Monday, April 29, 2013

How to think like Eric Falkenstein

I've become less enamored with trying to change opinions, because ideas need a zeitgeist, and if that's not fertile nothing you say will matter. . . . I don't see lot of value to being an advocate, though I know someone needs to sit down and write thoughtful things to counteract all the instinctive first-order solutions people think are great ideas (poor? give them money!). The problem is that it's hard not to become a partisan hack if you write too much, to pick on the other side's worst arguments, which regardless of what side you are on, will be indefensible and so prove nothing.

The original post is here. This, along with the fact that the number of political opinions I have has been on a steady decline, is why I don't post about politics anymore.

Friday, April 26, 2013

Inside the GDP sausage factory

Image source

It's useful to be aware of the difficulty of measuring the US economy. Those interested in today's advance GDP report might do well to look through this, a handbook about the concepts and methods behind US income and product accounting. GDP estimates are constructed from a combination of many datasets, most of which are produced by the Census Bureau but some of which come from BLS, BEA, the Department of Agriculture, Treasury, IRS, OMB, and state governments. Putting everything together is quite a task. "The source data available to BEA are not always ideal for the preparation of the NIPAs" (3-2).

The most reliable GDP estimates are based on the Economic Census, which occurs every five years. Between censuses, statisticians must rely on surveys that have sampling properties chosen based on, well, the most recent Economic Census (and the Business Register, which forms the backbone of many business datasets). Advance estimates are basically built entirely on survey data.

Today we see the advance estimate for 2013Q1 GDP. Here's what the handbook says:

For most of the product-side components, the [advance] estimate is based on source data for either 2 or 3 months of the quarter. In most cases, however, the source data for the second and third months of the quarter are subject to revision by the issuing agencies. Where source data are not available, the estimate is based primarily on BEA projections. (3-7)

The components for which only 2 months of data are typically available include several categories of construction, inventories, exports, and imports. Missing data have to be filled in somehow, and the solution will probably be something based on trends--so it may sometimes be difficult for advance estimates to catch turning points. Also, a rough rule of thumb might be that data frequency and data quality are negatively related (not to mention that survey quality may decline as time since the last Economic Census increases). In short, advance estimates require a lot of guesswork.

And this is to say nothing of the microdata. Survey microdata can be pretty nasty.

The people at BEA have a pretty tough job. It is therefore not surprising that GDP sometimes receives pretty big revisions. Advance data should probably be taken with a grain of salt.

Monday, April 22, 2013

Reinhart/Rogoff and policy outcomes: Let's be careful about drawing causal inference

By now everyone knows about the Great Reinhart and Rogoff Implosion of 2013. If you don't, read this. What has most amused me is that many journalists seem to think that the R&R 90% threshold had a nontrivial, causal impact on US fiscal policy. Consider the following headlines:
One journalist, Tim Fernholz, set out to answer the question, "How influential was the Rogoff-Reinhart study warning that high debt kills growth?" (here). But he does not answer that question, at least if "influence" is meant to refer to policy outcomes. The question he does answer is, "Are there examples of policymakers citing R&R in support of fiscal restraint?" The answer to that question, as Fernholz shows, is "yes." Fair enough.

If we operate from the assumption that policymakers are highly amenable to evidence; and if we further assume that a descriptive (not causal) result from a single empirical study is enough to drive a policymaker's decisions, then maybe a story about policymakers discussing R&R is enough to show that it influenced actual policies. But I think those are bad assumptions. Here's my Twitter conversation with Fernholz:

First off, he's a nice guy--some journalists don't respond to critical Twitter questions from nobodies. As I understand it, Fernholz believes that R&R90% affected the opinions of marginal, outcome-influencing lawmakers enough to change their vote. There is a counterfactual world in which R&R did the work more acceptably and fiscal policy outcomes in the United States are more accommodative.

Call me skeptical. Chalk it up to my cynicism about the degree to which politicians care about evidence. In any case, if they cared that much about evidence, they might have asked someone whether the R&R90% result could reasonably have been considered to be a causal point estimate. I think any responsible "wonk" would have told them they need more data and theory before changing their mind. In any case, the fact that a few policymakers, like Paul Ryan, mentioned R&R90% in support of their policy preferences is not sufficient evidence that the result drove policy. It's just as likely--some might say more likely--that policymakers have preexisting preferences about policy which they justify by grabbing whatever research results seem to support them.

This is slightly ironic since a reasonable criticism of R&R90% before we knew it was bogus was that there was no causal story and no attempt to tease one out of the data. We have to be careful about touting descriptive results as causal. Let's apply that standard to our attempts to blame Reinhart and Rogoff for whatever fiscal policies happened that we don't like.

Bottom line: If this matters, I think a really useful thing for a journalist to do would be to back up assertions of a causal chain from R&R90% to US fiscal policy outcomes with a story about the lawmakers who had the marginal vote and were swayed by the research. Fernholz seems to have a headstart since he already knows of some legislators who were swayed by the R&R claims.

Tuesday, April 16, 2013

The housing crisis was regional

I think a lot of people sometimes think of housing as a national market. It is, in some ways. But different regions experienced substantially different house price dynamics prior to and during the Great Recession.

Figure 1 plots the FHFA house price index for North Dakota (click for larger image). Observe that this state experienced no housing bust. Several other states (DC, Oklahoma, Texas, and West Virginia) experienced more of a plateau than a decline, though they still show a slight peak and trough pattern.

Figure 1

Among states that did experience declines in house prices, there is some heterogeneity in the timing of peak and trough as well as the depth of the decline. Figure 2 shows the distribution of states over peak timing; each bar indicates how many state housing markets peaked during the indicated quarter (click for larger image). I include all states but North Dakota.

Figure 2

Observe that most states peaked in the middle of 2007; interestingly, the national Case-Shiller index peaked in early 2006. The states peaking in 2006 include Nevada, Arizona, California, and Florida--the "sand states" that experienced the largest booms and busts led the national market by a year.

Figure 3 shows the distribution of states over trough timing--the timing of the state housing bottom (click for larger image). The data end in 2012q4, so some states may still fall further; but observe that no states were at a bottom at the end of the sample.

Figure 3

Many states bottomed in early 2011, and most of the rest bottomed a year later.

The biggest differences among states were the depth of the housing market decline. Figure 4 shows peak-to-trough house price declines as a percent of the index peak, where peak and trough are defined state by state (click for larger image).

Figure 4

By the FHFA index, Nevada saw a stunning 60 percent decline in house prices, with the other sand states not far behind at around 50 percent. On the other hand, thirteen states experienced declines of less than 10 percent.

The housing collapse was a few states--accounting for a nontrivial portion of the national housing market--beginning to dive in mid-2006, with most other states following a full year later. The early states saw the largest price declines. The price collapse ended for most states in 2011, with real growth just now starting to return. This variation in both the timing and the depth of the crisis is a reminder that housing markets are regional, but the fact that nearly every state experienced some degree of decline is telling.

Thursday, April 11, 2013

Why do Bitcoins have market value?

This is not a "Bitcoin is a bubble" post, nor is it a "Bitcoin is not a bubble" post.

Why does currency have value? The main reason seems to be that money solves the “double coincidence of wants” problem--barter is tricky since I want what you have but you don’t want what I have, so money is useful. We have a large literature that explores this. We also have a lot of models that implement money in a more reduced-form way: money in utility (i.e., people get happiness just from knowing that they have some green pieces of paper under their pillow), cash-in-advance constraints (i.e., there is a law of the universe that stipulates that a certain currency must be used to buy certain goods), shopping time, etc.

How would we go about incorporating Bitcoins into one of our workhorse models?

I think it’s a worthwhile question--for people who think talking about Bitcoins is worthwhile. A nice thing about Bitcoins is that we only have to think about money demand; the supply path is deterministic.

The reduced-form approach would be simple. We clearly can’t put all goods in a Bitcoin cash-in-advance (CIA) constraint because most goods can be bought with other currencies (and most goods can only be bought with currencies other than Bitcoin). But I think, for now, we can put a select few goods in a Bitcoin CIA constraint--the illegal or otherwise taboo goods we keep hearing about.* If this were the only friction associated with Bitcoins, we would expect a few people to hold a few Bitcoins (relative to total currency holdings). I suspect that we wouldn’t see the kind of volume and value we are currently seeing on the Bitcoin exchanges.

Suppose we put money in the utility function (MIU). We know that, on its own, this tends to produce results that look pretty similar to a CIA constraint. But suppose we use it in addition to the taboo goods CIA constraint. Whether this further boosts the equilibrium value of Bitcoins depends on the weight of Bitcoins in utility; if the weight is small, having enough Bitcoins to satisfy the CIA constraint will already be enough. If the weight is large, we get a few more people holding a few more Bitcoins. With something as novel and hyped as Bitcoins, there are some people who get utility just from being able to say that they own some. We can include the people who like Bitcoins simply because they’re not printed by government in here, too.

So, now do we have enough money demand to explain what we see on the exchanges? Maybe, but I don’t think so.

Are we missing something by being too reduced form? We can go a bit deeper with “turnpike” or search-and-matching models, but I don’t see them giving us a lot of mileage beyond what we’re getting from CIA. Are there any buyers and sellers of regular goods that are having trouble transacting due to thin market problems or failure to achieve a double coincidence of wants with the currencies they already have? I don’t think so. The truth is that Bitcoins only do a handful of things for us that cannot be done by other currencies.

Where am I going with this? Obviously I’m not saying anything that everyone doesn’t already know. I’m just thinking aloud. The difference between the market value of Bitcoins and the value we’d expect to see if there were only the CIA constraint and a bit of MIU going on can probably be roughly attributed to speculation.

But... speculation about what? Do Bitcoin holders anticipate that, in the future, more goods will be subject to a Bitcoin CIA? Do they think that more people will get utility from Bitcoins in the future? I don’t think either outcome is very plausible. Simply getting more businesses to accept Bitcoins in addition to dollars will only make Bitcoins more valuable (relative to dollars) if Bitcoin transaction costs are far lower than dollar transaction costs. The problem is that the cost of electronic transactions with dollars keeps falling. And the MIU factor will wear off as the hype recedes (though I admit that I thought we were close to peak Bitcoin hype two years ago; it could last awhile). Also, Uncle Sam.

A lot of the speculation is driven by multiple equilibria stuff--people think Bitcoin has value because people think Bitcoin has value, and some people think that, in the future, even more people think Bitcoin will have value. But multiple equilibria are pretty tricky and unpredictable things.

By the way, we could replace the word “Bitcoins” with “gold” and change “illegal goods” to “jewelry and dental implants,” and all the above analysis would hold up pretty well.

I’m not a pundit, so I’m not making a prediction about the future value of Bitcoin. I’m not saying it’s a “bubble” in the sense usually meant by journalists and bloggers who are always calling everything a bubble because they think current values are “too high” and a crash is inevitable. Going around calling things "bubbles" and making big price predictions is a fool's errand (and risks drawing the scorn of Scott Sumner). Bitcoin almost certainly is a bubble according to certain technical definitions; in some definitions, all currencies are bubbles (not to mention subject to multiple equilibria). But it may not be the kind of bubble that is guaranteed to “pop” eventually. Who knows? Nobody, and me least of all. I don’t have a prior about whether Bitcoins will be worth $1000 or $0 in a year. In fact, neither will surprise me (but both will be entertaining).

But I think it’s worth thinking about the sources of Bitcoin value.

*This doesn’t actually ensure value for Bitcoins, but it may mean that there is a high probability that some crypto currency can have value.