Whither Macroeconomics?

Yesterday, I went to the Second Story Secondhand Bookshop warehouse. The front store is located at Dupont Circle, but the warehouse Maryland, about one mile away from Ujang's apartment -- and he unbelievably has not came to that place yet :-D. It was not so much like The Strand of New York to find new books -- although they have some review copies --, but it's the place to look for some standard/classic off-print -- important stuffs that have been published in, say, the 80s or 90s.

Moreover, if you are a macro person, that's the place where you can still find a copy of Sargent-Wallace, or Tobin, books.

Looking at the economic section's shelf, it strikes me that the Reagan period (the late 70s and early 80s crisis) has produced substantial books on macro discussing the business cycles. It was a war between Lucas/Sargent/Wallace versus Solow/Tobin/Modigliani -- all are the giants of the professions. But the puzzle is that in recent crisis of the 2000s, macro people have been strangely silent. No books come out yet, so do the published article.

I mean, look at a series of respectable books on current crisis by Raghuram Rajan, Gary Gorton, and the likes. Mostly micro - with an exception of, probably, Shiller and Akerlof's Animal Spirit, which is, to me, more a sketch of reminder that uncertainty matters than a neat macro explanation on what is really going on.

Maybe macro people are truly caught on (and complacent about) the Great Moderation period, in which they think they knew how to tame business cycle -- and by that, leave the once a lively discussion on equilibrium, expectation, and market clearing process.

Is it the end of macroeconomics we at the Cafe used to know it? I don't know. But surely some books from macroeconomics perspective dealing with the latest crisis would help to confirm that macro is still able to generate ingenious ways of seeing things. The magic that in the past had been amazingly spelled out by Keynes, Friedman, Lucas, Tobin, and the likes.

Take-Home Final Exam Question

Suppose you have these finding from Reinhart and Rogoff (AER: 2009) showing that a banking crisis on average causes:

a. Unemployment to rise for 4.8 years, with an increase in the unemployment rate of about 7 percentage point.
b. Real GDP to decline for 1.9 years, with a decline in real GDP of about 9.3 percent.
c. Cumulative public debt to rise 186.3 percent in the three years following the crisis.

Questions:

a. What is the probability (P) you are willing to assign that not bailing-out Bank Century will not lead to a banking crisis?
b. Multiply P with either a, b, or, c finding above-mentioned. Do you still let Bank Century collapse? Of course you can put the cost of moral-hazard into your equation.

Instruction:

Submit your answer to those Indonesian lawmakers in that special committee before they get confused.

On Banking Crisis

So if you like Kindleberger's Manias, Panics, and Crashes, chance is that you'll like this Reinhart and Rogoff's This Time Is Different.

One of the reasons is that the latter gives not only narrative, but also some simple numbers to ponder. My favorite chapters are on banking crisis, inflation, and currency crisis. The discussion on the Second Great Contraction (a.k.a current US financial crisis) is also worth for perusal.

Chapter 10 starts with these sentences:

"Although many now-advanced economies have graduated from a history of serial default on sovereign debt or very high inflation, so far graduation from banking crises has proven elusive. In effect, for the advanced economies during 1800-2008, the picture is one of serial banking crisis."

also,

"...there is indeed significant theoretical and empirical support for the view that a collapse in a country's banking system can have huge implication for its growth trajectory."

Moral of the story: dealing with potential banking crisis is bloody difficult and easier said than done.

Krugman on Macroeconomics

Bias toward old Keynesianism and against Chicago school aside, Krugman writes a useful summary on the state of macroeconomics here. It'd help anyone who wants to know the difference between saltwater and freshwater schools as well who's who in the discipline.

My take is here, and for sure I don't take hostile perspective to the freshwater school the way Krugman did. Nonetheless, one thing I agree with Krugman: his opinion on the use of math in the profession that prefers beauty over truth. But it just reinforces my intention to learn more (gasp!) math. A heroically tall order for me indeed, but I just see no other way.

Ben Again

Obama has re-nominated Ben Bernanke for the 2nd term of Fed Chairmanship. A good move. As any student of monetary economics knows, Bernanke is the leading scholar when it comes into monetary policy transmission and business cycle.

His work on agency cost, net worth, and business fluctuation is important. For those who want to force Indonesian banks' lending rate down (by regulation or any non market mechanism), that article should be on the top of their reading list.

Waiting for a Keynes-like Macroeconomist

The Economist published an interesting article on the crisis of macroeconomics. If you happen taking, have had taken, or are about to take the subject, you may want to read that article too.

My personal take on that piece is this: one of the reasons on why I find macroeconomics fascinating is precisely the fact that the subject is still very much evolving. This is the branch of economics where the fight between schools of thought is still kicking, alive, and relevant, particularly after the recent crisis. And it's is a good sign, unless you just want things that already well-settled a.k.a boring.

True, as The Economist states, that for many economists the Great Moderation period from mid 80s to just before current crisis means the end of debates in macroeconomics as the business cycle was then tamed. But I was, and am, not convinced. Ten years ago, the Asia Crisis in 1998 got me thinking that there should be a new way to see the macro economy where economic activities and markets are now much more internationally linked at much speedier pace. I was expecting a new approach out of then the debates between market fundamentalists and panic approach on Asia crisis. Alas it never was.

Up to now, when it comes into macro, I can not really make up my mind and pick between (new) Keynesian or neoclassical school. Both are equally theoretically plausible and empirically defendable. I also am not fully convinced whether micro-foundation of macroeconomics is really the only way to progress, or more pragmatic positive methodology a-la Friedman and Keynes might be more useful.

But make no mistake, I very much enjoy every bit of this my state of not-knowing. It keeps me thinking and rethinking my position. It is good that the crisis of the subject forces macroeconomists back to the drawing board. Hopefully a Keynes-like figure would emerge and come up with a macroeconomics we never knew before.

And to those aspiring macroeconomists, I do not think the current state of macroeconomics should discourage you. If anything, this is the best time to study macroeconomics and join the game. Perhaps you are the Keynes-like we are waiting for.

Advice # 876: Take A Longer Perspective

I look at a graph showing Indonesia per capita GDP level and annual growth from 1970 to 2007 and could not stop to marvel (if it is the right word) that the depth of our 1997 crisis actually makes the US zero growth this year look like a one lazy Sunday afternoon.

It takes a mere two years from around 15 percent GDP per capita contraction to regain positive growth, as Reinhart and Rogoff (in pdf) rightly point out; but around 7 years to get back to pre-crisis income per capita level. Even more daunting, after the crisis, the average annual growth has been substantially lower than before, despite its accelerated upward trend.

And today we have global recession. I just hope that we don't take a wrong lesson by taking short-sighted economic populist policy and dramatically departing from market-based reform that has been responsible for much of the longer-run pre crisis growth and post crisis recovery.

Getting off the track is too expensive. Although the temptation is high, especially if you want to run for President/House members/funny pundit.

Keynes The Optimist

Keynes, I think before he said that in the long term we're all dead, in Economic Possibilities for our Grandchildren, a short paper presented before students of, according to Bob Solow, a less-snotty-than-Eton public school, Winchester, wrote:

We are suffering just now from a bad attack of economic pessimism. It is common to hear people say that the epoch of enormous economic progress which characterised the nineteenth cen­tury is over; that the rapid improvement in the standard of life is now going to slow down ‑-at any rate in Great Britain; that a decline in prosperity is more likely than an improve­ment in the decade which lies ahead of us.

I believe that this is a wildly mistaken inter­pretation of what is happening to us. We are suffering, not from the rheumatics of old age, but from the growing‑pains of over‑rapid changes, from the painfulness of readjustment between one economic period and another

I think this is relevant to current world economic affair, as well as to Indonesia.

Animal Spirits Explained (Not Yet)

I still find the New Keynesian approach for short term output fluctuation is one of the finest theoretical explanation. You can find the summary of their research in chapter 6 of the standard Romer's Advanced Macroeconomics. Their models are so cool in explaining the seemingly irrational behavior that was not yet elaborated in the old Keynesian school.

But against the backdrop of current crisis, Akerlof and Shiller in their latest book Animal Spirits, want to move further. They argue that New Keynesian approach is good to explain the small fluctuations, but not a deep crisis. Instead they believe that animal spirits --Keynes' phrase for irrational behavior- is responsible for such exuberance, booms, and eventually bust.

They offer some working proposition by describing five aspects of animal spirits: confidence, fairness, money, illusion, corruption and anti social behavior, and stories (or narrative).

Alas, until the end of the book, I fail to grab a coherent theoretical construct, or even its prospect. They, less fruitfully, go back to old battle by bashing new classical approach and, this is rather disconcerting, relying too much on anecdotal evidence. Plus some I-told-you-so tone.

Akerlof's paper on the market of 'lemon' is one of my favorite model. And I certainly expect more with his credential, including winning the Nobel. But maybe winning Nobel is a bad signal nowadays (think of Stiglitz and Krugman).

I am still looking forward from them, though, that eventually, a neat theory of animal spirits in macroeconomics come up and stands up for academic test. And they can take their time to do this, without hurrying to publish a book just to catch up with daily conversation topic at the moment.