Stay informed with free updates
Simply sign up to the Global Economy myFT Digest — delivered directly to your inbox.
Let me introduce you to Hank. It is a project in macroeconomics that, according to one Nobel laureate, has “an electric charge”. It is increasingly infiltrating the likes of the Federal Reserve Board, the European Central Bank and the Bank of England. And it is one of the few acronyms for which economists deserve forgiveness. “Heterogeneous Agent New Keynesian” doesn’t exactly roll off the tongue.
The aim is to combine a theory of how the macroeconomy moves with the details of inequality. Rather than boiling consumers down to an average “representative agent”, Hank models include a fuller distribution of people, whose spending might depend on whether they are underwater on their mortgage, how exposed they are to an inflation shock, the risk that they lose their job — and the interaction of all three.
Interest surged after the global financial crisis. May Rostom, head of macro-modelling for the Bank of England, points out that older representative agent models struggled to show the outsized effect of a small group of people, who were unable to borrow, yanking back their spending. Hank models are “a big deal”, she says.
More recent questions include how demand is affected by unequally distributed fiscal stimulus or savings, as well as how richer and poorer households have been hit differently by inflation.
Matthew Rognlie of Northwestern University says that more broadly, the Hank trend tapped into a “well of discontent” with older, simpler models. Those assume consumers respond very strongly to changes in interest rates, and hardly at all to changes in their income. A bit like a model of my one-year-old in which 100 per cent of his meal makes it into his mouth.
Hank models try to match real-life spending behaviour more closely, assuming a willingness to consume out of extra income roughly 10 times larger than in the older models.
That changes the emphasis when thinking about monetary policy transmission, away from the idea that greater rewards for saving encourage more of it. Other mechanisms could include an interest rate increase that hits people with variable-rate mortgages living hand-to-mouth, damping spending. Or an interest rate cut could stimulate investment, pumping up wages of people who are particularly likely to splurge, boosting consumption.
All this complexity might seem a little daunting for central banks, as it suggests that the transmission of monetary policy depends on factors beyond their control. If a channel gets clogged — for example, if investment is sluggish in responding to a change in rates, buoying consumption might require more aggressive interest-rate cuts.
Another difference is in the treatment of fiscal policy. Those simpler models take stimulus cheques as impotent, as people expect future tax rises to pay for them, and save their windfall. Under Hank models, if the government hands money to people who are eager to spend it, overall activity could get a boost. For some purposes, monetary policy is less useful than fiscal policy, which can be targeted towards the neediest and those most likely to spend.
Augmenting macroeconomists’ models to make them reflect the richness of household differences sounds good. So why hasn’t Hank taken over yet? Despite big technological advances, they are still tough to handle technically. The European Central Bank recently acknowledged that further work was needed before euro-area statistics can be plugged in and results spat out.
Despite including more detail, there are still areas where such models don’t seem to meet a reality check. They don’t capture the fact that individual spending can take a while to respond to an interest rate change. And worryingly, a staff report from the New York Federal Reserve found that a prominent Hank model was “much worse” at forecasting consumption than its predecessor.
Although it seems clear that accounting for inequality is important, it is not yet clear that economists have landed on exactly the right way to do it. Ultimately, tugging one part of simplified models closer to reality will be limited if other parts are wrong. Ben Moll of the London School of Economics recently suggested that the assumption of rational expectations should be ditched, given that it requires people to hold a whole distribution of inequality in their heads.
In highlighting the power of fiscal policy and the importance of inequality, a cynical assessment of the Hank boom is that it is merely bringing the theory of macroeconomics up to speed with its practice. Even if there is some way to go, it is a move in the right direction.
soumaya.keynes@ft.com
Follow Soumaya Keynes with myFT and on X
Source: Economy - ft.com
