Month: December 2008

The very well known macroeconomist Roger Farmer says yes:

It is time for a greatly increased role for monetary policy through
direct intervention of central banks in world stock markets to prevent
bubbles and crashes. Central banks control interest rates by buying and
selling securities on the open market.

A logical extension of this idea is to pick an indexed basket of
securities: one candidate in the US might be the S&P 500, and to
control its price by buying and selling blocks of shares on the open
market.

That is from the FT.  Though he says he is warming to the idea, to my ear Mark Thoma sounds skeptical as am I.  Public choice considerations aside, if the Dow is valued at 7000 in market opinion and the Treasury (Fed?) is propping it up at 8500, a lot of people will sell shares into the hands of the government.  How much are the shares worth then?  How hard will the government try to break the shorts who speculate on lower prices?  Will this work any better than currency pegs?  What are the implications for pursuing other monetary targets, such as the rate of inflation?  If the peg succeeds who would hold other, riskier assets?

Some people might even say that the "Greenspan put" was part of what got us into this hole in the first place.

Farmer is working on a book How the Economy Works and How to Fix it When it Doesn’t.

One request was this:

The role and future of intelligent agent modeling in economics.

Call me a stuck up sticky bit but I don’t see a bright future for this technique.  We already have, and have had, computable general (and partial) equilibrium models for decades.  In those models you try to estimate the parameters from empirical data.  The models rarely impress me but there are plenty of situations, such as estimating the effects of changes in the tax code, where we don’t have anything better.  And so those models survive, and will continue to survive.

What’s the important innovation behind intelligent agent modeling?  To introduce lots of arbitrary assumptions about behavior?  Greater realism?  Complexity?  Considerations of computability?  Learning?  We already have enough "existence theorems" as to what is possible in models, namely just about everything.  The CGE models already have the problem of oversensitivity to the initial assumptions; in part they work because we use our intuition to calibrate the parameters and to throw out implausible results.  We’re going to have to do the same with the intelligent agent models and the fact that those models "sound more real" is not actually a significant benefit.

What can be done will be done and so people will build intelligent models for at least the next twenty years.  But it’s hard for me to see them changing anyone’s mind about any major outstanding issue in economics.  What comes out will be a function of what goes in.  In contrast, regressions and simple models have in many cases changed people’s minds.

Sometimes a theory model tells you there are many many equilibria, as in much of game theory.
I believe that result is to be taken seriously and we should conclude
that many different things can happen in that situation.  I am
suspicious of trying to solve for the correct or most likely
equilibrium by introducing many more specific assumptions.

In my possibly overdogmatic view, economics is most useful when its models are relatively simple and intuitive.  We’ve run out of new models which are simple and intuitive.  So the theory game is over.  The standard, old data sets have been data mined to death.  We’re now on to the "can you build/create your own data set?" game.  That game can and will last for a long time; in some ways it will favor go-getter extroverts just as the theory game favored introverts.

I don’t yet see that there is a new game in town.  My preferred reform of economics involves more history and anthropology, I might add.

Addendum: Bob Murphy asks:

It may be apocryphal for all I know, but I once read that the editor
of the journal to whom Einstein sent his paper on special relativity
put it down and realized that physics would never be the same (or
something like that).

Is something like that even possible in economics?  What would it be like?  Say, the Lucas critique times 10?

The answer is no, in my view this is not possible, for reasons given above.

Paul Krugman writes:

…if you believe that a surge in private spending would raise employment – and even the critics agree on that – it’s very hard to explain why a surge of public spending wouldn’t have the same effect.

Brad DeLong writes:

But surely we believe that if the U.S. government were to follow the Countrywide plan–to send its representatives out onto the streets to have them walk up to people and say: "Here’s $500,000. You can have it if you go buy a house"–then that would drive a recovery, right?

What’s interesting about these statements is not so much whether they are right or wrong (let’s just say that it depends) but that Krugman and DeLong are so immersed in the Keynesian viewpoint that they cannot even see any other way of looking at the issue. Thus "even the critics" and "but surely we believe," as if no other view were conceivable.

Well if the only frame you can see is the "spending increases employment" frame then whether the spending is private or public may seem like a niggle. But many of the critics of mass fiscal stimulus have an alternative frame in mind, namely, that "employment increases spending."

Frame the issue this way and it becomes clear that the choice between private employment and public employment as a driver of spending is crucial.  Moreover, when we remember that employment drives spending we focus attention on the real allocation of labor and capital across sectors of the economy, on internal and external fiscal balance, on investment as well as on consumption and on time paths of development. The "spending drives employment" frame misses all this.