Saturday, April 19, 2014

Been Down So Long (HP Filter Edition)

it looks above-trend to me...

I'm teaching my advanced students about "Real Business Cycles" this week, and, as part of the set up I'm introducing them to the Hodrick-Prescott (HP) filter, a widely-used method of separating "cyclical" from "trend" components of time series data, like US GDP.  I recently updated my example - the red line is US real GDP, which tends upwards, with occasional interruption, and the blue line is the trend, according to HP filter:
When we study "business cycles" we're studying the deviations of real GDP (red) from its trend (blue) path (the trend is the subject of economic growth theory).

The striking thing is at the end, where filter shows GDP above its trend path.  This is clearer if we pull out the deviations:
These are the business cycles captured by this method, and you can see at the end, the distance from trend is positive.

So, we're "above trend"?  Economy's not so bad after all?!

Well, not really... the way the HP filter works is that it chooses a trend that minimizes the distance between the trend and the underlying data, subject to a constraint limiting the change in the growth rate of the trend, which is what forces it to be smooth.  The US economy's slump was deep and long enough that it pulled down the trend far enough that we're now a little above it.

Here is the growth rate of the trend:
You can see how much, according to the filter, the last several years pulled down the trend path.

I'm not sure whether this says more about the economy or the de-trending method (there's a whole literature on technical issues in de-trending...).  But it does remind us that we need to be careful in how we use our tools and interpret their results (i.e., we should actually look at the graphs).

A somewhat different picture, which is more consistent with what most of us think is the state of "the economy" is given by comparing real GDP to the CBO's estimate of "potential output":
That is, we still have a long way to go to close our "output gap".

Friday, April 4, 2014

March Employment

The BLS released the employment figures for March today - a fairly good report overall, consistent with the trend that has predominated over the past several years of an economy that is recovering, but far too slowly.

Nonfarm payrolls - the jobs number from the survey of firms - rose by 192,000.  The unemployment rate remained at 6.7%, but in the survey of households which is used to calculate it, employment rose by 476,000.  The reason the unemployment rate didn't fall is that the labor force - i.e., the number of people working, or looking for work, increased by 503,000.  The decline in labor force participation has been one of the most troubling figures over the past several years, so it is good to see it rising again - in March, it rose 0.2 to 63.2%.
 The employment-population ratio for people 25-54 also rose by 0.2 percentage points, to 76.7%.
Looking at this statistic provides a rough way to control for the effects of the changing age distribution of the population.  While it has shown improvement recently, its still considerably below its all time high of 81.9% from April 2000.

Overall, while the report was somewhat encouraging, 10.5 million people remain unemployed.  The broader measure of un- and under-employment, 'U-6', which counts discouraged workers and part-time workers who would prefer to be full time, is at 12.7%.

On a non-seasonally adjusted basis, the unemployment rate was 7.2%, down from 7.5% in February, and payrolls rose by 941,000 (i.e., March is a month that normally sees a big employment gain, which is removed by the seasonal adjustment).

Monday, March 10, 2014

TFP: Three Episodes or Four?

Zachary Goldfarb reports that this was CEA Chair Jason Furman's favorite chart from the latest Economic Report of the President:
That shows total factor productivity growth (TFP, though some call it "multifactor") which is a measure of technological progress calculated as a residual: the part of output growth that cannot be explained by increases in factors of production (capital and labor).  Another way to think of it is that it is the growth that would occur even if the amount of machinery and equipment as well as labor stayed the same.  The CEA's report explains it quite nicely starting on p. 181.

Technological progress is the key determinant of long run living standards, so if the trend of technological progress has risen after its slump in the 1970's and 80's, its a big deal (and a bigger deal than many of the short-run cyclical issues we tend to obsess over).

The CEA's chart shows 15-year averages which smooths out the year-to-year volatility in TFP growth.  This is sensible because it its hard to discern the long-run trends that the concept is meant to help us understand.  The average TFP growth rate can be split into three eras:
  • 1949-1973 -- 1.9%
  • 1974-1995 -- 0.4%
  • 1996-2012 -- 1.1%
That is, productivity growth has risen about halfway back to its "postwar golden age" level since the mid-1990's.  While identifying breaks in a series like this can be tricky, there does seem to be consensus that there was a slowdown in the mid-1970's and a resurgence in the mid-1990's.

However, the results are somewhat different than what I presented to my macroeconomics students a few weeks ago.  This is a chart made from the BLS' Historical Multifactor Productivity Measures for the private non-farm business sector (which I believe is the same data the CEA used).
The gray line is the actual annual growth (you can see why it helps to average out some of the volatility) and the red line is the centered 15-year average (i.e., the same as the CEA's graph).  However, the CEA's method of averaging means that their graph stops in 2005. The years since then have not been good ones for TFP.  Since their data point for 2005 is an average over the years 1998-2012, the CEA is not ignoring the bad news, but they are lumping it in together with some good years (the late 1990's and early 2000's).

The dashed lines in the chart above illustrate an alternative, less optimistic way of interpreting the same data by breaking it down into four eras instead of three:
  • 1949-1973 -- 1.9%
  • 1974-1995 -- 0.4%
  • 1996-2005 -- 1.6%
  • 2006-2012 -- 0.5% 
This would be consistent with a brief 'boom', perhaps attributable to information technology and the internet, in 1996-2005, but one that is already exhausted.  That is the view that Robert Gordon took in this NBER working paper (and recent update).

Identification of trends in short periods of volatile data is inherently uncertain, and it may be sensible to think the reduction in TFP growth over the past several years is largely the artifact of cyclical factors.  That seems to be, implicitly, the CEA's view (and Ben Bernanke also has argued for a more optimistic interpretation of long-run prospects).  Whether they're right or Gordon is will make a huge difference for standards of living a generation or two hence, but, just now, it is too soon to tell.

Friday, March 7, 2014

February Employment

A mildly encouraging employment report from the BLS today: in February, payrolls increased by 175,000.  The unemployment rate ticked up to 6.7% (from 6.6%), but that was partly due to a slight increase in labor force participation. 

The payroll number comes from a survey of firms and the unemployment rate from a survey of households (which has a smaller sample size); in the household survey, the number of employed people only grew by 40,000, while the labor force grew by 264,000.  Since the surveys are separate, they do not match up every month - last month the number of people reporting they were employed in the household survey was much stronger than the increase in payrolls.
The labor force includes everyone who is working, or looking for work.  In general, the decline in labor force participation (the percent of adults in the labor force) has been one of the more worrying trends of the last several years - in February, it stood at 63.0%, down from 66.3% seven years ago.  Since the unemployment rate is measured as a percentage of the labor force, to the extent that people are giving up on finding a job and leaving the labor force, the fall in the unemployment rate might make the labor market look better than it really is.  However, some decline might be expected due to demographic trends (i.e., retirement of the "baby boom" generation).  To try to set aside those effects, the employment-population ratio for 25-54 year olds can be useful:
This shows some recovery, but still a pretty deep hole relative to where we were before the recession.

'U-6', the broader measure of the unemployment rate which includes discouraged workers (i.e., people who are not looking for work but say they would like to have a job) and people working part-time but who would prefer to be full-time is at 12.6%, down from 14.3% a year ago.

10.5 million people are unemployed, and 3.8 million of them have been unemployed for longer than 27 weeks.

The data are all seasonally adjusted; on a non-seasonally adjusted basis the unemployment rate was 7.0% and payrolls increased by 750,000 (i.e., unemployment in February is normally high, so the seasonal adjustment is down, but payrolls normally grow, so the growth of payrolls is also adjusted down to remove the 'seasonal' effect).

Monday, February 24, 2014

FOMC 2008

On Friday, the transcripts of the Federal Open Market Committee meetings from 2008, the year when the financial crisis intensified and the economy collapsed.

The striking thing is how little sense the board members had of how bad things were getting.  Even late in the year, the committee was seriously concerned by inflation.  The Times' Binyamin Appelbaum writes:
The Fed’s understanding of the crisis, however, was clouded by its reliance on indicators that tend to miss sharp changes in conditions. The government initially estimated, for example, that the economy expanded in the first half of 2008 because it basically assumed that some economic trends, like the pace of business creation, had continued apace. The Fed also relied on economic models that assumed the existence of smoothly functioning financial markets, limiting its ability to project the consequences of a breakdown. And the outlook of Fed officials also reflected a deeply ingrained bias to worry more about the risk of inflation than the reality of rising unemployment.

As Fed officials gathered on Sept. 16 at their marble headquarters in Washington for a previously scheduled meeting, stock markets were in free fall. Housing prices had been collapsing for two years, and unemployment was climbing.

Yet most officials did not see clear evidence of a broad crisis. They expected the economy to grow slowly in 2008 and then more quickly in 2009.
The Times also put together a fantastic interactive graphic linking quotes from the meetings to the events of the year.

A couple of things stood out to me in looking over the transcript from September 16 (the day after the Lehman bankruptcy), when the committee voted to hold the fed funds rate target at 2 percent:

The committee member with the best perception of how bad things were getting was Eric Rosengren, President of the Boston Fed, who argued for a rate cut: 
This is already a historic week, and the week has just begun. The labor market is weak and getting weaker. The unemployment rate has risen 1.1 percentage points since April and is likely to rise further. I am not convinced that the unemployment rate will level off where the Greenbook is assuming currently.

The failure of a major investment bank, the forced merger of another, the largest thrift and insurer teetering, and the failure of Freddie and Fannie are likely to have a significant impact on the real economy. Individuals and firms will become risk averse, with reluctance to consume or to invest. Even if firms were inclined to invest, credit spreads are rising, and the cost and availability of financing is becoming more difficult. Many securitization vehicles are frozen. The degree of financial distress has risen markedly. Deleveraging is likely to occur with a vengeance as firms seek to survive this period of significant upheaval. Given that many borrowers will face higher interest rates as a result of financial problems, we can help offset this additional drag by reducing the federal funds rate.
I think those of us who reside in District One can be proud of our Fed president. District Eleven (Dallas), on the other hand, well.... Richard Fisher:
That said, in my anecdotal interchanges, I am still hearing about the likelihood, as I think President Pianalto mentioned, that people are seeking to preserve their margins. They’ve been stung for many years, and I’ll just give you one case because I think it tells us something. If you talk to the CEO of Wal-Mart USA, what they are pricing to be on their shelf six to eight months from now has an average price increase of 10 percent. Now, of course, you might have this reversed as we go through time. My biggest disappointment, incidentally, was that the one bakery that I’ve gone to for thirty years, Stein’s Bakery in Dallas, Texas, the best maker of not only bagels but also anything that has Crisco in it, [laughter] has just announced a price increase due to cost pressures.
Well, there's a pretty good case that the trend of academic economists supplanting bankers and businesspeople on the FOMC has been a good thing.  To be fair to Fisher, though, part of the reason for the use of anecdotal evidence is that the data does not give the Fed a clear, real-time picture of the state (and direction) of the economy.  The chart below, from ALFRED, compares what the GDP data that were released shortly after that meeting showed (blue line), compared to the most recent vintage of data (i.e., what we know now, in red):
It is easy, with the benefit of hindsight, to criticize the committee members whose worries over inflation and optimism about the impact of the financial crisis look so foolish today (and this applies to some of the academic members, not just Fisher).  But looking at the data they had at the time underscores the fact that their task isn't so easy.

Sunday, February 23, 2014

Fighting the last Methodenstreit

That's a German word that means "method war" and it came to mind reading Simon Wren-Lewis' post last week, "Are New Keynesian DSGE Models a Faustian Bargain?"

The reason they might seem so is the methodological underpinnings of DSGE (Dynamic Stochastic General Equilibrium) models, which are "micro-founded" macroeconomic models derived from the optimizing behavior of individuals (or, often a "representative agent") were brought into macroeconomics by Robert Lucas, Ed Prescott and others who were seeking to overturn "Keynesian" macroeconomics (see, e.g., Lucas and Sargent, 1979, "After Keynesian Macroeconomics").

The first generation of models of this type - "Real Business Cycle" (RBC - where "real" means non-monetary) implied that economic fluctuations could be optimal, and that monetary and fiscal policy were either useless or harmful (this JEP article by Charles Plosser is a good primer).

While these models failed to convince as explanations of economic fluctuations overall (as Larry Summers explained, though they can still be a useful part of the macro toolkit, as Chris House argues), the methods introduced by the RBC theorists have become nearly universal in macroeconomic modelling under the broader moniker "DSGE".  The last couple of decades have shown us that a number of "Keynesian" features, such as "sticky" prices can be incorporated into such models, which then go by the name "New Keynesian."

So the "New Keynesians" are using methods that were introduced by a cohort of macroeconomists that were explicitly anti-Keynesian.  That is, Lucas et al. won the methodological war about how to build macroeconomic models, but their anti-Keynesian view of the economy itself did not prevail.

Wren-Lewis' answer to the question posed in the title of his post is "no." Paul Krugman summarizes and responds:
Wren-Lewis’s answer is no, because New Keynesians were only doing what they would have wanted to do even if there hadn’t been a de facto blockade of the journals against anything without rational-actor microfoundations. He has a point: long before anyone imagined doing anything like real business cycle theory, there had been a steady trend in macro toward grounding ideas in more or less rational behavior. The life-cycle model of consumption, for example, was clearly a step away from the Keynesian ad hoc consumption function toward modeling consumption choices as the result of rational, forward-looking behavior. 

But I think we need to be careful about defining what, exactly, the bargain was. I would agree that being willing to use models with hyperrational, forward-looking agents was a natural step even for Keynesians. The Faustian bargain, however, was the willingness to accept the proposition that only models that were microfounded in that particular sense would be considered acceptable. It’s one thing to accept that models with an Euler condition at their core can sometimes be useful; it’s quite different to restrict your discourse to models with that characteristic, while ruling out everything else.
A couple of things to note here:

Politics: Both the academic sort in terms of who gets hired and what gets published - as Krugman alludes to, some of it was pretty vicious (at least that's my sense - this was all well before my time) and some are still holding grudges - and the political implications of the theory.  In its purest form, RBC theory has some pretty right-wing policy implications (though RBC macroeconomists are not necessarily Republicans), so some view RBC (and, by extension, DSGE) models as cover for a conservative political agenda.

How academia works: Publishing papers requires at least some incremental degree of novelty (i.e., a journal article must make a "contribution to the literature").  While the events of the last six years have underscored the usefulness of the standard textbook Keynesian approach I (and many others) teach our intermediate-level macroeconomics students, as far as publishing it, well, it was done 77 years ago.  While it is useful for policymakers and the economists working in policy institutions, academic economists are going to focus on developing new theory - which hopefully leads to better policy-making, in the long-run at least.  That is, the divide between "scientists" and "engineers" described by Greg Mankiw applies.

For more interesting thoughts on this see: Brad DeLong, Roger Farmer, Steve Williamson's response to the Krugman post quoted above, another post by Krugman.

Thursday, January 23, 2014

Rodrik on Our Science-ish-ness

On occasion, economists affect to be "scientists" - for example, I once was a TA for a professor who always gave his first lecture of the semester in a lab coat. Our papers sure do look science-y with all the greek letters and whatnot.  However, our scientific pretenses can leave us vulnerable to the charge of not being "real scientists" (or good ones), particularly when economists can be found on opposite sides of public debates.

While the question "is economics a science?" is a little pedantic - the answer is depends on how one defines science - raising it does sometimes lead to some useful reflections on what it is that we actually do.

In an essay for Institute for Advanced Study's Institute Letter,  "Economics: Science, Craft or Snake Oil?"  Dani Rodrik offers offers a number of characteristically interesting thoughts on the topic, including:
Economics, unlike the natural sciences, rarely yields cut-and-dried results. Economics is really a toolkit with multiple models—each a different, stylized representation of some aspect of reality. The contextual nature of its reasoning means that there are as many conclusions as potential real-world circumstances. All economic propositions are “if-then” statements. One’s skill as an economic analyst depends on the ability to pick and choose the right model for the situation. Accordingly, figuring out which remedy works best in a particular setting is a craft rather than a science.

One reaction I get when I say this is the following: “how can economics be useful if you have a model for every possible outcome?” Well, the world is complicated, and we understand it by simplifying it. A market behaves differently when there are many sellers than when there are a few. Even when there are a few sellers, the outcomes differ depending on the nature of strategic interactions among them. When we add imperfect information, we get even more possibilities. The best we can do is to understand the structure of behavior in each one of these cases, and then have an empirical method that helps us apply the right model to the particular context we are interested in. 
Or, as Keynes said: "Economics is the science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world."

See also related thoughts from Mark Thoma and Chris Dillow.  
 

Monday, December 16, 2013

The Phillips Machine

The Reserve Bank of New Zealand has a neat animation of Bill Phillips' famous hydraulic computer, which illustrates the stocks and flows of national income with tubes, tanks and gurgling noises. 

I've posted previously about the machine, and Phillips' (interesting) life.

In addition to the animation, the RBNZ has an actual working Phillips machine, which it demonstrates to the public every month (so that explains New Zealand's tourism boom!).

Tuesday, November 26, 2013

John Maynard Keynes

The Economist posts its beautiful 1946 obituary of John Maynard Keynes, which begins:
The sudden death of Lord Keynes on Easter morning has removed a great man. In turn civil servant, pamphleteer, don and college bursar, editor, company chairman, patron of the arts, government spokesman and adviser, member of the Upper House—he touched no career that he did not brilliantly adorn. More than any other man of his time he had the power to arouse informed opinion to the acceptance of novel proposals and if the public mind is better prepared in this country than in many others to face the problems of the period that is now opening, Keynes can claim far more than one man’s share of the credit. The story is told that when he was appointed a director of the Bank of England, he was accused by a friend of turning orthodox in his old age and replied, with his perfect self-assurance, “You are wrong. Orthodoxy has caught up with me.” What would have been conceit in another was the simple truth in his case. He had the gift that comes only to real leaders, of being well ahead of his generation and yet able to pull it along behind him. For this, more than intellect and more than lucidity are needed—though Keynes had both in plenty. He had also the integrity of the philosopher and, when he wished, the fervour of the prophet.
Cardiff Garcia brings my attention to Robert Skidelsky's memoir of writing his Keynes biography, which concludes:
"But, soon or late, it is ideas, not vested interests, which are dangerous for good or ill," Keynes wrote, in one of his most famous passages. I have often puzzled about the word "dangerous". Keynes was a most careful user of words. How can ideas be dangerous for good? A more obvious word would be "powerful"; the thought behind it being that ideas have a stronger influence on events, for good or bad, than have interests. And this is how the passage is usually interpreted. But the word "dangerous" adds a subtlety characteristic of Keynes: the thought that ignorance is dangerous, but that knowledge, too, is dangerous, because it tempts to hubris - the usurpation by men of divine powers - whose inevitable fruit is nemesis. That Keynes great revolutionary manifesto, The General Theory of Employment, Interest and Money should have ended on this oblique note of warning is striking testimony to a greatness that transcended economics. An intellect that could soar, seemingly without limit, accepted the discipline of earth- bound limits in the management of human affairs. This is the Keynes I love, and whose personality and achievements I have tried to convey.

Sunday, November 24, 2013

Signs of a Supply Shock off Monterrey?

The Times reports:
Humpback whales, pelicans and sea lions are all common summer sights off the Monterey coast, with its nutrient-rich waters. But never that anyone remembers have there been this many or have they stayed so long, feeding well into November.

“It’s a very strange year,” said Baldo Marinovic, a research biologist with the Institute for Marine Sciences at the University of California, Santa Cruz. 

What has drawn the animals is a late bloom of anchovies so enormous that continuous, dense blankets of the diminutive fish are visible on depth sounders. The sea lions, sea birds and humpbacks (which eat an average of two tons of fish a day) appear to have hardly made a dent in the population. Last month, so many anchovies crowded into Santa Cruz harbor that the oxygen ran out, leading to a major die-off.
I immediately thought of the Phillips curve shifting down (as in a positive 'supply shock').  I've discussed why anchovies matter for inflation previously.  I'm not sure they really do (and in the long run its only the money supply that matters of course), but its a fun example for macro students.