Saturday, January 24, 2015

Is Continuous Market Clearing a Good Premise for Macroeconomic Modeling?

I haven’t quite finished Kartik Atherya’s book, Big Ideas in Macroeconomics, but one proposition, in particular, seems implausible to me, and that’s Kartik’s claim that real world markets are very similar to a "Walrasian central clearinghouse."  In short, real world markets operate as if they were run by an auctioneer who's continuously finding the prices at which supply and demand are equal.

Just for the fun of it, I decided to explore the prices at which Big Ideas in Macroeconomics was being offered on  All the prices I recorded were for a new copy of the book and include the cost of standard shipping.  The chart below displays the offer price for Big Ideas and the "percent favorable ratings" for 23 sellers.  I’ve excluded one Amazon Prime offer because Amazon Prime membership costs $72, and provides free two-day shipping among other benefits.

Here are a few statistics from this single day on Amazon: 1) the mean price of Big Ideas was $49.65; 2) the lowest price was $23.99; 3) the highest price was $75.81; and 4) the standard deviation was $14.07.  (The Amazon Prime price with free two-day delivery was $35.11, but isn’t included in the chart). 

My question is: if this online market is like a Walrasian clearinghouse, how can we explain the wide dispersion of prices for this standardized item?  One possibility is that suppliers with good reputations (high favorability ratings) might be able to charge a higher price because buyers have more confidence that the book will be delivered on time.  As it turns out, the opposite is the case: lower prices are correlated with higher ratings.  

This pattern of prices is not what one would expect if actually resembled a Walrasian central clearinghouse.  Now it might be objected that the “higher” prices don’t really “count” because few transactions will take place at these prices.  Perhaps, but if so, why do "high-price" dealers bother to post a price at all?  Since anyone can find out what prices are being offered on Amazon, why would a bookseller who saw ten offers at $50 or less decide to offer the same book for, say, $65?

I’m open to other explanations, but my tentative conjecture is that, which typically has a wide range of prices for identical items, doesn’t look like a Walrasian market at all.  And if doesn’t fit the bill given all of its apparent market-like virtues, then how many other markets depart from the ideal?  

Monday, January 19, 2015

Are we all Friedmanites now?

Paul Krugman started an interesting debate (here) by claiming there are no serious conservative economists who are also public intellectuals.  The left has Nobel laureates Joseph Stiglitz and Krugman himself.  The right is stuck with Arthur Laffer and Stephen Moore.  Nick Rowe followed up (here) by claiming that the Great Economic Debate had already been won when Milton Friedman made mincemeat out of John Kenneth Galbraith.  Rowe concludes with this:

“The right won the economics debate; left and right are just haggling over details. The big debate is no longer about economics (sadly for me); and it won't be held on the pages of the New York Times or in the economics journals.”

This just seems incredibly wrong.  To begin with, there's no consensus among economists which would support the claim that the debate is over and "the right won."  The fact that a liberal like Brad Delong approvingly cites Friedman from time to time doesn't mean "we're all Friedmanites now."  Even if Friedman won his debate with Galbraith (JKG), "the right" would only be the ultimate victor if JKG were the sole leftist engaged in the argument.  He was not.

Galbraith once said, “Milton Friedman's misfortune is that his economic policies have been tried,” and, one could add, his theories have been tested too.  Let’s begin with Friedman’s monetarism and PQ = MV.  Assuming V is stable and M is exogenous, then the Quantity Theory is resurrected.  But V is not stable.  If it were, quantitative easing would have produced a lot more inflation than it has.  And as Nicholas Kaldor pointed out a long time ago, Friedman's equation can also be read from left to right, with MV adapting to PQ as in endogenous theories of money.  (Kaldor’s little book, The Scourge of Monetarism here, is a minor masterpiece of deconstruction.)

Friedman’s permanent income hypothesis is an important idea, but Friedman wasn’t its sole creator, nor is it an infallible guide to policy.  Perhaps a third of U.S. households live hand-to-mouth.  They spend their whole paychecks and probably spent the lion's share of their one-time stimulus checks from the Treasury. Imperfect capital markets make consumption smoothing very difficult for lower income households.

Friedman's plan for privatizing social security was implemented in Chile many years ago.  If you’re interested in the results, you’ll find Peter Diamond’s comparison of Chile’s system with the U.S. system instructive (here).  It does not favor the privatization manifesto.

Rowe mentions school vouchers as a winning Friedman formula, but here, too, the record is less clear than fans of the approach advertise.  One problem is that vouchers drain active parents from low-income schools, leaving the remaining students worse off.  This isn’t to say vouchers aren’t good for the parents and students who take advantage of them (though this too is questionable), but proponents ignore its adverse selection side effects.

Friedman's Essays on Positive Economics remain authoritative for many contemporary economists.  But positivism has long been in decline among philosophers like Hilary Putnam, and philosopher-economists like Vivian Walsh and A. K. Sen.  Their recent book, The End of Value-Free Economics, is a good antidote to Friedman.

Nick mocks Galbraith's concern with monopoly power, wage and price controls, and other "daft" ideas of the 1970s.  But, let us ask, was JKG's stress on the divergence between private luxury and public squalor in “The Affluent Society” not instructive?  Was his emphasis on the state's role in serving the interests of large corporations in “The New Industrial State” really off the mark?  Is perfect competition a more relevant model than imperfect competition?  Does the massive infrastructure of "advertising" not have a deep and wide-ranging impact on our way of life, not to mention on our "wants" and "needs"?

It's easy enough to say, "the debate is over, and our side won," but saying so doesn't make it so