Month: December 2009

Why hasn’t the Fed been targeting two or three percent inflation?

I've been thinking about this question more and I've come up with a speculative possibility.  Right now banks are earning their way back into profitability by playing the spread.  They're paying close to zero on deposits and earning fair sums on long-term loans.  Perhaps this term structure is sustainable because people are expecting little inflation in the short run but moderate inflation in the longer run, plus there is some risk on the loans.  (These inflationary expectations may be changing; if you wish pretend I am writing this six months or a year ago.)

So let's say we move from zero expected short-term inflation to three percent short-term expected inflation.  The nominal short rate rises to three percent and the real short rate remains more or less constant.  Long rates would go up a bit but not much, since beyond the short run there is already an expectation of moderate inflation.  In sum, the spread between short and long rates might narrow.

Here is the key point: from the bank's point of view, what is the correct measure of the real rate of interest?  Is it defined by the nominal rate relative to the expected growth in the CPI?  I doubt it.  When you're near the bankruptcy or nationalization constraint, it's often nominal profits that matter (relative to fixed nominal liabilities, accounting standards, capital standards, etc.), not "real profits" defined relative to the CPI.

In sum, maybe three percent expected inflation conflicts with the desire to rapidly recapitalize banks through maintaining a wide interest rate spread.  Maybe we need that zero nominal short rate or at least the Fed thinks we do.

I don't wish to push too hard on this hypothesis, it is speculative rather than confirmed by evidence.  And propositions about the term structure of interest rates do not always run the way you think they will or should.  I'm aware of other problems.  What kind of zero profit condition is imposed on the banks?  Given the odd objective function of the banks, how exactly does the Fisher effect work in the short run?  Or is it imposed from without by competition from non-bank lenders?  I'm not sure on these questions and they suggest possible holes in the above speculation.

I also regard this as a somewhat gruesome hypothesis.  It means that "Main Street" is paying for "Wall Street" (forgive me the use of those awful terms) in at least two ways: high unemployment and inability to earn much on one's savings.  Risk on the Fed balance sheet is also paying some big part of the bill, since presumably that is helping to maintain the interest rate spread.

The term structure also implies that the market is expecting rising short rates, so if the bank mess isn't cleaned up soon, heaven forbid.  The spread, as a means of restoring bank profitability, won't last forever.

Today’s music model: meet the 1950s

Someone teleported through time from the early 1950s to 2009 would find a music business curiously similar to the landscape of 60 years ago.  Few specialty record outlets.  Department stores dominating the market.  A singles-driven industry.  Pop music dominating radio.  TV musical talent shows all the rage.

That's from the 21 December issue of Variety.  One difference, of course, is that the best-selling album of this decade — but not the 1950s — was by The Beatles.

How does Delhi gridlock get cleared up?

Sometimes it's so bad that the cars can't even more, at least not without external assistance:

…heads begin to appear between the hoods and trunks.

Motivated by a meeting they wish to keep, men wade into the fray,
examining the crystalline structure of the traffic, looking for gaps,
irregularities, wiggle room. Because there’s always wiggle room. Six
inches here, a foot there, and this makes all the difference. It’s
reverse Tetris: move one this way, move another that way, and suddenly
some cars are free.

The amazing thing is this: these men don’t coordinate their actions.
They don’t formulate strategies. In fact, they probably think they’re
working against each other–as passengers in trapped cars, they care
about helping the other cars move only insofar as it helps get their
own car on its way.

The article is here and I thank Dave Prager for the pointer.  Here is one photo of a Delhi traffic jam.

Projects to ponder, and let’s drink a toast to fixed costs for once

Hans Larsson, the Canada Research Chair in Macro Evolution at
Montreal's McGill University, said he aims to develop dinosaur traits
that disappeared millions of years ago in birds.

Larsson believes by flipping certain genetic levers during a chicken
embryo's development, he can reproduce the dinosaur anatomy, he told
AFP in an interview.

Though still in its infancy, the research could eventually lead to
hatching live prehistoric animals, but Larsson said there are no plans
for that now, for ethical and practical reasons — a dinosaur hatchery
is "too large an enterprise."

The longer story is here and I thank Bookslut (one of my favorite blogs) for the pointer.  Here is Larsson's home page.

Assorted links

1. A good point: "The central failure of these interviews, like so many, is that they operate from the proposition, "what would my readers find interesting?" instead of "what does my subject find interesting?"

2. Reason to worry about the second half of next year.

3. The Japanese sex-breakfast-mother-appreciation correlations.

4. How Victoria's Secret modifies a photo (excellent link, safe for work).

5. Photo sequences which are truly and deeply baffling to me.  And here is Tavi Gevinson, 13-year-old fashion maven.  

6. The evolution of empires; 1960 is the highlight.

7. Palindromic date puzzle.

What are the odds that the best chess player in the world has never played chess?

The more general issues are how well the modern world allocates talent and how much exposure you need to something you eventually will be very good at. 

My view is that people who are born into a reasonably good educational infrastructure get exposed repeatedly — albeit briefly — to lots of the activities which might intrigue them.  If the activity is going to click with them, it has the chance.  To borrow the initial example, most high schools and junior high schools have chess clubs and not just in the wealthiest countries.  Virtually everyone is put in touch with math, music, kite-flying, poetry, and so on at relatively young ages. 

The idea of taking an economics class in college, or picking up some economics literature, strikes most educated people at some point, even if they squash the notion like a bug.  If there is some other Paul Samuelson-quality-would-have-been who didn't become an economist, perhaps he preferred some other avocation even more.

Billions of people are not exposed to quality economics, math, music, etc., but those people also don't have the nutrition, the education, the infrastructure, or whatever, to excel at world class levels.  The infrastructure and the exposure come together and in that sense we keep on mining the pool of potential talent.  (Their only modal scenario to #1 for these individuals is an entirely different life altogether; mere additional exposure won't do it.) 

Ernest Bazanye is blogging from Uganda.

Some people get stuck in local genres, such as a brilliant Nigerian learning funk or rap, in his teen years, but not modern jazz and besides he can't find a Nigerian market for the latter in any case.  These "specialization corners" are less of a problem for math or economics, although the unification of those areas is fraying with time. 

Magnus Carlsen's father suggested that if he hadn't had an older sister, he might not have taken up the game at all.  Magnus was uninterested at ages four and five, but grew intrigued at age eight when he watched his father play chess with his older sister.  I read this anecdote as suggesting he would have been exposed again to the game, one way or another, probably in school.

Two scenarios militate against my thesis.  First, mistreated savants may not receive the necessary exposure to the activity.   I am very much a believer in the potential productivity of mistreated savants.  Still, I believe they often do best when not trying to be pure #1 in some commonly contested, measurable area but rather by filling unusual and hard to specify niches in a broader production process and benefiting from the division of labor to an especially high degree.

Second, a large number of children are placed on medication at early ages.  This may not eliminate their exposure to an activity in the literal sense, but it may stop them from responding to potential interests.

In sum, I believe that the odds that "the best (modal) chess player in the world" has never played chess is well under fifty percent but probably above ten percent. 

Transparency in health care pricing doesn’t come easily

The health care reform bill before the U.S. Senate would require hospitals to publicize their standard charges for services, but New Hampshire and Maine have gone much further in trying to make health care costs more transparent to consumers.

New Hampshire and Maine are the only states with Web sites that let consumers compare costs based on insurance claims paid there.

In New Hampshire, the price variation across providers hasn't lessened since the Web site went live in 2007.

The link is here.  You'll find the background data from New Hampshire, and a study, here.  Here are some anecdotal accounts.  Here is a CBO background paper on the topic.  I can think of a few hypotheses:

1. People don't check the website.

2. People can't interpret the information on the website.

3. People still go where their doctors recommend or to facilities they are familiar with.

4. Many local choices, especially in these states (somewhat rural, so-so road connections), don't involve a lot of competition.

5. All of the above.


Christmas Game Theory

The lovely wife says the jewelry I bought her for Christmas has to be returned because "it's just too expensive!"  Excellent.  I get the credit without the credit bill!

What I will never reveal is how far I looked down the game tree before purchase.

Addendum: Do not try this at home.  Without extensive knowledge of game theory and your spouse this strategy can be very dangerous to your finances, c.f. Thomas Schelling, brinksmanship.  

More Engineers in Jihad

Gambetta and Hertog find that “the share of radical Islamic engineers is no less than nine times greater than the share we could expect if the proneness of engineers to radicalize was the same as that of the male adult population.”  (Tyler blogged this paper several years ago.)

Here is the latest bit of evidence:

Mr. Abdulmutallab grew up in a rarefied slice of Nigeria, the son of an affluent banker. He attended one of the West Africa’s best schools, the British School of Lomé in Togo. After high school, he went to Britain and enrolled at the University College London to study engineering.

Markets in everything China fact of the day

Wanted: One live-in protester, $146 a month, no days off.

When the managers of a Beijing restaurant marked for demolition were too busy to fight it, they posted an Internet ad and hired a stranger to stay there around the clock. The job seems to be a first for China, where frenzied urban construction has led to violent evictions, protests and even suicide.

Huddled on a makeshift bed in the trash-strewn, freezing restaurant, Lu Daren said he once worked for a demolition crew and understands their tactics.

"I'm tired," the 46-year-old said Thursday, after a long night of fending off the latest visit from what he suspects were hired thugs by the landlord. "Tired, tired, tired." He stays – wrapped in blankets, reading the newspaper or writing idle poetry, occasionally taking short walks_ because he thinks the restaurateurs have been treated unfairly.

The full story is here and I thank Daniel Lippman for the pointer.

Books of note

1. David W. Galenson, Conceptual Revolutions in Twentieth-Century Art.  We've covered Galenson in these posts.

2. Richard A. Posner, The Crisis of Capitalist Democracy.  Due out in April, this book is 400 pp.  The press release notes it "presents what Judge Posner has learned about the econom since writing [his last book]…[and he] thinks we're in for a financial aftershock because of the amount of money the government has poured into the economy to save it."

3. Günter Grass, The Tin Drum, new translation by Breon Mitchell.  I've only browsed this, but it appears to be far better than the earlier English-language translation.

4. Scott Berkun, Confessions of a Public Speaker.  If you get only one good tip from this book, it's worth it.  

5. Peter Singer Under Fire: The Moral Iconoclast Faces His Critics.  The critics include Bernard Williams, David Schmidtz, Jan Narveson, Michael Huemer, and myself'; Singer responds to each essay.

Christmas Bonuses for Fannie and Freddie

The Obama administration tried to sneak this one under the radar by making it official on Christmas Eve.  The Washington Post did a good job catching the story:

The Obama administration pledged Thursday to provide unlimited financial assistance to mortgage giants Fannie Mae and Freddie Mac, an eleventh-hour move that allows the government to exceed the current $400 billion cap on emergency aid without seeking permission from a bailout-weary Congress.

…But even as the administration was making this open-ended financial commitment, Fannie Mae and Freddie Mac disclosed that they had received approval from their federal regulator to pay $42 million in Wall Street-style compensation packages to 12 top executives for 2009.

The compensation packages, including up to $6 million each to Fannie Mae and Freddie Mac's chief executives, come amid an ongoing public debate about lavish payments to executives at banks and other financial firms that have received taxpayer aid. But while many firms on Wall Street have repaid the assistance, there is no prospect that Fannie Mae and Freddie Mac will do so.