Ed Leamer on Macroeconomic Patterns and Stories
May 4 2009

Ed Leamer, of UCLA and author of Macroeconomic Patterns and Stories, talks with EconTalk host Russ Roberts about how we should use patterns in macroeconomic data and stories about those patterns to improve our understanding of the economy. Leamer argues that economics is not a science, but rather a way of thinking, and that economic models are neither true nor false, but either useful or not useful. He discusses various patterns in the recessions and recoveries in the United States since 1950. The conversation closes with a discussion of the reliability of econometric analysis.

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Ed Leamer of UCLA talks with EconTalk host Russ Roberts about the state of econometrics. He discusses his 1983 article, "Let's Take the 'Con' Out of Econometrics" and the recent interest in natural experiments as a way to improve empirical...
Edmund Phelps on Unemployment and the State of Macroeconomics
Nobel Laureate Edmund Phelps of Columbia University talks with EconTalk host Russ Roberts about the market for labor, unemployment, and the evolution of macroeconomics over the past century. The conversation begins with a discussion of Phelps's early contributions to the...
Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


May 4 2009 at 9:41am

Great podcast at points it reminded me of something that George Selgin said in the podcast that you did with him. He said that keeping spending level rather than keeping prices level is what is needed to keep unemployment down. When he said it was just said and it was not elaborated on or examined but I thought at the time yeah that would explain a lot. The implication would be that the Federal Reserve is targeting the wrong thing.

David Chester
May 5 2009 at 2:41am

Macroeconomics is an exact science only it has to be expressed in terms that behave in exact ways. The trick here is to replace individuals whose various economic activities are undefined with a set of functions performed by sterio-typed entities whose functions are specific. This is analogous to perfect gas theory (physics) when the real gas contains molecules each of which has its particular behaviour but on aggregate all have a few related properties.

I have managed to express the macroeconomic motley in this simplified form and it is useful for understanding how the systerm actually works. My incomplete book on this subject is 150 pages long and contains some mathematics. Any interest?

May 5 2009 at 7:32am

Hi, David.

Human beings and gas molecules behave differently in an important way when it comes to modeling them. Humans engage in introspection, learning, and feedback that affects their behavior differently each time it is repeated. Attempts to model that subtlety as if it is an engineering project or as if it is an exact science are not only difficult, but have repeatedly failed.

Gas molecules don’t say to themselves: “Hmmm. There is a model of my behavior suggesting that I expand too much under certain extreme circumstances. So, next time I start expanding this rapidly, let me try something different.”

Gas molecules don’t learn from their past behavior: “Hmmm. Last time I expanded this rapidly, I personally got creamed when the expansion got out of control and even collapsed in on itself. So, this time, let me try something entirely new to protect myself.”

I suspect that in your 150 pages you’ve done a creditable job of describing past macroeconomics, classifying some of the basic categories of spending that macroeconomics has historically focused on. But, I also suspect you have not managed to express these ever-changing learning and feedback loops better than tens of thousands of economists attempted during the 1950s-1970s, including very sophisticated multi-equation probabilistic, feedback-loop oriented models in the U.S.S.R. and the U.S.

All those sophisticated models failed as science. They failed to be able to predict the onset of new events or the evolution of the economy after unusual new events. The ultimate test of a scientific model is its ability to make predictions and be tested against the data. Every equation-oriented macro model has failed to be able to make predictions that even remotely match actual events.

Markets for individual, specific goods or small groups of goods do exhibit enough consistency to be modeled reliably and scientifically. That is, microeconomics has a long and reliable history as a science. But even in microeconomics, big changes to individual goods markets are typically not predictable, and neither are the responses. What fails even more resoundingly and repeatedly is the attempt to aggregate large groups of markets over long periods of time with a goal of predicting swings in “the economy” as a whole. All the small corrections add up in ways that are too complex to model, particularly in extreme circumstances.

Leamer’s podcast is about going back to the data to see what we can glean and what we have missed. It is not easy to argue that macroeconomics is an exact science–because it’s not.

May 5 2009 at 2:02pm

Leamer’s tortured logic: Ed argues Bernanke and Paulson went to congress and asked for TARP, threatening economic downturn if nothing was done, this scared people and caused an economic downturn:

Bernanke-Paulson -> Congress -> Economic Downturn

Isn’t it more likely that Bernanke Paulson went to congress very afraid because an economic downturn was evident. Bear had collapsed, Lehman had no hope, and several other banks were failing. Perhaps it should be:

Economic Downturn -> B-P -> Congress

I think this is quite a testable hypothesis. If fear and google searches caused the downturn, then other countries should not be experiencing a downturn or experiencing much more mild downturns. Since they did not have Bernanke/Paulson scaring them, of course, a quick look around the world shows that is false.

May 5 2009 at 4:14pm


Leamer stated that Bernanke and Paulson freaked out over the possibility of bank insolvency and then went to congress insinuating that it could lead to a great depression unless TARP was passed. This led to panic in the markets, which led to economic downturn.

Threat of Bank Failure -> B/P -> Congress/Tarp -> Economic Downturn.

Seems quite logical to me.

As Russ pointed out, it seemed to be reaction to political policy that led to making an already bad situation very much worse. Perhaps on a future podcast Russ can have a guest willing to explore why people seem to have lost their confidence in free markets rather than the in the political policies that were the real culprits in the incorrect way that they were implemented.

Russ Roberts
May 5 2009 at 4:21pm


I don’t know if Leamer is right. But alas, your test is not much of a test. The rest of the world pays a lot of attention to the US economy and what Bernanke and Paulson were saying.

Having said that, I doubt that Leamer is simply doing some ex-post storytelling with nothing else to support his claim. There is evidence that the downturn came from the housing sector rather than the financial sector. I’ve seen it from Leamer and I’ve seen it from mainstream macro types. Is it convincing? It’s suggestive, not iron-clad. I’ll try to find a link to it.

May 5 2009 at 6:31pm

Professor Roberts,
I enjoyed the podcast —as I do almost all— but must disagree specifically with Professor Leamer’s ex-post comments regarding the Lehman bankruptcy; I say this respectfully from the viewpoint of a practitioner —someone who was and continues to be involved with the credit markets. By most measures, be it the oft mentioned TED Spread or the more useful LIBOR-OIS spread, it is understood that market participants woefully underestimated risk (both in terms of credit and liquidity) prior to the 2007 Credit Crisis. As any of your listeners can find out by reviewing a time-series, the spreads were in the range of 8-10 basis points at the beginning of 2007 and crested to just under 1% at about the time of Northern Rock Building Society —otherwise known as a mortgage lender in the US— collapse in the United Kingdom. This was the opening salvo to the large writedowns that were to follow; the Bear Stearns collapse in March 2008; the Lehman bankruptcy; and the massive bail-outs of the British and European banks in mid-October 2008.

I just wish to stress that ex-ante, credit market participants —liquidity and funding dealing desks on the sell-side or treasury desks on the buy side— were prepared for Lehman stock to go to zero or close to it. However, implicit in their forecasts was the notion that a takeover would be brokered by the dynamic duo: Paulson and Bernanke. This did not happen and we know why in retrospect: a number of institutions took a look at their books and walked away and Paulson —as a Glodman Sachs alum— was reticent in helping a ‘rival’ institution. As for the degree of counterparty risk? This must not be summarily dismissed. Lehman Brothers and Bear Stearns were primarily fixed income shops. This translated to derivatives exposure, and specifically OTC derivatives. Any financial institution with an international footprint had significant exposure to Lehman —often in the billions of dollars. Hopefully, the aftermath of the 2008 Financial Crisis has taught us that the concept of risk mitigation though securitization and counterparty relationships should be relegated to the dustbin of Financial Economic History. In the meantime, we can look back and see that only now have spreads returned to the level last seen just prior to the Lehman bankruptcy. Count me amongst the number who would welcome clearing houses for OTC derivative contracts. IN my opinion, there are too many participants who either do not understand or have underestimated the risk and nature of their derivatives exposure.

May 6 2009 at 10:15am

Gas molecules don’t say to themselves: “Hmmm. There is a model of my behavior suggesting that I expand too much under certain extreme circumstances. So, next time I start expanding this rapidly, let me try something different.”

Of course my understanding is that much of modern physics focuses on how something behaves differently when it is observed than when it is not.

Gas molecules don’t learn from their past behavior: “Hmmm. Last time I expanded this rapidly, I personally got creamed when the expansion got out of control and even collapsed in on itself. So, this time, let me try something entirely new to protect myself.”

John Maynard Smith discussed the place of learning rules in his Evolution and the Theory of Games. Suffice to say that human learning did not emerge in a vacuum; it has evolutionary origins and therefore can be analyzed the same way we analyze the behavior of any biological creature.

Unless you want to argue that evolutionary biology is not a science, or that human beings are in some way different from other biological creatures. I admit that the fact that the scientist is what he studies does contaminate the experiment; many of the problems of the social sciences comes from scholars who leave themselves out of the picture, as though they were an objective observer from Mars.

I think the problem with the macroeconomic models stems less from the inherent unscience of studying humans, and more to do with the fact that macroeconomists have simply been very bad at asking the right questions.

May 6 2009 at 10:56am

Good points, Adam.

Unless you want to argue that evolutionary biology is not a science, or that human beings are in some way different from other biological creatures.

Nah, I wasn’t arguing that. I was just arguing that humans are a little more advanced than gas molecules on the evolutionary scale. 🙂

I agree with you that it’s important to ask the right questions. I also think, though, that even the right questions may not be addressable with the particular kinds of data we as economists can hope to collect. That means that our current confidence in the predictive power of our models isn’t well-measured by 95% confidence intervals the way it would be were economics an exact science. A lot of the time economists are closer than they want to admit to Leamer’s third category of “We don’t know.”

May 6 2009 at 11:18am


Thanks, and I concur. I agree with you completely, adding only that I think the ability to say “we don’t know” is an admirable trait for any scientist (or indeed, anyone) talking about any subject. That for even the hardest of “hard” sciences it’s often our ability to refine the questions we ask that we excel at, while our ability to provide conclusive answers to even the best of questions is very limited.

Which is why I liked the passing remark that Leamer made early in the podcast when he said “I don’t think scientists do science”; because I think he may have had something similar in mind. But I could be reading too much into it.

May 6 2009 at 12:16pm

Is it just me or is Leamer’s talk about expanding and contracting military spending leading to prosperity or recessions pretty close to Keynesian ideas along with Leamer’s other ideas about needing to restore aggregate demand on ‘main street’.

I’m not as anti-Keynesian as I think many here are and I’m surprised that no one has touched on that.

I think the Bernanke-Paulson issue is an interesting one. Obviously they have a strong influence on the economy, exactly how much is hard to measure. Saying B&P destroyed confidence is an interesting issue because even if they did that doesn’t really explain whether they were justified in doing so or not. For example its possible that we were headed towards a massive de-leveraging and B&P made it worse by talking about it… in which case they should have in public ignored what they were fully aware was going to happen, not exactly the easiest thing to do.

Also losses in confidence are none-the-less real factors in an economy. If investors loose confidence whether justified or not (rational or not) it has a similar effect and therefore becomes rational in a way. It would be irrational to ignore confidence.

May 6 2009 at 3:37pm

Fantastic podcase. Thank you Russ.

I have a comment and a couple of questions, however.

My comment has to do with the “Did WWII get us out of the depression?” debate. Having read or listened to both sides of the argument, it seems to me (a non-economist) that, at least insofar as the basic story is concerned, there is more agreement than disagreement on the basic facts. As a matter of historical record, I don’t think it can be argued that WWII helped end the depression, at least in one sense — it put people back to work. Looked at strictly as a jobs program, both the ramp up to and the war itself were successful. But, as Higgs and Russ have pointed out, the drop in the unemployment level does not tell the whole story. I find their point well taken that the jobs were, for the most part, undesirable and war time rationing inhibited consumer spending. One does not need to consult a history book to conclude that the war years were not a time of great consumer satisfaction and growth. The issue then, is not whether WWII got us out of the depression. It is, rather, more general. Does WWII prove the point that large scale government spending is a good remedy for economic downturns?

While I am generally sympathetic to the argument that government spending can help, I find the argument that “WWII got us out the depression” somewhat wanting. It seems to me that the advocates of this position miss some important points. First — someone correct me if I’m wrong — most of the money borrowed to fund the war came from the pockets of US citizens. When the war ended the US had a high savings rate that, when combined with pentup consumer demand, helped stimulate(or at least contribute to) the post-war economic boom. Returning with a positive net worth, many GI’s got married and had babies — a sure recipe, I would think, for economic recovery.

These factors are missing today. Americans have a low savings rate. Their ability to consume, moreover, has not been inhibited over the past several years; if anything it has been artificially stimulated by easy credit. Second, a large portion of our national debt is owed to foreigners. I don’t think that foreign debt is bad per se, but I doubt that China and the oil states are going to spend their savings in the same manner as the WWII generation. Foreign savings may or may not be used to stimulate the American economy. Third, there is a surplus of housing and durable consumer goods. In light of these facts, I think one should be cautious before accepting the argument that government spending — particularly deficit spending — will work in the long run to get us out of the current downturn. It might, but I don’t think the Depression/WWII example provides much support for the argument.

Now for my questions. First, does it matter who holds our debt? In other words, in pondering whether the current stimulus plan will work, should we consider the fact that it will be funded largely by foreigners, rather than American citizens? My second question involves a hypothetical and is addressed to those who are opposed to the stimulus plan. Would your position change if you were advising the Chinese government? The last figure I read indicates that the Chinese hold almost 2 trillion dollars in foreign reserves, two-thirds of which are believed to be in American securities. Would it make sense in that case for the Chinese government to use some of that money for development and to counteract the effects of the global downturn on their economy?

If anyone has any thoughts on my comment or questions, I would appreciate a response.



May 6 2009 at 3:41pm

AH Britton:

With regard to Leamer’s comments regarding military spending, I noticed the same thing. There is a word for it — military Keynesianism. Writers like Chalmers Johnson and Noam Chomskey have used the term for years.

Lee Kelly
May 7 2009 at 1:45pm

Sometimes Leamer seems to make sense. But then he says something so shockingly ignorant (such as his comment about the “fundamental” problem of two-valued logic), that I am inclined to dismiss everything else he says on matters which I am not so familiar with. It’s such a fundamental error of reasoning, that the rest of his reasoning is immediately suspect in my opinion.

I am continually astounded at just how poorly economists grasp basic logic, and all the while often being perfectly competent mathematicians.

May 7 2009 at 2:36pm


You should listen to the podcast that featured Steve Fazzari:


This gives an ideal Keynesian view from Fazzari on stumulus, with Hayekian counterpoints by Russ.

So far as stimulus working in order to reverse an economic downturn, history shows that it does, and that it doesn’t. Taking Japan as an example, in the 1930’s Japan was one of the first countries to pull themselves out of the depression. The government threw money into the military, and the model proved effective. However, the same model twenty years ago was ineffective – although the money was invested into the infrastructure, the results were not so attractive.

My opinion has always been that stimulus is a temporary solution at its best when executed using the Keynesian model, which doesn’t care where the stimulus goes, just that it goes somewhere (i.e., hire a crew to dig holes, and hire another crew to fill holes). Any increase in aggregate demand would be temporary unless the government keeps pumping money into the economy. Not only that, but with a substantial increase in the money supply, inflation will result and is usually only effectively controlled with an increase in interest rates on loans, which is undesirable in an economy in the middle of recovery.

The argument concerning WWII pulling the U.S. out of the depression is difficult to validate or negate because there has only been one great depression, there is nothing else with which to compare it. One statistic I find important is that after WWII, the Korean war, and the Vietnam war, unemployment rates rose.

May 7 2009 at 7:40pm


It is easy to modify the test for your concerns. Many countries watch the U.S. economy, but not all equally. Canada watches much more closely than Spain for instance. Is it true that countries that watched the U.S. economy closest did the worst? Or are the countries that did the worst better explained by the size of their real estate bubbles or their leverage ratio or some other reason?

It’s so very strange that people find this convincing, as the TED spread is rising to unprecedented levels, bear has failed and Lehman is about to fail, the housing bubble is already deflating B/P lobby congress and Leamer thinks that is causing the world wide downturn? The real estate bubble and collapse in Spain is due to testimony by B and P. Would people not notice bank failures and collapses if they hadn’t testified? Would people have not noticed the legions of newspaper articles asking if the next great depression was coming?

I thought it was very funny that Leamer described the TED spread and how it measures fear banks have that other banks will fail, and how that spread was through the roof before B-P testified, but that it was the testimony that caused the problems and not the fact that banks were insolvent.

So the bottom line is if your ever in gov’t and you see signs of a financial crisis coming, don’t actually tell anybody, and then nothing bad will happen.

Of all the problems with macroeconomists, at least they aren’t microeconomists.


Russ Roberts
May 7 2009 at 8:50pm


Shockingly ignorant?

In general, I would suggest this is a bad strategy. It’s particularly unproductive and inaccurate to use in describing Ed Leamer.

And I don’t understand. What is ignorant about encouraging economists to be less certain about what they know and more open to the idea of saying “I don’t know?”

Russ Roberts
May 7 2009 at 8:58pm


You are building a straw man. Leamer didn’t say that Bernanke and Paulson caused a worldwide downturn merely that they aggravated the crisis. It may be true.

On the question of the degree of “watching closely,” I think you would have trouble making that concept operational in an econometric analysis.

BTW, see the analysis of Hall and Woodward on the effects of the housing collapse alone on the economy.

May 8 2009 at 5:59pm


First, I am not building a straw man. Go back and listen to the podcast, Leamer argues that Bernanke and Paulson caused the coordination that caused a stark change in consumer spending. So we have several countries that have made largely coordinated changes in consumer spending, was that caused by B and P? Leamer’s evidence is google trends. His argument requires B and P to cause google trends and google trends to cause (or at least correlate with) consumer behaviour.

As far as making “watching closely” an operational technique, it is easy. We have this with google trends. We get search terms by country. So we can see if key moments, when B/P gave testimony or spoke caused google trends to spike on things like “great depression.” We actually have it by regions within countries too. I don’t think either of Leamer’s assumptions will hold true. I don’t think B and P will cause “great depression” trends around the world, and I don’t think google trends will lead consumer spending when the right controls are entered. On the first point note that google trends already started spiking in the U.S. before TARP and B/P testimony. Lehman failed on the 15th, between the 1st and the 16th searches for “great depression” was already up over 600%. On the second point note that in the United States the peak of searches for “great depression” was only 20% higher than the first quarter of 2004. So it doesn’t seem like google searches do a very good job at all of predicting major consumption changes.

Beyond that my main argument was that several countries around the world have had major coordinated consumption declines. Did they all “watch closesly B and P” as Russ notes? It is an easy test, see how much B and P cause google trends, then see if the countries that watch closest B and P had the sharpest most coordinated consumption declines. I am limited by English speaking contries (the researcher need not be), but Canada has much more similar google trends for “great depression” and “financial crisis” than the U.K., but the U.K. has much more similar economic problems.

I think if Leamer tried to create a formal paper out of his informal musings about trends and coordination costs of the treasury and federal reserve testimony, and he realized he has to explain a cross-country coordinated consumption decline, his econometrics would find his theory faulty. But since I have done all the heavy lifting for him already, he just has to have a grad student gather the data and crunch the numbers and prove me and much of the profession wrong.

What if microeconomists did micro like they do macro, where consumers all acting the same way at the same time wasn’t attributed to them optimizing under similar constraints, but because they all heard some bureaucrat say something? Would that get published?


Russ Roberts
May 8 2009 at 6:45pm


I don’t know what you mean by “google trends.” Don’t remember that coming up in the conversation. I wish regression analysis was as simple as you describe it. Ed Leamer has spent a good chunk of his career getting people to be a little more careful about empirical work and easy conclusions. He is on the right track.

Leamer isn’t blaming Bernanke and Paulson for the collapse in worldwide consumption. He’s blaiming them for part of the panic and subsequent slow-down in investment along with financial disruption. But he cites the Lehman bankruptcy as well.

Go here:


and scroll down to Figure 13. I think Leamer is in agreement with Taylor.

May 8 2009 at 8:17pm

“Threat of Bank Failure -> B/P -> Congress/Tarp -> Economic Downturn.”

Except the recession started in Dec 07 and we had a very real housing bubble whose collapse caused the financial crisis.

Making people aware of the severity of the problem might have worsened it. Keeping it secret was not possible though.

May 8 2009 at 11:59pm

“Except the recession started in Dec 07 and we had a very real housing bubble whose collapse caused the financial crisis.”

Absolutely. Note that less than 2% of economists correctly forecasted it. And the discussion isn’t so much about what caused financial crisis, but more about whether such a crisis was aggravated by policy decisions. The market indexes suggest that it was.

May 11 2009 at 4:41pm


I see what you are saying. I guess my point is this — even if one grants the argument that WWII got us out of the depression, that does not prove that large scale fiscal spending will be effective in other situations. WWII+pent-up demand+consumer savings+baby boom+export opportunities to war ravaged countries would, to name a few, all have to be taken into consideration. None of those circumstances exist today. As you say, WWII and the depression were specific, idiosyncratic events that do not prove one way or another that massive fiscal stimulus will work in other contexts. In all the arguments on this question, I haven’t seen or heard any of the proponents ask the question, Why did WWII work? That question, it seems to me, is just as important as the more general — Did it work?

May 12 2009 at 2:02am


I’m not sure that there is a definitive answer for your last two questions. I’m not sure that the second World War brought the U.S. out of economic crisis. Arguably, there is no evidence that an increase in aggregate demand wasn’t simply a natural cyclical occurrence. Macroeconomics is probably still in its youth. I have a feeling that this question might not be answered appropriately for two or three generations from now.

May 12 2009 at 3:20am


You aren’t recalling the conversation well enough to discuss it, and you seem to be confounding Taylor and Leamer’s stories. Taylor’s is a story of “financial disruption” and a “slow down in investment,” but Leamer’s story is about “consumer coordination.” Quite different than Taylor he thinks consumers “got defensive” because of Bernanke and Paulson scaring them, which caused a spending fall, which caused an investment fall.

I know it is such a silly argument that it is easy to think it is a straw man, but since the only way to combat the calling of a straw man is to recount the actual argument I have transcribed the comments from Leamer where he outlined this:

“I have always thought that the biggest problem was on the consumer side. We had this overspent consumer, heavily in debt, not going to be earning magic income off of their houses for a very long time, and that the consequence of that would be we would have sluggish economic growth that the consumer as the locomotive wasn’t going to be there, and that’s a recipe for sluggish growth. But we didn’t think that there’d be a coordinating mechanism that would get all consumers to recognize at the same time that they weren’t as rich as they thought they were, so it was a recipe for a kind of on going problem, different consumers recognize at different points in time that they weren’t as wealthy as they thought they were and cut back spending, but I think what happened is that our leaders, Secretary Paulson and Chairman Bernanke and President Bush, went to congress and said that unless we pass that TARP bill we’re gonna have the great depression. If you do google trends which tells you how often people are looking at different words, you type in the great depression you see a huge spike of interest in what exactly the Great Depression was roughly in the middle of September, exactly when Paulson and Bernanke and the President went to congress to get that TARP bill passed. That unleashes fear on the part of consumers that the great depression is coming and they all of a sudden become defensive, so October, November, December were just terrible as far as retail sales were concerned, savings rates shot up, personal savings rates shot up dramatically, and we produced on wall street the catastrophic coordination which is what was worrying me all along. A coordination that I don’t think would occur. So I really do think we overemphasized the importance of Wall Street and the need to have that TARP bailout, which you know wasn’t pursued anyway. They dropped it a week later and in the meantime had frightened us all to death. They created the problem which is that dramatic rapid drop in consumer spending.”

I do agree with one technical point. I don’t think Leamer is assigning the worldwide downturn to B and P. In fact, I don’t think he is thinking about the worldwide downturn at all. If he was, I don’t think he would have ascribed a worldwide problem such a provincial cause.


PS- There are lots of potential problems with econometrics, but this is actually the type of argument it is very useful. When someone gives you the causal chain (and is even already agreeing on the correct evidence), it is the perfect time to use econometrics to test the theory. And since Leamer is already doing informal data analysis looking at google trends, it is perfectly reasonable to formalize that analysis.

May 12 2009 at 3:37am

The first sentence of my reply came across unduly harsh. I know that the podcasts are done well before they are posted and then even more time passes before they are listened to and commented on. I merely meant to stress that I am recounting Leamer’s argument as it was presented fairly and accurately as shown by the transcript.

Russ Roberts
May 14 2009 at 11:40pm


Thanks for transcribing the relevant portion. I actually had gone back to listen to the podcast but listened to the wrong part, I think just before the part you transcribed.

So yes, Leamer mentioned Google trends and yes, I conflated Leamer and Taylor’s stories.

I still don’t think that Google trends can be used in a regression. Leamer’s point is a simple one–the spike in interest in the Great Depression is correlated with the first TARP proposal which in turn is followed by a big drop in retail sales. Is he right? Could be. It’s a provocative idea, not a proof. Not sure how you’d “test” the claim.

Of course the recession officially has been dated to have begun in December 2007 so I assume what he is talking about is the seriousness of it rather than its existence.

Lowly The Worm
May 17 2009 at 2:42pm

Lee Kelly,

Before listening to this podcast, I read statistical inference for fun. (With an agenda.)

The problem with economic behaviour is found in the words itself. How can you predict what some else is going to optimize? Imagine your lovely integral discovering that there is a discontinuity in the function. It is not supposed to happen when you believe you understand the inputs (as a function or as numerical recipe.) But they appear inside economic theories all the time.

Anyone who does not get that probability theory is extended logic has made that decision to be ignorant.

But the problem remains, for some, on how to model, irrationality in the hypothesis and/or the observation. The hard sciences have a universe that has powerful constraints to give us hope that observations and hypotheses are “portable”.

Also, economic behaviour faces what St. Paul discusses, not until the rules were shared did the desire to break them exist.


May 19 2009 at 5:57am

Where can I find the 150 pages of David Chester?

Rick Evans
May 20 2009 at 2:37am

I really liked Leamer’s decomposition of the business cycle data into its main leading components. However, I felt like his criticism of macroeconomics was incorrect. He said that macroeconomics does not pay enough attention to the data and that we need a story. Well, “story” sounds a lot like “model” to me. Yet, early in the interview, Leamer revealed his distaste for those model-heavy (story-heavy) “RBC characters.”

I’ve posted a longer commentary on this topic at Econosseur.com. But my main point is that macroeconomics has been cycling in earnest through data, theory, and policy since the 1930s at least. In fact, a number of papers have recently been written about the convergence of the two main branches of macroeconomics and their improvements in models (stories), explaining the data, and informing policy. Again, I liked the analysis that Leamer described in the interview. I just feel like his inditement of macroeconomics was a little bit misplaced.

Russ Roberts
May 22 2009 at 1:55pm

Rick Evans,

I think you misunderstood Leamer’s critique of RBC characters. I understood him to be saying that their story doesn’t fit the data (the patterns) so it’s not a good story. I don’t think he’s against models at all. He’s against models that can’t explain the fundamental patterns and models that their authors confuse with reality. His key point there is that models are useful or not useful rather than true or false.

May 26 2009 at 6:49pm

Did Leamer ever explain the question of why the US economy grows at such a steady rate? I believe he mentioned that he is basically just taking that as given, and that’s why he’s spending more time talking about the business cycle.

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0:36Intro. [Apr. 23, 2009, recording date.] Book really a guide for anyone interested in getting to know economic data. Quotation on front cover: "We are pattern-seeking, story-telling animals." Picture on cover of someone looking through binoculars, father telling story to son: Once there was a country ruled by a powerful market. Invisible hand is a story. Pattern seeking. Most economists think of theory and evidence and think of economics as a scientific discipline; trying to argue that would be healthier if we recognized the limits of our knowledge, dealing with complex human systems. More accurate to say we are seeking patterns and telling stories, not whether it's true or not, but is it persuasive, compelling. Different kind of standard. Story-listening animals, like to be told stories, processed differently, left-, right-brained. Not easy to give exams based on stories. Encourages people to take the models literally. McCloskey: models are metaphors. In literature, metaphor is the hardest to understand. What is meant by "Joe's elevator doesn't stop on all floors"? English speakers get it immediately, but foreigners are thinking literally. Models have mathematical qualities but also have messages. Lonely view. Scientists tell stories, too; experimental data. Healthy to understand the limits to our knowledge. In a way, the crisis we are in now due to over-statement of the precision with which economists and financial analysts understand the way the world works. Rating agencies: two-valued logic--true/false, yes/no/ safe/not-safe. Teach in econometrics, only two possibilities. Complex human systems have third possibility: we don't know. With mortgage-backed securities, should have been given Triple-A-H, meaning hypothetical. Three-valued logic.
8:41Book. What are some of the more important patterns in macroeconomics? Disadvantage in writing about macroeconomics because not a macroeconomist; advantage as well because not a macroeconomist. Not burdened with ideology, methodological baggage; look at data first. Extreme example: Real business cycle characters, who impose on the data a severe straitjacket. Productivity shocks, somehow mysterious things; their job is to describe the transmission mechanism. What's wrong with that? Don't tell what the shock is or look at any real facts about how economy behaves. Two most important facts: First, U.S. economy in narrow corridor of economic growth for 30 years, growing at 3%/year. Sometimes a little more, sometimes a little less. When a little less, that's a recession. If you ask people to list what contributes to economic growth, oil price shocks, Reagan tax cuts, internet rush, Bush tax policy, monetary policy, trade deficits, budget deficits.... Most rhetoric is about long-term economic growth; data isn't there because on average growth is about 3%/year through all these things. Error-bands larger and larger every time: forecaster can estimate reasonably well what GDP will be a year from now, but more uncertainty as you go further into the future, plus or minus 30% error band far in the future. Don't know why 3% growth. Maybe really good policies just cancel out the bad ones. Is question answerable? Had there been a huge change in economic growth in the 1980s, you'd look at what policies had changed. Fundamental thing is that growth has been constant. Milton Friedman: We know why the economy has been so stable--it's because monetary policy has been so steady. Really good argument a year and a half ago. More to do with the dips within the corridor. Narrow corridor still has recessions; want to know why we've had those recessions. Monetary policy description is mostly about making recessions less frequent and less severe. Can have policy so bad it would kick us off that growth path; 1970s inflation could have done that but didn't.
18:30Other general pattern: not business cycle but consumer cycle. Keynesian thinking emphasized animal spirits and investment, but 8 times out of 10 the first thing to weaken is spending on homes--consumers--and next is consumer durables. Not until recession has officially begun that business cuts back on assets, first short-lived assets, then long-lived assets. Should worry more about what drives consumer spending up and down. Recently, three years of weakness in homes; catastrophic decline in consumer spending. Right remedy then is first to not have over-building of homes and cars, and when you are in the midst of the collapse, fiscal and monetary policy to help consumers buy homes and cars. Instead we are lending to businesses--not the precursor to either recessions or recoveries.
21:38In advance of the crisis, paper on housing presented at Jackson Hole, August 2006, well before the recession started, saying housing price changes play an important role in recessions. What time period? What was response of traditional macroeconomist? Jackson Hole was focusing on housing and monetary policy. Wrote on housing is the business cycle. At that point, 10 downturns since WWII; two not consumer downturns: 1953 disarmament downturn, Korean War, structural change; one other, 2001, internet comeuppance, only business downturn that we've had. Extremely mild unless you were in San Jose, but those people had a lot of skills and learned other languages. Quarterly data since 1947; housing gave 3-4 quarter warning of recessions. Two false positives: housing weakened but didn't have a recession; in both because Dept. of Defense spending offset weakening on consumer side--Korean War and Vietnam War. Housing sector: building or prices? Not prices, which are an imperfect indicator. Hard to measure; price discovery in homes very slow, sellers reluctant to accept price decline in homes. Prices had been sticky downward. Early 1990s California lost a lot of jobs, post-cold war defense spending reduction. Volume of sales dropped by about 50%; prices didn't appreciate but didn't decline. Then very slow decline in house prices. But volume moves very rapidly. Volume cycle, not price cycle. This time different, huge decline in house prices. Speculation: second homes, 1997 tax act had gotten rid of capital gains on house prices, even second homes if you lived in them 2 out of 5 years. Had to have motivated sellers--typically the builders are the motivated sellers, don't want to cut inventory. This time, motivated sellers are the banks, auctioning off homes. So if second home story is to be accurate, must be because of foreclosures on those second homes.
30:18Volume story: set of houses built each year. What do we see in the data? Volume of sales first, then building drop. Story: Why does that lead to a recession? One thing to say it leads; different to say it causes. Want to make causal conclusions, but don't have the data. Just have temporal orderings; have to add story to get to causality, as opposed to just coincidence. Houses are a small fraction of GDP, residential investment is only 4-5%. Why should one little sector struggling ripple through the economy? That was reaction at Jackson Hole; and also "we don't do sectors." "We do K (capital)"; H (housing) is a small part of K. Story: Minsky cycles: early in expansions, loans are given to people who have the income to service the debt and pay off the principal; home prices are increasing, so people come to think of that as a permanent condition. Lending standards loosen up, loans given to people who don't have the income to pay for the principal but rely on housing price increase to repay the principal. Later, Ponzi period, loans given to people who have income that is not even enough to do the debt service; relying completely on home price appreciation. Home is paying for itself; story of the subprime market, 2-28 product, 2 years of teaser rate followed by 28 years or reality. Lender knew there would be a constant string of service fees, refinancing every two years. Great business model so long as housing is appreciating. Federal Reserve complicit in supporting the low teaser rates; teaser rates came from Washington; low interest rates support high asset prices, some of run-up in home prices due to that. 2001-2004; even now, extremely low real rates of interest. Fed had deflation dread disorder: deflation not a symptom but some kind of cause of economic malaise, as it had gotten to Japan. Normally expect Fed to raise rates coming out of the 2001 recession, but instead low Fed funds rate; when raised, ended the subprime market. Foreclosures.
37:40In this particular recession, collapse of housing market in both price and volume had spillovers into financial sector. Previous recessions, that spillover to financial sector wouldn't be there. So how was housing an important precursor in those previous recessions when it's such a small part of GDP? Other big component that weakens is consumer spending on durables: so why does that weaken a quarter or two after houses? Because those are interest-rate-sensitive sectors, too. At ends of expansions, raises in interest rates kill off both of those sectors. Some consumer durables are furniture, which will naturally be weak when home sales down. Automobiles. Not getting income flow that came from home appreciation, repair old washing machine instead of buying new one. Then businesses postpone spending on equipment and software; start to get layoffs, depths of recession. Current episode: overemphasized importance of Wall Street. Credit freeze, freezing of credit markets, not clear what they are talking about. Problem was on the consumer side, consumers discovered they weren't as wealthy as they thought they were. Bernanke, Paulson, claimed TARP needed to avoid another Great Depression. Google trends, big spike in interest in what the Great Depression was in September 2008, when Bernanke and Paulson went to Congress. Fear on the part of consumers; personal savings rates shot up; catastrophic coordination. Dropped that a week later, but the fear they created created the problem. Auto sales. General Motors hemorrhaging cash recipe for continued hemorrhaging. Only hope is to bring the buyers back. Main Street problem. Ought to be getting people back buying homes and autos. Excesses of the past have now mainly been alleviated.
46:08Wall Street and Main Street problems have the same source: anxiety about the future, everyone's cautious. Policy response terrified everybody. Interest rates, TED spread went up before the September 2008 political panic. Lehman bankruptcy created fear about solvency in financial sector; stampede toward Treasuries; European banks had to raise interest rates to compete for deposits, leading to TED spread. Bernanke and Paulson put together the TARP plan and threatened Great Depression if not passed. Will never know what would have happened if Fed had let Bear Sterns fail in March 2008; signal that would have sent to other financial firms would have been a very strong one. Might have had a catastrophic effect but we had a catastrophic effect anyway, so the counterparty risks may not have been as important as they were described as being. At the time argument was that the contracts were all tied together. We'll never know what might have happened if we'd let the pain be short and intense. Claim: commercial paper market froze up. Balance sheets of non-financial organizations were very healthy at that time, more cash than indebtedness. Secondly, non-financial corporations were worried about the future, so their desire to borrow was diminished. Investment spending was still pretty normal till the fourth quarter: story that was being bought into was of a credit crunch. What is the hard evidence that a credit crunch affected the real economy? No question that it affected mortgages--that disappeared overnight. Housing sector very much afflicted by the higher interest rates and outright denial of mortgage loans. Credit spreads increased; interest rates for riskier stuff rose, but some of that was a return to normal. We don't want banks to lend to people who can't pay the loans back.
52:35What is prospect for identifying impact of fiscal policy? Government about to spend an enormous sum of borrowed money. Some economists saying it should be twice as big; others it shouldn't be anything at all. Government role more like Europe or less like Europe. Not a lot of science. Is there hope of getting some evidence? Embarrassing to see economists expressing opinions that have such little validity, not based on any evidence. Need to stop talking about the government creating jobs. In normal economy, government spending takes jobs from the private sector. Cost is foregone activities in the private sector. Only when you have unused capacity, workers that you have potential for stimulus, but have to focus on where the unused workers are. Four sectors: building in housing sector, durables like automobiles, restaurants, and retail. Spending would have to focus on those sectors; but only $8 billion of the $787 billion spending package is focused on those sectors. Worry about it because of myth-making after the Great Depression. Most of it hasn't been spent yet. If economy recovers in the next year the fiscal stimulus will be touted as a great success. If we have a ten year malaise like Japan's lost decade, maybe people will say it didn't work well. Will we actually learn something? Not too optimistic. There have been fiscal experiments--Department of Defense spending, some evidence. Higgs podcast counters that: military spending not so good for the rest of the economy. Korean War episode: huge ramp-up in 1951 when economy is weak; huge cut-back in 1953 when economy okay, tipped us into recession. Japanese ramp-up in infrastructure spending; didn't work to stimulate recovery, but then some conclude the spending however large it was just wasn't enough. For a lot of these episodes we have one data point. One Great Depression in the 20th century. Yes, no, and we don't know.
59:04Econometrics. Today emphasizing stories and patterns, but Leamer is a world-class econometrician. In economics we generally spend a lot of time giving students an arsenal of econometric techniques. Critical of the process and conclusions; Let's Take the Con out of Econometrics; faith-based. Are we finding truth? Rhetorical question. We emphasize the grammar and syntax, teaching how to do the mathematics, write papers that look scientific, but we don't teach people how to think like economists. Any impact? Ought to do sensitivity analysis. Used to some extent. Any econometric study that has brought about a consensus in the profession that hadn't been there before? Econometric profession is an enterprise that gives us standard errors. What is it that we economists believe that depends on the standard errors? Nothing. Explain. Standard errors give you the range of knowledge you have, either narrow or large; estimate of where the truth is, estimate and the error band. Sometimes sign of coefficients matter, but nothing depends on the error band. Patterns and stories. Display visually. If not more scientific, at least produce better literature.