Knowing and Making

Paul Krugman in " Bourbon Economics " (and his commenter Peter von zur Muehlen ) complain that we've had new ideas for decades in macroeconomics, but they don't take hold. By 1988, it was already obvious that equilibrium business cycle theory had failed. Shiller had already circulated his devastating demonstration that asset prices were much too volatile to be explained by fundamentals...nothing happened. Real business cycle theory continued to prosper, developing an increasing stranglehold over the professional journals. Behavioral finance stayed on the margins. The equilibrium guys had learned nothing and forgotten nothing... Our problem, in short, isn’t lack of nifty new ideas; it’s the refusal of too many economists to face up to the fact that some of their preferred theories don’t work I sympathise - as an adherent and practitioner of behavioural finance, I could hardly not. But it's too easy to blame this on the establishment for not listening. And really, ...

The Wall Street Journal's RTE blog (via Paul Krugman) has been spluttering about being misrepresented by Sarah Palin. RTE criticised her for saying "everyone who ever goes out shopping for groceries knows that prices have risen significantly over the past year or so". In fact, RTE pointed out, inflation in food prices has been at a record low this year, of just 0.6%. General inflation is also low, at 1.1%. Palin - and I have to give her credit for this - responded quite cleverly to RTE by citing the Wall Street Journal itself, which said in an article last week : "an inflationary tide is beginning to ripple through America’s supermarkets and restaurants…Prices of staples including milk, beef, coffee, cocoa and sugar have risen sharply in recent months" RTE correctly points out the facts of the matter: beef is up, but bananas are cheaper; producer prices are up but retailers have not yet passed them on; the catering industry is increasing quality and offeri...

Paul Krugman bemoans an externality imposed on him by Narayana Kocherlakota (or his ancestors): the need to fit more letters into a short column, the more he is discussed. While this problem has been solved over at WCI (see what I did there?) by compressing him to NK, this is a risky policy due to the frequent mentions of New Keynesian models alongside his name. Paul suggests that all economists should have short names like Ip and Ng. If this a problem now, surely it was a bigger problem in the days of mechanical movable type. With modern typesetting software and the greater readership of electronic media, long names are now more affordable to the reader. We can test this hypothesis statistically. Let's start with the founders of economics in the 18th century: Hume, Smith and Mill. So far, so good. Indeed, the first entry in my Routledge " Fifty Major Economists " is the tiny-surnamed Thomas Mun. In the 19th century the theory was developed further by Ricardo,...

Re-reading an old David Beckworth post , I was reminded of that ancient question: is economics a science? On the content of the post, I have no idea if the United States is an optimal currency area. Or the eurozone. But a deeper question is: why ask the question? If this kind of speculation was taking place in a discipline like physics, it would be ignored - if there is no way to test it, there's no point talking about it. But "the US is an OCA" is not a testable proposition. Therefore, is there no value in proposing it? Well, economists don't seem to think so - these things are discussed endlessly, and some of them even get peer reviewed and published. Economic "truth" (or economic arguments), even when not meeting the standard of science, can achieve two things. The first is their value as engineering. Sometimes, with the physics proved to scientific standard, the task is to apply it in a practical design. Nobody can prove that this design is t...

Today I'm in Hay-on-Wye , a small town buried miles from anywhere on the Welsh-English border, with the highest number of bookshops per inhabitant of anywhere in Britain and probably the world. Can this possibly be an economically stable situation? Today, a mild springtime Saturday, there are plenty of visitors - and I'm sure they will all spend some money in several shops. But is this really enough to make a living? There are several characteristics which probably make this local economy more sustainable than one would expect: Books, especially second-hand books, are not commodities - for most books here, there's probably just a single copy in one shop. This reduces the competition between shops and allows them to maintain greater margins. There's an annual festival where 80,000 people come here and the bookshops - and everyone else in town - makes an absolute fortune. The existence of the bookshops the rest of the year strengthens the credibility of the festi...

Robert Peston has been working hard reporting on results from RBS and Lloyds the last couple of days. A couple of points. He claims that taxpayer's money has gone down the drain at RBS, because: we as taxpayers put in £25.5bn of new equity into this bank last autumn...but...the equity of this bank has increased by less than £16bn to £80bn. So almost £10bn of the £25.5bn we've only just put into RBS has already been wiped out by losses. Well, that's half true. £10 billion has indeed been wiped out by losses. But it's not £10 billion of our  money, it's £10 billion of the former shareholders'  money. Our £45.5 billion has bought 84% of that £80 billion in equity, a £67.2 billion asset. The reason we're not in profit yet is because the market is still applying a discount due to uncertainty over future losses. We don't know if those losses will happen yet - it depends mainly on economic recovery - but on the book value of the bank, we got a good a...

There's a meme around which says that the euro is destined to break up because countries like Greece are fundamentally less productive than countries like Germany. A strategist at Societe Generale has put his name  to this idea, as has the director of the Open Europe (anti-EU) think tank. This argument supposes that the only way to become competitive is to devalue one's currency. But surely this applies within countries too? The southern half of Italy is much less productive than the north, while the reverse is true in Britain. But there are no calls for a London currency and when the lira existed, it was never under the threat of an Italian breakup. Different states in the US are just the same - with widely varying fiscal problems as well as the same diversity of competitiveness. At the individual company scale, Yahoo is less competitive than Google, but does Yahoo need its own currency to devalue? And 22-year-old new college graduate Travis is less productive than his e...

Paul Krugman is a great writer. And a pretty good economist. But just as as good economists can occasionally say silly things, good writers sometimes lapse too. How long does it take you to figure out this sentence outside of its context : Still, I think it’s important that just because I think Europe does better than Americans imagine doesn’t mean that it does everything right. Can you count the nested subclauses on less than two hands?

If Scott Sumner and Paul Krugman agree on something, it must be true. I think most of us would accept that as an axiom of economic sociology. Accordingly (see here and here ), we can take as read the idea that expectations of inflation and aggregate demand strongly influence actual inflation and aggregate demand. There's nothing really controversial about this: the idea of multiple equilibria is well established. If people expect deflation and recession, they will try to save more, spend little and invest less - and deflation and recession will result. If people expect inflation or growth, they will spend more quickly and invest in the hope of protecting their assets and capturing a share of that growth; and as a result, the expectation will be fulfilled. Or as it's caricatured by a self-help motto you've probably seen: if you think you can, or if you think you can't, you're right . Presumably we want to have more growth rather than less, and (mild) inflation rat...

I've had this article in draft for about three weeks. Paul Krugman's latest item seemed an opportune moment to finish it. Intriguing article by Sheng and Pomerleano in the Economists' Forum about zero interest rate policy . I don't think I agree with what they are saying (insofar as I can even tell what they're saying) but it stimulates a few thoughts along Scott Sumnerish lines. One bit (from Kevin Warsh, quoted approvingly by the authors) jumped out at me: A complication is the large volume of banking system reserves created by the non-traditional policy responses. There is a risk, of much debated magnitude, that the unusually high level of reserves, along with substantial liquid assets of the banking system, could fuel an unanticipated, excessive surge in lending. Now surely a surge in lending is exactly what we want? Isn't all this monetary activism meant to increase the effective money supply (or counter a fall in velocity) therefore sustaining nominal GD...

Everyone is looking for new macroeconomic models these days. Paul Krugman's recent article has been a prompt for a reopening of intense discussion on the matter. It seems that there are two major classes of proposal emerging: those based on cognitive/behavioural insights, and those which incorporate financial firms as part of the model instead of just assuming they transparently pass demand and money around the economy. Financial models include " New Models for a New Challenge ", Cecchetti, Disyatat and Kohler's proposal (via Mark Thoma - though a number of the comments on his posting point back towards the behavioural option). Another is Kobayashi's , which I may have mentioned before. I've explored the behavioural models more in past columns but I hadn't noticed this conference in Australia which looks to have had some interesting presentations. Krugman hints at behavioural explanations in his commentary but has not yet suggested a model incorporating ...

In a bizarre Art Laffer-like incident today, Alan Duncan reminded us of the good old days when all Tories were mad. In the midst of a number of other infelicities, widely reported in left and right wing newspapers nationwide, Duncan said of the House of Commons: Basically, it's being nationalised. Now I am spoiled by my choice of targets. I have: American economists who think that the government doesn't run Medicare American financial journalists who argue that Stephen Hawking would have been left to die by the NHS if he'd been British (which he, er, is) A British MP who thinks - and is willing to admit - that the House of Commons used to be a private company Republicans must be terrified that, if Obama gets his way, they are going to end up with a publicly owned government. Thank goodness free enterprise still reigns in that branch of the economy.

Paul Krugman has been cheerleading for Britain for a while. I'm not sure I agree with him that the pound is cheap, but it's good to see we that some of our signs of robustness are visible from outside. Why is our economic performance so good? This is one - charming - theory .

Any of these links could have made a blog posting of its own, but instead why not help yourself to a high-density nutritious snack selection of random commentary? During the first lecture of Paul Krugman's London visit last month he commented that the economy might be "stabilising". The stockmarket leapt a hundred points (giving rise to much hilarity on the second and third evenings). This perceptive writer points out a similar occasion in 1929 when someone "of no great note" called Roger Babson made a comment that the market was due to crash. At which point it duly crashed - for the next twenty-five years. Now a little later in the Robbins lectures Paul Krugman reviewed a history of not the 1929 but the 1873 depression - and how the economy recovered from that, in the absence of the modern era's gifts of Keynesian stimulus and World War II. Nothing to do with the earlier comments...except for one little thing... An interesting behavioural marketing tactic ...

Many of you will have noticed Paul Krugman's continuing demands for a bigger fiscal stimulus - he thinks it should be around double the size proposed by the administration. If nothing else, we have to give him credit for being consistent, right? Well...maybe not. You see, I came across an old article where he was, as usual, insisting that the stimulus should be doubled...but only to $600 billion! A double-take. Could it ever be true that the administration was proposing only a $300 billion stimulus? Yes it could - in fact in the early days of the election campaign Obama's proposal was for a stimulus of $60 billion . No wonder Paul originally supported Hillary. I thought it would be interesting to run a comparison of Paul Krugman's desired stimulus versus the stimulus proposed (and eventually passed) by the Obama administration. Here it is (click on the graph for a larger version). The red line is the administration's efforts and the blue is what Paul wants: The red lin...

I'm on a continuous quest to apply behavioural modelling to macroeconomics, and I have some way to go before I complete a model that is credible, tractable and predictive. But what I can do is use behavioural finance research to explain a trait that Paul Krugman discusses in his blog posting today . Put simply, people feel losses much more keenly than they imagine gains. Ask a hundred people whether they'd work an hour to earn £10 and most of them will say no. But overcharge them £10 on their mobile phone bill and watch them sit on hold, fill out forms and argue with shop assistants for as long as it takes to get their money back. And there is something about fiscal deficits that just feels like a loss. Carrying billions of pounds of debt and knowing that your income tax will go up to pay for it is a very concrete concern. But the idea that without it, you will lose 10% of potential growth in your income, is much harder to get worked up about. You could make a legitimate argume...

Maybe this should be titled part 3, but I combined the first two out of three lectures into part 1 . Although billed as a plan to reform finance and redesign the teaching of economics, most of tonight's lecture was an entertaining survey of the last 70 years of economics, and a story about how we got into the " dark age " Krugman says we're in. A few mild digs at freshwater economists, but mainly an explanation of the differences between the two schools and a rubbishing of the idea that the "civil war" is over - in fact, he says, the difference between freshwater and saltwater economists is that saltwater economists know the difference between freshwater and saltwater economists. But he believes the current recession is definitive proof that the real business cycle model is wrong. There wasn't much specific on finance: increased capital requirements, more transparency (though with the wry comment that everyone wants more of that and nobody knows what it ...

Unlike some people , I managed to get tickets for Paul Krugman's series of lectures at the London School of Economics this week. It's been very interesting, and has already reached the news. Yesterday he announced that he expected the recession to officially end this summer, and the Dow Jones index immediately jumped about 70 points. Ironically, Krugman said in the same lecture that the stockmarket is not a signal of recovery - though he didn't quite say that the stockmarket wouldn't respond to signals of a recovery. I think the phrase was "what the hell does the stockmarket know". Oddly, the Bloomberg report of yesterday's comments (which portrayed them positively) has been replaced with a much more pessimistic report of what Krugman said tonight. Yesterday, this link read: June 8 (Bloomberg) — The U.S. economy probably will emerge from the recession by September, Nobel Prize-winning economist Paul Krugman said. “I would not be surprised if the officia...

Nick Robinson has just written a fascinating post revealing lots of interesting detail about what's happening in the Democratic Renewal Council, which I mentioned on Saturday . It seems that both Lords reform and electoral reform are on the cards for quick action - though the electoral system being most seriously considered is not PR but Alternative Vote (interestingly, I had an informed response by email to Saturday's article which hinted at this). Nick explains the difference in his article linked above. I'm not sure if AV is more likely to favour Labour electorally than PR, but no doubt we will hear further analysis soon. Needless to say I think this bold and swift action is exactly the right political move for the government to take, and if followed up with consistently bold announcements from the other two cabinet Councils, will help to show that Labour does have a vision for the future of government. I'm not sure which should report first, but probably domestic p...

Paul Krugman this afternoon is, intentionally or not, " waiting for a delayed plan at O'Hare". Perhaps his flight is on Geithn Air? (sorry) While waiting, he discusses Eichengreen and Temin's paper about the "gold mentality". I strongly agree that the gold standard, equated by some "not just with prosperity, but with morality, decency, civilization itself" is a dangerous thing; and it's a symptom of a wider illusion. Those who fetishize the manufacturing sector and say a service-based economy is "hollowed-out"; those who say gold is the only real currency and fiat money is a fraud; those who think everything needs to be manufactured within the borders of their own country (but presumably don't take that to its logical conclusion, by operating a car factory, iron mine and arable farm inside their own house) - these people are suffering from a delusion about what reality consists of. If they think that only physical objects are re...