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Everything Old is New Again, Part 1934-1937

I have (vainly, I suspect, in both senses of the phrase), tried to start a meme on Twitter, #ifTimGeithnerrantheEmergencyRoom. “The defibrillator would only charge to 30 to prevent scarring; anything more and you’re on your own” probably isn’t winning friends or influencing people, but it does make me feel better.

It also makes me look back at the histories written of the time.  A detailed analysis of Keynes’s discussion of Goldman Sachs’s antics in the late 1920s, which echo their trading in middle 2000s, is left to someone else. (Suffice it to say, one never quite listens to John Denver’s “Take Me Home, Country Roads” the same way again after reading about Blue Ridge and Shenandoah.)

It’s the macro monetary moves that abide, and the lessons of history. Years ago, people failed to notice that money whose multiplier is 1 is not inflationary—most especially when you have one of the so-called “balance sheet recessions” where assets are being carried at a value significantly higher than can be realized even in Edward C. Prescott’s or Thomas M. Hoenig’s most lurid fantasies.  To wit:

Over time, Fed officials became increasingly concerned about substantial increases in bank reserves, especially excess reserves. During 1934 and 1935, gold inflows of some $3 billion contributed to a doubling of member bank total reserves (from $2.76 billion in January 1934 to $5.72 billion in December 1935) and more than a tripling of excess reserves (from $866 million to $2.98 billion; Board of Governors of the Federal Reserve System 1943, 371). The buildup of excess reserves alarmed Fed officials, who feared that these “idle” balances might permit a wave of speculation and inflation.

Using its traditional tools the Fed would have reduced reserves (or slowed their rate of growth) by selling securities and raising the discount rate. But this was not feasible in the mid-1930s. A discount rate increase would have had no effect on reserves since discount-window borrowing already was trivial, even at a discount rate of just 1.5 percent. Similarly, by mid-1935, member bank excess reserves alone equaled the Fed’s total security holdings, leaving the Fed unable to slow significantly the growth of total reserves through open market sales….

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And the result, Basel III-like, of ignoring that the accounting Fantasies of Solvency were dwarfing the lending realities:

Alarmed at the sharp increase in excess reserves that had taken place since 1933, and viewing it as potentially inflationary, the Board of Governors increased required reserve ratios in August 1936, and again in March and May 1937. In total, the reserve requirements on time deposits were increased from 3 percent to 6 percent. Requirements on demand deposits were increased from 7, 10, and 13 percent to 14, 20, and 26 percent for country, reserve city, and central reserve city banks, respectively. The increases, according to the Annual Report of the Board of Governors for 1936, were intended to eliminate those excess reserves the board deemed ‘‘superfluous for prospective needs of commerce, industry, and agriculture, and, if permitted to become the basis of a multiple expansion of bank credit, might have resulted in an injurious credit expansion” (14).

If “those who forget the past may be condemned to repeat it,” are those who remember it and still fail to do anything are just condemned to be economists?

All quotes from Charles W. Calmoris and David C. Wheelock, “Was the Great Depression a Watershed for American Monetary Policy,” 1996-1998, as published in Bordo, Goldin, and White eds., The Defining Moment, NBER Press, 1998

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Inequality, Infant Mortality and Adam Smith

Robert Waldmann

Tilman Tacke and I are quite cautious in this paper which does not support my pet theory described in this paper. The stylized fact (which has returned after a brief absence from the data) is that, given the income of poorer quintiles, where the rich are richer more babies die. My pet theory is that this is due to “distortion of consumption” where the poor imitate the consumption of the rich (which is more costly the richer the rich are) and this foolish spending causes infant mortality.

It turns out that this bold idea wasn’t totally new after all. I just found it in
The Wealth of Nations by Adam Smith first published in 1776.

I explain after the jump.

The idea appears really really appears on page 1103 (Book 5 Chapter 2 article 4 section 2 “taxes on consumable commodities”) of my copy of The Wealth of Nations by Adam Smith published in 1776.

“Consumable commodities are either luxuries or necessaries,

By necessaries I understand not only the commodities which are indispensably necessary for the support of life, but whatever the custom of the country renders it indecent for creditable people, to be without. A linen shirt, for example, is, strictly speaking, not a necessary of life. The Greeks and Romans lived, I suppose, very comfortably though they had no linen. But in the present times, through the greater part of Europe, a creditable day lobourer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty, which, it is presumed, no body can well fall into without extreme bad conduct.”

He argues that, therefore taxes on necessaries will drive up wages in the long run.
To understand you have to know Smith’s theory of wages which is that the steady state wage is such that population neither grows nor shrinks and at a lower wage population will shrink due to increased mortality due to poverty. So his claim is that taxing necessaries, including linen shirts in Europe in 1776, would cause the population to decline due to increased mortality. This only makes sense if he believes that, in order to wear a linen shirt, Europeans of his day would skimp on food to an extent which increased the mortality of their children.

This is made very clear when, in contrast, Smith argues that a tax on luxuries consumed by the poor will not affect wages in the long run

“The different taxes which have in the course of the present century been imposed on spirituous liquors, are not supposed to have had any effect on the wages of labour. …
The high price of such commodities does not necessarily diminish the ability of the inferior ranks of people to bring up families.”

That is a high price of linen shirts will necessarily diminish the ability of the inferior ranks of people to bring up families … by causing their children to die.

Smith definitely did not consider any form of contraception including abstinence. He is quite clear on the idea that steady state wages are determined by infant and child mortality in book 1 chapter 8.

To get to causation rich are richer so more babies die one just needs to add that average standards of living affect what goods “the custom of the country renders it indecent for creditable people, to be without.”

So I guess I wasn’t the first to come up with the idea. However, I was only 216 years late.

The most flaky far out interpretation of the stylized fact (destroyed by including pubhealth anyway) is clearly stated in The Wealth of Nations. Wow.

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Bleg: James Tobin and Paying for the Viet Nam War

In Conversations with Economists (h/t Kevin Quinn at Econospeak), James Tobin refers to LBJ having made “a mistake” in “raising taxes to pay for the Viet Nam War.”

Google Desktop can’t find the line of reasoning behind that in any of Tobin’s papers that have survived my migrating possibly-non-OCR PDFs over about six computers. Anyone able to point me to Tobin’s preferred alternative?*

UPDATE: The full quote:

Klamer: We experience stagflation….How would you account for this experience within a neo-Keynesian neoclassical framework?

Tobin: That gets us into the history of the economic world in the US since 1966. Probably there were some mistakes in demand management policy. I wouldn’t deny that. In fact, it was a council of neo-Keynesian advisors that told Johnson he should raise taxes for the Vietnam War.

Is this just a reference to the mismanagement pgl has discussed here and at Econospeak so often? And is there evidence that the advisors were arguing that the war was the reason to raise taxes?

*That’s “given that the War was in progress anyway”; not funding and not fighting was not an option, no matter how preferable it might have been without the presence of Dr. Manhattan and his “glowing blue schlong.”

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Clio’s Role in the Economics of QWERTY

by Tom Bozzo

Paul David (*) famously identified the QWERTY keyboard as a technology which we use as a matter of historical accident and not because the market identified the optimal keyboard layout. That the market outcomes don’t necessarily yield the best of all possible economies even in theory clearly may offend economists of Panglossian or maybe Que Sera Sera inclinations. It may not be a coincidence that a co-author of one of the better ripostes to David (**), Stanley Liebowitz of UT-Dallas, has gone on to burn some reputation to produce argumentation pinning the mortgage meltdown on the GSEs and the Community Reinvestment Act.

Fast forward to the present and Tyler Cowen points to a technology adoption experiment by Tanjim Hossain and John Morgan, presented at the recent AEA meetings, which purports to set up conditions such as claimed for QWERTY but does not find that the subjects get stuck in the bad outcome. Cowen reads the result and calls David’s path dependence via increasing returns story a “theory which probably should be laid to rest.”

I read the paper and draw other conclusions. Hossain and Morgan actually set up experimental conditions in which there aren’t really increasing returns in David’s sense, so there should be no surprise the subjects didn’t get stuck with inferior outcomes. An experiment to investigate the selection among multiple equilibria under David-style path dependence conditions is feasible for the interested experimenter. More discussion after the jump.

I had some youthful dalliances with the Santa Fe Institute and so like to turn to Brian Arthur’s technology lock-in model for a simple quantification of the scenario (***). In the Arthur model, the increasing returns part is that the payoff to a technology increases in cumulative adoptions. The history part is a random arrival sequence of agents with distinct payoffs (so, basically, one group of agents prefers technology A and another technology B unless the increasing returns part tips the market entirely to A or B). Arthur showed that there’s a family of payoffs that eventually tips the “market” to A or B with probability 1 and to an inferior technology (if the payoffs define one) with positive probability. While the equilibrium selection probabilities depend on the payoff parameters, the realized equilibrium depends on the history of agent arrivals.

Hossain and Morgan’s experiment actually leaves out both the increasing returns and history features a la Arthur/David. Regarding the former, the payoffs to the experiment’s technologies are bounded, which essentially puts the experiment in a constant-returns world. Indeed, Hossain and Morgan say that there is a unique equilibrium to their game — adoption of a superior technology constructed to be “Pareto dominant.” I assert without proof (because it’s trivial for readers of Arthur’s paper) that existence of a “Pareto dominant” technology implies boring dynamics in the Arthur model.

In the interesting cases, no technology is Pareto dominant but nevertheless there may be ex post regret in the sense that all types of agents could prefer that the market have tipped to a different technology. The possibly missing market is that by which future adopters might pay the early users to adopt the “efficient” technology.

Nor is there history in the sense of the Arthur model, since in every period of the experiment there are exactly two agents of each of two types in the market. So whatever the experiment is telling us, it isn’t saying much about technology adoption dynamics under the sort of increasing returns multiple-equilibrium conditions that are supposedly being investigated.

As an additional oddity, the payoffs are specified such that the payoff from one agent of a type choosing technology in a round A is X (which is increasing in the number of agents of the other type choosing A in the same round, but not e.g. cumulative adoptions), and if the other agent of the same type also chooses A, then the payoff is Y≤X. To get some flavor for what this might mean, let’s rename the experiment’s agent and technology types (“square” and “triangle,” and “%” and “#,” respectively). Call the agents “Graphic Designer” and “Accountant” and the technologies “Mac” and “PC.” If you’re a Graphic Designer, the payoff to choosing Mac is greater if more Accountants also choose Mac, but not if more Graphic Designers do so. These payoffs are inconsistent with some types of increasing returns mechanisms, a la “learning by doing/using” and “ecosystem” effects.

I’m occasionally skeptical that things like scale effects between economic experiments and the economic phenomena being studied are totally irrelevant, but in this case it’s easy to tune Arthur-esque payout functions to lead to lock-in quickly with usefully high productivity. So I think there’s a multiple-equilibrium selection experiment out there waiting to be done. But this paper isn’t it.

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(*) Paul David, “Clio and the Economics of QWERTY.” American Economic Review 75: 332-337.

(**) Stanley Liebowitz and Stepehn Margolis, “The Fable of the Keys.” Journal of Law and Economics 33: 1-26. It’s also not necessarily accidental that this paper found a home at the University of Chicago-domiciled JLE. Liebowitz and Margolis persuasively argued that the alternative Dvorak layout is not as good relative to QWERTY as Dvorak advocates have claimed, and that ergonomic studies further suggest that there are distinctly bad layouts of which QWERTY is not one. However, the conclusion along the lines of ‘history just so happens to have given us a not-necessarily-optimal but not-necessarily-terrible technology so what, me worry?’ does not refute path-dependence.

(***) W. Brian Arthur, “Competing Technologies, Increasing Returns, and Lock-In by Historical Events,” Economic Journal 99, 116-131. David referenced the working-paper stage of this work in his AER paper.

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