Category Archives: Economics

How the Fed Let the World Blow Up in 2008

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The Fed transcripts have been released. What was going on inside the Fed was actually worse than we thought. No, they didn’t have a time machine to see exactly how bad it would be, but some members had read their history and argued for action. Sigh. And it gets worse, as the Fed continues the tight money policy into 2009. Matt O’Brien writes: 

…But the Fed was blinded. It had been all summer. That’s when high oil prices started distracting it from the slow-burning financial crisis. They kept distracting it in September, even though oil had fallen far below its July highs. And they’re the reason that the Fed decided to do nothing on September 16th. It kept interest rates at 2 percent, and said that “the downside risks to growth and the upside risks to inflation are both significant concerns.”

In other words, the Fed was just as worried about an inflation scare that was already passing as it was about a once-in-three-generations crisis.

It brought to mind what economist R. G. Hawtrey had said about the Great Depression. Back then, central bankers had worried more about the possibility of inflation than the grim reality of deflation. It was, Hawtrey said, like “crying Fire! Fire! in Noah’s flood.” 

Note the discussion re Milton (and Scott Sumner), that you can’t judge easy money by short term rates. Here’s Scott Sumner on Matt O’Brien on the Fed’s mistakes during 2008 

…A few comments:

1. The flawed monetary regime (failure to level target NGDP) made these seemingly small tactical errors in mid-2008 much worse than they would otherwise have been.

2. I am pretty sure Matt is not a market monetarist, or at least he’s more Keynesian on issues like fiscal stimulus than I am. Thus it’s heartening to see the MM interpretation of 2008 become increasingly accepted by the mainstream press. When people like David Beckworth and I were starting out on this crusade, the notion that excessively tight money was the problem was almost laughed off the stage. ”Interest rates were 2%, how can you claim money was tight in 2008?” Now the MM narrative is becoming increasingly accepted in the media. That’s great news.

3. Elsewhere Matt praises Frederic Mishkin. He also directed me to a Hilsenrath piece that said Mishkin came off looking relatively bad in the transcripts. But Hilsenrath was focusing on Mishkin’s jocular style. If you look at content of his analysis he was ahead of most of his colleagues. (In terms of forecasting Rosengren seems to have been the best.) I did a post over at Econlog a few days ago praising Mishkin’s farewell comments, but forgot that he had been equally brilliant at the final meeting of 2007.

More from Scott Sumner here:

The market monetarist view that tight money caused the recession is getting some play in the press. Here’s an excellent piece by Ramesh Ponnuru:

There’s another view of the Fed’s role in the crisis, though, that has been voiced by economists such as Scott Sumner of Bentley University, David Beckworth of Western Kentucky University and Robert Hetzel of the Richmond Fed. They dissent from the prevailing view that the Fed has been extremely loose since the crisis hit. Instead, they argue that the Fed has actually been extremely tight, and that when its performance during the crisis is measured against the proper yardstick, the central bank emerges as the chief villain of the story.

In the second half of 2008, housing prices, many commodity prices, inflation expectations and stocks all suggested deflation was coming. Fed officials, though, kept talking about backward-looking measures of inflation that made it look high. Their hawkish pronouncements effectively tightened monetary policy by shaping market expectations about its future direction. In August 2008, the Fed minutes explicitly said to expect tighter money. Even after Lehman Brothers Holdings Inc. collapsed the following month, the Fed refused to cut rates and fretted about inflation (which didn’t arrive). A few weeks later, the Fed decided to pay banks interest on excess reserves, a contractionary move. Only then did it cut interest rates.

If a state becomes Bitcoin-friendly, it will see a huge increase in companies

Interesting Bloomberg story: State-level regulations are coming for Bitcoin and “the devil take the hindmost”.

California and New York, home to Silicon Valley and Wall Street, are preparing to write rules of the road for entrepreneurs driving a surge of interest in Bitcoin and other virtual currencies.The outcome could determine how big a threat Bitcoin poses to established payment companies including JPMorgan Chase & Co. and Visa Inc. as well as where venture capital and talent converge to form a geographic hub for U.S. startups.“If a state becomes Bitcoin-friendly, it will see a huge increase in companies,” said Adam Ettinger, an attorney with San Francisco-based Strategic Counsel Corp., which advises technology investors. “That will mean the brightest minds working on some of the most innovative payment technology we’ve seen in awhile.”Bitcoin, a five-year-old protocol for issuing and moving money across the Internet, has gained traction with merchants selling everything from Sacramento Kings basketball tickets to kitchen mixers on Overstock.com. Venture capitalists see promise in it as an alternative to the global payment system currently dominated by companies including Visa, Western Union Co. (WU) and large banks.

 

How average is perceived as being over

Tyler Cowen

If you actually take a close look at the numbers, it turns out that of the people who identified as middle class in 2008, nearly a third of them now identify as lower middle or lower class.1 This is even more dramatic than it seems. Class self-identification is deeply tied up with culture, not just income, and this drop means that a lot of people—about one in six Americans—now think of themselves as not just suffering an income drop, but suffering an income drop they consider permanent. Permanent enough that they now live in a different neighborhood, associate with different friends, and apparently consider themselves part of a different culture than they did just six years ago.

There is more here, from Kevin Drum.

 

Marc Andreessen: why Bitcoin matters

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What technology am I talking about? Personal computers in 1975, the Internet in 1993, and — I believe — Bitcoin in 2014.

This may not be the best essay on Bitcoin, but it is definitely the best essay that I have read. Because I respect Marc Andreessen I pay attention when he decides to write publicly. And when I see that Andreessen Horowitz has invested nearly $50 million in Bitcoin-related startups, that gets my completely focused attention.

Media coverage typically talks about much the value of a Bitcoin has risen (or fallen). Or how Bitcoin is a vehicle for buying drugs and guns. I think you will better understand the significance of Bitcoin by thinking of a fraud-free VISA payments system with nearly zero fees and no minimum transaction. That creates possibilities. Once the infrastructure is in place Bitcoin will enable many possibilities that are way beyond a no-fee VISA. Here’s just one of Marc’s many cases: Remittances. The hard-working people who picked your strawberries are sending cross-border remittances to their family. A big chunk of the funds sent (order of magnitude 10%) is lost to bank-fees and funds-transfer agents. A Bitcoin-based payment system will drop that 10% fee to nearly nothing. That will have a huge impact on the workers’ welfare.

Andreessen summarizes why Silicon Valley is “all lathered up”:

The practical consequence of solving this problem is that Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate.

What kinds of digital property might be transferred in this way? Think about digital signatures, digital contracts, digital keys (to physical locks, or to online lockers), digital ownership of physical assets such as cars and houses, digital stocks and bonds … and digital money.

All these are exchanged through a distributed network of trust that does not require or rely upon a central intermediary like a bank or broker. And all in a way where only the owner of an asset can send it, only the intended recipient can receive it, the asset can only exist in one place at a time, and everyone can validate transactions and ownership of all assets anytime they want.
(…)
Bitcoin is an Internet-wide distributed ledger. You buy into the ledger by purchasing one of a fixed number of slots, either with cash or by selling a product and service for Bitcoin. You sell out of the ledger by trading your Bitcoin to someone else who wants to buy into the ledger. Anyone in the world can buy into or sell out of the ledger any time they want — with no approval needed, and with no or very low fees. The Bitcoin “coins” themselves are simply slots in the ledger — analogous in some ways to seats on a stock exchange, except much more broadly applicable to real world transactions.

The Bitcoin ledger is a new kind of payment system. Anyone in the world can pay anyone else in the world any amount of value of Bitcoin by simply transferring ownership of the corresponding slot in the ledger. Put value in, transfer it, the recipient gets value out, no authorization required, and in many cases, no fees.

That last part is enormously important. Bitcoin is the first Internet-wide payment system where transactions either happen with no fees or very low fees (down to fractions of pennies). Existing payment systems charge fees of around 2 percent to three percent — and that’s in the developed world. In lots of other places, there either are no modern payment systems or the rates are significantly higher. We’ll come back to that.

Bitcoin is a digital bearer instrument. It is a way to exchange money or assets between parties with no preexisting trust: a string of numbers is sent over email or text message in the simplest case. The sender doesn’t need to know or trust the receiver or vice versa. Related, there are no chargebacks — this is the part that is literally like cash — if you have the money or the asset, you can pay with it; if you don’t, you can’t. This is brand new. This has never existed in digital form before.

Bitcoin is a digital currency, whose value is based directly on two things: use of the payment system today — volume and velocity of payments running through the ledger — and speculation on future use of the payment system. This is one part that is confusing people. It’s not as much that the Bitcoin currency has some arbitrary value and then people are trading with it; it’s more that people can trade with Bitcoin (anywhere, everywhere, with no fraud and no or very low fees) and as a result it has value.

If you give your attention to Marc’s essay for 30 minutes I think you will understand why his firm is actively seeking Bitcoin-related opportunities. Oh, I hear that Amazon will launch a Bitcoin payment window soon. Just kidding, but think about how skinny Amazon’s margins are – and the impact on profits when the 2 to 3% credit card fee goes to 0.01% for purchases by Bitcoin customers. Think about the network effects when Amazon starts accepting Bitcoin.

 

George Shultz: Achieving a Better Future

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Today I listened to George Shultz's July 23rd conversation at the Commonwealth Club (audio). This was my second review of this talk and Q&A. Soon I will listen to the podcast a third time, but after I have finished reading his 2013 book on these topics: Issues on My Mind: Strategies for the Future.

True wisdom is a rare commodity, and usually expensive to acquire (because it often accrues from mistakes). If you can learn from the wisdom of other, then I recommend as much time as you can allocate to Shultz.

George has a view on most of the issues that I worry about. On the issues that I have studied I usually find that he “gets it”. If I don't know much about the issue I find his approach to be logical, consistent and direct.

Directness has been a Shultz trademark as long as I've been exposed to him. His mind cuts the shortest path to the essentials, and then just as directly to a solution can be realized politically. For an efficient review of what Shultz has accomplished please see his Hoover Institution page.

 

Tyler Cowen: Forget Europe. Worry About India.

… these economically segregated islands of higher productivity suggest that success is achieved by separating oneself from the broader Indian economy, not by integrating with it.

India continues to have very sticky institutional problems. So argues Tyler Cowen in this NYT op-ed. Standout examples:

  • the reluctance to wholeheartedly embrace advanced agriculture, including GMO opportunities
  • the “license Raj” seems to be returning to “one of the world’s most unwieldy legal systems”
  • free markets are more the exception – example Wal-Mart has been given the cold shoulder

 Imagine how Wal-Mart would stimulate logistics and retail innovation! On agriculture Tyler wrote:

Agriculture employs about half of India’s work force, for example, yet the agricultural revolution that flourished in the 1970s has slowed. Crop yields remain stubbornly low, transport and water infrastructure is poor, and the legal system is hostile to foreign investment in basic agriculture and to modern agribusiness. Note that the earlier general growth bursts of Japan, South Korea and Taiwan were all preceded by significant gains in agricultural productivity.

For all of India’s economic progress, it is hard to find comparable stirrings in Indian agriculture today. It is estimated that half of all Indian children under the age of 5 suffer from malnutrition.

This is fundamentally the outcome of a dysfunctional political scheme. One possible way out is to launch one, hopefully several, of Paul Romer’s Charter Cities. The hungry, hard-working labor is certainly nearby and eager to migrate into such cities for better jobs. Is there suitable coastal land, appropriate for new links to global trade?

Uber’s ride-matching encounters a wee bit of dynamic pricing resistance

Megan McArdle did a short post on why surge pricing is the optimal mechanism to clear the market. And also why it might be net bad strategy for Uber. A fragment:

At the core, Uber is not a taxi company; it's a technology company. The company has a lot of data on where its customers are, and where they like to go. That enables some cool stuff: Travis Kalanick, the company’s chief executive officer, told me that Uber can slightly outperform gambling spreads on whether a team will win a home game, just by looking at stadium trips. More practically, data enables them to move cars to where they might be wanted, which means it’s easier to get a car if you are outside the dense urban core. And when demand is very heavy, data enables Uber to dynamically price rides to ensure that cars are always available — if you’re willing to pay.

I love Uber’s surge pricing; it means that we can get a car home on New Year's Eve. Yes, it costs a lot, but the alternative is hoofing it for a few icy miles through some not-quite-safe streets.

But I’m an economic policy journalist, not a normal person. Normal people hate this sort of dynamic pricing, which they call “price gouging.”

This came to a head last week, when a brutal snowstorm on the East Coast kept taxis off the streets. Desperate folks in the New York metro area turned to Uber — and then screamed at the bills they got for hundreds of dollars, even though Uber’s smartphone app seems to have clearly warned them that this was going to happen. Economically illiterate recrimination ensued…

CEO Travis Kalanick posted his reply to outraged customer

Surge Pricing email that just came in and my response. Get some popcorn and scroll down…

————— Forwarded message —————
From: Travis Kalanick

Date: Mon, Dec 16, 2013 at 8:44 PM
Subject: Re: I'm OUTRAGED!
To:

We regularly do surge pricing when demand outstrips supply. Remember, we do not own cars nor do we employ drivers. Higher prices are required in order to get cars on the road and keep them on the road during the busiest times. This maximizes the number of trips and minimizes the number of people stranded. The drivers have other options as well. In short, without Surge Pricing, there would be no car available at all.

Now granted, that the prices are significantly higher. BUT we notify every customer in big bold images in text, which each customer has to confirm in order to request. Furthermore, every customer also had to type in what the multiplier was in order to double confirm that they understood what they were agreeing to.

So, was it expensive. It was, and we wish it wasn't necessary. But if you did indeed take the rides described then you confirmed the price which was very up front, and then entered the multiple you read into a text box in order to double confirm.

Airlines and Hotels are more expensive during busy times. Uber is as well. We don't just charge to make a buck though, we take a small fee of the transaction, but the vast majority goes to the driver so that we can maximize the number of drivers on the road. The point is in order to provide you with a reliable ride, prices need to go up.

If you have other ideas for how to provide a reliable ride during busy times, I am all ears. In the end, Uber is reliable, always, and we will create a system that maximizes the number of people that can get safe and reliable rides. Not surging is saying you shouldn't have the option. Not surging is saying we should be just like a taxi and be unreliable when people need us most. These are outcomes that take choices away from the consumer and make it harder to get around cities – these are outcomes that we put a lot of hard work in to avoid so that at least you have the choice if you want one.

Thanks,

Travis

On Mon, Dec 16, 2013 at 5:01 PM, wrote:
Dear mr. Kalanick,

I used to love uber… I have written several blogs about the amazing service and how amazing I thought your company was. Key word, WAS! I called uber on sat. To take me to a show that was 60 blks away, and also called uber to pick me back up to bring me home. I usually get an email with my receipts, but havent received one yet… did a little research and was SHOCKED to see that i was charged $180 each way! That's $360 to go 120 blocks!

I WILL NEVER USE YOUR COMPANY AGAIN! I AM OUTRAGED AND DISGUSTED THAT YOU WOULD JACK UP YOUR CHARGES THAT MUCH BECAUSE OF A SNOW STORM!!!

I hope it was worth losing a loyal customer-like myself! I plan on telling this story to everyone I know and plan on writing about this on my blog!

You should be ashamed of yourself!

Megan links to the work of Duke University's Mike Munger. I agree that Mike is a superb source on this behavioral issue. His Econtalk interview with Russ Roberts explores real world examples of illogical reactions to dynamic pricing. If you don't like 1 hr podcasts, there is a partial transcript and rich resource links to papers on this topic. Abstract:

Mike Munger of Duke University talks with EconTalk host Russ Roberts about the psychology, sociology, and economics of buying and selling. Why are different transactions that seemingly make both parties better off frowned on and often made illegal? In theory, all voluntary transactions should make both parties better off. But Munger argues that some transactions are more voluntary than others. Munger lists the attributes of a truly voluntary transaction, what he calls a euvoluntary transaction and argues that when transactions are not euvoluntary, they may be outlawed or seen as immoral. Related issues that are discussed include price gouging after a natural disaster, blackmail, sales of human organs, and the employment of low-wage workers.

Another Munger Econtalk I recommend is Munger on price gouging.

 

Cowen on Sumner on Krugman on the UK

Tyler Cowen writes:

And here is a remark on timing:

I find it astonishing that Krugman and Wren-Lewis, having done post after post in 2012 describing how the UK does have real fiscal austerity in 2012, are suddenly happy to now argue that a relaxation of fiscal austerity in 2012 is the “reason” for GDP recovery in… erm, 2013.

Don’t let the emotionally laden talk of “Three Stooges” or “deeply stupid,” or continuing problems in the UK economy, distract your attention from the fact that this one really has not gone in the directions which the Old Keynesians had been predicting.

This whole set of linked essays is recommended, though I'm finding it challenging to unravel all the logic. Monetary policy is really hard.

 

The economics of cheap drone delivery

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Tyler Cowen

Let’s say 30-minute drone delivery to your home were legal, well-run, and, for purposes of argument, free or done at very low cost. You would buy smaller size packages and keep smaller libraries at home and in your office. Bookshelf space would be freed up, you would cook more with freshly ground spices, the physical world would stand a better chance of competing with the rapid-delivery virtual world, and Amazon Kindles would decline in value. Given that the storage costs for goods would fall (more storage by specialists, accompanied by later delivery), expected inflation would more likely be converted into price hikes today. The liquidity premium of money (NB: not currency) would rise and the liquidity premium of goods would fall. Some drug markets would be taken off the streets and the importance of gang “turf” would fall.

Addendum: What do we know about network economies in drone delivery systems? FedEx and UPS and USPS, taken together, dominate the market for physical delivery of parcels to homes. How much room would there be in the market for “lone drone” operators?

 Amazon is developing Amazon PrimeAir .

Brink Lindsey: Why Growth Is Getting Harder

 I just read Brink Lindsey’s new policy analysis Why Growth Is Getting Harder. Bearing in mind Seekerblog’s cautionary tagline from Niels Bohr, Brink’s outlook for growth deserves careful reading and reflection. From the executive summary:

Consider the four constituent elements of economic growth tracked by conventional growth accounting: (1) growth in labor participation, or annual hours worked per capita; (2) growth in labor quality, or the skill level of the workforce; (3) growth in capital deepening, or the amount of physical capital invested per worker; and (4) growth in so-called total factor productivity, or output per unit of quality-adjusted labor and capital. Over the course of the 20th century, these various components fluctuated in their contributions to overall growth. The fluctuations, however, tended to offset each other, so that weakness in one element was compensated for by strength in another. In the 21st century, this pattern of offsetting fluctuations has come to a halt as all growth components have fallen off simultaneously.

The simultaneous weakening of all the components of economic growth does not mean that slow growth is inevitable from here on out. The trends for one or more of them could reverse direction tomorrow. Nevertheless, it is difficult to resist the conclusion that the conditions for growth are less favorable than they used to be. In other words, growth is getting harder.

On October 29 Tyler Cowen, author of the excellent The Great Stagnation, will join Brink for a Cato Forum, on the subject of this paper. The forum will be available live and later in the archives as audio and video.

Is Slow Growth the New Normal?

Featuring Brink Lindsey, Vice President for Research, Cato Institute; Tyler Cowen, Professor, George Mason University; and Martin Baily, Senior Fellow, Brookings Institution; moderated by Annie Lowrey, Reporter, New York Times.

12:00pm Hayek Auditorium

More from Brink Lindsey The Boy Who Cried Wolf Was Eventually Right

“We are reaching end times for Western affluence,” warns economist Stephen King (insert obligatory horror joke here) in yesterday’s New York Times. King, who has authored a book entitled When the Money Runs Out: The End of Western Affluence, joins the ranks of economic Cassandras like Tyler Cowen and Robert Gordon, both of whom have made waves with pessimistic takes on the U.S. economy’s prospects. Like Cowen and Gordon, King couches his claims in overstatements that make it easier for skeptical readers to dismiss his arguments. Peel away the hype, though, and these growth pessmists are still fundamentally correct. The wolf really is at the door this time. In other words, the growth outlook really is darkening.