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California Pays Off Arnie’s $15 billion 2004 Loan from Wall Street

California Pays off $14 Billion in Costly Debt From 2004

Promoting the borrowing in Proposition 57 was one of Schwarzenegger’s first acts in office, and he pitched the measure as a way to avoid public service cuts and tax increases. The state had the lowest credit rating among all 50 states in the nation at the time, which added to the interest costs.

Critics, including then-state Treasurer Phil Angelides, warned that it was a mistake to shoulder long-term debt to solve short-term problems and could put the state in a more perilous financial position.

But thank God they were able to recall Governor Davis because he imposed a car tax . Which would have doomed California to —–.

Thanks Arnie! And who is laughing at Governor “Moonbeam” Jerry Brown now?

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Not A DSGE Model

I will try again to answer Larry Summers’s question “”What wouldn’t be a Dynamic-Stochastic General-Equilibrium model?” I won’t present a formal macroeconomic model in a blog but will try to describe what I might do if I got down to work.

I think the first step back to not DSGE starts with the simplest standard 3 equation New Keynesian DSGE model. That is, in this post, I will make lots of absurd simplifying assumptions to keep things very simple, even though I think the main point of not DSGE modeling is that one doesn’t have to make these assumptions (or even the weaker absurd assumptions in cutting edge NK DSGE models).

The assumptions are crazy. First there is no capital of any kind — people just produce goods by the sweat of their brows without using plant or equipment. There is no investment, There is also no Government consumption so aggregate demand is equal to private consumption. This is determined by intertemporal optimization yielding a first order condition or Euler equation which looks a lot like an old IS curve. Demand increases in the expected value of future GDP and decreases in the real interest rate. There is a micro founded forward looking Phillips curve so inflation increases in GDP and increases in expected future inflation.
Finally there is a Taylor rule with the nominal interest rate increasing more than one for one in lagged inflation and decreasing in lagged output.

This model doesn’t fit the data at all and is used mainly for teaching.

For an old Keynesian alternative model, I would stick with a Taylor rule, even though it doesn’t fit the data very well

I do not think the Euler equation for consumption (aslo known as the Permanent Income Hypothesis) has any useful role in macroeconomics. The simple equation is radically rejected by the data. It can be modified so that it no longer has the tested implications which have turned out to be false. They are basically all of the implications that have been tested. I don’t think it adds anything of value. I have discussed this at length here here, here, here here and in a long pdf here.

A model in which consumers have habits and are myopic fits the aggregate data better. As far as I know it explains all the stylized facts which convinced economists that the old Keynesian approach should be replaced first by the simple original PIH then by modified versions in which roughly one free parameter is added to fit every summary statistic. In this model, consumption is a linear function of current personal disposable income and a few lags of personal disposable income. I stress that the DSGE approach has lead economists to replace personal disposable income with GDP when explaining consumption. The data tend to suggest that this was moving away from the truth. A key difference between the PIH and older models (which I propose resurrecting) is that the PIH can imply Ricardian equivalence. There is almost no evidence of Ricardian effects let alone full Ricardian equivalence. Notably applied work measures the fiscal stance with the structural primary deficit — this is further from Ricardian equivalence even than the IS-LM model. Policy discussions often treat tax cuts and spending increases interchangeably — that is they have moved from IS-LM analysis in the direction opposite of academic models.

The forward looking Phillips curve is inconsistent with the data. To come close, economists add lagged inflatin terms talking vaguely about inflationary momentum and appealing to indexation. However, they insist that the true conditional mean of future inflation (rationally expected inflation) matters and should not have been left out by old Keynesians. I know of no evidence supporting this claim. Both survey expectations and TIPS breakevens are well fit by a simple autoregressive model. The equation does not fit achieved inflation at all well as it should if expectations were rational. The old approach fits actual data relative to expectations better than the new one. A Key episode which allegedly show the importance of a more sophisticated approach than the static autoregressive model — the effect of Volcker’s dramatic regime change, has an implication for a coefficient of the sign opposite the statistically significant coefficient estimate with actual data. The old Phillips curve, with coefficients on a few lags of inflation used to estimate expected inflation, works better than the new one. The alleged silly Phillips curve with no expected inflation effect was not, in fact used by old Keynesians.

The case against the old approach to the Phillips curve is that it had implausible implications for the effects of policies which were not being considered. Here Friedman argued that a model was not useful for evaluating policies within a given set, because it had implausible implications for policies not in that set (that is he said models must be true to be useful and that while he can use his methodology for positive economics, Keynesians can’t).

Now models which use the assumption of rational expectations do not have much effect on the policy debate. A Phillips curve subject to the extremely similar critiques of Friedman, Phelps, Lucas, Hicks, Samuelson, Solow and is used all the time.

However, it is not the one which fits the data well. It has been decided that the best crude simple Phillips curve relates unemployment and the acceleration of inflation — this means that a coefficient on lagged inflatin is set to one instead of being estimated with data. This means that policy makers are advised that the Natural rate of unemployment in Spain is over 20%. Current applied work has little to do with current academic research and has moved further from the data than 1960s Keynesian models were.

Unfortunately, bad as the NK approaches to modelling consumption and price formation are, they are much better than the approach to modeling investment. Current models use the ad hoc assumption that it is constly to adjust the rate of investment even though no one found this plausbile a priori. They do not distinguish between housing investment, non-residential fixed investment and inventory investment. They do not perform as well as the flexible accelerator (which says investment increases if real GDP growth is high and decreases if the real interest rate is high). I don’t think I have to argue that ignoring housing is problematic. It is also obviously extreme to Ignore inventories when modeling the business cycle.

I think the old approach of using flexible accelerators with different coefficients for housing, non residential fixed investment and inventories is better than the NK DSGE approach. For one thing, it would remind economists (other than Paul Krugman as usual) that interest rates affect aggregate demand mainly through residential investment and, to a much lesser extent through investment in plant but not statistically significantly through investment in equipment or inventories.

I guess I should write about net exports to finish off my proposal to resurrect old Keynesian macroeconomics, but I don’t have anything to write.

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What Wouldn’t be a Dynamic-Stochastic General-Equilibrium model?

In Which I Try to Answer a Question asked by Larry Summers as a Joke

The LSE held a discussion on Reconstructing Macroeconomics. Brad DeLong posted a transcript , the video is here.

Larry Summers opened with a joke

Larry Summers: You know I was tempted to blast off at Dynamic-Stochastic General-Equilibrium models. That is, actually, my inclination. But on the other hand it occurred to me to ask the question: “What wouldn’t be a Dynamic-Stochastic General-Equilibrium model?” That would be a Static-Certain Partial-Equilibrium model. It is hard to see how that represent any kind of an improvement. So I can’t be against DSGE on principle.

I have a sense of humor, but I am going to suppress it and pretend to take the joking answer literally. I note that the diametric opposite of a Dynamic-Stochastic General-Equilibrium model would be a Static-Certain Partial-Disequilibrium model. Even in jest, even Summers has trouble separating the concepts of model and equilibrium — which in context means Nash equilibrium. Also the joke is a joke, a Dynamic-stochastic-partial equilibrium model is not a Dynamic-Stochastic General-Equilibrium model.

It is also easy to answer the question, because there are models older than any DSGE model — Summers can propose we go back to using those models. For one thing, he clearly does use those models (as do DeLong and Krugman). They weren’t equilibrium models.

Bernanke and Blanchard (who have made huge contributions to Reconstructing Macroeconomics) assume in their answers that they are required to start with a standard new Keynesian DSGE model and modify it to reconcile it with reality.

Blanchard said

Suppose you are writing two textbooks, one undergrad, one grad. In the undergraduate textbook, it seems to me that when teaching the IS-LM, [skip]

At the graduate level, we now have this explosion of DSGE models which put one friction and another into the model. Again, targeting pedagogy, it seems to me that there are two mechanisms which are central. The first is leverage, which starting with Ben [Bernanke’s] work and earlier work we have, I think we know how to deal with it. The second is liquidity. And I think there we are much less far along the way. Again, I am hoping that someday we will put it together and have a simple way of thinking about leverage and a simple way of thinking about liquidity. These two things will come into our New Keynesian model, and we will be able to tell a simple story. We are at the stage at which the DSGE models have much too much in them to be fully understood.

Blanchard is not joking. He takes it as a given that the IS-LM model is for undergraduates and that graduate teaching and research should be based on new Keynesian DSGE models. He also notes a problem — current DSGE models do not clarify thought, because we don’t understand what is going on in the computer as it simulates them. He neglects another problem — DSGE models are based on extremely strong assumptions (including rational expectations but also including say the assumption that there is no housing sector or inventories) which we are all sure aren’t literally true. The only defense of the approach is that we should think about simple things which we understand which might give us insights into the much more complex real world. I find it hard to accept the assumption that macroeconmics must be based on incomprehensible models which fundamentally rely on assumptions we are sure are false in ways which seem to have been critically important and which yield, at best, mediocre forecasts.

I’d like to see a debate where Summers (or Krugman or DeLong) argues for the resolution “Old Keynesian models from the 60s and 70s are a more promising starting point for macroeconomic research than New Keynesian DSGE models”. Someone would have to argue contra. Oddly, I find it extremely difficult to think of (and impossible to find) anyone willing to do this. I can’t recall hearing or reading a defense of the NK DSGE approach. It is just assumed that this is what macroeconomics is and must be, but I honestly can’t recall an argument for why it should be (hmmm am I too young to be senile?).

Starting this post, I had planned to argue for the resolution, but this is getting long and I want to type about how we got where we are. Senile or not, I am too young to remember, Old-Keynes had been abandoned already when I arrived in economics in 1985. But this is a blog.

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RNC/Soccer League Debate: Relegation and Promotion

People who follow British Association Football (Soccer, Football, Footie) know that it consists of a number of tiered Leagues which have annual processes of relegation and promotion as the bottom performing teams move down a tier while the top performing ones in the lower tier move up.

I suggest we might have something like this going on with the first few Republican debates. For example while it certainly sucks for Perry and Graham to be relegated to the kiddy table at 5PM, somebody is going to emerge as the apparent winner of that group. While it is likely that one or two or three of those in the lucky top ten will flame out. For example Christie might have fared better had he been nosed out and not be faced with having to out shout and out bluster The Donald at the main event. Similarly whatever tiny chances Graham and Jindal have for clinging into the race probably would have evaporated if they had snagged a 9 or 10 spot. In contrast Perry is not in a bad spot at no 11 and even Santorum might have a chance to move up. But I am thinking this maybe a one time event with the two or three relegated out of the top ten not likely to ever crawl back in.

All this is speculative but I can easily see the bottom four or five of that bottom seven be flushed out of the race along with the bottom two of the top ten with maybe Perry and Santorum replacing Christie and Huckabee. So the questions are “How many tickets out of Thursday?” and “Can anyone leverage the Kiddy Table to get asked to the Grownup one for the next debate?”

Or you can consider all this silly and just call it a Politics and Debates Open Thread.

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More Shopping Around . . .

I want to stress the need to shop around when looking for healthcare insurance on the exchanges by citing one example of how it can make a difference. As mentioned earlier here and on Charles Gaba’s ACA Signups blog, Shopping Around does make a difference. If you did not do so, you could be suckered into paying far more than what is necessary for healthcare insurance. This is supposedly the impact of the free market and as there is a sucker born every minute, there are those who will invest the time to look for and find the best policy at the best price. The market is not static.

I pulled another example of how the market can vary by going from a state to state view to looking within one particular state. In particular, I chose Missouri as an example to portray as it is showing an advertised high increase of cost at 27 and 22%. Charles Gaba does an excellent job of explaining the impact of these two increases within Missouri, which I will portray at AB. Charles Gaba fills the gap which Healthcare.Gov does not fill by pointing out the number of policies which have lower rates of increase than 10% (Healthcare.Gov only mentions increases >10%).

invisible hand

As you read the top half of the chart (click on the chart for a larger chart), you can see Coventry Health and Life appears to dominate the market place with >80% market share. If we look at the number of participants in the market, Coventry is only being measured against 48% of the market place. The other half of the market place which is reporting less-than a 10% rate hike is not reported by Healthcare.Gov. It is there, Healthcare.Gov does the consumer a great disservice by not reporting market place increases less-than 10%; the PPACA a disservice as it creates only a picture of out-of-control increases; and a disservice by feeding the naysayers with data of >10% increases only. While the PPACA is not perfect, it is certainly a step in the right direction as we waited ~22 years since Hillarycare for the healthcare industry and the Republicans/Congress to bring something to the table.

The bottom half of Charles Gaba’s chart depicts what could be happening using an estimated increase of 9.9% with the other healthcare insurance companies. If Charles is to be wrong in his calculations, he has erred to the high side of a potential increase by them. The total increase for the state is not 33% or 42% as reported in the news media. Nor is it 21% using a weighted average calculation as Charles Gaba determines. It is an ~ 15% total increase (Charles Gaba calculated) as determined by a high estimate of what is being paid by >50% of the market place insured participants. Could the state’s 15% be decreased? Yes, if more people shopped around in the lower half of cost in the market place.

Is this a failure of the market place, a failure of people not to “Shop Around,” or a failure of Healthcare.Gov to advertise low increases by not reporting on those lower-than 10%? Some of each I suspect; but, do not expect the healthcare insurance companies to come to your door and tell you they are going to gouge you this year as they will not. Maybe Healthcare.Gov should report on the low increase companies and maybe people should spend more time looking for a low cost and better policy . . . the same amount of time they will spend investigating an automobile and looking for the lowest cost than what they will for something impacting their health. After all, which is more valuable?

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