Category: Equitablog

Must-Read: Olivier Blanchard: Do DSGE Models Have a Future?

Posted on by Brad DeLong

Must-Read: The thing about this paper that surprises me is in its last paragraphs: that Olivier Blanchard answers the question with a “yes”. I cannot quite figure out why. Consider this from the last paragraph I quote below:

I could often… summarize the… DSGE paper in a simple graph. I had learned something… but I was able (and allowed as the discussant) to present the basic insight… more simply than the author of the paper. The DSGE and the ad hoc models were complements, not substitutes.

The questions I want to ask are: Olivier, what if you could not have summarized the DSGE paper in a simple ad hoc model graph? Wouldn’t your conclusion then have been that the DSGE paper was wrong–that the flaws in the methodology had led us astray? In what sense, then, are these two “complements”?

Olivier Blanchard: Do DSGE Models Have a Future?:

The model is composed of three equations: an equation describing aggregate demand; an equation describing price adjustment; and an equation describing the monetary policy rule…

At least the first two are badly flawed…. Aggregate demand… with respect to both the degree of foresight and the role of interest rates in twisting the path of consumption are strongly at odds with the empirical evidence. Price adjustment… does not capture the fundamental inertia of inflation…. Their standard method of estimation, which is a mix of calibration and Bayesian estimation, is unconvincing…. The way distortions are introduced in the model… are analytically convenient but have unconvincing welfare implications…. DSGE models are bad communication devices….

I strongly believe that ad hoc macro models… have an important role to play in relation to DSGE models. They can be useful upstream, before DSGE modeling, as a first cut to think about the effects of a particular distortion or a particular policy. They can be useful downstream, after DSGE modeling, to present the major insight of the model in a lighter and pedagogical fashion…. In the right hands, they are beautiful art, but not all economists can or should be artists. There is room for both science and art. I have found, for example, that I could often, as a discussant, summarize the findings of a DSGE paper in a simple graph. I had learned something from the formal model, but I was able (and allowed as the discussant) to present the basic insight more simply than the author of the paper. The DSGE and the ad hoc models were complements, not substitutes….

DSGE models can fulfill an important need in macroeconomics, that of offering a core structure around which to build and organize discussions. To do that, however, they have to build more on the rest of macro- economics and agree to share the scene with other types of general equilibrium models.

My view: I am reminded of a saying from Voltaire that Paul Krugman likes: “You can kill sheep with witchcraft, if you also feed them enough arsenic.”

Must-Read: Ryan Avent: Absence of Evidence: The Fed Rethinking One Thing too Many

Posted on by Brad DeLong

Must-Read: Ryan Avent: Absence of Evidence: The Fed Rethinking One Thing too Many:

OFFICIALS at the Federal Reserve, a few of them anyway, seem to be rethinking their views of the economy in some dramatic ways….

Ben Bernanke suggests… top policy-makers still have confidence in their mental model of the economy; they have just been tweaking a few of the parameters… long-run… GDP growth… unemployment… and their benchmark interest rate…. The latter two [what I call (1) and (2)]—a lower unemployment rate and a lower long-run interest rate—clearly imply that rates will rise more slowly to a lower overall level. The projection of a lower potential growth rate [what I call (5)], however… suggests, for instance, that the American economy is running closer to its “speed limit”… push[ing]… toward a more hawkish stance…. These three revisions are not created equal…. [(1) and (2)] are clearly justified…. [(5)] is different, however. Available evidence is consistent with a world in which long-run potential growth has fallen… but… also… with an economy… growing slowly because of too little demand… in which both strong employment growth and low productivity growth are side effects of the low level of wages.

The only way to resolve the question in a satisfying way is to test it: to push the economy beyond the estimated potential growth rate and see if inflation rises…. Bernanke argues that Fed officials are willing to be a little patient with the economy, to see whether running it a little hot brings more workers into the labour force and encourages productivity-enhancing investments. It certainly seems clear to me that overshooting is the right way for the Fed to err….

But I am less confident than Mr Bernanke in the Fed’s openness to overshooting. It did not exactly intend to run the unemployment rate experiment that demonstrated how run its previous projections had been…. Now, the Fed looks all too willing to revise down its GDP growth projections without ever really testing them…. There is far too little radicalism at the Fed. It risks making permanent a low-growth state of affairs which is largely a consequence of its own excessive caution.

Five Revisions of Its Model That the Fed Should Make or Test

Posted on by Brad DeLong

Must-Read: Five Revisions of Its Model That the Fed Should Make or Test: And I do not think that the Fed is handling the process of revising its thinking properly.

I say that the Fed should, right now, be rethinking its estimates of:

  1. the long-run real natural rate of interest,
  2. the natural rate of unemployment,
  3. the slope of the Phillips Curve, and
  4. the gearing between recent past deviations of inflation from its target and expectations of future inflation.

Ryan Avent says that the Fed is rethinking (1) and (2), but also rethinking a (5): its estimate of long-run potential output growth. I don’t think there is evidence to rethink (5). I think that the consilience of a low pressure economy and apparent sluggish potential output growth is just too large for people to be satisfied rejecting it as a mere coincidence. Ryan agrees with me, and asks why the Federal Reserve seems to want to jump to conclusions about (5) rather than testing it. I agree. But I also want to ask: why isn’t the Fed rethinking its views on (3) and (4) as well? There is powerful evidence that they are different from the implicit model Fed policy has been running off of for the past decade as well:

Ryan Avent: Absence of Evidence: The Fed Rethinking One Thing too Many:

OFFICIALS at the Federal Reserve, a few of them anyway, seem to be rethinking their views of the economy in some dramatic ways….

Ben Bernanke suggests… top policy-makers still have confidence in their mental model of the economy; they have just been tweaking a few of the parameters… long-run… GDP growth… unemployment… and their benchmark interest rate…. The latter two [what I call (1) and (2)]—a lower unemployment rate and a lower long-run interest rate—clearly imply that rates will rise more slowly to a lower overall level. The projection of a lower potential growth rate [what I call (5)], however… suggests, for instance, that the American economy is running closer to its “speed limit”… push[ing]… toward a more hawkish stance…. These three revisions are not created equal…. [(1) and (2)] are clearly justified…. [(5)] is different, however. Available evidence is consistent with a world in which long-run potential growth has fallen… but… also… with an economy… growing slowly because of too little demand… in which both strong employment growth and low productivity growth are side effects of the low level of wages.

The only way to resolve the question in a satisfying way is to test it: to push the economy beyond the estimated potential growth rate and see if inflation rises…. Bernanke argues that Fed officials are willing to be a little patient with the economy, to see whether running it a little hot brings more workers into the labour force and encourages productivity-enhancing investments. It certainly seems clear to me that overshooting is the right way for the Fed to err….

But I am less confident than Mr Bernanke in the Fed’s openness to overshooting. It did not exactly intend to run the unemployment rate experiment that demonstrated how run its previous projections had been…. Now, the Fed looks all too willing to revise down its GDP growth projections without ever really testing them…. There is far too little radicalism at the Fed. It risks making permanent a low-growth state of affairs which is largely a consequence of its own excessive caution.

I would say may be rather than is. But one thing we agree on is that it is definitely the Fed’s responsibility to find out. And on its current policy trajectory it will find out only by accident–only if the economy turns out to be stronger than the Fed currently projects.

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A new proposal to reform the U.S. estate tax

Posted on by Bridget Ansel
The Internal Revenue Service Building in Washington, DC.

Over the past few decades, Americans at the top of the income ladder experienced income gains while those further down struggled with stagnant or declining income. But the focus on the rise in income inequality tends to overlook the equally important explosion in wealth inequality. The progressive U.S. income tax system helps reduce the disparities between the highest- and lowest-income families, yet Uncle Sam has little ability to tax wealth.

A new paper by New York University School of Law Professor David Kamin argues that we are missing an opportunity: Kamin contends that it is possible to expand and reform wealth taxes in a way that not only increases government revenue but does so without affecting overall savings rates—an important factor in future economic growth.

The federal government does attempt to tax large sums of wealth if they are transferred via gifts or inheritances. But the estate tax currently exempts the first $10.86 million of a married couple’s estate, or the first $5.43 million of an individual’s estate, and levies a 40 percent tax on the remainder (though the tax collects far less due to key loopholes). That means the estate tax only applies to a tiny slice of the population: Only 0.15 percent of Americans have levels of wealth that exceed that amount, or less than one in 600 among those who died last year.

This rate is historically low relative to prior levels and has a larger exemption, which means it now taxes fewer taxpayers than it used to, and taxes them at a lower rate. The few estates that are subject to the estate tax pay less than one-sixth of their value (about 17 percent) in tax—far less than the 40 percent statutory rate. And even this number is likely to be an overstatement, as there is evidence that these taxes undervalue the size of the estate. Kamin cites one Internal Revenue Service study that finds the internal valuations of estates are about half of what is listed in the annual Forbes 400 rankings. That may be because wealthy estates can afford to game the system by hiring lawyers to employ what Kamin calls “tax planning techniques,” such as perpetual trusts and grantor-retained annuity trusts to pass on their estate without it being subject to a full estate tax.

Kamin proposes two fundamental reforms for federal wealth taxes. First, instead of taxing wealth transfers as an estate tax (which taxes the “donor” of the estate), we should tax the recipient of the inheritance through an inheritance tax. He cites a proposal by Lily Batchelder, also at NYU Law School, which, among other things, would consider the economic status of the individual inheriting the estate. That means that if the estate was divided up between many heirs, there would potentially be a lower tax bill than if the estate were taxed as a whole.

Kamin also proposes a wealth tax that is applied at regular intervals, such as the one that is suggested by Thomas Piketty at the Paris School of Economics and Emmanuel Saez at the University of California-Berkeley. Piketty and Saez argue that combining annual wealth taxes with an inheritance tax can better balance the economic trade-off between equity and efficiency compared to just using the inheritance tax alone. Taxing wealth on a recurring basis also could raise significant revenue: A 1 percent tax on wealth exceeding $20 million would raise $80 billion in 2012 alone. Over ten years, that number would exceed $1 trillion.

While recurring wealth taxes are not a totally new innovation—11 other wealthy member nations of the Organisation for Economic Cooperation and Development currently use them—Kamin does point out that in the United States, a wealth tax could be subject to legal challenges for constitutional reasons. So in the meantime, he proposes ways to strengthen the estate tax under current law, including closing the loopholes that allow families to bypass taxation. He also suggests that we bring back the estate tax as it was in 2009, with a top rate of 45 percent and an exemption of $7 million per couple. The combination of the two reforms could together raise $160 billion to 170 billion over the next 10 years which, while not as much as a wealth tax, is still significant.

 

Reforming the way we tax wealth—or at the very least, returning to the way we used to tax wealth—could go a long way in combatting the widening wealth gap, which is currently at roughly the same level as the “Roaring Twenties.” The revenue would also boost public investment in areas that the rich and poor alike benefit from, including defense, the environment, scientific research, and infrastructure. Tax planning will always exist, but as Kamin points out in his paper, “the U.S. tax system can do much better than it does now; the current level of tax planning and distortions is not inevitable—it is a function of a system in need of reform.”

Must-Reads: August 10, 2016

Posted on by Brad DeLong

 

Should Reads:

Must-Read: Paul Krugman: Murky Macroeconomics

Posted on by Brad DeLong

Must-Read: This, from Paul Krugman, is 100% correct. The last eight years have taught us that as long as the distribution of near-term possible outcomes includes at least a 10% or so chance of landing back at the zero nominal safe interest rate lower bound, the policies we should follow now are pretty much the policies we ought to follow at the bound.

Of course, this is the situation we will be in until the trend and expected inflation rate hits 4%/year: we are going to be in this situation for a looooooonnnngggg time:

Paul Krugman: Murky Macroeconomics:

we’re not in the simple, depressed-economy world of 2011 anymore…

But here’s the thing: we’re not in what we used to call a normal macroeconomic situation either. Maybe we’re close to full employment, but maybe not, and that’s with near-zero interest rates; also, it’s all too easy to imagine adverse shocks in the near future, and not at all clear how the Fed could or would respond. We are, if you like, half-out of the liquidity trap, with one foot on dry land — but the other foot is still hanging over the edge, and it wouldn’t take much to topple us right back in.

What I would argue is that in this murky, fragile situation we should be conducting policy largely as if we were still in the trap–because we badly need to get both feet firmly on dry land with some distance between us and the quicksand. (And if I’m mixing metaphors–am I?–never mind. Throw the jackboot into the melting pot!) But it’s not the crystalline case we used to be able to make.

Still, we need to deal with this murky situation right, which means embracing the uncertainty as part of the argument. Make murkiness great again!

Must-Read: Aaron Carroll: Helpless to Prevent Cancer? Actually, Quite a Bit Is in Your Control

Posted on by Brad DeLong

Must-Read: Aaron Carroll: Helpless to Prevent Cancer? Actually, Quite a Bit Is in Your Control:

Of the nearly 90,000 women and more than 46,000 men, 16,531 women and 11,731 men fell into the low-risk group….

Over all… Minyang Song and Edward Giovannucci found 25 percent of cancer in women and 33 percent in men was potentially preventable. Close to half of all cancer deaths might be prevented as well. No study is perfect, and this is no exception. These cohorts are overwhelmingly white and consist of health professionals…. This also isn’t a randomized controlled trial, and we can certainly argue that it doesn’t prove causation…. “Low risk” status required all four healthy lifestyles… never having smoked or having quit at least five years ago… no more than one drink a day on average for women, and no more than two for men… a B.M.I. of at least 18.5 and no more than 27.5… 150 minutes a week of moderate-intensity activity or 75 minutes of vigorous-intensity activity…. I was surprised to realize that I’m already “low risk.” I bet many people reading this are “low risk,” too.

Preschool is about more than a third grade test score

Posted on by Bridget Ansel

The uneasiness over the “fade-out” effect of early childhood education programs in the United States certainly isn’t, well, fading out. There’s an ever-growing body of evidence that demonstrates the substantial individual, familial, and social benefits from investments in high-quality early childhood education programs, yet naysayers continue to argue that the academic gains of attending preschool dissipate in primary school, making it an ineffective policy strategy. These naysayers, unfortunately, focus only on a small subset of the medium-term effects of early education programs while ignoring both the full range of their effects and their long-run impacts.

Over the past few months, the early education pessimists have been egged on by a recent study from Mark Lipsey, Dale Farran, and Kerry Hofer of Vanderbilt University. Using a randomized control trial, the three researchers appraise the academic and behavioral outcomes—through literacy, language, and math assessments and teacher-rating instruments—of students who attended Tennessee’s Voluntary Prekindergarten program. Upon entry into kindergarten, the prekindergarten participants scored significantly higher on cognitive test scores than did the non-participants. The researchers, however, chart that after entry into kindergarten, the academic achievement gap between students who had attended the prekindergarten program and those who hadn’t begins to narrow. By third grade, children who had attended the Voluntary Prekindergarten program had test scores that were similar to those of their non-attending counterparts.

In short, the study, like some others before it, documents a fade-out in the “cognitive skills” thought to be developed by a preschool education.

But there are several problems in using the third grade outcomes of the Tennessee Voluntary Prekindergarten program to disparage investment in high-quality early education. First of all, the Tennessee program is not what most researchers define as “high quality.” This is important to note because the cognitive effects are larger and the fade-out effects are less pronounced in high-quality programs. As a consequence, the achievement gaps between participants and non-participants in high-quality programs may diminish, but they do not disappear.

Many scholars also note that the so-called fade-out of academic achievement should be more accurately described as a convergence between the cognitive achievement of preschool-goers and their peers as non-attendees catch up, not as a “fading” away of benefits. But, regardless of how you frame it, there’s something troubling about measuring the effectiveness of preschool as a policy lever through just the cognitive aptitude of third graders: Test scores simply don’t paint the whole picture.

Instead, the appeal of implementing high-quality prekindergarten programs lies in their long-term benefits, largely generated by the interaction of both “cognitive” and “non-cognitive” skills. Non-cognitive skills are the non-technical habits or skills, such as emotional intelligence, character, and grit, all of which play an important role in the life-long success of an individual. According to research by Melissa Tooley and Laura Bornfreund of the New America foundation, a high-quality prekindergarten environment and education can teach or nurture these traits early on.

Over time, well-developed cognitive and non-cognitive skills often help determine how successful a student will be later on in life. More specifically, longitudinal studies on programs such as the Chicago Child-Parent Center have found that attending a high-quality early childhood education interventions can:

  • Reduce grade retention rates
  • Reduce a student’s reliance on special education services
  • Increase a student’s odds of completing high school
  • Improve college attendance post-high school
  • Decrease a child’s exposure to abuse and neglect and, subsequently, welfare services
  • Decrease the potential for juvenile or adult arrest
  • Reduce the incidence of major depressive disorder
  • Decrease adult smoking rates
  • Increase a student’s earnings later in life

These benefits are by no means comprehensive, but they are demonstrative of the types of measures that can appropriately characterize the effectiveness of preschool programs. Instead of “fading,” many of these benefits persist and even “accentuate” over time. The benefit-cost ratio, for example, has been growing over time in the cases of the Chicago Child-Parent Center program and another famous longitudinal study involving the Perry Preschool program. In fact, because these outcomes are quantifiable, we can analyze the benefits and costs of preschool program investments.

In a report released last year by the Washington Center for Equitable Growth, researchers found that if the United States were to invest in a public, voluntary, high-quality universal prekindergarten program for 3- and 4-year-olds modeled on the Chicago Child-Parent Center (studied by Arthur Reynolds and colleagues) in 2016, the program would break even in eight years, and by 2050, it would return $8.90 for every dollar invested in it. That amounts to approximately $270.3 billion in net benefits in 2050, split among savings to government, increased compensation for students and their guardians, and individual savings due to less crime and better health. In other words, as a policy tool for improving socioeconomic outcomes, a high-quality universal prekindergarten program could more than pay for itself in the long-run.

Academics and policymakers need to be more mindful about how they measure the success of high-quality prekindergarten programs and then study their policy efficacy. The partial fade-out of cognitive skills alone cannot be an indicator of whether preschool is effective. But, at the same time, policymakers cannot disqualify concerns about the achievement gap diminishing in spite of substantial initial cognitive gains due to preschool programs’ high quality. The fade-out of cognitive achievement may be highlighting an important mismatch in our educational system—the quality of early childhood education may be high, yet the quality of primary school remains important in sustaining the gains.

Must-Read: Paul Krugman: Prudential Macro Policy: Fiscal

Posted on by Brad DeLong

Must-Read: Paul Krugman:: Prudential Macro Policy: Fiscal:

It was easy to say what U.S. monetary and fiscal policy should be doing…

the indicated demand policy was pedal to the metal all the way–no need to worry about inflation, no reason to believe that deficit spending would cause any crowding out (in fact it would almost surely crowd in private investment, because such investment depends on demand.)… The right kept warning about a debased dollar, while the Very Serious People were obsessed with debt and deficits, so that in practice we didn’t do the obvious. But it was obvious.

Now, however, we’re arguably not too far from full employment…. Has the macro case for strongly stimulative policy gone away?… [On] fiscal policy?… A similar [asymmery] argument applies… in particular about infrastructure investment, which takes a long time to get going…. A little crowding out wouldn’t kill us, given how badly we need infrastructure investment. On the other hand, if we do slide back into a liquidity trap we would be badly hurt by not having the public investment we could have had…. Public investment, in addition to its usual benefits, would provide valuable insurance against the all too possible return of the zero lower bound. It’s not quite as slam-dunk a case as it was in, say, 2013, but it’s still very strong. It’s still time to borrow and spend.

Must-Read: Nicholas Crafts: Brexit: Lessons from History

Posted on by Brad DeLong

Must-Read: Nicholas Crafts: Brexit: Lessons from History:

Joining the EU raised the level of UK real GDP significantly…

Leaving the EU will very probably have a negative effect on UK GDP, but history does not tell us how strong this effect will be…. The notion that there will be a faster rate of long-run trend growth facilitated by Brexit is not persuasive. The obstacles to better supply-side policy are, as ever, to be found in Westminster not in Brussels….

Gravity models of trade indicate that the EU has been highly effective in raising trade volumes, presumably because it has reduced trade costs more than is typical of trade agreements and achieved a relatively deep level of economic integration. Using the results in Baier et al. (2008), I estimate that leaving EFTA and joining the EU raised total UK trade by 21.1% by 1988 (Crafts 2016), and that this might be expected to have increased the level of UK GDP by 10.6%…. A key transmission mechanism was through the impact on productivity of increased competition, which was an antidote to bad management and dysfunctional industrial relations (Crafts 2012); at least through the 1986 Single Market Act, EU membership was an integral part of the Thatcher reforms. 
Third, the benefits of membership far outweighed any reasonable estimate of the membership fee entailed by net budgetary transfers and the Common Agricultural Policy, which amounted to less than 1% of GDP….

Although Eurosceptics complain about the costs of EU-imposed regulations, it should be recognised that the UK has persistently been able to maintain very light levels of regulation in terms of key OECD indicators such as product market regulation (PMR) and employment protection legislation (EPL), for which high scores have been shown to have significant detrimental effects (Barnes et al. 2011). In 2013, the UK had a PMR score of 1.09 and an EPL score of 1.12, the second and third lowest in the OECD, respectively. Moreover, it is noticeable that the regulations which it might be politically feasible to remove in the event of Brexit do not include anything that might make a significant difference to productivity performance (Booth et al. 2015)…