Os cantos escuros da macroeconomia

Uma excelente peça de Olivier Blanchard, do FMI, sobre o que sabíamos (ou pensavamos saber) sobre macroeconomia e tudo o que aprendemos nos últimos anos: Where danger lurks.

If the financial system had been less opaque, if capital ratios had been higher, there might still have been a housing bust in the United States in 2007–2008. But the effects would have been limited – a mild US recession at the worst, rather than a global economic crisis.

Can the financial system be made more transparent and more robust? The answer is a qualified yes. Authorities have required increases in bank capital ratios – an essential line of defence against financial system meltdown. But banks are only part of a complex network of financial institutions and markets, and risks are far from gone. The reality of financial regulation is that new rules open new avenues for regulatory arbitrage, as institutions find loopholes in regulations. That in turn forces authorities to institute new regulations in an ongoing cat-and-mouse game (between a very adroit mouse and a less nimble cat). Staying away from dark corners will require continuous effort, not one-shot regulation.

Macroeconomic policy also has an essential role to play. If nominal rates had been higher before the crisis, monetary policy’s margin for manoeuvre would have been larger. If inflation and nominal interest rates had been, say, 2 percentage points higher before the crisis, central banks would have been able to decrease real interest rates by 2 more percentage points before hitting the zero lower bound on nominal interest rates. These additional 2 percentage points are not negligible. Their effects would have been roughly equivalent to the effects of the unconventional monetary policies that central banks pursued when the zero bound was reached – purchasing private sector assets and long-term government bonds to lower long-term interest rates rather than using the standard technique of manipulating a short-term policy rate. (Harvard Professor Kenneth S Rogoff, former head of the IMF’s Research Department, has suggested solutions other than higher inflation, such as the replacement of cash with electronic money, which could pay negative nominal interest. That would remove the zero bound constraint.)

Turning from policy to research, the message should be to let a hundred flowers bloom. Now that we are more aware of nonlinearities and the dangers they pose, we should explore them further theoretically and empirically – and in all sorts of models. This is happening already, and to judge from the flow of working papers since the beginning of the crisis, it is happening on a large scale. Finance and macroeconomics in particular are becoming much better integrated, which is very good news.

But this answer skirts a harder question: How should we modify our benchmark models – the so-called dynamic stochastic general equilibrium (DSGE) models that we use, for example, at the IMF to think about alternative scenarios and to quantify the effects of policy decisions? The easy and uncontroversial part of the answer is that the DSGE models should be expanded to better recognise the role of the financial system – and this is happening. But should these models be able to describe how the economy behaves in the dark corners?

Let me offer a pragmatic answer. If macroeconomic policy and financial regulation are set in such a way as to maintain a healthy distance from dark corners, then our models that portray normal times may still be largely appropriate. Another class of economic models, aimed at measuring systemic risk, can be used to give warning signals that we are getting too close to dark corners, and that steps must be taken to reduce risk and increase distance. Trying to create a model that integrates normal times and systemic risks may be beyond the profession’s conceptual and technical reach at this stage.

Tudo o que falta saber

As economias desenvolvidas estão presas numa armadilha de liquidez para a qual há curas fáceis e comprovadas (política orçamental expansionista e/ou taxas de juro negativas)? Ou a situação é mais complicada e os diagnósticos disponíveis devem ser lidos com algum cepticismo? A questão tem animado um excelente debate entre Paul Krugman, Simon Wren-Lewis, Tony Yates (cujo post é parcialmente citado em baixo) e David Andolfatto.

The old (but, historically, still ‘post’) Keynesian, IS/LM account of deficient demand, pretty much resembles the more modern account embedded in the rational expectations, sticky price models, dubbed ‘new’ Keynesian.  But using these models to prescribe drastic fiscal expansions that greatly exceeded what we saw is problematic.  In the UK, inflation exceeded target substantially.  In the US, it has not fallen all that much below it.  Modifications of the New Keynesian model that have a financial sector explain the recession as a dramatic constriction in credit supply that both strangles output, and creates inflationary pressure (offsetting the depressing effect on inflation coming from the fall in demand).

Following this line of argument, conventional demand-side fiscal policy was roughly on track.   You might argue that we ought to have had very great deviations of above target inflation, and much looser conventional fiscal policy.  But to do this you would have to ditch what those models say about the costs of inflation.  They contain the view that inflation fluctuations are an order of magnitude more costly than fluctuations in real activity.   So much the worse for them, you might say.  And policy makers frequently have said this.  But, with the models thus binned, you are in the dark about what should be done.  And there’s no way you can then argue that economics gives a clear answer, since you have discarded the one bottom-to-top [microfounded] answer it does give.  Granted, not everyone goes in for bottom-to-topness.  But that just reinforces my point that there is no sound economic answer.

Things are obviously worse than this, because the models that Paul Krugman is using to reason his way to arguing for a drastic further fiscal stimulus don’t contain financial sectors.  And the ones that get bolted onto the New Keynesian models to argue that policy was about right contain financial sectors that aren’t subject to systemic runs;  don’t malfunction therefore in the way that the real one did.

One of the themes of the early post crisis debate was the controversy between those like the Tory-led Coalition in the UK who warned about the possibility of a run on UK sovereign bonds, and those like PK who dismissed these concerns as opportunistic invoking of the ‘bond market fairy’.

PK would have history judge that he made the right call on this.  Certainly there were no runs on UK or US bonds.  But economics itself could not have given such an unambiguous a steer as PK claims.  The literature on optimal fiscal policy is riddled with ambiguity.  How to view what government does: wasteful, substituting, complementing private expenditure?  How to model the possibility of runs, and on what they might depend?  Whether to accept the possibility of the fiscal theory of the price level. [And whether this should be viewed as a difficulty or, as Sims sometimes suggested, an opportunity].   How to account for why people hold money.  [Without a good account of that, we can’t confidently say how they will price nominal bonds].  Whether the government can be viewed as being able to commit;  if not, whether it can acquire a reputation for good behaviour.  [If they can commit, then borrow now pay later strategies will work better].  Whether prices are sticky or not.  [This affects how much work fiscal policy should do to stabilise].  How to assess the tensions in the intergenerational conflicts over fiscal policy.  [Another take on the commitment problem].  How to produce normative guidelines for good fiscal policy that weighs concerns of competing generations.  The imponderable questions regarding how policy should deal with uncertainty, applied to the task of designing fiscal policy.  [How to weigh the unknown risks of a sovereign run, versus a deflationary spiral, for example].

I don’t know what economics PK has read.  But the miserably small quantity of serious reading I have managed on the above issues leaves me thinking that economics does not offer the clear advice PK claims.   PK seems to be backing away from all these intractable debates about the detail, and saying that we can ignore it.  Big picture, demand was weak, public demand had to be stronger.  Politicians did not get this message clearly enough, and were able to ignore it.  End of story.  Well, maybe.  Maybe not.  Perhaps only great minds can see the wood for all these unfinished modelling trees.  But to me it looks like a mess that many decades of future research may not sort out.

I think a plausible account of public policy failure is  that our economics profession had not yet come up with clear answers.  And in the absence of this politicians were free (or perhaps had no choice but) to be guided by their baser political imperatives.

A crise em slides

Paul Krugman publicou uma excelente série de slides acerca dos grandes debates da macroeconomia desde que a crise rebentou. Os tópicos vão desde os problemas do shadow banking system ao colapso da economia em 2009, passam pela crise do euro e pela questão dos multiplicadores, acabando nos temas mais actuais: o risco de deflação e a estagnação secular.

Tiros ao lado

Frustrations of the heterodox, por Paul Krugman. Ler também When economics students rebel, no Mainly Macro.

(…) the heterodox need to realize that they have, to an important extent, been working with the wrong story line.

Here’s the story they tell themselves: the failure of economists to predict the global economic crisis (and the poor policy response thereto), plus the surge in inequality, show the failure of conventional economic analysis. So it’s time to dethrone the whole thing — basically, the whole edifice dating back to Samuelson’s 1948 textbook — and give other schools of thought equal time.

Unfortunately for the heterodox (and arguably for the world), this gets the story of what actually happened almost completely wrong.

It is true that economists failed to predict the 2008 crisis (and so did almost everyone). But this wasn’t because economics lacked the tools to understand such things — we’ve long had a pretty good understanding of the logic of banking crises. What happened instead was a failure of real-world observation — failure to notice the rising importance of shadow banking. Economists looked at conventional banks, saw that they were protected by deposit insurance, and failed to realize that more than half the de facto banking system didn’t look like that anymore. This was a case of myopia — but it wasn’t a deep conceptual failure. And as soon as people didrecognize the importance of shadow banking, the whole thing instantly fell into place: we were looking at a classic financial crisis.

What about the lousy policy response — austerity and all that? The key point here was that policymakers weren’t basing their decisions on conventional economics. On the contrary, they decided to blow off textbook macroeconomics and embrace exotic doctrines like expansionary austerity and a mysterious growth cliff at 90 percent debt relative to GDP. The disastrous policy responses that have perpetuated the slump are the result of mainstream economics having too little influence, not too much.

Now, to be fair, there is a civil war within academic macroeconomics, and what I’m calling “mainstream” is the saltwater side of that civil war. But the critics want much more than to boost saltwater macro at the expense of the new classical guys — they want to drive people like me out of the temple, too. And the thing is that they want to do this even though, as Wren-Lewis says, Keynesian macro has actually performed very well since 2008.

What about the new respect given to heterodox thinkers like Minsky, and heterodox ideas like secular stagnation? I agree that mainstream economists didn’t pay enough attention to such people — way back, one of my principles for working in economics was “listen to the Gentiles.” But it’s hard to claim that such work is deeply incompatible with mainstream economics when Janet Yellen embraces Minsky and Larry Summers becomes a secular stagnationist.

And what about inequality? Some people are annoyed at Thomas Piketty by presenting his data and ideas in a form that is fairly comfortable for conventional economists, at least those of eclectic disposition. But doesn’t that show that conventional economics is indeed capable of accommodating big concerns about inequality? You fairly often find heterodox economists insisting that to accept the idea that capital and labor are paid their marginal products, even as a working hypothesis to be modified when you address things like executive pay, is to accept that high inequality is morally justified. But that’s obviously not the case: there are plenty of economists who are willing to use marginal-product models (as gadgets, not as fundamental truth) who don’t at all accept the sanctity of the market distribution of income. So this complaint is, in its own way, as much of a distortion as the right-wing claim that anyone who so much as mentions inequality is a Marxist.

How should the crisis and the reemergence of very high income inequality affect how we do and teach economics? For sure, it says that we need to do a lot more history, including deep history. Events have also reflected very badly on the style of economics that prizes “microfoundations” based on ultra-rational behavior over evidence, and rules any kind of ad hockery out of bounds. But the heterodox want more than that; they want to interpret recent events as a refutation of the kind of economics Wren-Lewis, or Janet Yellen, or Larry Summers (as economist, not public official), or yours truly does. And that interpretation just doesn’t work. By all means, advance heterodox ideas if you believe they’re right. But don’t claim vindication from events that didn’t actually follow the script you wish they did.


Onde está a inovação?

Um excelente texto de Stiglitz no Project Syndicate. The innovation enigma.

Around the world, there is enormous enthusiasm for the type of technological innovation symbolized by Silicon Valley. In this view, America’s ingenuity represents its true comparative advantage, which others strive to imitate. But there is a puzzle: it is difficult to detect the benefits of this innovation in GDP statistics.

What is happening today is analogous to developments a few decades ago, early in the era of personal computers. In 1987, economist Robert Solow – awarded the Nobel Prize for his pioneering work on growth – lamented that “You can see the computer age everywhere but in the productivity statistics.” There are several possible explanations for this.

Perhaps GDP does not really capture the improvements in living standards that computer-age innovation is engendering. Or perhaps this innovation is less significant than its enthusiasts believe. As it turns out, there is some truth in both perspectives.

Recall how a few years ago, just before the collapse of Lehman Brothers, the financial sector prided itself on its innovativeness. Given that financial institutions had been attracting the best and brightest from around the world, one would have expected nothing less. But, upon closer inspection, it became clear that most of this innovation involved devising better ways of scamming others, manipulating markets without getting caught (at least for a long time), and exploiting market power.

In this period, when resources flowed to this “innovative” sector, GDP growth was markedly lower than it was before. Even in the best of times, it did not lead to an increase in living standards (except for the bankers), and it eventually led to the crisis from which we are only now recovering. The net social contribution of all of this “innovation” was negative.

Similarly, the dot-com bubble that preceded this period was marked by innovation – Web sites through which one could order dog food and soft drinks online. At least this era left a legacy of efficient search engines and a fiber-optic infrastructure. But it is not an easy matter to assess how the time savings implied by online shopping, or the cost savings that might result from increased competition (owing to greater ease of price comparison online), affects our standard of living.

Two things should be clear. First, the profitability of an innovation may not be a good measure of its net contribution to our standard of living. In our winner-takes-all economy, an innovator who develops a better Web site for online dog-food purchases and deliveries may attract everyone around the world who uses the Internet to order dog food, making enormous profits in the process. But without the delivery service, much of those profits simply would have gone to others. The Web site’s net contribution to economic growth may in fact be relatively small.

Moreover, if an innovation, such as ATMs in banking, leads to increased unemployment, none of the social cost – neither the suffering of those who are laid off nor the increased fiscal cost of paying them unemployment benefits – is reflected in firms’ profitability. Likewise, our GDP metric does not reflect the cost of the increased insecurity individuals may feel with the increased risk of a loss of a job. Equally important, it often does not accurately reflect the improvement in societal wellbeing resulting from innovation.

In a simpler world, where innovation simply meant lowering the cost of production of, say, an automobile, it was easy to assess an innovation’s value. But when innovation affects an automobile’s quality, the task becomes far more difficult. And this is even more apparent in other arenas: How do we accurately assess the fact that, owing to medical progress, heart surgery is more likely to be successful now than in the past, leading to a significant increase in life expectancy and quality of life?

Still, one cannot avoid the uneasy feeling that, when all is said and done, the contribution of recent technological innovations to long-term growth in living standards may be substantially less than the enthusiasts claim. A lot of intellectual effort has been devoted to devising better ways of maximizing advertising and marketing budgets – targeting customers, especially the affluent, who might actually buy the product. But standards of living might have been raised even more if all of this innovative talent had been allocated to more fundamental research – or even to more applied research that could have led to new products.

Yes, being better connected with each other, through Facebook or Twitter, is valuable. But how can we compare these innovations with those like the laser, the transistor, the Turing machine, and the mapping of the human genome, each of which has led to a flood of transformative products?

Of course, there are grounds for a sigh of relief. Although we may not know how much recent technological innovations are contributing to our wellbeing, at least we know that, unlike the wave of financial innovations that marked the pre-crisis global economy, the effect is positive.

DSGE e o teste do mercado

The most damning critique of DSGE, por Noah Smith.

So now let’s get to the point of this post. As far as I’m aware, private-sector firms don’t hire anyone to make DSGE models, implement DSGE models, or even scan the DSGE literature. There are a lot of firms that make macro bets in the finance industry – investment banks, macro hedge funds, bond funds. To my knowledge, none of these firms spends one thin dime on DSGE.

So maybe they’re just using the wrong DSGE models? Maybe they’re using Williamson (2012) instead of Williamson (2013). I mean, after all, there is a huge, vast, unending array of DSGE models out there, most of which purport to explain the entire macroeconomy, and most of which are thus mutually exclusive at any point in time. Maybe two or three of them are right at any given point in time, but maybe this set switches around as conditions change. Perhaps finance-industry people are simple unable to pick out the right DSGE model to use on any given day.

But if finance-industry people can’t know which DSGE model to use, how can policymakers or policy advisors?

In other words, DSGE models (not just “Freshwater” models, I mean the whole kit & caboodle) have failed a key test of usefulness. Their main selling point – satisfying the Lucas critique – should make them very valuable to industry. But industry shuns them.

Many economic technologies pass the industry test. Companies pay people lots of money to useauction theory. Companies pay people lots of money to use vector autoregressions. Companies pay people lots of money to use matching models. But companies do not, as far as I can tell, pay people lots of money to use DSGE to predict the effects of government policy. Maybe this will change someday, but it’s been 32 years, and no one’s touching these things.

A herança de Friedman

Uma excelente discussão da genealogia das ideias económicas no Equitable Growth: o clash de keynesianos nos anos 60, a absorção dos monetaristas pelos keynesianos e o destino das ideias de um dos maiores economistas do século (Milton Friedman). The Keynesian Revolution, the monetarist conterrrevolution, the New Classical Purge, the Neo-Keynesian Restoration, por Brad DeLong. Ler também Paul Krugman, em The neo-paleo-keynesians counter-counter-counterrevolution.

The competing New Keynesian research program is harder to summarize quickly. But surely its key ideas include the following five propositions:

  1. The frictions that prevent rapid and instantaneous price adjustment to nominal shocks are the key cause of business cycle fluctuations in employment and output.
  2. Under normal circumstances, monetary policy is a more potent and useful tool for stabilization than is fiscal policy.
  3. Business cycle fluctuations in production are best analyzed from a starting point that sees them as fluctuations around the sustainable long-run trend (rather than as declines below some level of potential output).
  4. The right way to analyze macroeconomic policy is to consider the implications for the economy of a policy rule, not to analyze each one- or two-year episode in isolation as requiring a unique and idiosyncratic policy response.
  5. Any sound approach to stabilization policy must recognize the limits of stabilization policy, including the long lags and low multipliers associated with fiscal policy and the long and variable lags and uncertain magnitude of the effects of monetary policy.

Many of today’s New Keynesian economists will dissent from at least one of these five planks. (I, for example, still cling to the belief–albeit without much contemporary supporting empirical evidence–that policy is as much gap-closing as stabilization policy.) But few will deny that these five planks structure how the New Keynesian wing of macroeconomics thinks about important macroeconomic issues. Moreover, few will deny that today the New Classical and New Keynesian research programs dominate the available space.

But what has happened to the third school, monetarism, at the end of the 20th century? Monetarism achieved its moment of apogee with both intellectual and policy triumph in the late 1970s. Its intellectual triumph came as the NAIRU grew very large and the multiplier grew very small in both journals and textbooks. Its policy triumph came as both the Bank of England and the Federal Reserve declared in the late 1970s that henceforth monetary policy would be made not by targeting interest rates but by targeting quantitative measures of the aggregate money stock. But today explicit monetarism seems reduced from a broad current to a few eddies.

What has happened to the ideas and the current of thought that developed out of the original insights of Irving Fisher and his peers?

The short answer is that much of this current of thought is still there, but its insights pass under another name. All five of the planks of the New Keynesian research program listed above had much of their development inside the 20th century monetarist tradition, and all are associated with the name of Milton Friedman. It is hard to find prominent Keynesian analysts in the 1950s, 1960s, or early 1970s who gave these five planks as much prominence in their work as Milton Friedman did in his…