Month: October 2008
Trey, a loyal MR reader, asks:
What are good techniques for becoming a better reader of popular non-fiction and history? I analytically approach articles and academic monographs in one way but often find myself having just finished a volume of history or popular non-fiction and am unable to bring my social scientific knowledge to bear on the topic. Rather than asking myself, "What is this a case of?" or "What does social theory have to say about this?" I find myself saying, "That was interesting. What’s for dinner?" Any advice for breaking down this wall is appreciated.
There are (at least) three kinds of useful popular non-fiction works. The first open up a whole new world to you where previously none had existed. Many people felt this way when they read Dawkins’s The Selfish Gene for the first time. For obvious reasons, books like this are increasingly hard to find as you continue your reading career.
The second kind are to be read in batches. No one of them is good enough to thrill you and maybe no one of them is accurate enough to trust. But if you read five to ten of them you get a sense of a field and its critical issues.
The third kind are to be read as marginal additions to a body of knowledge you already have a good grasp of.
The key is to have the kind of book that matches the kind you want.
Short-term nominal interest rates are rising and that is good:
The nominal short rate is the "shadow real interest rate" (as defined by the investment opportunity set) plus the inflation rate, or zero, whichever is greater.
That’s from Fischer Black and the implication is not a cheery one. It’s either deflation or an unproductive real economy or both. Here is the full abstract:
Since people can hold currency at a zero nominal interest rate, the nominal short rate cannot be negative. The real interest rate can be and has been negative, since low risk real investment opportunities, like filling in the Mississippi delta, do not guarantee positive returns. The inflation rate can be and has been negative, most recently (in the U.S.) during the Great Depression. The nominal short rate is the "shadow real interest rate" (as defined by the investment opportunity set) plus the inflation rate, or zero, whichever is greater. Thus the nominal short rate is an option. Longer term interest rates are always positive, since the future short rate may be positive even when the current short rate is zero. We can easily build this option element into our interest rate trees for backward induction or Monte Carlo simulation: just create a distribution that allows negative nominal rates, and then replace each negative rate with zero.
If a smattering of libertarian ideas can bring it [the system] all down, then the problem isn’t really libertarian ideas, is it? If the integrity of the economy in your preferred model requires a high level of ideological conformity, you might think to reconsider the wisdom of harnessing it so thoroughly to democratic political institutions meant to accomodate pluralism.
…stochastic calculus porn…
That’s Arnold Kling on the state of modern macroeconomics.
Frederik writes to me:
In the classifieds on the web of the daily Iceland newspaper Mbl, you find hard currency for sale (US dollar, Danish kroner, and Euro) ranging from USD 300 to USD 12000. With the breakdown of the official exchange rates, the market has emerged.
The article is here, in splendid Icelandic. Just imagine using classified ads to buy foreign currency; I don’t see any market on U.S. eBay but maybe I just don’t have the right keywords.
Back in February I pointed out that despite all the talk of a credit crunch commercial and industrial loans were at an all-time high and increasing. In September I once again pointed to data showing that bank credit continued to be high (even if growth was slowing.) At that time I also discussed how bank loans were not the only source of funds for business investment and that many substitute bridges exist which transform and transmit savings into investment. I suggested that despite the panic the problems which exist in the financial industry may be relatively confined to that industry.
Three economists at the Federal Reserve Bank of Minneapolis, Chari, Christiano and Kehoe, now further support my analysis pointing to Four Myths about the Financial Crisis of 2008.
- Bank lending to nonfinancial corporations and individuals has declined sharply.
- Interbank lending is essentially nonexistent.
- Commercial paper issuance by nonfinancial corporations has declined sharply and rates have risen to unprecedented levels.
- Banks play a large role in channeling funds from savers to borrowers.
Each of these myths is refuted by widely available financial data from the Federal Reserve. It’s a short paper, read the whole thing.
None of this means that everything is cheery. Like most people I think that we are in a recession which is likely to get worse but we need to remind ourselves that recessions are normal. What is not normal is the current level of panic. The panic feels to me like an availability cascade.
Hat tip to Mike Moffatt.
Addendum: By the way, I wouldn’t be surprised if credit does start to go down but it will do so because of a fall in the demand for credit not primarily because of a fall in the supply, again an entirely normal aspect of all recessions.
A Friday article says this:
The worldwide financial crisis is proving a lot more damaging than was expected. Not in Cayman, yet, but we had better get ready for it to affect us severely sooner or later.
I’ve googled around and can’t seem to find any reports worse than that one. It’s fair enough to argue those banks are doing OK because bailouts from abroad have limited systematic risk in the world as a whole. But still Cayman Island banks don’t seem to have gotten into trouble on their own, at least not so far.
Cayman banking is not laissez-faire as is sometimes believed, but still it is relatively unregulated and measured in terms of liabilities it is the world’s fifth largest banking center. And it’s doing OK. As Arnold Kling has been pointing out, transparency isn’t everything.
Panama, by the way, also does not seem to be having major banking problems. The country has no central bank or lender of last resort, yet the banking system is highly liquid.
The point is not that the private client-based, tax haven, sometimes drug money, Panama and the Cayman Islands systems are automatic models for the U.S. Rather many of the critics of deregulation are not trying hard to come up with the deepest possible explanation of the crisis. A key principle of science is to consider the outliers or the points which might appear to refute your hypothesis.
It would be useful if someone would do a comparative international study of where the banking crisis has been most severe, least severe and why.
Addendum: Larry Ribstein comments.
The fallacies of Cowen and Krugman are of the most basic sort — errors
only made possible by men captured by a deeply false conception of
"science", and hence a pseudo-scientific capital-free, causally impossible, aggregate "modeling" approach to the macroeconomy, rather than a causally real relative price / heterogeneous capital ordering process approach, just as Hayek explained in his Nobel Prize lecture.
Here is the full article. I thank Bryan Caplan for the pointer.
Addendum: Angus comments.
To be one of the great American painters, you must satisfy several criteria:
1. You must have an identifiable style and a consistent body of work.
2. Your pictures must complement each other and look better when shown en masse in the form of an exhibit.
3. Your very best pictures must stand among the very best in the American tradition.
4. You must have had a strong influence on other artists, and must capture some essential element of "the American experience."
Let’s start with the nineteenth century today and move on to the twentieth century soon.
Thanks to Paul Keating for posing the question.
Consider that the Greenspan Fed maintained a
1.75% Fed fund for 33 months (December 2001 to September 2004),
a 1.25% for 21 months (November 2002 to August 2004), and
lastly, a 1% Fed funds rate for 12+ months, (June 2003 to June
Here is the link. But no, I don’t side with Austrian Business Cycle Theory in citing loose monetary policy as the main factor in the artificial boom which preceded the crash. I view the boom as having been fueled by new global wealth, most of all in Asia, and the liquification of that wealth through credit and the desire for additional risk.
Note that if an increase in real wealth fuels the investment boom, consumption can be robust or even go up at the same time as the rise in investment. Now, in the boom preceding the current bust, was American consumption robust? Sure. If the investment boom had been driven mainly by monetary factors, investment would have gone up and consumption would have gone down, as explained here. (Try a rebuttal here.)
Loose monetary policy did contribute to the bubble. In that sense I would defend a modified Austrian theory. But other reasons also suggest that monetary policy was not the main driver. Money has a much bigger effect on short-term rates than long-term rates. Even long-term real rates have only mixed predictive power over real economic activity, including investment. The Austrians have never developed much of a theory of bubbles. Ideally you would have a good bubble theory, with Austrian-like monetary factors stirring up the bubble even more. But you can’t get away with pinning so much of the blame on the government, as modern Austrians are wont to do. "Bubbliness" is a private sector imperfection and relabeling it as "government distorting price signals through monetary policy" doesn’t much change that.
According to corruption fighters and election observers, votes can be
traded, depending on the town, for marijuana cigarettes or sold for up
to 100 leva, or $69. People document their votes by taking pictures of
their ballots with their cellphone cameras, according to Iva
Pushkarova, executive director of the Bulgarian Judges Association.
Trust, then verify, as they say. In fact you can’t trust the government either, so that requires a market in "decoy lawyers":
While corruption affects many corners of society, the impact is
particularly stark in the legal system, where some people without
political connections have resorted to hiring decoy lawyers, for fear
that their legal documents would vanish if presented to particular
clerks by lawyers recognized as working for them.
I cannot find a comparable concept of "decoy lawyers" in English-language Google. There is yet another market:
Sofia has a thriving black market for blood outside hospitals, where
patients’ families haggle over purchases with dealers, according to
Bulgarian news reports that track the prices.
Shouldn’t this story be on p.1 of every newspaper?
Now China’s government has unveiled a controversial plan to achieve universal care that would both increase health-care funding and control prices.
As this morning’s WSJ explains, the proposed plan would be quite a shift for China. The draft plan’s overall goal is to cover 90% of the population within two years and achieve universal care by 2020. It aims to return to non-profit national health care, an idea that was largely abandoned in the country 1980s.
This all stands in contrast to China’s current system, which provides little government funding to government hospitals and requires patients to pay heavy out-of-pocket expenses. The WSJ notes that out-of-pocket payments made up more than 60% of health spending in China at the end of the 1990s.
The plan – drafted in consultation with groups including the World Health Organization, the World Bank, consultant McKinsey & Co. and a few Chinese university-based public health experts – requires all revenue raised by public hospitals to be funneled to the state. The government also aims to set pricing standards for medical services.