Archive for November, 2012

Does the Minimum Wage Increase Productivity?

November 29th, 2012 Comments off

This Galbraith article — pointing to Ron Unz’s ongoing good thinking on the topic, got me thinking:

If employers are faced with higher wage rates, that gives them more incentive to invest in business capital that 1. makes workers more efficient and productive, and 2. reduces the number workers they need.

Is this incentive effect figured into the analyses of minimum-wage effects that you’ve seen? I haven’t laid eyes on such a thing, but my knowledge of the literature is far from comprehensive.

Cross-posted at Angry Bear.

The Efficiency of De Ebil Gubmint Man

November 29th, 2012 Comments off

I’ve pointed out before that in some areas (here, Medicare), government programs are hugely more efficient and well-run than their private counterparts.

I don’t know if this qualifies as one of those, but it does make a very important point that I’ve also made before:

Government is not the problem.

Bad government is the problem.

Good government is the solution.

the government-wide [payment] error rate has decreased to 4.3 percent, having steadily declined from its high-water mark of 5.4 percent in Fiscal Year (FY) 2009.

That high-water mark would represent the culmination of eight years of Republican laissez-faire administration (boy you can say that again), coupled with six years of Republican control of both houses of Congress.

OMB: Eliminating Billions in Payment Errors

Cross-posted at Angry Bear.

With Charity, Who Needs Taxes?

November 28th, 2012 2 comments

The idea that contributions to the public good, for provision of public goods, should be voluntary is certainly appealing. But I was curious about the numbers. Like most things libertarian, this notion is utopian and unrealistic.

Total charitable contributions by individuals, corporations, and foundations was an estimated $298.42 billion in 2011, up 4 percent in current dollars and 0.9 percent in inflation-adjusted dollars from a revised total of $286.91 billion in 2010, according to a report from the Giving USA Foundation and the Center on Philanthropy at Indiana University.

That’s 2% of GDP. Government spending over the years has been circa 30% of GDP. If taxes were eliminated, would charitable giving increase fifteen-fold?

Would it be donated to the sexy things like road maintenance and bank regulation?

American giving.

Modeling the Wealth, Income, and “Saving” Effects of Redistribution: More is Better?

November 27th, 2012 49 comments

Update: More expansive discussion of this model with more graphics, here.

Update 2: There is a revised and corrected version of the model and spreadsheet here, with discussion.

It has long seemed to me that redistribution is, for some reason, necessary for the emergence, continuance, and growth of large, prosperous, modern, high-productivity monetary economies. No such economy has ever emerged absent large quantities of ongoing redistribution. There are no exceptions; every such economy on earth engages in it on a large scale. The Economist recently devoted a whole special section to the need for Asian countries — notably China — to develop such systems of social redistribution in order to make the move from “developing” to “advanced.”

That’s the big-picture empirics. What I’ve been missing, have been unable to find, and have been struggling to conceive, is a straightforward, intuitively convincing economic model (mathematical or at least arithmetic) to explain this fact theoretically.

Paul Krugman says that thinking in terms of models will make you a better person. I want to be a better person.

I think I may have finally created such a model. (I’m feeling better already.) It’s a very simple dynamic simulation model (set it up, plug in parameters, and watch it run over the years), and it’s purely monetary. It makes no attempt to model the real economy of production and trade in real goods. It makes no distinction between consumption and investment spending; there’s just spending. It doesn’t require a theory of value, or of capital, or of profits. It simply assumes that production and trade happen, and that they yield a surplus. You can imagine that surplus as consisting of new real assets, or being embodied in new financial assets that are representative of those real assets. It doesn’t really matter.

The model is based on one and only one behavioral assumption: declining marginal propensity to spend out of wealth. (Something I fiddled with previously, here.) That in turn is based on the declining marginal utility of consumption (the millionth dollar spent yields less utility than the first). The assumption, which seems safe both empirically and theoretically:

Rich people spend a smaller portion of their wealth each year than poorer people.

In this model each person’s spending is replaced each year by income (with a surplus), but the spending is determined by the person’s wealth. It assumes that people expect the income to replace the spent wealth, but they’re not certain that it will, always. So they (especially those with low income/wealth) are facing a tradeoff between present spending and long-term economic security. Different wealth/income levels have different propensities to substitute one for the other.

This is basically looking at spending and income from the opposite direction of most such models. Here, spending drives aggregate income (all spending is income, when received), rather than spending being determined by income (which is how we tend to think about individuals).

The rest is just arithmetic.

Here’s the basic setup, with a population of 11 people. The spreadsheet is here (Google Doc version here); you can change of the numbers and see the results.

I’m assuming 0% inflation for simplicity.

One person has $1 million.

Ten people have $100K each: $1 million total.

The rich person spends 30% of their wealth annually ($300K to start).

The ten poorer people spend 80% of their wealth annually ($80K each, $800K total, to start).

Through work/production and gains from trade, each person gets 5% more income annually than they spend. I’ve black-boxed that whole surplus-creation process; it just happens. I’ve set it up so that income (including the surplus) is distributed to the population proportionally based on how much they spend. It’s a somewhat arbitrary choice (I had to make some choice), but since people’s incomes and expenditures do tend to correlate fairly closely, it doesn’t seem like a nutty one.

The additional money for this annual +5% would come from new bank lending and/or government deficit spending and/or Fed money printing and/or trade surpluses with other countries. Choose your monetary model/paradigm; in any case the surplus is monetized via trade and the financial system.

So no, Income ≠ Expenditure (or vice versa), unless you include purchases of new financial assets in “Expenditures.” Absent those purchases/receipts, Income is 5% greater than Expenditures. That’s what surplus from production/trade is all about, how it plays out in an economy that includes monetary savings.

Now add this: Some percentage of the rich person’s wealth is transferred to the poorer people every year (by the ebil gubmint man).

Does that wealth transfer make everyone wealthier, or poorer? Here’s the result with the numbers I set out above:

In this model, taking money from the rich and giving it to the poor make us more prosperous in aggregate, raises all boats, makes the pie bigger…you’ve heard all the metaphors.

The arithmetic, and the theory, is simple:

1. Redistribution results in more spending (because of declining marginal propensity to spend from wealth)

2. More spending spurs more production

3. More production (and trade) produces more surplus

4. Surplus (monetized) is the source of monetary savings

5. Bonus: More savings (wealth) results in more spending. (Note the exponential curves.)

6. Repeat loop.

The result seems to be an apparently counterintuitive, but on consideration very obvious, conclusion:

Saving doesn’t cause saving. Spending causes saving.

The preceding is halfway tongue in cheek. It points out how problematic the word “saving” is in a monetary context. Saving some of this year’s corn crop is straightforward enough — eat less of it. Money makes it into a far more complicated concept, cause you can’t eat money.

I would say instead:

Spending causes accumulation, because it spurs production and trade, resulting in a surplus. That surplus is what allows for accumulation.

So we want more spending, and less so-called “saving.” Some people call it money hoarding, but that’s confusing too. The best synonym for monetary saving is “not spending.”

I’m with Nick: we should stop using the word saving.

More monetary saving by individuals (the word works fine for individuals) — spending a smaller proportion of their wealth on real goods each year — results in less accumulation in aggregate.

Faithful readers will recognize that this purely monetary model sidesteps and obviates the need for the conceptual quagmire associated with S = I = Y – C — a construct which, in its effort to go in the opposite direction from mine and model a barter, real economy devoid of monetary savings, arguably makes it impossible or at least very difficult to think cogently about how monetary economies (i.e. all economies) work.

But how about sharesies? Is it fair? Here’s how it plays out:

20 Year Change in Income/Wealth
Redistribution Rich
Poorer People All
0% 35% 119% 96%
1 10 165 123
1.5 0 192 139
2 -10 221 158

At 1.5% redistribution in this model, the rich person’s income, spending, and wealth all stay the same over time (remember: no inflation here), while the poorer people’s income and wealth almost triple, and overall wealth and income more than doubles. Seem fair to you? Pareto devotees please comment.

I know exactly where everyone’s going with this: incentives and behavioral responses. And I have to admit that I did make one other behavioral assumption here: that there are no other behavioral responses.

Giving a bit less money to the rich person will give slightly less incentive to work. But at the same time it’s giving ten poorer people far more incentive to work. You do the math. (This all before we get into issues of substitution vs. income effects at different wealth and income levels, something I won’t even begin to address here.)

Whatever combination of behavioral effects one might posit, I would suggest that the burden of proof lies with the positor to demonstrate, empirically, that those effects are sufficient to overwhelm (or supplement?) the inexorable arithmetic of compounding that’s at play here.

Finally, note that this model doesn’t even touch on aggregate utility delivered under each regime. Since the spending of the poorer people is split among ten — each spending $80K/year to start — a larger proportion of that spending is on necessities like food, clothing, shelter, health care, and education. I think all economists will stipulate to the proposition that those purchases yield higher utility per dollar than a family’s purchase of a third car or a fourth TV. So the graph above greatly understates the higher aggregate utility provided by redistribution, and the table either understates the utility gains by the poorer people, or overstates the gains by the rich one. (It would be easy to add a somewhat arbitrary formula to represent that effect graphically, but I’ll leave it to your imagination.)

And: this utility effect would serve to multiply the incentive for poorer people discussed in the previous paragraph, giving the ten people even more incentive to work.

I’m rather taken with this spending + surplus = income dynamic approach to modeling. (But I would be, wouldn’t I?) I’d be delighted to see how others might analyze and display results using various parameters, and how they might adjust, improve, or dismantle the model. In particular: are there obvious, gaping flaws here?

Cross-posted at Angry Bear.

The Miasma School of Economics

November 24th, 2012 13 comments

I’ve been reading Steven Johnson’s The Ghost Map, about the London cholera epidemic of 1854, and one passage reminded me exactly of today’s economics discipline.

The sense of similarity was heightened because I also (instigated by Nick Rowe) happened to be reading Mankiw’s micro textbook section on the rising marginal cost of production — a notion that 1. is ridiculous on its face, 2. is completely contrary to how profit-maximizing producers think, and 3. is based on just-plain incorrect math.* It’s just one of many central pillars of “textbook” economics that are still being taught with a straight face, even though they been resoundingly disproved by the discipline’s own leading practitioners, on the discipline’s own terms, and using its own language, constructs, and methods. These zombie ideas just won’t die. (Or to quote my friend Ole, “People never learn, and they never forget.”)

Economics today has a profound resemblance to medicine before the germ theory of disease.

Lots of people in 1854 were trying to figure out what caused cholera, and how it was transmitted. The dominant theory was “miasma” — basically bad air emanating from smelly, unsanitary conditions, especially in poor areas with lots of leaking, overflowing basement cesspools full of shit. These were contaminating the water supply, of course, so the real transmission mechanism was people drinking the effluent from previous victims.

The solution to the miasma problem? Empty the cesspools into the Thames — systematically poisoning the water supply. Yes, that’s what they did.

The miasma theory had incredible staying power, even though it was clearly and patently disproved by the thousands of Londoners whose vocation was slopping through the sewers, day and night (presumably in the thickest of possible miasmas), searching for anything valuable that they could sell. They didn’t get cholera or die at any greater rate — perhaps even less.


Why was the miasma theory so persuasive? Why did so many brilliant minds cling to it, despite the mounting evidence that suggested it was false? … Whenever smart people cling to an outlandishly incorrect idea despite substantial evidence to the contrary, something interesting is at work. In the case of miasma, that something involves a convergence of multiple forces, all coming together to prop up a theory that should have died out decades before. Some of those forces were ideological in nature, matters of social prejudice and convention. Some revolved around conceptual limitations, failures of imagination and analysis. Some involve the basic wiring of the human brain itself. Each on its own might not have been strong enough to persuade an entire public-health system to empty raw sewage into the Thames. But together they created a kind of perfect storm of error.

Miasma certainly had the force of tradition on its side. … Just about every epidemic disease on record has been, at one point or another, attributed to poisoned miasma. …

But tradition alone can’t account for the predominance of the miasma theory. The Victorians who clung to it were in almost every other respect true revolutionaries, living in revolutionary times: Chadwick was inventing a whole new model for shaping public health; Farr transforming the use of statistics; Nightingale challenging countless received ideas about the role of women in professional life, as well as the practice of nursing. Dickens, Engels, Mayhew — these  were not people naturally inclined to accept the status quo. In fact, they were all, in their separate ways, spoiling for a fight. So it’s not sufficient to blame their adherence to the miasma theory purely on its long pedigree.

The perseverance of miasma theory into the nineteenth century was as much a matter of instinct as it was intellectual tradition. Again and again in the literature of miasma, the argument is inextricably linked to the author’s visceral disgust at the smells of the city. The sense of smell is often described as the most primitive of the senses, provoking powerful feelings of lust or repulsion…

I think it’s worth pointing out here the work of Jonathan Haidt et al showing that conservatives have a big “purity” and “disgust” dimension to their moral roadmap, a dimension that is largely absent or far more muted among liberals. Which leads to…

Raw social prejudice also played a role. Like the other great scientific embarrassment of the period – phrenology — the miasma theory was regularly invoked to justify all sorts of groundless class and ethnic biases. … The predisposing cause lay in the bodies of the sufferers themselves. That constitutional failing was invariably linked to moral or social failing: poverty, alcohol abuse, unsanitary living. One alleged expert argued in 1850: “The probability of an outburst or increase during [calm, mild] weather, I believed to be heightened on holidays, Saturdays, Sundays, and any other occasions where opportunities were afforded the lower classes for dissipation and debauchery.”

So disease epidemics are clearly the result of the 40-hour work week. You can find the modern-day equivalent in John Cochrane and Casey Mulligan’s assertions that today’s unemployment has nothing to do with the high job-seeker-to-job-opening ratio (caused by lack of demand for producers’ goods, and their ensuing non-need for more workers), but rather results from workers being unwilling to work at low wages (and being coddled by government programs).

Like much of the reasoning that lay behind the miasma theory, the idea of an inner constitution was not entirely wrong; immune systems do vary from person to person, and some people may indeed be resistant to epidemic diseases like cholera or smallpox or plague. The scaffolding that kept miasma propped up for so long was largely made up of comparable half-truths, correlations mistaken for causes. Methane and hydrogen sulfide were in fact poisons, after all; they just weren’t concentrated enough in the city air to cause real damage. People were more likely to die of cholera at lower elevations, but not for the reasons Farr imagined. And the poor did have higher rates of contagion than the well-to-do, but not because they were morally debauched.

Likewise, there are many valid and semi-valid ideas, theories, and constructs floating around in the world of textbook economics. But they are so intertwined with, caught up in the miasma, or phlogiston, or epicycle theories that today constitute mainstream economics (think: equilibrium, rational expectations, etc.) that it’s hard for even the clearest-eyed economist — much less the everyday person or Washington staffer, legislator, or policy wonk — to tell the shit from the shinola.

Without trying to take the metaphor too far, I’d like to suggest that today’s austerians are in favor of emptying the cesspools into the water supply — based on similarly loopy reasoning.

* The rising marginal cost theory is ridiculous on its face because it assumes that producers add one factor of production at a time — hire more workers, for instance, without renting more space for them to work. (This is exactly what Mankiw describes in his textbook; see “Thirsty Thelma’s.”) Voila! Each worker’s productivity declines. This is of course not what producers do, which is why only 11% of top-corporation execs say they face rising marginal costs of production. (I’m wondering if that 11% made the mistake of taking an intro econ class in college.) For a nice recap of that executive survey, and the faulty math of rising marginal costs, see here (PDF).

Cross-posted at Angry Bear.


Marginal Rates and Economic Growth: They Go Up Together

November 23rd, 2012 3 comments

With Republicans frantically clinging to discredited ideology and digging in their heels on raising top marginal tax rates, I thought it would be worth revisiting a post from a couple of years ago, showing some excellent long-term evidence that higher marginal tax rates are not associated with slower growth. Quite the contrary, in fact. Here you go:

Mike Kimel once again does yeoman’s duty to compare the two:

Tax Rates v. Real GDP Growth Rates, a Scatter Plot | Angry Bear.

In this post commenter Kaleberg adds a very cool scatterplot.

Each dot is a year (t), compared to another year one to four years later (t+1, t+2, etc.).

Bottom axis is the top marginal tax rate in the starting year. Left axis is annual GDP growth over the ensuing one to four years.

Starting years from 1929 to 2008.

With everything trending up and to the right, it sure looks like higher marginal rates and faster growth go together. But it’s hard to eyeball these kinds of things, so I pulled correlations. For ending years t+1 through t+4:

0.27 0.28 0.28 0.27

I also dropped in Real GDP/Capita in place of Real GDP. Of course the growth rates are slightly lower — the population (the denominator) was growing. But the graph looks basically the same.

Here are the correlations with marginal tax rate — also lower, but darn close:

0.23 0.23 0.23 0.21

Very consistent.

Short story, there is a statistically significant positive  correlation between marginal tax rates in year X and both GDP and GDP-per-capita growth over ensuing years.

It’s pretty small, but consistent and consistently positive – a higher marginal tax rate in year X correlates with faster growth over the ensuing four years.

Especially interesting: this encompasses a huge range of marginal rates — from a low of 28% (’88 through ’90) to highs of 84-94% (1944 to 1963 — when we saw the fastest growth in U.S. history; ’64-’69, the top marginal rate was over 70%).

It’s worth noting that the lowest rate since 1928 was 24% — in 1929.

Cross-posted at Angry Bear.

Screw the Rich to Protect Super-Rich Campaign Contributors?

November 23rd, 2012 Comments off

This item raised my eyebrows when I saw it. Joshua Tucker at The Monkey Cage points out that the Republicans are proposing we do exactly that.

The idea (NYT, emphasis mine):

tax the entire salary earned by those making more than a certain level — $400,000 or so — at the top rate of 35 percent rather than allowing them to pay lower rates before they reach the target, as is the standard formula.

This to avoid the inevitably apocalyptic increase of the top marginal tax rate by 4.6%, from 35% to 39.6%.

As Tucker points out, this proposal increases the taxes for everybody making >$400K by the same amount — whether their income is $500K or $50 million.

Holding up my thumb and squinting, I’m thinking the extra taxes for those folks would be $50-100K. This would be a massive percentage increase for $400K earners, but a drop in the bucket even for $4-million earners, much less the $40-million crowd.

Avoiding that 4.6% top marginal tax rate increase saves a $20-million earner almost a $1 million a year.

As Tucker also points out, this is a stupendous gift to those who have the means to really give back to elected officials — the donors who can make or break a campaign by signing a single check.

But I’m sure the Republicans haven’t considered that. They’re just trying to do What’s Best for America.

Cross-posted at Angry Bear.

It’s No Wonder People Don’t Understand the “Public” Debt

November 21st, 2012 21 comments

A friend of mine posted this on Facebook:

I started to explain it, but realized that the standard usage is wildly screwy and confusing for any normal human, and decided to explain it here instead.

The problem is that even in standard economists’ usage, “public” is used in two different ways:

1. “Public” debt: debt owed by the government. In this usage, “public” means “government.” It’s sort of metaphorical: the government r us. As in “the public [versus the private] sector.” “Public debt” is often called “gross public debt.” That includes money “owed” to Social Security, etc.

Note that these debts to trust funds don’t in any way represent the liabilities of those programs; they’re pretty much arbitrary numbers, accidents of the moment, bookkeeping artifacts of a political/ideological construct, that are best ignored if true understanding is the goal. “Gross public debt” a.k.a. “public debt” — the $14.3 trillion shown in this graphic — is not an even vaguely useful figure in understanding the fiscal position of the country or the federal government.

2. “Debt held by the public” (not the public as described in this graphic): in this usage, the public is exactly not the government. It refers to debt held by non government — including other governments, and private holders in other countries. This is often called “net public debt.”

Watch: two (contradictory) usages of the same word, in one equation!

Net public [government] debt = debt held by the public [non government]

You can see this if you search for “public debt” on Fred. Or, read this wikipedia graph caption:

Red lines indicate the debt held by the public (net public debt) and black lines indicate the total public debt outstanding (gross public debt), the difference being that the gross debt includes that held by the federal government itself.

It’s no wonder people are confused.

This graphic makes it even more confusing, because “the public” here is the domestic private sector plus state and local governments. And it excludes foreign-held debt, which is included in the normal definition of “debt held by the public.”

This is the fault of the New York Times, which uses the term in the infographic from which this graphic is prepared. Not only do they start with the gross figure rather than the more useful net figure, but they use “the public” in a completely idiosyncratic way.

A further complication: in standard usage, “debt held by the public” includes Fed holdings, even though the Fed is part of the government. The interest it is paid (by the Treasury) on government bonds is paid right back to the Treasury. (The presumption is that those bonds will eventually be sold back to the private sector.) This is not usually such a big deal, but these days the Fed is holding 17% of the Debt Held By The Public.

I suggest the word “public” should be eradicated from all these usages, in favor of more descriptive and precise terms. “Public” does nothing but confuse if you don’t know exactly what it means. Instead, say things like:

Net federal debt.

Net federal debt minus Fed holdings.

Federal debt held by the domestic private sector.

Government debt [including state and local]

And etc. The bookkeeping at this high level is not actually very complicated, so hopefully careful usage will help people better understand and discuss fiscal issues.

Update: JKH in the comments suggests an excellent, immediately understandable and precise term: Treasury debt. Use it!

Cross-posted at Angry Bear.

Medium of Account vs Unit of Account: Brazil Anyone?

November 12th, 2012 2 comments

I’d like to interject a very concrete example into the large swirl of quite theoretical, thought-experiment discussion about whether “demand for money” means “demand for the medium of exchange” or “demand for the medium of account.” Scott Sumner and Nick Rowe are, as so often, at the center of this discussion. But before I do, I need to work through some conceptual and terminology issues.

Nick — who so often cuts so clearly to the crux of things — injects what he seems to feel (rightly so, I think) is a necessary update and clarification into his sally on the subject:

…in my model, gold is the medium of account; and (say) an ounce of gold is the unit of account.

I’m not clear whether or not the update was in reply to M.R.’s comment, which addresses exactly the point I want to make:

I’m still not convinced that the concept of a “medium of account” is well enough specified. “Unit of account” is fairly straightforward; we measure everything in units (inches, kilograms, minutes, etc.) What is the “medium of account” in the current U.S. monetary system, analogous to the role that gold plays in your simple model? If your answer is “dollars” then I think you may have a very serious specification problem. This is very subtle and difficult.

Nick does reply directly to that comment, and his reply’s uncertain nature fully supports my thinking:

OK, but the unit of account (in my model) isn’t “ounces”, it is ounces of gold, as opposed to ounces of silver or ounces of hair.

Medium of account in the US? Hmm. Fed liabilities?

Here we see Nick Rowe — who thinks as deeply and curiously (but I think misguidedly) about monetary economics as anyone out there — wondering what the U.S. medium of account is. This, after hundreds of years of very hard thinking by very smart people about the nature of money. It’s enough to make you question economists’ understanding of economics. They don’t even understand money?

The more I think about it, the more I think that “medium of account” is an incoherent concept (and even worse, “demand for the medium of account,” which seems doubly incoherent) — a will o’ the wisp that lures otherwise coherent thinkers into dangerous and bottomless conceptual b(l)ogs.

Think about “medium” and “media” in a very common usage — relative to information and entertainment. In this context media are vehicles for transmission — books, newspapers, TV, web pages.

This meaning kind of works for “medium of exchange” — dollar bills and bank interchanges are vehicles for transmitting something — value. Just like power lines and cans of gasoline are media for transmitting energy.

There are many media of monetary exchange (especially if you include purely financial transactions) — physical pieces of currency, credits in bank (and money-market) accounts, credit-card lines of credit, treasury bonds, bank reserves, etc. Dollar bills and bank-account credits have traditionally been the dominant media of exchange for exchanges involving real-world goods and services, but even that is far less true these days, given the quantity of credit-card sales. “Medium of exchange” at least makes conceptual sense. But “the medium of exchange” doesn’t. There are many. To steal M.R.’s words, it has “a very serious specification problem.”

“Money as the medium of account” is really far worse. What is being transmitted, and what is the vehicle? What does this term — in particular the word “medium” here – mean? It’s obviously about counting and measurement. But what is being measured, counted? I would say: value — just like a thermometer measures temperature, or a ruler measures length. But in those contexts, the media of account are temperature and length. (The units of account are degrees and inches, or whatever.) I’d like to suggest that in economic thinking the medium of account is always value — not “money” (however you choose to define that word), and never dollars or ounces of gold, which are units of account. If this is safe, “demand for the medium of account” would mean “demand for value” — which strikes me as obvious, or tautological, or just not very useful, conceptually. And “demand for the unit of account” obviously makes no sense at all; is there demand for inches or degrees?

This is where M.R. gets it right, and Nick in his update glances toward more useful thinking: we should be talking, thinking, about units of account, and how value is ascribed to those units.

In the normal course of things, a (physical or electronic) dollar has the same designated, ascribed, agreed-upon value as “the dollar.” But as Miles Kimball points out in what he describes as “the most important thing I have ever said about monetary policy,” this need not necessarily be true. A physical dollar can, conceptually at least, have a different value than an electronic dollar. (Once again I would say that each of these is a financial asset, an embodiment of money or exchange value, with particular properties and characteristics which may be in greater or lesser demand — and supply — at different times.) Different kinds of dollars could have different values, as designated in dollars! We really need different words for these things. (See: concrete example, below.)

Let me put it another way: I think Nick, Scott, and most economists don’t fully understand that “a dollar” is, conceptually, a completely different type of thing from “the dollar.” (At least they talk as if they don’t.) One is a unit (and vehicle) of exchange, the other is a unit of account, or measurement. And as Miles points out, even “a dollar” is not sufficiently specified.

I promised a concrete example, and here it is, courtesy of This American Life‘s typically brilliant “The Invention of Money” episode: how Brazil ended years of rampant hyperinflation. I’m rather astounded that, searching through my blog reader, I find that nobody has looked at this real-world example, even though it’s exactly the situation that Scott and Nick are talking about. (I’m sure there are others like it. Readers?)

Here’s the short story, but I recommend the whole thing; it’s short and very entertaining.

The cruzeiro had been plummeting in value (relative to real goods) for years. This was true both of the units of exchange (“cruzeiros” of all types — physical, electronic, etc.) and the unit of account (“the cruzeiro”) — necessarily so, because they were uniformly conceived as the same thing.

The solution was to introduce a new unit of account — rather cravenly titled the real in an effort to get people to ascribe real market-basket value to it — and to require its use in designating the value of everything, regardless of what units were exchanged. (Conceptually, they could have just revalued “the cruzeiro,” but nobody would have fallen for it because nobody trusted either the cruzeiro or cruzeiros. They would have continued to ascribe low — and ever-lower — value to it.)

By legislative fiat, all wages, taxes, and prices were to be designated in the new “real” unit of account.

People had to be tricked into thinking money had value, when all signs told them that was absolutely not true. So Basha says, they wrote a plan for a new currency, one that was stable, dependable, trustworthy. The only catch was this currency would not be real. It would not be printed. There would never be coins. It was fake. They called it a virtual currency.

Edmar Basha

We called the unit of real value, URV. Yeah, it was a virtue that didn’t exist in fact.

Chana Joffe

People would still have cruzeiros, the local currency in their pockets. But when they got paid, their wages would be listed in URVs. Taxes were in URVs and all prices were listed in URVs. And URVs were stable. And so, for example, when you went to the store and bought some milk.

Edmar Basha

How much does it cost? Say well, know we have it cost X. Let’s say one URV. Well, how much is that because I cannot pay with URV. Well, I have this little table here and today’s value of URV in cruzeiros is seven cruzeiros per URV. So it cost one URV, seven cruzeiros.

You go next week, well, it’s still one URV. But then you say, how many cruzeiros? You look, well, 14.

Chana Joffe

Every night the central bank would put out a memo with the official conversion rate. And a table would get printed in the newspaper. The store clerk could look at the table in the newspaper and see, Monday, one URV is equal to seven cruzeiros. Tuesday, 12 cruzeiros. Wednesday, 14. Milk or whatever it was you were buying would stay the same price. There was no need for the sticker man.

Eventually they phased out cruzeiros and issued physical reals. It worked:

Brazil went from being an irrelevant, economic basket-case to one of the most important economies out there. The eighth largest in the world.

Notice “unit” in the name. (Not “medium.”) The stability of the unit of account was what mattered — what value people ascribed to it. That ascription was anchored to real value because wages and taxes were designated in that unit, which also made “reals” into units of electronic exchange. (For wages: labor theory of value, anyone? For taxes: got chartalism?)

You’ll notice I never used the word “medium” to describe what happened here. At best it was unecessary, and at worst it would have sown all sorts of confusion and incoherence. We don’t need no stinking mediums.

Update: I should add that “unit” here is also used in two senses: 1. Exchange units of which there are many, that can be shuffled around physically or electronically, and 1. a more abstract and necessarily singular measurement or accounting unit. The value of the former are designated in the latter.

Cross-posted at Angry Bear.


Jim Manzi: Correlation, Causation, Understanding, and Predicting

November 9th, 2012 4 comments

Jim Manzi, curious as always (especially about how to evaluate government policies), tries to plumb the problem of causality. Here’s where he begins:

Consider two questions:

  1. – Does A cause B?
  2. – If I take action A, will it cause outcome B?

I don’t care about the first, or more precisely, I might care about it, but only as scaffolding that might ultimately help me to answer the second.

I’ll risk going Manichaean here in an effort at (simplistic) clarity: I think this encapsulates a key difference between scientists and engineers.

Scientists want to understand how something works — not just “does A cause B?” but “what is the mechanism whereby A causes B?” Successful prediction is valuable (mainly? only?) because it validates or invalidates that understanding. Their main goal is to build coherent theory and understanding. Prediction is a happy by-product and necessary corrective.

Engineers want to understand how something works so that they can predict things — and create things that capitalize on that predictive power. They’re perfectly happy if they can predict successfully without understanding why the prediction works. Coherent theory is generally necessary to achieve this — they need to understand how things work — but it’s not their ultimate goal. Theory is a necessary evil.

An assertion of causality requires both. You need to show that B follows A reliably, but to be confident of causation, you need to explain — really tell a story — about how that causality works.

Both of these approaches are necessary and proper, of course, and they’re complementary. But I’d suggest that theory — the goal of science and most scientists — is what really matters in the long run. It’s easy enough to predict that the sun will rise in the east every day. Successfully predicting that yields many happy benefits. But understanding why — heliocentrism, earth rotation, gravity, momentum, etc. — now that is really profound. That coherent theory provides engineers with their necessary evil, so they can create and capitalize on further successful predictions.

With his “I don’t care about the first,” Jim puts himself squarely in the “engineers” camp that I’ve (again simplistically) described. Don’t get me wrong: I’m quite certain that Jim Manzi is quite curious and hungry for understanding (even while he’s skeptical about our ability to understand how complex human systems work). But by putting himself in that camp, he is aligning himself with, and providing aid and comfort to, a group that actively distrusts and dislikes egghead elitist types with all their fancy theories about evolution and climate and yes, economics. He aligns himself with a group that doesn’t really care about understanding, that just wants to know “which button should I push?”

It’s a group that tends to come up with answers like “Just cut taxes.”

Cross-posted at Angry Bear.