Economics: Why are mainstream views different from reality?

[pmaitra]

Look anywhere, it is the most common statistic. Look here: United States Interest Rate

Keep in mind, in normal times, no one charges nominal rate < inflation.

I went to the link, and searched for 4%. Didn't find it anywhere.

So you just made it up?

 

[Sakal Gharelu Ustad]

A 4% inflation target? | vox

 

[pmaitra]

A 4% inflation target? | vox

Quoted from the article:

The conventional wisdom in central banking circles is that monetary policy should aim for low inflation, such as 1-2%

Again, I don't know why.

And,

Oliver Blanchard, IMF Chief Economist, and his colleagues recently suggested on this site that policymakers might consider a higher inflation target at around 4% (Blanchard et al. 2010).

Now comes the fun part:

Exactly how low should inflation targets be?

The crisis has shown that large adverse shocks do happen. Should policymakers aim for a higher target inflation rate in normal times, in order to increase the room for monetary policy to react to such shocks? Are the net costs of inflation much higher at, say, 4% than at 2%, the current target range? Is it more difficult to anchor expectations at 4% than at 2%? Achieving low inflation through central bank independence has been a historic accomplishment. Thus, answering these questions implies carefully revisiting the benefits and costs of inflation. A related question is whether, when the inflation rate becomes very low, policymakers should err on the side of a more lax monetary policy, so as to minimize the likelihood of deflation, even if this means incurring the risk of higher inflation in the event of an unexpectedly strong pickup in demand. This issue, which was on the mind of the Fed in the early 2000s, is one we must return to.

Source: Rethinking macro policy | vox

You do realize that it is all about setting a target and hoping it will work out when cuts are required, and there is no mathematical basis to substantiate the 4%, or do you still not realize that?

Again, no answer how this 4% is arrived at. The only thing I can deduct is that these 'economists' and constantly shifting the goalpost, and changing their theories, and making claims, only after an event has happened, e.g. in your article, the performance of Japan's economy.

Economics is not a science bud!

 

[Sakal Gharelu Ustad]

Quoted from the article:

You do realize that it is all about setting a target and hoping it will work out when cuts are required, and there is no mathematical basis to substantiate the 4%, or do you still not realize that?

Again, no answer how this 4% is arrived at. The only thing I can deduct is that these 'economists' and constantly shifting the goalpost, and changing their theories, and making claims, only after an event has happened, e.g. in your article, the performance of Japan's economy.

Economics is not a science bud!

It is a standard optimization exercise and varies by country as well as time..You are not living in a static world to expect it to be the same policy everytime.

Now, how can central bank set inflation target? Everyone does a growth forecast, and then look at the growth rate of money(controlled by central bank) committed by the central bank. Central bank usually commits itself to such action by releasing regular statements. Now, you might say that this is based on growth forecast, which in itself can be wrong. Yes, there is an error but in the short run it is not big. And monetary policy does not work in long run as it is a short run policy tool based on unexpected behavior/change in policy by the central bank.

Now, there are different competing theories to arrive at the 4% number. One of the oldest one but still used by a number of banks is the IS-LM model. https://docs.google.com/viewer?a=v&q=cache:N7CCyoONyCQJ:www.econ.cam.ac.uk/faculty/aidt/macro/part1/l72004.ppt+monetary+policy+multiplier&hl=en&gl=fr&pid=bl&srcid=ADGEEShIkP81WhCMGqVyJ81szyisORQscr7_x0P2umSRbleeL4_EPNFyeMAXPKsdj1T2gWRef9gxxZeKxdIFDiCvNkr65uuCKH0SblQlf3dZytKmrZg_hVIaoYttBNLRM5UxY3bxHBz9&sig=AHIEtbQq6rQ-DXm4HB6h6BL6ziUOX3_UhA

Now, if you compute output fluctuation seen in the economy, you can calculate the interest rate cut needed to bring the economy back on track. This is one way to think about it.

If you do not understand the above look at this link: Fiscal multiplier - Wikipedia, the free encyclopedia
It gives similar idea but in case of fiscal stimulus, and this is more intuitive. You do not get 100$ increase in GDP for 100$ spent by government. For eg, the GDP increase might be 150$, and so the multiplier is 1.5.

If you understand some of it now, let me know and I will add some more parameters to the theory of 4%. Obviously, economics is not pure science but not everything is plain and simple.

 

[pmaitra]

It is a standard optimization exercise and varies by country as well as time..You are not living in a static world to expect it to be the same policy everytime.

Of course we are not living in a static world, and that is why economists' predictions fail so often.

Now, how can central bank set inflation target? Everyone does a growth forecast, and then look at the growth rate of money(controlled by central bank) committed by the central bank. Central bank usually commits itself to such action by releasing regular statements. Now, you might say that this is based on growth forecast, which in itself can be wrong. Yes, there is an error but in the short run it is not big. And monetary policy does not work in long run as it is a short run policy tool based on unexpected behavior/change in policy by the central bank.

Exactly, that is the point, so it is all a forecast, an estimate, or an assumption. I completely agree with your last sentence.

Now, there are different competing theories to arrive at the 4% number. One of the oldest one but still used by a number of banks is the IS-LM model. https://docs.google.com/viewer?a=v&q=cache:N7CCyoONyCQJ:www.econ.cam.ac.uk/faculty/aidt/macro/part1/l72004.ppt+monetary+policy+multiplier&hl=en&gl=fr&pid=bl&srcid=ADGEEShIkP81WhCMGqVyJ81szyisORQscr7_x0P2umSRbleeL4_EPNFyeMAXPKsdj1T2gWRef9gxxZeKxdIFDiCvNkr65uuCKH0SblQlf3dZytKmrZg_hVIaoYttBNLRM5UxY3bxHBz9&sig=AHIEtbQq6rQ-DXm4HB6h6BL6ziUOX3_UhA

Now, if you compute output fluctuation seen in the economy, you can calculate the interest rate cut needed to bring the economy back on track. This is one way to think about it.

First of all, I have no idea what those parameters mean. The slides do not explain anything. Could you explain them? Perhaps you could post a video lecture on it?

Secondly, Kinesian economics has been disputed, but then, those who discredited it, themselves don't know any better. Rule of thumb: no two economists will agree with each other.

Thirdly, could you replace those variables with number to show how you would arrive at the 4%? Are you saying that growth in most economies for the last 100 years has been in the vicinity of 4%?

I suspect that link you provided is based on a whole number of assumptions (correct me if I am wrong), and if I were to start off with another set of assumptions, I could come up with a theory and a number of, say, 8%.

If you do not understand the above look at this link: Fiscal multiplier - Wikipedia, the free encyclopedia
It gives similar idea but in case of fiscal stimulus, and this is more intuitive. You do not get 100$ increase in GDP for 100$ spent by government. For eg, the GDP increase might be 150$, and so the multiplier is 1.5.

This fiscal multiplier is based on the idea that there will be more national income if there is more consumerism. I am not denouncing this theory, but this is flawed, because it bases everything on consuming wealth, and not on producing wealth. This is the same thing as saying, when people save more and spend less, it is a bad thing. Some people might actually agree to that, I don't.

If you understand some of it now, let me know and I will add some more parameters to the theory of 4%. Obviously, economics is not pure science but not everything is plain and simple.

Glad you said that.

IMHO: Mathematics is pure science, Statistics is the art of representing the science of mathematics, and Economics is purely an art - like Nostradamus.

 

[pmaitra]

Another related thread: http://defenceforumindia.com/forum/...ents-deliberately-keep-unemployment-high.html

 

[Sakal Gharelu Ustad]

I wish the world were simple enough to be summarized in a post. I will try sometime to find an easier way to explain this to you.

If you are brave enough, then this article comes the closest to your answer and explaining the art of economics!!: http://www.imf.org/external/pubs/ft/wp/2009/wp09232.pdf
Abstract

This paper investigates how monetary policy can help ward off a protracted deflationary
slump when policy rates are near the zero bound by studying the experience of Japan during
the "Lost Decade" which followed the asset-price bubble collapse in the early 1990s.
Estimation results based on a structural model suggest that the Bank of Japan's interest-rate
policy fits a conventional forward-looking reaction function with an inflation target of about
1 percent. The disappointing economic performance thus seems primarily due to a series of
adverse economic shocks rather than an extraordinary policy error. In addition,
counterfactual policy simulations based on the estimated structural model suggest that simply
raising the inflation target would not have yielded a lasting improvement in performance.
However, a price-targeting rule or a policy rule that combined a higher inflation target with a
more aggressive response to output would have achieved superior stabilization results.

Some quick answers:

Secondly, Kinesian economics has been disputed, but then, those who discredited it, themselves don't know any better. Rule of thumb: no two economists will agree with each other.

Macroeconomists will always fight with each other. But there is a general consensus on how things work in the short and long run. Aggregate demand - Wikipedia, the free encyclopedia ...The economy is more Keynesian in short-run, while classical in long run.

Thirdly, could you replace those variables with number to show how you would arrive at the 4%? Are you saying that growth in most economies for the last 100 years has been in the vicinity of 4%?

I gave an easy example above that how it works in case of fiscal stimulus. And the slides show the relationship in terms of money supply. But the article attached above throws light on your question. The final formula is often a mixture of optimizing bad effects of inflation vs monetary policy room during depressions. And growth is a function of innovation and not inflation. You can only smooth out effect of depressions with monetary policy. In the long run, increase in money supply just goes into inflation. But the only catch is if you do not smooth out, sometimes you can be stuck in a bad spot for decades like in the 1930s.

I suspect that link you provided is based on a whole number of assumptions (correct me if I am wrong), and if I were to start off with another set of assumptions, I could come up with a theory and a number of, say, 8%.

Assumptions are always there. But the minimum, the better. 8% would be too high for any theory. Most models pre-2008 were comfortable with an inflation of 2-3%, but current downturn needed more monetary room which a 2% inflation could not provide. So, result is quantitative easing which I do not like so much when compared to inflation.

This fiscal multiplier is based on the idea that there will be more national income if there is more consumerism. I am not denouncing this theory, but this is flawed, because it bases everything on consuming wealth, and not on producing wealth. This is the same thing as saying, when people save more and spend less, it is a bad thing. Some people might actually agree to that, I don't.

Will talk about this hot topic later.

IMHO: Mathematics is pure science, Statistics is the art of representing the science of mathematics, and Economics is purely an art - like Nostradamus.

Definitely it is an art, but it involves informed learning just like in any other scientific discipline. And not as simple and easy as some of the books try to tell their readers. And ofcourse theories are always right until the next black swan.

 

[cir]

Sorry, for the late reply. I was away from my computer for some time.

As I expected, you are smoking Austrian economics. Will give you a detailed critique of their basic premises soon after I watch the videos that you have posted. But would make some quick comments from what I read above.

Its good that you agree with the financial accounting thing and that the debt shows on part of the financial institutions. In case of UK, the bailout shifted some of the financial debt to govt. debt and the figure that you see now for financial debt is the debt on financial institutions. This debt is backed by some form of collateral, and has the minimum exposure to Greece among the European banks. Any form of debt can turn out to be toxic in the future but that does not mean you stop lending. But it is good that you agree here on the financial accounting part. And banks borrow from everyone and not just in between themselves or central banks(how can you forget the FDs people have in India and their counterparts elsewhere).

On the CPI part, no economist believe one or the other measure completely captures inflation. All nations use variety of indicators for measuring inflation and the basket used is reported all the time. But, the basket does not change that frequently as pointed by you and it is reported. And not to forget the fact that there are families which report their consumption, so if prices of apples increase and families replace it with pear it would be reflected in the basket. So, that does not mean inflation has increased if families replace more or less the goods in the same category. So, inflation is a subjective statistic and people use it with caution depending what their point of interest is. Similar is the case for other indicators like Producer Price Index, GDP deflator, PPP calculations etc. People use them because these indicators are better than other naive calculations. The individual economists on the other hand try to bust govt. interpretations rather than support them. And the world is not controlled by PRC, so it is almost impossible to fudge the data. Economists are hawkish about pulling govt. legs as their is no one grand theory that unites all economists for a single cause. Statistics have to be taken with a pinch of salt to understand their implications, which economists understand and layman does not. For eg. You pay your maid 50k a year, but if she marries you then you pay nothing, although she might still do the same work for you. The GDP in the later case, given as we measure it today will fall by 50k. So, there are always problems in measurement of things and one has to keep eyes open for the pitfalls rather than look for conspiracies.

On the money supply front, all I can tell you right now is that there is no reason to keep the amount of money in the economy hostage to the amount of amount of gold in the central bank's vault. This is a wider subject and would share the appropriate links with you soon.

So long winded yet a single word PRC shows how ignorant and self-deceiving you are。

Stop bring in PRC when you talk about western economics since it is not science，not even art，but a pile of sh1t based on false assumptions and ill-conceived logics。It does NOT work in PRC。

 

[Sakal Gharelu Ustad]

So long winded yet a single word PRC shows how ignorant and self-deceiving you are。

Stop bring in PRC when you talk about western economics since it is not science，not even art，but a pile of sh1t based on false assumptions and ill-conceived logics。It does NOT work in PRC。

Yeah, PRC is really smart and long sighted but so gullible!

Just look at this: United States public debt - Wikipedia, the free encyclopedia
and this: U.S. Debt - How Much China Owns

In case of bad times, it would make perfect sense for US to default on its debt because a significant portion is being held by China. The only good thing for you is that US is not Argentina.

 

[pmaitra]

@Sakal Gharelu Ustad, @cir is correct. Western economics is not science.

Some countries in the West are not producing enough goods and services, yet are experiencing lot of growth. This clearly explains why western economics is best described as a massive Ponzi scam.

I am still waiting for you to explain that magical 4%.

 

[Sakal Gharelu Ustad]

@Sakal Gharelu Ustad, @cir is correct. Western economics is not science.

Some countries in the West are not producing enough goods and services, yet are experiencing lot of growth. This clearly explains why western economics is best described as a massive Ponzi scam.

I am still waiting for you to explain that magical 4%.

Here you go: http://emlab.berkeley.edu/~ygorodni/CGW_inflation.pdf

This paper basically suggests a <2% rate and contests the Blanchard view of 4% proposed during the recent crisis. But this is just part of literature, as there are others which are contesting to raise the number. But this will give you a flavor of how does mainstream economics approach the problem of calculating optimal inflation. It is a fairly technical paper so do not get put off if you do not understand it.

The basic idea is following:
- Define a measure of welfare for consumer and the economic environment
- Estimate different parameters which measure this welfare given macroeconomic data
- Use different inflation levels to derive the optimal level that maximizes welfare

 

[Sakal Gharelu Ustad]

Re: We're for 'socialist-type' economic policy, says Prashant Bhushan

Indeed, we disagree on a variety of topics. However, there are two things: one is a disagreement, and the other is a non-sequitur.

Let me explain what they mean in this context:

• Disagreement: When two persons are talking about the same topic, but offering different opinions.
• Non-Sequitur: When two persons are talking about different topics.

Now, you quoted @panduranghari, and the quote talked about how banks survive by the practice of usury, and you go on to talk about the government giving out benefits or doles, which is a different topic. In a country, whether the government may or may not give out doles, but does that mean there will be a consequential, and not merely correlational, absence or presence of usury? Unless you can demostrate that, your argument is a non-sequitur, and not a disagreement.

We can discuss government doles, and the graph posted by @panduranghari, but first, let me talk a very little about usury by banks.

Banks issue credit cards, personal loans, automobile loans, housing loans, etc., and they charge interest on the money loaned. This is obvious to @panduranghari and I, but perhaps not to you. This has got little to do with government doles, or even Socialism/Marxism. Usury existed long before Marx was born, so to drag him (or his ideology) into this discussion is quite meaningless, IMHO. I am not blaming you, but there are others who tend to confuse things.

Now, we can discuss the other things you want to talk about. Let us carry on in the other thread.

What I mentioned above about 'doles' was part of one sentence in the whole paragraph. And the rest was related to the topic and more than sufficient to explain my position on banks and usury.

But, I am yet to get your reply on my last post: http://defenceforumindia.com/forum/...olicy-says-prashant-bhushan-8.html#post617145
before answering further questions. With reference to the definition you provided from Wikipedia, I am still unable to know your position on usury, whether you stick to the moral definition(0%) or the excessive definition of usury? And if its the latter, how much excessive is excessive? Not to forget the other objections I raised about your assumptions in previous post.

Also, look at this: http://defenceforumindia.com/forum/...t-through-financial-systems-3.html#post619878 . Some more food for thought!

 

[pmaitra]

Re: We're for 'socialist-type' economic policy, says Prashant Bhushan

What I mentioned above about 'doles' was part of one sentence in the whole paragraph. And the rest was related to the topic and more than sufficient to explain my position on banks and usury.

But, I am yet to get your reply on my last post: http://defenceforumindia.com/forum/...olicy-says-prashant-bhushan-8.html#post617145
before answering further questions. With reference to the definition you provided from Wikipedia, I am still unable to know your position on usury, whether you stick to the moral definition(0%) or the excessive definition of usury? And if its the latter, how much excessive is excessive? Not to forget the other objections I raised about your assumptions in previous post.

Also, look at this: http://defenceforumindia.com/forum/...t-through-financial-systems-3.html#post619878 . Some more food for thought!

Read the definition again. Look for the terms 'moral' and 'legal.' See Wiki link.

 

[Sakal Gharelu Ustad]

Re: We're for 'socialist-type' economic policy, says Prashant Bhushan

Read the definition again. Look for the terms 'moral' and 'legal.'

Why don't you write it explicitly?

Ctrl+F did not help. Actually the entire article is very vague!!

 

[pmaitra]

Re: We're for 'socialist-type' economic policy, says Prashant Bhushan

Why don't you write it explicitly?
Ctrl+F did not help.

It is usury, either way, whether in the moral sense or the legal sense. It is written explicitly, just go to the Wiki page.

 

[Sakal Gharelu Ustad]

Re: We're for 'socialist-type' economic policy, says Prashant Bhushan

Although this one is interesting from the same link!!

Usury statutes in Canada

Canada's Criminal Code limits the interest rate to 60% per year.[48] The law is broadly written and Canada's courts have often intervened to remove ambiguity.

It is really a question of definition. Where do you stand on this spectrum? Although, I too would think 60% to be a bit too steep.

 

[pmaitra]

Re: We're for 'socialist-type' economic policy, says Prashant Bhushan

Although this one is interesting from the same link!!



It is really a question of definition. Where do you stand on this spectrum? Although, I too would think 60% to be a bit too steep.

Personally, charging any kind of interest is usury. Now, whether it is justified, or not, is a different question. But as long as there is even 0.000000000000001% interest, it is usury.

 

[Sakal Gharelu Ustad]

Re: We're for 'socialist-type' economic policy, says Prashant Bhushan

Personally, charging any kind of interest is usury. Now, whether it is justified, or not, is a different question. But as long as there is even 0.000000000000001% interest, it is usury.

Cool. I was looking for a modern definition from you, but anyway.

So, given your historic stance on the matter we cannot have any convergence on the first question. Given the beliefs one can stick with the historic(0%) or modern definition(some arbitrary % which can be called excessive).

- banks engage in usurious business(This is a belief, and not a conclusion of some study.)

But I will look forward to your answers to the other questions I raised.

 

[Sakal Gharelu Ustad]

Re: We're for 'socialist-type' economic policy, says Prashant Bhushan

Yes, I respect your right to disagree with me. The only thing that upsets me is when we avoid the question in hand and talk about something else. Anyway, now that usury stuff is more or less covered, I will discuss the other points you raised in the other thread.

I usually do not get upset during discussions but I definitely do not appreciate mixing beliefs and conclusions.

 

[panduranghari]

Re: We're for 'socialist-type' economic policy, says Prashant Bhushan

We disagree on a broad variety of questions and I would hold a different view here as well. The problem does not lie with the banks everywhere but the political institutions which survive on giving out doles and sometimes overdo themselves. I believe that there exists a market for financial innovations and also the fact there are various levels of risk associated with different projects. I see no other way to differentiate between them without using the interest differential. The choice again boils down to the trade-off between risk and innovation. And I would just not choose one over the other.

But I am very much interested in understanding the graph you presented in another thread and @pmaitra produced above. http://defenceforumindia.com/forum/...t-through-financial-systems-3.html#post616624

Is there any evidence for the convergence of two lines?

I do not doubt that there can be multiple financial products which can offer various ways to reduce risk.
The risk as defined by risk of loss.
The risk defined by risk of government will debase its currency to please the populace (eg Akhilesh Yadav waiving loans)

The risk has to be reduced but the whole game is rigged.

However, the concept is well explained by John Exters inverse pyramid

Everyone playing up in the top zone always has one eye on that single dollar bill. The perceived value of that single one dollar bill is imputed into every single contract in that upper pyramid. This is why everyone has their eye on it. Everyone knows it is not even worth the paper it is printed on, but they also know that as long as everyone else values it, it will hold its value which is the only thing holding up that entire top structure. This is called a network good that emerges from the network effect. Something has value only because a lot of people think it has value.

If you were to diminish the value of that single dollar by, say, 90%, then the whole top structure devalues 90% compared to the bottom pyramid instantly. No flow of funds is required. The reduced value is simply imputed to every quantum point in the pyramid. And no one would ride that devaluation out voluntarily when they could simply consolidate beforehand. So everyone is looking at that dollar thinking, believing, that they are quick enough to outrun everyone else at the first sign of trouble.

Now, in order to understand how this relates to the future financial system, we need to mentally picture something resembling this upper pyramid thousands of years ago when the money concept first emerged. Money was, is, and always has been that mental concept whereby we trade real goods in their relative value implicated by conceptual units of a network good. If you owed me a cow and the going price for a cow was three ounces of gold, I'd probably just say you owed me three ounces. But that doesn't mean you'd ever pay me three ounces of gold. You might just pay me back my cow. Or perhaps you'd pay me in milk over time. If I gave you credit to buy some of my chickens you might pay me back with eggs over time. But on the books it would be recorded in gold, even though neither of us ever had any actual gold.

Can you see it? This is the concept of money. This is what money actually is. And under that upper pyramid of 2,000 years ago you'd actually see a picture of a gram of gold sitting at the bottom.

Yes, it was still a network good just like the dollar is today, but people wouldn't have to keep such a close eye on it for a couple different reasons. First of all, the upper pyramid was not so big that it actually threatened to crush its foundation. And second, there was no one aside from a few gold miners that was able to threaten the foundation by multiplying it. (Note that the monetary base at the bottom of our modern pyramid has been multiplied 325%, that's 3.25x, in the last three years. The gold base usually multiplies only about 6% over that same timeframe.)

So now that we understand the different between a fragile foundation supporting a monstrosity versus a solid foundation supporting a much smaller, much more constrained credit structure, how would the future financial system make both better?

Well, I would argue that life in the physical plane is better under a healthy and vibrant (relatively large) credit system (upper pyramid). And don't let the word credit fool you into thinking I'm talking about yucky debt and evil usury. If Bill Gates showed up at my house and wanted my grand piano, he wouldn't have to carry a bag of cash with him. I'd accept his signature (maybe even just a hand shake) along with a nice agreed price. Think of Oprah Winfrey paying $52 million in 2001 for that Montecito house that was only worth half that at the time, but she really wanted it after filming there, and it wasn't for sale. At first the owner told her "sorry, not for sale." I imagine she then said "fifty million" and they said "fifty-two and it's yours." Now that's some credit (credibility)!

In both cases the deals were done with credit. A healthy credit (money concept) system lubricates a vibrant economy. But that doesn't mean that Bill Gates went into (bad) debt over my piano. Sure, you can have debt and even interest that is good and healthy for the economy. There is nothing intrinsically bad about borrowing capital for productive purposes. Just like the guy that borrowed a cow and paid with milk, or paid for the chickens with eggs. Same principle. We simply structure the agreement around conceptual units (credits) of the network good.

So how can we have a network good that is easy enough that it doesn't stifle the credit structure below its healthy potential, yet hard enough that it doesn't grow into an unhealthy monstrosity capable of bringing the whole thing down? This is exactly what the future financial system will do. It opens a free-flowing two-way trading valve between money and physical gold. And the flow through this open valve between the pyramids becomes the public indicium of the health of the upper credit system. Without such a valve, you either have strangling constraint or no indicia (indicator) of unhealthy growth.

Without such a pairing as fiat + unconstrained price of physical gold at the center of the hourglass, you will lurch back and forth between depressions and hyperinflations, century after century, with a few really nasty episodes like the French Revolution thrown in. Imagine coming up with this Thought out of thin air. Luckily we had the Gold Trail to lead us here. But this is how a grand induction works. Musta been quite the Aha moment for those guys when they finally worked it out!

These graphs are self explanatory.

Hope this helps.