Category: economy

Micro vs. Macro Economics and Predictions

Theodore A. Gebhard

In a Wall Street Journal op-ed, regular Journal contributor, Joseph Epstein, compares modern day economists with ancient augurs. Mr. Epstein points out that there has been an infusion of politics in economics as exhibited by the fact that prominent economists who frequently appear in the media seemingly interpret economic data and make predictions in accordance with their respective political leanings. With a good deal of ridicule, Mr. Epstein notes that, in the end, these predictions, regardless of political preference, prove more often than not to be inaccurate. Is there really an “economic science,” therefore, or are economists simply mystics?

To me it is indeed lamentable that the public’s perception of economists is framed by those few media-savvy “economists” who know how to present themselves in a way that makes for “good” TV and newspaper quotes. What’s more, this perception arises almost exclusively from observation of macroeconomists whose forecasts are grounded in highly aggregated data. Rarely does one see microeconomists in the general media. I maintain that, if the public knew more about this older branch of economics and its scientific richness, the perception of economists would be quite more favorable.

To make this point, I submitted the following “Letter to the Editor” to the WSJ in response to Mr. Epstein’s narrow focus on macroeconomic forecasters.

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As someone who has spent a career teaching and practicing applied microeconomics, it dismays me that the public’s image of economists is largely formed by TV-savvy macroeconomic forecasters claiming to be able to look at highly aggregated data and predict where the economy or various economic measures will be in X amount time.  As Joseph Epstein points out (Is that an Augur, or a Mere Economist? op-ed April 23), not only are such forecasters often all over the board about the likely efficacy or lack thereof of a given policy, but considerably more often than not their predictions, regardless of initial side, turn out to be way off base.  All this, of course, provides grist for the kind of ridicule that Mr. Epstein exhibits. 

By contrast, microeconomics has a far better record.  Indeed, in comparison to macroeconomists, microeconomists are far more likely to agree in their analyses of microeconomic policies (i.e. market-specific regulations and interventions) as well as their predictions of the consequences of such policies.  This near unanimity derives from the fact that microeconomics rests on well-developed theory that has stood the test of time and consistently lives up to empirical verification. Regrettably, the absence of controversy does not make for good television, and the public rarely is exposed to this major branch of economics and its practitioners.

Theodore A. Gebhard

How Does the Debt Stack Up?

Theodore A. Gebhard

According to some estimates, the present value of the cost of Social Security and Medicare’s unfunded promises now stands at more than $175 trillion.  Add $36 trillion more in federal debt ($26 trillion held by the public) and the total is well over $200 trillion.  Even with historical economic growth and productivity increases, there is no way that these obligations can ever be met out of real resources so long as they continue to increase.  What’s worse is that the nation cannot count on growth and productivity maintaining historical trends, as growing debt service and entitlement payments increasingly crowd out private capital investment.  This ever larger burden on the private economy threatens the entire free market system.

So that citizens can get a handle on just how large a trillion is, the Wall Street Journal published three Letters to the Editor this week providing illustrations of a trillion dollars. Hugh F. Wynn’s letter can be viewed here (The Painful Parade of Zeros, Letters, April 7), and William F. Meurs’ letter can be viewed here (A Quiz Question on the Debt, Letters, April 8).  The third letter is from me, which the Journal published today (print edition).  The published version, edited by the Journal for space, can be viewed here (How Does the Debt Stack Up?, Letters, April 11).

Below is my original, unedited submission.

William F. Meurs’ hypothetical of a person spending a trillion dollars a day for 2740 years to illustrate how enormous a trillion dollars is (A Quiz Question on the Debt, Letters, April 8) improves on Hugh F. Wynn’s string of zeros (The Painful Parade of Zeros, Letters, April 7), but still falls short of most people’s real world experience.  How many of us have ever spent a million dollars in a day?  Nearly everyone, however, has walked a mile.  A better question therefore is how high would a stack of a trillion dollar bills (new and crisp, not rumpled) reach?  The answer is 67860 miles, more than a quarter of the way to the moon.  Of course, were it hundred dollar bills, the stack would be merely 679 miles, just one long day’s drive.

Ignoring Microeconomic Conditions in Monetary Policy Risks Perpetual Failure

Theodore A. Gebhard

In a Wall Street Journal op-ed today, Hoover Institution Senior Fellow John H. Cochrane expresses his concern over the fact that some of President Trump’s potential nominees to the Fed’s Board of Governors have shown sympathy for a monetary system grounded in a gold standard. (John H. Cochrane, “Forget the Gold Standard and Make the Dollar Stable Again,” 1/18/2019) He argues that historical evidence shows that the gold standard the U.S. once had did not live up to the claims that current proponents of a return to such a monetary system make. He says that the evidence is that the gold standard prevented neither inflation nor deflation. Because of this history, Mr. Cochrane proposes a “CPI standard” as a rules-based means to determine monetary policy. Under this standard, the Fed would keep the CPI closely in line with a particular (and constant) value. He asserts that such a standard would be an improvement over the Fed’s current no-rules discretionary decision-making.

In my view, however, even if there were an improvement, it would be at best marginal and could result in undesirable outcomes under certain circumstances. The reason is because Mr. Cochrane’s proposal suffers from the same flaw that characterizes the rest of macroeconomics, namely a focus on aggregates and averages.  Such a focus neglects the significance of the underlying microeconomic variables that determine the path and composition of economic activity, including actual prices in individual markets.  So, for example, should significant productivity gains owing to technological advances or capital improvements take place across all economic sectors, the general price level should fall.  Such price deflation is neither a consequence of slowing economic activity nor indicative of the need for a policy response.  Yet, under the CPI standard unnecessary price inflation would have to occur to maintain the stability of the index.  An even worse scenario would occur if productivity gains are not spread evenly but instead are specific to certain of the index’s components.  In this situation, policies to keep the index stable risk inflating prices to bubble levels in those sectors for which there has been little or no productivity improvement in underlying microeconomic markets.  Moreover, relative prices would likely be distorted to the detriment of economy-wide allocative efficiency.  Perhaps, as Mr. Cochrane argues, returning to some form of gold standard is not workable under 21st Century conditions, but replacing discretionary policy with a CPI standard would also have its problems. 

Still More Trade Illiteracy from Peter Navarro

Theodore A. Gebhard

Sadly, President Trump’s instincts regarding trade wherein he believes negative trade balances to be a consequence of other countries’ ripping off the United States is reinforced by his chief trade advisor, Peter Navarro. Economists have long known this view to be specious, and acting on it in policy will only end up making Americans economically worse off. In an op-ed in today’s Wall Street Journal, Mr. Navarro rejects over 200 years of economic learning. In response, I have submitted the following to the Journal as a Letter to the Editor. (See also my earlier Posts on trade economics here and here.)

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As a former economics professor, I am disheartened to see one of Mr. Trump’s chief advisors, Peter Navarro, reject over 200 years of economic learning by speciously using GDP accounting to contend that current account imbalances should be a significant policy concern.  (“Why the White House Worries about Trade Deficits,” 3/6/2017)  Mr. Navarro contends that boosting net exports over imports boosts growth and, implicitly, the country’s economic well-being.  As many economists acknowledge, however, GDP is a poor proxy of economic well-being and, in turn, GDP growth is a poor measure of changes in a country’s wealth.  Indeed, by Mr. Navarro’s reasoning, we can increase wealth simply by enlarging government expenditures financed by fiscal deficits or money printing.

Starting with the indisputable premise that the ultimate end of economic activity is consumption, Adam Smith taught in The Wealth of Nations (1776) that a nation’s well-being is determined by the amount of final goods available to its people.  Exports thus are a cost to a nation (using up its scarce resources for foreigners’ consumption benefit) while imports a benefit (consuming out of others’ scarce resources).  Exports are the cost of paying for imports. 

A nation benefits from trade whenever it can obtain goods from abroad cheaper than it can produce those goods at home.  Obtaining goods cheaper from foreign sellers not only increases the available consumption pie (and thus a nation’s wealth), but it also frees up resources that can be deployed to expand wealth even further.  What’s more, it matters not whether the goods are cheaper because of comparative resource advantage or because other countries inflict harm on themselves by subsidizing their exports. 

Economic history has confirmed Smiths’ wisdom many times over.  One would hope that this wisdom is not entirely lost on our policy makers. 

Theodore A. Gebhard