Links and happenings

Busy times for yours truly over the last two weeks. Here is a list of things that I've been doing, plus one or two items that I spotted on ye olde internet.

1) I moved apartments! More or less the same size as our old place, but more comfortable and modern. Here is a little photo taken from the (car-free) route that I cycle to school everyday. Not too shabby, eh?

2) I had the pleasure of acting as moderator for the inaugural TEDxBergen conference. (My school has actually been hosting TEDx events for a while, but they've now expanded to include the other educational institutions in the city.) The speakers were all very interesting, with two or three in particular being excellent. I believe the video(s) for the event will be made available shortly, so I'll link to them then.

3) I gave a lecture on shale gas (and fracking) to the master's class in Petroleum Economics this week. My slides are here!

4) On a more prestigious note, two Nobel laureates recently gave lectures at my school. (i) As I pointed out on Twitter, Chris Sims is sounding an awful lot like an MMTer /Post-Keynesian lately. (ii) Finn Kydland makes a provocative claim that we are more resilient to energy price hikes today than we were in the past. His argument is that the adverse economic effects of the 1970s' oil shocks largely manifested themselves as inefficient tax rises due to the monetary and fiscal systems of the time. This in turn caused investment and employment to fall. I'm entirely not sure about this story -- the declining energy intensity of our economies would seem to play a bigger role -- but it's an interesting idea.

5) As predicted, some people are using the terrible events at the Westgate Shopping Mall in Nairobi to disparage "interventionist" foreign policy. I'm not saying that they don't have a point -- although, the ongoing anarchy in Somalia is certainly destabilising to the area and has negatively affected Kenya's economy. I'm saying that if blowback is the measure by which policy is to judged, then consistency dictates that one should make equally narrow arguments against (say) liberal immigration policy, subsidy revocation or economic austerity. What's sauce for the goose, is sauce for the gander after all.

6) To my American friends that have to suffer through the asinine politicking of the Republican party and the twilight-zone-thought-vacuum of Fox News, you have my sympathies.

China to reduce coal consumption?

I've tried to emphasise the importance of relative concepts many times on this blog. However, there are occasions when relative measures can also be more than a little misleading. Case in point: This article from Reuters, which describes how China plans to reduce its coal consumption to 65% of primary energy by 2017.

This policy prescription is primarily motivated by desire to improve the country's terrible air pollution. Of course, a reduction in coal will also bring climate benefits. (I have previously talked about the "co-benefits" of climate policy and local air pollution measures here.)

However, despite being a tentative step in a right direction, this is hardly a watershed moment. In fact, the US Energy Information Agency (EIA) was already forecasting a drop in Chinese coal consumption to 65% of total energy by 2017 (from 69% in 2012) in the reference scenario of its International Energy Outlook, which was published earlier this year.

More importantly, this relative decrease glosses over the fact that the absolute consumption of coal is forecast to increase by nearly 20% over the same period... Up from 79.2 quadrillion Btu in 2012 to an eye-watering 94.1 quad Btu in 2017!

Source: EIA data tool

THOUGHT FOR THE DAY: Be wary of anyone who tells you that China is leading the race in de-carbonising their economy, or winning the battle on renewables for that matter. There may be an element of truth in such statements, but the bigger picture is far more sobering.

How methane emissions could actually be good for the climate

This was the title of a post I wrote last week for the Recon Hub.

It may seem like I am merely trolling for viewer hits here. However, the logic behind this counter-intuitive statement is based on the political factors that shape people's opinion on climate change. (E.g. Rather depressingly, support for the theory of man-made climate change increases when the weather is hotter.)

The other important thing to realise is that methane is a much more powerful greenhouse gas than CO2 over the short-term. Yet, it's potency fades the further we look into the future, whereas CO2 remains in the atmosphere for millennia.

Here's the take-home:

Tying everything together, a move to natural gas might conceivably benefit the long-term climate in two ways. First, there is simply a direct elimination of carbon emissions due to the switching away from coal. This obviously presumes that fugitive methane leakages are not high enough to offset those gains. However, even that runs parallel to a second point which has been the focus of this post: Methane emissions in the present will drive up temperatures (but not over the long-term) in a way that likely encourages political action and hopefully helps to establish a coherent climate policy. 

To conclude, I’d rather see global temperatures follow a concave path over the coming decades, than a convex one. In less technical terms: Accepting an acceleration in near-term temperatures in order to secure the political will necessary to enact long-term climate policy, seems an acceptable trade-off from my perspective.

The more you read about ABCT... the more you read about ABCT

Chris responded last week to my previous post on the empirical (ir?)relevance of ABCT. I've been too busy to reply properly until now. (To be honest, I think that my original points remain intact.) I should also say that neither of us can afford to keep this dialogue going on for much longer. Still, here are some excerpts from his latest post, followed by my comments.

First, on the challenge of trying to distinguish between business processes that are fundamentally short-term in nature versus those of the longer-term:

My dad’s business, for instance, does multiple short-term contracting projects within long-term property development projects. In the normal production structure distribution his irrigation installations would be classified near the consumer level as it sits very close to final consumption, but he prices projects at the outset of long-term investment projects when the developer begins to plan and commence his project. My dad’s business therefore adjusts prices early in the business cycle at the same time that projects more remote of the consumer do, and will continue to price for projects throughout the period of the long-term project.

Unlike Chris' initial post, where he was bemoaning the use of statistical indices, I regard this as a more interesting observation. Yes, it is true that firms with short-term production horizons will in some sense be dependent on the activity of (other) firms with longer-term production horizons. However, I still don't regard this as a decisive barrier to an empirical investigation into ABCT.[*] First note, however, that Chris' objection could be seen as theoretical critique of ABCT as much as an empirical one. For if his remarks hold true, then it is extremely difficult even in principle to distinguish the way in which, say, products closer to the end consumer are made less attractive by a fall in interest rates. The mechanics of the classic (naive?) Hayekian triangle begin to unravel, since the underlying distortions -- the switch into capital goods at the expense of consumption goods during an initial period of credit expansion -- may not even occur in a qualitative sense. Indeed, if processes all along the chain of production benefit from credit expansion then we are closer to a theory of economic growth than of business cycles.

Nevertheless, what really matters in this case is the change in relative prices. If you buy the insights provided by ABCT, then it seems extremely implausible that conditions inherently favourable to long-term production processes could benefit short-term processes to a near (or even greater) extent, merely through the creation of auxiliary demand. This is particularly true if the economy is operating at anywhere near full capacity, as is typically emphasised as the starting point for their analysis by Hayek and Mises... i.e. Any increase in capital goods production must increasingly come at the expense of consumer goods.[**] The focus of Lester and Wolff (2013) was the changing nature of such relative prices. It therefore seems a perfectly valid approach from my perspective and, moreover, the failure of the data to conform to the theory's broad predictions, or show signs of economic/statistical significance, is indeed cause for scepticism of ABCT's relevance. A final point on this matter is that L&W trace the evolution of these relative prices over time, which further accounts for the dynamic shifts between sequential processes in the economy.

Chris also made a few other remarks that I thought were worthy of comment, so here are some brief(ish) observations on other parts of his post:

Of course we have only have had around 5/6 business cycles since 1972 that to my mind can’t produce any statistically significant results either.

Okay, and how many monetary policy interventions have we had in that time? Again, I would think that this reflects rather poorly on a theory that places central bank interventions at the (inevitable) heart of all swings in the business cycle.

ABCT does not claim to be a theory that can explain all observed economic phenomena,which is what Grant thinks it claims to do.

Strawman. I have been very clear -- directly following the paper by L&W -- that this was entirely a question of how relevant ABCT is for explaining observed business cycles in the macroeconomy. Nothing more, nothing less. (Although, one wonders about the usefulness of a theory on business cycles if it seemingly fails to achieve that primary goal.)

On the subject of cycles, here is a beautiful example of circularity:

Let me emphasize that the relevance of the Austrian theory can only increase the more one engages and learns about[...] Austrian theory.

I love this sentence and have re-worked the title of my post in its honour.

On theory versus data:

So to Grant’s point, it is more than just a tendency of Austrians to dismiss empirical ‘evidence’ that runs counter to ABCT and related concepts, because their theories are not built on empirical data but on rigorous logical deduction.

Firstly, I challenge anyone to show me that ABCT follows solely and directly from the action axiom alone. The list of subsidiary axioms and assumptions becomes enormous once we reach the full scope of the theory. This idea of an immaculately conceived business cycle theory, of pure logical cogency and free of any auxiliary pillars is, to be frank, so fanciful that not even the most zealous praxeologist could believe it. More importantly, the "choice" between theory and empirics is a false dichotomy. The above paragraph betrays a misunderstanding of how theory in mainstream economics (or elsewhere) is developed and exactly why it is mutually reinforcing to empirical observation. All economic theory is essentially deductive in nature. You start with some primary axioms or propositions and work through to the implications and consequences. Yet, how do we arbitrate between competing theories or measure their importance? Well, the same way that we do for any scientific field; we test them using data from the real world. Rejection of empirical scrutiny, validation and testing means that we are no longer debating economics or any kind of science for that matter. We are now in the realm of religion.

Chris ends his post in decidedly Churchillian mode:

But Grant should know, in our professions as economists and in the practice of economic forecasting, we are continuously, nay, every week, refining and enhancing our forecasting methods and theories based on what’s available and recent experience. Economic theory and economic forecasting are, of course, very different things.

Typing up that final paragraph must have been difficult whilst holding a bowler hat over his breast and staring defiantly into the distance. Just kidding, bud. I agree with the sentiments here. I ask only that theory shape our forecasting efforts and that we avail ourselves of the opportunity to reconsider these theories when the facts do not match the predictions.

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[*] As a technical point, there is also some confusion about data classification in the above paragraph. The PPI stage-of-process data is classified by commodities, not firms. Chris' dad's business -- hi Len! -- could therefore have goods classified in various stage-of-process categories, depending on where and who the end consumer was.

[**] This is analogous to an argument made by Tyler Cowen on the co-movement of investment and consumption over the business cycle. See pp. 8-9 of Daniel Kuehn's paper on the Hayekian version of ABCT, which I also mentioned in my previous post.

Empirical evidence and the relevance of ABCT

A new study by Lester and Wolff (2013), hereafter L&W,  is set to cause a bit of a stir in Austrian circles. [HT: Daniel Kuehn]

The paper, which was published in the Review of Austrian Economics no less, finds that Austrian Business Cycle Theory (ABCT ) is not particularly relevant from an empirical standpoint. In short: The unique predictions made by ABCT, concerning the relative price and output changes of goods in different stages of production, are not borne out by the data. It is therefore very difficult to argue that such dynamics are driving the business cycle of the macroeconomy.

I've read through the paper and think that it is a very thorough and technically sound piece of analysis. More importantly, it fills a gap in the literature by using good data to ask the right questions. The conclusion closely matches my own view on ABCT, which is that it constitutes an internally consistent framework for the most part, yet has limited relevance as an overarching macro theory. (That said, L&W also acknowledge that Austrians emphasise a number of concepts, from the coordinating role of market prices and the inter-temporal allocation of resources, that are very valuable to broader economics. Mainstream macro is certainly richer for incorporating these insights.)

Arguing with Austrian-types is something of a side hobby for yours truly and I sent a copy of the paper to Chris Becker, my friend since school days and staunch proponent of all things ABCT. He has written a thoughtful blog post on what he sees are the "flaws and shortcomings" of the study. However, I am not persuaded by his arguments.

Chris starts out by calling into question the various data and metrics used by L&W. For instance, he says that PPI is "only a proxy" for actual economic activity and market prices as "no statistical measure is 100% accurate". Wait a minute, that is simply a tautology. Statistics are by definition imperfect representations of the true state of nature based on probabilistic laws and frequency distributions. To claim that this invalidates their use in scientific research is to a) betray a misunderstanding of how statistics actually works and b) discard a great majority of scientific discoveries and technological advancements since before even the Enlightenment. All that really matters in this case is that these indexes constitute accurate representations of the underlying variables and populations that they refer to. I see no reason to think that they are biased in a manner that systematically renders them uninformative (or misleading) -- particularly if the proposed dynamics were truly the main drivers of large swings in economic activity. I should also say that Chris' objections here would strike me as more convincing if I didn't see Austrians constantly referring to PPI, money supply data, etc. in support of their own arguments.

Next, Chris walks through the various monetary policy variables used in the study and what he perceives as their shortcomings. For the record, L&W use the Federal Funds Rate (FRR) as their main monetary policy variable, while a number of other metrics (M0, M1, M2, etc ) are utilized for robustness checks. In each case, these various monetary policy variables return the same broad set of results that ultimately fail to find vindication for ABCT. (That's the point of running robustness checks after all; they should produce results that are consistent with each other.) Chris does seem to agree with L&W in regarding the FFR as the most appropriate variable to proxy for changes in monetary policy. He even writes: "It is instructive that distortions of the FFR provide the most significant response in favour of ABCT, as it is the divergence between this interest rate and the natural rate of interest that sets in motion the business cycle, according to the Mises-Hayek theory." Except it isn't really instructive at all, because even if some of the coefficients have the same sign as predicted by the theory, they are almost uniformly insignificant from an economic and statistical perspective! L&W are very clear about this and make the point several times throughout their paper. For example (and with emphasis added):

It is critical to note that the results lack statistical significance. In each IRF [Impulse Response Function], the 80 % confidence interval bands suggest that none of the four IRFs demonstrate impact or dynamic responses which differ significantly from zero for more than a few months. This point is particularly relevant when ABCT would otherwise rely on the large shifts in capital to drive business cycle dynamics. 

Once again, we are trying to discern whether ABCT is a plausible candidate for explaining the business cycle at large. According to this evidence, that doesn't appear to be the case.

Chris continues his discussion on monetary policy variables by describing ways in which they may or may not be directly relevant to ABCT, and how the theory can ostensibly accommodate findings that run counter to predictions made by the standard ABCT model. I won't go into too deeply into these issues except to say that I think he runs dangerously close to describing ABCT in pseudoscientific terms. As Popper correctly pointed out many years ago, a theory which claims its strength is to account for any possible outcome is no real scientific theory at all. On the flipside, to say that there are other factors that mitigate how the dynamics of ABCT play out in the economy, is tantamount to admitting that it has limited relevance for explaining observed economic phenomena! (Further, given that the dataset runs from 1972 to 2011 and the empirical analysis tracks variables over a 60-month period following a policy shock, I personally don't think that appealing to "credit injection points" and "historical contingencies" holds much water.)

The post ends with a helpful (ahem) reading list. I have taken the liberty of noting down the respective page numbers for each of the books that Chris recommends: "To really understand ABCT, one should read Ludwig von Mises’ “Human Action” [924 pages] , Friedrich von Hayek’s “Prices and Production” [594 pages], Murray Rothbard’s “Man, Economy, and State” [1,441 pages], and Jesus Huerta de Soto’s “Money, Bank Credit, and Economic Cycles.” [777 pages]". Now, I know that people like to make fun of some Austrians for inevitably referring them to incredibly lengthy treatises during internet debates (often in lieu of making actual arguments). I don't usually think of my friend as falling into that category, but come on... 3,736 pages! If that's what it takes to truly understand ABCT, then I sincerely doubt that anyone has a coherent grip on it.

Allow me to conclude by making two general observations:

1) I may be wrong, but I can't quite escape the feeling that econometrics is seen by many as the preserve of academics and government. That couldn't be further from the truth. Econometrics and statistical analysis has been fundamental to virtually every private company and industry that I have ever worked in, with or am aware of... from the energy sector to finance to consulting to media. If empirical methods were truly misleading, then surely the evolutionary dynamics of the market would have brought about their demise long ago?

2) As with any scientific field or theory, no single study -- no matter how well done -- is enough to invalidate an entire research programme. Similarly, I am hardly claiming that econometrics and empirical studies are infallible. (In addition to discussing the vexing problems of identification many times on this blog, I have also argued that theory and data are mutually reinforcing so that one acts as a check on the other.) However, I do wonder what evidence would be sufficient for Austrians to reconsider their theories. I detect a remarkable tendency to dismiss any empirical evidence that runs counter to ABCT and its related concepts. It should be said that all major schools of economic thought have had to face up to the challenges presented by the data... And are better for it. Keynesians made significant adjustments to their theories in the face of 1970's stagflation, as well as the intellectual challenges of the Lucas Critique and microfoundations movement. For their part, recent events have forced Monetarists to confront the limitations of Friedman's quantity of money supply rule and the potential ineffectiveness of monetary policy at the zero lower bound. Theory cannot advance if it is impervious to data.

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PS - An ungated version of the L&W paper can be downloaded here.

PPS - Those interested in this subject should also read Daniel's excellent overview of Hayek's version of ABCT, which I believe is forthcoming in Critical Review.

Advocacy and climate research

The latest furore to erupt in the climate blogosphere concerns whether climate scientists undermine their credibility by engaging in advocacy? (For some responses, see James Annan, Gretchen Goldman and HB&H.)

As it happens, I recently wrote a term-paper on this exact issue for my philosophy of science class. I've decided to make it available here for those who are interested in this debate!

To summarise, I don't see anything inherently wrong with scientists engaging in political advocacy, as long as they are explicit in their intentions... and the scope of their expertise. (E.g. I often see physical scientists make strong pronouncements about economic matters and that makes me uncomfortable.) One climate scientist whom I feel always struck a good balance on these issues and quote in my term-paper is the late Stephen Schneider. To channel Schneider: Our response to climate change must be underpinned by scientific facts, but it should ultimately also be reflective of society's value judgements -- including those of our scientists.

Some brief points/caveats:

• This was a “pass/fail” essay, aimed at gaining admission to sit the exam, and I hope that you’ll evaluate the material accordingly. That said, the emphasis on citations and quotations probably means that it provides a good overview of the issues.
• Apart from scientists working on the physical basis for climate change, I also tried to pay special attention to the role of economists. The Stern Review, which many people regard as the archetypal blend of economics and advocacy, therefore comes in for special attention.

Click to read the term-paper.

UPDATE: I've just finished listening to a very interesting discussion between the climate scientists, Gavin Schmidt, Richard Betts and Judith Curry, on this precise topic. I am again struck by something that was very clear to me whilst researching my essay: The various sides all seem to agree on the principles (i.e. being open about one’s area of expertise and clear on your value judgements when advocating for policy). The real sticking point appears to be one of application.

July playlist

My fellow Noondaytune.com contributors have outdone themselves with some very cool song choices during the month of July. I say this with some authority as it was my turn to go through them and select eight favourite tracks for an end-of-the-month playlist. Here it is!

Noonday Tune - Volume 2: Twelve from Noonday Tune on 8tracks Radio.

(In addition to the opening track of the above playlist, my own recent contributions include Nick Cave & The Bad Seeds and Mikhael Paskalev.)

Inflation-targeting, CPI measures and the poor

In a bid to get back to regular blogging, below is a comment that I've just left under a Daily Maverick column by Paul Berkowitz, entitled "Who benefits from inflation-targeting?" It includes the following provocative graph on the relative inflation levels faced by different consumer groups in South Africa.

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There are a number of legitimate reasons to critique an inflation-targeting regime. Further, the relatively high inflation burden felt by poorer segments of society certainly merits attention in of itself. That said, there are some persistent misconceptions among the public about inflation-targeting: What are its goals and what are the (theoretical) mechanisms by which these are achieved -- particularly w.r.t. a central bank's chosen CPI measure? My gripe with this article is that it may perpetuate such misconceptions by failing to acknowledge an important principle of inflation-targeting.

Rather than simply being an end in of itself, an inflation target is also seen as a means of stabilising the output gap (and ultimately smoothing of the business cycle). Theoretical justification for this so-call "divine coincidence" -- which implies no trade-off between the twin goals of stabilising inflation and maintaining optimal economic output -- is derived from the standard new Keynesian DSGE models favoured by a large segment of macroeconomists. See Blanchard and Gali (2005), or as Blanchard has written elsewhere:

This is a really important result. It implies that central banks should indeed focus just on inflation, and can sleep well at night. If they succeed in stabilizing inflation, they will automatically generate the optimal level of activity. (p. 3)

The upshot is that, if we are going to criticize the representativeness of headline CPI for all income groups, then we should at least acknowledge it's (intended) wider role in stabilising the output gap. (The CPI basket is chosen, after all, because it corresponds to average purchases within the economy as a whole.) You can certainly argue about the conditions under which "the divine coincidence" is satisfied, as well the theoretical underpinnings of the DSGE models. However, closing the output gap is probably very much in the poor's interest as well.

On a final and related note, there are severe drawbacks to the SARB targeting a predominantly commodities-based basket that would more closely accord with the average purchases of low-income families. Most obviously, the SARB is more or less powerless to control the inherent volatility of commodity groups, not to mention the potential for causing very counterproductive amplifications in the consumption cycle. (See here, esp. end of point 4.)

Personal note

I'm not normally one for broadcasting personal information and relationship updates on social media, but, hey, this a big one.

Very pleased, then, to say that I am recently returned from a trip to Veneto, Italy, engaged to the beautiful Miss LB. (Soon to be Mrs LM, although a rose by any other name...)

My five-year charm offensive has obviously paid dividends. 

Finally. 

In other news, Daniel Kuehn was kind enough to remind me on Facebook that I shouldn't make the mistake of thinking that my probation period is now over... Sage advice.

Music updates

My latest contributions to Noondaytune are a mix of classic rock and Nordic lo-fi (complete with a youth choir). Something for everyone!

1) Crosby, Stills, Nash & Young - "Almost Cut My Hair"

2) Mr Little Jeans - "Oh Sailor"