Sunday, September 25, 2011

Miscellaneous Lucas


Someday I intend to write a book about the history of modern macroeconomics. I plan on having Bob Lucas be a pivotal figure in this book, so I'm always interested what he has to say, even though he is now pretty old. Here's an interview Lucas gave recently for the Wall Street Journal. Here's a few excerpts:
One [thing on Lucas' mind] is the failure of the European and Japanese economies, after their brisk growth in the early postwar years, to catch up with the U.S. in per capita gross domestic product. The GDP gap, which once seemed destined to close, mysteriously stopped narrowing after about 1970... 
For the best explanation of what happened in Europe and Japan, he points to research by fellow Nobelist Ed Prescott. In Europe, governments typically commandeer 50% of GDP. The burden to pay for all this largess falls on workers in the form of high marginal tax rates..."The welfare state is so expensive, it just breaks the link between work effort and what you get out of it, your living standard," says Mr. Lucas. "And it's really hurting them."
Now, like I said, Lucas' age really does excuse him in a lot of cases. But doesn't he know that Japan has lower taxes (and more work hours) than the U.S., not less? That supports the idea that high taxes make people work less, but it definitely contradicts the hypothesis that taxes are behind the GDP gap. 

It's always struck me as kind of amazing how many economic phenomena Lucas and Prescott and others of their generation ascribe to marginal tax rates, even when it obviously makes no sense to do so.I guess it just goes to show how deep an imprint the high tax rates of the postwar period made on the minds of the economists who brought down that tax regime in the 70s and 80s.

Anyway, more Lucas:
Turning to the U.S., he says, "A healthy economy that falls into recession has higher than average growth for a while and gets back to the old trend line. We haven't done that. I have plenty of suspicions but little evidence. I think people are concerned about high tax rates, about trying to stick business corporations with the failure of ObamaCare, which is going to emerge, the fact that it's not going to add up. But none of this has happened yet. You can't look at evidence. The taxes haven't really been raised yet."
Lucas is being intellectually honest here. The line that Obama is keeping the economy from recovering by being a scary socialist has by now become a standard conservative argument, from the most disreputable hacks on CNBC all the way up to the lofty ranks of the Nobel-wielding demigods. But Lucas admits what few others will say, which is that this line is a guess and a hunch and a supposition, not the result of any economic theory or empirical work. Obama's attitude, even more than his policies, just feel wrong to conservatives, and they feel like this must be what is causing macroeconomists' models to break.

Here's Lucas on Rational Expectations:
"If you're going to write down a mathematical model, you have to address that issue. Where are you supposed to get these expectations? If you just make them up, then you can get any result you want."
This is true. But my problem with Rational Expectations is kind of the flip side of this statement; if you don't care about what result you get, you can make up anything you want! 

Do people have rational expectations? Sometimes they do. And sometimes they don't. I recently did an experiment in which people invested in a little toy financial market. Even the people who demonstrated that they understood the asset's value perfectly well also reported that they didn't believe that the market price would converge to that value. When there was a price bubble, even the savviest traders didn't predict a crash, and they were taken completely by surprise when the crash came. That kind of outcome just doesn't gel with Rational Expectations.

The moral of the story is that you can't derive people's expectation process just from deductive logic. You have to go see how people really behave.

Lucas on "foxhole Keynesianism":
Mr. Lucas believes Ben Bernanke acted properly to prop up the system. He doesn't even find fault with Mr. Obama's first stimulus plan. "If you think Bernanke did a great job tossing out a trillion dollars, why is it a bad idea for the executive to toss out a trillion dollars? It's not an inappropriate thing in a recession to push money out there and trying to keep spending from falling too much, and we did that."
It's interesting that this position would be contradicted by Lucas' own preferred macro models. I guess this just goes to show how deep the intuitive sympathy for Keynesian ideas runs, even among the titans of neoclassical macro. 

At any rate, although I disagree with a lot of what Lucas says, I've got to hand it to him: even at his age, he shows a decent amount of nuance and skepticism. That's great to see.

Update: However, As Brad DeLong points out, Lucas' position on stimulus is not exactly clear and consistent over time...

Update 2: Paul Krugman has a great summary of where Lucas fits into the history of modern macro. Now doesn't that story deserve a whole book? ;-)

21 comments:

  1. "[E]ven at his age, he shows a great deal of nuance and skepticism."

    You think? I tend to think it's faux-objectivity. Kind of like: "Krugman is a brilliant economist, but he's partisan" - the people who say this aren't really being fair and they're not really addressing substance; they're using the compliment to prop up the ad hominem attack.

    That's what this strikes me as. A bunch of faux-modesty and faux-objectivity being used to prop up claims for which there is NO factual support.

    If you think of the world in terms of Siths and Jedis (and I usually do...:)), Lucas is the Emperor.

    http://plutocracyfiles.blogspot.com/2011/09/keynes-and-holy-trilogy.html

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  2. I would argue that we can measure expectations (albeit imperfectly). And I would think a modern macroeconomist like Lucas would be concerned about an apparent break in households' income expectations (for example as appears in the Michigan survey since the fall of 2008). Inflation expectations are not the only expectations that can be self-fulfilling.

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  3. @Claudia:

    Very interesting. Yeah, I agree.

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  4. Anonymous1:23 AM

    Another thing on the "they're afraid of the big socialist job killer at 1600 Penn. Avenue" line: the trend of strong growth after recessions presumably isn't only a US thing. How could this "FOO" theory as Krugman calls it explain challenges in Europe?

    Also, technically, America lines up pretty well with financial crises data.


    http://dallasfed.org/research/eclett/2011/el1109.pdf

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  5. Adding on to Anonymous' comment, Lucas is pulling expectations out of his hat to justify what's happening. The prospect of Obamacare apparently destroys the US economy. And since this was only passed in (IIRC) fall 2009, it was working for a couple of years by that point.

    Adding on your example of Lucas not understanding which countries have higher/lower tax rates and working hours, a better explanation is that he just makes sh*t up.

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  6. Oh - about age as an excuse. My position is that age is only an excuse if the person was previously different. If Lucas had a long history of making stuff up and ignoring/dismissing belittling other theories (despite their merits), then it's not age, it's him.

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  7. Noah: One thing that I am confused by is how macroeconomics is presented to the public by academic economists.

    More specifically, interviews like this WSJ Lucas article strike me as bizarre at some level. It's not that Lucas's sentiments or policy comments are unusual. Indeed, as you mention, his comments follow along standard lines.

    Rather, what I find confusing is how often I read opinions by macroeconomics and how unclear they are about the assumptions they're making and the models they are assuming when they make very strong policy commentary.

    As a PhD student (I'm a lower year in your department), it strikes me as strange that this is the public presentation of macro by Professors who are (have been) celebrated within academia. I've actually mentioned this to several of my classmates and they also seem surprised that this is the state of discourse.

    It'd be interesting to hear your take on this, if you have any specific thoughts.

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  8. Anonymous10:39 AM

    Sweden was, and still is, one of the archetypal welfare states. But about 15 years ago, they did reform their banking mess. And two years ago, they're currency did depreciate, for some time.

    And guess what. This high tax lots of welfare country has a vigorous business sector, a projected government surplus in 2011 and had the highest economic growth of the entire non-transition European Union in 2010... And it has clearly outperformed the UK and Germany after 1997, when it comes to economic growth.
    http://epp.eurostat.ec.europa.eu/tgm/table.do?tab=table&init=1&plugin=1&language=en&pcode=tsieb020

    So, I have to agree with Noah: Lucas (among others) has to learn to check the facts. I know - that's not really part of an education in economics, but it's never too late! One other point: when it comes to productivity per hour, European countries like France and the Netherlands and, until some years ago, Germany, have catched up with the USA. GDP per capita is lower because labor in Europe is more free to choose between work and leisure. So, Lucas is also wrong with his statement that it's puzzling that there was not more convergence between the USA and Europe, after 1970. It's not puzzling at all. There was. And that's in fact common knowledge, among economists. http://rwer.wordpress.com/2011/07/28/productivity-in-europe-two-graphs/

    Merijn Knibbe

    Merijn Knibbe

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  9. I don't agree that this interview says anything good about Lucas. He repeats the canard that Obama is more liberal than Clinton. He talks about overbuilding without noting that we're now significantly below trend in residential construction.

    Regarding the GDP gap between the US and Europe (which seems to vary significantly depending on which dataset I use). How much of this may be due to differences in efficiency? I mean, European states all spend significantly less on health care, for instance. I assume that despite the better outcomes, this translates into lower measured GDP.

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  10. "[E]ven at his age, he shows a great deal of nuance and skepticism."

    Don't nuance and skepticism grow with age? I hope so, at least for myself.

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  11. Anonymous2:13 PM

    1) Good to see you promoting your own research
    2) I suspect what Lucas has in mind is very similar to what Lee Ohanian is claiming - that GD was also caused/sustained by expectations of high taxes and tilt towards labor. I know, sounds ridiculous for businesses to expect that with Hoover in power, but quite a few people in the Chicago/Minnesota camp take Ohanian for a serious scholar of the GD.

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  12. Honestly, Lucas believes that the length of the current depression is caused by fear of raising taxes a little bit and a less than perfect health care reform? Maybe a better answer is that there is some debt that needs to unwind to sustainable levels and that, combined with declined asset prices, is having a negative impact on consumer spending. Other than that, most of it is probably a self-reinforcing depressed state... i.e., lower spending leads to lower income leads to lower spending... Stimulus please?

    Oh, and why didn't Europe and Japan catch up to the per capita GDP of the U.S.? Hm... must be ... high taxes(?). Maybe one could look at the average growth rates of the U.S. economy and Europe when they had confiscatory tax policy on the high end of the distribution. Maybe there's a need for him to rethink the role of taxes. My guess is that we still have much to learn from Solow and those who have elaborated the causes of productivity growth.

    Anyway, check out my blog:
    http://socialmacro.blogspot.com/

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  13. @Tilman:
    I would hope so too. I'm trying to be generous to Lucas, though... ;-)

    @most recent Anonymous:
    Thanks! I don't want to promote my own stuff too too much...

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  14. If you want a model of how to be generous to Lucas, I'd suggest looking at Michael E. Kahn's piece

    First lesson: blame the interviewer for bad questions.

    The "shock" of 2008 was large enough to move the U.S. economy out of the corridor, within which we could reasonably expect the economy to return to trend. Since nearly the whole of modern macro has been solely about how things work within that corridor, there not much to say. Still plenty to apologize for, though.

    That's what I'd ask him for: an apology.

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  15. It would be good if you actually understood that the history of macro depends on the fact that it is the result of an incoherence between the marginalist theory of value (that says that if you reduce real wages you obtain full utilization of labor) and the Keynesian principle of effective demand. Without understanding Sraffa your future book will have significant problems. It's a pitty kids in mainstream graduate courses do not learn the capital debates anymore. But if you're serious about it I recommend you spend the time.

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  16. Anonymous11:22 PM

    Part of the GDP gap is explained if Wall Street is reporting entirely fictitious profits and productivity - which seems entirely plausible. Part of the gap is explained if the US "values" the annual production of a doctor at, say, $250,000 and France, for example, values the same production at, say, $100,000.

    In any event if there is extra production in the US it is all going to the top few percent of the population. It is difficult to see why the bottom 95-98% should support policies that might grow the pie a little but shift things so much in favor of the rich that the incomes (including government services) of the bottom 95-98% actually fall.

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  17. Anonymous11:24 PM

    If you write your book you should devote a whole chapter to the Ricardian fallacy.

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  18. Anonymous2:14 AM

    "Thanks! I don't want to promote my own stuff too too much..."

    That's right. Never talk about an interesting research result until you are ready to publish. I know of one case where people got scooped because they talked to the press about their interesting experiment and a competing group rushed their own research and got their paper to Nature first.

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  19. If you're doing the Lucas book, discuss Rational Expectations in the context of his divorce agreement: ex-wife gets half of the "Nobel" monies if the Prize is received within seven years.

    The last year it was possible for her to receive half, he wins.

    That is, iirc, the only time in history that Rational Expectations has worked.

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