My vision of macro

The following Venn diagram helps to explain how I visualize macro:

Screen Shot 2017-03-26 at 3.17.11 PMThere are three basic fields within macro:

1.  Equilibrium nominal

2.  Equilibrium real

3.  Disequilibrium sticky wage/price (interaction)

I’ll take these one at a time.

1. Within equilibrium nominal there are important concepts:

A.  The quantity theory of money

B.  The Fisher effect

C.  Purchasing power parity

The first suggests that a change in M will cause a proportionate change in P.  The second suggests that a change in inflation will cause an equal change in nominal interest rates.  The third suggests that a change in the inflation differential between two countries will cause an equal change in the rate of appreciation of the nominal exchange rate.

All three concepts implicitly hold something constant; either the real demand for money, the real interest rate, or the real exchange rate.  In all three cases the concept is most useful when the money supply and price level are changing very rapidly, especially if those changes persist for long periods of time.

2.  Equilibrium real macro can be thought of as looking at economic shocks that do not rely on wage/price stickiness.  These include changes in population, technology, capital, preferences, government policies, weather conditions, taxes, etc.  These can cause changes in the real demand for money, the real interest rate, the real exchange rate, the unemployment rate, real GDP, and many other real variables.

3.  Disequilibrium macro looks at nominal shocks that cause changes in real variables, but only because of wage/price stickiness.  Thus because prices are sticky, an increase in the money supply will temporarily cause higher real money demand, a lower real interest rate, and a lower real exchange rate.  These changes occur even if there is no fundamental real shock hitting the economy.  The effects are temporary, and go away once wages and prices have adjusted.

If wages and prices are sticky then an increase in the money supply will also cause a temporary rise in employment and real output.

And that’s basically all of macro.  (This is how I’d try to explain macro to a really bright person, if I were given only 15 minutes.)

I also believe that understanding the implications of this three part schema makes one a better macroeconomist. Talented macroeconomists like Paul Krugman tend to have good instincts as to which real world issues belong in each category. Here’s my own view on a few examples. For simplicity, I’ll denote these three areas: nominal, real, and interaction:

1.  Most business cycles in ancient times were real, with some interaction.  The 1500 to 1650 inflation was nominal.

2.  Recessions such as 1893, 1908, 1921 and 1982 were mostly interaction.

3.  The Great Depression was all three.

4.  The Great Inflation was mostly nominal, especially in high inflation countries.

5. The 1974 recession was more “real” than usual.  Ditto for the WWII output boom.

6.  The real approach works best for short run shocks to specific industries such as housing and oil, plus long run growth.  The nominal approach works best for high inflation rates and long run inflation.  The interaction approach works best for real GDP fluctuations in large diversified economies.

7.  If one set of economists say the Japanese yen is too strong, and another set say it’s too weak, they are probably using different frameworks.  Those who say its too strong are using a nominal framework, and are likely worried about deflation.  A weaker yen would boost inflation.  Those who think the yen is too weak are using a real framework.  Rather than worry about deflation, they worry that Japan has a current account surplus.  These views seem to contradict, but it’s theoretically possible for both to be right.  Perhaps the nominal exchange rate for the yen is too strong, and the real exchange rate is too weak.  You would then weaken the nominal exchange rate by printing money, and strengthen the real exchange rate by reducing Japanese saving rates.  (I don’t favor the latter, just saying that’s the proper implication of the misguided worry about Japanese CA surpluses.)

8.  Don’t let your policy preferences drive your analysis.  Throughout all of my life, it’s been assumed that monetary shocks drive real output by causing changes in the unemployment rate.  Not changes in trend productivity growth or population growth or labor force participation or any number of other variables.  Money matters because it affects unemployment.  If the unemployment rate is telling you that monetary policy is no longer holding back growth, the proper response is not to double down on your belief that we need easier money and then look for new theories to justify it, but rather to conclude that whatever problems we still have are now “real”, not “interaction.”

A good macroeconomist knows that all three fields of macro are very important, and which models apply to each of the three fields, and which field is most applicable to each real world macro issue.

Stop talking about interest rates

W. Peden directed me to this article:

Andy Haldane said low rates kept some “zombie” firms alive, but the trade off was far more people stayed in work.

A Bank modelling scenario found that years of 0.25% rates probably kept 1.5 million in jobs, he said in a speech.

He would not have sacrificed those jobs for an extra 1% or 2% productivity.

This sort of thing makes me want to pull my hair out.  Start with the fact that he’s reasoning from a price change.  I suppose his defenders would claim he meant “an easy money policy that caused low interest rates also tended to hurt productivity”. But of course that’s not what happened.  In fact, UK interest rates fell to very low levels because of extremely low NGDP growth after 2008, which was in turn caused by tight money.  In a counterfactual where the BoE adopted ECB style policy, NGDP growth would have been even slower, and interest rates would have been ever lower (indeed negative.)

Although BoE policy was far better than ECB policy, it was still too contractionary. But for simplicity let’s assume it was about right—that will make it easier to explain what’s wrong with Haldane’s comments.

Suppose NGDP growth in the UK were appropriate.  And suppose you saw falling interest rates and falling productivity growth in that environment.  How would you interpret those facts?  I’d make the following claims:

1.  The UK was probably hit by an adverse supply shock.  I can think of at least three components; falling North Sea oil output, a big decline in banking jobs in “The City” after the crash of 2008, and a drop in manufacturing jobs because of the collapse in world trade in 2008-09.  Of course the 2008-09 shock is a demand shock at the global level, but at the UK level it shows up as a supply shock.

2.  In oil, banking, and manufacturing, worker productivity is much higher than for the economy as a whole.  So when those sectors suddenly decline, overall productivity will take a hit. This has nothing to do with monetary policy.

3.  If monetary policy is sound (reasonable NGDP growth), then the workers losing jobs in those three sectors will initially re-allocate into less productive sectors, mostly in the service sector.  Again, overall productivity will suffer.

4.  I also suspect that the UK is suffering from some of the same “Great Stagnation” problems that are affecting the US and other developed countries.

If the BoE had adopted a very tight money policy, causing a big drop in NGDP, then the re-allocation of workers from declining sectors to growing sectors would have been less complete.  This might have actually raised productivity slightly, as the least productive workers often are the ones who have the hardest time getting re-employed.

To summarize, neither a low interest rate policy nor monetary policy more generally reduced UK productivity.  Rather productivity fell as part of the natural adjustment process in a free market economy, as workers get re-allocated out of high productivity sectors into lower productivity sectors.  To its credit, the BoE refrained from the sort of tight money policy adopted by the ECB, which would have led to much more unemployment, but which also might have led to slightly higher productivity in the short run.

The BoE is not a fireman that rescued the UK labor market at the cost of lower productivity; rather the ECB is an arsonist who trashed the eurozone labor market.

Is there a law of conservation of bigotry?

Continuing my grouchy old man series . . .

A few weeks ago I bashed modern society for giving in to 1984-style surveillance, without even putting up a fight.  Sad!

Now I’d like to bash the rise of political bigotry:

Whereas in 1960 only 5% of Republicans and 4% of Democrats said they would be “displeased” if their child married outside their political party, by 2010, those numbers had reached 49% and 33%, a far higher percentage than those who would be “displeased” if their child married outside their race.

Of course those figures would be roughly reversed if you asked about race.

I’m actually old enough to recall the time before widespread political bigotry.  Even as late as the 1980s, I recall that politics was a non-factor on the dating scene.  It simply didn’t matter (to me or to the women I dated.)  Now people tell me that even my home state of Wisconsin has become polarized by politics, with neighbors refusing to talk to each other.  This seems both very weird and very sad.

So here’s my question, is there a “law of conservation of bigotry”?  People simply must feel bigoted about something, and if it’s not one thing it will be another.  I’ve always suspected that grown-ups are just high school bullies who are more sophisticated at hiding their bullying.

Scott Alexander (who most certainly is not a bully) has one of his excellent posts on this general topic.  Using his terminology, I’d be a member of the “grey tribe” which makes it easier for me to avoid bigotry toward the blue and red tribes.

Because most people assume that others are like them (i.e. very tribal), they misunderstand my political posts, assuming that I am also very tribal.  Thus people will explain to me that some outrage by Trump also was done by Obama.  And I think to myself, “if you are trying to convince me to like Trump, why the heck would you mention Obama?  You should compare his idiocy to Bush!”  If these “red” commenters would explain to me that Trump is no more of a corrupt pathological liar than Bush, and cite examples from Bush, I might actually take them a bit more seriously.

The other mistake they make is to point to some link that presents a pro-red tribe data point, with a “so there” attached.  But I’m not anti-red tribe!  Or more precisely I’m just as anti-blue tribe as I am anti-red tribe.  So then why did I favor Hillary over Trump?  Because of Trump.  There are plenty of GOP candidates that I would have preferred to Hillary. I have no special antipathy toward the red tribe, indeed many (most?) of my best friends are red tribers.  At worst I might be biased by a distaste for Trump’s awful personality.  But I do think I’m capable of respecting politicians whose personality I dislike (such as Thatcher.)

[Indeed by Scott Alexander’s criteria, I might be more red tribe than blue tribe.  I was happy when Osama died, and sad when Thatcher died.  Scott says that blue tribers scolded people for celebrating Osama’s death, but then turned around and celebrated Thatcher’s death.  If that’s blue tribe, then count me out.]

Before you claim that I’m just as bigoted as anyone else, tell me which other pundits in the blogosphere are not opposed to any of these sorts of people serving on the Supreme Court:

1.  Liberals

2.  Conservatives

3.  Atheists

4.  Muslims

5.  Catholics

6.  Socialists

6.  Fascists

7.  Communists

8.  Vegetarians

I want specific names.

As long as they are good judges, why should I care about their personal beliefs on religious or political issues?  If I were on the Supreme Court I would not try to implement a libertarian agenda, even though I am a libertarian.  I would not rule big government “unconstitutional”, unless it clearly and unambiguously violated some specific part of the constitution.  I probably would not have ruled against Trump’s immigration restrictions, even though I despise them.  I don’t view our drug laws as unconstitutional.  I would hope that fascist and communist judges would not use the court to implement their preferred public polices.  A good judge is not a liberal or conservative or communist judge, it’s a judge free of bias.

PS. I might have voted against one small aspect of Trump’s immigration policy, which favored Christian refugees over Muslims.  But even there I’d first need to study the issue.  I believe that that particular policy has recently been adjusted–is that right?

PPS.  Mike Pence recently said the following:

We may be separated by an ocean, but the American people have always been bound by a kinship to the Chinese people, and we always will.

Actually, Pence didn’t say that, I made it up.  Pence said this.

PPPS.  So Trump completely made up a story that his predecessor had committed specific criminal impeachable offenses.  Then he failed to provide any evidence to back up this claim.  Then he failed to provide any coherent reason for failing to provide evidence backing up the claim.  Then when caught lying he refused to apologize, or even to admit he had lied.

But Obama said you could keep your insurance company, so we’re equal!

Belarus has no trouble generating inflation

Harding directed me to the example of Belarus, which like Japan has a falling population in recent years:

Screen Shot 2017-03-19 at 10.04.53 PMAnd yet Belarus has lots of inflation:

Screen Shot 2017-03-19 at 10.07.43 PMNot as bad as the 100% inflation of 2012, but still running around 10% per year in recent years, despite a falling population.

So why do demographics cause deflation in Japan but not Belarus?  Simple, demographics don’t cause deflation in Japan, or anywhere else.

If you have the right model of money, the world is a much less confusing place.

Current account deficits are forever

The back of the Economist magazine has current account deficits over the past 12 months for 42 major economies, comprising the vast majority of global GDP.  I noticed that they group neatly into 4 major blocks.  But first I’ll present the data for 5 regions:

1. Continental Europe (excluding Turkey):  $556.8 billion CA surplus

2.  East Asia:  $674.0 billion surplus

3.  English speaking countries (US/UK/Canada/ Australia)  $698.9 billion deficit

4.  Latin America:  $101.5 billion deficit

5.  Middles East/South Asia:   $116.0 billion deficit

Exceptions include Greece and Poland (which both have tiny deficits), Israel (which has a sizable surplus), and Indonesia and Philippines (which have tiny deficit). That’s it.

In theory, the numbers should add up to zero.  I presume the net global surplus reflects the fact that many of the smaller developing countries left off the list have CA deficits, and perhaps there is also a statistical discrepancy (measuring error.)

Let’s say I’m right that most of the missing countries are developing countries with deficits, and let’s mentally add them in with both Latin America and the Middle East/South Asia. Let’s call that big group “developing countries”, even though it technically excludes developing East Asia.  In that case the world has four blocks. Both English-speaking countries and developing countries have big CA deficits, and both continental Europe and East Asia have big surpluses.

So what’s going on here?  Basically, Europe and East Asia are investing lots of money in developing countries and English-speaking countries.  But why?

Developing countries have better growth prospects—thus India grows much faster than Switzerland and Singapore (two high surplus countries).  The English speaking world runs big deficits for several reasons:

1.  The Anglo-Saxon economic model is a good one, drawing in foreign capital.

2.  The Anglo-Saxon world is a safe place for investment, due to the legal system.

3.  The Anglo-Saxon world is a good place to move, as English is the global second language.  Thus if you are a Chinese person worried about the future of your country, Vancouver makes more sense than Vienna as a place to move if things go bad.  So you buy a house in Vancouver as a security blanket.

4.  The Anglo-Saxon world dominates high tech, which brings in lots of money that doesn’t show up in CA deficit data.

What am I missing?

I expect these “imbalances” to persist for many decades.  That’s because they are not “imbalances” at all, but rather equilibrium outcomes.  The world is basically Europe/East Asia on one side and English/developing on the other.  Why should that change in the future?