Category: Economics

Remember the guy who threatened to kill and eat the bunny rabbit, unless he was paid $50,000?  Was it real?  Here is the continuing saga, from a supposed friend:

Make a donation and help me expose Bion [the original perpetrator of the Toby scheme, supposedly]. Once I have received $5,000 in donations, I will publish Bion’s full contact information HERE.

Think about it: Bion’s contact info will be published to the net

• Everyone will have the chance to openly ridicule Bion
• We will make Bion rue the day he threatened to kill Toby
• The internet community will get what it wants
• The $5,000 will make me feel better about loosing [sic] a best friend

Here is my earlier post on Toby.  Do notice that the equilibrium price is falling.

Mark Thoma at Economist’s View is creating a repository for open source economics models.  The idea is to emulate open source software by releasing a beta model to the world and inviting others to improve it.   Mark has contributed a very nice paper on social insurance that could be expanded upon, Brad DeLong has contributed two beta models on finance topics, and I have contributed some very preliminary notes and a touch of Mathematica code on the implications of uncertainty about one’s own tastes for savings decisions and other behavior (an interesting idea but one I have not had the technical skills to exploit).  The models can be found in the right hand column of Economist’s View.

The new blog, EconBrowser.com, is written by James Hamilton, a very fine economist from University of California, San Diego.  So far the emphasis would appear to be macroeconomics.  Hamilton is best known for his work on the macroeconomics of oil price shocks.

In response to my previous query, the ever-intelligent Arnold Kling writes:

For an individual, I am willing to count a capital gain as income. I am more or less indifferent between earning a capital gain and earning a dividend.

For a nation as a whole, to a first approximation I do not believe that a capital gain is possible. Suppose a corporation issues a bond, and a year later the market revalues the bond upward by 10 percent. It seems to me that the bond owners’ gain is the corporation’s loss. I think that is true in general for capital gains and losses in the economy–they net out.

Another way to arrive at the view that capital gains and losses ought to net out for the nation as a whole is to consider that national income equals national output. If a re-valuation of assets produces no output, then it produces no income. It seems to me that the ups and downs of financial assets are quite properly excluded from national income and therefore from national saving.

Read more here.  Catallarchy.net offers a similar perspective.

My take: I have no desire to overturn the conventions of national income accounting.  But this view still fuels the belief that our currently measured low savings rate does not matter much.  (Non-bubbly) capital gains imply high future output and possibly high future savings as well.  Let’s say you received news that manna would drop from heaven in five years’ time.  No this news is not "savings" but you still have something to eat in the future.

Let’s say the capital gains are bubbly and thus temporary.  Some people still are more liquid in the meantime (exam question: is anyone less liquid?  Do these liquidity losses offset the gains?).  Surely this should count for something, although not nearly as much as non-bubbly capital gains would count.

Can the Keynesian distinction between individual and social liquidity be used to create a new version of Hayekian business cycle theory?

It’s sold as a must-have accessory to give urban SUVs a whiff of the outback. But U.K. officials say drivers who use spray-on mud to avoid identification by police speed cams face hefty fines for obscuring their license plates.

Targeting self-conscious 4×4 owners whose rugged vehicles seldom see obstacles bigger than a speed bump, the enterprising British e-tailer behind Sprayonmud sells the scent of the countryside in a squirt bottle.

For 8 pounds (about $14.50), buyers get 0.75 liters (.85 quarts) of genuine filthy water, bottled from hills near the company’s premises on the rural England-Wales border. The aim, says the website, is "to give your neighbors the impression you’ve just come back from a day’s shooting or fishing — anything but driving around town all day or visiting the retail park."

"The mud is from Shropshire," said Sprayonmud proprietor Colin Dowse, a financial consultant who has been selling the product in the United Kingdom for 12 months. "It contains mud plus some secret ingredients to improve stickability so that it dries before it runs off the paintwork."

But, while the site promises SUV owners a route around social stigma flung by a growing anti-4×4 lobby, motorists of other stripes are thought to use the same technique to freely flout speed limits.

Tipsters in motoring forums advise canny drivers they can smear mud over their license plate to avoid detection by police speed cameras, which photograph plates’ registration details to ID lawbreakers using a national vehicle database. A few squirts of dirt, and snapped speeders would become as good as invisible.

Here is the full story, and thanks to Joseph Weisenthal for the pointer.  By the way, this example is too ridiculous to deserve its own installment of "Markets in Everything."

Read this analysis and dialogue, courtesy of Brad DeLong.

Americans save a relatively small percentage of their disposable incomes.  Yet many commentators argue that capital gains on homes and equities, as well as expenditures on education, should count toward the national savings rate.  But are those savings "as good" — from a macroeconomic point of view — as plain old abstinence?  If they were, that would make our lives so much easier; we could worry less about a national shortfall in savings.

To make it interesting assume that the capital gains are not the result of a bubble.  Bubbly asset prices would be an illusory form of savings in the longer run.

Now capital gains in the form of real assets or human capital are less liquid. You might make better widgets, but can lug the machine down to the store to buy groceries?  Will it finance your retirement?  Well, why not?  The advance of capitalism liquifies real assets to an increasing degree; borrow against the assets when you wish.  The still underrated Benjamin Anderson stressed this point in his 1920 The Value of Money. 

So what is the problem?  Does liquifying real assets somehow bring excess leverage to the economy?  I don’t see why.  Or does borrowing against real assets lead to a later switch toward consumption, thereby necessitating transformation costs?  Each individual thinks he has a more liquid savings position than is the case; borrowing is cheap but society as a whole must incur reallocation costs to convert the real capital into consumption.  But how big a factor can this be?

All seems fine.  Yet in my neo-Austrian gut I cannot bring myself to think as capital gains as analytically equivalent to abstinence out of income.

I file this one under the category of "macroeconomic problems I’ve been thinking about for twenty years but haven’t made much progress on."  I’m not even sure I understand what others believe, much less what is true.  I’ve turned on the comments, in case you have a good argument why one form of savings is worth less than another.

It seems that monkeys can be taught to use money:

…[but] do the capuchins actually understand money? Or is Chen [the researcher] simply exploiting their endless appetites to make them perform neat tricks?

Several facts suggest the former. During a recent capuchin experiment that used cucumbers as treats, a research assistant happened to slice the cucumber into discs instead of cubes, as was typical. One capuchin picked up a slice, started to eat it and then ran over to a researcher to see if he could ”buy” something sweeter with it. To the capuchin, a round slice of cucumber bore enough resemblance to Chen’s silver tokens to seem like another piece of currency.

Then there is the stealing. Santos has observed that the monkeys never deliberately save any money, but they do sometimes purloin a token or two during an experiment. All seven monkeys live in a communal main chamber of about 750 cubic feet. For experiments, one capuchin at a time is let into a smaller testing chamber next door. Once, a capuchin in the testing chamber picked up an entire tray of tokens, flung them into the main chamber and then scurried in after them — a combination jailbreak and bank heist — which led to a chaotic scene in which the human researchers had to rush into the main chamber and offer food bribes for the tokens, a reinforcement that in effect encouraged more stealing.

Something else happened during that chaotic scene, something that convinced Chen of the monkeys’ true grasp of money. Perhaps the most distinguishing characteristic of money, after all, is its fungibility, the fact that it can be used to buy not just food but anything. During the chaos in the monkey cage, Chen saw something out of the corner of his eye that he would later try to play down but in his heart of hearts he knew to be true. What he witnessed was probably the first observed exchange of money for sex in the history of monkeykind. (Further proof that the monkeys truly understood money: the monkey who was paid for sex immediately traded the token in for a grape.)

Here is the full story.

The FT, The Economist, and the NY Times have all run articles pondering whether the Euro might end; here is another typical account.  If so, how would the end come?  Would Italy pull out to keep excess budget deficits?  Would Germany pull out on the belief that it would do better with its own monetary policy?  Might a "sound money country" pull out if the other members seek Euro inflation to stimulate their economies?

The arbitrage dynamics are tricky.  The Euro was introduced slowly and with a competent marketing and information campaign.  In contrast the end would come quickly and in a less cooperative setting.  Imagine a major European nation announcing that its citizens had six months to reconvert Euros back into a national currency.  How would the government know what the conversion rate should be?  Set the rate too high and a wrenching deflation will be required.

People had a good idea what the Euro would be worth but the road back would involve much more uncertainty.  I don’t even know if a resurrected deutschmark would be a stronger currency than the Euro (I can, however, give you my guess on the lira).  And wouldn’t either everyone in Europe, or no one, wish to cash in to the new currency right away, depending on the conversion rate and the associated degree of credibility?  Don’t currency substitution models, and all their tricky implications (it becomes very difficult to control prices), come into play?  Might short-term interest rates go whacky?  What would be the domino effect on, say, Polish asset values?

I’ve never been a huge fan of the Euro, but these are scary questions.  It would be ironic if the strongest argument against the Euro was simply the eventual need to dissolve it. 

This is one of those headache topics.  Daniel Gross presents a clear treatment:

…the yield curve…describes the relationship between interest rates on long-term and short-term U.S. government bonds. Interest rates on the shortest-term bonds correlate very closely with the interest rates set by the Federal Reserve Board. Long-term interest rates, by contrast, are influenced by many more factors, ranging from China’s purchase of debt to investors’ optimism about inflation and growth. Typically, bonds that mature further in the future pay higher yields–compensation for the risk of locking up money for a longer period.

The yield curve rarely inverts. And when it does, it usually spells trouble for the economy. It means that investors and the Federal Reserve are fretting about inflation in the short term, and that investors are pessimistic about long-term growth. According to Brian Reynolds, chief market strategist at MS Howells & Co., in the last 30 years, periods of prolonged inversion of the curve between two-year and 10-year government bonds have generally presaged recessions. The most recent period of inversion ran from February 2000 through December 2000–just before the 2001 recession.

A year ago, the yield curve was rather steep. But in the last year, the Federal Reserve Open Market Committee has taken the short-term Federal Funds rate from 1 percent to 3 percent in eight straight tightenings, the most recent one in May. (All the Fed’s 2005 actions can be seen here.) Today, with two-year bonds at about 3.5 percent and the 10-year bond having fallen to about 3.9 percent, only a few dozen basis points separate the two.

Gross is an excellent economic journalist but I must differ on one key point.  The yield curve is overrated as a predictor of future output.  Here is a more cautionary and accurate analysis:

…the 1985-95 sub-sample completely reverses the results.  The yield spread becomes the least accurate forecast, and adding it to lagged GDP actually worsens the fit.

Another recent study shows that the short rate, not the yield spread, holds most of the relevant predictive power.

The bottom line: The previous power of the inverted yield curve was based on a few good predictions.  But no such predictor will stand up over time.  First, asset prices are very noisy.  Second, knowledge that we had an accurate predictor would itself change the relationship we are trying to predict. 

We face some serious economic problems today; savings may be taking the wrong form (capital gains rather than income reallocation), and perhaps we are in a housing bubble.  But observed spread in the term structure of interest rates does not add to my worries. 

This may be old hat to a few of you, but it was news to me:

For more than 30 years, one of America’s best-kept secrets has remained a pop culture mystery. No, not Deep Throat. We’re talking about Carly Simon and her hit song You’re So Vain. Who was she singing about?

Simon says she’ll never reveal the answer, not even when she or the song’s subject dies. "I don’t see why I ever would. What would it advance?"

Officially, only three people know: Simon, the ex-lover and NBC Sports president Dick Ebersol, who paid $50,000 for the answer at a charity auction. (He was sworn to secrecy.)

Here is the story.  I had always assumed it was about James Taylor, though that is a naive rather than informed opinion.

Imagine a group of producers preparing for the Christmas season.  Some years they will produce bracelets instead of Star Wars figurines, and turkeys instead of ducks.  Business cycles are then the result of forecasting noise.  Every now and then, we simply have bad luck.

In contrast, Keynesian theories see weak aggregate demand as the problem.  "Real" business cycle theories cite negative real shocks; one example might be oil price hikes.  Black’s theory focuses on mismatched demands.

The dot.com bust would seem to be a partial example of Black’s thesis.  Entrepreneurs believed that consumers would pay for Web-ordered, home-delivered groceries, when in fact they wanted to buy more homes.

Black also believed that adjustment processes are slow.  Human capital is highly specific to particular endeavors.  So it takes an economy a good bit of time to recover from its bad guesses.

OK, but why do so many entrepreneurs err in forecasting consumer demand at the same time?  The Law of Large Numbers would seem to imply a more even distribution of errors.  You might expect that about ‘n’ percent of entrepreneurs guess wrong this year, next year, and so on.  I can think of three possible (and possibly wrong) answers to this criticism:

1. The American economy does not, in reality, have so many independent sectors.  Bad luck in a few of the larger sectors spreads to all or most sectors.

2. Many sectors may rely on common and sometimes erroneous forecasting techniques, or may be trying to forecast common variables.  (But what are those common variables?  Does Black’s theory then collapse into the Austrian or Lucasian argument that people are fooled by monetary policy?  What else could be fooling them?)

3. The Law of Large Numbers does imply that an economy, of a given size, is less risky when it has more independent sectors.  This does not mean that business cycles are impossible.  The frequency of cycles will depend on how many independent sectors are operating, how risky is each sector, and how frequently we are "rolling the dice" with demand forecasts.  So we can still get a business cycle more than once every 2 million years.

Black’s theory has one feature which is simultaneously appearling and infuriating.  It explains why economists find business cycles so hard to predict.  But at the same time this drains Black’s theory of any obvious testable predictions.  Black did not mind.  He once said to me: "The easiest theory to falsify is a theory which is false."

We might make other criticisms of Black’s account as well.  Must we not look to labor markets for a closer account of the true action?  What was the taste mismatch in the Great Depression?  Why does everyone pay so much attention to the Fed?

The final verdict: There are very few serious contenders in the area of business cycle theory, so I am not ready to dismiss this one, warts and all.