Tag: things worth reading

2019 Books

Books I read in 2019. I’m sure I’m forgetting one or two.

Novels and stories

Transit. This is a lovely short novel by the German communist Anna Seghers, which I stumbled across on my parents’ shelves. Set, and written, in World War II France, it tells the story of various refugees waiting in Marseilles to work through the interminable bureaucratic process of acquiring the exit and transit visas they need to leave the country. It’s a beautiful evocation of the mix of unsettledness and bureaucratic stasis that is the life of the refugee, but it’s also got the tight construction of a classic 19th century novel, where the plot unfolds with a retrospective inevitability. There was apparently (and coincidentally) a movie based on it that came out this year.

Jews without Money, by Mike Gold. The classic autobiographical novel of the early 20th century Lower East Side ghetto, which I was shamed into finally reading by my friend Ben. It is, obviously, a socialist realist novel, which walks through, with unconcealed anger, all the deprivations, petty and not-so-petty humiliations, pointless tragedies, and self-defeating compensations of being poor in a rich city. (“It’s better to be dead in this country than not to have money,” says the narrator/author’s father in his final defeat, when he fails even at selling bananas. “Promise me when you’ll be rich when you grow up, Mikey!”) But it’s also and even more a novel of the intense emotions and heightened contrasts of the world seen through a child’s eyes – what it reminded me of most was Bruno Schultz’s magical realist stories of his Polish childhood. 

Overthrow. A novel of Occupy, or more precisely the period immediately after Occupy was shut down, by my Brooklyn neighbor Caleb Crain. It’s the very rare novel of graduate school and radical politics that takes its protagonists seriously. The plot revolves around a post-Occupy working group, and their frictions and collisions with each other and, eventually, with the security apparatus. The working group is focused on something like ESP or telepathy, whose status is never quite resolved – it appears variously as a metaphor for the alternative forms of collective action and decisionmaking that  Zuccotti Park was an experiment in; or a metaphor for sociality itself (as in Ursula LeGuin’s story “Solitude,” where any kind of social relationship is understood as a form of magic); or as a literalization of hacking and surveillance and the various other intercepted signals of our world; or as the kind of shared imaginary object that holds together any community; or at face value, in which sense it functions as the McGuffin that keeps the story moving.

I am very much the target audience for this novel —8 years ago, a very pregnant Laura and I were running away from the cops after a brief reoccupation of Zuccotti Park, and a bit later our now-emerged son’s first political action was a rally in support of striking grocery workers organized by Occupy Kensington, a post Occupy working group not unlike the activists Crain writes about. So take my opinion with a grain of salt, but I liked this book very much.

Cloudburst, Tom McGuane. A greatest-hits collection of stories by the author of Gallatin Canyon and Crow Fair, both of which I liked very much. The stories are mostly set in Montana, among more or less downwardly mobile people. Not having spent any time in that part of the country, I can’t say how realistic they are, but to me they feel true to life. 

Books I read for teaching (do these even count?)

Modern Macroeconomics: Its Origins, Development, and Current State, by Snowdon and Vane. Delivers what it says on the tin. Randy Wray used to use this to teach macroeconomics at UMKC.I tried it for the first time this year, and I thought it worked pretty well. 

Data Visualization, by Kieran Healy, and Quantitative Social Science, by Kosuke Imai. I used these two for my research methods class in the John Jay MA program. They worked ok.

The Book of Why, by Judea Pearl. I would never have made it through this book if I hadn’t assigned it — the early chapters are full of over-the-top auto-hagiography, as if the author were the first person to ever think about how statistical evidence could be used to answer questions of cause and effect. But if you persevere, there’s actually quite a bit of interesting stuff in here on how to think rigorously about causality.

Books I read with Eli, age 7/8 (missing some for sure here)

What If and How To by Randall Munroe, the xkcd guy. These are genuinely good books about applying physics concepts and quantitative reasoning to interesting real-world problems. How To is the better one.

The Hobbit. I’d forgotten how charming and light-hearted and funny this book is. It was wonderful reading it with my son, but it didn’t leave me with any desire to move on to Lord of the Rings.

A Short History of the World, by Enrest Gombrich. This is really nicely done. I highly recommend it to anyone with kids aged six to 12 or so. 

Peter Pan. This is a much weirder book than I had realized – Barrie did have some ideas about mothers. But it kept Eli riveted.

The Pushcart War. On of those wonderful New York books everybody should read.

How to Invent Everything. Another pop science book. The joke ratio is a little high for my tastes – I don’t see why you would write a book about science if you don’t think the science is interesting enough to carry it on its own. But there is a lot of good practical science mixed in with the jokes. before I read it, I didn’t know what coppicing was, or how charcoal is made. Now I do.

Crossing on Time. The latest from the prolific David Macaulay, author of City, Cathedral, How Things Work, etc. (We probably read some of those too this year, come to think of it.) This combines a history of passenger steamships with the story of the particular ship he and his family sailed on when they immigrated to the US in the 1950s.

Books read for professional reasons

Austerity: When It Works and When It Doesn’t. See review here.

Open Borders, by Bryan Caplan. Caplan is a right-wing libertarian who I don’t agree with about much. But I do agree with him that there is a clear economic and moral case for unrestricted immigration. I reviewed this book for the publisher, and while I did suggest some changes — some of which were incorporated into the final draft — I had no reservations about recommending it for publication.

Books by friends

Never a Lovely So Real. A biography of perhaps my favorite novelist, Nelson Algren, by my neighbor Colin Asher. (Our kids are in the same karate class. It’s Brooklyn!) It’s a beautifully constructed book — when I’d finished it, I wanted to start it over again, just to see better how the story fit together. I don’t know how much people read Algren today — I used to have the habit, when I went into a bookstore, of looking for Never Come Morning on the shelves, and seldom found it. But in my opinion he should be in the first tier of the American canon, ahead of Updike and Hemingway and whoever else people read in high school. “The son of a Polish baker and mulatto pigsticker crouched across the canvass,” begins the final chapter of Never Come Morning; that’s more of humanity than you’ll find in the collected works of Saul Bellow. The book gets that, and it gets his writing, which combines lyricism and social realism in a way I don’t think anyone else has managed.

It also gets his politics, and how those politics were essential to the art. Like his friend Richard Wright, or like Mike Gold, Algren is someone who never would have become a novelist if it hadn’t been for the Communist Party. A major contribution of the book is to document, based on FBI files among other evidence, how the inexplicable stalling-out of Algren’s career after The Man with a Golden Arm was the country’s best-selling book and a movie starring Frank Sinatra, is fully explained by McCarthyism. Algren’s friends may have thought he was falling into paranoia, but he really was being followed on the street, his house was being surveilled, his mailed opened, his calls listened into. The publishers who rejected his books, and the editors who spiked his essays, were doing so on the advice of the FBI. It’s a huge loss for humanity: As Laura says, the cost of McCarthyism “is not only those imprisoned or deprived of their livelihood: it is the unions never organized, the books never written, and the films never made.” Algren, who knows, might have had a whole shelf. 

The People’s Republic of Wal Mart, by Leigh Phillips and Michal Rozworski. The fact that production under capitalism is organized not by markets but by the conscious plans of corporations, is one of those facts that is completely obvious when you think about it, but still somehow radical and controversial. I don’t, to be clear, mean plans for for world domination, I mean the routine plans of getting input a from the warehouse here via a truck driven by this person, in time for that person to combine it with this other input using those tools. These tasks are all assigned by planners. A huge number of people cooperate in the production in all of the worldly goods around us, and essentially none of this cooperation is organized through markets. (Which doesn’t mean that markets are not an important feature of capitalism, they just don’t coordinate production.) Phillips and Rozworski make this case clearly and pointedly for the world’s largest corporation, and draw the natural conclusion that there’s nothing utopian about a planned economy – the raw materials are all around us. In large part it’s framed around the “calculation debate” of the 1920s. This is possibly not the most direct way of approaching the topic. But it does pass through some interesting territory, like Project Cybersyn, the precursor to the internet developed in Chile under Allende, which I had never heard of before.

Capital City. A short book on the politics of real estate and of urban planning by Sam Stein. Sam is a graduate student in geography at CUNY, and the book is very much written from that social position — animated by an expansive vision of the possibilities of urban planning, and by fresh anger at the ways it instead functions as an adjunct to the landlords’ lobby. Arguably the book’s strengths would have been better communicated if it were presented as a book about city planning, rather than a book about cities. (I don’t imagine it would have gotten nearly as many readers that way, so Sam and Verso probably made the right call.) One of those strengths is his perfect ear for the cant of really existing planning. Here’s Amanda Burden, Bloomberg’s planning director, describing black neighborhoods as effectively uninhabited: “We are making so many more areas of the city livable. Now young people are moving to neighborhoods  like Crown Heights that 10 years ago wouldn’t have been part of the lexicon.” Here’s her successor in the de Blasio administration, Carl Weisbrod, explaining that what’s good for the landlords is good for New York: “There are very few industries where the self-interest of the industry and the fundamental interests of the citizens are so deeply intertwined as the real estate industry.” And here’s Mayor SUV himself, with one of his classic but-what-can-I-do? shrugs: “I think there’s a socialistic impulse, which I hear every day, in every kind of community, that they would like things to be planned in accordance to their needs. And I would, too. Unfortunately, what stands in the way of that is hundreds of years of history that have elevated property rights and wealth to the point that that’s the reality that calls the tune.” Sure, it would be nice to organize the city to meet human needs, says our progressive mayor, but landlord profits come first and that’s just the way it is. If quotes like this fill you with anger and you’d like to experience more of it, you should definitely pick up this book.

Other nonfiction books

The Racketeer’s Progress, by Andrew Wender Cohen. Nathan Newman has been telling me to read this book since forever and I finally did, mostly on a couple of long plane flights. The subject is the labor movement in Chicago in the early decades of the 20th century. It’s in the service of a very specific argument: that we misunderstand the historical labor movement if we think of it like today’s, as bargaining on behalf of employees of a specific employer. Rather, he argues that turn-of-the-last-century unions saw themselves — and were at least intermittently accepted — as sovereign governments of their crafts or industries. Membership as such didn’t matter, it was about establishing rules that everyone in an industry had to follow. Employers went along, at least sometimes,  partly because the unions enjoyed broad popular legitimacy; partly because they had the power to make their rules stick; and partly because, at least in industries exposed to national competition, workers and businesses had a shared interest in excluding outsiders. There were, for instance, major and successful strikes to enforce the principle that only Illinois milk could be sold in Chicago, and only local electrical components could be installed in Chicago’s skyscrapers.

Why “racketeer”, tho? It’s true that Al Capone got his entree into Chicago labor thanks to this system of craft governance — not, as you might expect, as an enforcer of it, but rather as the publicly-announced guarantor of local employers defying union authority. (It was dry cleaners specifically who enlisted the mob to enforce their property rights against labor.) The term “racketeering” meanwhile, was coined specifically to describe union activities aimed at a form of sovereignty rather than at narrowly-defined economic interests. The term from its beginning, in other words, was intended not describe a legitimate activity corrupted by the presence of organized criminals, but to suggest that unions as they existed were inherently corrupt. The idea that unions historically represented the interests of an industry or occupation as a whole, and not of a particular employer, suggests that the historical model of American unionism may be more, not less, relevant, in the gig economy. 

Turtles as Hopeful Monsters, by Olivier Rieppel. The best book I’ve ever read about evolution is Mary West-Eberhardt’s Developmental Plasticity and Evolution. This isn’t that, but it’s the best book I’ve read on evolution in a while. And it makes the same basic argument: Evolution, at the macro level, is more than natural selection. It isn’t just differential reproduction of randomly varying organisms, but rather depends on a set of specific mechanisms that generate useful variation in body plans, and that conversely ensures that the random genetic variation generally gives rise to a functional organism. The genes, in other words, are just one input to the developmental process; or to put it another way, the capacity for evolution on a more than bacterial scale is something that itself had to evolve. The specific issue with turtles, in this context, is not just their shell; it’s also the distinct but related fact that their shoulders are inside their ribcage, rather than outside it as in all other vertebrates. Like the double-jointed jaw in a handful of snakes — the original “hopeful monsters” — this is a feature that can’t have developed incrementally but had to arrive all at once.  The question then is what it says about evolution that such leaps are possible, and what it says about the study of evolution that there’s been such reluctance to acknowledge them.

Warfare State, by James Sparrow. A nice history of domestic policy during World War II, or more precisely, how the scope of government in American life expanded during the war and how people reacted to it. The book draws heavily on reports from the Office of War Information, the 1940s-era propaganda and morale agency, and that shows in its choice of topics — there’s a bit more than strictly needed on the PR side of the war effort. But there’s also lots of interesting, well-organized material on policy around labor, housing and so on during the war, as well as on the more radical but unrealized proposals of people like Walter Reuther, which are arguably one of the great roads not traveled in US history. I read this in the course of putting together a Roosevelt paper on the war mobilization as a model for the Green New Deal, which should be coming out soon.

 

Previous editions:

2017 Books

2016 books

2015 books

2013 books

2012 books I

2012 books II

2010 books I

2010 books II

Utz-Pieter Reich on the Nominal and the Real

What oft was thought, but ne’er so well expressed1:

The lack of realism in microeconomic value theory has been overcompensated by an unquenched desire for `real’ figures. Idealism in the concepts of theory has resulted in a plethora of empirical concepts for real value, and the development of index number theory is thus characterised by an inventive sequence of euphemistic terms. We have an `ideal’ index, a `true’ (cost of living) index, an `exact’ index, a `superlative’ index and, last but not least, a `hedonic’ index.

At the same time, the word `real’ is employed in more than one sense in economics. It can mean the opposite to `nominal’, in other words a value figure corrected for a change in the value of the currency unit through a general price index. It can also mean `volume’, which is correction by means of a price index specifically tailored to the aggregate under consideration. It may mean `material’ as in `real’ assets rather than `financial’ assets, or the `real sector’ which produces such assets, as opposed to the `financial sector’, which deals with non- produced assets. In none of these uses is `real’ opposed to `fictitious’, but to the layman the difference is nevertheless unclear. The very act of `speaking in real terms’ conveys the idea that one has happily left behind the cloudy and unreliable world of bookkeeping and institutional regulations, and settled safely in the world of tangible objects. …

But the operational issues stirred up by using these terms have not been adequately addressed. To obtain such real variables, nominal figures are simply divided by some notional price index without regard to the ways in which this index is produced and the change in meaning it may imply for the resulting aggregate. …

In this [book] we make every effort to convince the reader that nominal values are real values in the sense of `actual’, and of what is observable as a statistical fact, while real values, as conceived by economic value theory, are constructs. They are imputations in the proper sense of the word… The dual character of the national accounts, distinguishing between institutional units and transactions on the one hand, and functional units and product flows on the other, provides the theoretical background for this view.

From Utz-Pieter Reich, National Accounts and Economic Value

“On money, debt, trust and central banking”

The central point of my Jacobin piece on the state of economics was meant to be: Whatever you think about mainstream macroeconomic theory, there is a lot of mainstream empirical and policy work that people on the left can learn from and engage with — much more than there was a decade ago. 2 

Some of the most interesting of that new work is from, and about, central banks. As an example, here is a remarkable speech by BIS economist Claudio Borio. I am not sure when I last saw such a high density of insight-per-word in a discussion of money and finance, let alone in a speech by a central banker. I could just say, Go read it. But instead I’m going to go through it section by section, explaining what I find interesting in it and how it connects up to a larger heterodox vision of money. 

From page one:

My focus will be the on the monetary system, defined technically as money plus the transfer mechanisms to execute payments. Logically, it makes little sense to talk about one without the other. But payments have too often been taken for granted in the academic literature, old and new. In the process, we have lost some valuable insights.

… two properties underpin a well functioning monetary system. One, rather technical, is the coincidence of the means of payment with the unit of account. The other, more intangible and fundamental, is trust. 

This starting point signals three central insights about money. First, the importance of payments. You shouldn’t fetishize any bit of terminology, but I’ve lately come to feel that the term “payments system” is a fairly reliable marker for something interesting to say about money. We all grow up with an idealized model of exchange, where the giving and receiving just happen, inseparably; but in reality it takes a quite sophisticated infrastructure to ensure that my debit coincides with your credit, and that everyone agrees this is so. Stefano Ugolini’s brilliant book on the prehistory of central banking emphasizes the central importance of finality – a binding determination that payment has taken place. (I suppose this was alsso the point of the essay that inaugurated Bitcoin.) In any case it’s a central aspect of “money” as a social institution that the mental image of one person handing a token to another entirely elides.

Second: the focus on money as unit of account and means of payment. The latter term mean money as the thing that discharges obligations, that cancels debts. It’s not evenb included in many standard lists of the functions of money, but for Marx, among others, it is fundamental. Borio consciously uses this term in preference to the more common medium of exchange, a token that facilitates trade of goods and services. He is clear that discharging debt and equivalent obligations is a more central role of money than exchanging commodities. Trade is a special case of debt, not vice versa. Here, as at other points through the essay, there’s a close parallel to David Graeber’s Debt. Borio doesn’t cite Graeber, but the speech is a clear example of my point in my debate with Mike Beggs years ago: Reading Graeber is good preparation for understanding some of the most interesting conversation in economics.

Third: trust. If you think of money as a social coordination mechanism, rather than a substance or quantity, you could argue that the scarce resource it’s helping to allocate is precisely trust.  More on this later.

Borio:

a key concept for understanding how the monetary system works is the “elasticity of credit”, ie the extent to which the system allows credit to expand. A high elasticity is essential for the system’s day-to-day operation, but too high an elasticity (“excess elasticity”) can cause serious economic damage in the longer run. 

This is an argument I’ve made before on this blog. Any payments system incorporate some degree of elasticity — some degree to which payments can run ahead of incomes. (As my old teacher David Kotz observes, the expansion of capital would be impossible otherwise.) But the degree of elasticity involves some unresolvable tensions. The logic of the market requires that every economic units expenditure eventually be brought into line with its income. But expansion, investment, innovation, requires eventually to be not just yet. (I talked a bit about this tension here.) Another critical point here is the impossibility of separating payments and credit – a separation that has been the goal of half the monetary reform proposals of the past 250 years.3

Along the way, I will touch on a number of sub-themes. .. whether it is appropriate to think of the price level as the inverse of the price of money, to make a sharp distinction between relative and absolute price changes, and to regard money (or monetary policy) as neutral in the long run.

So much here! The point about the non-equivalence of a rise in the price level and a fall in the value of money has been made eloquently by Merijn Knibbe.  I don’t think Borio’s version is better, but again, it comes with the imprimatur of Authority.

The fact that inflation inevitably involves relative as well as absolute price changes is made by Leijonhufvud (who Borio cites) and Minsky (who he surprisingly doesn’t); the non-neutrality of money is the subject (and the title) of what is in my opinion Minsky’s own best short distillation of his thought. 

Borio: 

Compared with the traditional focus on money as an object, the definition [in terms of means of payment] crucially extends the analysis to the payment mechanisms. In the literature, there has been a tendency to abstract from them and assume they operate smoothly in the background. I believe this is one reason why money is often said to be a convention, much like choosing which hand to shake hands with: why do people coordinate on a particular “object” as money? But money is much more than a convention; it is a social institution. It is far from self-sustaining. Society needs an institutional infrastructure to ensure that money is widely accepted, transactions take place, contracts are fulfilled and, above all, agents can count on that happening. 

Again, the payments mechanism is a complex, institutionally heavy social arrangement; there’s a lot that’s missed when we imagine economic transactions as I hand you this, you hand me that. Ignoring this social infrastructure invites the classical idea of money as an arbitrary numeraire, from which its long-run neutrality is one short step. 

The last clause introduces a deep new idea. In an important sense, trust is a kind of irrational expectation. Trust means that I am sure (or behave as if I am sure) that you will conform to the relevant rules. Trust means I believe (or behave as if I believe) this 100 percent. Anything less than 100 percent and trust quickly unravels to zero.  If there’s a small chance you might try to kill me, I should be prepared to kill you first; you might’ve had no bad intentions, but if I’m thinking of killing you, you should think about killing me first; and soon we’re all sprawled out on the warehouse floor. To exist in a world of strangers we need to believe, contrary to experience, that everyone around us will follow the rules.

a well functioning monetary system … will exploit the benefits of unifying the means of payment with the unit of account. The main benefit of a means of payment is that it allows any economy to function at all. In a decentralised exchange system, it underpins the quid-pro-quo process of exchange. And more specifically, it is a highly efficient means of “erasing” any residual relationship between transacting parties: they can thus get on with their business without concerns about monitoring and managing what would be a long chain of counterparties (and counterparties of counterparties).

Money as an instrument for erasing any relationship between the transacting parties: It could not be said better. And again, this is something someone who has read Graeber’s Debt understands very well, while someone who hasn’t might be a bit baffled by this passage. Graeber could also take you a step farther. Money might relieve you of the responsibility of monitoring your counterparties and their counterparties but somebody still has to. Graeber compellingly links the generalized use of money to strong centralized states. In a Graeberian perspective, money, along with slavery and bureaucracy, is one of the great social technologies for separating economic coordination from the broader network of mutual obligations.

The central banks’ elastic supply of the means of payment is essential to ensure that (i) transactions are settled in the interbank market and (ii) the interest rate is controlled. The interbank market is a critical component of our two-tier monetary system, where bank customer transactions are settled on the banks’ books and then banks, in turn, finally settle on the central bank’s books. To smooth out interbank settlement, the provision of central bank credit is key. The need for an elastic supply to settle transactions is most visible in the huge amounts of intraday credit central banks supply to support real- time gross settlement systems

“Two-tier monetary system” is a compressed version of Mehrling’s hierarchy of money. The second point, which Borio further develops further on, is that credit is integral to the payment system, since the two sides of a transaction never exactly coincide – there’s always one side that fulfills its part first and has to accept, however briefly, a promise in return. This is one reason that the dream of separating credit and payments is unrealizable.

The next point he makes is that a supply and demand framework is useless for thinking about monetary policy: 

The central bank … simply sets the desired interest rate by signalling where it would like it to be. And it can do so because it is a monopoly supplier of the means of payment: it can credibly commit to provide funds as needed to clear the market. … there is no such thing as a well behaved demand for bank reserves, which falls gradually as the interest rate increases, ie which is downward-sloping.

An interesting question is how much this is specific to the market for reserves and how much it applies to a range of asset markets. In fact, many markets share the two key features Borio points to here: adjustment via buffers rather than prices, and expected return that is a function of price.

On the first, there are a huge range of markets where there’s someone on one or both sides prepared to passively by or sell at a stated price. Many financial markets function only thanks to the existence of market makers – something Mehrling and his Barnard colleague Rajiv Sethi have written eloquently about. But more generally, most producers with pricing power — which is almost all of them — set a price and then passively meet demand at that price, allowing inventories and/or delivery times to absorb shifts in demand, within some range.

The second feature is specific to long-lived assets. Where there is an expected price different from the current price, holding the asset implies a capital gain or loss when the price adjusts. If expectations are sufficiently widespread and firmly anchored, they will be effectively self-confirming, as the expected valuation changes will lead the asset to be quickly bid back to its expected value. This dynamic in the bond market (and not the zero lower bound) is the authentic Keynesian liquidity trap.

To be clear, Borio isn’t raising here these broader questions about markets in general. But they are a natural extension of his arguments about reserves. 

Next come some points that shouldn’t be surprising to to readers of this blog, but which are nice, for me as an economics teacher, to see stated so plainly. 

The monetary base – such a common concept in the literature – plays no significant causal role in the determination of the money supply … or bank lending. It is not surprising that … large increases in bank reserves have no stable relationship with the stock of money … The money multiplier – the ratio of money to the monetary base – is not a useful concept. … Bank lending reflects banks’ management of the risk-return tradeoff they face… The ultimate anchor of the monetary system is not the monetary base but the interest rate the central bank sets.

We all know this is true, of course. The mystery is why so many textbooks still talk about the supply of high-powered money, the money multiplier, etc. As the man says, they just aren’t useful concepts.

Next comes the ubiquity of credit, which not only involves explicit loans but also any transaction where delivery and payment don’t coincide in time — which is almost all of them. Borio takes this already-interesting point in an interestingly Graeberian direction:  

A high elasticity in the supply of the means of payment does not just apply to bank reserves, it is also essential for bank money. … Credit creation is all around us: some we see, some we don’t. For instance, explicit credit extension is often needed to ensure that two legs of a transaction are executed at the same time so as to reduce counterparty risk… And implicit credit creation takes place when the two legs are not synchronised. ….

In fact, the role of credit in monetary systems is commonly underestimated. Conceptually, exchanging money for a good or service is not the only way of solving the problem of the double coincidence of wants and overcoming barter. An equally, if not more convenient, option is to defer payment (extend credit) and then settle when a mutually agreeable good or service is available. In primitive systems or ancient civilisations as well as during the middle ages, this was quite common. … It is easier to find such examples than cases of true barter.

The historical non-existence of barter is the subject of the first chapter of Debt . Here again, the central banker has more in common with the radical anthropologist than with orthodox textbooks, which usually make barter the starting point for discussions of money.

Borio goes on:

the distinction between money and debt is often overplayed. True, one difference is that money extinguishes obligations, as the ultimate settlement medium. But netting debt contracts is indeed a widespread form of settling transactions.

Yes it is: remember Braudel’s Flanders fairs? “The fairs were effectively a settling of accounts, in which debts met and cancelled each other out, melting like snow in the sun.”

At an even deeper level, money is debt in the form of an implicit contract between the individual and society. The individual provides something of value in return for a token she trusts to be able to use in the future to obtain something else of value. She has a credit vis-à-vis everyone and no one in particular (society owes a debt to her).

In the classroom, one of the ways I suggest students think about money is as a kind of social scorecard. You did something good — made something somebody wanted, let somebody else use something you own, went to work and did everything the boss told you? Good for you, you get a cookie. Or more precisely, you get a credit, in both senses, in the personal record kept for you at a bank. Now you want something for yourself? OK, but that is going to be subtracted from the running total of how much you’ve done for the rest for us.

People get very excited about China’s social credit system, a sort of generalization of the “permanent record” we use to intimidate schoolchildren. And ok, it does sound kind of dystopian. If your rating is too low, you aren’t allowed to fly on a plane. Think about that — a number assigned to every person, adjusted based on somebody’s judgement of your pro-social or anti-social behavior. If your number is too low, you can’t on a plane. If it’s really low, you can’t even get on a bus. Could you imagine a system like that in the US?

Except, of course, that we have exactly this system already. The number is called a bank account. The difference is simply that we have so naturalized the system that “how much money you have” seems like simply a fact about you, rather than a judgement imposed by society.

Back to Borio:

All this also suggests that the role of the state is critical. The state issues laws and is ultimately responsible for formalising society’s implicit contract. All well functioning currencies have ultimately been underpinned by a state … [and] it is surely not by chance that dominant international currencies have represented an extension of powerful states… 

Yes. Though I do have to note that it’s at this point that Borio’s fealty to policy orthodoxy — as opposed to academic orthodoxy — comes into view. He follows up the Graeberian point about the link between state authority and money with a very un-Graeberian warning about the state’s “temptation to abuse its power, undermining the monetary system and endangering both price and financial stability.”

Turning now to the policy role of the central bank, Borio  starts from by arguing that “the concepts of price and financial stability are joined at the hip. They are simply two ways of ensuring trust in the monetary system…. It is no coincidence that securing both price and financial stability have been two core central bank functions.” He then makes the essential point that what the central bank manages is at heart the elasticity of the credit system. 

The process underpinning financial instability hinges on how “elastic” the monetary system is over longer horizons… The challenge is to ensure that the system is not excessively elastic drawing on two monetary system anchors. One operates on prices – the interest rate and the central bank’s reaction function. … The other operates on quantities: bank regulatory requirements, such as those on capital or liquidity, and the supervisory apparatus that enforces them.

This is critical, not just for thinking about monetary policy, but as signpost toward the heart of the Keynesian vision. (Not the bastard — but useful  — postwar Keynesianism of IS-LM, but the real thing.) Capitalism is not a system of real exchange — it shouldn’t be imagined as a system in which people exchange pre-existing stuff for other stuff they like better. Rather, it is a system of monetary production — a system in which payments and claims of money, meaningless themselves, are the coordinating mechanism for human being’s collective, productive activity. 

This is the broadest sense of the statement that money has to be elastic, but not too elastic. If it is too elastic, money will lose its scarcity value, and hence its power to organize human activity. Money is only an effective coordinating mechanism when its possession allows someone to compel the obedience of others. But it has to be flexible enough to adapt to the concrete needs of production, and of the reproduction of society in general. (This is the big point people take form Polanyi.) “You can’t have the stuff until you give me the money” is the fundamental principle that has allowed capitalism to reorganize vast swathes of our collective existence, for better or worse. But applied literally, it stops too much stuff from getting where it needs to go to to be compatible with the requirements of capitalist production itself. There’s a reason why business transactions are almost always on the basis of trade credit, not cash on the barrelhead. As Borio puts it, “today’s economies are credit hungry.” 

The talk next turns to criticism of conventional macroeconomics that will sound familiar to Post Keynesians. The problem of getting the right elasticity in the payments system — neither too much nor too little — is “downplayed in the current vintage of macroeconomic models. One reason is that the models conflate saving and financing.“ In reality,

Saving is just a component of national income – as it were, just a hole in overall expenditures, without a concrete physical representation. Financing is a cash flow and is needed to fund expenditures. In the mainstream models, even when banks are present, they imply endowments or “saving”; they do not create bank deposits and hence purchasing power through the extension of loans or purchase of assets. There is no meaningful monetary system, so that any elasticity is seriously curtailed. Financial factors serve mainly to enhance the persistence of “shocks” rather than resulting in endogenous booms and busts.

This seems right to me. The point that there is no sense in which savings finance or precede or investment is a key one for Keynes, in the General Theory and even more clearly in his subsequent writing.4 I can’t help noting, also, that passages like this are a reminder that criticism of today’s consensus macro does not come only from the professionally marginalized.

The flipside of not seeing money as social coordinating mechanism, a social ledger kept by banks, is that you do  see it as a arbitrary token that exists in a particular quantity. This latter vision leads to an idea of inflation as a simple imbalance between the quantity of money and the quantity of stuff. Borio:

The process was described in very simple terms in the old days. An exogenous increase in the money supply would boost inflation. The view that “the price level is the inverse of the price of money” has probably given this purely monetary interpretation of inflation considerable intuitive appeal. Nowadays, the prevailing view is not fundamentally different, except that it is couched in terms of the impact of the interest rate the central bank sets.

This view of the inflation process has gone hand in hand with a stronger proposition: in the long run, money (monetary policy) is neutral, ie it affects only prices and no real variables. Again, in the classical tradition this was couched in terms of the money supply; today, it is in terms of interest rates. … Views about how long it takes for this process to play itself out in calendar time differ. But proponents argue that the length is short enough to be of practical policy relevance.

The idea that inflation can be thought of as a decline in the value of money is effectively criticized by Merijn Knibbe and others. It is a natural idea, almost definitionally true, if you vision starts from a world of exchange of goods and then adds money as facilitator or numeraire. But if you start, as Borio does, and as the heterodox money tradition from Graeber to Minsky to Keynes to Marx and back to Tooke and Thornton does, from the idea of money as entries in a social ledger, then it makes about as much sense as saying that a game was a blowout because the quantity of points was too high.  

once we recognise that money is fundamentally endogenous, analytical thought experiments that assume an exogenous change and trace its impact are not that helpful, if not meaningless. They obscure, rather than illuminate, the mechanisms at work. … [And] once we recognise that the price of money in terms of the unit of account is unity, it makes little sense to think of the price level as the inverse of the price of money. … any financial asset fixed in nominal terms has the same property. As a result, thinking of inflation as a purely monetary phenomenon is less compelling.

“Not that helpful”, “makes little sense,” “is less compelling”: Borio is nothing if not diplomatic. But the point gets across.

Once we recognise that the interest rate is the monetary anchor, it becomes harder to argue that monetary policy is neutral… the interest rate is bound to affect different sectors differently, resulting in different rates of capital accumulation and various forms of hysteresis. … it is arguably not that helpful to make a sharp distinction between what affects relative prices and the aggregate price level…., not least because prices move at different speeds and differ in their flexibility… at low inflation rates, the “pure” inflation component, pertaining to a generalised increase in prices, [is] smaller, so that the distinction between relative and general price changes becomes rather porous.

In part, this is a restatement of Minsky’s “two-price” formulation of Keynes. Given that money or liquidity is usefulat all, it is presumably more useful for some things more than for others; and in particular, it is most useful when you have to make long-lived commitments that expose you to vagaries of an unknown future; that is, for investment. Throttling down the supply of liquidity will not just reduce prices and spending across the board, it will reduce them particularly for long-lived capital goods.

The second point, that inflation loses its defintion as a distinct phenomenon at low levels, and fades into the general mix of price changes, is something I’ve thought myself for a while but have never seen someone spell out this way. (I’m sure people have.) It follows directly from the fact that changes in the prices of particualr goods don’t scale proportionately with inflation, so as inflation gets low, the shared component of price changes over time gets smaller and harder to identify. Because the shared component is smaller at low inflation, it is going to be more sensitive to the choice of basket and other measurement issues. 20 percent inflation clearly (it seems to me) represents a genuine phenomenon. But it’s not clear that 2 percent inflation really does – an impression reinforced by the proliferation of alternative measures.

The Minskyan two-price argument also means that credit conditions and monetary policy necessarily affect the directiona s well as the level of economic activity.

financial booms tend to misallocate resources, not least because too many resources go into sectors such as construction… It is hard to imagine that interest rates are simply innocent bystanders. At least for any policy relevant horizon, if not beyond, these observations suggest that monetary policy neutrality is questionable.

This was one of the main points in Mike Konczal’s and my monetary toolkit paper.

In the next section, which deserves a much fuller unpacking, Borio critiques the fashionable idea that central banks cannot control the real rate of interest. 

 Recent research going back to the 1870s has found a pretty robust link between monetary regimes and the real interest rate over long horizons. By contrast, the “usual suspects” seen as driving saving and investment – all real variables – do not appear to have played any consistent role. 

This conflation of the “real”  (inflation-adjusted) interest rate with a rate determined by “real” (nonmonetary) factors, and therefore beyond the central bank’s influence, is one of the key fissure-points in economic ideology.5 The vision of economics, espcially its normative claims, depend on an idea of ecnomic life as the mutually beneficial exchange of goods. There is an obvious mismatch between this vision and the language we use to talk about banks and market interest rates and central banks — it’s not that they contradict or in conflict as that they don’t make contact at all. The preferred solution, going from today’s New Keynesian consensus back through Friedman to Wicksell, is to argue that the “interest rate” set by the central bank must in some way be the same as the “interest rate” arrived at by agents exchanging goods today for goods later. Since the  terms of these trades depend only on the non-monetary fundamentals of preferences and technology, the same must in the long run be true of the interest rate set by the financial system and/or the central bank. The money interest rate cannot persistently diverge from the interest rate that would obtain in a nonmonetary exchange economy that in some sense corresponds to the actual one.

But you can’t square the circle this way. A fundamental Keynesian insight is that economic relations between the past and the future don’t take the form of trades of goods now for goods later, but of promises to make money payments at some future date or state of the world. Your ability to make money promises, and your willingness to accept them from others, depends not on any physical scarcity, but on your confidence in your counterparties doing what they promised, and in your ability to meet your own commitments if some expected payment doesn’t come through. In short, as Borio says, it depends on trust. In other words, the fundamental problem for which interest is a signal is not allocation but coordination. When interest rates are high, that reflects not a scarcity of goods in the present relative to the future, but a relative lack of trust within the financial system. Corporate bond rates did not spike in 2008 because decisionmakers suddenly wished to spend more in the present relative to the future, but because the promises embodied in the bonds were no longer trusted.

Here’s another way of looking at it: Money is valuable. The precursor of today’s “real interest rate” talk was the idea of money as neutral in the long run, in the sense that a change in the supply of money would eventually lead only to a proportionate change in the price level.6  This story somehow assumes on the one hand that money is useful, in the sense that it makes transactions possible that wouldn’t be otherwise. Or as Kocherlakota puts it: “At its heart, economic thinking about fiat money is paradoxical. On the one hand, such money is viewed as being inherently useless… But at the same time, these barren tokens… allow society to implement allocations that would not otherwise be achievable.” If money is both useful and neutral, evidently it must be equally useful for all transactions, and its usefulness must drop suddenly to zero once a fixed set of transactions have been made. Either there is money or there isn’t. But if additional money does not allow any desirable transaction to be carried out that right now cannot be, then shouldn’t the price of money already be zero? 

Similarly: The services provided by private banks, and by the central bank, are valuable. This is the central point of Borio’s talk. The central bank’s explicit guarantee of certain money commitments, and its open ended readiness to ensure that others are fulfilled in a crisis, makes a great many promises acceptable that otherwise wouldn’t be. And like the provider of anything of value, the central bank — and financial system more broadly — can affect its price by supplying more or less of it. It makes about as much sense to say that central banks can influence the interest rate only in the short run as to say that public utilities can only influence the price of electricity in the short run, or that transit systems can only influence the price of transportation in the short run. The activities of the central bank allow a greater degree of trust in the financial system, and therefore a lesser required payment to its professional promise-accepters.7 Or less trust and higher payments, as the case may be. This is true in the short run, in the medium run, in the long run. And because of the role money payments play in organizing productive activity, this also means a greater or lesser increase in our collective powers over nature and ability to satisfy our material wants.

 

“Economic Growth, Income Distribution, and Climate Change”

In response to my earlier post on climate change and aggregate demand, Lance Taylor sends along his recent article “Economic Growth, Income Distribution, and Climate Change,” coauthored with Duncan Foley and Armon Rezai.

The article, which was published in Ecological Economics, lays out a structuralist growth model with various additions to represent the effects of climate change and possible responses to it. The bulk of the article works through the formal properties of the model; the last section shows the results of some simulations based on plausible values of the various parmaters. 8 I hadn’t seen the article before, but its conclusions are broadly parallel to my arguments in the previous two posts. It tells a story in which public spending on decarbonization not only avoids the costs and dangers of climate change itself, but leads to higher private output, income and employment – crowding in rather than crowding out.

Before you click through, a warning: There’s a lot of math there. We’ve got a short run where output and investment are determined via demand and distribution, a long run where the the investment rate from the short run dynamics is combined with exogenous population growth and endogenous productivity growth to yield a growth path, and an additional climate sector that interacts with the economic variables in various ways. How much the properties of a model like this change your views about the substantive question of climate change and economic growth, will depend on how you feel about exercises like this in general. How much should the fact that that one can write down a model where climate change mitigation more than pays for itself through higher output, change our beliefs about whether this is really the case?

For some people (like me) the specifics of the model may be less important that the fact that one of the world’s most important heterodox macroeconomists thinks the conclusion is plausible. At the least, we can say that there is a logically coherent story where climate change mitigation does not crowd out other spending, and that this represents an important segment of heterodox economics and not just an idiosyncratic personal view.

If you’re interested, the central conclusions of the calibrated model are shown below. The dotted red line shows the business-as-usual scenario with no public spending on climate change, while the other two lines show scenarios with more or less aggressive public programs to reduce and/or offset carbon emissions.

Here’s the paper’s summary of the outcomes along the business-as-usual trajectory:

Rapid growth generates high net emissions which translate into rising global mean temperature… As climate damages increase, the profit rate falls. Investment levels are insufficient to maintain aggregate demand and unemployment results. After this boom-bust cycle, output is back to its current level after 200 years but … employment relative to population falls from 40% to 15%. … Those lucky enough to find employment are paid almost three times the current wage rate, but the others have to rely on subsistence income or public transfers. Only in the very long run, as labor productivity falls in response to rampant unemployment, can employment levels recover. 

In the other scenarios, with a peak of 3-6% of world GDP spent on mitigation, we see continued exponential output growth in line with historical trends. The paper doesn’t make a direct comparison between the mitigation cases and a world where there was no climate change problem to begin with. But the structure of the model at least allows for the possibility that output ends up higher in the former case.

The assumptions behind these results are: that the economy is demand constrained, so that public spending on climate mitigation boosts output and employment in the short run; that investment depends on demand conditions as well as distributional conflict, allowing the short-run dynamics to influence the long-run growth path; that productivity growth is endogenous, rising with output and with employment; and that climate change affects the growth rate and not just the level of output, via lower profits and faster depreciation of existing capital.9

This is all very interesting. But again, we might ask how much we learn from this sort of simulation. Certainly it shouldn’t be taken as a prediction! To me there is one clear lesson at least: A simple cost benefit framework is inadequate for thinking about the economic problem of climate change. Spending on decarbonization is not simply a cost. If we want to think seriously about its economic effects, we have to think about demand, investment, distribution and induced technological change. Whether you find this particular formalization convincing, these are the questions to ask.

The King’s Two Bodies

This looks like a good book:

Private outposts in the state and public outposts in finance, central banks have historically moved back and forth between very different institutional forms: private, public and various combinations of the two. Far from constituting a rational-functionalist formation, they have performed widely diverse and often barely related functions—from the administration of state debt to the issuing of currency and the supervision of private banks—cobbled together more or less ad hoc according to political expediency… Central banks, Vogl argues, constitute a fourth power, overshadowing legislature, executive and judiciary, and integrating financial-market mechanisms into the practice of government.

Central banks’ claim to autonomous authority is based on their assumed, and asserted, technical competence. As they and their aficionados in the media and in economics departments are fond of telling us, central bankers know things about the economy that normal people, inevitably overwhelmed by such complexity, cannot even begin to fathom. … Central bankers themselves have always been aware … that what they sell to the public as a quasi-natural science is in fact nothing more than intuitive empathy, an ability acquired by long having moved in the right circles to sense how capital will feel, good or bad, about what a government is planning to do in relation to financial markets. (Economic theory is best understood as an ontological reification of capitalist sensitivities represented as natural laws of a construct called ‘the economy’.) At critical moments, such as when the Bank of England went off the gold standard in 1931 …, central banking relies on the trained intuition of great men and their capacity to make others believe that they know what they’re doing, even when they don’t. At a university event in London almost a decade after the 2008 crash, Alan Greenspan was remembered by an enthusiastic admirer as having had ‘a complete model of the American economy in his body’.

The Wit and Wisdom of Trygve Haavelmo

I was talking some time ago with my friend Enno about Merijn Knibbe’s series of articles on the disconnect between the variables used in economic models and the corresponding variables in the national accounts.10 Enno mentioned Trygve Haavelmo’s 1944 article The Probability Approach in Econometrics; he thought Haavelmo’s distinction between “theroetical variables,” “true variables,” and “observable variables” could be a useful way of thinking about the slippages between economic reality, economic data and economic theory.

I finally picked up the Haavelmo article, and it turns out to be a deep and insightful piece — for the reason Enno mentioned, but also more broadly on how to think about empirical economics. It’s especially interesting coming from soeone who won the Nobel Prize for his foundational work in econometrics. Another piece of evidence that orthodox economists in the mid-20th century thought more deeply and critically about the nature of their project than their successors do today.

It’s a long piece, with a lot of mathematical illustrations that someone reading it today can safely skip. The central argument comes down to three overlapping points. First, economic models are tools, developed to solve specific problems. Second, economic theories have content only insofar as they’re associated with specific procedures for measurement. Third, we have positive economic knowledge only insofar as we can make unconditional predictions about the distribution of observable variables.

The first point: We study economics in order to “become master of the happenings of real life.” This is on some level obvious, or vacuous, but it'[s important; it functions as a kind of “he who has ears, let him hear.” It marks the line between those who come to economics as a means to some other end — a political commitment, for many of us; but it could just as well come from a role in business or policy — and those for whom economic theory is an end in itself. Economics education must, obviously, be organized on the latter principle. As soon as you walk into an economics classroom, the purpose of your being there is to learn economics. But you can’t, from within the classroom, make any judgement about what is useful or interesting for the world outside. Or as Hayek put it, “One who is only an economist, cannot be a good economist.”11

Here is what Haavelmo says:

Theoretical models are necessary tools in our attempts to understand and explain events in real life. … Whatever be the “explanations” we prefer, it is not to be forgotten that they are all our own artificial inventions in a search for an understanding of real life; they are not hidden truths to be “discovered.”

It’s an interesting question, which we don’t have to answer here, whether or to what extent this applies to the physical sciences as well. Haavelmo thinks this pragmatic view of scientific laws applies across the board:

The phrase “In the natural sciences we have laws” means not much more and not much less than this: The natural sciences have chosen fruitful ways of looking upon physical reality.

We don’t need to decide here whether we want to apply this pragmatic view to the physical sciences. It is certainly the right way to look at economic models, in particular the models we construct in econometrics. The “data generating process” is not an object existing out in the world. It is a construct you have created for one or both of these reasons: It is an efficient description of the structure of a specific matrix of observed data; it allows you to make predictions about some specific yet-to-be-observed outcome. The idea of a data-generating process is obviously very useful in thinking about the logic of different statistical techniques. It may be useful to do econometrics as if there were a certain data generating process. It is dangerously wrong to believe there really is one.

Speaking of observation brings us to Haavelmo’s second theme: the meaningless of economic theory except in the context of a specific procedure for observation.  It might naively seem, he says, that

since the facts we want to study present themselves in the form of numerical measurement, we shall have to choose our models from … the field of mathematics. But the concepts of mathematics obtain their quantitative meaning implicitly through the system of logical operations we impose. In pure mathematics there really is no such problem as quantitative definition of a concept per se …

When economists talk about the problem of quantitative definitions of economic variables, they must have something in mind which has to do with real economic phenomena. More precisely, they want to give exact rules how to measure certain phenomena of real life.

Anyone who got a B+ in real analysis will have no problem with the first part of this statement. For the rest, this is the point: economic quantities come into existence only through some concrete human activity that involves someone writing down a number. You can ignore this, most of the time; but you should not ignore it all of the time. Because without that concrete activity there’s no link between economic theory and the social reality it hopes to help us master or make sense of.

Haavelmo has some sharp observations on the kind of economics that ignores the concrete activity that generates its data, which seem just as relevant to economic practice today:

Does a system of questions become less mathematical and more economic in character just by calling x “consumption,” y “price,” etc.? There are certainly many examples of studies to be found that do not go very much further than this, as far as economic significance is concerned.

There certainly are!

An equation, Haavelmo continues,

does not become an economic theory just by using economic terminology to name the variables invovled. It becomes an economic theory when associated with the rule of actual measurement of economic variables.

I’ve seen plenty of papers where the thought process seems to have been somthing like, “I think this phenomenaon is cyclical. Here is a set of difference equations that produce a cycle. I’ll label the variables with names of parts of the phenomenon. Now I have a theory of it!” With no discussion of how to measure the variables or in what sense the objects they describe exist in the external world.

What makes a piece of mathematical economics not only mathematics but also economics is this: When we set up a system of theoretical relationships and use economic names for the otherwise purely theoretical variables involved, we have in mind some actual experiment, or some design of an experiment, which we could at least imagine arranging, in order to measure those quantities in real economic life that we think might obey the laws imposed on their theoretical namesakes.

Right. A model has positive content only insofar as we can describe the concrete set of procedures that gets us from the directly accessible evidence of our senses. In my experience this comes through very clearly if you talk to someone who actually works in the physical sciences. A large part of their time is spent close to the interface with concrete reality — capturing that lizard, calibrating that laser.  The practice of science isn’t simply constructing a formal analog of physical reality, a model trainset. It’s actively pushing against unknown reality and seeing how it pushes back.

Haavelmo:

When considering a theoretical setup … it is common to ask about the actual meaning of this or that variable. But this question has no sense within the theoretical model. And if the question applies to reality it has no precise answer … we will always need some willingness among our fellow research workers to agree “for practical purposes” on questions of definitions and measurement …A design of experiments … is an essential appendix to any quantitative theory.

With respect to macroeconomics, the “design of experiments” means, in the first instance, the design of the national accounts. Needless to say, national accounting concepts cannot be treated as direct observations of the corresponding terms in economic theory, even if they have been reconstructed with that theory in mind. Cynamon and Fazzari’s paper on the measurement of household spending gives some perfect examples of this. There can’t be many contexts in which Medicare payments to hospitals, for example, are what people have in mind when they construct models of household consumption. But nonetheless that’s what they’re measuring, when they use consumption data from the national accounts.

I think there’s an important sense in which the actual question of any empirical macroeconomics work has to be: What concrete social process led the people working at the statistics office to enter these particular values in the accounts?

Or as Haavelmo puts it:

There is hardly an economist who feels really happy about identifying the current series of “national income, “consumptions,” etc. with the variables by those names in his theories. Or, conversely, he would think it too complicated or perhaps uninteresting to try to build models … [whose] variables would correspond to those actually given by current economic statistics. … The practical conclusion… is the advice that economists hardly ever fail to give, but that few actually follow, that one should study very carefully the actual series considered and the conditions under which they were produced, before identifying them with the variables of a particular theoretical model.

Good advice! And, as he says, hardly ever followed.

I want to go back to the question of the “meaning” of a variable, because this point is so easy to miss. Within a model, the variables have no meaning, we simply have a set of mathematical relationships that are either tautologous, arbitrary, or false. The variables only acquire meaning insofar as we can connect them to concrete social phenomena. It may be unclear to you, as a blog reader, why I’m banging on this point so insistently. Go to an economics conference and you’ll see.

The third central point of the piece is that meaningful explanation requires being able to identify a few causal links as decisive, so that all the other possible ones can be ignored.

Think back to that Paul Romer piece on what’s wrong with modern macroeconomics. One of the most interesting parts of it, to me, was its insistent Humean skepticism about the possibility of a purely inductive economics, or for that matter science of any kind. Paraphrasing Romer: suppose we have n variables, any of which may potentially influence the others. Well then, we have n equations, one for each variable, and n2 parameters (counting intercepts). In general, we are not going to be able to estimate this system based on data alone. We have to restrict the possible parameter space either on the basis of theory, or by “experiments” (natural or otherwise) that let us set most of the parameters to zero on the grounds that there is no independent variation in those variables between observations. I’m not sure that Romer fully engages with this point, whose implications go well beyond the failings of real business cycle theory. But it’s a central concern for Haavelmo:

A theoretical model may be said to be simply a restriction upon the joint variations of a system of quantities … which otherwise might have any value. … Our hope in economic theory and research is that it may be possible to establish contant and relatively simple relations between dependent variables … and a realtively small number of independent variables. … We hope that for each variable y to be explained, there is a realtively small number of explaining factors the variations of which are practically decisive in determining the variations of y. …  If we are trying to explain a certain observable varaible, y, by a system of causal factors, there is, in general, no limit to the number of such factors that might have a potential influence upon y. But Nature may limit the number of fctors that have a nonneglible factual influence to a relatively small number. Our hope for simple laws in economics rests upon the assumption that we may proceed as if such natural limitations of the number of relevant factors exist.

One way or another, to do empirical economic, we have to ignore mst of the logically possible relationships between our variables. Our goal, after all, is to explain variation in the dependent variable. Meaningful explanation is possible only if the number of relevant causal factors is small. If someone asks “why is unemployment high”, a meaningful answer is going to involve at most two or three causes. If you say, “I have no idea, but all else equal wage regulations are making it higher,” then you haven’t given an answer at all. To be masters of the hapennings of real life, we need to focus on causes of effects, not effects of causes.

In other words, ceteris paribus knowledge isn’t knowledge at all. Only unconditional claims count — but they don’t have to be predictions of a single variable, they can be claims about the joint distribution of several. But in any case we have positive knowledge only to the extent we can unconditionally say that future observations will fall entirely in a certain part of the state space. This fails if we have a ceteris paribus condition, or if our empirical works “corrects” for factors whose distribution and the nature of whose influence we have not invstigated.12 Applied science is useful because it gives us knowledge of the kind, “If I don’t turn the key, the car will not start, if I do turn the key, it will — or if it doesn’t there is a short list of possible reasons why not.” It doesn’t give us knowledge like “All else equal, the car is more likely to start when the key is turned than when it isn’t.”13

If probability distributions are simply tools for making unconditional claims about specific events, then it doesn’t make sense to think of them as existing out in the world. They are, as Keynes also emphasized, simply ways of describing our own subjective state of belief:

We might interpret “probability” simply as a measure of our a priori confidence in the occurrence of a certain event. Then the theoretical notion of a probability distribution serves us chiefly as a tool for deriving statements that have a very high probability of being true.

Another way of looking at this. Research in economics is generally framed in terms of uncovering universal laws, for which the particular phenomenon being  studied merely serves as a case study.14 But in the real world, it’s more oftne the other way: We are interested in some specific case, often the outcome of some specific action we are considering. Or as Haavelmo puts it,

As a rule we are not particularly interested in making statements about a large number of observations. Usually, we are interested in a relatively small number of observations points; or perhaps even more frequently, we are interested in a practical statement about just one single new observation.

We want economics to answer questions like, “what will happen if US imposes tariffs on China”? The question of what effects tariffs have on trade in the abstract is, itself, uninteresting and unanswerable.

What do we take from this? How, according to Haavelmo, should empirical economics be?

First, the goal of empirical work is to explain concrete phenomena — what happened, or will happen, in some particular case.

Second, the content of a theory is inseparable from the procedures for measuring the variables in it.

Third, empirical work requires restrictions on the logically possible space of parameters, some of which have to be imposed a priori.

Finally, prediction (the goal) means making unconditional claims about the joint distribution of one or more variables. “Everything else equal” means “I don’t know.”

All of this based on the idea that we study economics not as an end in itself, but in response to the problems forced on us by the world.

“The financialization of the nonfinancial corporation”

One common narrative attached to the murky term financialization is that nonfinancial corporations have, in effect, turned themselves into banks or hedge funds — they have replaced investment in means of production with ownership of financial assets. Financial profits, in this story, have increasingly substituted for profits from making and selling stuff. I’m not sure where this idea originates — the epidemiology points toward my own homeland of UMass-Amherst — but it’s become almost accepted wisdom in left economics.

I’ve been skeptical of this story for a while, partly because it conflicts with my own vision of financialization as something done to nonfinancial corporations rather than by them — a point I’ll return to at the end of the post — and partly because I’ve never seen good evidence for it. On the cashflow side, it’s true there is a rise in interest income from the 1960s through the 1980s. But, as discussed in the previous post, this is outweighed by a rise in interest payments; it reflects a general rise in interest rates rather than a reorientation of corporate activity; and has subsequently been reversed. On the balance sheet side, there is indeed a secular rise in “financial” assets, but this is all in what the financial accounts call “unidentified” assets, which I’ve always suspected is mostly goodwill and equity in subsidiaries rather than anything we would normally think of as financial assets.

Now courtesy of Nathan Tankus, here is an excellent paper by Joel Rabinovitch that makes this case much more thoroughly than I’d been able to.

The paper starts by distinguishing two broad stories of financialization: shareholder value orientation and acquisition of financial assets. In the first story, financialization means that corporations are increasingly oriented toward the wishes or interests of shareholders and other financial claimants. The second story is the one we are interested in here. Rabinovitch’s paper doesn’t directly engage with the shareholder-value story, but it implicitly strengthens it by criticizing the financial-assets one.

The targets of the paper include some of my smartest friends. So I’ll be interested to see what they say in response to it.

The critical questions are:  Have nonfinancial corporations’ holdings of financial assets really increased, relative to total assets? And, has their financial income risen relative to total income?

The answers in turn depend on two subsidiary issues. On the first question, we need to decide what is represented by the “other unidentified assets” category in the Financial Accounts, which is responsible for essentially all of the apparent rise in financial assets. And on the income side, we need to consistently compare the full set of financial flows to their nonfinancial equivalents. Rabinovitch argues, convincingly in my view, that looking at financial income in isolation is not give a meaningful picture.

On the face of it, the asset and income pictures look quite different. In the official accounts, financial assets of nonfinancial corporations have increased from 40% of nonfinancial assets to 120% between 1946 and 2015. Financial income, on the other hand, is only 2.5% of total income and shows no long-term increase. This should already make us skeptical that the increase in “financial” assets represents income-generating assets in the usual sense.

Rabinovitch then explores this is detail by combining the financial accounts with the IRS statistics of income (SOI) and the Compustat database. Each of these has strengths and weaknesses — Compustat provides firm-level data, but is limited to large, publicly-traded corporations and consolidates domestic and overseas operations; SOI gives detailed breakdowns of income sources for all forms of legal organization broken down by size, but it doesn’t include any balance-sheet variables, so it can’t be used to answer the asset questions.

iI the financial accounts, the majority of the increase in identified financial assets is FDI stock. As Rabinovitch notes, “it’s dubious to directly consider FDI as a financial asset if we take into account that it implies lasting interest with the intention to exercise control over the enterprise.” The largest part of the overall increase in financial assets, however, is in the residual “other unidentified assets” line of the financial accounts. The fact that there is no increase in income associated with these assets is already a reason to doubt that they are financial assets in the usual sense. Compustat data, while not strictly comparable, suggests that the majority of this is intangibles. The most important intangible is goodwill, which is simply the accounting term of the excess of an acquisition price over the book value of the acquired company. Importantly, goodwill is not depreciated but only written off through impairment. Another large portion is equity in unconsolidated subsidiaries; this accounts for a disproportionate share of the increase thanks to a change in accounting rules that required corporations to begin accounting for it explicitly. Other important intangibles include patents, copyrights, licenses, etc. These are not financial assets; rather they are assets or pseudo-assets acquired, like real investment, in order to carry out a company’s productive activities on an extended scale.

These are all aggregate numbers; perhaps the financialization story holds up better for the biggest firms? Rabinovich discusses this too. Both Compustat and SOI allow us to separate firms by size. As it turns out, the largest firms do have a greater proportion of financial income than the smaller ones. But even for the largest 0.05% of corporations, financial income is still only 3.5% or total income, and net financial income is still negative. As he reasonably concludes, “even for the biggest nonfinancial corporations, financialization must not be understood as mimicking financial corporations.”

What do we make of all this?

First, the view of financialization as nonfinancial businesses acquiring financial assets for income in placer of real investment, is widely held on the left. After my Jacobin interview came out, for example, several people promptly informed me that I was missing this important fact. So if the evidence does not in fact support it, that is worth knowing. Or at least, future statements of the hypothesis will be stronger if they respond to the points made here.

Second, the fact that “financial” assets in fact mostly consist of goodwill, interest in unconsolidated subsidiaries, and foreign investment is interesting in its own right, not just as negative criticism of the  financialization story. It a sign of the importance of ownership claims as a means of control over production— both as the substantive content of balance sheet positions and as a core part of corporate activity.

Third, the larger importance of the story is to the question of whether nonfinancial corporations and their managers should be seen mainly as participants in, or victims of, financialization. Conversely, is finance itself a distinct social actor? In a world in which the largest nonfinancial corporations have effectively turned themselves into hedge funds, it would not make much sense to talk about a conflict between productive capital and financial capital, or to imagine them as two distinct sets of people. But in a world like the one described here, or in my previous post, where the main nexus between nonfinancial corporations and finance is payments from the former to the latter, it may indeed make sense to think of them as distinct actors, of conflicts between them, and of intervening politically  on one side or the other.

Finally, to me, this paper is a model of  how to do empirical work in economics. Through some historical process I’d like to understand better, economists have become obsessed with regression, to the point that in academic economics it’s become synonymous with empirics. Regression analysis starts from the idea that the data we observe is a random draw from some underlying data generating process in which a variable of interest is a function of one or more other variables. The goal of the regression is to recover the parameters of that function by observing independent or exogenous variation in the variables. But for most macroeconomic questions, we are dealing with historical processes where our goal is to understand what actually happened, and where the hypothesis of some underlying data-generating process from which historical data is drawn randomly, is neither realistic nor useful. On the other hand, the economy is not a black box; we always have some idea of the mechanism linking macroeconomic variables. So we don’t need to evaluate our hypotheses by asking how probable the it would be to draw the distribution we observe from some hypothetical random process; we can, and generally should, ask instead whether the historical pattern is consistent with the mechanism. Furthermore, regression analysis is generally focused on the qualitative question of whether variation in one variable can be said to cause variation in a second one; but in historical macroeconomics we are generally interested in how much of the variation in some outcome is due to various causes. So a regression approach, it seems to me, is basically unsuited to the questions addressed here. This paper, it seems to me, is a model of what one should do instead.

V for Varoufakis

I have a long review up at Boston Review of three books by Yanis Varoufakis: The Global Minotaur, And the Weak Suffer What They Must?, and Adults in the Room. Here’s the start:

In the spring of 2015, a series of debt negotiations briefly claimed a share of the world’s attention that normally goes only to events where celebrities give each other prizes. Syriza, a scrappy left-wing party, had stormed into office in Greece on a promise to challenge the consortium of international creditors that had effectively ruled the country since its debt crisis broke out in 2010. For years, austerity, deregulation, the rolling back of labor rights and public services, the rule of money over society, had been facts of life. Now suddenly they were live political questions. It was riveting.

Syriza was represented in these negotiations by its finance minister, Yanis Varoufakis. With his shaved head, leather jacket, and motorcycle, he was not just a visual contrast to the gray-suited Eurocrats across the table. His radical but rigorous proposals for a different kind of Europe—one based on meeting human needs rather than rigid financial criteria—offered a daily rebuke to the old refrain “there is no alternative.”

The drama was clear, but the stakes were a little obscure. Why did it matter if Greece stayed in the euro? Orthodox economic theory, after all, gives little role for money or finance. What matters are real wants and real resources, for which money is just a convenient yardstick. University of Chicago economist John Cochrane probably spoke for much of the profession when he asked why it made any more sense to talk about Greece leaving the euro than about Greece leaving the metric system.

But money does indeed matter—especially in economic relations between countries, as Varoufakis himself has convincingly shown. In his three books—The Global Minotaur (2011), And the Weak Suffer What They Must (2016), and Adults in the Room (2017)—Varoufakis offers a fascinating lens on the euro system and its masters. While the first two books chart the history of the international monetary system from World War II up to the debt crisis, his last and most recent book is a reflection on his five months as Greek finance minister. Taken together, they read as if Varoufakis is the protagonist in some postmodern fable, in which he is transformed from a critic of the play to one of the main characters in it. …

Read the rest there, and then comment here if you are so inclined.

Posts in Three Lines

Seeing as I’m not teaching this semester, maybe I’ll start blogging more regularly. If so, here are some of the posts I might write.

*

Taxes and investment. Discussions of tax cuts’ effects on investment need to distinguish between two possible channels: changes in the expected return on investment, and changes in internal funds available to the firm. Economists tends to focus on the first, but if external funds are not a good substitute for retained earnings then the second may be more important. Tax cuts will fail to stimulate investment in the first case if they raise the opportunity cost for investment as much as expected returns, and in the second case if shareholder demands mean that internal funds are no longer available to finance investment; or in either case if monopoly power, demand constraints, etc. mean that the expected return on investment curve slopes steeply down.

The probability approach in economics. Empirical economics focuses on estimating the parameters of a data-generating process supposed to underlie some observable phenomena; this is then used to make ceteris paribus (all else equal) predictions about what will happen if something changes. Critics object that these kinds of predictions are meaningless, that the goal should be unconditional forecasts instead (“economists failed to call the crisis”). Trygve Haavelmo’s writings on empirics from the 1940s suggest third possibile goal: unconditional predictions about the joint distribution of several variables within a particular domain.

Walking the labor-market tightrope. There’s a tension in how to think about the past couple years of low unemployment and somewhat faster wage growth. On the one hand, we’re still very far from reversing the declines in employment and wages after 2008, or from any other reasonable measure of full employment; but on the other hand, it’s important that there has been some progress — it means that despite fears of robots/China/etc., there is still a reliable link from aggregate demand to employment and wages. It’s also worth noting that the faster wage growth has come without any pickup in inflation, but has translated one for one into a higher wage share (and lower profit share).

The interest rate and the interest rate. Every couple months, Martin Wolf writes something to the effect that central banks can’t change the real interest rate. The idea seems to be that the monetary interest rate influenced by central banks must fundamentally correspond to the intertemporal rate of substitution in a Walrasian world without money, set by preferences and production possibilities. It’s worth thinking through all the reasons why this doesn’t work; I think they point to some deep fissures opened up by the incongruence of economic map with social territory.

Financialization. One critical response to my conversation about financialization with Seth Ackerman was that a focus on finance as a device for disciplining nonfinancial firms ignores the ways those firms themselves have become major players in financial markets. Several very smart comrades in heterodoxy have made this same argument, that nonfinancial firms are increasingly seeking to profit from ownership of financial assets rather than of means of production. I’m not convinced — I think that most or all of the apparent rise in financial assets on the balance sheets of nonfinancial firms is really goodwill from mergers, interests in unconsolidated subsidiaries, and similar accounting devices, rather than the sort of financial assets that you can purchase and collect an income from.

The European central bank is not the central bank of Europe. I finally finished my review of Yanis Varoufakis’ three books, months past the deadline (hopefully they’ll still take it). One important issue I couldn’t address in the review, is whether he is right to dismiss as politically inconsequential the question of who runs the Bank of Greece. Personally, I’m not convinced — I still think the national central banks are important strategic terrain that any future left government in the euro zone needs to get control of.

The boss’s brain is under the worker’s cap. Business Insider has been doing some great reporting on the chaos created by Whole Foods’ new inventory management system. One of the key points that comes out is the heroic effort and emotional energy that employees, including line managers, put in to keep the machinery running, no matter how hard top management tries to wreck it. I feel like much of corporate America is run by mad kings who sit around burning their tribute while insisting they deserve credit for everything the peasants do to produce it.

Evolution ≠ natural selection. My recent reading has included two books on evolutionary biology — Peter Godrey-Smith’s Darwinian Populations and Natural Selection, a high-level, philosophical restatement of the logic of natural selection; and Olivier Rieppel’s Turtles as Hopeful Monsters, a ground-level narrative of some particular debates within evolutionary biology. Reading these two books together really highlights the distinction between evolution (the concrete development of living creatures over time) and natural selection (a mechanism postulated to account for that development). One way of thinking about the evo-devo revolution is that it’s saying the former is not reducible to the latter — the capacity to produce large-scale, complex structures is not a generic implication of natural selection but a specific trait that itself has evolved.