Ah. But, Mark, what real-world questions were DSGE models built to answer? I cannot think of any…
…IS-LM models were built to answer exactly the kinds of questions we encountered during the Great Recession and… provided good answers…. DSGE models were built to address other issues, and it’s not surprising they didn’t do very well when they were pushed to address questions they weren’t designed to answer…
…And wealthy men apparently fathered way more babies, according to a new study… a sharp decline in genetic diversity in male lineages across the world during the Stone Age…. 456 men living in seven regions across Africa, Asia and Europe… Y chromosome… passed down through the male lineage, and the mitochondria… from an offspring’s genetic mother…. Two ancient ‘bottlenecks’…. Migration from Africa drove the first…. The rise of agriculture… likely drove the second. For every 17 women who passed on their DNA, researchers could find genetic evidence of only one male whose lineage stretched to modern times.
…Researchers using a life-cycle model… conclude that most pre-retirees have an optimal level of wealth…. The comforting results of the optimal savings research depend crucially on two as- sumptions–that households’ consumption declines when the kids leave home and that households plan on declining consumption in retirement…. The target replacement rate analysis assumes that consumption does not decline when the kids leave
home and that retirees plan on level consumption in retirement. The question is which view best reflects the real world.
Let me thank Matt for doing some very serious and thoughtful digging. The upshot is that I am in an ideal position for a discussant: There are very interesting and important numbers that have not been put together before, and there is an author who is wise enough not to believe he has with the numbers mean nailed.
Thus I am in an excellent position to, if not add intellectual value, share lavishly in intellectual rents.
I was weaned on the explanation of recent trends in US inequality set out by the very sharp Claudia Goldin, Larry Katz, and company. It was skilled-biased technical change, coupled with the end of the era that had begun in 1636 of making increasing educational levels a priority. That combination greatly raised the return to education-based skills. That was the principal driver of rising income inequality.
But, recently, reality does not seem to agree.
To get large swings in the income distribution out of small changes in the relative supply of educated workers seems to require less substitutability between formal college and other factors of production then seemed reasonable. Higher experience-skill premiums and sharply higher education-skill premiums, yes. But the action seems to be far, far out in the upper tail.
A little family history: My Grandfather Bill was in not just the 1% or the 0.1% but the 0.01% back in the days before the rise in inequality. He sold his chemical construction company to the IMF conglomerate and retired back in 1968.
One of his other grandsons, my first cousin Phil Lord, might have a chance of making it into the same financial range–if he can make the transition from co-director to “producer” and “created by” credits–but if he does he will still be breathing much less rarified relative air.
Relative to 1968 you need 3.5 times the wealth now in the U.S. and 8 times the wealth worldwide. That is an income and wealth an order of magnitude higher than my grandfather ever did.
It is simply not possible to see such an extreme concentration of benefits as in any way a return to a factor of production obtained as the product of “hours spent studying” times “brainpower”.
Thomas Piketty has a guess.
He guesses that the real explanation is that 1914-1980 is the anomaly. Without great political disturbances, wealth accumulates, concentrates, and dominates.
What about what John Maynard Keynes called the “euthanasia of the rentier”? As accumulation proceeds the relative fall in the rate of profit exceeding the relative rise in concentrated wealth? Piketty points to remarkable constancy in the rate of profit at between 4% and 5% per year, but is agnostic as to whether the cause is easy capital-labor substitution, rent-seeking by the rich, or social structure that sets that as the “fair” rate of profit.
And this is why it is truly excellent that Matt Rognlie brings well-ordered and insightfully-organized data to these questions.
Matt’s focus on the net capital share is surely right.
I never understood why, in the Solow model, gross savings was supposed to be a function of gross output anyway. There are the big worries over the data.1 Let me skip those.
As Matt stressed, the big news in the post-World War II net capital share is the surge in housing: from 3% to 8% of private domestic value added.
How much of this is a real increase in housing intensity? How much reflects congestion driven by exhaustion of the low-hanging superhighways? How much is rent-extraction via NIMBYism? How much trust do we give to these “imputed rent” imputations anyway?
And what hat does this mean, anyway?
There has always been a problem with using our GDP estimates as social accounts. In GDP, we measure each unit’s contribution to production at the final unit’s marginal cost and each unit’s contribution to societal well-being at the final unit’s money-metric marginal utility. In the presence of anything like near-satiation in consumption, or of near-exhaustion in productive capacity, this does not convey a true picture.
Hard questions. No very good answers.
The fact that the big news since World War II is a rise in housing as a share of value added raises the question of whether this surge may be in significant part the reversal of story from a century ago–now the rise of valuable urban housing, then the decline of valuable Western European rural farmland.2
To the extent that land is the driver of shifts in our capital share, this is clear a problem to the extent that it is driven by NIMBYism. But is it a problem otherwise?
And as Matt also stressed, the secondary big news in his numbers is the pre-1990 fall in the net capital share, a fall driven by a very real rise in depreciation is real. Our capital stock has seen the replacement of long-lasting machines to perform Wellman-Lord desulfurization reactions with video editing machines rapidly obsoleted by Moore’s Law.
But it is puzzling that the pre-1990 fall in the net capital share not matched by a decline in the relative capitalization of the corporate sector. Matt points out a steady rise in capitalization up to the late 1960s, followed in the 1970s by a “negative bubble”–truly absurdly high earnings yields on equities–that lasts well into the 1980s. Then we see a bubbly rise in the relative capitalization of the corporate sector since the start of the 1990s–a rise that persists in spite of sub-par business-cycle performance. Very puzzling.
Let me end by strongly endorsing what I take to be Matt Rognlie’s bottom line. I take it to be that post-WWII variation in the observed net capital share is not explainable
via returns on the underlying assets. Instead, the decomposition in section 3 attributes most of the variation to pure profits, or markups…
Accumulation and returns play, outside of housing, a distinctly secondary role, if they play any role at all. But it is equally hard to find any role for the race between education and technology, and there should be if we think the factors of production are labor, education skills, and machines.
Likewise, variation in income inequality, is hard to attribute to wealth ownership or to human capital investment or to differential shifts in rewards to factors like raw labor, experience-skills, education-skills, and machines. Matt thus concludes that:
Concern about inequality should be shifted away from the split between capital and labor, and toward other aspects of distribution, such as the within-labor distribution of income.
The nly caveat I wish to make is: This is true now. This may not be true in 50 years, if Piketty is right
And Matt’s conclusion is bad news for us economists, for it leaves us in the same position as those trying to explain an earlier large puzzle in the production function, the twentieth-century retardation of the British economy.
It was Robert Solow who said:
Every discussion among economists of the relatively slow growth of the British economy compared with the Continental economies ends up in a blaze of amateur sociology…
I really would like for us to be able to do better.
Notes:
[1] These big worries are:
Worries about depreciation allowances in these accounts. Mine are perhaps bigger than most.
Worries about how much of the value that comes from installing capital comes from (local) learning about how to handle the technology, and is something that does not depreciate from the point of view of the individual firm. That is not captured.
Worries about, from the societal point of view, how much of the value that comes from installing capital comes from global learning about how to handle the technology.
Perennial worries about what in high-end labor incomes are really incomes earned by raw labor and human capital, and what are rent-extraction and thus sharing in the returns to capital.
[2] In America things are different: the frontier. But in Western Europe one thing going on at the end of the Belle Époque is the collapse in the value of rents on absentee-owned European farmland.
Downton Abbey–Highclear–was supportable on its entailed rents a generation before World War I. It was not so afterwards. Some of this was taxes. But there was also a steep relative fall in prices of staple foodstuffs. Not just Iowa and Kansas, but Odessa and New Zealand came online.
Western European farmland lost its value as a factor of production at the end of the nineteenth century. To what extent was that it? And to what extent is “it now the rise of housing prices in London, Paris, Rome, Milan, etc.? My teacher the late David Landes, a CUNY graduate, simply bought a Paris apartment as a postdoc post-WWII. Those of our postdocs who could not afford to go to private colleges do not pick up Paris apartments casually in the course of a research trip to take a look at bank records.
1509 words
A form of conventional wisdom has developed in the years since the beginning of the Great Recession about financial crises: When economies go through major systemic failures of their financial systems the ensuing economic recoveries will invariably be tepid and prolonged. This view is based primarily on research by economists Carmen Reinhart and Kenneth Rogoff, particularly their book, “This Time Is Different,” which looked at hundreds of years of data on financial crises.
A new working paper indirectly challenges that conventional wisdom by digging deeper in the question of how financial crises affect economic output. The new paper, by Christina D. Romer and David H. Romer of the University of California-Berkeley, isn’t a direct rebuttal to the work of Harvard University’s Reinhart and Rogoff and others who have done similar work. Rather, the new paper is a refinement of those analyses that may be more useful to policy makers in high-income countries today.
The biggest difference between the work by Romer and Romer and other research is that the two Berkeley economists focused specifically on financial crises in rich economies in the latter half of the 20th century, specifically from 1967 to 2007. In contrast, Reinhart and Rogoff looked at the long historical relationship between financial crises and the pace of economic recoveries, meaning their data set include crises that happened centuries ago and/or in developing countries. This kind of analysis is important and necessary, but its utility as guidance for policymakers in the United States and other advanced countries today is quite low.
So what do Romer and Romer find? According to their analysis, the impact of financial crises, or “financial distress” in their terms, doesn’t, on average, lead to large recessions. When a moderate financial crisis hits a country, Romer and Romer find that the decline in economic output is about 3 to 4 percent. When it comes to subsequent growth in gross domestic product, the hit leads to a long-lasting decline in output growth as the recovery take a while. But that result is merely the average. Japan, with its well-known “lost decade,” is driving the entirety of the result.
Then the two economists take a look at what happens to economic output during very large financial crises, such as those experienced by Scandinavian countries and Japan during the 1990s. Instead of finding a hard and fast relationship, Romer and Romer find a large variation in the response of economic output. Sometimes, as in the case of Japan, the crisis leads to significant recessions and slow recoveries. And sometimes, such as with Norway in the early 1990s, the effect was pretty much non-existent.
The reason for this variation is an open question. Romer and Romer wonder if policy responses aren’t the main driver.
So it seems that on the whole, the Reinhart-and-Rogoff result doesn’t seem to hold up for advanced countries in the recent history. A large financial crisis doesn’t necessarily mean a large economic downturn has to happen. Economic events aren’t forces that sweep over us, but things that we can react to and very possibly control.
Must- and Shall-Reads:
Should Be Aware of:
…There were really, in real time, no comments suggesting that it would be a stupid idea to increase the interest rate.
But in real time, the Riksbank’s inflation forecast was below the inflation target and unemployment and the unemployment forecast were far above the Riksbank’s estimate of a long-run sustainable rate…. My colleague in the Execeutive Board, Karolina Ekholm, and I indeed dissented from this tightening policy with very clear and logical arguments, namely that easier policy would in this situation lead to better target achievement…. Riksbank and the Fed FOMC forecasts for inflation and unemployment were very similar at the time. Given these similar forecasts, the Fed obviously did the right thing, keeping the policy rate very low and starting to prepare for QE2, whereas the Riksbank did the wrong thing, tightening. Or is Jansson suggesting that the Fed should have followed the Riksbank example?
Jansson refers to high GDP growth as a reason for tightening in the summer of 2010. But as Paul Krugman says… Jansson seems to make “a fundamental error, confusing levels with rates of change.”… Jansson… suggests that Krugman should look at the facts before criticizing the Riksbank. It seems that it is Jansson that should look at the facts. Jansson’s previous attempts to defend Riksbank policy, including his strange suggestion that the tightening was not motived by concerns about household debt and housing prices, have been discussed here, here, and here. The cost and benefit of the Riksbank’s leaning against the wind because of concerns about household debt are examined here (with the use of the Riksbank’s own estimates, the cost can be shown to be about 250 times the benefit).
The continued refusal by policymakers in 2008-2012 to admit any error whatsoever is what seems to me the most remarkable feature of the situation. It’s not just Jansson. Consider Tim Geithner, for example: the paragraphs in his book expressing regrets about policy choices were, when he was asked about them on his book tour, taken as opportunities to try to walk back the regrets–for, Geithner said at some length, the alternative policies really would not have done any good. The only first-rank policymaker I have seen in person clearly and visibly regret his overoptimism and his failure to grasp the reality of the situation was Ben Bernanke.
…Purchases will be composed of sovereign bonds and securities from European institutions and national agencies. The ECB Governing Council imposed limits to ensure that the Eurosystem will not breach the prohibition on monetary financing. However, these limits will constrain the size and duration of the programme…. The PSPP profits that will ultimately be repatriated to national treasuries will be small. This was to be expected, given current very low yields…
The United States leads the world when it comes to incarceration rates. According to one estimate, there are 2.4 million individuals in U.S. jails or prisons—a massive number that stands in sharp contrast to the decline in violent crimes over the past four decades. The increased incarceration also caused a steep rise in the imprisonment of so called marginal defendants, or those who are on the edge of going to jail or staying out of it. The costs of this incarceration rate to the U.S. economy are strikingly large, according to a new paper harnessing a large and impressive data set.
The paper, by Michael Mueller-Smith, a PhD candidate at Columbia University, looks specifically at the effects of incarceration in Harris County, Texas, which includes the city of Houston. While the paper only looks at one county, the data set Mueller-Smith uses covers every single defendant in the county. The data cover all 1.1 million defendants from 1980 to 2009. The data also connect via court records to other data that reveal information about future criminal activity, wages, reliance on government assistance programs such as the Supplemental Nutrition Assistance Program (known as food stamps), and marriage records.
Mueller-Smith’s impressive array of data enables him to demonstrate causality due to the sentencing procedures used by Harris County. The county court system randomly assigns defendants to courtrooms, judges, and prosecutors. Because judges and prosecutors vary quite a bit in their desire or willingness to put defendants in jail or prison, this variation (which is determined randomly) lets Mueller-Smith identify the causal effects of incarceration.
In his calculations, Mueller-Smith focuses on the effects of incarceration on the marginal defendant, which means his study factors out the kind of defendants that society expects to be incarcerated, such as rapists or murders, so that he can zero in on those who commit crimes that could be punished with probation.
Given Texas’s commitment to be “tough on crime,” it’s likely that the marginal defendant in Harris County is committing crimes deemed less dangerous in other legal jurisdictions around the country. This means Mueller-Smith’s estimates might be biased toward finding more costs to incarceration. Furthermore, the research literature on the labor market effects of incarceration are mixed.
Even so, his findings are striking. He finds that the incarceration of marginal defendants increases their future criminal activity, reduces their employment prospects, increases their use of public benefits, and reduces their opportunities to get or remain married.
Specifically, Mueller-Smith finds that each additional year of being incarcerated increases the probability of facing a charge for a new crime by 5.6 percentage points per quarter after release. And he finds that released individuals are more likely to escalate the type of crime they commit after release, such as moving up to theft and burglary or drug crimes.
Incarceration also causes severe labor market problems for these marginal defendants. For each year a person is in jail or prison, their employment drops by 3.6 percentage points. For those convicted of a felony, the drop is even more severe: five years after release their employment is reduced by 24 percent. These marginal defendants also come to rely more on public assistance programs such as food stamps, another sign of a fragile attachment to the labor force.
The effects bleed into the defendant’s family life, too. Mueller-Smith finds that incarceration reduces marriage rates for younger defendants and boosts divorce rates for older defendants.
Putting all these effects together, Mueller-Smith calculates the social cost of incarceration. According to his estimate, one year of prison or jail for a marginal defendant has a social cost of ranging from $56,200 to $66,800.
Incarceration is supposed to punish convicted criminals but also reform prisoners to help them prepare for a life after jail or prison. Mueller-Smith’s results show that incarceration severely harms those marginal defendants who are best suited to be rehabilitated by reducing their labor market opportunities, damaging their families, and increasing their criminal activity.
Today’s Must-Must-Read: This is an important point that is worth saying as often as necessary–perhaps as often as possible:
…At least that’s what Wall Street thinks. Gillian Tett… tell[s] us… they think in between their flights from Davos to Aspen… that:
ultra-low interest rates have a nasty habit of distorting markets in all manner of unexpected ways, all over the world… [in the money in] U.S. activist funds, angel investments, laying down wine or jumping into the art market.
In other words, we should worry that billionaires are paying so much for Picassos and pinot noirs as part of the hyperinflation in the Hamptons. Now it’s true that lower interest rates make asset prices go up, but ‘distorts’ is a funny way of putting that. After all, we don’t say that higher interest rates ‘distort’ asset prices down…. [If] rates are inappropriately low… where’s the inflation? It’s not like central banks can keep rates lower than they should without prices going higher….
It’s the economy, not interest rates, that are distorted. People want to save more than they want to invest, and that is why rates are so low…. The mistake that Wall Street, and even some famous economists, make is… they think that lower rates are what’s messing up the economy, rather than reflecting the fact that it’s already messed up….
Just look at the countries that have tried, and failed, to keep rates up after they’ve hit zero: Japan, Europe, and Sweden. Each of them told themselves a story about why they needed to hike rates—they thought they’d recovered, or inflation was coming to get them, or maybe a bubble–and they each did so…. Well, it turns out that raising rates when your economy is still kind of weak isn’t a good idea. All of them ended up having to cut rates back down to zero, and then start buying bonds with newly-printed money…. It’s not the Fed’s job to worry about the Billionaire Price Index. It’d be… unnatural if it did.
The neutral or natural rate of interest is the rate of interest that balances desired savings with planned investment when the economy is at full employment, and when people’s expectations of the prices and inflation rates which they will be able to charge or have to pay are by-and-large correct. That is how things have been ever since Knut Wicksell started this particular sub literature of economics back in 1898. As John Maynard Keynes wrote back in 1923, having the market interest rate below or above the natural interest rate corresponds to monetary policy that produces a money stock that is either inappropriately high or inappropriately low, and generates:
inflation [which] is unjust and deflation [which] is inexpedient. Of the two perhaps deflation is, if we rule out exaggerated inflations such as that of Germany, the worse; because it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier. But it is necessary that we should weigh one evil against the other. It is easier to agree that both are evils to be shunned…
The right way to think about it is: Yes, interest rates are scarily low right now. But they are so because the Federal Reserve and other central banks are trying to mitigate the damage caused by the fact that the entire global macroeconomy is so distorted–inappropriate fiscal austerity, a global savings glut coming from emerging markets and elsewhere, secular stagnation, and a clogged housing-finance channel.