Econometric testing

I've been reading through a metrics text and thinking about traditional significance testing. One of the problems is that you can data mine your way to significance regardless of whether or not your actual theory explains what's happening. Other tests compare two different estimators to determine if one does a better job of modeling the data than another.

This got me thinking. How about starting with a theory, creating a model based on that theory and use your data to estimate the parameters of that function. Next, set that aside and throw raw statistics at your data set to find the best estimator (or a few best estimators, based on multiple criteria) to model that data, feel free to fold, spindle and mutilate as much as your heart pleases, use parametric and nonparametric estimators, whatever functional forms you can think of, whatever, just get a good R^2 and high p-values.

For example, you are trying to estimate a firm's production function with a large chunk of data on inputs, factor prices, costs, output, etc. Theory might lead you to believe the firm  has a Cobb-Douglas production function of the form y = A*K^(p)*L^(1-p), and you use your data to estimate a, K, L, and P. Next, you pull out all the stops and try as many models as possible to use the data available to estimate y most accurately, regardless of the functional form or transformations necessary to get "good" results. This second model becomes your null hypothesis against which you test your Cobb-Douglas estimate on a new data set.

Finally, the real test is to take your theory-based model and your statistics-based models, and apply them to a new data set (preferable with at least some observations out of sample compared to what you created the original models with.) Accept your theory based model if it does a better job predicting the dependent variable than the purely statistical models, reject if it doesn't, and think carefully about it if you get a mixed bag of results. This would seem to cut down on type I errors, but would it give you more type II errors? I'm thinking it would act something like a traditional significance test, except we replace the null hypothesis of 0 with a null hypothesis of a data mined model, and I would think that the result would be somewhat more informative.

MN Government spending as a percent of GDP

Data from www.usgovernmentspending.com.

Pulled data from MN's budget office and the BEA for GDP data. because the earlier data don't go back very far. The spending numbers don't match up with the usgovernmentspending.com site, but the MN budget info isn't clear, there are "general fund" spending and "all spending" sections, both of which are smaller than what the other site showed.

Evidence of Rational Criminals

As gas prices rise, it seems like every news source I see is talking about increases in drive offs from gas stations and stolen gas. This sounds like reasonably strong evidence of rational criminals: As the price of gas rises, people are substituting from "gasoline" to "stolen gasoline." Given the number of gallons sold, number of customers, number of gallons stolen, and number of thieves at each price per gallon, you could probably estimate a cross price elasticity for stolen gas relative to purchased gas. Prepay and pay-at-the-pump stations might be confounding factors. Hmmm, it might also be interesting to see see if the relative price of gas compared to other stations is more important than the absolute price of gas in determining how much is stolen. And does everyone who steals gas fill up completely (or steal more gas on average than paying customers buy)?

From that, you could also estimate the marginal criminal's estimate of the expected cost of stealing gas. Add in the fine for stealing gas and the likelihood of getting caught, you should be able to estimate how risk loving the marginal criminal is.

I'd love to get my hands on some numbers.

Finally someone talking about Excess Reserves

We've had, what, 3 explicit rounds of quantitative easing now, as well as other rounds of less advertised expansions of the monetary base since 2007 yet we've seen no real inflation. I hear a lot of people talking about the increased M1, but very few people talk about the cause of the missing inflation: Increased excess reserved held by banks most likely because the Fed is now paying interest on reserves. Carpe Diem has a great graph:

Finally there is some discussion of this factor, according to Carpe Diem the NY Fed has a paper out titled "Why Are Banks Holding So Many Excess Reserves?"

From their conclusion:

Paying interest
on reserves allows a central bank to maintain its influence over market interest rates independent
of the quantity of reserves created by its liquidity facilities. The central bank can then let the size
of these facilities be determined by conditions in the financial sector, while setting its target for
the short-term interest rate based on macroeconomic conditions. This ability to separate
monetary policy from the quantity of bank reserves is particularly important during the recovery
from a financial crisis. If inflationary pressures begin to appear while the liquidity facilities are
still in use, the central bank can use its interest-on-reserves policy to raise interest rates without
necessarily removing all of the reserves created by the facilities.

This sounds to me like the rounds of quantitative easing, then, were not so much aimed at stimulating economic output, but were instead intended to shore up banks. You increase liquidity, and you increase bank revenue streams without significantly impacting anything outside of the banking sector... Sounds pretty similar to TARP but with less obvious numbers.

I haven't had a chance to read the paper yet, but I'm curious to see how far off the mark I am. And if this doesn't make for a subsidy to banks, what was the point of increasing the currency base without increasing the interest rate or price level?

Intrafirm Coasian bargaining

There are some situations even within firms where one department will pay the costs of an activity and another will reap the benefits. I imagine this can lead to as inefficient outcomes as out in the world when people face externalities.

Take IT support, for example. Generally this is its own department, it is staffed and funded to provide support (and often the IT related capital equipment) for the rest of the company. In large part, the budget of this department is based upon the costs required to support the needs of the rest of the firm. This can be fairly straight forward: A helpdesk that fields N calls a day needs X operators to support the volume, etc.

But not all costs are directly passed through and who determines the level of support? Take vendor support contracts for example. The IT department often pays for that contract, but they have multiple options on the service level: Should they get 24x7 support with a 4 hour response time, or 8x5 support with next business day response time? The value of the different options are based on the section of the business being supported, but the people buying the contract don't have direct access to that information. How costly is it for a site to be down overnight? That depends not only on how much business that site does, but the hours of operation. Is 24x7 support really superior to 8x5 support when the site is only open 8am to 5pm Monday through Friday?

Questions like this might best be addressed in a Coasian light: In the support contract example, rather than have the IT department handle everything, let IT use their experience negotiating the contract but have the supported business unit pay for it. That pushes the cost of the support down to the group that actually gains value from its exercise.

And when the IT support staff has to pass on the bad news that users will be down for the next couple days because the support contract sucks, at least they can blame somebody else =)

A new kind of bookstore

Maybe more of a value added service to a coffee shop. I'm thinking of a bookstore where most of the books are explicitly for browsing and reading, like in a library. Provide as much space for relaxing with a good read as shelf space, offer coffee and snacks.

Then sell ebooks. (Sure, keep a limited selection of paper books for sale directly, but focus your space on creating a good reading environment, not cramming in as many titles as possible.) Provide wireless internet connection and work with ebook providers to give you a cut on every sale from your IP address range. Sell ebooks from the register through a pay-now-download-later setup, and conversely, allow customers on your LAN to place their drink orders wirelessly.

It might not work well primarily as a bookstore, I really don't see ebooks carrying the same kind of margins as print books. But as a coffee shop, it might give you a competetive edge. And a chance to offer people a way to "try before you buy" comfortably and guiltlessly. A combination current bookstores never seem to manage.

Thought I found another great Japanese beer

Japan, East Asia in general, in my experience doesn't brew very good beer. Most of the beers I see from Asian countries are in the Budweiser territory, you drink them because you're thirsty, or to get drunk. They're mild and inoffensive, but they don't have a whole lot of flavor to recommend them, either.

Except for Hitachino Nest. This Japanese craft brewery does it right, they're easily up there with the best American and Belgian beers I've had. I would say it's my favorite brewery, and I certainly hope they expand production because at $6.50 to $9.00 a 12 oz. bottle in the liquor store, it's a rare treat.

This weekend I thought I found a comparable Japanese beer, Morimoto Soba Ale. Turns out that it's produced by Rogue (so I don't read labels closely while shopping, I like to call it minimizing search costs) so my dreams of a second excellent Japanese brewery were put on hold, but the beer is still excellent. Soba is buckwheat, so I expected something like a wheat beer. This was closer to an amber ale, none of the almost sweetness you get with wheat beer, but lighter in the mid palette than your average amber ale. Excellent from the first taste.

Add in Stone Brewery's Levitation Ale and it's been a good beer weekend. Granite City's Brother Benedict Bock is, I'm sure, a fine example of it's style but I mainly had it to confirm that bocks just aren't my thing. It's been a few years, tastes evolve, just wanted to make sure my impression was still relevant.