Wow. Leamer's book was the first purchase I ever made on Amazon, and it was that Econlog essay that caused me to buy it. I suddenly had lots of time on my hands because I had semi-retired the previous month.
Looking at Leamer's UCLA ed page - I imagined him and Arnold creating a "PSST" school of economics, which provides a more fruitful framework of maco that allows research, scientific-ish econ research, that is more amenable to policy recommendations.
Economic "engineering" is especially about gov't policy.
Lots of agreement here. "...budgets conforming to revenue, not the other way around..." However, we can't just "set it and forget it" because the world changes, e.g. geopolitical emergencies such as in Ukraine, or if China invades Taiwan, calling of sudden, large spending needs that must be paid for.
Paying down the debt: "definitely lies between 'right this second' and 'never'" leaves a lot of wiggle room and hence the need for economic engineering to devise a reasonable pace. Cochrane suggested "never" (surprisingly) so long as we adopt growth-oriented policies so that we can outgrow the debt as it stands.
"...we are shooting for 'acceptable' numbers, not optimal..." Agreed, since we can never know what's optimal! Good enough is good enough or, as the saying goes, "Good enough for jazz and government work."
'But I also share Cochrane’s assessment of 1970s macro. Every time there is a new shock to the economy, practitioners are caught with their pants down. They never predict the event, and only months or even years afterward do they settle on an explanation'
You are a generous one Arnold. By saying they never predict the event it makes it sound like shocks come out of nowhere and when they do happen the economists start trying to make sense of them. The reality has been that they not only fail to predict the events but they deny them in real time as they are happening, then they fail to predict the outcomes of their own policy decisions, and they they take credit for any good thing that happens later. Hmmm, sounds more like politics than science.
I follow Kevin Erdmann in thinking the fall in housing starts was at least in part due to bad policy rather than supply necessarily falling to equilibrate with demand.
Vacancy rates were climbing in the US while housing starts were accelerating. There was clear oversupply in the mid 2000s that had to result in a decline in starts at some point.
The answer to that is much more than a comment length. The very, very shortest I would say is that the Fed's compression of volatility caused an upward spiral in risk taking which took hold in housing thanks to federal government subsidization of risk taking.
As far as other cities go, I don't think there is a straight forward answer to the behaviors of individual cities absent the national conversation. If the Fed induces a financial bubble then there is no way to talk about NYC's housing market in a vacuum, and if there is a tech bubble then there is no way to talk about SFs market in a vacuum. A bubble is an overvaluing of some assets relative to other assets. Given that there is a housing boom coincident with outsized financial profits, yes there is going to be an apparent shortage in financial centers.
I want to pile in and add "length of 1st dollar planning to completion time" in the list of problems. Many places have long lead times for housing construction, in that one must start spending money on a project some 4-10 years before the project is complete and can be sold for money. As a result, builders are responding to long ago demand signals and unable to cut and run without huge losses if they see a down tick. That is a prime situation for the bullwhip effect we talk about in supply chain: always having too much or too little of a good on hand, swinging wildly as planning tries to catch the cycle.
"In no other field that I know of do the graduate courses tell you that what you learned as an undergraduate is utter nonsense. "
In undergraduate statistics you learn mostly about null hypothesis testing with classical statistics. That's true even departments where everyone is a Bayesian and views classical statistics as complete and pernicious nonsense.
I can think of a few others, like where the high school science explanation of how a wing creates lift is complete nonsense (it can't explain how planes fly upside down). The explanation of how friction works is also not really what is going on (or we couldn't have cold welding).
Do the statisticians keep teaching null hypothesis testing to undergrads as a joke then? Because that is just about all I see being used in scientific papers, usually to deleterious effect.
The PSST theoretical approach is obviously more correct than Cochrane's modern macro, and also more than Nobel winning Bernanke's more 70s-ish macro.
But did you, Arnold, more accurately predict the housing problems of 2006 and/or the financial meltdown in 2008, before they occurred? [I think not really.]
Predicting in 2009, after the 2008 (2006?) housing bubble pop, that the USA was likely to have a long, difficult recovery is certainly better than most other econ predictions. Conclusion of first 2011 paper:
>>"When new opportunities suddenly emerge, there can
be periods in which high productivity growth in industries with relatively inelastic
demand creates a surplus of workers. It takes time for entrepreneurs to discover
new ways to exploit specialization and comparative advantage, and it takes time
for the labour force to adapt to new skill requirements. These real adjustments
are needed in order to restore full employment" <<
For PSST to gain followers in gov't, it must answer the question, Lenin's question, "What is To Be Done?"
If "wait" is the right scientific answer, it needs a LOT more work to show that it's better than some other active gov't response.
Mankiw compares dentists with a test for a successful 'Economics As A Science':
>>"avoiding a recession would be as straightforward as filling a cavity. "<<
Mankiw fails to mention housing - but housing is more important than energy to the economy (in practice, if not yet fully in theory).
My not-quite PSST policy recommendation:
In every recession, the US gov't should be hiring building contractors to build new houses in good school districts - and auction them off as long as the auction price is at least 80% of the labor+building materials cost (excluding land).
A "Leamer-Kling" econ school of Patterns of Sustainable Specialization and Trade" could become an alternate econ, better than the current Austrian school but related. Tho it might also get popular sooner as a New Austrian school, from Mises-Hayek-Kirzner >>Leamer-Kling's PSST.
Your PSST approach seems to be getting at the evolving technological capacity of humanity. Science and technology are growing at an exponential rate with some combinatorial rates added in as we mix and blend ideas and concepts and these are the fundamental drivers of economic evolution. This results in dramatically increasing specialization. In the AS-AD type model lumping a quantum physicist working with qubits with a DMV employee managing the queue doesn't work in reality.
Yes, you are correct, science and engineering are tightly connected with the only real difference between science and engineering comes from engineers including $$$ as another variable.
"But I also share Cochrane’s assessment of 1970s macro. Every time there is a new shock to the economy, practitioners are caught with their pants down. They never predict the event,"
But wouldn't that be true of any model. The "shock" is the exogenous variable to predict the economic even they would have to predict the shock.
Arnold's blog is a useful overview of the macroeconomics field as it stands today, albeit one has to know something about 1970s and 1990s macro to fully appreciate the blog (not a high hurdle in my view). Being acquainted with but not having fully studied Arnold's PSST approach, I wonder if it will prove to be useful in economic engineering (practice) or another theoretical dead-end as '90s macro might be? Arnold, perhaps you could speculate about the future utility of the PSST approach in this blog?
To be fair to Arnold, it is not entirely obvious that economic engineering is possible in the first place. It may well be that the best method to deal with things is a hands off approach, and that trying to engineer things is exactly what causes the bulk of the problems. If so, then not being useful for economic engineering is probably a feature, not a bug.
Some engineering is inevitably necessary, so we need to understand how best to do so. Three arenas among others: managing the money supply, managing the government debt, and managing tax collection and tax rates. In principle, each of these could be defined simply - let the money supply grow at a Friedmanesque constant rate, match the maturities of the government's debt obligation to its assets, impose flat taxes on individual income defined comprehensively and impose zero taxes on corporations. But even in this simple scenario, achieving these targets requires economic engineering. What should the growth rate of money be? How much debt should we have in the future and how quickly should we get from where we are now (trillions of dollars in debt) to where we should be? What is the optimal flat tax rate on individual income?
Fair enough, there are some points like that what need to be attended to. I would stipulate that many are "set it and forget it" sort of things, however, and probably shouldn't be tweaked much after the fact. For example, optimal tax rate probably isn't something that can be engineered, but rather something that is selected as "as low as possible to still cover the obvious requirements" and then left alone, with budgets conforming to revenue, not the other way around.
How fast to pay down the debt, that is a good question. I am not entirely sure there is a good way of identifying the optimal rate, although it definitely lies between "right this second" and "never".
In most cases, however, we are shooting for "acceptable" numbers, not optimal, and quite possibly the seeking of optimal is what allows for so many non-optimal moves by policy makers. One can sneak in a lot via claims of improving the system when no one can really agree whether or not a particular move makes it better, but everyone agrees that you should be able to optimize.
Excellent points. Perhaps the 1990s+ orientation of academic economists is one reason that academic economists are silent from this decade's great macro debate--they actually have nothing to say on policy? In contrast, the 1970-80s were sweet and fruitful times for public debate. From the 60s to the 80s, scholars like Samuelson and Friedman made the effort to teach and inform by working out their ideas in then-popular Newsweek and Time.
On another note, it's wrong to mischaracterize the Scholastics as laboring "over the question of how many angels can dance on the head of a pin." As Murray Rothbard showed, the Scholastics made huge advances in understanding markets, market prices and prices. The development of economics in continental Europe drew heavily on Scholastic ideas.
Of course, the Scholastic were concerned with Christian theology, so angels were a topic of concern apart from economics. However, the argument over "angels on a pin" is a burlesque created by 17th and 18th British and Protestant writers to mock the Catholic scholarship of continental Europe.
That British mockery and split from continental and Catholic Europe had big consequences. Economics had to start all over again in Britain with Smith, Malthus and Richardo. While British economists puzzle over the water-diamonds paradox, continental economists like Cournot made huge progress with competition, monopoly, production and spatial equilibrium.
Maybe macro would be quite different if not for that vain breakup between British and continental scholarship and economics?
I think you must be right about 90s macro not needing to be that hard. I managed to follow the first few lectures of Cochrane's PhD finance MOOC with only a year more than AP Calc, and that from decades before. (And that was it for me and math, I have looked at Analysis textbooks, I would have imploded.) Part of it is that Cochrane is a gifted explainer, but surely there is a way to teach it with only basic calculus (or better yet, computer simulation) if someone tried.
I have not read either of your papers but the descriptions seem super reasonable. You call one Smith Ricardo, but I more immediately though of Leijunhufvud. All lead to the same rejection of vulgar Keynesian notions about using fiscal policy to combat inflation or recessions, which, though not uncontested, it not a niche view, just totally unknown in the public punditry that Simon Lewis calls Media macro. [In its favor, even vulgar Keynesianism could be useful in combatting the still more primitive “Swabian housewife” view that fiscal policy SHOULD be used to combat recessions by “tightening our belts.’]
For me the issue is, if we reject fiscal policy for managing macroeconomic fluctuations however they arise – fluctuations in animal spirits, disruptive technologies, supply chain disruptions, petroleum price supply shocks, pandemics, financial crises, whatever – what framework, mathematical or otherwise, should be used for guiding monetary policy.
Wow. Leamer's book was the first purchase I ever made on Amazon, and it was that Econlog essay that caused me to buy it. I suddenly had lots of time on my hands because I had semi-retired the previous month.
Looking at Leamer's UCLA ed page - I imagined him and Arnold creating a "PSST" school of economics, which provides a more fruitful framework of maco that allows research, scientific-ish econ research, that is more amenable to policy recommendations.
Economic "engineering" is especially about gov't policy.
(My MS was in Engineering-Economic Systems, which has evolved into Management Science and Engineering, but there's a more recent course including "Sustainability": https://online.stanford.edu/courses/cee146s-engineering-economics-and-sustainability)
But... but... William D. Nordhaus got a Nobel for 1970s, or maybe even 1930s macroeconomics.
Lots of agreement here. "...budgets conforming to revenue, not the other way around..." However, we can't just "set it and forget it" because the world changes, e.g. geopolitical emergencies such as in Ukraine, or if China invades Taiwan, calling of sudden, large spending needs that must be paid for.
Paying down the debt: "definitely lies between 'right this second' and 'never'" leaves a lot of wiggle room and hence the need for economic engineering to devise a reasonable pace. Cochrane suggested "never" (surprisingly) so long as we adopt growth-oriented policies so that we can outgrow the debt as it stands.
"...we are shooting for 'acceptable' numbers, not optimal..." Agreed, since we can never know what's optimal! Good enough is good enough or, as the saying goes, "Good enough for jazz and government work."
'But I also share Cochrane’s assessment of 1970s macro. Every time there is a new shock to the economy, practitioners are caught with their pants down. They never predict the event, and only months or even years afterward do they settle on an explanation'
You are a generous one Arnold. By saying they never predict the event it makes it sound like shocks come out of nowhere and when they do happen the economists start trying to make sense of them. The reality has been that they not only fail to predict the events but they deny them in real time as they are happening, then they fail to predict the outcomes of their own policy decisions, and they they take credit for any good thing that happens later. Hmmm, sounds more like politics than science.
I follow Kevin Erdmann in thinking the fall in housing starts was at least in part due to bad policy rather than supply necessarily falling to equilibrate with demand.
https://fred.stlouisfed.org/series/USHVAC
https://fred.stlouisfed.org/series/RRVRUSQ156N
https://fred.stlouisfed.org/series/HOUST
Vacancy rates were climbing in the US while housing starts were accelerating. There was clear oversupply in the mid 2000s that had to result in a decline in starts at some point.
What's your take on why there was oversupply? Investor irrationality? Fed too stimulative in 2000s? Too little regulation of mortgage origination?
Side note, do you agree that in NY, Boston, SF, etc., housing is undersupplied and was so in 2009 even if there was oversupply elsewhere and in total?
The answer to that is much more than a comment length. The very, very shortest I would say is that the Fed's compression of volatility caused an upward spiral in risk taking which took hold in housing thanks to federal government subsidization of risk taking.
As far as other cities go, I don't think there is a straight forward answer to the behaviors of individual cities absent the national conversation. If the Fed induces a financial bubble then there is no way to talk about NYC's housing market in a vacuum, and if there is a tech bubble then there is no way to talk about SFs market in a vacuum. A bubble is an overvaluing of some assets relative to other assets. Given that there is a housing boom coincident with outsized financial profits, yes there is going to be an apparent shortage in financial centers.
I want to pile in and add "length of 1st dollar planning to completion time" in the list of problems. Many places have long lead times for housing construction, in that one must start spending money on a project some 4-10 years before the project is complete and can be sold for money. As a result, builders are responding to long ago demand signals and unable to cut and run without huge losses if they see a down tick. That is a prime situation for the bullwhip effect we talk about in supply chain: always having too much or too little of a good on hand, swinging wildly as planning tries to catch the cycle.
"In no other field that I know of do the graduate courses tell you that what you learned as an undergraduate is utter nonsense. "
In undergraduate statistics you learn mostly about null hypothesis testing with classical statistics. That's true even departments where everyone is a Bayesian and views classical statistics as complete and pernicious nonsense.
I can think of a few others, like where the high school science explanation of how a wing creates lift is complete nonsense (it can't explain how planes fly upside down). The explanation of how friction works is also not really what is going on (or we couldn't have cold welding).
Do the statisticians keep teaching null hypothesis testing to undergrads as a joke then? Because that is just about all I see being used in scientific papers, usually to deleterious effect.
The PSST theoretical approach is obviously more correct than Cochrane's modern macro, and also more than Nobel winning Bernanke's more 70s-ish macro.
But did you, Arnold, more accurately predict the housing problems of 2006 and/or the financial meltdown in 2008, before they occurred? [I think not really.]
Predicting in 2009, after the 2008 (2006?) housing bubble pop, that the USA was likely to have a long, difficult recovery is certainly better than most other econ predictions. Conclusion of first 2011 paper:
>>"When new opportunities suddenly emerge, there can
be periods in which high productivity growth in industries with relatively inelastic
demand creates a surplus of workers. It takes time for entrepreneurs to discover
new ways to exploit specialization and comparative advantage, and it takes time
for the labour force to adapt to new skill requirements. These real adjustments
are needed in order to restore full employment" <<
For PSST to gain followers in gov't, it must answer the question, Lenin's question, "What is To Be Done?"
If "wait" is the right scientific answer, it needs a LOT more work to show that it's better than some other active gov't response.
Mankiw compares dentists with a test for a successful 'Economics As A Science':
>>"avoiding a recession would be as straightforward as filling a cavity. "<<
Mankiw fails to mention housing - but housing is more important than energy to the economy (in practice, if not yet fully in theory).
My not-quite PSST policy recommendation:
In every recession, the US gov't should be hiring building contractors to build new houses in good school districts - and auction them off as long as the auction price is at least 80% of the labor+building materials cost (excluding land).
A "Leamer-Kling" econ school of Patterns of Sustainable Specialization and Trade" could become an alternate econ, better than the current Austrian school but related. Tho it might also get popular sooner as a New Austrian school, from Mises-Hayek-Kirzner >>Leamer-Kling's PSST.
Your PSST approach seems to be getting at the evolving technological capacity of humanity. Science and technology are growing at an exponential rate with some combinatorial rates added in as we mix and blend ideas and concepts and these are the fundamental drivers of economic evolution. This results in dramatically increasing specialization. In the AS-AD type model lumping a quantum physicist working with qubits with a DMV employee managing the queue doesn't work in reality.
Yes, you are correct, science and engineering are tightly connected with the only real difference between science and engineering comes from engineers including $$$ as another variable.
"But I also share Cochrane’s assessment of 1970s macro. Every time there is a new shock to the economy, practitioners are caught with their pants down. They never predict the event,"
But wouldn't that be true of any model. The "shock" is the exogenous variable to predict the economic even they would have to predict the shock.
Arnold's blog is a useful overview of the macroeconomics field as it stands today, albeit one has to know something about 1970s and 1990s macro to fully appreciate the blog (not a high hurdle in my view). Being acquainted with but not having fully studied Arnold's PSST approach, I wonder if it will prove to be useful in economic engineering (practice) or another theoretical dead-end as '90s macro might be? Arnold, perhaps you could speculate about the future utility of the PSST approach in this blog?
To be fair to Arnold, it is not entirely obvious that economic engineering is possible in the first place. It may well be that the best method to deal with things is a hands off approach, and that trying to engineer things is exactly what causes the bulk of the problems. If so, then not being useful for economic engineering is probably a feature, not a bug.
Some engineering is inevitably necessary, so we need to understand how best to do so. Three arenas among others: managing the money supply, managing the government debt, and managing tax collection and tax rates. In principle, each of these could be defined simply - let the money supply grow at a Friedmanesque constant rate, match the maturities of the government's debt obligation to its assets, impose flat taxes on individual income defined comprehensively and impose zero taxes on corporations. But even in this simple scenario, achieving these targets requires economic engineering. What should the growth rate of money be? How much debt should we have in the future and how quickly should we get from where we are now (trillions of dollars in debt) to where we should be? What is the optimal flat tax rate on individual income?
Fair enough, there are some points like that what need to be attended to. I would stipulate that many are "set it and forget it" sort of things, however, and probably shouldn't be tweaked much after the fact. For example, optimal tax rate probably isn't something that can be engineered, but rather something that is selected as "as low as possible to still cover the obvious requirements" and then left alone, with budgets conforming to revenue, not the other way around.
How fast to pay down the debt, that is a good question. I am not entirely sure there is a good way of identifying the optimal rate, although it definitely lies between "right this second" and "never".
In most cases, however, we are shooting for "acceptable" numbers, not optimal, and quite possibly the seeking of optimal is what allows for so many non-optimal moves by policy makers. One can sneak in a lot via claims of improving the system when no one can really agree whether or not a particular move makes it better, but everyone agrees that you should be able to optimize.
Does Cochrane have a written review of Blinder's book. I don't like audio-visual format for trying to absorb complicated arguments.
Excellent points. Perhaps the 1990s+ orientation of academic economists is one reason that academic economists are silent from this decade's great macro debate--they actually have nothing to say on policy? In contrast, the 1970-80s were sweet and fruitful times for public debate. From the 60s to the 80s, scholars like Samuelson and Friedman made the effort to teach and inform by working out their ideas in then-popular Newsweek and Time.
On another note, it's wrong to mischaracterize the Scholastics as laboring "over the question of how many angels can dance on the head of a pin." As Murray Rothbard showed, the Scholastics made huge advances in understanding markets, market prices and prices. The development of economics in continental Europe drew heavily on Scholastic ideas.
Of course, the Scholastic were concerned with Christian theology, so angels were a topic of concern apart from economics. However, the argument over "angels on a pin" is a burlesque created by 17th and 18th British and Protestant writers to mock the Catholic scholarship of continental Europe.
That British mockery and split from continental and Catholic Europe had big consequences. Economics had to start all over again in Britain with Smith, Malthus and Richardo. While British economists puzzle over the water-diamonds paradox, continental economists like Cournot made huge progress with competition, monopoly, production and spatial equilibrium.
Maybe macro would be quite different if not for that vain breakup between British and continental scholarship and economics?
The cheapest used copy of Macroeconomic Patterns and Stories on Amazon is $65.11. Sheesh! (not to be confused with PSST)
I think you must be right about 90s macro not needing to be that hard. I managed to follow the first few lectures of Cochrane's PhD finance MOOC with only a year more than AP Calc, and that from decades before. (And that was it for me and math, I have looked at Analysis textbooks, I would have imploded.) Part of it is that Cochrane is a gifted explainer, but surely there is a way to teach it with only basic calculus (or better yet, computer simulation) if someone tried.
I rather enjoy the acronym for Patterns of Sustainable Specialization and Trade. It sounds like you have a secret you want share with your friend.
I have not read either of your papers but the descriptions seem super reasonable. You call one Smith Ricardo, but I more immediately though of Leijunhufvud. All lead to the same rejection of vulgar Keynesian notions about using fiscal policy to combat inflation or recessions, which, though not uncontested, it not a niche view, just totally unknown in the public punditry that Simon Lewis calls Media macro. [In its favor, even vulgar Keynesianism could be useful in combatting the still more primitive “Swabian housewife” view that fiscal policy SHOULD be used to combat recessions by “tightening our belts.’]
For me the issue is, if we reject fiscal policy for managing macroeconomic fluctuations however they arise – fluctuations in animal spirits, disruptive technologies, supply chain disruptions, petroleum price supply shocks, pandemics, financial crises, whatever – what framework, mathematical or otherwise, should be used for guiding monetary policy.