Lit in Review: 3 for Intermediate Macro

The July 2015 American Economic Journal: Macroeconomics had several papers that have something to say to my intermediate macroeconomics students.

How good is the Cobb-Douglas production function at describing the real world?
Berthold Herrendorf, Christopher Herrington, and Akos Valentinyi, "Sectoral Technology and Structural Transformation" (working paper)
They use three different functions, one each for ag, manufacturing, and services and they add imported intermediate inputs to the model we use. If they allow each one to have different technology growth, they can "capture the main technological forces behind the postwar US structural transformation" from ag/manufacturing to a services-oriented economy. They tested letting each sector have a different alpha, but it turns out that doesn't make much of a difference.

Permanent and transitory income shocks
Christian Bayer and Falko Juessen, "Happiness and the Persistence of Income Shocks" (2013 draft)
Persistent income changes "have a significant impact on happiness while transitory shocks do not."

The Trilemma
Michael Klein and Jay Shambaugh, "Rounding the Corners of the Policy Trilemma: Sources of Monetary Policy Autonomy" ungated
My time in Nigeria gave me some interesting insights on some of our macro models. While I can easily wave my hands a bit and put the US, Germany/Greece/any EU country, and China on the three edges of the impossible trilemma, Nigeria tried to have it all. They don't have free capital mobility, and their controls have been getting tighter over the last ten years; they try to have a fixed exchange rate, but they are classified as free because sometimes they have to let it fluctuate wildly before reeling it back in; and they want a central bank that can still impact the economy, but it's pretty weak.

This paper asks if Nigeria's strategy could be effective: "whether partial capital controls and limited exchange rate flexibility allow for full monetary policy autonomy. We find partial capital controls do not generally allow for greater monetary control than with open capital accounts, unless they are quite extensive, but a moderate amount of exchange rate flexibility does allow for some degree of monetary autonomy, especially in emerging and developing economies."

Another example of the importance of starting dates

Back in October, Yglesias reported on how the Trump stock market rally wasn't all that impressive. Other countries' stock market indices had risen by more than ours had. To illustrate this, he included this graph comparing the US S&P 500 with Japan's Nikkei, Germany's DAX, and France's CAC indices:

It clearly shows that, while the S&P500 has risen considerably since Aug 2016, the rise is not as large as the gains experienced by other countries. He concluded:

That said, the fact that stock market enthusiasm over the past year has been worldwide with the United States lagging other key countries seems like a strong indication that Trump hasn’t done anything that’s particularly successful or exciting. ... For whatever reason, markets are up just about everywhere, not only in the United States. And markets generally seem to be up by more in countries with boring, competent-seeming leadership than they are in the United States.

I liked the graph and it is a good idea to think in terms of such counterfactuals, but I also had my doubts. Why normalize all the indices at the end of July, half a year before he became president and months before he won the election? In the middle of the semester I felt it was interesting enough to mention to my honors students while bringing up a concern or two, but I eventually forgot my desire to investigate further.

Well, time to investigate! Compare if you will the following graphs with three different normalizations: Yglesias' end-of-July 2016, the election in 2016, and the inauguration in 2017. I'm extending the data out to today, using weekly closing numbers.

The S&P's relative performance has improved since Yglesias wrote, so that even using his normalization the US is now modestly outperforming Europe and has been for the most part since the Tax Cut and Jobs Act. The Nikkei is still outperforming the S&P by a wide margin, but his conclusion would now have to be that the President's antics haven't harmed the US.

If we normalize just before the election, however, we see that the US is right on par with Japan and outperforming Europe by a wide margin.

And normalizing from the inauguration shows the US ahead of every other country with the most boring and competent seeming Germany performing worst.

So what's the takeaway? We need more crazy antics? I doubt it. My three lessons for today are about how little we know:

1) If you're going to do this kind of analysis, be forthright about why you are choosing your starting dates. Starting dates are everything. That's part of why statistics gets its reputation for lies: you can make the same numbers tell almost any story you want. If you want US stock returns to look as bad as possible, start at July 3, 2016 (really close to Yglesias' starting point) so that Japan is 20 points ahead of the US. If you want the US stock returns to look as strong as possible, go back nearly 3 years ago to June 28, 2015 and give Trump credit for growth that happened during Obama's term, putting the US 20 points ahead of Japan. Or maybe just pick a credible day from which we can justly and reasonably judge the President's performance.

2) Let's please remember on all sides that the stock market is not a great indicator of how the economy as a whole is doing. The correlation may even be negative in the very long run (http://www.businessinsider.com/equity-returns-and-gdp-per-capita-2014-2)

3) Let's not draw too many life lessons about how to run an economy and a presidency until all the data points are in. 

Is a strong exchange rate good or bad?

So apparently Pres. Trump has asked his national security adviser if it was a strong dollar or a weak dollar was good or bad.

I ask this on my tests regularly ... almost every class I teach has it in one form or another, actually. And since the article doesn't answer it for you, here are the correct answers depending on the class:

Correct answer a) in every class - There is no such thing as "strong" or "weak". It's all relative. So then I ask whether "stronger" or "weaker" is better. [PS - This is the kind of pedantic right answer that is useful for students and should not be given to the President of the United States, just in case you are in that position.]

Correct answer for intro students - It depends on who you are. Exporters, the tourist industry, and firms competing with imports prefer weaker while importers, consumers, and tourists prefer stronger. So if you produce shirts, you like a weaker dollar at the office and a stronger dollar at home.

Correct answer for intermediate macro students: It depends on WHY the dollar changed. NEVER REASON FROM A PRICE CHANGE. I can tell you an example where a stronger dollar is good for just about everyone in the US and I can tell you an example where a stronger dollar is worse for just about everyone. The relative strength or weakness of the dollar by itself doesn't matter. WHY did it change?

Correct answer for international (trade) students: What matters for investors is what direction it might move in the future. If you are planning to invest abroad, you want the dollar to get weaker over time. If you want to attract foreign investment, you want them to believe the dollar will get stronger. Unless of course the WHY is something bad for your firm (Why still matters)

Correct answer for development economics students: One theory claims you can boost economic growth by weakening your currency so you export more. The problem with that theory is that the way you weaken your currency is via inflation or taxing your people so you can buy up a lot of foreign currency, either of which will have negative effects on your economy too.

Given that very long answer, I'm not surprised Trump didn't ask an economist.

Lit in Review: Social insurance programs

From the AER meeting in 2015:
"Despite the consensus that higher unemployment benefits lead to longer durations of unemployment, the precise magnitude of the effect is uncertain."

Card et al. "The effect of unemployment benefits on the duration of unemployment insurance receipt: new evidence from a regression kink design in Missouri, 2003-2013"
They find an elasticity of 0.35 pre-recession and between 0.65-0.9 during and after. [Translation: increase unemployment benefits by 1% and people stay unemployment 0.35% longer before the recession.] Why the difference? Could be jobs are harder to come by, so you're less likely to turn one down if your benefits aren't that generous. Could be that unemployment benefits lasted so much longer during the recession.

Coile, Duggan, and Guo. "Veterans' Labor Force Participation: What role does the VA's disability compensation program play?"
They find that increases over time in the generosity of disability compensation closely coincides with the decrease in veterans' labor force participation and that veterans have become increasingly sensitive to economic shocks. Back of the envelope calculations suggest no more than 55% of DC recipients who would not have been eligible before it became easier to get disability would be working without it.

Nekoei and Weber. "Recall expectations and Duration Dependence" in Austria
They survey a bunch of unemployed people and break them into two groups: those who expect to be hired back to their old job (temporary unemployment) and those who don't (permanent). Interestingly, 42% of separations are planned to be temporary, but only 58% of temporary layoffs actually are, while 19% of permanent layoffs are recalled. "On average, jobs ending in temporary layoffs lasted a shorter period but paid higher wages." They find that temporarily laid-off workers are less likely to look for a job (51% don't even try) and, even if they do, don't look as hard for one (use fewer search methods).

Poor, Unfortunate Students

Just a little something I find a way to squeeze in to the first day of class.

Big bag of blogs

Adam Smith put forward the basic idea of the stationary bandit vs. roaming bandit applied to India. Basically the Britishers overseeing India who expected to leave again were there primarily to take as much they could get their hands on, while those who had a more permanent interest wanted to invest in the country and make it more prosperous. Trying to get the incentives of the temporaries to align was difficult, in part because of the more permanent leaders didn't understand their own interest perfectly either.

People who lived in East Germany were more likely to cheat than people who lived in West Germany.

Cass Sunstein's (and Sumner's) defense of utilitarianism. The most interesting line for me is this argument:

the enterprise of doing philosophy by reference to such dilemmas is inadvertently replicating the early work of Kahneman and Tversky, by uncovering unfamiliar situations in which our intuitions, normally quite sensible, turn out to misfire. The irony is that where Kahneman and Tversky meant to devise problems that would demonstrate the misfiring, some philosophers have developed their cases with the conviction that the intuitions are entitled to a great deal of weight, and should inform our judgments about what morality requires. A legitimate question is whether an appreciation of the work of Kahneman, Tversky, and their successors might lead people to reconsider their intuitions, even in the moral domain.

Large retail chains give higher wages, mostly because there are a lot more middle-management and support positions.

A description of how people lived in Britain 100 years ago. It makes for a fascinating comparison to show how much living standards have improved.

Why you should probably self-publish.

Why do they matter? Fish and McD's

Pinstrup-Anderson, co-author on my textbook, recently asked what fish have to do with food and nutrition security. He answers that it matters a great deal and recommends a new report by a high-level panel of experts on the subject.

The current debate and the many papers written recently about how agriculture can be made more nutrition sensitive also miss the point.  We should talk about how the food system, including fisheries and aquaculture and the total supply chain, can be made more nutrition sensitive.  If we limit the discussion and policy recommendations to agriculture, we are foregoing some very big opportunities for improving food security and nutrition. ... 

The report, which is available at www.fao.org/cfs/cfs-hlpe or in hardcopy from cfs-hlpe@fao.org, is a goldmine of policy-related knowledge about the fisheries and aquaculture sectors, their importance, sustainability issues, governance and recommended policies for consideration by governments, the private sector, civil society and international organizations. It provides a comprehensive assessment of the interaction between the fisheries and aquaculture sector and food and nutrition security. The report is a must-read for those of us interested in food policy.

Handjiski points out that all of Sub-Saharan Africa only has two countries with McDonald's franchises. Even though countries like Seychelles, E. Guinea, Gabon, Botswana, and good old Nigeria have a higher income than Indonesia, Egypt, Pakiston, or Moldova did when they got their first. He suggests that, since having a McDonald's requires a certain level of infrastructure, entrepreneurship, and access to a large number of ingredients, it can be a development indicator:

In almost 60 percent of cases, developing countries grew [significantly] faster in the five years, compared to the previous five, following the opening of the first McDonald’s. ... What this means is that McDonald’s may be viewed as one of the tipping points for when a country has amassed sufficient urban middle-class, investment security and supply chains for economic take off.

 Speaking of which, there was also a recent article about how Americans' general stupidity with fractions stopped A&W from beating McDonald's Quarter Pounder with a "Third Pounder". People said 3 is less than 4 and therefore 1/3 is less than 1/4. Ouch. In related interesting news, New York states has decided that a burrito is a sandwich for tax purposes.

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