The quest to save macroeconomics from itself

0:00This message comes from Capital One. Capital One offers checking accounts with no fees or minimum. What's in your wallet? Terms apply. See CapitalOne.com slash bank for details. Capital One N.A. Member FDIC. This is Planet Money from NPR. You know what really drives me up the wall? Is it Jeff Guo rant hour? We're doing this right here. All right. What drives you up the wall? I really hate it when people talk trash about economics. You know, like, oh, economists, they don't know anything. They didn't even see the financial crisis coming. But they didn't see the financial crisis coming, Jeff. So what's the rub?

0:43OK, I know, I know. But the economists that don't know anything, those are not all economists. Those are just the macroeconomists. They're the ones giving econ a bad name. Right. So as every Planet Money listener knows, macroeconomists, they are in charge of studying all the big forces in the economy. inflation, unemployment, growth. Whereas the microeconomists, they think about how businesses and people make decisions out in the world. Right. And the microeconomists, they know things. Microeconomists look at actual data. They're running experiments. They are legitimately trying to do science.

1:21Which means, Jeff, your stance is that the macroeconomists are not trying to do science. Macroeconomics is basically astrology, Nick. Like, look at inflation. Macroeconomists still don't even know how it works, if it's mostly caused by real problems in the economy, or if it's like mostly a mind game, people like raising prices because they think everyone else is raising prices. Macroeconomists don't know. They're just out there making up theories, building their complicated models that famously don't work. Jeff, I've heard your macro rant before. I'm sure I'll hear it again. We've all heard it at Planet Money.

1:58Why today of all days are you doing the macro rant? Because, Nick, today I am turning over a new leaf. I've been reading up on this newer branch of macroeconomics that's been making a lot of breakthroughs recently. It's called empirical macroeconomics. As opposed to fantasy macroeconomics? Well, right. These empirical macroeconomists, they're doing the thing I've always wanted macroeconomics to do. Instead of relying so much on theories, they're out there looking for clues, hunting down new kinds of data, actual data. And I truly believe that if anyone is going to get us real answers to these big questions about the economy, it's going to be them.

2:44Hello and welcome to Planet Money. I'm Jeff Guo. And I'm Nick Fountain. And Jeff, today we are going to turn the entire show over to you because you're going to talk to one of these empirical macroeconomists, Emi Nakamura. She's a professor at UC Berkeley. Yeah, Emi is like this econ genius, and she is trying to use actual data to settle these longstanding economics debates. Like, can government spending pull us out of a recession? What's the best way to fight inflation? And it's all part of a bigger project to solve one of the most important and, frankly, most embarrassing problems in economics, which is how do we get macroeconomics to actually make sense?

3:23Today on the show, can Emi Nakamura save macroeconomics? Or at least convince Jeff that it's not total nonsense.

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4:17Her grandfather was an econometrician. Both her parents are microeconomists, you know, the good guys, the economists that actually use data. So that seemed like a good place to start our interview. You were kind of raised in the world of economics, right? Like, both your parents were economists. Your grandfather was an economist. Like, what were dinner conversations like? So it's funny, because I don't remember a lot of conversations about economics per se. But I do remember sort of a general undertone of the importance of measurement and of data and of natural experiments and experiments more generally.

4:56So one movie that I've actually remember very well watching with my parents, it's an old movie with Jeff Goldblum called The Race for the Double Helix. The Race for the Double Helix. Yeah, it's about the process by which the double helix structure of DNA was discovered. And I remember there's a quote from the movie that my parents repeated to me, which was, there's nothing worse than a wrong fact. Nothing worse than a wrong fact. Because then you're aiming your theories at the wrong endpoint. And if you can correct the fact, then of course, it might still be a long journey to the right theory, but at least you're not trying to fit something that isn't true.

5:36So that has been an idea that has really influenced me over time. And it's always been sort of a reflex for me to be very focused on measurement. And I think actually part of the way that I got interested in some of the microeconomic underpinnings and macroeconomic ideas is because it was such a reflex for me to think about, well, if I see a measure like GDP or inflation, how is that constructed? Where does it actually come from? What are the underlying facts? Exactly, exactly. Because if we're going to spend all our time working on these kinds of statistics, then we want to know where they come from and know that they're right.

6:12Make sure your telescope lenses are clean. Exactly, exactly. And then once you get started cleaning those telescope lenses, then you see a lot of things. But seeing things clearly, that's kind of been the big problem with macroeconomics. Macroeconomics, it's all about these big questions like, why do some economies grow so much faster than others? How long is the next recession going to last? How do we stop inflation without wrecking the rest of the economy? And even some macroeconomists are saying we're still kind of in the dark ages when it comes to all that stuff. And so in the next part of our interview, I asked Emi, why has progress been so slow?

6:51You know, every couple of years you have this like famous macroeconomist who comes out and says, we don't know anything. We actually have no idea how inflation works. We know nothing. And I'm like, you guys have been working on this for like maybe centuries. Like, surely we have to know something. Why are people saying that we don't know anything? Okay. So first, I think the humble answer is to emphasize the fact that the macroeconomic environment is changing pretty rapidly. So the current monetary environment really has only been around since the 1950s. So the world was on the gold standard for most of, you know, human, for a lot of human history.

7:27It was on other kinds of, there were stones, there were other monetary systems. in history, but those are not the same as the system we have today. And so one, I think, important answer to your question is that unlike physics, macroeconomics faces the challenge of a continually changing environment. Like the modern economic world was born like just a couple decades ago. That's right. And so how many recessions do we have to analyze in the current environment? I guess when I used to like, I don't know, roll my eyes at macro people, I guess I didn't realize how little data there was to work with.

8:04Yeah, absolutely. So I would say traditionally, macro focused on looking at, say, GDP or inflation in every year, maybe in every quarter of the year. But still, if you're going to say that the modern macroeconomic era only started in 1980 or 1950, you realize that if you're going to try to think about questions like recessions or the effect of fiscal stimulus or of monetary tightening or something like this, often we only have a few major episodes to think about. So thankfully, events like the Great Depression or the financial crisis, they don't happen often. But that does mean that we are in a situation of trying to extrapolate from relatively small numbers of events.

8:50Yeah, it's kind of like what you're describing. It's kind of like we have this ship called an economy and there are a bunch of like different dials and levers and knobs and things. And we haven't had it for that long. And we're trying to figure out which one does what. What do you press to make it go up? What do you press to make it go down? And sometimes the ship just kind of crashes into something and you're like, well, what was that? Yep. Yep. I think that's right because you're kind of you're potentially going into uncharted waters. And the longer you sail the ship, at least the same ship, if you're in the same ship, and that's the other issue that we're rebuilding the ship on a regular basis.

9:25But the longer you sail the ship, then the more you can kind of learn about the hazards that are out there, right? But then if you decide to change the ship so it has like a deeper hull or something like that, now you start running into new kinds of rocks and so on that you didn't even know existed. So I think that is the analogy. And that, according to Emmy, is the big challenge for macroeconomics. The economy is constantly changing and the data that's out there, it's just not good enough to make heads or tails of what's going on most of the time. So what are you supposed to do about all that?

10:00That is After the Break.

10:08This message comes from Capital One with the Quicksilver card. Earn unlimited 1.5 % cash back on every purchase, every day. What's in your wallet? Terms apply. See CapitalOne.com for details. This message comes from Charles Schwab. When it comes to managing your wealth, Schwab gives you more choices, like full-service wealth management and advice when you need it. You can also invest on your own and trade on Think or Swim. Visit Schwab.com to learn more. There's this very old idea in economics. You've all heard of it. It's called the invisible hand. And the idea is, you know, if something puts the markets out of whack, like if all of a sudden the wheat harvest fails or if someone invents a cheaper way to make clothing, the economy will eventually find its way back to equilibrium.

11:00The invisible hand will work its magic. And the way that works is through prices. The price of wheat will go up. The price of clothing will go down. And presto, supply will equal demand again. And in theory, the invisible hand means that economies are mostly self-correcting. They should just snap back to equilibrium. But in practice, that doesn't always happen right away. In fact, the question of how quickly or slowly this invisible hand works its magic is at the center of some of the biggest debates in macroeconomics. And for Emi Nakamura, that is the question she has spent a lot of her career trying to answer.

11:44So you've done a lot of work trying to understand how companies set prices. Why is that such a big deal? Yeah, that's a good question. I think many people's reaction to that is, why are we talking about the price of Cheerios? I really got into economics to think about something more important. But you have to recognize that this is the invisible hand that we think of as making markets work. What does that mean? It means that when you think about supply and demand, and how does it happen that we have supply equating demand, the way it works is by the prices adjusting to make the supply increase and the demand fall.

12:21And if the prices aren't doing that perfectly, maybe if they're just off by a little bit, maybe this could lead to a very large difference from the ideal efficient outcome that we could imagine coming from a market economy. Yeah. And it's almost maybe another way to think about that is like if you think that the invisible hand is super nimble and the economy adjusts really quickly, prices adjust really quickly, then anything that happens, whether it's a shock, a pale storm, the government printing more money, the government, you know, spending more money, like none of that really matters that much.

12:53That's exactly right. Things are buffered by the price mechanism to a much greater extent. The invisible hand is going to fix everything for us. That's right. But once you get into a situation where the prices are not adjusting in such a nimble way, then there's potentially much more room for it to be important for the Fed, for example, to have the right policies. Because if it has the wrong policies, it's not all just going to be fixed by the invisible hand. And I think sometimes people forget how surprising it is that monetary policy does anything at all. the simple analogy that you can give is if you double the amount of money in the economy but all the prices instantly double then absolutely nothing happens it's like saying you know if we measure your height in centimeters or inches you're still going to be the same height you know no effect what monetary policy is controlling is literally just the units yeah and so how do you get to a place where the units matter and that's where you have to come back to price adjustment Because in my little example of supposedly double the money supply and all prices double, then nothing happens.

13:56Well, this is an example where we think about completely flexible prices. Perfectly nimble, perfectly nimble, invisible hand. Exactly. So studying prices in the context of macroeconomics is a lot about thinking about where we are relative to this perfectly nimble, invisible hand. So all these debates about like, does the Fed matter? Does the Fed setting interest rates, does that even matter? Does the government spending money, does that even matter? All of that, in a way, is a debate about do these prices adjust fast enough on their own or not? Exactly. And that's where I think, again, we in macroeconomics and me personally, we're kind of triangulate from different forms of evidence.

14:33I want to talk about your work, really looking to see how this invisible hand works, because you went and got your own data, right? Well, so there was a group of researchers that had sort of started to use the price data underlying the U.S. Consumer Price Index because the government actually does go into stores all around the country and look at the prices on the shelves. That's how we know how much inflation there is. Exactly. That's how inflation is measured. And what hadn't been done was at the time, even actually people in the Bureau of Labor Statistics themselves weren't able to really do research with these data.

15:12It was a time when the data were kind of on some kind of big computer that was used to construct the inflation index, but it wasn't a data set that was very user friendly for doing other kinds of analysis. And so for my thesis, I spent quite a bit of time in like a windowless room at the Bureau of Labor Statistics. Wait, you gave me a picture. Where was this? The Bureau of Labor Statistics is a giant building. And because it's such a giant building, there are many rooms sort of in the bowels of the building with no windows. And the initial data set that we were using only went back to the 1980s.

15:48And so I kind of realized at some point from some of the older people who worked at the Bureau of Labor Statistics that there were these dusty old cabinets filled with microfilm cartridges of prices from the 1970s. And in addition to that, these microfilm cartridges, they actually did not have a reader to read them anymore. There had been a reader, but the last reader they could read these microfilm cartridges had actually broken. This sounds like the Da Vinci Code or something. So there's this like secret data set that only exists on, you said, microfilm. But it wasn't just microfilm. It was this old kind of microfilm cartridge, which modern readers couldn't actually read.

16:29Oh, my God. So what happened? Well, eventually we found this company that was willing to retrofit a modern cartridge reader to read these old cartridges. You had to build your own. It was definitely a labor of love. But in the end, the great thing about it is that we were successfully able to see the microdata. And the exciting thing, the reason that we were so excited about bringing these data back to the 1970s is because that's when the last major inflationary episode was in the United States. So we spent quite a bit of time talking about the small number of data points. And so this is the big data point on inflation in the United States in the recent period.

17:06It's the late 1970s and the early 1980s. It's like you were literally like an archaeologist and you found this fossil from the last time of the great inflation. Exactly. Exactly. And let me just give you some of Emmy's greatest hits here. Emmy has used detailed data to answer a lot of questions about how prices change in the economy. For instance, economists used to believe that with new technology and online shopping, you know, prices would start to change faster and faster. But Emmy found the opposite. If anything, prices in recent decades may have been slower to adjust. And that has big macroeconomic implications.

17:43Because if the invisible hand isn't all that nimble, then it's important for the government to step in to help bring things back to equilibrium. Emmy has also found clever ways of using data to weigh in on a lot of other big debates in macroeconomics. She's found a way to prove that when the government spends money, it's not just moving that money from one pocket to another. government spending can actually boost the economy. She's also used patterns in the data to point out new mysteries, like why was inflation so low in the years leading up to the pandemic? Emmy says that, according to the data, people's expectations about inflation are actually way more important than we used to think.

18:24You know, I used to love to make fun of macroeconomics, but I gotta say, this research, it's pretty impressive stuff. Like we are legitimately starting to find answers to some of these big macro questions. And by the end of the interview, I kind of felt bad for being such a big hater. So I had to come clean. When I first heard about you, you had won like a bunch of really big prizes. Everyone was talking about all of these papers that you were coming out with. And people described you as an empirical macro economist. And that was the first time I'd ever heard that phrase. And I was like, that truly does sound like an oxymoron.

19:06I'm very excited about that phrase. I'm seeing it more and more used by others as well. And, you know, I think it's a field that to me clearly should exist. You know, I think it's an exaggeration to say that there wasn't anybody in this field before, but I think it's growing. And I think that makes a lot of sense given the world that we live in, where there's an increasing amount of data and the fact that, you know, there's no question that we still need to make progress on these macroeconomic questions. And credit where credit's due, because of empirical macroeconomists like Emmy, that progress, it is actually happening.

19:42Just slowly, one dusty microfilm cartridge at a time. This show was produced by Dave Blanchard with help from Sam Yellowhorse Kessler. Additional recording help from Jazz Williams. It was engineered by Josephine Neonai and fact-checked by Sierra Juarez. Keith Romer edited the show. Alex Goldmark is our executive producer. I'm Jeff Guo. This is NPR. Thanks for listening.