Required for Exam 1, 2/19/14

1) All old posts in the list in the sidebar to the right.
2) Chapters I to IV of the text, and all lecture materials.
3) The first 3 questions and answers from the Quodlibet on my website.
4) Specific questions abut homeworks (or Excel) will not be asked. General questions about the concepts involved are fair game.
5) All these posts made on this blog since January 1:

• Should Policymakers Be More Like Doctors?
• Why Is Macroeconomics So Hard? Argentina Edition
• Correcting The Wall Street Journal
• A Case for 1) Not Worrying About Inequality, but 2...
• Bank Run?
• The Topic for Spring 2014: Income Inequality, Inco...
• Income Mobility
• Economic Possibilities for Our Children
• Macro vs. Micro
• Inflation and Unemployment
• If You’re So Smart Why Aren’t You Rich–DSGE Editio...
• A Retrospective on the “War On Poverty”
• What’s Wrong with America’s Right Now? Is It the E...
• John Cochrane* On the Weak Recovery
• John Cochrane* On Recessions with Financial Crises...

No posts more recent than this one will be covered on the test. Also, these posts will not be covered on Exam 1.

• A Misconception About Income Mobility
• Is the Employment/Population Ratio Decline As Big ...
• Why Is Macro So Hard? (What Passes for Expert Advi...
• High R-Squared
• A Forecasting Example
• How Are the PIIGS Doing?
• How Are the PIIGS Doing?
• John Cochrane on Dodd-Frank

A Misconception About Income Mobility

It is often touted as a fact that it’s far less likely for someone to move out of the lowest income quintile than it is for someone in the middle class, and that it’s far less likely for someone at the top to move out than someone in the middle.

This is a fact. But, it’s a totally useless fact.

Consider this table:

The bold numbers show this fact. The table is drawn from this post by Alan Reynolds writing at Cato at Liberty. David Henderson made a similar point on Econlog. Reynolds is generally regarded as a conservative who is too partisan. Henderson is merely a Libertarian. I found there explanations a tad weak.

For my part, what we need to be looking at is the numbers just above or below the diagonal. Like so:

69	22	5	2	1
19	49	24	7	2
7	21	45	23	4
3	7	22	50	18
2	1	4	18	78

I’ve just repeated the numbers here (and rounded for simplicity). If we’re concerned about downward mobility, we need to highlight the 4 cells where it’s possible for someone to go down. When I look at those 4, I don’t see much evidence that downward income mobility depends much on your current position.

Doing the same for upward mobility I get:

69	22	5	2	1
19	49	24	7	2
7	21	45	23	4
3	7	22	50	18
2	1	4	18	78

Again, there's a small difference in the numbers, but not much.

Is the Employment/Population Ratio Decline As Big a Problem As It Looks?

Employment is down. A lot.

Many people attribute this to the Great Recession. Poke around a little with the search tool to the right, and you’ll see that I’ve been pushing the idea on this blog for a few years that we’re in the midst of a long-term demographic wave: it peaked in the mid-90’s, and participation has been declining ever since. I attribute this to the baby boomlet (sometimes called the echo boom). The raw data looks like this:

That looks like a pretty serous case for a bunch of people dropping out of the labor force due to the Great Recession, and not coming back (presumably because of the weak expansion).

Not so fast argue economists from the Federal Reserve Bank of New York. The broke down the population into 280 cohorts: basically, fractions of the population assumed to act about the same way. For example, I might be grouped with white males born in 1964. They then modeled the employment/population ratio for each of those groups, and aggregated them up. And here’s what they got:

The first chart corresponds roughly to the rightmost third of this chart.

What they found is that the effect of the Great Recession is still there, but it’s quite small: the red line is less than 1 percentage point below the blue curve where it’s estimated that it should be.

The Great Recession (and Weak Obama Expansion) really has 3 components: 1) a drop from supernormal employment, 2) a comparable drop of employment below average, and 3) a recovery that is non-existent but shouldn’t be expected to be that big anyway.

One other salient feature to take away from this work is that our collective memory of what normal used to be is conditioned by the 13 years of above normal employment, running from 1994 to 2008. We should be above average about half the time, but this extended period no doubt has colored our perception of what is normal in a direction that isn’t very helpful when we come down to Earth.

Should Policymakers Be More Like Doctors?

The core of the Hippocratic oath taken by doctors for hundreds of years is primum non nocere, which translates as “First, do no harm.”

Is this the way politicians an bureaucrats behave?

The hot new reading for Libertarian/Austrians is entitled “In Praise of Passivity”, by the philosopher Michael Heumer.

Voters, activists, and political leaders of the present day are in the position of medieval doctors. They  hold  simple,  prescientific  theories  about  the  workings  of  society  and  the  causes  of  social problems, from which they derive a variety of remedies–almost all of which prove either ineffectual or harmful. Society is a complex mechanism whose repair, if possible at all, would require a precise and
detailed understanding of a kind that no one today possesses. Unsatisfying as it may seem, the wisest course for political agents is often simply to stop trying to solve society’s problems.

This motivates a basic question about policy. Can we define what constitutes harm?

For example, how would we know if, say after 10 years, Obamacare actually made things worse? How would we measure that? Compared to what?

I’m not sure most people can answer that. Now, if you can’t even define what harm would look like, how do you feel about pursuing the policy?

I think this is a cogent point. But, as a macroeconomist, I’m not sure that most policies don’t already pass this test. Through the middle of the semester we’re going to be discussing how we’d measure trends. The evidence we already have, that real GDP growth through time is broadly similar across countries suggests that most policies aren’t actually taking countries far away from the path followed by other countries.

Why Is Macro So Hard? (What Passes for Expert Advice)

The source of this post is the article entitled “The Economist Who Exposed ObamaCare” from the February 8th issue of The Wall Street Journal.

The main topic of that article will be the subject of another post that we’ll cover later this week, or next. I’ve put a minor part of it here.

The article is the product of an interview with Casey Mulligan. He’s a mid-career economics professor at the University of Chicago. I’ve posted about his stuff on this blog before. The article gives off somewhat of the wrong tone at the front though:

… Many more people may recognize the University of Chicago professor as a serious economist after this week.

Macroeconomists have recognized Mulligan as an important figure in the field since the mid-90s. I think that literally that quote might be true, but figuratively I think it may give the wrong impression.

The money quote for today’s class comes from Mulligan:

Mr. Mulligan reserves particular scorn for the economists making this "eliminated from the drudgery of labor market" argument, which he views as a form of trahison des clercs.* "I don't know what their intentions are," he says, choosing his words carefully, "but it looks like they're trying to leverage the lack of economic education in their audience by making these sorts of points." [emphasis added]

I’ll be covering that argument (i.e., whether or not it’s a good thing that ObamaCare is likely to reduce employment) in the other post.

But the bold quote gets right to the heart of the matter about why macroeconomics is hard: a lot of people make macroeconomic pronouncements that either 1) don’t display much clear thinking, or 2) are targeted at listeners that are unlikely to think clearly about the issues involved.

Those kind of conclusions are tarnishing the field of economics …They're sure not making it look good by doing stuff like that."

The bigger question is why Mulligan’s position wasn’t part of the debate in D.C. until this month, years after ObamaCare was passed?

… How did Mr. Mulligan end up conducting such "unconventional" research?

"Unconventional?" he asks with more than a little disbelief. "It's not unconventional at all. The critique I get is that it's not complicated enough."

Well, then how come the CBO's adoption of his insights is causing such a ruckus?

"I would phrase the question a little differently," Mr. Mulligan responds, "which is: Why didn't conventional economic analysis make its way to Washington? Why was I the only delivery boy? Why wasn't there a laundry list?" The charitable explanation, he says, is that there was "a general lack of awareness" and economists simply didn't realize everything that government was doing to undermine incentives for work. "You have to dig into it and see it," he explains. "The Affordable Care Act's not going to come and shake you out of your bed and say, 'Look what's in me.' " [two levels of emphasis added]

Keep in mind that this is an opinion piece, coming from The Wall Street Journal, so this view shouldn’t surprise you:

Judging by their reaction to the CBO report, the less charitable explanation is that liberals would have preferred that the public never found out.

* Really good students (like you) will look up the meaning of “trahison des clercs”. I did.

Why Is Macroeconomics So Hard? Argentina Edition

There is a lecture embedded in this blog entitled “Why Is Macroeconomics So Hard?” Put that into the search box at the right, and you can come up with about 8 pages of links on the topic.

One of the ideas that comes up repeatedly is the willingness of people with little macroeconomics background to claim certainty about the issues.

Keep in mind that there’s nothing wrong with having opinions. What’s unusual about macroeconomics is the willingness of people to bloviate their uninformed opinions.

A rather amazing example of this came up this past week in Argentina.

Argentina’s government is “fighting” inflation. I have fighting in quotes because the government’s policies (lack of credibility about keeping spending in line with their ability to raise tax revenue) is probably the source of the inflation. Argentina’s version of fighting inflation is to blame decision-makers for choosing to change their prices. Their current method is inflammatory posters featuring the pictures of those decision-makers. I wonder how far off they are from a lynching.

Now, here’s the money quote:

On Friday, though, [President] Kirchner’s cabinet chief, Jorge Capitanich, slammed economists for blaming the government’s economics policies for rising inflation. He equated economists with hired mercenaries representing private-sector interests looking to destabilize the economy.

“I know all of them,” Mr. Capitanich said. “They are all undercover agents. Argentinians should know that independent, objective economists don’t exist. I want to say emphatically that when unscrupulous businessmen raise prices it has absolutely nothing to do with macroeconomic variables.”

In part, this is in response to the IMF which has refused to accept the Argentinian government’s estimates of inflation because they are not credible when compared to evidence on the ground.

Read the article entitled “Argentina War On Inflation Gets Personal” in the February 8th issue of The Wall Street Journal.

Correcting The Wall Street Journal

A chart on the front page of the January 31 issue of The Wall Street Journal was informative, but not correct.*

There are a lot of ups and downs within individual business cycles. It makes sense to smooth them. That’s what The WSJ did, but it looks like they used Excel to make a bar chart. The problem with this is that it accentuated the length of recessions, both in absolute and relative terms.

Take a look at that. Do we really think the Great Recession was longer than the expansion that’s followed it? No, it was about a third the size. It gets worse: the 2 quarter recession in 1980 is shown to be longer than the only recessions that compete with the Great Recession for the title of worst since World War II (1973-5, and 1981-2). Or how about the halcyon days of the 1950’s; were they really  dominated by 3 recessions that were longer than the intervening expansions? In sum, the spirit that inspired this chart is on the right track, but the execution is poor.

The solution to this is to do an XY chart and connect the dots. For the chart below, I subdivided the data around NBER peaks and troughs. I then calculated the annualized geometric average† growth rate for each expansion and contraction.

The advantage of this presentation is it shows accurately 1) the length of expansions and contractions going horizontally, 2) the average strength of expansions and contractions going vertically, and further the 3) total impact of an entire expansion or contraction is proportional to the area between the blue line segments and the 0% gridline.

A disadvantage of this sort of presentation is that it does a bad job with the relative size of double-dip recessions (as in 2001) or triple-dip ones (as in 1981-2): the upward spikes within the recessions make their overall growth look OK.

Keep in mind that the threshold for what feels good is around 2% rather than at 0%. This is why Obama’s expansion is so poorly regarded: it’s barely beating the threshold. And there certainly seems to be a pattern of declining average growth in expansions over the last generation (although 3 expansions is not a big sample). Here's the same chart, with the contractions removed, and the threshold for "good times" set at 2% rather than 0%:

Many thanks to Jon Peltier of Peltier Tech Blog for help getting the charts to look right.
* Read the whole thing, entitled “US Economy Shows Signs of Gearing Up”.

† The geometric average is the rate which, when compounded, would produce the observed growth over the entire period.