The value of microfoundations

by  Tyler Cowen in

Here is Noah Smith on microfoundations, responding to Matt Yglesias (here and here, here is also a Krugman post on the topic).  I am usually pro-microfoundations, though without any particular philosophy of science-derived attachment to the idea.  Here is why:

1. In some very important, simple, and intuitive models, there is nominal stickiness but money is still neutral.  Caplin and Spulber 1980 is one of my favorite pieces and time spent studying their model will be repaid with value.  I don’t think the model applies to 2007-2009, or say 1929-1933, when we have “out of the ordinary” shocks, but it may apply to many other time periods.

2. Often the data suggest that money is neutral or roughly neutral or at least the data are not inconsistent with neutrality.  I know that one does not hear much about that in today’s economics blogosphere, but I kid you not.  Again, I differ strongly from this literature for “the times which really matter,” such as 2007-2009 or 1929-1933, but still I take the data seriously.  Try this relatively “atheoretical” piece by Harald Uhlig, which does not reject monetary neutrality (nor does it cover 2007-2009).  Nominal stickiness models have trouble explaining why money doesn’t matter more than in fact it does.  Understanding microfoundations will keep you out of the trouble you will get in if you keep trying to use money to expand output.

3. We can try to nudge people into more flexible wages, but again that requires some understanding of microfoundations.  The Fed can prevent any risk of a deflationary downward spiral, and please note it is no coincidence we are in the two percent inflation range.  You don’t have to view this as a high return activity to favor it  (it is funny how the mere mention of wage nudges will cause many people to suddenly turn against the nudge idea, at least temporarily.)

4. Microfoundations don’t have to mean intertemporal maximization with extreme assumptions about rational or well-behaved preferences.  George Akelof has written some of the best papers on microfoundations.  Nor do microfoundations have to mean staking out an extreme position on the Lucas critique.

5. There are plenty of flex-wage professions which still have been seeing high unemployment.  Like real estate agents.  Or what happened to all those Mexicans who used to stand around on street corners?  Were their wages sticky too?  I don’t think so.  Does their return to unemployment or underemployment in Puebla refute the sticky wage model?  I personally don’t think so, but it’s hard to answer that question — an obvious one to a critical observer — without a clear sense of microfoundations.

6. Just how bad is monopoly?  We wish to know when designing a competition policy.  Under some microfoundations models, the existence of market power is essential for ongoing stickiness, in other models not.  This question matters, and we need microfoundations to better resolve it.

7. Should a government subsidize, tax, or be neutral toward contract indexation?  Try answering that question, or even getting started on it, without some sensible microfoundations.

8. If you are trying to end a hyperinflation or high rate of inflation, do you need to get fiscal policy right, in some kind of credible manner, before enacting monetary restraint?  It is hard to imagine answering this question without good microfoundations.

I could go on.  I am worried that people are rejecting microfoundations because they think microfoundations imply objectionable attitudes toward macro policy.  But note: if those attitudes are objectionable and indeed wrong, they won’t be implied!  It is entirely defensible to argue “we should have a more expansionary monetary policy today, even without the microfoundations to support that view.”  It is much tougher to argue “economics should deemphasize microfoundations altogether.”  The broader the range of questions one considers, the more important microfoundations turn out to be.

A password so secret even you don’t know it

by  Tyler Cowen in

From Rebecca Rosen:

Researchers from Stanford, Northwestern, and SRI have a new paper laying out a crafty little solution: Make people memorize passwords that they don’t know. If you don’t know your password, you can’t tell it to anyone.

Huh? How can you have a password you don’t know?

Perhaps the best analogy is the playing of a song on a musical instrument. If you’ve ever memorized a piece of music, you know that, given the instrument, you could play it no problem. The piece is in your muscle memory. But given a staff sheet and a pencil, writing it out would be a challenge. You would need to thump it out with your fingers and write down your observations, but you don’t just know the order of the notes.

…The catch is that unlike a piece of music, for which you’ve memorized a sequence that someone could, perhaps, record if they watched you tap it out enough times, this system then “tests” whether you are the real you, by having you “play” all sorts of strands, with the ones you’ve practiced mixed in. Only someone who has received the training will play their own sequences more smoothly and rapidly. “A performance gap that is substantially different from the one obtained after training indicates an attack,” the authors explain.

In effect, the software is creating a code by which you can say, I am who I say I am, and the computer recognizes it. Of course, all passwords convey that to some extent, this one is just much, much harder to pass on.

CBO forecasts Medicaid Wars

by  Tyler Cowen in

In 2022, for example, Medicaid and the Children’s Health Insurance Program (CHIP) are expected to cover about 6 million fewer people than previously estimated, about 3 million more people will be enrolled in exchanges, and about 3 million more people will be uninsured…

Only a portion of the people who will not be eligible for Medicaid as a result of the Court’s decision will be eligible for subsidies through the exchanges. According to CBO and JCT’s estimates, roughly two-thirds of the people previously estimated to become eligible for Medicaid as a result of the ACA will have income too low to qualify for exchange subsidies, and roughly one-third will have income high enough to be eligible for exchange subsidies.

There is more here.

Iceland and Ireland

by  Tyler Cowen in

From a new Mercatus working paper by David Howden, here is the conclusion:

When the tale of these two crises is told, the conclusion is typically that one set of policies was more beneficial than the other. In this paper we have shown that the truth lies somewhere in the middle. Icelanders have benefited by evading a debt overhang through an undue bank bailout that has shielded entrepreneurs and investors from losses. The Irish commitment to open capital flows and willingness to reduce domestic prices to regain competitiveness has allowed prices to return to levels necessary for entrepreneurs to use as signals to invest. Countries facing similar crises—be they currency, banking, or general economic crises—would be well-advised to heed these two lessons when drafting recovery plans of their own.

The future of the war on drugs

by  Tyler Cowen in

At the same time, one branch of that thinking has itself evolved into a new project: the notion of creating downloadable chemistry, with the ultimate aim of allowing people to “print” their own pharmaceuticals at home. Cronin’s latest TED talk asked the question: “Could we make a really cool universal chemistry set? Can we ‘app’ chemistry?” “Basically,” he tells me, in his office at the university, with half a grin, “what Apple did for music, I’d like to do for the discovery and distribution of prescription drugs.”

Here is more, hat tip goes to the excellent Eli Dourado.

From Scott Sumner (I agree)

by  Tyler Cowen in

It’s beginning to look like Keynes was wrong about liquidity traps, at least when he argued that there’s a certain minimum nominal yield that government bond investors demand, and that long term rates can be reduced no further.  Wherever people draw a line, bond yields just seem to plunge right through, to one record low after another.  And we know from Japan that they can go even lower.  But what does this mean?

It probably means multiple things.  For instance it suggests that the Keynesian/market monetarist AD pessimists and the Great Stagnation AS pessimists are both right.  We are looking at BOTH low inflation and low real GDP growth for many years to come.  Why don’t I think AD explanations are enough?   Partly because even the 20 year T-bond now has a negative real yield. Indeed it suggests the Bernanke “global savings glut” hypothesis is also correct, a point I’ve argued previously.  Japan is the future of the world.

Here is more.  And this:

The rate of nominal GDP growth in the US over the past 3 years has been above 4%, which is considerably higher than in Japan.  I would have thought that might well be enough.  (The fact that it wasn’t makes me think Japan is light years away from exiting the zero bound.)

Gary Gorton’s *Misunderstanding Financial Crises*

by  Tyler Cowen in

Everything by Gary Gorton is worth reading.  I am not sure when this book is due out (Amazon claims Nov.2012), but it is not out yet.  The link is here.

Imagine a rewriting of earlier American financial history, though the lens of our recent financial crisis and extant ideas about bank runs through the shadow banking system.  Here are two short bits:

And interestingly, the figure below shows that capital input was actually higher in countries that did not have capital requirements.

…Bank capital was not the focus of bank regulation until recently.  In the 1980s regulators began focusing on bank capital as a buffer against idiosyncratic bank failures and associated losses that could have bankrupted the deposit insurance fund.  But it has been recognized that historically systemic bank crises are about cash.  They can be prevented or mitigated by the design of regulatory infrastructure, whether it is public or private.  They cannot be prevented by bank capital.

Recommended!

Sicily fact of the day

by  Tyler Cowen

In lieu of the Austerians:

Today, Sicily’s regional government has 1,800 employees — more than the British Cabinet Office — and the island employs 26,000 auxiliary forest rangers; in the vast forestlands of British Columbia, there are fewer than 1,500.

Out of a population of five million people in Sicily, the state directly or indirectly employs more than 100,000 of them and pays pensions to many more. It changed its pension system eight years after the rest of Italy. (One retired politician recently won a case to keep an annual pension of 480,000 euros, about $584,000.)

Here is more.

Honduras may appeal to London courts

by  Tyler Cowen in

Tricky legal dispute in Central America? Sort it out in the London courts. Honduras, the state with the highest homicide rate in the world, is preparing to send appeal cases to the judicial committee of the privy council (JCPC) in Westminster.

The extraordinary expansion of UK legal jurisdiction is being negotiated in an effort to support the development of a pioneering enterprise zone in the crime-scarred republic.

The Honduran government is establishing what amounts to semi-independent city states, hoping that improved governance backed by international partners will attract business investment and create employment.

The complex constitutional agreement under discussion involves Mauritius – an island 10,000 miles away in the Indian Ocean – guaranteeing the legal framework of the courts in the development zones, known locally as La Región Especial de Desarrollo (RED).

Here is more, and for the pointer I thank P.

There Will Be Blood

by  Alex Tabarrok in

Economists often reduce complex motivations to simple functions such as profit maximization. Writing in The Economist, Buttonwood ably criticizes such simplifications. Buttonwood is too quick, however, to conclude that simplification falsifies. For example, Buttonwood argues:

If there is a shortage of blood, making payments to blood donors might seem a brilliant idea. But studies show that most donors are motivated by an idea of civic duty and that a monetary reward might actually undermine their sense of altruism.

As loyal readers of this blog know, however, the empirical evidence is that incentives for blood donation actually work quite well. Mario Macis, Nicola Lacetera, and Bob Slonim, the authors of the most important work on this subject (references below), write to me with the details:

The decision to donate blood involves complex motivations including altruism, civic duty and moral responsibility. As a result, we agree with Buttonwood that in theory incentives could reduce the supply of blood. In fact, this claim is often advanced in the popular press as well as in academic publications, and as a consequence, more and more often it is taken for granted.

But what is the effect of incentives when studied in the real world with real donors and actual blood donations?

We are unaware of a single study of real blood donations that shows that offering an incentive reduces the overall quantity or quality of blood donations. From our two studies, both in the United States covering several hundred thousand people, and studies by Goette and Stutzer (Switzerland) and Lacetera and Macis (Italy), a total of 17 distinct incentive items have been studied for the effects on actual blood donations. Incentives have included both small items and gift cards as well as larger items such as jackets and a paid-day off of work.  In 16 of the 17 items examined, blood donations significantly increased (and there was no effect for the one other item), and in 16 of the 17 items studied no significant increase in deferrals or disqualifications were found.  No study has ever looked at paying cash for actual blood donations, but several of the 17 items in the above studies involve gift cards with clear monetary value.

Although many lab studies and surveys have found differing evidence focusing on other outcomes than actual blood donations (such as stated preferences), the empirical record when looking at actual blood donations is thus far unambiguous: incentives increase donations.

Given the vast and important policy debate regarding addressing shortages for blood, organ and bone marrow in developed as well as less-developed economies, where shortages are especially severe, it is important to not only consider more complex human motivations, but to also provide reliable evidence, and interpret it carefully. The recent ruling by the 9th Circuit Court of Appeals allowing the legal compensation of bone marrow donors further enhances the importance of the debate and the necessity to provide evidence-based insights.

Here is a list of references:

Goette, L., and Stutzer, A., 2011: “Blood Donation and Incentives: Evidence from a Field Experiment,” Working Paper.

Lacetera, N., and Macis, M. 2012. Time for Blood: The Effect of Paid Leave Legislation on Altruistic Behavior. Journal of Law, Economics and Organization, forthcoming.

Lacetera N, Macis M, Slonim R 2012 Will there be Blood? Incentives and Displacement Effects in Pro-Social Behavior. American Economic Journal: Economic Policy 4: 186-223.

Lacetera N, Macis M, Slonim R.: Rewarding Altruism: A natural Field Experiment, NBER working paper.

Immigration to Australian jail

by  Tyler Cowen in

MANDATORY sentencing — a key element of Labor’s policy to deter asylum boats — is having the opposite effect, encouraging Indonesian crew attracted by Australia’s relatively high prison pay.

Lawyer and former diplomat Anthony Sheldon says jailed crew members can make $20 a day in Australian jails, in his submission to the Gillard government’s expert panel on asylum-seekers.

Sadly, the rest is gated…but there is also this bit:

“The preference of a number of older fishermen is to remain in detention in Australia,” Mr Sheldon says in the submission.

“Depending on their jobs in prison, they can earn up to $20 per day, making them wealthy beyond comparison upon their return to their villages after their sentence is served.

“They also receive free dental and medical services during their imprisonment. “Combined with the relative safety of their work in prison compared to the dangerous work at sea, Australian imprisonment is very desirable.”

For the pointer I thank Philip Hegarty.