Sunday, November 23, 2014

Why


To speak of cause and effect in economics, one must have in mind some kind of model.  It may be an entirely subconscious model, or a model spelled out in theory but never quantified or tested, or an explicit, quantified model that has been subjected to careful testing and scrutiny. I need hardly add in which sort I have the greater confidence.

Friday, November 21, 2014

Columns in a spreadsheet go up-and-down, like columns in a building. Rows go across.


Following up on the post of 18 November...

When I picture an economic model, I picture doing it in a spreadsheet. I need a column for "Year", one for "GDP", one for "Debt", one for "Addition to Debt", and stuff like that -- whatever it turns out that the calculation seems to need. And then, make a row for each year of the model's life. I plug in a few numbers on the top row, then fill the rest of the first couple rows with calculations. And that's it.

I copy my last completed row down to the rows below, for each year of the model's life, 50 years maybe.

The trick is to plug in the right calculations. Those calcs want to mimic the actual relations between GDP and Debt and Additions to Debt and stuff, or what I imagine those relations to be. You know: If we spend a little less, we save a little more this year, but our reduced spending could affect GDP next year. Those kinds of relations.

When the bug bites I'll set up a spreadsheet like that and mess with it for a while, changing calculations, adding columns for new quantities, and looking at graphs of the resulting data.

I never manage to get graphs that mimic graphs of economic data. So I play with it for a while, then set it aside.


After I wrote the notes above, I went and read the first few pages of Clopper Almon's The Craft of Economic Modeling. Actually, Clopper says "The first section of chapter 1 does not require the use of computers." I printed out those six pages, so I could hold them in my hand.

Looking at the equations like

C = .6*Y[1] + .35*Y[2]

and

Q = C + I + G + X - M

where C is Consumption and Q is output, it occurred to me that each of the equations in the model could fit to a column of my spreadsheet. You copy the equation down the cells of the column to get each year's number. Oh -- you leave out the Q to the left of the equal sign, and you put the equation in the column that you have labeled Q!

Do you know how long it took me to figure that out???

So each of the equations in a model can be a column in a spreadsheet. Understanding this helps me understand economic models. What I've been doing for all these years is making a column for each variable I want to calculate, and then fudging the equations without ever really getting to look at the equations. I would start out with something that made sense to me, and keep filling in blanks until I had two or three rows worked out, then copy the last row down to represent 50 years or so, and then graph it.

Then I'd look at the graph, decide it didn't look right, and start tweaking my equations. First it would be adding columns to get more variables, and then working those variables into calculations and copying them to the rows below. Then it was things that made less sense, but might have some bearing. After a while it would be acts of desperation, just trying to come up with numbers that would produce a graph I could live with. And then I'd put the thing aside for a while.

I think it's probably better to pull out the equations so you can look at them like Clopper does, like I always see when somebody is describing a model.

But at least now I know: If there's two equations I need two columns in a spreadsheet for variables; if there's six, I need six.

No, no -- I'm not going to work only in spreadsheets. I want to download the free G7 software and learn how to use it. But I have to get there at my own pace. And I have to start with what I know.

Spreadsheets it is, then.

Tuesday, November 18, 2014

how to understand an economic model


So I finally Googled how to understand an economic model, something I really need to understand.

It was the article of the week at Reddit that drove me to it. I didn't read the linked article, just the comments on it at Reddit. Integralds lays out an overview of growth theory, of the development of growth theory, what standerby calls a "timeline of thought". It's easy reading, just a summary of developments. But it's impressive.

I didn't even click on any of the links. It wouldnt do me any good. Every time they start laying out a model my brain becomes impenetrable. Said to myself I need to know how to understand an economic model. Next thing I knew, it was Googled.

The fourth item in the Google results -- and the first one I hadn't been to before -- was The Craft of Economic Modeling, Part 1 (PDF, 149 pages) by Clopper Almon. Here's two bits of it, from the intro:
Simply put, an economic model is a set of equations which describe how the economy or some part of it functions. In my view, a model should incorporate and test our understanding of how the economy works. Its equations should make sense. And it should be possible to test how adequate our understanding is by running it over the past and seeing how well it can reproduce history. By changing some of its assumptions and rerunning history with the changed assumptions, it is possible to analyze the effects of policies. Finally, it should be useful not only for policy analysis but also for forecasting. By studying the errors of the forecast, the builder of the model may hope to improve his or her understanding of the economy.

Some of the equations in our models have constants which describe the behavior of firms, consumers, or other economic agents. These constants, often called "parameters", must somehow be estimated. The most frequently used way is by choosing them so that the equation describes accurately the behavior of those agents in the past. Thus, estimating the parameters is just a way to sum up the lessons of the past to forecast the future or examine how the past itself might have been different had different decisions been made. A large part of this book is about how to do that...

Yeah, I have to read this. I know, 149 pages. Usually if the page count is more than a single digit I start to worry. But I have to read this.

Oh yeah, one more thing:
The computer software, the G regression package, version 7.3, (referred to as G7) and the Build model builder, are comprehensive, easy-to-use programs that run under Windows XP and Windows 7 or 8. They are designed for work with time-series data. Public domain versions accompany the book or are available via Internet (www.inforum.umd.edu), where thousands of economic time series are also available as data banks for G7. Assembling equations into a model requires the use of the Borland C++ compiler, which is also available for free download...

Oh, my.

Monday, November 17, 2014

"An extremely persistent slowdown in long run growth rates since the 1970s"


Gavyn Davies, from his blog at FT:
NOTE: Davies' two "here" links didn't work for me, so I disabled them.
Three of my colleagues at Fulcrum have been examining the behaviour of long run GDP growth in the advanced economies, using developments of dynamic factor models to produce real time estimates of long run GDP growth rates. See the summary paper here by Juan Antolin-Diaz, Thomas Drechsel and Ivan Petrella, and the more academic version here.


The results (Graph 1) show an extremely persistent slowdown in long run growth rates since the 1970s, not a sudden decline after 2008. This looks more persistent for the G7 as a whole than it does for individual countries, where there is more variation in the pattern through time.

Averaged across the G7, the slowdown can be traced to trend declines in both population growth and (especially) labour productivity growth, which together have resulted in a halving in long run GDP growth from over 4 per cent in 1970 to 2 per cent now.

Impressive graph.

EDIT: Crossing things out:
I remember, probably 30 years ago, reading a review of a book by Glynn and Gavyn Davies. It was... At the time, the name of the book reminded me of Sidney Homer's A History of Interest Rates. I think the title was A History of Money. Glynn was Gavyn's father. This is all from memory; I could have it all wrong.

There ya go. The title: A History of Money: From Ancient Times to the Present Day. Author: Glyn Davies, only one "n". Maybe Gavyn wrote the review? I definitely remember both names. First published in 1994, according to Amazon; I was way off on the date. Price of the hardcover book, new, at Amazon? "From $2000". Oh, maybe that's why I didn't buy the book.

Anyway, that graph is huge.

Sunday, November 16, 2014

Rooting for inflation?



From VOX: The NAIRU, explained: why economists don't want unemployment to drop too low by Matthew Yglesias:
A middle ground would be to argue that perhaps the NAIRU did correctly characterize the economy of the 1970s. Back then, after all, a large share of the American workforce was represented by labor unions. Union contracts often included clauses that provided for automatic raises in the case of inflation. It's easy to see why any particular person would love to have such a clause in his contract. But it's also easy to see how widespread use of such clauses could inadvertently set off a spiral. Whether or not this was the case three or four decades ago, it's not a major issue in the American economy today, when many fewer workers have such contracts.

That's the whole paragraph. Here's the piece of it that's relevant for today's post:

It's not a major issue in the American economy today,
when many fewer workers have such contracts.

If you're thinking a little more inflation would help reduce our debt, you might want to think about whether your paycheck would be seeing that inflation. Debt doesn't inflate when wages inflate, so inflation can be helpful (though I do not favor that solution). But if prices inflate and wages do not, increasing inflation will leave us in worse shape than we're in now.

Saturday, November 15, 2014

"The role of the state in economic growth"


From the Abstract of The role of the state in economic growth (PDF, 59 pages) by Erik S. Reinert:

This paper attempts to trace and describe the role played by the government sector -- the state -- in promoting economic growth in Western societies since the Renaissance. One important conclusion is that the antagonism between state and market, which has characterised the twentieth century, is a relatively new phenomenon. Since the Renaissance one very important task of the state has been to create well-functioning markets by providing a legal framework, standards, credit, physical infrastructure and -- if necessary -- to function temporarily as an entrepreneur of last resort.

Friday, November 14, 2014

Real Adjusted Total Bullshit


Some time around 1994 apparently they changed the definition of M1 money. Before 1994 the definition of M1SL money included "sweeps". After 1994 it didn't.

So now, if you want to look at the same money measure before and after 1994, you have to look at what's called "M1 Adjusted for Retail Sweeps", or M1ADJ.

But this nomenclature is wrong. It's backwards. They changed the definition of M1 money, M1SL. That was the change. So when you look at M1SL, what you see after 1994 is not the same measure as before 1994. When they made the change, they should have made a new series to show the new numbers. This new series is the one that should have been called "adjusted for retail sweeps". I should be able to look at the old M1 money series M1SL and not see numbers that change suddenly and dramatically because of the adjustment.

Graph #1: M1SL (blue) and M1ADJ (red)
The data series title "M1 Adjusted for Retail Sweeps" implies that the change occurs in the M1ADJ data series, when really the change occurs in M1SL, the data series whose title makes no mention of the adjustment.

This is exactly the same kind of deceptive language you get when economists take GDP -- a measure of the stuff we actually bought, at prices we actually paid for it -- when they take GDP, and take the inflation out of it, and call the result "real" GDP.

Total bullshit.

Thursday, November 13, 2014

U.S. Public and Private Debt Relative to GDP, 1916-1970


Graph #1

... and the more recent picture:

Graph #2

Work with me here.

Graph #1 shows private debt (red) at a high level in the 1920s, and rising. Public debt was low by comparison, but drawn upward by troubles -- World War One, and the Great Depression, and World War Two. From around 1933 private debt started falling, finally (during World War Two) falling below the level of public debt.

After the time of troubles, public debt (blue) started falling. Private debt (red) started rising. And our economy had a Golden Age.

Graph #2 shows that, after the Golden Age, public debt (blue) fell a little more, then leveled off, and finally started rising. Rising since about 1980. After the Golden Age, private debt (red) continued to rise, then continued to rise, and finally rose until the sudden crisis that occurred just before 2010.

The late peak, just before 2010, I want to compare it to the 1930s peak during the Great Depression. I want to compare the two situations. The two sets of circumstances.

Before the time of the first peak, private debt was high. But then it fell severely. Public debt grew in response to the troubles, and finally public debt rose above the level of private debt. Soon thereafter, the troubles disappeared.

Before the time of the second peak, private debt was high. And it continued to rise without letup. Public debt grew in response to troubles that arose, but private debt continued to grow faster than public debt, Therefore, there was no end of troubles after 1974. There was no end of troubles after 1987. And there is no end of troubles today.

What's different about the two peaks? What's different is the growth of private debt. During the Great Depression, private debt collapsed. But since that time -- since the end of the Second World War -- there has been no collapse of private debt. No collapse until the crisis. Private debt only grew higher.

And if you think of it in simple terms, you can see that the end of troubles for some reason requires public debt to rise above the level of private debt (just as it did in the 1940s).

Well, that was easy to do in the 1940s, for private debt was falling.

Since probably 1966 we have needed public debt to again rise above the level of private debt. But this has been impossible to achieve, because private debt has been rising faster than public debt.

The people who say we need more Federal spending are right, except for one thing. Federal spending has been "more" since 1980 and it has not solved the problem. It has not solved the problem because private debt is not falling.

Private debt is growing faster than public debt. That is what has to change.

You with me?

Wednesday, November 12, 2014

"This was a direct challenge to Keynesian-style fiscal policy and ushered in monetarism."


From my monthly RePEc stats I got to Top 25 Working Papers by File Downloads 2014-10, where the top item was How did we get to where we are now? Reflections on 50 years of macroeconomic and financial econometrics by Michael Wickens.

It's a 53-page PDF; I'll never get to the end of it. I have to say, though, that it is fascinating -- and easy reading, far as I've got. This is from the opening of Section 2: Macroeconomic models:
This procrustean approach to macroeconomic modelling was challenged by a number of undermining analyses that achieved considerable prominence and led to the increased use of small-scale models. One of the first such studies was by Anderson and Jordan (1968) who found that in a simple regression of output on distributed lags of the money supply and government expenditures, it was money that was significant and not government expenditures. This was a direct challenge to Keynesian-style fiscal policy and ushered in monetarism.

So by page eight, I tripped over the sentence that serves as the title of this post, sending me off in search of Anderson and Jordan (1968). I want to know what years Andersen and Jordan studied, that gave them the results they got.

Why? Because the economy changes, that's why.


Anderson and Jordan found that
it was money that was significant
and not government expenditures.


Andersen and Jordan turned up at the St. Louis Fed: Monetary and Fiscal Actions: A Test of Their Relative Importance In Economic Stabilization (PDF, 14 pages).

Andersen and Jordan:

The data are seasonally adjusted quarterly averages for the period from the first quarter of 1952 to the second quarter of 1968.

So, yes: The Andersen & Jordan paper examines the economy's reactions in a brief window at a time when the economy's performance was particularly good.

The irony is that the economy's performance in the 1950s and '60s was particularly good because of the large amount of government expenditures in the 1940s.