The need for new Macro

There is a vast consensus around the need for the -rapid- improvement of macroeconomics. It certainly can not be neglected. Although the path of the Animal Spirits may have a number of weaknesses, it argues boldly for reforming the way macro is done can not wait anymore. De Grauwe writes an interesting opinion about the latter.

Maybe the need for understanding the so called Herd Economics can help in completing macro models that fail to model the financial market as an imperfect market. The current macro profession crisis will also prove valuable for those in search of a thesis.

Animal spirits -After some reading-

In a recent post, I described a lecture given by one of the authors. After the completion of the 9th chapter out of 14 my impressions have not changed much. The book proposes some new "variables" that modern economic theory does not use. The so called "animal spirits". Defined as a set of variables such as confidence, money illusion, stories and corruption.

The approach of the book can be shortly summarized in the following: Macroeconomics has taken too far rationality assumptions. After more than 100 pages, evidence and arguments presented are in my view far from conclusive.

The authors construct most arguments based not on facts but on frequent guessing. No doubt behavioral economics rely it's findings on an interesting psychological framework. No doubt it will eventually develop to a sounder stage. But the animal spirits theory contributes little to economic modeling.

It is hard in the profession to consider seriously a theory without a model to assess reality. Not to mention in economic policy-making. The only animal spirit that could be tested at present is the one that is based in stories. Something particularly similar to adaptative expectations. The Economist magazine made available a bold description of the current state of the economist profession in terms of those soft spots of macro.

This explanation is much more centered than Akerlof and Shiller's. It states an important fact too. We economist prefer an elegant and formal theory. Not because of vanity, but because science grows based on sound facts and abstraction of them. We now know for a fact that financial markets can not regulate by them selfs. It seems that this is the most notable weakness of modern macroeconomics, not the rationality assumptions for the rest of the economic agents, nor the microeconomic foundations that modern macroeconomist agree are important. Including recent advances of the Dynamic Stochastic General Equilibrium Models.

The article of the Economist says also, that we consider only theories that can be modeled. That is true. Again not for vanity but for its usefulness for real life problems. An example. Keynes's breakthroughs in economics translated in to reality with a deep and a comprehensive fashion until Hicks developed the IS-LM model, until then, keynesian theories were only provocative philosophical arguments.

Maybe behavioral economics will provide the theory for serious improvements of macroeconomic theory. The Animal Spirits book does not provide a model for this end.

Is the IS-LM Model Outdated?

As an undergraduate student, I used to disdain the IS-LM model as an obsolete tool of macro policy analysis. In time I have come to the conclusion that there is not a sounder model out there. Despite its limitations -such as its static set up, ad-hoc nature and lack of microfundations- the IS-LM model provides accurate information on the behavior of some variables after a public policy decision.

The lack of microfoundations is important in second order. Lets not forget that it is, at the end, a general equilibrium model. Moreover, the IS-LM model is a synthesis of the goodnes of general equilibrium economics and comparative advantages of Keynesian economics.

Although Paul Krugman is lately a maverick economist, opposing to every other collegue, it is worth taking a look at Krugman's thoughts of the IS-LM model. Personally, I have more respect now for the model. Not because its limitations are minor, but because its usefulness has been proved over years of economic policy.

The fact that international agencies such as the IMF or central banks use the model -along with some dynamic stochastic general equilibrium- shows its value for the profession. I find it hard to believe that after tons of macro papers written out there, only a small proportion has proven useful for macro policy.

Two facts have changed my view of the model: First, I prefer to be an "engineer macroeconomist" in Mankiw's definition. Second, when learning advanced models of economic growth and policy, the IS-LM provides the right intuition. So it makes it easier to understand the important results.

Hopefully the current economic crisis will trigger interest in making economic modelling closer to reality. It is true, economic science evolves slower than it looks. Maybe modern macro models are over a path in o a new and more useful model than the IS-LM. In the mean time, it is not a waste of time to learn it well if you like macro.

The Economist on Mexico's last Election

It is fairly straight to conclude that the following three years -before elections for President- will be the hardest of the Calderon administration. The Economist sum-up a clear picture of it.

The liberal magazine also displays the only way out of the "political gridlock", stating that co-governance with the PRI party is a necessary condition, with the implicit hope that the PRI will allow for critical reforms and thus would receive a country in expansion. If you are interested in estimated numbers of the low chamber composition, Eduardo's Blog provide some from the media.

The Economist's view of Mexico it's almost fully accurate, it only fails to mention the low proportion of total votes with respect to registered citizens, and all nule votes.

With the Congress majority leaned to the PRI party, much of economist's creativity should be invested in the next fiscal reform. VAT in food and medicines will not be an option.

IMF Issues Debt!

The IMF will issue debt soon according to the FT. The latter rises some interesting questions. How will IMF's debt affect economic variables? Will prices in countries be distorted? If so, in which countries lenders or borrowers? To what terms would be issued? John Cochrane explains how can long term debt be useful for a government trying to exchange present for future inflation. Will effects like this lack of importance?

It sounds like some details should be discussed, one thing for sure is that the US will stop receiving savings from surplus countries, if the dollar depreciates, trade deficit in the western hemisphere will fall, still, trade surplus in Asia will not necessarily fall.

Another interesting feature is that if the IMF's absorbs saving excess, the consumption and investment components of aggregate demand in rich countries will suffer. There are a few untied ends of the proposal, but it is probably in the right direction. A popular direction at present.

The Political Economy of the Next Fiscal Reform -After the election-

Results of the election show that the Revolutionary Party (PRI) will be the first minority in Mexican lower chamber with more than 210 seats. A strong position with respect to its present 106 seats. The official National Action Party (PAN), will have 133 seats a big lost from the former 206. In the last three years, history has recorded that whenever the PAN wanted to go ahead with any major reform, it had to agree with the PRI first.

Now all negotiations will be harder for the official party. Taken PRI's ambitions to return ruling Mexico in 2012 as given, a fiscal reform that raise the tax base or the marginal tax rate of existing tributes looks ever more difficult.

Taking a glimpse in to the future, and assuming the PRI is willing to raise tax revenue, the optimal strategy for the Democratic Revolution Party (PRD) will be -with emphasis- to condemn those taxes and then trying to re-gain the second place in voters' preferences. The PRD did very bad too in the recent election, it will have only 67 seats nearly half of its current number 126.

All the latter would leave the PAN in a historical weak position and as an all time looser. The PAN would present to the 2012 elections as a party with the poorest performance in both economic and public safety terms. Taken the last election as an advanced indicator of the 2012's, the PAN should focus in not loosing its place as the second major party.

One of the few ways a fiscal reform would take place, must involve the PRI's akcnowledgement of the fact that without enough revenues, Congress alocates fewer resources. At the same time, the fiscal reform should include all parties, so that none of them could make campaign against it.

Sadly, evidence of reforms including all parties in the current period shows that they have turned out to be weak when compared with its motivations. The latter is the case of the last fiscal, energy and voting system reforms.

Only reforms agreed by a small number of parties are near to satisfy the needs reality demands, such as the pension reform of the State workers of 2007.

Mexico's President will face tougher obstacles now, with its safety policy struggling to convince Mexicans it is the right way, an economý faltering and expected to grow slowly, added to low expected public revenues, the PAN has to take serious action and deal with the PRI, otherwise, the country of 2012 will be ever more distant from that promissed in 2006. Voters acknowledge that.

Animal Spirits -A First Glance-

Berkeley economics' professor George A. Akerlof and Yale's Robert J. Shiller recently published a book that awake interesting feedback so far. The title reads "Animal Spirits" invoking a popular phrase of J. M. Keynes regarding the underlying factors that come to play when it comes to investment decisions.

This already shows some biased in the convictions of the authors, which can be summed up in the following: governments should play a more active role in the economy than free-market advocates claim.

I have not read the book yet -I will soon- however, I have a clearer picture of its contains. Shiller visited recently the LSE and gave a lecture on it. One of the central points made was that, unlike we economist assume, individuals make decisions based in shakier, less technical premises. One in particular caught my attention. Akerlof and Shiller state that individuals base their decisions in "stories". This is, in someone else's experiences. Frankly, this falls in place if we look to how investment decisions are made in cities like Guadalajara, in Mexico.

It is fairly common to hear that someone decided to get in the carwash bussines because he heard how well someone else was doing. It is easy to replicate the latter in mobile phone stores, haircutt shops, caffe internet, real state buying, and so on. There are no feasibility studies behind, just stories from acquaintances.

Of course, it is true that not only Guadalajara corroborates Akerlof and Shiller's hypothesis, just as is true that there are hundreds of counter examples. Nevertheless, the "stories" story seems a lot like the forgotten adaptative expectations. So, in a way, the authors suggest that models -such as the modern macro models- should be re-assessed to include the latter and delete the "rational" approach.

This is my hope at least, otherwise it would be hard to model those indivuduals' "animal spirits". Still, there is some reading to do.