Saturday, December 31, 2016

Pushing the Boundaries of Economics

As a macroeconomist, I mostly research the types of concepts that are more traditionally associated with economics, like inflation and interest rates. But one of the great things about economics training, in my opinion, is that you receive enough general training to be able to follow much of what is going on in other fields. It is always interesting for me to read papers or attend seminars in applied microeconomics to see the wide (and expanding) scope of the discipline.

Gary Becker won the Nobel Prize in 1992 "for having extended the domain of microeconomic analysis to a wide range of human behaviour and interaction, including nonmarket behaviour" and "to aspects of human behavior which had previously been dealt with by other social science disciplines such as sociology, demography and criminology." The Freakonomics books and podcast have gone a long way in popularizing this approach. But it is not without its critics, both within and outside the profession.

For all that the economic way of thinking and the quantitative tools of econometrics can add in addressing a boundless variety of questions, there is also much that our analysis and tools leave out. In areas like health or criminology, the assumptions and calculations that seem perfectly reasonable to an economist may seem anywhere from misguided to offensive to a medical doctor or criminologist. Roland Fryer's working paper on racial differences in police use of force, for example, was prominently covered with both praise and criticism.

Another NBER working paper, released this week by Jonathan de Quidt and Johannes Haushofer, is also pushing the boundaries of economics, arguing that "depression has not received significant attention in the economics literature." By depression, they are referring to major depressive disorder (MDD), not a particularly severe recession. While neither of the authors holds a medical degree, Haushofer holds doctorates in both economics and neurobiology. In "Depression for Economists," they build a model in which individuals choose to exert either high or low effort; depression is induced by a negative "shock" to an individual's belief about her return to high effort.

In the model, the individual's income depends on her effort, amount of sleep, and food consumption. Her utility depends on her sleep, food consumption, and non-food consumption. She maximizes utility given her belief about her return to effort, which she updates in a Bayesian manner. If her belief about her return to effort declines (synonymous in the model to becoming depressed), she exerts less labor effort. Her total (food and non-food) consumption and utility unambiguously decrease, leading to "depressed mood." In the extreme, she may reduce her labor effort to zero, at which point she would stop learning more about her return to effort and get stuck in a "poverty trap."

The depressed individual's sleeping and food consumption may either increase or decrease, as consumption motives become more important relative to production motives. In other words, she sleeps and eats closer to the amounts that she would choose if she cared only about the utility directly from sleeping and eating, and not about how her sleeping and eating choices affect her ability to produce.

While this result does match the empirical findings in the medical literature that depression may either reduce or increase sleep duration and lead to either over- or under-eating, it seems implausible to me that depressed individuals sleep ten or more hours a day because they just love sleeping, or lose their appetite because they don't enjoy food beyond its ability to help them be productive. I'm not an expert, but from what I understand there are physiological and chemical reasons for the change in sleep patterns and appetite that could be independent of a person's beliefs about their returns to labor effort.

However, the authors argue that an "advantage of our model is that it resonates with prominent psychological and psychiatric theories of depression, and the therapeutic approaches to which they gave rise." They refer in particular to "Charles Ferster, who argued that depression resulted from an overexposure to negative reinforcement and underexposure to positive reinforcement in the environment (Ferster 1973)...Ferster’s account of the etiology of depression is in line with how we model depression here, namely as a consequence of exposure to negative shocks." They also refer to the work of psychiatrist Aaron Beck (1967), whose suggested that depression arises from "distorted thinking" motivates the use of Cognitive Behavioral Therapy (CBT), a standard treatment for depression.

The authors note that "Our main goal in writing this paper was to give economists a starting point for thinking and writing about depression using the language of economics. We have therefore kept the model as simple as possible." They also steer clear of suggesting any policy implications (other than implicitly providing support for CBT.) It will be fascinating to see whether and how the medical community responds, and also to hear from economists who have themselves experienced depression.

Monday, December 5, 2016

The Future is Uncertain, but So Is the Past

In a recently-released research note, Federal Reserve Board economists Alan Detmeister, David Lebow, and Ekaterina Peneva summarize new survey results on consumers' inflation perceptions. The well-known Michigan Survey of Consumers asks consumers about their expectations of future inflation (over the next year and 5- to 10- years), but does not ask them what they believe inflation has been in recent years.

In many macroeconomic models, inflation perceptions should be nearly perfect. After all, inflation statistics are publicly available, and anyone should be able to access them. The Federal Reserve commissioned the Michigan Survey of Consumers Research Center to survey consumers about their perceptions of inflation over the past year and over the past 5- to 10-years, using analogous wording to the questions about inflation expectations. As you might guess, consumers lack perfect knowledge of inflation in the recent past. If you're like most people (which, by dent of reading an economic blog, you are probably not), you probably haven't looked up inflation statistics or read the financial news recently.

But more surprisingly, consumers seem just as uncertain about past inflation, or even more so, as about future inflation. Take a look at these histograms of inflation perceptions and expectations from the February 2016 survey data:

Source: December 5 FEDS Note

Compare Panel A to Panel C. Panel A shows consumers' perceptions of inflation over the past 5- to 10-years, and Panel C shows their expectations for the next 5- to 10-years. Both panels show a great deal of dispersion, or variation across consumers. But also notice the response heaping at multiples of 5%. In both panels, over 10% of respondents choose 5%, and you also see more 10% responses than either 9% or 11% responses. In a working paper, I show that this response heaping is indicative of high uncertainty. Consumers choose a 5%, 10%, 15%, etc. response to indicate high imprecision in their estimates of future inflation. So it is quite surprising that even more consumers choose the 10, 15, 20, and 25% responses for perceptions of past inflation than for expectations of future inflation.

The response heaping at multiples of 5% is also quite substantial for short-term inflation perceptions (Panel B). Without access to the underlying data, I can't tell for sure whether it is more or less prevalent than for expectations of future short-term inflation, but it is certainly noticeable.

What does this tell us? People are just as unsure about inflation in the relatively recent past as they are about inflation in the near to medium-run future. And this says something important for monetary policymakers. A goal of the Federal Reserve is to anchor medium- to long-run inflation expectations at the 2% target. With strongly-anchored expectations, we should see most expectations near 2% with low uncertainty. If people are uncertain about longer-run inflation, it could either be that they are unaware of the Fed's inflation target, or aware but unconvinced that the Fed will actually achieve its target. It is difficult to say which is the case. The former would imply that we need more public informedness about economic concepts and the Fed, while the latter would imply that the Fed needs to improve its credibility among an already-informed public. Since perceptions are about as uncertain as expectations, this lends support to the idea that people are simply uninformed about inflation-- or that memory of economic statistics is relatively poor.