Worst News of the Day
The market at Intrade is predicting a probability of a U.S. Depression (10% or greater decline in GDP) in 2009 to be 56%. I am shocked. The probability is up significantly over the past two weeks. Why?
Addendum: MR Readers are fast! Within two minutes Marc points us to this post from Donald Luskin who says that it is a contract error. Here is the key clause from the contract:
as a cumulative decline in GDP of more than 10.0% over four consecutive
quarters [that sounds ok, AT]. This is calculated [here is the error] by adding together the published
(annualized) GDP figures (as detailed below). If these annualised
figures add up to more than -10.0% over four consecutive quarters then
the contract will expire at 100.
As Luskin notes
change-figures that are already each annualized, you will get a far
larger cumulative result than the actual change over a four-quarter
period. Suppose there are four successive quarters each showing an
annualized 2.5% decline in GPD. Intrade will add those together and get
10%. But over the year, the annual decline in GDP will acually be 2.5%.
Thanks readers, I was about to open an Intrade contract to bet heavily against!
Hat tip to Tim Groseclose.
Comparing Recessions II
From Terry Fitzgerald at the Minneapolis Fed.
You are correct that the "mildest, median, and harshest" recession lines do
not represent single recessions. Please allow me to try to justify our
procedure. We spent considerable time weighing alternative approaches.
In drawing our timeline "length of recessions" graphs, we wanted to
illustrate where the current recession lies relative to past recessions at
each month of the recession. So for each month (or quarter), the lines
would tell you what had been the largest, median, and smallest decline in
any recession to that point.
The median line would indicate that one-half of the past recessions had
experienced larger declines, and one-half had experienced smaller declines
to that point. Similarly, no recession had a larger decline to date than
the "harshest" line. (And similarly for the mildest line.)
One feature of this approach is that the mildest, median, and harshest lines do not shift over time. So we can update just the "current" line in our graphs without all the lines shifting.
…I knew that insightful readers might wonder about this point, and I hoped that the note would at least explain what we did.
We are not trying to do anything deceptive or misleading with these charts.
Our aim is only to provide some empirical context to the current recession.
Tabarrok at TED
I will be speaking on The Future of Economic Growth at this year's legendary TED Conference, TED 2009, which takes place in Long Beach, Feb 3-7. Other speakers include Tim Berners-Lee, Oliver Sacks, Daniel Lebeskind, Herbie Hancock and Bill Gates. In my session, I am paired with Nate Silver, Bruce Bueno de Mesquita, and Dan Ariely. Yeah, I'm a little nervous. Fortunately, TED provides a masseuse for speakers before they hit the stage! I kid you not.
Rationality is a Property of Equilibrium
Some thoughts on rationality and economics, perhaps for a future paper, motivated by the financial panic:
Rationality is a property of equilibrium. By this I mean that
rationality is habitual and experience-based and it becomes effective
as it becomes embedded in the rules of thumb and collective wisdom of
market participants. Rules of thumb approximate rational decision
rules as market participants become familiar with an economic
environment. Individuals per se are not very rational; shift the
equilibrium enough so that the old rules of thumb no longer apply and
we are likely to see bubbles, manias, panics and crashes. Significant innovation is thus almost always going to come accompanied with a wave of irrationality. When we shift to a significant, new equilibrium rationality itself is
not strong enough to tie down behavior and unmoored by either reason or
experience individuals flail about liked naked apes – this is the realm of behavioral
economics. Given time, however, new rules of thumb evolve and
rationality once again rules but only until the next big innovation arrives.
Summing up the AEAs
In case you missed the AEAs, Paul Kedrosky created a tag cloud (using Wordle) from the titles of all 505 papers. Paul is a little surprised that Keynes and crisis are not more prominent – don't worry just wait till next year!
The Nude Deal
Larry Flynt's plea for a porn stimulus plan has attracted much ridicule. Nevertheless, during the thirties burlesque was part of FDR's National Recovery Administration. Here's Jonathan Bean at The Beacon on the history.
The National Recovery Administration
(NRA) was the first New Deal effort at recovery. The agency mandated
that all industries draft “Codes of Fair Competition” to benefit
business and labor. NRA codes – all 700 of them –corporatized the
entire economy. Wage and price fixing was o.k. as the experimenters rid
themselves of old superstitions that price fixing was somehow harmful
to Mrs. Consumer. As long as everyone put in the “fix,” all would be well. The Supreme Court disagreed and ended the experiment in May 1935 (Schechter v. United States).
Yet there was an upside to the code-making. It made Americans
realize how complex the economy had become by 1933. After all, there
were codes for the Dog Food Industry (Code 450), Curled
Hair Manufacturing and Horse Hair Dressing Industry (Code 427),
Shoulder Pad Manufacturing (Code 262), and the Burlesque Theatrical
Industry (Code 348). The latter limited burlesque dancers to four strip
teases per evening. The goal was to spread the work, and it simply
wasn’t fair that the pretty girls got to strip more than the other
gals.
Comparing Recessions
It you look at job losses in this recession compared to previous recessions this recession looks very bad but the labor force is much bigger today than in previous recessions. Thus, if you look at the percentage change in employment you get a different story. The Minneapolis Fed crunches the numbers:
and
Of course, this recession is not yet over but this is useful information. We might not like it but recessions are normal.
Important Addendum: The Fed defines Mildest, Median, Harshest by taking the Mildest employment drop of any recession in that quarter and plotting that. Thus, the Mildest, Median, and Harshest recessions are Frankenstein recessions, cobbled together from other recessions. I do not think this is a good way to express the data. See this update for a better method.
Obama at GMU
President-Elect Obama just spoke at GMU. I was fortunate to have an invite. He had a number of good lines including as good a one-line explanation and justification for Keynesian economics as you will find:
Only government can break the cycle that is crippling
our economy, where a lack of spending leads to lost jobs, which leads
to even less spending, where an inability to lend and borrow stops
growth and leads to even less credit.
He emphasized that jobs would be created in the private sector and saved in the public sector. Nicely put.
His goal is "not to create a slew of new government programs, but a foundation for long-term economic growth." Very good.
In terms of long-term investment, I was pleased to see him mention the smart grid in particular, an idea I pushed as recently as today.
Overall, my view is that the Obama fiscal stimulus plan is evolving in a sensible direction. As promised, he is a pragmatist who is listening to a wide variety of well-qualified, centrist economists.
A substantial fraction of the fiscal stimulus is tax cuts, a substantial fraction is preventing state and local funding from plummeting, a modest but reasonable fraction is on maintenance and improvements of old infrastructure (projects that are mostly already on the books), and a modest (but increasing over time) fraction is on longer term projects which are likely to pay off in future returns.
At present, I see very little in the way of Keynesian pyramid building. Nor do I see an attempt to grab the revolutionary moment by the horns and push the U.S. in a new direction. Thus, thankfully, No New Deal. There is plenty of uncertainty in the economy but it’s not regime uncertainty.
Addendum: Do note that I am
evaluating Obama relative to what we can expect given the situation and
our current politics and also relative to say the New Deal.
The Smart Grid and the Fiscal Stimulus
Earlier I pointed out that a) regulatory problems have prevented investment in the smart grid and b) subsidies to wind power in some states have driven prices to negative levels (yes, people are being paid to consume power). These two problems are closely related.
The states control whether transmission lines get built but states with a lot of wind energy don’t have an incentive to build transmission lines to move the power out. In effect, states with a lot of wind energy are preventing exports which lowers their own internal price of electricity but raises everyone else’s price and reduces the use of wind power.
A new article in Technology Review makes the point.
One effect of these regulatory moves was that companies had less incentive to invest in the grid than in new power plants, and no one had a clear responsibility for expanding the transmission infrastructure. At the same time, the more open market meant that producers began trying to sell power to regions farther away, placing new burdens on existing connections between networks. The result has been a national transmission shortage….
[Many states have a lot of wind potential]…But the existing transmission system doesn’t have the capacity to get that much electricity to the parts of the country that need it. In many of the states in the [wind] region, there’s no particular urgency to move things along, since each has all the power it needs. So most of the applications for grid connections are simply waiting in line, some stymied by the lack of infrastructure and others by bureaucratic and regulatory delays.
Hat tip to Andrew Samwick who writes:
The federal government is the entity that can resolve that failure, by taking the lead and making those expansions itself. It can recoup its costs by levying a fee on subsequent power consumed through the grid. I hope the fact that we need this investment isn’t a reason for it to be excluded from plans for fiscal stimulus.
Cancer and Statistical Illusion
The cover of this month’s Wired promises "The Truth About Cancer" but the article inside is a tissue of misleading statistics and faulty logic. The article begins with fancy graphics telling us "If we find cancer early, 90 percent survive" but "If we find cancer late, 10 percent survive." And this:
Find the disease early "and the odds of survival approach 90 percent…This reality would seem to make a plain case for shifting resources toward patients with a 90 percent, rather than a 10 or 20 percent, chance of survival."
Thus, the opening block of text commands, "Scientists should stop trying to cure cancer and start focusing on finding it early. It’s the smart way to cheat death."
The fallacy in all of this is painfully easy to spot. If we measure survival, which these studies do, with a 5 or 10 year survival rate then obviously people whose cancers are detected early will survival longer than people whose cancers are detected late.
The key question is whether people who are treated early survive longer than people whose cancers are detected early but who are not treated. In Thomas Goetz’s long article there is not a single piece of evidence which demonstrates that this is true. Indeed, quite the opposite. About 9 pages into the article, after the jump, we find this about CT scans for lung cancer:
As with the Action Project, these studies found that, yes, CT scans detected a huge number of early cancers–10 times as many as they would expect to find without scanning. In that regard, the scans did their job as a screening test. And as expected, the number of surgeries based on those diagnoses jumped. But when Bach looked at the resulting mortality rates, he found essentially no difference between those who received a CT scan and those who had not. Despite the additional surgeries, just as many people were dying as before.
Nowhere does the author mentions that this finding invalidates just about everything he has told us in the first eight pages.
Addendum 1 : Do note that I have nothing against early detection and I am not claiming that it never works. My problem is with misleading statistical analysis.
Addendum 2: Careful readers will note that this is an almost perfect example of the economicitis fallacy that I blogged about late last year.
Economists v. Historians on the New Deal and the Great Depression
Writing at The Beacon Jonathan Bean nicely reminds us of Robert Whaples survey of economists and historians on questions in economic history. Among the questions that Whaples asked members of the Economic History Association to express agreement or disagreement on was the following:
Taken as a whole, government policies of the New Deal served to lengthen and deepen the Great Depression.
About half of the economists agreed (or agreed with some provisos) that the New Deal lengthened and deepened the Great Depression. Thus this point of view among economic historians is basically mainstream. Among historians there was much less agreement with the statement, although a significant minority, 27%, agreed, mostly with some provisos.
Good News
My chances of winning the John Bates Clark Medal just doubled. Oh wait, I am over 40. Damm…it’s still zero. Still, if you are an economist under the age of 40, your chances just doubled since the executive committee of the AEA has voted to make it an annual rather than a biennial award.
New Media Innovations
The Kauffman Foundation hosted a number of econ bloggers, including myself, at the AEAs to discuss blogging, communication and new media. Tim Kane at Growthology summarizes the stimulating discussion:
Some of things I learned include (1) the process of collaborative filtering is increasingly useful for discovery and evaluation, and a pioneer to watch is Slashdot, (2) commenting on blogs is arguably more valuable than posting for evaluating ideas … look for weighted commenting/evaluation systems to supplant formalized referee systems over time, (3) blogs are just part of the spectrum of idea sharing, as is journal publishing, and simply having a web page is now essential to be part of a research community, (4) good ideas can filter up much faster through the academic community thanks to blogs, (5) it is very difficult to determine what revenue models will sustain the print news media, but one possible trend to watch for is the return of ideological patronage (e.g. think tank magazines) — it’s not just advertising and subscriptions that will sustain the sector, (6) it’s still probably not advisable for graduate students or junior faculty to blog instead of focus on tenurable research … for now, and (7) if blogging is representative, then risk-taking entrepreneurship will thrive, even in a recession.
You will be happy to know that it was brought up in the discussion that the MR comment section is especially good so take it away readers.
Intelligent agent modeling
I am more optimistic about intelligent agent modeling than is Tyler. For one we already have an important, convincing, and Nobel-bestowed variant of intelligent agent modeling, namely experimental economics. Experimental economics uses one particular type of intelligent agent, the type based on…genetic algorithms. True, the intelligent agents used in I-A models are typically not as sophisticated as the agents used in experimental economics but they are rapidly improving. (Moreover, such agents are already important economic actors in their own right in limited areas, e.g. portfolio insurance, and they will continue to become more important as time continues.)
I see bringing experimental economics and I-A modeling closer as an important goal with potentially very large payoffs. Here, for example, is my model for a ground-breaking paper.
1) Experiment
2) I-A replication of experiment (parameterization)
3) I-A simulation under new conditions
4) Experiment under the same conditions as 3 demonstrating accuracy of simulation
5) I-A simulation under conditions that cannot be tested using experiments.
Now that would be a great paper. I-A agent modeling is already very useful for modeling contagion, peer effects, and highly non-linear environments. It will become even more useful when combined with experimental economics in a way that demonstrates the equivalence of the two types of intelligent agents.
Macroeconomics without Supply
Paul Krugman writes:
…if you believe that a surge in private spending would raise employment – and even the critics agree on that – it’s very hard to explain why a surge of public spending wouldn’t have the same effect.
Brad DeLong writes:
But surely we believe that if the U.S. government were to follow the Countrywide plan–to send its representatives out onto the streets to have them walk up to people and say: "Here’s $500,000. You can have it if you go buy a house"–then that would drive a recovery, right?
What’s interesting about these statements is not so much whether they are right or wrong (let’s just say that it depends) but that Krugman and DeLong are so immersed in the Keynesian viewpoint that they cannot even see any other way of looking at the issue. Thus "even the critics" and "but surely we believe," as if no other view were conceivable.
Well if the only frame you can see is the "spending increases employment" frame then whether the spending is private or public may seem like a niggle. But many of the critics of mass fiscal stimulus have an alternative frame in mind, namely, that "employment increases spending."
Frame the issue this way and it becomes clear that the choice between private employment and public employment as a driver of spending is crucial. Moreover, when we remember that employment drives spending we focus attention on the real allocation of labor and capital across sectors of the economy, on internal and external fiscal balance, on investment as well as on consumption and on time paths of development. The "spending drives employment" frame misses all this.