Asymptosis

Inflation, Credibility, and Expectations: Again Some More

Asymptosis — Thu, 17 May 2012 16:32:32 +0000

Paul Krugman rightly attacked the confidence fairy again yesterday — claiming that the unemployment of the 80s following Volcker’s tightening proves that Fed credibility doesn’t help — but I think he misfires this time. Here’s what I sed over there, with some tweaks:

To be fair, Paul, isn’t the point here that in 1980 the Fed was decidedly lacking in inflation-fighting credibility? Volcker changed that — as you say, at great cost — and reluctance to lose the resulting credibility has been grounds for not sufficiently addressing the employment side of the Fed’s mandate ever since.

More to the point, though: I am utterly mystified why the Fed thinks that saying it will allow slightly higher inflation (3 or 4 percent), doing so, then presumably bringing it back down, would hurt its inflation-fighting credibility. Quite the contrary.

Unless: they actually believe that they couldn’t pull it off — that a wage-price spiral would ensue, destroying their credibility. Which is the same as saying “if we let things go a little now, allowing more inflation while spurring employment, we may have to allow a lot of unemployment in the future (a la Volcker) to control runaway inflation.”

Given our (their) inability to predict economic futures, and their at-least-perceived decades-long ability to control inflation without big Volcker-style employment hits, this seems like a ridiculous concern.

The more likely explanation in my view: each extra point of inflation would transfer hundreds of billions of dollars of buying power every year from creditors to debtors. Permanently. This isn’t just Econ 101; it’s simple arithmetic.

And the Fed is run by creditors.

This explanation is completely in keeping with the rightie mantra that (only personal financial) incentives matter.

This raises a question I have, especially for (Market) Monetarists:

Suppose two or three years from now inflation is at 4% and employment is strong. Could the Fed bring inflation down by saying they’re going to be less expansive — setting expectations for lower inflation? Or is expectations-setting asymmetrical?

Can the Fed set higher expectations for growth/inflation largely through Open Mouth Operations, while lowering expectations would require (more) actual monetary operations, Volcker-style?

Cross-posted at Angry Bear.

The Top Two Criteria for Expert Judgment: Curiosity and . . . Curiosity

Asymptosis — Tue, 15 May 2012 15:59:55 +0000

First a recap:

Philip Tetlock’s Expert Political Judgment was a groundbreaking look at whether political experts really are expert, as judged by their success at making predictions. His overall conclusion: they aren’t. But (lifted from a previous post):

…among the experts, ”foxes” — those who in Nicholas Kristof’s words are “are more cautious, more centrist, more likely to adjust their views, more pragmatic, more prone to self-doubt, more inclined to see complexity and nuance” — resoundingly beat out the “hedgehogs” — those who “have a focused worldview, an ideological leaning, strong convictions.”

This even while hedgehogs end up getting the biggest megaphones for their incorrect predictions.

But as Bryan Caplan pointed out quite cogently, there were two key flaws in Tetlock’s methodology (my words here, again from my previous post):

1. He only examines questions that are highly controversial among experts. (If 50% believe each way, 50% will inevitably be wrong.) Tetlock explicitly ignores the “dumb” questions that seem to the experts to have obvious answers, but which everyday folks might consider controversial.

2. He doesn’t compare the the experts to the average person on the street. The only such comparison in the book is between experts and Berkeley undergrads — who are darned high on the elite/expert spectrum, in absolute terms. And even in that comparison, the experts win in a landslide. The undergrads aren’t even as good as chimps or dartboards.

Back to the present: Tetlock’s latest initiative, the Good Judgment Project, looks to address those shortcomings. The first-round results are in — reported in an email to Tyler Cowen – and they’re eye-opening. Their predictors:

collectively blew the lid off the performance expectations that IARPA had for the first year. Their original hope was that in Year 1 the best forecasting submissions might be able to outperform the unweighted average forecasts of the control group by 20%. When we created weighted-averaging algorithms that gave more weight to our most insightful and engaged forecasters, these algorithms beat that baseline by roughly 60% (exceeding IARPA’s expectations for Year 4).

And what, you may ask, are the characteristics of their successful expert predictors?

(1) an intense curiosity about the workings of the political-economic world; (2) an intense curiosity about the workings of the human mind; (3) cognitive crunching power (“fluid intelligence” and a capacity for “timely self correction”).

Again: the foxes kick the hedgehogs’ butts.

I always agreed with the commentary about George W and his ilk — that they have no real curiosity about how the world works, they just seek confirmation of their existing (and often simplistic) beliefs — but I never considered it much of a knock-down argument. These results — once we see them explained (the email is pretty thin stuff) — may change my beliefs about that.

Caveat: these “curiosity” criteria are uncannily good at describing Philip Tetlock, Bryan Caplan, Tyler Cowen, and me. I tend to look askance at findings that are self-congratulatory.

Justin Fox reports and ruminates on his experience as a fairly mediocre forecaster in the project (emphasis mine):

So what distinguishes a bad forecaster? In my case, two things: (1) a discomfort with expressing my level of confidence with the size of my bets — this is a real flaw, perhaps traceable to the fact that I had never played a game of poker until two weeks ago; and (2) an almost complete lack of interest in the events being forecast. I think I’m pretty curious about the workings of the political-economic world. I just wasn’t interested in whether the IMF would officially announce before 1 April 2012 that an agreement had been reached to lend Hungary an additional 15+ Billion Euros.

… Hedgehogs who are obsessively focused on a particular theory of how the world works aren’t very good at forecasting. But foxes who don’t care aren’t very good at it either. The best forecasters would appear to be foxes who really really want to win the game of forecasting. To quote Saffo again, the key is to “hold strong opinions weakly.” Don’t be stuck in your views; be willing to revise them quickly when new information comes in. But have bold views, or don’t bother trying to make forecasts.

Cross-posted at Angry Bear.

U.S. Versus Europe: Who’s Winning Now?

Asymptosis — Mon, 14 May 2012 13:40:08 +0000

Now that the OECD has updated their GDP data for 2010, I thought I should revisit the question I asked a few years ago:

Who’s growing faster? The U.S. or Europe?

The answer’s the same as it was then: it’s a dead heat.

As I pointed out in that previous post, people love to cherry-pick periods and show how the US has grown so much faster than Europe. (Funny how liberals don’t seem to play this particular game, while conservatives do, quite constantly — usually while going all gooey about people named Reagan and Thatcher.)

The problem is, what they’re saying isn’t true.

Being a curiously curious cat, with an apparently blithe disregard for my own mortality, I went out and looked at the changes in real (inflation-adjusted) GDP per capita over the last forty years. Which I share with you here. Feel free to cherry-pick at will.

(Click for larger.)

Example, for the upper-right cell:

Starting Year	1970
Ending Year	2010
EU Starting GDP	$14,462
EU Ending GDP	$30,590
US Starting GDP	$20,544
US Ending GDP	$41,976
EU Change	$16,128
US Change	$21,432
EU Change %	112%
US Change %	104%
Change difference subtractive	-7%
Change difference percent	-6%

In the 40 years between 1970 and 2010, real GDP per capita grew by 112% in the EU15, and 104% in the U.S., for a difference of 8%. (Rounding results in 7% showing here; I chose not the display the extra digit everywhere because it makes the table hard to scan easily.)

It’s also easy to show how much growth rates varied proportionally to each other, by percent (the difference between the US and the EU growth rates, divided by the EU growth rate; that’s “Change difference percent” in the last row above).

This is a useful comparative, but it can result in showing big (and rhetorically spurious) swings for short periods, swings that smooth out as soon as you look at periods longer than even six or eight years. Scan along the bottom diagonal horizon and you’ll find no shortage of wonderful cherry-pickable moments. Have at it.

But if you’re actually curious about how our different economic models play out over decades — which is what we do or at least should care about — look to the upper right. I’ve highlighted periods greater than twenty and greater than thirty years for your viewing pleasure.

If you can see any kind of long-term pattern anywhere, I’d be delighted to have it pointed it out to me. The average for those upper-right, dark blue cells is -2.6%, meaning that over the long run, U.S. growth shows as 97.4% of the EU15′s — well within the statistical noise.

Also note that the new data for this post — the right column, for 2010 — seems just as random as all the rest. (Though the two bottom cells do provide some juicy numbers, which I’m sure commenters can spin out into an endless and truly fruitless and specious series of arguments. You go girls.)

Speaking of statistical noise, even though this is about the best national-level data we’ve got (we have to use some data to make our judgments), there’s inevitably some messiness in here. So for the curious and/or skeptical, here are the details.

The data is from stats.oecd.org. The OECD — a think-tank cum rich-country club – assembles this data from individual countries’ national accounts. (They just updated US 2010 GDP in March.) They also compile it to some extent, and apply various conversions using best practices. Viz:

For comparison to the U.S., I used the OECD’s compiled data for the 15-country European Union (Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden and the United Kingdom). In my previous post I used a simple average of GDP/capita for non-English-speaking Western European countries (excluding Luxembourg and Norway, for instance, because of size, banking, and oil). I think that selection provided a better representative comparison group, but the OECD does a better job of agglomerating the data than I could do. I’ll just say that judging from my non-systematic journeys through the data over the years, changing country choices doesn’t change the top-line results much at all. Please feel free to prove me wrong.

I chose GDP/Capita as a measure because it’s a pretty good big-picture yardstick of prosperity, and removes one key confuting variable from the comparison: population growth over the decades. GDP has lots of things wrong with it (it only counts remunerated work, for instance, which gives the U.S. a notable advantage in the comparison, because Europeans have more free time for productive but unremunerated “home work”), but it’s hard to name a better big-picture measure for which we have consistently compiled data for lots of countries, going back four decades.

All the foreign numbers are converted to US dollars based on “purchasing power parity.” This adjusts for different purchasing power in different countries, in an effort to impart people’s relative buying power in those countries. It’s not a perfect method, by any means. But just using market exchange rates isn’t either. Since I’m curious about standards of living in the two areas, PPPs made more sense than exchange rates.

Adjusting for inflation — especially in different countries — is also an imperfect science. Many European countries, for instance, don’t use “hedonic adjustment” to correct for massively increasing computer value per euro or dollar. (This makes those countries’ growth rates look worse.) The U.S. and several other European countries do. I’m not a ShadowStats fan (CPI tracks too closely with the Billion Price Index, for instance, to give much credit to their rather wild claims), but I do realize that adjusting for inflation requires holding up your thumb and squinting some. Again, though, if we want to compare countries’ prosperity over decades, we need to talk about real buying power as opposed to nominal units of currency.

Those were my choices. If you think there are better ones, and that they would change these results significantly, please go do it yourself and report back. I’m wildly curious. Here’s my spreadsheet. I’m happy to help anyone figure out how to use it (the Data Tables are especially neat), and also how to navigate the OECD’s stats.

I should end by pointing out the fact that commenters will undoubtedly raise: the EU remains way behind the U.S. in (at least) this measure of prosperity. Europeans buy 20-30% less stuff per person than Americans. After catching up fast (and predictably) in the decades following WWII, they’ve been stuck at about the same level (relative to us) for forty years. Standard economic convergence theory suggests that they should have continued that catch-up. But that’s a topic for another post.

Cross-posted at Angry Bear.

Conservative or Liberal? One Question to Rule them All

Asymptosis — Mon, 23 Apr 2012 19:35:08 +0000

I’m devastated that Christian Rudder hasn’t posted to the OKTrends blog for more than a year.* He did statistical analysis of the monstrous database of OK Cupid — a dating site that asks participants hundreds of often odd and quirky questions about themselves — to draw out conclusions about various, sundry, and often fascinating topics.

I also can’t believe that I never posted about a finding in one of his posts that really caught my eye — from The Best Questions for a First Date:

If you want to know…

Do my date and I have the same politics?

Ask him or her…

Do you prefer the people in your life to be simple or complex?

Because…

We were very surprised to find that this one question very strongly predicts a person’s ideas on these divisive issues:

Should burning your country’s flag be illegal?

Should the death penalty be abolished?

Should gay marriage be legal?

Should Evolution and Creationism be taught side-by-side in schools?

In each case, complexity-preferrers are 65-70% likely to give the Liberal answer. And those who prefer simplicity in others are 65-70% likely to give the Conservative one.

This correlation is for a nationwide dataset; it won’t be as useful in places where one ideology is much more prevalent than the other. For example, in New York City there are lots of people who like simplicity and yet have Liberal politics.

This jives perfectly with my own anecdotal observations: that conservatives tend to like simple answers to everything: “Just cut taxes!” or “It all boils down to X.” (Scott Sumner deserves unlimited praise for acknowledging and battling that predilection in this link. That admission — along with the Rudder’s finding here — might also go a long way towards explaining why Steve Randy Waldmann thinks that professedly right-ish Market Monetarists have more in common with generally lefty MMTers and Post-Keynesians than they or others might suspect, or than any of those groups have in common with simplistically delusional freshwater neoclassicals.)

And I would also add: people aren’t simple. Ever. Especially when there’s more than one of them. (Can you name a single family that you know well that doesn’t have all sorts of odd and complicated stuff going on?) So this portrays conservatives wishing for things that don’t exist — like, for instance, prosperous, modern, high-productivity countries that don’t have massive doses of redistribution.

I’ll leave you with that. But I can’t resist sharing another beauty from the same post:

Okay, if you want to know…

Will my date have sex on the first date?

Ask…

Do you like the taste of beer?

Because…

Among all our casual topics, whether someone likes the taste of beer is the single best predictor of if he or she has sex on the first date.

This caused me some difficulty recently. I was out with a friend and his girlfriend. She took a big swallow from her glass, put it down firmly, and announced, “Damn I love the taste of beer.” I almost spewed mine across the room.

Finally, for those who’ve read this far: if you’re thinking that the title of this post is ironic…you’re right.

* Ah. He sold his shop to Match.com just over a year go — for $50 mil. Just six days ago a “rumored seven-figure” deal was announced for the book on big data that he’s writing/has written, titled Dataclysm. I’ll be buying it.

Cross-posted at Angry Bear.

Beckworth Promotes Platinum Coins as Obama’s “FDR Moment”!

Asymptosis — Sat, 21 Apr 2012 17:31:49 +0000

You know things are weird when pretty strongly right-of-center economists are proposing ideas first touted by MMT econocranks (yes, beowulf, I’m talking about you) to bring about the Obama breakout moment that progressives (despairingly) dream of at night.

The world is a very strange place.

And people argue with Steve Randy Waldman when he says that MMTers, post-Keynesians, and Market Monetarists agree on lots of things… Sheesh.

Macro and Other Market Musings: Obama Needs His FDR Moment.

Cross-posted at Angry Bear.

Mitt Romney, American Parasite, Destroys America’s Mittelstand

Asymptosis — Sat, 21 Apr 2012 16:26:44 +0000

Speaking of “extractive elites,” don’t miss Pete Kotz’s cover story in the Village Voice, Mitt Romney, American Parasite. (I read it in their subsidiary Seattle Weekly.)

It details a whole string of Bain purchases under Romney — thriving companies that were saddled with debt so Romney could extract cash in the form of “profits,” leaving the companies to devolve into bankruptcy and dissolution.

Just one example:

“When Bain Capital took over, it seemed like everything was being neglected in our plant,” says Sanderson. “Nothing was being invested in our plant. We didn’t have the necessary time to maintain our equipment. They had people here that didn’t know what they were doing. It was like they were taking money from us and putting it somewhere else.”

History would prove him correct. While Georgetown was beginning its descent to bankruptcy, Romney was helping himself to the company’s treasury.

Be very clear on this: that is the business model of private equity:

Charlie Hallac, a top deputy to Larry Fink at BlackRock and head of the firm’s analytical arm, BlackRock Solutions, distilled it down with precision: “Of every twenty deals, the large aggressive PE firm expects seventeen of the companies to fail under the added debt. Two have to survive and one has to hit big for the firm to have a fairly strong return on its PE fund. So that’s three out of twenty.”

The whole purpose of the private equity industry is to destroy the kind of mittelstand, long-lived, profitable, specialized, often family-owned and -operated companies that The Economist, Business Week, et al keep touting as the backbone of Germany’s remarkable success and resilience — its very “model of success.” Private equity’s model is to extract the expected future value of those companies in cash, while simultaneously, in most cases, destroying that value.

Is that what they mean by “creative destruction”?

But here’s the question that keeps nagging at me: who lends them the money? Presumably savvy financial-system lenders know that a large percentage of these companies are going to go bankrupt and walk away from their creditors. Why do they lend the money? I’m thinking it must be a principal-agent problem, where the individuals approving the loans make out well, while the companies they work for (and their shareholders, and taxpayers) take the hit.

Cross-posted at Angry Bear.

The American Conservative: “Extractive Elites” and “Macro-Corruption”

Asymptosis — Sat, 21 Apr 2012 15:23:30 +0000

It’s pretty amazing to read a cover story in, and by the publisher of, The American Conservative that could have run in The Nation, Mother Jones, or on Daily Kos — almost.

Certainly America’s top engineers and entrepreneurs have created many of the world’s most important technologies, sometimes becoming enormously wealthy in the process. But these economic successes are not typical nor have their benefits been widely distributed. Over the last 40 years, a large majority of American workers have seen their real incomes stagnate or decline.

Ordinary Americans who work hard and seek to earn an honest living for themselves and their families appear to be suffering the ill effects of exactly this same sort of elite-driven economic pillage. The roots of our national decline will be found at the very top of our society, among the One Percent, or more likely the 0.1 percent.

This is in The American Conservative!

Strangely disguised under the title China’s Rise, America’s Fall, Ron Unz riffs like so many of late on Daron Acemoglu and James A. Robinson’s new Why Nations Fail, describing America over recent decades as a country plagued by “extractive elites” and “macro-corruption.”

Macro-corruption is a great coinage. Former S&L enforcer Bill Black should adopt it in place of his perhaps more descriptive but not very catchy “control fraud.”

Unz (emphasis mine):

although American micro-corruption is rare, we seem to suffer from appalling levels of macro-corruption, situations in which our various ruling elites squander or misappropriate tens or even hundreds of billions of dollars of our national wealth, sometimes doing so just barely on one side of technical legality and sometimes on the other.

Sweden is among the cleanest societies in Europe, while Sicily is perhaps the most corrupt. But suppose a large clan of ruthless Sicilian Mafiosi moved to Sweden and somehow managed to gain control of its government. On a day-to-day basis, little would change, with Swedish traffic policemen and building inspectors performing their duties with the same sort of incorruptible efficiency as before, and I suspect that Sweden’s Transparency International rankings would scarcely decline. But meanwhile, a large fraction of Sweden’s accumulated national wealth might gradually be stolen and transferred to secret Cayman Islands bank accounts, or invested in Latin American drug cartels, and eventually the entire plundered economy would collapse.

Does this sound like the American financial industry to you?

But is Unz talking about the financial industry and its government (particularly Republican) toadies? Of course not. That would be admitting that he and his movement are largely at fault for the problems he’s describing.

When parasitic elites govern a society along “extractive” lines, a central feature is the massive upward flow of extracted wealth, regardless of any contrary laws or regulations. Certainly America has experienced an enormous growth of officially tolerated corruption as our political system has increasingly consolidated into a one-party state controlled by a unified media-plutocracy.

What’s amazing here is the two bolded passages. What in the heck does he mean by “regardless of any contrary laws or regulations”? Perhaps that the institutions responsible for enforcing and writing those laws and regulations are defunded, defanged, and co-opted by the extractive elite? Sound familiar?

And the final passage is just breathtaking. The financial industry, empowered and unleashed by that defanging (with American conservatives cheering and pushing every step of the way), has captured 20-40% of corporate profits over the last decade or so. But it’s the media that’s doing the extracting?

All I can say is they’re not very damned good at it. Wouldn’t you expect the extractive elite to successfully . . . extract a lot of money into offshore bank accounts? Exactly which industry is doing that?

Some might find it significant that the word “banks” never appears in the article.

I don’t need to detail all the other ironies that pervade this piece. (Notably: an excellent extended and off-topic rant against Obama’s continuation and expansion of Bush-era conservative, authoritarian military, intelligence, and surveillance policies, and their popular glorification in shows like 24: “Throughout all of modern history, I am not aware of a single even semi-civilized country that publicly celebrated the activities of its professional government torturers in the popular media.“). They’re rife and manifest.

But I would highly recommend this piece to those seeking to understand and explicate the problems plaguing this country. “Extractive elites” and “macro-corruption” encapsulate it pretty perfectly. It’s also essential reading for those like me who can’t seem to look away from the decades-long train wreck of contorted, self-contradictory conservative “thinking.”

* Irresistible aside: I heard an NPR interview years back with a businessman from a South American country saying that his country is far more democratic than ours. In his country, anyone can bribe officials. In America, only the rich get to make bribes.

Hat tip: Beowulf

Cross-posted at Angry Bear.

Encouraging Deadly Financial Viruses

Asymptosis — Thu, 19 Apr 2012 15:50:59 +0000

Randall Wray highlights two great insights that arose at the annual Minsky conference last week in NYC.

First Joseph Stiglitz (Wray’s words, emphasis mine):

Recall that part of the reason for the creation and explosion of derivatives was to spread risk. For example, mortgage-backed securities were supposed to make the global financial system safer by spreading US real estate risks all over the world. He then compared that to, say, a deadly flu virus. Would you want to spread the virus all over the world, or quarantine it? Remember Warren Buffet’s statement that all these new financial products are “weapons of mass destruction”–like the 1914 flu virus. And, indeed, just as Stiglitz said, spreading those deadly weapons all over the world ensured that when problems hit, the whole world financial system was infected.

Next, Frank Partnoy:

He said that these innovations mostly exploit information asymmetries in order to:

a) dupe customers (think Goldman Sachs and John Paulson constructing synthetic CDOs sure to blow up, and betting against Goldman’s customers who bought them); and

b) engage in regulatory arbitrage (evade rules, laws, supervisors, etc; ie, move trash into SIVs to evade capital requirements).

But the financial industry and its Republican toadies would have you believe that regulating our outlawing these derivatives will destroy American “innovation.” Yeah: and we should also encourage innovation in suicide-vest technology.

21st Annual Hyman P. Minsky Conference: Debt, Deficits, and Financial Instability « Multiplier Effect.

Cross-posted at Angry Bear.

Lending, Velocity, and Aggregate Demand

Asymptosis — Fri, 30 Mar 2012 16:22:51 +0000

JKH likes this line in Keen’s response to Krugman:

The endogenous increase in the stock of money caused by the banking sector creating new money is a far larger determinant of changes in aggregate demand than changes in the velocity of an unchanging stock of money.”

It struck me as an empirical question: how do those changes compare in magnitude? I didn’t know offhand.

Let’s start with MZM (money of zero maturity, the broadest definition of money), and GDP:

There’s about $10 trillion in MZM right now, and GDP (annual spending) is at about $14 trillion.* The money stock turns over about 1.4 times per year.

If money supply was unchanged — no new net lending/borrowing — but the musical chairs/logrolling game sped up so money turnover increased by 5%, because people were more optimistic — ready to take chances, consume now while worrying less about later, invest in new housing and productive capacity, etc. (“animal spirits”) — that would add $.7 trillion to aggregate demand. (5% is quite a GDP jump given no new net lending…)

Now lets look at annual net borrowing/lending — annual change in debt owed by households and nonfinancial firms:

Plus $1.6 trillion, to minus $.4 trillion. We’re looking at magnitudes far beyond what we could reasonably expect from pure animal-spirit-driven velocity changes.

Now it’s true that much of that lending/retiring might not translate directly into purchases/production/consumption of real goods. Much of it might (does) leak into changes in financial asset prices. (Keen is keenly aware of this. It’s pure Fisher/Minsky.) Yes, that portion could affect real-good transaction volumes via a second-order wealth effect, but the magnitude of that effect is unclear.

But it seems from the magnitudes that Keen’s statement is probably correct: changes in borrowing and de-borrowing have a lot more potential effect on aggregate demand, at least, than changes in velocity.

* Note that this does not include spending on intermediate goods — those that are turned into final goods within the accounting period — or used stuff. Adding these into total spending when calculating velocity might yield interesting insights. See Nick Rowe, Macroeconomics and the Celestial Emporium of Benevolent Knowledge.

Cross-posted at Angry Bear.

Keen Answers Krugman

Asymptosis — Wed, 28 Mar 2012 23:11:28 +0000

I think Steve handles it admirably, and admirably briefly, so in this case I’ll simply point you over there.

On bank lending’s creating deposits and Paul Krugman’s response | Credit Writedowns.

Cross-posted at Angry Bear.

The Central Flaw in Krugman’s Argument Against Keen

Asymptosis — Wed, 28 Mar 2012 15:08:41 +0000

The key failing in Krugman’s response to Steve Keen’s response to Krugman’s paper (PDF) is here:

If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand.

Krugman assumes here that people have to save (spend less) in order for other people to borrow. It’s actually the fundamental assumption, the sine qua non, of his paper (and of Krugman’s beloved IS-LM — the linch-pin of “New” Keynesianism — created by Hicks to subsume Keynes into neoclassicism, and later disclaimed and discredited by Hicks as a “classroom gadget”; see my post, and Phillip Pilkington here).

But that’s not how things work (and it’s the very assumption that Keen is disputing). I tried to explain this in clear and simple terms here:

Think about it:

You get $100,000 in wages. Your employers’ bank account is debited, and yours is credited. Your bank can lend against your higher balance; your employer’s bank can’t. Net zero.*

You spend $75,000. It’s transferred from your account to other people’s/businesses’ bank accounts. Their banks can lend more, yours can lend less.

Is the total stock of loanable funds affected by whether the money is on deposit at your bank, your employer’s bank, or the banks of people you bought stuff from? No.

Meantime, you don’t spend $25,000. You “save” it. The money sits there in your checking account. If the action of spending — transferring money from one account to another — doesn’t change the total stock, how could not transferring money do so? Your bank still has the money, which it can lend out. Other banks still don’t, and can’t.

So here’s how the argument plays out:

Krugman assumes that people need to save in order for others to borrow.

Keen points out that they don’t.

Krugman explains that Keen is wrong by … assuming that people need to save in order for others to borrow.

And so the world goes round.

Cross-posted at Angry Bear.

Steve Keen Flexes His Muscles

Asymptosis — Thu, 22 Mar 2012 13:38:28 +0000

Super Corporate Heroes: Truth, Justice, and How Much Does It Pay?

Thinking About the Fed

Asymptosis — Tue, 20 Mar 2012 15:31:17 +0000

JKH has magisterial post up on the recent dust-up over Saving as perceived in various sectoral models — one-sector (global, for instance, or government- and trade-balanced domestic private sector); two-sector (government and private including international); the most common MMT construct, the three-sector model (government, domestic private, and international); the rather uncommon four-sector model (government, international, domestic household, and domestic business); or even a seven-billion-plus-sector model, in which each individual (and business, and government) is represented as a sector.

His key point, I think — one I agree with profoundly — is that people need to be very clear on which model they’re assuming when they use the word Saving, or the construct “S.” (People sometimes use those two differently, with different implied sectoral models, sometimes within a single discussion or even a single sentence.) In most cases the different constructs of saving and S that people throw around are absolutely valid within their (implicit) sectoral models. The problem arises when people are talking about different sectoral consolidations within the same discussion, without themselves and/or their interlocutors being (fully) aware of it.

I’ve left a few glancing comments over there, but it’s prompted me to write up some thinking here that’s conceptually related.

How do we think about the central bank, and actually the nature of money and the monetary system? I see a lot of people talking past each other because they’re talking about different levels of accounting consolidation. Here are four ways to look at the Fed:

1. It’s an independent institution, separate from Treasury and the reserve-holding banks.

2. It’s part of “government” — a consolidated entity comprised of Treasury and the Fed.

3. It’s part of the private sector monetary system — a consolidated entity consisting of the Fed and all the banks holding reserves at the Fed.

4. It’s part of a fully consolidated monetary system consisting of Treasury, the Fed, and all the reserve-holding banks.

I’m not going to explore all these fully — there’s a book (or several) there — but here are some thoughts on each that might illuminate how the thinking is very different depending on which you adopt, perhaps showing how quite a lot of unecessary confusion and cross-discussion might be avoided.

1. It’s an independent institution, separate from Treasury and the reserve-holding banks.

Even though this is the “reality” of our monetary system (as a result of legislative diktat), thinking about it this way results in an odd conceptual situation. We end up with a sovereign currency issuer (Treasury) that (like a household or business) has to borrow in order to spend, and a bank (the Fed) that can issue unlimited funds ex nihilo to purchase assets. This seems exactly the opposite of how one would imagine things would work.

2. It’s part of “government” — a consolidated entity comprised of Treasury and the Fed.

This is a preferred MMT construct, and it has much conceptual appeal. “Government” issues new money through Treasury spending, and Fed open-market and QE operations are basically fiddling around the edges of the money “supply,” largely for the purpose of interest-rate management. Yes, the Fed actually issues the money, but in this consolidated view “government” is doing the issuing through deficit spending, crediting people’s bank accounts with newly-created money.

3. It’s part of the private sector monetary system — a consolidated entity consisting of the Fed and all the banks holding reserves at the fed.

This makes conceptual sense, because all deposits ultimately resolve, consolidate, back to reserves at the Fed. In this construct, all the banks (including the Fed) are issuing private money as licensees of of the Fed, which ultimately derives its licensing authority from “government” (Treasury).

4. It’s part of a consolidated monetary system consisting of Treasury, the Fed, and all the reserve-holding banks.

Looked at this way, we could conceive of it all as a single big national bank, with deposits resolving back to reserves, which ultimately resolve back to the full faith and credit of the government (Treasury).

These are fairly sloppy characterizations. I know the JKHs and SRWs, Ramanans, Vimothys et. al could (and I hope will) express them more cogently and accurately. But I wanted to keep them brief to highlight my central point:

Different views, consolidations, of these entitites result if very different understandings of “how the monetary system works.” Each (properly presented, unlike here) is valid within its own construction, and each imparts an important understanding of how things work. The problem arises, as with Saving and “S,” when a person, or people in discussion, confute and confuse these different views, or switch among them during thinking and discussions.

Cross-posted at Angry Bear.

It’s a Spending Problem, Right?

Asymptosis — Sun, 18 Mar 2012 00:14:21 +0000

Well if so (something I’m not asserting), it’s a Republican spending problem:

Economist’s View: Per Capita Government Spending by President.

Cross-posted at Angry Bear.

When Do Humans Want to Share the Wealth?

Asymptosis — Fri, 16 Mar 2012 15:53:16 +0000

Jonathan Haidt reports an interesting experimental result:

Two three-year-olds walk up to a marble-delivery machine that has two bins. Each stands in front of one bin. Three scenarios:

1. One bin has three marbles in it, the other has one: the winner is unlikely to share to equalize the takings.

2. There are two ropes to pull; one delivers one marble, the other three: the winner is unlikely to share to equalize the takings.

3. Two ropes, but both must be pulled together to deliver the one/three marbles: the winner is likely (75%!) to share to equalize the takings. (Either spontaneously, or on request from the loser.)

If people feel that they must work together to get the goods, they also feel that they should (or even want to) share the goods.

Haidt’s take (my emphasis):

If there’s a problem with the ultra-rich, it’s not that they have too much wealth, it’s that they bought laws that made it easy for them to gain and keep so much more wealth in recent decades.

Sarah Palin gave a speech last September lambasting “crony capitalism,” which she defined as “the collusion of big government and big business and big finance to the detriment of all the rest – to the little guys.” I think that she was on to something and that she was right to include big government along with big business and big finance. The problem isn’t that some kids have many more marbles than others. The problem is that some kids are in cahoots with the experimenters. They get to rig the marble machine before the rest of us have a chance to play with it.

Now add this:

The losers know the game is rigged, so their innate intution tells them that the winners should share.

The winners refuse to know that the game is rigged — deny it vehemently — so they think the losers are unreasonable in their expectations of sharing.

Contributing: The American cult of individualism — the widespread belief among the successful that their success is a result of their efforts only, so they deserve their winnings — means that their natural human work-together-share-together instincts aren’t invoked. This even when they’re wrong about the relative contribution of their individual efforts.

So the winners are deluded about two things: 1. the relative contribution of their individual efforts (compared to A. luck and B. the rules/playing field), and 2. the (rigged) state of the playing field.

Here’s the problem: the losers are also deluded about #1 (because the rigged game provides the winners with the necessary resources to delude them through tens of billions of dollars of propaganda and economist-buying).

So here’s the rhetorical challenge faced by those who seek greater equality: convince the losers that much or most of the winners’ success is in fact the result of everyone pulling on ropes together (and luck), not just the winners’ industrious rope-pulling. Not an easy task, but one worth focusing on.

To add, a problem with Haidt’s analysis: if big business and big finance (and rich people) couldn’t buy big government to rig the game in their own favor, big government wouldn’t be the problem. Absent that buy, government is essentially indifferent to relative distributions — or arguably even more inclined to sharing the wealth widely to garner lots of votes — one person one vote versus one dollar one vote.

He suggests a three-way symmetry for a situation that is not symmetrical.

Cross-posted at Angry Bear.

Business Roundtable Proposes Obamacare to Restore American Competitiveness

Asymptosis — Tue, 06 Mar 2012 16:55:51 +0000

Or: You Just Can’t Make This Shit Up

“Health Care Costs Put U.S. at Significant Disadvantage Compared with Global Competitors”

I’ll let you read the details, but short story:

Whodathunkit?

And what do they recommend?

Creating greater consumer value in the health care marketplace by using health information technology and empowering consumers with more information about good quality health care.

Providing more affordable health insurance options for all Americans by creating an open, all-inclusive private market for health insurance and replacing today’s fragmented state-by-state market with multistate markets. To ensure that insurance plans are solvent and meet certain minimum requirements, the role of individual states as the primary regulator should continue. Broader, more competitive markets will create more choices for more health care consumers.

Engaging all Americans in taking an active role in their health care. First, this means placing an obligation on all Americans to obtain health insurance either through their employer or the private market. Second, we must encourage all Americans to participate in employer- or community-based prevention, wellness and chronic care programs.

Offering health coverage and assistance to low-income, uninsured Americans that create a stable and secure public safety net. This assistance would be financed from the cost savings and efficiencies generated by a more competitive and value-driven health care system.

The Business Roundtable Health Care Value Index – Executive Summary | Business Roundtable.

Cross-posted at Angry Bear.

Note to ‘Pubs: The Demographic Tidal Wave is Hitting the Beach

Asymptosis — Mon, 05 Mar 2012 21:49:28 +0000

Or: Even a Stopped Clock is Right, Eventually

For quite a while I’ve been explaining the rabid, frantic vehemence of tea partiers and Republicans in general with a single visualization:

They’ve got their backs against the seawall, and a massive, overwhelming demographic tidal wave is looming over them.

The terror that situation provokes among old, white, rich, “educated” male types is enough to mobilize a hell of a lot of political activity and influence (especially when it’s coopted and channeled by tens of billions of dollars in corporate propaganda). This goes a long way toward explaining the backlash of the 2010 election.

But desperate maneuvering can’t stop the tides.

This demographic notion got its first major airing in Judis and Teixeira’s 2002 The Emerging Democratic Majority, which seems to have been a little ahead of its time. But as Jonathan Chait suggests in ”2012 or Never,” the demographic clock may finally be ticking up to high noon.

The modern GOP—the party of Nixon, Reagan, and both Bushes—is staring down its own demographic extinction.

Despite assorted and sadly wishful pooh-poohing on the right (“the Republicans will just rebrand themselves”; “second-generation Latinos will be more conservative”), the demographic reality is displayed quite starkly in two graphs from a recent Pew report (PDF; hat tip Ruy Teixeira).

Say “buh bye.”

Nevertheless, as Robert Reich reminds us: for the present, “the loony right” remains “a clear and present danger.”

Update Mar. 5: “According to the latest survey from Fox News and Latin Insights, 73 percent of Latinos approve of President Obama’s job performance, compared to 35 percent approval for Mitt Romney, 13 percent for Ron Paul, 12 percent for Newt Gingrich, and 9 percent for Rick Santorum. What’s more, in a head-to-head matchup with the president, none of the GOP candidates would win more than 14 percent of the Latino vote.”

Cross-posted at Angry Bear.

Where’s the High Point on the Laffer Curve? And Where Are We?

Asymptosis — Sat, 03 Mar 2012 16:32:24 +0000

Anti-taxers love to haul out the legendary napkin-inscribed Laffer curve to demonstrate that lower taxes would yield more government revenue. But this ploy only works because they assume that we’re at or past the high point — that higher taxes would move us down the right slope. (Note the cross-marks-the-spot in the image here?)

But where are we really, relative to that high point? James Kwak gives us an answer, based on a great recent paper by Christina and David Romer (emphasis, interjections, mine):

…an [income] elasticity of 0.19 [from the Romer paper] implies that tax revenues would be maximized with a tax rate of 84 percent; that is, you could raise taxes up to 84 percent before people’s reduced incentives to make money would compensate for the higher tax rates.

This is obviously not to say that we should be taxing at that level — only that Laffer-curve arguments are ridiculous because we’re nowhere near the high point.

Kwak adds another key insight about the paper:

Second, remember that this is a study of the super-rich: not the top 1%, but the top 0.05%. These are the people whom one would expect to have the highest income elasticity, precisely because they don’t need the marginal dollar. Elasticities tend to be lower for ordinary people because they need to cover their expenses.

So we’re even father from the peak than suggested by the .19 elasticity.

Takeaway:

…when you raise taxes on the rich, they don’t stop trying to make money: they just pay their lawyers and accountants more to avoid paying taxes.

Hat tip Karl Smith and Mark Thoma.

Cross-posted at Angry Bear.

How Much Do Taxes Matter? | The Baseline Scenario.

More on Interest on Reserves

Asymptosis — Thu, 01 Mar 2012 20:09:17 +0000

I did a couple of posts a while back asking (and concluding) what would result from the Fed ending their interest on reserves policies. (Not suggesting they do so — just wondering what the effects of that one change would be.)

I got a lot of good answers and discussion, but nobody mentioned the very interesting paper by Alex Tabarrok discussed here (emphasis mine):

…there was typically a daily shortage of reserves which the Fed made up for by extending hundreds of billions of dollars worth of daylight credit. Thus, in essence, the banks used to inhale credit during the day – puffing up like a bullfrog – only to exhale at night. (But note that our stats on the monetary base only measured the bullfrog at night.)

Today, the banks are no longer in bullfrog mode. The Fed is paying interest on reserves and they are paying at a rate which is high enough so that the banks have plenty of reserves on hand during the day and they keep those reserves at night. Thus, all that has really happened – as far as the monetary base statistic is concerned – is that we have replaced daylight credit with excess reserves held around the clock.

This explanation finds support in a post from Liberty Street Economics (NY Fed blog). The key graphic:

Cross-posted at Angry Bear.

Public vs. Private Debt: The Long View

Asymptosis — Mon, 27 Feb 2012 16:23:59 +0000

Poking around in FRED while thinking about money created by banks and by government, I came up with the following graph, which I found to be pretty eye-popping:

Federal Debt Held by the Public as a Percentage of Total Credit Market Debt Owed

That’s a pretty profound secular shift. But far from delivering any obvious conclusions for me, it raises several questions.

• First, what’s included in TCMDO? (Is there a glossary of these measures available somewhere? I haven’t been able to find one.) I assume government bills and bonds are included — including those held by the Fed. I assume it does not include bonds held by the Social Security trust fund — nonpublic debt. (Or does it?)

• Since financial industry debt is “different,” what does the graph look like if we exclude that?

Federal Debt Held by the Public as a Percentage of (Total Credit Market Debt Owed – Financial Sector Debt Owed)

• Should we adjust for credit-market instruments held by the Fed?

• Are there more illuminating measures to display in this graph?

• What does this say about the stock of “safe assets” in the economy?

• How does this relate to JKH and Steve Waldman’s notions of government money (created through deficit spending) as “leverage” — in Michael Sankowski’s words: “JKH points out (S-I) is like the denominator in leverage. When (S-I) [govt deficit spending plus/minus trade imbalance] gets too small compared to S or I, then the private sector steps in with private creation of S. But these claims aren’t always as credible as government NFA. Plus, private sector S can sometimes be marked to market in ways which makes valuation difficult.”

Sorry to be so inconclusive. As always I’m hoping to be educated by finer minds than mine.

Cross-posted at Angry Bear.

Republicans: More Education, Less Reality

Asymptosis — Mon, 27 Feb 2012 14:26:10 +0000

Via Chris Mooney to Digby to Krugman then me — this remarkable item from a Pew report:

College-educated Republicans are more likely to deny scientific reality.

They don’t spend their time in college (or life) trying to learn how the world works; they spend it learning how to mine, harvest, cherry-pick, and twist any “facts” they can find to conform to, and support, their faith-based beliefs.

Is it any wonder that among scientists — who devote their lives to trying to figure out how the world works — 55% are Democrats and only 6% are Republicans? (Click for source.)

Curious about the reality of Republican thinking? Check out Mooney’s The Republican Brain: The Science of Why They Deny Science—and Reality, due out in April from Wiley.

Cross-posted at Angry Bear.

14 Ways an Economist Says I Love You.

Asymptosis — Sun, 26 Feb 2012 16:04:44 +0000

I’ll just share two of these. HT Yoram Bauman.

via 14 Ways an Economist Says I Love You.

Cross-posted at Angry Bear.

Why the Government Must Keep Running Deficits. Forever.

Asymptosis — Sun, 26 Feb 2012 14:59:52 +0000

Imagine an economy that consists of two households, one firm, one bank, and one government.

The government issues $50 to each household (maybe they do some work for it), crediting their bank accounts and running a $100 deficit. Voila! There’s money!

Now one household works for the firm, creating $50 in value, goods. The firm gives the household $50 in equity — company stock — basically a promise to give them some amount of money in the future. (The firm posts the $50 in newly created value as an asset on the lefthand side of their balance sheet, and $50 as shareholder equity on the righthand side — a liability).

The household can’t use that equity to buy a pack of gum today, so they want to monetize it — sell it to someone else. There’s only one “someone” — the other household.

But what if the other household doesn’t want to buy it because they’ve only got $50 and want to hold it for the future? (It’s the babysitting coop dilemma.)

This is why in a growing economy where extra value is being created through people’s efforts, the government has to run deficits — creating money by crediting people’s/firms’ accounts with newly “printed” dollars.

If people can’t convert that extra value they’ve created into general-purpose “credit” (dollars) that can be exchanged for a variety of goods, they can’t spend. Which 1) gives them notably less incentive to create the value in the first place, and 2) prevents them from continuing the buying/selling log-rolling exercise that is our economy.

You’ve got a lot of newly created value/goods, but nobody with money to buy them.

Imagine if the cumulative government deficits today — the stock of money that government has spent into existence — were at the same level it was in 1900. The economy would be completely inoperable, locked up in primitive barter arrangements for lack of general-purpose money.

This is why government debt is not never, has not ever been, cannot ever be, paid off.

Another way to think about this: money — created, provided, by government as a public good — is a means for us to save consumption for the future. (“Saving consumption” is a funny concept, but it’s what we do when we put dollars under a mattress.) The only other way to do so is to create consumable real assets that will last, including those that can be used to create more consumables in the future (themselves being consumed in the process). It’s pretty impractical for a household to save all their consumption in this way, for all sorts of physical, personal, and logistical reasons.

Cross-posted at Angry Bear.

Matthew Yglesias: Do Low Taxes Cause Inflation?

Asymptosis — Sun, 26 Feb 2012 13:37:56 +0000

It’s nice to see Matthew Yglesias embracing Modern Monetary Theory, but I wonder if he totally gets it:

The point of collecting taxes isn’t that the government needs money (it can print money) it’s that if the quantity of taxes is too low relative to the stock of money, then the money loses its value and the price level rises.

He’s riffing on the the idea that tax obligations are the ultimate source of sovereign currencies’ value, the reason everyone has to accept that currency’s value, but I think he’s simplifying things to the point of error.

At least, he should be talking about deficits/surpluses and their Inflation/deflation effects, not just taxes. Now I suppose if you add ceteris paribus re government spending to his statement, it carries more water. But still, this doesn’t really follow: A) the ultimate value of dollars derives from their utility in retiring tax obligations, so B) more taxation makes dollars more valuable.

Cross-posted at Angry Bear.

Length of Unemployment is Worst Since World War II

Asymptosis — Sat, 25 Feb 2012 13:48:24 +0000

Middle Class Political Economist: Basics: Length of Unemployment is Worst Since World War II.. (HT Brad DeLong.)

The key graph:

Assuming the economy is “trying” to reach equilibrium, this suggests that it “wants” less workers.

If that is a secular trend, as suggested by the steadily lengthening jobless recessions since the 80s,

…we’re faced with the need for a new structure wherein people’s claims to a decent share of the pie are not linked to their ability (luck) in finding well-compensated employment. Alternative means are necessary to provide widespread prosperity and the widespread demand that gives producers the incentive to expand and innovate.

Have I mentioned expanding the EITC lately, and indexing it to unemployment?

Cross-posted at Angry Bear.

Another Comprehensive Approach: The Fair Share Tax Reform Proposal

Asymptosis — Tue, 14 Feb 2012 17:14:06 +0000

I just came across a fellow internet econocrank’s tax proposal, and find it quite interesting — especially its proposed progressive tax on net worth, which echoes the flat tax on financial assets that I’ve bruited. It also reflects many of the notions I suggested I’d implement if I was the Dictator of America.

The basic problem with this and all comprehensive tax reforms, of course, is that the political system doesn’t work this way, can’t work this way, never has worked this way. We only move forward, improve the system, over centuries — with fitful, stumbling, fumbling steps, forward and backward, never addressing the whole economic ecosystem.

It makes biological evolution look downright intentional and speedy, by comparison.

All that said, I like this proposal. See what you think.

1. Federal Income Tax:

All income and compensation is taxed at a 20% rate except:

- Income under a realistic poverty line (eg $15,000 for a single person), which is taxed at 2% instead

- Income used to pay for large medical expenses (>10% of income) is tax-free

- Income placed into tax-free education-retirement savings account (with modest caps)

- No other adjustments, deductions, or exemptions

Effective rates: 10% on $60,000; 15% on $160,000; 19% on $1,000,000.

Totals about 65% of federal revenue.

2. Federal Net-Worth Tax:

All net worth (accumulated wealth), except the first ~$800,000 is taxed at a progressive 1-1.7% rate.

This tax replaces property, capital gains & estate taxes. Net-worth is the best measure of how much a household has profited from the economic infrastructure governments (all taxpayers) provide.

Effective rates: 0.2% on $1million; 1.0% on $3million; 1.7% on $27million and over.

Totals about 20% of federal revenue.

3. Federal War Tax: Everyone contributes to any war effort: A 6% surcharge increases a federal taxes bill of $10,000 to $10,600 while the nation is at war.

4. Eliminate all these taxes:

- Social Security Taxes – Social Security & Medicare funded from general revenue instead

- Estate Taxes & Capital Gain Taxes – Replaced by more efficient and fair Net-worth Tax

- State Income Taxes in their current form – Replaced by more efficient and fair surcharge – See #5

- Property (real estate) taxes – Replaced by more efficient and fair surcharge – See #5

- Sales taxes, tolls, etc. – Replaced by more efficient and fair surcharge – See #5

- Corporate Taxes – Profits distributed to corporate owners and taxed as income.

5. All states and local governments eliminate all their current taxes and instead set and collect a surcharge on a household’s combined Federal Income and Net-worth Tax.

6. Excise taxes only on products that have a cost to society that is not reflected in their price … e.g. cigarettes, gasoline. Totals only about 10% of federal revenue.

Cross-posted at Angry Bear.

Innovation and Market Constraints: The Case for Artificial Selection

Asymptosis — Mon, 13 Feb 2012 15:57:01 +0000

Bruce Wilder had an excellent comment recently in the Crooked Timber thread on markets, economic rents, and the constraints on economic actors, excerpted by Dan here, and more with comments by Jazzbumpah here. (If you like the thinking there, run don’t walk to read this windyanabasis post and comments.)

The emphasis on constraints prompts me to revisit a post I made a few years back, pointing out that constraints, not innovation, are the shaping forces of economies:

Lane Kenworthy’s Big Idea

Attributing the robust state of modern economies to the “free” market is like saying that Arabian stallions, champion Rottweilers, and freshly-picked sweet corn are the result of mutation.

Would you and your family rather live with a wolf, or Good Dog Carl?

That’s the thought I come away with after reading Lane Kenworthy’s chapter on “The Efficiency of Constraints” in his book In Search of National Economic Success: Balancing Competition and Cooperation (1995).

After quoting Smith’s seminal “invisible hand” passage, Kenworthy says (emphasis mine):

The reason actors engage in economically beneficial behavior, according to the [neoclassical] theory, is not that they have unlimited freedom of choice, but that they must choose within a particular set of constraints – the constraints imposed by market competition. … It is this constraint, rather than freedom of choice, that is the crucial efficiency-generating mechanism in a capitalist economy.

In other words, extolling the “free” part of free markets is like getting all drippy about mutation without selection. More Kenworthy:

The issue is not free choice versus constraints, but what type of constraints produce economically productive activity.

Natural selection — in this case the constraints imposed by the natural and human environment and by other free-market agents — is a powerful force. But Kenworthy asks, quite reasonably, whether it is always more efficiency-producing than artificial selection (a.k.a. human-directed selection, a.k.a….breeding). In many cases, the visible hand of government creates more efficient markets.

Free-market advocates tend to ignore the reality that market-generated constraints often act directly against the formation of efficient markets. To choose what is perhaps the most obvious example: competition creates huge incentives for market participants to make sure that all information is not known. Disclosure regulations address that inefficiency, and result in the kind of robust open markets we see today in prosperous countries. Kenworthy gives three more (detailed and well-analyzed) examples in his chapter.

Even Adam Smith doesn’t assert that market constraints have some a priori claim to superiority. Says Kenworthy, quoting Smith,

…an individual who “intends only his own gain” is “led by an invsible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it.”

“Nor is it always.” “Frequently.” Cherry-picked, at least, it verges on a mealy-mouthed endorsement. Smith, in his wisdom, is not nearly so categorical as his latter-day disciples.

Kenworthy’s attention to constraints — market-imposed and otherwise — strikes me as a profound insight, cutting straight to the heart of the laissez faire philosophy of neoclassical economics. But the idea — at least in this form — has not been taken up much by mainstream economists. A notable exception is Kenworthy’s colleague Wolfgang Streeck (who Kenworthy credits with inspiring his chapter in the first place).*

Not surprisingly, Kenworthy has a lot more than one good idea. National Economic Success has a boatload. Ditto his latest, Egalitarian Capitalism: Jobs, Income and Growth in Affluent Countries (2007). This post is already altogether too long, so I’ll leave it to other posts — and other posters — to delve into those ideas.

* “Beneficial Constraints: On the Economic Limits of Rational Voluntarism.” In Contemporary capitalism: the embeddedness of institutions, ed. von J. Rogers Hollingsworth.

Cross-posted at Angry Bear.

GDP and American (Non-)Exceptionalism: Again Some More

Asymptosis — Fri, 10 Feb 2012 17:26:51 +0000

Any knowledgeable economist will tell you that GDP (or GDP/capita) is a profoundly imperfect and non-inclusive measure of national well-being.

In particular, GDP doesn’t count any work isn’t paid for with money — painting your mom’s house, volunteering for the Rotary Club or your church (David Brooks, are you listening?), caring for your kids and your friends’ kids, cooking dinner for your family — even though that work clearly “produces” immense quantities of real human value. (Can you say “family values”?)

A while back I did a rough calc (based on Census time-use surveys and median hourly wage) suggesting that counting unpaid work would increase U.S. GDP by something like a third (and I think that’s an underestimate.) Since Europeans have much more free time for unpaid work, counting it would presumably increase their GDP by an even greater percentage.

If this thinking holds water, you’d expect to see other measures of well-being giving very different readings from the GDP/capita measure.

You would be right. Kentaro Toyama laid out out ten other measures in The Atlantic last month (hat tip: Don), all of which show the U.S. trailing European countries — often by quite dismaying amounts:

(ODA is official development assistance.)

The U.S. only stands out by one measure (and it’s still not #1) — GDP/capita — and that only if you calculate it by purchasing power parity. (How large a basket of goods would your share of GDP buy in different countries?)

Conservatives constantly point to the U.S.’s high GDP/capita to “prove” that their preferred model of unfettered capitalism and stripped-down government is superior in delivering national well-being. Even if they ignore all those other measures (which conservatives are happy to do, as with any facts that contradict their faith-based beliefs), their claims for GDP superiority themselves contradict their own beliefs.

Think about it: PPP adjustment — the procedure that’s necessary for conservatives to claim American exceptionalism by the one measure that they cling to — by its very nature asserts that currency exchange rates are wrong – that they’re not being properly arbitraged by the market to represent the “true” value of the different currencies in terms of real goods.

So yeah: America kicks everybody else’s ass (except Norway’s) — as long as you assume that markets are imperfect.

Cross-posted at Angry Bear.

No: Saving Does Not Increase the Supply of Loanable Funds

Asymptosis — Wed, 08 Feb 2012 20:05:15 +0000

Or: It’s The Velocity, Stupid.

I got quite a bit of blowback on my recent post suggesting that economists don’t understand accounting.

In response I give you Exhibit A: the almost-ubiquitous notion that more saving increases the supply of “loanable funds” — hence that more saving causes or at least allows more investment. (The absolute classic fallacy of the S=I accounting identity.)

On casual consideration, it seems like it would be right, right? You spend less than your income, so you have more money (stuffed in your mattress?), and you can lend it out.

Or more likely: you “put money in the bank” – deposit more than you withdraw — so the bank has more money; it can lend more.

It’s A Wonderful Life.

Here’s Mankiw in his textbook, saying exactly that:

Saving is the supply of loanable funds — households lend their saving to investors or deposit their saving in a bank that then loans the funds out.

But:

1. A little careful consideration shows that this casual consideration is logically incoherent — just plain wrong, by accounting identity.

And:

2. Economists are not supposed to be thinking, giving their sage advice, or corrupting our youth based on casual consideration.

Think about it:

You get $100,000 in wages. Your employers’ bank account is debited, and yours is credited. Your bank can lend against your higher balance; your employer’s bank can’t. Net zero.*

You spend $75,000. It’s transferred from your account to other people’s/businesses’ bank accounts. Their banks can lend more, yours can lend less.

Is the total stock of loanable funds affected by whether the money is on deposit at your bank, your employer’s bank, or the banks of people you bought stuff from? No.

Meantime, you don’t spend $25,000. You “save” it. The money sits there in your checking account. If the action of spending — transferring money from one account to another — doesn’t change the total stock, how could not transferring money do so? Your bank still has the money, which it can lend out. Other banks still don’t, and can’t.

It may help to think about this as if there was only one bank. (Which is not so far off. Bank deposits all consolidate back to accounts at the Fed.) Every person and business has an account. All the spending/transfers (or non-transfers, a.k.a. “saving”) just shift deposits between accounts, with no change in the (single) bank’s total deposits.

So the saving/spending mix has no effect on the stock of loanable funds. Shifting (or not shifting) those stocks around has no aggregate effect on the total stock.

But what about the flow — new loans from banks? Again: no.

Here’s a behavioral, rather than accounting-based assertion — not a controversial one, I think: In any period, banks in aggregate lend more — “print” more new money and deposit it in people’s/businesses’ accounts — because they think they can make money doing it at current interest rates. They think that for one primary reason: they are confidently optimistic about future prosperity — borrowers’ future income streams. If they’re less confidently optimistic they lend less, or ask for higher interest rates — which has the same effect: less lending.

Likewise borrowers: they borrow because they think future conditions will be good, and they’ll be able to service their loans at the asking rate out of strong income streams (and/including rising financial asset values).

Likewise spenders: they spend (that new) money because they think it will yield good returns from investment, and/or because they think they can consume today and be able to earn more money to pay for it (repay the loans) in the future.

So how does the saving/spending mix affect those expectations? Another behavioral assertion: Those expectations are set, to a great degree, by current conditions, because they’re the best predictor we’ve got. It’s difficult at best to predict future “shocks” that will change those conditions. Or as the Eight Ball says: “The future is … unclear.” Life is uncertain.

So how does a higher proportion of saving to spending affect current conditions?

It makes them worse. GDP is spending. Less spending (as a proportion of either income or wealth) means less economic activity. Less velocity. Less transactions. Less surplus from trade. Lower GDP. People, businesses, and banks, borrowers and lenders, are less prosperous, and less optimistic. So banks lend less, borrowers borrow less, and (in a potential downward spiral) spenders spend less.

Takeaway: An increased saving/spending proportion has no effect on the stock of loanable funds (it can’t), and it has only a second-order, expectation-driven behavioral effect on flows — it decreases them.

You really have to wonder sometimes where economists get this stuff that they put in their textbooks.

Nick Rowe attempted to save this conceptual situation recently in a comment posted hereabouts (emphasis mine):

Suppose there’s an increased demand for financial assets by households (a rightward shift in the demand curve). Will that increased demand lead to an increased quantity of investment by firms and an increased quantity of financial assets sold to households (a movement along a supply curve)? It may do. That depends on the model. It’s a behavioural question, not an accounting question.

His questions in the middle, and the last statement, are completely on the money. But his explanation begins right in the midst of the conceptual confusion, putting the modeling cart before the behavioral horse. The behavior doesn’t “depend on the model”; the model’s accuracy and usefulness depends on its assumed human response to incentives and constraints.

Or perhaps, rather, he’s climbed aboard the wrong behavioral horse — one that is wandering off rather aimlessly.

The “desire to save” is a conceptual representation, a mini-model, if you will, of one aspect of the economic situation. I’m suggesting that that construct is outside of, peripheral and irrelevant to, the behavioral chain of cause and effect.

People might want to save more/spend less in aggregate for various reasons:

• Times are tough — GDP and employment are weak — and they’re worried about future ability to consumption.

• Times are good, and they’re satisfying all their consumption desires.

• Rich people have a larger proportion of income and wealth, and their lower marginal propensity to consume drags down aggregate spending, relative to income and wealth.

Or some other scenario. (As Keynes said — not looking up the exact quote here – all economic activity is driven by the desire to consume.)

In the second scenario banks will want to lend more — but not because people and businesses (want to) save more. If that were true, banks would also want to lend more in the first scenario — which is completely contrary to what actually happens. (The results in the third scenario seem uncertain.)

Here’s a syllogism to make this widespread confusion clearer:

More investment results in more prosperity.

More saving results in more investment.

More pessimism (or less-confident optimism) results in more saving. (I think monetarists will stipulate to this.)

So more pessimism results in more prosperity!

Mankiw’s conceptual confusion is inevitable, and arises from two causes:

1. He’s starting with snaky (and conceptually confused) assumptions about the sources of human behavior, and:

2. New but related subject: He’s trying to think about flows (and get tender young minds to think about flows) using static, of-an-instant models like the standard S/D and IS-LM diagrams. The problem, when you’re trying to think about “supply,” is that a flow can’t exist in an instant (only stocks can); it’s a meaningless, impossible concept. And since stocks in our discussion here are unaffected by saving, he’s in a pickle, cause it’s all about flows. (And no: “comparative-static” methods don’t solve the conceptual confusion; they arguably only contribute to it because they impart the illusion of time and dynamism.)

The only way (that I know of) to model “flow supply” in a conceptually coherent way – or even think or talk about it really, which is mental modeling — is using a dynamic simulation model. Of late I’ve been quite taken with the power grid as a good metaphor for a dynamic model of the economy — one that I’ll expand and expound upon in a future post.

For now I’ll leave you with this: Clower/Burshaw on the difference between “stock supply” and “flow supply,” or peruse the literature here. Nick also talks quite a bit about the largely forgotten old 70s notion of “nominal” (roughly: “potential”) supply and demand — though mainly regarding money, not real goods.

I almost never see any consideration of these seemingly crucial concepts in economic discussions — much less cogent analysis, or incorporation of said concepts.

Which leads me to ask a question of economists:

Are you sure that you’re perfectly clear on what you mean when you use the words “supply” and “demand”?

Are we?

* I won’t even touch here on the widespread misconception among economists regarding bank lending, except to say that in practice bank lending is not constrained by deposits — banks lend most of their deposits then lend (much) more based on their excess capital (times X) — which, thus, is their effective constraint on lending. Not deposits.

Cross-posted at Angry Bear.

David Frum Savages Charles Murray — And Rightly So

Asymptosis — Mon, 06 Feb 2012 23:19:58 +0000

David Frum was excommunicated from the Righties Club a few years back because he insisted on occasionally saying sane and accurate things.

He continues that aberrational behavior today in his review of AEI uber-zealot Charles Murray’s new book, Coming Apart: The State of White America, 1960-2010 (which I will not link to here — no Google love from me).

Frum’s takedown is so good that I won’t try to recap it. I’ll just comment on one quote that he provides from Murray (paragraph break and emphasis added):

Recall figure 2.1 at the beginning of the book, showing stagnant incomes for people below the 50th income percentile.** High-paying unionized jobs have become scarce and real wages for all kinds of blue-collar jobs have been stagnant or falling since the 1970s.

But these trends don’t explain why [working-class white] men in the 2000s worked fewer jobs, found it harder to get jobs than other Americans did, and more often dropped out of the labor market than they had in the 1960s.

It doesn’t? Doesn’t “textbook economics” — not to mention common sense — tell us that if you pay people less, they’ll have less incentive to work?

But Murray knows better — they’ve got plenty of incentive:

Insofar as men need to work to survive – an important proviso – falling hourly income does not discourage work.

As long people are reduced to the level of survival — so they have to take any available job, no matter how shitty or badly compensated, or die (along with their families and children) — it’s no problem getting them to work.

That takes a big load off my mind.

Cross-posted at Angry Bear.