Month: December 2010

Markets in everything the culture that is Swiss

Earlier this year, in the wake of several studies, including one conducted by the Swiss government, that found that young teenagers had trouble finding suitably sized condoms, a company called Lamprecht AG started selling the Hotshot, a smaller-than-usual condom marketed to 13- to-15-year-olds.

The link is here and it leads you to the latest and 10th annual NYT Year in Ideas, a superb series from the beginning.

Has knowledge capital been depreciating more rapidly?

The excellent Michael Mandel writes:

Over the past 10-15 years, the strengthening of information flows into developing countries meant that knowledge capital was being distributed much more quickly around the world.  As a result, the normal process of knowledge capital depreciation greatly accelerated in the U.S. and Europe–beneath the radar screen, because no statistical agency constructs a set of knowledge capital accounts.  

I agree with the conclusion but I am not sure that globalization was the mechanism.  I sometimes think of an imaginary economy with two sectors: music and bathtubs.  I believe that my bathtub is over thirty years old, yet for me it works fine and I have no desire to buy a new one.  When it comes to music, most people want to listen to what is new and hot, not Bach's B Minor Mass.  Furthermore, even within the music sector, acts seem to have declining longevity, in part due to the decline of the iconic album, the rise of the iTunes single, the fall of entry barriers, and the proliferation of genres.  The Rolling Stones are still around, or U2, but more rapid turnover is the trend. 

A while ago I read a good article about how few people on Netflix rent or stream the indie movies from the 1980s or 90s.

The more that your economy "looks like" the music sector, the more rapid the rate of depreciation for production capital and knowledge capital.  This means we may be overestimating our national wealth.

Here is Michael on our aging capital stock.

The Ethics of Random Clinical Trials

In New York City a random clinical trial over a housing program has many people upset (as Tyler noted earlier):

…some public officials and legal aid groups have denounced the study as unethical and cruel, and have called on the city to stop the study and to grant help to all the test subjects who had been denied assistance.

“They should immediately stop this experiment,” said the Manhattan borough president, Scott M. Stringer. “The city shouldn’t be making guinea pigs out of its most vulnerable.”

The controversy brought to my mind this story from Dr. E. E. Peacock:

One day when I was a junior medical student, a very important Boston surgeon visited the school and delivered a great treatise on a large number of patients who had undergone successful operations for vascular reconstruction.

At the end of the lecture, a young student at the back of the room timidly asked, “Do you have any controls?” Well, the great surgeon drew himself up to his full height, hit the desk, and said, “Do you mean did I not operate on half the patients?” The hall grew very quiet then. The voice at the back of the room very hesitantly replied, “Yes, that’s what I had in mind.” Then the visitor’s fist really came down as he thundered, “Of course not. That would have doomed half of them to their death.”

God, it was quiet then, and one could scarcely hear the small voice ask, “Which half?”

Dr. E. E. Peacock, Jr., quoted in Medical World News (September 1, 1972), p. 45, as quoted in Tufte's 1974 book Data Analysis for Politics and Policy.

Hat tip for the quote source to Raw Meat.

The health care plan of Kim Meyers

If in a calendar year a person has in excess of $100,000 in medical expense they are transferred over to Medicare, regardless of age.

The remainder of the citizenry is able to choose from a competitive insurance market, which is essentially selling $100,000 “Term” health insurance policies.

That is from Kim Meyers of Northwestern.  As she notes in an email to me, this can be combined with health savings accounts and various kinds of deregulation for the coverage of the lesser expenses.  You also can raise the Medicare eligiblity age and I would say you could raise it to a very high level indeed

I view this as the most plausible way of bringing a Singapore-like health care system to the United States.

Fill in the blank

Does this story sound familiar?  Perhaps it is more familiar than you think.  Which country is this article excerpt about?

Rising debt charges are forcing [???]…to reshape its…economy…[a] congress, scheduled for April, will discuss and likely ratify policies that are already starting to be implemented. These include cutting 20 per cent of state workers, cutting social benefits, eliminating state subsidies, improving [the] trade balance and liberalising rules for small business and foreign investment.

No peeking.  The answer is here, the article is here, and the leading creditor is…here.

Brain teasers from monetary theory and Scott Sumner

First, here is Scott Sumner's ideal world:

In an ideal world, we’d remove all discretion from central bankers. The Fed would simply define the dollar as a given fraction of 12- or 24-month forward nominal GDP, and make dollars convertible into futures contracts at the target price. If the public expected NGDP to veer off target, purchases and sales of these contracts would automatically adjust the money supply and interest rates in such a way as to move expected NGDP back on target. It would be something like the classical gold standard, but with the dollar defined in terms of a specific NGDP futures contract, instead of a given weight of gold. The public, not policymakers in Washington, would determine the level of the money supply and interest rates most consistent with a stable economy.

To proceed, not everyone will understand this post, which is DeLong on Scott Sumner:

As I understand Scott's proposal, it is this: Nominal GDP in the fourth quarter of 2007 was $14.291 trillion. A 5% growth rate from that base would give us a value of $17.455 trillion for the fourth quarter of 2011. Add on another 3% for the average short-term nominal interest rate we would like to see, and we have $18.153 trillion. Therefore the Federal Reserve would, today, announce that it stands ready to buy and sell dollar deposits to qualified customers at a price of $1 = 1/18,155,000,000,000 of 2011Q4 GDP.

If investors thought that nominal GDP in the fourth quarter of 2011 was likely to be lower than $18.15 trillion, they would take the Fed up on its offer: demand the cash now, pay off the contract in a year by then paying 1/18,155,000,000,000 of 2011Q4 GDP, and (hopefully, if they were right) make money–thus the money stock would increase. If investors thought that nominal GDP in the fourth quarter of 2011 was likely to be greater than $18.155 trillion, they would take the Fed up on its offer: give cash to the Fed now, collect the contract in a year by receiving 1/18,155,000,000,000 of 2011Q4 GDP, and (hopefully, if they were right) make money–thus the money stock would fall.

If nominal GDP were expected to fall, the Federal Reserve would be shoveling money out the door at negative expected nominal interest rates. If his scheme were applied today it would be quantitative easing on a pan-galactic scale, as everybody would run to the Fed with bonds to use as collateral for their promises to pay the expected futures contract in a year in exchange for the cash now.

The Federal Reserve would then become truly the lender of not just last but first resort. Why would anybody borrow on the private market even at 0% per year when they could borrow from the Fed at -3%/year? Savers would simply hold cash rather than try to match the terms that the Fed was offering borrowers. Borrowing firms would borrow from the Fed exclusively. The Fed would thus create a wedge between the minimum nominal interest rate that savers would accept (zero, determined by the alternative of stuffing cash in your mattress) and the nominal interest rate open to borrowers.

I expressed related reservations about a related version of the idea in the 1997 JMCB.  I am all for (rough) nominal GDP targeting, and considering the forecast, and for Scott's work in general, but I don't think the "automaticity" versions of it work.  NGDP targeting does best as a general guideline for the central bank, which the central bank follows to make the world a better place, but without renouncing some ultimate degree of discretion with regard to timing and targeting and how good a deal they offer everyone at this new and somewhat unusual version of the discount window.

It's a general problem with strict pegging schemes that some prices (or pxq variables) adjust more quickly than others, or are better and more quickly forecast than others, and that means arbitrage opportunities against the pegger and/or very dramatic swings in nominal interest rates.

So on this question I agree with Brad and not with Scott.

Still, there is a general rule: when Scott Sumner says you are wrong, you are wrong (this is somewhat distinct from the claim that "Scott Sumner is always right," though if he worded all his pronouncements in a particular way I suppose it would not be).

So perhaps Scott will say that Brad and I are wrong.  Or perhaps he will say that I am wrong about the general rule in the first place.  Or perhaps he will say that we have misunderstood him.

The broader underlying question is how strict a nominal GDP target or NGDP forecast target can be and that question is not very well understood.

David Alexander on Australia

Australia is one of the most economically free countries in the world, and has for some time been among the smallest governments in the developed world, with low levels of tax and spending. Last year, according to the OECD’s Economic Outlook, Australia was the Thatcherite’s number one performer, with not only the lowest level of government spending of all developed countries but also the lowest level of taxes of all developed countries equal with South Korea).

Alexander also stresses that Australia both is and feels relatively egalitarian, while having a high level of ethnic diversity.  He writes to me:

One key to this is that Australia is the means-testing capital of the world, with the lowest proportion of transfers to high earners of any country; The second key is the very low taxes on low earners; This highly progressive tax and transfer system produces small and dynamic government – I call it egalitoryan – but it turns Hayek and Buchanan upside down.

There is much more here.

The inequality that matters

Here is a new and longish piece by me, on the inequality debates, in The American Interest.  It's about which kinds of inequality matter and which do not.  Most of them do not:

A neglected observation, too, is that envy is usually local. At least in the United States, most economic resentment is not directed toward billionaires or high-roller financiers–not even corrupt ones. It’s directed at the guy down the hall who got a bigger raise. It’s directed at the husband of your wife’s sister, because the brand of beer he stocks costs $3 a case more than yours, and so on.

Furthermore there is a natural rising inequality in a world of strivers and slackers.  But some forms of inequality are more dramatic and are associated with unstable incentives:

If we are looking for objectionable problems in the top 1 percent of income earners, much of it boils down to finance and activities related to financial markets…The first factor driving high returns is sometimes called by practitioners “going short on volatility.” Sometimes it is called “negative skewness.” In plain English, this means that some investors opt for a strategy of betting against big, unexpected moves in market prices. Most of the time investors will do well by this strategy, since big, unexpected moves are outliers by definition. Traders will earn above-average returns in good times. In bad times they won’t suffer fully when catastrophic returns come in, as sooner or later is bound to happen, because the downside of these bets is partly socialized onto the Treasury, the Federal Reserve and, of course, the taxpayers and the unemployed.

An understanding of the Black-Scholes idea of synthetic positions drives home the point that such strategies are very hard to stop by regulatory means.  Furthermore politicians have incentives to play the very same socially risky strategies; if things are "good now" they will get reelected and they pay few penalties for the severity of their eventual mistakes.  The fight against excess leverage is probably a non-starter (who now wishes to "slow down" the recovery?).  It is possible that our current system of state capitalism is "Arrow-Hahn-Debreu gameable" and that the financial sector has opened a hole in the proverbial bathtub and is sucking on a very large straw.

There are many other points about inequality in this piece which I have not presented on MR.

*The New Lombard Street*

The subtitle is How the Fed Became the Dealer of Last Resort (home page here) and the author is Perry Mehrling.  The entire book is good but the paydirt comes in the last two chapters, where we are treated to a persuasive and original account of what the crash- and post-crash Fed is all about.

Mehrling tells us that the Fed is now committed to supplying liquidity in money markets through its role as a dealer, on both sides of its balance sheet, and that is a critical shift in the nature of central banking.  He discusses (pp.126-127) how the collateral behind the shadow banking system relied on CDS markets for its pricing.  In Mehrling's account, insurance companies (including AIG) were indirectly serving as dealers of last resort, believing that they held invulnerable positions but nonetheless exposed.  Investment banks, on their side, thought they held matched books but the higher and lower CDO tranches turned out to be less similar than they had been expecting, based on historical price risk.  None of these expectations survived contact with the reality of the crash.

Now it's the central bank which sells AAA protection because eventually, in Mehrling's view, this activity cannot forever remain a private function (for a start, which insurer is itself safer than AAA?).  A good and indeed central question to ask anyone who is proposing a financial system is to ask who will sell AAA insurance.  

To quote Perry, the new Fed principle seems to be: "insure freely but at a high premium."

Mehrling also suggests that looking at the Fed's balance sheet, or its transactions, is misleading.  The key question is what kind of liquidity dealing option the Fed is promising to the market.

I continue to ponder Mehrling's main claims, but in any case this is an important book about the new Fed.

Assorted links

1. Update on Arizona Medicaid transplant rationing.

2. Fear of one's own glance, from Japan.

3. Read both Pirrong and Steve Waldman here, on OTC clearinghouses.  And Felix Salmon.

4. The world's best presentations?

5. Occasionally obscene, NSFW cartoon video on Becker-Murphy rational choice theory of addiction.  It's funny.

6. David Epstein, Columbia scholar of political economy, is charged under the law.  It's not funny.