End June Links

Abolish the equity premium now! - I like this sort of whimsy...
Krugman and Stiglitz: Our most widely ignored public intellectuals
Soros on the new German empire & Remarks at the festival of economics, Trento Italy
Fair enough: A Supply Side Liberal joins the Pigou Club, Carbon taxes won't work, here's what will & Henry George and the carbon tax
The disinflation will continue until morale improves
Peak oil and price incentives - an outstandingly good post from James Hamilton.
Stagnation and recession - sums things up brilliantly.
What's wrong with economics?
Stabilizing prices is immoral

Look beyond summits for euro salvation - Martin Wolf's analysis is fantastic: "the crucial elements would seem to be: clear plans for resolution of banks largely at the expense of creditors, instead of relying on recapitalisation by fiscally stressed states – an approach that would automatically share more of the pain between creditors and debtors; a strong commitment to symmetrical economic adjustment across the eurozone, instead of today’s debtor-focused adjustment; recognition by the ECB of its obligation to sustain demand; and enough conditional financing to give governments committed to reform the ability to manage their economies without entering calamity."
Fighting over claims  - the Stiglitz quote is outstanding.

 

The International Energy Workshop 2012

I attended the International Energy Workshop 2012 conference in Cape Town last week, presenting my paper on the possibility of an economy whose price levels respond to energy scarcity in such a way as to disincentivise the use of marginal energy resources and alternatives (and conditions for this to be true).

This conference consisted of a mixture of effectively three disciplines:

• The smallest set of attendees (it seemed to me) were engineering academics. Despite their small number, this group were well represented amongst the keynote speakers. Prof Filip Johnsson from Chalmers University in Sweden spoke on progress (not much!) of Carbon Capture & Storage deployment, and made the point that even if CCS is not ultimately needed for energy infrastructure, with current technology something like CCS will be needed for industrial CO2 emissions from e.g. iron, steel and cement industries, since these are process emissions rather than emissions associated with the energy that these sectors use. Prof Alexander Glaser of Princeton spoke on propects for nuclear (there will be no large scale early expansion, especially after Fukushima), with some focus on small modular reactors which could cut costs and mitigate proliferation and safety concerns. He did not think there were any short term imperatives to develop fast breeder technologies, and he did not mention thorium or fusion.  

• A major group both amongst the keynote speakers and the speakers at the parallel sessions were the energy modelling community. This work, as far as I understand it, takes energy demand and policy constraints exogenously, and uses large computational models (e.g. OSeMOSYS) of the energy sector to generate the optimum energy supply. These models are used in scenario analysis for reports for e.g. Rio+20 (Prof Mark Howells), IRENA (Dr Asami Miketa), IEA-ETSAP (Dr Uwe Remme), among others. A typical example of this type of work was Energy, economic and environmental implications of unconventional gas - Gabrial Anandarajah of UCL Energy Institute, which asked how the availability of cheap unconventional gas affects energy scenarios under various policies.

• Others, including me, are economists who work on energy or climate change issues. Amongst the keynote speakers, Prof Tom Rutherford of Wisconsin talked about one of his favourite energy economics papers: Hogan & Manne (1977) 'Energy-Economy Interactions: The fable of the elephant and the rabbit'. This paper makes the point that energy demand may be inelastic and so the contribution of energy to aggregate production cannot be determined from its current factor share: as availability falls to zero, the share of income to this factor of production may tend to 100%. Highlights for me from this group (other than my own paper of course!) amongst the parallel sessions were:

• A Consumer-Producer Model for Induced Technological Progress - Bob van der Zwann: This presentation was a good summary of theories of the learning curve, and how it can be decomposed. This has obvious applications to renewable energy given the large cost reductions that have been seen in solar: how much of these large cost reductions are due to learning-by-doing and how much are due to economies of scale and other factors?

• Funding low-carbon investments in the absence of a carbon tax - Julie Rozenberg: The idea is that if climate mitigation investments are a cost to this generation and a benefit to future generations (I don't think I accept this premise - it's possible that we, or our parents, are the richest generation - but taking it as given...) then an appropriate way to fund these investments is issuing certificates (creating money) and tightening monetary policy such that overall consumption for the current generation is unaffected. The certificates function as an investment subsidy for green technology whilst higher interest rates penalise other investments. The productive capacity of the future generation is adversely affected at the expense of the low carbon infrastructure. Therefore the future generation benefits from the climate change mitigation at the expense of its own consumption. This is quite a neat idea and a side effect would be that in present circumstances, with monetary policy at the ZLB, we get climate mitigation for free using otherwise unemployed resources.

• A multi-phase model of optimal transition to global climate stabilization - Adriaan van Zon: This is an endogenous growth and optimal investment model that derives optimal stabilisation paths given a climate threshold. I especially liked this because its approach is consistent with the approach I advocate in my paper 'A balance of questions: what can we ask of climate change economics'.

• Overlapping generation extension of DICE-2007 model - Andrey Polbin: The dispute between Nordhaus and Stern centred on the use of parameters that produced real interest rates consistent with those we observe (Nordhaus) or using ethically determined parameters (Stern). Using an OLG model allows agents to make consumption-savings decisions using their high private time preferences, but policymakers can set climate policy by maximising a weighted sum of the utilities of all generations where the weights use a very low, ethically determined, rate of time preference. We end up with a result that can match the observed interest rates and but is intermediate between Stern and Nordhaus in the level of optimal climate mitigation.

• When starting with the most expensive option makes sense - Adrien Vogt-Schilb: Reading off the optimal carbon price from a Marginal Abatement Cost Curve can be sub-optimal in that it may not take into account the time to deploy the various technologies. The current real-world example of this issue is the widespread advocacy for using gas as a low carbon "bridging technology" that will allow intermediate targets to be met, but which could lock us into carbon emitting infrastructure and prevent long term targets from being reached. The social planner's solution may be to invest in difficult and expensive mitigation technologies first, whilst saving some cheap and quick projects for later. However, any price signal that causes the decentralised economy to implement the difficult and expensive mitigation technologies from the outset, will mean that the quick and cheap technologies are also deployed immediately (therefore, it's not clear what the decentralised policy is that could implement the social planner's solution).

• Demand for gasoline is more inelastic than commonly thought - Tomas Havranek: This was a meta analysis of gasoline price elasticities which controls for publication bias. It produces a short run elasticity of 0.1 and a long run elasticity of 0.3. This compares with a previous study which did not control for publication bias which found 0.3 and 0.8 respectively. These results seem consistent with those reported by James Hamilton (blog & paper).

• Imperfect cartelization in OPEC - Samuel Okullo: This presentation described an ingenous model of OPEC where the relationship between the OPEC members could vary between a perfect cartel (where they act as a single supplier) and Cournot oligopolistic competitors. Given their available resources, and the external competition that they face, the optimal strategy of OPEC members is intermediate between a perfect cartel and a competive oligopoly. The model predicts that, in this optimum, Saudi Arabia sticks to its OPEC quota whereas other members overproduce - as is seen in the data.

Finally, here's a picture:

End May Links

Austerity has brought Europe to the brink again, particularly the line: "Normally, an individual helps his creditors by borrowing less; but a person who stops borrowing to finance commuting to his job does his creditors no favor."
Macro: Intuition vs Theory. The number of Noah Smith posts that I'm linking to is getting embarassing. I've no idea why I like the politically liberal, physics to economics switcher...
The incredulity problem, brilliant argument for general rather than partial equilibrium analysis.
Ex-President Bling-Bling, especially the starkness of the policy choice: "But this means, yes, overall inflation in the euro area significantly higher than the less than 2 % target. It certainly means a lot higher than the 1.5% the market currently expects. Don’t like that? OK, so no euro. It’s that stark."
The problem of living with capital-ism, this plays to my prejudices. I need to compare and contrast with the Ed Glaeser book "Triumph of the city" that I'm reading at the moment.
The left & shareholder activism
Is it all Gordon Brown's fault, which follows on from On major macroeconomic policy mistakes
The return of schools of thought in macroeconomics
The zero lower bound and output gap uncertainty
Inflation targeting is not working
Dangerous voices and macroeconomic spin & Cameron is consigning the UK to stagnation
What makes countries rich or poor? Jared Diamond reviews Robinson & Acemoglu's Why Nations Fail
The liberal Keynesian dilemma "Very few people are arguing for a big shift from current to capital public spending" - not sure about this? I'd argue that we certainly don't want to be cutting current spending in a depression (but if it's more than average revenues over the business cycle then it does need to be cut eventually) but the countercyclical boost to government spending should be predominantly capital spending. To at least some extent therefore, I would definitely argue for a big shift, at least in relative terms, from current to capital public spending.
State dependence and fiscal multipliers
The end of the Euro: A survivors guide
The riddle of German self-interest
Economists who don't do it with models
Mervyn King and the fiscal multiplier - I heard the interview on Radio Scotland of Spencer Dale (by Gillian Marles I think): it was another BBC Scotland can't do economics moment - all "inflation's bad" and "government deficits are bad" as self evident truths, true at all times and in all circumstances, that don't need questioned.
Balance sheet monetary policy a primer

Testing the Infallibility of Paul Krugman's Pontifications

Noah Smith says: "I could count on my fingers the number of times Paul Krugman has obviously been wrong about something, and still have enough fingers left to type 60 words per minute."

Well Krugman has outlined a couple of definite scenarios for how the crisis in the Eurozone may pan out over the next 6 months or so. We'll see if he's right...

End April Links

New Classical, New Keynesian, and Real Business Cycle Models
Demand or productivity? Do I agree with this? I think there is a supply problem due to lack of growth in energy inputs; but I don't think I agree with "the policy remedies are less likely to involve fiscal expansion" - am I being inconsistent?
From gold standard to CPI standard
A puzzler on statistical risk and fundamental uncertainty
Because the stakes are so small
Exponential economist meets finite physicist
Going it alone is the way forward
Depression is a choice & Two quick responses
Mo money, mo problems - I argued for negative interest rates 6 years ago though (though not very well (I was just wee) and in relation to conserving renewable environmental assets rather than fighting recessions) 
DSGE vs weather forecasting & Roger Farmer Response & Only ever equilibrium . See also Equilibrium Analysis & On Equilibrium, Disequilibrium and Rationa Expectations.
Plutocrats & Printing Presses
Neither real, nor business, nor cycles

Great Britain as a case study: which sticky price?
3 Arguments for NGDP Targeting & Why NGDP Targeting 

Economists need taught about physical constraints - but physicists need to learn about prices

Another excellent post from Tom Murphy entitled "Exponential Economist Meets Finite Physicist" is causing some interest. In the post the point is made that exponentially increasing use of energy is impossible, and that economic growth without energy use growth is difficult to imagine. These issues need to be more widely considered within economics, especially in these times of depressed output amid high energy prices. They are not simply for 400 years hence but are worth considering now - see relatively recent New Scientist article "How Clean is Green Energy?".

However certain points are made in the post that I don't think are justified and which are the sort of thing that is frequently stated without sufficient analysis at (informative and interesting) places like The Oil Drum and Our Finite World.

First of all, it is asserted that "If the flow of energy is fixed, but we posit continued economic growth, then GDP continues to grow while energy remains at a fixed scale. This means that energy—a physically-constrained resource, mind—must become arbitrarily cheap as GDP continues to grow and leave energy in the dust." This cannot be simply asserted - within most models it's simply not true, and the models in which it is true are the most unrealistic models (we would need elastic substitution of energy and other factor inputs but it appears that other factors can only substitute for energy on a very inelastic basis).

The baseline, first-order model of economic growth is the Ramsey model with Cobb-Douglas production and logarithmic utility (which the representative agent maximises in order to make consumption/investment decisions). If we suppose a constant returns to scale Cobb-Douglas production function with labour (fixed), energy (fixed) and capital (endogenous) subject to some exponentially growing productivity (*), then we derive a balanced growth path in which output, consumption and capital stock all grow at the rate of productivity growth (despite fixed labour and energy implying effective diminishing returns). The prices of the factors of production on the balanced growth path in this model are: constant for capital (i.e. interest rate is a positive constant); exponentially growing (at the rate of productivity growth) for energy and labour. This is because under Cobb-Douglas production, factors earn a constant share of output i.e. payments to energy are constant as a share of output, but the quantity of energy used is constant whilst output is exponentially growing: therefore energy's price must be exponentially growing.

So the first order model for describing economic growth predicts that if we had an economy with fixed energy inputs but positive economic growth, then energy prices would be growing, not falling. The post then relies on a floor for energy prices as it's mechanism in generating subsequent phenomena: but economic growth with constant energy input implies growing prices that do not run into this floor constraint, so the rest of the argument does not necessarily follow.

The post then also repeats various assertions that have been made for a steady state economy: "it’s not your father’s growth. It’s not ... , interest on bank accounts, loans, fractional reserve money, investment." I'm not sure where the idea comes from that a positive rate of interest on bank accounts relies on economic growth, but it's a meme that I've seen expressed before. It doesn't seem logical to me: a simple case is a model of generations in which the young work, consume and save (i.e. make loans) whilst the old consume out of their savings. These savings/loans are just pieces of paper so in reality the young work and their earnings provide the consumption goods for themselves and the older generation. The interest rate on the savings is just a price(**) that agents take when splitting their consumption from their own earnings into consumption whilst young and consumption whilst old - a high interest rate is perfectly compatible with a steady state economy if agents have a high rate of time preference. Fractional reserve banking likewise has nothing to do with economic growth. 

The post is fantastic at outlining an issue that economists have not grappled with, but in considering the economic impacts of the issue, the article makes clear a need for economists to provide some of the analysis!

(*) I'm not saying that this is a good model of long term growth, in particular I agree with this criticism of Noah Smith: "

Step 1: Take the parts of the economy you can't explain (i.e. the residuals) and label them either "culture" or "technology".
Step 2: Make ultra-confident pronouncements about the future behavior of culture and/or technology.
What I don't like, first of all, is that Step 2 just never makes any sense. The thing you are calling "culture" or "technology" is precisely the part that you couldn't explain with your models. Hence, it is the least likely thing for you to be able to predict going forward.
Admit it, economists: You don't know what is going to happen with technology. You don't know what is going to happen with culture. If you did, you would have included those things as endogenous variables in the model instead of simply labeling the residual."

(**) Though in steady state equilibrium it will be a positive function of both the growth rate and the rate of time preference.

Complex Systems

I've just noticed that Prof Yaneer Bar-Yam of the New England Complex Systems Institute replied to my letter (full version here) on the New Scientist's Limits To Growth article. I'm quite chuffed about this - Prof Bar-Yam is a big guy in the world of applying complex systems theory to the social sciences: for example see his recent (joint) paper on social unrest and food prices, incorporating speculators and biofuel production, which makes a definite prediction that "Policy actions are needed to avoid a third speculative bubble that would cause prices to rise above recent peaks by the end of 2012."

Naively, and certainly before I started studying economics, I would have guessed that the above paper would have been classified as an economics paper. It's not though: complex systems is a separate discipline, and although of interest to many economists, it's a difficult topic for economists to get involved in. (On a seperate but potentially related topic, I recently came across this record of correspondence that Prof Ken Judd compiled on his difficulties in getting computational work published.)

The basic problem as I see it is that the economics profession has collectively made a methodological decision to study how decisions are 'optimally' made. This is a perfectly valid choice for microeconomics, and it does a good job of constraining and disciplining our models i.e. we cannot just assume any old behavioural rule or heuristic.

It is much more difficult to conclude that this choice is valid for macroeconomics (see recent debate on microfounded models in macro), partly because of aggregation issues, but also because this choice actively gets in the way of studying what many people would regard as economics: the allocation of scarce resources, regarding human society as part of an ecosystem that is subject to the same rules of thermodynamics as any other ecology. Has it really been demonstrated that the growth of human society within the fixed boundaries of the Earth is any more rational and forward looking than the growth of bacteria in a petri dish?