The Ambrosini Critique

The Economist marvels that the percentage of households that have had someone in the house lose their job last year is greater than the unemployment rate. They say the first number, 24%, shows “a lot of people directly affected by recession”. But is this true?

Let me start by giving the obvious disclaimer: the recession has been hard on people. Yessir. Nothing I say below should suggest otherwise.

Outside of recessions and booms, 1.3% of employed workers become unemployed every month (look at this neat graph). This means employed workers have about an 15% chance of being “affected” by unemployment in a year. There’s something like 1.22 workers per household so a household has about an 18% chance of being “affected” by unemployment in a year (I have to assume these proportions are the same whether or not the worker is the primary earner in the house). This is in “normal” times.

Survey error notwithstanding, it appears this recession is associated with a 6% increase in the number of households “affected” by unemployment. I don’t know if that’s a big number or not.

I do know that the separation rate is down in this recession (hire rates are down further, though).

I also know that lay-offs rates have only slightly increased in the last year or so.

The unemployment rate is high because the job finding rate is low not because the separation rate is high.

You can call Federal Reserve policies aimed at the sending of signals that alter the expected rate of future inflation “monetary policy” if you want, but then you lose analytical clarity–because the way such policies work (if they work) is not the “normal” way that “normal” monetary policy works.

— Prof. Delong

New rule: to opine on monetary policy you have to have opened a textbook on the subject that was written in the last 30 years.

From Micheal Woodford’s text (in a section in the introduction called “Central Banking as Management of Expectations”):

For successful monetary policy is not so much a matter of effective control of overnight interest rates as it is of shaping market expectations of the way in which interest rates, inflation and income are likely to evolve over the coming year and later. On the one hand, optimizing models imply… behavior should be forward looking… Moreover, given the increasing sophistication of market participants… it is plausible to suppose that a central bank’s commitment to a systematic policy will be factored into… forecasts… Not only do expectations about policy matter, but… very little else matters…

From Carl Walsh’s text:

Macroeconomic equilibrium depends on both the current and expected future behavior of monetary policy.

From Dornbusch, Fischer and Startz’ undergrad text:

You will remember that the nominal interest rate has two parts: the real interest rate and expected inflation… should [a zero interest rate liquidity trap] occur… policymakers are prepared… to pump money into the economy [and thus raise expected inflation].

From Jones’ new (and excellent) undergrad text:

To the extent that policymakers can influence, or manage, these expectations, they can reduce the costs of maintaining a low target level of inflation. This is one of the most important lessons of modern monetary policy… To the extent that the central bank can coordinate people’s expectations of inflation, it can maintain low and stable inflation without the need for [the bank to induce] recessions. Such coordination requires credibility and transparency on the part of the central bank.

From the Encyclopedia of Economics James Tobin says:

While not all monetarists endorse Friedman’s rule, they do stress the importance of announced rules enabling the public to predict the central bank’s behavior… Long rates depend heavily on expectations of future short rates, and thus on expectations of future Fed policies. For example, heightened expectations of future inflation or of higher federal budget deficits will raise long rates relative to short rates because the Fed has created expectations that it will tighten monetary policy in those circumstances.

Even if the free banking argument is correct, and the Fed should be abolished, I would continue to advocate the ideas expressed in this essay. As I indicated, we are currently stuck with the system we have, and if it performs poorly (particularly in the direction of deflation), people will almost certainly blame the resulting problems on the failures of capitalism, not monetary policy. (As interest rates are low during deflation.)

— Sumner

I’ve mentioned before that I’ve attempted The General Theory on several occasions but have never really “got” it. Knowing Keynes was a smart guy and he basically founded the field I research in, I assume the problem is me not him. Really.

Judge Posner wrote a “Nixon in China” summary of the book which is quite good. Posner says the fundamental tenants of Keynes’ thought are¹:

• Consumption spending is more important than investment spending
• Hording leads to the paradox of thrift
• Animal spirits and Knightian uncertainty

Consumption is more important than investment spending, except, of course, investment spending IS consumption spending only in the future. I’m not sure what to make of this concern in the context of modern dynamic models where a trade-off is made between consuming today and consuming tomorrow. And the idea that consumption drives growth is alien to me in light of all the research in growth that’s happened since Keynes. I guess we can thank him for being the first to tell us to keep our eyes on the ball. Thanks dude!

The paradox of thrift is interesting for two reasons. First, its a case were micro-based thinking gives you wrong answers when you aggregate up. Saving is good unless everyone does it, then its bad and counter-productive. Learning this paradox gives one good instincts about the macroeconomy: the sum doesn’t look like its parts. Second, the paradox is only an issue when prices can’t adjust and monetary policy is ineffective. Thanks again Lord Keynes!

Now for some good ‘ol psychology. Posner says Keynes says investors have “animal spirits” and he, apparently, goes on to commit a fallacy of composition of his own. Its true that investors are frightenable creatures, manic depressive and dumb. I kid. But even if we take this investor psychology as given, its not obvious that it matters in aggregate. Unless these mood swings are highly correlated, crazy investor A’s zig will be matched by crazy investor B’s zag. Just to repeat myself: it is not enough to identify systematic individual psychological biases. You have to show those biases change over the business cycle and those changes are heavily correlated.

Also, I wonder what is meant by animal spirits exactly. Did Keynes mean investors respond to interest rates? That’s uncontroversial. Does he mean risk preferences are volatile? In which case, how important is this effect? This is an empirical question; one needs to model “animal spirits” and quantify their importance.

This leads to my final point. Keynes had tons of insight into the macroeconomy. For that, thanks dude! Its not clear, though, how these insights fit together and its doubly uncertain how they interact with his policy prescriptions. For example, Russ Roberts wonders how animal spirits are impacted by large deficit spending. The only way to answer this question would be to model these effects and see if that model generates data that looks like data generated by the actual economy.

To me the difference between old style, Keynes-influenced macroeconomics and modern macro is this empirical discipline². As I’ve said before, its not enough to come up with plausible mechanisms, you have to show how those mechanisms generate the data. Almost every mechanism that the critics of modern macro have come up with, at least the ones I’m aware of, has been tested and has been found to be quantitatively irrelevant.

Posner, and most everyone else, doesn’t like the stories modern macro tells (i.e. exogenous technology and monetary shocks drive business cycles). He likes the stories Keynes told. For what ever reason, quantitative relevance isn’t an important criterion for folks to like a story.

1. Also, he mentions the book’s most important historical context was the persistent unemployment in the UK, not the Great Depression. Embarrassingly, this is the first I’ve heard of that. [↩]
2. This is a nice way of saying THE SALT/FRESH WATER “DEBATE” IS MOOT!!! [↩]

I don’t think I’ll be participating in the planned walk out Thursday at UC campuses. I’m not clear what the goals of the walk out are to be. Are they to protest a short-term budget shortfall? To dispute the priorities in budget balancing? To lament the lack of voice in the process?

I’m not sure how walking off the job on Thursday will change the short-run budget issues. Short of printing their own money, neither the State nor the University can do much about the deficit. Of course, they could have done things in the past to have mitigated some of these problems (e.g. the University could be less dependent on State funds and the State could have institutions that make it less of a fiscal mess). But a protest today can’t change past actions. The best that can be said on this front for the walk out is that it could provide a modest encouragement towards making structural changes in the way the State and University do business; a very modest encouragement.

Also, the president doesn’t act as dictator nor the Regents an oligarchy. Shared governance means the University is also run by the faculty and they’ve weighed in on the issue. According to them, faculty and research quality should have precedence over access and affordability. “Our view about affordability is simple: if the state of California once again adopts the view that access and affordability are public goods worth supporting, they will be readily achievable.” To them, getting poor folks into the University is a public good and thus, it should be provided by the public, not from cuts in their paychecks.

Now voice: maybe there’s a point in protesting because we didn’t have a say in the process. But we do have a say. Students, mostly new students, can vote with their feet. There are plenty of private universities in the State and plenty of competition of all stripes outside the State. If fellow grad students don’t like the product they’re buying, then they should stop buying it.

I bought the book. The comics are still funny the second time around. Here’s my favorite:

That’s the title of Ben Mandel’s new paper in the AER. I mentioned the paper before.

I want to know if this is true:

Under the Recourse Rule, an AA- or AAA-rated asset-backed security, such as a mortgage-backed bond, received a 20-percent risk weight, compared to a zero risk weight for cash and a 50-percent risk weight for an individual (unsecuritized) mortgage. This meant that commercial banks could issue mortgages—regardless of how sound the borrowers were—sell them to investment banks to be securitized, and buy them back as part of a mortgage-backed security, in the process freeing up 60 percent of the capital they would have had to hold against individual mortgages. Capital held by a bank is capital not lent out at interest; by reducing their capital holdings, banks could increase their profitability.

Is it true that this is what the rule change required and is it true that this is how banks responded? Also, is there a way to quantify the impact of this rule change (assuming this paragraph is a correct summary of what happened)?

Berkeley is right on the SF bay which is filled, of course, with salt water. That said, Strawberry creek — fresh water — runs through the campus.

Ask your friendly local UC Davis prof and/or grad student. They’ll have intelligent answers. (Hint: things they call trade costs have risen.)