Time to add the epicycles!

During the golden age of macroeconomics (roughly 1984-2007), many economists understood that interest rates were not monetary policy. After 2008, economists have been drifting back to old-school Keynesianism, with its emphasis on fiscal policy and interest rates.

For the umpteenth time, it makes no sense to talk about interest rates causing changes in other macro variables. To do so is to engage in reasoning from a price change. Interest rates can change for multiple reasons, and the effects of the rate change will depend on the underlying factors that caused rates to change.

Not surprisingly, this highly flawed approach has produced lousy results. The Financial Times reports that dissatisfaction with our current models has led to the search for alternatives:

Matthew Rognlie of Northwestern University says that more broadly, the Hank trend tapped into a “well of discontent” with older, simpler models. Those assume consumers respond very strongly to changes in interest rates, and hardly at all to changes in their income.

I cannot say I’m surprised by the fact that models that assume consumers respond to interest rate changes in a predictable way have not done well. Unfortunately, instead of scrapping the interest rate approach to macroeconomics (which I recommend in my recent book) economists are adding epicycles:

Hank [Heterogeneous Agent New Keynesian] models try to match real-life spending behaviour more closely, assuming a willingness to consume out of extra income roughly 10 times larger than in the older models.

That changes the emphasis when thinking about monetary policy transmission, away from the idea that greater rewards for saving encourage more of it. Other mechanisms could include an interest rate increase that hits people with variable-rate mortgages living hand-to-mouth, damping spending. Or an interest rate cut could stimulate investment, pumping up wages of people who are particularly likely to splurge, boosting consumption.

Another way that economists handle the failures of modern macro is by making the predictions more ambiguous, a technique used by successful astrologers. For instance, they can invoke those mysterious “long and variable lags”:

Despite including more detail, there are still areas where such models don’t seem to meet a reality check. They don’t capture the fact that individual spending can take a while to respond to an interest rate change.

High interest rates don’t reduce aggregate demand? You just wait. It must be those long and variable lags. The phrase “a while” is so much better than “6 months” or “18 months” or “30 months”. In early 2023, economists told us the recession was delayed because of long and variable lags. OK, but for how long? It’s already April 2024; is the recession coming soon?

Perhaps the following analogy would be useful: How do rising oil prices affect consumption, other things equal? That’s not even a question. Other things equal, oil prices never change. If oil prices rise due to reduced supply, then consumption falls. If oil prices rise because of increased demand, then consumption rises. But other things equal? What does that even mean?

If interest rates rise because of tight money, then aggregate demand may decline. If interest rates rise because of fiscal deficits or booming immigration or strong “animal spirits”, then aggregate demand may rise. It depends.

Doesn’t the Fed determine interest rates? Well, it has a target, which it moves up and down in response to what it perceives as changes in the equilibrium interest rate. But is it leading the market, or following?

No doubt the defenders of these models will insist that they’ve already incorporated all the various factors that move the equilibrium rate of interest. All I can say is that the proof is in the pudding—apparently we are still not able to model that “natural” rate with any degree of accuracy. As a result, we end up reasoning from a price change.

Monetary policy is not interest rates, it is the market forecast of future NGDP.

Bleak chic

Janan Ganesh has an piece in the FT entitled “The Rise of Bleak Chic”.

I don’t demand show trials or the ritual egging in public squares of people who were bearish on cities. There is no need for a mea maxima culpa from those who doubted if even the handshake, let alone the restaurant, would return. But let’s imagine that things were reversed: that we optimists were the ones proven wrong. We wouldn’t have been allowed to slink off like Homer Simpson into the hedge. There would have been recriminations. 

There is an asymmetry in public life. If you err on the side of optimism, it can dog you forever. Ask Francis Fukuyama. Erring the other way incurs much less cost. Ask . . . well, whom? Who is the reference point for incorrect pessimism? If a name doesn’t occur, it’s because we tend to let these things go.

In the past, I’ve made a similar argument about asset price “bubbles”. Those who wrongly suggest that high prices are the new normal are mercilessly criticized after the crash. People still cite Irving Fisher’s claim that stocks had reached a permanently high plateau in 1929.

[Actually, Fisher’s claim was probably reasonable. Stock valuations were not out of line in 1929, and the crash occurred because of a severe economic depression that almost no one forecast.]

In contrast, asset price bears get off almost scot-free when asset prices soar after inaccurate bearish calls.

After the 2006-09 house price crash, claims were made that housing prices at the peak were obviously excessive. (Kevin Erdmann was a notable exception.) By the late 2010s, that no longer looked to be the case. But even then, people would often single out a few places like Phoenix as being obviously overpriced in 2006. Yes, they argued, high prices in California and New York might be justified by restrictions on new construction, but surely there was no justification for the insanely high prices in Phoenix, which is surrounded by endless expanses of desert. Even I found it hard to explain what had occurred.

Well, if prices in Phoenix were obviously irrational in 2006, they are just as high today. In the graph below I presented the Case-Shiller index deflated by the price level—in nominal terms Phoenix houses are now much more expensive than in 2006.

People that assured us that high prices in 2006 were justified are ridiculed, while we ignore those who suggested that the low prices of 2009-13 were justified.

Bleak chic is just one of the many psychological flaws that contribute to belief in bubbles.

Leftists for Trump

How are leftists working to re-elect Trump? There are almost too many ways to count:

1. Trump was reeling after his candidates did horrible in the 2022 midterms, and people like Ron DeSantis were soaring in the polls. Then leftists saved him by making him seem like a victim, and he began rising in the polls. Even better, they insured that the only case likely to be decided before the election is the one bogus case:

Trump faces more serious charges elsewhere, over his alleged attempts to interrupt the peaceful transition of power and retention of classified documents in the bathroom of his Mar-a-Lago mansion.

But it is the “hush money” case — revolving around allegations of a sordid, backroom deal made in the days before the 2016 election to prevent the revelation of an extramarital affair — that looks increasingly likely to be the only one to be heard by a jury of Trump’s peers ahead of November’s election.

2. Woke leftists have greatly helped Trump by promoting a completely over-the-top version of identity politics, combined with Chinese Cultural Revolution style cancel culture. Even moderate liberals are disgusted.

3. On economics, the left wing of the Democratic party has moved away from the pragmatic centrism of Clinton (and to a lesser extent Obama) and re-embraced the once discredited big government policies of the 20th century.

4. The left blames Biden for being too pro-Israel, even as Trump is far more pro-Israel. Ditto for Biden’s supposedly pro-fossil fuel policies. Trump also says and does lots of things conservatives don’t like, but that doesn’t cause conservatives to attack Trump, rather it energizes them to attack the left even more vigorously. One thing America’s right and left have in common is contempt for Biden. I also don’t like Biden, but ever heard of the concept of “the lesser of two evils”?

5. “Progressive” city officials enact weak on crime polices, as well as education policies that discourage excellence. This taints the Democratic brand.

I understand that Republicans are working hard to re-elect Trump, but none of that matters. It will be woke leftists that put Trump over the top, by delivering swing voters. I hope Trump remembers to thank them in his victory speech on election day.

Is inflation re-accelerating?

I don’t know. But the possibility is greater than I would have wished to see.

Inflation data is often noisy and unreliable, for a wide variety of reasons. Wage inflation is the most meaningful for monetary policy. Among all of the various price indices, the service sector inflation ex-housing and energy is probably the most closely tied to wages. Wages aren’t closely linked to housing or gasoline prices, but they are fairly closely linked to the price of haircuts, fast food, and medical care. And while this series is pretty noisy (red line), it does seem to be trending up since last May and June, when the monthly rate bottomed out at only 0.1% Here’s Bloomberg:

The most recent reading is 0.6%, and the most recent three month average is even higher than 0.6%.

Again, this data is erratic, and it may well slow again going forward. But as I’ve been saying ad nauseam over the past few years, it’s not at all clear that the Fed has adopted a tight money policy. Money is still too loose. I expect 2024:Q1 NGDP to be “hot”. In other words:

Wake me when the tight money starts.

Update: Jason Furman has an interesting thread.

What do the smartest people think?

There are many different types of superintelligence. Some people understand quantum mechanics. Some people are really good at chess. Some people can read Finnegan’s Wake.

[I’m tempted to say, “Some people understand supply and demand

Scott Alexander is really, really good at analysis. So good that he’s become famous for engaging in this activity, with a cult following all over the world. (In recent years, the new people I meet in Orange County are largely through Scott Alexander meet-up groups.)

Thus it would be interesting to see what would happen if Alexander took a deep dive into the Covid origins debate, and looked at all of the evidence that’s been presented by both the Lab Leak and Zoonosis advocates.

Now he’s done so. First in a post that looked at a highly publicized debate between the two sides, and now in a follow-up post that dealt with a wide range of comments on his first post. (For those who don’t know, his comment sections are very long and full of high quality observations. If the objection is not in his comment section, it’s probably not worth considering.)

In the end, Alexander comes down pretty close to where I am:

For now, I’m still at 90-10 zoonosis.

And like me, he gets frustrated with the game of whack-a-mole played by Lab Leak proponents:

I know this comments post won’t be the end of the story. I know that (just as with every other one of my posts, I’m not blaming origins debaters in particular here) someone’s going to go “Sure, Scott confronted 489 arguments. But he failed to confront the strongest argument against his case – this one obscure article in a Nepalese journal that nobody except me has ever heard of. That means he’s a bad-faith actor strawmanning everyone he disagrees with!” I know that someone will find some detail I’m wrong about and spam it all over Twitter with “Scott didn’t realize that an 91Q mutation is different from a ZY6 mutation, how can you ever trust anything he says?” And I know that next month, someone will come up with another SMOKING GUN! – and if I don’t respond to it immediately they’ll say I’m scared and know I’ve lost and am refusing to admit I’m wrong out of sheer stubbornness, and twist some quote of mine to show I’ve admitted I’ve changed my mind.

You need to devote a considerable period of time to the debate if you truly wish to become informed on this issue. Alexander’s two posts are a good place to start.

I occasionally read some really smart bloggers who view both lab leak and zoonosis as being roughly equally probable. I respect their views, as that likely means they didn’t waste enormous portions of their life taking a deep dive into this debate like I did. Good for them. I suspect that if they read Alexander’s two posts carefully, they’d switch their views toward strongly favoring zoonosis—the evidence is pretty strong in that direction.

A couple years ago, commenters raked me over the coals for refusing to admit what they thought was obvious—that Covid came from a lab leak. They claimed I was stubbornly refusing to admit the obvious out of some sort of strange loyalty to the CCP (despite the fact that I said lab leak is a danger worth worrying about, and despite the fact that I severely criticized the CCP at the beginning of the pandemic, and despite the fact that zoonosis is far worse for China’s reputation than lab leak, which explains why the CCP has vigorously tried to cover-up the zoonosis evidence.)

No doubt these commenters will show up here and apologize for their slander against my character.

Just kidding!!

PS. I enjoyed this comment, in reference to a picture of WIV scientists:

This is the Wuhan Institute of Virology’s coronavirus research group, out for a team dinner at a local restaurant on January 15th 2020 (ie a month after the pandemic started). This isn’t the most rational probabilistic evidence in the world. But we’ve already seen people take the rational probabilistic evidence twenty different directions. So let’s ask the same question Peter did – do these look like people who secretly know they just started the worst pandemic in modern history?

If they secretly knew they’d just started the worst pandemic in modern history, wouldn’t they at least be wearing masks?

Like Alexander, I don’t see the picture as being definitive evidence, rather it’s a reminder that these are real people. When I read lots of recent western commentary on China, I get the impression that the Chinese people are viewed as some sort of totalitarian cyborgs. But when I visit China and talk to people, they seem kind of like Americans. I’m slightly more persuaded by a western scientist that met the WIV people at a conference at the end of 2019, and reported that their mood seemed completely normal. Scientists aren’t like lawyers—they’re pretty transparent.

I also believe that people underweight the fact that the Chinese scientists clearly thought it was zoonosis in the early stages of the pandemic, before the CCP told them to keep quiet and began pushing alternative theories.

People who’ve never been to China often have this weird idea that the CCP is omniscient, and that nothing happens in China without the CCP knowing about it. China is different in some respects, but nowhere near as different as many of you assume. Like the US, it’s a vast and endlessly complicated place.