Archive for the Category Teaching economics


The new Rubb/Sumner principles textbook

I’m very pleased to announce that my 5-year project to write a principles textbook is now complete. Macmillan/Worth has just released the new book I co-authored with Steve Rubb, which is aimed at the mainstream principles of economics market.

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Like Hubbard and O’Brien’s principles textbook, it has a business flavor that should make the subject more interesting for many students.  Our book tries to be shorter and more concise, however, as many of today’s students simply don’t have the time to read an 1176 page textbook like H&O.  Ours came in just under 800 pages—with a word count that is probably pretty similar to Mankiw’s relatively concise principles text.  (Ours is actually 100 pages shorter than Mankiw, but each page is a bit bigger.)  This picture shows our new text (in blue) next to Hubbard and O’Brien (in white).
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Don’t be fooled by the business flavor, we still cover all the basics of economics, including important public policy issues such as price controls, externalities, labor, inequality, health care, and fiscal and monetary policy.

This book should be of interest to both monetarist and Keynesian instructors.  Obviously my own views lean more monetarist, but we’ve covered the material to reflect the views of the profession as a whole. Thus there is much more coverage of inflation than NGDP, reflecting the consensus of the profession.  Keynesians will find an optional “aggregate expenditure” chapter containing the Keynesian cross, if they are so inclined.  If I were still teaching I would not cover the Keynesian cross, but would cover the part of the AE chapter that discusses the intuition behind Keynesian economics.  Although I’m not a fan of fiscal stimulus, I believe it’s important for students to understand why these policies are so popular.

We also have the normal mainstream macro chapters, including a three chapter sequence of AS/AD, fiscal policy and monetary policy, as well as a two chapter money sequence that looks first at the basics of how the Fed controls the supply of money, and then the classical theory of inflation (i.e. money and prices in the long run.)  I especially like our money/inflation and economic growth chapters.

In my view, the book is most successful at adding a business flavor in the micro chapters, especially those covering market structure.  I believe students will find those chapters to be especially interesting, with lots of good real world examples.  But we’ve tried to add as many business examples as fit at various spots throughout the book.  Many students take economics because they have an interest in business.

As far as my own views, we’ve sprinkled the “never reason from a price change” concept into several of those chapters, including both S&D and AS/AD.  There’s a brief discussion of monetary offset of fiscal policy in the section that covers issues such as crowding out.  And there is some coverage of the logic behind NGDP targeting toward the end of the macro section.  In monetary policy, we point out that low interest rates can reflect either easy money or a weak economy/low inflation.

But again, I didn’t think it appropriate to use a principles text to try to indoctrinate students into my own views where I have not (yet) been successful in convincing my colleagues.  Students need to begin with the well-established basics.  As a result, readers will occasionally run across statements in the text that conflict with opinions offered in this blog.  That doesn’t worry me at all, indeed it’s appropriate.

For instance, you won’t come across “inflation doesn’t matter, only NGDP matters” in this textbook.  You won’t find “fiscal policy is useless” in this textbook.  Both monetarists and Keynesians should be quite comfortable with the presentation.  When I taught at Bentley, most students were not aware of my views on economics—indeed were just as likely to view me as liberal than as conservative.  The book reflects that balance.

If you do like my views on economics, I’d argue that we do a better job of presenting many macro topics than what you see in the other textbooks.  For instance, our transition from MV=PY to the AS/AD model (using Y = C + I + G) is far more understandable than in most other textbooks. Indeed students would be utterly confused by this transition in many other textbooks (although Cowen and Tabarrok are an excellent exception.)  I also like the way we explain topics such as the quantity theory of money, or the challenges of doing monetary policy when interest rates are zero.  The fiscal chapter includes both supply and demand-side perspectives.  Like some other newer texts, the economic growth chapter emphasizes the importance of good institutions, not just a mechanical model with “labor”, “capital” and “natural resources”.

Toward the end we have an optional chapter on expectations, covering issues such as the Phillips Curve and rational expectations.  I believe we do a particularly good job of explaining the concept of expectations.  At the end of this chapter is a brief section on how the Phillips Curve approach could be applied to NGDP growth instead of inflation (Ignore “FPO”, an editorial note not contained in the final version):

Screen Shot 2018-10-30 at 6.29.31 PMIn terms of level, I suppose it’s in the eye of the beholder.  In my view our book is aimed at the middle of the market—not too difficult, but not dumbed down so much as to be misleading.  Note that the preceding graph comes in a chapter that has already covered the pros and cons of the basic Phillips Curve, with inflation on the vertical axis.

BTW, if I could do a book with no constraints, I’d make it even shorter.  However, textbooks are expensive projects for publishers and you need to address the preferences of the instructors.  They each have topics that they view as essential.

Goodbye to Boston

[Probably not of interest to most people–academics may chuckle here or there.]

Just a few days after Scott Alexander heads for the West Coast, I’m also heading west.  I was nearly 27 when I arrived in Boston (in 1982), and today I leave for Southern California, where I’ve always wanted to live (since I was 10.)

I’ve always been a “late bloomer”, perhaps because my parents sent me to school at too young an age.  In first grade I was rated “below grade level” in reading and my high school GPA was only 3.2.

In a public high school.

In the early 1970s.

But I was accepted to the University of Chicago, perhaps because my SATs were much better.  The UC expected each of my parents to contribute $1000/year—good luck with that!  Since I could not afford Chicago, I went to the UW-Madison where tuition was $330 a semester.  I did go to Chicago for graduate school through a combination of student loans for tuition, and working 20 hours a week for room and board.

It was the same story in the job market—a real slow start.  Three months unemployed, then one semester at a branch of the UW, then one year at St. Bonaventure, and then I ended up at Bentley College.  In my second year at Bentley I was given an ultimatum—30 days to produce a letter from my adviser that I was making good progress on my dissertation.  That’s when I started on the project.  I basically did most of the dissertation in about 25 days, sent it to Robert Lucas with the request for a letter, and lucked out.  A few years later I was told that I was up for tenure, which was news to me. Seems I had brought in a year when I was hired.  Who knew that we were supposed to read our contracts?  I asked for a one-year delay and was granted my request.  Then I went up for tenure and was turned down.  Seems I didn’t have any publications.  Oops.

By then I was sending a bunch of papers out to journals like the JME and JPE.  My NGDP futures targeting paper was revised and resubmitted to the JME four times before being rejected.  (That’s unusual.)  My JPE paper (with Steve Silver) was rejected the first time, but then I complained and it was accepted.  (That’s also unusual.)  Indeed I had a number of papers flat out rejected the first time around, but later accepted after I complained.  I think that’s because I wasn’t a very good writer, and it was only in my complaint letter that I properly explained what the heck I was trying to do.  Ironically I got three pubs immediately after being rejected for tenure, including the JPE

So I re-applied for tenure in my terminal year at Bentley, while I also went on the job market.  I got an offer from the New York Fed for $57,000, but decided to stay at Bentley for $33,000.  My colleagues thought I was crazy.  I probably was—but the NY Fed might not have let me do TheMoneyIllusion, at least the way I actually did it.  Then after doing almost nothing on my extra long tenure track period, I started averaging three or four publications a year after I got tenure.  That’s sort of the reverse of how it’s supposed to be done.

Initially I was a very poor teacher.  My evaluations were below 3 out of 5, which is bottom 10%.  After about two years I rose to 4 out of 5, which is average at Bentley, and stayed there until I started blogging.  I expected the blogging to hurt my student evaluations, because I was so busy.  Instead they rose to well above average, until finally in my very last semester (fall of 2014) I got a perfect score (by now the scale was out of 6) on at least some of the questions.  It’s so weird, I had to take a picture to convince myself:

William Galston has a nice piece in the WSJ where he describes returning to a much richer Prague after being away for 22 years, and feeling kind of melancholy. It lacked the romance of his first visit:

In 1995 I could still pass for young, and Europe was young again. As we convened in Prague for an international conference on civic education, everything seemed possible. If history had not quite ended, it was moving in the right direction, and more rapidly than sober analysts had thought possible. With Vaclav Havel in the Castle, the idealists had turned out to be the true realists.

Prague was still struggling to remove the accumulated grime of four communist decades, but the surface didn’t matter. Spirits were high. Music was everywhere, in churches as well as bars, announced on huge placards that magically appeared each morning before breakfast. Students thronged the squares. The ancient buildings were more than reminders of the past; they had become part of a new drama written and staged by a generation that had prevailed against all odds. As Wordsworth wrote of a similar moment: “Bliss it was in that dawn to be alive, But to be young was very heaven!”

I landed in Prague this time under different circumstances. The surface was gleaming, but the spirit had darkened.

Boston was a bit run down when I arrived in 1982, and is now being spruced up in all sorts of ways.  Objectively is a far better city, indeed one of the finest in the world.  But when I think of my life in my 20s and 30s, all this improvement seems kind of meaningless.

I also have mixed feelings about my house, which is a Georgian 2-family built in 1930.  People tell me it was a good investment, but I regret ever becoming a landlord.  I like the appearance of old houses, but over time I got sick of the constant problems.  In retrospect, I realize that this is a sort of toxic waste dump, full of asbestos, lead paint, etc.  I don’t care about the lead, but I have a family history of lung disease so I probably shouldn’t have spend so much time doing dusty construction projects without wearing a face mask.  It’s also a good feeling to get rid of an enormous mountain of junk that I had accumulated.  Whatever possessed me to accumulate stuff like a pile of old Fortune magazines from the 1930s?  I don’t seem able to throw anything away.  Millennials are smart in being less materialistic.

Tomorrow morning I start a cross-country drive.  I won’t miss driving in Boston, which is bad in almost every conceivable way (bad traffic, potholes, no street signs, rude drivers, low speed limits, no parking, snow, unfriendly cops, etc.)  But I will miss the movie scene, especially the Harvard Film Archive.  I plan to switch to watching “films” on TV, since everything is becoming digital anyway.  If only the price of 77-inch OLEDs would drop . . .

Back in 2011, my dream was a midcentury modern house high up in the hills of Sherman Oaks, with a view out over a kidney shaped pool to the valley below.  I’d spend my retirement years reading (or re-reading) my favorite 19th century Anglo-American authors or 20th century European/Latin American and Japanese authors. (Not sure why my taste switched continents around 1910.) Then prices soared and I ended up buying in boring Orange County.

Moving has been a hassle, but visions of my new gazebo with a lake view have kept me motivated:

I still have some packing to do tonight, and won’t have much time for blogging over the next 12 days.  But I’ll try to check in occasionally.

Print the legend

As I get older, I become increasingly interested in the mythological folktales that are believed by most economists.  For instance the idea that LBJ refused to pay for his guns and butter program, ran big deficits, and kicked off the Great Inflation.  All you need to do is spend 2 minutes checking deficit data on FRED to know that this is a complete myth, but apparently most economists just can’t be bothered.

Screen Shot 2016-05-04 at 10.23.16 AMDuring the 1960s, the budget deficit exceeded 1.2% of GDP only once, in fiscal 1968 (mid-1967 to mid-1968.  LBJ responded with sharp tax increases in 1968, and the deficit immediately went away.

The LBJ guns, butter and deficits story is too good to drop now, it’s in all the textbooks. It would be like admitting that the textbooks were wrong when they tell students that the classical economists believed that money was neutral and that wages and prices were flexible.  We can’t do that, it’s too confusing.

Another one I love is that monetary policy impacts the economy with “long and variable lags”.

I’ve talked about this before, but today I have a bit more evidence.  The idea that monetary policy affects RGDP with long and variable lags has three components, one or more of which must be true for the theory to hold:

1.  Monetary policy affects NGDP expectations with a long and variable lag.

2.  Changes in NGDP expectations affect actual NGDP with a long and variable lag.

3.  Changes in actual NGDP affect actual RGDP with a long and variable lag.

All three are false.  The third claim is obviously false; NGDP and RGDP tend to move together over the business cycle.  So the entire theory of long and variable lags boils down to the relationship between monetary policy and NGDP.

The first claim is also obviously false, as it would imply a gross failure of the EMH. Now the EMH is clearly not precisely true, but it’s also obvious that market expectations respond immediately to important news events.  Even EMH critics like Robert Shiller don’t claim that an earnings shock hits stocks two week later; it hits stock prices within milliseconds of the announcement. That part of the EMH is rock solid.  There is no lag between policy shocks and changes in expectations of future NGDP growth.

So the entire long and variable lags theory rests on the second claim, that NGDP responds with a lag to changes in future expected NGDP.  Unlike the first and third claim, that’s possible.  But it’s also highly, highly unlikely.  While we don’t have an NGDP futures market, the markets we do have strongly suggest that markets (and hence expectations) move with the business cycle, not ahead of the cycle.

Perhaps the best period to test this theory is the 1930s.  That decade saw massive RGDP and NGDP instability, which was clearly linked to asset price changes.  Put simply, the Great Depression devastated the stock market.  Here’s the correlation between stock prices and industrial production, from my new book:

Screen Shot 2016-05-04 at 10.42.33 AMThe stock market is clearly not a leading or lagging indicator; it’s a coincident indicator.  And that’s not just true in the 1930s; it’s also true today:

Screen Shot 2016-05-04 at 10.48.03 AMThe onset of the recession lines up, as does the steep part of the recession.  The stock recovery in 2009 did lead by a few months, but the recent slump in IP led stocks by a few months.  In any case, there are no long and variable lags; it’s basically a roughly coincident indicator when there are massive changes in NGDP.

If there actually were long and variable lags between changes in expected NGDP and changes in actual NGDP (and RGDP), then forecasters would be able to at least occasionally forecast the business cycle.  But they cannot.  A recent study showed that the IMF failed to predict 220 of the past 220 periods of negative growth in its members.  That sounds horrible, but in a strange way it’s sort of reassuring.

Suppose that the business cycle is random, unforecastable, as I claim.  And suppose that declines in GDP occurred one out of every five years, on average.  In that case, the rational forecast would always be growth.  As an analogy, if I were asked to forecast a “green outcome” in roulette, I never would.  Each spin of the wheel I’d forecast red or black.  I’d end up forecasting 220 consecutive “non-greens” outcomes.  And yet, there would probably end up being about 11 or 12 green outcomes during that period, and I’d miss them all.  A 100% failure to predict greens.  Because I’m smart.

Of course if there really were long and variable lags, say 6 to 18 months, then there would be occasions where the IMF would notice extremely contractionary monetary policy, and accurately predict recessions a year later.  I’m not saying they’d always be accurate. The lags are “variable” (a cop-out to cover up the dirty little secret that there are no lags, just as astrologers cover their failures with the excuse that their model is complicated, and doesn’t always work.)  No, they would not always be successful, but they’d nail at least some of those 220 recessions.  But they predicted none of them. And that’s because there are no lags.  Because recessions begin immediately after the thing that causes recessions happens.

That’s the message the markets are sending loud and clear.  But economists can’t be bothered; they have their comforting stories. Who can forget this line from The Man Who Shot Liberty Valance:

Ranson Stoddard: You’re not going to use the story, Mr. Scott?

Maxwell Scott: No, sir. This is the West, sir. When the legend becomes fact, print the legend.

EC101: The fallacy of composition

I get tired of correcting Keynesians who don’t understand how to estimate the multiplier.  But as long as they keep saying things like this, I’ll have to keep doing so:

In general, cross-sectional comparisons are proving to be a very good way to test some propositions in macroeconomics. I’d cite, for example, the Nakamura-Steinsson paper (pdf) that uses fluctuation defense spending “” which has very unequal impacts across states “” to estimate the multiplier on fiscal policy (it’s about 1.5).

Actually cross-section studies are a lousy way to test for the multiplier, as they suffer from the fallacy of composition.  I’ve pointed this out many times, but Paul Krugman obviously doesn’t read my blog, otherwise he wouldn’t keep making these elementary errors.  Of course he’s told us that he doesn’t like to read conservative blogs because they contain nothing of value.

Then there is this, from the very same post:

Calculated Risk sends us to two papers by Amir Sufi and Atif Mian using county-level data to investigate the causes of the recession. Their work strongly supports the balance-sheet view: a fall in demand from highly indebted households is the big story, and you can confirm that by showing that the big declines in nontradable employment “” that is, employment in industries that sell locally “” is in those countries where debt levels were high.

And let me guess, counties with economies dominated by autos and steel usually suffer bigger job losses in recessions than counties dominated by hospitals and colleges.  Does that tell us anything about what causes recessions?  Doesn’t EC101 also teach that correlation doesn’t prove causation?

Let’s suppose recessions were caused by tight money, not balance sheet problems.  And let’s suppose that tight money reduces nominal income.  And let’s suppose that most debts are nominal, not indexed to inflation.  In that case wouldn’t you expect tight money to lead to bigger spending declines in highly indebted areas, even if debt played no role in causing the recession?

Fallacy of composition.  .  .

Correlation doesn’t prove causation.  .  .

Krugman’s textbook must have something to say on those topics.

We’re getting closer

The blogosphere response to the recent Swiss move is quite interesting.  But let’s back up a minute so that I can better explain why I am bemused by the discussion.  Recall that I look at monetary policy from an asset price approach.  Easy money is a policy that pushes NGDP futures prices above target, and vice versa.  If the government is so monumentally stupid that it hasn’t spent a few million dollars to create and subsidize trading in an NGDP futures market, and is doing monetary policy with a blindfold on, then look at a collection of assets like stocks, commodities, TIPS, etc, and then estimate NGDP growth expectations.

I spent lots of time studying the 1930s, when FDR routinely moved the price of gold around as a lever of monetary policy, and all the markets responded exactly as you’d expect if the policy was credible and effective.  I’m very comfortable operating in a world where the central bank pegs the price of some sort of nominal anchor.  That’s how I think monetary policy works, or should work.

Lots of proponents of monetary stimulus on both the left and the right are basically saying “Look, if the Swiss can do it, why can’t we?”  JimP sent me an excellent Ryan Avent post that makes this point clearly.  First he discusses the Swiss move, and then says:

There seems to be more scepticism that the Fed could similarly talk the economy toward a specific inflation or nominal growth rate. I understand the reason for the intuition; prices and wages aren’t set in the same clear way that security prices are. The principle is the same, however. If the Fed declared””credibly””that it would intervene in markets such that nominal growth in 2012 was 6%, asset-market prices should adjust immediately, pushing firms and households to behave in a more optimistic way, leading to faster growth. Expectations for growth couldn’t rise too high, however, lest the spectre of Fed tightening be raised, leading actors to push the economy toward the desired nominal target.

The Fed would need to act enough to demonstrate its credibility, and nominal growth of 6% wouldn’t guarantee anything about real growth. But examination of the Swiss National Bank’s action, and the resulting effect, should give us pause. From it, we can either conclude that the Fed is implicitly targeting a higher rate of nominal growth but isn’t credible, or that the Fed is credibly targeting growth within a range consistent with actual recent experience. In fact, I think it’s a bit of both. Ben Bernanke may say he wants a faster recovery, but the Fed’s actions are inconsistent with his statements, and markets and economic actors have therefore concluded that the Fed is happy with current growth rates. Nominal growth above 5% per year is not the rate the markets are looking for. And so it’s not the rate they get.

At first I was slightly annoyed by the “Ben wants more growth” comment.  Bernanke has consistently said the Fed has plenty more ammunition.  If they aren’t using it, it’s because the Fed doesn’t think it’s needed.  It doesn’t think faster expected NGDP growth would be desirable.  I imagine Bernanke is disappointed by NGDP growth in the recent past, but he favors growth rate targeting, not level targeting.

But on second thought I realized that the Fed isn’t Avent’s intended audience.  Very few people know what Avant and Yglesias and us quasi-monetarists know–that the only solution for the recession is faster NGDP growth, and only the Fed can deliver it.  It’s almost pathetic to listen to NPR these days.  You have all these earnest liberals who sincerely want Obama to succeed, talking about various screwball ideas to create a few thousand jobs here or there, when we need 10 million jobs.  Only the Fed can to that.  We need to wake up Congress, the WaPo editorial board, and all the other movers and shakers.  We need for them to suddenly realize; “You mean to tell me if the Fed did something analogous to what the SNB did, it would create millions of jobs!  And they know they can do it, but just don’t happen to think the economy needs more demand, more spending, more NGDP!”  When that happens the Fed will suddenly be under tremendous pressure to create jobs.  NPR also has lots of heart-wrenching stories about what happens to average people in America when they’ve been unemployed for a long time.  I wonder how the hawks at the Fed can be so confident that more stimulus wouldn’t help those people.  Do they even listen to those stories?

One person at the Fed does realize the severity of the jobs problem, and that the Fed has the duty to address it.  Several commenters sent me an excellent speech by Chicago Fed President Evans:

Some believe that this pause is entirely appropriate. They claim that the economy faces some kind of impediment that limits how much more monetary policy can do to stimulate growth. And, on the price front, they note that the disinflationary pressures of 2009 and 2010 have given way to inflation rates closer to what I and the majority of Fed policymakers see as the Fed’s objective of 2%. These considerations lead many to say that when adding up the costs and benefits of further accommodation, the risk of over-shooting our inflation objective through further policy accommodation exceeds the potential benefits of speeding the improvement in labor markets.

I would argue that this view is extremely, and inappropriately, asymmetric in its weighting of the Fed’s dual objectives to support maximum employment and price stability.

Suppose we faced a very different economic environment: Imagine that inflation was running at 5% against our inflation objective of 2%. Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate? No, there isn’t any doubt. They would be acting as if their hair was on fire. We should be similarly energized about improving conditions in the labor market.

In the United States, the Federal Reserve Act charges us with maintaining monetary and financial conditions that support maximum employment and price stability. This is referred to as the Fed’s dual mandate and it has the force of law behind it.

The most reasonable interpretation of our maximum employment objective is an unemployment rate near its natural rate, and a fairly conservative estimate of that natural rate is 6%. So, when unemployment stands at 9%, we’re missing on our employment mandate by 3 full percentage points. That’s just as bad as 5% inflation versus a 2% target. So, if 5% inflation would have our hair on fire, so should 9% unemployment.

And he saves the best for last:

There are other policies that could give clearer communications of our policy conditionality with respect to observable data. For example, I have previously discussed how state-contingent, price-level targeting would work in this regard.  Another possibility might be to target the level of nominal GDP, with the goal of bringing it back to the growth trend that existed before the recession. I think these kinds of policies are worth contemplating””they may provide useful monetary policy guidance during extraordinary circumstances such as we find ourselves in today.

Evans makes me seem like a hawk.  I think it’s too late to go back to the old trend line (we’re about 12% below it.  I’d be happy going 1/3 of the way back—7% NGDP growth for two years and 5% thereafter.

I hope this doesn’t sound too conceited, but I can’t help taking satisfaction with the way the conversation over monetary policy is developing:

1.  Fed people discussing NGDP targeting, level targeting.

2.  The Economist magazine comes close to endorsing NGDP targeting.

3.  Ryan Avent talking about monetary policy in terms of pegging asset prices, and then drawing analogies with NGDP targeting.

4.  Nick Rowe is drawing upward sloping IS curves (I plan a post when I have time.)

My very first paper was written in 1986, presented at the AEA in 1987, sent 4 times to the JME with revise and resubmits before being rejected, then published in 1989 in an obscure British journal.  The topic was how the central bank should create NGDP futures contracts, and then peg the price in such a way that the market determines the money supply and interest rates.  NGDP expectations are always on target.  I still feel that’s the end of macro.  No more fiscal multipliers.  No more broken windows fallacies.  No more confusing of structural and demand problems  No more mercantilist arguments for reducing unemployment.  No more demands that GM must be saved to preserve jobs.  Students could just take one semester of econ—we could stop calling it “microeconomics” and start calling it “economics.”

I feel we are getting closer every day.  I just hope I live long enough to see it happen.

PS.  I’m still running way behind on comments–I know there are many from before my vacation that I haven’t even read.  My priorities are:

1.  Get my ideas out there before the critical Sept. meeting.

2.  My job.

3.  Dealing with flooding in my basement.

4.  Dealing with papers people send me for comments.

5.  Buy a new toilet.

6.  Answer comments.

You’ll just have to wait.