money illusion in housing markets

November 23rd, 2014

Why do home buyers today think that mortgages are more affordable today than they were three or four decades ago? Tim Harford, the FT ‘undercover economist’, explains.

[C]ontrast today’s low-inflation economies with the high inflation of the 1970s and 1980s. Back then, paying off your mortgage was a sprint: a few years during which prices and wages were increasing in double digits, while you struggled with mortgage rates of 10 per cent and more. After five years of that, inflation had eroded the value of the debt and mortgage repayments shrank dramatically in real terms.

Today, a mortgage is a marathon. Interest rates are low, so repayments seem affordable. Yet with inflation low and wages stagnant, they’ll never become more affordable. Low inflation means that a 30-year mortgage really is a 30-year mortgage rather than five years of hell followed by an extended payment holiday. The previous generation’s rules of thumb no longer apply.

Because you are a sophisticated reader of the Financial Times you have, no doubt, figured all this out for yourself. Most house buyers have not. Nor are they being warned.

Tim Harford, “Why a house-price bubble means trouble“, Financial Times, 22 November 20014 (metered paywall).

Nominal interest rates were, indeed, high in the 1970s and 1980s, but inflation was also high. The result was low and sometimes negative real interest rates (the rate of interest minus the rate of price inflation). Borrowers’ positive reaction to low nominal rates of interest, disregarding price inflation, is an example of ‘money illusion’, although Mr Harford does not use the term.

This reasoning, by the way, applies to all debt – including student loans and credit card debt, not just mortgage debt.

World Toilet Day

November 21st, 2014

The contribution of toilets — both waterless and flushing — to public health has not received much attention. Tim Taylor seeks to correct this oversight.

The reason that the United Nations voted last year to designate November 19 as World Toilet Day is because … on that day in 2001 … the World Toilet Organization [was formed]. Out of the global population of 7 billion, about 1 billion people defecate in the open, with about 600 million of those people living in India. According to the World Health Organization and UNICEF, there are 19 countries in the world where more than half the rural population still practices open defecation.

Especially in areas with relatively dense populations, this practice has health consequences. ….

In the bulk of this post, I have manfully avoided referring to Sir Thomas Crapper, who greatly improved and popularized the flush toilet in the 19th century. I have not discussed the We Can’t Wait promotions or the dancing turds ads in India. I have sidestepped whether toilet policy should be pursued through a bottom-up or top-down approach.

Timothy Taylor, “World Toilet Day“, Conversable Economist, 19 November 2014.

I would like to to add that Thomas Crapper (1836-1910) was not knighted by Queen Victoria, nor did he invent the flush toilet, though he did manufacture and promote them. He was a successful industrialist and plumber, born in Thorne, Yorkshire (UK). John Harrington invented the flushing toilet in 1596, long before Thomas Crapper was born. George Jennings in 1852 also patented a flush toilet. Mr Crapper held three patents for water closet improvements, but none for a flush toilet. Because of his surname, many writers (emphatically not Tim Taylor) erroneously credit him for invention of the flush toilet.

monetary stimulus in Japan

November 20th, 2014

Canadian economist William White argues that Japan’s planned expansion of the money supply can “quickly take inflation to very high levels”. Many economists think that is precisely what Japan needs. Mr White, on the contrary, believes that monetary action “is not needed and it will not succeed in stimulating the economy”.

Here, from his op-ed, is a brief introduction to Mr White’s reasoning. Among economists, his is definitely a minority view. It might even be correct. Unfortunately, in macroeconomics everything changes at once, so we will never know for sure, even if the Bank of Japan goes forward with its plan.

Japan’s recent slow growth has been largely driven by demographic trends. Since 2000 growth in GDP per person of working age has been significantly above that in the US. As for persistent deflation, the level of Japanese consumer prices has fallen less than 4 per cent in the past 15 years. There is no evidence of an accelerating deflationary trend, nor of consumers delaying spending in anticipation of lower prices. Indeed, the household saving rate has fallen since the 1990s from a traditionally high level to zero today. Finally, the BoJ estimates that the amount of spare production capacity is also close to zero.

William White, “Japan’s plan for further stimulus is not courageous but foolhardy“, Financial Times, 20 November 2014 (metered paywall).

William White (born 1943) was at the Bank of Canada from 1972 until 1994, when he joined the Swiss-based Bank for International Settlements (BIS). He retired from the BIS in 2008. The following year he was appointed chairman of the Economic Development and Review Committee at the Paris-based Organisation for Economic Co-operation and Development (OECD.

the War for Independence in British North America

November 19th, 2014

FT reader Ted Gaffney, who resides in Connecticut (USA), reminds us of oft-forgotton facts of the rebellion launched in 1775 by British colonists in North America. The war (actually a civil war) ended in 1783 with independence for 13 British colonies.

One-third of the populace could be described as “patriots” opposed to parliamentary interests and controls; one-third were “loyalists” – supportive of the king’s policies; and one-third were not committed either way.

Although the loyalist segment were ultimately driven from their homes and resettled in Upper Canada, it was the Native American population that bore the greatest impact in defeat.

In particular, George Washington commanded that a “scorched earth” policy be used to break the power of the largely pro-British Iroquois Confederacy. John Sullivan’s campaign of 1779 devastated the Iroquois heartland, destroying dozens of villages, burning cornfields, and inducing a wintertime famine that led to thousands of deaths by disease and hunger. However cruel the guerrilla war fought between fellow American neighbours, it was far worse and more merciless when directed against the indigenous peoples.

Ted Gaffney, “Native American people bore the greatest burden“, letter to the editor, Financial Times, 18 November 2014.

Without minimizing the unspeakably cruel treatment of indigenous peoples, I would add that United Empire Loyalists suffered loss of property, for which they were never compensated. Their only crime was to support the government of the day.

ordoliberal Germans

November 17th, 2014

German journalist Wolfgang Münchau complains that his country’s dominant economic ideology is out of sync with the rest of Europe. Until recently, Germany had a national currency, so this exceptionalism did not matter very much. Now Germany dominates a large currency area (the eurozone), and its policies matter a lot.

German economists roughly fall into two groups: those that have not read Keynes, and those that have not understood Keynes. To describe the economic mainstream in Germany as conservative misses the point. There are some overlaps with the various neoclassical or neoconservative schools in the US and elsewhere. But as compelling as a comparison between the German mainstream and the Tea Party may appear, it does not survive scrutiny. German orthodoxy straddles the centre-left and the centre-right. The only party with some Keynesian leanings are the former communists. ….

The Germans have a name for their unique economic framework: ordoliberalism. ….

After 1945, ordoliberalism became the dominant economic doctrine of the centre-right. In the 1990s, the Social Democrats started to embrace it, culminating in Gerhard Schröder’s labour and welfare reforms in 2003. Today the government is ordoliberal. The opposition is ordoliberal. The universities teach ordoliberal economics. In the meantime, macroeconomics in Germany and elsewhere are tantamount to parallel universes. ….

[O]rdoliberals have no coherent policy to deal with depressions – once or twice in a century disasters. Whenever I ask one of them what one should do in a depression, the answer usually includes some reference to “creative destruction”.

Wolfgang Münchau, “The wacky economics of Germany’s parallel universe“, Financial Times, 17 November 2014.

German ordoliberals seem to have much in common with followers of Hayek, though Mr Münchau does not explicitly mention this.

inflation and deflation

November 16th, 2014

Since the 1007/2008 financial crisis, austerians have consistently warned that fiscal stimulus and loose monetary policy would produce severe inflation. This did not happen, so austerians have been quiet lately. One outspoken austerian (Chicago economist John Cochrane) now admits that we face a problem of deflation, not inflation. Does he admit that his forecasts were terribly wrong? No. Does he say he is sorry for encouraging policies of austerity in the Great Recession? No. He now thinks that economies are robust, that markets are self-correcting so long as governments do not interfere too much.

“The danger now is inflation,” warned University of Chicago economist and Paul Ryan dinner companion John Cochrane in 2009. He warned of this again in 2010: “A substantial inflation will follow — and likely a ‘stagflation’ not inflation associated with a boom.” And again in 2011. (“As a result of the federal government’s enormous debt and deficits, substantial inflation could break out in America in the next few years.”) And again in 2012 (“Inflation Should Be Feared”).

Inflation has stayed very low. And look, here is John Cochrane in today’s Wall Street Journal editorial page, no longer warning of inflation. Now he is arguing that deflation might be coming, but it’s not so bad:

Jonathan Chait, “Inflationista John Cochrane Wrong But Not Sorry“, New York Magazine, 14 November 2014.

Here is part of Cochrane’s WSJ op-ed:

With European inflation declining to 0.3%, and U.S. inflation slowing, a specter [of deflation] now haunts the Western world. ….
Clearly, our central banks want higher inflation, and the current slow decline was unintended. So, just as clearly, central banks have a lot less understanding of and control over inflation and deflation than most people think. ….

Maybe the economy isn’t so inherently unstable and in need of constant guidance after all. Bottom line? Relax.  

John Cochrane, “Who’s Afraid of a Little Deflation?“, Wall Street Journal, 14 November 2014.

Princeton economist Paul Krugman is in Argentina, recommending austerian policies. Really!

And if anyone starts yelling that I’m being inconsistent in saying that deficit spending and money-printing are a problem in Argentina, because those are the same policies I want in the US, the answer is, yes, they are — because the US is in a liquidity trap, suffering from persistent suffering from persistent lack of demand, while Argentina is overheated.

Paul Krugman, “Inflation Truth, Really“, The Conscience of a Liberal, New York Times blog, 14 November 2014.

finance and the jelly bean problem

November 15th, 2014

Tim Harford, FT undercover economist, examines the problem of data mining and spurious correlation – which he calls “the jelly bean problem”. This is a serious and growing problem. It affects published research in economics, finance, epidemiology, and many other fields. Mr Harford concentrates on finance because, well, because he is writing for the Financial Times!

Finance, by the way, is distinct from economics. It is sometimes regarded as a branch of economics; it is, but only in the way that chemistry is a branch of physics. Economists typically receive little or no training in finance. My degree is in economics, so I know little about the world of finance. I have studied public finance, but this is limited to government spending and taxation, which is very different from the world of stocks, bonds and foreign exchange markets. Finance is very math-intensive, and tends to attract highly trained, underemployed physicists, known as ‘quants’ when they build and estimate financial models.

Here are key passages from Harford’s longish column. The full column is behind a metered paywall. Non-subscribers can access it, subject to free registration.

What … might influence portfolio returns? There is literally no limit to the number of different variables that could be examined, because variables can always be transformed or combined with each other, for instance as ratios or rates of change.

… [I]n practice both academics and quantitatively minded investment managers have been known to throw in all sorts of possibilities just to see what happens. Why not, for example, use the cube of the market capitalisation of the shares? There’s no economic logic behind that variable – at least, none that I can see – but that hasn’t stopped the quants stirring such things into the mix.

The issue here is what we might call the “jelly bean problem”, after a cartoon by nerd hero Randall Munroe. The cartoon shows scientists testing whether jelly beans cause acne, applying a commonly used statistical test. The test is to assume that jelly beans don’t cause acne, then rethink that assumption if the observed correlation between jelly beans and acne has less than a 5 per cent probability of occurring by chance. The scientists test purple, brown, pink, blue, … [and 17 more types of jelly beans]. It turns out that the green ones are correlated with acne!

This is, of course, no way to perform a statistical analysis. If 20 statistical patterns are analysed and there’s no genuine causal relationship in any of them, we’d still expect one of them to look strikingly correlated.

Tim Harford, “Finance and the jelly bean problem“, Financial Times, 15 November 2014.

If you were previously unaware of this problem, I recommend that you read this column. It is an amusing description of the “jelly bean” problem, and an informative explanation of why it is important. One take-away point is that many (possibly most) published research findings are false, in part because of publication bias: authors and editors prefer to publish ‘significant’ findings, ignoring papers with no findings of statistical significance.

Tim Harford’s latest book is The Undercover Economist Strikes Back: How to Run—or Ruin—an Economy (Penguin, 2014).

universal basic income

November 13th, 2014

Timothy Taylor, in his regular column in  the current issue of Journal of Economic Perspectives (Fall 2014 , pp. 227-234) points us to an article that extols the virtues of a policy that promises to end poverty immediately, with administrative efficiency and maintenance of incentives to get up and go to work each morning. The author is Edwin G. Dolan (born 1943), an American economist with an impressive cv.

Are you frustrated by the interminable quest to end poverty in the face of ideological division and widespread cynicism? Why not just cut to the chase, sending everybody in the country a monthly check that covers the rudimentary needs of even the poorest among us? ….

The concept goes by many names: unconditional basic income, basic income guarantee, demo-grant. I prefer “universal basic income,” or UBI for short. Whatever you call it, though, the feature that distinguishes a UBI from other sorts of social safety nets is its universality. Unlike other income-support programs, it is not means-tested. Instead, a UBI would provide subsistence-level grants to everyone, regardless of need, earned income, age or job status. …

Hardly anyone sees a UBI as a perfect safety net. It offends conservatives by offering something for nothing. And it raises serious questions for progressives who worry there is more to poverty than a lack of income—that a UBI would not do enough to transform the culture of poverty that weighs down the underclass. But it has pragmatic advocates (including me) who believe that a UBI offers a better compromise than do other income-support programs among the mutually incompatible criteria of effectiveness in reducing poverty, maintenance of work incentives, administrative efficiency and accurate targeting.

A big worry, of course, is that a UBI would end up as budget-buster or require a raid on private wealth to finance it. However, as shown, it need be nothing of the sort—provided it were part of a bargain in which other antipoverty efforts (save medical care) were abandoned, and middle-income earners traded in a hodgepodge of tax breaks for the universal basic income grant.

The most encouraging sign is that the liveliest debates over a UBI today are taking place within, rather than between, the main ideological camps. At a time when macroeconomic forces and the politics of big money are leading to ever- greater inequality, perhaps America is still capable of finding common ground for a pragmatic antipoverty effort.

Ed Dolan, “The Pragmatic Case for a Universal Basic Income”, Milken Institute Review, Third Quarter 2014, pp. 14-23.

This is a universal age pension, with a qualifying age of 18 or even zero rather than 65 or 70. None of the links above are gated. Enjoy!

universal pensions in Iceland?

November 12th, 2014

The US Social Security Administration (SSA) has published, since 1937, very useful periodic reports on “Social Security Programs Throughout the World“. I often consult these volumes for information on specific countries. For the first time, I decided to use these reports to examine changes, over time, in the number of countries with universal pensions.

The SSA consistently describes Iceland’s basic old-age pension as a “universal pension”. In an article published in World Development (January 2007) p. 38, I classified Iceland as a country with “recovery-conditioned” basic pensions, i.e. pensions that are clawed back from other income that otherwise qualified applicants declare. This is a form of income-testing, so such a pension is clearly not universal. It is subject to an income test, in addition to the usual age and residence tests.

Nonetheless, nearly all sources, including the Government of Iceland, describe the pension as ‘universal’, most often with no explanation.

The ILO (International labour Organisation) follows the crowd in describing Iceland’s non-contributory pension as “universal”. But the ILO helpfully provides detailed information:

8. National basic pension – Old age pension

No means-test

Determining factors in old-age pension are duration of residence in Iceland and income. Pension rights are calculated pro rata according to periods of residence, minimum is 3 years and maximum 40 years. Old-age pension for a single person after 40 years of residence: Full basic old-age pension (grunnlífeyrir) for a single person after 40 years of residence is ISK 297.972 (Euro 3,401) per year. Reduced when annual capital or income from work criterion exceeds ISK 2.056.404 (Euro 23.475) and withdrawn when it exceeds ISK 3.049.644 (Euro 34.813).

ILO, “Iceland – Overview of schemes – 8. National basic pension – Old age pension“, accessed 12 November 2014.

An income test exists, so it is not true that there is “no means test” for this pension. The annual €3,401 benefit (€285 a month) is clawed back from annual income in excess of €23,475 (€1,956 a month) at the rate of 30%. This is a very small pension for such a high-income country as Iceland (the figures are for 2010), and it is clawed back from those who have other pension income and/or continue to be gainfully employed in old age. I would like to know what proportion of older persons in Iceland are affected by the clawback, but such information is not readily available.

I conclude that the pension is not universal, and fail to understand why it is described as such. For age pensions, the term ‘universal’ is frequently used as a synonym for ‘non-contributory’. This is a constant source of confusion, for it becomes difficult, if not impossible, to distinguish means-tested pensions (which are very common) from  universal minimum pensions (which are less comon) and truly universal pensions (which are quite rare).

That concludes my rant of the day. I am upset because loose use of the term ‘universal’ makes my work more difficult.

return of the neocons

November 12th, 2014

This is scary. American writer Jacob Heilbrunn (born around 1965) explains.

[T]he Republican party is resurrecting the unilateral foreign policy doctrines that first took hold under President George W Bush and his vice-president Dick Cheney.

Unlike the Democrats of the Kennedy and Johnson administrations, who later came to express regret over their role in the Vietnam war, leading Republican figures such as Mr Cheney and former deputy secretary of defence Paul Wolfowitz have never admitted to making missteps in Iraq or Afghanistan. On the contrary, they have argued that it is President Barack Obama who has erred by failing to prosecute combat in Iraq and Afghanistan vigorously enough.

Until recently they did not get much of a hearing. But recent events have blown fresh wind into the sails of the neocons. ….

Perhaps no one has been more impassioned in their support of the foreign policy of George W Bush than Tom Cotton, a 37-year-old Iraq war veteran who has won election as senator in Arkansas. Mr Cotton has called the Iraq war a “just and noble” cause and said that victory in Afghanistan is simply a matter of finding enough willpower. In Iowa incoming Republican senator Joni Ernst, another Iraq veteran, also lauded the war. Based on her service in Iraq, she said: “I do have reason to believe there were weapons of mass destruction in Iraq.”  [Emphasis added.] ….

Whether a Republican president would result in wholesale reversion to Bush-era policies is an open question. But the fact that the neocons are driving the debate in the Republican party and putting Mr Obama on the defensive is itself a remarkable tribute to their resilience. Indeed, to say that they are back may be something of a mistake. They never went away in the first place. The difference is that the Republican party is listening to them once again.

Jacob Heilbrunn, “Unvanquished Republican neocons surge back“, Financial Times, 12 November 2014.

Mr Heilbrunn is author of  They Knew They Were Right: The Rise of the Neocons (Doubleday, 2008) and editor of The National Interest (TNI), an American international affairs magazine. TNI was founded in 1985 by Irving Kristol.  Henry Kissinger is the magazine’s honorary chairman.

Candidate Joni Ernst (born 1970) was endorsed by the Tea Party.  According to Wikipedia, she opposes cap and trade, a federal minimum wage, and same-sex marriage while supporting gun rights and partial privatization of Social Security old-age pension accounts. She won the 2014 race for the US Senate 52.2% to 43.7%. Senator-elect Tom Cotton was also supported by the Tea Party movement.