Results for “age of em”

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The core idea is that the government prints more money but people just hold it.  If nominal interest rates are low, OK, maybe no one wants to buy more bonds (however under some assumptions this will lower bond prices and raise rates again, bonus points if you can work through the whole analysis with real and nominal rates and price level paths).  But they will buy more goods, thereby stimulating aggregate demand.  If they won’t buy more goods, just print even more money.  The spending impulse will kick in. 

For another view, Paul Krugman argues people may not expect the inflation to continue for long enough, and therefore won’t spend their money but will instead expect a future deflation further down the road.  I think that creating and maintaining the inflationary expectations is quite easy, especially if the inflation will boost output and employment and thereby make politicians popular with voters.  If you print money, people don’t think "hmm…that is inflationary…that means someday the central bank will have to deflate, I’ll wait six years and spend this new money when prices are really low."  Yes, I see the intertemporal equilibrium concept, but nope, that fails Psych 101.  Krugman also borrows the idea of an ongoing negative real rate of interest, but this describes Battlestar Galactica, not the twentieth century.

Open market operations, when tried, seem to have worked in 1932.  Was Japan in a liquidity trap in the 1990s?  They could have printed more money and given it to me.  With an interpreter at my side, I would have spent it right away.  Who knows, maybe you could have helped me.  Here is a good critique of Krugman on Japan.

Perhaps there is a knife edge setting where printing too little money leads to hoarding and printing too much money leads to hyperinflation.  So a risk-averse central bank is stuck.  I doubt this, people don’t act so closely in accord but rather they adjust their cash balances at different speeds.  So again, just print some more money to get out of the liquidity trap.

What is the evidence for a liquidity trap?  Low nominal rates and the absence of a recovery?  That’s not much evidence.  I suspect real coordination problems are at fault in most of these settings, and hoarding is at most a secondary issue.  Few serious economic problems are purely monetary in nature, yet the liquidity trap encourages us to embrace that dangerous idea.

The bottom line: I once wrote a paper arguing the liquidity trap is possible.  Now I think that Milton Friedman was right all along.

Readers will not be surprised to know that I am not normal.  Indeed, I have not been normal for a long time as this post from 4 years ago attests:

Roosevelt and the Great Depression

I was amused to see Conrad Black writing with shock:

Jim Powell of the Cato Institute (cited approvingly in a recent column by Robert L. Bartley) argues in a new book that FDR actually prolonged the Depression!

Of course, Powell is correct. Imagine, increasing the power of
unions to strike and raise wages during a time of mass strikes and mass
unemployment. Imagine thinking that cartelizing whole industries
thereby raising prices and reducing output could improve the economy.
Not everything Roosevelt did was counterproductive – he did end
prohibition (although in order to raise taxes) – but plenty was and
worst of all was the uncertainty created by Roosevelt’s vicious attacks
on business. (See, for example, the work of Bob Higgs especially this important paper and historian Gary Dean Best’s overlooked classic Pride, Prejudice and Politics.)
Business investment failed to recover because business people
legitimately feared a regime change like that which had occured in
Germany and Italy. Sound extreme? Roosevelt himself threatened/promised
this in his first inaugural:

…if we are to go forward, we must move as a trained and
loyal army willing to sacrifice for the good of a common discipline,
because without such discipline no progress is made, no leadership
becomes effective. We are, I know, ready and willing to submit our
lives and property to such discipline, because it makes possible a
leadership which aims at a larger good… I assume unhesitatingly the
leadership of this great army of our people dedicated to a disciplined
attack upon our common problems….in the event that the Congress shall
fail to take one of these two courses, and in the event that the
national emergency is still critical, I shall not evade the clear
course of duty that will then confront me. I shall ask the Congress
for… the power that would be given to me if we were in fact invaded
by a foreign foe.

The key issue is what we can expect from China and India.  As I understand the evidence, if China and India continue to grow, the United States cannot succeed in much limiting global warming on its own.  Let us assume, somewhat dubiously (many European countries are further from Kyoto targets than is the United States), that Europe is already on board, what are the options?

1. China and India are less locked into fossil fuels than is the United States, and as Brazil has done they will take the lead in moving toward energy alternatives.  America does not need to get them "on board," and given their cooperativeness American energy policy will matter at the margin.

2. We can cut a deal with China and India at a suitably presented international convention.  China and India will enforce this deal and abide by it, overcoming previous problems they have had ruling their provinces and avoiding excess decentralization.

3. Forget about the international conference, we can pressure China and India by twisting their arms.  Like we’ve done with the Chinese currency.  We also can threaten them with trade taxes, as has been discussed in Europe.

4. We are best saying nothing to China and India and calling no conference.  There is some chance they will act unilaterally, out of pride and the desire to upstage the United States.  External pressure will be counterproductive, remember British imperialism and the Opium Wars?

5. China and India will continue to be major polluters.  If we tax American-generated carbon we pay a big price in terms of economic growth but make no real progress on global warming.

6. We do not know what China and India will do, but the United States is a world leader and ought to move first, set a good example, and do the right thing.

Do we know the relative merits of 1-6?  I don’t.  Keep also in mind that what works for China may not work for India, and vice versa.

Of course #5, however ignoble it sounds, is the most serious argument for doing little or nothing.  #6 sounds good, but at what point is the chance of #5 high enough to scare us off?

What would it cost China and India to make progress on global warming?  Yes Stern estimates it would be a relatively small percentage of gdp, but that is naive.  A major problem is institutional, not technological.

I am reminded of some estimates of the costs of cleaning up avian flu in Asia.  Measure how much it costs to kill (or vaccinate) one chicken.  Not much.  Multiply by the number of sick chickens.  You have your number.

Not.  Many Asian countries simply can’t get rid of avian flu.  Their institutions are too weak, too lacking in transparency, too decentralized, and too lacking in accountability.

Or how much would it cost to improve the standard of living in Haiti?  A few cops, some rule of law, free trade at the ports, and set up some real schools, right?  Under one plausible view of the world, that is only a few billion dollars or so.  But if we consider some of the very tight institutional constraints faced in Haiti, most of all the almost total unwillingness of the elites and the common voters to support a better politics, the price can seem almost infinite.  Which perspective is correct? 

The bottom line: When it comes to global warming, the most important question is how China and India will behave, and what kind of leverage "the good countries," if indeed there are any, might have.  The correct answer is not a simple matter of fact, but rather rests upon deep questions of how to measure the costs of institutional change and what we can justifiably take as an open variable amenable to change.

All other issues aside, that is why global warming is such a tough problem.  I don’t like #5, but if you want to sell me on your solution, talk to me some sense about China and India.

Addendum: Jane Galt has a lengthy post on discount rates.

In the blogosphere, anti-Stern, high discount rate advocates tend to come from the political right.  The left is more pro-Stern and pro- low discount rate.  In a forthcoming article in the University of Chicago Law Review, I argue that this distribution of opinion does not follow naturally:

Counterintuitively, a concern for the distant future sometimes will militate against some environmental investments. For instance some of the costs of global warming appear to be "one-time" in nature, such as the costs of relocating coastal and inland settlements…At the same time stopping or limiting global warming might lower permanently the rate of economic growth. When the rate of intergenerational discount is sufficiently low, maximizing the growth rate tends to take priority over avoiding one-time expenditures and one-time adjustments. Even if those one-time expenditures are large, we will earn back that value over time and more, due to the logic of investment compounding.

Alternatively, other environmental issues will become more important. For instance many scientists have argued that global warming will increase the number of virulent and persistent storms. This can limit the prospects for economic growth (this is illustrative; I am not seeking to debate the facts). [Insofar as we are utilitarians] when it comes to global warming, we should be more concerned with the growth-affecting elements of the phenomenon, and less concerned with the one-off effects.

If the costs of moving away carbon are one-time in nature, and the benefits of energy alternatives show up in the growth rate, a zero discount rate encourages global warming activism.  Alternatively, to the extent the costs of moving away from carbon lower the growth rate and the benefits are one-time, the logic flips and a zero discount rate encourages passivity.

I am aware how much a low discount rate can skew expected value calculations.  I nonetheless believe that current debates are overestimating the importance of the choice of discount rate.  I hope to soon discuss the truly important factors in reaching a policy decision.

By the way, here is some rhetoric on global warming.

The case for a low discount rate is stronger than you think.  If we are uncertain what is the right discount rate, and we count values in our averaging (rather than averaging discount rates per se), lower discount rates get more weight in the expected value calculation.  In his book on catastrophe, Richard Posner writes:

Suppose there’s an equal chance that the applicable interest rate throughout this and future centuries will be either 1 percent or 5 percent. The present value of $1 in 100 years is 36.9 cents if the interest rate used to compute the present value is 1 percent but only .76 cents (a shade over three-quarters of a cent) if it is 5 percent. Now consider the 101^st year and remember the assumption that the two alternative discount rates are equally probable. If the interest rate used to discount the future to the present value is 1 percent, then the present value of $1 at the end of that year will have shrunk from 36.9 cents to 36.6 cents. If instead the interest rate used is 5 percent, the present value of .76 cents will have shrunk to about .75 cents. This means that the average present value of $1 at the end of the 101^st year will be 18.68 cents, implying an average discount rate of less than 2 percent, rather than 3 percent. The reason is that the more rapid decline in value under the higher discount rate (5 percent) reduces its influence on present value.

The bottom line: If we are unsure what is the right discount rate, in practice that usually means something like a low discount rate.