Waldman on "Econometrics, open science, and cryptocurrency"

Econometrics, open science, and cryptocurrency by Steve Randy Waldman

Mark Thoma wrote the wisest two paragraphs you will read about econometrics and empirical statistical research in general:

You are testing a theory you came up with, but the data are uncooperative and say you are wrong. But instead of accepting that, you tell yourself "My theory is right, I just haven't found the right econometric specification yet. I need to add variables, remove variables, take a log, add an interaction, square a term, do a different correction for misspecification, try a different sample period, etc., etc., etc." Then, after finally digging out that one specification of the econometric model that confirms your hypothesis, you declare victory, write it up, and send it off (somehow never mentioning the intense specification mining that produced the result). 

Too much econometric work proceeds along these lines. Not quite this blatantly, but that is, in effect, what happens in too many cases. I think it is often best to think of econometric results as the best case the researcher could make for a particular theory rather than a true test of the model.

What Thoma is describing here cannot be fixed. Naive theories of statistical analysis presume a known, true model of the world whose parameters a researcher need simply to estimate. But there is in fact no "true" model of the world, and a moralistic prohibition of the process Thoma describes would freeze almost all empirical work in its tracks. It is the practice of good researchers, not just of charlatans, to explore their data. If you want to make sense of the world, you have to look at it first, and try out various approaches to understanding what the data means. In practice, that means that long before any empirical research is published, its producers have played with lots and lots of potential models. They've examined bivariate correlations, added variables, omitted variables, considered various interactions and functional forms, tried alternative approaches to dealing with missing data and outliers, etc. It takes iterative work, usually, to find even the form of a model that will reasonably describe the space you are investigating. Only if your work is very close to past literature can you expect to be able to stick with a prespecified statistical model, and then you are simply relying upon other researchers' iterative groping.

...

Dan Davies

Bedtime for market efficiency by Dan Davies

"People have been calling on the economics profession to make some fairly serious revisions to the way the subject is taught.... I think there’s one thing that really can’t be denied: when this particular phoenix rises from the flames, it ought to leave the Efficient Markets Hypothesis back in the ash pit.... Efficient markets gets a chapter of its own in John Quiggin’s Zombie Economics as an idea that won’t go away, no matter how thoroughly it’s refuted.... The temptation will be to try and avoid going “cold turkey” on efficient markets, by reducing the overarching claims, but hanging on to the general story that markets are 'broadly efficient'.... The hypothesis that there is no information in the past history of share prices which can be used to predict the future... doesn’t work.... Companies like AQR have been offering funds based on them, and generally outperforming, for ages. And when you get to anything stronger than the very-weak form versions, the performance is really quite embarrassing. Robert Shiller’s share of the Nobel Prize was for noticing that securities prices are, in general, much too volatile to make sense as forecasts.... DeLong, Summers, Shleifer & Waldmann have shown that there is no real theoretical basis to the idea that 'traders competing against each other make markets efficient'--it’s just as likely that they create meaningless volatility. Market prices are... a weighted average of the views of a large group of well-resourced and intelligent people with an incentive to get things right. But nobody would build a theory of politics around the infallibility of opinion polls.... All that’s really left of market efficiency is a sort of woolly idea that 'it’s difficult to make money in the stock market'. Which it is, but it’s pretty difficult to make money in any other way too, a fact which has fewer implications for fundamental economic truth than you’d think..."

 (via DeLong)

macro

The entirely predictable recession by Simon Wren-Lewis

How did America's austerity beginning in 2011 compare? How did QE compenstate?

The Dismal Science 'Seven Bad Ideas,' by Jeff Madrick reviewed by Paul Krugman

Waldman and welfare economics

Welfare economics: normative is performative, not positive (part 5 and conclusion of a series) by Steve Randy Waldman

macro

Wages, compensation, investment returns (more or less) and debt contracts are set with certain asssumptions about inflation and price levels. When inflation changes, so does the amount of money flowing in these relationships. The original contract didn't have this change in inflation in mind so someone benefits because of public policy. Will inflation-indexing become more prevalent (like worker profit-sharing?)

Lately the problem has been slow recoveries after recessions. Recessions reset these contracts. Before it was the Fed that would set off recessions. Now it's the bursting of bubbles and balance sheet recessions.

The Fed relays new needed demand via the banks and profitable investments (although lowering interest rates makes governments' borrowing cheaper.) The government relays new demand via spending (and it can temporarily cut taxes).

Interfluidity

Welfare economics: the perils of Potential Pareto (part 2 of a series) by Steve Randy Waldman

What's an economist? A person who knows the price of everything and the value of nothing.

The Pernicious Prison of the Price Theory Paradigm by Steve Roth


Price versus value and what's the slippage. DeLong's deserved profit verus rents.

Piketty's example of German manufacturers. "For instance, I have a long discussion about the value of German manufacturing companies and the fact that their market value may not be as large as British, American or French corporations, but apparently that does not prevent them from producing good cars. The market does a number of things well, but there are also a number of things that the market does not do so well, and putting a price on assets is always a complicated business."

Naidu: 
"The book points out that German shares are “underpriced” because shareholders there do not have the same level of political power as shareholders in the US and UK, since they have to share power with workers’ councils and other stakeholders. The same thing is true of unions in the US. David Lee and Alexandre Mas shows that strong union victories in NLRB elections once reduced stock prices, yet it is very unlikely they changed the replacement value of the company’s underlying assets."

Yglesias interview:
"I think the lesson from this graph is that the market value of a corporation and its social value can be two different things. Of course you don't want the market value to be zero, but the example of the German corporation shows that even though their market value is not huge, in the end they produce some of the best cars in the world. They export a lot, and they are very successful. I think getting workers involved on the board of German corporations maybe reduces the market value for shareholders, but in the end, it forces workers and unions to be a lot more responsible for the future of the company."

interfluidity

Welfare economics: the perils of Potential Pareto (part 2 of a series) by Steve Randy Waldman

What's an economist? A person who knows the price of everything and the value of nothing.

The Pernicious Prison of the Price Theory Paradigm by Steve Roth

Waldman

Welfare economics: an introduction (part 1 of a series) by Steve Randy Waldman

There's no free lunch in economics!

Why the Fed’s taper could still cause a market meltdown by Ylan Mui

The Fed and the Skittish Financial Markets by Jared Bernstein

2014 US Monetary Policy Forum

Elementary: “The One Percent Solution” by By Genevieve Valentine

I liked how Sherlock disparaged the financial sector as "three card monte." And the episode got at the sense of entitlement of the one percent.

price change / Fed policy

Never Mistake a Change in Quantity Demanded for a Change in Demand by David Glasner

economics and interest rates

I have no idea if JW Mason is right here:

In general, I do think the secular stagnation conversation is a real step forward. So it's a bit frustrating, in this context, to see Krugman speculating about the "natural rate" in terms of a Samuelson-consumption loan model, without realizing that the "interest rate" in that model is the intertemporal substitution rate, and has nothing to do with the Wicksellian natural rate. This was the exact confusion introduced by Hayek, which Sraffa tore to pieces in his review, and which Keynes went to great efforts to avoid in General Theory. It would be one thing if Krugman said, "OK, in this case Hayek was right and Keynes was wrong." But in fact, I am sure, he has no idea that he is just reinventing the anti-Keynesian position in the debates of 75 years ago. 

The Wicksellian natural rate is the credit-market rate that, in current conditions, would bring aggregate expenditure to the level desired by whoever is setting monetary policy. Whether or not there is a level of expenditure that we can reliably associate with "full employment" or "potential output" is a question for another day. The important point for now is "in current conditions." The level of interest-sensitive expenditure that will bring GDP to the level desired by policymakers depends on everything else that affects desired expenditure -- the government fiscal position, the distribution of income, trade propensities -- and, importantly, the current level of income itself. Once the positive feedback between income and expenditure has been allowed to take hold, it will take a larger change in the interest rate to return the economy to its former position than it would have taken to keep it there in the first place. 

There's no harm in the term "natural rate of interest" if you understand it to mean "the credit market interest rate that policymakers should target to get the economy to the state they think it should be in, from the state it in now."And in fact, that is how working central bankers do understand it. But if you understand "natural rate" to refer to some fundamental parameter of the economy, you will end up hopelessly confused. It is nonsense to say that "We need more government spending because the natural rate is low," or "we have high unemployment because the natural rate is low." If G were bigger, or if unemployment weren't high, there would be a different natural rate. But when you don't distinguish between the credit-market rate and time-substitution rate, this confusion is unavoidable.

DeLong and Mason tweet on subject

Mark Thoma’s classic crack — “I’ve learned that new economic thinking means reading old books”

We don't need new ideas, we need "old" ideas.

New Thinking and Old Books Revisited by Krugman

I learn from Francesco Saraceno that some people are attacking me for, as they see it, defending an economic orthodoxy that has failed. It’s kind of an odd place to find myself, given how critical I’ve been of the way the economics profession has dealt with the crisis. But it’s not entirely unfair: I am quite skeptical of people whose response to the sorry state of affairs is to declare that what we need is a whole new field.

Why my skepticism? I’m all for new ideas that add to our understanding. But ideas like that aren’t easy to come by! Mark Thoma’s classic crack — “I’ve learned that new economic thinking means reading old books” — has a serious point to it. We’ve had a couple of centuries of economic thought at this point, and quite a few smart people doing the thinking. It’s possible to come up with truly new concepts and approaches, but it takes a lot more than good intentions and casual observation to get there.

So, for example, what do I say when I read something like this from someone who apparently considers himself a bold rebel against orthodoxy?

“Rational thinking is an important aspect of human nature, but we have imagination, we have ambition, we have irrational fear, we are swayed by other people, we get indoctrinated and we get influenced by advertising,” he says. “Even if we are actually rational, leaving it to the market may produce collectively irrational outcomes. So when a bubble develops it is rational for individuals to keep inflating the bubble, thinking that they can pull out at the last minute and make a lot of money. But collectively speaking . . . ”

My answer, to put it in technical terms, is “Well, duh.” Maybe grad students at some departments, who are several generations into the law of diminishing disciples, really don’t know that rational behavior is at best a useful fiction, that markets aren’t perfect, etc, etc. But does this come as news to Robert Shiller? To Ben Bernanke? To Janet Yellen? To Larry Summers? Would it have come as news to Irving Fisher or Walter Bagehot?

The question is what you do with this insight.

There is definitely a faction within economics that considers it taboo to introduce anything into its analysis that isn’t grounded in rational behavior and market equilibrium. But what I do, and what everyone I’ve just named plus many others does, is a more modest, more eclectic form of analysis. You use maximization and equilibrium where it seems reasonably consistent with reality, because of its clarifying power, but you introduce ad hoc deviations where experience seems to demand them — downward rigidity of wages, balance-sheet constraints, bubbles (which are hard to predict, but you can say a lot about their consequences).

You may say that what we need is reconstruction from the ground up — an economics with no vestige of equilibrium analysis. Well, show me some results. As it happens, the hybrid, eclectic approach I’ve just described has done pretty well in this crisis, so you had better show me some really superior results before it gets thrown out the window.

Oh, and if you think you’ve found a fundamental logical flaw in one of our workhorse economic models, the odds are very strong that you’ve just made a mistake.

Does this mean that nothing should change in the way we teach economics? By no means — it’s quite clear that the teaching of macroeconomics has gone seriously astray. As Saraceno says, the simple models that have proved so useful since 2008 are by and large taught only at the undergrad level — they’re treated as too simple, too ad hoc, whatever, to make it into the grad courses even at places that aren’t very ideological.

Furthermore, to temper your modeling with a sense of realism you need to know something about reality — and not just the statistical properties of U.S. time series since 1947. Economic history — global economic history — should be a core part of the curriculum. Nobody should be making pronouncements on macro without knowing a fair bit about the collapse of the gold standard in the 1930s, what actually happened in the stagflation of the 1970s, the Asian financial crisis of the 90s, and, looking forward, the euro crisis.

I’d put my oar in for history of thought, too. Watching highly trained economists reinvent old economic fallacies suggests to me that there would be real payoff to requiring that students have some idea how the current leading doctrines got to where they are.

But must we reconstruct all of economics? No. Most of what we need, at least for now, is in those old books.

textbook economics

Colleges are teaching economics backwards by Mike Konczal

It used to be different. The preeminent economist Robert Samuelson once said "I don't care who writes a nation's laws, or crafts its treatises, if I can write its economics textbooks." And he was the one writing its textbooks for a long while. In the first version of his blockbuster textbook Economics (1948), the study of macroeconomics came first. And institutions were emphasized before the more abstract microeconomics that start off the education now. One of the central ideas was the “fallacy of composition,” or how things true of individual people or markets were not true of the aggregate behavior of the economic system.

That should be Paul not Robert, as a commenter notes.

On the Importance of Little Arrows (Wonkish) by Krugman

Williamson has a lot of equations running around — fearful plumbing, as Rudi Dornbusch would have put it — but the essence of this story, whether he realizes it or not, involves movements in the Wicksellian natural rate of interest — the real interest rate that would match savings and investment at full employment.

mainstream macro

Attacks on mainstream economics and reforming economics teaching by Simon Wren-Lewis

The Trouble With Economics Is Economists by Krugman

academic economics, old and new Keynesian theory

 Keynesian Economics and the Journals by Krugman

So consider two hypotheses. One — which Cochrane appears to believe — is that being inside the Beltway has rotted Janet’s and Olivier’s brains, not to mention that of all their researchers, causing them to revert to primitive concepts that “everyone” knows are false. The other — which is what I hear from young economists — is that there is an equilibrium business cycle claque in academic macroeconomics that has in effect blockaded the journals to anyone trying to publish models and evidence that stress the demand side.

Obviously you know which story I believe. The main point, though, is that trying to argue from authority is even sillier here than in most situations. There’s a huge difference between “nobody believes that” and “none of my friends will let that get published in the journals they control”.

Oh Dear: Megan McArdle Relies on John Cochrane, and so Goes Badly Astray… by DeLong

How to be a New Keynesian and an Old Keynesian at the same time by Simon Wren-Lewis

economics as science

Is Economics a Science? by Robert J. Shiller

positive outlook

Economy keeps plugging along despite shutdown and sequester.* Deficit is down to ~$650 billion/year. Debt is up but deficit will continue to shrink as economy grows faster.

Snapshot: November gets off to healthy start

The stock market started November on a strong note as investors reacted to an expansion in US manufacturing last month. The improvement came during what could have been a difficult month for the economy, with a partial government shutdown. The Institute for Supply Management said its manufacturing index rose to 56.4, the highest since April 2011. The positive start to this month’s trading follows a strong October. But some investors are skeptical stocks can keep up this pace. Stocks are also starting to look expensive by some measures. Investors are paying more than $16 for every $1 of earnings in the S&P 500, the most since February 2011.

-----------
*That is despite the Republicans' best efforts. And if they gain power they'll try to cut taxes for the rich, deficits be damned. See the Bush tax cuts.

economics and morality

Economics as a moral science by Ingrid Robeyns

stock-to-flow

Dan Davies comments at Frances Coppola's blog:

Stock-to-flow ratios aren't per se silly or meaningless - return on capital is a ratio of stock to flow, as is labour productivity. But comparing stocks to flows is a dangerous business, because if you don't know what you're doing (as Nelson doesn't), you're always in danger of making the mistake that he has actually made in Chart 1, which is to compare a change in a stock to a flow.

This is a bit of a quibble as the key point here is the one you make - if you're borrowing £2 of "debt" for every £1 of "growth" then you're almost certainly doing very well, because the debt stays at £2 until you pay it back, but the growth gives you a new £1 every year (making the correct stock/flow division would tell you that the UK was getting a 50% return on marginal borrowing, which anyone can see is a pretty fantastic return on investment to be getting. This would still be dumb economics because it's wrongly aggregated, but at least the division would be giving you something at least potentially meaningful).

As I say more of a quibble than anything - I just worried that people might get the impression that comparing a stock with a flow was always wrong, rather than something like starting a sentence with a preposition - probably best avoided but sometimes necessary.