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Mike Konczal Is Highly Shrill--and Thinks We Need a Different Way of Picking Fed Bank Presidents

The intellectual collapse of the Chicago School of Economics continues. Mike Konczal:

The Fed Dissenters, Or: Examining Narayana Kocherlakota’s Gut: [T]hree (three!) dissenters. How often has this happened? Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser all dissented…. What’s their motivation? We looked at Richard Fisher before.  In April 2011 his ”gut tells [him] that [QE2] will result in some unpleasant general price inflation” – something that was absolutely wrong….

But what is going on with Kocherlakota? Why is he dissenting in favor of tightening sooner?  Last time we saw him, he was talking about job openings taking off, numbers that turned out to be exaggerated by modeling assumptions at the BLS.  So that’s off the table.

What’s his deal now? Let’s go to his big discussion paper, "Labor Markets and Monetary Policy"…. [H]e uses a Diamond, Mortensen and Pissarides (DMP) model of unemployment…. First thing you should notice is that Kocherlakota of the Minneapolis Federal Reserve is basing his opinion on unemployment on an equation in which the Federal Reserve has no role.  Lots of people think the idea that the Fed can’t set a negative interest rate – that there is a “zero lower bound” – has something to do with our current problems.  Agree or don’t, there’s no possible way it impacts this model.  Product markets not clearing doesn’t factor into this model, which is all about how lazy workers are.  Some people, most notably Stanford economist Bob Hall, have tried to put the DMP model into a world of zero lower bounds and product markets not clearing and found results closer to our world – this isn’t mentioned in the report.

Second, many economists have tried to use this model to explain how unemployment spikes during a recession.  The main thing that would drive changes in unemployment in this model are changes to productivity.  As mentioned above, it was a major breakthrough when Shimer (2005) showed that there’s no way wild swings in productivity can cause the major swings in unemployment we’ve seen.  This goes double for the recent recession, where productivity has increased. As Hall pointed out:

First, Shimer’s (2005) influential paper showed than it would take a gigantic drop in productivity to cause the rise in unemployment in a typical recession, based on realistic values of the parameters of the DMP model. Second, productivity has increased in recent recessions…Productivity grew almost at normal rates during the huge contraction that started in 2008. To generate an increase in unemployment driven by productivity, an actual decline in productivity would be needed….

Here’s Kocherlakota, who explains a doubling of the unemployed with a (p-z) shift….

Given the enormous rise in the benefits of creating job openings, why weren’t firms creating more of them?  A common answer to this question is that firms face “insufficient aggregate demand.”…. But the DMP model suggests two other possible reasons…. [E]xpected after-tax productivity p fell. Over the past three years, the U.S. economy has experienced large increases in the federal budget deficits…. What about the utility that a person derives from not working? In response to the recession, the federal government extended the duration of unemployment insurance benefits…. [S]uppose that, for the reasons just mentioned, p fell by 10 percent in the past three years and z increased by 0.05 during this period. These are large changes, but they are not implausible…

There it is.  Job creators hate future taxes, and unemployment insurance has left our workforce weak, so don’t expect unemployment to come down anytime soon….

Where to begin?  If unemployment insurance extensions are causing a rampant increase in the time people are unemployed… you could compare the duration of unemployment for those who get unemployment insurance to quits and new entrants – or people that don’t get unemployment insurance.  If UI was causing unemployment, you’d see very different results.  In fact, Mary Daly, Bart Hobijn and Rob Valletta of the Federal Reserve Bank of San Francisco did this in January… “the results of this analysis suggests that the availability of extended unemployment benefits has increased the overall unemployment rate by about 0.4 to 0.8 percentage points”…. And why don’t we assume that “z” has gone up in this recession?  It is harder to find a job than in normal times per week of unemployment duration, outstanding debt loads hang larger over household net worth – having a job seems more important than ever.

If you believe that the natural rate of unemployment is near 9% because President Obama has terrified the job creators and the unemployed aren’t starving enough, I am unlikely to convince you otherwise using various forms of econometrics…

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