Thomas Sargent, Master Macroeconomist
By Arnold Kling
In an interview, he says,
the more dynamic, uncertain and ambiguous is the economic environment that you seek to model, the more you are going to have to roll up your sleeves, and learn and use some math.
Pointer from Mark Thoma. Self-recommending, because Sargent is to rational expectations macro what Hicks is to Keynesian macro. Samizdat versions of Sargent’s graduate macro lecture notes were for us what “Mr. Keynes and the Classics” was to an earlier generation.
You know that I am not a fan of mathematical economics, but I am a fan of Sargent. There is a great deal to chew on in the interview, including his thoughts on the relationship between modern finance and macro as well as this on the labor market:
Lars [Ljungqvist] and I believe that when people now become unemployed, they’re taking a more or less permanent hit to their level of human capital, a larger one than they might have received before 1980. We have a theory that people build up human capital while they’re working on a job, but lose human capital when they’re displaced from a job. We think that after 1980, people in Western economies started suffering bigger drops in their human capital at the moment that they suffer a job displacement.
…Our models have cohorts of aging heterogeneous workers. Our models imply that people in Europe, especially older workers, are suffering from long-term unemployment because of the adverse incentives brought about by a generous social safety net when it interacts with these human capital dynamics.
So, we don’t have a representative agent working at the GDP factory, but instead we have heterogeneous workers. And some of them take big hits to their human capital. This is very close to the ZMP and Recalculation Story. The marginal product falls, not to zero, but to the point where safety-net supported unemployment is preferable to taking a job at one’s marginal product. As Sargent puts it,
Unemployment compensation systems typically award you compensation that’s linked to your earnings on your last job; those past earnings reflect your past human capital, not your current opportunities or current human capital. That can make collecting unemployment compensation at rates reflecting your past (and now obsolete) human capital more desirable than accepting a job whose earnings reflect a return on your current depreciated level of human capital. This mechanism sets an incentive trap that induces the European worker to withdraw from active labor market participation.
What does that mean for the U.S. now?
the politics of the current situation can imply that so long as unemployment is high, we’re going to extend the duration and generosity of benefits. And that extension, done out of the best of motives, is exactly what can lead to the trap of persistently high unemployment.
Again, I would say that we could ameliorate this risk by allowing people to continue to collect unemployment compensation after they take a new job. At the margin, this would make taking the new job more lucrative than when you lose unemployment benefits upon taking the job.
The final section of the interview discusses sovereign debt issues. As I read through it, I nodded my head vigorously in agreement. Then Sargent hit me with,
notice that throughout our discussion, Art, we’ve been using the vocabulary of rational expectations.
Ouch! On the one hand, I use Krugman’s dismissive term Dark Age Macro to describe what Sargent unleashed on the profession. On the other hand, my guessing the trigger point paper stands on the shoulders of some of that stuff.