Category: Equitablog

Understanding the importance of household credit in high-income economies

Posted on by Emilie Openchowski
A new working paper discusses the importance of household debt in the overall cycle of the economy.

In the wake of the Great Recession, it was clear that policymakers and economists alike needed to pay more attention to household debt. The dramatic rise in household debt prior to the recession was, to some at the time and everyone in hindsight, a dangerous sign for the U.S. economy. A decade after the recession began, two economists have pulled together research on household credit and spending to get a better understanding of the forces that drive both expansions and recessions.

Economists Atif Mian of Princeton University and Amir Sufi of the University of Chicago recently released a working paper pulling together the evidence for what they call the “credit-driven household demand channel.” In the paper, Mian and Sufi present the case for the importance of changes in the flow of credit to households in understanding the overall cycle of the economy. The Great Recession is a particularly powerful example of this channel, but the two economists show that the channel played out in Europe and in the United States during the 1980s and 1990s, as well as in the first decade of the 21st century.

Mian and Sufi lay out three “pillars” for the channel. The first is that the expansion of credit to households is due to forces unrelated to changes in technological growth or income growth for households. In other words, the expansion in credit comes from lenders being more willing to lend out money to households, but has nothing to do with their expectations of higher overall economic growth or individual incomes. So, why do lenders increase the supply of credit in these cases? The research isn’t definitive yet, but Mian and Sufi point toward the “global savings glut” and higher economic inequality within the United States as the “financial excesses” that lead to more saving and then more lending.

The second pillar relates to “household demand.” Credit could expand, but its impact on demand and the business cycle depends on where that credit ultimately flows. If it ends up going toward businesses, then that might spur investment and increase productivity growth and the long-run potential of the economy. But what Mian and Sufi, along with their co-authors, find is that in high-income countries, the credit doesn’t go to business but rather to households. The result is that households increase their demand, boosting housing prices, inflation, wages, and employment in nontradable industries such as construction. The credit-driven boost in household demand creates an economic boom.

The researchers’ third pillar holds that household a credit-and demand-driven boom creates the conditions that will make the inevitable recession particularly painful. Once credit starts drying up, the increased indebtedness of households means that consumption in the economy drops dramatically. The higher wages in the nontradeable sector (such as construction) make it harder for the labor market to adjust to this reduced amount of demand. The severity of and potential response to the recession is due to the forces that created the boom before it. In this way, the credit-driven household demand channel means economists and policymakers have to consider both the expansion and the recession together.

What would paying attention to this new channel entail for policy? First, policymakers should be vigilant about increases in household debt. Large increases in household debt, particularly over a short period of time, appear to be a good indicator of a looming recession and a nasty recession. Secondly, a breakdown in the channel may explain why the very low interest rates since the Great Recession haven’t been as stimulative as many expected. If the previous boom was due to credit-driven demand and households are still trying to recover from the last run up in household debt or if the financial sector isn’t as willing to lend, then trying to use credit to boost demand might not be so effective.

The Great Recession revived interest in the sources of fluctuations in the economy. In this new paper, Mian and Sufi present a new approach to this question that puts households and credit at the heart of the story. It’s a story well worth paying attention to.

Should-Read: Simon Wren-Lewis: Labour’s embrace of a customs union could end the Brexit fantasy

Posted on by Brad DeLong

Should-Read: If British politics were even a quarter rational, Brexit would now be quietly forgotten by everyone. But British politics—like U.S. politics—is less than a quarter rational. Brexit in name only—which means that Britain is to some degree ruled from but has no influence on Brussels—seems to be where both the Tories and current Labour are going: Simon Wren-Lewis: Labour’s embrace of a customs union could end the Brexit fantasy: “The UK was always going to stay in a customs union with the EU the moment that the EU put the Irish border as one of the three items to be settled at the first stage…

…The EU would not sign any trade agreement which resulted in a hard border. To avoid a hard border Northern Ireland has to be in a customs union with the EU and in the Single Market for goods. There is no wish in the UK to have a sea border between Northern Ireland and the rest of the UK. Parliament will not allow a No Deal Brexit. So any deal will have to involve the UK being in the Customs Union…. Labour triangulating over Brexit… support[ing] staying in a customs union….

Labour’s move could start to unravel Brexit…. The emphasis that Labour put on avoiding a hard Irish border requires staying in the single market for goods. If this is helpful for goods, why not services which are the UK’s comparative advantage? We need doctors and nurses from the EU to save our NHS. Each time we take a step further to BINO (Brexit in name only) it becomes clear it is better to have a seat at the table. This is the only way that Brexit can end…

Who becomes an inventor in America? The importance of exposure to innovation

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02272018-WP-inventor-america-exposure

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Authors:

Alex Bell, Ph.D. Candidate in Economics, Harvard University
Raj Chetty, Professor of Economics, Stanford University
Xavier Jaravel, Assistant Professor of Economics, London School of Economics
Neviana Petkova, Research Economist, Office of Tax Analysis, US Treasury
John Van Reenen, Gordon Y Billard Professor in Management and Economics, Massachusetts Institute of Technology

Abstract:

We characterize the factors that determine who becomes an inventor in America by using deidentified data on 1.2 million inventors from patent records linked to tax records. We establish three sets of results. First, children from high-income (top 1%) families are ten times as likely to become inventors as those from below-median income families. There are similarly large gaps by race and gender. Data on test scores in early childhood suggest that differences in innate ability explain relatively little of these gaps. Second, exposure to innovation during childhood has significant causal effects on children’s propensities to become inventors. Growing up in a neighborhood or family with a high innovation rate in a specific technology class leads to a higher probability of patenting in exactly the same technology class. These exposure effects are gender-specific: girls are more likely to become inventors in a particular technology class if they grow up in an area with more female inventors in that technology class. Third, the financial returns to inventions are extremely skewed and highly correlated with their scientific impact, as measured by citations. Consistent with the importance of exposure effects and contrary to standard models of career selection, women and disadvantaged youth are as under-represented among high-impact inventors as they are among inventors as a whole. We develop a simple model of inventors’ careers that matches these empirical results. The model implies that increasing exposure to innovation in childhood may have larger impacts on innovation than increasing the financial incentives to innovate, for instance by reducing tax rates. In particular, there are many “lost Einsteins” – individuals who would have had highly impactful inventions had they been exposed to innovation.

Should-Read: Katharine G. Abraham and Melissa S. Kearney: Explaining the Decline in the U.S. Employment-to-Population Ratio: A Review of the Evidence

Posted on by Brad DeLong

Should-Read: A finding that robots are becoming important. And I would question whether increased disability is cause or effect here. They say “cause”: I am not sure why: Katharine G. Abraham and Melissa S. Kearney: Explaining the Decline in the U.S. Employment-to-Population Ratio: A Review of the Evidence: “Within-age-group declines in employment among young and prime age adults have been at least as important…

…Labor demand factors, in particular trade and the penetration of robots into the labor market, are the most important drivers of observed within-group declines in employment.

Labor supply factors, most notably increased participation in disability insurance programs, have played a less important but not inconsequential role. Increases in the real value of the minimum wage and in the share of individuals with prison records also have contributed modestly to the decline in the aggregate employment rate.

In addition to these factors, whose effects we roughly quantify, we also identify a set of potentially important factors about which the evidence is too preliminary to draw any clear conclusion. These include improvements in leisure technology, changing social norms, increased drug use, growth in occupational licensing, and the costs and challenges associated with child care. Our evidence-driven ranking of factors should be useful for guiding future discussions about the sources of decline in the aggregate employment-to-population ratio and consequently the likely efficacy of alternative policy approaches to increasing employment rates…

Should-Read: Ramesh Ponnuru and David Beckworth: Federal Reserve’s Monetary Policy & Economic Reaction

Posted on by Brad DeLong

Should-Read: But where in the Republican coalition is there a faction that wants to learn from history? If they learned from monetary history, they would presumably have to learn from other kinds of history as well. And would that not require that they learn inconvenient things?: Ramesh Ponnuru and David Beckworth: Federal Reserve’s Monetary Policy & Economic Reaction: “In practice, the Fed’s current inflation target is asymmetric: The Fed is less concerned about undershooting it than overshooting it…

…A commitment to stabilize spending growth should in contrast be symmetric. Achieving symmetry would require an abandonment of the Fed’s current policy of paying banks more for holding excess reserves than they could earn from lending and buying Treasuries…. The Fed is unlikely to take any of these steps, however, unless it first jettisons the conventional wisdom about our allegedly hyperstimulative policies over the last decade. It should get our recent history right, lest it condemn us to repeat it…

Should-Read: Zachary Torrey: TPP 2.0: The Deal Without the US

Posted on by Brad DeLong

Should-Read: I could not enthusiastically support—I could barely support—the old TPP: it charged poor countries too much through the nose to use U.S.-located intellectual property, for little if not negative benefit to the median U.S. citizen and for substantial harm to world economic growth. This new CPTPP is significantly better, and I can enthusiastically endorse the U.S.’s joining it on its present terms: Zachary Torrey: TPP 2.0: The Deal Without the US: “What’s new about the CPTPP and what do the changes mean?…

…The new Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) is still a powerful pact in its own right… includes all the original members of the TPP except the United States: Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam. The total combined gross domestic product of the CPTPP would be $13.5 trillion or 13.4 percent of global GDP… one of the biggest trade agreements in the world…. When Trump withdrew from the TPP he also withdrew two of the most controversial provisions for which the United States had been advocating. One of the most ridiculed provisions in the TPP, the investor-state dispute settlement (ISDS) provision, has been scaled back while a government’s right to regulate its markets has been afforded increased protections. This was only possible after the United States withdrew…. Another key provision the United States pushed for that has fallen to the side is the extension of copyright, or intellectual property, protections. Washington had negotiated for copyright to exist for the author’s lifetime plus an additional 70 years…. The removal of these two provisions highlights what happens when the United States is not involved in regional affairs: the region moves on without it….

Washington could rejoin the agreement…. Far from being dead, the CPTPP perhaps signals a new chapter in global trade, one without the United States…

Should-Read: David Vines and Samuel Wills: rebuilding macroeconomic theory project: an analytical assessment

Posted on by Brad DeLong

Should-Read: Once again: I believe this fundamentally misconceives the origins and the utility of New Keynesian models. There are things that they are good for. But there are things that they are not good for. Getting a sensitivity of aggregate demand to the real interest rate via an Euler equation is not a good thing. Calvo pricing is not a good thing. Technology shocks as putting the residual from a production function on the right hand side and claiming it as a primitive shock is not a good thing. And what else is there in a New Keynesian model? A money demand function (or an interest rate rule). That is not very much that is useful. The things that make New Keynesian models different from VARs are, pretty much, things that make them less accurate and valuable. Do a VAR. And then argue about what the underlying shocks behind the VAR shocks really are, and how the VAR impulse response coefficients constrain the underlying structural shock ones: David Vines and Samuel Wills: rebuilding macroeconomic theory project: an analytical assessment: “We asked a number of leading macroeconomists to describe how the benchmark New Keynesian model might be rebuilt…

…The need to change macroeconomic theory is similar to the situation in the 1930s, at the time of the Great Depression, and in the 1970s, when inflationary pressures were unsustainable. Four main changes to the core model are recommended: to emphasize financial frictions, to place a limit on the operation of rational expectations, to include heterogeneous agents, and to devise more appropriate microfoundations. Achieving these objectives requires changes to all of the behavioural equations in the model governing consumption, investment, and price setting, and also the insertion of a wedge between the interest rate set by policy-makers and that facing consumers and investors. In our view, the result will not be a paradigm shift, but an evolution towards a more pluralist discipline…

Keynes’s General Theory Contains Oddly Few Mentions of “Fiscal Policy”

Posted on by Brad DeLong
File WhiteandKeynes jpg Wikipedia

Something that has puzzled me for quite a while: Keynes’s General Theory contains remarkably few references to fiscal policy in any form:

  • “Government spending”: no matches…

  • “Government purchases”: no matches…

  • “Fiscal policy”: 6 matches:

    • Four in one paragraph about how fiscal policy is the fifth in an enumerated list of factors affecting the marginal propensity to consume…
    • One about how an estate tax changes the marginal propensity to consume…
    • One about how fiscal policy in ordinary times is “not likely to be important”…
  • “Public works”: 10 matches:
    • Three in a paragraph about how the multiplier amplifies the employment effect from public works…
    • Two in a paragraph warning that multiplier calculations are overoptimistic because of import, interest rate, and confidence crowding-out…
    • Four on how public works have a much bigger effect when unemployment is high and “public works even of doubtful utility may pay for themselves…”
    • One a criticism of Pigou’s logic…

And yet it also contains this one paragraph:

In some other respects the foregoing theory is moderately conservative in its implications. For whilst it indicates the vital importance of establishing certain central controls in matters which are now left in the main to individual initiative, there are wide fields of activity which are unaffected. The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rate of interest, and partly, perhaps, in other ways. Furthermore, it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative…

Chasing back this “banking policy” that is the alternative to the “somewhat comprehensive socialization of investment”, there are three cites to “banking policy”: this paragraph is one, and the others are:

  • “to every banking policy there corresponds a different long-period level of employment…”
  • and the “it is, I think, arguable that a more advantageous average state of expectation might result from a banking policy which always nipped in the bud an incipient boom by a rate of interest high enough to deter even the most misguided optimists. The disappointment of expectation, characteristic of the slump, may lead to so much loss and waste that the average level of useful investment might be higher if a deterrent is applied…. [But] the austere view, which would employ a high rate of interest to check at once any tendency in the level of employment to rise appreciably above the average of; say, the previous decade, is, however, more usually supported by arguments which have no foundation at all apart from confusion of mind…”

The question of why “it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself… a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment…” is left hanging. And how “a somewhat comprehensive socialisation of investment” is to be implemented are left hanging as well.

So will somebody please explain to me why “fiscal policy” plays such a small part in the General Theory and yet such a large part in mindshare perceptions of “Keynesianism”?

Economic Methodology: Thinking Math Can Substitute for Economics Turns Economists Into Real Morons Department

Posted on by Brad DeLong
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The highly estimable Tim Taylor wrote:

Tim Taylor: Some Thoughts About Economic Exposition in Math and Words: “[Paul Romer’s] notion that math is ‘both more precise and more opaque’ than words is an insight worth keeping…”

And he recommends Alfred Marshall’s workflow checklist:

  1. Use mathematics as a shorthand language; rather than as an engine of inquiry.
  2. Keep to them till you have done.
  3. Translate into English.
  4. Then illustrate by examples that are important in real life.
  5. Burn the mathematics.
  6. If you can’t succeed in 4, burn 3.

This is sage advice.

And to underscore the importance of this advice, I think it is time to hoist the best example I have seen in a while of people with no knowledge of the economics and no control over their models using—simple—math to be idiots: Per Krusell and Tony Smith trying and failing to criticize Thomas Piketty.

(2015) The Theory of Growth and Inequality: Piketty, Zucman, Krusell, Smith, and “Mathiness”: It is Krusell and Smith (2014) that suffers from “mathiness”–people not in control of their models deploying algebra untethered to the real world in a manner that approaches gibberish.

I wrote about this last summer, several times:

  • Department of “Huh?!”–I Don’t Understand More and More of Piketty’s Critics: Per Krusell and Tony Smith
  • The Daily Piketty: Ryan Avent on Housing in the Twenty-First Century: Wednesday Focus for June 18, 2014
  • In Which I Continue to Fail to Understand Why Critics of Piketty Say What They Say: (Late) Friday Focus for June 6, 2014
  • Depreciation Rates on Wealth in Thomas Piketty’s Database

This time, [it was a] reply… to Paul Romer… with a Tweetstorm. Here it is, collected, with paragraphs added and redundancy deleted:

My objection to Krusell and Smith (2014) was that it seemed to me to suffer much more from what you call “mathiness” than does Piketty or Piketty and Zucman. Recall that Krusell and Smith began by saying that they:

do not quite recognize… k/y=s/g…

But k/y=s/g is Harrod (1939) and Domar (1946). How can they fail to recognize it? And then their calibration–n+g=.02, δ=.10–not only fails to acknowledge Piketty’s estimates of economy-wide depreciation rate as between .01 and .02, but leads to absolutely absurd results:

  • For a country with a K/Y=4, δ=.10 -> depreciation is 40% of gross output.
  • For a country like Belle Époque France with a K/Y=7, δ=.10 -> depreciation is 70% of gross output….

Krusell and Smith had no control whatsoever over the calibration of their model at all. Note that I am working from notes here, because http://aida.wss.yale.edu/smith/piketty1.pdf no longer points to Krusell and Smith (2014). It points, instead, to Krusell and Smith (2015), a revised version. In the revised version, the calibration differs. It differs in:

  • raising (n+g) from .02 to .03,
  • lowering δ from .10 or .05 (still more than twice Piketty’s historical estimates), and
  • changing the claim that as n+g->0 K/Y increases “only very marginally” to the claim that it increases “only modestly”. The right thing to do, of course, would be to take economy-wide δ=.02 and say that k/y increases “substantially”.)

If Krusell and Smith (2015) offer any reference to Piketty’s historical depreciation estimates, I missed it. If it offers any explanation of why they decided to raise their calibration of n+g when they lowered their δ, I missed that too.

Piketty has flaws, but it does not seem to me that working in a net rather than a gross production function framework is one of them.

And Krusell and Smith’s continued attempts to demonstrate otherwise seem to me to suffer from “mathiness” to a high degree.

Here are the earlier pieces:

DEPARTMENT OF “HUH?!”–I DON’T UNDERSTAND MORE AND MORE OF PIKETTY’S CRITICS: PER KRUSELL AND TONY SMITH: As time passes, it seems to me that a larger and larger fraction of Piketty’s critics are making arguments that really make no sense at all–that I really do not understand how people can believe them, or why anybody would think that anybody else would believe them. Today we have Per Krusell and Tony Smith assuming that the economy-wide capital depreciation rate δ is not 0.03 or 0.05 but 0.1–and it does make a huge difference…

Per Krusell and Tony Smith: Piketty’s ‘Second Law of Capitalism’ vs. standard macro theory: “Piketty’s forecast does not rest primarily on an extrapolation of recent trends…

…[which] is what one might have expected, given that so much of the book is devoted to digging up and displaying reliable time series…. Piketty’s forecast rests primarily on economic theory. We take issue…. Two ‘fundamental laws’, as Piketty dubs them… asserts that K/Y will, in the long run, equal s[net]/g…. Piketty… argues… s[net]/g… will rise rapidly in the future…. Neither the textbook Solow model nor a ‘microfounded’ model of growth predicts anything like the drama implied by Piketty’s theory…. Theory suggests that the wealth–income ratio would increase only modestly as growth falls…

And if we go looking for why they believe that “theory suggests that the wealth–income ratio would increase only modestly as growth falls”, we find:

Per Krusell and Tony Smith: Is Piketty’s “Second Law of Capitalism” Fundamental? : “In the textbook model…

…the capital- to-income ratio is not s[net]/g but rather s[gross]/(g+δ), where δ is the rate at which capital depreciates. With the textbook formula, growth approaching zero would increase the capital-output ratio but only very marginally; when growth falls all the way to zero, the denominator would not go to zero but instead would go from, say 0.12–with g around 0.02 and δ=0.1 as reasonable estimates–to 0.1.

But with an economy-wide capital output ratio of 4-6 and a depreciation rate of 0.1, total depreciation–the gap between NDP and GDP–is not its actual 15% of GDP, but rather 40%-60% of GDP. If the actual depreciation rate were what Krussall and Smith say it is, fully half of our economy would be focused on replacing worn-out capital.

It isn’t:

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That makes no sense at all.

For the entire economy, one picks a depreciation rate of 0.02 or 0.03 or 0.05, rather than 0.10.

I cannot understand how anybody who has ever looked at the NIPA, or thought about what our capital stock is made of, would ever get the idea that the economy-wide depreciation rate δ=0.1.

And if you did think that for an instant, you would then recognize that you have just committed yourself to the belief that NDP is only half of GDP, and nobody thinks that–except Krusall and Smith. Why do they think that? Where did their δ=0.1 estimate come from? Why didn’t they immediately recognize that that deprecation estimate was in error, and correct it?

Why would anyone imagine that any growth model should ever be calibrated to such an extraordinarily high depreciation rate?

And why, when Krusell and Smith snark:

we do not quite recognize [Piketty’s] second law K/Y = s/g. Did we miss something quite fundamental[?]… The capital-income ratio is not s/g but rather s/(g+δ) no reference to Piketty’s own explication of s/(n+δ), where δ is the rate at which capital depreciates…

do they imply that this is a point that Piketty has missed, rather than a point that Piketty explicitly discusses at Kindle location 10674?

?One can also write the law β=s/g with s standing for the total [gross] rather than the net rate of saving. In that case the law becomes β=s/(g+δ) (where δ now stands for the rate of depreciation of capital expressed as a percentage of the capital stock)…

I mean, when the thing you are snarking at Piketty for missing is in the book, shouldn’t you tell your readers that it is explicitly in the book rather than allowing them to believe that it is not?

I really do not understand what is going on here at all…

In Which I Continue to Fail to Understand Why Critics of Piketty Say What They Say: “Per Krusell II: So I wrote this on Friday, and put it aside because I feared that it might be intemperate, and I do not want to post intemperate things in this space.

Today, Sunday, I cannot see a thing I want to change–save that I am, once again, disappointed by the quality of critics of Piketty: please step up your game, people!

In response to my Department of “Huh?!”–I Don’t Understand More and More of Piketty’s Critics: Per Krusell and Tony Smith, Per Krusell unfortunately writes:

Brad DeLong has written an aggressive answer to our short note…. Worry about increasing inequality… is no excuse for [Thomas Piketty’s] using inadequate methodology or misleading arguments…. We provided an example calculation where we assigned values to parameters—among them the rate of depreciation. DeLong’s main point is that the [10%] rate we are using is too high…. Our main quantitative points are robust to rates that are considerably lower…. DeLong’s main point is a detail in an example aimed mainly, it seems, at discrediting us by making us look like incompetent macroeconomists. He does not even comment on our main point; maybe he hopes that his point about the depreciation rate will draw attention away from the main point. Too bad if that happens, but what can we do…

Let me assure one and all that I focused–and focus–on the depreciation assumption because it is an important and central assumption. It plays a very large role in whether reductions in trend real GDP growth rates (and shifts in the incentive to save driven by shifts in tax regimes, revolutionary confiscation probabilities, and war) can plausibly drive large shifts in wealth-to-annual-income ratios. The intention is not to distract with inessentials. The attention is to focus attention on what is a key factor, as is well-understood by anyone who has control over their use of the Solow growth model.

Consider the Solow growth model Krusell and Smith deploy, calibrated to what Piketty thinks of as typical values for the 1914-80 Social Democratic Era: a population trend growth rate n=1%/yr, a labor-productivity trend growth rate g=2%/yr, W/Y=3.

Adding in the totally ludicrous Krusell-Smith depreciation assumption of 10%/yr means (always assuming I have not made any arithmetic errors) that a fall in n+g from 3%/yr to 1%/yr, holding the gross savings rate constant, generates a rise in the steady-state wealth-to-annual-net-income ratio from 3 to 3.75–not a very big jump for a very large shift in economic growth: the total rate of growth n+g has fallen by 2/3, but W/Y has only jumped by a quarter.

Adopting a less ludicrously-awry “Piketty” depreciation assumption of 3%/yr generates quantitatively (and qualitatively!) different results: a rise in the steady-state wealth-to-annual-net-income ratio from 3 to 4.708–the channel is more than twice has powerful.

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We have a very large drop in Piketty’s calculations of northwest European economy-wide wealth-to-annual-net-income ratios from the Belle Époque Era that ended in 1914 to the Social Democratic Era of 1914-1980 to account for. How would we account for this other than by (a) reduced incentives for wealthholders to save and reinvest and (b) shifts in trend rates of population and labor-productivity growth? We are now in a new era, with rising wealth-to-annual-net-income ratios. We would like to be able to forecast how far W/Y will rise given the expected evolution of demography and technology and given expectations about incentives for wealthholders to save and reinvest.

How do Krusell and Smith aid us in our quest to do that?

Depreciation Rates on Wealth in Thomas Piketty’s Database:: Thomas Piketty emails:

We do provide long run series on capital depreciation in the “Capital Is Back” paper with Gabriel [Zucman] (see http://piketty.pse.ens.fr/capitalisback, appendix country tables US.8, JP.8, etc.). The series are imperfect and incomplete, but they show that in pretty much every country capital depreciation has risen from 5-8% of GDP in the 19th century and early 20th century to 10-13% of GDP in the late 20th and early 21st centuries, i.e. from about 1%[/year] of capital stock to about 2%[/year].

Of course there are huge variations across industries and across assets, and depreciation rates could be a lot higher in some sectors. Same thing for capital intensity.

The problem with taking away the housing sector (a particularly capital-intensive sector) from the aggregate capital stock is that once you start to do that it’s not clear where to stop (e.g., energy is another capital intensive sector). So we prefer to start from an aggregate macro perspective (including housing). Here it is clear that 10% or 5% depreciation rates do not make sense.

No, James Hamilton, it is not the case that the fact that “rates of 10-20%[/year] are quite common for most forms of producers’ machinery and equipment” means that 10%/year is a reasonable depreciation rate for the economy as a whole–and especially not for Piketty’s concept of wealth, which is much broader than simply produced means of production.

No, Pers Krusell and Anthony Smith, the fact that:

[you] conducted a quick survey among macroeconomists at the London School of Economics, where Tony and I happen to be right now, and the average answer was 7%[/year…

for “the” depreciation rate does not mean that you have any business using a 10%/year economy-wide depreciation rate in trying to assess how the net savings share would respond to increases in Piketty’s wealth-to-annual-net-income ratio.

Who are these London School of Economics economists who think that 7%/year is a reasonable depreciation rate for a wealth concept that attains a pre-World War I level of 7 times a year’s net national income? I cannot imagine any of the LSE economists signing on to the claim that back before WWI capital consumption in northwest European economies was equal to 50% of net income–that depreciation was a third of gross economic product.

One more remark: if more than half LSE macroeconomists really do believe that net domestic product is 28% lower than gross domestic product—for that is what a depreciation rate of 7% per year gets you with an aggregate capital-output ratio of 4—then more than half of LSE macroeconomists need to be in a different profession. I don’t believe Krusell and Smith’s survey. I don’t believe their LSE colleagues told them what they claimed they had…

Should-Read: Tim Taylor: Some Thoughts About Economic Exposition in Math and Words

Posted on by Brad DeLong

Should-Read: Very smart pickup about teaching—and doing—economics from Paul Romer and Alfred Marshall by the highly estimable Tim Taylor: Tim Taylor: Some Thoughts About Economic Exposition in Math and Words: “[Paul Romer’s] notion that math is ‘both more precise and more opaque’ than words is an insight worth keeping…

…It reminded me of an earlier set of rules from the great economist Alfred Marshall, who… wrote in 1906 letter to Alfred Bowley (reprinted in A.C. Pigou (ed.), Memorials of Alfred Marshall, 1925 edition, quotation on p. 427): 

But I know I had a growing feeling in the later years of my work at the subject that a good mathematical theorem dealing with economic hypotheses was very unlikely to be good economics; and I went more and more on the rules:

  1. Use mathematics as a shorthand language; rather than as an engine of inquiry.

  2. Keep to them till you have done.

  3. Translate into English.

  4. Then illustrate by examples that are important in real life.

  5. Burn the mathematics.

  6. If you can’t succeed in 4, burn 3.

This last I did often…. Mathematics used in a Fellowship thesis by a man who is not a mathematician by nature—and I have come across a good deal of that—seems to me an unmixed evil. And I think you should do all you can to prevent people from using Mathematics in cases in which the English language is as short as the Mathematical…