Garett Jones Watch

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Review by Scott Alexander. Review by Stuart Ritchie. Interview with Jones.

Alexander makes the point that I tried to make, which is that aggregation can produce higher correlation in noisy data. Ritchie says because the correlation between self-control and IQ is only 0.4, it is a bit of a swindle to say that self-control is a big factor explaining why nations with high average IQ do well economically. Among other interesting things in the interview, Jones says

Years of education is terrible measure of human capital. Look at broad-based test scores to get a sense of where a country’s economic future is heading.

Evidence for Nominal Wage Rigidity

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Bruce C. Fallick, Michael Lettau, and William L. Wascher write,

Given the relative magnitudes of the various measures of rigidity at the 1- and 2-year horizons, it seems clear that nominal rigidities are less important when one takes the longer view of wage changes over more than one year, suggesting that time is, indeed, an ally of wage flexibility. Even at the 2-year horizon, however, operative wage rigidity appears to have increased in the low-inflation environment of recent years.

Pointer from Mark Thoma.

The paper thus goes against my own views. The excerpt I pulled out is the one that comes closest to giving comfort to my way of thinking.

As you know, I think that many macroeconomists rely much too heavily on the sticky-wage story, which says that real wage rates are strongly countercyclical. I do not think of the job market as a single firm, laying off and hiring workers. Instead, I think in terms of PSST.

The data on Job Openings and Labor Turnover show millions of jobs being lost and found each month. When the creation of new jobs is 10 percent less than the flow of lost jobs, you see a large increase in unemployment. If the creation of new jobs is too slow, I do not attribute much of that to the stickiness of wages in existing jobs.

Given that it took until 2015 for labor utilization to recover from its collapse in 2009 (and it might be argued that labor utilization remains below trend), I think that the sticky-wage story is hard to defend as a main causal factor. It is even more difficult to argue that the 2015 recovery was due to a dramatic upsurge in inflation and consequent decline in real wages.

Bureaucratic Rump-Covering

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Timothy Taylor points to a report by a new bureaucracy, the Office of Financial Research. Taylor writes,

The report emphasizes three main risks facing the US economy: 1) credit risks for US nonfinancial businesses and emerging markets; 2) the behaviors encouraged by the ongoing environment of low interest rates; and 3) situations in which financial markets are not resilient, as manifested in shortages of liquidity, run and fire-sale risks, and other areas.

There is a difference between actionable intelligence and bureaucratic CYA. If somebody says, “we are seeing a lot of chatter laately among these four terror cells. We had better watch these individuals closely,” that is actionable. If somebody says, “there is a risk that in the current climate terrorists will attempt a major attack,” that is not actionable, it is just CYA.

Reading Taylor’s post, I doubt that there is anything actionable in the OFR report. If the OFR had existed in 2006, we would have been told that the high level of house prices posed a potential risk. Which everyone already knew. They just did not have actionable intelligence about the state of the portfolios of key players, like Merrill Lynch, Citigroup, and Freddie and Fannie.

Kling on Matt Ridley

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My review of The Evolution of Everything is here. I end my review with a series of questions.

If ideas emerge from the “adjacent possible,” how is it that some rare individuals thousands of years ago were able to anticipate ideas that only began to penetrate our culture in the late 18th century, when Adam Smith published his most important works? And why does the idea of evolution continue to face so much resistance today? As Ridley points out, on the one hand there are many religious conservatives and others who insist that biology comes from design, not from evolution. And there are many on the left who insist that economic well-being comes from government planning, not from markets. Are those of us who see decentralized evolution as superior to central planning forever doomed to be in the minority? Or is it possible to envision evolutionary progress on that front as well?

The New Eric Weiner Book

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It is Geography of Genius. I have seen a number of reviews. I do not rate it as must-read, but it will keep you entertained on an airplane ride.

He is looking at times and places that we view as loci of genius flourishing: ancient Athens, Scotland in the Hume era, Vienna in the Mozart era and in the Freud era, etc. Some commonalities:

1. The periods tend to be short, on the order of decades. High rates of creativity and growth are difficult to sustain.

2. The locations tend to be ones that are high in trade and population mobility.

3. The societies seem to be relatively open and tolerant.

4. Golden ages tend to be multidisciplinary. You get art, philosophy, and science together.

Above all, excellence seems to flourish in fields where it is valued in the culture. The Viennese loved their music. Silicon Valley venerates computer skills and start-ups. So the message is very McCloskeyan.

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?

Dean Baker on Health Industry Economics

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He writes,

Ordinarily economists treat it as an absolute article of faith that we want all goods and services to sell at their marginal cost without interference from the government, like a trade tariff or quota. However in the case of prescription drugs, economists seem content to ignore the patent monopolies granted to the industry, which allow it to charge prices that are often ten or even a hundred times the free market price.

Pointer from Mark Thoma.

His point, with which I agree, is that we should try to find other ways to subsidize drug research, so that drug prices will be closer to manufacturing cost, which is low.

Otherwise, I disagree with a fair amount of his post. I do not think that the wage rate of American doctors is notably high relative to their foreign counterparts. Keep in mind that American wages in general are higher, so that opportunity costs are higher. Keep in mind that American doctors tend to work longer hours. Finally, keep in mind that the mix of American doctors is much more skewed toward specialists than the mix in other countries.

In Crisis of Abundance, I looked at various possible explanations for the high rate of health care spending in the U.S., and I decided that the relative price of medical services is not such a big factor. The main factor is that we utilize many more services that have high costs and low benefits. A government-run health care system, which Baker advocates, ultimately would have to address this issue through refusing to pay for services as readily as we do now. A more market-oriented system would force people to decide for themselves when a procedure has expected benefits that are low relative to costs and hence not worth undergoing.

Machine Learning and Holdback Samples

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Susan Athey writes,

One common feature of many ML methods is that they use cross-validation to select model complexity; that is, they repeatedly estimate a model on part of the data and then test it on another part, and they find the “complexity penalty term” that fits the data best in terms of mean-squared error of the prediction (the squared difference between the model prediction and the actual outcome).

Pointer from Tyler Cowen.

In the early 1980s, Ed Leamer caused quite a ruckus when he pointed out that nearly all econometricians at that time engaged in specification searches. The statistical validity of multiple regression is based on the assumption that you confront the data only once. Instead, economists would try dozens of specifications until they found one that satisfied their desires for high R-squared and support for their prior beliefs. Because the same data has been re-used over and over, there is a good chance that the process of specification searching leads to spurious relationships.

One possible check on the Leamer problem is to use a holdback sample. That is, you take some observations out of your sample while you do your specification searches on the rest of the data. Then when you are done searching and have your preferred specification, you try it out on the holdback sample. If it still works, then you are fine. If the preferred specification falls apart on the holdback sample, then it indicates that your specification searching produced a spurious relationship.

Machine learning sounds a bit like trying this process over and over again until you get a good fit with the holdback sample. If the holdback sample is a fixed set of data, then this would again lead you to find spurious relationships. Instead, if you randomly select a different holdback sample each time you try a new specification, then I think that the process might be more robust.

I don’t know how it is done in practice.

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.