Must-Read: As I understand it, Paul Romer’s critique of RBC and DSGE models is wide of the mark only insofar as people no longer take the conclusions of RBC and DSGE models seriously. Paul quotes Smets and Wouters from 2007 about the U.S. since the 1970s:

Monetary policy shocks contribute only a small fraction of the forecast variance of output at all horizons… account for only a small fraction of the inflation volatility…. “Demand” shocks such as the risk premium, exogenous spending, and investment-specific technology shocks explain a significant fraction of the short-run forecast variance in output, both the wage mark-up (or labor supply) and, to a lesser extent, output-specific technology shocks explain most of its variation in the medium to long run…. Third, inflation developments are mostly driven by price mark-up shocks in the short run and wage mark-up shocks in the long run…

And points out that there is something very wrong. Volcker said he was going to hit the economy on the head with a monetary policy shock brick to reduce inflation. He did so. Inflation fell from 10% to 4%. Unemployment spiked to 11%. And yet Smets-Wouters cannot see it. Instead, they see a great many driving shocks that are nothing but equation residuals.

If anybody believed this, it would be a YUGE problem. That (most) people do not believe this and yet still feel that they must talk this way is a big problem:

Simon Wren-Lewis: Paul Romer on Macroeconomics: “The microfoundations project, which was meant to make macro just another application of microeconomics, has left macroeconomics with very few friends among other economists….

The latest broadside comes from Paul Romer. Yes it is unfair, and yes it is wide of the mark in places, but it will not be ignored… because he discusses issues on which modern macro is extremely vulnerable. The first is its treatment of data…. The only models deemed acceptable in top journals… are… selective about the data…. Both micro and macro evidence is either ignored because it is inconvenient, or put on a to do list for further research… an inevitable result of making internal consistency an admissibility criteria for publishable work. The second vulnerability is a conservatism which also arises from this methodology… [that] makes it intractable to model some processes: for example modelling sticky prices where actual menu costs are a deep parameter. Instead DSGE modelling uses tricks, like Calvo contracts. But who decides whether these tricks amount to acceptable microfoundations or are instead ad hoc or implausible? The answer depends a lot on conventions….

Paul’s discussion of real effects from monetary policy, and the insistence on productivity shocks as business cycle drivers, is pretty dated…. Yet it took a long time for RBC models to be replaced by New Keynesian models, and you will still see RBC models around. Elements of the New Classical counter revolution of the 1980s still persist in some places. It was only a few years ago that I listened to a seminar paper where the financial crisis was modelled as a large negative productivity shock….

In no other discipline could you have a debate about whether it was better to model what you can microfound rather than model what you can see. Other economists understand this, but many macroeconomists still think this is all quite normal…   

Bruce A. Blonigen and Justin R. Pierce: Evidence for the Effects of Mergers on Market Power and Efficiency: “Study of the impact of mergers and acquisitions (M&As) on productivity and market power has been complicated…

…by the difficulty of separating these two effects. We use newly-developed techniques to separately estimate productivity and markups across a wide range of industries using detailed plant-level data. Employing a difference-in-differences framework, we find that M&As are associated with increases in average markups, but find little evidence for effects on plant-level productivity. We also examine whether M&As increase efficiency through reallocation of production to more efficient plants or through reductions in administrative operations, but again find little evidence for these channels, on average. The results are robust to a range of approaches to address the endogeneity of firms’ merger decisions.

Must-Read: Dennis K. Berman and Jamie Heller: Wall Street’s “Do-Nothing” Investing Revolution: “Picking stocks is at heart an arrogant act…

…It requires in the stock picker a confidence that most others are dunces, and that riches await those with better information and sharper instincts. Entire cities—notably New York and London—have been erected in service of this belief. And the image of the clever, dauntless stock maestro is embedded in the American ideal.

Yet there is a simple, destructive idea taking over Wall Street: that stock pickers can’t pick stocks well—or at least well enough for the fees they charge. And even those who do can’t sustain it year after year. In short, the idea of the “active manager” is rapidly losing its intellectual legitimacy to the primacy of the “passive investor” who merely buys an index of shares. That has certainly been true for the last 10 years, when between 71% and 93% of U.S. stock mutual funds either closed or failed to beat their closest index funds…

Must-Read: The IMF is, for moral hazard reasons, not a redistributionist but a system stability-preserving agency. In a better world, either a WTO or private sector insurers would provide developing country social insurance to cushion the impact of commodity price fluctuations. That is not the world we live in:

Carmen Reinhart: The Return of Dollar Shortages: “Seven decades later, despite the broad global trend toward more flexibility in exchange-rate policy and freer movement of capital across national borders, a “dollar shortage” has reemerged…

..The source of the dollar shortage is not the need for post-conflict reconstruction (though in some cases that is also a contributing factor). Rather, countries… have been hit very hard by plunging oil and commodity prices since 2012…. For countries that had embraced more flexible exchange rates… the initial reversal of oil and primary commodity prices ushered in a wave of currency crashes, while those that maintained more rigid exchange-rate arrangements experienced rapid reserve losses. Because the price slump has persisted, by 2015 capital controls were being tightened and currency pegs were being adjusted or abandoned. Fining, threatening, or even jailing informal currency traders have not been particularly successful….

Of far greater urgency is that dollar shortages have become food shortages in countries such as Egypt and Venezuela, as well as much of Sub-Saharan Africa…. The most vulnerable segments of the population have been left at real risk. The Marshall Plan, through its generous provision of grants, was designed to relieve the dollar shortage in post-war Europe. No modern-day equivalent is visible on the horizon…. It is more plausible to expect a variant of the 1980s, with more emerging and developing countries seeking IMF programs. This, perhaps, may be an opportunity for China to fill a void at the top.

Must-Read: Ricardo J. Caballero and Alp Simsek: A Model of Fickle Capital Flows and Retrenchment: Global Liquidity Creation and Reach for Safety and Yield: “Gross capital flows are very large and highly cyclical…

…They are a central aspect of global liquidity creation and destruction. They also exhibit rich internal dynamics that shape fluctuations in domestic liquidity, such as the fickleness of foreign capital inflows and the retrenchment of domestic capital outflows during crises. In this paper we provide a model that builds on these observations to address some of the main questions and concerns in the capital flows literature. Within this model, we find that for symmetric economies, the liquidity provision aspect of capital flows vastly outweighs their fickleness cost, so that taxing capital flows, while could prove useful for a country in isolation, backfires as a global equilibrium outcome. However, if the system is heterogeneous and includes economies with abundant (DM) and with limited (EM) natural domestic liquidity, there can be scenarios when global liquidity uncertainty is high and EM’s reach for safety can destabilize DMs, as well as risk-on scenarios in which DM’s reach for yield can destabilize EMs.

Must-Read: Izabella Kaminska: The Robot Revolution May Be Exaggerated: “UBS is back… 34-page[s]… re-shoring and automation trend much touted by tech utopians as the silver lining to the [globalization] reversal may be exaggerated…

…You will have heard the narrative…. Automation, algorithms and robotics… means developed countries will soon be able to reshore all production, leading to a productivity boom which leads to only major downside: the associated loss of millions of middle class jobs as algos and robots displace not just blue collar workers but the middle management and intellectual jobs as well. Except… there’s no quantifiable evidence anything like that is happening yet…. As for our friends the robots:

We also don’t find clues of items being made by robots at such a scale that it is shutting down factories and killing exports in EM. For instance, DM imports of low value added items such as textiles, apparel, shoes and toys have slowed down, but only in line with the slowdown in overall imports. To the extent that there is demand for them, these items still seemed to be shipped from the emerging world rather than produced by or printed by machines at home….

The analysts don’t want to be deemed unimaginative ‘tech utopia’ killjoys…. It’s just that. Well. None of it is likely to make an significant impact on the macro level in the next five years…