Wednesday, November 30, 2011

The Great Depression in a nutshell

This was based on a comment I made here.

In the late 1920s, most developed economies were on the gold standard. The Bank of France and the Fed took gold out of (pdf) the monetary system, driving up the price of gold inside the monetary system, which drove up the price of money (since gold set the price of money) which drove down the price of everything else, and so people’s incomes. A significantly leveraged economy suffering an income crash (for debt, nominal income is what counts) leads to bankruptcies and bank failures in a disastrous downward spiral in economic activity.

The quicker countries left the gold standard, which the Bank of France and the Fed had turned into a doomsday machine, the quicker they recovered from the Great Depression. (If they were not on the gold standard, they did not suffer it at all.) There does not seem to be much mystery to all this.

R. G. Hawtrey (pdf) and Gustav Cassell (pdf) accurately predicted the danger in the early 1920s and explained what was going on at the time. Alas, Hayek was a brilliant economist who brilliantly expounded the Austrian (the real one, not the internet one) theory of the business cycle at precisely the wrong moment. Alas, Keynes was a brilliant economist who decided to revamp macroeconomics in quite unnecessary ways, when a Swedish economist and a British Treasury official had already got it right. But a Swede and a bureaucrat were not nearly as well placed as Keynes-the-public-intellectual and brilliant (if not always entirely honest) rhetorician to capture the debate.

It is strange, how much people seem to want complicated or new, or complicated and new, explanations for grand disasters in preference to a simple one already available.

Tuesday, November 29, 2011


It is a striking thing, that those who look for racism always seem to find it.

Another triumph of human analytical ingenuity and confirmation bias.

Sunday, November 27, 2011

Bad metaphysics parading as economics

Based on a comment I made here.

Bill Woolsey made the observation that: Critics treat nominal GDP as the product of real output and the price level.

We do not live in a barter economy with money add-ons, we live in a thoroughly monetised economy where prices, contracts and debts are set in money terms. I find this thinking that there is a "real" economy that generates monetary "epiphenomena" just bizarre. It is bad metaphysics parading as economics.

(As I discuss in my previous post.)

Friday, November 25, 2011

Money is not an epiphenomenon: the unreality of the “real”

There is no such thing as “real wages”. Economists talk about “real wages” but what do they mean by that? In a monetized economy, prices and costs are measured in money terms. So, a firm has to worry about the terms of labour—the ratio of labour costs to the prices of what it sells (weighted by how much labour produces how much product: so constraints on the use of labour will still affect the terms of labour). It experiences these things, and makes judgements accordingly. If the ratio moves adversely (which might be because the prices of its products have fallen, or because they have risen less than labour costs: any movement in either labour costs or output prices is potentially compatible with an adverse shift in its terms of labour, since it is the ratio of the two that matters) the firm will tend to cut back on hiring. If the ratio moves positively, the firm will tend to increase hiring.

But the terms of labour are not the same was the terms of wages—the ratio of payment to the worker to the prices of what the worker purchases. First, because wages received are not the only labour costs. Second, because what a worker purchases has no particular connection to what the firm sells. Indeed, different workers will have different terms of wages, since they will not have exactly the same pattern of purchases; just as the terms of labour will vary between firms and, even more, between industries.

So, when economists talk of “real wages”, what do they mean? Do they mean the terms of labour or the terms of wages? If they mean both, they effectively mean neither but instead some mystical (because very unclear) amalgam of both which is not specifically either.

And how do we measure “real wages”? By “deflating” wages (which are not the price of labour, but leave that aside) in terms of some general price index? If it is some specific index, such as the CPI, then that is yet another general amalgam which, at best, crudely correlates to what either the worker or the firm is experiencing and making their judgements about. If it is a general measure, such as a GDP deflator, it has less arbitrary selection problems but still has only a crude connection to what the worker or the firm experiences and makes judgements about.

But, why bother going to that effort? The process of deflating adds nothing to the information to be had from terms of labour and terms of wages. Indeed, it is worse than that, because it actually takes information away. Sticking with the money prices and costs both reflects what people actually make judgements about and does not lose information.

The underlying idea that the notion of “real wages” taps into is that money is some epiphenomenon which overlays a “real” economy. But, as we have seen, trying to postulate something called “real wages” fails to pick out a specific phenomenon, suppresses information as it does so and does not capture what people actually make judgements about. If our concern is with human behaviour then the issue becomes what information do people use to make their decisions. The notion of “real” wages fails to accurately capture any specific thing.

Consider the asymmetry between increases and cuts in (money) wages. If money was an epiphenomenon over some “real” economy, there should not be any difference between raising money wages when the price level is rising and cutting money wages when the price level is falling. But contracts, debts and financial obligations are set in money terms and operate across time periods, so there is a clear difference between the two. Cutting money wages increases the burden of existing debts and obligations. So, it is perfectly rational for workers to resist cuts in money wages even if their general terms of wages are rising. Looking at “real wages” again suppresses information; indeed, it seriously misleads.

Nor is the notion of “real prices” any better. There are only two sorts of prices: money prices and barter prices—prices in terms of money and prices in terms of other goods and services. The first can be expressed in a common range of numerical values, a measure of prices that operates across goods, services and assets. It is one of the great advantages of money. The second can only be expressed in terms of other goods and services. The notion of “constant price” is not a “real” price: it is simply prices expressed in “frozen” money abstracting away from general shifts in money prices/the barter prices of money. One is using a key characteristic of money while pretending to get “past” it. To so attempt to use money to get “underneath” to the “real” economy is to, in fact, express how much money is not an epiphenomenon. One is still using money, just in a particular way.

Yes, people are aware of shifts in the barter prices of money: which is to say, the inverse of money prices. But there is not some “real price” beyond that.

Money is a transaction good: people use it to transact to get the goods and services they want. So, if we have three goods in an economy (consumption, assets and money) then we have two markets (money for consumption goods, money for assets). The process of transacting uses a medium of account (money) and does so for good reasons. The advantages of money over barter are not some epiphenomenon. They are major advantages that change how people behave and so how the economy works, particularly given money operates across time periods (we can spend now or later; we have previous entered into obligations expressed in money terms).

Using the concept of "real" prices abstracts away from “actual” money while continuing to invoke its functions. This is not analytically helpful, for we then make money what it is not—immediately, transparently “neutral” about prices in terms of goods and services. Cognitive simplification—being able to express prices in common numerical values—means precisely that and is a genuine economic function. It takes time to register general shifts in the barter price(s) of money and for credit, contracts and other prices to adjust. Which means that shifts in spending have effects on output, until people adjust for any general change in what money buys (in terms of goods, services and assets). By "abstracting away” from money (even though we are actually not fully doing so) we also abstract away from money being a cross-temporal constraint due to contracts, debts and other financial obligations.

The notions of “real wages” and “real prices” do not get to “underlying” realities, they obscure economic realities because they abstract away from how people are actually making decisions and constraints on those decisions. Money is the prime form of information in a monetised economy. By treating it as some epiphenomena, we are not revealing, we are obscuring.

Money is not an epiphenomenon and it is actively misleading to use economic language that implies it is: particularly when such language ends up suppressing relevant information.

Wednesday, November 23, 2011

A Socratic dialogue with the inflationphobics

This is based on a comment I made here.

Perhaps we need a bit of Socratic dialogue with the inflationphobics.

Q: What has caused more damage; entrenched inflation (the 1970s) or massive deflation (1929-32)?
A: Deflation. But that is not what we face.
Q: What has caused more damage; entrenched inflation (the 1970s) or unexpected disinflation* during a leveraging crunch (2008-?).
A: But inflation is evil.
Q: Why is inflation bad?
A: Because it distorts private decisions.
Q: Does it do that making basic parameters for judgement unreliable?
A: Yes.
Q: So it is about creating a clear and reliable framing for private decisions?
A: Yes.
Q: So, a central bank should provide a reliable framework for private decisions?
A: Yes.
Q: So it is about framing expectations in a credible way?
A: Yes.
Q: So, what is more important to people, expectations about income or expectations about prices?
A: [Some obfustication]
Q: So, should not a central bank seek to credibly generate expectations about income?
A. [Some more obfustication]
Q: In a highly leveraged age with many wages set by contracts operating across time and a range of "sticky" prices, which is more important to people, expectations about money income or "real" income?
A. [Even more obfustication]
Q: So, would not a clear target about aggregate income (aka NGDP aka Py) create a framework to anchor expectations in what people actually care about?
A: [Meltdown]

* Yes, other things are going on, but the surreptitious disinflation was when the US economy really nosedived.

ADDENDA Lars Christensen was good enough to repost the comment as a blog post.

Tuesday, November 22, 2011

Forms of employment, unions and wages

Loath as I am to disagree with an economic historian as eminent of Peter Temin, his paper The Great Recession in Historial Context (pdf) has a claim about wage stickiness and its source I disagree with.

In explaining the development of stickiness of wages and the rise of unions. Temin writes:
As the size of production units, whether mines or factories, became larger, the ability of labor markets to be optimally competitive also diminished. Large employers yielded little bargaining power to workers to negotiate wages and working conditions. If a factory, for example, was the only large employer in town, the options for workers were even more limited and the market power of the employer more obvious. Workers formed unions to countervail the market power of employers, and wage bargaining and strikes supplanted the individual wage negotiations implicit in Hume’s and Smith’s analyses.
This is a wonderful (indeed popular) “just so” story. The trouble is, it is clearly wrong. Large employers tend to pay more than small employers, just as large supermarkets tend to be cheaper than corner stores. Size does not equal market power and does not determine comparative wages or prices.

There is a much simpler reason why unions arose in response to large employers. The workforces of large employers are easier to organize. The rate of unionization increases with the size of the employer (hence the public sector is far more unionised than the private sector) because the bigger the employer, the easier its to organize the employees—they are easier to identify, collectively talk to and have more commonality of interests. Moreover, the power of unions comes from their ability to exclude competing workers. The true enemy of a union is not the company, it is the “scab”, the non-unionised competing worker. The more centralised the workplace, the easier to exclude.

Similarly, wages are “sticky” outside unionised workplaces and across employers regardless of size. The “stickiness” comes from the labour relations being across time periods and asymmetric information. Reliable workers who understand how the firm operates are worth keeping, are valuable. Massively undermining their status as bargaining agents—and your own reliability as a bargaining agent—by unilaterally cutting wages is not the way to have a good relationship with your employees. Particularly given they have obligations set in money terms, so cutting their money income makes their situation worse regardless of what money prices are doing generally. Nevertheless, that money is how contracts “keep score”—so go directly to employee status as bargaining agent and employer reliability as bargaining agent—is even more important.

Moreover, with the development of extensive regional, national and global markets, and increased complexity of products, it becomes harder to workers to judge employer claims. A medieval peasant could see how good the harvest was, and could observe grain prices, so variability in income was much more manageable because far less trust was involved. A modern employee has far less information to directly observe about inputs and outputs in what they produce. That leads to more emphasis on what workers can judge as “proxies” for what they cannot. The reliability of employer behaviour, the respect (or lack) of employee status as bargaining agents has to be increasingly relied upon in an ongoing interaction (a repeated game, if you like).

It is not the size of the company that determines “stickiness”, but the form of the employment contract. “Spot” markets in labour allow much more flexibility in wages since there is no ongoing relationship. It also provides an example where unionisation provided large gains to (some) workers—the unionisation of the waterfront. But that is a case where unionisation changed the form of the labour contract. It is also a case where exclusion of competing labour is particularly intense—employment on the Australian waterfront, for example, has practically become hereditary.

It was not unionisation, but changes in the forms of labour contracts, in the structure of labour relations so that labour became much more an across-time interaction with increased information asymmetries, which increased the “stickiness” of labour. Unions are a symptom of that change far more than they are a source of wage “stickiness”.

Contemporary unions confront a range of problems. First, with the growth of two-income households, variation in income became rather less of an issue for many households, so workers become more willing to shift to forms of labour provision not susceptible to unionisation. Second, the increase in incomes and growth of regulation and other government interventions has meant that legal mechanisms (lawyers) and political ones (politicians and media) became increasingly competitive to unions as bargaining mechanisms. Third, the interests of unions is to make employment remuneration as complex as possible—both because that increases the need for a bargaining agent and because that provides various “victories” for unions to trumpet. The problem is that such a strategy increasingly generates wasted resources that can be harvested by moving to different forms of labour provision or contractual arrangements. Just as it was not employer market power which drove the rise of unions, nor is it driving their decline.

As to why large corporations tend to pay more than small employers, consider why large supermarkets have lower prices than the corner shop. The corner shop is, indeed, the corner, that is local, shop. A large supermarket has to make it worth your while to go that extra distance. Once you have decided to travel further (typically drive) to shop, then it is competing with all the providers in reasonable driving distance. It offers range and low prices to compensate for more travel time and less personalised service.

A large corporation finds it easier to spread/manage risk than a small employer but harder to tie worker effort to productive outcome. So, it pays a “hostage premium”—more than the employee can get elsewhere so that they police themselves more, as they have more to lose. This “hostage premium” is not merely basic salary; it includes a range of benefits and common activities to try and encourage self-policing. So, even in the absence of a unionised labour-exclusion premium, wherever the corporation finds it hard to tie employee effort to productive outcome, we can expect a “hostage premium” to encourage self-policing.

This does not explain what we observe of CEO pay, however. Tying the pay of CEOs to performance should be a lot clearer than executives further down the corporate hierarchy. Yet, what we observe is pay rates that seem unconnected to performance. A (very high) premium that is apparently often not hostage to productive behaviour.

So, consider the mechanism that selects pays for CEOs. In political science terms it is like rigged election autocracies. What we get is an "insider's game": insiders agree that you should be rewarded for being an insider, a game they all hope to benefit from so seek to maximise the return for being an insider. Benchmarking just increases the “gaming” (pdf), since it just increases information to insiders without increasing effective accountability since it does not breach the insider dominance of such decisions: the problem is not information asymmetries, it is insider privilege. The real puzzle is not why CEOs are paid so much, it is why their compensation can be notoriously unconnected to actual performance.

Forms of employment (including expected length of interactions), degree of centralisation of workplaces, information assymetries, insider privilege/outsider exclusion: they explain a lot more of how labour markets work than alleged employer market power. Including wage stickiness and the rise and decline of unions.

Tuesday, November 15, 2011

Of human bondage and history’s selection processes

In farming (i.e. agrarian) societies it has been standard for about 8 out of 10 people to be farmers. The land/labour ratio is a crucial determinant of social patterns in such societies. For example, which of the two factors – land or labour – is more constrained affects profoundly the use of human bondage.

If land is more constrained than labour (i.e. the fertile area is densely populated for the existing technology level), then the cost of labour will be low and control of land will provide the basis for extracting a surplus (for production above the level required to support the producers). Any use of slavery is likely to be limited to households, specific forms of production that dangerous or unpleasant and easily supervised (e.g. mining, cotton production, rowing galleys) or to tie loyalty to rulers by eliminating family ties (eunuchs, state slaves, slave warriors).

If labour is more constrained than land (i.e. the fertile area is lightly populated for the existing technology level) then the cost of free labour will be high, the return to control of land low and there is likely to be extensive use of bondage to extract a surplus, since the cost of subsistence plus supervision and lessened productivity will still less than that of free labour. Some form of bonded farming (such as serfdom) is likely to be used, since it has lower supervision costs and productivity loss than outright slavery and, unlike slave populations, serf or similar populations will reproduce themselves, so provides more reliable continuous labour supply than outright slavery.

(The only substantial slave population which might have reproduced itself is that of the antebellum American South and, even there, is seems likely that slave smuggling was significantly larger than has been commonly admitted. Elsewhere, the total lack of family rights usually pushed slave fertility well below replacement. Even in the Roman Empire, the significant prospect of manumission [pdf] is unlikely to have substantially improved fertility before freedom was gained.)

Some classic examples where loosening of the land constraint led to mass use of human bondage are the Americas after the importing of the Eurasian disease pool decimated the existing population, enserfment in Eastern Europe after the defeat of the “Tatars” and blocking of the Ottoman Turks freed large tracts of land for farming and the development of coloni in the later Roman Empire after the devastation of the Antonine plague and the Cyprian plague, a process which accentuated after the population crash at the end of the Western Roman Empire. Demand for staple products such as grain, sugar, tobacco (production of which are easily supervised) accentuated the process.

There is one great exception to all this: post Black Death Latin Christendom. Attempts to re-imposed serfdom failed, because the various Crowns refused to provide the necessary enforcement. The most obvious reason why they failed to do so is that knight’s service (i.e. military service by landlords) was no longer their key source of military power: taxes paying for the hire of free peasants was a crucial part of their forces and their men-at-arms were often contracted rather than feudal levies. (In Eastern Europe, by contrast, the reliance of the local Crowns on the military service of the servitor class meant that the Crowns were willing to enforce serfdom.)

But even among the knightly class of C14th Latin Christendom, the pressure for re-enserfment was uneven. This was not merely a matter of great magnates having other options (they were to be also less interested in enserfment in Eastern Europe than the lesser servitors) or the uneven impact of the Black Death (which just encouraged labour to “spread out”). It was also that tenancy and capital substitution provided alternative ways landowners could respond to labour shortages. The technological and capital market dynamism of medieval Europe, along with the depth of available skilled (i.e. “craft”) labour, the range of enforceable contracts and forms of property, made capital substitution a much more “live” option than it was in any of the other cases.

In other words, C14th Latin Christendom had, far more than the others, more intensive use of capital as an alternative to imposing bondage on human labour. Social capital in the form of effective laws and range of property rights; human capital in the form of skilled labour; financial capital in the form of sophisticated capital markets; and physical capital in the form of a machine-oriented production. The efficiency of mixed production (pigs, sheep, cattle, crop rotation), by raising supervision costs, may also have been a factor.

One might object: why did this not happen in the later examples of the Americas and Eastern Europe? To which the answer is: it did, eventually. As the institutions of the Commercial and then Industrial Revolutions seeped into Central and Eastern Europe, serfdom decayed and was eventually abolished. Greater New England adopted the free labour/capital intensification approach while the antebellum South remained with the “tropical zone” pattern of cheap labour and concentrated wealth. Unfortunately, the combination of British institutions and American practicality led to slavery becoming more profitable and efficient, hence the resistance to any abolition of slavery (which would have wiped out about a third of the wealth of the South and reduced significantly the value of white votes). Latin America lagged somewhat, as one would expect from its lower level of capital intensity. Islam lagged further still, in part due to slavery having Sharia endorsement. Conversely, densely populated and comparatively capital-intense Japan was one of the first non-Christian countries to abolish slavery in the medieval and post-medieval era.

The Soviet Union re-introduced both slavery (state slavery, in the forced labour camps) and serfdom (as workers were banned from leaving their workplaces without permission: the essence of serfdom). Neither proved particularly efficient and the man who oversaw them longest – Lavrentiy Beria – moved to abolish both as soon as Stalin was dead.

The shift to the capital/labour ratio playing an increasingly important role in society (generally) encouraged the abolition of bondage. (The antebellum South, the Soviet Union under Lenin and Stalin and Nazi Germany being conspicuous exceptions to the general trend: In the first and last case, the arbitration of war resolved the issue.)

Selection processes
To put the early exceptionalism of Latin Christendom another way, there was a lot more for the selection processes of history to work upon in C14th Latin Christendom than there was in the other cases (such as the later Roman Empire). Which is a general reason for the rise of North-Western Europe and its descendant societies. A significant number of competitive jurisdictions in close proximity between which ideas, capital and skills were relatively mobile; displaying a range of institutional forms; with legal and cultural diversity plus a rich intellectual and historical heritage from its Classical predecessor civilisation to draw upon. There was both more for the selection processes of history to work upon and more intense selection processes which were nevertheless operating within sufficient political stability for institutional learning and evolution to take place.

No other civilisation centre in Eurasia had that mix of features. Most others were dominated by autocracies as essentially the sole (or overwhelmingly dominant) form of government. Many had long periods of a single, dominant, autocracy. Even when that was not so, the ability of ideas, capital and skills to move between jurisdictions was often somewhat limited. In the case of Islam and Hindu India, laws being held to be of divine origin (Sharia, the laws of Manu) limited the possibilities of legal evolution.

The civilisation centre which had the largest overlap in features was Japan, with its competing daimyo—unsurprisingly, it was the non-Western civilisation which was most easily able to adapt Western methods because it already had the most similar institutional structure. But it lacked the cultural diversity of Europe or the intellectual depth provided by the Classical heritage incorporating memory of institutional variety and mathematised abstract theorising about the structure of things. It was unable to achieve the take-offs North-Western Europe did: but it was able to be first to catch up.

Having much more for the selection processes of history to work from, and a competitive-but-continuing institutional framework for them to work in, proved to be a world-beating advantage for North-Western Europe and its descendant societies.

Tuesday, November 8, 2011

On the stupidity of (some) Central Banks

The short answer from history to the question of how stupid can a central bank be? is: a central bank can be really, really stupid.

I am using ‘stupid’ in a technical sense: doing things that seriously adversely affect lots of people with no justifying benefits to any wider public good—that is, which show a lack of intelligence, understanding, reason, wit or sense. The actions may seem a good idea to the central bank at the time—due to perverse incentives, policy framings disconnected from economic reality or whatever—but in terms of wider public policy, they are (to varying degrees) disastrous. Central banks exist to serve, so how that “serving” is framed can make a great difference.

For example, hyperinflation is usually a deliberate attempt to inflate away government debt and/or generate revenue well beyond the willingness or ability to tax. It may be wicked, but it is not stupid in quite the above sense. (There are justifying benefits for decision-makers, without necessarily justified benefits.)

Beware of the French and central banks
Among stupid central banks, the all-time winner is the interwar Bank of France turning the gold standard into a doomsday device (pdf), helped by the US Federal Reserve, by building up its gold reserves without issuing money to match, so taking gold out of the monetary system, thus driving up the price of gold in the monetary system (and so the price of money, as such gold set the price of money) and thus driving down the prices of everything else. It and the Fed created the Great Deflation of 1929-32 we call ‘the Great Depression’ and so mass unemployment, the impoverishing of millions, the unravelling of much of (pdf) the world trade system, the fall of Weimar Germany and the rise of Nazism (followed by the Fall of France). It was a disaster of monumental proportions.

It was hardly the only disaster of central banking, however. Another (in)glorious episode also came from France with John Law’s Banque Générale gaining the right to issue paper money, which stimulated economic activity. The Regent, the duc d’Orleans, decided that if some paper money was good then even more paper money must be even better, leading to the truly spectacular Mississippi Bubble. This French disaster was based on the same logic (using that term loosely) as that which created the Great Deflation/Depression namely, “if some is better (some paper notes, some level of gold backing of the franc) then more is better and even more is better still.” One is reminded of the Abbe Sieyes dismissing the argument for bicameralism on the grounds that if the upper house agreed with the lower it was pointless and if it disagreed it was pernicious. Pernicious simplification passing itself off as sophistication: how very French. (Perhaps the baleful influence of Cartesian rationalism?)

By contrast, the Bank of England has a long history of considerable policy success, starting with vast improvement in management of government debt. The South Sea Bubble was rather less of a problem than the Mississippi bubble precisely because the Bank of England had disapproved from the beginning. While the Bank’s management of the gold standard over the two centuries up to 1914 suffered various bumps and problems, it had nothing to equal the aforementioned French disasters.

In our own time, the Bank of Japan’s management of the yen since the collapse of the bubble economy has come in for much criticism. However, the demographics of Japan make some of that criticism less clear-cut than is often suggested.

Even though some of the ECB’s problems are “built in”, there are also plenty of grounds for criticism for the European Central Bank (ECB), until recently with a French head (perhaps not encouraging; especially as the euro is effectively an artificial gold standard for its member countries).

Doing right
A contemporary example of successful central banking is the Reserve Bank of Australia. It has run an inflation target since 1993 (pdf). Its website is very clear on its policy target. In the words of the Reserve Bank:
The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3 per cent, on average, over the cycle. This is a rate of inflation sufficiently low that it does not materially distort economic decisions in the community. Seeking to achieve this rate, on average, provides discipline for monetary policy decision-making, and serves as an anchor for private-sector inflation expectations.
The minutes of its Board meetings are published two weeks after each meeting: this matters much less than that it has a clear monetary policy regime.

The Reserve Bank sees its role as providing an anchor for private sector inflation expectations and it does so by being upfront about its policy target. That it has an explicit target since 1993 is no coincidence: the experience of the severe 1992-93 recession where inflation was squeezed out of the Australian economy in a particularly costly way made it clear to policy-makers that being explicit about monetary policy was preferable. As had the problems with monetary policy in the 1980s:
In the early 1990s, the Reserve Bank did not enjoy the largely uncritical press it receives today.
The conduct of monetary policy in the 80s was fundamentally incoherent, unsuccessfully pursuing multiple objectives and shrouded in a veil of secrecy.
Without a policy commitment to price stability, the Australian economy lacked a nominal anchor.
(Does any of this sound familiar, by chance, to American readers?)

The success of the Australian economy since then has provided strong evidence for the good sense of this approach of a clear monetary policy regime via an explicit target. But there is also no mystery about why being explicit has been a successful approach. The point of money is to facilitate transactions by massively decreasing transaction costs. Not only are the search costs that barter imposes avoided by use of money, but there are a range of problems with barter than using money eliminates or greatly ameliorates, thereby greatly facilitating transactions.

If people have reasonably accurate expectations of how (money) prices in general will go, they can make arrangements (including contracts) based on those expectations. As Canadian economist Nick Rowe points out, inflation targeting in Canada came out of pressure from the private sector. They wanted reliable expectations about prices so as to set wage contracts.

Sudden, unexpected changes in prices can leave these arrangements misaligned with actual prices. If, for example, that results in changes in the terms of labour—the ratio of labour costs to the price(s) of what the firm sells—so that wages become seriously over-priced (in normal, somewhat imprecise, economic speak, “real wages have risen”) then firms will stop hiring, workers may be sacked, firms may collapse (i.e. they absolutely stop hiring and all their workers lose their jobs). It is not good to have significant, unexpected downward shifts in price movements, since that essentially guarantees that the terms of labour will rise unexpectedly. (So unexpected disinflation can have similar effects to deflation.)

Doing wrong
Which is what happened at the beginning of the Great Recession in the US. When uberblogger Matt Yglesias calls it a “huge failure of central banking” he is absolutely correct. To put it another way, serious expectation failures were imposed on the US economy, resulting in a dramatic drop in transactions. (That the Federal Reserve decided to surreptitiously disinflate as a financial crisis—the sub-prime crash—was building made things much worse: including the financial crisis, providing some reprise [pdf] of the Great Depression.)

How did this happen? Have a look at the US Federal Reserve website. There is no statement about what the specific aim of US monetary policy is. The US Federal Reserve provides no explicit anchor for expectations in the economy. So, the US Federal Reserve can decide to disinflate—to significantly reduce the inflation rate—and there was no warning for private agents that this was happening. To act in this way is to actively degrade the level of information in the economy and so misdirect expectations.

This is deeply stupid in both theory and practice. There is no economic gain from changing monetary policy surreptitiously, there are only unnecessary costs. Australian policy makers found this out the hard way in 1992-93. They learnt the lesson and have moved on. But, alas, almost no one takes what Australia does seriously: we are too small, too far away, too “lucky”, too “colonial”. Europeans and Americans tend to be deeply parochial people, seeing themselves as the measure of all things, and so are rather bad at learning from the policy experience of others.

[Read the rest at Skepticlawyer or a slightly revised version at Critical Thinking Applied.]

Saturday, November 5, 2011

Understanding history differently

This is based on a comment I made here.

The big divide between the Sceptical Enlightenment and the Radical Enlightenment is that the former believes in a constant human nature, so history provides lessons, and the latter believe in a malleable human nature (either in the sense of a "true" nature which is being horribly distorted or a "better" nature which can be created) so history has no lessons, it is merely a legacy of oppression and failure to be transcended. In the former, human reason discovers and (hopefully) acts upon those discoveries. In the latter, human reason (properly directed) can direct and transform human history. The Glorious and American Revolutions were Sceptical Enlightenment Revolutions, and succeeded. The Jacobin French Revolution (and its descendants) were Radical Enlightenment Revolutions, and so failed.

Mainstream economics is very, very Sceptical Enlightenment, since a constant human nature is taken as a fundamental premise. But something to keep in mind about radical critiques of economics is that such folk typically believe in malleable human nature--which is part of what offends them about mainstream economics: it "celebrates" things which (allegedly) block positive human transformation.

But one reads history very differently if one views human nature as constant than if you believe it to be malleable. ('Constant' meaning 'have enduring structures and patterns', even if beliefs, framings and expectations can vary widely--such as, between those who view human nature as constant and those who view it as malleable.)

Viewing human nature as malleable also leads naturally to demonisation of those who disagree (they are "blocking history") and massive discounting of existing human preferences (they are pre-transformation).

Which makes me wonder about the Euro project. Is it pushing the envelope of "transforming people"? Or are we in a form of Counter-Enlightenment, where faith, emotion & will trump reason? Maybe it is just a form of Machiavellian arrogance: create a structure which can only work with full political union so that people are driven to go all the way. Or possibly it is just the continuing consequences of a flawed conception of European history.

The profoundly differing implications of ideas about human nature is just a particularly powerful example of ideas having consequences.

Wednesday, November 2, 2011


Wikipedia claims that:
Contrary to popular conception, there is no evidence of a society or economy that relied primarily on barter.[2] Instead, non-monetary societies operated largely along the principles of gift economics. When barter did in fact occur, it was usually between either complete strangers or would-be enemies.[3]
It cites the work of two anthropologists (Marcel Mauss, The Gift: The Form and Reason for Exchange in Archaic Societies and David Graeber, Toward an Anthropological Theory of Value) in justification.

The claim is misleading. There was extensive trade, across long distances, in societies without money (which, in the world before printing, essentially meant before/without coins). This was so in hunter-gatherer/forager societies: there is evidence of long distance trade in Australia before European arrival, for example. It was even more so in agrarian societies. Thus the Khmer Empire had no coinage but the testimony of Chinese ambassador/commercial attache Zhou Daguan—the only eyewitness evidence we have for the Empire—is that there were vigorous markets and a significant foreign trade community.

It is perfectly true that gift-connections and guest-host connections could be very important in pre-money societies, but these were often implicit exchanges: a form of mediated trade. The almost universal arrangement in forager societies of men hunt and women gather was precisely such an implicit exchange. (The one known exception was a society where the foragers exchanged meat for the produce of the neighbouring farming society: so both men and women hunted and then traded—i.e. bartered—what they caught.)

Similarly, when Chinese sources talk of ‘tribute’ what they are often doing is reconstruing trade relations as an acknowledgement of Chinese superiority, of China being the “Middle Realm”. Notably in the exchange of horses-for-silk that was so central to the trade networks of Eurasia for so long.

The reason why rulers could introduce coins so successfully is precisely because there were already considerable barter-trading which coins make dramatically cheaper and easier. When Adam Smith wrote of:
a certain propensity in human nature … the propensity to truck, barter, and exchange one thing for another.
he was far more accurate than what Wikipedia™ is trying to claim.