Category Archives: PSST and Macro

Tyler Cowen Juxtaposes

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There is this.

whoever you think the four most likely Americans to be the next president of the United States—who are probably Ted Cruz, Donald Trump, Bernie Sanders, and Hillary Clinton—none of them are in favor of TPP.

That is a quote from Larry Summers.

Then there is this:

Adjustment in local labor markets is remarkably slow, with wages and labor-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock commences. Exposed workers experience greater job churning and reduced lifetime income. At the national level, employment has fallen in U.S. industries more exposed to import competition, as expected, but offsetting employment gains in other industries have yet to materialize.

That is from David H. Autor, David Dorn, and Gordon H. Hanson.

Politicians, unlike tenured academics, have to cater to what the authors call “exposed workers.”

But note that the last sentence in the quote from Autor, et al. Does it not sound like the PSST story for recessions?

Market Monetarism Watch

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David Beckworth, with Romesh Ponnuru, makes the NYT.

It took a bigger shock to the economy to bring the financial system down. That shock was tighter money. Through acts and omissions, the Fed kept interest rates and expected interest rates higher than appropriate, depressing the economy.

In a way, this is an easy argument to make.

1. A recession is, almost by definition, the economy operating below potential.

2. Operating below potential is, almost by definition, a shortfall in aggregate demand. The only other type of adverse event is a supply shock, which reduces potential but does not force the economy to operate below that reduced potential.

3. The Fed controls aggregate demand.

4. Therefore, all recessions are the fault of the Fed. Either by commission or omission, the Fed has messed up if we have a recession.

It is an easy argument to make, but I believe close to none of it. I do not believe in the AS-AD framework. And I do not believe (3). If you do not know why I have my views, go back and read posts under the categories “PSST and Macro” and “Monetary Economics.”

My view is that the housing boom and the accompanying financial mania helped hide some underlying adjustment problems in the economy. The crash, the financial crisis, and the response to that crisis all helped to aggravate those underlying adjustment problems. I suspect that, on net, the bailouts and the stimulus diverted resources to where they were less useful for maintaining employment than would have been the case if the government had not intervened. My basis for this suspicion is my belief that people who do not need help are often more effective at extracting money from the government than people who do need it.

There has been much other commentary on the op-ed–see Scott Sumner’s post.

PSST?

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A reader asks if John Hussman is stealing the PSST story.

Emphatically, recessions are primarily points where the mix of goods and services demanded by the economy becomes misaligned with the mix of goods and services being produced. As consumer preferences shift, technology introduces new products that dominate old ones, or market signals are distorted by policy, the effects always take time to be observed and fully appreciated by all economic participants. Mismatches between demand and production build in the interim, and at the extreme, new industries can entirely replace the need for old ones. Recessions represent the adjustment to those mismatches. Push reasonable adjustments off with policy distortions (like easy credit) for too long, and the underlying mismatches become larger and ultimately more damaging.

Looking over the entire piece, I would say that the Hussman is 90 percent generic Austrian and maybe 10 percent PSST. I find Hussman worth reading when people point me to his commentaries, but I do not go all in on his or any other market/macro analyst’s viewpoint.

Mike Munger on Specialization

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He writes,

Admittedly, it was a significant intellectual achievement to show that the weaker trading partner benefits from trade, even if the stronger partner is better at everything. But those fixed differences have largely disappeared in many markets. The question of what should be produced, and where, is now answered by dynamic processes of market signals and price movements, driven by human ingenuity and creativity. The cost savings resulting from successfully dividing labor and automating production processes dwarf the considerations that made comparative advantage a useful concept in economics.

Read the whole thing. In The Book of Arnold, I express a similar disappointment with Ricardian comparative advantage, because it is always taught as the “two by two” case, which hides the complexity of specialization in the real economy.

Scott Sumner on Robert Hetzel

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Scott writes,

Friedman, Hetzel, and I all share the view that the private economy is basically stable, unless disturbed by monetary shocks.

Scott refers to this paper by Hetzel.

Very broadly, I place explanations of cyclical fluctuations in economic activity
into two categories. The first category comprises explanations in which real
forces overwhelm the working of the price system. . .

In the second class of explanations of cyclical fluctuations, the price system
generally works well to maintain output at its full employment level.

My own mantra is that all recessions are adjustment problems, and that adjustment problems are local. Do not think of the economy as one big GDP factory governed by the relationship between “the” wage, “the” price level, and the money supply. Instead, think of it as patterns of specialization and trade, with the sustainability of those patterns determined by profits. When patterns are disrupted by innovation or by changes in credit conditions, the economy must re-allocate resources. It takes time for entrepreneurs to figure out how to do that.

So, relative to Sumner and Hetzel, I am in the “other” camp.

By the way, in about a week, I should have up a review of Sumner’s treatise on the Great Depression, The Midas Paradox.

Brad DeLong Stumbles

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He writes,

The combination of representative-agent modeling and utility-based “microfoundations” was always a game of intellectual Three-Card Monte. Why do you ask? Why don’t we fund sociologists to investigate for what reasons–other than being almost guaranteed to produce conclusions ideologically-pleasing to some–it has flourished for a generation in spite of having no empirical support and no theoretical coherence?

Pointer from Mark Thoma.

About the very same methodology, Olivier Blanchard famously wrote, “The state of macro is good.” Instead, Brad DeLong has stumbled over the truth, but will he pick himself up as if nothing happened?

We have one historical macroeconomic path, and we have many interpretive frameworks from which to choose. We can reconcile very disparate frameworks to the observed data. How shall we choose among frameworks?

The “microfoundations” criteria, whether used by New Classicals or New Keynesians, are silly. The macro-economy is not one owner-worker employed (or not) in a single GDP factory.

Still, there is something to be said for using microeconomic principles to guide your interpretive framework in macroeconomics. Every economist does so. We just diverge in which microeconomic principles we use as focal points.

In my view, the workhorse AS-AD model is already too aggregated. I am convinced by neither DeLong’s Wicksellian version nor Sumner’s Market Monetarist version. Instead, A short version of my macro framework is here. A longer version is in progress.

A Commenter Reviews The Midas Paradox

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It’s ‘Handle’:

Any proposed answer to the question of “What really caused the Great Depression” is inevitably pregnant with policy implications, and so is unavoidably incredibly politically charged. That’s one of the reasons so many top economists are so keen on studying it. Big names like Keynes, Hayek, Friedman, and Bernanke, just to name a few.

[more below the fold] Continue reading →

Narayana Kocherlakota on How the Fed Spoiled the Economy

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Scott Sumner correctly sees Kocherlakota as supporting Sumner’s view of Fed policy during the financial crisis and its aftermath. Kocherlakota says,

I use the public record to document that, as of late 2009, the FOMC felt that it would be appropriate to use its monetary policy tools to foster a relatively slow recovery in both prices and employment. (The recovery that actually unfolded was slower than the FOMC intended in terms of employment, but close to the FOMC’s intentions in terms of inflation.) I argue that the FOMC’s guarded response can be traced back to its pre-2008 policy framework—that is, to the Taylor Rule. Indeed, because of this baseline “normal” policy framework, the FOMC and many outside observers actually saw the Committee as pursuing a highly accommodative policy.

Read the entire speech, or at least read Sumner’s excerpts from it.

Kocherlakota has lobbed a grenade into the macro establishment’s room. If he (and Sumner) are correct, then history will not be kind either to the Bernanke Fed or to the Taylor rule.

Much as I would love to see those icons brought down, for the moment I am going to stick to my view that the Fed did not set the course for the economy.

Scott Sumner’s Theory of Hysteresis

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In The Midas Paradox, he writes,

if depressions do encourage statist policy interventions, then deflationary policies may impose costs that are much larger that [sic] those predicted by natural rate models of the business cycle.

Recently, Blanchard and Summers have argued that demand shocks cause supply shocks in the private sector. That is, if you have a recession, the economy’s potential output falls. Sumner’s view is that demand shocks cause governments to come to power that implement bad supply-side policies. Examples he gives include Roosevelt’s NRA and Argentina’s left-wing government of the early 2000’s. Perhaps the U.S. after 2008 will turn out to be another example.

Of course, I am not as ready as Sumner to go with the AS-AD paradigm.