Answering the hardest question in economics – marrying behavioral to rational thinking..

Noah Smith isn’t just pointing to evidence that debunks old ideas but also to new ideas which could help macro gain some credibility.

In his recent post, he points to new papers which could shape macro in future:

Xavier Gabaix, a New York University economist who gets far less attention than he should, has written what might prove to be the most interesting macroeconomic theory paper in years. The title, “A Behavioral New Keynesian Model,” isn’t exactly exciting and the paper is still incomplete, but it might help resolve the most important and difficult macroeconomic debate in academia today — whether low interest rates cause inflation, deflation or neither. And it might signal a sea change in the way macroeconomic theory gets done.

Traditionally, macroeconomists have believed that low interest rates encourage inflation. But first Japan, and now the U.S. and Europe have kept rates low for years now, and inflation has stayed stubbornly low. A radical group of macroeconomists, including Stephen Williamson of the Federal Reserve Bank of St. Louis and John Cochrane of the Hoover Institution, have introduced a new theory called Neo-Fisherism, which says that a long period of low interest rates actually holds prices down instead of pushing them up. Williamson and Cochrane have both repeatedly stressed that New Keynesian models — the most mainstream type of macroeconomic theory — can easily yield the Neo-Fisherian result instead of the traditional view. One problem is that the standard models are often ambiguous — they offer a number of possible, radically different outcomes for the economy, with no way to tell which will happen.

Gabaix tackles these problems with a simple, intuitive, yet bold step. Instead of assuming that people are perfectly rational, he theorizes that they have limited attention — what psychologist Herbert Simon called “bounded rationality.” When interest rates or gross domestic product change, people in Gabaix’s model don’t quite realize that things are different. Even more importantly, they’re short-sighted — they don’t think as much about the probability of a recession happening 10 years from now as they do about one occurring in the next six months.

Those ideas probably seem obvious to most people. When events are further in the future, you worry about them less, right? I know I do. But to macroeconomists, this is a pretty radical step. Most macroeconomic researchers are strict adherents to the cult of perfect rationality. If the economy looks like it’s being driven by behavior that isn’t quite rational, macroeconomists usually bend over backward to explain it as a failure of economic institutions, rather than a result of human psychology.

Wonder what took it so long. It was just waiting to happen.

His paper shows following outcomes:

1. Fiscal policy is much more powerful than in the traditional model:1 in the traditional model, rational agents are Ricardian and do not react to tax cuts. In the behavioral model, agents are partly myopic, and consume more when they receive tax cuts. As a result, we can study the interaction between monetary and fiscal policy.
2. The zero lower bound (ZLB) is much less costly.
3. The model can explain the surprising stability in economies stuck at the ZLB, something that is difficult to achieve in traditional models.
4. Equilibrium selection issues vanish in many cases: for instance, even with a constant nominal interest rate there is just one (bounded) equilibrium.
5.  Forward guidance is much less powerful than in the traditional model, offering a natural behavioral resolution of the “forward guidance puzzle”.
6. A number of neo-Fisherian paradoxes are resolved. A permanent rise in the nominal interest rate causes inflation to fall in the short run (a Keynesian effect), and rise in the long run (so that the long-run Fisher neutrality holds with respect to inflation).

Will be interesting to see what direction does all this take. Though, a glance at the paper shows no behavior, it is just equations..

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Seeing China Through Its Economic History

Tyler Cowen who also writes for Bloomberg View now has a piece there.

He says we are too pessimistic on China. He draws lessons from history:

IMF’s Independent Evaluation Office on IMF rescue programs in Europe..

IMF’ IEO has been critical of IMF programs in the past as well. One can look at role of IEO in two ways. One is it provides an independent assessment of IMF programs and tells you all is not as bad as imagined in the Washington based body. The other is IMF IEO is just like any other IEO which act just as a cover up to hide the mess in the organisation. IEO keeps writing stuff and IMF keeps ignoring it.

Anyways, IEO reviews IMF’s crisis management in Europe. It says past lessons have not really been learnt:

Using behavioral insights to figure UK Police’s 101 phone calls

Simon Ruda and Alex Tupper of UK’s Behavioral Insights Team have a piece on the analysis.

UK introduced a phone number 101 to address all police related issues. This led to lot of calls which had nothing to do with police. Could BIT help find patterns for the Police to seperate calls to attend vs not t attend?

When conducting the analysis, as ‘inappropriate calls’ weren’t coded in the data, BIT assumed that any phone calls which were resolved in under 30 seconds were likely to be inappropriate for the Police (i.e. where the caller was quickly told their enquiry wasn’t something the police deal with).

One of the most intriguing findings was that the proportion of inappropriate calls received is dramatically reduced if the call waited at least five seconds before being answered. It could be that just five seconds of ringing time is enough to enable the caller to reflect on the purpose of their call and its appropriateness for the police.

As the graph below shows, around four in every ten calls answered within 1 second were inappropriate, whereas only one in ten of those that wait at least 6 seconds are. The possible conclusion from this analysis is that a ring time of just 6 seconds could help cut down inappropriate calls, enabling those in real need of support to be prioritised and more rapidly assisted by the police.

Hmmm..Interesting stuff..

 

History of spices and how they shaped much of the world trade..

Superb post at OUP Blog.

On supermarket shelves, we are given a mind-numbing array of choices to select from. Shall we have some peppercorns on our macaroni, some cinnamon for baking, or a sprig of rosemary with roast pork? Five hundred years ago, however, cooking with herbs and spices was a much simpler choice. Many of the spices we use nowadays still flourished only in their native habitats, and were not as widely enjoyed as they are today. In fact, Christopher Columbus made it his quest to collect spices from around the world, deeming it as worthy as gold. “In truth,” he said, “should I meet with gold or spices in great quantity, I shall remain till I collect as much as possible, and for this purpose I am proceeding solely in quest of them.”

Thanks to these early explorers, cultures around the world have created delectable dishes based on spices and herbs both homegrown and imported, and it is fascinating how often these additions can change the essence of an entire meal. Indeed, many spices have been so commonly used they have come to represent entire cuisines. We cannot imagine Indian food without curry, for instance, nor conceive of any sashimi platter without that indispensable wad of wasabi.

In addition to spicing up dishes, studies have also shown that adding seasoning to your diet leads to copious health and other physical benefits. This is not a recent discovery. In ancient Roman times, the philosopher Pliny advised his students to wear a “crown of mint” upon their heads while studying, as it “exhilarates the mind.” Modern studies reveal that his advice was spot-on. Other than headaches, mint also alleviates asthma, nausea, and digestion problems. Other herbs and spices, such as the nutmeg, similarly helps prevent infection and ageing due to their antibacterial properties.

If you possess a green thumb, cultivating your own herbs is also a peaceful activity that calms the nerves. Thomas More, who kept his garden alongside the Thames, said of rosemary “I let it run alle over my garden walls, not onlie because my bees love it, but because it is the herb sacred to remembrance and to friendship.” Likewise, many other herbs also convey their own “flower language,” or floriography. Basil channels good wishes, sage pronounces wisdom, while tarragon, curiously enough, expresses “lasting interest.”

They have a map as well to figure where certain spices and herbs came into being. I think Indian contribution is not fully represented..

Neo-Fisherism: Raising interest rates to raise inflation

The usual bit on monetary is raise rates if inflation is rising and lower them when inflation is falling. This is called as Fisherism based on Irving Fisher.

How about turning the idea on its head? How about raising rates to push higher inflation? This is called Neo-Fisherism  (trust economists to come with bad names).

Steven Williamson takes us through this radical idea:

What we should do in the 25 years of 1991? Read the Indian classics…

Bibeky Debroy makes a great argument here on the even of 25 years of 1991 agenda.

He says most of Indian classics suggest that government should do minimal things. So just read them and that is what we should do in future as well:

What came first – money or credit?

One standard narrative on evolution of money is this. Earlier people would just barter to exchange their surplus with something they needed. Over a period of time, they realised this was complicated and through this evolved money which allowed people to quote all goods in the money. This eased lives considerably as one could now just buy and sell anything without any barter. This is called as Mengerian account of money based on Carl Menger’s work.

However, this thinking has been disputed by scholars recently. They say Barter was non-existent in most societies. Infact the credit instruments came much before money. These credit instruments circulated as IOUs enabling people to buy and sell. This is called as Innesian view based on A. Mitchell Innes.

Needless to say, there was a war of words between the two camps. Much of these war of words is fascinating as they get to core of so called monetary economics.

Michael V. Szpindor Watson of Mises Institute says there is no need to fight. One could merge the two views by looking at intertemporal barter:

Barter is ordinarily understood as spot transactions, where two people trade two different goods at some instant and not over time. The same occurs in an economy with a common medium of exchange, except that one of the goods (money) is usually used for transactions and purchases. Credit in an economy without a common medium of exchange is simply inter-temporal barter. It is no different than credit where a common medium of exchange exists, except the prevalence of what the credit is redeemable in.

Even when there is no common medium of exchange it is reasonable to expect that people will still want to transact over time and not always in the given moment. Within communities of trust or where there is a method of enforcing contracts we can expect that Casimir promises Anastasia a part of his future grain harvest for milk that her cow just produced. Anastasia has credited milk to Casimir for a claim on his future grain harvest — a credit market has been created where Anastasia and Casimir have engaged in inter-temporal barter.

Inter-temporal barter doesn’t have claims on a common medium, but to one of a variety of goods (and maybe even services). As Innes et al. suggest, tallies or other means of recording debts and credits could have been invented as primitive economies and populations grew. Such means of recording credits and debts would bring down the transaction costs of inter-temporal barter. Conceivably such instruments of recording credits and debts could have been negotiable and exchanged for other goods.

Imagine that Anastasia has a promissory note (IOU) for a portion of Casimir’s grain harvest, but prefers apples now to a future claim on Casimir’s grain. Thaddeus prefers a future claim on grain than the apples hanging on his trees. So Anastasia offers Thaddeus the promissory note in exchange for apples. If not for the promissory note Anastasia, Casimir, and Thaddeus would have all had to meet to agree to such a transaction. Without inter-temporal barter in the form of a promissory note, Anastasia and Casimir would have never made the transaction and Anastasia wouldn’t have had the promissory note to use to barter for other goods.

The rejection of Menger based on the fact that credit existed before money is invalid. However, what Innes and Graeber argue is not entirely irrelevant. The story we tell to students and ourselves is oversimplified. We should rewrite our textbook accounts to include the possibility of credit preceding a common medium of exchange and call it inter-temporal barter.

 All this is just so fascinating. These intertemporal IOUs in turn are nothing but forwards. Then one has to think how were these financial instruments priced and so on.

It is a pity that none of this is taught even at a PhD level. Monetary economics has just been reduced to thinking about targets and rules/discretion which are just around a few equations.  One hardly gets a sense of how all these things have evolved. Atleast students should be made aware of these issues/discussions.

If one uses these ideas to figure monetary history of India, one does read about both barter and IOUs existing. What came first is a big puzzle to figure as well.

It is interesting to see how monetary wisdom is being challenged. One another debate was what comes first deposits or credit? So far, we were taught that deposits lead to creation of credit and then the whole thing multiplies to become money supply. Now they say all this is rubbish, Banks always create credit first and then comes deposits.   This changes the entire thinking on money multiplier and so on.

Plenty to think and ponder upon than the usual question of how much the inflation target should be…

Economists giving pp on Milton Friedman’s biggest idea – Permanent Income Hypothesis

Today is perhaps a Friedman day on Mostly Economics.

Noah Smith the usually good economist turned columnist has a piece. He says how more and more empirical evidence is coming against Friedman’s biggest idea – Permanent Income Hypothesis:

How will digital currency shape the future of banking and monetary policy?

Marilyne Tolle of BoE discusses the several issues with respect to digital currency in Bank of England’s blog.

There is little doubt that these currencies as they gain ground could pull the carpet under the central banks monopolist chair. Central bankers who are habitual to tell the politicians and businesses about allowing disruptive innovations are going to get a bit on their game as well. More than anything else, it will be interesting whether central banks try and preserve their monopolies or let it go.

Tolle says digitial currencies will create problems for both banks and central banks. One key reason is the payment bit is going to get divorced from the deposits:

Did Milton Friedman influence the Thatcher policy of 1980s?

It is fashionable in the financial media to project certain economists as superheroes. How certain economist came and changed the country/world is a common theme. In this story creation, lots of myths are hyped and facts ignored. Much of economic changes in any country are a combination of many factors and persons. It is hardly about a few people here and there.

Even given this limitation, it is for certain believed that and Hayek and Friedman played a central role in Thatcher and Reagan regimes in early 1980s. It would be a huge shock if anyone disagreed with this now well accepted fact.

Prof James Forder of University of Oxford does just that. He says there is hardly any evidence of Friedman playing any big role in Thatcher era.

Using a range of sources, it is argued that, contrary to common belief, Milton Friedman had no special influence on British policy in the 1970s and 1980s. The opposing impression appears to be derived in part from the work of Friedman’s admirers, but principally from the allegations of Margaret Thatcher’s opponents who believed they could taint her with his name.

Extracting from the PDF is difficult so can’t discuss the paper. Prof Forder digs through plenty of sources to question this well accepted fact as a piece of fiction. Infact he points to a similar paper which questioned influence of Friedman in Israel economic policy in 1977 as well.

Interesting bit..

 

Why ethnic favouritism is a global phenomenon

A group of researchers dispel the myth that ethnic favouritism is not just an African (even Asian) thing. It is pretty much a global phenomenon.

Learning Indian economic history from EPIC TV channel – case of Chapparbands the coin forgers

If people have not yet seen this TV channel – EPIC, please do. It is perhaps the best thing to have come on Indian TV for a long long time. It takes you back to those olden days of Doordarshan when TV meant even some knowledge and information as well. Now most TV channels including the news ones are just plain idiotic. Most would agree our news channels are just entertainment actually.

Here is where likes of EPIC come with a breath of fresh air. Most of the shows on EPIC TV are of excellent content and quality. The centre theme here is indology. I have learnt quite a bit about Indian economic history especially on the currency and monetary matters.It has these short clippings (called epified) on different currency systems run in different kingdoms in India. Epified also has these short clippings on how various commodities came into being in India and began to be traded. Then there are shows on Indian food (which tells you quite a bit about eco too), Indian philosophy (usually good Devdutt Pattnaik atthe helm), Interpreting Indian classics like Mahabharata (in a show called Dharmakshetra) and so on.

In a recent show called Lootere (robbers), one got to know about this community called Chapparbands which were expert coin forgers. They gave the British a run for money literally and figuratively. The seem to have learnt these coin making tricks with their ancestors serving the Mughal empire Treasury.  This knowhow was transmitted through generations before they got into forging British coins. It was thrilling to learn about this bit of Indian monetary history which is not covered anywhere.

I found this bit on Chapparbands on one of the sites:

The Chapparbands are manufacturers of spurious coin, who hail from the Bombay Presidency, and are watched for by the police. It is noted, in the Police Report, 1904, that good work was done in Ganjam in tracing certain gangs of these coiners, and bringing them to conviction. For the following note I am indebted to a report by Mr. H. N. Alexander of the Bombay Police Department. The name Chapparband refers to their calling, chapa meaning an impression or stamp. “Among themselves they are known as Bhadoos, but in Hindustan, and among Thugs and cheats generally, they are known as Khoolsurrya, i.e., false coiners. While in their villages, they cultivate the fields, rear poultry and breed sheep, while the women make quilts, which the men sell while on their tours. But the real business of this class is to make and pass off false coin. Laying aside their ordinary Muhammadan dress, they assume the dress and appearance of fakirs of the Muddar section, Muddar being their Pir, and, unaccompanied by their women, wander from village to village. Marathi is their language, and, in addition, they have a peculiar slang of their own. Like all people of this class, they are superstitious, and will not proceed on an expedition unless a favourable omen is obtained. The following account is given, showing how the false coin is manufactured. A mould serves only once, a new one being required for every rupee or other coin.

It is made of unslaked lime and a kind of yellow earth called shedoo, finely powdered and sifted, and patiently kneaded with water to about the consistency of putty. One of the coins to be imitated is then pressed with some of the preparation, and covered over, and, being cut all round, is placed in some embers. After becoming hardened, it is carefully laid open with a knife, and, the coin being taken out, its impression remains. The upper and lower pieces are then joined together with a kind of gum, and, a small hole being made on one side, molten tin is poured in, and thus an imitation of the coin is obtained, and it only remains to rub it over with dirt to give it the appearance of old money. The tin is purchased in any bazaar, and the false money is prepared on the road as the gang travels along. Chapparbands adopt several ways of getting rid of their false coin. They enter shops and make purchases, showing true rupees in the first instance, and substituting false ones at the time of payment. They change false rupees for copper money, and also in exchange for good rupees of other currencies. Naturally, they look out for women and simple people, though the manner of passing off the base coin is clever, being done by sleight of hand. The false money is kept in pockets formed within the folds of their langutis (loin-cloths), and also hidden in the private parts.”

The following additional information concerning Chapparbands is contained in the Illustrated Criminal Investigation and Law Digest13:—“They travel generally in small gangs, and their women never follow them. They consult omens before leaving their villages. They [18]do not leave their villages dressed as fakirs. They generally visit some place far away from their residence, and there disguise themselves as Madari fakirs, adding Shah to their names. They also add the title Sahib, and imitate the Sawals, a sing-song begging tone of their class. Their leader, Khagda, is implicitly obeyed. He is the treasurer of the gangs, and keeps with him the instruments used in coining, and the necessary metal pieces. But the leader rarely keeps the coins with him. The duty of passing the false coins belongs to the Bhondars. A boy generally accompanies a gang. He is called Handiwal. He acts as a handy chokra (youngster), and also as a watch over the camp when the false coins are being prepared. They generally camp on high ground in close vicinity to water, which serves to receive the false coins and implements, should danger be apprehended.

Superb stuff..

There is much more on EPIC channel. Quite a bit on economic history as well. It gets all these scholars to talk on the show which just enriches the overall discussion.

Kudos to the team..

A ‘secret’ underground passage in Mumbai between CST and Indian central bank…

Well, well, well. This is an interesting bit of history:

Human Face of Banking – slowly getting killed..

Adfer Rashid Shah of New Delhi has sent a comment to EPW. It is likely to be ignored by most but is worthy of a discussion.

He ponders over how banking is just becoming faceless:

Continuous hype over upcoming fears is fostering crises (why having less economists talk will help here..)

Thomas Fricke says there is this continuous sense of fear and insecurity blown by media and experts.

Our disastrous monetary system: A new must-read book

I was just reading this interview of Nathan Bond, a budding entrepreneur. He wonders why Austrian School is not even mentioned in economics textbooks:

Why services inflation matters and is much higher than official figures..

The Indian Government and central bank have been patting their back over lower inflation in last few years. The financial markets too joined in the celebration as all they care for is reported inflation. No credit is given to the positive oil shock which just pushed inflation lower not needing any policy really.

But what about people who would laugh off such pats. Infact there are some concerns that inflation has again started rising. It was reported as 5.77% in June 2016, the highest in 22 months (the previous month number was 5.76% which was reported as 21 month high!). For most of us commoners, even this figure is much lower. The average inflation is 10-15% easily across most things we buy. I mean the disconnect between official figures and actual ones is amazingly wide. There is always talk of overestimating GDP but little on underestimating inflation.

Part of the problem is poor coverage of service inflation in our price index. Rajalakshmi Nirmal has a piece on services inflation which has been zipping at the rate of 10-15% for most services and even higher for others:

The rising culture of Indian CEOs as superheroes which is not such a good trend..

What was essentially a western fad has caught up big in India as well. It is all about being superstars and superheroes in whatever you do. The trend has particularly caught up in economic policymaking and business circles. The India media has started to love superstar policymakers and CEOs and hypes it with no holes barred. And then when it realises the follies of projecting an individual over an organisation, the blame is put on the individual!

Sundeep Khanna in this article points to this rising trend in India. We need CEOs as company faces but not overblown superstar images:

SEBI’s role in shaping capital markets since 1991: progress, cooperation with finance ministry and humility….

In the 25 anniversary celebrations of 1991, we are seeing quite a bit of activity. It has given a continuous fodder for this blog as well.  There are all kinds of articles (this one is a good summary) with each of the key actors trying to assess how things happened and their roles in the same. Some like Dr MM Singh call it a team work whereas others like Montek point to how their document was the brainchild. This is truly the finest hour for the lost legacy of the then PM PV Narasimha Rao who has a mixed record with success in economics but not politics. This was interesting in itself as he had no understanding of economics and was always a politician. But then I guess things are being carried too far away pointing to all kinds of characteristics which were behind the reform. We tend to overdo all such things and not just accept that somehow certain things happen.

Anyways, there is plenty of learning happening.

So far the discussion has been around the Prime Ministers, Finance Ministers, Central bank people and Planning Commission members. Most of these interviews were but expected. Most of them have been superstars of financial media in their own way.

This one article looks at a silent player – SEBI – which changed the capital market game in a big way. This is one area where our progress has been huge but it is barely discussed. The person here is DR Mehta whose seven year tenure changed quite a few things at SEBI. Unlike others, he just calls it a job. He also adds there was never a conflict with any of the Finance Ministers: