John Cochrane and Janet Yellen

On his blog, John Cochrane discusses the possibility of an alternative monetary policy regime in which the Fed tightly controls expected inflation. He states, repeatedly, that given our current understanding of the matter he would refrain from implementing such a regime if he became Fed chair (rather than stating that he would not currently advise to move in that direction). Given that Janet Yellen is expected to retire next year and John Cochrane is mentioned as a possible successor, I find the statement remarkable.

Bitcoin Unlimited

On Bloomberg, Yuji Nakamura and Lulu Yilun Chen report about conflicting views in the Bitcoin community on how to address capacity limits in the blockchain.

Bitcoin Unlimited is essentially a software upgrade to the blockchain. Years ago, bitcoin’s early developers imposed a cap on the amount of data it could process. While that slowed down the network, it was seen as a necessary safety measure against potential attackers who could overload the system. Now, Unlimited supporters say the blockchain is robust enough that it doesn’t need any limit at all.

While most agree the blockchain is stronger, critics … say that removing the data cap is a risky move which will leave bitcoin vulnerable to governments and global banks. Without a limit, large organizations would use their resources to out-muscle smaller miners and effectively take control of the blockchain and bitcoin itself.

Julian Baggini’s “Freedom Regained: The Possibility of Free Will”

In his book, Julian Baggini points out that materialism, not determinism, undermines the notion of free will. He accepts that man is subject to the laws of nature but simultaneously seems to argue for a holistic model of man and human choice. He concludes that the concept of free will is consistent with predetermined causes; with unconscious choice; and that it does not require that a choice could have been different.

Discussion in The Guardian.

Douglas Adams’ “The Hitch Hiker’s Guide to the Galaxy”

In Douglas Adams’ book (volume one in the trilogy of four) we learn, among other things:

  • Towels are particularly useful for interstellar travelers on a shoestring.
  • It’s not clear whether humans conduct experiments on mice or vice versa.
  • The answer to Life, Universe, and Everything is “forty-two” as Deep Thought found after an extended period (seven and a half million years) of number crunching.
  • But what is the question? To find out, an even more powerful computer was built: The Earth. “Deep Thought designed the Earth, we built it and you lived on it.”
  • Unfortunately, the Vogons destroyed the planet just five minutes before the program was completed. The badly timed intervention was communicated as follows: “This is Prostetnic Vogon Jeltz of the Galactic Hyperspace Planning Council. As you will no doubt be aware, the plans for development of the outlying regions of the Galaxy require the building of a hyperspatial express route through your star system, and regrettably your planet is one of those scheduled for demolition. The process will take slightly less than two of your Earth minutes. Thank you.” And after some moments: “There’s no point acting all surprised about it. All the planning charts and demolition orders have been on display in your local planning department in Alpha Centauri for fifty of your Earth years, so you’ve had plenty of time to lodge any formal complaint and it’s far too late to start making a fuss about it now.”
  • Another artificial planet may be under construction. It might feature fjords as in Norway (on the original Earth), but this time in Africa.

See here or here for quotes from the book(s).

Stable Long-Run Money Demand

On VoxEU, Luca Benati, Robert Lucas, Juan Pablo Nicolini, and Warren Weber argue that long-run money demand in many countries is rather stable.

… using a specific, narrow monetary aggregate, M1, we study a dataset comprising 32 countries since the mid-19th century (Benati et al. 2016). The main finding of this large-scale investigation is that, contrary to conventional wisdom, in most cases statistical tests do identify with high confidence a long-run equilibrium relationship between either M1 velocity and a short-term interest rate, or M1, GDP, and a short rate – that is, a long-run money demand.

On the Performance of Swiss Portfolio Managers

In the NZZ, Michael Schaefer reports on a study about the performance of Swiss portfolio managers in 2016.

  • The median portfolio returns in all investment strategies except those not investing in stocks fell short of the corresponding benchmark returns.
  • Only a fifth of the portfolios generated returns in excess of their benchmark.
  • These numbers do not yet account for management fees.
  • No portfolio manager generated high returns across all strategies.
  • But some managers consistently generate high returns in certain strategies.

America’s Miserable 21st Century

In Commentary, Nicholas Eberstadt recounts how low employment, deteriorating health, and declining social mobility in the United States foreshadow a “Miserable 21st Century.”

  • Between 2000 and 2016, the work rate for Americans aged 20 or older fell by almost 5 percentage points, to 60 percent.
  • In the “prime working age” group, it fell by almost 4 percentage points.
  • While work rates for men had been falling for much longer, a similar decline for prime age women set in in 2000.
  • Death rates for white men and women aged 45–54 rose slightly since 2000; they increased sharply for the subset with high school or lower education.
  • In 2016, life expectancy at birth in the US fell for the first time in decades.
  • By 2013, more Americans died from drug overdoses than from either traffic fatalities or guns.
  • Alan Krueger’s research suggests that about 50% of prime working-age male labor-force dropouts take pain medication on a daily basis.
  • This group spends its time watching TV, movies, or playing video games, and many take drugs.
  • The “welfare state” (Medicaid) helps the unemployed pay for their drugs.
  • In 2013, roughly 20% of civilian men aged 25–55, and roughly 50% of non-working prime-age people were Medicaid beneficiaries.
  • Roughly 60% of the non-working prime-age male non-Hispanic population collected disability benefits.
  • While the U.S. has a higher incarceration rate than almost any other country, only few of the Americans ever convicted are incarcerated. “Maybe 90 percent of all sentenced felons today are out of confinement,” due to release, probation, or parole, adding to a stock of roughly 20 million people.
  • Geographical mobility and job churning are in decline.
  • Chances of surpassing one’s parents’ real income are lower than ever before in postwar America.

Stability vs. Equality?

In The Great Leveler, Walter Scheidel argues that over thousands of years, only mass violence and catastrophes have triggered significant reductions in inequality.

From the book’s introduction:

For thousands of years, civilization did not lend itself to peaceful equalization. … stability favored economic inequality. This was as true of Pharaonic Egypt as it was of Victorian England, as true of the Roman Empire as of the United States. … Four different kinds of violent ruptures have flattened inequality: mass mobilization warfare, transformative revolution, state failure, and lethal pandemics.

… there is no compelling empirical evidence to support the view that modern economic development, as such, narrows inequalities. There is no repertoire of benign means of compression that has ever achieved results that are even remotely comparable to those produced by the Four Horsemen.

Money, Banking, and Dreams

In another excellent post on Moneyness, J P Koning likens the monetary system to the plot in the movie Inception, featuring

a dream piled on a dream piled on a dream piled on a dream.

Koning explains that

[l]ike Inception, our monetary system is a layer upon a layer upon a layer. Anyone who withdraws cash at an ATM is ‘kicking’ back into the underlying central bank layer from the banking layer; depositing cash is like sedating oneself back into the overlying banking layer.

Monetary history a story of how these layers have evolved over time. The original bottom layer was comprised of gold and silver coins. On top this base, banks erected the banknote layer; bits of paper which could be redeemed with gold coin. The next layer to develop was the deposit layer; non-tangible book entries that could be transferred by order from one person to another.

The foundation layer has changed over time:

One of the defining themes of modern monetary history has been the death of the original foundation layer; precious metals. … as central banks chased private banks from the banknote layer … and then gradually severed the banknote layer from the gold layer. By 1971, … [b]anknotes issued by the central bank had become the foundation layer. The trend towards a cashless world is a repeat of this script, except instead of the gold layer being slowly removed it is the banknote layer.

Fintech improves the efficiency of the layer arrangement and its connections. It also adds new layers: For instance, some payments made via mobile phone effectively transfer claims on deposits. And it may circumvent layers:

In U.K., the Bank of England is considering allowing fintech companies to bypass the banking layer by offering them direct access to the bottom-most central banking layer.

In contrast, a krypto currency like bitcoin establishes a new foundation layer, on which new layers may be built:

Even now there is talk of a new layer being developed on top of the original bitcoin foundation, the Lightning network. The idea here is that the majority of payments will occur in the Lightning layer with final settlement occurring some time later in the slower Bitcoin layer.

I fully agree with this characterization. In addition to the theme emphasized by Koning—adding layers—I would also stress the theme of untying higher-level layers from lower ones: Central bank money typically is no longer backed by gold; deposits typically are not fully backed by notes; and mobile phone credits may no longer be backed by deposits. The process of untying layers relies on social conventions and trust, and it is fragile. Important questions concern the cost of such fragility, and its necessity. Fragility is not necessary when the social cost of liquidity provision at the foundation layer is negligible.

General Equilibrium Theory up to Arrow and Debreu

On his blog A Fine Theorem, Kevin Bryan discusses the history of economic thought leading from the classical economists and Walras to Arrow and Debreu.

My read of the literature on GE following Arrow is as follows. First, the theory of general equilibrium is an incredible proof that markets can, in theory and in certain cases, work as efficiently as an all-powerful planner. That said, the three other hopes of general equilibrium theory since the days of Walras are, in fact, disproven by the work of Arrow and its followers. Market forces will not necessarily lead us toward these socially optimal equilibrium prices. Walrasian demand does not have empirical content derived from basic ordinal utility maximization. We cannot rigorously perform comparative statics on general equilibrium economic statistics without assumptions that go beyond simple utility maximization. From my read of Walras and the early general equilibrium theorists, all three of those results would be a real shock.

Currency Denomination Risk in the Euro Area

In the FT (Alphaville), Marcello Minnena explains what type of currency denominations of Euro area sovereign debt constitute credit events; and how markets assess the risk of such denominations.

After the Greek default in 2012

new ISDA standards entered into force: contracts made since 2014 protect against euro area countries redenominating their debt into new national currencies [unless the debt is redenominated] into a reserve currency: the US dollar, the Canadian dollar, the British pound, the Japanese yen, or the Swiss franc. In all other cases, the only way to avoid the triggering of a credit event is if the switch to the new currency does not result in a loss for the investor: “no reduction in the rate or amount of interest, principal or premium payable”.

Since 2014 two types of sovereign CDS therefore coexist: the old (ISDA 2003) and the new (ISDA 2014). The latter has always traded at spreads wider than the CDS-2003, but the difference (the ISDA basis) has generally been small: 15-20 bps for Italy, 8-12 bps for Spain, 2-4 bps for France, and 1-2 bps for Germany.

Since January 2017, the spread difference for Italy and France has increased by roughly 20 basis points.

Money without a Government

In the FT, David Pilling reports about Somalia which has managed without central bank issued money for decades.

… up to 98 per cent of local banknotes are fake … With the help of the International Monetary Fund, Mogadishu plans to print official banknotes for the first time in more than a quarter of a century … No official Somali currency has left the presses since the Horn of Africa nation descended into clan warfare after the collapse of the government in 1991.

… warlords, businessmen and breakaway regions printed counterfeit notes or shipped them in from abroad. … several important issues, including what the government would use to back its new currency, were still being discussed. So was the question of what the conversion rate would be of fake Somali shillings for the new official ones. Use of Somali shillings, largely limited to the less well-off rural population, comes a poor third to US dollars and electronic money in what is a mostly dollarised economy. … Some dollars in circulation are also fake …

U.S. Health Care Spending

A blog post on Random Critical Analysis argues that high wealth (proxied by high consumption) rather than GDP explains US health care expenditures.

Total per capita health care spending increases as wealth increases because people actually demand more goods and services (volume) per capita and because it is relatively labor intensive sector that does not enjoy the productivity gains found in some other sectors of the economy, i.e., overall costs increase through both volume and price together (volume * price).  GDP per capita is a relatively weak measure for these purposes and those few other high GDP countries happen to be much more export dependent (which does not independently predict significant increases in expenditures).  If you use a better measure like Actual Individual Consumption (AIC) or run multiple regression analysis on GDP expenditure categories most of the apparent excess health care spending shrinks quite dramatically.

Additional analysis of several major claims here (e.g., high prices due to limited market power of payers, high physician incomes, etc) show that these arguments suffer from similar issues.  The best available evidence show that across multiple measures our healthcare labor costs and overall apples-to-apples price levels are generally very much inline with our material standard of living.  US total per capita costs are probably somewhat more than expected, but this appears to be driven through higher volume (~100% more than EU28 average according to PPP study estimates), though even this is significantly, if not quite entirely, explained by our higher material standards of living.

Economics as Bullshit Detection

In separate blog posts, Russ Roberts and John Cochrane have called for humility on the part of economists. Asking “What do economists know?,” Roberts and Cochrane point out—correctly—that economics is not as strong on quantification as some economists and many pseudo economists pretend, and as is often expected from economists.

Economics is not the same as applied statistics although the latter can help clarify, at least to some extent, the empirical relevance of economic theories. Correlation does not imply causation. Identifying assumptions that aim at establishing causal claims based on correlation analysis deserve skepticism, especially when the process that led to the empirical results remains in the dark (see notes on replicability here, here, here).

Sound economics heavily relies on consistency checking, or bullshit detection in Cochrane’s words. It insists on keeping accounting identities in mind and never forgetting about incentives. And it is acutely aware of the fact that good models are nothing more than consistent stories—but at least they are consistent stories.

Fintech in China

The Economist reports about the fintech revolution in China.

By just about any measure of size, China is the world’s leader in fintech (short for “financial technology”, and referring here to internet-based banking and investment). It is far and away the biggest market for digital payments, accounting for nearly half of the global total. It is dominant in online lending, occupying three-quarters of the global market. A ranking of the world’s most innovative fintech firms gave Chinese companies four of the top five slots last year. The largest Chinese fintech company, Ant Financial, has been valued at about $60bn, on a par with UBS, Switzerland’s biggest bank.

“Fiscal and Monetary Policies,” Bern, Spring 2017

MA course at the University of Bern.

The classes follow chapters 11–13 in this text (updated April 12, 2017) and build on the material covered in chapters 1–5. Uni Bern’s official course page. The course TA is Christian Myohl.

Main contents:

  1. Concepts.
  2. RA model with government spending and taxes.
  3. Government debt in RA model.
  4. Government debt and social security in OLG model.
  5. Neutrality results.
  6. Consolidated government budget constraint.
  7. Fiscal effects on inflation. Game of chicken.
  8. FTPL. Active and passive policies.
  9. Primal and dual approach.
  10. Tax smoothing.
  11. Time consistent policy.

The IMF In Greece

The IMF has released a report with an ex-post evaluation of Greece’s 2012 Extended Fund Facility (Exceptional Access under the 2012 Extended Arrangement under the Extended Fund Facility with Greece).

A critical discussion by Charles Wyplosz on VoxEU.

The Greek authorities are more optimistic than IMF staff about the economy’s outlook.

“Secular” Stagnation, A Return to Trend

On Bank Underground, Gene Kindberg-Hanlon criticizes the secular stagnation hypothesis:

Real interest rates have fallen by around 5 percentage points since the 1980s.  Many economists attribute this to “secular” trends such as a structural slowdown in global growth, changing demographics and a fall in the relative price of capital goods which will hold equilibrium rates low for a decade or more (Eggertsson et al., Summers, Rachel and Smith, and IMF).  In this blog post, I argue this explanation is wrong because it’s at odds with pre-1980s experience.  The 1980s were the anomaly … The decline in real rates over the 1990s and early 2000s simply reflected a return to historical norms from an unusually high starting point.  Further falls since 2008 are far more plausibly related to the financial crisis than secular trends.