Quantifying confidence

by on January 8, 2015 at 2:58 am in Economics | Permalink

Angeletos, Collard, and Dellas serve up another important entry (NBER gate) in the growing literature on the importance of the risk premium for macroeconomic fluctuations:

We enrich workhorse macroeconomic models with a mechanism that proxies strategic uncertainty and that manifests itself as waves of optimism and pessimism about the short-term economic outlook. We interpret this mechanism as variation in confidence and show that it helps account for many salient features of the data; it drives a significant fraction of the volatility in estimated models that allow for multiple structural shocks; it captures a type of fluctuations in aggregate demand that does not rest on nominal rigidities; and it calls into question existing interpretations of the observed recessions. We complement these findings with evidence that most of the business cycle in the data is captured by an empirical factor which is unlike certain structural forces that are popular in the literature but similar to the one we formalize here.

There are ungated versions here.  The funny thing is, these theories are in some key regards more true to the spirit of John Maynard Keynes than many theories which are called “Keynesian.”

1 Ray Lopez January 8, 2015 at 7:22 am

Animal spirits indeed.

Off-topic: does anybody know how Sumner’s “Target NGDP” works, which is pegged to something to prevent excessive animal spirits? I await for an answer on his blog, but he gives short one liners, mixed with insults on occasion, so it’s hard to figure out. Briefly, Sumner is setting up a futures market in NGDP. Then this NGDP futures market will be used to guide the Fed in issuing money supply. When I suggested NGDP futures will fluctuate wildly, and hence Sumner’s framework is flawed, he said the Fed will “peg” their expectations (not clear how). So how does that work? Sounds like South Seas and and John Law’s Mississippi company to me.

2 Ray Lopez January 8, 2015 at 7:26 am

BTW, I read an article once that stated John Law was a prototype monetary genius, and his Mississippi company, which spurred the English to invent the South Seas company, was an early attempt to monetize the French government debt, and spread the tax base. It does kind of make sense. It might be that the target NGDP framework is a backdoor Fabian / Trojan Horse way of introducing more Keynesianism in monetary policy at the Fed. The devil is in the details and the details seem murky.

3 Mike Sankowski January 9, 2015 at 3:32 pm

NGDP futures are fatally flawed – from a contract specification and market structure perspective.

Scott S has suggested at least three different market structures. Each of them has extremely serious and incredibly dangerous flaws. Additionally, I do not think there is a possible set of contract specifications which result in a healthy and viable market.

4 tedm January 8, 2015 at 8:08 am

Don’t expect an answer from Sumner or this blog. As a matter of pure definition, the Fed’s monetary tools need not necessarily lead to an increase in the price level nor real GDP (the components of NGDP). Why? Because velocity may change instead of inflation or real activity. Historical examples of velocity absorbing the difference in monetary policy include the Great Depression and the Great Recession. You can easily look up velocity yourself for the most recent business cycle on the StLouis Fed FRED webpage.

Thus, the Fed, the ECB, and the Bank of Japan can target NGDP all they want, doesn’t mean that NGDP will necessarily respond to their policy tools. Velocity might decline instead. Did it decline during the great monetary expansion of 2007-2010? Don’t pay attention to me. Look it up. To those who say that the central bank can always double the money supply, velocity can always be cut in half.

Like I said, don’t expect a response from the NGDP targeting folks. Sumner doesn’t want to look at velocity because it undermines his theory. Krugman doesn’t want to look at velocity because it undermines his. Neither side has any incentive to actually look at the data as long as they can keep the discussion within their narrow debating points.

5 steve-o January 8, 2015 at 8:23 am

Congrats – you managed to be as retarded as Ray. No small feat.

6 Ray Lopez January 8, 2015 at 1:48 pm

@tedm- thanks! This goes a long way to explain why Sumner blew up when I mentioned ‘velocity’ in a post. Later, a certain Major Freedom explained basically what you are saying. Amazing. BTW here is my post summarizing Sumner’s Targeting NGDP from reading his paper (it’s very vague): http://www.themoneyillusion.com/?p=28320&cpage=1#comment-375083

I think economics is a fraud, and that includes btw Friedman to a degree (he’s not much different that Keynes in my mind). Of course our host is an exception.

7 tedm January 8, 2015 at 9:23 am

Thanks, Steve, for setting me straight.

You showed me where as a matter of economic principles a change in the money supply NECESSARILY must affect either the price level or real GDP (the components of NGDP), rather than be offset by a change in velocity.

You showed me where as an empirical observation, velocity did not decline significantly during 2007-2010 in the United States when the Federal Reserve significantly increased the money supply.

You have demonstrated that NGDP targeting is the way to go. How could I ever have raised theoretical or empirical doubts? I will have to console myself with the knowledge that even a retarded squirrel occasionally finds a nut.

8 steve-o January 8, 2015 at 11:57 am

yo moron – as long as the central bank owns the printing presses (be they literal or metaphorical), the sky is the (literal) limit

name me a central bank that wanted to create inflation and failed

that’s right, you can’t


and no, I don’t think NGDP targeting is optimal – what I think is optimal is targeting wage inflation (as opposed to price inflation)

9 msgkings January 8, 2015 at 3:26 pm

Seems like the ECB, BOJ, and even the Fed are all failing to get inflation up to where they want it.

10 steve-o January 8, 2015 at 3:55 pm

seeing as how all three central banks mentioned have explicitly stated they will not tolerate inflation, I’d say you’re an idiot

but then again, this is the internet, so you’re the norm

11 tedm January 8, 2015 at 4:09 pm

Quoting the Federal Reserve. “The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate.”

Not only will central banks tolerate inflation, they seek it out. As msgkings points out, they have been undershooting despite massive money injections. During that time, velocity fell by a large amount compared to similar periods during prior recessions. I’m not saying money never causes inflation. I’m saying (1) in theory, it doesn’t have to, and (2) during our most recent recessionary experience, it did not. I am happy to then discuss other historical experiences both consistent and inconsistent with the views of NGDP target advocates, but NGDP target advocates won’t recognize and engage the recent data observations.

12 steve-o January 8, 2015 at 4:26 pm

First of all, try turning on your brain before typing.

Second of all – no, a central bank simply cannot fail to generate inflation. The fact that they do so only proves that their actual target is different from their stated one (it’s called “public choice theory”, look it up).

You cannot fail to generate the desired amount of inflation as long as you own the printing presses. PERIOD.

Oh, and you’re a moron.

13 msgkings January 8, 2015 at 4:37 pm

LOL at steve-o calling us names. I guess I have to agree with his bullshit now.

14 steve-o January 8, 2015 at 4:45 pm

I guess I have to agree with his bullshit now.

that would require a functioning brain – so I guess it’s off the table

15 msgkings January 8, 2015 at 5:00 pm

Oh beHAVE! Do another one!

Call me a filthy dumdum now!

16 Art Vandalay January 9, 2015 at 9:05 pm

Steve-O is not smart. Neither is Ray Lopez or tedm. But that makes sense, given that Tyler Cowen isn’t smart either.

17 Miguel Madeira January 8, 2015 at 2:49 pm

“engineers, mathematicians and scientists today are (unfairly) stereotyped as awkward nerds”

I wonder if it is not simply an illusion derived from the tendency to join engineers, mathematicians and scientists in the single group engineers-mathematicians-and-scientists (mixing the “normal” engineers with the “nerdy” mathematicians and scientists

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