potential gdp is a policy variable

between summer 07 and winter 13
i guess we lost lots of potential
    due  to intervening lower  ...errrr " policy targets "


did we fail to build the expected additions to production capacity ?

or simply lower our calculations of reality  to suit our policy

more brad stress test results: a common blunder

date line:

May 1, 2009



brad;


" If you hold your money in a six-month Treasury Bill you get essentially no interest—0.3% per year Monday afternoon—and you run the small risk that interest rates might rise over the next month and your Bill might lose a little value."

if you want to cash it in ahead of its 6 month  maturity date

why'd u buy the note ?


 "If you hold your money in cash you get exactly no interest and it is safe—FDIC insured. "

ya they are both default risk free
but
how is this better then holding the note to maturity ?
uncertainty about cash needs

if such exist
why can't you borrow against your notes ?

transaction cost> then loss from note sale cost

obviously if you expect to need cash between now and maturity date
.you either buy a shorter note or hold more cash

so its liquidity in the face of uncertainty
that drives deposit holding

and mistakes in optimal liquidity are a separate calculation

------------------------------------------
more basic


"start with the quantity theory of money:

PY = MV"

yup when lecturing the public brad uses 18th century notions
like velocity

and gives it a life of its own

dancing about with  interests rate

" When the central bank tries to boost nominal spending through standard monetary expansion it might prove ineffective: interest rates will drop even closer to zero as the ratio of money to bonds rises, and the velocity of money might well drop to offset the boost to the money stock"

velocity this  vast abstraction  with unstated motives
"might well drop to offset the boost to the money stock "

the purchase of notes and bonds on the secondary markets by the FOMC
drives up the price and lowers the effective rate
on the note  to any other agents  simultaneously purchasing these note

we have a gain on the note to holders selling etc etc

then comes this gem

"The Federal Reserve is boosting the money supply with extraordinary force
 and the velocity of money is dropping like a stone."

" In order to ensure that monetary expansion is effective,
you need to do something to boost interest rates"
get that
"boost interest rates "

comes the rest of the ass backwards narrative


"Here is where “large and continuous deficit budgets” comes in."

" When the government runs a deficit it floods the market with bonds. Once again by simple supply and demand more bonds means a lower price of bonds which is the same thing as higher interest rates. "

brad has uncle run deficits to raise interest rates to put the money stock into hot potato mode
thru increasing the opportunity cost of holding this money

"The government cannot hold on to the money it gets from selling bonds for that would reduce the money stock"

when uncle wants to increase its velocity

" the whole point of the exercise is to make the increase in the money stock effective."
that line is a monuent to mud making
continuing


uncle " has to return the money to the private sector by spending it"

". And it can spend it in four ways:

• By buying up assets like mortgage-backed securities.
• By buying up companies like GM and Citigroup.
• By refunding the money to taxpayers by cutting taxes.
• By spending the money directly."

"Which of these ways would be most effective at keeping the velocity of money from falling further to offset expansionary monetary policy?"


" The answer is that we really do not know which of the ways would be most effective"


and that is the reason that we are trying them all right now,

 with Tim Geithner
buying GM and mortgage-backed securities with the government’s money
and Peter Orszag
 directing the flow of spending and tax cuts that is the American Recovery and Reinvestment Plan"

amazingly fearful symmetry !!!!!

and what a four  flusher  and bully mouth  sycophant

brad's low bar for chest thumping

he fished this up lately to show he was on the side of god and the little guy

 "I think the odds are one-in-three that in two years we wish we would have done more [than the Recovery Act], and that the odds are close to zero that in two years we wish we would have done less."

one in three !!!!!!

great call brad

i'd  prolly would have given  three to get one

optimal Delong monetary off sets

"Suppose that we have a system in which future unemployment u_t+1 is a function of variables V (which include past, present, and expected future unemployment and inflation rates), of the stimulative impact of monetary policy m, and of a shock:

(1) u_t+1=ƒ(V_t) + m_t + ε^u_t+1 ;

in which inflation is a function of variables V (which include past, present, and expected future unemployment and inflation rates) and of a shock:

(2) π_t+1 = j(V_t) + ε^π_t+1 ;

and in which there is an objective function h depending on present and future values of unemployment and inflation (but not directly on monetary or fiscal policy variables):

(3) h(π_t, π_t+1, …; u_t, u_t+1, …)

At each point in time the monetary authority will choose an optimal m'_t in order to maximize the expected value of that objective (3) subject to (1) and (2), and the unemployment rate will consequently be:

(4) u_t+1=ƒ(V_t) + m'_t + ε^u_t+1

Now consider what happens if we replace (1) with (1a), with the difference between (1) and (1a) being that fiscal policy g also affects unemployment:

(1a) u_t+1=ƒ(V_t) + m_t + g_t + ε^u_t+1

Then as long as m'_{t is the optimal choice of m for the system (1), (2), and (3):}

(5) m"^*_t = m'_t − g_t

is the optimal choice of m’ for the system (1a), (2), and (3).
Why? In system (1a), (2), and (3), define:

(6) n_t = m_t + g_t

Then (1a) becomes:

(7) u_t+1=ƒ(V_t) + n_t + ε^u_t+1

By hypothesis, the objective h is maximized for the system of (7), (2), and (3) by choosing:

(8) n'_t =m'_t

And so the objective is maximized for the system of (1’), (2), and (3) by choosing:

(9) m"_t =m'_t - g_t

You take your optimal policy if fiscal policy were neutral--if g_t=0--and you then subtract the stimulative value of the actual g_t from it.
The important point here is that m and g cannot enter into the objective function h directly, but only indirectly through their effects on inflation and unemployment.
For this reason this argument breaks down at the zero nominal lower bound. At the zero lower bound the central bank does care only about inflation and unemployment. It cares as well about the magnitude of the non-standard monetary policy measures it must take in order to achieve its net monetary policy impetus value m."


yup
assume optimal monetary policy job one
is
  off set any fiscal macro impacts

fiscal policy must be neutralized if not neutral


orrrrrrrrr if the nominal rate of interest hits the zero barrier
and  optimal  policy dictates the rate  must go south....
now you accomodate the fiscal poicy

then of course fiscal policy may be stymied ....
then you
go non conventional and buy assets lots and lots of assets

this is where you end up when monetary policy plays macro manager

the voice of common sense cries out

use fiscal policy always
blow the road blocks

of course this gives uncle control of out put not corporate guardian elites

macro demand constrained vs supply constrained market based systems

that simple distinction tells a huge tale

ricardian systems are pure supply side systems

jevonian systems pure demand side

marshall put these two together
but failed to note the remaining distinction

demand or supply constrained in aggregate

the capitalist system in its several histortic  institutional forms
requires chronic macro  demand constraints to sustain itself
this fact was well recognized at the micro level in stiglitzian  micro

but the macro constraint condition was left an inditinct implication

in his elementarty text book
stiglitz himself
asks the question is it supply or demand constraint in aggregate
as if the whole system is possibly in either

no where can i find him stating
the capitalist system requires chronic demand "rationing
despite his clarity on the two key aggregates

 the system  rations  both total  job hours  and total  outstanding credit

the law of motion for capital accumulation: ramsey's way

:

"where k is capital per worker, is change in capital per worker over time, c is consumption per worker, f(k) is output per worker, and is the depreciation rate of capital. This equation simply states that investment, or increase in capital per worker is that part of output which is not consumed, minus the rate of depreciation of capital. Investment is, therefore, the same as savings.

where I is the level of investment, Y is level of income and s is the savings rate, or the proportion of income that is saved.
The second equation concerns the saving behavior of households and is less intuitive. If households are maximizing their consumption intertemporally, at each point in time they equate the marginal benefit of consumption today with that of consumption in the future, or equivalently, the marginal benefit of consumption in the future with its marginal cost. Because this is an intertemporal problem this means an equalization of rates rather than levels. There are two reasons why households prefer to consume now rather than in the future. First, they discount future consumption. Second, because the utility function is concave, households prefer a smooth consumption path. An increasing or a decreasing consumption path lowers the utility of consumption in the future. Hence the following relationship characterizes the optimal relationship between the various rates:
rate of return on savings = rate at which consumption is discounted − percent change in marginal utility times the growth of consumption.
Mathematically:

A class of utility functions which are consistent with a steady state of this model are the isoelastic or constant relative risk aversion (CRRA) utility functions, given by:

In this case we have:

Then solving the above dynamic equation for consumption growth we get:

which is the second key dynamic equation of the model and is usually called the "Euler equation".
With a neoclassical production function with constant returns to scale, the interest rate, r, will equal the marginal product of capital per worker. One particular case is given by the Cobb–Douglas production function

which implies that the gross interest rate is

hence the net interest rate r

Setting and equal to zero we can find the steady"

Ramsey, Frank P. (1928). "A Mathematical Theory of Saving". Economic Journal 38 (152): 543–559. JSTOR 2224098

"Phase space graph (or phase diagram) of the Ramsey model. The blue line represents the dynamic adjustment (or saddle) path of the economy in which all the constraints present in the model are satisfied. It is a stable path of the dynamic system. The red lines represent dynamic paths which are ruled out by the transversality condition"





very much the perfect clark kent no ?

ned rats out ratex

ned wants us to think about real expectations

which ratex has neutered in the cause of  a higher invisible ordering

much as the red of tooth and claw competition out there
was turned into the court eunick in arrow-debreu


"In the expectations-based framework that I put forward around 1968, we didn't pretend we had a correct and complete understanding of how firms or employees formed expectations about prices or wages elsewhere. We turned to what we thought was a plausible and convenient hypothesis. For example, if the prices of a company’s competitors were last reported to be higher than in the past, it might be supposed that the company will expect their prices to be higher this time, too, but not that much. This is called "adaptive expectations:" You adapt your expectations to new observations but don't throw out the past. If inflation went up last month, it might be supposed that inflation will again be high but not that high. "



" The "scientists" from Chicago and MIT came along to say, we have a well-established theory of how prices and wages work."

" Before, we used a rule of thumb to explain or predict expectations: Such a rule is picked out of the air."


" They said, let's be scientific. In their mind, the scientific way is to suppose price and wage setters form their expectations with every bit as much understanding of markets as the expert economist seeking to model, or predict, their behavior. "

"The rational expectations approach is to suppose that the people in the market form their expectations in the very same way that the economist studying their behavior forms her expectations: on the basis of her theoretical model."


" And what's the consequence of this putsch?... Craziness for one thing."

" You’re not supposed to ask what to do if one economist has one model of the market and another economist a different model."


" The people in the market cannot follow both economists at the same time. "

"One, if not both, of the economists must be wrong."



" Another thing: It’s an important feature of capitalist economies that they permit speculation by people who have idiosyncratic views and an important feature of a modern capitalist economy that innovators conceive their new products and methods with little knowledge of whether the new things will be adopted -- thus innovations."


" Speculators and innovators have to roll their own expectations. They can’t ring up the local professor to learn how."

" The professors should be ringing up the speculators and aspiring innovators."


" In short, expectations are causal variables in the sense that they are the drivers. They are not effects to be explained in terms of some trumped-up causes. "

" So rather than live with variability, write a formula in stone! "


" What led to rational expectations was a fear of the uncertainty and, worse, the lack of understanding of how modern economies work."


" The rational expectationists wanted to bottle all that up and replace it with deterministic models of prices, wages, even share prices, so that the math looked like the math in rocket science."


" The rocket’s course can be modeled while a living modern economy’s course cannot be modeled to such an extreme."


" It yields up a formula for expectations that looks scientific because it has all our incomplete and not altogether correct understanding of how economies work inside of it, but it cannot have the incorrect and incomplete understanding of economies that the speculators and would-be innovators have. "

"people are grossly uninformed, which is a far cry from what the rational expectations models suppose. "

"Why are they misinformed? I think they don’t pay much attention to the vast information out there because they wouldn’t know what to do what to do with it if they had it."


" The fundamental fallacy on which rational expectations models are based is that everyone knows how to process the information they receive according to the one and only right theory of the world. "


"The problem is that we don't have a "right" model that could be certified as such by the National Academy of Sciences. And as long as we operate in a modern economy, there can never be such a model. "


" I am far from being the only economist who has critiqued the premise of rational expectations."

" I’m just the main victim, since that approach drove people away from my approach -– from my emphasis that expectations are a driver of what happens in modern economies."

" Several economists saw that the emperor has no clothes. Oskar Morgenstern explained that rational expectations would be untenable in the modern world, and Friedrich Hayek got the point."


" A Danish economist complained about it in the 1940s. Axel Leijonhufvud attacked it. Roman Frydman has made his career uncovering the impossibility of rational expectations in several contexts. He explained that if the data are always bouncing around because expectations are bouncing around, we can’t use the data to calculate the right expectations"

". I have an image in my mind of a dog chasing its tail."



" When I was getting into economics in the 1950s, we understood there could be times when a craze would drive stock prices very high. Or the reverse: An economy in the grip of weak business confidence, weak investment, would lead to loss of jobs in the capital-goods sector. But now that way of thinking is regarded by the rational expectations advocates as unscientific."


"By the early 2000s, Chicago and MIT were saying we've licked inflation and put an end to unhealthy fluctuations –- only the healthy “vibrations” in rational expectations models remained. Prices are scientifically determined, they said. Expectations are right and therefore can't cause any mischief. "



"At a celebration in Boston for Paul Samuelson in 2004 or so, I had to listen to Ben Bernanke and Oliver Blanchard, now chief economist at the IMF, crowing that they had conquered the business cycle of old by introducing predictability in monetary policy making, which made it possible for the public to stop generating baseless swings in their expectations and adopt rational expectations."


" My work on how wage expectations could depress employment and how asset price expectations could cause an asset boom and bust had been disqualified and had to be cleansed for use in the rational expectations models. "


" The rational expectations treatment of inflation did not perform well in predicting inflation.
 In the 1990s, we had a boom with none of the inflation that was predicted.
 In 2004-2006 there was another boom without much inflation."

 "The bond market would be right to have very little confidence that the Fed has the right model."

" It's only a small exaggeration to say the Fed doesn't have any important structural forces in its model. It's just guessing about the new normal (for the unemployment rate). It seems to me that they don’t even want to think about it. "


" I would tell them not to assume they have hit upon a model that captures expectations so they don't need to think about expectations anymore"

". Expectations are a living thing and flighty; beliefs are flimsy, as Keynes said."

" The Fed is banking that expectations will behave according to the model the Fed wants people to adopt"

" But no central bank or anyone else should bank heavily on the correctness of its model. "

"Expectations will almost certainly surprise the Fed and surprise Wall Street, too"

". Furthermore, the Fed model doesn't allow for animal spirits in Silicon Valley or evil spirits on Wall Street.'

" It can't know about those things."

" Washington is banking on a best-case scenario to bail it out of the entitlements mess in the 2020s."

" The world is still in a crisis. Not a hospitable place for models based on rational expectations."