Yet another in my series of articles on economic theories, empirical hypotheses and policy programs that have been refuted, or undermined, by the Global Financial Crisis. This one, on Real Business Cycle Theory, is a bit econowonkish, but I’m putting it up here because
(a) I hope some econowonks among the readers might find errors and correct me
(b) Judging by some other recent commentary, RBC still has some interest.

* As indeed, they have. My suggestion of a link between calibration and the GMM has been roundly refuted both here and at Crooked Timber. I can only say, it seemed like a good idea at the time. Thanks for the very useful comments on this point, and on RBC more generally.

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I’ve been planning a post with reviews of lots of the books I’ve been reading, but haven’t got to it. So, I’m going to post a couple now, and try to get back to it later. Here’s a review of Akerlof and Shiller Animal Spirits
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A week ago, just before the blog went off air, I was part of the expert panel at a community consensus conference on the topic “Should there be a tax on fatty foods”. This was organised by students at the UQ School of Journalism and was largely about exploring the process, though there was also plenty of interest in the substantive question. It was very professionally organised with its own website, video and news coverage.

The setup for these exercises is that members of the public with an interest in the question get together with a panel of experts to explore the issues, and try to reach a resolution that will hopefully be both well informed and more likely to gain public acceptance than simple reliance on expert judgement. I am sympathetic to the idea, but somewhat sceptical, in the light of experiences like the Constitutional Convention on the Republic (also mentioned by Kate Carnell, former ACT Chief Minister and now CEO of the Australian Food and Grocery Council who was on the panel). It seems to me that the experts ability to persuade the public participants in a process like this does not necessarily translate into an ability to gain broad public acceptance.

As it turned out, the majority of the public “jury” were sympathetic to the idea of a tax on fatty foods at the outset. Opinion among the experts, on the other hand, ranged from dubious to firmly opposed. Not surprisingly, this swayed the majority of the public participants. There was some interesting discussion of alternatives, but the concise nature of the process tried here (one half-day, as opposed to the multiple weekends adopted in other implementations) didn’t really allow for a full-scale alternative policy.

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Also a bit belatedly, my Fin column from Thursday. I got a call from a cotton grower who was upset by the column, but as we talked about it, was reacting more to the general tendency to demonise irrigators, something I’ve criticised in the past . It’s important not to blame people for decisions that made sense in the light of public policy at the time, and certainly, those of us who wear cotton clothing are in no position to talk as if growing cotton is a bad thing. That said, too much water was allocated in the past, leading to a situation where promised allocations can’t be met and the residual flow to the environmental is disastrously low. We need a policy that allows farmers positive opportunities for adaptation through the sale of water rights at a fair and acceptable price.

Update The Bonfire of the Vanities dvd

Going to Pieces: The Rise and Fall of the Slasher Film dvdrip

88 Minutes rip

This column was perfectly timed. On the very day it came out, Victoria caved in on allowing water sales to the Commonwealth, though South Australia still wants the remaining restrictions lifted.

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I wasn’t all that surprised that Bryan Caplan

didn’t like my interpretation of our bet on EU and US unemployment rates, which was that the combined rates of unemployment and incarceration in the US would exceed those in the EU over the next ten years. I was, however, surprised by the vehemence with which libertarian-inclined* commenters here and at Crooked Timber objected to this interpretation.

A string of them echoed Caplan’s argument that

From a labor market perspective, though, Quiggin’s incarceration adjustment would only make sense if you thought that most or all of the people in jail would be unemployed if they were released.

Caplan has missed my main point. I’m not suggesting that incarceration is disguised unemployment (though obviously it reduces measured unemployment). Rather, I’m saying that, like unemployment, incarceration should be regarded as a (bad) labor market outcome. If you want to evaluate the performance of the labor market, you need to look at both.

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Bryan Caplan and I have now agreed on the settlement conditions for a bet on US_EU jobless rates while also agreeing to differ on the interpretation. The stake is $US100 and the agreed criterion is that, for Bryan to win, the average Eurostat harmonised unemployment rate for the EU-15 over the period 2009-18 inclusive should exceed that for the US by at least 1.5 percentage points.

Since the implied difference in the proportion of the population who are unemployed is almost exactly equal* to the difference in the proportion of the population who are incarcerated, I interpret my side the bet as follows

Averaged over 2009-18, the sum of incarceration and unemployment rates in the US will exceed that in the EU-15

Caplan wants to leave incarceration out of the discussion and focus only in unemployment. Since we’re agreed on how to settle the bet, there’s no problem with differing on how to interpret the result.

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Bryan Caplan responds to the data on US and EU-15 unemployment by offering a bet

Cry of the Owl psp .

The average European unemployment rate for 2009-2018 (i.e., the next decade) will be at least 1 percentage point higher than U.S. unemployment rate. The bet will be resolved when Eurostat releases its final numbers for 2018.

Betting is usually unwise, but nonetheless I’m willing to take Bryan on, with one amendment. I will take the bet provided that people in prison are counted as unemployed. By my estimate, that raises the US rate by about 1.5 percentage points and the the EU-15 rate by about 0.2 percentage points. That is, assuming current imprisonment rates remain unchanged, the bet is that the Eurostat measure of unemployment (which excludes prisoners) should be no more than 2.3 percentage points higher in the EU-15 than in the US.
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According to the latest data, the unemployment rate in the US was equal to that in the EU-15 in March, and is now likely to be higher. Writing in the NY Times, Floyd Norris refers to the conventional wisdom that flexibility inherent in the American system — it is easier to both hire and fire workers than in many European countries implies that unemployment should be lower (at any given point in the business cycle) in the US than in Europe.

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Now that everyone is rushing to bone up on the late Hyman Minsky

and at least some of us are concluding that New Keynesian macro needs to be dumped in favour of something more like behavioural economics Left for Dead psp , I thought I’d trawl through the hard disk and see what I had to say on the subject in the past. It turns out I had something of an each-way bet. Here’s something from my 2006 paper with Stephen Bell, advocating controls on financial innovation as the best approach to preventing asset price bubbles.

One obstacle to acceptance of Minsky’s work has been the lack of microeconomic foundations, that is, of a rigorous formal account of individual behavior and the markets in which individuals interact. The idea that such an account is a necessary prerequisite for a coherent macroeconomic theory became popular in the 1970s and reached its high point with new classical macroeconomics in the early 1980s. Since then, however, emphasis on microeconomic foundations has declined for several reasons. First, users of new classical models have found it necessary to make ad hoc adjustments to microeconomic assumptions in order to improve the capacity of their models to match the “stylized facts” about the macroeconomy that they seek to capture. Second, it has been shown that, in important instances, modest deviations from standard neoclassical microeconomic assumptions (rational optimization in competitive markets) can produce large changes in macroeconomic outcomes. Third, evidence arising from fields such as generalized expected utility theory and behavioral finance has cast doubt on the empirical validity of the standard assumptions of neoclassical microeconomics.

As improved models of individual behavior are developed, it seems likely that microeconomic foundations for models similar to Minsky’s will emerge. Such foundations will take account of the fundamental role of uncertainty, emphasized by writers as diverse as Keynes, [Frank] Knight, and Minsky. For the moment, it is sufficient to observe that none of the competing models of asset markets combine rigorous microeconomic foundations with empirically realistic predictions about market behavior.

So back in 2006, I hoped that New Keynesianism ( modest deviations from standard neoclassical microeconomic assumptions producing large changes in macroeconomic outcomes) would help in the process of shifting macro away from neoclassical microfoundations, along with the generalized expected utility/behavioral economics approach. I’ve now shifted to the view that NK macro is part of the problem, and that the generalized expected utility/behavioral economics understanding is the right way to go.
This reflects the fact that the second approach has helped me to understand the crisis and the first has not.