You are currently browsing the monthly archive for June 2010.
Two blog posts I’ve read in the last day struck me like the ghost of christmas yet to come, and arose in me an urge to quit blogging, quit reading blogs, and quit reading the daily news. The first is an admonition from Robin Hanson against consumption of novel information:
Until you reach the state of the art, and are ready to be at the very forefront of advancing human knowledge, most of what you should read to get to that forefront isn’t today’s news, or even today’s blogger musings. Read classic books and articles, textbooks, review articles. Then maybe read focused publications (including perhaps some blog posts) on your chosen focus topic(s).
The second I came across while searching for an old post at Greg Mankiw’s blog. It is his advice for new junior faculty, which I am not, but it never the less resonated with me:
Avoid activities that will distract you from research. Whatever you do, do not start a blog. That will only establish your lack of seriousness as a scholar.
Perhaps I am on the verge of being persuaded by these appeals because, unlike Katja Grace, I am not entirely comfortable with my level of thinking vs reading. Katja writes:
The extreme of thinking with no intellectual input gets you as far as a thoughtful caveman. The other extreme is zero improvement on what exists around you. I’m not sure what the optimal compromise is, and it would depend on the topic, but I suspect I am biased in favor of thinking….[M]ore people seem toward the reading end of your spectrum and like a lot of detailed knowledge, keeping up with everything that happens without trying to add much to it… I mostly feel like I don’t read enough personally because reading seems so slow compared to thinking, but I suppose if I really cared I would have learned to speed read by now.
The thinking that blogging involves thinking is usually relatively short term focused, and doesn’t require you to stay with an idea or topic as long as reading a great book does, nor does it usually draw you as deeply in. Blogging also allows you to think about whatever piques your interest in the moment, and think about whatever your brain feels like thinking about. I don’t think this is a good way to learn about the world, because this draws you to ideas and topics that have an immediate novelty or are obviously interesting. In contrast, when you’re reading you’ve made a several hundred page commitment to focusing on a topic, and can’t just switch topics when things get a little dry or lose their novelty.
Blogging is like a conversation, you’re covering a lot of ground, thinking, and learning, which seems good. But topics change quickly and the focus tends to be on being things that are obviously interesting and can be communicated relatively quickly and easily. Some of the most important and ultimately interesting ideas come slowly and take a lot of heavy lifting and hard work. I am worried this conversation is too distracting for my own good, and is crowding out the heavy lifting.
I blame Yglesias and Cowen.
Tyler Cowen recently linked to a Wikipedia article for BitCoin; a decentralized, peer-to-peer (crypto-)currency. I originally found the idea quite confusing (but I’m not a master of p2p technology), but Leigh Caldwell recently brought it up and after doing a little research, and joining the network myself, I’ll offer some comments.
BitCoin is a money that uses a p2p protocol similar to HashCash to resolve transactions. Apparently there is planned to be a finite amount of this currency generated (at BC 21,000,000). Currency is “earned” by using your CPU clocks to resolve transactions, which ensures that each BitCoin unit only gets spent for a single transaction once…or, of course, buy selling goods and services.
In effect, what you are doing is hiring your computer to work for you in the former scenario. You also happen to be your own banker, and your own transaction clearing house. I’m not sure exactly how much you “earn” for each transaction you resolve, but I haven’t appreciated a sizable amount of currency as of yet. The downside to this is that at some given exchange rate, it might not be profitable to run your computer 24/7 to generate BC…but of course if you leave your computer on all the time anyway (as I do), then the opportunity cost is zero.
(Note: Second Life has this kind of structure too, where you can earn small amounts from the game itself, and in Entropia: Universe you can earn money by “sweating” things.)
In any case, this is literally a “wild-west” of money, and there are infinite sorts of possibilities.
Currently, BC is in an “inflationary” state, where currency is being issued. Apparently there are around BC 2-5 million units in circulation. However, you cannot earn interest — BUT, there is nothing stopping you from creating an amortization schedule by purchasing BitCoin on an exchange, thereby creating an interest-bearing account.
There is a marketplace at the site in which I’ve found ideas for a lottery, an operational casino, quite a few ads for electronics, and apparently some guy was able to get a Papa John’s pizza.
However, these types of transactions don’t intrigue me as much as the possibility for entirely new financal institutions to arise, due to the open-ended nature of the project. No “banks” have arisen, but it seems possible that they could. There is some sort of bond market that is denominated in BitCoin, but I can’t find the link right now. There are both nominal and real exchange rates, which means it is definitely possible that a more robust “forex” market could arise. Unfortunately without robust, forward-looking markets, it is nearly impossible to tell how the knowledge that the currency will be fixed at some point in the future affects current variables…and I don’t even think that is a good idea, although BitCoin does resolve to the eighth decimal place, so there is ample room for deflation…
BitCoin loans backed by diversified assets is another realm to explore — although the founders seem to be against fractional-reserve banking.
Okay, now for the sobering part. If you are a fan of alternative currency systems, the turn-of-the-century looked like a golden age for your aspirations. The internet seemed to offer unlimited promise…but of course, that was all shattered by reality. Peter Thiel started PayPal as an alternative exchange system, only to become a simple payment clearing house due to the harsh realities of regulation. RevolutionMoney had similar high ambitions. e-Gold became a favorite among money launderers, and was subsequently shut down, and BitCoin runs the same risk. Exchanges are currently a legal gray area, but you can probably assume they are illegal, and any meaningful sort of banking is out the door…and should you find yourself incredibly “BitWealthy”, you can bet that when you make your first large transaction, you’ll get a (not so) friendly knock at the door from the IRS.
Of course, this suspicion is inextricably linked to the fact that a popular “feature” of BitCoin is the perceived privacy…and also the talks of people in China using this currency to exchange for dollars using proxies, circumventing the state.
In his book, Alan Greenspan said he “foresees private currency markets in the 21st century”. This may be a step in the that direction, but the state is a terrible beast to overcome.
And finally, three questions:
It seems the only risk to hoarding is that the currency might not even exist by the time the “deflationary period” sets in. This actively discourages me from selling anything of marginal value (to me)…and discourages me from investing. This limits both my income, and the types of transactions that get made to odd junk and novelties (of course one man’s trash…) Are the benefits in terms of the reduction in transaction costs sufficient to be able to overcome these “features”?
Currently, there is no eBay-style reputation system. This obviously poses an incredible problem…but transactions in BC are non-recourse (as there is no clearing house)…so you have to rely on a mutual agreement on returns. Does this justify the lack of transaction costs in the long run?
There is no postal service that will deliver goods for BC. This necessarily pushes you into the “dollar economy” anyway. I wonder at what point BitCoins become useful enough that something like that could arise? Could it arise in a deflationary environment?
Addendum: Last thought, I swear! BitCoins seem insufficiently immobile. As it stands, I need to get a 34 character alphanumeric address unique to each user to be able to transfer credits. I also need to be at my one computer to be able to access my account. This is no doubt due to the emphasis on privacy…but it seems like a very large drawback to the use of the currency. I wonder how hard it would be to adapt mobile technology to this format.
Paul Krugman asks a provocative question with his slides, which accompanied his presentation regarding income inequality and crises:
So a return of inequality to 1920s levels was followedby a financial crisis similar to the onset of theGreat Depression. Why? Three possibilities:
2. Common causation –e.g., neoliberal ideology
3. Actual causation: inequality somehow createsmacroeconomic vulnerability
Really, we can scratch off number two (at least the pet example Krugman gives). As Scott Sumner has pointed out, the US is actually behind the curve on neo-liberalism. The much more “equal” countries in western Europe have been neo-liberalizing like crazy (to the point where Denmark is the ‘freest’ economy on earth, by multiple measures), but retain their egalitarianism.
What is it that European countries do? Massive income redistribution. That may seem superficial, but it’s the answer that I’m most happy with. It has long been known to network theorists that competitive networks (with a return to scale to node connection) are characterized by power law distributions. This is a natural phenomenon; it happens in the blogosphere, the financial markets, in sports, and it happens in economies as a whole. Left to its own devices, it is inevitable that such networks will evolve an shockingly large disparity between the best-performing actors, and the mean actor. This fact is entirely independent from characteristics which make the network robust. Much like a network can be in any configuration of complexity and centrality at any given time, so can a network be in any configuration of equality and robustness.*
Remember, we are working with two data points; the Great Depression, and the Great Recession. Of course there are coincidences that may imply causation, and lead us down a twisty road looking for transmission mechanisms…but it’s not immediately clear (to me) that the simple answer isn’t the best answer — and that answer is number one: coincidence.
This may not satisfy the intellectual urge to connect crises and inequality that some people have…but at this point, I’m going to stick with the popular narrative of the Great Depression being caused by increased money demand not accommodated by the Fed. This is the same line of causality that I’ve been arguing regarding the Great Recession.
Why, you may ask, am I so eager to de-link inequality and recession? Because I think that both of these questions have to do with two things (social policy and stabilization policy) that will each inevitably be made worse off if people are eager to make desperate links. Social policy will suffer from an overbearing focus on situations which aren’t the norm — and stabilization policy will suffer from inevitable politicization.
What is my solution? Stabilize the growth path of NGDP by level targeting a nominal variable (and I favor complementary currencies), and make social transfers in ways that promote Pareto efficiency. I don’t really see a need to entangle the two.
*This is independent of the fact that violent revolutions due to perceived inequality have happened in the past…which obviously affects macroeconomic stability.
Dennis Prager says you can’t believe all those studies saying that US health care is worse. After all they came from untrustworthy lefties.
If you believe that Americans have lousy health care, it is probably not because you have experienced inferior heath care. It is probably because you were told America has lousy health care.
Only later in the report does the discerning reader have a clue as to how agenda-driven this report and this study are. The otherwise unidentified Karen Davis, president of the never-identified Commonwealth Fund, is quoted as saying how important it was that America pass President Obama’s health care bill.
Could it be that Ms. Davis and the Commonwealth are leftwing?
They sure are, though Reuters, which is also on the Left, never lets you know.
This article highlights lots of intellectual problems
1) He thinks these studies are wrong / biased / etc. Shouldn’t one then be able to produce some alternative study that addresses whatever methodical problems you have with this one.
As Yudkowsky likes to say “The dumbest man in the world could say that the sun is shining but that doesn’t make it dark outside”
That is, it is not enough to show that your opponent is a fool, biased, evil or untrustworthy. You must actually show that he is wrong. Evil fools are sometimes right, if only by chance.
Indeed, Arnold Kling, a self-avowed libertarian, supported by CATO, the leading libertarian think tank, went out to prove exactly that. He came back saying that, no the crazy liberals were actually correct on that point.
They misunderstood the reasons, he said. The reasons were not greedy insurance companies. The reason was quite simply that much of our medical costs go towards premium medicine which is not particularly useful.
2) People who don’t agree with Dennis Prager are automatically on the Left. Karen Davis is a lefty, no doubt. But Reuters? The financial news service accused of shilling for Goldman Sachs? What do you have to do these days to get your right wing card?
It seems that agreeing with Dennis Prager is the only criteria.
3) Prager doesn’t even address the obvious retort, often ignored by those who complain of bias, that all of these journalist and researchers and think tank folks are on the left because that’s the answer they came to after studying the issues.
If it turns out that everyone who investigates something winds up supporting the other team, doesn’t that raise the possibility that the other team is right?
I am willing to take both sides to task on this. If for example, minorities consistently score lower on math tests, it could be that the test is biased. OR it could be that on average minorities are worse at math.
Similarly, if all the experts endorse “left-wing” positions, it could be that the experts are all biased. OR it could be that the left-wing position is objectively correct.
One should at least consider these possibilities.
Ireland opted for chastity but it is still waiting for salvation.
“When our public finance situation blew wide open, the dominant consideration was ensuring that there was international investor confidence in Ireland so we could continue to borrow,” said Alan Barrett, chief economist at the Economic and Social Research Institute of Ireland. “A lot of the argument was, ‘Let’s get this over with quickly.’ ”
Rather than being rewarded for its actions, though, Ireland is being penalized. Its downturn has certainly been sharper than if the government had spent more to keep people working. Lacking stimulus money, the Irish economy shrank 7.1 percent last year and remains in recession.
Joblessness in this country of 4.5 million is above 13 percent, and the ranks of the long-term unemployed — those out of work for a year or more — have more than doubled, to 5.3 percent.
Now, the Irish are being warned of more pain to come
The economy is made up of human beings. But, at the macro level that humanity decoheres like the wave functions of quantum particles. The result is a cold calculating machine that doesn’t care whether you have been good little boys and girls who ate their vegetables and saved their pennies.
The only way out is to attempt to understand the mechanics of this leviathan and bend it to our will. This is not a short cut. This is not the easy way. It is the only way.
You resort to common sense and age old wisdom at your peril.
Paul Krugman and Ezra Klein suggest that inequality leads to recessions. Adam doesn’t find the mechanism plausible.
My gut reaction is that there is likely a connection and it likely runs through common causation. That is, there is another force which produces both inequality and recessions.
Unlike Paul, I am skeptical that the force is political.
My patchwork general theory runs as follows
1) There are recessions caused by shocks to money supply (see 1980s)
2) There are recessions caused by shocks to money demand (see 1929, 2008)
The BIG money demand recessions come about when there has been a mispricing of risk. The world appears to be much safer than it is and people are willing to invest in riskier assets.
Overconfidence is almost a precondition for big swings in money demand because it is much easier to suddenly become aware that one has been overconfident than to suddenly become aware that one was under confident. Very fast changes in expectations are needed to produce huge swings in money demand. Thus large changes in money demand are more likely to come in the form of surges in money demand rather than collapses in money demand.
This increased investment in risky assets yields higher returns. And, note these are higher real returns. There is a fundamental risk reward tradeoff and if people mistakenly believe that risk is less than it really is they will push into investments that do in fact yield high rewards.
This high rewards mean that highly leveraged individuals see their wealth increase rapidly. It also means that industries which produce high yielding assets (tech and finance) do very well.
This is what produces the run-up in inequality.
This is as opposed to the smoke and mirrors financial asset model that Klein proposes. Klein suggests that inequality comes first and that wealth is chasing illusory returns.
Nonetheless, once it becomes clear that expectations were misplaced money demand surges. This is accompanied by a collapse in the price of risky assets. If this surge in money demand is not met by an increase in money supply the result is a deep recession.
Both concede it is difficult to find a mechanism that explains the relationship, which is also why I am skeptical. Ezra offers up this theory:
One theory that’s made intuitive sense to me is that the problem is not just the demand for credit but the accompanying supply of idle money. When someone making $25,000 a year gets a raise, they spend it. When someone making $2,500,000 a year gets a raise, they invest it. And the more money there is sitting around, the more demand there is for high-yield investments, which means the more reward there is for people who can invent new investment vehicles with high yields. Hence, you have explosive innovations in weird financial instruments that look good for a while because the risk is underpriced but end up making the system more fragile when their risks come clear and everyone flees.
This doesn’t seem correct to me. When they demand for investments goes up the price should go up, and since price of an investment is the inverse of the rate of return, the market rates of return on investments should go down . So if there are a lot of people with a lot of money to invest they bid down the required rate of return on a given investment.
This means that when Ezra says that the more investment demand there is the “more reward there is for people who can invent new investment vehicles with high yields“, I think he should be saying low yields. For example, if an investment can generate a 5% return, then when required market rate of return is above 6% the demand is zero. In contrast, a 10% investment will be in high demand when the required rate of return is 6%. So when investment demand increases, and thus rates fall, the marginal investments that become profitable should be increasingly low return, since high return investments were profitable in the first place.
Let me give a concrete example. If I have a factory that costs $1,000 to build and generate a $20 a year in profit, then it has a 2% return on investment. I will only be able to find investors for this factory when the market rate of return is 2% or lower. In contrast, if I have a factory that costs the same amount to build but generates $200 a year in profits, then it has a 20% rate of return, and I will be able to find investors as long as the market rate of return is 20% or lower. As market rates lower, factories and other investments with lower rates of return should increasingly be supplied.
I’m not completely averse to Ezra and Krugman’s proposed relationship between income inequality and recessions. But I don’t think this mechanism is correct, and I will be skeptical until I hear a believable story.
A big question, however, is over how to measure the impact of monetary policy in an environment such as the present one, when short-term interest rates are close to zero and the credit system is damaged.
This is, indeed, the major question of our times. As you may know, I am of the “Scott Sumner” persuasion that the bulk of the recent recession (or the third depression?) was caused by the Fed allowing NGDP to plummet. The really depressing fact is that most commentators stop at “interest rates are at zero”, and thus proclaim that money has been surprisingly easy. Fortunately, Wolf sees through this facade:
The difficulty arises because of the huge divergence between what is happening to the monetary base (the monetary liabilities of the government, including the central bank) and what is happening to broader measures of money (principally the liabilities of the banking system). The former has exploded. But the growth rate of the latter is extremely low.
As has been known for quite some time, the monetary base is a highly misleading indicator of the stance of monetary policy. A slow (and stable) growing base was the essence of the original form of monetarism that was subsequently discarded as unworkable in the 80′s. There is an important implication here: the monetary base is utterly meaningless given endogenous money. When the Fed began a policy of paying interest rates on reserves, this is exactly what happened — the monetary base became analogous to any other risk-free interest-bearing asset. If you have a model of demand shocks based on the supply and demand for government debt, then the base can be counted within those assets. Wolf goes on to talk about the broader aggregates (truncated quote, read the whole thing):
So which measure is relevant? My responses would be as follows:
First, the monetary base does not itself have any impact on spending by the public.
Second, such reserves have no direct impact on lending by commercial banks (their assets) or on the broad money supply (their liabilities).
Third, should commercial banks be stimulated by the possession of reserves to expand their assets and liabilities, it is possible for the central bank to sell bonds to the non-bank private sector, to reduce those reserves.
Fourth, the policy of expanding the balance sheet of the central bank has an inflationary impact if and only if it succeeds in expanding the overall broad money supply beyond what the public wishes to hold, given the levels of economic activity, interest rates and expected inflation.
Finally, such an inflationary impact of “money printing” can indeed only happen if the overall money supply starts to grow rapidly.
But why stop at the broader aggregates? Mishkin tells us that they can be misleading as well. How about prices of various asset classes (that aren’t gold)? Maybe the interest rates on nominal bonds, which are appalling lows (no, fiscal policy is not the solution)? I generally favor the TIPS spread. A lot of the times I just plainly get confused by M3, so I don’t look at it — but it has been in the news as of late, and not good news either.
My conclusion is that what is happening to the balance sheet of the central bank is unimportant, except to the extent that it has prevented a collapse of credit and money. What matters is the overall supply of credit and money in economies. This continues to be stagnant in the developed world. Concern about an imminent outbreak of inflation is consequently a grave mistake. To the extent that there is a danger of “monetisation” of debt, it will emerge only if we fail to return to growth, because that is the situation in which it is most likely that public sector deficits will fail to close. It follows that strong monetary tightening now may increase the long-term threat of inflation, rather than reduce it.
The bolded is a very counter-intuitive point. I think a lot of people, when speaking about monetization, start from the causal perspective of the fiscal authority running up a lot of debt. Of course, true to economics, you have to nearly reverse causality to see the real picture. Sovereign debt crises are the result of stagnation — a period when government is loathe to be able to raise revenue. This can happen from supply-side problems, or a demand-side recession…of the sort we are seeing now, that has consumed Greece and threatens other European countries that do have other supply-side problems, as well. Of course, austerity measures have failed to do anything in Europe…and that’s just as economic theory would predict.* Economic growth can take care of nominal debt on it’s own, no inflation necessary…but if markets are forecasting low growth, that is when governments run into severe problems with large debt-loads.
The irony of the current fear of inflation — and this is key — is that given a widespread “Austerians” view; monetary policy would be especially effective, with just a modest (credible) commitment to inflate.
Dr. Friedman Mr. Wolf, for articulating that so clearly. Fed, are you listening?
*Lest you believe that Krugman is being to hasty, remember that policy actions should have immediate results in even weak efficient markets (like the bond market). Unfortunately, Krugman seems to selectively articulate this point clearly.
Catherine Rampell asks
Perhaps this has something to do with Claudia Goldin’s findings that some of the fields that require the most educational investment upfront — like pediatrics, or veterinary medicine — also happen to be fields whose work schedules allow for a healthy work-family balance. High-achieving women who want children may be discovering this, and making their career choices accordingly.
Are there other explanations for why the country’s most educated women are more likely to have children today than they were in the 1990s?
That is, highly educated women today are not drawn from the same pool as highly educated women of yesterday.
40 year old female professional / PhD in the 1990s had to have started down that track in the late 70s when it was far more rare and they faced higher social costs.
It is likely that only those who really wanted to pursue professional / PhD careers endured those costs. They were then more likely to pursue their career to the exclusion of other things.
Now, the costs are lower and more women who want these career but also want children are choosing to pursue advanced degrees.
Expectations show up in almost all modern business cycle models. However, the question is “whose expectations” Via Calculated Risk Fed Governor Walsh muses:
In my view, any judgment to expand the balance sheet further should be subject to strict scrutiny. I would want to be convinced that the incremental macroeconomic benefits outweighed any costs owing to erosion of market functioning, perceptions of monetizing indebtedness, crowding-out of private buyers, or loss of central bank credibility. The Fed’s institutional credibility is its most valuable asset, far more consequential to macroeconomic performance than its holdings of long-term Treasury securities or agency securities. That credibility could be meaningfully undermined if we were to take actions that were unlikely to yield clear and significant benefits.
The governor is clearly saying that he is worried about expectations of loose monetary policy. If it appears that the Fed is simply moving to alleviate short term concerns without paying attention to its long term mandate then it will loose its grip on the markets.
There is also no doubt that expectations of loose monetary policy exists. Pundits have been bleating about them for since the recession began. Should we be listening.
I’ve answered before: No
But, I want to be more formal about it so I am introducing two formal notions.
The Weak Price-Expectations Hypothesis: Any macro-economically relevant expectations can be captured in price data. That is, if an expectation matters then either a market exists or a futures market can be created which will capture all relevant information.
The idea is that if information is important to people they will be willing to trade on it. Information that no one will trade on is information that will not affect their choices and hence has no macroeconomic relevance.
The Strong Price-Expectations Hypothesis: Any macro-economically relevant expectations are captured in price data. In other words, prices are the transmission mechanism of expectations. If there is no price that moves when a given expectation moves then that expectation cannot affect the macro-economy.
I write these down in part to clarify my own thinking. Implicitly I believe I have been working from the Strong PEH, but I may be willing to back down to the Weak PEH.
In either case the conclusion is that the Federal Reserve need not concern itself with causal observations of expectations in the media or elsewhere. In the strong version there must be a price someone can point to. In the weak version information may be missing but the optimal solution will always be to create a futures market for that information.
A good article in the new issue of American Prospect provides an excellent example of how the rigidity of regulation can prevent innovation and variety in production, and can lead to homogeneity and favor large and incumbent corporations. The regulations at hand are the USDA’s slaughterhouse requirements, which really hits home for progressives because it hurts small, local, and organic farmers:
USDA meat-processing guidelines are tailored to high-volume packing plants, such as those owned by giants ConAgra and Tyson. As a result, ever more mom-and-pop slaughterhouses are being forced out — and, unable to shoulder the capital costs, new ones can’t open.
According to Eric Shelley, who runs a slaughterhouse that doubles as a schoolroom at the State University of New York, Cobleskill, “All the costs of running a slaughterhouse are basically the same whether you’re a small plant or a large plant. But if you’re a large plant, those costs get diffused, spread out.” Small operators have to buy the same gear that the big places do, such as stainless-steel equipment and high-end stun guns, saws, and knives. While it makes sense that anyone handling food should have the most professional tools, these industrial accoutrements can easily exceed what a small facility will ever need. They also typically drive the cost of opening a USDA-approved local slaughterhouse to well over a million dollars, creating serious barriers for potential newcomers.
This kind of problem with regulation is not exclusive to the local food movement. For example, the Consumer Product Safety Improvement Act, which was passed in 2008 in the wake of incidents of lead being found in Chinese toys, requires lead testing for toys. The law is burdensome for small toy makers and is threatening to put many out of business, especially handmade toys which must comply with the testing even if though are often made of nothing more than wood and beeswax:
“This is absurd,” said Mr. Woods, whose toys are made of maple, walnut and cherry and finished with walnut oil and beeswax from a local apiary. He estimates it would cost him $30,000 — a figure he calculated from having to pay $400 in required tests for each of the 80 or so different items he produces — to show that they are not toxic.
In contrast, large manufacturers like Mattel have the required scale to conduct the tests in their own internal labs, which is much cheaper per toy than the 3rd party testing that small manufacturers have to utilize.
It’s really encouraging to see this kind of problem recognized in TAP. It would be even more encouraging if they were bothered when regulation had these negative effects in any industry, not just those that make products that are important to progressives.
Daniel Indiviglio has a strange post at The Atlantic that I have been trying to ignore, but the website editors there keep putting it on their front page in a box called “Things you might have missed”. His argument is that credit should be criminalized because that would make the economy more stable. Daniel recognizes that the effects would be devastating in the short run, but claims that eventually it would only mean that the economy grows “a little slower”. This is not just my ungenerous interpretation:
It would involve an extraordinarily difficult transitional period, including massive job losses, deflation, and a deep recession as the government and population adjust. But if Congress managed to embrace a credit ban, we would end up with an overall economy that grows a little slower, but is incredibly stable. All that systemic credit risk? Gone. That reward would be well worth the cost. [Emphasis mine]
Would it really be worth the cost? Let’s consider what criminalizing credit would really mean. In reality it would mean lending would be pushed into the black market, because people would not be ridiculous enough to abide by a law that prevents borrowing to make investments with positive net present value, or making loans with a positive expected return.
To the extent that people don’t circumvent the law, a credit ban would mean a lot of terrible growth destroying stuff in the long run, not just during a “transitional period”. One growth destroying impact would be that people couldn’t borrow money to go to college, which would gradually erode the human capital stock of the country. People also couldn’t borrow money to buy cars to drive to their jobs, which would mean settling for worse jobs that are closer by, thereby inefficiently distorting the allocation of labor. They also couldn’t borrow money to make simple investments in durable goods that would save them money in the long run, like buying a washer and dryer instead of spend money at a laundromat.
It would also mean that when someone suffered a temporary and unexpected income shock that wiped out their savings they would have to begin selling off their possessions instead of using credit cards to make it through. Of course that’s only if they have valuable possessions to sell. The evidence in developing countries suggests that when poor families have no or limited access to credit, they are more likely to respond to income shocks by pulling their children out of school and putting them into child labor. So we’d probably see some child labor, which also represents a massive destruction of human capital.
Of course rich people wouldn’t see their access to education or mobility limited, nor would their resources to weather income shocks be noticeably diminished, because they have lot’s of wealth and savings to draw on. Thus banning credit would mostly hurt the poor, and thus would significantly increase income inequality. The ability to borrow money is much more important to low income people, and for so many it is an absolute necessity if they are to pull themselves out of poverty.
So no, even in theory, even on paper, we should not criminalize credit.
Today I was listening to the EconTalk podcast with Garett Jones, which was excellent. If you don’t follow Mr. Jones on Twitter, you’re definitely missing out, as he has an informal project where he is attempting to distill macro concepts into tweets…which seems like a very hard thing to do. He also “likes” my Facebook links from time to time, which is pretty awesome.
Anyway, in the course of the conversation Jones makes a very provocative statement to the effect of:
“If businesses claim that they don’t need a tax cut, you should cut their taxes.”
The logic behind this statement is fairly simple, but very counterintuitive. When a business makes decisions, they think much closer to the margin than the median person does, as they are able to spend a lot of time thinking through different decisions. However, surrounding the margin are a lot of inframarginal decisions that businesses have to make. These are decisions that are generally inconsequential to the person (or company) making them, for which others might have a much greater stake. These types of decisions are generally characterized by a highly elastic supply curve, such that a small change in the price will cause a very large change in behavior.
They discuss the example of locating a gas station on the east or west side of a street — which can be largely inconsequential to the business itself, however the townspeople may have a larger stake in wanting the gas station on either side. In this case, a very easy (Coasian) solution can be found. Offering the business a relatively minuscule amount of money can change their behavior dramatically — and everyone can get what they want for a very low transaction cost.
However, these are not the type of tax cuts that businesses typically agitate for. Businesses tend to like the government to cut taxes on things that they’re already doing very successfully, such that the tax cut will be relatively useless. Why? Because the supply curve is relatively inelastic, and thus a large change in incentives generally produces a much smaller change in behavior. This brings me to one of the core underlying statements in complexity economics:
Firms don’t innovate, markets innovate.
This statement is similarly counterintuitive. We have a sort of caricature of entrepreneurs and firms as lone innovators, toiling away in pursuit of the next big idea. This is epitomized by a fascination with “small business” and “mom and pop stores”. But the fact is, entrepreneurs fail constantly. There are entire shelves in the dens of collectors that are filled with failed products. In fact, if there is anything that characterizes entrepreneurship it would probably be the ability to “fail fast and efficiently“. What is happening is that, in an evolutionary context, entrepreneurs play the role of differentiation, whereas markets play the role of selection and amplification.
The preference for tax cuts on what a business already does well is a manifestation of the lack of innovation that characterizes monopolistically competitive firms. If you surveyed a lot of high-level businesspeople, you would probably find that they support some abstract concept of “the free market”, but revealed preference is that most of them quite enjoy protectionism. They like it when the government tips the scales in a way that helps them do what they’re already doing — and they almost never agitate for the government to give them breaks at the inframarginal level — the level in which shaping incentives produces the greatest resulting change in behavior.
This is a very powerful tool in the arsenal of public policy, and I think that a lot more time should be spent analyzing (and instituting) ways in which we can use taxes to get the most “bang for our buck”. As they say: work smart, not hard. It would likely lead to much better outcomes than using the tax code to buy off constituencies and play budgetary games.
Update: Andrew Sullivan provides a choice example of exactly what I was saying:
They [print magazine publishers] keep trying to replicate the magazine model online – like trying to make counter-insurgency work in Afghanistan. It’s all they know how to do. So they do it.
I guess it’s understandable because, like the record companies and the publishing houses, they don’t want to admit that their gig is up and their concept of a magazine is essentially defunct. You can’t really blame them for that, can you?
I seem to recall hearing about how the government now needs to subsidize media outlets…hmm…
Do you like short quips of nerdy econo-talk? Want to keep up with the bleeding edge of posts on this blog? Wish to interact with Karl, Adam, or Niklas in a completely public fashion that feels marginally more personal*? Then follow the blog’s Twitter feed!
*Don’t fret, your job at the Washington Post is safe…for now ;].
I have a request for the econ blogosphere. I have the solutions manual for Jeffrey Wooldridge’s Econometric Analysis of Cross Section and Panel Data in which he says he can provide a pdf with answers to even numbered questions, but I haven’t been able to get an email response from him. So does anyone have the pdf that they could send me? Let me know in the comments. (This is not for a class, so there’s no ethical dilemma to worry about here.)
There’s been ample coverage and opining on the Washington Post firing Dave Weigel, so I won’t rehash the story. The one upside is that this unfortunate incident did provide us with the opportunity to see Weigel’s blogging friends and defenders really let loose with some awesome Washington Post bashing. I’ve gathered up the best ones I’ve seen:
It sort of surprises me that this campaign worked, and The Washington Post seems to have felt that these emails constitute a good reason to accept Weigel’s resignation. I say “sort of” because obviously no organization that employs Charles Krauthammer on a regular basis can be counted on to exercise sound judgment in a consistent way.
Mr. Goldberg suggests that this episode might “lead to the re-imposition of some level of standards” atThe Washington Post, suggesting that the newspaper’s problem is that it employs people like Ezra Klein and Dave Weigel, who’ve exercised poor judgment in writing intended for a private audience. I submit that seeing these two staffers — who are intellectually honest and talented, whatever their flaws — as the problem at The Post is to miss the Mark Theissen for the trees….To be more specific, by firing Dave Weigel, and continuing to employ columnists like Marc Thiessen, the Post is saying that it is inexcusably poor judgment to utter honestly held, intemperate opinions if they wind up being made public, but it is perfectly acceptable to write an intellectually dishonest, error-filled book on the subject of your main expertise, and to publish columns of the same quality.
I do believe that Weigel resigned rather than was fired, and it’s easy to see why he’d want to do that after reading the absolutely horrendous column by their lame, sad toady of an ombudsman today.
The Washington Post, in particular, is a paper that–for all the good its done–once accepted a Pulitzer for a wholly made-up story, and publishes a magazine whose arguably defining moment was announcing that a 40 year old woman was more likely to “be killed by a terrorist” than ever be married.
The best headline award goes to Alex Pareene at salon: “Dave Weigel resigns because old media can’t have nice things”
The only thing I have to add is that it didn’t take very long for Tucker Carlson to burn up his new image as a friend of journalism who just wants to put more reporters on the beat. This bit of information from Ezra Klein really does not put Carlson in a good light:
It was ironic, in a way, that it would be the Daily Caller that published e-mails from Journolist. A few weeks ago, its editor, Tucker Carlson, asked if he could join the list. After asking other members, I said no, that the rules had worked so far to protect people, and the members weren’t comfortable changing them. He tried to change my mind, and I offered, instead, to partner with Carlson to start a bipartisan list serv. That didn’t interest him.
In the spirit of turnabout is fair play I wonder if Ezra will release the emails from Tucker Carlson where he tries to weasel his way into JounoList and obviously lies about his intent. Probably not.
Despite the power of big banks, small institutions still dominate huge swaths of the country and hold nearly half of bank deposits overall.
The original had a stab at Arianna Huffington, who was making a really bad argument at the time (and probably still holds the same view), but I’ll omit it from here.
A little late, perhaps, but according to the BEA, first quarter growth in real GDP in the US was 2.7%, revised down from a previous 3%. This poses a problem for two reasons; the first is that weak growths obviously means weak recovery. Weak recovery, of course, means that cyclical unemployment turns into structural unemployment — and that is a much bigger policy problem. The second problem (and this is much bigger) is that the long-run trend rate of growth rate from the Great Moderation was around 5%, with +-3% real growth and +-2% inflation. Right now, we are 5-8% below the level of growth we would be at had the recession never happened. The imperative for policymakers is to get the economy back to this level of nominal output as quickly as possible, and 2% real growth (plus near-zero inflation) per quarter is not going to cut it.
Not to mention, the revision puts a bigger dent in the prospects of a “V-shaped” recovery.
This all brings me around to the “new normal” hypothesis. People around where I work and live seem to be very interested in the prospect that we won’t ever recover to our previous NGDP trajectory, and (like the 1970′s) this represents a new normal of lower growth rates (a statement that is usually followed by “higher taxes, and more regulation”). Economists are still debating what caused the shift to lower growth rates in the 70′s; but looking around today there is only one sector in which we should consider lowering output for an extended amount of time, and that is housing. Other than housing, I don’t see any reason to accept the “new normal” hypothesis, other than that it is a choice of the central bank. However, as Scott Sumner points out today, it’s seemingly only a choice of a few members of the central bank, namely: Thomas Hoenig, Charles Plosser, and Jeffrey Lacker. Here is Scott:
Just like in the Great Depression, the regional bank presidents are the biggest problem. And just like in the Great Depression, the British press had a better understanding of the deflationary impact of US monetary policy than did the American press. Funny how things never seem to change.
I hope repeating their names here, in bold, will draw a lot of attention to them.
I laughed at him; mocked him even. He warned us that our government was run by totalitarians who were preparing to come crashing down upon us, taking away our precious freedoms. Sure, I warned people that they came for the cigarettes, then the sugar, then the salt, and so what next? But the extreme paranoid theories he peddled; the malicious motives he impugned our leaders with; the constant claim that tyranny was on the march. Absurd I thought, never in a million years would they take away long cherished and fundamental freedoms like Beck was warning. What a damn fool I was… Let me tell you friends, the tipping point has come: via the oppressive arm of the activist judiciary the final crackdown of the totalitarian, freedom-hating government has begun. God help us all.
Krugman reminds us of Keynes
But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.
Virtually all of my students misunderstand and misquote Keynes to be saying that
In the long run we will all be dead
But, this misses the point. It suggests that “by the time the long run gets here we will all be dead anyway. So why worry” The natural response is that our decedents won’t be dead, humanity won’t be dead, etc. The conclusion is that Keynes was selfish and shortsighted.
Yet, what is meant is that in long run we ARE all dead. Or, as I tell my students: This story only has one ending. If you’re worried about whether things will work out in the end – don’t. They won’t work out in the end. In the end everyone is dead.
In the end, everyone we’ve ever known and cared about has died. In the end, the earth has grown cold and everything that humanity has built either withered away or froze in the blackness of space. That’s what the end is like.
So it can’t be about the end. It has to be about the experiences that people will have before the end comes. And, those experiences are currently miserable. That matters and it matters as much as anything because there is no cosmic final act in which all wrongs will be righted and all sacrifices rewarded.
So if you want to argue that current misery is warranted then the argument must be that future misery will be alleviated. In which case we need to talk about what that misery is. Is it greater or lesser than the current misery? Will it occur with probability one? Will we have additional methods for alleviating pain at that time, etc? This is the argument I have not seen elucidated by the Austerity Now crowd.
In general, however, the notion that wisdom always requires sacrificing the short term for the long term and that what matters it was happens in the “end” is naive in its understanding of our ultimate fate.
Anyone care to offer an economic rationale for this?
…the bill gives the Federal Reserve the ability to set a limit on the fees that stores must pay to accept debit cards. The catch here, though, is that only banks with more than $10 billion in assets would be subject to the cap. As a result, merchants may have to pay more to accept debit cards from smaller banks and credit unions than big banks like Bank of America and Chase.
A couple of weeks ago I was going to write a blog post asking why liberals weren’t pushing for a consumer banking public option as part of the financial regulatory overhaul, but I decided against it. Now Mike Konczal comes out with the same suggestion, and I’ve missed a chance to be ahead of the curve in liberal thinking and producing policies I disagree with. Never again I told myself. So with that in mind, I would like to propose some ideas for liberal policies that I completely and wholeheartedly disagree with, but I think some liberals might embrace and I haven’t seen anywhere else:
CASC Standards: the cousin of CAFE standards, corporate average sodium content would set the averaged amount of sodium per serving that a food corporation can have over their entire product line. There are a couple ways that companies could bring their average sodium levels down: decrease the sodium levels in their existing products, raise the prices (and thus decrease quantity sold) on high sodium items, or decrease prices (and thus increase sales) on low sodium items.
However they chose to do it this would mean the average sodium consumption of the population would go down, even if that means companies have to essentially give low sodium items away. Despite it’s incredible inefficiency and high-likelihood of being gamed for the industry’s advantage, this is better for politicians because, like CAFE standards, the costs are hidden.
Organic food stamps: $1 worth of food stamps are worth $1 if you spend it on most food, but if you spend it on certified organic, local, and sustainable foods it’s worth $1.20.
Green-ify the home mortgage interest deduction: A lot of liberals don’t like the home mortgage interest deduction, but given it’s political popularity, it’s not going anywhere anytime soon. So instead of getting rid of it altogether, make it only work for homes that are certified energy efficient. They could either have to be LEED certified, or there could be a public option for home energy efficiency certification… hey, there should be a public option for home energy efficiency certification.
It may layer a terrible inefficiency on top of another terrible inefficiency, but it’s at worst budget neutral and will get consumers spending, which will generate Keynesian stimulus and fight global warming.
I consider these sincere suggestions that fit well within the mainstream of progressive policy proposals (ok, the organic food stamps are a little ridiculous), and I’d be curious to know if any liberals would embrace any of these. I of course hate all of these ideas. Since turnaround is fair play: do any liberals have original libertarian policy proposals they hate but think libertarians would like?
P.S. I recognize this is a pretty pointless activity that doesn’t do anyone any good. Writing it felt weird and exercised a part of my brain I’m not used to using, like writing with your opposite hand.
There are two basic strategic problems I see with the current Republican party. First, the party establishment seems completely uninterested in winning the war over ideas. This mistake is indeed the more devastating of the two, as I believe in the end ideas determine reality.
Not in some squishy metaphysical sense but in the cold practical sense that someone must actually write policy and someone must educate the next generation of bureaucrats. If those people all have left wing ideas then you can pretty much bet dollars to donuts that you are going to have left wing government. It may come with enough right wing coating for the public to swallow it but ultimately the public neither authors nor administers the law.
The second mistake is more obvious. The GOP seems uninterested in appealing to the fastest growing demographic groups. Its problems with urban voters are well established and probably deeply rooted. However, its current trouble with Hispanics are of its own making.
Here are some charts I ganked from the Chicago Fed and they focus on the Midwest. However, I know of no particular reason the rest of the country should be any different.
New Urbanism is proceeding full throttle. Michael Steele says he wants to bring the GOP to a “hip-hop urban-suburban” audience. However, suburban doesn’t look like its going to cut it. The country is urbanizing. Whether its “re” urbanizing or continuing a long run trend towards density is a matter of debate. I tend to think this is a new phenomena but that’s an argument for another day.
Urbanites clearly see government in more favorable lights than suburban and rural dwellers for the simple reason that proximity breeds externality. Spillovers of all sorts, positive and negative are more likely in the city and demands for a government capable of handling negative spillovers will increase.
So yes, this is perhaps a fundamental problem for the GOP. This, however, is not.
I hate to go all Comte but these demographics do look a whole lot like destiny. I mean good god man. There are basically no Hispanic senior citizens and a ton of — apparently fertile given the fraction of the population under age 4 — twenty-somethings.
The GOP seems to be doing its best to antagonize this tidal wave but as far as I can tell there is nothing inherently “Democrat” about Hispanics. They tend to be religious, family oriented, entrepreneurial and generally culturally conservative.
Hispanics look to me like the natural future of the GOP yet, the party seems hell bent on making permanent enemies.
Felix Salmon has responded to my concerns about whether or not the proposed financial regulation will reduce the likelihood that future disruptive technologies will emerge and present a competitive challenge to the Visa/Mastercard duopoly. I don’t find his case particularly convincing, and certainly not convincing enough to overcome the substantial burden of proof that should be required when we’re discussing regulation that could impede innovation and competition.
Felix has several disagreements with me. First, he says, we don’t necessarily want a competitive or innovative solution to high interchange rates if that means injecting a lot more instability into the financial system. Agreed. Not every competitive solution would be a good solution.
He sees the best possible innovative solution to be mobile payments, but sees them as unlikely because a) they’re mostly used in under-banked developing economies, b) phone companies won’t want to do it, and c) regulatory barriers would prevent it.
To points a) and b) I would point to the examples of Japan, South Korea, and Finland, all of which have significant mobile payment systems in place. The Japanese mobile payment industry evolved mostly at the work of the telecoms, none of which are monopolies. In South Korea, the telecoms were first movers but financial institutions soon took over. This paper from the Kansas City Fed has more history and details. Given this evidence, I’m not sure how one could conclude with any degree of confidence that the future development of U.S. mobile payments is unlikely or predictable.
To point c), if he’s correct and regulation is what would prevent mobile payments, then shouldn’t we be pushing to eliminate whatever barriers are in the way? Does Felix really think mobile payment systems present such a threat to the financial system that they should be prevented? And aren’t the minor odds there worth the tradeoff of potentially weakening the Visa/Mastercard duopoly?
Niklas discusses the grand achievements of the modern age. The exposure to culture and ideas; the opportunities for travel and intellectual collaboration that would have been the nearly exclusive province of the upper-crust even 30 years ago.
Here is a less serious glimpse of the more mundane. And, by mundane I mean the stuff that, you know, regular people actually care about.
Hat tip Sullivan.
Arnold Kling doesn’t think we can construct cathedrals, anymore:
Charlton says that we no longer have the sort of concentrated expertise that enabled us to fly to the moon. Perhaps. If you go to Europe, you will see cathedrals that I do not think we could build any more. Does anyone think that we could produce a Constitution as brilliant as that devised in 1787?
Few people realize that the great economic and spiritual enlightenment that happened after the Dark Ages in Europe also coincided with the beginning of the use of the Brakteaten money system. Local lords issued silver plaques which were called in every six months or so, taxed (physically, which made the coins thinner, and thus reduced their value) and returned to the users. The demurrage fee was around 2-3% per month for the entire period of about 1150-1300AD. Again just as in Egypt, this prevented hoarding by the people, and increased the velocity of the money, creating ample investment demand.
What did lords invest in? Since this was a time of globalization, cities were looking to attract Christian immigrants from around Europe. What better way than massive (and impressive) cathedrals as celebration of their spirituality? The Brakteaten money system facilitated this kind of long-term investment. What event coincided with the downfall of this architectural era? The king’s monopoly on money.
Now, it is patently obvious that we can build cathedrals today. And, given enough capital, you could build a cathedral to the very exact specification of your favorite Medieval building. This isn’t the point that Arnold is trying to make; the point of the post is that we lack the organizational capital to build the network — the innate bond between people — which allowed humans to previously build large works of wonder with voluntary participation of the community.
I think this phenomenon (to the extent that it is true, and I don’t think it’s as true as Kling may believe) largely has to do with our money system.
Update: I want to add that I think Bruce Charlton’s simple model is very, very wrong. He lays it out in this paragraph:
This may sound bizarre or just plain false, but the argument is simple. That landing of men on the moon and bringing them back alive was the supreme achievement of human capability, the most difficult problem ever solved by humans. 40 years ago we could do it – repeatedly – but since then we have *not* been to the moon, and I suggest the real reason we have not been to the moon since 1972 is that we cannot any longer do it. Humans have lost the capability.
Now, what would suggest that we should repeatedly go to the moon? I want to go to the moon — is the fact that consumer demand is there, but we simply can’t make it cost effective the problem? No. Going to the moon remains very expensive, we’ve already been there, gotten what we needed (unless, you know, there IS an alien base on the dark side of the moon), and now it’s pointless. The marginal costs FAR exceed the value of another trip to a dead rock just to say we did (again). Plus, we’ve put a rover on Mars…is that not impressive?
Moreover, I can now reliably communicate with people anywhere in the world for free or very cheap. I can interact with some of the greatest minds in economics, of which I would have never had the chance to hear them speak at 25 in any other time. I can collaborate with people from around the country, whom I’ve never met (indeed, that is what I’m doing right now). I can travel distant cities with the confidence of a free map, with suggestions as to where I should visit. I can listen to the greatest musicians and view the works of the greatest artists of my era (and every other) for negligible marginal cost. From literally anywhere I find myself, I can be steeped in more culture, opinion, and knowledge than anyone of any wealth level of any other period in time — for a fraction of what just one of these activities would cost them. Is this not impressive?
However, I don’t think Bruce’s argument is even about material accomplishments. Here is the key passage:
By 1986, and the Challenger space shuttle disaster, it was clear that humans had declined in capability – since the disaster was fundamentally caused by managers and committees being in control of NASA rather than individual experts.
Indeed, this fits in the “organizational capital” category. Bruce is lamenting our inability to form networks, not achievements. However, I’m not very inspired by how he understands networks work.
(The update has little to do with my comment about money systems above and in the comments.)
The interchange debate involves a lot of details that I haven’t had the time to fully digest, so I won’t claim to have a high level of confidence about whether regulations being proposed are good idea or not. But I would like to offer a note of concern and skepticism about an issue I haven’t seen seriously addressed by the otherwise very informative bloggers, like Felix Salmon and Mike Konczal, who have been covering this topic: what impact will the proposed regulation have on potential market entry?
I think we can all agree that more competition is, when feasible, the best way to deal with undesirable market power. This point has been echoed several times by Matt Yglesias, but the most I have seen it discussed so far is by Konczal, who is not optimistic that this represents a feasible solution:
Technology breakthroughs, the other things to break up oligarchies, also don’t look likely. I can’t find it now, but recently there was an article about the future of consumer finances online (maybe in Wired?). A lot of revolutionary stuff could be coming, but none of it looks to be able to cut the legs out from the interchange system. I talk a lot to the online tech finance people, and try to keep up on what is happening in the medium term, and I don’t see much that is moving in order to put competitive pressure on the credit card model. I think that plastic will be the future in the 21st century, and there’s a clear structure of who sets these prices.
I think this issue deserves a much closer look, because some not so futuristic technologies like mobile payment seem to be potentially disruptive market entrants that could upset the Visa/Mastercard duopoly. Lawmakers need to be cautious with this, because if you’re going to start setting prices, then you’re messing with the profits for potential entrants, and thus possibly disrupting the future path of innovation. The welfare impacts of accidently preventing a market entrant or technological innovation here would be huge, and would likely trump any welfare benefits of the proposed regulations.
Price floors strike me as very dangerous in this regard. If the Fed gets tasked with ensuring that card issuers only charge “fair” prices that reflect marginal costs, then potential market entrants will never be able to recover the large up front costs needed overcome the initial network effects and economies of scale, and so they won’t make the necessary investments.
And even if the initial regulations don’t function as barriers to entry, how hard would it be for Visa and Mastercard to use regulatory capture to make sure that they evolve into them? Mr.Konczal is doing a great job writing about the goings on of interchange regulations now, but two years down the line will anyone still be holding legislators to task on this issue? Probably just Visa and Mastercard.
Maybe I’m worrying about nothing here, I certainly hope so, and if I am I would sincerely like to be convinced. Would the proposed interchange regulations reduce the incentives for market entrants and disruptive technologies? Please, disabuse me of my worries.
Back in 2009 John Cochrane debated Scott Sumner about the causes of the crisis, and pushed back pretty heavily against Scott’s interpretation that by 2008:Q3, money had become too tight relative to the needs of the economy. He made a few salient points, but ultimately I wasn’t very persuaded by Cochrane’s position. However, his recent paper, which is poised to be all the rage (or cause all the rage?) sooner or later, he makes a mention of the monetary disequilibrium in this passage:
Why did a financial crisis lead to such a big recession? We understand how a surge in money demand, if not accommodated by the Fed, can lead to a decline in output. I argue that we saw something similar — a “flight to quality,” a surge in the demand for all government debt and away from goods, services and private debt. In the fiscal context of (1), this event corresponds to a decrease in the discount rate for government debt. Many of the Government’s policies can be understood as ways to accommodate this demand, which a conventional swap of money for government debt does not address. This story is in contrast to “lending channel” or “financial frictions” stories for the recession, essentially falls in aggregate supply.
(I want to preface this by saying that I have only skimmed the paper so far, so Cochrane may have addressed this issue at some point)
I want to argue that these things aren’t similar in a way where you can separate the two, and claim that a “flight to quality” is a fundamentally substitutable concept with monetary disequilibrium. In fact, analyzing a “flight to quality” phenomenon as a cause is kind of foreign to me. As far as I’m concerned, any level and composition of debt structure is an effect. If there is a “flight to quality”, which depresses the yields on nominal bonds, it is almost assuredly the macro-effect of some (or many) other cause(s). The most likely (in the case of the recent recession) being an commodity price appreciation filtering into core CPI, causing the Fed — using its backwards-looking indicators — to target interest rates at a level that was patently too high for the macroeconomic conditions developing in the real-life economy. In other words monetary disequilibrium, exactly as Cochrane said in the quote.
Now there may, indeed, be some people out there that wake up on random day X, and decide that they want to drastically increase their holdings of government debt…however, I don’t think that this odd behavior is an aggregate phenomenon. Therefore, a “flight to quality” is necessarily an effect of some other variable. Cochrane seems to reject the “lending channel” and “financial frictions” models of the recession…but on the same token, he doesn’t seem to embrace the “tight money” model. So, from what I’ve read, this seems to leave him in a position of arguing that an effect is a cause.
My question is, why does he so strongly wish to reject the tight money interpretation? Isn’t it in his intellectual ‘bloodline’ so-to-speak to always be suspect of the money supply, and if not the money supply the aggregates…and if not the aggregates, some other measure of the stance of monetary policy that isn’t the Fed’s nominal interest rate? What would Milton Friedman say?
The most likely answer is that I’ve missed something.
P.S. I’m starting the analysis from 2008:Q3…which I suppose is a stylistic approach which would make my argument the same as Cochrane’s. Starting earlier may make tight money look like an effect — but Cochrane’s “flight to quality” from 2006-2008 wasn’t causing as many problems as the flight to quality which happened very suddenly in 2008:Q3-4, when the recession deeply intensified.
Update: It had been a while since I listened to the Sumner/Cochrane debate, so I decided to read Sumner’s take again. It turns out, this paper is actually an academic manifestation of the points he made during the debate:
I can’t bear to watch myself, so I’ll rely on memory. There seemed to be three areas where Cochrane had trouble accepting my views:
1. He couldn’t understand how I could claim monetary policy was “tight” last fall.
2. He was skeptical that the Fed could do much to create inflation, at least if its tools were restricted to things like setting an explicit inflation target, negative rates in ERs, and quantitative easing. He does believe that a combined fiscal/monetary “helicopter drop” could get the job done. And I recall that his first choice was having the Fed buy riskier assets.
3. He also worried about overshooting toward high inflation.
Also, Bennett McCaullum has been highly critical of the Fiscal Theory of the Price level, and is definitely worth reading.
University of Chicago’s John Cochrane has a new NBER paper out that is sure to generate some debate. He outlines the following scenario of how the U.S. could conceivably go from the current state of affairs to a situation of high inflation:
Will we get inﬂation? The scenario leading to inﬂation starts with poor growth, possibly reinforced by to larger government distortions, higher tax rates, and policy uncertainty.
Lower growth is the single most important negative inﬂuence on the Federal budget. Then, the government may have to make good on its many credit guarantees. A wave of sovereign (Greece), semi-sovreign (California) and private (pension funds, mortgages) bailouts may pave the way. A failure to resolve entitlement programs that everyone sees lead to unsustainable deﬁcits will not help.
When investors see that path coming, they will quite suddenly try to sell government debt and dollar-denominated debt. We will see a rise in interest rates, reﬂecting expected inﬂation and a higher risk premium for U.S. government debt. The higher risk premium will exacerbate the inﬂationary decline in demand for U.S. debt. A substantial inﬂation will follow — and likely a “stagﬂation” not inﬂation associated with a boom. The interest rate rise and inﬂation can come long before the worst of the deﬁcits and any monetization materialize. As with all forward-looking economics, no obvious piece of news will trigger these events. Oﬃcials may rail at “markets” and “speculators.” Economists and the Fed may scratch their heads at the sudden “loss of anchoring” or “Phillips curve shift.”
Not being a macro guy, I will allow others more capable than myself to evaluate his claims; I’ll simply pass along the gated and ungated versions, step aside, and wait hopefully for an elucidating debate.
In an article on China’s need to begin the transition to a more service based economy, Barry Eichengreen has some very Bryan Caplan like optimism about China’s lack of a democracy: it may mean less occupation licensing. First he outlines how in Asia, much like in the U.S., occupational licensing is used in the service sector to protect incumbents from competition:
In both Korea and Japan, large firms’ entry into the service sector is impeded by restrictive regulation, for which small producers are an influential lobby. Regulation prevents wholesalers from branching downstream into retailing, and vice versa. Foreign firms that are carriers of innovative organizational knowledge and technology are barred from coming in. Accountants, architects, attorneys, and engineers all then jump on the bandwagon, using restrictive licensing requirements to limit supply, competition, and foreign entry.
If China follows a similar path as Asia and Korea, they would shift to a much lower growth rate:
One can well imagine Chinese shopkeepers, butchers, and health-care workers following this example. The results would be devastating. Where value added in Chinese manufacturing has been growing by 8% a year, service-sector productivity is unlikely to exceed 1% if China is unlucky or unwise enough to follow the example of Korea and Japan.
His Caplan-esque observation is that the lack of democracy in China may allow them to avoid this fate, and thus experience the productivity growth in the service sector that other Asian countries haven’t had. Barry Eichengreen is no democratic fundamentalist.
The big story in this article in the Times is that the CBO has estimated that Freddie and Fannie could end up costing taxpayers as much as $389 billion. But the interesting side story is that the obsession with homeownership has not subsided despite history recently providing us with an important lesson in the costs of homeownership and homeownership encouraging policies. Community groups are pushing Fannie and Freddie to work at getting homeowners rather than investors to buy their foreclosed properties, and apparently they are succeeding:
Executives at both Fannie and Freddie say they have an overriding obligation to limit losses, but that they are taking steps to sell more homes to families.
Fannie Mae last summer announced that it would give people seeking homes a “first look” by not accepting offers from investors in the first 15 days that a property is on the market. It also offers to help buyers with closing costs, and prohibits buyers from reselling properties at a profit for 90 days, to discourage speculation.
This seems incredibly misguided to me. If preventing investors from bidding in the first 15 days means the house is selling for less than it otherwise would, than this policy is depressing house prices in the areas that most need house price appreciation. In addition, preventing investors from selling in 90 days is really an attempt to prevent arbitrage, which again will depress prices.
It strikes me as ludicrous that as we are finding out we may have a $389 billion bill for our past efforts to encourage homeownership, people want to restrict investment in real estate right just when it is needed most in service to more homeownership.
Hoisted from the comments over at Scott Sumner’s blog, we get this little bit of wisdom:
And the irony is that Yglesias’s approach actually prepares his readers for battle much better than Krugman’s. If I debate a Krugman reader, I have no problem picking apart their arguments. They’ve been told that conservatives are morons who lack any good arguments. They don’t know what they have missed. It’s like shooting apples in a barrel.
How true this is. Krugman regularly makes blunt points that — to argue them with success — need to be backed up with subtle modifications, asides, and caveats. Unfortunately (as I said in the comments), Krugman tends to leave these types of things out (at least in his columns, and it is understandable with the limitations of the format)…or, he buries them underneath a strong point that supports his claim.
So when Krugman’s less economically sophisticated NYT crowd reads, “We’re in a liquidity trap! The laws of economics don’t apply! Only fiscal stimulus can save us!”; most probably don’t end up going to his blog to read about how a monetary policy of inflation targeting is the first best solution…and they don’t head over to the PKArchive to read about how Krugman reformed his (Keynes’) model of liquidity traps to include rational expectations. But they certainly do know that Republicans (and conservatives in general) are 1. evil, 2. racist, and 3. stupid.
Not to say that there is anything wrong with what he does…I write like that too, sometimes. I don’t even wholly disagree with him about conservatives. However, it hands your audience just the bare bones of the argument that you’re making, and that weakens their position (even while strengthening yours with numbers). In contrast, Yglesias often goes out of his way to add meat to the bones of his argument (while he’s making it). It sets his audience up in a better position.
Would the world be a better place if everyone wrote with the thoughtfulness and respect of Tyler Cowen? I think so.
Update: Mark Thoma points out that I should have worded things more subtly. I often write hastily, so it is my fault…and he is correct, so here is an update to his criticisms on from my Facebook page:
1. Paul Krugman’s argument for fiscal and monetary policy in a liquidity trap (as I understand it) is that first, a monetary policy of inflation targeting is the optimal solution. Not only would this be the optimal solution, but it would increase the multiplier effects of fiscal policy, so we should use both to combat a deficit in aggregate demand. If the commitment to these policies is credible, then with expectations of an increase in the future price level, inflation targeting will cause the current AD curve to shift to the right. Since SRAS is fairly flat in recessions, a subtle increase in the price level will produce a large jump in real output, and a negligible rise in inflation. Taken together with fiscal policy, which can be much more finely-targeted (I note that Krugman uses the “opportunity costs of borrowing at low rates argument”), not only can we boost output, but we can also achieve various social investments at a bargain, as well. However, since it seems politically impossible to go after inflation (and even I blame conservatives for this), then our (only?) next-best option when in a liquidity trap is fiscal policy.*
Now why, in Paul’s model, do the normal rules of economics not apply? I think it’s the residual effect of an intense focus on the interest rate as monetary transmission mechanism. Indeed, the standard NK model uses no money at all — just movements in *the* interest rate. You can, of course, assume money in the parameters, but it makes little difference in the world of bonds or consumption goods. Indeed, the NK models can predict wild things happening at the ZLB. Of course, in the papers** Paul cites regarding these bizzare phenomenon; there are all kinds of the “subtle modifications, asides, and caveats” that I alluded to earlier.
Here is what I believe happens to the central bank reaction function
2. The “74-year old theory” comment has been retracted. Krugman does, indeed, use modern NK models to justify his policy stances. And he does, indeed, build models on his blog. I explicitly didn’t compare his blog to his columns. I realize that the two are different vehicles, as said as much.
I take issue with Krugman’s delivery. In offering an opinion, you can say something to the effect of, “There are quite a few models out there, some are garbage, some are well worth exploring…but I personally believe that Keynes got it mostly right in saying…” This is not what Krugman does. I’m pointing out that I think it is a better way to make a point.
3. Mark offers a warning to Yglesias readers:
Finally, a note of caution for Ygleisias readers. He hasn’t been consistent in his policy recommendations and at times, without knowing it, has taken contradictory positions. I don’t think is very helpful to readers even if it is couched in language you happen to approve of (the problem is that he doesn’t seem to fully understand the modern monetary transmission mechanisms).
*This paragraph written in my own language, not necessarily Krugman’s.
**This, for example.
Matt Yglesias says he’s not the kind of liberal like Kevin Drum who wants to micro-regulate the economy:
Regulate business to prevent negative environmental externalities, sure. Basic safety, okay. But the idea that what we need is for a bunch of people to get together and say that it would be better to ban this and that and the other capitalist act between consenting adults just strikes me as the wrong way of going about things.
He goes on to cite regulatory capture and corporations ability to use regulation to stop competition as reasons to be skeptical that these policies will make people better off.
What I like about Matt is not just that he believes this -because being right is nice, but it’s not a virtue-, but that he writes about it, points it out when it’s relevant, and isn’t shy about bringing it up. Paul Krugman, in contrast, knows what Matt is saying is true, but he doesn’t write about it. Dan Klein and Harika Barlett document that in 654 New York Times columns Paul argued for market liberalization only 16 times. I think the difference in their approaches can be attributed to their goals in writing: Matt writes to inform his readers and argue for the truth as he sees it, Paul writes to arm his readers for battle against Republicans, which are ruining this country.
Brad Delong is sort of a combination of Yglesias and Krugman; managing a war-with-Republicans goal, but also being unafraid to argue against progressive ideas for markets. It’s sort of tangential to the regulation/market liberalization issue, but I think contrasting Brad and Paul’s obituaries sort of reflect their differences: Paul cannot remove himself from the holy war against Republicans long enough to write a balanced assessment.
I think if more liberals were like Matt and less like Paul then they would be more succesful at achieving Matt’s goal, which I think is also Paul’s:
…take the rich people’s money and use it to pay for stuff, don’t tell them what to do with the companies they run.
There are libertarians and conservatives who would be willing to make that tradeoff.
(Do I need the requisite statement one must make when criticizing Krugman? Ok. He’s all the nice things (most of) his critics agree he is: genius, great writer economist.)
…that monetary policy is too tight:
Putting his money where his mouth is? Eric Cantor, the Republican Whip in the House of Representatives, bought up to $15,000 in shares of ProShares Trust Ultrashort 20+ Year Treasury ETF last December, according to his 2009 financial disclosure statement. The exchange-traded fund takes a short position in long-dated government bonds. In effect, it is a bet against U.S. government bonds—and perhaps on inflation in the future.
I don’t really care if Eric Cantor enjoys losing money hand over fist…but more seriously, we need some inflation to close the output gap (current NGDP vs trend NGDP from the Great Moderation), and get the real economy moving again…lest we want more socialism (or more fiscal “stimulus”)?
Karl responded to my request for a GM bailout proponent to analyze a BP bailout, and he highlights some crucial differences between the two scenarios. By the commodity nature of oil, a BP competitor would know they could take over BP wells and immediately keep pumping, and not face as much uncertainty as a potential buyer of a GM plant would. This is a big point in favor of GM vs BP.
Karl also argues:
…all three US manufacturers were tied together through the supply chain. This not only magnifies the intensity of a collapse but also has unique consequences for labor. US manufacturers used UAW labor while foreign manufacturers do not. This makes the two imperfect substitutes and would have contributed significantly to a difficult transition.
With respect to the supply chain impacts, that depends on whether the bankruptcy disrupts the supply of oil enough to effect prices. A disruption in supply chain of oil would be much worse than one in autos because oil is non-durable, so you can’t just use yesterday’s oil again today like you can with a car, and because it’s an input into almost every industry and product. James Hamilton has presented persuasive empirical evidence that oil shocks can cause recessions, while no such evidence exists for auto shocks. Regarding the UAW issue in this paragraph, I’m not sure why defunct union status would add frictions to hiring for whoever buys GM’s factories and brands. I suspect that former union workers would probably pretty quickly accept new jobs at lower wages. It’s not like the alternative employment prospects in the rust belt present many alternatives.
He also argues that because oil is a classic perfectly competitive product, the market should respond without problems:
BP on the other hand produces the classic perfectly competitive product. Its completely fungible. Its traded on an exchange. It has a healthy futures market. Its exactly what a textbook economic product should look like. Shortages will be sorted out in the markets, prices will respond and equilibrium will be restored.
As Hamilton shows, though, high oil prices can cause serious macroeconomic problems. The key question, I think, is whether a BP bankruptcy has any chance of disrupting oil production enough to cause a significant spike in prices. As Karl points out, the commodity nature of the product suggests that new owners could keep pumping and selling oil without much of a problem. However, I can imagine scenarios where supply would be disrupted. When Texaco went bankrupt in 1987, credit and supplies were being cut off:
In an affidavit filed in a Texas appeals court, Texaco outlined in detail the pressures it was under. Chase Manhattan had demanded that Texaco maintain new minimum balances in its accounts before the bank would transfer funds to satisfy commercial obligations. Worse, Manufacturers Hanover Trust had canceled a $750 million line of credit.
At the same time, some of Texaco’s suppliers were refusing to do business, or setting tougher terms. According to the Texaco affidavit, Venezuela’s state-owned oil companies had at least temporarily stopped pumping oil for Texaco. (Venezuela denies that it has cut Texaco off.) Southern California Edison started requiring Texaco, its largest customer, to pay its electric bill every week.
The BP bankruptcy would be inherently more uncertain because litigation damages have a much higher potential upside than Texaco’s worst case scenario of $10.2 billion. As Andrew Ross Sorkin reports, the final tally for BP could possibly (although unlikely) be in the hundreds of billions. In addition, we have an administration and a populist electorate that has shown itself willing to intervene in bankruptcy preceding. All of this could deter mergers or buyers. And selling off assets may be complicated by long-term leases, regulatory approval and other legal matters. Given all of these uncertainties, and difficulties in merging of divesting to a solution, I am not convinced that a disruption in production is not a possibility.
Karl also points out correctly that we were in the middle of an extreme credit crunch in 2008, and we aren’t right now. I grant that that is the strongest argument for the GM bailout. So my question is this: if Greece defaults or some other disaster like that occurs, and we begin once again to teeter on the brink of a credit crunch, would there then be a case for a BP bailout?
Bryan Caplan likes “trembling hand perfect” equilibriums, but identifies the concept as an obscure academic concept…and indeed it is. Then he offers a challenge:
My challenge for other econ bloggers: Name yours. What’s your favorite obscure-but-genuinely-enlightening academic economic concept?
The G-R Conditions of Wealth-Creating Economic Activity
- Irreversibility: All economic transactions that create value are thermodynamically irreversible.
- Entropy: All transactions that create value reduce entropy locally within the economy and increase entropy globally.
- Fitness: All transactions that create value produce goods/services that are fit for human purposes.
From David Beckworth
This figure shows the difference between the nominal interest rate on the 5-year Treasury and the real interest rate on the 5-year Treasury inflation protected security (TIPS). This difference amounts to the markets expectation of future inflation. This figure, which goes through June 15, 2010, reveals a clear downward trend in inflation expectations over the first half of this year.
You may have noticed that there is an increased interest in Gold as of late. Right now I am not going to go into the details of what I think is driving this, but instead just look at some of the historical behavior of Gold.
Here is a chart of real gold prices since 1913.
We can see clearly that prior to the 1970s that the convertibility of dollars into gold meant that gold and the general price level moved in tandem. Consequently the real price of gold was more or less stable.
I would just take a brief moment to note that while this is the way we all assume that world works (gold linked to money implies gold linked to overall prices) this is not a logical necessity but an empirical observation.
However, we can also see that since the collapse of Bretton Woods the real price of gold has been quite volatile and that the majority of the movements in the nominal price have been real movements.
Moreover, the real price of gold does not tend to stabilize because consumer prices generally move towards the price of gold but because the price of gold returns to the level of consumer prices generally.
On a very crude level this tells us the gap between gold and consumer prices is not because consumer goods are “under-priced” and due for a rally. A rally that most of us would simply label – inflation. Instead, it looks as if gold is over priced and due for a correction.
Adam wonders today about whether the rise in fuel economy of automobiles is a result of regulation, or a response of technology and wealth to price. I don’t have a lot of time, so here are a couple charts:
Inflation-Adjusted Price of Gasoline
Average Fuel Economy
Two things I would like to note from a quick comparison:
- The spike in fuel economy is not abnormal*, and could probably be fully explained by ratex. There was a LOT of low-hanging fruit to be picked in by the end of the ’70s that would facilitate such a large spike.
- Progressives will likely lament that average fuel economy has actually decreased…but of course that likely has nothing to do with physical engines becoming less efficient. It is most likely due to both increased luxury and safety — some of which is mandated, some of which is response to demand.
Addendum: CAFE standards were first ruminated in 1975 as a response to the (first 1970′s) oil shock of the previous years. However, the first laws were passed in 1978, setting a regulation of 19mpg for cars and 17.2mpg for trucks (4WD is a little lower). However, these individual numbers don’t matter. What matters is the average fuel efficiency of a company’s entire fleet of vehicles. The first combined fuel economy standard was 17.2mpg. Thus, a company could have any mix of vehicle as long as it hit this number (i.e. a truck with 5mpg and a car with 30mpg would pass CAFE standards). These standards were raised every year (except 1985, when they were relaxed) until 1991; where the CAFE standard stood at 20.7 until 2007, when George W. Bush expanded it to mandate 35mpg by 2020…and it has once again begun slowly climbing.
I don’t have the study at my fingertips, but CAFE standards have actually hurt the competitiveness of US automakers. High-end European automakers (BMW in particular) regularly balk the CAFE standards because of the premium they command, and thus simply pass the cost of the penalty on to their customers. Japanese automakers have steadily increased fuel economy beyond the standard ever since it was created. It is only US automakers who ride the line on the CAFE…having to play catch-up every time it changed.
Now, return to the graphs. If you look at the green line, it tells a very interesting story. It jumps almost immediately to 19mpg by 1979…which connects to its previous trajectory. But there is a languish between 1977 and 1979 where it levels off completely. My guess? Regulatory uncertainty. So CAFE, of course, can be held responsible for the jump in mileage — but the counterfactual that this would have happened anyway in the late 70′s – early 80′s, without activist government (and not to mention, CAFE is horrendous policy**), is just as strong.
Addendum 2: I suppose that one who was skeptical of the market price mechanism would point out that fuel economy has pretty much languished along with the CAFE standards…to that I would say 1. take a look at the price chart again, and 2. keep this is mind:
The average new car or light-duty truck sold in the 2003 model year tipped the scales at 4,021 pounds, breaking the two-ton barrier for the first time since the mid-1970′s, according to a report released by the Environmental Protection Agency last week.
In that light, cars are ridiculously more efficient. Since the early 90′s, we’ve just been piling on the luxury and safety at a very quick rate.
*By not abnormal, I mean with the numerous supply-side inefficiencies, a reaction of this magnitude to a move in price could be expected.
**My preferred policy? Gasoline taxes.