Archive for January, 2012

On civility, and the purpose of the blogosphere

January 19, 2012 4 comments

There’s two basic positions you can hold on the purpose of the economics blogosphere. One position is that it is now one of the main avenues by which advancing knowledge of economics is generated and disseminated, as opposed to the slow-moving journals and small cabals of elite scholars who all knew what was happening and got to see the papers. Paul Krugman put it well in a recent post:

So now we have rapid-fire exchange via blogs and online working papers — and I think it’s all good. Work circulates even faster than it did then, there are quick exchanges that can advance understanding, and while it’s still hard to break in, connections aren’t as important as they once were and the system is much more open.

Another way to think of it is that all the stuff we’re arguing about is incredibly important, and that the primary aim is to advocate our best view of policy. Another Nobel prize winner put this view well:

Cowen apparently wants me to make the best case for the opposing side in policy debates. Since when has that been the rule? I’m trying to move policy in what I believe to be the right direction — and I will make the best honest case I can for moving in that direction.

Ok, I lied. It wasn’t another Nobel winner, it’s the same guy. Krugman wants to both advance our collective knowledge and efficiently proselytize what he thinks to be the truth at once, and I’m afraid that doesn’t work very well. A vibrant intellectual environment requires forceful argument, but also making a proper effort to understand your opponent’s position, to not mischaracterise their views or deliberately present a weakened version of their argument – and to lay off ad hominem attacks. I’d submit that it is pretty much the definition of an honest argument that you provide your opponent’s best case and clearly show why you think it is wrong. As for ad hominem attacks, John Cochrane provides a pretty good summary of some of Krugman’s more egregious offences.

Like most economists, Krugman is highly attuned to fallacies of composition. So consider the following statement:

… there are people writing about economic issues who are a lot less confrontational than I am; how often do you hear about them? This is not a game, and it is also not a dinner party; you have to be clear and forceful to get heard at all.

But what if everyone behaves this way? If everyone shouts, then no one is heard. If the purpose of the blogosphere as a system is to advance collective knowledge, then I think this is a self-defeating strategy at what one might call the ‘macro’ level.

I would argue that civility is even more important in the blogosphere than normal academic settings, because one of the things that is highly valuable and unique about it is the quick feedback – but with that comes the tendency to initially misunderstand and mischaracterise. I cannot count the number of times that I have begun writing a post, and upon re-reading what I was linking to realised I had missed a key point. Sometimes I don’t catch it until after I’ve hit publish, and it really pains me that something wrong that I’ve written is ‘out there’. Not only is it is embarrassing, but it must also be so frustrating for the person who has been mischaracterised.

Now, I have only a very limited training in economics, but I’m also not exactly a dumb guy. This stuff is hard! And all the different parties have very different ways of talking about and conceptualising various issues, which can cause big problems with the more conversational style that blogging lends itself to. It’s very easy to see how something someone else has said doesn’t fit in to your framework, but to be able to step back and understand why a smart guy might believe something that seems *so* obviously wrong – that is actually a very difficult thing to do. I’m terrible at it. But then again, no one has seen fit to give me a Nobel prize.

Of course, if your view of the world is that the people you are arguing with are either mendacious idiots, or deliberately spewing falsehoods to advance their own agenda, then it is somewhat more understandable to take a more hostile attitude. If this really was a world of simple, Marxist ideological warfare then that point may have some merit. But to take that hostile attitude to everyone who disagrees with you is clearly counterproductive. Talking about Ari Fleischer’s tweeting, Krugman had this to say

this is an example of why policy debate is so frustrating, and why I’m not polite. The key thing about how the conservative movement handles debate is that it never gives up an argument, no matter how often and how thoroughly it has been refuted. Oh, there will be more sophisticated arguments made too; but the zombie lies will be rolled out again and again, with little or no pushback from the “respectable” wing of the movement.

In comments and elsewhere I fairly often encounter the pearl-clutchers, who want to know why I can’t politely disagree, since we’re all arguing in good faith, right? Wrong.

I’m sorry, but I completely fail to see why Bush’s former press secretary spouting nonsense on Twitter has anything to do with the live academic debates taking place in the blogosphere. If we had to document every misleading or false statement by someone who might inhabit some similar aspect of the political spectrum, we wouldn’t have time to do anything else. And I don’t exactly see Krugman pointing out every time a Democat says something utterly ludicrous about economic policy.

To cap it off, Krugman said this recently:

…by and large, ad hoc models like IS-LM are actually more useful [than rigorous models], in my judgment. But you probably do want to double-check your logic using fancier optimization models. Case in point: when I first got worried about the liquidity trap, I thought it was a myth, and set out to show that it was a myth using a simple NK model; what I actually found out was that my verbal logic was wrong, and it can indeed happen.

Was Krugman a fool and a knave before he discovered what he thought were good and rigorous arguments for something he previously believed was a myth? Of course not. So just don’t be surprised when we demand a very high standard of argument to be persuaded, rather than having our intelligence continually insulted. The condescending tone of his awful post on comparative statics, in the context of what was ostensibly a “debate” with Scott Sumner was staggering to anyone who had actually, you know, been reading what Scott was writing.

Understanding is an iterative process. It is incredibly easy to fail to grasp all the intricacies of what someone else has said, to know which particular choices of phrase were deliberate or not, and to accept the possibility of honest error. But as the process of understanding is iterative, and requires repeat interaction, this is only possible with a good dose of academic civility and the principle of charity. If we are to believe that the econoblogosphere really is the evolutionary adaptation of the profession to the age of the internet, then maybe we should start acting like it.

For the record, I’d like to say that I personally consider Nick Rowe to be the gold standard* for argumentative style among bloggers, in terms of both the way he clearly lays out his assumptions and responds to comments and rebuttals. We would do well to emulate him.


*pun (and irony) fully intended

Categories: Economics

You don’t think about taxation the right way: capital gains edition

January 18, 2012 3 comments

Assume 50% income tax, 10% capital gains tax, and that a man (let’s call him Mitt) earns $1m in Years 1 and 2.

Scenario 1: Mitt spends all his post-tax income. His effective tax rate in Year 1+Year 2 is 50%.

Scenario 2: Mitt saves all his post-tax income from year 1, and it doubles in value. In years 1+2, Mitt’s earned income is $2m, unearned income $500k. He pays $1m in income tax and $50,000 in capital gains tax. His effective tax rate in Year 1 + Year 2 is 1.05/2.5 = 42%. But his effective tax rate in year 2 is 0.55/2 = 28%. Quoting the effective tax rate for the year in which capital gains are realised understates his overall effective tax rate, but does appear to generate the result that is overall tax burden is lower than someone without investment income.

However, this is not the right way to calculate the total ‘burden’ of the tax on Mitt. Steven Landsburg thinks about it a bit differently, as per usual, and arrives at a different result (emphasis his)

To understand Mitt Romney’s tax burden, you have to compare him to his doppelganger Timm Romney, who lives on a planet with no taxes. In the year (say) 2000, Mitt and Timm both earned (say) a million dollars. Timm invested his million dollars, saw it double over the past decade or so, and cashed out his investment this year, leaving him with two million dollars. Mitt, by contrast, paid 35% tax in 2000, leaving him with $650,000. He invested it, saw it double, and cashed out last year, paying 15% tax on the $650,000 capital gain. That leaves him $1,202,500, which is about 60% of what Timm’s got. In other words, the tax system costs Mitt almost 40% of his income.

By contrast, people on our planet without investment income collect their wages, pay 35% in taxes, and spend what’s left. The tax system costs them 35%, while it costs Mitt almost 40%. In other words, people with investment income bear a higher tax burden, as a percentage of their income, than anyone else

When I read this quickly on the train this morning, I thought this was misleading and wrote the first couple of lines of this post in an email to myself in order for me to finish it later. But very quickly I realised that Steve’s way is the right way to think about it.

Same assumptions as above

Scenario 1: Mitt spends all his post-tax income in years 1 and 2. Had there been no tax, Mitt’s income would be 2.0 times what it was ($2m rather than $1m).

Scenario 2: As above, Mitt saves all his post-tax income from year 1. Had there been no tax, Mitt’s income would be c.2.1 times what it was ($3m rather than $1.45m).

On this method, Mitt’s effective tax rate in my example above would be 52% rather than 42%. I think this is the right way to think about it, insofar as the total cost of all taxation to you is equal to the benefit you would accrue through the elimination of all taxation.

A few weeks ago, I linked to a Megan McArdle post, where she said

…we think about taxes the wrong way around. Most people think that raising a 5% tax rate to 10% is more noticeable (and painful) than raising a 50% tax rate to 55%. After all, the first represents a doubling of your tax rate; the second is only a 10% increase. But this is exactly the wrong way to think about it. The pain of a tax hike is determined not by how your current tax rate compares to your earlier tax rate, but by how your current disposable income compares to your earlier disposable income. Doubling the tax rate from 5% to 10% decreases your disposable income by about 5.25%. But raising it from 50% to 55% decreases your disposable income by 10%. That’s a much bigger whack.

Our instinct when we think about the burden of taxation is to take the tax we think we actually pay, and divide that by our pre-tax income under the existing tax regime. The right way to think about our total tax burden is the difference between post-tax income under the tax regime and post-tax income under a no-tax regime, and the right way to think about the burden of a marginal tax increase is the change in your post-tax income relative to your current post-tax income.

Alexander the Meerkat.

Categories: Economics

The somewhat suspect epistemology of economics

January 13, 2012 2 comments

“Don’t think, but look!” – Wittgenstein, Philosophical Investigations (66)

I’ve been wanting to write something about the epistemology of economics for a while, and have been spurred on by Noah Smith’s post yesterday, linking back to an older piece from Frances Woolley at Worthwhile Canadian Initiative. I recommend you go and read them yourselves if you like, and here I take a very similar line to Noah.

As anyone who did the equivalent of Logic 101 will know, deduction is essentially a schema for truth preservation. A logically valid inference is one where it is not possible for the premises and the negation of the conclusion to be true at the same time. If you put in truth and do it right you will get more truth out at the end – but if you start with garbage, then all bets are off.

People often talk about the idea of there being a conflict or dichotomy between inductive and deductive styles of reasoning. I don’t think that’s the right way to think about it. Sure, if you deduct from premises that are self-evidently false (read: most premises in economic models) then you have no reason to think the conclusion will be true. But if you go about inducting will-nilly without some kind of vaguely deductive model about how the world works, then you will end up believing all kinds of crazy things. What I think we do most of the time is create models from simplified premises that may not be ‘true’, but are a starting point from which we can see whether the simplification still gets us to the right answer. But how can we know whether it gets us to the right answer?

By testing it. By making predictions and seeing if they come true.

Deductive models, when they begin with premises that are either obviously false or gross simplifications, are only ever worth anything as a preliminary to inductive testing. Furthermore, if you are beginning with premises that you think are self-evidently true, then you need to seriously question whether you are right*, or even saying anything at all**.

In Frances’ post, she describes a genuine distinction between the ways in which traditional economist and behavioural psychologists in fact go about trying to understand the world, and ends on a wistful note:

Dabbling in economic psychology or behavioural economics is a little like taking the red pill –  you go down the rabbit hole, and wake up realizing that the entire world is an illusion…

I want a purple pill – a merging of the red and the blue – that would allow me to merge behavioural insights into a coherent model of economic behaviour…

But I don’t know if such a thing is even possible.

I can see there is a genuine issue with the mathematical complexity of a more realistic model of decision making. The model may become too complex to manipulate in order to generate novel results. But I don’t think this is the biggest problem. I’m pretty sanguine about the fact that straightforwardly false assumptions are knowingly put into models (it works in physics!). The economist’s biggest problem is that even with really simple assumptions, the phenomena he/she is attempting to model are often too complicated to be amenable to robust inductive testing. And this can be used as an excuse not to try***.

My belief that recessions are caused by monetary disequilibrium is basically the product of a model where you simplify the economy to assume there is only money, generic units of ‘output’ and sticky prices. It generates the prediction that reducing the value of currency in such circumstances will help achieve full employment of resources and an economic recovery. But who says this is the ‘right’ simplification to make? Well, this chart from a 1992 book by Barry Eichengreen, is a good place to start (h/t Brad DeLong)

Obviously, this graph by itself doesn’t constitute proof. Some people who would disagree with me also cite this chart in support of their view, or disagree that it provides much by the way of evidence. But if it wasn’t for the fact that the graph looked like this rather than the other way around, I’d think that maybe the money-output simplification is not a good one to make. The point being, the model generates predictions about what we should expect to happen in recessions when either the money supply is increased, or it is signalled that the central bank will do so if necessary. The model gives you an idea for where to look. It is not a substitute for looking.

People trained in economics are often very good at thinking at the margin. And at the margin, in macroeconomics I think we**** need a bit less abstract thinking and a lot more casual empiricism. It doesn’t take a genius to point out that some very popular explanations for the housing boom don’t even pass the laugh test once you take a cursory glance at the relevant data. It shouldn’t be a point of dispute, pace John Cochrane, that nominal changes obviously have real effects. People with some economics training ought to be very good at quickly correcting such things. But quite frankly, we could do a lot better – especially when it comes to correcting ourselves. Too often we don’t even bother to look; easily satisfied by a little just-so story about incentives, or an elegant but unrealistic model of a messy reality.

(File under self-admonishment.)


*I’m not going to argue now about what may or may not count as ‘self-evidently true’, but suffice to say that the set of things that are self-evidently true is a somewhat miniscule subset of the things people believe to be self-evidently true

**I’ve heard people defend the economist’s model of ‘rationality’ on the basis that you can take pretty much any action by any person and identify a set of preferences that makes that action ‘rational’. But if you say that, you haven’t created a ‘theory of action’ with any useful content, but rather created a schema by which we can model people’s actions if we can identify the terms of the schema empirically. If you have no way of telling what a person’s preferences are except insofar as they are revealed by their actions, and you stipulate the preferences are always consistent, then you don’t have a useful theory of anything. You can ‘model’ ex-post facto anything I do by attributing some set of beliefs and desires to me, but that doesn’t mean you remotely understand or predict what I will do or have done

***If you think that it is not in the business of economics to generate empirical predictions, then I have the right to ask why I should give a rat’s ass about economists’ views on policy

****I did IB economics and intro micro/macro at Oxford. It counts, OK?

Categories: Economics, Philosophy

The real lesson of the debt burden debate

January 7, 2012 1 comment

It was such a simple argument.

Every ‘IOU’ has a corresponding ‘UOMe’. So, if you consider the set of all people alive at any point in time, the IOUs can’t be a burden on those people because (at the aggregate level) any repayment is being made to other people who are alive. The set of people alive cannot be burdened (if there is no transfer between time periods). Here’s Nobel laureate Paul Krugman on the topic a few days ago (emphasis mine):

That’s not to say that high debt can’t cause problems — it certainly can. But these are problems of distribution and incentives, not the burden of debt as is commonly understood. And as Dean says, talking about leaving a burden to our children is especially nonsensical; what we are leaving behind is promises that some of our children will pay money to other children, which is a very different kettle of fish.

I used to buy this line, until I grokked Nick Rowe’s argument that if different cohorts of people overlap, then Krugman’s argument (that it is nonsensical to say that debt could be a burden on our children) falls apart. There are still empirical questions as to how much of a burden it is*, but it is not a question of identity or tautology.

This is an illustration of a profound epistemological problem with using grossly simplified models of reality. Before this argument began bouncing around the blogosphere, I had a kind of model in my head that did not factor in overlapping generations of people. It produced the result that debt cannot be a burden on future people. In the context of that model, that is the correct result. But by leaving out overlapping generations, it so happened I left out a crucial detail.

There are good reasons that we simplify in order to model and understand. Sometimes (arguably always) it is just not possible to factor in everything. Whether or not this is a problem basically boils down to whether the stuff you omitted makes a difference to the answer to the question you’re asking. But how do you know you haven’t omitted a crucial detail? In the physical sciences, you can create testable predictions on the basis of your model and run experiments. Most of the time, you can’t do that in economics (or at least every result is controversial due to the problems of trying to isolate particular variables in complex systems). We can’t run an experiment in the real world and say “hmm, the future people in this experiment have been burdened by the debt, so I guess my model is missing out something important”.

Luckily, in the case of the debt burden you can show the model is quite possibly missing out something important just through a simple thought experiment. That’s the exception rather than the rule. Most of the time, we have a lot less independent confirmation of our models than we think we do.

To paraphrase CS Lewis – not only do we believe that our models are right, but it is often by our models that we decide what is right. This is, to put it mildly, a problem.


*Essentially, it depends on the degree to which either the debt is sustainable because NGDP growth is higher than the interest rate, or older cohorts leave bequests to their children

Categories: Economics

Nick Rowe’s utterly brilliant argument that public debt can be a burden to future people

January 6, 2012 6 comments

I didn’t properly understand Nick Rowe’s overlapping generations apple economy model the first time I read it. Like many people, I used to think it was an identity that debt can never be a burden to future people, considered as a whole. At any point in time bonds are held by people alive, and people who pay taxes are alive, so how can bonds and taxes be a ‘burden’ to the set of people alive at a particular point in time? Isn’t the burden of a taxpayer to pay bondholders automatically offset by a benefit accrued to the bondholder? Here’s why that identity is wrong (I almost exactly copy Nick’s model, but with less econ-speak).

Assume any person alive produces 100 apples a year. In year 1, Annie is the only person alive. The government* says ‘100 free apples for Annie’! This is financed by the government borrowing Annie’s apples, promising to give her 110 next year (10% interest). Annie produces and consumes 100 apples.

At the beginning of year 2, Annie gives berth to Bessie, and there’s been a 10% increase in apple productivity to 110 apples. Annie and Bessie each produce 110 apples. Annie’s bond matures and needs to be paid back. The government finances the 110 apples it owes to Annie by issuing a bond bought by Bessie. In year 2, Annie eats 220 apples, Bessie none. At the end of year 2, Annie dies of old age.

In year 3, Colin is born to Bessie, and apple productivity increase by 10% to 121 apples each. Bessie’s bond matures, but since Colin is a man and can’t give birth to anyone, and Bessie will die at the end of the year, there’s no market for a bond as there’s no prospect for it being paid back. Therefore, the government taxes Colin and takes his 121 apples and gives them to Bessie. Colin gets no apples, and Bessie gets 242. Bessie dies at the end of the year.

In year 4, apple productivity increases by 10%. Colin produces and consumes 133.1 apples and dies at the end of the year.

Had Annie the government not issued any bonds, Annie would have eaten 210 apples rather than 320. Bessie would have eaten 231 instead of 242, and Colin would have gotten 254.1 apples rather than 133.1. The debt accomplishes a transfer of consumption from Colin to Annie even though they weren’t alive at the same time, and even though (in any given year) the output was exactly the same and was consumed only by people alive at that time.

Wow, I got chills just writing that.

The lesson is: overlapping generations screw up a seemingly compelling identity statement. I can now fully understand why Bob Murphy was so astounded to change his mind on this. In fact, my mind is so thoroughly blown right now that I’m left seriously wondering which other models I use have some kind similar deficiency that I haven’t yet noticed.


*Assume for the sake of argument the ‘government’ is a deus ex machina

Categories: Economics

A note on the ‘debt burden’ debate

January 6, 2012 1 comment

[UPDATE: My argument is completely different to Nick Rowe's, and relies on distrubitional issues between current bondholders and taxpayers and how they are not the same people. Which, on the terms of the debate, I believe has been assumed away. His argument is much more brilliant and I will post something on it soon.]

I know I’m a little late to the party… but I think people have been missing the nub of the disagreement, which I’m pretty sure is semantic. Here’s Nick Rowe on the question of whether government debt ‘burdens’ our grandchildren (he has links there for those of you not up on the debate):

There are 4 possible positions to take on the debt. One of them doesn’t make sense; the other 3 do. Which of those 3 is right is an empirical question.

Here are the 4 positions. I gave each one a name. I made up the quotes.

1. Abba Lerner. ‘The national debt is not a first-order burden on future generations. We owe it to ourselves. The sum of the IOU’s must equal the sum of the UOMe’s. You can’t make real goods and services travel back in time, out of the mouths of our grandkids and into our mouths. The possible second-order exceptions are: if we owe it to foreigners; the disincentive effects of distortionary future taxes; the lower marginal product of future labour if the future capital stock is smaller.

2. James Buchanan/uneducated person on the street. ‘The national debt is a burden on future generations of taxpayers. Foreigners are basically irrelevant. Any second order effects of distortionary taxes and lower capital stock are over and above that first order effects of the taxes themselves.

3. Robert Barro/Ricardian Equivalence. ‘The national debt is not a burden on future taxpayers (except for the deadweight costs of distortionary taxation) but only because ordinary people take steps to fully offset the burden on future generations by increasing private saving to offset government dissaving and increasing bequests to their heirs to offset the debt burden.

4. Samuelson 1958. ‘If the rate of interest on government bonds is forever less than the growth rate of the economy, the government can run a sustainable Ponzi finance of deficits, where it rolls over the debt plus interest forever and never needs to increase taxes, so there is no burden on future generations.

Nick thinks that 1 is false and the truth of 2-4 is an empirical question. I have spent a lot of time on the sidelines trying to decide what I think, and have held at least three different positions on this since the recent debate started. As of right now, I also think 1 is false – but in all honesty I actually changed my mind about halfway through writing this. Here is why I agree with Nick (although I’m not 100% sure our reasons are exactly the same).

1 basically has the assumption

‘assume for the sake of argument that output will be the same in each period regardless of whether the government borrows/taxes/spends’

One might say – if that is the case, how could government debt be a ‘burden’? All transactions stay within the system, so everything must cancel out… right? Wrong. Taxation is coercive. It is something you have too pay regardless of whether you want to or not. It is a ‘burden’. Governments borrow on the back of their ability to tax in the future, and people freely give the government money on the basis that it has the ability to forcible extract that money (plus interest) from future taxpayers. Government borrowing that is not ‘ponzi sustainable’ in the sense of Nick’s proposition 4 will eventually mean higher taxes. Borrowing rather than taxing takes what would otherwise be a burdensome coercive act (tax paid by current people), turns it into a free exchange (funds willingly supplied) on the basis of a future burdensome coercive act (tax paid by future people).

Of course, the opportunity cost is the same either way and lies in the first period, with current people either having resources forfeited to the government through taxation, or through crowding out in the case of borrowing (assuming full employment). But the opportunity cost of government commandeering of resources is only one sense of the word ‘burden’*. And, indeed, a reduction in output (even though it is assumed away) is also only one sense of the word ‘burden’. I think this is a case where everyone is pretty much in agreement about what really happens, but disagrees about what to call it. Everyone agrees (absent sustainable ponzi finance) that more taxes will be paid eventually if the government increases spending via borrowing. I think that counts as a ‘burden’ on the future generation, even though an equal amount is received by bondholders (who are also members of that generation). Paul Krugman, I think, doesn’t believe that counts (prepared to be wrong on that, seeing that mere mortals such as myself don’t get the chance to ask such things). Whether or not you agree should depend on whether you think taxation (considered independent of whatever effects it has on output) is always and everywhere a ‘burden’ on the group, even if it gets redistributed back to members of the same group. That’s the nature of the disagreement, and it’s over the semantics of ‘burden’**.

What I think has been conspicuously absent from the debate is trying to add in utility, rather than just using output (like Nick’s ‘apple economy’ models). But that’s really, really hard to do even on a theoretical basis, because people have inconsistent intertemporal preferences. If Richard today discounts the consumption of Richard in a year’s time by 10%, but Richard in a year’s time enjoys an apple as much as he would today, what’s the correct way of scoring ‘utility’ in a way that is time-independent? If we imagined that “Richard in a year’s time” was a different person to “Richard”, and therefore of equal moral value to “Richard” (rather than another version), I’m inclined to say that it seems we should be good consequentialists and value his consumption at par with “Richard” today (ignoring Richard’s intertemporal consumption preferences). Therefore, no discounting of utility would be allowed on a moral basis (i.e. the moral fabric of the universe consists of time-independent value). Which would make this a lot easier… but I haven’t made up my mind on the matter.


*I think I agree with Steve Landsburg, in that I read his argument about Ricardian equivalence potentially holding at an aggregate level meaning that the domestic/foreign dichotomy a la Krugman is wrong. I see Steve as essentially agreeing that government borrowing creates a burden on future generations in the sense I have identified, except that rather than bondholders v taxpayers it is (to caricature) considerate/knowledgeable savers v selfish/ignorant spenders. I would say he has provided an expansion of my/Nick’s position, rather than a disagreement.

**The only exception that springs to mind would be if each individual when taxed was literally writing a cheque to themselves. But of course, they’re not – even if (arguably) it is true to say that they are at an ‘aggregate’ level. I may be inclined to agree with Krugman if you assumed that each individual gets back exactly what they put in. Otherwise, I think it is appropriate to describe the group as ‘burdened’ by a tax.

Categories: Economics

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