The Chicago School of Economics

Congratulations to Pace University, for winning the 2014 Fed Challenge.  The Bentley team (which was superb, as usual) represented the New England region in the competition.  After they returned I was told that the University of Chicago team presented a proposal that involved NGDP targeting.

As a Chicago alum, I’m happy to hear that the economics program is still do a good job of teaching its students.  I was also told that at one point the Chicago team mentioned NGDP futures targeting as an option.  That actually made me a bit sad, as I was never taught that cool idea when I attended the UC in the late 1970s. That’s not fair!

Then I remembered why; NGDP futures targeting had not yet been invented when I attend to UC. So there would be no way for me to have learned about the sort of monetary policies that make sense in a world of efficient markets.  At least I was fortunate to study at a university that had people like Lucas and Fama, and hence I learned the tools necessary to create those sorts of proposals. And that’s all you can ask for.

PS.  I was told that Evan Soltas was on the Princeton team, which came in second. Nice job.

PPS.  I have a post on the ECB over at Econlog.

Germans now favor a dual mandate for the eurozone; inflation and growth

Back in 2011, rising oil prices (and higher VATs) briefly pushed inflation above the ECB’s near 2% target.  Some pundits suggested it was unwise to tighten, because unemployment was so high, and the price increases were transitory, but the German’s insisted that the ECB must focus like a laser on inflation, and ignore all other factors.  So the ECB tightened repeatedly in 2011, driving the eurozone into a catastrophic double dip recession (depression?)

And now we face the opposite situation.  Eurozone inflation is down to 0.3%, and plunging oil prices seem likely to send it even lower.  So once again the Germans are suggesting that the central bank focus like a laser on . . . both inflation and growth:

German council member Jens Weidmann signaled how oil is now a focal point in the quantitative-easing debate when he said last week that the drop in energy costs is like a mini stimulus package, suggesting no need for the ECB to expand its current measures. The opposing view, previously argued by Draghi and ECB Chief Economist Peter Praet, is that temporary price shocks can deliver lasting harm to an economy as feeble as the euro area’s.

Seriously, it doesn’t matter what the data show, the Germans will always find a reason to favor ever tighter money, ever more deflationary policies.  Even if their own preferred policy (inflation targeting) calls for easier money.

PS.  Over at Econlog I have a related post on the IMF’s shameful record.

HT:  Michael Darda

Update:  For fans of Monty Python, Peter Tasker’s updating of the “What Have the Romans Ever Done for Us?” skit to Abenomics is wonderful.  I won’t quote the whole thing, but the punch line is:

Cleese – Alright, alright. Apart from full employment, higher asset prices, lower interest rates, record-high profit margins, better corporate governance, a tourism boom, more working women, exports and capex, what has Abenomics ever given us?

Twelfth voice – Nominal GDP growth?

Cleese – Growth! Oh, SHUT UP!

HT:  Nicolas Goetzmann

Update#2:  Lars Christensen has an excellent post on the fallacy of pointing to low eurozone bond yields as evidence that monetary stimulus is not needed.

Capex rising strongly during Japan’s “recession.”

If there’s one business cycle regularity, it’s that investment tends to fall more sharply than the other components of GDP.  Keep that in mind as you read the latest data dump from Japan:

TOKYO (Reuters) – Japan’s fall into recession between July-September could turn out to be less severe than feared, with new capital expenditure figures out on Monday suggesting revisions will put third quarter economic growth in a more positive light.

The 5.5 percent year-on-year rise in capital expenditure over the third quarter reported on Monday followed a 3.0 percent annual increase in April-June, which could ease concerns about recovery from a sales tax increase earlier this year.

“The revised data will show a smaller contraction in GDP that could be close to zero,” said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management Co.

“Other data on consumer spending, factory output and business investment show these three factors will drive future growth.”

Compared with the previous quarter, capital spending excluding software rose a seasonally adjusted 3.1 percent, versus a 1.5 percent decline in April-June in an encouraging sign of vigorous business investment.

Preliminary data showed the economy contracted an annualized 1.6 percent in July-September, confirming Japan had entered its third recession in the past four years as a sales tax hike in April hurt consumer spending and business investment.

In preliminary GDP data, capital expenditure shrank 0.2 percent, versus the median estimate for 0.9 percent increase.

OK, so capex didn’t fall 0.2%, it rose 3.1%, quarter over quarter.  Just a tiny mistake.

Now about that “recession .  .  . “

The map and the territory

I’m still seeing overwhelming confusion in the media about the definition of a recession, and more importantly, what a recession actually is.  Here’s the BEA, which computes GDP:

Recession: how is that defined?

In general usage, the word recession connotes a marked slippage in economic activity. While gross domestic product (GDP) is the broadest measure of economic activity, the often-cited identification of a recession with two consecutive quarters of negative GDP growth is not an official designation. The designation of a recession is the province of a committee of experts at the National Bureau of Economic Research (NBER), a private non-profit research organization that focuses on understanding the U.S. economy. The NBER recession is a monthly concept that takes account of a number of monthly indicators—such as employment, personal income, and industrial production—as well as quarterly GDP growth. Therefore, while negative GDP growth and recessions closely track each other, the consideration by the NBER of the monthly indicators, especially employment, means that the identification of a recession with two consecutive quarters of negative GDP growth does not always hold. 

And here is the NBER, the group that economists consider authoritative on all questions about definitions of recessions:

Q: The financial press often states the definition of a recession as two consecutive quarters of decline in real GDP. How does that relate to the NBER’s recession dating procedure?

A: Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. In 2001, for example, the recession did not include two consecutive quarters of decline in real GDP. In the recession beginning in December 2007 and ending in June 2009, real GDP declined in the first, third, and fourth quarters of 2008 and in the first quarter of 2009. The committee places real Gross Domestic Income on an equal footing with real GDP; real GDI declined for six consecutive quarters in the recent recession.

Q: Why doesn’t the committee accept the two-quarter definition?

A: The committee’s procedure for identifying turning points differs from the two-quarter rule in a number of ways. First, we do not identify economic activity solely with real GDP and real GDI, but use a range of other indicators as well. Second, we place considerable emphasis on monthly indicators in arriving at a monthly chronology. Third, we consider the depth of the decline in economic activity. Recall that our definition includes the phrase, “a significant decline in activity.” Fourth, in examining the behavior of domestic production, we consider not only the conventional product-side GDP estimates, but also the conceptually equivalent income-side GDI estimates. The differences between these two sets of estimates were particularly evident in the recessions of 2001 and 2007-2009.

Fortunately, when you look at various monthly indicators, it is usually incredibly easy to date recessions—they look really, really different.  Here’s industrial production over the past 30 years, how many recessions can you spot?

Screen Shot 2014-11-30 at 10.15.08 AM

For those readers still struggling with the question, let’s try the unemployment rate:

Screen Shot 2014-11-30 at 10.15.53 AM

Interesting how the answer “3″ keeps popping up.  But the “2 quarters of falling GDP” proponents insist that 2001 was not a recession (even though economists almost universally agree it was), and that Japan has recently experienced a recession, despite a falling unemployment rate.

Recessions really are distinct events.  Why does this matter?  Isn’t it just a question of semantics? By now it should be obvious that words matter.  Many economists think in terms of words, not reality.  The map, not the territory.  Distinguished economists tell me to stop harping on the definition of “tight money.”  But it’s precisely because most economists thought money was easy in 2008 that they don’t believe the recession was caused by a tight money policy of the Fed.  If the Fed had suddenly raised the fed funds target to 8% in early 2008, they would have blamed the recession on the Fed.  They wrongly exonerated monetary policy becasue they don’t understand the meaning of the term ‘tight money.’  In the same way, pundits who wrong believe Japan entered a recession this year are more likely to believe that monetary stimulus in Japan has not boosted AD, whereas it clearly has.

PS.  One LA Times story claimed that Japan has had 4 recessions since 2008!  And no, I’m not joking.  When looking at the following graph keep in mind that sampling errors explain movements of a few tenths of percent.  How many recessions can you spot?

Screen Shot 2014-11-30 at 11.00.48 AM


PS.  I have a new post on oil prices at Econlog.

A quick follow-up on Keynesian economics

Tim Worstall has a new piece in Forbes:

Scott Sumner points us to this interesting proof that the Keynesian economic model must be true. For the Financial Times is crowing about the fact that when government spending rises then so does GDP. And when government spending falls, so does GDP. Thus, getting government to spend more increases GDP. Proof perfect that the Keynesian model works! Unfortunately there is a little flaw with this argument. That flaw being that right at the beginning, when we define GDP, we say that an increase in government spending increases GDP. It’s absolutely nothing at all to do with the Keynesian model, nor any other economy model: it’s an attribute of the way that we calculate GDP, nothing else.

Just to be clear, I believe that if it could be shown that an increase in G will lead to an increase in GDP, at least over any significant period of time, then it would prove the Keynesian model, at least to some extent. And there are a few cases where it is true, at least to some extent.  Tim is looking at an entirely separate issue, whether government spending actually has any value.  That’s a very important point, but I’m more interested in whether it creates jobs (which I doubt.)

In the post he links to I was making a different point.  I was amused that Jim Edwards pointed to a graph that refuted the conservative criticism of Keynesianism.  What did the graph show? It showed changes in government spending (as a share of GDP.)  It showed “delta G.”  And that was it.  It showed that when G changes, G changes.  Let me repeat that in case it went over your head.  It showed that when G changes, G changes.  That was the proof.  I thought that was really funny, but I guess it went right over the heads of some of my commenters. The post had nothing to do with the validity of the Keynesian model.