Tuesday, March 6, 2018

Lesson 21 Macroeconomic Fuzziness

I had another one of those chats with a nice person who reads my blog. It always starts out with a nice compliment but then winds its way around to the fact that some people cannot understand one thing I say. They count the number of times I use the word JD and then go back to their usual productive lives.

This is both frustrating and understandable. I started learning macro from Professor Bill Shaffer at Georgia Tech in 1965. Since that first course, I have taken an embarrassing number of econ courses in college and graduate school, and I've taught an even larger number of econ courses since starting my career. While some of my econ colleagues were rocket scientists, I always loved the idea that you could help people understand the world better by studying econ.

Because some of my blog friends don’t have a lot of background in econ, I wish I could help them better understand what is happening “out there”. And there is a lot happening. The economy is or isn’t about to implode. The Fed might raise interest rates three or four times in 2018. The Federal government is planning to make its very large debt position even larger. Inflation is going to rise, the value of our stocks is going to fall, and we will all soon be panhandling on the sidewalk in front of Nick’s English Hut.

There is plenty “out there” to discuss. And that’s the problem, or should I say that’s the challenge. Economics has three parts. First, economics wants to provide answers about what is going to happen in the future. Second, to do that, economics must have some basic fundamentals that can be applied to the future. Third, economists are always checking the reliability of these fundamentals by looking backward. If they seemed to hold in the past, then maybe they can be used to think about the future.

Fundamentals? There are lots of them. For example, we believe that if you give a person an extra dollar that person will spend some of it. The marginal propensity to consume (MPC) tells us how much of an extra dollar received will be spent. (Some of the extra dollar goes to taxes and some goes into saving. The rest is spent.) This fundamental is used, among other things, to estimate how much extra spending will be done by people receiving tax breaks in 2018 and beyond.

The MPC is a potentially useful idea but we don’t want to apply this idea if it isn’t true. So we look backwards. Economists do studies to inquire how people really act. Give a dollar to Nolan. Let’s see what he does with it. Here’s a dollar for Ashley, let’s see what she does with it. We won’t all do the same thing with an extra dollar. But studies of the usefulness of the MPC in macroeconomics look to see if it is a reliable indicator of what all of us did when given an extra dollar. Thus, the past can be very useful. How have Americans behaved when given tax cuts in the past? When Americans were given a tax break of $1 billion, did they spend more on goods and services? If so, how much? Looking at more than one tax cut over time and over many families, did they have a reliable spending response?

Fundamentals can be argued about in terms of basic intuition. Focusing on income and spending might be too narrow. And history might find that tax cuts have had different impacts at different times. Thus, we might have a lot to argue about the past. If we can’t all agree about the nature of an economic fundamental and its reliability in the past, then clearly we will have a lot to argue about its application to the future.
Atoms don’t behave like humans. Apply heat to an atom and it behaves according to physical laws. Physical sciences, therefore, are more useful for predicting the future. Social sciences have fundamental laws of behavior but because they involve human behavior, they have less predictability.

We don’t give up trying to predict the future, though, just because Nathan doesn’t act like an atom. People are very curious about the future and are willing to tolerate a less than 100% accurate economic prediction. This underscores why macroeconomics always seems so iffy and controversial and why economic predictions are often off the mark. We spend a lot of time arguing about fundamentals and even more time disagreeing about whether a given fundamental was accepted or not accepted by a given past historical period.

To complicate matters further, we have ideologies mucking up our discussions. If macroeconomics sounds precarious based on past behaviors of fundamentals, this apparent unsoundness is compounded by the fact that we have extreme camps of economists who differ almost as radically as Catholics and Baptists. Conservative economists believe government is an evil that disturbs the natural and good order of things. Liberal economists have faith that the government is necessary to restore order and save us from the greed and stupidity of mere mortals.

This ideological split taints every fundamental and every economic prediction and ensures that each camp will totally disagree with the other ones about everything from peanut better to BB guns.  

This brings us full circle. It is fun and challenging to help some of you understand current macroeconomic issues. To do that takes blog posts that can never lack at least a few ifs, ands, and buts. A discussion of any topic worth writing about will be full of definitions and theories along with attempts to verify them with historic episodes. But history never proves anything perfectly, and ideology always provides ample grounds for near-theological disagreement. So I will ask for your patience and hope that this little post today helps you understand why things always have to sound so complicated.


  1. Dear LSD. Google and a thesaurus help me unnerstand your stuff. Your periodic ‘splainations also help. Please keep up the good work. BTW, if you get bored with Bloomington—on one hand—you could consider Washington, D.C., where there is a very good paying job vacancy for an economist. 1600 Pennsylvania Avenue is looking for an economist now that Gary Cohn has resigned. But you’d better hurry as Larry Kudlow has been reported as a likely replacement. On the other hand, sitting in a plush desk in the White House might not be conducive to afternoon JD sipping. You’d also have to refresh your clip-on polka dot bow ties. Your tie dye T- shirts will be a no-no. It’s a big decision that will require much consideration and JD. Cheers!

    1. Dear Tuna. It is nice to have you back in the swim. I appreciate your support for the job but I want to give Paul Krugman a chance to jump in first. Next week's post will feature my thoughts on protectionism and I am guessing that the current administration will not love it -- titled Nero Fiddles while Rome Burns. Best.

  2. It seems to me that what I really want out of Macro is actionable intelligence. So while sit is important to understand what MPC is, and how it might work, what translates to actionable intelligence is when the data surfaces to show what variation is talking place within the economy as a consequence of both having an additional increment of disposable income and knowing how that increment is being spent in a moving economy. I have a fuzzy, intuitive sense that newly available disposable income is increasingly being spent on experientially based expenditures rather than capital or income producing assets. Knowing whether such trends are true, and how they might vary from traditional expenditures, seems to me to be what I want to know.

    1. Good point Ed. I just read a nice piece by McKinsey on their website. It was all about the decline in capital expenditures and resulting decrease in growth and productivity. I don't have trouble finding such "actionable intelligence." But even that suffers from the same points I made about the MPC. Capital spending is even more volatile than consumer spending. Our interpretations of past behavior allow for considerable disagreement about cause and effect. It gets even hairier when we try to predict the future. Even our basic models about capital spending can disagree. Macro ain't physics but we try. And the more we try the more we either put people to sleep or totally confuse them.

    2. Dear LSD and Ed. My intro to econ was supply and demand curves and how price affected both—clear and simple—got it. It worked well in the classroom in the 60s. Today’s globalization, expanding and contracting economies, governments’ legislations and policies, fiscal and monetary policy as well as central banks’ actions, shifting demographics, et al confound econ prognostications—even by the most learned PhDs in the dismal science whether they be left- or right-handed or one-handed—making difficult the task of making actionable intelligence. Econs deserve sympathy for attempting the difficult given Russian manipulation of social media. But, there may be help on the horizon. AI is gaining use in everyday life and decision-making such as managing driverless cars, portfolio composition and investment, home and industrial lighting, vacuuming, cooking, and ‘fridgerators . . . . Is it time to consider turning econ prognostication over to AI, crystal balls, or ouija boards and give the econs a break?

    3. I vote for AI. :-)

      I have an ap on my phone that turns my lights on and off when I am away. Is that cool or what? I played with it so much that I think I burned the lights out.