a thread in which ilx interprets economics and finance, sometimes linen by linen*, and disagrees a lot (probably)

Haven't got to the end of this piece though you could possibly insert a few funny phrases and...maybe it could work in a novel.

This is a solid critique of Diamond-Dybvig. Firstly, the Nobel Committee got the model's central insight wrong. Secondly, even if that flaw is fixed, the model still has no relevance to modern banking!https://t.co/YniFNjf10t

— Rethinking Economics (@rethinkecon) October 21, 2022

Either way lowering interest rates when there is high inflation runs counter to orthodoxy, right.

I don't believe there is an accepted model of inflation in mainstream economics, in the sense that everyone agrees on what factors affect it and to what degree, like in the form of a mathematical formula. It does seem fairly widely accepted though that in "normal times" raising interest rates lowers inflation and vice versa. However, there are famous counter-examples, such as the recent experience of central banks lowering interest rates to even negative numbers in an effort to generate inflation which failed to materialize.

hi teenwolf's dad

I'm confused about Erdogans continued policy of lowering interest rates as inflation increases. The oft-given reason given of 'Islamic economics' seems unconvincing. Other reasons given are aims to reduce unemployment, and reduce bond yields.

Either way lowering interest rates when there is high inflation runs counter to orthodoxy, right. So where does this end up, is there a rabbit to be pulled out of the hat here in the next 6 months or so?

― anvil, Friday, October 28, 2022 12:34 AM (one hour ago) bookmarkflaglink

yes, it's extremely unorthodox. however, there is one quasi-orthodox-adjacent theory that recommends cutting interest rates to fight inflation: neo-fisherism

it's kind of a weird theory and doesn't really have any contemporary proponents. for a brief period during the econ blogosphere era it was associated with Steve Williamson and John Cochrane, but i believe both have renounced or distanced themselves from it (at least, i haven't seen either of them cheer on Erdogan's policies recently—though here's a video of Williamson on Bloomberg TV defending Turkey's monetary policy back in 2018)

i'll try to explain the gist of it

neo-fisherism derives from a relationship known as the "fisher equation" (after Irving Fisher) which states that the nominal interest rate equals the real interest rate plus expected inflation

the real interest is the return on investment in units of goods (as opposed to prices denoted in dollars). i.e., if i invest 10 linens today, in a week i get 11 linens back, real interest rate is 10%

expected inflation is the expected rate of growth of prices. i.e., i expect that linen will cost 2% more in dollars next week

the fisher equation says that if the real interest rate is 10% and the expected inflation rate is 2%, then the lowest nominal interest i would agree to is 12%. if i lend you 10$, you need to promise to give me at least 11.20$ next week.

the fisher equation is a "no arbitrage" condition. if i had the option to invest in linen at the real interest rate of 10% or to buy a bond at a nominal rate of 13%, then i could get a risk-free profit by exploiting the difference in prices. no arbitrage assumes prices have adjusted so that all such risk-free profit opportunities exist. when the fisher equation holds, i am indifferent between investing in linen and buying the nominal bond

the fisher equation holds in the data very robustly over the long run. the neo-fisherian proposition, however, comes from interpreting the fisher equation causally. the central bank manipulating nominal interest rates to be lower will reduce inflation

my understanding is that it is somewhere in the jump from "a pattern that holds in the long-run" to "a manipulable relationship policymakers can exploit" that things fall apart

it's also not entirely clear just how wrong neo-fisherism is. japan has had rock bottom rates and under-target inflation for decades. episodes like the volcker shock would seem to reject it, but central banks at that time didn't target nominal interest rates directly. turkey's experiment is probably the strongest evidence against it

mainstream academic macro has mostly not engaged with neo-fisherism. there are two exceptions i'm aware of that published in top journals

one is a paper by leading new keynesian macro-economist Michael Wooldridge. the idea is to study the "stability" of the neo-fisherian equilibrium when people in the economy don't immediately converge on the correct values of future prices. rather than have "perfect foresight", they have to grope around, guess, adjust, etc. it turns out that neo-fisherism is very sensitive to the slightest relaxations of perfect foresight

the other is an empirical paper by Martin Uribe. the paper makes the distinction between transitory (short-term) increases in nominal interest rates and permanent (long-term) changes. transitory increases should have negative short-term effects on inflation, but no long-term effect. permanent increases should have positive long-run effects on inflation (consistent with the fisher effect). the author does some sketchy macro-econometrics (nothing against his technical skills, but macro-econometrics is a fundamentally sketchy endeavor) and finds this to be the case in the data

for the most part, people ignore it and think anyone who believes it is a bit crazy

Interesting to see this thread developing. I wasn't understanding it well back when Mark S was talking, charmingly, about Quality Street, so I would probably understand less now.

It does seem like the meta-issue is how something seemingly so important, which ought to refer logically to real things we can recognise, is so incomprehensible.

But then lots of idioms that try to describe reality are, to me, also incomprehensible - most of science for instance.

if/when i have time my plan is to continue to drag at least certain topics towards small attempts at pinefox-friendly translation! (i hope others also attempt this, including ppl far more deftly familiar than me with the rebarbative topics at hand)

i also plan to explore why such translation often fails and what's going on when probably needful jargons congeal into multiple alienating monoliths

I am reminded that I actually read Lanchester's LRB short cuts on the mini-budget yesterday. It was full of swearing and blokeishness, in the Lanchester way I do not like. But again, overall, I did not comprehend it.

pinefox it could be fun if you'd c/p some stuff you read and didn't understand into the thread and ppl can try to talk about it in plainest terms

It does seem like the meta-issue is how something seemingly so important, which ought to refer logically to real things we can recognise, is so incomprehensible.

the level of economics which is recognizable to someone based on their day-to-day experience is a very small part of what economics considers. most people only have to make decisions about how they spend their time and deal with their personal finances. there is a part of economics that is concerned with this, but it's small--and arguably a bit boring

most of economics implicitly takes the perspective of a government setting laws and regulations, or a central bank setting interest rates

unlike an individual person's day-to-day choices, the choices of these large systemic actors will affect all aspects of the economy, and taking these into account requires thinking about all kinds of concepts that just don't matter to an individual person

if i buy 4 yards of linen or 5, that won't have any effect on the price of linen. but if the government imposes a tax on linen, it'll affect the price of linen, the price of other goods similar to linen, the wages of workers who are employed making linen, and so on, in ways that are hard to predict or discern ex post

it's a pretty unnatural and alien point of view to anyone imo. i don't think one should expect their day-to-day life to give them insight or intuition into how it works

FDIC insurance is $250k (per account w/ limits

this is why a lot of affluent people in the US (at least back in the early 2000s, most of these were also old people, so idk if this is still a thing) would have accounts at many banks, so they can have the FDIC insurance on all of their income.

unlike an individual person's day-to-day choices, the choices of these large systemic actors will affect all aspects of the economy, and taking these into account requires thinking about all kinds of concepts that just don't matter to an individual person

idk there are certain aspects of economic policy (e.g. tax policy) that have moral/ethical assumptions built into them, as well as making moral/ethical judgments. These things definitely affect an individual's day-to-day choices and they do kinda matter, if the person were to think about it, or be in a position where they had to think about it?

I'm only interested in individual persons. All the markets, the political managers who make hideous macroeconomic decisions subservient to the markets - that ultimately impoverish or kill millions of people, the billionaires that own them - they all need to be liquidated in a BIG death pit. Along with all the hideous posh wanker think-tank ghouls who constantly speak like this is the only way to manage economies.

idk there are certain aspects of economic policy (e.g. tax policy) that have moral/ethical assumptions built into them, as well as making moral/ethical judgments. These things definitely affect an individual's day-to-day choices and they do kinda matter, if the person were to think about it, or be in a position where they had to think about it?

i 100% agree w this and didn't mean to imply otherwise

the decisions policy makers make affect people's day-to-day lives/choices, but for the most part any individual normal person's day-to-day choices don't affect the broader economy. so the choices people make in their own lives are different from the choices governments or central banks make, in the chains of cause and effect they have to consider

Poster flopson: since you asked:

I didn't understand this:

Under normal circumstances, the fall of sterling would have limited immediate consequences for most citizens. (Big stress on ‘immediate’.) Bad news if you’re going on holiday, and likely to lead to higher interest rates in the undistant future, but not a systemic crisis. What was different this time was that thanks to innovations in the UK pension system, pension funds were exposed to derivatives risks linked to UK bond prices.

Or this:

During QE, the government printed electronic money and used it to buy back its own bonds – that is, its own debt. That made the price of bonds go up, which in turn made the yield on bonds – the interest rate, in effect – go down. This policy had upsides and downsides. One principal criticism of QE has always been that it would be difficult to undo. The bank’s plan was – officially, still is – to divest itself of £80 billion of QE-bought bonds a year. But now the bank is overwhelmingly likely to raise interest rates. A crash in the currency is a sign that people don’t want to invest in your country. Unfortunately, the government needs to borrow money to pay its bills. To get doubters to lend you money, you have to pay them more – and when you raise interest rates that’s effectively what you’re doing. It’s the opposite of buying your own debt; the opposite of QE, which makes interest rates go down.

same

if you folks don’t mind me adding: i think i lack even just the most primitive understanding of how bond markets work. i know that they are essentially loans. governments can “issue” bonds. the buyers of these bonds are either private individuals, or investment firms, or pension funds, or whatever. and the reason they’re buying them is because after a set period of time they will get back the money they paid for them plus an agreed percentage (the bond’s “yield”). what i don’t understand is how the yields can fluctuate. i thought when you bought the bond it came with a guarantee on its yield. if it’s a 5-year bond the yield will be (x). which is why bonds are safer than stocks, whose prices can rise and fall on the basis of, like, what elon musk happens to be tweeting that day. but during the truss debacle people were talking about bond yields changing by the minute! so.. what is that about?

i THINK the answer is: all of that is right, but: people can buy and sell bonds they hold, and the price they're buying and selling can certainly change based on demand etc. and if the price goes up, the yield, in effect, goes down.

I THINK

Casino economics!

I have trouble formulating my basic question coherently, but it think it is:

what is/are 'the markets'?

With sub-questions:

- do they really give an instant reaction to political decisions that is easily interpreted/understood?
- how free are we politically to develop policies that 'the markets' don't like?
- do/does 'the markets' understand long-term policies or are they always focussed on immediate actions.
- can you develop a coherent economic policy if you have an instant market judgement each day?
- do 'the markets' understand that without some kind of net zero/sustainability policy, economies are likely to collapse in the medium/long term?

I agree with poster Schlosser. I do not know what 'the markets' are.

in the old days the "markets" were the various big-city stock exchanges -- the london stock exchange, the new york stock exchange, the tokyo stock exchange -- where sellers physically gathered duting opening hours to find ppl who wd buy what they were selling*, and buyers gathered to find ppl who selling what they wished to buy. different spaces focused on different kinds of ware (hence markets)

there's a scene in the film trading places which gives you sense of such a space (hubbub verging on hell: one of the villains literally has a heart attack)

from the late 19th century some of the buy and selling switched to the telephone and a layer of stock brokers came to the fore who had the requisite knolwdge of prices and relevant movement of prices and (for a fee) handled the exchanges in question, at which point the "markets" began to move off into a virtual and even a conceptual space, and also an ever more unified and connected space

in the digital age the physical element is no longer especially of consequence: the markets take place on-line and never really sleep (the nikkei is awake when london sleeps and vice versa) and tho human stockbrokers still play a role, many active brokers are now basically robots and algorithms programmed to repond to minute fluctuations: again different "types" of market can still respond in different ways but they are ever more tighly integrated -- asymptotically we are always approaching just one single cap-M market (and the smaller, specifics-dedicated markets are no longer able to behave untouched by the activity of the single cap-M market)

*(commodities in paper form akak stocks, bonds etc, rather than actual barrels of apples or whatever)

tl;dr: *a* market is any space where buying and selling is happening, "the market" is the (still perhaps imagined, or anyway not-yet-measurable) totality of all buying and selling, "the markets" is the sum of the first as it tends towards the second

like it.

and if the price goes up, the yield, in effect, goes down.

literally every single wall street journal article mentioning bonds in any way explains this, usually in a parenthetical, seemingly as a point of style. v funny imagining the stereotypical business-minded wsj reader constantly having to be reminded of this, each morning, how does it go again, a moment of blank panic, oh right.

Pertinent to this is that many trades are automated and rely on computers being able to get the jump on other computers by a few nanoseconds. This article probably won't help the pinefox but illustrates how high stakes these are https://www.wsj.com/articles/high-frequency-traders-push-closer-to-light-speed-with-cutting-edge-cables-11608028200

*(commodities in paper form akak stocks, bonds etc, rather than actual barrels of apples or whatever)

I don't think I understand this.

I have heard about the high electronic speed of trading via articles by Donald Mackenzie in the LRB. But I usually didn't get to the end of the articles.

literally every single wall street journal article mentioning bonds in any way explains this

I note this, but, not having read the WSJ, I don't understand it, though I think I have also seen it mentioned in the UK press.

*(commodities in paper form akak stocks, bonds etc, rather than actual barrels of apples or whatever)

just that if you turned up unannounced at shrewsbury markethall with a barrel of apples you probably could set up a stall and sell them but if you turned up at the stock exchange with a barrel of apples you would probably be chased away by a policeman: what's for sale at a stock exchange is basically documents -- and stocks, bonds and so on are (or were) objects made of paper, tho in the digital age this may be less the case

(akak is a typo for aka viz "also known as", which didn't help clarity i agree)

amazing explanatory post, mark s!

if i remember right, the 'grain' chapter of William Cronon's Nature's Metropolis tells a pretty engaging tale of the birth of large-scale modern-ish commodity and 'futures' trading, situated in late 19th century Chicago. pretty amazing book overall IIRC (it's been 7-8 years and i definitely binged it).

FWIW, i took dlh's "literally every single wall street journal article..." remark as the beginning of an (imo amusing) meditation on the nature of that explanation appearing so frequently in the publication. in other words, this all highlights how normal and reasonable it is that anyone here wouldn't understand it - people who read the WSJ regularly aren't expected to recall it from the last time it got pointed out.

xp - Frank Norris' "The Octopus" deals with a similar subject and is situated around the same time. Also, around that time was the conceptual beginnings of the Federal Reserve Bank in the U.S. ... I forget the name of the book I read a year or so back that was a really good history of the Federal Reserve and what America was like before central banking.

I started to reflect that rather than attempting something like Blakeley (I gave up) I should try something like, say, an A-level Economics book. But would I understand that? Actually, no. Maybe there is a lower level - Economics for age 12, or something.

IIRC Animal Spirits was approachable and interesting in general and in terms of understanding (1) the 2008 recession and (2) challenges within economics as a discipline.
https://press.princeton.edu/books/paperback/9780691145921/animal-spirits

https://www.investopedia.com/terms/b/bond.asps

xp - in terms of the 2008 recession, that youn mentions, another possibly good recommendation for pinefox is "Diary of a Very Bad Year" (published by n+1) -- basically it's conversations between a hedge fund guy and a literary person interviewing him.

DC is correct re my post yes, sorry if thrust appeared to be “well no shit, don’t you read the wall street journal”

I doubt there is any simple way to interpret finance to pinefox or the rest of us, apart from a few of the most basic ideas. there are far too many different kinds of financial instruments, with new ones being invented constantly, each one with their new bits and bobs of intricacy, designed to squeeze out a bit more profit or shift a bit more risk away from the issuer. to an outsider like me it looks much like chaos.

For those interested, there’s a couple podcasts/YouTube channels that will help suss out the history and convoluted development of capitalism & economics, and also point out the deficiencies in Graeber & Wingrowe’s analysis.

-Derick Varn’s VarnVlog - https://varnvlogvoice.buzzsprout.com/
-What is Politics? - https://podtail.com/podcast/what-is-politics/
-The Regrettable Century - https://regrettablecentury.buzzsprout.com/

Specifically this one: https://www.youtube.com/watch?v=rbz4iAOzc7g
—
Also, this essay by History Prof Chris Wickham:

Chris Wickham, THE OTHER TRANSITION: FROM THE ANCIENT WORLD TO FEUDALISM, Past & Present, Volume 103, Issue 1, May 1984, Pages 3–36

(Those shows all handle things from more of a Marxist, anthropological one, rather than say an anarchist one)

what i don’t understand is how the yields can fluctuate. i thought when you bought the bond it came with a guarantee on its yield. if it’s a 5-year bond the yield will be (x)

OK, I'll bite. The fixed yield that you're referring to, the one that is set when you buy the bond, doesn't fluctuate. It stays fixed for the life of the bond. But that's not what people in the market mean when they talk about yields fluctuating. The fixed payment that you are guaranteed to receive is usually called the "coupon" (since in the very old days it was literally a paper coupon that you clipped off of your bond and exchanged for your interest payment). Perhaps the easiest way to think about yield is that it's the going coupon for new bonds sold today. If yields are going up, that means people now expect a higher coupon on a newly purchased bond than they did yesterday, and bond sellers must offer that higher coupon if they want their bonds to sell.

gotcha

Pretty sure I could still draw the Perfect Competition diagram, and explain the Laffer Curve. I’m just showing off.

Economics/finance is a massive blind spot for me too. I've been trying to understand central banks, and if I've got this straight, they can just print as much money as they like, when they like - ie, for quantitative easing they are basically buying government debt and paying for it by magicking up money out of thin air. Obviously this puts more money into circulation, which leads to inflation. But why is inflation such a bogeyman, why isn't it just a zero sum game? Let's say for example that instead of taxing people, governments simply printed the money they needed. Yes, this would lead to massive inflation, which would diminish the value of people's money. But at the same time, people wouldn't be paying tax and the extra money they had would compensate for the reduction in the value of the currency. Wouldn't it? I guess not, or all governments would be doing this!

i think you are in a prime position to read about modern monetary theory! https://en.wikipedia.org/wiki/Modern_Monetary_Theory

Thanks for that, interesting! I find the whole idea of fiat money fascinating - it's like a collective illusion or something, it only exists because people will it into existence...

no different than the gold standard - an arbitrary rock that people collectively will into believing has value

But why is inflation such a bogeyman, why isn't it just a zero sum game? Let's say for example that instead of taxing people, governments simply printed the money they needed.

it's a great question. some level of inflation actually is desirable

one reason why is that deflation is very undesirable as it leads to a "deflationary spiral": if consumers anticipate that prices will be lower tomorrow, they will delay purchasing, this then lowers demand, causing prices today to fall further, with causes firms to layoff workers and incomes to fall, which makes demand falls further, and so on. a positive inflation rate provides a "buffer" against deflation. this is especially important over the business cycle since prices tend to fall at the onset of a recession. during the early period of the great depression prices fell by something like 7% every year. central banks nowadays try really hard to avoid this

another reason is that monetary policy becomes ineffective at the "zero lower bound". nominal interest rates can't go (far) below zero (since at some point it becomes profitable to store cash under your mattress rather than buying bonds), which blunts the ability of central banks to stimulate the economy through rate cuts. a higher inflation rate pushes the economy further from this point

there has been a discussion over the last 10+ years about the fed increasing its inflation target for exactly these reasons. there's lots of speculation today that rather than aim to get inflation back to its previous target of 2%, the fed may "settle" at a new permanent higher rate of 3% or 4%

what's usually undesirable isn't inflation itself, but accelerating inflation, or more generally unstable inflation. in theory any given level of inflation should be "neutral" in the way you describe as long as it is stable

accelerating or unstable inflation can be a problem because it increases uncertainty in the economy, which is usually a bad thing. one way this manifests is that at the margin a higher baseline level of uncertainty will make people invest in safer (usually lower return) assets rather than riskier (higher return) ones

unstable inflation can also create lots of arbitrary and unequally distributed costs. many contracts are either written in nominal terms (i.e., no inflation-adjustment, or the inflation adjustment is only updated irregularly) and so people who signed a contract with an ex post low inflation indexation will get large wage cuts if inflation surges

How did I miss this thread for the last week??? Need to catch up.

Thanks flopson, that all makes sense - I can see that accelerating and unstable inflation is destructive, and maybe inflation in inherently unstable. But if it's possible to take that out of the equation - and maybe it isn't - then it seems to me that inflation is still the zero sum game, where value is transferred from people holding money to governments, or to people holding debt or other assets - but the value itself is not destroyed.

As for the gold standard being the same as fiat currency in terms of people willing it to believe it has value - I don't think that's quite right. Gold has an inherent scarcity value that fiat money doesn't. Governments can simply print more money, but you can't just print gold - you have to buy it or dig it up from the earth. Also gold has a use value (or did more obviously so when it first became a currency) because it has an aesthetic value as decoration.

Gold has an inherent scarcity value that fiat money doesn't.

okay yeah, but what you're saying is that humans value scarcity, not gold. for example, at various points in history people have valued cowrie shells, or wampum, on a similar basis to gold, believing these items to be similarly scarce. and governments can artificially create scarcity too - by just not issuing too much money. or, to put it a different way, to only make one entity (the government) capable of issuing money, and carefully regulating that process.

Also gold has a use value (or did more obviously so when it first became a currency) because it has an aesthetic value as decoration.

aesthetic value not limited to gold! why gold and not other items that had aesthetic value at the time? perhaps you mean some other property of gold? and what of non-western societies that were never on the gold standard?

flopson, I don't have an interesting econ question, but I am vulgarly interested in whatever juicy academic econ beefs various schools or luminaries have with each other, but the only thing that I've subconsciously absorbed from popular media is that the chicago school is some kind of abstract jerk generator, and that the behavioral economists think the non-behavioral economists are peddling scientology bracelets (or is it vice versa?), but as for professional talking-to-the-media economists, they all seem pretty polite and deferential to each other.

What's the inside scoop? Are there secret vicious twitter beefs between Ha-Joon Chang and Tyler Cowen we don't know about? Bitter school rivalries that only reveal themselves at seedy invite-only parties after conferences?

re: intrinsic properties of gold, just want to chime in to say that (like other precious metals) gold is extremely resistant to oxidation

Yeah I accept that there's an arbitrary quality to the gold standard - why gold and not cowrie shells - but ultimately it still constrains money as something that the issuer promises to exchange for an actual thing. With fiat money, there's no 'thing' at the bottom that the system is based on. It's just a lot of people agreeing to accept that a complete abstraction has value, so it seems to me to be on a different conceptual level.