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I Think Noah Smith Gets One Wrong: State-of-Macroeconomics Weblogging

If Noah Smith does not want to call what I see as serious and significant deficiencies “failures of technique”, then what does he suggest that I call them?

Noah Smith:

Noahpinion: Macro, what have you done for me lately?: Paul Krugman says the state of macroeconomics is rotten. Steve Williamson disagrees…. On the question of whether macro is divided into warring "schools", I'd say Williamson is 85% right, and Krugman only 15%. Yes, there are some systematic disagreements, but they're not very bitter or rancorous, and everyone uses mostly the same "language". The old "freshwater"/"saltwater" distinction is still there to a limited degree among older faculty, but younger faculty don't seem to see much of a dividing line…. So if collegiality and similarity of technique are measures of a field's health, then macro is doing quite well...

I think that is wrong. It depends, I think, on what you take "technique" to mean:

Exhibit A of the wrongness: Stephen Williamson on the consequences of nominal interest rate targeting:

If the central bank targets the nominal interest rate at a low enough rate forever, you have to get deflation. By arguing against this you're making yourself look silly…

In my view, if a central bank sets and holds the nominal interest rate at a low level for a "long enough" period of time, two things can happen: (i) if the central bank's action is a response to expected deflation and sets the real interest rate at the natural rate at which price-change outcomes are consistent with expectations, you get the expected deflation; (ii) if the central bank's action is a shift in policy from a state in which there is not expected deflation, you get accelerating inflation and then hyperinflation.

There is no "have to get deflation" in what I at least regard as "standard monetary theory". In my view, Stephen Williamson does not understand how to use the techniques of macroeconomic modeling when he simply wipes the accelerating-inflation-leading-to-hyperinflation outcome from his scenario.

Exhibit B of the wrongness: Stephen Williamson on bubbles:

What is a bubble? You certainly can't know it's a bubble by just looking at it. You need a model. (i) Write down a model that determines asset prices. (ii) Determine what the actual underlying payoffs are on each asset. (iii) Calculate each asset's "fundamental," which is the expected present value of these underlying payoffs, using the appropriate discount factors. (iv) The difference between the asset's actual price and the fundamental is the bubble. Money, for example, is a pure bubble, as its fundamental is zero.

As Noah Smith complained back then: "What is "fundamental value"? Is it consumption value? If that's the case, then a toaster has zero fundamental value, since you can't eat a toaster…. So does a toaster have zero fundamental value, or is its fundamental value equal to the discounted expected consumption value of the toast that you will use it to produce?… If the toaster has fundamental value, the money should too…"

Noah is, of course, correct.

A toaster has fundamental value because it performs the useful service of making toast. Money has a fundamental value because it performs the useful service of enabling transactions. Money is a substitute for trust. In the absence of money, you can transact only with people with whom (a) you have an (unlikely) double coincidence of wants, or (b) you have an ongoing non-economic relationship that enables you to trust each other to make your credit good. In the presence of money, you can transact with damn near everybody. This increase in the scope of potential market transaction partners is immensely valuable. This is the service flow that money provides. This gives it "fundamental value". Positive value of an asset that paid no dividends or coupons in any state of the world and that did not enlarge the scope of those you could transact with would be a bubble. Positive value of money is not a bubble.

Once again, Williamson does not understand how to use what I would call the "techniques" of macroeconomics.

Exhibit C of the wrongness: Stephen Williamson on seasonal adjustment:

The Employment Picture July 2, 2010: The employment report for June might make one somewhat pessimistic about growth in aggregate economic activity. Certainly some of the private sector economists surveyed here think so. The establishment survey showed a decline in seasonally adjusted employment…. But let's not be too hasty. Following the same approach as for last month's employment report, I looked at the 12-month growth rates in unadjusted establishment employment…. Employment growth is still negative (just barely) year-over-year, but it is coming back strongly, and faster than was the case during the last recession. Conclusion: How you filter the data matters a lot. There is no reason you should trust my year-over-year filter more than what the BLS uses (X11, X12, or some variant) to do seasonal adjustment, but at least the year-over-year filter is simple enough for a simpleton like me to understand exactly what it is doing. The more I think about seasonal adjustment, the less I trust it…

As I noted at the time: I Do Not Think Stephen Williamson Knows What He Is Doing with his year-over-year filter. The X11 and X12 filters deseasonalize employment: the level of the filtered series then tells you (the filter's guess at) the amount of employment, the slope about the change in employment. A twelve-month year-over-year change filter both deseasonalizes employment and takes a derivative: the level of the filtered series then tells you whether things have gotten better or worse over the past year, and the slope tells you whether things are getting better or worse more rapidly or more slowly. Williamson eyeballs his series and finds it "innocuous" because it is telling him that things are getting worse more slowly. When the rest of us eyeball the BLS series, our hair is on fire because it tells us that things are bad and not getting better. Williamson's claim that "how you filter the data matters a lot" is, to my mind, simply wrong. Williamson thinks the X11 and the year-over-year filters are both producing data series that answer the same question: he does not recognize that year-over-year differencing not only deseasonalizes but also takes a derivative.

Exhibit D of the wrongness: Stephen Williamson:

The scarcity [of financial assets] we are observing is not a traditional currency scarcity... correct[able] by... open market operations in short-term government debt…. [T]he inability of monetary policy to correct the liquidity scarcity problem has nothing to do with the zero lower bound on short-term nominal interest rates..... If monetary policy cannot do it, that leaves fiscal policy…. But there is a tendency... to frame the problem in Old Keynesian terms... the LM curve is flat, monetary policy doesn't work, so shift the IS curve instead. Further, unemployment is very high and persistent, so it might seem natural to have the government employ people directly by spending more. But the problem here is financial, and it's not a Keynesian inefficiency associated with real rates of return being too high; in fact real rates of return are too low...

This, too, seems to me to be completely wrong: if all real prices were the same but we weren't at the ZNLB--if inflation were not 1.5%/year but 4.5%/year and the federal funds rate were not 0%/year but 3%/year--does anybody doubt that the situation could be greatly improved by open market operations in short-term government debt to reduce the federal funds rate? Our current problems have everything to do with the zero lower bound on short-term nominal interest rates.

All four of these errors on Williamson's part appear to me to be due to significant failures of technique. He does not (a) understand how to take a basic monetary model and characterize the set of outcomes it generates, (b) what the use-value of money comes from or what a bubble is, (c) the implications of different filters on time series, and (d) what other economists mean by a "liquidity trap".

Noah would presumably say that Williamson knows how to take a fixed-point math problem similar to those that are already in the literature and solve a modified version of it--and that that demonstrates the "similarity of technique" of macroeconomists.

I think that is wrong: I think that the techniques of macroeconomics include much more than that.

And I think this failure of Williamson to master the techniques of macroeconomics has a number of very bad consequences. Consider Williamson's latest--his reiterated attacks on the motives of Narayana Kocherlakota for supporting and endorsing the Federal Reserve's current Evans-Rule QE ∞ policies:

New Monetarist Economics: Kocherlakota Joins the COGCB: What's the COGCB? Club of Goofy Central Bankers…. The Fed may have good reasons for changing its behavior. If so, Fed officials should articulate those reasons.... That seems to be what Kocherlakota is attempting.... His conclusion is:

...monetary policy is, if anything, too tight, not too easy.

If you have not fainted and fallen on the floor, take a couple of deep breaths, and we'll figure out what Narayana has on his mind. His argument is:

  1. We had a big shock, and this calls for extreme measures.
  2. The current inflation rate is too low.
  3. Forecast inflation is too low….

Big shock: Of course we had the big shock - four years ago. Now, in 2012, what is it about that big shock that creates macroeconomic inefficiency that can be corrected by central bank action - and by central bank action that has not already been executed? Prices and wages are so sticky they have not adjusted? We are in the midst of some coordination failure that Ben Bernanke (or Narayana Kocherlakota for that matter) can fix? What? There has been massive intervention on an unprecedented scale…. Is the inflation rate too low?… I don't think so.... You would think Kocheralakota would know better…. Arguing that the the Fed's forecasts could justify a more accommodative policy than what we already have is nonsense…. [Has t]he Kocherlakota of 2 1/2 years ago... changed his mind for good reason? I don't think so. The new Kocheralakota seems to be a flimsy-excuse guy….

[Kocherlakota] eems to be going through a bad period, though. Maybe he'll come around....

[Matthew] Yglesias simply does not have the expertise.... To have Yglesias call Kocherlakota a "hero of rigor" makes me giggle every time I think of it.... I have never done brain surgery, but I'm willing to assert that economics is MUCH more complicated than that. It isn't always as scientific as it might be, but that's the fault of some of the practitioners.... [T]rying to figure out Kocherlakota is a whole field of study unto itself.... [Yglesias] wouldn't know good policy from bad policy, and thus I don't think we should pay attention to what he writes.... [Kocherlakota] has sold out. That's a fact.... Ambition collides with economic science....

There is nothing in the data between old Kocherlakota and new Kocherlakota that provides any convincing evidence for the new Kocherlakota position.... There is no serious theory to tell you how QE works, and the empirical work on the subject is poor.... When I see a smart person doing what seems to be stupid things, I assume that person is not telling me something. The "lot of people" you mention can be forgiven for not knowing any better, but Kocherlakota should know better...

If Williamson were just an outlier with a weblog, I might agree with Noah Smith that the state of the academic macro conversation is good.

But Williamson's view that policy right now is dangerously overexpansionary and needs to become more austere is a plurality view in the academy and a majority view in political policymaking circles right now. I trace the strength of this view to a failure of many to learn and understand the proper and appropriate techniques of macroeconomics.

If Noah doesn't want to call what I identify as an intellectual failure of Williamson and others as a failure of technique, what does he propose that I call it?

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