The Middle-Class Comeback Is Under Way

Wall Street Journal op-ed "The Middle-Class Comeback Is Under Way" (February 12th, 2015) makes a painful error while trying to pin the world's woes on the Fed.

The Fed’s easy-money policies were also slamming the middle class by encouraging speculation in—and thus pushing up the price of—commodities like oil and food, which are an incidental expense for the rich and a real burden for everyone else.

Normally of the left, this sort of talk belongs in the economic dark ages (60's, 70's).  Markets are driven by supply and demand.  Speculators essentially never take delivery of their product: they purchase a contract for future delivery with the intent to sell later.  They can, of course, sell to other speculators, but eventually speculators must sell to an agent that will actually take delivery of oil.

Assume first there is no storage market.  Agents who take delivery inelastically supply oil, and demand determines price.  This price determines what the delivery agent is willing to pay, which pins down the price they are willing to buy from speculators.  Whatever heights the oil may reach during speculation is pinned down by what it will actually be worth when it arrives.  Speculation can't impact prices at the pump in this world.  (One might say: "but maybe they can sell at a higher price to the agent and he will pass it on to consumers!"  The question this raises is "if he could sell at a higher price to consumers, why wasn't he before?  They don't care about his costs, only their value and the price.")

There is little difference with a storage market.  With a storage market, speculators can actually temporarily bring up prices, but only at a loss to themselves, if they brought it up incorrectly.  Say speculators anticipate (or act like they anticipate) a demand shock: oil will be pricier, they think.  They purchase many shares and drive the price up because they think it will be valuable in the future.  This causes less oil to go on the market today, and the price at the pump to rise today, and less oil is consumed.

After this, there will be a sharp plunge in oil prices, as storage capacity is sold but demand hasn't gone up.  (That is, speculators could potentially shift supply down and then up.  If there is no fundamental demand shift, this will cause a rise, then a fall in prices, easily mappable to storage).

Inventories did not change enough, and prices were not sharply changing enough, to allow speculation to have any role in the rise in oil prices.  Instead according to Knittel and Pindyck (2013), it seems that (as economic theory would predict) speculation lead to the smoothing of oil supply over demand shocks, actually reducing the price volatility (but not changing the level: changing the level over the long run is highly unrealistic, for the reason discussed earlier).

While theory and empirics line up to tell a clear story (viz., speculators are not to blame for price rises the way you ever read in newspapers), February 12th's Wall Street Journal's op-ed page doesn't just seem to abandon coherence of multiple signals, but even a sensible signal to begin with.  For shame.

Theory: the Federal Reserve is a liberal "long con."  The idea is to drive conservatives to heights of irrationality, causing the party to twist itself in knots to blame the Fed for each new and imagined ill, bringing them to the point of making up easily refuted historical and current "facts."

The Religious Right Turns 33: What Have We Learned?

Jonathan Merritt writes an embarassingly wrong op-ed in The Atlantic:  The Religious Right Turns 33:  What Have We Learned? (June 8th, 2012).  In it, he attacks the Religious Right, arguing that the movement into politics of Evangelicals and the Religious Right has diminished interest in Christianity.

Economics has special ways of dealing with time-series theses like "The Christian Right got into politics, and their share of the population went down.  Therefore, it must have been because of the politics."  On its own, this has little empirical content:  post hoc ergo propter hoc.  But a good analysis can be convincing by showing parallel data.  We can examine other religions that didn't get into politics (or didn't change their relative immersion into politics), or look at factions of Christianity that went into politics more.

In other words, we can say "if that thesis is true, then it has testable implications."  Corrections offers two testable implications:

• Other branches of Christianity haven't gone into politics as much as Evangelicals:  therefore, Evangelicals should be suffering the most.
• Judaism, a religion strongly tied to the left for more than a century, has not changed its political position very much.  Therefore, it should be untouched by the last twenty years.

Obviously these aren't the only stories one can tell: Corrections is glad to entertain other testable hypotheses of Merritt's otherwise empty theory.  First, we use the Statistical Abstract of the United States to depict the proportions of different religions with a logarithmic scale (otherwise, Evangelicals, Muslims, and Jewish proportions are too small to distinguish) (click to enlarge).

One can see that Christianity and Judaism have declined while Athiests, Muhammadans, and Evangelicals have seen an increase in their proportions.  It would be easier to compare them all to their 1990 proportion, to see the change (click to enlarge):

This figure tells our whole story:  if being political has hurt Christians, then why has Judaism, which hasn't changed its political orientation seen a larger fall, while the subset of Evangelicals in Christianity seen the largest rise?  

As a note, it is true one can begin to tell stories (ex:  Evangelicals rose by draining other Christians while the rest left, Judaism has its own thing going on, etc.) to make sure Merritt's claim is devoid of testable hypotheses.  Such a tack would ironically and safely bring one's own politics into a religious (non-testable) sphere.

Bridging the achievement gap

Los Angeles Times opinion editorial "Bridging the achievement gap" (September 22nd, 2010) discusses the achievement gap between black males and all other students (black females and white males being the primary groups of comparison). It speaks only of educational means to fix the graduation gap, while discussing crime. Corrections would like to entertain a different possibility that might help solve both. The Times also confuses correlation and causation.

These disparities aren't new — the Schott report could have been published a generation ago. What is new and noteworthy is solid evidence that this gap can be bridged, with well-tested approaches that don't require massive changes in public education and don't depend on superhero teachers and administrators.

An economic idea might be that individuals, both black and white, make decisions about education today based on what they believe their income differentials will be tomorrow. One way to encourage education is to ensure higher wages for the educated. Another is to ensure lower wages for the uneducated.

The Times suggests that some of these students might be on the "prison track." "All too often they're on what educators privately dub 'the prison track.'"

If the Times is concerned that black males (or, for that matter, individuals of any race or gender) are opting out of educations and into lives of crime, one way of reducing their involvement in crime and increasing their graduation rates might be to lower their future wages as criminals.

We do a quick back-of-the-envelope calculation to test this hypothesis. We should see a correlation between an increase in law enforcement officers tomorrow and an increase in graduation rates. For the 50 states from 1998-2003, we plot the two, and offer a fitted least squares line. This is displayed graphically below (click to enlarge).
The relationship is indeed positive, which is itself phenomenal. If high schoolers were myopic and unresponsive to future police presence, we would have expected a drop in graduation rates to result in an increase in police next period--an increase in bad high school students should make more police next period a necessity. The fact that we see this indicates that the difference between our two effects is rather large. At a first glance, while the relationship is only near significant, it would appear tantalizing. For those concerned about the outliers, the relationship remains positive dropping them from a fixed effects panel data regression.

The Times discusses young black males, their graduation rates, and crime. Following our above analysis, we might think that a way to increase the graduation rates of young black males (who head into crime at higher rates than young white men or young black women) might be to decrease their wage differential between crime and legitimate employment through the hiring of more law enforcement officials over the course of several years. This would have the added effect of decreasing crime. Indeed, if individuals are forward looking and we have a believable commitment mechanism, we needn't wait to see the effects.

Clearly the analysis Corrections provides is both preliminary and inconclusive--it is merely suggestive. Nevertheless, it offers an interesting avenue to improve education by rational forward-looking individuals of all races and genders.

Beyond this discussion of heterogeneous impacts by race of an increase in future police presence on future crime and graduation rates, we might also add a particularly offensive quote by the Times:

A large-scale study in Chicago found that 74% of the boys who attended preschool graduated from high school, compared with 57% of those who didn't.

This is a correlation. It is not clearly causal.

The Recession Officially Ends

Newsweek Magazine/The Street article "The Recession Officially Ends" (September 20th, 2010) struggles with even marginally objective journalism. Throughout an article discussing the decision by the National Bureau of Economic Research (NBER) that the recession had ended in June 2009, it can't help itself but snipe, repeatedly. Newsweek, doing its best to imitate Pravda, would doubtless desire the reformation of the Tsentralniy Komitet Kommunistitcheskoi Partii Sovetskogo Soyuza, the Soviet Central Committee, to make centralized decisions concerning recessions.

The recession isn't just over, it actually ended in June 2009, according to a statement made Monday by the elite, ivory tower cadre of U.S. economists known as the National Bureau of Economic Research (NBER).

[...]

In its typically obtuse economist language, NBER noted in calling a June 2009 end to the recession that in "determining that a trough occurred in June 2009, the committee did not conclude that economic conditions since that month have been favorable or that the economy has returned to operating at normal capacity. Rather, the committee determined only that the recession ended and a recovery began in that month."

[...]

To support their claim that the recession ended over a year ago, while for many Americans there has been little indication of a recession lessening, NBER notes 'economic activity is typically below normal in the early stages of an expansion, and it sometimes remains so well into the expansion.'

The problems associated with assigning recessions in real time are manifold. With noisy information that changes over time, changing relationships between economic variables, different predictions from different variables, and multiple variables of interest, it is a task that's easy to criticize when an institution hates economics, like Newsweek. However, Newsweek's criticism is not well-placed.

The NBER's approach is to avoid denoting recessions until they have a relatively large amount of data. For example, The NBER's Business Cycle Dating Committee waited 28 months to declare the end of the 2001-2003 recession. In this case, it agrees with a "real-time" approach James Hamilton developed using Stock and Watson's historical work. An example of Hamilton's work that this article has been influenced by was "Calling Recessions in Real Time" (Working Paper, 2010).

Hamilton runs a regime-switching Kalman Filter, a general tool discussed elsewhere by Corrections in "How to Lose an Election Without Really Trying" and "Census as a Celebration". Starting with the data, we can observe his assigned probability of whether the United States is in a "recession" state or not, along with the current Bureau of Economic Analysis issue of the GDP growth rate (click to enlarge):

Hamilton's approach generates results very similar to the NBER's based solely on GDP, not NBER's recession dates. We can see this by depicting Hamilton's probabilities of recessions, and coloring in both his recessions in red and NBER's in blue (click to enlarge).  Near-complete overlap with red can be seen on most blue bars.

We can see Hamilton's methods find this recession only lasting one more quarter than the NBER's Business Cycle Committee's. The calling of recessions is not a falsifiable endeavor, though updates are possible if the call is made in real time.  Nevertheless, when the NBER and James Hamilton, (who literally wrote the book on time series analysis) are susceptible to the same criticism by Newsweek, it is vastly more likely that Newsweek's understanding of the world is flawed, not theirs.

Old age robs criminals' skill

Boston Herald article "Old age robs criminals' skill" (September 18th, 2010) offers a rarity for opinion editorials: an intellectually stimulating article and relatively original idea. The article's interesting question is: why does crime rise in some recessions, and fall in others? The article's proposed answer is recessions with high inflation drive crime because criminals see individuals as holding large amounts of cash now in anticipation for needing it in the future (implicitly, an economic "cash-in-advance" model). Recessions with low inflation will simply find individuals with less in their pockets, and therefore less to steal.

But in previous recessions, in the 1970s and ’80s, the crime rates went up. The difference perhaps was that those recessions were in times of high inflation, giving robbers an incentive to take your money while it still held its value.

Being broke, people don’t go out late and thus are less likely to be mugged. And if folks do travel, the thieves know they’re probably not carrying much of value.

If newspaper writers are going to undertake causal analysis or conjecture, it's enjoyable when they use good structure or thoughtful analysis. If the reflexive premises of the New York Times are that firms are evil and people are very dumb and easily tricked, this article argues that even criminals respond to incentives, and puts forth their testable conjecture--the pinnacle of a non-empirical opinion editorial.

As Corrections sees it, the testable prediction the Herald's conjecture offers is as follows: real goods, such as automobiles or jewelry, are relatively robust to inflation. Cash is not. If burglary and robbery are substitutes for one another, but inflation causes robbery to become relatively less valuable than burglary, then a difference-in-difference will bring out the causal link between inflation and crime.

That is to say when inflation changes from low to high, we should expect the difference between the change in robbery and the change in burglary to be negative. Below, we first graphically display the data: inflation rate, robbery and burglary rates over time (click to enlarge), from 1960-2003.

A graphical and first-approximation is to plot percent change in inflation on the x-axis and the difference between percent changes in robbery and burglary on the y-axis. As we can see from the positive slope, if anything an increase in inflation appears to lead to a relative increase in robberies, not burglaries, as the Herald's theory might predict (click to enlarge).

Of course, this is only a first-pass approach. Consumers, recognizing that inflation will cause more robberies, could reinforce their homes and cause less total robberies (due to security) that has a larger effect than inflation causing more robberies. However, the empirical evidence behind the Herald's theory appears weak--rather than burgling more inflation-robust assets when inflation increases, individuals are robbing more inflation-insecure assets when inflation increases.

What if the end isn't near?

USA Today article "What if the end isn't near?" (August 23rd, 2010) discusses a large subpopulation in America that ostensibly believes that the Second Coming of Christ will occur within the next forty years. The article is deeply concerned about this and its effects on public policy (e.g. if Nuclear Disarmament or Global Warming are long-term threats, we need spend resources on them, as the world ends before they become problems).

A new poll from the Pew Research Center for the People and the Press finds that roughly four in 10 Americans believe the Second Coming will happen by 2050.

and

Thankfully, Wigg-Stevenson and many new-breed evangelicals like him are refusing the kind of end-times bait that lets believers off the hook — off the hook of inspired social action that can make their faith a powerful blessing to their society and their time.

Corrections, from its own a priori beliefs, finds this statistic difficult to believe. The proper economic method for discerning beliefs is to watch what individuals do, not what they say. Our a priori beliefs are so strong that Corrections suggests that individual economic activity simply doesn't match up with these beliefs--people are professing things to pollsters that they don't believe.Corrections ventures out of its area of expertise into christian eschatology to understand this poll figure. Any corrections are welcome; the purpose here is just to get a grasp on what individuals might believe, as various interpretations impact economic behavior.There are five important events or periods that are relevant to the Christian End Times: 1) The First Coming, 2) Tribulation 3) The Second Coming 4) The Millenial Reign 5) The Last Judgement.

1. The First Coming kicks off the sequence of events, bounding the sequence of events and marking the beginning of the "countdown".
2. The Tribulation is a period of time after the Rapture (taking of Christians to Heaven, and their disappearance on Earth). In this period of time, for many, the Four Horsemen of the Apocalypse come, many individuals die.
3. The Second Coming is the arrival of Christ on earth.
4. The Millennial Reign is the Thousand-Year Reign of Christ before Judgement Day.
5. Judgement Day is the point at which all economic activity ceases (e.g. August 29, 1997 as Judgement Day would signal the cessation of all economic activity, as individuals are separated into good and bad, and sent to the afterlife).

First, we stipulate all individuals believing in the Second Coming are Christians. In our understanding, there are several ways to interpret "The Millennium," mentioned in the bible before the Last Judgement (after which we suppose all economic activity to cease). These beliefs can be broken down into two categories and two sub-categories within those.The first is Premillennialism, which includes both Post-tribulational Premillennialism and Pre-tribulational Premillenialism. These believers hold that there is economic activity after the Second Coming--that the Second Coming occurs before the Millennial Reign.

In this case, these individuals do not believe that economic activity will cease upon the second coming. (Though Pre-tribulational Premillennialists may believe that the rapture will remove them or others from economic activity upon the Second Coming. Neither of these allows for the end of the world before 2040, requiring at least a Millennial Reign.

The second category are individuals who believe the Second Coming and the Last Judgement will be concurrent--in this case, all economic activity ceases. Included in this are Postmillennialists and Amillennialists, the former thinking that the Millennial Reign will occur before the Second Coming (and may have been happening for some time) and Amillennialists believing that the Bible only refers to a "symbolic" Millennial Regin. Both allow for the end of the world to occur in or before 2040.In any case, the article can only be concerning itself, as far as Corrections can see, with Postmillennialists and Amillennialists, as it would be difficult for either Premillenialists to believe the Second Coming will happen, due to the requirement of the Millennial Reign which has not happened--these people should still be willing to invest in their futures or their children's futures, as the Second Coming may happen in 2040, the world doesn't end.

Do people act as if the world will end by 2040 rather than at an indeterminate time? Corrections suggests not. To understand why, we merely need to understand that individuals would have starkly different consumption patterns. To understand why, take two individuals, starting out with the same consumable resource. They enjoy consuming it, but given they don't consume it, it grows or reproduces at some rate. An example of this might be any animal herding, or saving money (which grows at the real interest rate). Individuals are impatient, but also want to smooth consumption. One individual believes in an infinite-horizon world, where they save for themselves and future generations. Another believes the world will end in forty periods. How would their consumption patterns look? We solve the dynamic programming problem for when to sell a herd stock for both individuals. Their stock of animals and number of animals sold is displayed graphically below (click to enlarge):


As one can see, savings and consumption patters are starkly different in the two groups quite quickly--people who have dynastic preferences and solve an infinite-horizon problem (or something approximating it) are able to take advantage of exponential growth in a way that finite-horizoned individuals cannot. The question is whether or not we see this sort of behavior among the 40% of the population the Pew Research Center claims. It is also worth noting that the difference seen would be enlarged further by any comparison before today's date (we assume the same resources today--were individuals to have started with the same resources five years ago, a difference would be even more noticeable, because there is more time for divergence).

How might we see this in public policy? Any individual believing that Judgement Day would happen before 2050 and born after 1983 will not see any social security benefits, while paying in for social security and other retirement programs. Indeed, individuals born before 1983 will not come remotely close to being paid their contributions, and should rebel equally agianst this program.

Such individuals should not be saving for retirement, and certainly not be taking care of their bodies--many of this 40% who believe the world will end by 2050 should begin smoking, and planning for a family may be seen as mildly short-sighted.

In summary, Corrections believes that the lack of evidence on this 40% of the population, the lack of articles noting the incredible rise of unhealthy behavior and savings is evidence of individuals not believing what they claim to believe in surveys. Corrections might further note that while one may joke about short-sightedness among Americans today, the question is about whether or not people are behaving with the degree of extremity necessary to act as if the world was going to end in 40 years.

Shrouded in secrecy, decision makers gambled and Harvard lost

Boston Globe article "Shrouded in secrecy, decision makers gambled and Harvard lost" (December 12th, 2009) makes two economic errors in his excoriation of Harvard's dealing with its endowment.

Harvard’s treasurer acknowledged that in hindsight, the university might have managed its investments differently. Yet, he noted, even with the downturn, the endowment grew over the past decade at a healthy annualized rate of 8.9 percent. True enough, but the Corporation manages not only Harvard’s balance sheet, but the expenses of the university as well. The 8.9 percent growth of the endowment wasn’t nearly healthy enough to cover the staggering growth in costs.


First, the touted 8.9% growth rate over a decade with the endowment's 30% fall still means vast growth over the decade. Indeed, the endowment is only around where it was in 2005. Second, it is not clear ex ante that the idea was poor ex post. We cannot say if Harvard failed to understand the probabilities in the bets it was making, or if the bets simply failed to materialize. We would be wrong to censure a man who loses millions on a bet that has 1:1 payoff and 90% chance of winning. He made the right decision, ex ante. The same may be true of Harvard--the world it expected to materialize as time went on may have been wrong, but that does not imply that it was wrong ex ante. Third, while the "staggering growth in costs" may be true, the University also gained from those costs. An increase in costs in and of themselves imply nothing. The difference between benefits and costs do.

What if a Recovery Is All in Your Head?

New York Times article "What if a Recovery Is All in Your Head?" (November 21st, 2009) is deeply troubling, as it offers an unfalsifiable hypothesis. The author offers the following idea:

Consider this possibility: after all these months, people start to think it’s time for the recession to end. The very thought begins to renew confidence, and some people start spending again — in turn, generating visible signs of recovery.

Without any exogenous variation on this somewhat amorphous concept, the argument is ludicrous, and appears untestable. Indeed, the article admits as much:

According to the standard schedule, we’re due for recovery. Given this knowledge, the mere passage of time may spur our confidence, though no formal statistical analysis can prove it.

If philosophy gained anything in the 20th Century, it was the concept that statements are scientific if and only if they are falsifiable, if they are testable. By its own admission, the article is unscientific in its conjectures. Insofar as it takes economics out of the realm of science, Corrections follows Hume's self-condemnatory suggestion at the end of "An Enquiry Concerning Human Understanding" (1748)

When we run over libraries, persuaded of these principles, what havoc must we make? If we take in our hand any volume; of divinity or school metaphysics, for instance; let us ask, Does it contain any abstract reasoning concerning quantity or number? No. Does it contain any experimental reasoning concerning matter of fact and existence? No. Commit it then to the flames: for it can contain nothing but sophistry and illusion.