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Karl posted something that he should have titled “Stream of Consciousness” instead of “Unsubstantiated Claims” where he thought out loud. One of those thoughts landed on the Fisher effect.

My sloppy writing makes it sound as if I am saying Reihan should read up on the Fisher effect. What I mean to say is that Reihan brought up the fact that people fear inflation eroding savings. These fears are common. I have had many a Facebook debate over them. Indeed, Ron Paul has repeatedly pointed to this has his main reason for fearing debasement of the currency.

I believe that the Fisher effect is controversial among Austrians, and Keynes didn’t believe in the relationship at all, except under hyperinflation. Using price inflation in the Fisher equation makes a lot of things confusing, because the composition of output under recession circumstances (less than full employment — or a flat SRAS) is that raising inflation expectations to, say, 3% from 2% will likely cause an increase in real output, leaving inflation at it’s long-run target. Indeed, the Fed isn’t even interested in boosting inflation expectations past its set 2%, and has made that very clear. What the Fed wants is higher NGDP…but unfortunately it operates under a target for nominal interest rates.

Scott Sumner has a post about how inflation is, counterintuitively, good for savers. The thrust of it is that raising NGDP expectations will raise the Wicksellian real interest rate. People will spend more on investment (maybe not consumption, but probably), and we will get far more output, while trend inflation remains intact (and if it doesn’t, then the Fed can act as necessary). This is a boon to savers, as it raises not only the interest rate on savings accounts, CD’s, and the yield on bonds…it raises other asset prices as well, like stocks, real estate, commodities, etc. All are vehicles for saving, and a higher level of NGDP causes every type of investment to increase its yield.

This is the fundamental reason inflation is confusing. People think a lot about cash, but not many people save in cash (as in safes) under a normal positive trend inflation rate — criminals mostly. I think that price inflation is just muddying the debate here, and is completely useless.

A little late, I know, but Happy Thanksgiving everyone!

A couple days ago, Reihan Salam put forth the question of why the United States is so great. Which means how has the US economy performed so well over the last century? Karl answers with what he deemed a “conventional answer”, and FreeExchange grapples with the question, concluding a mix of market size and the influx of talent to America (read: immigration).

I agree that market size has a lot to do with the wealth that the US generates. The most important thing to note is that the US is a free trade area. Capital and labor are free to migrate easily and efficiently across the borders of states in the US. This advantage, the comparative advantage of trade, has allowed the US to innovate in ways that having trade barriers would not allow. The most striking example comes from (I believe) David Friedman, when he noted that there are two ways to make automobiles; you can erect a factory and build them with steel, or you can plant a field and build them with agriculture…or, presumably, you could erect a tower, and build them with finance. The easy with which this division of labor can manifest itself within the United States is definitely a key to the prosperity we enjoy. Although I believe that the advantage of market size has run its course, it has still been very important.

I want to touch on an element that fell out of favor among researchers in the 60’s, but has since seen a tepid renaissance. That is, culture matters.

Conveniently, that is the title of a book that was put out after a Harvard international studies conference headed by Lawrence Harrison and Samuel Huntington. To begin, I’d like to turn to Robert Putnam, from his book, Making Democracy Work, in which Putnam describes his visit to the government offices of the poor Puglia region of Italy:

In the dingy anteroom loll several indolent functionaries, though they are likely to be present on an hour or two each day and be unresponsive even then. The persistent visitor might discover that the offices beyond stand only ghostly rows of empty desks. One mayor, frustrated at his inability to get action from the region’s bureaucrats exploded to us, “They don’t answer the mail, they don’t even answer the telephone!”

Putnam then contrasts that experience with the experience of the government offices in the rich Emilia-Romangna region in the north:

Visiting the glass-walled regional headquarters is like entering a modern, high-tech firm. A brisk, courteous receptionist directs the visitors to the appropriate office, where as likely as not, the relevant official will call up a computerized database on regional problems and policies…A legislative pioneer in many fields, the Emilian government has progressed from words to deeds, its effectiveness measured by dozens of daycare centers and industrial parks, repertory theaters adn vocational training sites scattered throughout the region.

These two regions stand but 400 miles away from eachother, but they may well be worlds apart. The curious question is, why? They are both populated by Italian people who share the history of Italy. Putnam concludes that the source of this disparity is low trust leading to an inability to achieve large-scale cooperation. He argues that the differing histories is the source, tracing all the way back to medieval times. While the south was traditionally monarchist, hierarchical, closed, and dominated by the church; the north was more egalitarian, communal, and open to trade. Later, the north was influenced by the ideas of the enlightenment.

The idea is that while the south was discouraging networks from forming, as they presented challenges to the hierarchy (and especially the church), the north embraced the formation of social networks, which allowed it to form valuable human (and social) capital.

In their book, Harrison and Huntington present data regarding trust and economic performance (measured in PPP per capita GNP). Not surprisingly, there is a strong correlation between the percentage of people who “trust people in general”, and GNP per capita (sorry I don’t have a link, but if I find suitable data, I’ll reconstruct). The question is, why? Argentinean scholar Mariano Grondona has proposed typological rules. These rules fall into three broad categories.

  • The first category are norms related to individual behavior. These include norms that support a strong work ethic, individual accountability, and a belief that you are the protagonist of your own life and not at the whim of mystical powers or “powerful leaders”.
  • The second category are norms related to cooperative behavior. Foremost is a belief that life is a non-zero-sum game and that there are payoffs to cooperating in a larger group. Societies that believe in a fixed pie of wealth have a difficult time creating social capital, and are often characterized by looting and cheating.
  • The third category are norms related to innovation. Cultures that look to rational scientific explanations of the world tend to be more innovative. It is also very important that a culture be tolerant of heresy and experimentation. Orthodoxy stifles innovation. It is also important that a culture welcome competition and celebrate achievement. Overly egalitarian societies reduce the incentives for risk-taking.

Not surprisingly, those cultural traits are also the key to well-functioning organizations, including businesses, charities, and governments. A final norm, and one that is possibly the most important, is how people view time.[1] As Eric Bienhocker states:

Cultures that live for today (or, conversely, are mired in the past) have problems across the board, ranging from low work ethic, to inability to engage in complex coordination and low levels of investment in innovation. Why work hard, and invest in cooperation and innovation if tomorrow doesn’t matter? In contrast, cultures that have an ethic of investing for tomorrow tend to value work, have high intergeneration savings rates, demonstrate a willingness to sacrifice short-term pleasures for long-term gain, and enjoy high levels of cooperation.

Trust also affects the intangible wealth of nations. Bryan Caplan is fond of touting the fact that poor immigrants are extremely productive, as long as they work in America. The amount of physical capital (A, k, L in Cobb-Douglas) in the US certainly tells part of the story, but as the World Bank has pointed out, it can’t come anywhere near telling the whole story. In fact, our institutions contribute 80% to the US’ capital stock. Contrast that with the poorest nation on earth, the Democratic Republic of Congo, whose intangible capital actually depresses the total wealth of the country.

William Easterly has pointed out that in the last half-century, the developed world has provided more than $1 trillion in economic assistance to the developing world. Yet poverty in places like Africa and South America still persists. Africa even regressed[2] (until recently). The lesson? It is important not to ignore the cultural basis of economic growth.

[1]The Origin of Wealth, Eric Bienhocker. I’d like to thank Bienhocker as well, for providing a guide to much of my analysis of culture.
[2]Just wanted to let you know that that is one of my very favorite TED speeches. It is incredibly inspiring.

Karl does not like karma. Now obviously, being the anti-theist that I am, I don’t believe that there is a benevolent god dishing out karmic punishments and rewards…nor do I think there is a necessary causal link between actions in your social life, and haphazard physical consequences (i.e. helping an old lady across the street, and then finding five bucks…or yelling at your sister, and then stubbing your toe on a chair).

Karl is quite right that human lives are basically a fight against entropy, in which entropy always eventually wins. We strive to use energy inputs to create fit order (which of course, is called “wealth” in economics), in order to escape griding poverty. And in order to maintain such a regime, we need a constant influx of energy inputs and a constant outflow of waste. If these conditions aren’t maintained, everything falls back into a disorder and disarray…most of the population on earth dies, and all of our crowning achievements whither away.

However, this fact need not lay waste to the entire concept of karma. Due to the nature of our societal setup, there is ample opportunity for repeated interaction. This is what I view as the key to the concept of karma. In a world where there is no repeated interactions with people, then there is no need for the concept, as your past circumstances are unknown upon future interactions. Because our society offers ample opportunity for us to repeatedly interact with multiple groups and individuals. Thus, our past actions have a causal link to future interactions.

For example, imagine Robinson Crusoe and Friday are stranded on an island in which they are forced to interact daily. The probability of friendly our hostile interaction is directly related to the results of past interactions. Thus, if Crusoe stabs Friday, he increases the probability that Friday will respond with either violence, or avoidance. One can imagine extrapolating this simple model into a society with multiple complex interactions, and see how someone who always acts in a way that is hostile toward people would end up living in a world where he/she was either under constant threat of retaliation, or seclusion. This may seem like just desserts doled out by a just god…but it is really just the sum of all of the interactions people have.

Ostensibly, we are all perceived to be “mean” to some people, and “nice” to others…most people work to gather and groom a social network, and human interaction is of course very complex, so the probability distributions are never nice and tidy…and are generally always in flux. However, it is a useful way to think somewhat scientifically about a popular moral concept.

P.S. One note about the Tea Party’s notion of economic “fairness”. It is generally a conservative attitude that through grit, determination, and hard work; a person will be able to pull themselves up by their bootstraps into a higher income and better life. However, as liberals like to point out (and often oversell), mobility is oftentimes lower than what intuition tells people. Tom Hertz of American University produced a study (PDF) of income mobility in America which is actually pretty good. What it shows is that mobility within the middle class is often exactly what intuition would tell you…but mobility out of deep poverty, and into the highest echelons of wealth are much, much less than popularly perceived.

That mostly happens to be a lottery, however in a study named “The Apple Doesn’t Fall Far from the Tree” (gated), the team of researchers found that there is a high correlation in pro- and anti-social behavior between parents and their children. It is my opinion that success is often attributable to the (often inadvertent) learning and second-nature understanding of social norms of behavior. These norms are not the same for each societal class…and to have any hope of breaking into a different class, these norms have to be mastered. I’m sure you’ve heard of the contempt of “old money” to the “newly-minted wealthy”. This gives people who have grown up imitating these values a home-field advantage. It is also why the “middle class” is a relatively mobile section of the income distribution — middle class is a very large range of incomes, for which similar values hold.

So in short, I tend to agree with Matt Miller (with whom I rarely agree) that the type of society we should try to build should give maximum equality of upside opportunity combined with a downside safety net. The idea being that (as a society) it is in our interests to have a lot of wealthy people…so it would benefit everyone to help the poor get rich, rather than economically punish the rich. The structure of private/public interaction in this setup is something that I’m sure I’ll differ from many on the left.

P.P.S. I’ve always struggled with the question of “fairness” of economic outcomes. Are there any “fair” economic outcomes? What would constitute such? Is the the completely wrong question to be asking? I kind of think so, but I’d be interested in hearing what you readers have to say on the subject.

Karl has a post today arguing that Brian Wesbury is wrong for taking the view that fiscal stimulus is not effective (indeed harmful!) for two reasons: 1) that it pushes up interest rates through government borrowing (crowding out), and 2) people will expect future taxes to pay for the stimulus.

Unfortunately these are annoying arguments that get conservatives in a lot of trouble with smart commentators on the other side, and then tend to discredit their entire enterprise. Paul Krugman has made a cottage industry out of sniping these crude arguments from otherwise distinguished economists (see Robert Barro via flexible-price models).

However, while Googling Mr. Wesbury, I came across an article that I want to dredge up from February 2008. I want to do this not to point out that Wesbury has no credibility (like some commentators *ahem*), but to show how thinking in terms of interest rates screws people up, and how uncertainty is very dangerous to reputations. The title of the article is “Brian Wesbury Sees No Recession Ahead“.

Q: You say we are not in a recession and we are not even headed for one, right?

A (Wesbury): That is correct. Every single recession in the United States for the last 80 years has been preceded by a tight Federal Reserve policy — in other words, excessively high interest rates. And we clearly don’t have that today. Recessions are also preceded frequently by tax hikes or protectionism. So I would say that today we have very low interest rates, we have low tax rates, and we are not moving in a protectionist direction. As a result, those conditions that have led to recessions in the past don’t exist. One last point: I know of no point in history where we have ever scared ourselves into a recession. It just has never happened before and I don’t think it will happen this time, either.

This is a bombshell of a quote. My main point is that given the events that had happened up until then, saying that we won’t experience a terrible-horrible recession was not an unreasonable position to take. The problem is equating the setting of interest rates with the stance of monetary policy. I also know of no correlation between taxes and recession, and I’m sure he had in mind Smoot-Hawley when he was talking about protectionism…but that tariff was a drop in the bucket of what the actual problem was (then and today): falling NGDP.

By late 2008, in hindsight, Wesbury looks like a fool…but how would he have possibly known that the Fed would let NGDP fall at the fastest rate since 1938 later in the year? As a counterfactual, had the Fed kept up expectations that it would hit its 5% NGDP growth target, Wesbury’s statement wouldn’t look so bad today.

Arthur Laffer was (YouTube) famously in the same boat while talking with Peter Schiff, and of course made to look like a moron. My first piece of advice would be to not attempt to make public predictions. Since that is impossible, my second piece of advice would be to err on the side of caution when making predictions based on models (that is also true with NK multiplier models)…especially when facing strong headwinds.

P.S: I’m happy about the “Babble” tag.

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