April 2008 Archives

My class was right... including about who the dissenters would be. (Though they actually predicted more dissent, I cautioned them that two was probably the most you'd see in the vote.) Not that this was a particularly hard call. On the surprise meter, today's move by the Fed--from the amount and direction of the change to the dissenters to the apparent shift in stance going forward--barely registers. Indeed, what is there to say that hasn't been said already?

For the record, here is the statement from the Fed:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 2 percent.

Recent information indicates that economic activity remains weak. Household and business spending has been subdued and labor markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters.

Although readings on core inflation have improved somewhat, energy and other commodity prices have increased, and some indicators of inflation expectations have risen in recent months. The Committee expects inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization. Still, uncertainty about the inflation outlook remains high. It will be necessary to continue to monitor inflation developments carefully.

The substantial easing of monetary policy to date, combined with ongoing measures to foster market liquidity, should help to promote moderate growth over time and to mitigate risks to economic activity. The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Sandra Pianalto; Gary H. Stern; and Kevin M. Warsh. Voting against were Richard W. Fisher and Charles I. Plosser, who preferred no change in the target for the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 2-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Atlanta, and San Francisco.

There are two very obvious differences between this statement and the last (in addition to a few more subtle variations of the wording that are also consistent with the overall shift but probably not worth obsessing over). Those two obvious differences are that what was

Recent information indicates that the outlook for economic activity has weakened further.

is now...

Recent information indicates that economic activity remains weak.

The interpretation being that we may have "hit bottom," to put it rather bluntly. The other is that the sentence in the last statement...

However, downside risks to growth remain.

... is simply gone. Hard to be more obvious than that.

The inflation paragraph is interesting. There is some acknowledgment of the improvement in the core numbers. Also, the sentence in the last statement,

Still, uncertainty about the inflation outlook has increased.

Is now...

Still, uncertainty about the inflation outlook remains high.

As with the statement about economic activity, the implication is that while there hasn't been much improvement in the level, the first derivative looks better. It's almost as if an academic economist had a hand in crafting it.

Barring any new developments, expect no change in June.

Now, over to the GDP report. James Hamilton's post on the subject is my pick of the day for excellent analysis of the report. To tell you the truth, the GDP figure was pretty close to what most of us were expecting. Most expectations that I saw were in the positive-but-under-1-percent range. Also, it is important to remember that it is subject to revision, so I wouldn't make any big deal out of it beating expectations by a small fraction of a percent. It's what we expected, and it is not particularly good. The difference in economic activity over a 6 month period between growth of 3.5% and growth of 0.6% is a couple hundred billion dollars. Far from pocket change, that amount of lost economic activity in 6 months is roughly comparable to the current annual federal budget deficit.

But is it a recession? No. Not yet, anyway. And though some forecasts show an improvement in the 2nd half of 2008, we're not out of the woods yet. The increase in inventories and the accompanying decline in real final sales is particularly worrisome going into the 2nd quarter. The recovery from this slowdown (if not recession) will take some time.

In my intermediate macroeconomics course, the final project is a simulation of an FOMC meeting where members of the class play the roles of Fed officials. They did exceptionally well. The presentations and discussion were excellent.

My class voted 9 to 7 to cut by another quarter point. (The 7 wanting to hold rates steady)

As far as I can remember, my class has never been wrong, and also as far as I can remember, when the class predicts dissent, there usually, if not always, is (though never as much in the real vote).

It's an unscientific indicator, to be sure. But it is very rewarding to see the students take it so seriously and really learn about how the Fed works.

The real meeting, of course, is tomorrow. More on that later.

Word comes from Janet at SCSU Scholars that King Banaian is in the hospital. He had surgery to remove his gallbladder today. Stop by SCSU Scholars and wish him well.

April.

It's a word that conjures up images of pleasure and pain in the academic world. The academic year is almost over, but indeed we have miles to go before we sleep. So it has been for this April.

No need to bore you with the details. I've been spending a lot of time at the computer doing research and revamping a course. Both are activities that are not very conducive to blogging breaks. On more than one occasion I sat down to write a post never to finish.

But there is light at the end of the tunnel, and more blogging lies ahead.

I am going to be out of the office for the rest of the day, but here are links to the usual sources:

Economics Unbound, Angry Bear, Big Picture, Calculated Risk

Also MSM pieces from Reuters and NY Times.

BLS press release

80,000 jobs lost and the unemployment rate went up to 5.1% from 4.8%.

My recession probability is not yet at 100%, but getting close.

The IMF publication Finance & Development profiles John Taylor.

Hat tip: Greg Mankiw

This all started with my post on how a computer demonstration allowed me to illustrate a certain technical feature of the Solow model that would otherwise require a lot more setup time. The (unstated) implication being that it allowed me to get to the "good stuff" sooner.

That's a little ironic because both John Palmer and Gavin Kennedy clearly want to focus on the other important institutional aspects of growth. Kennedy wants more attention to a careful and correct reading of Adam Smith (I can't disagree with that), and Palmer wants to focus on reducing transaction costs a la Coase. No doubt that others could come up with entirely reasonable things to add to that list, and no doubt many of those additions are things that, given enough time in the semester, would be beneficial to cover in class.

Yet I think that both John and Gavin overstate the objection to the Solow model (and presumably other models) as just a mathematical exercise--math for math's sake. As John puts it, "Yes the models are a great seive for filtering the students and putting them through the hoops." But in his later post he writes:

Second, the basics of economic growth are extremely important: consumption uses scarce resources that cannot then be available for producing capital goods; saving allows investment, which means more will be available for consumption in the future. We all (I hope) teach something like this in our intro courses when we show that saving today shifts the production possibilities frontier outward for the future.

We agree! And there's probably no better way to quickly and coherently communicate this than a simple undergraduate treatment of the Solow model. You have the most simple dynamics possible. You can talk about investment and depreciation. You can talk about stocks and flows. You can talk about capital seeking a high rate of return. You can talk about the tradeoff inherent in the consumption/saving decision. It's all there in a convenient package that can be covered in one class period.

And really, the Solow model as typically presented at the undergraduate level is not much of a math problem. It reduces to a couple lines of algebra. One does not have to do the full-blown differential equations version.

Perhaps this would be a good time to lay out the way that I approach growth in an intermediate macro course. It is based on the presentation in Steve Williamson's text, but I add my own twist.

1. Overview of growth experiences across the world. Evolution of average world GDP since the industrial revolution. Demonstration of gapminder.org website. Parente and Prescott stylized facts.
2. Malthusian pre-industrial revolution scenario. No growth. Mercantilism.
3. Industrial revolution. Economies begin to accumulate physical capital in a serious way. Solow model is introduced. Growth accounting. Solow model can explain how high marginal product of capital attracts investment. Solow model can't explain why countries take off or why sustained growth occurs. Convergence happens among wealthy countries with similar institutions but no worldwide convergence. Finish with Alwyn Young analysis of TFP in Asia before the financial crisis, which leads directly to...
4. Modern growth. Robert Lucas and Paul Romer style models (sketch... little math). "It's not factor accumulation, it's 'A'" a la Easterly and Levine. Endogenous TFP. Discussion (institutional issues are raised).

It's not particularly math heavy, though there are some opportunities for the motivated student to show off a little. If anyone had the impression that I dwell on the Solow model, I'll clear that up now. But it is a very important part of the context of the whole discussion (not to mention the only way I know to introduce growth accounting). Plus, while the Parente and Prescott approach is not exactly the Solow model, it is of that lineage.

There are so many interesting things to talk about when the time of the semester comes around to discuss growth theories. The simple algebra of an undergraduate version of the Solow model is one of the boring parts, but it is, I believe, necessary. Not as a filtering device (it is a rather coarse filter), but as a way of showing the "measure of our ignorance" (as the Solow residual is sometimes renamed) before moving on to (attempt to) lift the veil of that ignorance.

So anyway, I think we should have more and better presentation tools for streamlining the presentation of the Solow model to make the mechanics clearer and to better allow us to communicate how it revolutionized thinking about growth and how it ultimately showed us that there is so much we don't know without getting our students bogged down in the technical details.

That's what started this whole discussion anyway.

See also: Mike Moffatt (whose comments on the Coase theorem I will take up at a later time), Gabriel Mihalache (who agrees with me while maybe overdoing the case for analytical precision--at least if we're mainly talking about undergraduate pedagogy--but that is to be expected of a soon to be first year Ph.D. student [been there, done that]), and YouNotSneaky (who agrees with me for essentially the right reasons).

John Palmer asks this question in response to yesterday's post.

My response was:

Same reason we teach the Ricardian model of comparative advantage.

Even though it oversimplifies reality to nearly the point of absurdity, it contains many useful insights that are vital to understanding more sophisticated models and policy discussions.

It introduces a way of organizing one's thinking about the topic at hand. (Growth accounting, in Solow's case... a very important concept.)

It is a touchstone in the literature for an entire field. One cannot be considered to be educated in that field without an understanding of it.

It can be augmented and extended fairly easily to obtain more interesting and potentially useful results.

Despite all that, we know that it is a bit too simple to be the only tool in our arsenal. Indeed, to use it as the only tool in our arsenal would be dangerous.

Would not each of these statement apply to the Ricardian model as well as the Solow model? (Readers are invited to suggest others.)

John responds:

Recently a colleague asked me if I teach anything about growth in my intro course. I replied that I teach nothing explicit about growth theories, but I do teach the Coase theorem and the importance of property rights and transaction costs in understanding exchange and growth.

In contrast, Ricardian comparative advantage lies at the heart of exchange; some would argue it is the only argument we have in favour of free trade. It is indeed based on heroic assumptions, but in many instances these assumptions do not detract from the usefulness of the concept. And at least comparative advantage depends on such basic concepts as opportunity costs and relative prices.

I wholeheartedly agree with the emphasis on the Coase theorem--which may be one of the most important ideas in economics. And yes, the Ricardian model is where we show off our propensity to make opportunity cost and relative prices the cornerstone of the entire edifice of our theory. The Solow model does not give opportunity cost and relative prices the same central role. Indeed, they play almost no role (unless you count the rental rate being the marginal product of capital, but one could overlook that if one is not careful).

But the successors of the Solow model do give prices that role. And so again I go back to my assertion that Solow's model provides the basic framework for thinking about the problem of growth accounting, for taking a measure of our ignorance, and for laying the foundation for half-a-century of research. Not a bad record.

And let's be honest. Any model that can get our attention and cause us to take stock of the measure of our ignorance about a problem as deadly serious as economic growth and development is very much worth teaching.

Gabriel M. also comments.

I've got a couple of presentations to make on Thursday and Friday and a full slate of meetings and classes. Light blogging continues until things settle down a bit.

Of the whole academic year, late March and early April always seem to me to be the biggest crunch time.

Office hours today: A student had a question about the golden rule saving rate in the Solow growth model. No problem. Bring up the Mathematica demonstration on the Solow model. Use the sliders to show how changing the saving rate causes consumption on the balanced growth path to rise or fall. The concept was effectively communicated faster than I could have stood up, found a dry erase marker, and started to sketch out the model on the whiteboard in my office.

If you teach the Solow model, you really should check it out.

A student sends me this piece by Dani Rodrik.

How does globalization reshape wealth and opportunity around the world? Is it mainly a force for good, enabling poor nations to lift themselves up from poverty by taking part in global markets? Or does it create vast opportunities only for a small minority?

To answer these questions, look no farther than soccer. Ever since European clubs loosened restrictions on the number of foreign players, the game has become truly global.

Read the whole thing.

It is severe weather season around here, so this is a good time for this kind of announcement. For many years I have had a radio capable of receiving National Weather Service broadcasts. But in the internet age, I rarely use it. I go to the web, watch the radar, get the scoop on the severe weather prognosis for the day (if something is expected), and just keep track of what's going on in the atmosphere. My radio did not have an alarm that would alert you in the event of a warning. It was basically an ordinary radio.

So this weekend, I bought one with the alarm that will go off when there is a warning specifically for your county or a county near you.

This morning, we had a line of thunderstorms move through very early (which is unusual but not unheard of).

The alarm worked. It was loud enough to wake a sound sleeper like me.

Fortunately, it was not a tornado, and our neighborhood escaped anything too severe. But still... it is that time of year, and early morning storms do happen. I seldom get caught off guard by severe weather during the day, but nighttime storms can be deadly.

A good "all hazards" radio with an alarm can be had for around $30. If you live in tornado alley, it's a good addition to your bedroom.

Longtime readers will know that I am somewhat of a weather buff. This spring, I finally managed to get to a storm spotter training session put on by our local National Weather Service office. If you enjoy weather and live in a tornado prone area (and I know a few economists who do...is it a forecasting thing?), you should go to one of these sessions too.

Janet at SCSU Scholars reports that in Minnesota they had snow. Somewhat hopefully, she titles the post "Last snow?" I don't know. I remember some April snow, including one as late as about April 29. I remember the date because it was study day before final exams.

I do not miss April snow. I want to be out on the soccer field in shorts with the kids this weekend.