Covid-19 will have effects akin to what economists call a seasonal business cycle — which is to say, it will be over quickly and without much lasting damage.

. . .This less sanguine option might look like this: The Chinese economic slowdown leads to a permanent loss of momentum and a global recession. At the same time, with Lombardy closed down, the Italian government defaults, but the European Union is unable to resolve the matter (and the associated bank failures) in a timely and resolute manner. Governments vacillate between policies that make it easier for people to stay at home to limit the spread of the disease and policies designed to get them back in the workplace.

The U.S. would be caught up in the general loss of confidence, as well as the contagion from European banks. . .

Let’s distinguish primary effects from secondary effects, short term and long term.

Primary effects are reductions in activity in certain industries that are a pretty direct result of the virus crisis. Secondary effects would be reduction in activity that take place because people who lose their livelihoods in a directly-affected industry at some point will have to cut back on purchases, and that will affect industries that otherwise you might think would escape problems.

The airlines take a short-term hit from a primary effect. Conferences and other events are being canceled, governments are making it harder to fly into or out of certain countries, and many of us are questioning the wisdom of taking discretionary trips. But at some point air travel will get back to normal.

Cruise ships would seem likely to take a long-term hit from a primary effect. My guess is that some of the fifty-somethings who have watched this crisis unfold have sworn off ever going on a big cruise ship when they reach retirement age, so I would lower my long-term estimates for demand in that industry (and presumably the short-term demand falls of a cliff).

Will the hit to convention traffic be short-term or long-term? What if video conferencing proves its effectiveness? Corporations might decide to save on travel expenses long after the virus scare is over.

Also, there are primary effects that come from disruptions to the international production system, commonly referred to as the supply chain. Some of these are merely short term. But long term, firms will be thinking about building in some redundancy or reducing the use of overseas suppliers. If China no longer needs to build manufacturing facilities, then they do not need to import any materials from the U.S. to build them.

Conventional “aggregate demand” policies would seem to me to be useless for dealing with primary effects. And it’s possible that the secondary effects will not be so severe. So the economists who are eager to flap their gums about what the Fed should be doing might instead want to just hold off for a while.

If there are large secondary effects, they probably will operate through the banking and financial sectors. Banks and shadow banks are often highly levered, meaning that a small adverse development can make a firm go bankrupt. And financial institutions are often intertwined, so that one bankruptcy can lead to another. As the saying goes, when the tide goes out, you find out who is swimming naked.

Perhaps governments have to be included as being among the highly levered financial institutions. Tyler mentions the government of Italy, which seems to be having considerable difficulty with the virus and is in a precarious financial situation.

When financial institutions are worried about their own survival, they are less likely to help the firms that are suffering from short-term primary effects to ride out the storm. So an airline that could still be viable if it could get some loans to tide it over might instead have to declare bankruptcy.

The specific nature of the primary effects argues against thinking that conventional fiscal or monetary stimulus will work. Instead, such policies strike me as equivalent to pouring gasoline all over a car in the hope that some of it seeps into the fuel tank.

In theory, what you want is precisely targeted support, aimed at keeping alive the firms that deserve to survive short-term effects. But what you are likely to get instead are policies that mostly favor firms that do not need help or other firms that deserve to fail.

Giving globalization a bad name

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Reacting to a post by Peirre Lemieux on the coronavirus, Alberto Mingardi writes,

Will people learn the lesson, and realize that a closed economy is poorer, as Pierre hopes? I fear not. Though the emergency measures somehow provide us with a preview of the kind of country the economic nationalists would like us to live in, they will quickly turn the tables, blaming the virus on globalization, and making trade with China the villain of the story. Italy’s reaction to coronavirus is convincing other countries to treat Italians as we treat ourselves – limiting direct flights, imposing quarantines, etc. This will also increase the perception that reliance on international trade is a weakness, thereby fueling a renewed rhetoric of the marvels of autarky. Sure enough, when people travel they carry their diseases with them: this is not news. Prepare for a new nationalist narrative built around this idea.

I agree. I don’t think that this will make people appreciate globalization–quite the opposite.

Incidentally, I think that this makes it unlikely that President Trump will suffer a political setback because of the coronavirus. Closing the border is his signature issue, and the Democrats have staked out a position as the “resistance” to that. I know that they think they can benefit from this crisis, but I would be surprised if they do.

As for the economics of the crisis, I see it in terms of a PSST story. Many patterns of specialization and trade depend on globalization. The conventional wisdom seems to be that the central banks will be prominent actors, but I could not disagree more. I would suggest that instead of monitoring the Fed, one should watch the transportation hubs–especially ports–and manufacturing centers. To the extent that the attempts to contain the virus cause those places to be shut down, patterns of specialization and trade will be broken, and there won’t be anything that the Fed can do about it.

In my view, Scott Sumner and Jason Furman and other macroeconomists who apply a monetarist or Keynesian “model” are simply not capable of interpreting the world as it really exists. That is a harsh judgment, but I cannot be more gentle.

As Peter Zeihan puts it,

Modern manufacturing is a logistical marvel that taps hundreds of facilities in dozens of countries, but that system is based on frictionless international trade. Break just a few links and the entire network collapses. A modern car has about 2000 parts. If you are missing ten, you’ve got a large paperweight.

I suspect that for the economy, the best-case scenario is that authorities gradually decide that it’s not such a crisis, they let everyone go about their business, and whoever gets the virus, gets it. The worst-case scenario is that clusters of cases continue appearing, and each appearance leads authorities to strangle more transportation and production centers. If the latter happens, then I am pretty sure you will find the PSST paradigm more useful in explaining and predicting outcomes.

Paula Bolyard draws an interesting analogy with the Y2K computer scare. If that analogy proves correct, then we should be closer to the best-case scenario. But one thing about the Y2K scare is that it had a definite endpoint–by mid-January of 2000, doomsday was a dud. I only see the coronavirus panic ending when the media can no longer attract eyeballs to the story.

As to the outlook for the virus itself, consider three scenarios:

1) the proportion of people exposed to the virus approaches 100 percent

2) the proportion of people exposed to the virus approaches 0.

3) the proportion of people exposed to the virus approaches some middle number.

I am not a virologist, but this virus seems optimized for spreading. So wouldn’t you bet on 1)?

Suppose that the virologists in the media successfully convince us to become OCD handwashers and germophobes. Will that actually be able to stop the virus? What other consequences, good and bad, might accompany such a change in culture?

Note that I wrote this at the end of February, adding the Bolyard paragraph on March 2 and the references to Peter Zeihan and Jason Furman on March 6. By the time this post appears, I may have to correct some of my claims in light of developments.

UPDATE: John Cochrane has thoughts. Also, Scott Alexander. And Tyler Cowen.

Wages and the cycle

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John Cochrane writes,

John Grigsby has a very nice paper I saw last week pointing out that wages rose in the Great Recession. Why? Well all the low-wage people got fired, so the average wages of those remaining got hired [sic–he must mean “higher”]. Right now, we are seeing some of the opposite. People who have been out of the labor force for years are returning. Even ex-cons are getting jobs. Employers are skipping the drugs tests. Hire a lot of people at less than average wages, and average wages go down. It is possible for every individual to get a raise but the average decline.

The paper to which he refers has the following abstract:

What determines the joint dynamics of aggregate employment and wages over the medium run? This classic question in macroeconomics has received renewed attention since the Great Recession, when real wages did not fall despite a crash in employment. This paper proposes a microfoundation for the medium-run dynamics of aggregate labor markets which relies on worker heterogeneity. I develop a model in which workers differ in their skills for various occupations, sectors employ occupations with different weights in production, and skills are imperfectly transferable. When shocks are concentrated in particular industries, the extent to which workers can reallocate across the economy determines aggregate labor market dynamics. I apply the model to study the recessions of 2008-09 and 1990-91. I estimate the distribution of worker skills using two-period panel data prior to each of these recessions and find that skills became less transferable between the 1980s and 2000s. Shocking the estimated model with industry-level TFP series replicates the increase in aggregate wages in 2008-09, and decline in 1990-91. The model implies that if either the composition of industry shocks or the distribution of skills in the economy had been the same in the 2008-09 recession as in the 1990-91 recession, real wages would have fallen, while employment would have declined less. The declining industries during the 2008-09 all employed a similar mix of skills, which induced many low-skill workers to leave the labor force and limited downward wage pressure on the rest of the economy. Finally, the model inspires a novel reduced form method to correct aggregate wages for selection in the human capital of workers, which accounts for cyclical job downgrading by focusing on the wage movements of occupation-stayers. This correction recovers pro-cyclical wages, suggesting the changing composition of the workforce was crucial for aggregate wage dynamics during the Great Recession.

In textbook macro, there is no worker heterogeneity. There is just one type of worker in the GDP factory, and when demand falls, “the” wage is too high for the factory to keep all of its workers. We get an increase in unemployment until “the” real wage falls, in the textbook case due to prices rising faster than wages, thanks to monetary policy.

As you know, I don’t buy this story. I think of the economy as highly specialized, and I tell the PSST story. Some patterns of specialization an trade become unsustainable, and that results in higher unemployment until new patterns can be established. The quoted abstract struck me as closer to a PSST story than to a textbook macro story.

As an aside, I perhaps could link to John more often. I certainly agree with him often. But in choosing material to which to link, I lean in the direction of looking for facts or analytical points that are new to me or that I want to ponder further. I don’t want to automatically link to stuff just because I agree with it. And I try to stay away from the “Somebody said something wrong on the Internet” genre, meaning finding something you disagree with and acting on the urge to attack it.

The output gap as an outmoded AD story

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The output gap is a concept in simplistic Keynesian economics. It was most widely used fifty years ago. It never worked very well as a policy tool. Moreover, it has become much less relevant as the economy has moved away from concentration in automobile and steel production toward a highly diverse set of industries, with high technology as well as health care and other services particularly important.

The idea of an output gap is easy to explain. Suppose that the economy consists of a single factory. For some reason, demand for output falls. The factory will lay off workers and operate at less than full capacity. The difference between full-capacity production and actual production is the output gap.

When the concept of the output gap is applied to our nation’s data, the implicit assumption is that the economy is like a single factory, producing GDP. The capacity of the GDP factory is estimated using a trend line connecting years in which the unemployment rate is near its minimum. When GDP is below this trend line, that is said to signify an output gap.

But the economy is most certainly not a single factory. This makes the output gap an increasingly problematic calculation. Perhaps the measured output gap was a decent approximation in the 1950s, when most job losses consisted of temporary layoffs at large manufacturing firms that had accumulated too much in inventory. Once the excess inventory had been sold off, workers could be recalled to their same jobs and the output gap could be closed. In that sense, the economy operated somewhat like a single GDP factory.

In today’s economy, most job losses are permanent, due to reconfiguration of industries. Unemployed workers cannot simply be recalled to their old jobs. Instead, entrepreneurs must create new jobs, and then matches must be found between these new jobs and unemployed workers.

Each month in the United States, approximately four million jobs are destroyed and about the same number are created. When slightly more jobs are destroyed than created, the measured output gap goes up. When slightly more jobs are created than destroyed, the measured output gap goes down.

In recent years, the main challenge with job creation has been the mismatch between the skills and reliability desired by employers and the characteristics of people who are unemployed or not in the labor force. This is a much more nuanced problem than the concept of the output gap would suggest.

I recommend Nicholas Eberstadt’s recent article “Education and Men without Work”. He points out that the problem for low-skilled men in our economy is not one of demand. Instead, data on job openings show that we are

a country awash in low-skill jobs at a time when millions of men with high-school diplomas or less are out of the workforce. . .positions go unfilled because of a lack of interest by non-workers, or because of unreliable applicants who do not show up for work regularly and on time, or because applicants cannot stay sober or pass drug-screening tests.

Eberstadt would argue that the most important problem in our economy is not a generic output gap that can be treated by the Federal Reserve. Instead, it is a breakdown in families and social norms more generally as well as an education system that has not adapted to current realities.

On Modern Monetary Theory

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Greg Mankiw concludes,

In the end, my study of MMT led me to find some common ground with its proponents without drawing all the radical inferences they do. I agree that the government can always print money to pay its bills. But that fact does not free the government from its intertemporal budget constraint. I agree that the economy normally operates with excess capacity, in the sense that the economy’s output often falls short of its optimum. But that conclusion does not mean that policymakers only rarely need to worry about inflationary pressures. I agree that, in a world of pervasive market power, government price setting might improve private price setting as a matter of economic theory. But that deduction does not imply that actual governments in actual economies can increase welfare by inserting themselves extensively in the price-setting process.

I prefer my own analysis of MMT as a claim that government can run an unlimited Ponzi scheme.

The best analysis of the financial outlook for the U.S. government comes from the Congressional Budget Office. And some experts believe that the CBO reports show that the government will not keep all of its promises.

If these experts are correctly interpreting the CBO projections, then the U.S. government is running a Ponzi scheme. As with any Ponzi scheme, the collapse, when it comes, will be sudden and unexpected.

In any Ponzi scheme, the fact that it has not yet collapsed is by no means a guarantee that it will never collapse. In fact, the longer that a Ponzi scheme can be sustained, the more catastrophic will be its collapse.

My guess is that Mankiw had to reach to find this economic interpretation of MMT. I am reminded of Paul Samuelson claiming that the only way most economists could reproduce classical and neoclassical monetary theory was to think “If I were a jackass, where would I go?”

I predict that no devotee of MMT will agree that Mankiw’s interpretation is the correct one. I fear that MMT is deeply irrefutable, because there will be no agreement about what it means.

That sort of irrefutability is not a unique feature/bug of MMT. I have written,

Keynesian economics has always eluded a precise definition. The controversy over “what Keynes really meant” that began as soon as The General Theory was published remains active and unsettled. This poses a problem for those of us who would attack Keynesian economics. There is usually a rebuttal available that says “You are criticizing a straw man. What Keynesians really believe is . . . ”

You should read that essay. It is probably my best writing on the subject of macroeconomics and PSST.

Uber and macroeconomic adjustment

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Vyacheslav Fos and other write,

Following Uber’s entry into a market, workers with access to the ridesharing platform are 4.8 percent less likely to receive UI benefits. Moreover, they experience a relative decrease in total outstanding balances of $544, or 1.3 percent of the average individual’s debt burden. Finally, we find that the effects of the ridesharing platform extend to credit performance, with workers experiencing a relative decrease in delinquencies of 2.9 percent.

I know someone who does IT consulting who, between jobs, used driving for Uber to make ends meet. The article insinuates that the ability to do this helps reduce the burden of unemployment in general. But this has not been stress tested by a recession. I doubt that we could add half a million Uber drivers in the course of a couple of months without creating a significant excess supply.

Employee tenure

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The BLS reports,

The median number of years that wage and salary workers had been with their current employer
was 4.2 years in January 2018

(in the future, the link may take you to a then-current survey)

Pointer from Alex Tabarrok, indirectly from Tyler Cowen.

The overall figure includes workers under age 25, and that may skew the number downard. If you dig into the BLS release, you find that for workers aged 35-44, the median tenure is around 5 years. That is still not terribly long. This is not the textbook picture of the labor market, in which everybody works in the GDP factory in “the” job at “the” wage rate. I see it as another reason to prefer the framework that I call patterns of sustainable specialization and trade.