Category: Equitablog

Must-Read: Roger E.A. Farmer (2013): Animal Spirits, Financial Crises, and Persistent Unemployment: “This article uses a rational expectations model with multiple equilibrium unemployment rates…

…to explain financial crises. The model has equilibria where asset prices are unbounded above. I argue that this is an important feature of any rational-agent explanation of a financial crisis, since for the expansion phase of the crisis to be rational, investors must credibly believe that asset prices could keep increasing forever with positive probability. I explain the sudden crash in asset prices that precipitates a financial crisis as a large shock to expectations that leads to a permanent increase in the unemployment rate.

Must-Read: If you are going to read only one tech newsletter… I believe this is the one you should read:

Ben Thompson: The Funnel Framework: “The post-Internet Microsoft was the proverbial emperor with no clothes…

…That reality would only manifest itself… as soon as something better came along…. In the case of Apple… winning via the user experience…. iOS owns the best customers, i.e. the customers who are most willing to pay…. The companies who… own the funnel… are the ones who gain… in the long run, outsized profits…. Google[‘s]… search engine was, and is, superior…. And, now that they own access to the most consumers looking to buy something online–now that they own the funnel–they have outsized influence and outsized profits. Facebook… built a superior product that connected an extraordinary number of people, all generating content that made the product even more attractive and able to capture even more attention. And, now… that they own the funnel… have outsized influence and outsized profits.

All three companies succeed with very different product focuses, but all share the ability to capture a specific type of customer and funnel them to someone who is willing to pay…. If you look around you can see the funnel framework everywhere: Taxis… Uber…. Hotels… Airbnb…. Messaging apps… LINE and WeChat…. Newspapers… BuzzFeed…. Broadcast channels… Netflix and HBO…. Failing business models… most… were based on something other than providing a superior product…

Must-Read: The obvious thing. The technocratic thing. The reasonable thing. So why does the Federal Reserve think otherwise?

IMF Warns Fed to Hold Its Fire on Rate Rise: “The International Monetary Fund has urged the Federal Reserve…

…to wait until next year to raise interest rates, cautioning that the central bank’s credibility was at stake and that there was too much uncertainty to justify a much-anticipated lift-off. In its annual review of the state of the US economy released on Thursday, the IMF said it expected the US economy to grow 2.5 per cent this year despite a contraction in the first quarter. ‘The underpinnings for continued growth and job creation remain in place,’ fund economists wrote. But the IMF said conditions were still not right for the Fed to raise rates for the first time in almost a decade. It urged the central bank to wait for ‘greater signs of wage or price inflation than are currently evident’.

Must-Read: Paul Krugman: Multipliers and Reality: “When Bernstein and Romer assumed that [the fiscal multiplier] was 1.5, Robert Lucas accused them of ‘shlock economics‘…

…and smeared Romer’s professional ethics. Since then there has been quite a lot of empirical work, which generally indicates a multiplier of about… 1.5. Now… Simon Wren-Lewis and Robert Waldmann raise… interesting issues. Wren-Lewis argues for a multiplier of around one… [from] a priori reasoning…. Waldmann counters that… real consumption decisions reflect rules of thumb that can easily lead to a multiplier much more than one….

And I would add: don’t forget the investment accelerator as well. Tobin’s q is really not a sufficient statistic for the determination of business investment; capacity utilization measures matter a lot.

Krugman:

The point [Wren-Lewis] makes about the implications even of perfectly well-informed and rational consumers was and as far as I know still is totally misunderstood by freshwater economists…. Lucas’s attack on Romer rested in part on the [false] claim that government spending on a new bridge would lead consumers, anticipating future taxes, to offset it one for one with cuts in their own spending; this is completely wrong if the spending is temporary….

Rigorous intertemporal thinking, even if empirically ungrounded, can be useful to focus one’s thoughts. But as a way to think about the reality of spending decisions, no…. Consider (from Vox) what the public knows about the biggest new government program of recent years[, ObamaCare]…. If people are that uninformed about something that big, imagining that they do anything like the calculations assumed in DSGE models is ludicrous. Surely they rely on rules of thumb that don’t make use of the kind of information that plays such a large role in our models…

Fold: The Omega Point Discussion: On the Adequacy of Hicks-Hansen-Wicksell for Understanding 2008-Present

Is this “Fold” possibly going to be a useful thing?

About Fold

Must-Read: Cullen Roche: Does a “Liquidity Trap” Ever End?: “Brad Delong has a very smart post over at Equitable Growth…

…discussing the recent Feldstein commentary on inflation as well as Paul Krugman’s Liquidity Trap model of the current economic environment. Brad, unlike Paul, is not so quick to assert that the Hicksian model that Dr. Krugman has been using, is a big success.  He says:

The problem is that the macroeconomics that Paul Krugman learned at Jim Tobin’s knee wasn’t just 1930s-style Hicks-Hansen Keynesianism. It was the 1970s adaptive-expectations Phillips Curve neoclassical synthesis–nearly the same stuff that I first learned at Marty Feldstein and Olivier Blanchard’s knees in the spring of 1980. That is the framework that Marty is using know, and that generates his puzzlement. That framework had a short run of 1-2 years, a medium-run transition-dynamics phase of 2-5 years, and a long run of 5 years or more baked into it. You cannot–or at least I cannot–just throw away the medium run transition dynamics* and the declaration that the long run Omega Point is five years out, and say that mainstream economics does well.

Another way of saying this is that we’ve supposedly had a ‘Liquidity Trap’ in Japan for several decades and now we’re starting to get very long in the tooth in the ‘Liquidity Trap’ in the USA.  Given the apparent permanence of this environment we have to wonder at what point we begin to question whether we’re in a ‘Liquidity Trap’ at all. Or, were we never in a Liquidity Trap?

To be clear, a Liquidity Trap, according to Paul Krugman, is when conventional monetary policy (changing interest rates) doesn’t work. This isn’t the old Keynesian definition, but who cares because Paul isn’t using a Keynesian model anyhow (Keynes flatly rejected the Natural Rate of Interest that is so central to Krugman’s theory).

So, with the USA now into year 7 in its Liquidity Trap we have to wonder – is traditional monetary policy permanently broken?  Is it going to become ‘normal’ some time soon? If so, when? OR, could it be that traditional monetary policy was never quite as powerful as we thought which means that its recent lack of efficacy is nothing abnormal at all?

That last question is particularly interesting because it would mean that models like Paul Krugman’s Hicksian model, which are based on the Natural Rate of Interest, are a lot less useful than one thinks.  And that would mean that New Keynesian economics has much bigger holes in it than some of its adherents believe. Most importantly, it means that Paul Krugman hasn’t been right for the right reasons. It means he has been right for the wrong reasons.

Watching a Discussion: The Omega Point:

• Brad DeLong: New Economic Thinking, Hicks-Hansen-Wicksell Macro, and Blocking the Back Propagation Induction-Unraveling from the Long Run Omega Point
• Paul Krugman: Backward Induction and Brad DeLong
• Brad DeLong: Paul Krugman Was Right. I, Ken Rogoff, Marty Feldstein, and Many, Many Others Were Wrong
• John Hicks (1975): The Crisis in Keynesian Economics
• Brad DeLong: Live from Evans Hall: When I arrived…
• Nick Rowe: Back propagation induction does not work under inflation targeting
• Brad DeLong: Convergence to the Long-Run Macroeconomic Omega Point and Inflation Targeting: Nick Rowe’s View
• Mark Thoma: Krugman vs. DeLong

Must-Read: The hawk-eyed Mark Thoma picks up and develops a very important point:

Mark Thoma: Krugman vs. DeLong: “Theoretical models often act as if there is only one type of demand shock…

…and the short-run depends upon a single variable, e.g. the time period when inflation expectations are wrong. But the short-run depends upon the type of recession we experience, and the variable that signals the length of the recovery will not be the same in every case. A monetary induced recession will have a much shorter short-run than a balance sheet recession induced by a financial collapse, and an recession caused by an oil price shock will recover differently from both.

Early in the Great Recession, policymakers, analysts, and most economists did not fully recognize that this recession truly was different, and hence required a different policy approach from the recessions in recent memory. Krugman, due to his work on Japan, did see this early on, but it took time for the notion of a balance sheet recession to take hold, and we never fully adopted fiscal policy to deal with this fact (e.g. sufficient help with rebuilding household balance sheets).

To me this is one of the big lessons of the Great Recession — we must figure out the type of recession we are experiencing, realize that the ‘short-run’ will depend critically on the type of shock causing the recession, and adopt our policies accordingly. If we can do that, then maybe the short-run won’t be a decade long the next time we have a balance sheet recession. And there will be a next time.