"Thus I find myself becoming more Paleokeynesian by the hour, as the world keeps hitting me on the head with a brick, pausing after each blow to say: "Now do you understand?!" "

"Density forecasts, including the pioneering Bank of England ‘fan charts’, are often used to produce forecast probabilities of a particular event. We use the Bank of England's forecast densities to calculate the forecast probability that annual rates of inflation and output growth exceed given thresholds. We subject these implicit probability forecasts to graphical and numerical diagnostic checks. We measure both their calibration and their resolution, providing both statistical and graphical interpretations of the results. The results reinforce earlier evidence on limitations of these forecasts and provide new evidence on their information content and on the relative performance of inflation and gross domestic product growth forecasts. In particular, gross domestic product forecasts show little or no ability to predict periods of low growth beyond the current quarter, in part because of the important role of data revisions."

"When the Financial Times's Martin Wolf asked former U.S. Treasury Secretary Lawrence Summers what in economics had proved useful in understanding the financial crisis and the recession, Summers answered: “There is a lot about the recent financial crisis in Bagehot...”. “Bagehot” here is Walter Bagehot’s 1873 book, Lombard Street. How is it that a book written 150 years ago is still state-of-the- art in economists’ analysis of episodes like the one that we hope is just about to end? There are three reasons. The first is that modern academic economics has long possessed drives toward analyzing empirical issues that can be successfully treated statistically and theoretical issues that can be successfully modeled on the foundation of individual rationality. But those drives are disabilities in analyzing episodes like major financial crises that come too rarely for statistical tools to have much bite, and for which a major ex post question asked of wealth holders and their portfolios is: “just what were they thinking?”. The second is that even though the causes of financial collapses like the one we saw in 2007-9 are diverse, the transmission mechanism in the form of the flight to liquidity and/or safety in asset holdings and the consequences for the real economy in the freezing-up of the spending flow and its implications have always been very similar since at least the first proper industrial business cycle in 1825. Thus a nineteenth-century author like Walter Bagehot is in no wise at a disadvantage in analyzing the downward financial spiral. The third is that the proposed cures for current financial crises still bear a remarkable family resemblance to those proposed by Walter Bagehot. And so he is remarkably close to the best we can do, even today."

That was not one of Noah's better performances, no.

"The business cycle is a fundamental yet elusive concept in macroeconomics. In this paper, we consider the problem of measuring the business cycle. First, we argue for the output-gap view that the business cycle corresponds to transitory deviations in economic activity away from a permanent, or trend, level. Then we investigate the extent to which a general model-based approach to estimating trend and cycle for the U.S. economy leads to measures of the business cycle that reflect models versus the data. We find empirical support for a nonlinear time series model that produces a business cycle measure with an asymmetric shape across NBER expansion and recession phases. Specifically, this business cycle measure suggests that recessions are periods of relatively large and negative transitory fluctuations in output. However, several close competitors to the nonlinear model produce business cycle measures of widely differing shapes and magnitudes. Given this model-based uncertainty, we construct a model-averaged measure of the business cycle. This measure also displays an asymmetric shape and is closely related to other measures of economic slack such as the unemployment rate and capacity utilization."
--- Worthy, but at the same time makes me want to lock them in a room with a copy of Li and Racine's _Nonparametric Econometrics_, or even _The Elements of Statistical Learning_, and not let them out until they understand it.

One of those essays which would really be much clearer, and easier to judge, as a mathematical model.

A normal-shaped recession of unusual size?

"These top economists discuss future directions for monetary policy, fiscal policy, financial regulation, capital account management, growth strategies, and the international monetary system, and the economic models that should underpin thinking about critical policy choices. Among the new realities they consider are the swing of the pendulum toward regulation; the need for new theoretical approaches, incorporating advances in agency theory, behavioral economics, and understanding of credit markets and finance based on theories of imperfect information; and the importance for macroeconomic policy to target not just inflation but also output and financial stability."

Programmatic: "The crisis has exposed the failure of economic models to deal sensibly with endogenously generated crises propagating from the financial sectors to the real economy, and back again. The goal of this paper is to review the method of stock flow consistent modeling to highlight areas in which it is deficient. I argue there is a fruitful research agenda in shoring up these deficiencies. The objective of stock flow modeling should be the ability to practically model unstable macro-economies, and in particular their interactions with the financial sector. These models should provide ‘Words to the Wise’, and until they do, they are just thought experiments."

DeLong is missing a trick. The rational-expectations dogmatist could simply insist that the true probability of an event like 2008 in 2008 _was_ 0.02%, and we were just unlucky.

Oldie but goodie from Uncle Paul.

"...as clear and concise a description of the fundamental contribution of the General Theory that I have ever read. And it reveals just how far from the original vision of Keynes the so-called Keynesian economics of our textbooks has come. The downward inflexibility of wages and prices is viewed in many quarters today to be the hallmark of the Keynesian theory, and yet the opposite is closer to the truth. The key problem for Keynes is the mutual inconsistency of individual plans: the inability of those who defer consumption to communicate their demand for future goods and services to those who would invest in the means to produce them.

The place where this idea gets buried in modern models is in the hypothesis of "rational expectations." A generation of graduate students has come to equate this hypothesis with the much more innocent claim that individual behavior is "forward looking." But the rational expectations hypothesis is considerably more stringent than that: it requires that the subjective probability distributions on the basis of which individual decisions are made correspond to the objective distributions that these decisions then give rise to. It is an equilibrium hypothesis, and not a behavioral one. And it amounts to assuming that the plans made by millions of individuals in a decentralized economy are mutually consistent. As Duncan Foley recognized a long time ago, this is nothing more than "a disguised form of the assumption of the existence of complete futures and contingencies markets."..."

This cries out for simulation.

Lucas is indeed a significant, and malign, influence.

"I imagine that every day Kocherlakota interviews people – from banking, from the top 1%, from the corporate offices of our largest firms – who will kindly explain to him that the problem in the economy is that they just don’t get their demands answered quickly enough.  If only they paid even less in taxes, if only regulations were weakened further, if only every pet demand they ever wanted was granted, then they would allow the economy to take off.
How often does he hear the opposite?  How often do the unemployed disrupt his speeches, chanting about how they aren’t on a magical vacation but instead desperate to find a job?  How often do students show up in huge numbers in his office explaining they they are terrified of entering this terrible job market, a job market likely to scar their careers for decades, instead of apathetic losers who’d rather just play on facebook all day enjoying their “z”?   Maybe it is time that changed."

(If only.)

The methodological ideas here are suspect.  It is true that there is not much to predict about an in-control system, and what is happening is largely random and so unpredictable, so that even the true model would show low forecasting ability.  The question however is why we are supposed to think that the DSGE _does_ give us good information about counterfactuals.  If you could show that it had much better predictive performance than baselines like constants or random walks during _out-of-control_ periods, that would be something; but they don't.

"From my perspective, the strange thing is that people kept trying to prove uniqueness and stability of general equilibrium.
Simply look at: [time-series of US employment to population ratio] and try to avoid the conclusion that to first order the U.S. economy can be in at least meta-stable equilibrium with an adult employment-to-population ratio of about 63% or with an adult employment-to-population ratio of 58.5%--and probably anywhere in between as well.
Proposing that economists pursue the research program of demonstrating that the economy has a unique stable equilibrium has thus always seemed to me to be like proposing that physicists pursue the research program of demonstrating the feathers fall unusually rapidly..."

I am a bit boggled that they write a whole paper about how to explain economic fluctuations in terms of input-output matrices without even mentioning the name of Leontief...

We call this memorizing the training data, yes.

"I stand before you repentant..."

Looks interesting, and co-edited by my old office mate Troy.  (Oh, and Blake has a paper as well!)  ETA: We don't subscribe. :(

Worth reading?

"By 1988, it was already obvious that equilibrium business cycle theory had failed. Shiller had already circulated his devastating demonstration that asset prices were much too volatile to be explained by fundamentals, and the 1987 market crash had provided an object lesson in panic. ... And nothing happened. Real business cycle theory continued to prosper, developing an increasing stranglehold over the professional journals. Behavioral finance stayed on the margins. The equilibrium guys had learned nothing and forgotten nothing; and by the time 2008 came around, the ravages of time had left people who actually understood demand-side shocks much thinner on the ground than they had been 20 years earlier. Our problem, in short, isn’t lack of nifty new ideas; it’s the refusal of too many economists to face up to the fact that some of their preferred theories don’t work, a fact that has been obvious for decades."

Shorter DeLong: fucked is the new normal.

"Knowing that the market is good, their task is to figure out why a good market has decreed that employment in America needs to fall by 8 million relative to trend. (It's not unlike grappling with a just and all-powerful God who doesn't mind a tsunami every so often.)

The workers-have-no-productive-skills explanation is the only one that makes sense, if we first start from the premise that the market is all-good. Never mind that we have a lot of evidence that the market is not good — that we have been periodically suffering from these finance-driven grand mal seizures of the body economic that we call the industrial business cycle for 185 years.

Nevertheless, you can shut your eyes — and economists are very good at doing so. It was Joseph Schumpeter, one of the smartest economists of three generations ago, who began a lecture with: "Gentlemen! A depression is a healthy shock! It is like an ice-cold douche!""

"To be frank, when I dug into the Alesina and Ardagna paper and finally understood the work their 1.5% primary deficit reduction was doing I wandered around stunned for a day or two. I called a bunch of people I trusted on macroeconomics and tried to see if I was missing something; was our elite discourse, the Sensible People Stuff, really being driven by this?"

"While the other side was making these predictions, people like me were saying that classical economics was all wrong in a liquidity trap. Government borrowing did not confront a fixed supply of funds: we were in a paradox of thrift world, where desired savings (at full employment) exceeded desired investment, and hence savings would expand to meet the demand, and interest rates need not rise. As for inflation, increases in the monetary base would have no effect in a liquidity trap; deflation, not inflation, was the risk. ... The 10-year bond rate is about 2.5 percent, lower than it was when Ferguson made that prediction. Inflation keeps falling. The attacks on Keynesianism now come down to “but unemployment has stayed high!” [but] if you took a Keynesian view seriously,... given what we knew in early 2009 ... the stimulus was much too small to restore full employment."

But surely the _scientific_ answer is that we all continue to have a much higher preference for leisure than we did in 2007!

Shorter Stiglitz: I am sickened by the weakness of your microfoundations; prepare to die.

"Narayana Kocherlakota (who the bankers of Minnesota, Montana, North Dakota, South Dakota, northwestern Wisconsin, and the Upper Peninsula of Michigan have selected to exercise important public functions) certainly knows more about economics than me. So when he says “[m]ost of the existing unemployment represents mismatch that is not readily amenable to monetary policy” I’m prepared to defer to him or to leave the job of explaining why he’s wrong (if he is wrong) to other people. But ... as a reason to avoid monetary stimulus this makes no sense, and is just a piece of misleading rhetoric that distracts people from the real issue. ... Say that of that 5.1 percentage point increase [in unemployment], 2 ... are due to inadequate demand and 3.1 ... are due to structural factors... monetary expansion could reduce the unemployment rate by 2 percentage point ... [which would be] a big deal. ... we’d alleviate a substantial quantity of human suffering up to and including suicide."

Ans.: No.

The Tobin paper sounds interesting.

"challenges the mainstream paradigm, which is based on the inter-temporal optimisation of welfare by individual agents. It introduces a new methodology for studying how it is institutions which create flows of income, expenditure and production together with stocks of assets (including money) and liabilities, thereby determining how whole economies evolve through time. Starting with extremely simple stock flow consistent (SFC) models, the text describes a succession of increasingly complex models. Solutions of these models are used to illustrate ways in which whole economies evolve when shocked in various ways. Readers will be able to download all the models and explore their properties for themselves. A major conclusion is that economies require management via fiscal and monetary policy if full employment without inflation is to be achieved."  In library.

Solow's prepared remarks for testifying before Congress about modern macro.  To put it in "shorter" form: "I helped invent macroeconomics, and let me assure you that this was not what we had in mind."

"Bear in mind that what protectionism does, according to textbook economics, is to cause a misallocation of resources, reducing the economy’s efficiency. It does not cause mass unemployment of resources — which is what the Depression was about. ... But going back to Hayek: attributing the failure to recover to trade restrictions was, in a way, characteristic. Hayek, like his modern followers, never could get his mind wrapped around the fact that the key problem in depressions, and the key observation his theory needed to explain, wasn’t misallocation of labor and other resources — it was mass unemployment. It’s not surprising to see that in the depths of depression he was focused on removing what was, in the end, a minor source of allocative inefficiency. But it’s a stark reminder of the extent to which he really, truly, didn’t get it."

I am only surprised he doesn't end this "This has been another edition of Simple Answers to Easy Questions".

"On the critical question of how to portray the industrial sector, I submit the below historical document..."

"With these basic concepts, plus sufficient scribbled arrows, more or less any problem in monetary economics can be solved, up to the level of accuracy of any other model."

I have just advised D.M. to use a copy of this figure in his dissertation proposal.

"But knowing their hypocrisy, he said unto them, "Why are you putting me to the test? Bring me a dime and let me see it."

And they brought one. Then he said to them, "Whose head is this -- FDR's or Herbert Hoover's?"

They answered, "Roosevelt's."

And he said unto them, "Right. So shut up. Have you morons already forgotten the 20th Century? When the choice is between imitating what worked and what really, really didn't work, why are you pretending it's terribly complicated?"

And after that, no one dared to ask him any question."

"Much has been made of the failure of modern macroeconomics to predict or understand the Great Recession of 2007–2009. In this MACRO FOCUS, our resident time-series econo- metrician, James Morley*, explains what is currently meant by “modern” macroeconomics, what is behind its failure, and what can be done to rehabilitate its reputation."

"How is it a waste of their time to take someone who is otherwise unemployed and pay them to do such work, especially if it provides us with something of long-term value and them with earned income? AND it stimulates demand. Where is the down side, pray tell? Even if we guess wrong, we'll have much needed improved infrastructure, mass transportation, new energy sources, better educated kids and safer streets and highways.

I believe the problem for Glaeser (and many others who dither while unemployment is high) is a morbid fear that putting people to work with taxpayer money (much as we have done for investment bankers) will crowd out efficient private sector productivity and jobs....some day. I'm left to wonder why crowding out of public infrastructure and education by unproductive, inefficient speculation in private financial and mortgage markets is OK, but I digress."

On the radical implications of orthodox economics: "If it was conventional wisdom that a bunch of unelected bankers looking out for rich people were the reason everyone was out of work, politicians would be forced to explain to angry voters why we had this crazy system and might actually consider doing something about it. But, incredibly, it just seems like nobody has any idea. Voters don’t realize it, politicians don’t understand it, journalists don’t cover it. And, in fact, they’re so far from having any idea that it’s really difficult to explain it to them. When you say a bunch of unelected bankers are the reason there are no jobs, they just look at you like you’re crazy. I’ve just spent a page or two explaining it and you still probably think I’m crazy. But it’s true! This isn’t some Ron Paul-type crackpot idea; this is mainstream economics, from Paul Krugman to the head of George W. Bush’s Council of Economic Advisors."

I find it interesting that the economic/dynamic programming nature of the DSGEs plays no role at all in the argument; all of the work is done by the effective linear model for the observables and latent "shocks" (their Eq. (1)). So this is really about the identifiability of state-space models.

Sounds promising, but much depends on the model, about which he is vague here.

Ans.: nothing and no one; it "deserves to be buried".

""the claim that `modern macro' somehow has the special virtue of following theprinciples of economic theory is tendentious and misleading... The otherpossible defense of modern macro is that, however special it may seem, it isjustified empirically. This too strikes me as a delusion.""

I think you mis-spelled "smoothing spline". HTH. HAND.

My reaction to the first half is "preach it, brothers and sisters!" Perhaps inevitably, the constructive proposals of the 2nd half are less compelling.

The key part is the observation that there is NO POWER to detect reasonably-sized deviations from random walks in only forty years' of data.

Damn.

"Inference about an impulse response is a multiple testing problem with serially correlated coefficient estimates. This paper provides a method to construct simultaneous confidence regions for impulse responses and conditional bands to examine significance levels of individual impulse response coefficients given propagation trajectories. The paper also shows how to constrain a subset of impulse response paths to anchor structural identification and how to formally test the validity of such identifying constraints. Simulation and empirical evidence illustrate the new techniques. A broad summary of asymptotic analytic formulas is provided to make the methods easy to implement with commonly available statistical software."

Note: the Hansen of the abstract is not the author!

Robert Solow on the financial collapse, in the form of reviewing Richard Posner's book on the same. I am reassured to find that my own half-baked thoughts align with Solow's.

The Keynesian explanation for why depressions don't last forever: "recovery comes because low investment eventually produces a backlog of desired capital stock, through use, delay, and obsolescence. And eventually this leads to an investment recovery, which is self-reinforcing." --- This suggests a "natural" time-scale for slumps, related to the rate at which the capital stock gets used up. Probably not enough data to try to to estimate this, though.

Aaronsw channels Krugman.

Note to self: try to replicate Henwood's calculation in _Wall Street_ of how much net corporate investment is actually raised from the stock market (+ bonds, I guess), vs. retained earnings. Construct time series. ---I no longer remember why I tagged this "to_teach:data-mining".

Clearly, McArdle hurts America by pretending her MBA lets her comment on economics, and always getting things wrong. But, as my father says, one must always consider the counterfactuals: perhaps she'd do _more_ harm to America by using her MBA to administer a business.

An attempt at explaining some "post-Keynesian" ideas about money and credit. Plausible-sounding but much depends on the strength of the econometric evidence he mentions but does not detail.

Truly dreadful page design, but I can't help liking the last line: "Neoclassical economics—and especially that derived from Milton Friedman’s pen—is mad, bad, and dangerous to know."

"One thing I've learned from the current episode is not to automatically trust that the most well-known economists in the field have done due diligence before speaking out on an issue, even when that issue is of great public importance, or even to trust that they've thought very hard about the problems they are speaking to. I used to think that, for the most part, the name brands in the field would live up to their reputations, that they would think hard about problems before speaking out in public, that they would provide clarity and insight, but they haven't. In fact, in many cases they have undermined their reputations and confused the issues. "