Jun28
This is just a very quick post to make my paper at the Levy Institute available. Later I’ll add a post of the paper itself and a video of the presentation.
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Analysing the Global Debt Bubble
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@sj – its seems to me formal education = formal influence….somewhat parallel, I find it interesting when I see self-made millionaire/billionaires business folks (not investment guys) on financial shows they always seem way more sensible than CEOs that did not build their businesses but who simply rose thru the ranks, a different skill set than creating, growing a business…sometimes some of initial success looks like a lot of luck, but guys like Branson, Mark Cuban, they seem to have much more lively, independent minds and seem, strangely, more connected to real economic world.
Steve,
Congratulations on your latest work. I agree that you are way ahead of the pack, but still a way to go (well, that will always be the case).
Some thoughts on your equation (15). As I understand it your basic equations are (k=1/taus)
PQ = kF (1)
LW=k(1-s)F (2)
Q=aL (3)
Dividing (2) by (1) and substituting L/Q = 1/a from (3)and a minor rearrangement gives your result
W/P = a(1-s) (4)
I think this simple derivation shows firstly that an assumption of “equilibrium” is not required. Equation(4) holds even when all variables depend on time or on all the other variables.
The key assumption I think is that Q in (1) is the same as Q in (3). It seems to me that the simplest way to ensure this is to define Q as units sold rather than produced, in which case productivity a includes the efforts of workers in distribution, sales, marketing etc. With P defined as cash received by the firm (approximately the same as price but allowing for delays in payment) I think (1)-(4) are exact. Such things as variable inventories could be allowed for with k as a function of time. But since (4) is independent of k it is not affected. There is an obvious advantage in having P understood as price in (4) but I think it would be much easier to introduce a correction such as a time delay in a final result, rather than attempt to incorporate delays in the differential equations.
Taking (4)-(3) gives
W/P-Q/L = -as
again not requiring an equilibrium assumption. In fact, I think this shows that equilibrium is impossible and why your treatment is needed (rather than: there is an equilibrium, but capitalists can’t make a profit). I think it also shows that equilibrium cannot be considered a reasonable approximation (unless a and/or s vary with time, including negative values so that -as somehow averages to zero; or if some angel is available to supply cash at the rate as).
It also seems to me that all these results follow in a multi-firm model with the variables expressed as appropriately weighted averages.
When I can find the time I will have a go at QED.
@ AK and TruthIsThereIsNoTruth
I believe AK only meant to provide an illustration of unproductive resource allocation with the PhD guy designing HFT software example. That, I would say, does not mean IT is the only or indeed the main place where resources are this kind of thing happens.
The paragraph where AK mentioned the PhD guy was preceded by measures to fix the “leaky bucket”: “Capital gains tax and resources rental tax could help. Instead of hoarding money and speculating people should be ‘gently’ encouraged (by a 90% capital gains tax on real estate and 10% annual tax on wealth above $10mln for example) to invest in modern productive technologies and move us away from dependency on fossil fuels”.
This, it seems to me, implies that resources are allocated unproductively in other markets. Perhaps AK had mining and real estate in mind as he wrote that?
As I am not in IT, I can’t judge by myself, on my own experience, but I find it quite possible that TruthIsThereIsNoTruth has a point when he states that FIRE IT is chiefly concerned with other kind of things.
This, I suppose, does not mean that TruthIsThereIsNoTruth is denying that FIRE sector is indeed innovative and that some of these innovations are indeed detrimental to the stability of the system.
From my humble perspective, the morals of the story is: this discussion (as is often the case with discussion ideologically motivated) started by someone misreading someone else’s probably unfortunate example.
Just my two cents. Now, please, by all means, carry on.
I’m getting a message: zipped folder is invalid or corrupted when I try to open QED on my computer. Anyone else?
I’ve found Robert Samuelson’s article quite instructive:
Economics: the shaky science
http://www.washingtonpost.com/wp-dyn/content/article/2010/06/27/AR2010062703257.html
In short: Mr. Samuelson is AFRAID that the stimulus-generated deficit and debt will somehow cause a catastrophe.
One should be afraid too, Mr. Samuelson seems to believe.
In Samuelson’s words:
“This means that the benefits of higher deficits can be lost in many ways:
[1] through higher interest rates if greater debt FRIGHTENS investors;
[2] through declines in private spending if consumers and businesses lose confidence in governments’ ability to control budgets; and
[3] through a banking crisis if bank capital — which consists heavily of government bonds — declines in value.
There’s a tug of war between the stimulus of bigger deficits and the FEARS inspired by bigger deficits.”
Samuelson makes it appear that there are two separate channels (i.e. [1] and [3]) through which the financial markets could collapse.
That’s not true. Samuelson explains it as two separate, different channels, but it is only one (I guess, two things look scarier than one).
You see, the present value of a bond is related to the coupons paid to the bond-holder and the interest rate by the following formula:
V = C/r [*]
In this formula, V is the present value of the bond, which is also its market value; C is the coupon, and r is the interest rate. If interest rate goes up (i.e. r “grows”), as the coupon does not change, then V falls as well, and so falls the market value of the bond.
So, it’s misleading to explain this as two separate things: interest rates increases and falling bonds market values go together.
But this does not address the question: is it likely that interest rates will go up?
Curiously, Samuelson admits he doesn’t have any immediate reason to be afraid: “Interest rates on 10-year Treasurys are just over 3 percent”. So, no, they aren’t high right now.
Thus, whatever the risks of a financial collapse are, they seem remote. Consequently, “lenders haven’t lost confidence in U.S. Treasury bonds”.
But even though interest rates are rising now, is there any reason why interest rates in the US should go up any time soon? No, not really. Inflation in the US is low and in the US as in Australia, central banks consider their main duty to control inflation.
Further: the decision to increase interest rates belongs to the Fed. By rising interest rates, the Fed also hurts the employment perspectives of millions of Americans. However, nobody seems to care much for them. In particular, Mr. Samuelson does not even mention them. But he is very concerned about US bank stockholders… Hmmm.
But if this is how things are in the US, what about Europe, where the debt situation is, in some senses, worse than in the US?
Let’s particularly have a look at Ireland, where the local experts have done what Mr. Samuelson wants the American Government to do (i.e. cut down Government spending and taxes):
A Terrible Ugliness is Born
http://krugman.blogs.nytimes.com/2010/06/29/a-terrible-ugliness-is-born/
In Ireland, a Picture of the High Cost of Austerity
http://www.nytimes.com/2010/06/29/business/global/29austerity.html?_r=1&hp
And let’s have a look at Iceland, another little island, not too far from Ireland, where the Government could not do what local experts wanted to do:
The Icelandic Post-Crisis Miracle
http://krugman.blogs.nytimes.com/2010/06/30/the-icelandic-post-crisis-miracle/
So, the Irish have done what Mr. Samuelson asks, and they aren’t doing too well. The Icelanders haven’t done it, and the sky hasn’t fallen.
This is clear a sign that Mr. Samuelson is right, no doubt… Hmmm.
As we have seen many times here, monetary policy in Europe follows a largely different set of rules than in the US, because of the Monetary Union. As it has been treated here before, probably much better than I’d manage, I will save myself the trouble.
Okay, we have dealt with three of the channels Mr. Samuelson considers things can go pear shaped. What about the remaining channel, that is [2]?
What happens if people lose confidence?
Frankly, I don’t know. The potential consequences, I believe, might range from people jumping off a cliff; to just taking a warm shower, a cold beer and going to bed early. Your guess is as good as mine.
Is there any reason to believe the loss of confidence will be catastrophic? No, there isn’t. As far as I know: no real data, no theory. Nada.
By the way, I don’t know what the consequences could be, but neither does Mr. Krugman (and he is a Nobel Prize):
The Conventional Superstition
http://krugman.blogs.nytimes.com/2010/06/29/the-conventional-superstition/
Does Mr. Samuelson know? He might, but thankfully, he spared us the shilling details.
However, for someone who is so awfully concerned about panics and loss of confidence, Mr. Samuelson seems very comfortable scaring people, as his article does. Maybe he should have campaigned to get the Obama administration to impose more rigid controls and regulations on the financial industry, as Frau Merkel wanted to do in the recent G20 meeting.
NOTE:
[*] Any Macro 101 NEOCLASSICAL book, available pretty much anywhere, contains either this formula or an equivalent. Those interested need just to search for it.
Hi again steve. I am not fiished reading this latest output of yours but I wanted to question this bit:
“Circuit theory
gives the best foundation for understanding the dynamics of credit creation, but initial attempts
to devise a model from this theory reached paradoxical results—in particular, the widespread
conclusion that capitalists could not make profits in the aggregate if they had to pay interest on
borrowed money, or if workers saved any of their wages”
I tentatively suggest that the initial conclusion above is correct. Sectoral balances tell us that if we assume no government sector then the income of the business sector must equal the deficit of the household sector. These are flows.
These flows can only be sustainable (e.g. avoid an increase in private debt) if the business sector spends all its profits such that they recirculate as wages.
However to expect such recirculation without some dissiapative effect in a closed zero growth economy seems to me to be a matter of theoretical license.
Is it not the case that rising public sector debt combined with the illusion of the perpetual reliability of sovereign AAA ratings has served to keep the household sector afloat and mask the essential and inescapable conclusions of business-household sector balance identies?
Had people not believed 1980-2010 in the infallibility of soveraign debt then existing private debt-gdp levels could not possibly have reached the heights they have actually attained.
I am suggesting that the excess business sector profits that have been realised 1980-2010 above that which was actually sustainable long term can more or less now be measured as the global public sector deficit.
Steve,
Further to my comments on your eq(15): modifying the basic equations to allow for some helicopter money to be dropped on the economy (H in $/time) gives
PQ = kF
LW=k(1-s)F + H
Q=aL
which leads to a steady-state (“balanced”) economy when H = sPQ. This leads to W/P = a instead of your W/P = a(1-s). The source of H could be fiat money created at the rate g ($/time) combined with credit created at the rate m.g where m is a dimensionless multiplier. Then g(1+m) = sPQ is required for steady-state. Taking s=0.4 (which I think from memory you have used) and PQ as GDP then g(1+m) needs to be 40% of GDP. This seems plausible – say, g=0.1*GDP, m=3. Note that this is a no-growth economy, so actual observed values for g(1+m) are likely to be higher. BTW, this formulation doesn’t imply that m is fixed and that g determines m.g but rather that together they need to be such that g(1+m) = sPQ for steady-state. For instance, it seems to me that in the US Bernanke has been substantially increasing g because m is too small.
My thought is that steady-state values for the variables might lead to a better fit of your model to data than the “equilibrium” values, without much change to the qualitative dynamics; that is, dP/dt = b(Pss-P) rather than b(Pe-P), etc