Archive for July, 2014

Gasp!!!: An Example of Good Economic Policy by the House

July 30, 2014 3 comments

I know – you are wondering if there is a misprint in the title. While I have been a frequent critic of economic policy by the government, I am here to write about an example of good behavior by the House of Representatives. Specifically, a bill has been introduced (read BILLS-113-hr5018-10-pages) which would require a policy rule to be used by the Fed as it conducts monetary policy.

Economists have devoted a great deal of research to the study of rules-based policymaking by the monetary authorities. Here is an example of a rule that might be used.

i = π + .5·(Y – YP)/YP + .5·(π – 2) + 2

In the above equation, i is the interest rate controlled by the Fed (such as the Federal Funds rate), π is the inflation rate, and YP is the level of real output at full employment. There are a number of advantages to using this rule. Read more…

The Affordable Care Act As Lawyer Relief Act

July 25, 2014 3 comments

This week brings us media reports of two conflicting decisions by federal appellate courts regarding the Affordable Care Act. The issue in each decision is whether subsidies may be provided in states that do not run their own insurance exchange where policies may be purchased. One court decided that the law was unclear and that the IRS was therefore justified in making the decision to permit subsidies in all states. Another court decided that the law was clear and that subsidies could not be given to people in states that do not run their own insurance exchange. What accounts for this conflict? Several possibilities come to mind.

One possibility is that the Congress was unable to write a document that makes clear its intentions. This is always a possibility of policy by committee. Whenever a large number of individuals get involved in a policy process, there is always the possibility that what comes out, intended to accommodate everybody on the committee, is so confusing that the end product is a logical mess.

A second possibility is that the people drafting the legislation are simply incompetent and did not notice the inconsistencies built into the law. Related to this is the fact that the law ran thousands of pages and was not read by many who voted for it. It is hard to be sympathetic with any politician voting for a law when he or she has no clue as to the law’s contents.

Finally, there is always the possibility that judges just “make it up” to satisfy their prior policy preferences.

My own belief is that the conflicting legal decisions speaks to the complete breakdown of the federal government’s ability to function. No sane person can read a document that is two thousand pages long while having any real idea about what is in the law. In addition, why even construct laws that are this long and detailed? Surely the size of the law by itself reveals profound incompetence since it is incomprehensible to the politicians asked to consider it. Or perhaps the law is so large precisely to prevent many politicians from knowing what is in it to allow the few who do know to have an unduly large effect on the law’s contents.

Whatever the explanation, it is hard to put a good face on the Affordable Care Act. Whatever the economic merits of the law (and I have written frequently about how bad it is as economic policy), this is a prime example of incompetent policymaking, no matter how you slice it. The spate of lawsuits generated by this law, while a great boost to the incomes of lawyers, partly reflects policy differences between political parties but it also reveals that the law is dreadfully constructed.

Economists and Their Models

July 16, 2014 1 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
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A blog by John B. Taylor

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