Archive for April, 2013

Reading Mankiw in Seattle

April 14th, 2013 7 comments

A while back Nick Rowe challenged amateur internet econocranks (my word, not Nick’s) like me to actually go read an intro econ textbook. (He was specifically targeting the author of Unlearning Economics — who I, at least, don’t consider to be an econocrank, he’s far better-versed than I am,  though Nick might.)

I took him up on the challenge, and am finally writing up my thoughts because I need to reference this from another post.

Figuring I ought to go straight to the belly of the beast, I picked up a used copy of Greg Mankiw’s Principles of Microeconomics. I didn’t read every word — I’ve been poring through various econ textbooks online, plus innumerable papers and blog posts, for years, so I knew a lot of it already. But I did go through it fairly carefully (especially the diagrams), and it had some of the effect that Nick was hoping for. Some of the things that I didn’t think were (sensibly) covered in intro econ, in fact are. And not surprisingly given my autodidact’s typical spotlight (and spotty) pattern of knowledge, I learned quite a few new things.

But still, my overall impression was amazement at what is not covered, and in particular what is not covered right up front.

In place of Mankiw’s nostrums about tradeoffs, opportunity costs, margins, incentives, etc., I would expect to see discussion of the fundamentals that underpin all that:

Value. What in the heck is it? How do we measure it? This was the topic of the opening class in my one accounting class, at the NYU MBA school. Basically: accounting for non-accountants, teaching us to deconstruct balance sheets and income statements into flows of funds. A darned rigorous course, taught by a funny and cranky old guy, formerly on the Federal Accounting Standards Board, with a young assistant prof playing the straight man and the enforcer. That first class was one of the most valuable (?) I’ve ever sat through.

The phrase “theory of value” doesn’t even appear in Mankiw’s text, even though he uses the term “value” constantly, and it’s obviously a term that has some import in economics. Imagine an undergraduate who’s had zero exposure to the ideas of subjective versus objective value, or the centuries of (continuing) discussion and debate on the subject, trying to parse the following sentence, and think critically about what it really means.

…we must convert the marginal product of labor (which is measured in bushels of apples) into the value of the marginal product (which is measured in dollars).

Money. What is it? What’s its value relationship to real goods, and in particular real capital? How is it embodied in financial assets? Where did it come from? (Hint: from credit tallies and for coins, military payments of soldiers, not barter between the butcher and the baker. That’s an armchair-created fairy tale.) The phrases “medium of account” and “medium of exchange” don’t appear in the book. Since economics is all about monetary economies, this seems like a significant omission.

Utility. The most fundamental construct in economics — the demand curve — is derived from utility maps. But Mankiw doesn’t even mention the term until page 447, where it’s discussed as “an alternative way to describe prices and optimization.” Alternative? There’s no discussion of ordinal and cardinal utility, or of the troublesome doctrine of revealed preferences (which 1. is the doctrine that allows economists to avoid talking about utility, 2. constitutes a circular definition, and 3. is never mentioned in the book).

All this gives me a feeling of indoctrination into a self-validating, hermetically sealed body of beliefs floating in space, with no egress outside that bubble, into thinking about the thinking going on therein. There are huge and not-wacky bodies of thinking out there that seriously question what goes on inside, often refuting it on its very own terms, and in the words of its own most eminent practitioners.

Yes, you could argue that I’m asking too much of undergraduates, but I would suggest that you’re asking too little (or the wrong thing) of undergraduate professors.

Is Mankiw teaching his “customers” to understand — the hallmark of the North-American higher-education system, in my opinion, compared to most other countries — or is he teaching them to adopt an undeniably ideological world view (no, neoclassical economics is not purely “positive,” not even close), and to just go obediently through the motions as prescribed in the textbook? In my opinion, he’s doing the latter.

I’m tempted to suggest that this is all true because (neoclassical?) economists don’t have a coherent or non-circular theory of value, and  money, and utility. (Neither do I, but I’m working on it!) But saying that would make me sound like an internet econocrank.

Cross-posted at Angry Bear.

Solow on Bernanke (and both, on Libertopians)

April 14th, 2013 Comments off

I’m just sayin’. (Emphasis mine, words Solow’s):

[Bernanke’s] preferred answer is better and more system-oriented regulation. One has to ask then why regulation failed to see the crisis of 2007–2008 coming and take action to head it off. Bernanke suggests that regulators were lulled into inattention by the so-called Great Moderation. Our masters are all too eager to take the Panglossian view that a system of “free markets,” including financial markets, is self-regulating and self-stabilizing. Bernanke is surely right about this. The scholar of the 1930s has to be aware that there was similar talk about the New Era in the years before 1929. Dr. Pangloss has lots of helpers among the sharpshooters who profit most from the absence of effective oversight, and among simpleminded ideologues. They are still with us.

Cross-posted at Angry Bear.

How Money Moves

April 10th, 2013 1 comment

The title should actually be “How Dollar Bills Move,” but it’s not as alliterative.

A fascinating item on the work of Dirk Brockmann, who’s used to map the movement of dollar bills, and the boundaries over which they’re least likely to cross:

I have no idea what to do with this, or whether it even has any useful application. But it’s at least a fine example of the fruits of human curiosity.

Cross-posted at Angry Bear.

Saving and “Government Saving”

April 10th, 2013 Comments off

Steve Randy Waldman and Scott Sumner (plus many others, linked from Steve’s post) wade in on notions of saving and investment.

(I’m endlessly amazed that the best econothinkers on the web — add Nick Rowe, Andy Harless, David Beckworth, Josh Mason, and many others to the list — constantly feel the need to think, re-think, and debate this fundamental economic concept. Economists haven’t figured this out yet?)

I’d like to reply to one assertion of Scott’s, because I think it cuts to the crux. This time I’ll keep it brief, at risk of obscurity. Scott:

In every case where an individual seems to be saving more and yet investment doesn’t rise, someone else is dissaving.

Scott’s far from alone in asserting this; it’s central to Krugman’s thinking.

But: This only seems right if you’re imagining an isolated private domestic nonfinancial sector, in which no new financial assets can be created. (Essentially the “loanable funds” notion.)

If you bolt on a (international) financial sector that constantly creates new/additional financial assets, and (especially) a sovereign fiat-money-issuing government sector (with the arabesques of bond issuance and OMOs), and other sovereign- (and bond-)issuing governments worldwide, and account for flows to and from those sectors, I don’t think the statement is true.

Because: “government saving” (in particular) is a meaningless concept, akin to a bowling alley “saving” points.

Cross-posted at Angry Bear.

My Patriotic Millionaires Pitch

April 9th, 2013 Comments off

Erica Payne sent out a request for writeups from Patriotic Millionaires members, and I provided this. I hate not to re-use perfectly good copy…

I live (quite well) off financial investments — no need to work any more — and my taxes every year are ridiculously, embarrassingly low. Meanwhile tens, hundreds of millions of hard workers who spend all their money — enriching entrepreneurs like me, and spurring economic growth — are throttled by tax bites that far exceed mine.

This tax structure and its terrible incentives are destroying, for my children and grandchildren, the opportunities for personal fulfillment and enrichment that America provided me. I wholeheartedly support the specific initiatives of Patriotic Millionaires, but I think far more is needed to create a national tax structure that actually is progressive above $60 or $80K a year in income. Us rich folks aren’t paying nearly our share of the bill — paying for what we receive — or re-investing in the country that gave us such remarkable opportunities. Don’t we care about our kids?

Americans have told us what they want — rich and poor, tea partiers and raging liberals (the polls aren’t hard to read) — and we need to pay for it.

True conservatives pay their bills.

Cross-posted at Angry Bear.

Does Reduced Consumption, and Increased “Saving,” Result in “Capital” Formation?

April 9th, 2013 22 comments

Matthew Yglesias riffs off my recent post, “Saving” ≠ “Saving Resources,” and there’s been quite a bit of commentary there, plus on Asymptosis and Angry Bear (plus a bit of twitter talk that I can’t figure out how to link to easily and usefully).

There are a dozen things I want to discuss on the topic, but I’d like to address the key belief underpinning much of the commentary (including Matthew’s). In my words:

If you don’t spend all your income, the unspent part is used by others to produce/purchase* “fixed” or “real” or “productive” assets. More money gets spent on investment, and less on consumption.

There are all sorts of problems with this notion, empirical and theoretical (notably the confusion of an accounting identity, “S is identical to I,” with economic incentives). I want to try and cut to the crux, with this:

A. If I transfer $100K from my bank to yours to purchase goods or labor, is there more money to produce/procure productive assets?

B. If I (or all of us) instead transfer $75K, leaving (“saving”) $25K in my bank, is there more money to produce/procure productive assets?

The answer to B is obviously “no.”

I hope not skipping too many steps here, so as to render this incomprehensible, I think Dan Kervick makes the key point in his comment on Matthew’s post:

a significant portion of monetary saving is just used to purchase government bonds

I would add, “directly or indirectly.” And: government bonds are only part of it.

This imparts the crucial understanding of aggregate, inter-sectoral balances that people lose sight of when thinking in terms of personal, individual “saving” of “money.” (Usually, implicitly, people are thinking about an isolated, domestic, private, non-financial sector — U.S. households and non-financial businesses.)

The financial system (including treasury and Fed) is constantly creating new, more, financial assets. New government bonds and currency, in particular, have no direct relationship to real investment. When you (or your bank) buy(s) a newly-issued government bond, you’re not funding/financing/incentivizing real private-sector investment in productive/useful capacity. (Though in one accounting view, you could argue that you’re “funding” government investment.)

So in a very real sense those financial assets (and arguably many [private-though-not-necessarily-“real”-sector] others) “absorb” “money” without creating new productive capacity. (This does not imply “crowding out.” Interest rates are at historic lows, and corporate cash hoards are at historic highs, even while government bond issuance has also been at historic highs.)

Funds flow from the private domestic nonfinancial sector into the the financial and government sectors (in return for an increased stock of IOUs). But absent intentional action (lending by the banks, deficit spending by government), they don’t flow back into the private domestic nonfinancial sector — and even less certainly into investment by that sector.

This is greatly simplified, and there’s much more I’d like to say, but I’m hoping to impart a straighforward (though incomplete) understanding of this view.

Here’s how I see it (this is the most important part of this post):

Production produces surplus. Output > Input.

That aggregate surplus is monetized by trade and a financial system (including treasury and fed), in a stunningly complex process that I won’t detail here. That’s why the quantity of financial assets (“money”) keeps increasing — because the surplus increases the stock of real assets, and the stock of financial assets (loosely) represents the value of those real assets.

If producers can’t sell (trade) their goods — in the process monetizing the value of the surplus created — they don’t produce them (as a successful serial entrepreneur, I’m here to tell you…), and you get less surplus. So less saving. My saving happened because people spent.

Spending causes saving. (Counterintuitive, huh?)

Though I prefer the term “accumulation.” The moral valences associated with “saving” — and the misunderstandings of its technical meaning(s?) in the national accounts — have resulted in no end of economic confusion (and confution*).

And yes: spending — and the production/trade/surplus-creation it spurs — causes monetary saving. The creation of surplus effectively forces the financial system to create new financial assets, so the producers of that surplus (workers and businesses) can monetize that surplus, and store it in their accounts. If the financial system doesn’t effectively monetize workers’ and producers’ surpluses via wages and profits, they have less incentive to work and produce, so a weak economy/slow growth results. Fed governors get replaced, politicians get voted out, and banks lose money or at least lose out to competitors who are willing to monetize the surplus.

I really have to finish this up by citing Dan Becker again, in a response to Pete Petepete at Angry Bear:

As I read your postings, it seems you are moving the discussion toward the chicken or the egg type.

But it’s not just Pete Petepete. We’re all really rehashing the old Say’s Law argument here: does production cause consumption (“demand creates its own supply”), or the reverse? The obvious answer is “Yes. Both.” But I think it’s clear which side I fall on, and I fall on that side because we have a sovereign-currency-issuing government, and a massive financial system which also constantly creates new financial assets. Say’s Law only makes sense if 1. there’s full employment***, and 2. there are no new financial assets to monetize/store/”hoard” the surplus from production and trade.

If all the “so-called” quotation marks in this post are driving you batty, my apologies. So many of the key terms in economics are used so sloppily and in so many ways, I often find it impossible to talk about the subject without constant parenthetical definitions of terms — which definitions themselves often deserve full blog posts. I hope this post will at least encourage my gentle readers to think very carefully about what I (and they) mean when using these terms.

* The produce/purchase distinction is conceptually problematic in itself (and as it’s tallied in the national accounts), as made clear by discussions among Kuznets and company back in the days when they were creating the national accounts; trade is the juncture where real surplus from production is monetized, which drops us into the thorny theoretical thickets of “value,” “capital,” and the mysteries of “money profits.”

** Yes I know that’s not a word. But it should be. Hey: good name for a new blog?!

*** Full employment is another problematic concept. Are there realistically imaginable scenarios — i.e. wage inflation without commensurate price inflation — in which large numbers of permanent non-workers would be coaxed into the work force, increasing employment without changing the percent “unemployed”? Full employment compared to what?

Cross-posted at Angry Bear.

“Saving” ≠ “Saving Resources”*

April 7th, 2013 31 comments

Many economists — mostly the freshwater/neoclassical/supply-side/conservative types, but also many on the left — hold in their heads a very peculiar model of how economies work. It’s a model of a barter/real-goods economy in which money only plays the role of convenience.

In this model, if you don’t eat some portion of the corn you grew this year, you’ve “saved.” You can eat it next year. Makes perfect sense.

You can see this thinking played out in Scott Sumner’s justification for consumption taxes:

I’d tax people on the basis of how many resources they consume, or take out of society, not what they produce.

He describes the opposite approach — taxing returns on financial investments or “savings” — as “morally grotesque.”

Now let’s think about this, and think about how these economists think about this. They’re assuming that if you “save” (a.k.a. don’t spend), you don’t “consume resources.” You “save” them, and don’t “take them out of society.”

This makes absolutely no sense. If you forego a massage this week, or wait a few years to get your house painted, is the labor for that massage or paint job “saved”? How about this year’s sunlight — the ultimate source of that labor power? Can you use it next week, or next year? Understand: services comprise 80% of U.S. GDP. And that’s before you even think about Apple and similar, with their just-in-time, on-demand supply chains — when you buy it, and only when you buy it, they produce it.

If you don’t buy it, it doesn’t get produced.

And if you don’t buy it, and they don’t expect you to buy it soon, they don’t invest to build the capacity needed to produce more in the future. (That investment and real-capacity building is true “national saving.” S really is I.)

That mental model, which is so widely prevalent, is a fundamental error of composition: confusing the individual with the aggregate. (And a confution of money-saving and real saving.) Sure, you’ve saved money for your (or your great-grandchildren’s) future. And when you don’t get a massage, others can sign up for that time slot, or buy a massage for a lower price. This is about competition among individuals, not how many resources we as a society produce and consume. If we all consume less, as a society we produce (and “save”) less — both for current consumption and for future production.

So in a very real (dynamic) sense, it’s the savers who are “taking resources out of society.” (And in a somewhat abstract sense, you can imagine those foregone resources being stored, hoarded, and  rendered impotent in ever-growing and largely inert Cayman-island bank accounts.)

This is not really revelatory; I know these economists understand the paradox of thrift. But they ignore and eschew it in their real-good, barter-based mental economic models. I would suggest that the explanation for this error of composition is revealed by Scott’s words: “morally grotesque.” Moralistic beliefs about how individual humans should behave make it impossible for many economists to embrace an aggregate economic reality of which they are fully cognizant.

* Yes: non-renewable natural resources are consumed when people produce, buy, and consume stuff (both goods and services). But 1. Compared to human effort, those resources constitute a small part of the inputs to GDP, and 2. this is not what economists who are subject to this thinking are talking about. All those in-ground resources are not counted as existing “capital” in the national accounts, for instance — so they can’t be depleted from those accounts — and the accounted “cost” of those resources consists almost entirely of the cost of digging them up. This is the subject for another post.

Cross-posted at Angry Bear.


The Great Moderation Just Moderated the Risks of the Rich

April 7th, 2013 Comments off

Following up on my earlier post, about people swimming in a stream of economic change over which they have no control:

As I often do, I was re-reading some old Steve Randy Waldman posts, and came across one that made the same point quite elegantly: “Stabilizing prices is immoral“. (If you want to understand how economies work, just read everything he’s ever written. Twice.)

One line stood out for me. Wonkish, but remarkably pithy and apt (and accurate):

Symmetrical price targeting turns debtors, taxpayers, and marginal workers into high-beta speculators on the state of the broad economy

He explains (emphasis mine):

Just when these groups need a break, when the economy is bad due to an adverse supply shock, they are hit with additional costs in the name of price stability. Sure, when things are good all over, they get some frosting on their cake. Their highs are higher, but their lows are lower. Symmetrical price targeting turns debtors, taxpayers, and marginal workers into high-beta speculators on the state of the broad economy, while reducing the risk exposure of creditors and secure workers. It represents a vast subsidy, a transfer paid in risk-bearing, from debtors, taxpayers, and marginal workers to creditors and secure workers. A symmetric price target is a better deal than asymmetric price restraint for debtors, taxpayers, and marginal workers — better to have some benefit than no benefit for the burden of guaranteeing other peoples’ purchasing power! But a symmetric price target is still a raw deal.

IOW, “the great moderation” as engineered by the Fed was a thirty-year campaign (still continuing) to protect, preserve, and expand the wealth of creditors and stable job-holders at the expense of those other groups.

Remember: an extra point of inflation transfers hundreds of billions of dollars per year in real buying power from creditors to debtors, from financial-asset holders to real-asset holders (with “real assets” very much including the ability to work).*

And the Fed is run by creditors.

Which reminds me of a post I wrote some time ago:

Demand Inflation Now!

* Nick Rowe has responded to this statement in the past by saying this is only true of “unexpected” inflation. I would reply by asserting that all changes in the inflation rate are unexpected. Maybe I’ll finish up my post demonstrating that one day.

Cross-posted at Angry Bear.

Swimming in the Stream: How Economic Forces Force Household Indebtedness

April 5th, 2013 Comments off

Update 4/7: Josh brings home the very same point, but regarding sovereign debt, in a new post.

If you’re a fish merrily swimming in a stream, is it your fault if a flood — say from a large release from the dam upstream — causes you to be washed out through the sluicegates? Or if a drought leaves you trapped in a shrinking pool from which you cannot escape?

That’s the question that comes to my mind when reading J. W. Mason and Arjun Jayadev’s paper, “Fisher Dynamics in Household Debt: The Case of the United States, 1929-2011.” I’m prompted to write about this now by Carola Binder’s response (“Wealth and the Motivations for Saving”) to Noah Smith’s Atlantic column, “Building the Wealth of the Poor and Middle Class.”

Mason and Jayadev look at household debt the way that (responsible) economists look at sovereign debt: considering primary surpluses/deficits (borrowing vs. payoffs before interest), and the effects of economic forces on household indebtedness: 1. growth, 2. interest, and 3. inflation rates. The whole thing is informed by an intimate understanding, analysis, and explication of sectoral financial balances.

These three variables — over which households have absolutely no control — often, and in some periods completely, overwhelm the borrowing/saving decisions of individuals. They are the stream in which those individuals swim, and over which they have no control.

I’ll just excerpt two passages about recent periods that make this reality manifest (emphasis mine):

1981-1999 During this period, households switched to primary surpluses, but as a result of financial deregulation and higher interest rates following the Volcker shocks, household debt ratios rose at about half the rate of the postwar years (1.4 percent annually compared with 2.6 percent). This increase took place despite primary surpluses averaging 1.4 percent of household income. With growth rates essentially unchanged from the previous period, the growth of leverage was entirely due to higher real interest rates, with higher nominal interest rates contributing two thirds of the increase and lower inflation the other third. It is striking to realize that over this period, accounting for about half of the post-1980 increase in leverage, saw the lowest levels of household spending relative to income of the whole postwar period. Leverage rose only because of the effect of higher real effective interest rates on households’ existing stock of debt.

2000-2006 This was the only sustained period since 1980 in which households ran primary deficits. Household leverage rose by 5.2 points per year, by far the fastest rate of increase in the twentieth century. (Before 2001, there had been only three years in total in which household leverage increased by more than four points; this period included six in a row. During the 1920s, to which this period is sometimes compared, annual increases in household leverage averaged 1.7 points, and never exceeded 3 points.) About two thirds of this was due to primary deficits, so the conventional assumption that increases in debt are driven by higher borrowing does hold good for this period. But about a third of the extraordinary rise in household leverage in this period can be attributed to real interest rates continuing to exceed real growth, a gap that added about two points annually to household leverage.

To summarize: the miracle of compounding interest.

Carola points out that most people just don’t get it. They put income from savings (interest, dividends) at the bottom of their priority lists. (Making Noah’s suggestions for education quite commendable.) Which leaves the notion of rational actors, with realistic lifetime expectations and plans, in a stagnant and imaginary intellectual cesspool.

This also skewers the morality-play representations of economics espoused even by good guys like Paul Krugman, with his “patient” (read: responsible, upstanding) savers and “impatient” (read: feckless) borrowers. Is the person who turned 30, got married, and bought a house in 2003 more patient and responsible than the one who turned 30, got married, and bought a house in 2006?

I’ll leave it to my gentle readers to consider policy recommendations based on that reality.

Cross-posted at Angry Bear.



Bernanke (Mis)Explains the Effect of the Tech and Housing Bubbles

April 4th, 2013 2 comments

Discussing the failure of modern macro to incorporate the financial system into its models, Ben asks, why did the bursting of the housing bubble spank the economy so much harder than the dot bomb crash? He sez (courtesy Brad DeLong, emphasis mine):

the decline in wealth associated with the tech bubble bursting [in 2001] and the decline in wealth associated with the decline in house prices as of, say, late 2008 was about the same–maybe even more on the [2001] stock [market] bubble. From a standard macro model or even one elaborated with financial factors, you would not have really thought that the housing bubble would have been more damaging than the stock bubble. Now the reason it was more damaging, of course, as we know now, is that the credit intermediation system, the financial system, the institutions, the markets, were far more vulnerable to declines in house prices and the related effects on mortgages and so on than they were to the decline in stock prices. It was essentially the destruction of the ability of the financial system to intermediate that was the reason the recession was so much deeper in the second than in the first.

This familiar (and delusional) self-serving lionization of financial-industry “intermediation” completely misses the most significant difference between the two bubbles: one briefly dinged the wealth of a small proportion of the population — those who own stocks — while the other slammed hundreds of millions of people, permanently (click for larger):

(U.S. Census Survey of Consumer Finance)

Is it hard to imagine the effects of this picture on demand for real-world goods and services that humans consume, or the incentives for producers to invest, and produce (and sell) those goods and services?

Takeaway: if we want widespread prosperity and stability, we need a financial and political system that delivers…widespread prosperity.  Pace (even) Paul Krugman, you don’t get it by making (and keeping) the rich people richer, and justifying it with the old “intermediation” rationalization.

Cross-posted at Angry Bear.