So, I finally took up Matt Yglesias’ suggestion and played around with the ECB’s online monetary policy game. And as he said, it’s pretty revealing. The first time I played, I was very aggressive in cutting interest rates in response to demand shocks, and I even cut rates in response to a supply shock. By 2018, unemployment was at under 4%, but inflation over the period had been c.4.5% with medium variability (mostly due to an oil supply shock, which I cut rates in response to). I got no stars.
Then I decided to try and play it how the ECB wants me to play it. After a number of attempts , I eventually managed to get one star. In this scenario, inflation averaged 0.36% with high variability. I got one star (woo!) – even though unemployment was at over 10%.
And then I played again. I got an average inflation rate of 1.24%, with medium variability. This was deemed worthy of two stars (double woo!). Only thing was, the unemployment rate at the end of the period was 9.81%. I then managed to get two stars again, with an inflation rate of 1.65% with medium variability – but on the way I managed to plunge Europe into a second Great Depression, with unemployment running at a whopping 13.13% in 2018.
This is, of course, completely insane. The whole purpose of keeping inflation low and stable is because it is believed by very serious people that this is the most conducive monetary policy for – wait for it – economic growth and full employment!
Oh and by the way, at one point I had inflation running a little out of control at c.5% in 2017. I increased interest rates from 5.25% to 25% (just to see what would happen), and inflation kept on rising and showed no signs of coming down. On another attempt I let inflation get to c.5% in 2013, and even five whole years of 25% interest rates was not enough to bring inflation down. So, for my own peace of mind, I’m going to assume that this is a bug in the game and not indicative of some crazy model inside the minds of the ECB. Because I would really hate to think that the ECB believes they couldn’t control an inflation rate in the mid single digits by increasing the interest rate by two thousand basis points.
Sadly, announcing an 5% NGDP target (or, indeed, making any communication to the market) was not an option. So the game also perpetuates the myth that the only thing that central bank can ‘do’ with regards to monetary policy is increase or decrease the interest rate.
It must be nice to get two gold stars for your monetary stewardship, while being insulated from the impact of continent-wide double-digit unemployment.
Let’s a imagine a simple game. Two people are put in a room with a button. They are told if one of them presses the button, they will get £100, but the other will get £10,000. The button only works for an indeterminate period of time and if you wait too long, it goes dead. It’s very easy to see how this could end up with neither person getting the money, because at any given point in time it is highly unlikely that the button is about to go dead; so, at any given moment it seems best to wait for the other person to press it. Lo and behold, eventually the button goes dead*.
Now imagine another game. It’s exactly the same, except that if the button goes dead, then both players lose all their savings and their jobs. Only a crazy person would wait for the other person to press the button. But the other guy knows that too. So if you can convince the other guy that you are prepared to be crazy, then you can get them to press the button. But he knows this as well, so if you start making crazy noises the most rational thing for him to conclude is that you are, in fact, not crazy but merely pretending to be. You can’t get the other person to press the button.
In the Euro-version of this game currently playing out in Brussels, Germany is the person pretending to be crazy. They want everyone else to press the button and bow to German pressure for a more fiscally integrated Europe. They also seem to think they will be able to tell if the button is about to go dead.
But they can’t. No one knows when a catastrophic run on European financial institutions could begin. Believing that you can manage this crisis in order to achieve what you believe is to the mutual long-run advantage of all concerned is unbelievably dangerous. But the logic of the game is brutal – everyone agrees that failing to press the button before it goes dead would be a catastrophe, but at any given point in time it will never seem like the right thing to do for any individual player. The issue here is, I think, not a lack of understanding of what it would take to prevent a European financial crisis (at least in the short-term), but rather that the crisis is seen as potential source of leverage for accomplishing other goals. This is hardball politics.
The debt ceiling showdown in the US worked out in the end, insofar as the button got pressed – but there was also a pretty good idea of when zero-hour would hit. For this crisis, that is simply not the case. Oh, and instead of two parties at the table, you have seventeen.
God help us all.
*If there has ever been any research (remember Cowen’s first law) I could possibly understand as to game-theoretical situations with time-dependent payoffs, or if you wanted to explain it to me, I sure would be interested to hear about it
WARNING: this is me in full thinking-out-loud mode. Please take it in that spirit. I would, in fact, be positively delighted to be shown this isn’t something I should worry about.
MV=PQ is a tautology. Of itself, it places no constraints on reality and is merely a device for organising our thoughts. But if you start empirically defining the variables, then it becomes useful. For example, it seems to me that there is an M pretty amenable to definition – the monetary base. And whilst a fair amount of electrons have been spilled on the blogosphere about the impossibility of defining P, (almost) everyone seems to agree that PQ can be defined – as NGDP. V is then left over as whatever it is than happens to the monetary base in order to produce PQ. NGDP-targeting fans such as myself say the central bank should set a rule such that it will manipulate M (and, most importantly, our expectations about future path of M) in such a way as to produce a certain level of NGDP. Whilst we can’t observe V empirically and can only infer it from M and PQ, we know the kinds of things that affect it just be thinking how the economy works (the banking system, the payments system, anything that affects demand for money relative to goods and services etc.). So when we see changes in those things, we forecast changes in NGDP (assuming constant M), and NGDP-targeting advocates like me think the Fed should pinky swear to offset these changes by producing more or less M, if necessary. We don’t need an independent way of accurately measuring V, we just need to know the kinds of things that affect it in order to stabilize the forecast for PQ, which itself stabilizes PQ. Isn’t theory beautiful.
…But, I have learnt to always be VERY wary when dealing with tautologies. One minute you can be saying something interesting and useful, and the next minute you can be saying, well, nothing at all. So, bearing in mind this is me thinking out loud, what if it is the case that we can’t define PQ? For example, because NGDP does not factor in depreciation, whether you count something as an intermediate good or a final investment good seems to affect NGDP (because you count intermediate goods being used up, but not capital). This distinction does not seem to me to be an economically relevant one, and has big implications for what counts as ‘PQ’.
So, suppose I’m right and there is no economically relevant distinction between using up intermediate goods and depreciating the capital stock, or that there is no way of drawing a line between the two in reality (completely prepared to be proved wrong on this). What has happened to MV=PQ? Well, we can define M and… er… that’s it. To be consistent, we can either start counting (some) intermediate goods as final investment goods, or we can start factoring in depreciation of final investment goods. Whichever way we go, we have some extremely nasty conceptual issues before we even get into the question of making oranges equal to Apples for real GDP/price level disentangling purposes.
I’m inclined to say that there is no fact of the matter as to what NGDP is, because there is no fact of the matter as to what counts as ‘final goods and services’. And I’m also inclined to say that it is decidedly non-obvious that NGDP is the relevant nominal expenditure figure for macroeconomic stability, as we’re getting into the issue of what exactly it means for ‘the economy’ to be stable. When I have been saying things like ‘recessions are caused by an increase in the demand for money relative to goods and services’, I thought I had a pretty tight concept of what goods and services meant. Now I’m not so sure.
The reason this worries me is that the statistical organisations have some kind of way of producing a final number, and I haven’t got the foggiest idea how they can possibly do it. The measurement issues alone boggle the mind, but there seem to me some fairly profound questions about what it is they are trying to measure at all. Which leaves me with my biggest worry: that when trying to calculate a statistic with both deep conceptual issues and high potential for mismeasurement, even if you can arrive at an empirical definition of the concept, you will (consciously or otherwise) start making the tricky judgement calls in such a way that the result fits with your prior understanding of the world. And that, my friends, would be a problem.
I’ve experienced a massive surge in my blogging productivity recently, driven by a) figuring out I could write emails to myself on the train to and from work and then publishing them when I get home, b) going from 5-10 hits per post to 50-100 which seems to have energised me somewhat and c) friends and others saying very nice things about what I’ve been writing. So thank you all for your support, and I hope I can keep the quality (and your interest) high.
[now resuming regular programming]
This morning, I was re-watching the short presentations given by a number of my favourite bloggers at the Kauffman Institute back in April. All the talks are available online, and all are worth watching (only 5-15 minutes each). But the one that stands out in particular for both importance as a topic and incredibly astute analysis is Megan McArdle on antibiotics, which she calls in one of her slides “The world’s most broken market”. I highly recommend you watch the presentation and read her post at The Atlantic on the same topic.
Her point got me thinking about something I wrote a couple of weeks ago. In my post on the 99% meme, I said this
… if I had decided to do a Philosophy PhD instead of being a consultant and had zero income, I would still have had the option to take a high-paying job. That option is a form of wealth, even if I had chosen not to exercise the option.
I’m starting to come to the view that what matters from the standpoint of living standards is not income, but wealth. But when I say that wealth is what matters, I mean to construe it extremely broadly. One of the problems with the market for antibiotics is that our over-consumption is reducing the chance that we will be able to purchase antibiotics in the future which successfully treat disease. Knowing how to make pills in large quantities that can successfully fight disease is one of our most valuable assets, but the consumption of antibiotics reduces the value of that asset by increasing resistance. It’s capital depreciation.
Can you really imagine a world without bankable, go-to antibiotics? Here are some of the consequences Megan lists
- Without antibiotics, there would be very little elective surgery. Before sulfa drugs, surgery was a very serious business with a high risk that a patient might die of some complicating infection.
- Without antibiotics, forget organ transplants. The immune suppression would almost certainly be fatal in a pretty short time period. HIV would also be more dangerous.
- Without antibiotics, retirements would get shorter again. Before antibiotics, the average 60 year old who caught pneumonia was more likely than not to die of it than not. That’s why they used to call pneumonia the “old man’s friend”. Nor is pneumonia the only potential killer.
- Without antibiotics, maternal mortality would be a lot higher. So would mortality from abortions, dramatically. While backalley abortions were horrible, and did kill people up until legalization, the theatrical figures thrown around by the pro-choice movement were mostly due to the lack of antibiotics, not the butchery of the freelance abortionists. Between 1936 and 1960, the number of deaths from abortions seems to have fallen by something between 80-95%. Looking strictly at mortality, you’d probably be much better off getting an illegal abortion with antibiotics than a legal one without.
- Neonates would also be much more likely to succumb to infection, since their immune systems are underdeveloped.
- Chronic infections can lead to various sorts of cancer (H. Pylori, the bacteria that causes ulcers, also causes stomach cancer). These would take more people before they got Alzheimer’s.
- The severely disabled would have much shorter life spans. Without antibiotics, there would be no way to treat the bed sores, or the lung and urinary tract infections that are common for people with limited sensation or mobility.
- Strep and its evil cousins, scarlet and rheumatic fevers, would once again be a major killer and disabler of children.
I’d also add onto that list the fact that a reduction in infectious disease-fighting capital has consequences for one of humanity’s most successful innovations for increasing productivity and living standards: cities. The intermingling and interbreeding of ideas, the relative ease with which you can build organisational capital, sufficient economies of scale for niche goods and activities that small numbers of people value very highly… all these things and more cities bring to the world. But if that world is without antibiotics, cities become a relatively more dangerous place to live*. And that is not good for our future economic prospects.
Wealth of this kind cannot be measured, and ‘assets’ of this kind cannot be identified as anything other than abstract entities; theoretical leftovers of grossly simplifying economic models of reality. But that does not mean that they aren’t some of the most valuable assets we have. Thinking about wealth more broadly is, I would claim, a necessary condition of correctly identifying where our energies ought to be directed when it comes to evaluating and agitating about public policy.
*Think of it this way, cities might still increase our productivity, but city dwellers would be subjecting themselves to massive tail risks
(For this topic, I must tip my hat to Tyler Cowen, Scott Sumner, Nick Rowe, Karl Smith, Megan McArdle, Ezra Klein and Matt Yglesias, without whom my economic autodidactism would have been considerably less successful, and certainly less enjoyable. I would also like to thank my father, who has made some very helpful comments on an earlier draft of this piece)
With a growing number of my friends asking me what I think of the Eurozone debacle, I thought it was time to put together a general guide to the crisis. Below I try to explain what has happened, why it has happened and the things you should know in order to understand whatever happens next. If there is anything here that I have missed out or you think is wrong, please do leave a comment and if I am convinced by your point I will update accordingly and note your contribution. If anything is not clear, leave a comment and I will update the post if I think a better explanation would be generally helpful.
I have not referenced every claim I have made here, as I would if this were a proper piece of scholarship. If you think any particular piece needs referencing, leave a comment and I will put in a link or two.
And if you doubt my credentials to write this guide, I’ll have you know I scored 10/10 on the CFA Institute’s “So You Think You Understood the Financial Crisis?” quiz.
So, without further ado…
People sometimes seem to talk about ‘saving’ or ‘indebtedness’ as if somehow people from the past or future could make a claim on things produced in the present. The world as a whole (a ‘closed economy’ in econ-speak) cannot be ‘lent’ money from future generations to create more goods and services, because goods and services are made in the present, with materials available in the present, manipulated by people actually working in the present. Debt (for example) redistributes claims to real resources amongst presently existing people, not between presently existing people and future people.
This has important implications, as the flipside of debt ‘taking’ from future generations is that by saving, future generations could ‘take’ from the present. Thinking about economic problems in terms of money or other financial assets can often obscure our thinking about what’s going on with the actual production and distribution of, you know, actual stuff. Once we think about things being made and sold/provided, the problem of the world getting older becomes incredibly clear.
Simply put, if our ability to make stuff is a function of how many people are making stuff, then as the ratio of people making stuff to people wanting stuff declines, in order to maintain the same distribution of consumption between makers of stuff and wanters who aren’t makers, then a greater proportion of what the former make must be consumed by the latter.
This will be a problem.
I really, really want there to be a carbon tax. Even if I am not 100% convinced by the science (seriously, if there is an explanation out here for why on the famous Al Gore chart temperature changes precede CO2 level changes, I really want to hear it), the risk of my amateur scepticism being mistaken means I am right behind you on the carbon front. And hey, if it turns out we were wrong, we can always get rid of the tax. It might even have the benefit of spurring investment in technologies which save energy, which would also be pretty awesome.
But here’s the thing, I don’t share most of the other political sensibilities of those who consider themselves environmentalists. I have no desire to see the size of the state expand, although any disagreements I have had always seemed to be in good faith. But good faith is not the political norm, and people who think a lot of things that I do about the state are suspicious of you. Some people think (largely unreflectively) that environmentalism is a cover for your socialist conspiracy or something, or more mild cases of just not trusting you or speaking your language.
So, here’s my very simply suggestion: come out strongly for a revenue-neutral carbon tax. In fact, if you really want to get it done, have it offset by corporation, income or capital gains tax cuts (my people love that shit).
The environment should not be an ideological issue, and it really is within your power to prevent it from being so. There isn’t a necessary connection between environmentalism and any ideological commitment, and you have the ability to demonstrate it. I’m not claiming that implementing a revenue-neutral carbon tax is the optimal action to take, but that its serious entertainment by the environmentalist movement could facilitate a serious step forward in the dialogue across the political spectrum on this issue.
What do you say?
Your evil capitalist buddy,