Finding the Max/Min: Modern Monetary Theory Part 1

Tonight, I finally decided to read an article explaining the details of Modern Monetary Theory. (It’s 4AM when I’m writing this and I’ve nothing better to do on a Friday morning.) The article’s summary purported MMT as a school of economic thought.

To be honest, it is not entirely a school of thought. It lacks the expansive nature of claiming that role. MMT is more of a classroom than a school; its proponents have taken a small slice of a very large pie and have tried to derive various insights from their perspectives. Let’s look at some of them:

  1. In a world of fiat money, there is no limit to the amount of money that can be printed.
  2. Because of the relative insignificance of inflation, fiat economies can print/borrow enough money to take on massive capital-intensive projects.
  3. In fiat economies, there exists a natural interest rate of zero (because money can be printed pay off any interest as it accumulates).
  4. Deficits don’t matter.
  5. Fiscal policy > greater than monetary policy; though, monetary policy can be used to great effect in ensuring the success of fiscal policies.
  6. The government should provide everyone with a job guarantee.
  7. The banks, the loaning of funds, and actions of a variety of other industries should be subject to central planning.

Though, it isn’t technically false, the error in the first proposition is obvious enough that it warrants very little consideration and it comes in the form of the equation of exchange: MV=Py. In other words, a change in the amount of nominal money M will also cause an equivalent change in the price level P. (This is an oversimplification, but Michael Darby’s text provides a great overview if you’re interested.)  In other words, the more money printed equals a proportionate rise in prices. A central bank with a fiat currency can print as many notes as there are resources to make them, but this comes at the not so insignificant cost of the decreasing value of those notes. This is called inflation, and unless you haven’t seen anything about Venezuela in the past year, you know it is very much a real phenomena. MMT doesn’t completely decry the validity of inflation, but they do some hand waving through a Keynesian full-employment argument and assume away any bad effects as long as this full-employment is maintained. 

The most egregious conflict of their ideology manifests itself in this statement: “MMTers believe that the natural rate of interest in a world of fiat money is zero and that pegging it higher is a giveaway to the investor class.” This poses a serious issue with their earlier premise that we should spend money now on programs we see fit without any regards to future generations.

Harking back to my first year of grad school macro, Bohm-Bawerk provided three reasons for the existence of a positive interest rate:

  1. Time preference — the perspective undervaluation of future wants
  2. Dated endowment mix — the anticipation of higher income in the future
  3. Intertemporal transformation opportunities — the technical superiority of present goods over future goods

MMT treats the creation of money as higher income; which is a workaround to Bohm-Bawerk’s second criterion. Is printing money the equivalent of income? Maybe for a short time, but eventually the creditors begin to notice the devaluation of the currency (relative to all other currencies) and will demand that the indebted country pay back in a given exchange rate. They may be somewhat correct in thinking deficits don’t matter in the moment, but they would definitely matter if all the creditors demand repayment at once (this would be worsened in the event of massive inflation.

By wanting to use the resources now without regards to any interest rate, MMTers effectively take from the future and remove significant transaction costs by doing so. I often worry about extraction economies, like those of the colonial era, in which countries extracted resources without regard to the livelihoods and needs of the contemporary generations. MMT allows for this, except the effected generations are those in the future. One might argue that they have good intentions by doing so, but good intentions aren’t enough. Furthermore, where would the wont of spending end? If you’re incentivized to spend future resources now with no recourse, why not spend all of it?

I’ll leave you with that to ponder until next time.

Not your father’s macroeconomics

The decision of the Fed not to raise interest rates raises some immediate doubts about the future of the economy; though, I question the validity of these doubts. Has the Fed been at the helm of the economy in a meaningful way over the past few years? I would argue that at most it has been a standard-bearer that the economy has looked up to since the Great Depression, but for a long time, there has been a disconnect between the actions of the economy and Fed policy. Just looking at the immediate trends: unemployment is low at less than 4% and interest rates are still near-zero when compared to historical averages. Is there an issue with this? Not really, unless you take stock in the Phillips Curve — the same curve taught today in many intermediate macro courses, but has been thoroughly debunked since the beginning of stagflation in the 1970s.

So what does this mean? Justin Wolfers sums it up nicely:

Fine tuning the economy is over… Controlling for u and r in face on inflation fails muster; the rudders connected to this helm aren’t as large or as sensitive as previous thought.

The discipline of economics is changing for the better. Two years ago, David Wilson Sloane claimed that economics as we know it is dead The stories economics uses to explain the world are extremely useful, but in all their explanatory power, they are merely fictions that simplify the world into understandable pieces. (I don’t mean to understate their importance, only to state that economics can go further. For all it’s simplifying, economics during the past century has had truly brilliant insights.) Macroeconomics is currently at sort of crossroads, one that will help define the discipline for generations to come. The useful fictions can be maintained, but their explanatory power can be made to be more robust through the integration of economic thought with the processes and knowledge of other sciences towards a common goal of creating a more humane science. Beinhocker et al. sum it all up in a recent response to their neoclassical counterparts, “We believe that in order for economics to progress it needs to fully embrace a transdisciplinary approach and modernize a number of its key concepts.” The authors of that essay come from a wide variety of backgrounds and believe that their combined insights allow for more perfect version of the truth. Given the exponential nature of combinatorial interactions, I am sympathetic to this claim.

They posit that economics can do three things to increase its explanatory power:

  1. Most of us admit to the downfall of homo economicus, we should bring in insights from the fields of neuroscience, psychology, etc. to advance the understanding of homo sapien.
  2. Heterogeneity goes mostly unexplored in neoclassical because most things are generalized to help simplify things. Complexity thrives in a heterogenous space; people are not homogenous.
  3. We need to look at the economy from the systems level. (I’m most in tune with with this action.)

In an aside to all of this by Dani Rodrick, he claims that we must take up FDR’s credo of nothing less than “bold, persistent experimentation” in order to advance the field. I couldn’t agree more.

You might find yourself asking, “Where will macroeconomics take us next?” That’s not the question we should be asking. The better question is: Where will we take macroeconomics?

One final thought, Noah Smith is right, the Fed is our scapegoat no matter what happens.

 

More thoughts on “The Economy of Cities”

Jacobs’ main thesis is that cities experience growth through import replacement: the economies of the cities begin producing the products that they are currently importing from other economies. One of her examples was that Tokyo started manufacturing bicycles once they became technologically able (the costs became sufficiently low) to produce them in the city rather than importing the bicycles from abroad. What this entails is the internalizing of economic activity– a city may seek to be self-sustaining, and this seeking causes economic growth. But this comes at a significant cost: the city, and its contents, must always be in constant adaptation and change. In fact, Jacobs remarks, “The primary economic conflict, I think, is between people whose interests are with already well-established economic activities, and those whose interests are with the emergence of new economic activities.”

I do not think that this is merely an anti-rent seeking argument. Surely, there is some of that implicit in the statement; people who want to maintain the status quo may want to stifle further innovation and may do so by seeking legal and political tools to prevent others from infringing upon their profit opportunities. These interests may attempt to exert control over who may enter the markets via certain qualifying measures, certifications, and fee structures; some may go as far as attempting to set up a government-licensed monopoly. Jacobs’ argument speaks to something far more devastating to economic evolution: not in my backyard.

It’s not only the resistance of change from those who own the methods of production but the resistance from those who would benefit from future economic evolution.  She states, “Conformity and monotony, even when they are embellished with a froth of novelty, are not attributes of developing and economically vigorous cities. They are attributes of stagnant settlements.” Economic evolution must advance the interests and benefit the lives of the average person– an argument I heard earlier this week said the same thing of climate change regulation. Import replacement, as Jacobs describes it, is a process of entrepreneurial discovery and division of labor within a city. These processes are part of a larger Schumpeterian system of creative destruction: new economic activities evolve to replace older activities. These stand to increase the wealth of both the city and its inhabitants.

Who carries the costs of these import replacements? There are immediate costs of undergoing change; this is where the NIMBYs can strike with the most damage. By refusing to change or limit the amount of growth, those with interest in older economic activities can prevent the evolution of new ones before they even get started. There is a cost in saying yes to development, but remember, there is no cause of poverty — that is the base condition — there is a cause to prosperity, which a key to which is the change of economic activity. There may be short-run costs to those exporters of goods from the which the city previously consumed, but these will be made back in the long-run by more and better technologies being produced in the city. These technologies then get imported to other cities and rural areas. The long walk of progress determines that growth is not simply for some, but all can prosper in the long-run. Recent trends in poverty reduction are proof to this. The reason that so much food can be grow with so little labor involved originates in work and innovation done in urban areas, not with the farms themselves. As I noted in an earlier post, urban and rural economies must work in a cycle for both to survive. (This will probably be true until someone figures out to grow enough food in urban  areas; vertical farms aren’t enough to feed an entire city. A lot of this is due to the limited selection of foods that can be grown in a vertical farm.)

Jacobs has a wonderful bit on discrimination in cities and how it is inefficient for unequal governance to be operation. Prior to gender/race equality, an economy is losing out on a large portion of labor, creativity, and human capital. Engaging in such discriminatory behavior only allows for more stagnation, sooner.

Side note for future thought: If contracts are unable to be performed, then there will be inefficiencies. Think apple trees and bees– Where is the Coasean bargain?

“Five myths about socialism,” response

On March 1, 2019, Sheri Berman of Barnard College published a column entitled “Five Myths about Socialism” at the Washington Post. This is my response:

Socialism is making a comeback in recent thought. There is a multiplicity of causes for this; some of which being the seeming rise in relative wealth inequality, the forgotten knowledge of previous generations, and a way to overcompensate for strong voices originating in the political far right.

The five myths purported by Berman are as follows: 1) Socialism is a single coherent ideology. 2) Socialism and democracy are incompatible. 3) All socialists want to abolish markets and private property. 4) When socialism is tried, it collapses. 5) Socialism offers a ready-made solution to numerous current problems. None of these myths are technically false, but technicalities do not always pass muster.

The first myth is an attempt to differentiate various strains of socialism so that if one has failed in the past, is currently failing, or may fail in the future, the author and all other socialists can stand on a platform as they decry the fallen economic system, claiming that it was never true socialism. Given their ardent cognitive dissonance, they have nothing to fear from the failures of others claiming to be socialists. This further aides them in future potential failures: “If the system fails, it was because we didn’t get X correct; therefore, this couldn’t have been a true test of socialism. The ideal form of socialism still prevails and we will succeed next time.”

Often times, supporters of socialism engage in the “No true Scotsman” fallacy as way to continue their ideology without coming into direct contact with any of the logical flaws that might persist underneath. It still stands to reason that the purest form of socialism ever attempted by an economic system, War Communism. The top goals of this regime were as follows:

  1. Nationalization and centralization of all industries
  2. State control of foreign trade
  3. Control over labor
  4. Forced labor of citizens
  5. Prodrazvyorstka
  6. Rationing of goods, complete with centralized distribution centers.
  7. The abolition of free markets and enterprise
  8. State control of intranational transportation

In many of these goals, the Soviet Socialist government succeeded, but at what cost? according to multiple sources, the Russian Civil War (1917-1922), including the time of War Communism (1918-1921), resulted in between 9 and 20 million casualties. Only a relatively small percentage of these were due to combat; the overwhelming majority were due to famine and disease. Berman’s critique that the division of Democratic-leaning socialism and Bolshevik-style communism shows that socialism stays true to a democratic form of governance is another example of her allowing room to decry these experiments as being untrue forms of socialism.

Perhaps the abolition of markets and private property is not explicit in all forms of socialism, but underlying the expanse of socialist ideology is the implicit knowledge that such forms of market governance and institutions will be overturned in the name of the “greater good.” She points to redistribution as a virtue in that it does not abolish the market; though, she fails to posit that redistribution by definition entails the destruction of property rights for some and the creation of new rights for others. Intuitively, this changes the market mechanisms and causes the potential destruction for some markets.

Berman points to the Scandinavian countries as lights upon a hill for socialism; however, a quick look at their histories show that many of these nations are more capitalist than socialist. Furthermore, they built up their capital and institutions far before “socially-democratic” words were being slung at them. It is not hard to find perspectives that mesh with one’s priors in the information age. Yet, we haven’t seen the long term outcomes for many of these systems; nor do we know what additional issues other countries not being as homogenous would have to resolve. Furthermore, one cannot merely transplant the institutions from one country to that of another. There exists no anti-immune pills for economic systems.

Her final myth is the truest of all. Though it might be purported by its proponents, socialism fails to offer a panacea for all the world’s problems. Given its history, socialism might offer short-term solutions that remedy a few economic ailments, but the final cost of these solutions might outweigh the losses from the initial problems.

 

 

The Efficacy of Groups, Group Selection, and an Ecology of Plans

Richard Wagner posits that the macroeconomy is made up of an ecology of plans; I am sympathetic to his views because this allows for a framework of the economy to be seen as more than just the sum of its parts. This is because macroeconomic action is not just an aggregate of microeconomic action. The exception to this is at the very first encounters where the macro level interactions have yet to be formed (there are no institutions, formal or informal, that dictate behavior). After these are established, the micro transactions rely on the macro economy to enable them while the macro economy can only be perpetuated by the continuance of micro-level human action. One cannot exist without the other once the cycle has been initiated. Though, it is very possible that either one of these may wane in presence of the other.

The mediator between micro and macro action is that of the meso-level. Agents form themselves into groups; in fact, many agents will self-select or be selected into several groups. Families are one such type of these groups, while political parties, friendships, civic organizations, and religious congregations are all examples of groups in which any one agent can simultaneously take part. In both the public and private sphere, what causes these groups to survive throughout more than just one generation? What about an even smaller time scale, like more than a few meetings? What about Black Swan groups like the Bolsheviks? What are the behavioral mechanisms that ensure their continued survival? How does this compare to those who do not propagate for more than one life cycle?

I do believe that in the case of many of these sets, there exists a form of group selection similar to that in the evo-bio literature. Groups evolve a specific set of geno/phenotypic traits that occur at the group level instead of at the individual level. There is some argument in the evo-bio literature, but given that social systems can exhibit increasing returns to scale because of institutions or technology, I intend to sidestep their disagreements until another time. This means that a social system (a collection of groups into a very large group) is able to evolve certain traits that are different from those of another social system. I’ve argued in short essays that these traits may be readily copied by another group because knowledge is non-excludable and nonrival in nature. It has been pointed out to me that this means very little because it depends not on transference of knowledge but on the use of knowledge. I can’t agree more given that most people today have access to the entirety of human knowledge via a device in their pockets, but instead of using it for the advancement of our species, many play video games or feed a dopamine addiction. (This is pot calling the kettle black; I guilty of both of these.)

What I propose is an extension of Dr. Wagner’s hypothesis: the ecology of plans matters at the meso-level as well. Groups have plans. They are a way to lower the transaction costs of many people into a singular goal. Some of these groups seek domination of an entire economic system, others simply want to enjoy the fellowship of their members. I think I’ve mentioned Ostrom’s rules on common pool resources; these extend to efficacy of groups. In future posts, I hope to work out some agent based modelling of this.

Sidebar for myself: Demand will eventually create a supply through a variety of mechanisms and processes that necessitate the actions of entrepreneurial agents, but the converse is not true.

Ostrom, CPRs, and the Efficacy of Groups

Elinor Ostrom’s work in her study of common pool resources is paramount to my ideas. Ostrom defined the conditions in the form of eight core design principles:

  1. Clearly defined boundaries
  2. Proportional equivalence between benefits and costs
  3. Collective choice arrangements
  4. Monitoring
  5. Graduated sanctions
  6. Fast and fair conflict resolution
  7. Local autonomy
  8. Appropriate relations with other tiers of rule-making authority

These design principles are what is necessary for group survival and success to take place. Ostrom also defines success, for institutions: institutions are successful when they enable agents within the system to engage in productive outcomes despite the ever-present temptations of shirking and free-riding. I think this focus on “productive outcomes” could lay the basis of future system effectiveness/ efficiency, but that still leaves and immense amount of gray area to be resolved.

Using the CPR framework, the Soviet Union was destined to fail because its scores on conditions 2, 3, 6,7, and 8 were subpar. I would further claim that the USSR was doomed to failure (by productive outcomes) because it failed to meet certain criteria applied to socio-ecological systems. Namely, it failed to create a coherent system that allowed for interaction in a resilient and sustained manner. Furthermore, it failed to allow for a dynamic economy that allowed for continuous adaptation. Central planning and mono-centricity are anathema to adaptivity at the micro and meso levels.

[1] Wilson, Ostrom, and Cox. “Generalizing the core design principles for the efficacy of groups.” Journal of Economic Behavior & Organization, 90S (2013) S21–S32. 2012.

[2] Ostrom, Elinor. Governing the Commons. Cambridge, 2018.

Krugman (gasp!) talks on evolutionary economics and biology

Okay, okay, okay… It was at the European Association for Evolutionary Political Economy in November of 1996 (which is before the blogging Krugman we all know and love). In this talk, Krugman offers some bridges in between the two fields, finds common ground, and even suggests that we use the same methodologies to accomplish our studies. Which I think is appropriate given that the variables studied in both of our fields are not as concrete as physics but can be infinitely more complex (and thus, according to Michael Shermer, more difficult).

Here are some notes:

Krugman offers a four-part approach to economics:

  1. Economics is about what individuals do.
  2. Individuals are self-interested.
  3. The individuals are intelligent.
  4. The primary focus of these individuals is their interactions.

The primary difference between evo-bios and econs is that evo-bios don’t assume requirement number (3). Agents in evo-bios can be myopic. My own interjection here is that agents need not seem rational to the outside observer, only that they are rational insofar as their rationality is bounded.

Reading John Maynard Smith’s (not Keynes’) “Evolutionary Genetics” is probably a good start to recognizing the parallels between the fields.

The differences between evo-econs and neoclassicals is that evo-econs want to get away from maximization and equilibria. I think the latter is a recurring theme in heterodox economics, especially that of Austrian which lends some bias into my formal training. Nonetheless, I often argue that the economy is always trending towards an ever-changing equilibrium; therefore, it is always in disequilibrium. If we ever reached equilibrium, either communism has succeeded or the human race is extinct… possibly both.

Krugman points to Leslie Orgel’s Second Law: “Evolution is smarter than you are.” Maybe so, if only in that evolution is an organic process and there is no way that any one person can predict the eventual outcomes of these marginal changes over time. We can’t necessarily know a priori what is and is not efficient. Often we assume whatever outcome is reached is inherently efficient. Also, evo-bios look at evolution from a stationary perspective, and not in a dynamic shift that is presently occurring. This is not so much unlike certain models in economic growth theory.

The most useful concept in this talk is that of “Evolutionary Stable Strategies.” These are the strategies that any one agent should follow given the strategies everyone else is following. Krugman points to equilibrium, but I think more towards game theory (both have equilibria, but game theory allows for probability of repeated games).

In conclusion, Krugman offers sage advice on what econs can learn from evo-bios: “that models are metaphors, and that we should use them, not the other way around.” Many economists fully believe in their mechanisms versus acknowledging them for what they are, merely useful fictions that allow us to simplify the complexity that is human action.