Saturday, September 20, 2014

Why Not Just Mail Out Checks?

A friend writes:
Let's suppose that the United States could get a Universal Basic Income, but it had to trade a bunch of stuff for it. What would be important to keep after a UBI? 
Obviously, various income support could right out the door (food stamps, unemployment insurance). But would we be willing to trade labor regulations (minimum wage, union laws)? Public schools? Medicare? Curious as to your thoughts.
This sort of choice comes up all the time these days. Of course in practice it's a false choice: They take our parks and public insurance, and never send out those UBI checks. Or occasionally, as in New York, they give us our universal pre-K and parks and bike lanes, and we don't have to give up our meager income-support checks to get them.

Still, it's an interesting question. How should we answer it?

1. At least for an important current on the left, the goal isn't to distribute commodities more equally, but to liberate human life from the logic of the market. Or, a society that maximizes positive freedom and the development of people's capacities, as opposed to one that maximizes consumption of goods. From that point of view, diminishing the scope of the market -- incremental decommodification, as Naomi Klein used to say -- is the important thing, so we'd always reject this kind of trade. (Assuming it's on more or less "even" terms.)

2. Setting that aside. Shouldn't we have a presumption that the goods that are currently publicly supplied are subject to some kind of market failure? Presumably there's some reason why many governments provide insurance against old age and health costs, housing, education, police and fire services, and very few governments provide clothing or restaurant meals. Of course one wouldn't want to say the current mix of public-private provision is ideal. But one wouldn't want to say it carries no information, either.

3. There's a genuine value in institutions that pursue a public purpose, rather than profit. We can debate whether hospitals should be public, nonprofit or even private at the level of management, but presumably in the operating room we want our doctor thinking about what's most likely to make this surgery successful and not what's most likely to make him money. (And we don't think reputation costs are enough to guarantee those motives coincide -- so back to market failures as above.) In the same category, and close to many of our hearts, are professors and other teachers, who teach better when they're focused on just that, and not worrying about their paycheck.

4. Related to (3), how do we manage a system in which the public sector is disappearing? Seems to me the logical outcome of the UBI-and-let-markets-do-the-rest approach is stuff like this. Either you agree that intrinsic motivation is important, in which case you have to honestly ask in each particular case whether self-interest adds more than it detracts. Or you deny it, but then you're left with the problem of how to you assure the honesty of the people sending out the checks. (Not to mention all the zillion commercial transactions that happen every day.) DeLong somewhere calls neoliberalism a counsel of despair, which makes sense only once you've given up on the capacity of the state. But without minimal state capacity even neoliberalism doesn't work. If the nightwatchman won't do what's right because it is right, you can't have markets either. Better pledge yourself to a feudal lord. And if the nightwatchman will, then why not the doctor, teacher, etc.?

5. How confident are we that unfettered markets plus UBI is politically sustainable? Being a worker expecting a certain wage gives you some social power. Being a participant in a public institution gives you, arguably, some social power, an identity, it helps solve the collective action problem of the poor. (Which is the big problem in all of this.) But receiving your UBI check doesn't give you any power, any capacity to disrupt, it doesn't give you a sense of collective identity, it doesn't form a basis of collective action. My hypothesis is that the parents at the local public school are more able to act together -- they have the PTA, to begin with -- than the same number of voucher recipients are.

Friday, September 19, 2014

Piketty and the Money View: A Reply to MisterMR

The last post got some very helpful comments from MisterMR (the regular commenter formerly known as Random Lurker) and Kevin Donoghue. Both of them raise issues that are worth posts of their own. I'll reply to MisterMR now, and perhaps to Kevin Donoghue later. Or perhaps not -- the biggest thing I've learned in four years of blogging is: Never make promises about future posts.

* * *

MisterMR is coming from what I hope he won't mind my calling a classical Marxian perspective -- a perspective I'm simpatico with, tho I haven't been taking it here. One aspect of this perspective is the idea that capital can be understood in physical terms, as embodied labor. Now I agree that Marx does clearly say this, but I think this can be seen as a concession he is making to the orthodoxy of the day for the sake of the argument. Capital is subtitled "A Critique of Political Economy," and I think we should take that subtitle seriously. In effect, he is saying to Ricardo: OK, let's accept your way of thinking about capital, the system based on it is still conflictual, exploitative and in contradiction with its own conditions of existence.

I'm not sure how widely this view is held -- that Marx adopts the labor theory of value ironically. Anyway, that's not the argument I want to have here. What I want to do is clarify the perspective I'm offering in place of the labor theory. It's more in the spirit of the other core Marxian idea about capital, that it is a social relation between people.

MisterMR writes:
I think that there are 4 different kinds of capital assets (though in reality most capital assets are a mix of the four kinds). 
1) There are some capital goods that are stuff that is materially produced, such as factories. This stuff has a cost of production, that arguably has some relationship with its "value". This is what I would call "real" capital. The ambiguity in Piketty comes from the fact that he speaks as if all capital is "real" capital, and as if every money flow translates in "real" capital. 
2) There are some assets that are a finite resource that someone controls, like land. In fact, classical economists distinguished between "capital" and "land". The value of land can't be linked to the "cost of production" of land, because said cost doesn't exist. So arguably the value is just the cashflow derived from the asset divided by the normal rate of profit. I'd call this kind of assets simply "land". 
3) While land is certainly something that exists, there are some assets that have an economic value but that don't relate to something that clearly exists or that can be produced: for example, ownership on patents, or a famous brand that has an high market penetration and visibility etc. I think that these assets have dinamics that are similar to land, although they are mostly non material. 
4) Finally, there is credit. Credit also is a non material thing, and is different from all the 3 previous classes of capital for these reasons: 
4.1) It doesn't have a "cost of production";
4.2) It isn't related to any fixed resource, something that differentiates credit from both 2 and 3;
4.3) It has a fixed nominal value (which implies that the currency provider can literally print it out of existence).
4.4) It usually has a nominally fixed interest rate, something that can obviously cause chain bankruptcies. 
My problem with the "monetary view" is that it sounds like if assets of the 2 and 3 classes all are just a "montary" thing, as opposed to a "real stuff view" that sees all assets as if they were of the 1 class.
My response is that the money view is not a substantive claim about the nature of particular assets, but a way of looking at assets in general -- "real" capital goods as much as the more vaporous claims in categories 2 through 4. It does imply some kind of ontology, but in itself, the money view is just a choice to focus on money payments.

But I do want to explain the broader view of social reality that, for me at least, lies behind the money view.  Here's the way I want to look at things.

* * *

On the one hand, there is the human productive activity of collectively transforming the world and maintaining our conditions of existence, along with the conditions that make that activity possible. When you sit down and write a blog post, you are engaged in creative activity with the goal of building up our collective knowledge of the world, and you are also maintaining the network of social ties through which this kind of activity is carried out. Your ability to engage in this activity depends on a great number of objective conditions, ranging from your physical health to the infrastructure that communicates your words to the rest of the world. Many of these conditions are the result of past human activity.

Under capitalism, a subset of human productive activity gets marked off as "labor." Labor has a number of special characteristics, most obviously that it is carried out at the direction of a boss. But for current purposes, the most important distinctive characteristics of the activity that we call "labor"  are (a) it carries a price tag, the "wage," with labor that is somehow similar carrying a similar wage. And (b) labor becomes substantively more similar over time, with the disappearance of specific skills and increasing interchangeability among the human beings performing it; it follows from this that the wage also become uniform. To the extent that (a) is true, we can attribute a "cost" to some particular set of conditions and to the extent (b) is also true, that cost will correspond to the hours of labor expended maintaining those conditions. Of course all productive activity additionally requires many conditions, both natural and social, that are not reflected in labor hours. In particular, a great deal of passive social cooperation is required for any productive activity, especially when there is an extensive division of labor.

Even in the pure case, where labor is completely homogeneous and all production is carried out for profit, under identical conditions and with no barriers to competition, there will not in general be a unique mapping from labor hours to costs or relative prices. The best we can do is to reduce all the infinite possible sets of relative prices to variation along a single dimension, with one set of relative prices corresponding to each possible profit rate. (I think this is Sraffa's point.)

So the description of assets in group 1 is correct -- but only with respect to one particular way of describing one particular way of organizing production, not as statements about reality in general. The productive activity that takes place in a factory does, of course, require the past activity that resulted in the existence of the factory. But it requires lots of other activity as well, much of which is not counted as "labor." And the fact that "labor" is a measurable input at all only holds to the extent that the productive activity has been deskilled and homogenized, a sociological fact that is never completely true and is not true at all in most historical contexts.

The think you have to avoid is believing that quantities like "value" or "cost" have any existence outside the specific social relations of capitalism.

The next question is what it means to “own” some conditions for productive activity, like a factory. The beginning of wisdom here is to recognize that ownership is a legal relationship between persons, not a relationship with a physical object. To own a piece of land means you have certain legal rights with respect to other people — to exclude them from the use of that land, to receive some equivalent from them if you do permit use of the land, to transfer those rights to someone else — and that no one else has those rights with respect to you. However, that’s only the first step. Next, we have to recognize that what constitutes “use” of piece of an asset is not a physical fact, but a social one. (As in the old story, the baker can exclude others from eating his rolls, but not from enjoying the smell of them.) So it would be more accurate to say that ownership of a piece of property is simply a form of social authority — a bundle of rights over other people. Indeed, if we want to relate the world of money flows to broader social reality, the most fundamental fact is probably this: The person who receives a money payment labeled “profit” gives orders, and the people who receive money payments labeled “wages” have to follow them. To say you own a piece of property is simply to say there is a set of commands that, if you issue them, other people are compelled to obey. Those rights are metonymously referred to by a label which bears a picture of some tangible good, just like the insignia on an officer’s uniform bear a picture of a leaf or a bird.

So:

When you say, here is a means of production, a factory, with a certain cost, you have already chosen: to ignore all the various conditions that make a certain form of collective productive activity possible, and let the existence of this one tangible object, the factory, stand in for all the rest; to ignore all the various forms of productive activity and social coordination that were necessary to bring the factory  (and the rest of the conditions of production) into existence, except for those we class as wage labor; to convert that wage labor to some common quantitative standard by measuring it in wage payments;  to assume some exogenously given profit rate, to give you the discount rate you need to add up wage payments made at different dates. Only then can you say the factory has a cost — and even then, this money cost is calculated by adding up a certain set of money payments.

At that point we have MisterMR's category (1) as a concrete social reality. We still have to establish the profit rate, since it cannot be reduced to a marginal physical product. Only then do the issues specific to the other three categories come into play.

I should be clear: the money view is not a complete account of the sphere of social reality we call the economy. (And again, I’ve adopted the term from Perry Mehrling, it’s not my invention.) The money view is defined by making the atomic units of analysis bundles of money payments. I would argue that it is logically consistent to think of any capital good as simply a bundle of income streams contingent on different states of the world, in a way that it is not logically consistent to think of it as a physical object producing a stream of physical outputs.

The fact that this is a logically consistent account doesn’t mean it’s sufficient. Obviously the money view doesn’t give a complete story, since we don’t know why the income streams attached to different assets are what they are, or why they change over time, or why assets in the monetary sense are attached to tangible goods or production processes, or for that matter why anyone cares about money payments in the first place. But by adopting a consistent story about money payments and assets, we get a clearer view of these other questions. We distinguish the questions that can be addressed with the formal techniques of economics from other questions that require a different approach. This is a step forward from the perspective that mixes up questions about money flows with questions about tangible productive activities and so can’t give a coherent story about either.

Thursday, September 11, 2014

Piketty and the Money View

I recently picked up Capital and the 21st Century again. And what's striking to me, on revisiting it, is the contrast between the descriptive material and the theory used to make sense of it.

Piketty’s great accomplishment is the comprehensive data on wealth he has compiled, going back to the 18th century. He deserves nothing but praise for making that data easily accessible. (You could think of his project as an iceberg, with most of the substance hidden below the waterline in the online appendixes.) I have not seen any serious doubts raised about the accuracy of this data; and the descriptive generalizations he draws from it, while not above criticism, are obviously based in a deep study of the concrete historical material. But the connections between this material and the theoretical claims it's mixed in with -- r > g and all that -- are tenuous at best.

It’s important to remember that all the underlying data is in nominal terms. All the empirical material in the book relates to stocks and flows of money. But when he turns to explain the patterns he finds in this data, he does it in terms of physical inputs to physical production. The money wealth present in a country is assumed to correspond to the physical capital goods, somehow converted to a scalar quantity. And the incomes received by wealth owners is assumed to correspond to a physical product somehow attributable to these capital goods. I am hardly the first person to suggest that this is not a sensible way to explain trends in private wealth as measured in money, and the money-income derived from it. But what I haven’t seen people say — even people who jump at the chance to revisit the Cambridge Capital Controversies — is the remarkable difference in the attitudes of Piketty the historian and Piketty the economic theorist to data. Shifts in the scale and distribution of private wealth are described on the basis of years of meticulous study of the tax records of various countries. But the production processes that are supposed to explain these shifts are described without any data at all, purely deductively.  You would think that if Piketty believed that the share of property income in total income depends on physical production technologies, returns to scale, depreciation, etc., then at least half the book would be taken up with technological history. You’d think he would spend as much energy studying the inputs and outputs associated with different degrees of mechanization of major production processes, how long is the useful life of different kinds of buildings in different eras and how much annual maintenance they require, and so on. After all, these are the kinds of factors that he believes — or claims to believe — drive the money-wealth outcomes the book is about. In fact, of course, these topics are not discussed at all. Terms like “production” and “depreciation” are black boxes, pure mathematical formalism. You would think that Piketty, who presents himself as a historian and is admirably critical of the deductive character of so much of economics, would have hesitated before staking so much on deductive, evidence-free claims about physical production.

Because when you take a step back and think about it, this is what Piketty has done:  He has carefully described the historical evolution of monetary wealth, and then postulated an imaginary physical reality that exactly matches that evolution. It’s a kind of economic preformationism, or like the folk psychology that tries to explain your actions by imagining a little homunculus in your head that is choosing them.  The “real economy” in Piketty is just a ghostly mirror-image of the network of money payments and money claims that is actually observed.

* * *

Let me give a concrete example. Piketty shows that around 1800, the wealth-income ratio was relatively low in the United States -- about 300% of national income, compared with 600-700% in England and France. About half of this difference was the lower value of agricultural land, which totaled about 150% of national income in the US and over 300% in both England and France. Piketty suggests that this is because the great abundance of land in the New World meant that its marginal product was relatively low. This sounds reasonable enough -- but it flies in the face of Piketty's larger argument about the capital share. His big theoretical claim is that the capital share is determined by the growth rate of cumulated savings relative to the growth rate of income. And this only works if the return on "capital" is relatively insensitive to its scarcity or abundance. (This is the question of the elasticity of substitution between capital and labor, which has dominated economists' debates about the book.) If having more land makes the share of land rents in national income go down, why won't the growth of "capital" similarly push down its return?

This isn't meant as a gotcha. Piketty frankly acknowledges the problem. He suggests two possible solutions: First, constant returns might only apply over some range of capital-output ratios. Beyond that that range, further accumulation might make capitalists as a group poorer rather than richer. Second, it might be easier to substitute between labor and modern capital goods, than between labor and agricultural land. Both these assumptions sound reasonable, altho I think they are both more problematic than they seem at first glance. But that's not the argument I want to have right now. The point I want to make now is that Piketty just takes it for granted that behind the smaller flow of money going to land owners in US circa 1800, there must have been a smaller physical flow of output coming off the marginal piece of land. Of course this isn't logically necessary -- the money-value of agricultural land will also depend on the legal rights associated with land ownership, the terms on which new land can be acquired, the ease with which land can be sold or borrowed against, etc. Presumably the same physical mix of land, tools and people would have led to a different share of money income being claimed as land rents if frontier land in the early United States had been owned by a few large landlords, instead of being freely distributed to white families by the government. But these types of explanations are not even considered. For Piketty, behind each flow of money there must be an identical flow of stuff.

The other strange thing is that, despite his insistence that money flows are fully explained by physical conditions of production, Piketty shows no interest in investigating those conditions. The numbers on the level and composition of money wealth in US are meticulously sourced and documented. The claims about physical production conditions, on the other hand, are entirely speculative. There is no shortage of material you could turn to if you wanted to ask whether whether land was really more abundant, in an economically meaningful sense, in the early US than in France or Britain, or if you wanted to know if adding an acre to an 1800-era American farm would increase its output proportionately less or more than adding an acre to a similar-sized British or French farm. But Piketty doesn't even gesture at this literature.

* * *

I draw two conclusions. First, it's hard to say anything sensible about the book until you realize it consists of two distinct, almost unrelated projects. There is the historical data on money wealth and money incomes. And then there is the whole rigamarole of "laws of capitalism." The book is mostly written as if the latter somehow distill or summarize the former, but they are really very loosely articulated. Let me give one more quick -- but important -- example. You might think that with all the huffing and puffing about r > g, the data would tell a story in which the share of wealth in national income rises in periods when r is relatively high and g is relatively low, and falls when g is high and r is low. But the data tell no such story.

The great fall in the capital share took place between 1913 and 1950, according to Piketty. But his own data show that this was the period of the highest returns to capital, and the lowest growth rates, in the whole 240 years the book covers. I've reproduced his graph of r in the UK below; the figures for other Western European countries look similar. Meanwhile, he gives an average growth rate for Western Europe over 1913-1950 of 1.4%, compared with 1.8% in the high-capital share 19th century, and 2.1% in the period of rising capital shares since 1970. This is exactly the opposite pattern that we would expect if r and g were the central actors in the story.


Of course Piketty has an answer for this too: The fall in the capital share in the first half of the 20th century is explained by the World Wars and the destruction of the old social order in Europe. No doubt -- but if factors like these dominate the historical trajectory of wealth and income, why not tell your story in terms of them, instead of a few dubious equations from the orthodox growth model? Unfortunately, discussion of the book has been almost entirely about the irrelevant formalism. I think that is why the conversation has been so noisy yet advanced so little. To return to the earlier metaphor, it's as if everyone is ignoring the iceberg and talking about a little igloo built on top of it.

My second conclusion is that the disconnect between the two different Pikettys shows, in a negative way, why what I've been calling the money view is so important. The historical data assembled in Capital in the 21st Century is a magnificent accomplishment and will be drawn on by economic historians for years to come. Many of the concrete observations he makes about this material are original and insightful. But all of this is lost when translated into Piketty's preferred theoretical framework. To make sense of the historical evolution of money payments and claims, we need an approach that takes those payments and claims as objects of study in themselves.


LATE UPDATE: A friend forwards the following (verbal) comment from Joe Stiglitz:

"There is a confusion in Piketty on valuation and physical stocks. In France, the main 'increase' in wealth is because of higher prices of land. Do we really think that France has become wealthier (using Piketty's physical understanding of wealth in his model) because while the manufacturing capital stock has declined, the Riviera has become more expensive?"

Tuesday, August 19, 2014

Liquidity Preference on the F Line

Sitting on the subway today, I was struck by the fact that the three ads immediately opposite me were all for what you might call liquidity services. On the left was an ad for "personal asset loans" from something called Borro: "With this necklace ... I funded my first business," says a satisfied customer. Next to it was an MTA ad trumpeting the fact that you can pay your fare with a credit card. And then one from AptDeco.com, which I guess is a clearinghouse for used furniture sales, with the tagline "NYC is now your furniture store."


the Borro ad was the next one to the left
This was interesting to me because I've just been thinking about the neutrality of money, and what an incoherent and contradictory idea it is.

The orthodox view is that the level of "real" economic activity is determined by "real" factors -- endowments, tastes, technology -- and people simply hold money balances proportionate to this level of activity. In this view, a change in the money supply can't make anyone better or worse off, at least in the long run, or change anything about the economy except the price level.

Just looking at these ads shows us why that can't be true. First of all, the question of what constitutes money. All three of these ads are, in effect, inviting you to use something as money that you couldn't previously. Without the specialized intermediary services being hawked here, you couldn't pay the startup costs of a business with a necklace (what's this thing made of, plutonium?), or pay for a subway ride with a promise to pay later, or pay for much of anything with a used couch. And this new liquidity has real benefits -- otherwise, no one would be buying it, and it wouldn't be worth the cost of producing (or advertising) it. The idea -- stated explicitly in the Borro ad -- is that the liquidity they provide allows transactions to take place that otherwise wouldn't. The ability to turn a piece of jewelry or a car into cash allows people to use productive capacities that otherwise would go to waste.

And of course this makes sense. The orthodox view is that money is useful -- there must be a reason that we don't live in a barter world, and more than that, that all this huge industry of liquidity provision exists. But money, for some reason, is not subject to the same kind of smoothly diminishing returns that other useful things are. There is a fixed amount you need, you can't get by with less, and there's no benefit at all in having more. The problem is worse than that, since the standard view is that money demand is strictly proportionate to the volume of transactions. But, which transactions? Presumably, the amount of economic activity depends on the availability of money -- that's what it means to say that money is useful. And furthermore, as these ads implicitly make clear, some transactions are more liquidity-intensive than others. No one is offering specialized intermediary services to help you buy a hamburger. So both the level and composition of economic activity must depend on money holdings. But in that case, you can't say that money holdings depend only on the volume of activity -- that would be circular. In a world where money is used at all, it can't be neutral. An increase in the money supply (or better, in liquidity) may raise prices, but it won't do so proportionately, since it also enables people to benefit from increasing their money holdings (or: shifting toward more liquid balance sheet positions) and to carry out liquidity-intensive transactions that were formerly unable to.

This is a very old issue in economics. The idea that money should be neutral is as old as the discipline, and so is this line of criticism of it. You can find both already in Hume. In "Of Money," he lays out the argument that money must be neutral in the long run, since it is just an intrinsically meaningless unit of measure; real wealth depends on real resources, not on the units we count them in. Unlike most later writers, he follows this argument to its logical conclusion, that any resources devoted to liquidity provision are wasted:
This has made me entertain a doubt concerning the benefit of banks and paper-credit, which are so generally esteemed advantageous to every nation. That provisions and labour should become dear by the encrease of trade and money, is, in many respects, an inconvenience; but an inconvenience that is unavoidable, and the effect of that public wealth and prosperity which are the end of all our wishes. ... But there appears no reason for encreasing that inconvenience by a counterfeit money, which foreigners will not accept of in any payment, and which any great disorder in the state will reduce to nothing. There are, it is true, many people in every rich state, who having large sums of money, would prefer paper with good security; as being of more easy transport and more safe custody. ... And therefore it is better, it may be thought, that a public company should enjoy the benefit of that paper-credit, which always will have place in every opulent kingdom. But to endeavour artificially to encrease such a credit, can never be the interest of any trading nation; but must lay them under disadvantages, by encreasing money beyond its natural proportion to labour and commodities, and thereby heightening their price to the merchant and manufacturer. And in this view, it must be allowed, that no bank could be more advantageous, than such a one as locked up all the money it received, and never augmented the circulating coin, as is usual, by returning part of its treasure into commerce.
You can find similar language in "On the Balance of Trade":
I scarcely know any method of sinking money below its level [i.e. producing inflation], but those institutions of banks, funds, and paper-credit, which are so much practised in this kingdom. These render paper equivalent to money, circulate it throughout the whole state, make it supply the place of gold and silver, raise proportionably the price of labour and commodities, and by that means either banish a great part of those precious metals, or prevent their farther encrease. What can be more shortsighted than our reasonings on this head? We fancy, because an individual would be much richer, were his stock of money doubled, that the same good effect would follow were the money of every one encreased; not considering, that this would raise as much the price of every commodity, and reduce every man, in time, to the same condition as before. ...
It is indeed evident, that money is nothing but the representation of labour and commodities, and serves only as a method of rating or estimating them. Where coin is in greater plenty; as a greater quantity of it is required to represent the same quantity of goods; it can have no effect, either good or bad, taking a nation within itself; any more than it would make an alteration on a merchant’s books, if, instead of the Arabian method of notation, which requires few characters, he should make use of the Roman, which requires a great many. 
From this view -- which is, again, just taking the neutrality of money to its logical conclusion -- services like the ones being advertised on the F train are the exact opposite of what we want. By making more goods usable as money, they are only contributing to inflation. Rather than making it easier for people to use necklaces, furniture, etc. as means of payment, we should rather be discouraging people form using even currency as means of payment, by reducing banks to safe-deposit boxes.

That was where Hume left the matter when he first wrote the essays around 1750. But when he republished "On the Balance of Trade" in 1764, he was no longer so confident. [1] The new edition added a discussion of the development of banking in Scotland with a strikingly different tone:
It must, however, be confessed, that, as all these questions of trade and money are extremely complicated, there are certain lights, in which this subject may be placed, so as to represent the advantages of paper-credit and banks to be superior to their disadvantages. ... The encrease of industry and of credit ... may be promoted by the right use of paper-money. It is well known of what advantage it is to a merchant to be able to discount his bills upon occasion; and every thing that facilitates this species of traffic is favourable to the general commerce of a state. But private bankers are enabled to give such credit by the credit they receive from the depositing of money in their shops; and the bank of England in the same manner, from the liberty it has to issue its notes in all payments. There was an invention of this kind, which was fallen upon some years ago by the banks of Edinburgh; and which, as it is one of the most ingenious ideas that has been executed in commerce, has also been thought advantageous to Scotland. It is there called a Bank-Credit; and is of this nature. A man goes to the bank and finds surety to the amount, we shall suppose, of a 1000 pounds. This money, or any part of it, he has the liberty of drawing out whenever he pleases, and he pays only the ordinary interest for it, while it is in his hands. ... The advantages, resulting from this contrivance, are manifold. As a man may find surety nearly to the amount of his substance, and his bank-credit is equivalent to ready money, a merchant does hereby in a manner coin his houses, his household furniture, the goods in his warehouse, the foreign debts due to him, his ships at sea; and can, upon occasion, employ them in all payments, as if they were the current money of the country.
Hume is describing something like a secured line of credit, not so different from the services being advertised on the F line, which also offer ways to coin your houses and household furniture. The puzzle is why he thinks this is a good thing. The trade credit provided by banks, which is now "favourable to the general commerce of the state," is precisely what he was trying to prevent when he wrote that the best bank was one that "locked up all the money it received."Why does he now think that increasing liquidity will stimulate industry, instead of just producing a rise in prices that will "reduce every man, in time, to the same condition as before"?

You can't really hold it against Hume that he never resolved this contradiction. But what's striking is how little the debate has advanced in the 250 years since. Indeed, in some ways it's regressed. Hume at least drew the logical conclusion that in a world of neutral money, liquidity services like the ones advertised on the F train would not exist.


[1] I hadn't realized this section was a later addition until reading Arie Arnon's discussion of the essay in Monetary Theory and Policy from Hume and Smith to Wicksell. I hope to be posting more about this superb book in the near future.

Thursday, August 14, 2014

Innovation in Higher Ed, 1680 Edition

Does anybody read Bagehot's Lombard Street any more? You totally should, it's full of good stuff. It's baffling to me, as a sometime teacher of History of Economic Thought, that most of the textbooks and anthologies don't mention him at all. Anyway, here he's quoting Macaulay:
During the interval between the Restoration and the  Revolution the riches of the nation had been rapidly increasing. Thousands of busy men found every Christmas that, after the expenses of  the year's housekeeping had been defrayed out of the year's income, a surplus remained ; and how that surplus was to be employed was a question of some difficulty. In … the seventeenth century, a lawyer, a physician, a retired merchant, who had saved some thousands, and who wished to place them safely and profitably, was often greatly embarrassed. … Many, too, wished to put their money where they could find it at an hour's notice, and looked about for some species of property which could be more readily transferred than a house or a field. A capitalist might lend … on personal security : but, if he did so, he ran a great risk of losing interest and principal. There were a few joint-stock companies, among which the East India Company held the foremost place : but the demand for the stock of such companies was far greater than the supply. … So great was that difficulty that the practice of hoarding was common. We are told that the father  of Pope, the poet, who retired from business in the City about the time of the Revolution, carried to a retreat in the country a strong-box containing near twenty thousand pounds, and took out from time to time what was required for household expenses... 
The natural effect of this state of things was that a crowd of projectors, ingenious and absurd, honest and knavish, employed themselves in devising new schemes for the employment of redundant capital. It was about the year 1688 that the word stock-jobber was first heard London. In the short space of four years a crowd of companies, every one of which confidently held out to subscribers the hope of immense gains, sprang into existence… There was a Tapestry Company, which would soon furnish pretty hangings for all the parlors of the middle class and for all the bedchambers of the higher. There was a Copper Company, which proposed to explore the mines of England, and held out a hope that they would prove not less valuable than those of Potosi. There was a Diving Company, which undertook to bring up precious effects from shipwrecked vessels, and which announced that it had laid in a stock of wonderful machines resembling complete suits of armor. In front of the helmet was a huge glass eye like that of Polyphemus ; and out of the crest went a pipe through which the air was to be admitted. … There was a society which undertook the office of giving gentlemen a liberal education on low terms, and which assumed the sounding name of the Royal Academies Company. In a pompous advertisement it was announced that the directors of the Royal Academies Company had engaged the best masters in every branch of knowledge, and were about to issue twenty thousand tickets at twenty shillings each. There was to be a lottery : two thousand prizes were to be drawn; and the fortunate holders of the prizes were to be taught, at the charge of the Company, Latin, Greek, Hebrew, French, Spanish, conic sections, trigonometry, heraldry, japanning, fortification, book-keeping, and the art of playing the theorbo.
Many of Macaulay's examples, which I've left out here, are familiar, thanks to Charles Mackay and more recent historians of financial folly. (Including everyone's favorite, the company that raised funds "for an Undertaking which in due time shall be revealed.") The line about Pope is also familiar, at least to reader of The General Theory: Keynes cites it as an illustration of the position of the wealth-holder in a world where the rentier had been successfully euthanized. But I, at least, had never realized that the diving suit was a product of the South Sea bubble. And I'd never heard of this spiritual ancestor of Chris Whittle and Michelle Rhee.

It would be interesting to learn more about the claims that were made for this company, and what happened to it. Alas, Google is no help. Although, "Royal Academies Company" turns out to be a weirdly popular phrase among the Markov-chain text generators that populate fake spam blogs. (Seriously, guys, this is poetry.) We can only hope that today's enterprises that promise to give gentlemen a liberal education on low terms  (or at least an education in japanning and/or ski area management) will vanish as ignominiously.

Sunday, August 3, 2014

Strange Defeat: An Exchange

My EPW article with Arjun prompted an interesting exchange with Parag Waknis. Since the letters, like the article, are behind a paywall, I'm reposting them here, below the fold. Waknis' letter is first, followed by our response.


Thursday, July 31, 2014

Strange Defeat

Following up on the previous post, below the fold is an article Arjun and I wrote last year for the Indian publication Economic and Political Weekly, on how liberal New Keynesian economists planted the seeds of their own defeat in the policy arena. 

I should add that Krugman is very far from the worst in this respect. If I criticize my soon-to-be colleague so much, it's only because of his visibility, and because the clarity of his writing and his genuinely admirable political commitments make it easier to see the constraints imposed by his theoretical commitments. You might say that his distinct virtues bring the common vices into sharper focus.


The Call Is Coming from Inside the House

Paul Krugman wonders why no one listens to academic economists. Almost all the economists in the IGM Survey agree that the 2009 stimulus bill successfully reduced unemployment and that its benefits outweighed its costs. So why are these questions still controversial?

One answer is that economists don’t listen to themselves. More precisely, liberal economists like Krugman who want the state to take a more active role in managing the economy, continue to teach  an economic theory that has no place for activist policy.

Let me give a concrete example.

One of Krugman’s bugaboos is the persistence of claims that expansionary monetary policy must lead to higher inflation. Even after 5-plus years of ultra-loose policy with no rising inflation in sight, we keep hearing that since so “much money has been created…, there should already be considerable inflation.” (That’s from exhibit A in DeLong’s roundup of inflationphobia.) As an empirical matter, of course, Krugman is right. But where could someone have gotten this idea that an increase in the money supply must always lead to higher inflation? Perhaps from an undergraduate economics class? Very possibly -- if that class used Krugman’s textbook.

Here’s what Krugman's International Economics says about money and inflation:
A permanent increase in the money supply causes a proportional increase in the price level’s long-run value. … we should expect the data to show a clear-cut positive association between money supplies and price levels. If real-world data did not provide strong evidence that money supplies and price levels move together in the long run, the usefulness of the theory of money demand we have developed would be in severe doubt. 
… 
Sharp swings in inflation rates [are] accompanied by swings in growth rates of money supplies… On average, years with higher money growth also tend to be years with higher inflation. In addition, the data points cluster around the 45-degree line, along which money supplies and price levels increase in proportion. … the data confirm the strong long-run link between national money supplies and national price levels predicted by economic theory. 
… 
Although the price levels appear to display short-run stickiness in many countries, a change in the money supply creates immediate demand and cost pressures that eventually lead to future increases in the price level. 
… 
A permanent increase in the level of a country’s money supply ultimately results in a proportional rise in its price level but has no effect on the long-run values of the interest rate or real output. 

This last sentence is simply the claim that money is neutral in the long run, which Krugman continues to affirm on his blog. [1] The “long run” is not precisely defined here, but it is clearly not very long, since we are told that “Even year by year, there is a strong positive relation between average Latin American money supply growth and inflation.”

From the neutrality of money, a natural inference about policy is drawn:
Suppose the Fed wishes to stimulate the economy and therefore carries out an increase in the level of the U.S. money supply. … the U.S. price level is the sole variable changing in the long run along with the nominal exchange rate E$/€. … The only long-run effect of the U.S. money supply increase is to raise all dollar prices.
What is “the money supply”? In the US context, Krugman explicitly identifies it as M1, currency and checkable deposits, which (he says) is determined by the central bank. Since 2008, M1 has more than doubled in the US — an annual rate of increase of 11 percent, compared with an average of 2.5 percent over the preceding decade. Krugman’s textbook states, in  unambiguous terms, that such an acceleration of money growth will lead to a proportionate acceleration of inflation. He can hardly blame the inflation hawks for believing what he himself has taught a generation of economics students.

You might think these claims about money and inflation are unfortunate oversights, or asides from the main argument. They are not. The assumption that prices must eventually change in proportion to the central bank-determined money supply is central to the book’s four chapters on macroeconomic policy in an open economy. The entire discussion in these chapters is in terms of a version of the Dornbusch “overshooting” model. In this model, we assume that

1. Real exchange rates are fixed in the long run by purchasing power parity (PPP).
2. Interest rate differentials between countries are possible only if they are offset by expected changes in the nominal exchange rate.

Expansionary monetary policy means reducing interest rates here relative to the rest of the world. In a world of freely mobile capital, investors will hold our lower-return bonds only if they expect our nominal exchange rate to appreciate in the future. With the long-run real exchange rate pinned down by PPP, the expected future nominal exchange rate depends on expected inflation. So to determine what exchange rate today will make investors willing to holder our lower-interest bonds, we have to know how policy has changed their expectations of the future price level. Unless investors believe that changes in the money supply will translate reliably into changes in the price level, there is no way for monetary policy to operate in this model.

So  these are not throwaway lines. The more thoroughly a student understands the discussion in Krugman’s textbook, the stronger should be their belief that sustained expansionary monetary policy must be inflationary. Because if it is not, Krugman gives you no tools whatsoever to think about policy.

Let me anticipate a couple of objections:

Undergraduate textbooks don’t reflect the current state of economic theory. Sure, this is often true, for better or worse. (IS-LM has existed for decades only in the Hades of undergraduate instruction.) But it’s not much of a defense, is it? If Paul Krugman has been teaching his undergraduates economic theory that produces disastrous results when used as a guide for policy, you would think that would provoke some soul-searching on his part. But as far as I can tell, it hasn’t. But in this case I think the textbook does a good job summarizing the relevant scholarship. The textbook closely follows the model in Dornbusch’s Expectations and Exchange Rate Dynamics, which similarly depends on the assumption that the price level changes proportionately with the money supply. The Dornbusch article is among the most cited in open-economy macroeconomics and international finance, and continues to appear on international finance syllabuses in most top PhD programs.

Everything changes at the zero lower bound. Defending the textbook on the ground that it's pre-ZLB effectively concedes that what economists were teaching before 2008 has become useless since then. (No wonder people don’t listen.) If orthodox theory as of 2007 has proved to be all wrong in the post-Lehmann world, shouldn’t that at least raise some doubts about whether it was all right pre-Lehmann? But again, that's irrelevant here, since I am looking at the 9th Edition, published in 2011. And it does talk about the liquidity trap — not, to be sure, in the main chapters on macroeconomic policy, but in a two-page section at the end. The conclusion of that section is that while temporary increases in the money supply will be ineffective at the zero lower bond, a permanent increase will have the same effects as always: “Suppose the central bank can credibly promise to raise the money supply permanently … output will therefore expand, and the currency will depreciate.” (The accompanying diagram shows how the economy returns to full employment.) The only way such a policy might fail is if there is reason to believe that the increase in the money supply will subsequently be reversed. Just to underline the point, the further reading suggested on policy at the zero lower bound is an article by Lars Svennson that calls a permanent expansion in the money supply “the foolproof way” to escape a liquidity trap. There’s no suggestion here that the relationship between monetary policy and inflation is any less reliable at the ZLB; the only difference is that the higher inflation that must inevitably result from monetary expansion is now desirable rather than costly. This might help if Krugman were a market monetarist, and wanted to blame the whole Great Recession and slow recovery on bad policy by the Fed; but (to his credit) he isn’t and doesn’t.

Liberal Keynesian economists made a deal with the devil decades ago, when they conceded the theoretical high ground. Paul Krugman the textbook author says authoritatively that money is neutral in the long run and that a permanent increase in the money supply can only lead to inflation. Why shouldn't people listen to him, and ignore Paul Krugman the blogger?


[1] That Krugman post also contains the following rather revealing explanation of his approach to textbook writing:
Why do AS-AD? First, you do want a quick introduction to the notion that supply shocks and demand shocks are different ... and AS-AD gets you to that notion in a quick and dirty, back of the envelope way. 
Second — and this plays a surprisingly big role in my own pedagogical thinking — we do want, somewhere along the way, to get across the notion of the self-correcting economy, the notion that in the long run, we may all be dead, but that we also have a tendency to return to full employment via price flexibility. Or to put it differently, you do want somehow to make clear the notion (which even fairly Keynesian guys like me share) that money is neutral in the long run. That’s a relatively easy case to make in AS-AD; it raises all kinds of expositional problems if you replace the AD curve with a Taylor rule, which is, as I said, essentially a model of Bernanke’s mind.
This is striking for several reasons. First, Krugman wants students to believe in the "self-correcting economy," even if this requires teaching them models that do not reflect the way professional economists think. Second, they should think that this self-correction happens through "price flexibility." In other words, what he wants his students to look at, say, falling wages in Greece, and think that the problem must be that they have not fallen enough. That's what "a return to full employment via price flexibility" means. Third, and most relevant for this post, this vision of self-correction-by-prices is directly linked to the idea that money is neutral in the long run -- in other words, that a sustained increase in the money supply must eventually result in a proportionate increase in prices. What Krugman is saying here, in other words, is that a "surprising big" part of his thinking on pedagogy is how to inculcate the exact errors that drive him crazy in policy settings. But that's what happens once you accept that your job as an educator is to produce ideological fables.


Tuesday, July 15, 2014

Ancient Economists: Two Views

John Cochrane, reporting from the NBER Summer Institute:
The use of ancient quotations came up several times. I  complained a bit about Eggertsson and Mehrotra's long efforts to tie their work to quotes from verbal speculations of Keynes, Alvin Hansen, Paul Krugman and Larry Summers. Their rhetorical device is, "aha, these equations finally explain what some sage of 80 years ago or Important Person today really meant."  Ivan Werning really complained about this in Paul Beaudry's presentation. What does this complex piece of well worked out "21st century economics" have to do with long ago muddy debates between Keynes and Hayek? It stands on its own, or it doesn't. (In his view, it did, so why belittle it?) 
Physics does not write papers about "the Newton-Aristotle debate." Our papers should stand on their own too. They are right or wrong if they are logically coherent and describe the data, not if they fulfill the vague speculations of some sage, dead or alive. It's especially unhelpful to try to make this connection, I think, because the models differ quite sharply from the speculations of the sage. Alvin Hansen certainly did not think that a Taylor interest rate rule with a phi parameter greater than one was a central culprit in "secular stagnation." I haven't checked against the speech, but I doubt he thought that inflation would completely cure the problem in the first place. 
Sure, history of thought is important; tying ideas to their historical predecessors is important; recognizing the centuries of thinking on money and business cycles is important. But let's stand up for our own generation; we do not exist simply to finally put equations in the mouths of ancient economists. 
But, tying it all up, perhaps I'm just being an old fogey. Adam Smith wrote mostly words. Marx like Keynes wrote big complicated books that people spent a century writing about "this is what they really meant." Maybe models are at best quantitative parables. Maybe economics is destined to return to this kind of literary philosophy, not quantified science.
(via Suresh, who was also there.)

For the case in favor of ancient economists, here is Axel Leijonhufvud:
According to Sir Peter Medawar
A scientist's present thoughts and actions are of necessity shaped by what others have done and thought before him: they are the wave-front of a continuous secular process in which The Past does not have a dignified independent existence of its own. Scientific understanding is the integral of a curve of learning; science therefore in some sense comprehends its history within itself.
... Not every field of learning can claim to "comprehend its history within itself." For the current state of the art to be the "integral of past learning" in Medawar's sense, the collective learning process must be one that remembers everything of value and forgets only the errors and the false leads. But this requires the recognized capability to decide what is correct or true and what is in error or false. These decisions, moreover, must compel general assent. Once an answer is arrived at, it must be generally agreed to be the answer. The field must be one in which answers kill questions so definitively that the sense of alternative possibilities disappears. ... 
A science, or a subfield within it, may come to approximate these conditions because of its positive successes. But two other mechanisms that are not so nice will also be at work. First, the people in the field agree that certain questions, which they would have a hard time deciding, are somebody else's responsibility. So economics among the social sciences, like physics among the natural sciences, had first pick of problems and left the really hard ones, on which their methods did not give them a firm grip, for the younger sister disciplines to deal with as best they might. Second, the insiders to the field will agree to exclude some people who refuse to assent to the manner in which certain important questions have been settled. Both the exclusion of undecidable questions from the field of inquiry and the exclusion of undecided people from the professional group help to achieve collective concentration and intensive interaction within the group. … 
These reflections … offer some suggestions about when scientists might find the history of their field relevant and useful to current inquiry. One suggestion is to look for situations when a research program has bogged down, when anomalies have cropped up that cannot be reduced to or converted into ordinary puzzles within the paradigm. Another is to look for cases in which three conditions seem to be met:
a) certain central questions cannot be decided in a way that commands assent,
b) the (for the time being) undecidable questions cannot very well be left for somebody else to worry about, and
c) the people who withhold their assent from some popular suggested answer cannot be ignored or excommunicated.

... Economists are wont to reduce everything to choices. Economics itself develops through the choices that economists make. To use the past for present purposes, we should see the history of the field as sequences of decisions, of choices, leading up to the present. Imagine a huge decision tree, with its roots back in the time of Aristotle, and with the present generation of economists -- not all of them birds of a feather! -- twittering away at each other from the topmost twigs and branches. 
The branching occurs at points where economists have parted company, where problematic decisions had to be made but could not be made so as to command universal assent. The two branches need not be of equal strength at all; in many cases, universal agreement is eventually reached ex post so that one branch eventually dies and falls away. The oldest part of the tree is, perhaps, just the naked trunk; but the sap still runs in some surprising places. 
If you want to translate Medawar's image of science into my decision tree metaphor, you will have to imagine his sciences as fir trees -- with physics, surely, as the redwood – majestic things with tall, straight trunks and with live branches only at the very top. Economics, in contrast, would come out as a rather tangled, ill-pruned shrub … 
As long as "normal" progress continues to be made in these established directions, there is no need to reexamine the past … Things begin to look different if and when the workable vein runs out or, to change the metaphor, when the road that took you to the "frontier of the field" ends in a swamp or in a blind alley. A lot of them do. Our fads run out and we do get stuck occasionally. Reactions to finding yourself in a cul-de-sac differ. Tenured professors might often be content to accommodate themselves to it, spend their time tidying up the place, putting in a few modern conveniences, and generally improving the neighborhood. Braver souls will want out and see a tremendous leap of the creative imagination as the only way out -- a prescription, however, that will leave ordinary mortals just climbing the walls. Another way to go is to backtrack. Back there, in the past, there were forks in the road and it is possible, even plausible, that some roads were more passable than the one that looked most promising at the time. At this point, a mental map of the road network behind the frontier becomes essential.

Friday, July 4, 2014

The Rentier Would Prefer Not to Be Euthanized

Here’s another one for the “John Bull can stand many things, but he cannot stand two percent” files. As Krugman says, there's an endless series of these arguments that interest rates must rise. The premises are adjusted as needed to reach the conclusion. (Here's another.) But what are the politics behind it?

I think it may be as simple as this: The rentiers would prefer not to be euthanized. Under capitalism, the elite are those who own (or control) money. Their function is, in a broad sense, to provide liquidity. To the extent that pure money-holders facilitate production, it is because money serves as a coordination mechanism, bridging gaps — over time and especially with unknown or untrusted counterparties — that would otherwise prevent cooperation from taking place. [1] In a world where liquidity is abundant, this coordination function is evidently obsolete and can no longer be a source of authority or material rewards.

More concretely: It may well be true that markets for, say, mortgage-backed securities are more likely to behave erratically when interest rates are very low. But in a world of low interest rates, what function do those markets serve? Their supposed purpose is to make it easier for people to get home loans. But in a world of very low interest rates, loans are, by definition, easy to get. Again, with abundant liquidity, stocks may get bubbly. But in a world of abundant liquidity, what problem is the existence of stock markets solving? If anyone with a calling to run a business can readily start one with a loan, why support a special group of business owners? Yes, in a world where bearing risk is cheap, specialist risk-bearers are likely to go a bit nuts. But if risk is already cheap, why are we employing all these specialists?

The problem is, the liquidity specialists don’t want to go away. From finance’s point of view, permanently low interest rates are removing their economic reason for being — which they know eventually is likely to remove their power and privileges too. So we get all these arguments that boil down to: Money must be kept scarce so that the private money-sellers can stay in business.

It’s a bit like Dr. Benway in Naked Lunch:
“Now, boys, you won’t see this operation performed very often and there’s a reason for that…. You see it has absolutely no medical value. No one knows what the purpose of it originally was or if it had a purpose at all. Personally I think it was a pure artistic creation from the beginning. 
“Just as a bull fighter with his skill and knowledge extricates himself from danger he has himself invoked, so in this operation the surgeon deliberately endangers his patient, and then, with incredible speed and celerity, rescues him from death at the last possible split second….
Interestingly, Dr. Benway was worried about technological obsolescence too. “Soon we’ll be operating by remote control on patients we never see…. We’ll be nothing but button pushers,” etc. The Dr. Benways of finance like to fret about how robots will replace human labor. I wonder how much of that is a way of hiding from the knowledge that what cheap and abundant capital renders obsolete, is the capitalist?


EDIT: I'm really liking the idea of Larry Summers as Dr. Benway. It fits the way all the talk when he was being pushed for Fed chair was about how great he would be in a financial crisis. How would everyone known how smart he was -- how essential -- if he hadn't done so much to create a crisis to solve?


[1] Capital’s historic role as a facilitator of cooperation is clearly described in chapter 13 of Capital.