Wednesday, November 14, 2012

Public perceptions of freshwater macro


Cato scholar and Forbes writer Timothy B. Lee is hardly what you'd call a liberal. Nevertheless, he's written a scathing column on conservatives' "Reality Problem". He mentions Nate Silver denialism, climate change denialism, and evolution denialism, but this part especially caught my eye:
On macroeconomics, a broad spectrum of economists, ranging from John Maynard Keynes to Milton Friedman, supports the basic premise that recessions are caused by shortfalls in aggregate demand. Economists across the political spectrum agree that the government ought to take action counteract major aggregate demand shortfalls. There is, of course, a lot of disagreement about the details. Friedman argued that the Fed should be responsible for macroeconomic stabilization, while Keynes emphasized deficit spending. 
But rather than engaging this debate, a growing number of conservatives have rejected the mainstream economic framework altogether, arguing—against the views of libertarian economists like Friedman and F.A. Hayek—that neither Congress nor the Fed has a responsibility to counteract sharp falls in nominal incomes.
Basically, Lee is saying that freshwater (or "New Classical") macro is essentially a political shibboleth - an intellectual excuse for conservatives to oppose government action, rather than a serious attempt to model economic reality.

This is a point of view I hear expressed more and more frequently, not just in liberal circles, but in libertarian ones as well. It is an accusation that I myself have been unwilling to make, though I don't rule it out either. If this is becoming the conventional wisdom, it represents serious trouble for freshwater macro. Supporters of that school of thought should sit up and take notice.

What's interesting is that conservatives have long viewed Keynesianism as a thinly disguised Trojan horse for socialism. Suggestions that money is non-neutral, that recessions are caused by demand shocks, that the Fed should try to stabilize output, or that Congress should use fiscal stimulus to fight recessions are often waved away as excuses to redistribute wealth. Now, it seems that mainstream American opinion is concluding the exact opposite - that the modeling of recessions as supply shocks is the more politicized assumption.

The financial crisis probably has a lot to do with this, as does the recession. Prices fell in the crash and grew only slowly afterward, making it very hard to portray the recession as a shortage. The financial crisis itself made it difficult for the current generation to accept the idea - central to freshwater analysis - that markets run smoothly when left to their own devices.

But I must say, freshwater macroeconomists have not gone out of their way to eschew political motivations. Casey Mulligan, a well-known labor economist who claims that government benefits caused the slump, entitled his book "The Redistribution Recession" - an obvious jab at liberals. Conservatives who cite "policy uncertainty" as the root of our woes routinely fail to identify the Debt Ceiling Standoff of 2011 as the high point of uncertainty (as serious scholarly analysis suggests), instead focusing on supposed anticipation of socialist redistribution by the Obama administration. And freshwater economists confronted with the question of "Why did the financial crisis of 2008 occur?" routinely state - in the absence of evidence - that the root cause was government policy encouraging lending to poor people.

All of this does not look good in the eyes of people who are not firmly wedded to the conservative movement. It looks like politicization. And while attitudes and statements like this don't prove that RBC models and the like are political sales pitches for laissez-faire policies, they certainly don't do much to discredit the growing ranks of critics who, like Timothy B. Lee, speculate openly that this is the case.

Freshwater macro has an image problem that it really needs to address. People are whispering, but they're not giggling.

Update: A commented asked "Who are the freshwater people?" I had written a big explanation of this, but deleted it because I felt it was pedantic. Briefly, they are mainstream macroeconomists who think that supply shocks are the main cause of business cycles. This includes RBC theorists like Ed Prescott, Charles Plosser, and much of the Minnesota economics dept. Other famous New Classicals include Robert Lucas and Robert Barro. New Classical thinking appears to be strong at Wash U (Steve Williamson, for example, is there, and his work has a freshwater flavor). Tim Kehoe, Robert King, and Randy Wright are some other prominent New Classicals I know of. The freshwater school is also generally held to include Casey Mulligan and other labor economists who argue that labor supply shocks caused the Great Recession. All in all, the New Classicals are a very powerful faction within macro these days, though not quite as influential as the dominant New Keynesians.

Update 2: I'm definitely not saying that all the people listed above are politically conservative. Some are (Mulligan, for instance). Others may not be; people tell me Steve Williamson is politically liberal. But the image exists...to say the image doesn't exist, I'd have to deny reality. Also, I struck Robert King from the "freshwater" list; he did a lot of prominent work in the RBC field, which is the only work of his that I knew, but it has been brought to my attention that he's done work in the "New Keynesian" area as well. It's very difficult, and usually inaccurate, to assign individual people to these "schools".

80 comments:

  1. Anonymous10:04 PM

    "CATO scholar and Forbes writer Timothy B. Lee is hardly what you'd call a liberal. "

    It's hard to think of any issues where his views are much to the right of Matt Yglesias.

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  2. Anonymous10:09 PM

    I don't think RBC models (and by that I mean the basic Kydland and Prescott sort) were built with a political ideology in mind, but it is true that the assumptions of the model essentially guarantees that no intervention can ever do any good. It's like the platonic ideal of capitalism; perfectly competitive, perfectly rational agents with perfect foresight, no rigidities, stickiness, or frictions, no ponzi schemes, etc. etc. When, by design, everything works perfectly, no policy intervention can make anything any better. I imagine this was done just for simplicity and tractability at first. I think the real issue is that somewhere along the line, people confused the assumption of perfection as proof of perfection.

    But mostly, I just found it silly to have an economics model that didn't something as basic as money or price levels.

    I also found it silly that there was so much hatred for Keynesians when the only big difference between a New Keynesian model and the standard RBC model was that money and prices were added. Of course, that adds nothing to the model unless you add some sort of market "hiccup" (like price-stickiness) so that money and prices actually do something in the model. Maybe RBC theorists don't like that because, by assumption, you're saying something doesn't work perfectly, or maybe because it's too ad hoc, but it never struck me as any more silly than assuming the economy runs perfectly.

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  3. "Freshwater macro has an image problem that it really needs to address. People are whispering, but they're not giggling."

    Agreed. Maybe folks will start paying more attention to us Missouri folk soon.

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  4. First of all, I'm pretty sure conservatives who are referred to in Lee's column don't hold their opinions because they've been blown away by beauty and elegance of Bellman equations in RBC models. Using terms like new-classical or freshwater is not necessary to explain their positions.

    But even if you wanted to so, it might be good to first define what you mean by "freshwater macro". You refer specifically only to two people, Mulligan and Fama, and Fama is not even macroeconomist. Even adding few others (say Prescott, Cochrane, perhaps Lucas) seems rather small sample for such generalizations.

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    1. Read your update. The question remains - do all these people really believe that "neither Congress nor the Fed has a responsibility to counteract sharp falls in nominal incomes."? I don't think so - e.g. Kocherlakota, who can be considered freshwater, now seems to agree that monetary policy should be loose until economy improves. On the other hand you have Mankiw, whose academic contributions were definitely New-Keynesian, yet now falls into conservative camp. Reality is probably more complicated than outdated freshwater/saltwater labels.

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    2. The question remains - do all these people really believe that "neither Congress nor the Fed has a responsibility to counteract sharp falls in nominal incomes."?

      Not sure. This post is about public perceptions. I can't claim to specify the exact beliefs of every member of the "freshwater" school.

      I don't think so - e.g. Kocherlakota, who can be considered freshwater, now seems to agree that monetary policy should be loose until economy improves.

      That is true! Then again, it was considered a pretty big deal that he changed his mind on this. Everybody commented on it.

      n the other hand you have Mankiw, whose academic contributions were definitely New-Keynesian, yet now falls into conservative camp.

      Oh, of course, not all conservative macroeconomists are New Classicals! Fallacy of the converse, even if I weren't just talking about public perceptions...

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    3. The freshwater/salt water distinction was introduced by the very salty extreme conservative Robert Hall. At the time he was arguing that Kemp Roth (the Reagan tax cuts for the kids) was the best thing since sliced bread and advocating a flat tax.

      Now what can explain someone falling for the fallacy of the converse in this conversation ? Someone who can spell correctly too (as far as I can tell which isn't very far). I don't think elementary logic is as difficult as English spelling. I think that the words "liberal" and "conservative" drive people crazy.

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  5. Noah, why hasn't a macro school emerged that acknowledges some recessions are caused by demand-side factors and some are supply-side? Is it just me or does this not seem obvious?

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    1. Wait...the main New Keynesian models all include various supply shocks in their models (Smets-Wouters, for example). It's just that when they calibrate or estimate the models, the supply shocks end up not being very important.

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    2. Well Nick, I'm glad you asked.

      http://somethingcleverish.blogspot.com/2012/11/first-rule-of-fight-club-we-talk-about.html

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    3. I see. From that point is the problem that they are using calibration instead of traditional metrics? That's all we talk about in Clemson.

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    4. Are any recessions caused by supply shocks? I remember scott sumner did a post on this and his answer was no. (at least post WWII)

      But what do we mean by recession anyways? Negative GDP growth? Drop enough bombs on someone and their economy will shrink, doesn't take a macro economist to explain that. I take Nick Rowe's view that a recession is a period where it becomes difficult to sell output but easy to buy it, meaning its a demand side problem with a monetary solution.

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    5. From that point is the problem that they are using calibration instead of traditional metrics?

      Not really. I also happen to think calibration is dumb, but that's a story for another day...

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    6. Recessions which could, perhaps, be caused by supply shocks are pretty damn obvious. They involve a large, visible supply shock, and a bunch of shortages due to the inability of the economy to adjust. Arguably the 1970s stagflation was driven by *OPEC turning off the oil spigot*. It's probably not hard to think of other historical examples.

      Most recessions, however, have no plausible link to supply shocks, including this one and the 1930s one.

      I suppose you could say that these recessions are due to a "lack of supply of money to the poor", which you could construe as a supply issue if you thought of money as a good, but that's what's usually called a demand-side problem...

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  6. Is Stephen Williamson a conservative? I've never read enough of him to pick up his political views.

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    1. Anonymous7:22 AM

      facist accordingly to people who read his blog, at least on inflation, doing anything for the 47%, unemployed, etc.

      attends a meets on saturday Mormon Church (thems the worst) location and memebership of congregation is a secret

      comes from a good family that owned slaves, thus carrying a large chip on his shoulder about the civil war.

      Dreams of reparations for slaves lost, etc.

      has paranoia about inflation. prays for inflation in his lifetime (or actually before his last options on Gold expire, as he has removed all his savings and retirement on bet the farm on inflation before New Years and the next triple witch

      thinks that the FBI plot against the CIA that netted Petraeus is all part of a plan by Obama and Eric Holder to pack the FED and print even more money

      his blog writing broke the spell checker for wordpress, so he had to move blog to another server

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    2. Anonymous10:46 AM

      Nonsense.
      Steve Williamson is Canadian = liberal.
      He is a smart liberal that believes in using the scientific method and economic fundamentals in building macro models.

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    3. mmm...
      But are "the scientific method" and "economic fundamentals" compatible? (Or for that matter "the scientific method" and macro models compatible?)

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    4. Anonymous1:28 PM

      SW is the dullest knife in the drawer

      if he is so damn smart with his models, where is his model that forecast or predicted the Crisis?


      And, why does his fascist forecaster anti-inflation forecaster model keep missing?

      Maybe SW is (1) not smart ; (2) not scientific" and (3) a really really bad model builder.

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  7. BrettM4:49 AM

    I'm a private sector economist (and die hard liberal leftie) but every model I use starts with: "Define a probability space..." and after endless ravings about convexity ends with "... by fixed point theorems equilibrium exists". I follow a very neoclassical microfounded approach and I nearly always end up with Saltwater policy outcomes.
    The model is only as good as the modeller and you can write down a fairly neoclassical (RBC eqsue) model that does pretty much anything you want. The point is choosing a specification that matches real world observations.
    And whats wrong with calibration? I thought you had a physics background!?

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    1. Anonymous12:14 PM

      Any examples? I have seen Noah post on your last question a number of times (so have a look at RBC and calibration posts).

      That said, the main problem I have with calibration is that I can fit a model to match real world observation that can't predict a damn thing. Point being, matching real world observations is not a very good indicator of a good model.

      Prediction is the ultimate test. Problem is that you cant always check the predictions because if what is being predicted is not very concrete, well then your out of luck. However, the performance of RBC predictions (for the most part) has been, shall we say, lackluster since about 2007.

      At this point, I find RBC defenders sound a lot like Gallup and Rasmussen when their election predictions are compared to Sam Wang or Nate Silvers for example.

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    2. And whats wrong with calibration? I thought you had a physics background!?

      Well, OK, what I really have a problem with is testing hypotheses suggested by the data...you take some data, make a model, calibrate the parameters of the model, and then call it a day...No, calibration by itself is not dumb, you just need some way to see if the model actually fits reality.

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    3. BrettM2:53 AM

      Surely calibration is pointless exercise unless you test against reality? Although I do conceed that this is not always the case in in academic economics- a fact that always worries me.

      And for exmaple my PhD (soon to be complete I hope) demonstrates that redistributative tax can increase financial stability (by reducing incentives to borrow, thereby defaults and borrowing premium). It's by no means a neoclasical model but it draws from their tool kits extensively.

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  8. Anonymous9:49 AM

    Being a U of M grad, where does their econ department fall? RBCs, New Keynsians, or some other type on your bestiary? ;)

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    1. If by U of M grad you mean Minnesota, I consider them almost a school of their own. They've been influenced by Chicago, but they do things their own way.

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    2. U of M (University of MICHIGAN, thank you very much) is kind of in the middle of the "freshwater/saltwater" divide.

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    3. Probably a pretty sweet place to go to grad school

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    4. If you don't mind 5 months of snow every year.

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    5. Anonymous12:01 PM

      Noah:

      Yeah, Michigan is what I meant. ;)

      That was my impression as well; they had a even mix of fresh and salty, a Marxist, and perhaps an Austrian (?)...

      More like three months a year, since it does rarely snow in November and March, but I guess just the mere chance of snow can be a bummer to some...

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  9. Here is what appears to be a dead school in terms of academia:

    http://en.wikipedia.org/wiki/Carnegie_School

    My viewpoint is once one of your adherents is given a Nobel you get a school named after you.

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  10. As others have noted, I think it is unfair to lump Williamson along with the other conservatives you listed. I recall reading on his blog that he is a Democrat. And he has big problems with the anti-science stance of the GOP. He wrote one blog where he totally ripped into Rick Perry and the GOP presidential candidates.

    Noah, can you explain what Williamson means when he says he is a 'New Monetarist'. Because I've never been able to distinguish him from a RBC theorist.

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    1. Don't ask Noah to explain to you what I think, or what I do. I don't think he has a clue. More cluelessness:

      "Briefly, they are mainstream macroeconomists who think that supply shocks are the main cause of business cycles."

      That sentence would cause Ed Prescott to scream in agony. "Supply shock" or "demand shock" is language associated with an undergraduate paradigm that some people find useful. The language is not useful for describing anything that Prescott did or does.

      Noah seems to think the people he mentions are all wedded to some neoclassical competitive equilibrium growth model. Randy Wright and I like to think about monetary and financial frictions, how monetary policy works, etc. Plenty of room for the government to matter there. Bob King has done work on sticky price models - he's famously Keynesian, if you keep up with things. If modern macroeconomics has an image problem, it's because people like Noah don't take the time to understand it before they spout off in public.

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    2. I didn't say Williamson was conservative. I just listed him as a "freshwater" macro guy. Remember, this post is about public perceptions that freshwater macro is a screen for conservative politics.

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    3. Steve, are you mad?

      That sentence would cause Ed Prescott to scream in agony. "Supply shock" or "demand shock" is language associated with an undergraduate paradigm that some people find useful. The language is not useful for describing anything that Prescott did or does.

      ??? Can you think of a better term to group together "technology shocks", "shocks to workers' preference for leisure", and "shocks to taxes"? Sorry for speaking loosely, but it is a blog, you know.

      If modern macroeconomics has an image problem, it's because people like Noah don't take the time to understand it before they spout off in public.

      I'm flattered, but somehow I don't think the public gets its perceptions from my little blog here...I get like 4000 hits a day, that's peanuts...

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    4. Anonymous1:22 PM

      SW writes that we, the great unwashed, "don't take the time to understand it before they spout off in public."

      Sorry, but I have been reading you blog since you started in April 2010, your first writing being on April Fools Day and have not really learned anything not obvious to those of us with a good 1978 understanding of economics.

      Your second post ended, "To have some ignoramus with a Nobel Prize telling the world you are an idiot doesn't go down well."

      Since that time I have learned the following about SW.

      1) Since the Big Bang he has been predicting inflation (the ultimate bubble) using an economic model that he proudly claims cannot predict bubbles

      2) He has never explained why he can predict inflation bubbles without a model.

      3) He has never been able to offer any insight into what anyone, private or public, should do about the Crisis, but he constantly claims that he is smarter than Bernanke, the rest of the Fed, all other economists, and the worst offenders, some with or near the Fed who changes their mind. He blog is a running, so and so is stupid . . . .

      4) Anyone who has done anything about the Crisis (President, Sec. Treasury, Congress, reg agencies, the Fed, etc.) have been wrong, making him the most conservative voice in America.

      5) Delong has at least twice shown him to be the second dumbest person in America.

      6) He has even attacked Mark Thoma who by reputation is a really nice person

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    5. I've been to his blog and politely commented. Never again.

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    6. I've been to his blog and politely commented. Never again.

      Yes, Steve is pissed off. But think about it from his point of view. You work your whole life in a field, attain a reasonably high level of success and prominence in that field, and then after all that, a bunch of punk journalists and young upstarts start squawking in the media that all your work (which they haven't even read) is crap, what you're doing is not even science, and that you are probably motivated by political hackery as well. You start a blog to defend your field from its most high-profile critic (Krugman), and you are promptly assailed by the usual swarm of anonymous comment trolls (which tends to astonish and disgust anyone from a pre-internet generation especially).

      You'd be pissed off too!

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    7. Anonymous8:59 AM

      Noah

      Good insights, but a point must be added.

      SW is a big defender of Lucas. Before the crisis Lucas famously lied and said Macro was a science and that there would be no more depressions. SW was part and party to that misrepresentation.

      Now, it turns out that macro isn't a science. Maybe someday, but not yet. What galls everyone about SW is that he is right when he says we have lots to learn about causes, what to do, etc., which is completely inconsistent with his claims that macro was healthy before the crisis, and he defends macro while claiming that its models shouldn't be expected to see bubbles.

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    8. Stephen Williamson has a great blog. There are only a few other bloggers on the net who I've learnt more from. That doesn't mean I agree with it all. But it's worth putting up with SW's grouchy streak so you can soak the theory up.

      I'm not strong on theory, but I'm pretty good with the minutiae of how the Fed and other central banks work. SW is one of the only monetary econ bloggers who can keep up with minutiae.

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    9. I agree! I like Steve's blog a lot.

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  11. If you conducted of survey of "educated" political operatives and journalists whether they favored unhampered free trade or some sort of interventionist policy, I'm guessing over 90% favor the latter. Does that mean Ricardo, with his insights into comparative advantage, was a political hac?

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    1. No.
      It's just that most people don't consider the assumptions behind Ricardo's work, and why they may not always be satisfied.

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    2. Although thinking about it - you could well argue Ricardo WAS a political hack. At least it is debatable.

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    3. This slander against Ricardo will not stand! The fact that Ricardo was not a hack was demonstrated by a change that he made to the second edition of Principles. In the first, he had argued that although the introduction of machinery caused some workers to lose their jobs, it increased social wealth enough to employ them in other sectors. After reading a pamphlet by a critic whose name escapes me, he altered his opinion. This shows that he was no hack.

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    4. Ricardo wasn't a hack, but he was somewhat pre-scientific. He altered his views when he got new information, but he avoided actual empiricial work...

      ...and apparently, according to what I've read, there is little or no empirical evidence for the theory of comparative advantage (as opposed to absolute advantage)! Interesting, eh?

      It turns out that countries, on the whole, do *not* overspecialize in a single field; if one country has an absolute advantage in two fields, it keeps doing both of them. A country may, indeed, continue to operate factories in a field where it does not even have an absolute advantage, and this seems to frequently be a long-term benefit.

      Countries which overspecialize in one field thanks to "comparative advantage" theories end up in economically poor positions because they are extremely fragile when technological or social changes cause demand changes.

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  12. By the way the title of Casey Mulligan's book is really funny. Because in a way it is correct (just not the way he means). Because, before this depression and the Great depression there was a lot of Redistribution - upwards.

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  13. The economist on Casey Mulligan:
    http://www.economist.com/blogs/freeexchange/2009/01/casey_mulligan_is_a_brilliant

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  14. Anonymous2:30 PM

    Noah, you are completely right. I don't know about the general public but as a member of scientific community in one of the hard sciences, I can say that in our department, there are some people who read about macro as a hobby and we all agree with your description of freshwater macro. We don't consider it as a part of scientific literature anymore and only see it as political hackery.



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    1. ecolode8:55 PM

      I went to an Edward Prescott presentation a few years ago and he said macroeconomics is now considered one of the hard sciences. :)

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    2. ecolode

      Was the presentation at a Comedy Club ...

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  15. What if your Recession isn't "caused" by shortfalls in aggregate demand but rather by perversions of credit and valuation that then in turn create panic AND THEN shortfalls in aggregate demand.

    Any reasonable person gets that the government can have a constructive roll in helping demand, but what if it does so in such a way that continues to pervert the credit reality?

    I'm not trying to argue, so much as complicate.

    This is perhaps a "information moral hazard take" on the situation.

    And if you say I'm conflating Easing with Stimulus, yes I am.


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    1. What if your Recession isn't "caused" by shortfalls in aggregate demand but rather by perversions of credit and valuation that then in turn create panic AND THEN shortfalls in aggregate demand.

      I think that's what most of the "aggregate demand" people believe. The "demand shock" is usually a financial shock.

      Any reasonable person gets that the government can have a constructive roll in helping demand, but what if it does so in such a way that continues to pervert the credit reality?

      Well, this is the "Austrian" critique of countercylical policy, and I think there's something to it...look at the zombie companies in Japan, kept alive only because banks can get such cheap money, whose existence crowds out new entrants who would be able to pay banks higher rates of return, which in turn keeps growth low and forces the Bank of Japan to keep interest rates ultra-low forever...

      And if you say I'm conflating Easing with Stimulus, yes I am.

      Well, I think most people do these days...

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    2. Right

      I guess the question can be put in terms of the balance between
      structural damage caused by by "Demand shock" to the eceonomy/labor force VS information distortion/credit addiction.

      It seems fairly clear when we need to stimulate, but what about when we need to tamp down on credit or information bloat?

      Japan is an excellent case study.

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    3. Noah,
      my view of this is that the Austrian is wrong headed - not because it talks of financial distortion - but because it tries to interpret this financial distortion as a real phenomenon. Austrians don't really have a realistic model of the financial sector any more than neo-classicals do.

      My own policy take, is the Davyde is on the right path, but still missing something. I think YES - we shouldn't have just bailed out the financial sector, we should have temporarily part-nationalised the bankrupt parts of the financial sector, throwing out their management - letting bondholders and shareholders take a hit - and we should have bailed out mainstreet (preferably in my view with some sustained transfers and also infrastructure investment). But going forward, we should have a policy mix which targets a somewhat looser fiscal policy - partly financed direct from the central bank (yes - printing money), but tighter monetary policy. We need a higher proportion of money to be base money, and less private debt. Nobody seems to be explicitly embracing this conclusion, but some seem to be edging in this direction. Growth that requires ever higher rates of private indebtedness, is not sustainable - and the alternative (e.g. German) of neo-mercantilism is impossible for every country to do simulaneously. Basically the USD system has worked until the US became excessively indebted. Now that it has failed we need a more balanced system.

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    4. P.S.
      Note that my policies imply a governmental wealth transfer to offset the huge relative net wealth change that occured during the financial crash.
      http://economistsview.typepad.com/economistsview/2012/11/net-wealth-shock-in-us-by-net-worth-percentile.html
      Redistribution needs to stop being a dirty word. Sometimes its needed in order for the world to work properly again.

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    5. "Any reasonable person gets that the government can have a constructive roll in helping demand, but what if it does so in such a way that continues to pervert the credit reality?"

      This is what "institutional economics" is for. Studying how to create institutions which are *not* corrupt, *not* perverted, well-functioning, etc.

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  16. I suppose the more nuanced posts don't solicit enough comments, so here Noah goes again with another post that contains provocations and false statements.

    For example, we read that "freshwater macroeconomists" are people who believe that recessions are driven by supply shocks. Then, we read that Robert Lucas is one of them. So logic should lead us to conclude that Lucas also believes that recessions are caused by supply shocks. Then comes reality.

    In his paper "Expectations and the Neutrality of Money" published in 1972 in the Journal of Economic Theory, Lucas shows that changes in the supply of money (a demand shock) can affect output and employment even without the Keynesian assumptions of money illusion or price stickiness. So, contrary to what is implied, Lucas is going out of his way to show that money can be non-neutral in the short run even under a broader set of assumptions. Noah should know this; Lucas won the Nober Prize in part for this contribution. Plus, it is not his only paper with a similar theme. See, for example, his 1994 paper with Michael Woodford (not exactly someone you would call New Classical) here: http://www.columbia.edu/~mw2230/RealEffectsWoodfordLucas.pdf

    Since Steven Williamson has addresses Noah's reference to Robert King and others, I don't see a need to go further. The point is that anyone who reads Noah's posts on macroeconomics will end up with a very distorted view of what the people he mentions are all about. This is unavoidable given his effort to fit scientific research, usually messy and often contradictory, into neat little boxes. The problem is, Noah should know-ah better!

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    1. This is unavoidable given his effort to fit scientific research, usually messy and often contradictory, into neat little boxes.

      True, and even harder to fit specific researchers into neat little boxes.

      You have a point about Lucas...but check out this recent Lucas presentation and you'll see what I mean. Also, Lucas definitely never intended his Islands model to apply to the Depression, which he admitted he couldn't explain. I will let Robert Waldmann say more about this if he is reading these comments, since he knows much more about Lucas than I do.

      The problem is, Noah should know-ah better!

      OK that was groan-worthy...

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    2. Noah, I read the presentation. I still don't see any substantiation of your claim. Lucas clearly attributes both the Great Depression and the Great Recession to demand factors. Now, one may disagree with his conclusion that private spending remains depressed because of the fear of a government expansion (my guess is that the fiscal cliff and the European crisis have more to do with it). But it certainly is a demand story.

      P.S. OK, OK, sorry about the punch line.

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    3. Is "policy uncertainty" a demand story? Seems more like a tax wedge to me - you're basically taxing risk capital - but I could be wrong, since I haven't seen an explicit model of uncertainty-driven business cycles.

      But it's hard to argue with the observations that A) Lucas is commonly associated with the freshwater school, and B) his attribution of the recession to Obama Socialism is clearly conservative politicking.

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    4. I suppose the more nuanced posts don't solicit enough comments, so here Noah goes again with another post that contains provocations and false statements.

      Also, this is silly...if I want comments (and, more importantly, pageviews), I can just write columns for the Atlantic. One Atlantic column generates more pageviews than a month's worth of Noahpinion posts.

      Yes I want to be provocative, but not for the sake of attention. It's to get people outside econ departments to sit up and take notice of what would otherwise be a dry academic debate.

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    5. "I haven't seen an explicit model of uncertainty-driven business cycles."

      There are several recent papers incorporating uncertainty shocks, the most known is probably by Bloom and coauthors. The problem is that in all such models, increases in uncertainty are simply exogenous shocks, so any interpretation about whether uncertainty is caused by bad policy, by democrats or republicans lies outside the model.

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    6. "It's to get people outside econ departments to sit up and take notice of what would otherwise be a dry academic debate."

      Fine, but if you are doing it for the benefit of these people you should be more careful of how you present the issues. At least that's my humble opinion.

      As for a tax wedge, is this a demand or a supply factor? Neither "curve" shifts, you slide along both of them. And what if it is a response to an expectation of a future tax? Williamson is right that the distinction between demand and supply is simplistic and merely pedantic. What I see instead is models where all markets are in equilibrium, models where at least some markets are in disequilibrium because prices are sticky, and models where some markets are in disequilibrium because of frictions. How does all that fit in the "freshwater" vs. "saltwater" narrative? My opinion is, not at all!

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    7. Fine, but if you are doing it for the benefit of these people you should be more careful of how you present the issues. At least that's my humble opinion.

      We should discuss this more over dinner...you're in Long Island, right? Come down to Stony Brook!

      As for a tax wedge, is this a demand or a supply factor? Neither "curve" shifts, you slide along both of them.

      No, not really, but a tax wedge should raise after-tax prices, so it should look like a supply shock.

      And what if it is a response to an expectation of a future tax?

      Then it should look more like a productivity news shock.

      And yes, I realize that the idea of news shock models is that they can replace sticky-price type models, but from what I've seen they haven't been so good at that yet.

      What I see instead is models where all markets are in equilibrium, models where at least some markets are in disequilibrium because prices are sticky, and models where some markets are in disequilibrium because of frictions.

      I don't see this as a natural division, since A) sticky prices are a friction, and B) equilibrium/disequilibrium is a confusing concept unless time scales are specified.

      I think the real difference is: Are recessions departures from Pareto efficiency (i.e. market failures), or not?

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    8. A tax wedge will raise the after-tax price in the market in which it is imposed, but what about other markets? For example, how would a tax on financial transactions affect the overall price level?

      If I remember correctly, in Lucas' model of imperfect information recessions do result in efficiency losses. But I think the real issue is whether nominal shocks can have real effects or not. Let me elaborate a bit (for the benefit of anyone else who may still be reading this post).

      If prices do adjust quickly to changes in demand then it is hard to explain why changes in nominal spending would affect production. Lucas' suggestion was that each producer mispercieves the drop in nominal spending caused by the decrease in the money supply as a drop in the demand for their product only. Since they falsely believe that their product has become less valuable relative to other products, they cut production. If everyone does this, GDP declines. So there is a role for monetary policy: central banks should restore the money supply. However, if I interpet Lucas' comments about the current recession correctly, his problem with his own theory is that the Fed has done exactly that. Moreover, by now producers should be aware that the decrease in spending is not specific to their product. So the only remaining suspects are real shocks (as in RBC models), like changes in the cost of production, or fiscal shocks (e.g., tax increases) that affect people's decision on how much to work, how much to save, how much to invest, etc. This is why Lucas is looking there.

      If prices are sticky (new-Keynesian models) then it is much easier to explain why nominal shocks may have real effects. If firms cannot lower prices following a drop in demand, they will have to lower production. In this case there is a role for both monetary policy and fiscal policy (e.g., increased government spending to offset the drop in private spending). But even in these models real shocks do affect production, and tax increases do have a negative impact on GDP (through different channels than in equilibrium models). Thus, Lucas' suggestion is also consistent with a New-Keynesian view of the world. At the same time, Williamson and others have been asking an important question. Well how long does it take firms to print those damn new menus and adjust prices? Shouldn't this adjustment be over by now?

      Finally, you have models with other frictions, like asymmentric information, costly search, etc., but not necessarily sticky prices. In this case markets do not move to equilibrium because mutually beneficial trades are hard to identify and therefore not always exploited. In this case nominal and real shocks can affect production. And fiscal policy may be effective in neutralizing these shocks, depending on certain assumptions. However, most economists working on these types of models prefer to emphasize a different role for the government. They focus on market design and regulation as ways of reducing frictions and imrpoving the functioning of markets. I think this is where Williamson falls into.

      Anyway, yeah, let's get together, especially if you are staying in the area for Thanksgiving.

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    9. A tax wedge will raise the after-tax price in the market in which it is imposed, but what about other markets? For example, how would a tax on financial transactions affect the overall price level?

      A tax wedge is a negative shock to long-run aggregate supply, so a simple AD-AS reasoning says it should raise the price level.

      If I remember correctly, in Lucas' model of imperfect information recessions do result in efficiency losses.

      Relative to the perfect-info equilibrium, yes. Not sure about whether monetary interventions can raise welfare, though. And Lucas spent lots of time arguing that business cycles don't cause big enough welfare losses to worry about.

      At the same time, Williamson and others have been asking an important question. Well how long does it take firms to print those damn new menus and adjust prices? Shouldn't this adjustment be over by now?

      It's a good, important question, and in fact that is why I always say "Nobody really understands how demand shocks work"...

      Finally, you have models with other frictions, like asymmentric information, costly search, etc., but not necessarily sticky prices. In this case markets do not move to equilibrium because mutually beneficial trades are hard to identify and therefore not always exploited. In this case nominal and real shocks can affect production. And fiscal policy may be effective in neutralizing these shocks, depending on certain assumptions. However, most economists working on these types of models prefer to emphasize a different role for the government. They focus on market design and regulation as ways of reducing frictions and imrpoving the functioning of markets. I think this is where Williamson falls into.

      Pretty much.

      BTW my email is nquixote@gmail.com !

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    10. In hysterisis models an AD shock is also a shock to long-run AS. But it is still a demand shock. A tax on profit may reduce the capital stock in the long-run, but in the short run it also drives invesment spending down (AD shock). Things are not as clear-cut.

      I think Lucas says that in comparison to the importance of long-run growth, and because losses in GDP during recessions are offset by gains during booms. On average, and for most recessions I would agree with him. The 1991 and 2001 recessions are minor hiccups in the economic history of the last 25 years. However, the losses during recessions are not equally spread among individuals. And this is an even bigger problem during big recessions like today's. So I do think they deserve more attention than what Lucas would prefer. At the same time, I am a growth theorist. :)

      Will email you soon.

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  17. Do we know that Mr. Lee was referring to freshwater? Or might he be referring the seemingly growing popularity of "Austrian?"

    Or do I not understand how those things fit together?

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  18. Enough of all this acrimony against modern macroeconomics and it real busines cycle version. I have the impression a whole lot of people are frustrated nowadays by our economic situation, and there's a tendency to seek scapegoats.Macroeconomics is bloody hard. The interaction of millions of agents is hard. Predicting crises is even harder. Believing it's easy to solve these problems just by some mechanistic fiscal multiplier or other or the central bank changing the average maturity of government debt is frankly ignoring all the complexity of the macroeconomy, and the myriad of small, hard to control or observe, private sector interactions that make it up. Meanwhile an RBC model just means a model in which only relative prices of things matter. Modern RBC models can have 5 or 6 different channels for financial shocks like the one of 2008 to matter. And none of these effects have anything to do with sticky prices (or anyways not sticky prices that actually affect real aggregate outcomes:situations where both prices and production are sticky due to long term contracts or habitual purchases don't generate the aggregate behaviour postulated in sticky price keynesian models), nor do they deliver a phillips curve (which has been quite misleading lately because we still haven't seen the big deflation predicted by many keynesian models), and they don't justify government spending multipliers above 1 that are needed to make argue that any random government spending progress will both increase GDP and private activity levels. How come none of these in the end quite plausible effects are even discussed by your typical Keynesian analysit? Please stop associating real business cycle models with just the initial Ramsey model with stochastic productivity. They're about a lot more than this. And yes, in general they make you more skeptical about the ability of governments to smooth out business cycles. But what if government really is much better at solving less glamorous micro problems and income distribution issues 1 issue at a time, as opposed to the big problem of recessions (I'm thinking the micro development people from MIT who are so popular these days could support this position).What if government programs to alleviate a recession really are much more complicated than dy/dg>1? Maybe what really matters is how exactly you target government transfers in a recession to certain groups or you implement your bank recapitalisation in a certain specific way? I don't get this sense from most of the pro fiscal stimulus/anti austerity commentators at all. And what if we really did want to take into account all the psychological biases and behavioural stuff but it' damn hard while taking into account macro interactions and almost no one does? And no, writing down some old style simultaneous equations which have some right hand side variables you think are plausible while potentially ignoring tons of other things is not more realistic, it just increases the chances you're actually missing something important. So I don't see how the CBO or private sector macro forecasting model people seem to like to rely on are doing any better anyways. Meanwhile, DSGE modelers, with those using RBC models maybe more than others (because they can focus on modelling real variables without the extra complication of the Phillips curve and central bank interest rate rule equations), have been busy analysing how to model and capture financial issues to death in recent years. And, all we can talk about is how the old 1970's or 80's classification of fresh water or saltwater macro reflects ideology? (and I'm not saying Keyenesian price rigidity doesn't matter- heck in work with a model that says it does, and I have no problem doing so, just that there's more to RBC models than frankly facile,superficial critiques would have you believe ).

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    1. Anonymous12:00 PM

      Macroeconomics is bloody hard. The interaction of millions of agents is hard. Predicting crises is even harder.

      This is SW mendacity, at its worst. If you believe what you have written, then you would want the head of Lucas on a pike.

      Remember, Lucas said macro economics was easy and that we had the answers and there would be no more depressions, implicitly and tacitly representing that the models would predict a crisis.

      Thus my beef with SW, etal is with the mendacity of maintaining two different positions at the same time. First, you saw it is hard and we don't know. Then, they turn around and say that, in the case of SW, my models work and I can see the bubble of inflation, which he has been saying for 5 or 6 years.

      If intellectually honest, SW et al would just say, "We don't know, have no idea."

      It is the lack of honesty which is the core part of the fresh water part of Macro.

      As for the print money crowd, no one thinks that are absolutely right, but they are honest and you know where there are coming from and the assumptions they are making.

      I don't think printing money would ever work for Obama, for he doesn't yet get the confidence/vision thing. But Obama's known shortcomings doesn't justify how SW and others go after Krugman

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  19. Navid7:39 PM

    In the field of congestion control, there are totally stupid algorithm that work amazingly well and there are algorithms with nice, neat theory that are $%# in practice. (e.g., one of the most famous one is to just randomly through away the received data). We however, understand that The second group are just intellectual curiosity and nothing more.

    My perception of freshwater guys is the people who are stock at the nice, neat theory and do not care the practice. Is there political hackery behind this. I don't know and honestly don't care. They are dangerous to the economic discourse of the world either way and they should be stopped.

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  20. I'd name Lars Hansen and Thomas Sargent as two fresh water economists who are politically left of center.

    There are also extremely conservative salt water economists notably including Robert Hall, the guy who came up with the phrases "fresh water" and "salt water." I think his point was that you don't have to be fresh water to be a conservative.

    But the correlation is strong.

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    1. I think his point was that you don't have to be fresh water to be a conservative.

      That is absolutely true. Nor do you have to be a liberal to be a Keynesian (Mankiw!).

      I'm just talking about the public perception, which has shifted against the freshwater school...

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    2. Robert - Noah asked for your expertise on Lucas earlier in the thread. Did you see that?

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    3. Mankiw's extraordinarily dishonest, intellectually, for a "Keynesian".

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  21. Lulz4l1f37:32 AM

    Good. Reputations are earned.

    I am seriously considering becoming a kind of political activist. Not a Democrat, not a Republican, but an advocate for Rationality, Reality, and Data.

    Now, it's probably clear that one major political party more than the other has inspired this idea, and it may sound quixotic to some, but I think a "Reality bias" has the virtue of not being tied to a partisan agenda while not being tied to Fake Neutrality like pretending that particular policy positions of the parties might be equally flawed and other false equivalencies.

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    1. Oh, it's a good idea. If you do this, though, you'll find your main enemies are religious organizations. Watch out, they're powerful.

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  22. Lee responds, saying he's not talking about New Classicals but "internet Austrians".

    I watched Mulligan's video, and he said he thinks it's about 1/3 (or maybe it was 1/4) aggregate demand because non-labor inputs also dropped with output in certain industries, which seems a drastic underestimate to me but still allows it as a theoretical possibility.

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