Economics is More Than You Think

and it helps you learn how to think....

One of the challenges in teaching economics is that many come to it with incorrect expectations - people seem to view it as akin to accounting or finance.  In a liberal arts setting, the students (and their parents) may believe it is the closest thing they can get to a business major (this paper provides evidence on this point).
This short video from the American Economic Association - "A Career in Economics - It's Much More Than You Think" - does a nice job of correcting some of these misconceptions.

However, I think the video misses one of the main reasons for studying economics: the habits of mind - "critical thinking skills" - it helps students develop (I wrote more about this here).  Most of our students aren't going on to careers in economics, and they will forget many of the specifics, but being able to think coherently about tradeoffs and the linkages between assumptions and conclusions is a lifelong benefit.

So, yes, people who are interested in business should study economics, as should people who are interested in a career in economics (my own advice about that is here), but so should everyone else!

Opportunistic Flexibility

Last week, China moved to allow more flexibility in its exchange rate.  In this case, that meant a downward movement - headlines about a "devaluation" were rather overstated, though, as the depreciation from Monday to Thursday was about 3% (followed by a slight rise on Friday).  Last week's change is at the end of the graph:

Note, the graph is the yuan price of a dollar, so a downward movement is a yuan appreciation.

China has been criticized over the years for keeping its exchange rate undervalued to support its exports.  The graph shows that it has allowed the yuan to rise quite a bit since 2005, though it has done so in a controlled manner and took a pause for about two years starting in mid-2008.  Its appreciation has helped China make progress on one aspect of "rebalancing" - reducing its dependence on exports.  China's current account surplus is considerably smaller relative to GDP than it was in 2006-08:

So, does this move represent a return to China's old ways of undervaluing its currency to gain a competitive edge for its exports?

Well, yes and no...

As it has followed the dollar, and the dollar has risen, the yuan has appreciated in real terms.  This chart shows a trade-weighted average of the dollar:

During the last year the dollar has appreciated significantly and the yuan has been along for the ride.  Currency appreciation - which makes Chinese goods relatively more expensive on world markets - combined with a slowing economy led to political pressure for a change of course.  The Times' Keith Bradsher writes:

In a little-noted advisory to government agencies, the cabinet said it was essential to fix the export problem, and the currency had to be part of the solution.

With the government keeping a tight grip on the value of the renminbi, Chinese goods were more expensive than rivals’ products overseas. The currencies of other emerging markets had fallen, and China’s exporters could not easily compete.

Soon after, the Communist Party leaders issued a statement also urging action on exports.

However, China has also been moving in the direction of greater financial openness; this entails allowing freer exchange rate movements (as I discussed in this previous post), particularly if it wants the yuan to become an international reserve currency (a status Krugman rightly notes is highly overrated).  At Project Syndicate, Yu Yongding writes:

From now on, China’s government declared, the renminbi’s central parity rate will align more closely with the previous day’s closing spot rates. This suggests that the devaluation was aimed primarily at giving the markets a greater role in determining the renminbi exchange rate, with the goal of enabling deeper currency reform.

So, yes, China has other reasons for moving to a more flexible exchange rate, but it is convenient for them to take a step in that direction at a moment when doing so means a fall in the yuan that will boost demand for Chinese goods.

See also: Ambrose-Evans Pritchard, Gavyn Davies, Michael Klein, David Beckworth, Michael Pettis.

Stories from the Macro Wars

Ian Parker's recent New Yorker profile of Yanis Varoufakis included this nugget: "He has written of his hope, as a professor, to present economics as 'a contested terrain on which armies of ideas clash mercilessly.'"

That may be an apt description of macroeconomics in the 1970s and 1980s.  On his website, Paul Romer has offered an interesting take on the methodenstreit between the dynamic general equilibrium approach (so-called "freshwater" macro, championed by Robert Lucas) and Keynesian macro-econometric models (the "saltwater" camp).  Romer is particularly critical of Robert Solow, arguing that his dismissive attitude towards Lucas et al., contributed into a counterproductive hardening of differences. He writes:

Solow also seemed to be motivated to attack harshly because he was concerned that the type of model Lucas was developing might undermine political support for active countercyclical policy. To his credit, there was a legitimate basis for this concern. The new Chicago school of macro eventually did oppose an active response to the financial crisis and its aftermath. But the type of response that Solow exemplified may actually have contributed to the emergence of this new Chicago school. In retrospect, if the goal was to maintain support for active macro policy, the better course would have been to take seriously what the rebel group that was forming around Lucas was saying. This might have kept the rebels from cutting off contact with all outsiders, even those who were taking seriously the issues they were raising.

Brad DeLong and Paul Krugman responded in defense of Solow. DeLong writes:

And, at this point, Romer ought to say that Solow’s and Hahn’s criticisms were (a) no more biting in their rhetoric than the criticisms that Stigler, Friedman, and company had been inflicting on their victims at Chicago for a generation, and (b) correct and accurate.

Romer has more interesting detail in his response, including this summary of the main points:

In the summer of 1978, Lucas and Sargent were making three claims:

(a) Existing multi-equation macro simulation models were not identified. That is, these models summarized correlations in the data but did not yield reliable statements of the form “if the government does X, this will cause Y to happen.”

(b) It was time to use SAGE models to address such fundamental questions about economic fluctuations as why changes in the supply of money influence economic activity; and

(c) SAGE models will imply that an active monetary policy cannot stabilize economic fluctuations.

Solow thought that Lucas and Sargent were wrong about the policy ineffectiveness claim (c). DeLong, Krugman, and I all agree. In the 2013 introduction to his collected papers, Lucas uses some asides about the Great Depression and the Great Recession to admit that now even he agrees. Claim (c) is what DeLong and Krugman have in mind when they say that  Solow was right and Lucas was wrong.
Yet all macroeconomists now agree that Lucas and Sargent were correct about the fatal problems with the large simulation models. Much of Solow’s response amounted to an implausible denial that there was anything wrong with them. So on this point, the roles are reversed. Lucas and Sargent were right and Solow was wrong.

[Romer uses "SAGE" to refer to general equilibrium models].  See also: this from Krugman, and this from DeLong.  David Glasner has a thoughtful post putting things in a broader context.

In his post, Romer cites several papers, including Lucas and Sargent's "After Keynesian Macroeconomics," from the 1978 Boston Fed conference.  Perhaps it should be known as "the throwdown in Edgartown."

Fascinating stuff... but fortunately for contemporary macroeconomists - particularly those of us with conflict-averse midwestern temperaments - things aren't nearly so rancorous now.  There certainly are differences of inclination and opinion, and economists can be blunt in expressing their differences, but the "saltwater" vs. "freshwater" cleavage is largely a thing of the past, as this Steven Williamson post explains.  Since the wars of the 1970s and 80s, there has been some convergence: macroeconomists have developed a class of models - sometimes called "New Keynesian" - which respond to Lucas' methodological critique but also allow for a stabilizing role for macroeconomic policy.  That's not to suggest we've figured it all out, of course; this recent Mark Thoma column highlights some of the weak points of contemporary theory.

NPR Visits Keynes' (Sister's) Grandchildren

One of the pleasures of teaching is the opportunity to re-read the articles I assign to my students; one particular favorite that I look forward to each semester is Keynes' essay "Economic Possibilities for Our Grandchildren."  NPR's Planet Money recently did an episode about it, focusing on Keynes' famously incorrect (thus far) prediction of a 15-hour workweek.  Although Keynes had no progeny, they did check in with his sister's grandchildren, as well as Harvard economist Richard Freeman - all of whom seem to be hard workers. I discussed some ideas about why we're not enjoying so much leisure in a post last year.  Tim Harford also has some thoughts on his blog.

The prediction about leisure was part of Keynes' more general forecast that economic growth would solve the "economic problem" of scarcity (and his guess about the rate of growth was pretty accurate), and speculation about the social change that would result.  In a similar spirit, in his Bloomberg column, Noah Smith suggested that a post-scarcity world might be like Star Trek: The Next Generation.  He concludes:

In other words, the rise of new technology means that all the economic questions will change. Instead of a world defined by scarcity, we will live in a world defined by self-expression. We will be able to decide the kind of people that we want to be, and the kind of lives we want to live, instead of having the world decide for us. The Star Trek utopia will free us from the fetters of the dismal science.

Or, as Keynes put it in 1930:

Thus for the first time since his creation man will be faced with his real, his permanent problem- how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well.