Recent Posts

Sunday, March 18, 2018

Understanding Fiscal Sustainability Debates

I have encountered a number of discussions of fiscal sustainability over the past weeks. In particular, there have been debates between proponents of Modern Monetary Theory (MMT) and mainstream economists. This article does not attempt to settle the debate (although I am in the MMT camp, and obviously biased), rather frame the discussion. One of the problems with the debate is that the sides tend to talk past each other, as they have a quite different theoretical views, and this article explains why.

Wednesday, March 14, 2018

The Curious Profit Accounting Of DSGE Models

One of the more puzzling aspects of neo-classical economic theory is the assertion that profits are zero in equilibrium under the conditions that are assumed for many models. One should re-interpret this statement as "excess profits" are zero, but there are still some awkward aspects to the treatment of profits in standard macro models. This article works through the theory of profits for an example dynamic stochastic general equilibrium (DSGE) model, and discusses the difficulties with the mathematical formulation.

The example is taken from Chapter 16 ("Optimal Taxation With Commitment") in the textbook Recursive Macroeconomic Theory, by Lars Ljungqvist and Thomas J. Sargent (I have the third edition). For brevity, the text will be abbreviated as [LS2012] herein. If the reader is mathematically trained and wishes to delve into DSGE models, this textbook is the best place to start. The mathematics is closer to the original optimal control theory that DSGE macro is based upon, whereas other treatments follow the mathematical standards of academic economics, the difficulties with which are discussed later in this article.

Sunday, March 11, 2018

Why Cross-Currency Bond Yield Spreads Do Not Matter

Chart: CAD-USD Exchange Rate

I have been running into cross-market yield comparisons in the news flow in recent weeks. For example, the raw U.S. Treasury/German bund yield spread often comes up in valuation discussions.The simple rule of thumb is that one should never make such cross-currency yield comparisons; they only matter if the currency value is being pegged. Since I do not have a handy source for euro-denominated bond yields, I will use the Canada-U.S. comparison.

Friday, March 9, 2018

U.S. Labour Market Trends Continuing, Pushing Fed In Hawkish Direction

Chart: U.S. Prime Age Employment-Population Ratio

Based on a quick scan of the latest U.S. labour market data, the chart above best encapsulates my reading of the state of the market. I have been a perma-dove on inflation, and I do not see any immediate reason to change that view. Inflation has been anchored for a very long time, and I think it will take a lot to move core PCE inflation to more than 2.5%. Nevertheless, this does not necessarily translate into a perma-dove view of the Fed. As the chart above shows, it is easy to come up with reasons for a less sedate pace of rate hikes going forward.

Wednesday, March 7, 2018

Comments On "Skin In The Game"

Skin in the Game: Hidden Asymmetries in Daily Life is the latest instalment of Nassim Nicholas Taleb's Incerto series, which is "a combination of a) practical discussions b) philosoophical tales, and c) scientific and analytical commentary on the problems of randomness, and how to live, eat, sleep, argue, fight, befriend, work, have fun, and make decisions under uncertainty" (description from the Introduction). This article is a limited review of some of the aspects of the discussion of the book that relates to economics and finance. My beat is bond market economics, I am not here to offer advice on how to live, eat, sleep, etc. As a result, my discussion here is not really enough information to decide whether to buy the book or not, instead, I am just discussing a few points that intersect with the subjects I normally discuss.

Sunday, March 4, 2018

Back To Gradualism

Chart: U.S. Breakeven Inflation, Slope

My reading of the consensus view is that the change in personnel at the Federal Reserve has coincided with a more hawkish outlook, although the tax cut presumably helped push matters. I do not have a strong reason to disagree with such a view; the Fed is probably going to revert back to its historical policy of gradualism -- which was a 25 basis point hike per meeting.

Saturday, March 3, 2018

The Easy Way To Deal With Factionalism In Economics

Professor Simon Wren-Lewis recently wrote: "The dangers of pluralism in economics: the case of MMT." (I believe that he later wrote that "factionalism" would have been be a better chouice than "pluralism" in the title, and better reflects the tone of what he wrote.) There's a lot of stuff in his article, but the reality is that there is a simple solution to the problem he identifies: mainstream economists need to act like real academics, and respond to heterodox criticisms in the academic literature. If you live in an intellectual bubble -- like many mainstream economists (Wren-Lewis himself is presumably an exception) -- you cannot be shocked by the response you get when you leave that bubble.