GDP: A Brief But Affectionate Review

For a neo-paleo-Keynesian like me, the first week of an undergraduate macroeconomics lecture is taken up with accounting: Tedious but necessary. What is GDP? How is it different from GNP? National Income? How do we measure it? Does it matter? I've always struggled with outside readings to fill this material out and make it interesting. Now I have one. Diane Coyle has written a timely and very readable little tome about her love affair with national income accounting. It's very short, and you will be able to gobble it down in an afternoon. I did, while whiling away a few hours on a flight.

Thought for the Day: Animal Spirits as a New Fundamental

 In IS-LM models there is always something in the background shifting the IS curve.  What is it?  

In my view that 'something' is Keynes' animal spirits that we should add to our models as a new fundamental.

In my work, I close my models by adding an equation that I call a 'belief function'. The belief function is an effective way of operationalizing the Old Keynesian assumption of ‘animal spirits’. It is a forecasting rule that explains how people use current information to predict the future. That rule replaces the classical assumption that the quantity of labor demanded is always equal to the quantity of labor supplied.

Here is a link to the blog I wrote on that topic last year.

Multiple Equilibria and Financial Crises

Models of sunspots and multiple equilibria were developed in the 1980s as an alternative to the dominant Real Business Cycle agenda. For the last couple of decades, these models have taken a backstage role as explanations of the macroeconomy. Now they are back with a vengeance. 

On Thursday and Friday of this week, Jess Benhabib and I are running a conference at the San Francisco Fed that showcases new research on multiple equilibria and financial crises. The papers at this conference trace their roots to an agenda on sunspots, developed at the University of Pennsylvania in the 1980s.

The sunspot agenda began with the seminal paper by David Cass and Karl Shell, Do Sunspots Matter?, the pathbreaking paper on Self-Fulfilling Prophecies by Costas Azariadis and a paper by myself and Michael Woodford in which we developed techniques that form the basis for dynamic models of indeterminacy that are now widely used to understand monetary policy regimes. 

Another important landmark was the 1994 conference at NYU, published in the Journal of Economic Theory as a symposium on Growth Fluctuations and Sunspots.  Here is a link to a survey paper that explains the history of the sunspot agenda and its connection to endogenous business cycles.

I'm looking forward to the dinner talk on Thursday night by Karl Shell and I'm also looking forward to seeing the tremendous range of papers that are moving this agenda forwards in new and exciting directions. Here is a link to the conference papers. 

The Unit Root of the Matter: Is it Demand or Supply?

John Cochrane responds to my piece on why there is no evidence that the economy is self-correcting with an excellent blog post on unit roots. John's post raises two issues. The first is descriptive statistics. What is a parsimonious way to describe the time series properties of the unemployment rate? Here we agree. Unemployment is the sum of a persistent component and a transitory component.

The second is economics. How should we interpret the permanent component? I claim that the permanent component is caused by shifts from one equilibrium to another and that each of these equilibria is associated with a different permanent unemployment rate. I’ll call that the “demand side theory”. (More on the data here and here and my perspective on the theory here and here).

Modern macroeconomics interprets the permanent component as shifts in the natural rate of unemployment. I’ll call that the “supply side theory”. That theory is widely accepted and, in my view, wrong. As I predicted in the Financial Times back in 2009, "the next [great economic idea] to fall will be the natural rate hypothesis". 

Beyond 1950's Economic Theory: Nonlinearity, Multiple Equilibria and Sticky Prices

David Glasner has a very nice post on Price Stickiness and Economics with great comments from Rajiv Sethi,  Richard Lipsey and Kevin Donoghue among others. David reacts to a post from Noah Smith: this is all classic stuff

 

Here is David

While I am not hostile to the idea of price stickiness — one of the most popular posts I have written being an attempt to provide a rationale for the stylized (though controversial) fact that wages are stickier than other input, and most output, prices — it does seem to me that there is something ad hoc and superficial about the idea of price stickiness and about many explanations, including those offered by Ball and Mankiw, for price stickiness. I think that the negative reactions that price stickiness elicits from a lot of economists — and not only from Lucas and Williamson — reflect a feeling that price stickiness is not well grounded in any economic theory.

There is No Evidence that the Economy is Self-Correcting (Very Wonkish)

David Andolfatto asks in a twitter exchange for evidence that deviations of GDP from trend are non-stationary. Here is the raw data. Figure 1 is the residual from a regression of the log of real GDP on a constant and a time trend for quarterly US data from 1955q1 through 2014q4. I will refer to this series as "X".

Figure 1: X = Log of Deviation of Real GDP from Trend

Table 1 reveals the regression of X on itself lagged and on a constant. Remember that these data describe deviations from trend so persistence reflects potentially permanent deviations from the trend growth path. Notice that the coefficient on lagged X is 0.996. That of course, does not establish that the data has a unit root. 

New Solutions to Old Problems

There was an interesting exchange over the last couple of days between two of my favorite bloggers; Frances Coppola, aka Femina Spectabilis, and Brad DeLong, aka Distinguitur Oeconomicarum. Frances delivered a talk at my alma mater,  Manchester University, on the need to use non-linear models and to recognize the importance of multiple equilibria. Brava! Brad Delong, over at Equitable Growth, takes umbrage at Frances’ charge and rushes to the defense of his former teacher, Olivier Blanchard, aka Nobilis Vir. 

Here is Frances at full tilt

… some of the most influential people in macroeconomics have spent their lives developing theories and models that have been shown to be at best inadequate and at worst dangerously wrong. Olivier Blanchard’s call for policymakers to set policy in such a way that linear models will still work should be seen for what it is – the desperate cry of an aging economist who discovers that the foundations upon which he has built his career are made of sand. He is far from alone.