October 11, 2011
Sargent and Sims
I'm a little late getting to this (by standards of cyberspace time anyway), but I wanted to comment on Monday's announcement about the Nobel prize in economics.
NYU Professor Thomas Sargent and Princeton Professor Christopher Sims were justly recognized for their contributions to characterizing dynamic relations between economic variables. For concreteness, let me give an example of what I mean by "dynamic relations." We've observed that when monetary policy becomes looser, GDP will often temporarily grow a little faster. But these responses don't happen instantaneously, and they don't last forever. A key question economists would like to ask is how big these effects are and how they unfold over time.
Prior to Sargent and Sims, there was a great deal that was ad hoc about the way economists would approach these questions. What I would characterize as Sims' greatest contribution is noting that it is possible to summarize the key facts about these relations without having to believe in what he referred to in his 1980 paper Macroeconomics and Reality as "the discouraging baggage of standard, but incredible, assumptions macroeconometricians" had been used to making. Sims suggested that we should always begin with straightforward and completely objective forecasting questions, such as, if I learned that the Fed is setting a lower interest rate this month than I had been expecting, how should that cause me to revise my forecast of what GDP growth is going to be 1, 2, and 3 quarters from now? Sims developed the objective tools we can use for answering those questions that do not depend on my ideological biases or preconceived theories. He suggested that the answers that such an objective analysis produces should be recognized as the basic facts that any model needs to be able to explain. This was a radical step in the direction of transforming macroeconomics into a much more objective, scientific inquiry, and is part of the bedrock of the discipline these days. We still have quite a ways to go in terms of achieving this goal, but owe a great debt to Sims for helping to steer us onto the right track.
Sargent made parallel contributions in terms of economic theory, developing the basic tools needed to extend theory itself to studying questions about what these dynamic relations should look like. If a sensible business planner knows that these effects are going to take time to develop, how should that affect your decisions today, and how does your behavior then feed back into determining the dynamic effects of the policy itself? This is such a fundamental aspect of modern macroeconomics, it's almost hard to imagine that it was not always the case. But Sargent was very much at the forefront of showing just how it could be done. And although they worked on separate aspects of understanding dynamic economic relations, I think it's a great choice to honor Sargent's and Sims' contributions together.
Congratulations to a couple of the giants on whose shoulders we stand today.
Posted by James Hamilton at October 11, 2011 04:09 PMdigg this | reddit
I had dinner last night with a senior planner for one of the IOC's, and I asked him about his oil supply outlook for 2012. Their forecast calls for +0.8 mbpd next year, of which half oil and half other liquids, primarily NGLs.
Now, in a weak year, we might expect demand to rise by 1.4-1.7 mbpd. In a normal year, given China's rapid motorization, our forecast would call for 2.4 mbpd demand growth.
So the planner's outlook is half our expectation for demand growth in a pretty mediocre year.
This is pretty grim. It means that either we will see a recession or pretty high oil prices next year.
Posted by: Steven Kopits at October 12, 2011 04:23 AM
According to Professor Hamilton,the price of oil is strictly correlated with demand for oil.Trying to find his statement among his numerous publications on oil,requires more than memory but a methodology.
Should the oil prices have peaked a recession should follow,demand being subdued oil prices should correlate.Markets have not exhibited much volatility but the 8 weeks risk premia did (Econbrowser Changing behavior of crude oil futures prices Hamilton C. Wu) Does is qualify for price variance volatility?
Do they qualify for Hamilton 1983 negative relationship between oil prices and future GDP growth (tested by the fed St louis http://research.stlouisfed.org/publications/review/05/11/KliesenGuo.pdf)?
In summary trough oil variables the next recession is predicated upon the crossing of the asymptote on the oil price curve that is a pick in price.Correlatively should the demand for oil fall, then prices will.
Posted by: ppcm at October 12, 2011 08:43 AM
I'm working on our presentation for the ASPO-USA conference in early November, in Washington, D.C. and following are descriptions of some slides we are working on. BTW, the ASPO-USA link is: www.aspousa.org
From 2002 to 2010, US oil consumption fell 3%. The top 33 net oil exporting countries' combined consumption increased 27%. India's consumption increased 40%. China's consumption increased 72% (BP). I am going to prepare a chart showing normalized oil consumption for 2002 to 2010 for the three countries and the top 33 data set.
My premise--based on recent data--is that the top 33 exporters have first claim on exporting country production, then the Chindia region, then the non-Chindia net importers (principally the oil importing OECD countries, e.g., the US).
I am preparing a chart showing three curves: (1) Top 33 net exporters' production; (2) GNE (which is production less consumption for top 33) and (3) ANE (Available Net Exports, i.e., GNE less Chindia's combined net imports). The intervals between and curves for Top 33 consumption, for Chindia's net imports and for ANE will all be shaded different colors.
A second slide would show extrapolations out to 2020, with a vertical line highlighting the extrapolated data. I am thinking of simply extrapolating the 2005 to 2010 rates of change.
Assumptions: no change in top 33 production, but top 33 consumption increases at 2.7%/year; Chindia's combined net imports increase at 7.5%/year. This would result in GNE falling to 36.7 mbpd in 2020, from 42.6 mbpd in 2010. Chindia's net imports would increase to 15.8 mbpd in 2020, from 7.5 mbpd in 2010. And ANE would therefore decline to 20.9 mbpd in 2020, versus 35.1 mbpd in 2010 (and versus 40.4 mbpd in 2005).
So, if we extrapolate the 2005 to 2010 rates of change for top 33 production & consumption and for Chindia's net imports, then in round numbers, for every two barrels of oil that non-Chindia net importers net imported in 2005, they would have to make do with one barrel in 2020.
Note that there are several variables, among them: top 33 production & consumption; China's production & consumption and India's production and consumption. But in any case, recent data suggest that the US, and most other oil importing OECD countries, are stuck with accepting what is left over after the exporting countries and most developing countries take what they want from the "Export Pie."
Posted by: Jeffrey J. Brown at October 12, 2011 10:37 AM
We've observed that when monetary policy becomes looser, GDP will often temporarily grow a little faster. But these responses don't happen instantaneously, and they don't last forever. A key question economists would like to ask is how big these effects are and how they unfold over time.
Perhaps a better question to ask is since GDP growth is temporary and doesn't last doesn't that mean that any apparent change from a losser monetary policy is actually an illusion.
Posted by: Ricardo at October 12, 2011 11:16 AM
Here is an amazing quote from Sargent about how a gold standard accomplishes what governments attempt to do by passing laws and regulations.
Remember that under the gold standard, there was no law that restricted your debt-GDP ratio or deficit-GDP ratio. Feasibility and credit markets did the job. If a country wanted to be on the gold standard, it had to balance its budget in a present-value sense. If you didn’t run a balanced budget in the present value sense, you were going to have a run on your currency sooner or later, and probably sooner. So, what induced one major Western country after another to run a more-or-less balanced budget in the 19th century and early 20th century before World War I was their decision to adhere to the gold standard.(h/t to Mises.org)
Posted by: Ricardo at October 12, 2011 11:19 AM
What would be interesting: Ratio of GDP/oil consumption (or over way around) for the various OECD countries. Are any countries reducing their reliance on oil? Are they doing it by consuming less oil while keeping their GDP flat? Or by maintaining oil consumption while growing their economies?
Will our economies shrink as fast as available oil declines?
Posted by: Randall Parker at October 12, 2011 09:12 PM
Germany is certainly a case history of economic growth, versus declining oil consumption. The EIA shows that Germany's oil consumption fell from 2.9 mbpd in 1998 to 2.5 mbpd in 2010, but their overall total energy consumption was basically flat.
Posted by: Jeffrey J. Brown at October 13, 2011 08:13 AM