Bosun’s Holiday

A couple of things EP didn't see at the Meetings

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The annual meetings of the American Economic Association convention unfolded over the weekend, on Zoom.  In Boston, where AEA members had hoped to meet in person, it snowed. After I shoveled (and read the news from Kazakhstan), I went through the motions, watching half a dozen sessions over two days, all of them interesting, none of them possessing the elusive quality of newsworthiness, at least where Economic Principals is concerned, given  the rest of the work at hand.

So EP turned instead to two more deliverable items of interest:  the Kenneth J. Arrow Lecture at Columbia University, which David Kreps, of Stanford University’s Graduate School of Business, delivered in Manhattan last month; and an intriguing new paper by William A. Barnett, of the University of Kansas, editor of Macroeconomic Dynamics and first president of the Society for Economic Measurement.

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Kreps, described by Columbia’s José  Scheinkman as “one of the most accomplished theorists of our generation” (“and our generation wasn’t bad”), spoke under the title “Not Every Couple Should Have a Pre-Nup: How the Context of Exchange and Experience Affect Personal Preferences, and Why This Matters Both to Economic Theory and to Practical Human Resource Management.” The reference is to a long ago BusinessWeek column by the late Gary Becker, of the University of Chicago.

If a contract were required before a couple could legally marry, Becker argued, no bad vibes or stigma would attach to divorce.  Not so fast, Kreps countered.  There was abundant reason to suspect that preferences are not fixed; that such contracts might interfere with their evolution over the course of a marriage.  He proceeded to carefully sort through the implications, in the manner he learned as a close reader of Arrow.

Since the World War II, mainstream economics had become “mathematical,” Kreps said. Everyone understood what he meant: formal models had become the standard means of professional discourse. Developments then came in two broad waves. The first wave, between 1945 and 1970, developed choice theory, price theory, and general equilibrium theory, he said.

The second wave, beginning in 1970 and not over yet, consisted of information economics: “getting serious about the formation of beliefs, especially beliefs about the actions of other economic agents (and how they will react to your own actions).”

“It is well past time for the third wave,” he continued, “Getting serious about preference-determination and preference-evolution.”  He connected the movement to concerns that Arrow had expressed as long as fifty years ago.  He cited a couple of present-day books as  serious curtain-raising work – Identity Economics: How Our Identities Shape Our Work, Wages, and Well-Being,  by George Akerlof and Rachel Kranton; and The Moral Economy: Why Good Incentives Are No Substitute for Good Citizens, by Samuel Bowles. And he elaborated his own views, “as a commentator, not an originator” – of the extensive careful modelling and testing that would be necessary to establish preference formation as a contribution to serious economics.

On “shaky grounds,” Kreps concluded, “I contend that taking more seriously how preferences are affected by context and experience within context, will— on net — be good for our discipline.” Joseph Stiglitz, of Columbia University, contributed a lively discussion.

All the more reason then, to tune in, when you can, to the Distinguished Lecture that Nathan Nunn, of Harvard University, delivered to the AEA meetings on Friday.  A recording of “On the Dynamics of Human Behavior: The Past, Present, and Future of Culture, Conflict, and Cooperation” presumably will be available for free viewing on the AEA website in a day or two.  If you like this sort of thing, it is definitely worth the wait.

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Barnett is less well-known in the profession than is Kreps, but he is an unusually interesting gadfly, a talented outsider with a knack for connecting with talented insiders over the course of a long career. Trained as a rocket scientist at the Massachusetts Institute of Technology, he spent most of the 1960s at Rocketdyne in suburban Los Angeles before leaving in 1969 for Carnegie Mellon University, and a PhD in Statistics.

After seven years in the Special Studies Section of the Federal Reserve Board, a unit since abolished, Barnett left with the conviction that instead of depending on classical accounting procedures, the central bank should be using modern methods devised in the 1920s by the French economist François Divisia. a founder of the Econometric Society, and not well-understood by Anglophone economists until 1973.  Erwin Diewert, of the University of British Columbia, suggested employing a class of index numbers. known as “superlative” indices, as a suitable alternative to the Fed’s accounting aggregates. Barnett continued to advocate an approach known as the Törnqvist-Theil Divisia index. (Elaboration added)

In 2012, MIT Press published Barnett’s Getting It Wrong: How Faulty Monetary Statistics Undermine the Fed, the Financial System, and the Economy. He has been lobbying for the change (the “Barnett Critique”) ever since, first at the University of Texas, then Washington University, and, since 2002, at the University of Kansas. He was a founder of the Center for Financial Stability, a Manhattan-based think-tank, and is director of one of its programs, as well.

Last week a paper by Barnett and four others circulated widely on the Internet.  “Shilnikov chaos, low interest rates, and New Keynesian macroeconomics,” from the latest Journal of Economic Dynamics and Control, was sufficiently interesting that Barnett arranged to have it published open access online. “[I]t might be very important,” he wrote.

I wrote back to say that Shilnikov chaos attractors were well above my paygrade.  Barnett replied in plain English:

We have another paper about how to fix the problem.  It isn’t difficult to fix.  The source of the problem is that attaching a myopic interest rate feedback equation (Taylor rule) to the economy’s dynamics without a long run terminal condition alters the dynamics of the system to produce downward drift in interest rates.  Our results produce an amazing match to the 30-year downward drift of interest rates into the current liquidity trap.  The solution is for the Fed also to have a second policy instrument to impose a long run anchor (no surprise to the ECB).  Since the short run interest rate is useless as a policy instrument at the zero lower bound, central banks are now experimenting with other instruments.  It would have been better if they had done that before interest rates had drifted down into the lower bound.

That wasn’t hard to understand at all, at least intuitively. Ever since William Harvey in 1628 demonstrated the heart’s circulation of the blood, economists, from John Law and François Quesnay to the designers of today’s flow of funds accounts, have sought to understand the mysteries of the economy’s circular flow of money, products and services. Though never a boatswain, I have had enough experience anchoring boats in sometimes powerful currents to recognize the virtues of havening more than one anchor out, sometimes in a completely different direction.

The last fifty years have been a wild ride for the Fed’s managers of the world’s money. Don’t expect to enter a quiet harbor any time soon.