Arnold Kling  

Morning Commentary

Since You Asked, Scott... My Responses to Readers Questi...

Paul DeGrauwe writes,

My contention is that the rational expectations models are the intellectual heirs of these central planning models. Not in the sense that individuals in these rational expectations models aim at planning the whole, but in the sense that, as the central planner, they understand the whole picture. These individuals use this superior information to obtain the "optimum optimorum" for their own private welfare. In this sense they are top-down models.

The first sentence is one to ponder, as Tyler would say. But the rest of the paper did not excite me. Pointer from Mark Thoma. [UPDATE: More de Grauwe here. Thanks to a commenter on another post for the pointer.] In another post, Mark points to two other interesting pieces.

From The New York Times:

"Hindsight is a wonderful thing," said Timothy W. Long, the chief bank examiner for the Office of the Comptroller of the Currency. "At the height of the economic boom, to take an aggressive supervisory approach and tell people to stop lending is hard to do."

Another sentence to ponder. When I say that there is difference between the personality of an entrepreneur and the personality of a bureaucrat, this is an illustration. Entrepreneurs take ownership of mistakes and seek to learn. Bureaucrats makes excuses and seek to deflect blame.

Maynard writes,

I don't think there's any mystery here. The reason that unemployment was slower to fall after the last two recessions than in previous recoveries was that GDP growth was anemic.

He says that Okun's Law, which relates GDP growth to unemployment, has held up consistently over the past forty years. No structural change to see here. Move along.

However, Okun's Law results from two relationships--productivity and labor force participation. Both of these relationships have changed dramatically. We are seeing much higher post-recession productivity growth (reducing the ratio of jobs to GDP) and a larger decline in labor force participation (cushioning the impact on the unemployment rate). Those of us who see the latest two recoveries as jobless recoveries are not idiots. If you look at the unemployment rate, sure, there is nothing unusual to see. But if you look at payroll employment and hours worked, they support the jobless recovery story.

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David Stinson writes:

"Not in the sense that individuals in these rational expectations models aim at planning the whole, but in the sense that, as the central planner, they understand the whole picture."

The thing that strikes me about many rational expectations models is the high level of agreement or consensus assumed in the model and the fact that the consensus is usually supposed to be a correct interpretation of how the economy works. The academic writing a paper is working with one model and assumes implicitly that everyone agrees with him - a sort of "knowledge equilibrium". Individuals the academic is attempting to model however recognize that there is a multiplicity of models and vast uncertainty as to which if any are valid. Learning can take place but only over time and, in any case, misspecified and/or multiple models can be confirmed by particular sets of data. Information collection and analysis are costly. The world changes, what people thought was right turns out not to have been. In such a world, confusion reigns and expectations can be both rational and heterogeneous.

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