Thursday, May 03, 2012

Macro: intuition vs. theory


Two items regarding macro policy have caught my eye this past week. The first is Gideon Rachman arguing for fiscal austerity. The second is Paul Krugman's assertion that Ben Bernanke has been assimilated by the hard-money Borg.

Why are all these people arguing for things like hard money and austerity? Do they believe in some model - some RBC variant, perhaps - that tells them that now is not the time for quantitative easing and fiscal stimulus? If so, they aren't publicizing the fact. My guess is that it's not really about models and theories at all - policymakers and pundits basically don't buy into any macro model, and so are falling back on their own reflexive intuition.

First, take Rachman. His arguments for European austerity are far weaker than his typical logical perspicacity would lead one to expect.

First, he argues that infrastructure spending in Greece and Spain over the past 30 years failed to prevent the current crisis. But that is obviously irrelevant, since Greece and Spain grew robustly before the crisis, and no advocate of stimulus believes that infrastructure spending will prevent recessions in the future.

Second, Rachman points out that European debt levels are already high. But if you broke your arm and didn't have health insurance, it would be moronic to say "Well, I'm already deeply in debt, so I shouldn't borrow any more money to treat my broken arm." If austerity hurts growth - and there is strong evidence that it does - then existing debt levels are irrelevant.

Third, Rachman says that Europe's real task is structural reform. This opinion echoes that of economists like John Cochrane. But does the case for structural reform affect the case for countercyclical fiscal policy? No. Because unless you believe that bad business environments cause recessions, improving structural factors won't stop the business cycle.

So Rachman is making weak arguments (for a more constructive rebuttal, see Ryan Avent). Why? Rachman is a smart, reasonable guy. My guess is that he doesn't really believe in any model or theory of the macroeconomy, and he's just recommending austerity because it sort of seems prudent. After all, spending more than you earn is usually a bad idea, right? I mean, come on, everybody knows that, it's obvious. It's "common sense". Economic theories, like all scientific theories, are built to be counterintuitive - if our common sense was sufficient to allow us to understand the economy, we wouldn't need science. By chucking theory and saying "Come on, cut the crap, everyone knows that austerity is the sensible, responsible, prudent thing to do," Rachman is implicitly saying that economic science is crap and common sense is all you need.

Now, Ben Bernanke. Paul Krugman points out that as a professor, Bernanke wrote papers that advocated quantitative easing; now, as a policymaker, he's much more shy about doing it. Krugman's explanation is social; being around a bunch of hard-money Fed guys (who are obsessed with the Fed's inflation-fighting credibility but blase about the Fed's depression-fighting credibility) has swayed Bernanke by good old peer pressure.

I have a somewhat different hypothesis: I think Bernanke is dealing with a severe case of model uncertainty. Think about it. A professor's job is to say "Here is a way the world might work." A policymaker has to say "OK, I am going to act as if the world works this way." The latter requires a LOT more faith in the model's correctness than the former. It seems highly likely to me that Fed Chairman Bernanke does not believe in Professor Bernanke's theories enough to make big bets on them.

The more I read about monetary policy, the more convinced I become that humankind does not really understand it very well. With some assumptions - a certain kind of price stickiness, for example - you can derive an optimal monetary policy rule. But those assumptions are almost certainly crap, included for mathematical tractability (e.g. Calvo pricing), or capturing only one small piece of what's really going on. When you're a policymaker, you don't care about mathematical tractability, and you can't afford to focus only on one piece of what's going on.

The fact is, we just don't know what monetary policy is the best. Maybe QE is a good idea (I think it is!). Maybe a rule like NGDP level forecast targeting is a good idea (I am skeptical but it doesn't sound too bad). Or maybe the amount of QE needed to produce a noticeable movement in employment is so huge that it really would cause serious inflation. Maybe monetary policy operates with "long and variable lags," as Milton Friedman suggested, meaning that it's very difficult for the Fed to know the consequences of its actions. I am not economically illiterate. I can easily find, read, understand, and explain a paper supporting any of these contentions. But at the end of the day I'm willing to bet you that I won't really know how right the paper is. At best, my opinions will probably only have shifted slightly. I am guessing this because I've never read a monetary policy paper that convinced me that "OK, this has got to be how the world works."

So I think that Ben Bernanke has been paralyzed into inaction by the realization that, his academic papers aside, he doesn't really know if QE would be good or bad.

So the upshot of this blog post is this: People do not believe in macro models. Macroeconomics is not a science that has, as of May 2012, proven itself in the way that chemistry, biology, or various branches of microeconomics have proven themselves. And so when push comes to shove - as it has - people fall back on their gut reactions, going "Hrrrrrm, austerity, yes, prudent!" or "Hrrrrrm, inflation, yes, scary!" Do I disagree with this Hrrrrrrm-ing?? Sure! MY intuition says something different. And I think the academic literature supports my position more than that of the austerians and hard-money people. But I understand how model uncertainty makes the case for stimulus and QE less than a slam-dunk.

49 comments:

  1. Tobin1:40 AM

    I am bored to hear about “structural reforms” which in the end make the poor poorer and the rich richer...What about income and wealth distribution. Has someone a proposition about that or this is irrelevant to Macroeconomics???

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  2. Hey Noah, what Paul keeps pointing out is that it is far riskier to do nothing, since we know what that is going to lead to. QE might not be a certain way out of years of sluggish growth in the US or outright depression in the case of Europe but trying beats doing nothing. Even three years inflation of 4 % would be a more than fair price to pay for a decent recovery. I'm with PK here, it has nothing to do with the models.

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  3. It's possible to come to the conclusion of being anti-austerity-in-depressions without deriving that from a model or from intuition.

    I am very anti-deficits, anti-big government, and libertarian-leaning, but I think austerity should wait 'til there is an organic self-perpetuating recovery. Why? Am I deriving this from some kind of macro model?

    Nope, I'm deriving it from real world experience and economic data. Hoover raised taxes and slashed expenditures to "focus on deficits" and hey-presto contraction. Greece, Portugal and Spain have slashed public services to a bone and hey-presto contraction and unemployment spike, and most significantly... bigger deficits due to falling tax revenues. Romania during the 90s slashed spending during a contraction, which led to bigger deficits and a double dip. Krugman's graph on this shows that the more austerity European governments undertake, the more contraction they get.

    As a deficit hawk, the last thing I want is bigger deficits. So I know that generally if the economy is depressed that slashing the government's net position (i.e. hiking taxes or slashing spending or some combination of both) will lead to bigger deficits, because it has tended to in the past.

    Most of the counter-examples (e.g. post-1945) have not had the problem of pre-existing depression. Yes, spending was massively slashed then, but there was the stimulatory effects of bringing all the troops home, and finding employment for them. This was a natural growth agent that replaced the output lost from government spending (we know this for a fact because GDP rose).

    I debate austerians about this a lot, coming from the libertarian-ish end of the economic spectrum, and the one main guy I debate (we probably put about 200 blog comments into it over 6 months) finally admitted that it will lead to bigger deficits, but that some pain is necessary to satisfy bondholders and that it will "stabilise" at a more viable level and begin to grow organically again. I point out to him that even once this has happened there will generally be a proportionally larger debt burden than there was before the austerity (how the heck will that satisfy bondholders?) and that his own country (he's Romanian) spent the 90s engaging in IMF-enforced austerity programs, and even now Romanian GDP and industrial output TODAY are lower than they were during the 80s. So the only choice to lower the burden is to grow GDP faster than government debt.

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    1. /* So the only choice to lower the burden is to grow GDP faster than government debt.*/

      Why is liquidating bad debt a bad idea? Why should we add more debt, rather than erase existing debt that cannot be serviced?

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    2. Well, I don't see much political hope for any kind of debt jubilee (of the Krugmanite inflationary form, or the absolute form) or political enthusiasm for liquidationism (which is, in my view a huge error). I am extremely disappointed the residual debt overhang wasn't allowed to liquidate in 08, for example, and it's not junk debt that should clear, it's all the junk shadow securities, junk chains of intermediation, junk business models. The market was (painfully) clearing in '08, but politicians went and bailed out a whole load of unviable things. Whoops. I hope next time they let bad things break. Better to "bail out" the jobless with a job program or the foodless with a food program than to save a broken banking system to break again another day.

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    3. Aziz,

      To just add on to what you were saying, Here's Prof. Burton Klein, from his book: Prices, Wages and Business Cycles: A Dynamic Theory.

      “the degree of risk taking is determined by the robustness of dynamic competition, which mainly depends on the rate of entry of new firms. If entry into an industry is fairly steady, the game is likely to have the flavour of a highly competitive sport. When some firms in an industry concentrate on making significant advances that will bear fruit within several years, others must be concerned with making their long-run profits as large as possible, if they hope to survive. But after entry has been closed for a number of years, a tightly organised oligopoly will probably emerge in which firms will endeavour to make their environments highly predictable in order to make their environments highly predictable in order to make their short-run profits as large as possible.”

      The biggest problem with the bailouts is that, it is terrible short-term thinking and sacrificing the good of the long-term.

      Trading off resilience for stability is not a good idea and we are learning that the hard way, I'm afraid.

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  4. I think you are pretty close to spot-on as to why Chairman Bernanker is reluctant than Prof. Bernanke.

    And Of course, also spot-on that macro is not science. I think macro today is more leaned towards "special pleading of selfish interests", as Hazlitt put it.

    One thing I don't get fully is: why is a one-way road towards more consumption (in an already 70% or more consumer driven economy) considered sustainable? Therefore, does thinking in terms of just "aggregate demand" make sense when an economy is a balancing act between consumption and production?

    Secondly, why is it that PK completely ignores the trade deficit that US is in, and further QE's implications towards it?

    Here's a thesis on why trade deficit is a bigger threat to the dollar than nominal debt servicing.

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    1. Anonymous8:38 AM

      Why would you think PK could not properly asses the importance of the trade deficit? You do know international trade is is specialty, do you, getting him his Swedish thingy? I do remember PK has explained the importance (or irrelevance) of the trade deficit and QE in all this on his blog (you'll have to search his blog yourself for this.) And PK is never someone who keeps things he knows are important under the rug just because they're inconvenient. I take PK's opinion on trade deficits over a random blogger (who is FOFOA?) any day. Oh, and PK also has explained on his blog that "the dollar" is really not as important as you'd think.

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    2. You're missing the key here -- investment is a form of aggregate demand. Aggregate demand is demand for consumption _and_ investment. If people just shifted from consumption to investment, there would be no recessions. The mystery of the business cycle is that you get both less consumption and less investment.

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    3. Anon,

      Why don't you post a specific link where Paul Krugman talks about the risk of widening trade deficit due to further QE and the associated risks of a currency confidence crisis?

      /* I take PK's opinion on trade deficits over a random blogger (who is FOFOA?) any day.*/

      Sure, I can -- if you are willing to post something. I can't find any on his blog that talks about trade deficit + QE. And secondly, why don't you critique the content of FOFOA as opposed to stating simply that he is a random blogger? What is specifically wrong in that thesis?

      Walt,

      /* investment is a form of aggregate demand. Aggregate demand is demand for consumption _and_ investment.*/

      Investment involves a certain degree of risk. There's a third component, which should involve no risk -- and that is saving. Check out the personal savings rate of the United States over the last 2 decades.

      At the moment, this savings (which should be risk-free) has been completely squashed and ignored by QE. Think of it as an unintended consequence of QE, which is causing a global shortage of safe assets.

      Here's a write-up on the global shortage of good collateral.

      Therefore, my point still stands that -- aggregate demand does not account for everything in the economy. And increasing aggregate demand should not be seen as a panacea for solving the problems in the economy.

      An economy is not a static being that is suffering from just an "aggregate demand" problem. It is a dynamic complex system which faces unintended consequences from well-intended actions and has statistical properties of risk (such as fat tails), which most mainstream economists happily ignore away in their quest for "modeling".

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    4. r_f, in aggregate, savings is investment. And you just completely recapitulated one version of the Keynesian argument for fiscal stimulus (the Brad DeLong version). If there's a shortage of safe assets, then the only way to increase that is for governments who are good credit risks to increase their borrowing, i.e. fiscal stimulus.

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    5. Walt,

      /* in aggregate, savings is investment.*/

      Completely wrong. Savings = preserving purchasing power for a future use. Investment = undertaking risk for increasing purchasing power, again for a future use. Not the same thing. Savings should be risk-free.

      /* And you just completely recapitulated one version of the Keynesian argument for fiscal stimulus (the Brad DeLong version).*/

      I know the Brad DeLong version and I think he's fundamentally wrong in not recognizing the difference between savings and investment.

      /* If there's a shortage of safe assets, then the only way to increase that is for governments who are good credit risks to increase their borrowing, i.e. fiscal stimulus. */

      LOL, seriously - are you saying that increasing the supply of treasuries has no unintended consequences?

      I see why you would say something like that, having failed to recognize the difference between saving and investing.

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    6. Dude, you don't get to invent your own definitions.

      Delete
  5. "The more I read about monetary policy, the more convinced I become that humankind does not really understand it very well. "

    I guess that is partly true. But isn't the real problem with monetary policy - that policy ideas don't cover the bit between we WANT to do so and so and so we should DO so and so very well. The problem is not the targets or the instruments, it is the mechanisms in between. That is what undid Milton Friedman's simple ideas - controlling any given measure of the money supply (and the different ones tend to behave very differently) didn't turn out to be at all easy to do. The easiest way to actually get money to people who will get it circulated is to actually directly give it to them. (And that in my terminology is actually fiscal policy - although some market monetarists like to pretend it is really monetary policy.) When it comes to actually doing a helicopter drop, something gets in the way. They prefer to bribe the very rich into giving up their bonds for cash in the hope that it trickles down.

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  6. It's a long post that in an economics blog sounds a bit like an atheist's view in a meeting of theologians: humankind does not really understand monetary policy, and that includes economists (provided they're human).
    The sad truth is that for the vast majority of economists, that's probably true. I was struck however by the paper of Brad Delong on Bagehot. In the 19th century, Bagehot had understood all of the role of a central bank, summarized in four short rules. They were forgotten in the 1930's, and they've been forgotten again now.
    Looking at those rules, you'll see that it's not a model, or mechanisms or even a theory. It's just game theory:
    - economic agents must not believe that the central bank will help them out of the bad situation they put themselves into (in order that they don't do it in the fist place)
    - but if they do, the central bank needs to help them out

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  7. Anonymous4:39 AM

    I really "like" Noahs following paragraph: "First, he argues that infrastructure spending in Greece and Spain over the past 30 years failed to prevent the current crisis. But that is obviously irrelevant, since Greece and Spain grew robustly before the crisis, and no advocate of stimulus believes that infrastructure spending will prevent recessions in the future." - Wow, robust growth before 2008? Most growth in Greece and Spain before 2008 was due to EU subsidies supporting consumption, real estate and construction i.e. nothing you can export/ trade or build a viable future on! And any infrastructure investment over the last 30 years matters even if totally useless and meaningless? What about those ghost airports in Spain (Leon & Huesca & Ciudad Real & Lérida & Castellón) with overall building cost (wasted) of more than EUR3B? What about the fudged Greek statistics about growth and GDP for a decade getting billions of EU money with it and consuming all? Structurual reforms are also about tackling unproductive/ corrupt investment practices. Infrastructure investments serving increased productivity and competetiveness are very relevant but seldom done. Ignoring that is just naive at best.

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  8. Hi Noah. I guess common sense is not so common anymore. People never use it at times.

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  9. This is being too hard on Bernanke, Noah. (And, by proxy, you too, Mr. Krugman.)

    What is required is for the Fed to credibly commit to being "irresponsible" for, say, the next five years. Bernanke is not an autocrat, with sole and absolute power to make the Fed do whatever he wants, no matter how strongly he believes in it. Even if he were, there's no way he could stop a successor undoing his work.

    Bernanke would have to be more persuasive than ... a very persuasive person, to be able to shift the Borg to believing that irresponsibility is the right behaviour, and therefore ensure that his programme would be carried out even in his absence. (Here I am assuming that the Borg is more or less a synonym for the VSPs, the Very Serious People, rather than (more narrowly) the Fed and people who might take leadership roles in it.)

    The Borg, CJs to the last unit, didn't get where it is today by being irresponsible.[1] What "Professor Bernanke" advocates flies in the face of all that is Borgish. And there is the fact that corporate profits are doing just fine. From the Borg's point of view, there is no crisis, and therefore no need to listen to anyone about anything. Even less need to listen to wild heresies.

    I don't think we can claim Bernanke has been assimilated into the Borg. But he has been beaten by it.

    As for Rachman: as a layperson, perhaps he can be excused for dismissing macro after its 30-year trip into the rational addiction of RBC, and in the light of its lack of coherence.

    [1] http://en.wikipedia.org/wiki/The_Fall_and_Rise_of_Reginald_Perrin#Background_and_influence

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    1. This is being too hard on Bernanke, Noah

      really? Noah sounds like a Bernanke apologist here.

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  10. Doc at the Radar Station8:19 AM

    "It seems highly likely to me that Fed Chairman Bernanke does not believe in Professor Bernanke's theories enough to make big bets on them."

    I think this is your best post yet. Bernanke's (and others) situation is a lot like the confusion in the fog in Apocalypse Now... "I said I can't see a thing, captain. I'm stopping
    this boat. Ain't risking no more lives."

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    1. "I said I can't see a thing, captain. I'm stopping
      this boat. Ain't risking no more lives."

      Wrong. It's more like 'we evacuated the officers; I'm now declaring that the weather is too bad to fly"

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  11. I agree that there is a lot of model uncertainty
    1. When faced with model uncertainty, most smart people i know "triangulate" and take the average of the models and the market (with much more weight on the market, because models are based on those time series regressions smart people are skeptical of).
    http://www.bloomberg.com/quote/USGGBE03:IND/chart
    epic fail!

    2. $1 of QE is likely to do very close to nothing, except for the signalling effect. $50 Bn might do more. $100 even more, and $1Tn more than that and so on. There is no threshold or critical point. Model uncertainty is not an excuse for paralysis, but it might be an excuse for small tepid steps.
    The main way QE works, IMO is by signalling the Fed's committment to closing the output gap and lowering unemployment. It might also work through a host of other "real" channels. So, commit to doing a small amount at a time to ensure things dont get out of control!

    3. You know in the past, the Fed caused these things called recessions to tame inflation. I recall this guy called Volker tamed double digit inflation. I dont think the Feds credibility on this issue is going away cause they let inflation get to 3%. Yes Australia has a 2-3% band and their world has not ended.

    4. Model uncertainty needs to be tempered with empirical evidence. Sure, we might have structural problems or wages might merely be sticky. you decide. if wages are sticky you cant precipitate a lot of inflation by stimulating the economy.

    http://www.frbsf.org/publications/economics/letter/2012/el2012-10.html

    At the Bernanke press conference he talked about a higher inflation target producing a distribution of outcomes which might be reckless.

    So, wheres the actual evidence for these claims?

    5. Model uncertainty is not new. been dealing with it for 70 years. Its the responsibility of the central bank to choose a reaction function that accounts for it.

    by the way, what exactly is the Feds reaction function?

    I dont even think Bernanke knows. its a committee decision every six weeks, and every six weeks it seems to change.

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  12. oh i should add:
    6. there is a certainty that as long as unemployment stays high, mortgage delinquencies will stay high, foreclosures and defaults will continue, and home prices maintaining pressue of home prices and new home construction. the certainty of a bad thing weighed against the possibility of less-bad thing favors action.

    7. we dont know when the next Tsunami or political crisis will be and how bad. Eternally looking backwards (which is what a model fundamentally does) and not buying insurance is bad risk management.

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  13. Great post (as usual). I think you go a little easy on Bernanke as perceived by Krugman. The case for a policy is almost never a slam dunk and people who are paralized unless they can dunk should never be passed the ball. Now as to Ben Bernanke as perceived by me, I am still thanking God, Harriet Myers and George Bush (ouch physical pain typing that) that Bernanke is Fed Chair. You know I think most academic macro (definitely including my own efforts) is crap. I do make (more than 2) exceptions for the work of Bernanke Gertler et al. The thought that George Bush (ouch) not only appointed a highly respected economist, but also one of the few with actually relevant actual insights boggles my mind ................

    OK mind no longer in tilt. Uh where am I (Rome). Uh my point if any is that it is not only true that the risk of say 6% inflation due to QE 3-32 is tiny but also that no one has come up with a case tat 6% inflation implies significant social costs. Inflation is hated by the general public because they think it means higher prices and the same nominal wages so wage increases are hated by centrak bankers, in effect, because they act as if they think that higher nominal wages imply higher prices and the same nominal wages and employment. This is so insane that relying on a DSGE model is comparitively sane (OUCH why do I keep typing in a way which makes my head spin).

    Oh well back to adding implausible but convenient assumptions to a DSGE model to make it generate amusing results (sometimes reality is so painful that I have to escape into a dream world).

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    1. Regarding the costs of inflation, my intuition says that the main cost is not due to high inflation but rather to uncertain inflation, which makes nominal contracting riskier. (I wonder why people don't just make inflation-adjusted contracts, but that's a topic for another day...)

      Also, I suspect the money illusion you're talking about may be rooted in something real. Higher inflation may alter the bargaining power between workers and employers, allowing employers to reduce real wages. I have some ideas for how this might happen...maybe someday I'll decide I'm being too productive and useful with my time, and decide to write a macro paper... ;-)

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    2. business do make inflation adjusted contracts. its in many contracts.

      its unexpected inflation that has costs, not necessarily expected inflation.

      nominal debt contracts are very long, so even a small shift unexpected inflation can be costly for one of the parties (really, a shift in trend inflation).

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    3. business do make inflation adjusted contracts. its in many contracts.

      You know, I didn't even know that! I'm so ignorant...

      its unexpected inflation that has costs, not necessarily expected inflation.

      Yes, that's why I think inflation uncertainty has much more costs than inflation level.

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    4. i did not mean to imply you were ignorant (i think exactly the opposite). If "I wonder why people don't just make inflation-adjusted contracts, but that's a topic for another day" was just sarcasm, my bad- sarcasm does not translate well in emails and print.

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  14. Brian A. Graham9:59 AM

    It is class and ideology. The Fed is surrounded by well to do credentialed professionals who have survived the rigors of self selection in a neoliberal millieu. Professor Krugman was lucky enough to have been educated before 1985 and has kept his outsider status. The neoliberal culture is not grounded in reality. Krugman and the Keynesian model works best in this situation, and we are destined for a lost decade of depression much like the 1870s or 1990s Japan.

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    1. Agreed. In the end, what's going on is (as close to as you get with real people) 100% consistent with the macro field being dominated by right-wingers who face absolutely no problems with being wrong and repeatedly wrong.

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  15. marcel10:21 AM

    People do not believe in macro models.

    Talked to any fresh-water economists lately? or ever? Ever heard of a guy named Ed Prescott? Look him up. Read one of his rants someday.

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  16. I don't know why you don't just believe Rachman when he says the goal is to force European governments to do structural reform by blackmailing their people with pain.

    And remember that not everyone who wants to shrink governments or alter their structure is motivated by macroeconomic concerns. There is more going on than debates over the best way to optimize aggregate growth.

    The people who own most of Europe want to own even more of it when all this dust clears. It's no different that situations in the past when powerful people and governments have advocated wars because those wars would enhance their own positions. The unemployed of Spain, Greece and elsewhere, and the stagnation of living standards are casualties in a war for power and control. People don't seek to gain the commanding heights because they are so, so concerned about all the little people in the valleys.

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  17. Larry Headlund10:55 AM

    I think Bernanke is dealing with a severe case of model uncertainty.
    This person(http://www.nakedcapitalism.com/2012/04/pavlina-tcherneva-no-mr-krugman-bernankes-conundrum-is-completely-different.html) has a different theory on Prof. Bernanke vs. Chairman Bernanke. The short form is that the Professor Bernanke advocated fiscal policy that Chairman Bernanke, monetary Bernanke if you will, has no control over.

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  18. Larry Headlund10:58 AM

    Rachman is implicitly saying that economic science is crap and common sense is all you need.

    Half right?
    (Couldn't resist)

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  19. Noah:

    I agree with the diagnosis, but disagree with the treatment. As economists, we build all kinds of models. Most of us don't believe them, but I don't think that's to say we should discard them.

    Rather, there's an extra step in jumping from the model world to the real world. That step is thoroughly understanding the assumptions and limitations of your model, and looking at the recommendations of other models which perhaps make different assumptions or focus on other aspects of the economy. We should be skeptical of our own research and training, but that should lead us to be multi-model thinkers, not model-free thinkers.

    In this framework, it's not too hard to be a Bernanke apologist. My knowledge of macro is very limited, but I'm not aware that there's many competing theories on QE. If Bernanke is (rightly) skeptical of his own research, he may not want to take any bold policy steps based off of model recommendations.

    On the other hand, it's more difficult to excuse (the current) austerians. While NK models need a heroic level of price rigidity to explain the data, just about any macro model with a zero lower bound and any level of price or wage rigidity will reproduce the 'paradox of thrift.' Once you're off the zero lower bound, there's room for debate again.

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    1. what I see is a whooooooooooooollllllllllllllllleeeeeeeeee bunch of special pleading from economists of 'uncertainty', but only in the sense of refraining from doing things which the right doesn't want done in the first place.

      We *know* what the status quo is - years and decades of stagnation and suffering, *if* no additional shocks hit the system in the next several years (i.e., if we're extremely lucky).

      That's a lot of risk, which right-wing economists just write off.

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  20. "Or maybe the amount of QE needed to produce a noticeable movement in employment is so huge that it really would cause serious inflation."

    Thanks for a very interesting post. But I would differ with this portrayal. One can argue that QE is incapable of leading to inflation at all. At infinitel levels, it drives long-term rates to zero, matching short rates, and loads the banks with infinite reserves. That still doesn't force banks to lend or borrowers to borrow, if repayment prospects are poor or deflation is in prospect. QE seems to face the same zero bound that short policy does.

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  21. Interesting post, as usual. I had (as a complete outsider) a couple of thoughts - 1, we are, as humans, not built for deep, thoughtful analysis: we're built for snap judgements (usually based on such useful alternatives to thinking as ideology, stereotypes and other tribal beliefs like philosophy/religion), quick decisions, and paradoxically, limpet-like adherence to the decision once taken (unless it is the correct decision, in which case it will be discarded as soon as possible); and 2, Your ideas about Prof. Bernanke vs. Chairman Bernanke have a lot of resonance to them - there is a reason, after all, why the old historical disdain for "ivory-tower theoreticians" existed. It wasn't based on ideology as much as on the apparently common theoretician's paralysis when faced by uncertainty and 'the fog of war'. Again, a human thing; it's common in every facet of life, but most commonly noticed, of course, in warfare. We would all rather have someone (or some model) tell us what to do than take the helm ourselves. The old Wehrmacht rule of "something done now is better than the right thing done later" is one of the big reasons they have been such a potent military force. The old Boy Scout rule of "Be prepared" is tremendously helpful in dealing with this problem, as well. You don't have to be prepared for everything, just prepared to do something when faced by a crisis. It's simply too easy to become paralyzed, and then inertia becomes your worst enemy. Indecisiveness feeds on itself until doing nothing is all you can do. And, being human, there are endless rationalizations for doing nothing. Perhaps there should be a big sign over the door to the European Commission's meeting room: "We are all Hamlet now".

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  22. Art Brown1:39 PM

    I think you are neglecting the dominant force in the system: the political ideology of the right. Instead of economists "falling back on their own reflexive intuition", they are circling around the party position (e.g. "playing for team Republican"). Witness your favorite grand-advisor and inflation targeting. Physics has nothing like this phenomenon.

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    1. Larry Headlund2:27 PM

      In defence of economics (by counter-attack) physics isn't entirely immune to party positions, both internal and external. Examples: Teller vs. Oppenheimer in the wider world, quantum theory and its opponents at the beginning of the last century.
      Even mathematics has some of this:the constructionist movement, Cantor's infinities, etc.

      Maybe it's just that economics' warts are more visible, since it more often has feuds that are noticed by outsiders?

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    2. Art Brown7:27 PM

      I was thinking of Lysenko in biology, but your examples are good also: even within the quantum community, David Bohm certainly took a lot of grief for his work (some of it from Oppenheimer, for that matter). However, the money involved in these cases is negligible in comparison with that in play with economics. I think that difference goes a long way towards explaining the correspondingly greater ideological pressures.

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    3. Larry HeadlundMay 3, 2012 11:27 AM

      "In defence of economics (by counter-attack) physics isn't entirely immune to party positions, both internal and external. Examples: Teller vs. Oppenheimer in the wider world, quantum theory and its opponents at the beginning of the last century.
      Even mathematics has some of this:the constructionist movement, Cantor's infinities, etc."

      Here's a trick - the evidence is in, and the dominant side was wrong. Flat-out wrong. And your reaction to it is to continue to be wrong.


      At this point, the only credible theory is that right-wing economics is a collection of highly-politicized right-wing liars, who are to science what Marxist theoreticians in the USSR were. Just more math.

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    4. Larry Headlund11:33 AM

      And your reaction to it is to continue to be wrong.
      And what pray tell is my reaction to it? Cites, please.
      At this point, the only credible theory is that right-wing economics is a collection of highly-politicized right-wing liars, who are to science what Marxist theoreticians in the USSR were.
      And this proves physics has nothing like this phenomena how? Look up the history of N-rays or more recently slow fusion.

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    5. Art Brown2:19 PM

      (ignoring the interlude...) OK, I take your point: human nature shows up in physics too. However, I think I will stand by three things:
      1) Young Master Smith neglected the force of right-wing party pressure in his analysis. Like a good physicist, he concentrated on technical aspects. In physics, that would be enough: while party pressure might temporarily distort the debate, in a reasonably short time the truth would out, with holdouts consigned to the wing-nut gallery.
      2) Here, however, party pressure is huge and on-going because of the money and power on the line, which are much larger than in, say, the kerfuffle over cold fusion. I don't see how one can understand the current debate without including this force. The feuds are not just noticed by outsiders; those folks have vested interests in the outcomes. (For another example, a recent paper by Professor Mankiw concludes that the dynamic scoring effects of tax cuts are "surprisingly large, ... half of a capital tax cut is self-financing". In fact, the paper refutes Laffer, but Mankiw doesn't say that, instead spinning it in the most right-wing favorable light possible.)
      3) On the left, arguments are generally like Noah's, that is, technical.
      So I concede that qualitatively my original contention is incorrect, but as a quantitative comparison I think it holds.

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    6. Art Brown3:02 AM

      For more examples, see P. Edwards, "A Vast Machine", Chapter 15, for how vested interests disrupt scientific debate in the tobacco safety and climate change cases.

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    7. Larry Headlund10:12 AM

      I broadly agree with you and would not argue against the notion that economics has a much more serious politics problem than most other sciences. Perhaps it is that I think pointing out other fields problems can illuminate how and why economics is worse.
      In physics, that would be enough: while party pressure might temporarily distort the debate, in a reasonably short time the truth would out, with holdouts consigned to the wing-nut gallery.
      Didn't one quantum physicist quip that physics advanced one funeral at a time? (Kuhn got a whole book out of this.) One difference is that we haven't had a real knock down drag out fight in physics refereed by facts for quite a while. String theory has no referee. The second difference is that in economics even funerals bring no advance: they are having the same arguments now they had in the 1930s.


      Here, however, party pressure is huge and on-going because of the money and power on the line, which are much larger than in, say, the kerfuffle over cold fusion.
      Agreed, plus the lack of a fact based referee. It would be interesting to do a compare and contrast with sociology, which has a lot of the same issues, as far as I can see.

      On the left, arguments are generally like Noah's, that is, technical.

      Perhaps part of the problem is that someone like Noah is seen as left? Some fire breathers farther along the spectrum would be a tonic.

      So I concede that qualitatively my original contention is incorrect, but as a quantitative comparison I think it holds.

      As a certain economist said, quantitative changes can become qualitative and vice versa.

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  23. OT Noah, but this ones for you (less "tricking" going to be going on, i guess):

    http://www.bloomberg.com/news/2012-05-04/goldman-sachs-said-to- prepare-trading-system-for-corporate-bonds.html

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  24. Anonymous11:37 AM

    Ultimately, I think that whichever current economists have succeeded in approximating the actual workings of the economy most closely owe their success not to greater intellectual rigor, or the ability to set aside their biases, or to a superior capacity for constructing and assessing arguments for soundness. Instead, I think they owe their success primarily to intellectual luck. I think it is entirely possible for two economists to be equally rigorous, equally immune to bias, equally honest, equally smart, and so on, and still ultimately arrive at substantially different conclusions. Whichever one of them happens to achieve a better approximation of the truth just got lucky--lucky to be socialized in the right way, lucky for the right propositions to seem intuitive, and ultimately lucky enough to have the right causal forces kicking around in her brain. I think we should bear this in mind when we lavish praise on economists for their successful predictions, only to become confused when they fail to replicate their success.

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