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“Chapter 2: In Which the Traders Crucible slays the Intertemporal Government Budget Constraint, and Mr. Rowe demonstrates his Worth

April 29, 2011 41 comments

There has been lots of confusion lately over at Brad Delong’s place by the usually unconfused Brad.  Nick Rowe of the incorrectly named Worthwhile Canadian Initiative jumped in.  (why incorrectly named? Should be named “Essential Canadian Initiative” – the dude is freakin’ smmmmaaaarrt, and you’ll see why later.).

But this is about the budget constraint.  The Intertemporal Government Budget Constraint has a single, seemingly innocuous assumption of no Ponzi for government spending. The no Ponzi assumption is that the net present value of our spending/debt must equal the net present value of future taxation.  The books must balance across generations. If this doesn’t hold, the currency must go to zero.  Sounds prudent right?

There is only one problem with this assumption.  We cannot know if it is being violated or not with much certainty at all.  We cannot see the future.  We do not know with perfect knowledge if this constraint holds. We cannot know if the no Ponzi criteria is being held with certainty, because we cannot see the future.

And it gets worse, much worse.  We cannot tell if the no Ponzi criteria is being violated within a rather large band of certainty.  In fact, anyone who says we conform to the no Ponzi criteria must be lying, given the history of governments.  But then, anyone who says we are not conforming to the no Ponzi assumption is lying too.  They ignore hard empirical data from today, right now, given todays data, and given history of the United States.   So far, the U.S. has held to the no Ponzi quite well.

All the data points to that the U.S. holds to the no Ponzi over time. And yet we are foolish to assume we can hold to it

This to me sounds like a paradox.  There is no reasonably certain correct answer.

Is Observation the Key?

Still, We can only know what we observe today.

All we can know today is what people think about the value of their money.  If the no Ponzi assumption holds or does not hold, we have to look to current inflation rates to tell us the opinion of what people think is the ultimately unknowable answer.  There is no other way to tell other than inflation rates today, because the future is obscured to our observation.

It turns out the assumption is irrelevant for this reason.

The no Ponzi assumption is irrelevant

The no Ponzi assumption kinda sorta ignores the fact that any violation of the assumption has to be observable today.

We know this because the conclusion of the no Ponzi assumption says words like “We would see rates of inflation increase to levels that make g < r if people think the no Ponzi assumption is being violated.”  But then people forget we cannot know the future with much certainty, so there is this eternal hand wringing over current inflation rates.

These people cannot know if there is a Ponzi violation.  It’s a guess, at best. It’s mad-cap speculation at worst.  How can we ever really tell?

Future Ponzi violations or no violations are impossible to know information. They are not falsifiable for any current levels of real growth or real interest rates.  Nobody knows, or can know, what the future levels of primary deficits will be 20 or 100 years or 1000 years from today.  Anyone can always say “Well, future levels of spending might be too high and spur hyperinflation,” and there nothing anyone could ever say that will prove that statement false.  Those levels of future spending might turn hyperinflationary or not, and we cannot know.

Of course they could also say “We are going to be so rich in the future when we  energy that costs 5% of current costs that these current deficits are trivial”.  How can you tell?

Todays evidence shows we are within the bounds of any reasonable no Ponzi assumption given by Scott Fullwiler.  But who in the hell knows? We cannot know the future.

So how does can the no Ponzi assumption help us manage policy real world policy in any practical way?  It doesn’t. It’s a myth, a spook story economists tell their kids at night. “Spend too much, and the Intertemporal Government Budget Constraint will get you.”

The only way we can possibly guess if this assumption is being violated is through current inflation rates, real interest rates, and rates of real growth.   Even then, these observable rates change all the time.  Over the course of decades, these observable rates are all over the place.

Still we have some guidance here with observable market prices of things.  All violations of the no Ponzi assumption must be observable. If we don’t have significant inflation, the no Ponzi cannot be being violated as far as we could ever know.

Inflation is the observable change in the price of money in real world goods, services, and transactions, including all financial assets.  In other words, the overall market for money will show us the violations of the no Ponzi assumption.

Violations of the no Ponzi assumption must be observable otherwise the EMH is false for the largest, most transparent, most liquid market possible 

If the violations of the no Ponzi criteria are not observable for the most liquid and transparent possible market in any economy, then the EMH must be wrong. No EMH in the market for money has devastating consequences.

It’s at this point where I raise the head of the IGBC and proclaim the dragon slain.  Either you believe the inflation rate as the only way to tell if people believe the IGBC is holding, or go back to believing in crystal balls telling the future.  If you insist on a strong belief in magic, then I hand over the head of the EMH.

As an aside, even if the violations are not observable, it would be foolish to act in any way but to accept the EMH as true in the market for money – which as far as i can tell, is the largest, most transparent, most liquid market possible within current human experience.

This might sound astonishing, but I am not over yet.  Living in a no Ponzi world has incredible consequences.  Nick Rowe knows exactly what I am talking about.  We are living in a world where g is greater than r, nearly all the time, except when some normal business cycle pushes g below r.   

Next up, “Chapter 3, in which Mr. Rowe proves his worth.”

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Job at McDonalds harder to get than acceptance to Harvard

April 29, 2011 6 comments

Ronald accepts award for lowest acceptance rate

McDonalds just hired 62,000 people. Over 1 million people applied for these jobs. That’s a 6.2% acceptance rate – and it’s probably lower lower because “at least 1 million people applied”.  They had said they would hire only 50,000, but upped the number to 62,000:

McDonald’s Corp. (MCD), the world’s biggest restaurant chain, said it hired 24 percent more people than planned during an employment event this month.

McDonald’s and its franchisees hired 62,000 people in the U.S. after receiving more than one million applications, theOak Brook, Illinois-based company said today in an e-mailed statement. Previously, it said it planned to hire 50,000.

The April 19 national hiring day was the company’s first, said Danya Proud, a McDonald’s spokeswoman. She declined to disclose how many of the jobs were full- versus part-time. McDonald’s employed 400,000 workers worldwide at company-owned stores at the end of 2010, according to a company filing.

Then we have this from the Harvard Crimson:

Acceptance Rate Falls to New Low

A record-low 6.9 percent of applicants have been accepted to the Harvard College Class of 2014.

The coveted fat envelopes will be mailed today to 2,110 students, the Office of Admissions announced earlier yesterday. Applicants will also receive their decisions via e-mail after 5 p.m. today.

6.2% acceptance rate for McDonalds.  6.9% acceptance rate for Harvard.

When I was a kid, getting a job at McDonalds is what kids did. Adults did not work at McDonalds unless they were supervisors or on the day shift.   Kids stocked shelves at stores too, and bussed tables.  When was the last time you saw a 14 year old bussing tables?

The economy is recovering, but is still in appalling shape.  When the acceptance rate for Harvard is higher than it is for a gigantic block of minimum wage, no future jobs, something is seriously broken with the system. These people are not Zero Marginal Product workers. We can and must do better.

[Important Update: Oops!  Major factual error!  Harvard reduced their acceptance rate to 6.2% this year. I somehow used the record low acceptance rate from 2010, instead of the record low acceptance rate for 2011.   I apologize for wildly misrepresenting the difficulty of getting a job at McDonalds.  It is only as hard to get a job at McDonalds as getting into Harvard, not more difficult as I stated.  I retract any claims about “more difficult”. Matt Yglesias – are you going to apply?  You might not make the cut.]

The Hyperinflation Hoax is worse than we thought: We can’t change the price of Oil

April 26, 2011 5 comments

Another Hoax?

Remember that post about the futility of using monetary policy to impact the price of oil?  It turns out that the elasticity of oil is even lower than I thought!  The IMF – ok, no jokes – came out with a report showing the short term price elasticity is nearly irrelevant, while the long term price elasticity is freakishly tiny.  The Blog world is a-titter about this.

The IMF says that a 10% increase in the price of oil results in 0.007% less demand in the short term.

The U.S. uses about 15 million barrels a day.  A 10% increase in the price of oil results in – wait for it – a decrease of 1050 barrels of oil per day. Increasing the price of oil from $90 to $99 results in 1000 less barrels of oil demanded.  That is 1 futures contract at the CME/NYMEX.  A 1 lot.  To put this in perspective, 319,000 contracts traded yesterday.

What level of interest rates – in the standard model- could be high enough to push down oil prices 20% or so, back to$90 a barrel? The demand for oil will not change in the slightest even if rates were increased to 5% tomorrow.  People won’t say “Oh, this quarter point increase in the Fed Funds rate makes me want to use less gasoline – or at least pay a lower price for it.”   A 10% increase in the actual price impacts demand by an amount so small it is a rounding error.  Tiny movements in interest rates will have zero observable impact on the price we are willing to pay for gasoline.

Why in the world are people shouting about energy inflation?  Even smart people can make this mistake, like Kevin Drum.

A self-inflicted cure of higher rates in response to high oil prices would be far worse than the disease.   We know what it takes to get the price of oil down to $40 a barrel.  It takes a global depression. It takes losing 500,000+ jobs a month in the U.S.

This is another reason to fight the Hyperinflation Hoax.

[Update: Seems the people over at Reason do not have quite as much reason as they might have thought.]

 

[Update: I made a mistake in oil demand.  The actual numbers are a 10% increase in the price of oil causes a drop of .2% in demand after 20 years.

This translates to a decrease of demand of about 30,000 barrels a day.  It does take 20 years for this to happen.  So if we assume a linear drop, then it’s a drop of about 125 barrels/day a month, every month for 20 years.  This is still very small.  I wonder how this number is significantly different than zero – it seems impossible that such a small effect would have an error term that’s even smaller, considering the data used. ]

QE has only 2 months to go, but 30yr haven’t broken highs yet

April 25, 2011 4 comments

Expectations matter in the markets.  Everyone and their brother “knows” that the end of QE means a huge, huge jump in yields.  People must be scrambling to sell Treasuries while they can, before Treasury yields hit 10 or even 20%.

And yet, 30 yr yields  – which are the most sensitive to long term expectations – cannot make new multi-year highs.  According to most textbooks, QE is about as inflationary as it gets.  Not only should we have high inflation today – we should have rocketing inflation expectations expressed through much higher yields in long bond yields.

I expect lower yields once QE II ends, not for long, and not a massive drop.  The cash for clunkers post-program effect might be quite impressive this time.   During QE I, yields did actually go higher.  During QEII, yields are just remaining stable.  I would find this market action very worrisome, if I was Bill Gross. Maybe Bill Gross will short even more Treasuries — ya know, double up to catch up.

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Nick Rowe begins the walk to MMT

April 25, 2011 2 comments

Nick Rowe is a smart guy – I knew he would come around.   He gets about 60% of the way there with this post.  He gets it about the limits of spending money – there are no limits but inflation.

He still makes a fundamental error.  He needs to update his ideas about government debt.  Nick – take a look why QE is like issuing treasury bills from Randal Wray or the original from Warren Mosler.

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TC Blast from the past: The most important event in the history of humanity since the domestication of animals and plants” happened in a country with Debt to GDP greater than 150%

April 22, 2011 1 comment

I have a soft spot for one of my old posts.  It’s about the industrial revolution and debt to GDP ratios.

“One of the most important developments in  human history – the industrial revolution in Britain – happened in a country where the Debt/GDP ratio was always greater than 100%. For much of the time, debt was higher than 150% of GDP.

Here is some Wikipedia goodness on the Industrial Revolution:

Economic historians are in agreement that the onset of the Industrial Revolution is the most important event in the history of humanity since the domestication of animals and plants.

From New Deal 2.0. via this excellent Mike Rorty post, it turns out  the Industrial Revolution happened while debt to GDP was over 150%:”

Read more here.

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Anti-Democratic Conspiracy in the Economics Profession

April 22, 2011 10 comments

Since 1967, it has been obvious to economists the dual mandate is BS.

It is difficult for me to write this post, but I suspect it is true.  There is an anti-democratic conspiracy in the economics profession.

“Sargent and Wallace published their classic “Some Unpleasant Monetarist Arithmetic” in the Minneapolis Fed’s Quarterly Review in 1981. Since that date, there has been a growing appreciation of the role of fiscal policy in the determination of the price level. The idea is a simple one. Consider a government that borrows only using non-indexed debt denominated in its own currency. There is an intertemporal government budget constraint that implies that the current real value of government liabilities — including the monetary base — must equal the present value of future real surpluses. Because the liabilities are nominal and non-indexed, the government budget constraint provides a linkage between the public’s assessment of future real tax collections and government spending and the current price level.More subtly, regardless of the FA’s solvency, sovereign debt issues can fail simply through a co-ordination failure among investors. If I, as an investor, don’t anticipate that others will buy into the debt issue, I won’t either. In this sense, sovereign debt issues may be susceptible to suboptimal “runs”. The CB can eliminate this possibility by ensuring the nominal promises of the FA whenever the FA is threatened with default.

Thus, I see trade-offs. On the one hand, the CB is known to be willing to intervene to keep the FA solvent, then inflation is necessarily shaped by fiscal considerations and by the short-run incentives of elected officials. We know from many years of theoretical and empirical research that this effect is not a desirable one. On the other hand, if the CB is fully committed to allow the FA to default if necessary, then even optimal debt management by the FA may end up exposing the country to troubling risks.

Let me wrap up. I’ve argued that even if the fiscal authority borrows exclusively in its country’s own currency, the central bank can have a large amount of control over the price level. But the central bank can only achieve that control if it is willing to commit to letting the fiscal authority default. Such a commitment may expose the country to risks of short-term and medium-term output losses. How this trade-off should best be resolved awaits future research. But I suspect that it may be optimal for central banks to guarantee fiscal authority debts in some situations. If so, we again have to think of price level determination as something that is done jointly by the fiscal authority and the central bank — just as Sargent and Wallace taught us 30 years ago.”

Read the quote from Kocherlakota carefully.

  1. Economists have known for at least 30 years the FA (aka The Treasury) controls or at least impacts the inflation rate under reasonable assumptions.
  2. They told people for decades that the MA controlled the inflation rate exclusively while badgering the FA to keep balanced budgets.

Then, go read the paper he references in his first line.  In the first paragraph of that paper, Milton Friedman is quoted as saying in 1967 that monetary policy cannot impact unemployment or aggregate demand.

Yes, there are huge risks in letting people know that they can always print money.  It is vastly dangerous.  There are risks in letting the Treasury control inflation and unemployment, because the Treasury is controlled by Congress.

It is also democratic to allow congress to control the Treasury. That’s what we agree to when we remain in the United States, instead of moving to a dictatorship where government spending is controlled by a central authority, or to a non-existant libertarian paradise where there is no Congress or government spending.

Basically, the entire economics profession mis-represented basic facts to non-insiders, so a non-elected cabal with a vague mandate and nearly zero accountability could try to control the fate of the world economy through an imperfect tool that only works if they are willing to let their friends and family suffer.

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