Economists and Their Models

July 16, 2014 Leave a comment

Economics research heavily involves the use of mathematics. The late Paul A. Samuelson, the first Nobel laureate in economics, is widely credited (or sometimes criticized) for starting the trend towards the use of math. It is now the case that all quality graduate economics programs stress mathematical models in almost every course that is offered. Economists are very good at developing mathematical models for business cycles and many other subject areas. For example, my text in macro describes four models of business cycles and each of those models builds in somewhat different assumptions about how the various sectors of the economy operate.

But one unfortunate side effect of the talent for model-building is that it is possible to find a model that will provide almost any answer that one may want on a topic. A well-known economist was once quoted as saying that he had desk drawers full of economic models and, if he were given any result that a person thought to be true, he could find a model in one of his desk drawers that would produce the desired result. As a result, it is far too often the case that, on a given subject, one economist will appeal to some model of his/her choosing to justify a position. Another economist may use a different model, justifying another position that he or she prefers. As a result, it is possible to find all sorts of policy recommendations that differ across economists. To a lay person, this may seem bewildering but this multiplicity of opinions actually reveals the importance of empirical work.

One of the primary purposes of applied testing of economic theories is to allow economists to choose among alternative economic theories. Without the ability to discriminate, economics becomes much like a religion where anything goes. Just pick your preferred model, and one may believe almost anything. One of the unfortunate aspects of macroeconomics is that there is no widely agreed upon model of the business cycle and aggregate economies. It is difficult to test models of the business cycle and so statements about policy in a business cycle setting are frequently without substance. They are “religious” exercises based upon the preferred model of the economist pontificating on a topic.

My advice to the lay person is this. Pay almost no attention to business cycle statements since, most of the time, they are without serious empirical support.

Categories: Business Cycles

Political Polarization

June 12, 2014 Leave a comment

A recent study by the Pew Research Center (the study may be found here) provides some interesting data on the public’s political views. The data reveals that there is increasing polarization among U.S. voters as compared to earlier polling that they have done. This is interesting because it reveals the causal link between the polarization in Congress and that of the public.

In an earlier blog post, I pointed out that elections are what economists call an agency problem. In that setting, the voters are the principals who elect agents, the politicians, to represent their interests. So it follows that if government is polarized, so too are the voters who elected them. The Pew study essentially provides the empirical support for this scenario.

Tooting my own horn, I told ya’ so!

Economic Growth Since the Last Recession

First quarter 2014 economic growth was recently revised downward to -1.0 percent. The media response seemed to focus entirely on the effects of seasonality, with the argument that negative real growth was caused by the harsh winter that recently ended. This seasonality story obviously has some truth to it but the more compelling data is not one single data point for real growth. It is much more important to examine the trend in real growth because this is much more revealing about future living standards in the United States.

The last U.S. recession ended in June 2009 (got to for business cycle dates). In the table below, there is data on real economic growth at quarterly annualized rates taken from the government agency that reports NIPA (National Income and Product Accounts) data, The table suggests a pattern that should be a concern for all members of society. Read more…

Two Lessons from the VA Scandal

The press has been full of reports on the dreadfully low quality health care provided by several VA hospitals and the attempts to cover up this low quality by VA employees. As most all of us would agree, this really is a terrible and tragic situation but, as with almost every tragedy, there are lessons to be drawn from it. Two are worth mentioning here both of which have been stated previously on this blog.

One is that there is simply no good management in government by the Congress because of the sheer size of the organization. The federal government is now a gargantuan bureaucracy with thousands of employees (the Bureau of Labor Statistics provides data on government employment at  One of the best arguments for shrinking the size of the federal government is that it may be possible to do a better job of management if the government is smaller. It is hard to believe that anything like the VA scandal could arise if there was competent management by the Congress.

Second, the VA scandal reveals the reality of what government-run health care would be if we actually had socialized medicine as found in the U.K. and elsewhere. Barack Obama and other Democrats have expressed the opinion that what they would prefer is a single-payer medical insurance system or Medicare for all. On first glance, you might say that this system would not be what is found in other countries but look at the way Medicare currently operates. It sets the prices that it will pay for medical services and it determines the quantities (that is, the medical procedures) that it will cover. This is functionally equivalent to running almost all medical care facilities since, for the vast majority of patients, the Medicare insurance system will dictate how they are treated. People with the resources will go outside the system to get whatever care they deem best for their health. This is precisely how the U.K. system operates. People who stay in the system get lower quality care (for example, they may wait months to see a specialist) whereas those who go outside the system and pay their own way get higher quality care (they get to see the same specialist in a short time). Medicare for all will provide low quality health care for all are confined to it.

If you want to know why the VA scandal is a disaster for Democrats, it is not just because of the scandal itself which is indeed terrible. It is a disaster for what it reveals about the espoused health care policies of the Democratic Party.

Why Italy Declines

Media headlines no longer contain articles about debt crises in EU countries. But there is the possibility that these troubled countries (Portugal, Italy, Greece, and Spain) may experience debt crises again because they have deep-seated structural problems that are the ultimate causes of their stagnation. A recent article about Italy provides some insights into Italy’s economic circumstances.

Consider the following facts from this article.

  • Since 2008, GDP has declined by 9 percent.
  • The ratio of government debt to GDP is 133 percent.
  • Ninety eight percent of the firms in Italy have 15 or fewer employees.
  • Bureaucratic red tape is severe.
  • The legal system processes court cases very slowly.
  • Tax avoidance is widespread.

Each of these facts provides insights into the Italian economy’s structural problems.

The decline in GDP, and the debt-income ratio, reveal that Italy’s problems stretch back over many years. The government has yet to implement any serious structural reforms that may reverse the decline. Structural change is extremely difficult to impose because there are entrenched interests who benefit from the status quo.

The fact that firms are usually so small is striking. Economists usually argue that there are scale economies associated with size so that, as firms grow, they can provide products more efficiently (and cheaply). The small size of firms provides part of the explanation for the inability of the economy to grow but the article points out that there are cultural aspects associated with the population making Italians reluctant to expand the size of their firms. In addition, the larger is the firm, the more likely it is that government regulations affect the management of the firm, providing an incentive for firms to avoid expansion.

The government has imposed barriers to entry that are so severe that regulations prevent firms from moving into Italy. The article provides an anecdote that it took over 4o years for a firm to get building permits! Further, the legal system is slow to determine property rights and settle disputes so a firm has difficulty managing itself properly.

Finally, tax avoidance by individuals and firms (for example, doing work off the books in the underground economy) means that those who do pay their taxes wind up paying more than they should, further reducing the rewards to their labor supply. Thus the tax burden is arbitrarily distributed across households and firms. Tax avoidance is a response to hight marginal tax rates and/or a lack of respect for the government’s activities.

The overall picture is one of an economy hobbled by many structural impediments put in place because they benefit entrenched interests. For example, workers who can’t lose a job will fight hard to keep their benefits, punishing any politician who removes their pet program. Politicians respond to incentives. The real question is whether there are enough people in Italy who will make it politically profitable for politicians to implement the structural reforms that will allow Italy to grow again and create wealth for its citizens.



Categories: Uncategorized

Equal Pay

April 8, 2014 Leave a comment

The Bureau of Labor Statistics (BLS) has issued a report, entitled “Highlights of Women’s Earnings 2012.” The President has decided to seize on this report ( to claim that there is a disparity in the earnings of women compared to men. Like many issues addressed by politicians, the claims made by politicians don’t follow from the source document. Here I want to mention two reasons why typical claims about the “evidence” backing up these unequal pay claims are bogus.

Adjusting for Hours Worked

Suppose that I told you that a woman earned $150.00 last week and that a man earned $300.00 in the same week. Does this imply unequal pay? Superficially it does but suppose further that the woman worked 10 hours to earn her income for the week but the man worked 30 hours. The woman was paid $15.00 per hour while the man earned $10.00 per hour. When we look at hourly wages, the impression conveyed by weekly earnings is clearly reversed. Any claims about unequal pay should be based upon hourly wages so that account is taken of hours worked. Advocates of the unequal pay viewpoint typically look ay weekly earnings to support their claims but, as our simple analysis shows, weekly earnings are not informative. Hourly wages are the better measure. My point is simply that hours worked must be taken into account for a useful analysis of pay differences.

Adjusting for Occupations

Wage rates vary across occupations. BLS provides data for various occupations (to find this data, use the phrase “wages by occupation” to search the BLS web site). You will turn up data on incomes for many occupations and you will see how different incomes can be. Suppose that a woman works as an Community Health Worker (BLS reports mean wages 0f $37,640 for this occupation) and a man works as a Computer and Information Analyst (BLS reports an income of $86,100 for this occupation). The income difference is substantial but does this reflect discrimination or unequal pay? Of course not. Wage differences across occupations occur for many reasons, including the risk of the job and the scarcity of workers with the skills needed for the occupation. So to look for some sort of discrimination, it is important to look at the same occupation to search for pay disparities.

Is There Pay Discrimination?

The examples given here make two simple points about how to go about searching for evidence of labor market biases against women; adjustments need to be made for hours worked and occupations. There are reports in the press (see this article for a discussion of evidence on incomes by gender) that once appropriate adjustments are made permitting valid comparisons, pay differences narrow enormously. And there may not even exist statistically significant differences in income. Thus inappropriate use of data provides wildly inaccurate implications about labor market pay differences between men and women.

The Consumer Finance Protection Bureau

March 27, 2014 Leave a comment

The Dodd-Frank bill passed after the most recent recession created the Consumer Finance Protection Bureau (CFPB). I got to thinking about this new agency when I recently read about the Fed paying just under $80 Billion dollars to the U.S. Treasury. The Fed earns interest on its bond holdings and covers its expenses from these earnings, giving whatever is left over to the U.S. Treasury. What does this have to do with the CFPB?

It turns out that this agency is financed out of the Fed’s interest earnings but, remarkably, the Fed has no budgetary authority over it and neither does Congress (although there have been attempts to give Congress budgetary authority). I am not sure that there is any oversight at all which is of course organizationally absurd. Why would the agency be financed this way? Was it an attempt to prevent the budgetary cost of the bureau from becoming readily known by the public. Obviously its existence reduces the interest earnings paid to the Treasury so, all else the same, it increases the government’s deficit.

Further, can you imagine the waste in this bureau without any oversight by the Fed which is paying the bills? There was a claim in the Wall Street Journal by a Congressman some time ago that the secretary to the bureau director was being paid $160,000.  Think it is possible to get a decent secretary for half that? I bet you can.

Categories: Uncategorized
Economics One

A blog by John B. Taylor

The Grumpy Economist

One economist's views on economic policy. News

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