It seems to me that an important distinction needs to be made between at-risk capital and deferred consumption. The application of and returns to at-risk capital mostly play out through equity investments and returns on equities, which have high and relatively stable expected returns that are riven by real shocks. The application of and returns to deferred consumption play out through low-risk securities and interest rates.
I think it makes more sense to think of deferred consumption as a service provided by the borrower to the lender, and in order to provide that service, the borrower needs to have an income-producing asset that can credibly fund the deferred consumption. Frequently some of the assets that function as part of at-risk capital can serve as the collateral for deferred consumption, but otherwise the two markets are not particularly described with the same characteristics. I think it is hard to create a coherent model of the economy if they are combined into a single factor of production, called "capital", whose supply and demand is driven by interest rates.
Thanks for this. At first pass, market monetarism seems complementary to PSST - steady NGDP expectations giving space for PSST adjustments to play out. The nominal MM complementing the real PSST.
Arnold, Have you read Tim Harford's "The Underground Economist Strikes Back: How to Run--Or Ruin--An Economy"? It's from 2014, mostly about "engineering" macro. I remember thinking it was good. I now have a firm grasp of why so many central banks want a 2% inflation rate.
When is a new revision on PSST coming out? Ver. 3 of Three Languages of Politics, with a possible Trump influenced elite vs non-elite fourth language was excellent.
PSST is more TRUE than the econ taught, or researched, or used by gov't. Stanford used to give a degree in Engineering-Economic Systems to use engineering math on economics. It was considered an applied Operations Research group; it's now been absorbed into Management Science and Engineering.
The 2011 essay on macroeconometrics is great. Estimates which would be more accurately but less persuasively called guesstimates are combined & calculated to 3 or 4 significant figures of accuracy, like Spock saying "approximately 5.3 seconds." [Arnold, you were VERY productive in 2010-2011] (Too bad I was so busy IRL to read it all, then.)
Macro aspires to be a "science" - but without repeatable experiments; >>in macroeconometrics, we have, in effect, no more than a few dozen data points, with thousands of plausible control variables
(taking into account alternative specifications). There is not even a remote resemblance to a quasi-experiment.<<
... like historians, economists are dealing with individual episodes rather than repeatable experiments. <<
Mankiw's Scientists & Engineers is a good way to describe post 90s & 70s econ, but both fail. They fail to predict the turning points, and what are optimal policies after such disruptions.
But >>the policy advising community have brushed off the Lucas critique without refuting it.3 After all, if the critique is valid, then the models are not.<<
If they admitted the truth, that the models are about as good as astrology, they wouldn't get the big bucks. AND - they need some policy answer to "What Is To Be Done?"
My answer - faster & quicker bankruptcy, especially for the Big Banks when they bet wrongly (S&L; LTCM; not so bad in dot.com bubble, and terrible in MBS failed risk evaluation).
The gov't has now rigged the market against the workers and too much in favor of the rich and super rich.
What I find interesting is that the concept of real interest rate (nominal rate - inflation) seemed to die. Why?
What interest rate are you considering? With real interest rates being -4% or so, for anyone who could borrow it makes sense to borrow as much as possible and invest in anything that will maintain a true (go up with inflation). I remember seeing people invest in rebar stored in their back yards in Brazil while their printing presses were devaluing the currency. The politically connected could get loans in Brazil but the poor were no so lucky.
Hicks used a nominal interest rate in his paper, and that became standard for IS-LM. Logically, the real rate belongs in the IS curve, but that breaks the simplicity. I'm not excusing the use of the nominal rate, just trying to give the context.
Thanks. I just remember the added difficulty in making projections and a business plan for my sideline business that became my full time business in 1980. How do you rationally justify a 20 year capital investment when the value of money itself keeps changing?
A side note: We were studying IS-LM in 1963-64 (when I was an undergrad), and the GRE in economics in 1965 was loaded with IS-LM material. ... all pre-70s.
The PSST story does not lend itself to “fine tuning” the economy. It does not reinforce politicians’ desire to write checks to people in the name of “stimulus.”
Of course New Keynesian models that recognize monetary policy dominance do not "reinforce politicians’ desire to write checks to people in the name of 'stimulus,'" either. Politicians’ desire to write checks to people during a recession can be better done in the name of "relief."
The story that expansionary policy increased employment by raising prices faster than wages was enshrined in textbooks and encoded in macroeconometric models. But economists came to agree with Friedman and Phelps that in the long run the real wage should settle at an equilibrium level, consistent with the Natural Rate
The mistake here is that the issue of different prices being asymmetrically flexible upward and downward does not apply just to (undifferentiated) wages and (undifferentiated) everything else. Any shock that requires relative prices to adjust will require an increase int the average price level to maintain/retore full market clearance/full employment of resources. Translated into the expectation of constant, multiple shocks this implies an expected rate of increase in the average price level, an inflation target.
"Expansionary fiscal policy (greater government deficit) shifts the IS curve in a way that increases income and interest rates (moving along the LM curve)."
Yes, but that implies a specific kind of monetary policy, one that is NOT consoling 'r' in order to achieve a target inflation + employment or NGDP target. There have often been periods in which this is not a bad assumption about Fed behavior, most recently in the Bernanke-Yellen era.
First link seems broken, I believe this is correct version of same... https://www.youtube.com/watch?v=MOgxHLciIt4
It seems to me that an important distinction needs to be made between at-risk capital and deferred consumption. The application of and returns to at-risk capital mostly play out through equity investments and returns on equities, which have high and relatively stable expected returns that are riven by real shocks. The application of and returns to deferred consumption play out through low-risk securities and interest rates.
I think it makes more sense to think of deferred consumption as a service provided by the borrower to the lender, and in order to provide that service, the borrower needs to have an income-producing asset that can credibly fund the deferred consumption. Frequently some of the assets that function as part of at-risk capital can serve as the collateral for deferred consumption, but otherwise the two markets are not particularly described with the same characteristics. I think it is hard to create a coherent model of the economy if they are combined into a single factor of production, called "capital", whose supply and demand is driven by interest rates.
Great overview of macro, Arnold- the most lucid one I have ever read.
Mises always wins, in the end.
Thanks for this. At first pass, market monetarism seems complementary to PSST - steady NGDP expectations giving space for PSST adjustments to play out. The nominal MM complementing the real PSST.
Arnold, Have you read Tim Harford's "The Underground Economist Strikes Back: How to Run--Or Ruin--An Economy"? It's from 2014, mostly about "engineering" macro. I remember thinking it was good. I now have a firm grasp of why so many central banks want a 2% inflation rate.
If you have read it, what did you think of it?
When is a new revision on PSST coming out? Ver. 3 of Three Languages of Politics, with a possible Trump influenced elite vs non-elite fourth language was excellent.
PSST is more TRUE than the econ taught, or researched, or used by gov't. Stanford used to give a degree in Engineering-Economic Systems to use engineering math on economics. It was considered an applied Operations Research group; it's now been absorbed into Management Science and Engineering.
The 2011 essay on macroeconometrics is great. Estimates which would be more accurately but less persuasively called guesstimates are combined & calculated to 3 or 4 significant figures of accuracy, like Spock saying "approximately 5.3 seconds." [Arnold, you were VERY productive in 2010-2011] (Too bad I was so busy IRL to read it all, then.)
Macro aspires to be a "science" - but without repeatable experiments; >>in macroeconometrics, we have, in effect, no more than a few dozen data points, with thousands of plausible control variables
(taking into account alternative specifications). There is not even a remote resemblance to a quasi-experiment.<<
... like historians, economists are dealing with individual episodes rather than repeatable experiments. <<
Mankiw's Scientists & Engineers is a good way to describe post 90s & 70s econ, but both fail. They fail to predict the turning points, and what are optimal policies after such disruptions.
But >>the policy advising community have brushed off the Lucas critique without refuting it.3 After all, if the critique is valid, then the models are not.<<
If they admitted the truth, that the models are about as good as astrology, they wouldn't get the big bucks. AND - they need some policy answer to "What Is To Be Done?"
My answer - faster & quicker bankruptcy, especially for the Big Banks when they bet wrongly (S&L; LTCM; not so bad in dot.com bubble, and terrible in MBS failed risk evaluation).
The gov't has now rigged the market against the workers and too much in favor of the rich and super rich.
What I find interesting is that the concept of real interest rate (nominal rate - inflation) seemed to die. Why?
What interest rate are you considering? With real interest rates being -4% or so, for anyone who could borrow it makes sense to borrow as much as possible and invest in anything that will maintain a true (go up with inflation). I remember seeing people invest in rebar stored in their back yards in Brazil while their printing presses were devaluing the currency. The politically connected could get loans in Brazil but the poor were no so lucky.
Hicks used a nominal interest rate in his paper, and that became standard for IS-LM. Logically, the real rate belongs in the IS curve, but that breaks the simplicity. I'm not excusing the use of the nominal rate, just trying to give the context.
Thanks. I just remember the added difficulty in making projections and a business plan for my sideline business that became my full time business in 1980. How do you rationally justify a 20 year capital investment when the value of money itself keeps changing?
An excellent whirlwind tour of the history of thought in macroeconomics!
"But I keep expecting labor demand to “fall off a cliff,” with firms finally realizing that they need to get rid of excess workers."
Of course this could also be explained as a change in "animal spirits."
More accurately described as a coming to one's senses.
That too, but "animal spirits" is classical terminology developed long before even '70's macro.
Also, "Everybody who disagrees with me is acting irrationally."
Thanks for this summary. It is excellent.
A side note: We were studying IS-LM in 1963-64 (when I was an undergrad), and the GRE in economics in 1965 was loaded with IS-LM material. ... all pre-70s.
The PSST story does not lend itself to “fine tuning” the economy. It does not reinforce politicians’ desire to write checks to people in the name of “stimulus.”
Of course New Keynesian models that recognize monetary policy dominance do not "reinforce politicians’ desire to write checks to people in the name of 'stimulus,'" either. Politicians’ desire to write checks to people during a recession can be better done in the name of "relief."
The story that expansionary policy increased employment by raising prices faster than wages was enshrined in textbooks and encoded in macroeconometric models. But economists came to agree with Friedman and Phelps that in the long run the real wage should settle at an equilibrium level, consistent with the Natural Rate
The mistake here is that the issue of different prices being asymmetrically flexible upward and downward does not apply just to (undifferentiated) wages and (undifferentiated) everything else. Any shock that requires relative prices to adjust will require an increase int the average price level to maintain/retore full market clearance/full employment of resources. Translated into the expectation of constant, multiple shocks this implies an expected rate of increase in the average price level, an inflation target.
"Expansionary fiscal policy (greater government deficit) shifts the IS curve in a way that increases income and interest rates (moving along the LM curve)."
Yes, but that implies a specific kind of monetary policy, one that is NOT consoling 'r' in order to achieve a target inflation + employment or NGDP target. There have often been periods in which this is not a bad assumption about Fed behavior, most recently in the Bernanke-Yellen era.