Tag Archives: economics

measuring inflation is hard

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Measuring inflation is hard for a variety of reasons, and it gets even harder when you try to compare across countries and regions. Some of the reasons include methodological choices in averaging, weighting, how housing and transportation are accounted for, how urban and rural consumers are included, and many others. There is a measure called the Harmonized Index of Consumer Prices (HICP) that is used to try to compare across countries and regions. This differs from the U.S. CPI in a variety of ways.

mathy inflation hand waving headlines

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Breitbart headline: Wholesale Inventories Rose More Than Expected, Pointing to Even More Inflation Ahead

Okay Breitbart, but couldn’t an increase in inventories indicate that supply is starting to catch up with demand, which would put downward pressure on inflation? Or it could indicate a sudden drop in demand, which would also hopefully put downward pressure on inflation, although maybe not right away, which could lead to the dreaded “stagflation”. Either way, this headline is either stupid or intentionally misleading. Either the logical relationship is the opposite of what they are suggesting, or there is no relationship at all.

In the actual article,

Economists had expected many businesses to go into liquidation mode to rid themselves of unwanted inventories in the first quarter of this year. Indeed, declining or decelerating inventories were widely expected to be a drag on GDP as well as a moderating factor on inflation. Instead, inventories have been building faster than expected, which will likely force GDP expectations and inflation to rise.

Wholesalers act as middlemen between producers of goods and retailers. The business requires speculation about future demand. A rising wholesale inventory generally indicates expectations for robust demand from consumers for goods. It can go awry, however, if consumer spending is weaker than expected and wholesalers are left with unwanted stockpiles of goods. For this reason, economists watch the inventory to sales ratio, which remains at a historically low level that indicates wholesalers have not built up big piles of goods in compared to consumer activity.

Breitbart

Let’s try to follow this convoluted logic. I don’t see why declining inventories would put downward pressure on inflation, unless businesses are expecting a big slowdown in demand in the near future so they preemptively stop ordering goods. We hear speculation that inflation and interest rate hikes could trigger a recession, but businesses tend to react to economic fluctuations rather than gamble on what they think might happen. At the moment, both supply and demand are picking up, but demand is picking up faster and causing inflation.

Inventory to sales ratio is at a historic low – this again would suggest demand is picking up and supply is still struggling, triggering inflation. This is logical – and the exact opposite of the headline, which is completely illogical! People who read only the headline or only skim the text (probably most people) are going to get the exact opposite of the right idea. I am going to stamp this as naked propaganda and shame on Breitbart.

U.S. labor market growth

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Axios has a brief piece on the demographics of the labor force in the U.S. A tight labor market is not just a short-term phenomenon during the pandemic recovery.

In the 2010s, the massive millennial generation was entering the workforce, the massive baby bo0m generation was still hard at work, and there was a multi-year hangover from the deep recession caused by the global financial crisis. But now, boomers are retiring, millennials are approaching middle age, and the Gen Z that follows them is comparatively small.

Axios

So combine this trend with anti-immigrant politics, and we may have a problem. It could lead to the double-edged sword of higher wages and inflation, a trend toward toward greater automation and technological innovation, a general drag on economic growth (which could ultimately lead to deflation), left wing politics, right wing politics, business pressure for more globalization/offshoring, or some combination of any of these (other than inflation and deflation, but maybe it is possible to have a sudden reversal between these and hard for policy to react quickly even if we knew what to do). It is hard to know what to do, but rational immigration policies based on skills and education to fill jobs available would be a start.

supply, demand, and prices do not really exist

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This statement by James Galbraith makes my head spin a bit.

Just as Einstein had erased Euclid’s axiom of parallels, Keynes’s General Theory had long since obliterated the supply curves for labor and saving, thereby eliminating the supposed markets for labor and capital.

It followed that the prices of production were set by costs (mostly labor costs and interest rates), while quantities were determined by effective demand. Markets were not treated as if they were magical. It was obvious that most resources and components did not move under the influence of an invisible hand. Rather, they moved according to contracts between companies on terms set by negotiation, as had been the case for more than a hundred years. Technology was managed by organizations – mostly by large corporations – in what was sometimes called “the new industrial state.”

Project Syndicate

This is in a review of a book arguing that prices are really important. It’s a bit disturbing to me to think that there might not be a consensus among economists about how the economy actually works. We ordinary people can grasp theories like prices equilibrating supply and demand, and even how interest rates are related to the money supply and inflation, if we try really hard. But we assume the experts understand this stuff on a much deeper level, and that it is fundamentally science. If our understanding of civilization turns out to be based on pseudoscience, we might be in trouble.

the Simon-Ehrlich bet

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Paul Ehrlich has probably won his 1980 bet with Julian Simon in a number of parallel universes, according to this analysis:

Better lucky than good: The Simon-Ehrlich bet through the lens of financial economics

In 1980, Julian Simon and Paul Ehrlich bet on the future of natural resource prices as a vehicle for their public debate about mankind’s future. Simon ultimately won, and his victory has been used as evidence that innovation can offset material scarcity induced by human economic activity. But does the outcome of the bet truly suggest this? We recast the bet as a short-sale by Simon of Ehrlich’s portfolio of assets, allowing us to carefully analyze the choices made in the bet, including the resources chosen and their amounts and the period of the bet, conditioned on the information available to each man in 1980. We also investigate the role of randomness in the outcome of the bet. We find that, with careful portfolio construction, Ehrlich should win this bet more often than not, validating the age-old adage that it’s better to be lucky than good.

Ecological Economics

Does this mean that humanity as a whole is better off than we maybe “should be” on average? Hard to say.

the (thing everybody calls the) Nobel Prize in economics

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This year’s Nobel prize for economics, which we are supposed to call the “Sveriges Riksbank Prize in Economic Sciences”, is for a method of identifying natural experiments in data. The importance of this is to get over the “correlation is not causation” hump and actually be able to make some statements about causation. In my very simplistic understanding, you would find at least two data sets where at least two variables are correlated in one but not the other, and the state of the system they represent is roughly the same except for one other variable. Then you can infer that other variable had some role in causing the correlation or lack thereof. This is how you design an experiment of course, but in this case you are looking in existing data sets for cases where this occurred “naturally”.

That’s my simplistic understanding. Let’s look at how Nature describes it.

In 1994, Angrist and Imbens developed a mathematical formalization for extracting reliable information about causation from natural experiments, even if their ‘design’ is limited and compromised by unknown circumstances such as incomplete compliance by participants3. Their approach showed which causal conclusions could and could not be supported in a given situation.

Nature

It seems like this would have applications well beyond economics and social science. For example, ecology, and environmental science in general, where there are just so many variables and complex interactions that setting up randomized controlled experiments in daunting. (Although it can be done – in ecological microcosms, for example). It must have evil applications too of course, from advertising to politics.

What is infrastructure?

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This apparently is a political question. I am not an expert on all types of infrastructure, or a financial expert, but I am somewhat of an expert on urban water infrastructure. The definition of infrastructure I typically use is from the Statement No. 34 of the Governmental Accounting Standards Board: Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments. Here is how it goes:

As used in this Statement, the term capital assets includes land, improvements to land, easements, buildings, building improvements, vehicles, machinery, equipment, works of art and historical treasures, infrastructure, and all other tangible or intangible assets that are used in operations and that have initial useful lives extending beyond a single reporting period. Infrastructure assets are long-lived capital assets that normally are stationary in nature and normally can be preserved for a significantly greater number of years than most capital assets. Examples of infrastructure assets include roads, bridges, tunnels, drainage systems, water and sewer systems, dams, and lighting systems. Buildings, except those that are an ancillary part of a network of infrastructure assets, should not be considered infrastructure assets for purposes of this Statement.

GASB 34

This seems like as good a definition as any. So Biden’s proposed bill is really a capital assets bill. Which doesn’t have much of a ring to it. But neither did infrastructure, it’s a bizarre word that we’ve just been saying a lot so it has started to sound less bizarre. Capital assets, I learned in my undergraduate economics classes, are the economy’s food, and as it consumes them we have to add more just to keep the amount of them level (maintain, repair, rehabilitate, or replace when the time comes). We can increase economic output up to a point by adding even more capital assets to increase the absolute level, although there is such a thing as adding too much (looking at you, old Soviet Union, and possibly modern Japan), and we are almost certainly way below the point that would be too much. It makes total sense to borrow at a reasonable interest rate and invest in capital assets that will provide a return on that investment, and if you can borrow at no interest or even a slight negative interest rate, and you are below that optimal level of capital assets, warm up those printing presses! You can also, in theory, incentivize the private sector to make appropriate capital investments on their side. Investments in education, training, research and development then round out the investment in capital assets by providing the work force and capacity to innovate that set the stage for long term investment. Oh, and you want to try to do all this without irreversibly fucking up the atmosphere and oceans. Easy peasy!

What infrastructure is definitely not is only roads, bridges, and highways. That has been the limit of imagination of many of our elected officials when talking about infrastructure. So good for this administration for taking a more expansive view, and seizing the initiative. We’ll see if this is the one big thing this administration manages to get done in its two year “grace period”. Why do we have a system where we can only do one thing every 8 years?

what’s up with the U.S. dollar?

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The U.S. dollar has declined sharply against the Euro, a basket of major currencies, and gold since mid-May. What does it mean? I don’t know, you should ask the experts! But I’ll try to figure it out.

First, the actual numbers. The dollar has declined sharply, but the actual exchange rate at the moment is around the middle of a band the dollar has traded in since 2014 or so, and it has declined sharply during that time only to recover. So the fluctuations could be random about some long-term mean, or in response to events, but followed by a reversion to the mean with random fluctuations thrown in.

Second, the textbook answer to whether a strong (or weak) dollar is good or bad. All other things being equal (which they are not), investors would trade other currencies for U.S. dollars if they could get a better interest rate on U.S. dollars than on their home currencies. This might be the case in recent years, as interest rates have been low around the world, and even negative in Europe, but slightly higher in the U.S. All other things (including interest rates) being equal, investors in other countries would trade their currencies for U.S. dollars if they thought this was a safe place to put their long-term savings. Most governments (maybe the Swiss) don’t actually keep enormous vaults full of gold bars hidden under mountain fortresses any more. This has been exactly the case since the 1997 financial crisis, with developing countries and China in particular buying and stashing enormous quantities of U.S. dollars. This might be changing for a few reasons. China may be gaining more confidence in its own currency. Europe has decided to pull together and start backing its currency with EU bonds rather than just bonds from individual countries. Countries also have the option of holding baskets of foreign currency rather than just the U.S. dollar, and also the option of forming sovereign wealth funds with more diversification and potentially much higher returns than currency reserves alone. Finally, the long-term health and stability of the U.S. financial and political systems look shakier than they have in a century or so.

Third, is it good? It’s good for exporters, bad for ordinary people paying higher prices for things that have to be imported, maybe good for home-grown industry which could be more competitive with pricier imports. It’s bad for Americans living and traveling abroad, as I found out from personal experience, but that is a small fraction. So on balance, the main risk domestically seems to be price inflation, and that seems somewhat unlikely in the midst of a historic recession. Exploding debt and low or no growth for an extended period of time could lead to a problem making interest payments down the road, but we need to get through the current crisis before there is a long term to worry about.

modern monetary theory

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This might be the clearest explanation of modern monetary theory for the layman (like me) that I have seen so far. This is specifically in a developing country context.

Kaboub is an advocate of Modern Monetary Theory (MMT), an approach that views states as the source of money creation through the issuing of currency, and taxation as the destruction of that money supply. In this formulation, states do not use taxes to fund policies but rather create funding through issuing currencies, while taxation is used to curb inflation or disincentivize social practices that are seen as harmful, such as pollution or extreme inequality. MMT has grown increasingly popular among left-leaning politicians in North America and Western Europe, and is beginning to make its way into African political discourse as well.

Rosa Luxemburg Stiftung

Money is a store of value and a means of exchange, I learned in my one or two lectures on the subject in the 1990s. I’ve always wondered if you could separate the two by having one form of money that has an expiration date and one that does not. Of course you can – think of coupons or frequent flyer miles. If you need to stimulate the domestic economy, you can use the one with the expiration date. You would use the other in international trade, for retirement savings, etc. You would have to decide if you would let people pay taxes in the temporary currency. Businesses would have to decide if they are willing to accept the temporary currency, unless you forced them. An exchange rate would probably develop between the two forms of currency, unless you outlawed that. Prices and exchange rates could be volatile. New mutant forms of debt and derivatives would probably arise. Foreigners and corporations would speculate and manipulate unless you tried to stop them. Come to think of it, maybe there is a reason currency is the way it is and the status quo is hard to change.

revisiting the trophic theory of money

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One of my most popular posts ever is a brief musing about the “trophic theory of money” I wrote back in 2014. Brian Czech, who developed or at least clarified and named the theory, has a new journal article about it here. He writes pretty well for a lay audience so I would encourage people to read the paper rather than rely on me to summarize, but nonetheless here are a few key points in my own words so people can start yelling at me:

  • Before humanity figured out how to produce an agricultural surplus, everybody was trying to scratch a living out of the dirt and there was no need for money to be invented. Once the agricultural surplus became significant, many people were freed up to do other things and this led to money. So money is essentially measuring the amount of activity happening outside of agriculture, and indirectly measuring the amount of agricultural surplus that allows this to happen.
  • Towards the end of the paper, Mr. Czech acknowledges that improvements in technology over time (usually driven by intentional investment in research and development) have been able to reduce environmental impact per unit of economic activity, even though total environmental impact has continued to grow. However, he believes this process has nearly reached its limit and will not continue much longer.
  • It is possible the economy could transition to a steady state where GDP (adjusted for inflation) is no longer growing. It is also possible our environmental impact will overshoot the planet’s carrying capacity enough and for long enough that a sharp contraction in GDP (and necessarily, the amount of agricultural surplus) will occur.

Where do I stand on this? I take the laws of thermodynamics, and the fact that humanity is a species existing within and not apart from nature, as a given. I think there is a lot of knowledge out there yet to be discovered, and if our society took the right steps we might be able to keep growing in a sustainable way for some time. I don’t think there is any evidence that our sociopolitical system even understands the problem let alone is likely to take those steps. I don’t think action on the necessary scale will take place unless and until we reach a crisis stage. About the most positive I can be is to hope for a relatively minor crisis rather than a civilization ending one.