Thefutureofmacroeconomics:whycentralbankmodelsfailedandhowtorepairthem
JohnMuellbauer,[email protected],October232017
Edinburgh
AttacksonNewKeynesianDSGE
• Buiter (2009)voxeu.org/article/macroeconomics-crisisirrelevance
• ”Researchtendedtobemotivatedbytheinternallogic,intellectualsunkcapitalandaestheticpuzzlesofestablishedresearchprogrammes ratherthanbyapowerfuldesiretounderstandhowtheeconomyworks- letalonehowtheeconomyworksduringtimesofstressandfinancialinstability. Sotheeconomicsprofessionwascaughtunpreparedwhenthecrisisstruck.”
• “BoththeNewClassicalandNewKeynesiancompletemarketsmacroeconomictheoriesnotonlydidnotallowquestionsaboutinsolvencyandilliquiditytobeanswered. Theydidnotallowsuchquestionstobeasked.”
• “Marketsareinherentlyandhopelesslyincomplete.Livewithitandstartfromthatfact.”
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Muellbauer(BIS,2010)
• “UnderlyingconceptualreasonsforthefailureofcentralbankmodelsoftheDSGEtypeincludetheirtypicalassumptionsaboutrepresentativeagents,perfectinformation,zerotransactionscosts,andofefficientmarkets.
• Formostofthesemodels….itisasiftheinformationeconomicsrevolution,forwhichGeorgeAkerlof,MichaelSpenceandJoeStiglitz sharedtheNobelPrizein2001,hadnotoccurred.
• Thecombinationofassumptions,whencoupledwiththetrivialisationofriskanduncertaintyinthesesupposedlystochasticmodels,andthelinearisation techniquesusedintheirsolution,rendermoney,creditandassetpriceslargelyirrelevant.
• Thecalibration/estimationmethodscurrentlyusedtoapplythesemodelstothedatatypicallyignoreinconvenienttruths.“
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• PaulRomer (2016)complainsthat`Formorethanthreedecades,macroeconomicshasgonebackwards’.Hefocusesoncalibration/identification.Butthreeseriousproblems,seehttp://voxeu.org/article/why-central-bank-models-failed-and-how-repair-them,werenot raisedbyhim:
• thechoiceofthewrongmicro-foundationsignoringtheasymmetricinformationrevolutionofthe1970sandDeaton-Carrollresearchonbuffer-stocksavingwhenhouseholdsfaceidiosyncraticuncertaintyandliquidityconstraints.
• theflawedbasisofinter-temporaloptimizationwhenstructuralbreaksandradicaluncertaintyareendemic,Hendry&Mizon,VOXEU2015;
• andthefailuretoallowforthemajorchangesinfinancialarchitectureandtolinkbalancesheetsandflowoffundstospending intherealeconomy.
• InthefashionableNewKeynesian‘scienceofmonetarypolicy’(Clarida,Gali andGertler,1999)creditsectors,moneyandassetpriceswerethoughtirrelevant.
Romer critiqueandbeyond
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Blanchard’smildercritique
• Blanchard(2016,2018)acknowledgesthatcurrentDSGEmodelsmake‘simplifyingassumptions,asanymodelmust,butassumptionsprofoundlyatoddswithwhatweknowaboutconsumersandfirms’.Healsoquestionscalibrationandestimationmethods,normativeimplicationsandtheireffectivenessascommunicationdevices.
• HefavoursmajorrepairsandalessimperialisticattitudesothatalternativeGEmodels,closertothedata,canflourish.
• Many(BOC,DNB,ECB,evenBOE)haverealisedtheneedfornon-DSGEmacromodels.
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Flowoffundsandbalancesheets
• Postcrisis,centralbankshavestudiedtheflowoffundsandfinancialbalancesheetsmuchmorecarefully.
• NewattentiontooldideasofTobin,resurrectedinstockflowconsistent (SCF)approachesofGodleyandLavoie(2012),Burgessetal(2016),BOE,StaffWorkingPaperNo.614.
• Butbehaviourallinkswithspendingandhencetherealeconomyareasyetweak inallthesemodels,includingFRB/US.Somissbusinesscyclefeedbackloopsandunderstandingofriskstofinancialstability.
• FRB/USfailedacidtestincrisis:in2007JacksonHolesymposium,Mishkin reportedFRB/USsimulationsofa20%declineinrealhousepricesover2007-2008:GDPlowerthanbaselinebyatmostONLY0.25%inearly2009!
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NKDynamic,Stochastic,GE:thatwouldhavebeennice!
NewKeynesianDynamicStochasticGeneralEquilibriummodels• Notnew,basedonoutdatedideasmaderedundantbytheasymmetricinformation
revolutionofStiglitz,Akerlof,Spence.• NotKeynesian,ignoringco-ordinationfailures,especiallybetweenrealeconomyand
finance.• Notdynamicenough,misleadingonrealworldlagstructures.• Hardlystochastic(statisticaldistributions),missingbothradicaluncertainty(time
dimension)andheterogeneity(cross-sectiondimension)ofdistributions.• HardlyGE,missingmostofsystemfeedbacks.• Rationalexpectationsandinter-temporaloptimizationneedreformulationwhen
structuralbreaksandradicaluncertaintyareendemic,Hendry&Mizon,VOXEU2014;
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Outline
• Theendoftherepresentativeagentmodel• Asymmetricinformation,liquidityconstraints,incomeuncertainty.• Theimplicationsoftherevolutionincreditmarketarchitectureandwhydebt
matters.• Aconsumptionfunctionrelevantforunderstandingthefinancialaccelerator.• Modellingjointconsumptionandportfoliodecisions– towardsbettereconometric
macromodels.EvidencefromUK,FranceandGermany.• ThistalkdrawsonpaperwithDavidHendry,forthcomingOXREPspecialissueonthe
futureofmacroeconomicsincludingpapersbyBlanchardandStiglitzhttps://ideas.repec.org/p/oxf/wpaper/832.html
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1.Norepresentativeagent
• Unemploymentriskvariesgreatlybyoccupationandeducation,makingnonsenseofRBCrepresentativeagentmodelofunemployment.
• Creditconstraints,mortgagedefaults,negativeequityvaryhugelyacrosshouseholds:norepresentativeagent.
• Stochasticaggregation- workingwithmeansandotherdistributionalparameters- suggestswecanstillmakegreatprogresswithaggregatedata,includingunemploymentrate.
• Houthakker (1956)showedfixedcoefficienttechnology(nosubstitution)atthemicro-levelimpliedhighdegreeofcapital-laboursubstitutionformacro,givenParetocoefficientdistribution.
• Aron&Muellbauer(J.Urb.Econ.July2016)trackaggregateincidenceofUKnegativeequitygivenstabledistributionofmortgagedebt/equity.Driverofarrearsandrepossessions.
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2.Incomeuncertainty,liquidityconstraintsandbufferstocksaving
• OneareaofAngusDeaton’sworkhighlightedbyNobelcommittee:
• 1991Econometrica paper:
– laidthemicro-foundations,implyingbufferstocksavingandshortertimehorizons,i.e.muchhigherdiscountsonfutureincomethanincanonicalpermanentincome.
• 1992book,last10pages:
• summaryofthemassivemicro- ¯o-dataevidenceagainstthesimplepermanentincometheory.
• ChrisCarroll(1992,2001,2014)hastakenthebufferstocktheorytonewlevels,evenwithoutcreditconstraints.
• Studyingstochasticincomeprocessesempirically,hecalibratesconsumptionresponsesunderplausiblepreferenceassumptions,atdifferentcash-on-hand/incomeratios.
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Illiquidassets
• Deaton(1992)saysthatsinceconsumers’balancesheetsincludeilliquidassetssuchaspensions,stocksandbonds,andhouses:
– “thepresenceoftheseilliquidandsometimeshigh-yieldingassetsneedstobeintegratedintothemodelofcredit-constrainedconsumers”.
• Recentliteratureonheterogeneousagentmodelsisdoingthis:KaplanandViolante(Econometrica 2014)andKaplan,Moll&Violante HANKwp 2016,forthcomingAER);Hedlund,Karahan,Mitman &Ozcan,2017withbettertreatmentofhousingandliquidity.
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3.UKcreditmarketarchitecture
• UKabandonedexchangecontrolsin1979;eliminated‘corset’onbanklending;
• Banksinvadedmortgagemarket;
• Buildingsocietiesresponded,newlibertiesin1986BSAct.
• Centralisedmortgagelendersinvadedin1986-1990.
• Mortgagecrisisledtocreditcrunch.
• After1996,creditliberalisationforbuy-to-letmarket;increasedsecuritisation;newbreedofcentralisedlenders.
• Fernandez-Corugedo andMuellbauer(BOEWP2006)trackmortgagecreditconditionsindexconsistentwithabove.
• From2008,creditcrunchandre-regulation,partialrelaxed.
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4.Whydebtmatters
• IrvingFisher’s1933debt-deflationtheoryofgreatdepressionsandbookonBoomsandDepressions:– creditavailabilityexpands,pushesupspending,debtandassetprices,
irrationalexuberanceraisespricestovulnerablelevels,negativeshockscanthencausefallsinassetprices,baddebt,creditcrunch,riseinunemployment,deflation.
• ExplainingthecollapseinUKpersonalsaving(MuellbauerandMurphy,1990):– (unsustainable)credit-liberalisation-drivenhousepriceboom:evidencethat
debthadfarmorenegativeeffectonspendingthanpreviouslythought
– Hencecrucialtocontrolfortheshiftincreditconditions!• AdairTurner(2015) BetweenDebtandtheDevil:Money,Creditand
FixingGlobalFinance• Mian andSufi(2014)HouseofDebt.• Jorda,Schularick andTaylorEconomicPolicyJan2016onroleofreal
estatecollateral.
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Modellingthehouseholdfinancialaccelerator(Ducagraphic)
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LowerDemandforHousing
SlowerGDPGrowth
? HomePrices&Wealth,SlowerConsumption
MortgageandHousingCrisis
LessHomeConstruction
LowerCapitalofFinancialFirms
? Counter-PartyRisk,Money&BondMktsHit
CreditStandardsTightenedonAllLoans
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5.Amoregeneralconsumptionmodel
• Weneedamoregeneralconsumptionfunction&incomeforecastingmodeltocapturetheconsumptionchannelinthefinancialaccelerator.
• UnlikeEulerequation,thebasisofNK-DSGE,donotthrowawaylong-runinformation onincomeandassets.
• Networth=liquidassets– debt(mortgageandother)+illiquidfinancialassets(pensions+stockmarket)+housingwealth.
• Absurdtoassumeeffectonaggregatespendingisthesameforeachelementandtoassumenoshiftsincreditaccessalsoinnon-DSGEpolicymodels,e.g.FRB/US,newECB-MC,oldMTMM&OBR.
• Consumptionfunctionisconditionalonendofpreviousperiodportfolios,onassetpricesandonaccesstocredit,soneedtoexplaintheseinafullmacromodel.
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Institutionsmattergreatly
• Restrictive(conservative)creditmarketssuggestaggregateconsumptionfallswhenhousepricesrise:- (e.g.GermanyorJapan)
- futurefirsttimebuyers(andrenters)savemoreforadeposit(orhigherfuturerents),thoughaggregatenegativeeffectshouldbelowerwhereproportionofowner-occupiersishigh(Italy).
- home-ownershavelimitedaccesstohomeequityloans.
• Liberalmortgagemarketsimplytheopposite:- alowerratioofdown-paymentstovalueapplies,sofuturefirsttimebuyers willsave
littleandnotrespondmuchtohigherhouseprices;
- Greateraccesstohomeequityloansraisesresponseofspendingtohousingcollateral.
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CCIincludingpost2001dummies
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DecomposeUKlong-runsoln (a)
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DecomposeUKlong-runsoln (b)
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InsightsfromUS&UKconsumptionfn
• Onhowconsumption/incomebehavedoverthelong-run,inthebuild-uptothefinancialcrisisandduringthecrisis.
• Notebuildupofdebtobligationduringlongperiodofcreditliberalisationandrisesinassetprices.
• Insightsintoroleofdebtandshiftingcorrelationswitheconomicgrowth:negativeroleforlevelofdebt,positiveforgrowthofdebt noticedbymanyobservers.
• Reconciledbyshiftsincreditsupplyandcontinuousnegativeimplicationsoflevelofdebtforconsumption.i.e.omittedcreditsupplyexplainsshiftingbivariatecorrelationsofdebtwithgrowth.
• Short-runroleforchangeintheunemploymentrate- proxyforincomeinsecurity,andinUK,cash-floweffectsofchangesinnominalinterestrates.
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Householdsystemneeded
Needconsumption-portfolio-assetpricesystem.• Toplugconsumptionfunctionwithdisaggregationofwealth
intoamacromodel,weneedequationsforassetsanddebt.
• Extractcreditconditionsaslatentvariablesfromsamesystem(LatentInteractiveVariableEquationSystem).
• ECBw.paper1904onGermanywithFelixGeigerandManuelRupprecht ofBuBa;draftpaperwithValerieChauvin,BdeFrance
– estimate6-equationsub-systemforconsumption,unsecureddebt,mortgagedebt,liquidassets,housepricesand‘permanentincome’.
• EstimatedunsecuredandmortgageCCIsimplysmalleffectsonGermanconsumptioncomparedtoUKorFrance.
• Solvespuzzleofdivergentrealhousepricesandhh savingrates.
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Neweconomicstories
• MonetarytransmissioninGermanyisverydifferentfromtheUSandUK,andsomewhatdifferentfromFrance.
• Changingdemographyismuchmoreimportantforchangingcompositionforaggregatehh portfoliosthanforconsumption,conditionalonthoseportfolios.
• Willslowlyfeedthrough,viaportfolios,toconsumption–relevantforsecularstagnationhypothesis.
• Empiricalevidenceonnegativespendingimplicationsofhouseholddebtcastsdoubtonpost-crisismonetarypolicy.
• Micro-evidenceISimportant:testbehaviourhypotheses,helpcalibrateeffectsofdemographyanddistributionalchanges.
• Macro-shiftsincreditconditionsandassetpriceshavemacroeffectsthatshouldnotbeignored.
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Otherinsights
• Someremarkableempiricalinsightsnotavailablefrommicro-cross-sectionsorshortpanels:
• Contrarytotext-bookview,majorroleforNOMINALinterestrateindrivinghouseprices(andmortgagestock);roleofusercostincreaseswhereleverageishigher(highLTV).
• Increasedaccesstounsecuredcreditreducesdemandforliquidassets– ignoredbypreviousresearchonhh demandformoney.
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DefendersofNK-DSGEclaim…
• thatmodelisflexible• needmodeltotell‘economicstories’builtonmicro-
foundationsandtoincorporateexpectations.Aucontraire:• Eulerequationisstraitjacketstronglyrejectedbythedata.• Theclaimedmicro-foundationsaresand:thereisno
representativeagent;information-economicsrevolutionimpliesheterogeneityand,onaverage,shorthorizonsinthefaceofliquidityconstraintsandincomeuncertainty.
• KeyeconomicstoriescannotbetoldinNK-DSGEbutcan betoldwithnewformulationofhouseholdbehaviour.
• NK-DSGEisnotstochasticenough,notdynamicenoughandnotgeneralequilibriumenough:failstocapturesystemfeed-backs.Moreover,notnewandnotKeynesian.
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