More on Stock-Flow Consistent models

This is a follow-up to this post, but which is prompted by this Bank of England paper, which builds a stock-flow consistent model for the UK. If you are not familiar with the term ‘stock-flow consistent’ (SFC) then read on, because in a sense this post is all about why I think the way the authors and others define this class of models is misleading.

SFC models are popular with Post-Keynesians, and the definition you find on Wikipedia is “a family of macroeconomic models based on a rigorous accounting framework, which guarantees a correct and comprehensive integration of all the flows and the stocks of an economy.” Now I suspect any mainstream macroeconomists would immediately respond that any DSGE model is also stock-flow consistent in this sense. This point is made in a post by Noah Smith, and it is completely valid, although otherwise I think his account of the weaknesses of SFC models is wide of the mark.

If you think this is a trivial debate about titles, take this description of the pros and cons of SFC compared to DSGE models taken from the paper:

Take the cons (merits of DSGE compared to SFC) first. Number one is almost definitional: DSGE models have to be microfounded, but SFC models start with aggregate relationships. But that is not a defining feature of SFC models, because there is a long tradition of macro modelling that is not microfounded but starts with aggregates, a tradition that begins well before DSGEs with the simultaneous creation of national accounts data, econometrics and Keynesian economics. This tradition goes by many names: ‘Structural Econometric Models’ (SEMs), ‘Cowles Commission’ (favoured by Ray Fair) or most recently ‘policy models’ (see Blanchard). I’ll just call them aggregate models here.

A key question, therefore, is what marks SFC models out from other aggregate models? The authors obviously think there is something, because of their second ‘con’. The third and fourth ‘cons’ are common to many large SEMs. (I once wrote a paper on how to mitigate the first of these problems.) The fifth ‘con’ just follows from the first.

At first sight the sixth ‘con’ does the same, but I would argue that if there is anything that characterises SFCs among aggregate models it is this. Aggregate models would generally involve an extensive discussion of the theoretical origins of the relationships they used, but if this paper is anything to go by that is less true for SFCs. If you think this last point is unfair, look at the discussion of the consumption function (before equation 4).

This failure to acknowledge the existence of other aggregate models is even more apparent among the ‘pros’. The first and second can be true for any model, including a DSGE model, but the third is critical. It is true, but again it is also true for many aggregate and some DSGE models. As I argue in my previous post, the key point about the archetypal DSGE model is that it does not need to track household wealth, because there is no attempt by consumers (given the theory) to achieve some target value of wealth.

The fourth is true for any model, including DSGE models. The fifth is true for any aggregate model as long as expections variables are explicitly identified. The sixth is also almost bound to be true of any aggregate model, because starting with aggregates and being eclectic (and potentially internally inconsistent) with theory allows you to more closely match the data than DSGEs.

To summarise, if you were to ask how this model compares to other aggregate (non-microfounded) models, the answer would probably be that it takes theory less seriously and it has a rather elaborate financial side.

The New Classical counter revolution had many good and bad consequences, but one of the undesirable consequences was, it seems, to define the equivalent of a year zero in macroeconomics, where nothing that was not in the New Classical tradition created before (or even after) this revolution is deemed to exist. The same should not be true for heterodox economists. If you are going to effectively return to a pre-DSGE tradition, please do not pretend that tradition did not exist.

There is a well known UK professor of econometrics who was very fond of admonishing authors who failed to cite work that they were either extending or just copying. The intention here is not just to do the same. One of the big dangers with any kind of elaborate aggregate model is that you can get bizarre model properties from not thinking enough about the theory, or imposing enough because of the theory. Knowing some of the authors I doubt that has happened in this case. But it would be a mistake for others to believe that the properties of their model show the importance of accounting rather than the theory they have used.        

Competence and strategic vision

I keep trying not to write stuff about Labour: I think it will be therapy but it just makes me more depressed. But events, dear boy, events.

With Corbyn’s victory now almost certain, both sides (the Corbyn camp and the PLP) have been thinking about what happens next. This piece by Stephen Bush, reporting from inside the Corbyn camp, is very revealing. First, there is an understanding that Corbyn will have to try and bring at least some of the PLP back on board. Here are two direct quotes from the article:

“If we show competence, that will bring some people back onside,” says one senior figure. Another sums up the view: “The reality is that most MPs are not out to get him every day or talking to press. There are 10 or so who are, we could both name them, but there is a winnable middle out there.”

This suggests that there are those within team Corbyn who understand that

1. What I call the anti-Corbynistas - the far too vocal critics of Corbyn within the PLP - are a small minority. This is a very different picture from that held by some Corbyn supporters among the membership, who like to pretend that most of the PLP was always out to get Corbyn.
   
   
2. That the majority of the PLP are a “winnable middle”. Again, on most issues there is no fundamental policy divide between Corbyn and the PLP.
   
   
3. A major problem, as I have said many times, has been the lack of competence shown by the leadership. Once again, I have been told by many supporters that the countless complaints from MPs about this has been an exaggerated sham. Again, team Corbyn do not see it that way, which is positive (although I wish they would tell their supporters)!

As for the PLP, according to George Eaton they are following up a suggestion made by deputy leader Tom Watson to reinstate PLP elections for the shadow cabinet. It seems to me that, if suitably structured (in particular, allowing Corbyn to keep McDonnell as shadow Chancellor), this proposal could do two very helpful things for Corbyn. It would bring some of the talent among the PLP back to the front line, and it would have the possibility of rebooting Corbyn’s attempts to unite Labour. It would also give MPs something concrete to convince themselves, and tell the media, that things have changed since the vote of no confidence. But

“a Corbyn source dismissed the idea when I recently raised it: "It’s not going to happen, they don’t have the numbers to get it through conference." He added, however, that the election of a "PLP representative" was a possibility.”

It is not just about competence, but it is also about having an imaginative strategic vision. What team Corbyn should be doing now, before conference, is working with Watson to ensure that a compromise version of this idea can be agreed at conference.I am more than willing to be surprised.

Theresa May’s Brexit choice

William Wallace asks whether Brexit could split the Conservative party, even though we have voted for Brexit. The reason why this is still conceivable is clear to all except those who tweet ‘get over it’ or who are silly enough to think Brexit means Brexit has any meaning. There is, in economic terms at least, a world of difference between a Norway style deal or hard Brexit: thousands of pounds worth of difference for the future average UK household in fact. (Making trade more difficult with your immediate neighbour will reduce trade overall, which in turn will hit productivity growth and therefore living standards.)

Which option Theresa May chooses will be down to politics rather than the economic welfare of UK citizens. This is why the Conservative party will not split. Divisions over Europe have not split the party for the last two decades, and are much less likely to now that the Europhobes have had their victory. Nor will any decisions be made quickly, because the exact trade-off between single market access and free movement depends on the stance taken by the EU.

The EU could conceivably rule out membership of the single market under any account, in which case some form of hard Brexit would be inevitable. If the main objective of the EU is to ensure that the British economy does badly as a result of leaving, to offer a warning to those in other EU member states tempted to go down the same path, then the UK is simply screwed. However if the EU takes a more constructive line, along the lines of this Breugel paper, then the issue becomes how much of the single market the UK can get with some form of limits on EU migration. A simple model of the subsequent debate will be that Remainers within the cabinet will push for more single market and less restrictions on migration and the Leavers vice versa.

At first sight it appears bleak for the Remainers. Two Leavers, Fox and Davis, have been put in charge of working out what Brexit actually means. Are there any reasons to be optimistic from a Remain point of view? The answer is that there are quite a few.

1. Remainers have the big guns at the cabinet table: principally Hammond as Chancellor and Johnson at the Foreign Office. (Yes, Johnson was the lead campaigner for Brexit, but he neither wants to leave the single market nor restrict immigration. He did, however, want to become Prime Minister.) No Prime Minister likes overruling her Chancellor on economic matters. It will be May, not Fox or Davis, that will make the final choice of the point on the trade-off she is given in negotiations with the EU
   
   
2. UK business will overwhelmingly want to retain single market access, and in many cases also free movement, and this would normally be a powerful influence on any Conservative government. Some Conservative MPs are prepared to argue this case.
   
   
3. At their meeting yesterday the cabinet agreed that restricting immigration will be a red line in any negotiations. But this is the same party, led by the same politician, that has put immigration control as a key objective for the last six years, and has in practice failed to control non-EU immigration. Judged by what she has done during her period as Home secretary rather than what she has said, May is not too concerned with actually reducing immigration.
   
   
4. Part of the reason the Conservatives have focused on immigration in the past is because of the UKIP threat. But it has become clear that UKIP in practice is probably more of a threat to Labour than the Conservatives.

Yet having said all that, I cannot help feeling that I’m clutching at straws here. The Treasury nowadays often seems to only really care about the deficit and the City, and it is highly unlikely other EU countries will pass up the opportunity of stealing a lot of City business The rest of UK business can perhaps be bought off in other ways. As home secretary May’s efforts to restrict immigration may have been hampered by the concern of others (including Osborne) to help business, and she may be itching to now call the shots. And with Corbyn as Labour leader, she really has nothing to worry about in electoral terms. UK productivity stagnated under Cameron and Osborne for the first time since WWII, and she may be content to just be no worse that her predecessors on that score. So from a Remain perspective, and the prospects for UK living standards, hope is not yet lost but it is walking out of the door.