Guns don't kill people. Labor kills people.

Arthur Chu, Jeopardy champ extraordinaire, tweets:

"Capitalism made your iPhone" 

No, LABOR made your iPhone. Labor makes things under any -ism. The -isms just determine who gets paid

He's right that "-isms", in econ terms, are about distribution of resources (though he should broaden his definition of resources to include control, not just payment).

But is he right that "labor made your iPhone"?

Consider the following two situations:

A) I make fire by rubbing two sticks together.

B) I make fire by using a butane lighter.

In both of these situations, you can say "labor made the fire". But in the first situation, there was a lot more labor for the same amount of fire. Saying only that "labor made the fire" leaves out this important fact.

Now suppose I want to make fire with no tools. No matter how much labor I apply - the labor of millions of people over millions of years - I will not be able to make fire. 

So saying that "labor makes fire" also leaves out this important point - the necessity of having tools.

Labor is a necessary input into producing an iPhone. But there are other necessary inputs - machines, buildings, land, natural resources, vehicles, tools, etc. And labor is not a sufficient input for making an iPhone - without the right tools and the right organizational system, no amount of labor will get the job done.

But didn't labor "make" the machines, buildings, etc.? Since labor is necessary to create any intentionally produced good, you can say "Labor is what makes everything" if you want to. But you know what else is necessary to create those goods? Electromagnetism, gravity, and the strong and weak nuclear forces. So I could reply to Arthur Chu by saying "Labor didn't make your iPhone. Physics made your iPhone." Now who's right?

The basic point here is that our language, and our intuitive way of thinking about causation, views everything as perfect substitutes. A + B = C. If A + B = C, then you can determine how much of C is due to A, and how much is due to B.

But in reality, things are only partial substitutes. You more often have stuff like
(A^a)(B^b) = C. When you have complementarity, it doesn't make sense to ask how much of C is due to A, and how much is due to B. But we always do it anyway. Arthur Chu's tweet is one example. The slogan "Guns don't kill people, people kill people" is another example. A third example is the perennial debate over whether humans have "free will."

Our intuitive concept of causal attribution is simply wrong and useless in most cases.

Steve Williamson is right that I am confused

In a post for Bloomberg View, I wrote about the history of the sticky-price revolution of the late 1990s and early 2000s:

In 1994, economists Greg Mankiw and Lawrence Ball wrote an essay for the National Bureau of Economic Research entitled “A Sticky-Price Manifesto.”...[T]he essay heralded the beginning of a macroeconomics mini-revolution. It was a direct threat to the line of research that had been dominant in the 1980s, which tried to explain recessions without sticky prices... 

The economic establishment reacted harshly to the upstarts. “Why do I have to read this?" fumed Robert Lucas, the dean of macroeconomics. "This paper contributes nothing.” He went on to accuse the sticky-pricers of being opposed to science and progress. 

But Lucas fumed in vain. During the following decade, the sticky-price models went from strength to strength. New math was developed to make them easier to use. Possible reasons for price stickiness were investigated -- for example, “menu costs,” in which the seemingly trivial costs of changing prices add up to a big problem across the broader economy. 

Even more telling, sticky-price theorists proved that you didn’t need a lot of price stickiness to mess up the smooth working of the economy. Even the tiniest dash of stickiness would turn all kinds of theories on their heads. Economists Susanto Basu, John Fernald, and my doctoral adviser Miles Kimball, for example, showed that when prices are even a little sticky, bursts of technological progress actually hurt the economy for a short while, by causing a burst of deflation, before eventually boosting growth. Over time, the addition of various other economic mechanisms, like labor search, has further reduced the amount of price stickiness required to cause major recessions. 

Sticky-price models have become the dominant models used at central banks. The smoothly adjusting, flexible-price models of the 1980s are basically not used anywhere, by anyone, for anything. 

Even some of the biggest skeptics of sticky prices are coming around. In 2004, economists Mark Bils and Peter Klenow looked at how businesses changed prices, and found that the changes were too frequent to be consistent with the sticky-price story. But in 2014, they reversed their stance, looking at evidence on the adjustment of markets in recessions and concluding that “sticky prices...deserve a central place in business cycle research.” Meanwhile...Patrick Kehoe...long-time [opponent] of the mainstream sticky-price models, nevertheless wrote a paper in 2010 entitled “Prices are Sticky After All.”... 

The moral of the story is that if you just keep pounding away with theory and evidence, even the toughest orthodoxy in a mean, confrontational field like macroeconomics will eventually have to give you some respect.

Steve Williamson wrote a response to my post, and for the life of me I can't tell what he's trying to say. He calls me "confused". Well, after reading his post, I am confused.

Williamson takes some potshots at Ball and Mankiw:

The "Sticky Price Manifesto" is in part a survey of the menu cost literature, but it reads like a religious polemic... 

Why should we care what Ball and Mankiw think is going on in the minds of their staw-men opponents, or in the classrooms of those straw-men? Why should we care what Ball and Mankiw "believe?"... 

Noah seems to think that Lucas was being unduly harsh [in his response to Ball and Mankiw], and that he was somehow feeling threatened by these "upstarts." It's pretty clear, actually, that Lucas just thinks it's a bad paper - religion, not science - and that Ball and Mankiw could do a lot better...

He then asserts that New Keynesian models don't have anything to do with the stuff Ball and Mankiw were writing about:

Noah is more than a little confused about the genesis of sticky-price New Keynesian (NK) models. In particular, he thinks that Ball and Mankiw's "Sticky Price Manifesto" was a watershed in the NK revolution. Far from it... 

Where did NK come from? Which of the three threads in post-macro revolution Keynesian economics - coordination failures, sunspots, menu costs - morphs into Woodfordian NK models? To a first approximation, none of them. Perhaps NK owes a little to the menu cost approach, but it's really a direct offshoot of real business cycle theory. Take a Kydland and Prescott (1982) RBC model, eliminate some bells and whistles, add Dixit-Stiglitz monopolistic competition, and you have Rotemberg and Woodford's chapter from "Frontiers of Business Cycle Research." Add some price stickiness, and you have NK. So, NK basically leapfrogs most of the "Keynesian" literature from the 1980s. It's much more about RBC than about Ball and Mankiw.

(For a brief intro to Mankiw's contribution to the New Keynesian research program, see the Wikipedia page for New Keynesian economics. See also the Wikipedia page for Steve Williamson.)

Williamson then tries to claim ownership of New Keynesian models for Chicago/Robert Lucas/RBC/His Majesty the King of Spain/I'm not sure:

[I]t's worth noting that Mike Woodford, the key player in NK macro, was at the University of Chicago from 1986 to 1992, the latter 3 years in the Department of Economics with - guess who - Bob Lucas. Indeed, they wrote a paper together. It's about - guess what - a kind of sticky price model with non-neutralities of money. Later on, Lucas wrote about sticky prices with Mike Golosov. So, I think we could make the case that the influence of Lucas on NK is huge, and that of Ball and Mankiw is tiny.

He then goes off on a long tangent about how central bankers might use sticky-price models to think about financial stability (which, apparently, he thinks is now the main priority for central banks).

It's kind of funny to see Williamson trying to wrest historical credit for New Keynesian models from Mankiw & co., since just in his previous post he had this to say:

Mike Woodford can correct me on this, but my impression is that he came out of graduate school with a specific goal in mind, which was creating a version of Keynesian economics that would fit into modern macro. Ed Prescott's project left central bankers scratching their heads about what they were supposed to be doing, and Woodford and others stepped into the void. Interest and Prices is, I think, intended as a handbook for central bankers. There was a lot of effort put into marketing the whole NK project to the world's central banks. This is ongoing, and has been institutionalized[.]

So NK was reverse-engineering of Keynesian ideas. But actually it was just RBC. But it succeeded because it was promoted via a slick marketing campaign. But actually Lucas was one of its founders.

Also, microfoundations are important. But Mankiw's efforts to microfound sticky prices with menu costs was totally unimportant to the creation of sticky-price macro models.

Got that?

Damn, I guess I am confused.

Did macro theory fail us in the crisis?

David Andolfatto and Mark Thoma have posts defending macro theory from (some of) the people who say it failed us in the crisis. Both are good posts, and you should read both.

Anyway, here's a quick (and probably incomplete) taxonomy of criticisms people make about macro with regards to the crisis:

1. "Macro models failed to predict the crisis, therefore DSGE sucks."

This is the criticism that Andolfatto and Thoma reject. I basically agree. There are no other models out there that did forecast the crisis. Nor are expert predictions any better.

Personally I think DSGE techniques haven't  reaped dramatic benefits (yet). But what other alternative is better? When I ask angry "heterodox" people "what better alternative models are there?", they usually either mention some models but fail to provide links and then quickly change the subject, or they link me to reports that are basically just chartblogging. Yeah, sure, if you put out hand-wavey reports saying "capitalism sux, there's gonna be a crash!" every year or two, you're eventually going to be able to say "see, I told you so". But that's no replacement for real modeling.


2. "Macroeconomists were too confident before the crisis, and that gave policymakers false confidence."

It is pretty obvious to anyone who has ever interacted with macroeconomists that most of them take their models way too seriously (this is even more true of the "heterodox", to the degree that they even have models). It's a common disease of academics in general - you have to spend so much effort pushing your theories that overconfidence is selected for.

Did this confidence leak over into the policymaking sphere? I don't have evidence here, but I doubt it. Most of the Fed people are a LOT less confident than academics. And they were being advised by a lot more than just the academic crowd - they had a big stable of chartbloggers, hand-wavers, etc. to draw upon. Plus they themselves had Old Keynesian models in their bag of tricks. As for politicians, it's not clear they even know that academic macroeconomics exists.

If the Fed people were overconfident in 2005-6, I suspect it was mostly due to natural cognitive biases - "Everything seems like it's been going OK for a couple decades, I guess we're doing something right" - rather than the overconfidence of the academics they interacted with.

But I could be wrong.


3. "Macroeconomists weren't focusing on finance enough before the crisis."

Thoma says that this is a valid criticism, and I agree. There are a bazillion models out there. But just having models out there isn't enough; if you're going to give policymakers real advice, you're going to have to choose which model - or which basket of models - to base your advice on. Macroeconomists weren't very worried about finance before the crisis - you didn't see a lot of people waving copies of Geanakoplos (2003) and saying we could be courting disaster.

Belief in the Great Moderation, and in the Fed's ability to stabilize the economy, was too strong. The central problem of depression prevention had not, in fact, been solved. But an awful lot of top macroeconomists - not just Lucas, but the New Keynesians too - thought it had. Their favorite models didn't have any finance in them, with the possible lone exception of the Bernanke-Gertler "financial accelerator" models.

That was a big mistake, especially since the Great Depression and crises in other countries (e.g. Japan) should have suggested that financial crashes were a big deal. To their credit, though, mainstream macroeconomists have been hastening to correct the mistake. Certainly they're going to pay more attention to finance for at least a few more decades.


4. "Macroeconomists don't do enough to kill their models off."

This is something I hear surprisingly few people say, given that I think it's the best of the criticisms out there. If you let a million flowers bloom but don't cut any of the flowers, you get a big warehouse full of flowers. OK, so that metaphor went nowhere, but you get the point. Macroeconomists, when they get defensive, tend to say something along the lines of "We got models for everythin'!" But is that a good thing??

I feel like if you have models for everything, you don't actually have any models at all. Without a way of choosing between models, your near-infinite stable of models turns into one big giant mega-model that can give anyone any results he wants. Worried about a financial crisis? Pull out a model that tells you a financial crisis could be looming. Worried about inflation? Pull out a model where inflation is a big danger. And so on.

Now, technically, you could choose between models based on the plausibility of the assumptions. But three things make this impossible in practice. First, the need for tractability means that the assumptions in almost any modern macro model will be utterly implausible to anyone who has not spent decades in a monastery high in the Himalayas training himself in the art of self-deception. Second, the assumptions are so stylized that it takes a huge amount of talent just to figure out what they are - in fact, we're starting to see the emergence of top macro people, like Matt Rognlie, who specialize in figuring out what the heck models are actually saying. And third, with a near-infinite catalog of models to comb through, there's just no way to compare any significant number of them all at once.

If you ever want macro models to actually be useful, it's not enough to just wave your hands and say "all models are wrong". It's not enough to treat models as ways to "organize our thinking". You've got to have a way to take them to data and decide if you should keep them around, send them back to the shop for alterations, or burn them in a fire.


5. "The crisis exposed the fact that macroeconomics doesn't work."

Well, sure. But it also showed that we need to keep trying to make it work. And macroeconomists, as a whole, don't absorb a significant fraction of our GDP, so I'm not incredibly worried.



Updates

Bumped from the comments, by an anonymous commenter:

[D]on't focus on macro *theory*. It's macro empirics I'd worry about. theory ahead of measurement etc. The difference post crisis is you see greater prominence of macro papers using micro data (e.g. mian sufi or autor/dorn/hanson/acemoglu).

Great point.