The Filter^

Tale of the day

This is exactly the sort of thing I can imagine myself doing.

Austrians and the Quantity Theory

A few fragmented thoughts...

• "Marget's deep conviction in, and spirited argument for, the Quantity Equation's system of conceptual organization arose precisely because it was capable of the disaggregated, individualistic, and subjective analysis of temporal process that has always identified the Austrian method." "Arthur Marget in the Austrian Tradition of the Theory of Money" by John B. Egger, The Review of Austrian Economics Vol. 8, No. 2

• One of the most interesting theoretical issues to emerge from the current financial crisis is that in some instances - such as quantitative easing - the distinction between monetary and fiscal policy appears slim at best.

• According to Alex Tabarrok:

One way of understanding the current recession is that V has fallen by a lot and it is dragging down Y (just as would a sharp fall in M).  We can counter with an increase in M (monetary policy) or by an increase in V (fiscal policy).

The problem with this is that V is not an independent variable!

• Dani Rodrik:

I agree that it is absolutely essential to separate the financial packages from the fiscal ones.  The former are essentially asset swaps, the spending effects of which, if any, are indirect.  The fiscal packages, meanwhile, are intended to spur spending directly.

This reminds me of the Bank of England's defence that their QE isn't the same thing as Zimbabwe QE:

Also - and crucially - the Bank has every intention of unmonetizing the debt when the storm is past

Again, can we stop using the word "intention" in the definition of economic policy????

Bryan Caplan asks: "But what exactly is "money velocity"?" My response would be that the concept of velocity is bizarre, but is really the inverse of the demand for money. What's the demand for money? The proportion of someone's assets that they wish to hold as cash. This makes sense to me. It's what I understand by the original Cambridge equation, and the way that Greg Mankiw explains the Quantity Theory in his textbook. When Bryan says

I think I have a better way to explain velocity.  Forget turnover.  Velocity is the inverse of the percentage of income that people keep in the form of money. 

...he's repeating what I considered to be the conventional understanding. I don't know whether Bryan's overstating his own originality, or if I'm missing a subtle nuance, but I notice Scott Sumner in the comments:

I always tell my students that V isn't really the velocity of circulation, but k really is the ratio of money to gross income.

Bonus

I'm intrigued by the furor surrounding the MOD bonuses. I suspect it's mostly an invention of the media, but following the issue of banker's bonuses there's something clearly controversial about a "bonus culture". Firstly, I think it's pretty ridiculous to criticise the compensation packages of people we know nothing about. I have no idea whether the MOD civil servants "deserve" their awards, but I know that comparing their salaries to frontline troops is virtually meaningless. By that standard we might as well point to the billions of people who live on less than a dollar a day, and dictate that no one in Britain should earn more than a £220 a year.

All I know is that the MOD bonuses are spread over a large number of people, and form part of their standing pay agreements (i.e. make up for base salaries that are lower than what they would otherwise receive). For this reason, coupled with my ignorance about what they really do, makes me ambivalent about the news.

But this does tap into a deeper issue. I'm similarly apathetic towards banker's bonuses, since I lack the knowledge of the specific people involved to judge whether they've deserved them or not. John Thain of Merrill Lynch sums up my views pretty well in this interview with Robert Peston (scroll down to 07:50 and start listening at 5min 20sec). His point is that Merrill is a big company with lots of different business units. The people in the departments that lost money have pretty much left, and it's simply impractical to not pay those who had nothing to do with the financial crisis and were engaged in profitable activity.

And this ties into the socialisation of wages that indicates where the hostility might stem from. In principle we should all be compensated based on our unique value creation. In other words, your manager should be able to distinguish between the contribution that you've made to the company, versus your colleagues. In reality most managers cannot do this. Partly because it's difficult to measure (companies require team production, after all), but chiefly because they don't understand their business. If you're reading this thinking I'm being idealistic, I disagree. You should be able to make pay decisions that are non-arbitrary and fair.

The outcome is that high value employees subsidise low value employees. It's no surprise that the company will fail to create wealth if they don't reward value creation.

Because managers usually take the easy route they reward based on things that are easy to measure - e.g. time. Most compensation packages are done in this manner. It's increasingly rare for people to have to clock in and out, but ultimately it's some notion of time that determines your perceived value. Fortunately academics like myself tend to be measured on other things. Whilst the teaching component of our salaries is almost entirely measured by time (e.g. classroom hours), the research component is more likely to be measured based on outputs (i.e. publications). This is why I'm an academic - I don't need to sit in a traffic jam every day, I am at liberty to spend the morning in my study, provided I have something to show for it (and blogging doesn't count).

Part of the hostility to bonuses is, I think, because they're usually used incorrectly. Either it's for overtime (i.e. you exceed your time measure), or it's an arbitrary prize driven by available resources. If the company turns a profit, the communal pot gets bigger. This might play an important role in terms of corporate culture, but employees will quite rightly point to the complete disjoint between their individual performance and the headline figures. If we tie individual pay to the company as a whole, why not outlaw all bonuses if the UK is in recession? This is why so many companies create business units (to capture local knowledge), but note that scaling down shouldn't stop until you reach the individual.

The real issue is whether different roles have systematically different costs of monitoring performance. I suspect that the higher up an organisation you are, the greater your leadership role, the easier it is to estimate unique value creation. Mainly this is because the profit of the business unit you lead is a decent measure. Therefore we'd expect people higher up an organisation to be more likely rewarded on performance (e.g value creation) than efforts (e.g. time).

The way I read this issue is that the majority of the general public associate bonuses with people above them in the corporate hierarchy, and thus part of corporate greed, state-building, the myth of leadership, etc. The bonuses that people tend to receive are arbitrary and detached from what they actually do. This is a failure of management. In an ideal world (or just an ideal company), all employees would see their compensation driven primarily through bonuses. The stigma of having open conversations about value creation and wages would disappear since people realise that such numbers are not purely an incentive mechanism, but a signal that reveals where the actual wealth-creation is taking place.

Time & recovery

I'm trying to reconcile the following. According to George Selgin:

The boom ends because relative prices have adjusted
The boom is unsustainable because factor prices eventually "catch up" to their GE values

Whilst in a wonderful post Mario Rizzo says:

Resources were misallocated. In light of the overexpansion of the housing sector and of other sectors sensitive to interest rates, the new equilibrium will be – for a while – at a point where there are fewer resources in these sectors

Is there a substantive difference between the way the two are using the concept of equilibrium?

Rothbard vs. Friedman

At a reading group the other night I made a comment about how the financial crisis might be seen as vindication of Murray Rothbard's pessimism about global currency exchanges versus Milton Friedman's more benign beliefs. In Chapter 7 of "What Has Government Done to Our Money" Rothbard says the following:

It is true that governments persisted in interfering with exchange fluctuations ("dirty" instead of "clean" floats), but overall it seemed that the international monetary order had sundered into a Friedmanite utopia. But it became clear all too soon that all is far from well in the current international monetary system. The long fun[!] problem is that the hard money countries will not sit by forever and watch their currencies become more expensive and their exports hurt for the benefit of their American competitors. If American inflation and dollar depreciation continues, they will soon shift to the competing devaluation, exchange controls, currency blocs, and economic warfare of the 1930s.

According to the IMF there have been 124 "systemic" banking crises since 1970, suggesting that the surprising thing about the 2008 credit crunch is not that it happened, but why such a regular economic phenomena has not happened in the US for so long. (I was even tempted to write "in the UK for so long" but as recently as 1992 we had our previous "meltdown"). The "global imbalances" explanation for the financial crisis is not seriously disputed, and for me that resurrects Rothbard.

November 9th, 1989

Berlin (March 2009).

In Defense of Capitalism & Human Progress: The Fall of the Berlin Wall and the Tyranny of the State by Richard M. Ebeling

It is worth recalling how and why the Berlin Wall was constructed in the first place, and what it meant in the great struggle between freedom and tyranny in the stream of 20th century political events.

via defenseofcapitalism.blogspot.com

LA conference 2009

A fortnight ago I spoke on "Banking, Honest Money, and the Free Market" at the Libertarian Alliance Annual conference. A video of the talk has now been released, and Brian Micklethwait has flattered me with some photos on his blog and a quotation on Samizdata. I've noticed other responses from Samizadata and Andy Janes. The survey results that I used in the talk are under embargo but I am happy to email them to anyone who is interested. Please email me.

laconf09, Anthony Evans: "banking, Honest Money and the Free Market" from Sean Gabb on Vimeo.

FT.com / Comment / Opinion - A fruitless clash of economic opposites

The “Keynesians” seem not to have studied Keynes and the neoclassicals misread or do not read Hayek. No wonder fallacies abound.

via www.ft.com

Stop telling me to cheer up

An Australian psychology expert who has been studying emotions has found being grumpy makes us think more clearly.

In contrast to those annoying happy types, miserable people are better at decision-making and less gullible, his experiments showed.

Introspectively, this makes sense.

New categories

Since we started this blog in 2004 most of my posts have fallen into a category labeled 'economics'. It's time to be a little more specific. In line with my three main areas of research, most of my posts will now be in one of the following categories:

• Management
• Monetary theory
• Sovietology

Broadly speaking, the first is microeconomics, the second macro, and the third institutional/constitutional. But that'll probably evolve.

Steve Baker - Wycombe candidate for the Conservatives

I have just heard that the Wycombe Conservative Association have chosen Steve Baker to be their parliamentary candidate at the next general election (see here for more details). This is very exciting news. I have known Steve personally for some time now, and we've been working closely to launch The Cobden Centre - a think tank devoted to banking reforms.

What strikes me most about Steve is his ambition. He is not a career politician and has a fascinating background with the RAF and computing. But the first time we met it was clear that he was dissatisfied with the current political system and intended to do something about it directly. Steve is the sort of person that sets a clear goal and then achieves it. It's therefore no surprise that he's found a constituency that want to back him, and that wants him to represent their views in Westminster. I think the people of Wycombe are very lucky to have him.

Although most politicians and commentators have come round to the view that the financial crisis was the result of an artificial boom caused by excess credit creation, Steve has systematically tried to understand the full implications of this. He is incredibly well read on this subject, and even manages to balance this understanding with the sort of pragmatism and sense of reality that academics like myself fail to get! Congratulations Steve.

I might have it wrong on legal tender

During the Q&A after a talk I gave at the LA Conference last Sunday (video, I believe, to follow), a discussion arose on legal tender laws. This is important to me because I advocated a repeal of legal tender laws as one of the three pillars of financial liberalisation in my recent Guardian Unlimited article. One of the commentators then raised a point on this that I didn't fully get, and the same issue arose last weekend - how important are legal tender laws.

My reason stems from a reading of Hayek's Denationalisation of Money - if legal privilege is associated with one particular currency then people don't have a choice. This inability to opt out means that there's no competitive pressure on the supplier of that currency, and all else equal they'll over inflate. Hayek therefore saw the legal tender laws as crucial: if you get rid of them and allow choice amongst different currencies, even if they're issued by governments, there is some competitive pressure to maintain the value of the currency. But there seems to be three separate stages of legal tender:

1. Currency that both buyers and sellers are obligated to use
2. Currency that sellers are obligated to accept, but buyers are not obligated to offer
3. No obligations regarding currency

What has been pointed out to me is that the UK at the moment (possibly in contrast to the US and the EU) is type 2 legal tender - whilst shopkeepers are obliged to accept sterling if it is offered, they can accept other currencies. I was aware of this - I believe Marks and Spencer are the most famous example of a company that routinely accepts non-sterling currency (in this case Euros) - and I'm sure many shops on the South Coast do likewise. I don't know if the same is true elsewhere in Europe.

So technically the UK can have parallel currencies, and perhaps I've under estimated the amount of currency competition that does exist. Underpinning all of this is the fact that the use of Euros to settle bills is not widespread, and Euros are subject to the same politicised problems as sterling, but from a Hayekian position maybe the repeal of legal tender laws isn't the panacea I thought it was.

Finally, whilst I was aware that the UK had type 2 legal tender laws, my bigger concern was the degree to which "obligation" is fluid. If companies are mandated to use sterling for tax returns, for example, this gives a massive "nudge" in the direction of the nationalised currency. Some people have argued that this will always be the case, but I'm not so sure. Many businesses use dual pricing, so why can't government accept different currency units?

To sum up, I need to give this a bit more thought, and I'm hoping others can jump in. I still feel though that there's a very simpe piece of legislation that would lead to where I want to be - private institutions being legally able to supply their own currency, and we the people having freedom to choose which to use.

Narrow banking, and other alternatives

I was interested to see Mervyn King advocate "narrow banking". At last the debate seems to be moving away from monetary policy, and towards monetary regimes. The Economist has a useful list of alternatives:

• Higher capital ratios
• Living wills
• Catastrophe insurance
• Higher fees for lender-of-last-resort service
• Windfall tax on bank profits

The problem with most of these are that they are piecemeal social engineering. I have no idea what the unintended consequences of any of these would be, and neither do their advocates. Rather than neat ideas (and borderline gimmicks) for particular policy measures, and reforms of the financial system need to be widespread and based on principles. Principles such as:

• No one is too big to fail
• No one can mis-match maturities without auditors approving it
• If people want their deposits to be safe, they should be safe

I find the notion of narrow banking intuitively sensible, however in practice I struggle to see how you'd divide "utility" and "casino" banking in a clear way. Ultimately these sorts of distinctions should be made by individual customers, not regulators. And whilst I wouldn't mandate this, I would like to think that in future banks would publish their reserve ratios in the financial newspapers, and customers would use these as one of a number of factors influencing where they deposit.

Update: Greg Mankiw links to a proposal by Laurence Kotlikoff and John Goodman for "Limited Purpose Banking". The original link seems to be broken but there is a discussion of it here.

More evidence for epistemic primacy

Firstly, to reiterate a point made by Jeff Friedman:

A study by Rüdiger Fahlenbrach and René Stulz [3] showed that banks with CEOs who held a lot of stock in the bank did worse than banks with CEOs who held less stock, suggesting that the bankers were simply ignorant of the risks their institutions were taking.

So all this talk about bonuses has the potential to be plain wrong. Maybe bonuses weren't the problem. In fact, maybe it wasn't primarily an incentive problem, but one of ignorance. Even The Economist is on to this:

Far from expertly manipulating their firms’ books, many could not understand them.

There's a really simple point here that no one seems to be grasping: the main cause of the credit crunch was the fact that we're not omniscient. Not bankers, and not regulators. And like it or not, a policy-solution is forced to assume that we are.