Irwin's Alchemists

I've finally made my way through Neil Irwin's The Alchemists, and it's been a worthwhile trip. Well: it's been a long slog actually, but that remark isn't nearly as negative as it may sound. In many ways it's a very good book, sometimes spectacularly good. And while it has its limitations, I have to admit I'd be hard put to know how to make it much better.

Anybody who reads this far will already know the terms of engagement: Irwin proposes to bring us up to date on three central bankers: Ben Bernanke (of course); Jean-Claude Trichet, president of the European Central Bank from 2003 to 2011; and Mervin King, governor of the Bank of England from 2003 to just this year. In short, the three most powerful voices in banking during the late uproar (for extra credit: who is the Ben Bernanke of China?).

It's a promising framework and it almost works, with the qualification that the institutional limits on Trichet were strong enough that it makes him hard to compare. And like it or not—the Brits will not like it—the hard fact is that Britain comes across as a second-tier player, mostly mired in its own problems, sometimes buffeted by its larger neighbors.

There's an additional problem that I will specify in the moment, but first the good stuff: Within the limits of the engagement, Irwin has done a splendid job of marshaling and presenting so much abstruse material. Clearly, his time out at Columbia Business School served him well: he's got a (seemingly) easy mastery of arcanae of central banking, with a good teacher's knack for making the tough stuff accessible. If nothing else, you could do worse than pull this one down whenever you need to pretend that you understand the virtues and limitations of, say, inflation targeting or the twist. [Just as an aside: would I be right that financial journalism has improved markedly since 2008? Back in the old days, we had Greg Ip: now we have half dozen or more first-stringers who can go pretty much toe to with their sources. Brad DeLong likes to ask why we can't have a better press core. I wonder if maybe we have one).,

There's a limitation, as I've already suggested, in that the three stories are not quite comparable: even though they overlap, each faced his own issues with his own tools and institutional limitations. A bigger problem is the focus on central banking. For good or ill, the point (which the book makes abundantly clear) is that central banking could serve at best as only part of the solution. If you're an American reader, you probably already understand that; you whatever fiscal policy emerged in Washington between 2008 and today was a joint effort of the Fed and Treasury. You can't really blame Irwin for not telling the whole story—his book would have been twice as long and many times as unwieldy had he tried—but you really are getting only part of the picture without it. The European situation is even stranger, what with its multiple sovereignties and its single currency. I don't feel I have much of a handle on it, but my consolation is I really don't think anybody else does either. The British experience is simpler, but perhaps starker. King seems to have been unconstrained about dipping his finger into the political pot (you get the impression that Irwin really doesn't like King very much). British leaders do seem to have made some catastrophically bad decisions lately, but for the most part, hey, it's only Britain and how much can it matter?

In short, I'm just as glad Irwin didn't try to tell us "the full story.” But if we want “the full story,” we'd better have read—or be prepared to read—somebody else.

A difficulty, less important than the others, but it may account for my feelings of slog. Irwin shares a vice with a number of journalists-turned-bookies, and that is: the closer you get to the present, the more you feel like you are reading the pages of his notebook, the less you get by way of sustained analysis. At times, I found myself remembering what Dr. Johnson said about Paradise Lost. On the other hand, I'm glad I read that one, too.

I'm Not an Economist But ... [IS-LM and What they Teach in 1A]

This may be old stuff to everybody but me but this morning I was reading Krugman on IS-LM and a light dawned about econ is taught to beginners, and later to others (it's a wonderful piece, by the way, whether my inferences are correct or not).

Here's the deal: in 1A (and again in 100A) we all learn boot camp supply and demand: price goes down, demand goes up.  But it turns out that macroville, it doesn't quite work that way.  As K says: 

 [W]e are at minimum talking about two variables, not one – GDP as well as the interest rate. ... That means that loanable funds doesn’t determine the interest rate per se; it determines a set of possible combinations of the interest rate and GDP, with lower rates corresponding to higher GDP. And that’s the IS curve.

So far so good.  But what struck me is that this is only one place where the 1A relationship doesn't hold.  Here's another: call it "Soros reflexivity" or if you want to be less hifalutin, just "herd behavior."  Anyway, suppose everybody starts to dump BigCo stock.  From 1A,  you would think that the drop would draw new buyers into the market and firm up the price.  But no: a big drop may lead to an even bigger drop--ask former British Prime Minister John Major what George Soros did to the pound, and watch him sputter.  Which, again, is not what they taught us.

I can think of another: portfolio insurance.  You can sketch a fairly simple model (ninth grade algebra only) where you buy some stock and protect against losses by buying some bonds.  You here the stock is going into the dumper, you want to stay insured so you sell even more stock, driving the price down further (use the same model--this may look like a special case of the previous example but I think the motivation is different.)  It's what (a) did (b) did not cause the flash crash of '87.

There's also the little matter of Giffen goods--price of potatoes go down, people buy fewer potatoes.  Actually I gather this one they sometimes do teach in 1A but I don't think anybody believes there are (m)any Giffen  goods to begin with.

That's it.  Maybe there are more. But my point is that the world is a lot more complicated than it looks in 1A.

The Thought of Alan Greenspan in a Bathtub Is a Bit Unsettling, Though

MacroMan (via Ritholtz) thinks Greenspan cribbed it from Shiller.  Shiller returns the serve.

More on Macro Books

I spoke my piece last night on Mark Thoma's exposition/defense of macro.  I have no instinct to restate or reconsider, but I do want to offer a brief extension of remarks.

Specifically: Thoma's list, however respectable, is pretty abstruse and technical, way above the ordinary reader.  By which I mean me: I should say I assume it is respectable but I'm really not informed enough to judge any of the works he offers.  

Which set me to wondering: is there anything in macro from which the attentive outsider might actually gain enlightenment?  Of course in the nature of things, I cannot say, but I do herewith offer a few titles that gave me some satisfaction.  One: David A. Moss' A Concise Guide to Macro* Economics (2007), written, I gather, for the uninitiated among students at the Harvard Business School.  I'm a great admirer of Moss' When All Else Fails (2002) about "government as the ultimate risk manager."  The Guide gives me at least the illusion that I am actually learning something.   In the same vein with a somewhat different teaching strategy, I find I have not yet thrown away my copy of Peter Kennedy, Macroeconomic Essentials (2d ed. 2000).**

Harder but still accessible, I think: Buce Champ and Scott Freeman, Modeling Monetary Economies (1994), with equations and graphs that do not require an undue amount of heavy lifting.  Dryer but mostly readable, Peter Bernholz, Monetary Regimes and Inflation (2003), the summary of  life's work in studying the topic. 

And to round out five, I suppose I can throw in a novel--Arthur G. Solmssen's  A Princess  in Berlin (1980) about the legendary Post-WWI calamity in Germany (thanks again, TaxMom, this is your copy and yes, I should return it).

Final defensive thought: I suppose a critic will carp that Thoma was really writing about econometrics, not macro. I remarked last night that I think this a mischaracterization. In any event, I've never found anything remotely helpful for basic econometrics (Angrist and Pishke, Mostly Harmless Econometrics) ought to be banned under the Trade Descriptions Act.
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*One word or two?  I know the accepted convention is "one," but I perversely want to stick with two.  And Moss had it as two words on his cover.

**It occurs to me there may very well be a later edition, but I am too lazy to check.

Known Unknowns, and our Enduring Malaise

Had an interesting, if inconclusive, discussion this morning with my friend about Ignota about what we (know) (do not know) about the enduring malaise, and how that affects our impulse to deal with it.  I think Ignota's analysis (crudely oversimplified) goes something like this: we live in a world increasingly dominated by financial elites who have no incentive to tell us "the truth."   And this pervasive lack of motivation is aggravated by an overriding irony: in fact, they don't have any idea themselves what went wrong, or how to set it right.

This is interesting, and I don't want to reject it out of hand, though it seems to me more complicated than my primitive summary.  I'd certainly agree, at least in broad outline, that we live in a world more and more dominated by financial elites who really don't give a rat's patootie about the ordinary functioning of good government (saying nothing of more contentious issues like succoring the dispossessed and whatnot).

But as to "know":  I think a difficulty here is that this matter of known/unknown breaks out into a number of  independendent (albeit overlapping and interrelated) issues.

One: algorithmic trading.  Ignota has just lately focused her attention on the remarkable fact that so much market activity is being carried on by robots acting on galactic volume at galactic velocity..  She's certainly right about the novelty of the trading.  I'd concede that there is so much difference of degree here we must have a difference of kind.  Yet I guess I'd rank this one rather low on the ladder of issues that rattle me.  The whole point of markets has always been that we never know exactly what is going on out there and that, indeed, our ignorance of the inner workings more feature than bug.

Two: "macro," by which I mean the stuff conventionally taught in Econ1B and  its ilk: Keyesianism, monetarism, money supply, pump priming,booms and busts and suchlike.  Now here, I think she really is onto something.  Face it, the failure of the good and great in macro is simply appalling--so much so that I can't understand why the entire sodality didn't just resign its tenured positions, put on false mustaches and retire to a monastery (assuming one would take them).  Remarkably, I think a good many macro types did understand the flaw in their enterprise: it is the utter impossibility, systematic and in principle, to forecast future behavior.  I've been there, done that, in a small way.  In the law school, I've sketched out those "models" (fables) where we identify possible future states (windy/rainy/cloudy/sunny), attached probability weights to them and sum to a value.  Like most, I've usually forgotten to say--you know this is all hokum. The truth is, we haven't the foggiest notion what will impel people to act one way or another, and how they will act when so impelled.  We know that  but we continue to build models that assume people behave like robots (for a tantalizing possible exception, go here).  I don't know if "the elites" understand how vacuous this modeling has proven to be; at any rate, if they did have the impulse to tell "the truth," on this issue, it is hard to imagine just what they would say.

Three, the nature and structure of banking.  Now here, I think we do know quite a bit.  We understand that the structure of banking has undergone a sea change over the past generation, almost entirely to the profit of bankers and the expense of everyone else.  There are some disagreements over remedy (do we, or do we not, need to go back to Glass-Steagall?).  But there is fairly general agreement (even among the elites) that a smaller, tamer, banking sector would be better for society as a whole, even if worse for bankers.

But again, there is a separate issue with regard to execution.  If you wanted to explain the banking system to the multitudes, how would you go about it?  The history of (say) 100 years of public policy in banking does not offer a hopeful augury.  Indeed, it is hard to think  of any area of public life more liable to misunderstanding and confusion--not to say outright hokum--than the workings of the banking system.  The are very few grounds for optimism on the prospect that we might ever have a useful broad-based discussion of this issue.

In short (thanks Bill Greider) who will tell the people?   Not "the elites," whom I suspect I should really be calling "the oligarchs."  And even if (counter factual) they did undertake to tell, how could they possibly explain it, particularly considering little they actually know?

Everything that Bugs You about Macro

Straight steal from MR:

Larry Summers speaking at IMF/World Bank meeting:

The challenge is “finding the language that generates [the] alarm that drives action, but not the despair that proves self-fulfilling.” 

The WSJ continues: 

Attempting to sound reassuring, he said, “These are solvable problems.” His audience didn’t look reassured.

Great catch, but it tells you exactly what bugs you makes you so uncomfortable about macro, not so?  After a textbook (or a library) full of charts and graphs, we are left with the uncertain whims of the rude multitude, yes?  And as if to drive home the point, isn't this what bugged Keynes about Hicks? 

Macro: Outsourced to God Knows Who

Here's a book I'm waiting for: I'd like a single tour d'horizon of all the four-and-twenty warring sects of macro--or at least the "major" sects, somehow defined.  The premise is that I can't think of any field of pretended "science" with less claim to a unified set of first principles, body of belief, common agenda, whatever  (most of "social science" doesn't even pretend to be science anymore, it seems). Note that I say "macro" here and not "economics." Basic micro, as if in a separate universe from macro, presents a reasonably united front: a remarkable range of thinkers from wherever on the spectrum share some core fealty to a version, however vulgarized, of Arrow-Debreu equilibrium.  Opponents, such a they are, find themselves stuck with a tactical embarrassment akin to the difficulty faced by those who think that Shakespeare did not write Shakespeare: they're always up against the main guy,  never free to combat with each other.  "Dissenters" in macro--but can you speak of dissent in a field where there is nothing like general consent?  Macro is far more like "the origin of language"--a field in which the French Academy once stopped accepting papers, there being too many competing views and no chance of any that might be plausible.

You can find good, straightforward narrative history--as, for example, Peter Bernholz' Monetary Regimes and Inflation--or more technical but still largely noncontentious accounts of the mechanics--as, for example, Champ & Freeman's Modeling Monetary Economics.  But I don't know of any single book, at once informed and technically fluent, that is also a fair-minded conspectus.  I suspect that such a book, to achieve its purpose, would have to be the work of a skeptic, a nonbeliever, a nihilist.  And that may be the problem: it may be that nobody but a believer is going to take the time to master the rudiments of even one field in such a murkey landscape. 

Mainstream Nihilism

Here's one of the most nihilistic takes on current policy I've seen from a normally temperate mainstream blogsite.   Also correct.

Mankiw on What We Know and What We Don't Know

Yesterday I was complaining about the abysmal low level of discourse in macroeconomics. As if on cue, here's the nation's leading retailer of economic dogma to undergraduates, serving up as whole heapin' platter of what drives me so nuts.

Yes, I'm talking to you, little N. Gregory Mankiw, with your 800 students a year (and the 100,000 more on your textbook). Mankiw's topic for the moment is the Obama stimulus and you will not have perhaps already guessed that he doesn't like it (Mankiw is one of those academics who never seems to come upon a finding that surprises him--a pretty good negative index in any field of intellectual slackness, IMO).

Mankiw begins with suave plausibility: he gives the case of a doctor who treats a patient in reliance to a well-established theory of disease. The patient does not get better. The doctor can abandon the theory as discredited, or he can double down. Which shall he choose? To answer that question, he'd love to run a rigorous lab experiment. But he doesn't have that option. He has to make prudential professional calculation, also known as a guess.

In the same vein, the Obama folks decided they needed a stimulus to keep unemployment from hitting nine percent. They got the stimulus; unemployment hit 10 percent. Oh dear, they said, the economy must be much worse than we thought.

Reading the Obama story in the light of the doctor example, Mankiw responds: "There is no way to decisively prove or disprove the Obama administration's argument." So far, he is 100 percent right. An unsympathetic viewer would rank it as the worst sort of adhoccery--rank it alongside all those finance types who said that the 2008 meltdown was "a six sigma event," when in fact it may have been nothing more contentious than a proof of the bankruptcy of their theory.

Mankiw knows the culprit, and again, you can guess the name: John Maynard Keynes, propounder of what Mankiw calls "standard textbook theory." That last is pretty rich coming from somebody whose own fantastically successful "standard textbook" propounds just the opposite. But let pass. He's right enough, considering that there is a lot of Keynesianism in the air.

But run the tape slowly and watch the clever hand movement here: Mankiw hasn't said that Obama was "wrong." He hasn't even said that Keynsianism is wrong. He isn't even saying that Keynsianism is discredited. The most he has said is that on the basis of the evidence at hand, there is no basis in principle to choose between the principle and the application.

I'm actually still on Mankiw's side at this point, although I do have my hand on my wallet. I am open--eager, actually--for one of the nation's leading economics/explainers to enter into a thoughtful discussion of just how a thoughtful public person, lacking good evidence but doomed to decide, would go about choosing between these two.

Now you anticipate me. Of course we get nothing of the sort. What we get instead are two things. First, Mankiw offers a miscellany of target practice at some of the more absurd or indefensible "data" about the actual working of the stimulus. Most of these are, so far as I know, spot on, but they aren't particularly new and it seems almost beneath the dignity of an eminence to wear out his cortical tissue regurgitating stuff he's read in blogs. And in any event, they seem to have exactly nothing to do with his initial point about theory and practice.

But he's not done yet. Setting aside his Red Ryder air gun, he turns to a different tactic: he turns to rehashing some economist's studies that call into question the Obama package. Fine, except he seems airily indifferent to the fact that these are subject to exactly the same sort of analytical criticism that he offered at the beginning. So: at the beginning, he has derided the use of "multipliers" in Keynesian analysis. "Humility," he cautions; "economics is still a young science." Somehow all these cautions have gone to the wind when we get down towards the bottom of his paper and find him citing Obama's own Chrstine Romer as one who has generated "multipliers" who support his side of the case. " At odds with most traditional Keynesian analysis," he declares triumphantly. Well, fine, but if multipliers are so elusive, how can we possibly know she is right? Indeed, how can we care?

Mankiw goes on to summarize a number of other studies that deploy just the kind of techniques that he seemed earlier to deride. Perhaps the one most seemingly helpful to his cause is the Alesina/Ardagna study that undertakes a "results" comparison of different sorts of stimuli over time. Mankiw does seem to like this study and, perhaps coincidentally, it does appear to support the result he liked before. He doesn't seem troubled by the fact that it is vulnerable to the same kinds of criticisms that seemed to him so compelling earlier (is the United States truly comparable to Europe? Are the 80s comparable to the naughties?--there's a Krugman snippet with a pretty good comment thread here).

I don't want to tumble into complete nihilism here, as in "we report, you decide." I think the claims of economics are vastly overblown (or were, until the began to look so ridiculous in the late contraction). But it doesn't follow that they are worth nothing. I'm not even willing to give up on rational discourse. No, rephrase that: I love rational discourse. I just wish I heard a bit more of it from people who are so quick to see the mote in the other guy's eye without noticing the beam in their own.

More on the Macro Recipe Book

I'm still puzzling over the scandal of economic theory that I was mulling over yesterday--the other discontinuity of view between competing schools of macro policy. That would be: the view(s) that (a) we've got to juice more into the system; or (b) we've got to cut, cut, cut. I tend to ally myself with those of my betters who propound the juice theory. And I'd certainly agree that the cut school is heavily populated with the terminally ignorant: people who don't seem to have the most primitive notion of how an economy works, and who are disposed to use government policy of any sort as a focus for their resentment (particularly when propounded by a suspected Kenyan).

But even a blind hog finds a few acorns and an idea has a truth value independent of the person who embraces it. Even if it is not the right remedy for the moment, still the cutter school has defenses or justifications far more sophisticated and plausible than what you are likely to hear on talk radio.

What is lacking, so far as I can tell, is anywhere near enough candid and responsible dialog between grownups who ought to know better. I'm willing to give the yahoos a bye; I'm happy to excuse politicians (at least provisionally) from the class of those who know better. That leaves a tranche--maybe two tranches--of impressively trained professionals who can fashion analytic advocacy of great sophistication, and marshal formidable batteries of data in their support. But they gaze across the void with an attitude of suppressed indignation (the cutters) or ironic indifference (the juicers). On both sides, it is unworthy of them. We the wide-eyed and gap-jawed outsiders deserve better.

Macro as Phrenology: A More Nuanced View

Willem Butler (via Mark Thoma) offers an account--far more elaborate and sophisticated than my own, of the similarity between Macro and Phrenology:

The most influential New Classical and New Keynesian theorists all worked in what economists call a ‘complete markets paradigm’. In a world where there are markets for contingent claims trading that span all possible states of nature (all possible contingencies and outcomes), and in which intertemporal budget constraints are always satisfied by assumption, default, bankruptcy and insolvency are impossible. ...

Both the New Classical and New Keynesian complete markets macroeconomic theories not only did not allow questions about insolvency and illiquidity to be answered.; They did not allow such questions to be asked. ...

But read the whole thing, it'll scare the daylights out of you. There's also useful commentary by Thoma and a somewhat half-hearted rear guard defense by Brad DeLong.

Update: Looks like the theme is almost viral.