Category: economics

when the facts change…

This economic paper is strange:

Over the past thirty years, a great deal of business cycle research has been based on purely real models that abstract from the presence of nominal rigidities, and so (at least implicitly) assume that the Phillips curve is vertical. In this paper, I show that such models are fragile, in the sense that their implications change significantly when the Phillips curve is even slightly less than vertical. I consider a wide class of purely real macroeconomic models and perturb them by introducing a non-vertical Phillips curve. I show that in the perturbed models, if there is a lower bound on the nominal interest rate, then current outcomes necessarily depend on agents’ beliefs about the long-run level of economic activity. The magnitude of this dependence becomes arbitrarily large as the slope of the Phillips curve becomes arbitrarily large in absolute value (closer to vertical). In contrast, the limiting purely real model ignores this form of monetary non-neutrality and macroeconomic instability. I conclude that purely real models are too incomplete to provide useful guides to questions about business cycles. I describe what elements should be added to such models in order to make them useful.

Isn’t this…obvious? Keynes, after all, expected that at full employment the economy would be basically classical.

In the Phillips curve context, that is to say that the slope is shallow with significant unemployment, gets steeper as we approach full employment, and is vertical thereafter. If you relax the assumption of a vertical Phillips curve, of course you’ll get different results. What on earth would you expect otherwise?

And it’s pretty common in economics that changing a parameter estimate has profound qualitative consequences. I remember learning IS-LM as a student and being really impressed by the insight that changing the slope of the LM schedule implies a fundamentally different world – if it’s steep, we’re in a monetary dominance, Brad DeLong-ish republic of the central bankers, if it’s shallow, we’re in a Keynesian or at least Hicksian world. Uh…better be right on that one!

That said, the second half of the abstract seems to suggest Kocherlakota’s point is more fundamental and there’s a domain of unusually great instability where the slope is high, but less than unity. Which makes me think about the fixprice/flexprice distinction and what institutional arrangements would be associated with different Phillips curves.

Anyway, I guess I better think of a way of reading the whole paper.

Science, dammit.

So this chart happened.


It looks like the Fistful of Euros model of the labour market has a serious problem, in that I can’t replicate JW Mason’s original results. The compositionally weighted ECI measure of earnings is more strongly correlated with the output gap, i.e. more cyclical, than the constant-weighted ECEC, at least for 2002-2014.

So I’ll have to change my mind. Hey, economics is a science, right?

They don’t have any money.

I was saying that nobody seemed to bother to check the claim that defined-contribution pensions were cheaper. Nobody but weirdos like me ever suggested the following until now:

Once you account for falling wages among young workers—if you must: “the Millennials”—many mysteries of the economic behavior of young people cease to be mysterious, such as this generation’s aversion to home-buying, auto loans, and savings. Indeed, the savings rate for Americans under 35, having briefly breached after the Great Recession, dove back underwater and now swims at negative-1.8 percent.

Gee willikins! Could it be that they have no damn money? It’s not like this wasn’t obvious in 2006 or 2009 or 2011. Lost decade? Try lost 15 years.

How transparency met total corruption and they beat Napoleon

Reader Simon Hinrichsen’s MSc thesis on the Bank of England in the Revolutionary and Napoleonic Wars is here. He argues that the UK paid for the war by borrowing as much as France, but on better terms, and by printing much more money, but it also succeeded in keeping inflation lower and more stable. Inflation in France was both very high, and also incredibly volatile.

I think what we’re getting at here is the evolution of a financial system, comprising a monetary authority and a finance ministry, that was able to manage the currency, collect taxes, and issue government debt of a quality that made it an attractive financial product (the 3% Consol) to what seems to have been a pretty big market for fixed-income securities, and one that grew substantially over time.

All this printing and issue had to go somewhere. One explanation is that the UK was running a trade surplus. Money issued for the use of the army deployed in Flanders, Portugal, and Spain, King George commands and we obey, was spent there. Somebody eventually held it because they could buy goods coming from or through Britain. This is a bit like the US in the high postwar.

Another is that there was a transition from a gold standard, before the suspension of convertibility, to a chartalist tax standard. The announcement of suspension made it very clear that paper money would be accepted in payment of taxes. With the huge expansion of public spending, you can see why this would work as a sink for the money supply.

A third, perhaps more interesting, is financial deepening and economic growth. Erik Lund has an interesting post up about Anson’s circumnavigation and the financial history of the UK just before the period covered by Simon Hinrichsen’s paper. This was a bit wild, but you can see the evolution towards the institutions that worked so well in the late 18th century, especially the standardised government bond and the central bank rediscount window. Erik also points out that economic growth picks up, which you can also see in Simon Hinrichsen’s paper – the biggest reason why the debt-to-GDP and M0-to-GDP ratios don’t go crazier than they do is that the real economy grew.

So what’s going on? I reckon that there are a lot of transactions that were nonmonetary, that now become monetised. That would explain part of the demand for all those notes. I also think that constraints on investment have been loosened by the emergence of a managed currency, a standard financial product for both wealthy savers and also local banks (which started to emerge a bit later), and a government that was determined to spend or die.

The first two are, in a really grandiose geosynchronous orbit view, either products of increased social trust, or else substitutes for it. Either people are willing to buy into the nation-state polity, or else they’re willing to delegate trust to it – perhaps it’s the same thing. And a big deal here is that the economy is getting more legible, taxable, knowable. Even if the government can inflate the money, it’s worth about the same nationally and borrowing it costs the same. Simon points out that the British government budget is a public document, it’s thrashed out in parliament, and the Bank of England’s accounts are public too. In fact, the Bank Return was published weekly, making it a much higher resolution indicator than, say, GDP.

But here’s the interesting bit. Erik points out that one of the very biggest spending line items, procurement of timber for navy shipbuilding, is restricted by absolutely ridiculous levels of corruption, even though the very survival of the state depends on it. It’s really silly – only oak from the Home Counties will do. Also, the same people who benefited from the timber cartel are also some of the biggest savers into 3% consols.

So there’s an apparent contradiction here between the nicely liberal, Whiggish notion that we beat the French with open data and financial transparency, and the ugly mess of interests on the Weald starving Jack of quality spars if they don’t get enough pork.

Perhaps, though, the crookedness was what convinced them to back the new system, to hold the notes, to put their surplus capital in consols, not to howl for gold. After all they knew the system would look after them, in a sort of Schmittian founding crime behind the launch of modern British public finance. Well, everyone thinks there’s some sort of weird bargain between southern squires, the City, and the defence industries behind everything in Britain anyway! Go read the both of ’em.

The budget and the bogus hairdressers

Chris Dillow has a nice chart, plotting the government deficit out-turn against a forecast based on its historic relationship with unemployment, swinging off John Maynard Keynes’ remark that if you look after unemployment the budget will look after itself.


As he says, the interesting bit is what happens after January 2012. Unemployment dropped sharply, but the budget didn’t come in anywhere near as much as you might expect, although it did improve a bit. A gap has opened up. Chris thinks this is a story about productivity.

I half-agree; it’s also a story about the policy-driven shift from unemployment, mitigated by Jobseekers’ Allowance, to underemployment mitigated by Working Tax Credit, aka the bogus hairdresser phenomenon (see here, here, and here). There has been some improvement in the economy, but much of the reduction of unemployment is accounted for by people declaring self-employment with nugatory hours, plus various other fiddles on the Government’s side, like not counting Work Programme attendees or persons under sanction as unemployment. They aren’t earning-out of the tax credit regime, and they aren’t paying income tax, so the budget doesn’t improve.

It’s trivially true that if you aren’t getting any hours, your productivity is zero. Importantly, though, efforts to improve productivity as such won’t help this problem at all, because low productivity is an effect rather than a cause. It’s an effect of policy, but it’s also an effect of the weakness of the labour market, because if the bogus hairdressers were in work they wouldn’t have to find ways to get Iain Duncan Smith off their backs.

How tight the labour market really is may be the most important question in British politics at the moment. Hence Duncan Weldon:

Balls has decided not to offer any new capital investment funded by central government borrowing. In this view, GDP growth is up, and therefore growth should bring down the deficit, and there is no case for fiscal expansion. If there is going to be more public spending there should be more taxation. This shouldn’t be a reason to harrumph off in the corner, though. Resolution did this rather nice chart of the parties’ fiscal plans.


As you can see, before anything else, just going slower is a big, big improvement on Osborne’s plans. Pushing the deadline out to 2019 and finding another £10bn of revenue or savings would allow for a 2% real-terms annual increase for the departments, while the Tory plan requires a 7% annual cut for the departments even with an additional £12bn taken out of social security. And we’re not even discussing Cameron’s giveaway yet, which takes the total cuts in the pipeline to £33bn. Labour would be fools not to run on the Tories’ £33bn cuts bombshell and to repeat the number every five minutes; personally I’m going to bore everyone to tears with it from here to May.

The problem, though, is Chris’s chart; although GDP growth is up and measured unemployment is down, the budget still sucks. And, you know, one in ten young people despair, because they’ve been stuck in the queue since 2007. As the EEF economics blog says, it sucks on the revenue side because income tax revenues are poor, because incomes, i.e. wages are poor. That is, to say the least, not what you’d expect in a tightening labour market.

It might, however, be what you’d expect in a market that is still pretty close to a high-unemployment equilibrium, but one that expresses the insufficiency of effective demand via underemployment rather than unemployment. If we were, that would explain why it is so difficult to reduce the deficit and why wages are so poor, and also why productivity is so poor, via Verdoorn’s law, where productivity gains usually happen when industry is operating at capacity. This is the crucial issue, and I suspect it’s roughly what is happening in France. The risk is that we end up running to stand still, deficit reduction keeps failing because wages and productivity are too low, and the statistics get progressively worse as the low-trust society becomes entrenched.

The good news is that there are some options for Labour investment to go with the absence of more Tory cuts. The public bank plans have evolved, and now foresee National Savings & Investments as its main depositor, which could give it enough welly for quite a substantial capital programme, and you know where I think it should go.

In a parallel universe, I scored!

So the economists are now saying that even if you made testable predictions and they came true it doesn’t mean you’re right because of, you know, quantum and catallaxy and hey What the Bleep?! Do We Know. There’s an infinity of possible universes in which I might be right, and averaging over the Gaussian copula, therefore I’m considerably richer than yow:

Simon Wren-Lewis and Paul Krugman dispose of the intellectual rubbish, but there’s a better gut point here as follows.

All right, you’re committed to radical scepticism, are you? You’re unwilling to move without a solid evidence base of randomised-controlled trials? So where was this scepticism when everything from public housing to the interior design of buses became part of a war on the Keynesian legacy? Where was this scepticism in 2006? In 1978? In 1992?

Few people have ever been as sure of the truth of their ideas as economists have been. They didn’t just believe that they were logically consistent, or borne out by empirical evidence, or representative of a greater moral truth – they believed all three at the same time. It was economic rationalism. There was no alternative. It was built on microfoundations arising from sheer mathematics. It was literally equivalent to democracy itself. If you disagreed you were a Stalinist or you were trying to deny economic development to the poor.

Steve Levitt’s now celebrated attempt to give advice to the prime minister is a case in point. Noah Smith points out that Levitt didn’t have an alternative or even a sensible criticism to offer, but that didn’t detract for a moment from his superb certainty. But in fact it’s worse than that. What strikes me about the Levitt/Cameron story is Levitt’s utter incuriosity.

He trotted out his little parable but never paused to wonder if, in fact, the British actually do use infinite amounts of medicine. It is fairly well known that the US healthcare system is really expensive compared to any European country’s. This is the sort of thing any newspaper reader ought to be aware of, and if you reflect on the fact for a moment, it’s obvious that demand cannot therefore be roaring out of control due to the unpriced nature of the NHS. Despite all his talk about natural experiments and questioning everything, in practice, he completely ignored a huge natural experiment and questioned nothing. He evidently didn’t feel facts would inform his thinking in any way. The shocking thing is the incuriosity.

The whole thing reminds me, most of all, of the old German general staff. Nobody doubted, or doubts, that they were smart, deeply smart. They possessed a wealth of professional competence. They made a number of major methodological achievements that are still used today. They were as respectable as it was possible to be. But they got it wrong; repeatedly, desperately, disastrously wrong. And they blamed everyone else and proceeded to do it all over again. Interestingly, their institutional history is closely similar to the emergence of the classic executive career path.

It’s just not good enough to discover scepticism now. The whining now only highlights the swagger of the past. After all:

And (I think I’m making my own position clear here) I think this is why Friedmanism fails. Because actually, the buck does have to stop somewhere, and pretending that you can manage a complex system via a simple rule is basically impossible (it falls foul of Stafford Beer’s Principle Of Sufficient Variability). In practice, in a system based on a Taylor Rule, an Evans Rule or even an NGDP target, the buck stops with whoever it is that is responsible for maintaining the model which generates the forecasts of the control parameter. And this person is always going to deny that he’s making activist policy and claim that he’s a technocrat who simply goes where the data takes him. Friedmanism in economic policy, in the general sense I’m talking about here, is nothing more nor less than a distributed responsibility avoidance system.

But, y’know, pass the bong, we can’t, we…uhh…can’t really know anything…right…?

A short post

Schuller pointed out that, if the economic theories of Mises’ book Human Action really are derived by painstaking and valid deductive argument, then it should be possible to set the book out in a formal symbolic form in which all axioms, premisses, and deductions are shown formally and proven.

No Austrian has ever done this…

But if we could somehow persuade them to try, the Internet would be so much quieter!

A novel theory of the business cycle, with an old critique

Charles Murray, as far as I can make out, has dropped racism in favour of old-school reactionary elitism. It’s not that other races are inferior, any more, it’s that the race, in general, is inferior. I understand this to mean he’s realised that Gang A are no closer to the White House than they were in 2008, and a strategy that doesn’t require popularity is therefore career enhancing. And then there’s this.

Murray has, without knowing it, created a novel theory of the business cycle. Fluctuations in manliness drive boom and recession. We are thrown around by the Cockdratiev wave. Now this could actually give you a fairly sophisticated understanding of the macroeconomy.

The transition through Minsky’s stages, from hedge finance to speculation and eventually to Ponzi schemes, might be ascribed to manly competitiveness and status seeking. Austrians might see something similar at the root of malinvestment. Joseph Schumpeter might have pointed out that capitalism overinvests in the boom, but that’s the point – without the fundamentally irrational drive of entrepreneurship, we would miss out on all kinds of innovations. That said, if you identified this with testosterone, you’d be wrong.

But that’s not Murray’s point. It’s not a fundamentally masculine hunt for risk on the part of entrepreneurs that’s doing the work, but rather, that workers are all girly and out of work, or something.

The Keynesian critique would be that, if manhood is socially defined as Murray requires, then the opportunities to live up to it are defined by the market for labour. Demand determines income, and therefore it determines the opportunities young people have to live up to the expectations of society. After all, the era of the Great Compression, the Keynesian years, is also known as the baby boom.

The enduring radical punch of Keynes is simply that he accepted that causality might point the other way.