The Ambrosini Critique

Back in the dark ages there was a debate about whether or not aspiring academics should blog pseudonymously before tenure. There was some speculation that Dan Drezner lost tenure at Chicago because of his blog and I remember, but can’t find, a good discussion at Crooked Timber on the subject.

Via email, a fellow grad student pointed me to Economics Job Market Rumors where Anonymous is having a discussion with herself about my fate as an “out” grad student blogger:

Blog is pretty opinionated. Is the guy as full of himself as he seems? Will the blog hurt him when he’s on the market?

help him. a) he doesn’t do personal attacks, but b) sticks his neck out there and says what he thinks. Gotta have some guts in this Econ academic-status game.

It won’t hurt him. Anyone who wouldn’t interview/hire someone because of that (well-written, intelligent, and respectful) blog is a buffoon, and he’d be better off elsewhere.

Revealed preferences exposes my favored hypothesis. It seems many “aspiring academics” forget they have a very nice outside option or two. In any case, let’s just say the experiment is still running and we won’t have preliminary results for at least several more months.

In the previous post, I mentioned two types of catastrophe: cliff-diving and gradual. Suppose the first is a sudden major decrease in output. How much would returns to capital have to decline to get 1% average yearly returns over a century (given 6% “usual” returns)? This is the solution to this problem:

If I got my sums right, this implies about a 99% reduction in returns to capital in the year of the catastrophe.

Now, suppose the catastrophe plays out over a decade. How negative would growth in capital productivity have to be to get an average 1% returns for a century? Doing a similar calculation, returns to capital would have to be about -35% every year for a decade to get average returns that low over the century.

These examples make the catastrophes of the 20th century pale in comparison. In the US in the 1930s, GDP growth was, on average, positive. Austria was the biggest loser during WWII, in terms of GDP, and it only decreased by about 10% a year from 1938 to 1945.

In Weitzman’s calibration, there’s a 1 in 200 chance of having 1% yearly returns over the next century. These examples make this calibration look rather unrealistic.

Risk aversion usually makes investments look less attractive. In the standard story, then, as risk aversion goes up, we would spend less money today to avert future catastrophes. Martin Weitzman argues, however, this relationship reverses when we’re uncertain about future productivity levels. For if it turns out that productivity is low in the future (e.g. because of a climate catastrophe) then consumption will be low. Low consumption means high marginal utility and so low discount rates.

My purpose here is to focus sharply on clarifying the long-run discounting issue by using a
super-simple super-crisp formulation… There is no good substitute for seeing clearly before one’s eyes the basic structure of a model laid bare.
…
Suppose [there's uncertainty about discount rates in the future and] that discount rate ri > 0 will occur with “probability-like weight” wi > 0, where sum wi = 1… The [expected] discount rates … decline over time starting from their average value and going down over time to approach their lowest possible value. Over time, the impact of the higher discount rates … diminishes because the higher rates effectively discount themselves exponentially out of existence, leaving the …field to the lower discount rates (and, eventually, to the lowest).
…
[A]ny given value of [future productivity level] subsequently determines the endogenous future growth rate … and endogenous consumption level … as the solution to a Ramsey optimal growth problem (given that value of [productivity]). The paper shows that when future productivity … is uncertain, then higher values of [risk aversion] are associated with lower future discount rates, thereby reversing the conventional wisdom.
…
[An example using standard parameter values] indicate[s] that the risk-aversion effects of uncertain future productivity on lowering distant-future discount rates might be quite powerful. The driving force is a “”fear factor” ”associated with the possibility of low-probability but catastrophically-high permanent damages to future productivity.
…
I personally would be inclined toward a much lower climate-change discount rate than 6% per annum, but the ultimate goal of this paper … will be to show that under uncertainty, even with expected discount rates as high as 6%, the “effective ”discount rate, which “ought” to be used, can be much lower than 6%.

The results in the example he gives depend very much on the distribution of future productivity, especially on its variance. Here’s his assumed distribution:

In his model, this distribution should be interpreted as the distribution of the average productivity over a very long time (i.e. the next century or so). To me, his assumed uncertainty about productivity is too high (i.e. the variance of the distribution is too wide). Is it even remotely possible that the capital-output ratio will average 50 or 100 for the next century? Even if there’s a sudden, cliff diving catastrophe, I can’t imagine people won’t invent their way around it thus increasing the productivity of capital in the long run. And if catastrophe happens in slow motion, certainly people will be adjust fast enough to keep returns on capital high on average.

The most striking stylized fact about growth is its constancy. For whatever reason, people route around the particular circumstances of their time and space and invent their way to 2% growth. Why would climate change pose fundamentally different obstacles to innovation than what has been seen over the last 200 years? Do the open systems studied in Diamond’s Collapse tell us anything about the closed global system?

Knittel on TV:

The big problem with this system is that it doesn’t appeal to politicians who want to fiddle with everything in sight.

— Daniel Lakeland

That was the subject of an email from Prof. Knittle to the economics mail list regarding his new event study. The SF Examiner writes it up better than I can, but here’s the key graph.

Companies that had endorsed Woods saw dramatic negative abnormal returns (i.e. stock returns relative to a comparison group of stocks) days after the announcement of his retirement.

It would be interesting to see what the long-run impact of Tiger’s demise will be on these companies’ stocks. Have we uncovered a “Tiger Woods” anomaly?! If not, paparazzi perform a valuable function. They make markets more rational!

I don’t think it’s unemployment. The hire rate?

In the next two years — before the memory of this recession fades, but long enough from now that it doesn’t risk unanchoring expectations — Ben Bernanke will begin peppering his speeches and testimony before Congress with references to some form of history contingent policy (e.g. price level or nominal output targeting, state-dependent inflation targets, etc). This will signal a move of policy in this direction.

I give (much) lower odds that there will be a Volker-esque announcement of an explicit move to such a policy.

We watch too many movies if we think the Fed chairman giving heroic speeches would affect people’s expectations of Fed policy¹. As Forrest Gump might say, “policy is as policy does”.

1. At least affect them in the way he or she would want. If Ben gave a speech tomorrow announcing a return to the gold standard, people would think he was crazy. [↩]

In the previous post, I argued upping the inflation target would have no impact on unemployment and it would risk unanchoring inflation expectations. If expectations became unanchored we would be trading off a permanent increase in expectations for a temporary decrease in unemployment.

Assume we gave half of those currently unemployed a job, output would rise by about 5%. Without retargeting, I’m guessing it’ll take 5 years for unemployment to get below 5% (unemployment has a two-year half life). So we’re getting about 13% of GDP by retargeting.

The costs of 10% of inflation are estimated between 1% and 5% of GDP per year. Woodford estimates that under a discretionary policy, inflation would be about 10% (I’m looking at figure 7.1 in his textbook). Discretion isn’t really permanent, its just really hard for the Fed to get expectations reanchored. Suppose x is the number of years of unanchoredness and so its the number of years we’d have 10% inflation.

How big can x be and still make retargeting cost effective? Using a low-end estimate of cost of inflation of 1%, x is 17 years. Using a high estimate of 5%, x is 2 years.

Because the rest of the world seems crazy. Even Cowen and Sumner seem to think changing the inflation target right now would be a good idea.

First, does the Fed have an inflation target and are expectations anchored, i.e. are they equal to the target? Yep and yep, see the graph Prof. Delong put up.

Second, what would the impact of a change in the target be? Suppose expectations remain anchored, increasing the target will increase expected inflation, shift the Phillips curve up and we would be right back where we started. More precisely, there would be no change in output and assuming the mechanism behind Okun’s law is invariant to this change in policy, there would be no change in unemployment. (No, I don’t think expectations of inflation are backwards looking, especially now. And even if they are backwards looking, this would increase the chance that changing the target would unanchor expectations. If I did something wrong, my parents were always more pissed if I lied to them about it.)

Third, why might increasing the target unanchor expectations? The Fed could be seen as acting with discretion; that they’ll up the target anytime the public or politicians start whining. Here’s a post explaining why discretion is bad. Its really hard for the Fed to get expectations reanchored.

Fourth, what would be the impact of unanchoring expectations? Inflation would increase and its volatility would be greater. If the public thinks the Fed will do whatever is expedient, they will expect higher inflation. Also, because the Fed’s behavior is less predictable, expectations and actual inflation will be more volatile. High inflation and highly volatile inflation are bad. My bet is that this *permanent* negative effect would be much greater in welfare terms than the cost of the *temporary* high unemployment we’re experiencing now.