Secular stagnation: a neo-paleo-Keynesian perspective

I first posted this piece back in January but it got deleted by from my blog by mistake. Since secular stagnation is back in the blogosphere with a vengeance: its time to repost it.

In a recent piece on his blog, David Beckworth has taken another swing at the secular stagnation hypothesis. Secular stagnation is a term coined by Alvin Hansen in a 1938 article in which he claimed that public expenditure might be required to maintain full employment.

Here is Alvin, as quoted by David...

"The business cycle was par excellence the problem of the nineteenth century. But the main problem of our times, and particularly in the United States, is the problem of full employment. ... This is the essence of secular stagnation— sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment."

Hansen is writing in 1938, before Keynesian economics had been forever altered by Samuelson's bastardization of Keynes' key idea: that high involuntary unemployment is an equilibrium that can persist for decades. 

The Greek dance with debt

If you thought that the Greek debt crisis was over; think again. Tomorrow, the Greek parliament will try, for the third time, to agree on who will be the next president. If parliamentarians cannot agree (and that now seems likely) we are headed for the first potential rock in the road to recovery for 2015.  There is a real danger that the Greek debt crisis will emerge with a vengeance and, once again, throw world financial markets into turmoil.

Under the rules of the Greek constitution, if no candidate receives an absolute majority, parliament will be dissolved, and there will be a general election, most likely in early February. If that happens, all signs point to a victory by Syriza, a left of center party that proposes to renegotiate the Greek debt.

A Syriza victory would force the core Euro countries to decide either to give up on the project of European integration, or to move to the next stage of full scale fiscal union in which German taxpayers assume responsibility for Greek debt.

If the Euro breaks apart, the fallout will be global. The world economy has been hit by a falling demand for raw materials and oil is trading at less than US$60 a barrel. Some of this is caused by newly discovered proven reserves and that is a good thing. But Jim Hamilton has argued that  falling world demand is a big part of the reason for lower oil prices and that does not bode well for a truly global recovery.

The US economy has been the single flickering light in a dark sky. If the Euro collapses, the knock-on-effect will derail the US recovery and send the entire world economy back into recession.

Is a Greek default and a breakup of the Euro the most likely outcome? Probably not. But it is the first of many building storms that the global economy will need to weather in 2015. All eyes on Greece tomorrow!

Real business cycle theory and the high school Olympics

I have lost count of the number of times I have heard students and faculty repeat the idea in seminars, that “all models are wrong”. This aphorism, attributed to George Box,  is the battle cry  of the Minnesota calibrator, a breed of macroeconomist, inspired by Ed Prescott, one of the most important and influential economists of the last century.

All models are wrong... all models are wrong...

Of course all models are wrong. That is trivially true: it is the definition of a model. But the cry  has been used for three decades to poke fun at attempts to use serious econometric methods to analyze time series data. Time series methods were inconvenient to the nascent Real Business Cycle Program that Ed pioneered because the models that he favored were, and still are, overwhelmingly rejected by the facts. That is inconvenient.

Ed’s response was pure genius. If the model and the data are in conflict, the data must be wrong. Time series econometrics, according to Ed, was crushing the acorn before it had time to grow into a tree. His response was not only to reformulate the theory, but also to reformulate the way in which that theory was to be judged. In a puff of calibrator’s smoke, the history of time series econometrics was relegated to the dustbin of history to take its place alongside alchemy, the ether, and the theory of phlogiston.

John, Paul and Say's Law

I've followed, with a great deal of interest, the debate between John Cochrane and Paul Krugman. I have a lot in common with both of them.

I agree with Paul that, for the most part, the IS-LM model provides the right answer to policy questions. I agree with John, that we have learned a lot since 1955, when Paul Samuelson invented the Neo-classical synthesis.

But there were a couple of ideas in the General Theory that have been buried by MIT macro. The first, and most important, is that high unemployment is an equilibrium. Repeat after me. E-Q-U-I-L-I-B-R-I-U-M. The second is that animal spirits are an independent causal factor that determines which equilibrium the private economy will select.

Let me ask a simple question that you should feel free to answer. And do please also try to guess the PK and JC answers. (To answer this question, you will need to arm yourself with a knowledge of the textbook IS-LM model. A good introduction would be Greg Mankiw's textbook or, the book I learned from, the intermediate text by Dornbusch, Fischer and Starz.)

Figure 1

Risk and Return in the Bond Markets

This is the second post to advertise the work of a UCLA graduate student who is looking for a job this year. My first post introduced Sangyup Choi who is working on uncertainty shocks in emerging markets. This post introduces Chan Mang who is working on the implications of term structure models for the foreign exchange market.

Chan Mang

Chan Mang graduated from UCLA two years ago. In 2012 he was awarded a post doc position at the prestigious National University of Singapore and last year he worked in the private sector.  Chan's research builds on the  widely cited bond pricing model developed by John Cochrane and Monika Piazzesi. 

Repeat After Me: The Quantity of Labor Demanded is Not Always Equal to the Quantity Supplied

I've been teaching a class on intermediate macroeconomics this quarter. Increasingly, over the past twenty years or more, intermediate macro classes at UCLA (and in many other top schools), have focused almost exclusively on economic growth. That reflected a bias in the profession, initiated by Finn Kydland and Ed Prescott, who persuaded macroeconomists to use the Ramsey growth model as a paradigm for business cycle theory. According to this Real Business Cycle view of the world, we should think about consumption, investment and employment 'as if' they were the optimal choices of a single representative agent with super human perception of the probabilities of future events. 

Although there were benefits to thinking more rigorously about inter-temporal choice, the RBC program as a whole led several generations of the brightest minds in the profession to stop thinking about the problem of economic fluctuations and to focus instead on economic growth. Kydland and Prescott assumed that labor is a commodity like any other and that any worker can quickly find a job at the market wage. In my view, the introduction of the shared belief that the labor market clears in every period, was a huge misstep for the science of macroeconomics that will take a long time to correct.

In my intermediate macroeconomics class, I am teaching business cycle theory from the perspective of Keynesian macroeconomics but I am grounding old Keynesian concepts in the theory of labor market search, based on my recent books (2010a, 2010b) and articles (2011, 2012, 2013a, 2013b).  I am going to use this blog to explain some insights that undergraduates can easily absorb that are adapted from my understanding of Keynes' General Theory. Today's post is about measuring employment.  In later posts, I will take up the challenge of constructing a theory to explain unemployment.

Ever since Robert Lucas introduced the idea of continuous labor market clearing, the idea that it may be useful to talk of something called 'involuntary unemployment' has been scoffed at by the academic chattering classes. It's time to fight back. The concept of 'involuntary unemployment' does not describe a loose notion that characterizes the sloppy work of heterodox economists from the dark side. It is a useful category that describes a group of workers who have difficulty finding jobs at existing market prices. 

The Impact of Financial Market Volatility on Emerging Market Economies

Early in the New Year, economists from all over the world will congregate in Boston for the 2015 annual meetings of the American Economics Association. The main purpose of these meetings is to interview new Ph.D. candidates for potential jobs as academics and in the public and private sectors as research and/or policy economists.  

Sangyup Choi

As an academic economist at UCLA, my job includes teaching undergraduates, carrying out economic research for publication in books and journals and, (my favorite part), training new Ph.D. economists. Teaching graduate students is a rewarding experience for an academic as we get to watch our students progress from undergraduates to colleagues. What begins as a teaching experience in year 1 ends up as a learning experience in year 5. 

Today's blog features my student, Sangyup (Sam) Choi, who is working on  the impact of financial market volatility on emerging market economies.  My colleague Aaron Tornell and I are Sam's principal advisors.

Sam is studying the VIX and its impact on economic activity. This is a hot topic amongst macroeconomists ever since Nick Bloom showed, in a paper published in Econometrica,  that shocks to uncertainty are a causal factor in US. recessions. What, you ask is the VIX?


The VIX is an index of volatility that goes up when traders are less certain about the future. In his Econometrica paper, Nick showed that shocks to the VIX are an independent causal factor that helps to predict future U.S. output. Here is a graph of the VIX for the period 2000 to 2014.

Figure 1: The VIX from 2000 to 2014

In a paper published last year in Economics Letters, Sam showed that Nick’s results are sensitive to the period of study. The VIX does predict future output in data from 1950 through 1982, but that result goes away after 1983. The largest recession in post war history in which the VIX jumped by a factor of four, (see Figure 1), did not have a significant independent impact on the U.S. economy, once other explanatory variables have been accounted for. That in itself is surprising. But it gets better.