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DanS
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Kickball Capital of the World
Jan 1970
time: 00:23
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Cleaning up from the last of the other thread...
"Is that an argument pro or contra NAIRU?"
Not an argument either way. I was just describing what filtered down through the press and what I observed about the "talk" over time. Even though The Post never said "NAIRU" (since they were written for a non-technical audience), that's clearly what they described. In fact, I'd never heard of NAIRU until Spike mentioned it.
The articles made clear that this was something that policy makers were looking at, and that they were surprised about not seeing any increasing inflation at such low unemployment levels. This is extemely important to official Washington (and hence The Washington Post), because sustained low unemployment makes our social problems a heck of a lot easier to solve. For instance, the politicians took the opportunity to reform welfare (i.e., to throw people off the dole).
Edit: Thought you might be interested in a Taylor speech given earlier this month about the history of monetary policy...
http://www.treas.gov/press/releases/docs/fried.pdf
Don't know if he's too widely published to be the next Fed chairman, but he's interesting to watch...
Last edited by DanS on 21-11-2002 at 23:13
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Adam Smith
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Maryland, USA
Jan 1970
time: 00:23
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DanS:
Here is a quick and dirty derivation of NAIRU which may help illustrate why this is both a useful concept for organizing thinking and at the same time very difficult to apply in practice. (This is my recollection from Robert J. Gordon’s graduate macro class 20+ years ago, so please don’t hold me to the details.  )
Start with a production function, which relates the inputs used by the economy to the total output produced
(1) Q = ZL^aK^bE^c
where
Q = real GDP
Z = productivity factor
L = labor
K = capital
E = energy
a, b, c = known shares of labor, capital, and energy in GDP. ^ is an exponent.
Assume a + b + c = 1 (constant returns to scale) for simplicity.
Converting (1) to annual growth rates,
(2) q = z +al + bk + ce
where lower case letters represent the annual growth rates of their upper case counterparts.
We want to use this relationship to tie together the two macroeconomic concepts which we care about : unemployment and inflation.
For unemployment,
(3) l = w - u
where
w = annual growth rate in the labor force, which is given by demographics
u = unemployment rate
For inflation, start with the standard monetarist equation of value
(4) PQ = MV
where
P = price level
Q = real GDP
M = quantity of money
V = velocity of money
Converting to annual rates of growth,
(5) p + q = m + v
Substituting (3) and (5) into (2) results in
(6) m + v – p = q = z +a(w-u) + bk + ce
The left side of (6) is the monetary side of the economy, and the right side of (6) is the real side. If we take all the other rates of growth as given, then there is some u (unemployment rate) such that p (inflation rate) is zero. This is the NAIRU.
The good news: we pulled all the factors in the economy into one equation, which is very valuable in organizing one’s thinking.
The bad news: NAIRU depends on a whole bunch of factors which don’t necessarily stay constant.
The worse news: we can only measure these factors imperfectly (e.g., productivity) or with a lag, which makes policy decisions imprecise.
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DrSpike
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Enthusiastic member of Apolyton
Sep 2001
time: 05:23
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Nice one AS.....I'd expect anyone who learnt macro from R J Gordon to exhibit a similar level of sense.
Hersh: Good questions.......addressing a very wide range of topics, so forgive me if this gets lengthy.
1) I agree there was a belief (and a reasonable one at that) that a productivity improvement had raised the rate of growth that could be sustained without generating inflation.
Now if the economy can grow faster without inflation is there a good reason to keep monetary policy tighter and not realise the potential gain? No, there isn't. And what is more the costs to overly tight monetary policy are huge. The fed does what it is legally bound to do, use monetary policy to hit an inflation target.
I cannot agree that monetary policy was ever too loose. Now there are 2 wrong arguments I see regularly from laypeople here: firstly, and most annoying, is the view that post dotcom crash rates were slashed too aggressively, leading to a present bubble in the property market. The alternative, of course, when investment plummeted, would have been a full blown recession without doubt. Should one criticise the fed? Hell no, you should applaud them.
The second misconception I can empathise with, because it contains an (albeit small) element of truth. This is the view that the initial stock market bubble was the fed's fault. The thing here is, you can hit but one target with one instrument, and it is not the fed's responsibility to use monetary policy to affect the stock market. You can choose to believe that would be a better target than an inflation target, but of course you would be wrong.
2) A lot of what I said in 1) applies. In addition I feel you would benefit from reading what you can find about monetary policy in the 80s, where monetary aggregates were king. You see the question of whether to target monetary aggregates or have an explicit inflation target may seem like no big deal to the casual observer. It turns out to make a huge difference.......due to where in relative terms most of the uncertainty lies, in the real sector or the monetary sector. Hehe, this is back to Gordon again, IIRC he did some of the key work in the 80s on this very topic. It turns out that velocity (in AS's quantity theory of money equation earlier) changes make monetary aggregates too slippery, even when you can control them, which you only can to a limited extent.
3) Question 3 is a very different kettle of fish than the first 2......and opens up a whole new area for debate. There have been many attempts to explain the worldwide rise in unemployment since the 60s......ultimately a lot of the change is due to 'inflation illusion', because how expectations are formed is critical......but there are other factors. I'll mention another key one - productivity growth fell post 1970 all across the world, this undoubtedly played a role as well.
Ultimately it is easy to criticise the fed, because you can't see the alternative realities and there is always something in the actual reality to ***** about. Do central banks make mistakes? Hell yes.......but the ONLY question that is relevant here is does discretionary monetary policy perform better than simple rules? History/theory/empirics all suggest OVERWHELMINGLY that it does. And monetary authorities make far fewer mistakes because they use models and concepts like output gaps and NAIRU to make their guesstimates. This is why I objected to the claim that such concepts were useless, and I stand by that.
Last edited by DrSpike on 22-11-2002 at 01:53
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Colon
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Antwerp, Colon's Chocolate Canard Country
Jan 1970
time: 06:23
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quote:
Originally posted by DrSpike
Well what are the main 2 topics we discussed in the last 40 or so posts?
1) Are NAIRU/output gaps and such concepts near useless.
You: yes
Me: No, with lengthy explanations, despite your attempts to paint me as someone who merely repeats textbooks. |
Let’s see.
These was my last post:
quote:
Think so? The history of economic forecasts and policies based on that is pretty bad. How often hasn't it been that a CB kept increasing the rate while the economy was already entering a downturn? Or that govt passed tax cuts that only had their effect when the economy was already blossoming again? |
And these were your last posts:
quote:
I have to say in all seriousness I really do do my best in trying to answer any questions that are asked of me, and to answer them without resorting to technical models, which is very hard at times. I do not know why you imply that this is not the case, since I have spent much time doing what I can to help people understand various concepts, and I have to say it is my belief that for the most part I have succeeded in this.
You are, of course, free to disagree with this, just as you are free to disagree with anything you choose. I have never called you or anyone else an inferior being for disagreeing with me..........though I admit freely your seeming belief that a professional economist possesses no more insight than an intelligent but ultimately unskilled layperson is frustrating at times. |
quote:
Don't be silly. The point is that we have tried lots of things, and what we do now works better than all those things.
Anyway, enough. I have to do some work this afternoon.
I hope I have succeeded in convincing you all of the worth of imperfect tools like output gaps and NAIRU, and I hope there is none among you that seriously believes in ditching discretionary policy. |
quote:
There is no lumping together.........each economy estimates its own NAIRU and uses that to help guide policy. And yes, in my opinion (and thankfully, in the opinion of everyone who counts in the world of economics), policy based on good guesstimates is better than policy based on flipping a coin.
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I see levels of hot air that could cause global warming, but no counterarguments.
The ultimate irony is that AS said pretty much the same thing as I did, just stuffing it with formulas, and you commend him for it. Is it that you don’t like brevity?
quote:
2) Are rules preferable to discretion?
You: yes.
Me: No, with further lengthy explanations. |
Me:
quote:
Why not, set a money supply target and ban discretionary spending based on output fluctuations. Discretionary spending is usually a pork barrel fest anyway.
(ok, don’t take that too literally but it seems a better starting point) |
You:
quote:
The importance of knowing recent economic history raises its oversized head once more. We didn't reach the dominant paradigm of an independent central bank using an inflation target and floating exchange rates overnight.......it is the culmination of years of painstaking research and trial and error. The targeting of various monetary aggregates......targeting of exchange rates......mechanistic non-discretionary rules, these are all possible. Ultimately they are all inferior to the dominant paradigm. |
I’ll freely admit that my post of a money supply target combined with no discretionary spending is a bit outrageous, but there’s no reason why we can’t discuss what the practical problems would be. Instead you just dismiss it because I supposedly wouldn't know the basics and then blow off some high-pitched rhetoric.
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DrSpike
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Enthusiastic member of Apolyton
Sep 2001
time: 05:23
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quote:
Originally posted by Colon
Spike, I posted everything what you wrote in reply to me after what I wrote about NAIRU. The only think you said about NAIRU is that I should just believe you because you 'know' the basics and I don't.
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Anyone can read through and see I have posted far more than the ones you selectively quoted.
I am all for exploring new ideas.....ironically within academia I am very much non-mainstream, since I believe in building models with agents that have bounded rationality when I think it helps. But when it comes to these discussions I usually end up defending orthodoxy in face of criticisms that just haven't been thought through because orthodoxy is orthodoxy for a good reason - hell when all economists agree on something it a rare thing.
Sure orthodoxy can change.......maybe it will again......let a hundred flowers bloom. But I will not have you implying I have not argued with points, because I have, as is evident.
Let's get to it.....you played devil's adocate a bit without really thinking about your position, on both the discretionary policy (I gave you a chance to admit you were playing devil's advocate, and you desisted, so I was forced to take your opinions as stated) and NAIRU disagreements. Through the course of the discussion it was clear whose side was intellectually consistent, but you felt in too deep to concede that. I think we both know the score here, as does anyone bored enough to read through recrimination and counter-recrimination.
But enough.......short of you calling me the devil incarnate in your inevitable response I can't be assed with this further.........If they have queries I will continue to respond to those such as Dan who seemingly like to gain an insight into the world of economics over and above the interesting but leisurely discussions that often go on here .......for you Colon, since my style repulses you so, I shall trouble you with my opinions no further.
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DrSpike
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Enthusiastic member of Apolyton
Sep 2001
time: 05:23
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Dan's fault 
*loose monetary policy*
Now if the economy can grow faster without inflation is there a good reason to keep monetary policy tighter and not realise the potential gain? No, there isn't. And what is more the costs to overly tight monetary policy are huge. The fed does what it is legally bound to do, use monetary policy to hit an inflation target.
I cannot agree that monetary policy was ever too loose. Now there are 2 wrong arguments I see regularly from laypeople here: firstly, and most annoying, is the view that post dotcom crash rates were slashed too aggressively, leading to a present bubble in the property market. The alternative, of course, when investment plummeted, would have been a full blown recession without doubt. Should one criticise the fed? Hell no, you should applaud them.
The second misconception I can empathise with, because it contains an (albeit small) element of truth. This is the view that the initial stock market bubble was the fed's fault. The thing here is, you can hit but one target with one instrument, and it is not the fed's responsibility to use monetary policy to affect the stock market. You can choose to believe that would be a better target than an inflation target, but of course you would be wrong.
*To clarify the dominant paradigm post*
I feel you would benefit from reading what you can find about monetary policy in the 80s, where monetary aggregates were king. You see the question of whether to target monetary aggregates or have an explicit inflation target may seem like no big deal to the casual observer. It turns out to make a huge difference.......due to where in relative terms most of the uncertainty lies, in the real sector or the monetary sector. Hehe, this is back to Gordon again, IIRC he did some of the key work in the 80s on this very topic. It turns out that velocity (in AS's quantity theory of money equation earlier) changes make monetary aggregates too slippery, even when you can control them, which you only can to a limited extent.
*this bit goes to the heart of all the various posts disputing my claims......it really isn't the point to ask whether the CB makes mistakes.......of course they do.....but the way we do things is the best of the ways we have tried. By all means suggest new things.....but that isn't the same as suggesting things we have already attempted and have already observed to be inferior. I made that point because it did not seem you were aware of the relevant economic history*
Ultimately it is easy to criticise the fed, because you can't see the alternative realities and there is always something in the actual reality to ***** about. Do central banks make mistakes? Hell yes.......but the ONLY question that is relevant here is does discretionary monetary policy perform better than simple rules? History/theory/empirics all suggest OVERWHELMINGLY that it does. And monetary authorities make far fewer mistakes because they use models and concepts like output gaps and NAIRU to make their guesstimates. This is why I objected to the claim that such concepts were useless, and I stand by that.
Ha I am not your teacher.......nor would I want to be......but I am someone you can learn from if you so choose.
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HershOstropoler
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DrSpike:
As you aren't the teacher, I suggest you no longer try to rely on the priviledge of academic authority here. We don't even have evidence of your credentials, for all we know you could be a bum housing in a cardboard box with internet access...  As for substance, I don't mind lengthy posts, but you are relying strongly on orthodoxy where things get interesting and I feel a bit like in an atheism/religon thread.
"I agree there was a belief (and a reasonable one at that) that a productivity improvement had raised the rate of growth...."
A very speculative belief. 2 GDP revisions ago it all came from computers (mostly the hedonic game, and a bit from other deflator adjustments + cyclical effects) as a certain Mr Gordon has IMO quite convincingly shown back then already. 2 revisions later it should be roughly the same still...
"And what is more the costs to overly tight monetary policy are huge."
Not so fast. Let's assume an Mwhatever growth target that is inflation target + trend growth rate of GDP. Assuming further increased productivity growth by 50 or 100 bps. Staying with the old policy should in the most simple quantative assumptions reduce inflation by that amount, say from 3 % to 2.5% or 2 %.
Is that overly tight, are there risks associated with that ? IMO, no.
"The fed does what it is legally bound to do, use monetary policy to hit an inflation target."
The Fed uses monetary policy to sustain the viability of the financial sector at all cost. That is its real mandate.
"I cannot agree that monetary policy was ever too loose."
That is an amazing proposition. Even not in the Y2K rampup ? Can you explain it ? That is one thing that keeps me puzzled about contemporary economics....
"Now there are 2 wrong arguments I see regularly from laypeople here:"
There you go again....
"the view that post dotcom crash rates were slashed too aggressively, leading to a present bubble in the property market."
Let me refine that argument: the problem there is not so much with fed rates here but with the creeping nationalization of the US mortgage markets through the GSEs. But as to the economy as a whole:
"The alternative, of course, when investment plummeted, would have been a full blown recession without doubt. Should one criticise the fed? Hell no, you should applaud them."
First they should have prevented the extreme boom to prevent that recession. Lacking that, they can't avoid the backlash in growth, they can just try to spread it out over years. That has its own drawbacks and risks.
The US boom was based on expanding imbalances in the US economy. The US economy went downhill when those imbalances stopped expanding - they have mostly not been corrected yet. On the interest rate structure and in real estate, new ones have been added. The whole economic structure is extremely vulnerable to any kind of shock. Is that really better than a recession ? On the whole, I don't think so.
"This is the view that the initial stock market bubble was the fed's fault.... it is not the fed's responsibility to use monetary policy to affect the stock market."
First it was the Fed's fault that it did not manage the cycle properly, and went cheerleading with a lot of stupid lines (and don't make me quote McTeer).
More importantly, yours is a very theoretical argument. The Fed has approached stock market and financial developments in a very asymetric way. It goes down, Alan to the rescue. It goes up, Alan the cheerleader (after the cautious "irrational exuberrance" remark - just shows you that Fed indepency is a joke).
"In addition I feel you would benefit from reading what you can find about monetary policy in the 80s"
There you go again... poopsie, I only know too well. Hey, let's talk about the german reunification shock to get some traction o nthe "irrelevance" of monetary aggregates, shall we ?
"It turns out that velocity... changes make monetary aggregates too slippery"
Velocity changes affecting the aggregates by 3-5 % a year, over several years ? Or is it just a mirage of velocity vis a vis output, as money goes chasing assets ?
I'll leave nr 3) open as this is getting long and you didn't really address it anyway.
"And monetary authorities make far fewer mistakes because they use models and concepts like output gaps and NAIRU to make their guesstimates."
I am convinced around 2010 it will be orthodoxy that the Greenspan Fed beat the BOJ's incompetence record. Maybe we should continue our debate then....
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21-11-2002 13:20
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