Sunday, 12 November 2017

Werner on GDP and Interest

Werner on GDP and Interest Rates

Lee and Werner have posted a paper  destined for the Journal of Ecological Economics in 2018. According to Lee and Werner there is essentially complete agreement amongst all schools of economic thought, that lower interest rates stimulate economic growth; they extrapolate to a belief that when the Bank of England lowers ‘Bank Rate’ (the overnight rate of interest at which it lends to commercial banks) it is trying to boost growth of the economy. Lee and Werner’s object is to test, against the data, whether low interest rates cause the economy to grow. Of course, they cannot show causation, but they can test whether or not a fall in interest rate precedes a rise in ‘growth’. Their answer is the complete opposite – not only does increased rate of ‘growth’ lead a change of interest rate (rather than lag it), but raised rate of ‘growth’ correlates with a raised interest rate (rather than a fall).

I propose to return to the question of how to determine the growth of the economy, but wish first to consider why the Bank of England tinkers with the base rate of interest on the overnight loans it offers to its commercial bank customers, which we call “Bank Rate” or “Base Rate”. Ostensibly ‘Friedmanite’ central banks such as the Bank of England (BoE) are tasked with maintaining the stability of the currency by controlling inflation at a steady rate of 2%. The Bank of England currently uses two methods to manipulate the purchasing power (in Britain) of the pound (i.e. the cost of the basket of goods in the Consumer Price Index). These are: [i] rate of interest charged on overnight loans from the Bank of England, and [ii] asset purchase (i.e. Quantitative Easing). 

The idea behind the first is presumably the monetarist belief that the quantity of money in circulation directly affects prices; doubling the money will double the price of goods (and halve the value of the money). And of course, money nowadays is mostly credit, rather than coin. I have no idea what volume of business flows into and out of the BoE reserves every night, nor what a commercial bank would do if the BoE said “sorry, you cannot borrow from us this evening.” I imagine that Bank Rate is largely operating as a signal. If Bank rate rises, all the lenders in the country gleefully raise their rates. If the economy stagnates and the Governor fears a recession, he will signal a willingness to encourage lending by lowering base rate. However, when base rate is essentially zero he cannot use that tool to encourage inflation; he turns to Quantitative Easing.

The idea behind Quantitative Easing seems to be as follows. The Treasury issues gilt-edged IOUs at such an interest rate that they do not all get sold. The Bank of England buys (up to 70% of) them, so holding down longer-term interest rates. If the Bank of England buys these ‘assets’ from commercial banks these latter acquire (in exchange) money they can lend out, or reserves at the BoE they can use as surety against extending credit to smaller customers. You might ask where the BoE gets the money with which to buy the Gilts? But remember, it has the power to print notes; so it (therefore) does not need to; it simply gives the liquid asset of digital cash in exchange for the gilt-edged IOU; it can always swap it back again. In many ways QE is simply doing, for longer-term interest rates, what the BoE routinely does for its overnight Bank Rate. But the process injects ‘broad money’ (in the form of credit) into circulation, and that can cause inflation if it gets into the hands of the general public. There can be a delay, of months or years, depending on what the commercial banks do with their new money (sit on it or lend it out); and on whether the general public borrow that money to build factories or fund purchases. But it will eventually cause inflation, unless the BoE swaps back the IOUs it purchased. 

Lee and Werner’s question (whether low interest rates cause the economy to grow) is timely in that there seems to be a growing disconnect between the efforts of the central bank and the performance of the economy. However, the performance of the economy is a preoccupation of the government, and above all of the media. It is not the concern of the BoE which is is focussed on keeping inflation low and stable.

For two centuries Britain has watched the economies of other countries grow faster than its own. This growth represents capital accumulation and in its early phase is logarithmic (auto-catalytic). It is usually measured as gross domestic production (GDP), which is a compilation of all the incomes of all the people in an economy, expressed in the local currency. If we do not grow as fast as our competitors we loose market share; and we cannot grow as fast because we are no longer in the logarithmic phase of growth. 

Because nominal GDP is expressed in local currency, it reflects not just accumulation of capital, but also inflation. Let us consider a peculiarly simple but quite plausible form of inflation in which, at the beginning of every financial year, all prices and all wages rise abruptly by 5%. The citizens and businesses would be no better off; nor worse off. A bag of flour would cost 105% of what it did the previous year, but citizens would soon realise that their salary would stretch exactly as far as before.  At the end of the year the macroeconomists would note a 5% jump in nominal GDP, but this is not growth – except to ‘the media’. Any sensible discussion of GDP must start by correcting nominal GDP for the change in value of the currency (using e.g. RPI or CPI). (See also my post on Growth; and on Coppola Comment.)

Let us now look at the data of Lee and Werner. They plot the “year-on-year growth” in nominal GDP over a period of 50 years from 1960, presumably taking the published GDP for each 3-month interval and subtracting that of 12-months before (thereby introducing a 6-month offset into the profile; any growth in the 12 months to December 1970 being ascribed to December 1970 and not to June 1970). On the same graph they plot interest rates on 3-month Treasury bills or (on another graph) 10-year government bonds. These interest rates are not simply base rate, but are complex reflections of (a) instantaneous base rate, (b) what the markets think will happen to base rate and (c) what the markets think will happen to inflation over the period of the loan. 

My interpretation of their data is that in all 4 major economies the rate of inflation rises and falls irregularly (but with a tendency towards a 5-7 year periodicity) over the 50 years of the study, causing a similar fluctuation in nominal GDP, and (with a slight lag) the 3-month and 10-year interest rates. Lags are the essence of the over-shoots and under-shoots of the business cycle. If information were instantly available to businesses and bankers, and if the spreading of rumours and building of factories were instantaneous, there would be no business cycle.

(It would be interesting to compare, for each time-point, (i) the 3-month rate, (ii) 10-year rate, (iii) base rate, (iv) inflation rate, and (v) ‘corrected’ GDP growth-rate ascribable to that time-point; but that was not done.)

‡‡  There are old men in pubs remembering when beer was 20p a pint and their fist car cost £600. In 1970 the average house cost £4975 and the average annual wage was £5700 [;]. So in 1970 the annual wage was equivalent to 28,500 beers or 9.5 cars, or 1.1 houses.  Today our average annual wage of £25,000 is equivalent to 8,000 beers or 2.5 average cars, or 0.11 average houses.  But these figures do not capture the whole picture, or you might think we were considerably worse off now than in 1970. We work less, live longer, fly to the sunshine for our holidays. We throw away worn clothes and broken umbrellas, and play with our smartphones in front of our flat-screen TVs. I have not met anyone who would prefer 1970 to 2017. Nor would I, even if it meant being young again – I think. 
★★  If the real (i.e. corrected) GDP of Britain increased 5% on the previous year, what has increased? To simplify, it could be the population, leaving us identically well off on a per caput basis; or we could all work longer days; or (finally) it could be that a new machine makes 110 shirts per diem instead of a mere 100. That new machine could be bought on credit if interest rates were temptingly low. Believing that is easy; proving it is hard. 

Tuesday, 7 November 2017

George Nathan

           "I drink to make other people interesting"

     I like the George Nathan quote, painted on the wall by the fruit machine: "I drink to make other people interesting".  So true. I had 2 pints today which is most unusual, and we had some enjoyable conversation. 
     'H' had been woken by his hot-water system, John was furious with an electrician who wanted to charge 10 times the list price for a replacement wireless thermostat. John and I talked, as is usual, about aspects of safety in the London underground, the explosive properties of warm dusty air, and such. Attention turned to the Mail's Quick Crossword where there was one remaining clue:
 2. (down) — Toxophilite (6),   A-C-E-, 
I suggested ARCHER, to general amazement. Barry said he knew that fletchers made arrows, which seemed to me a golden opportunity to remind everyone of the Fletcher's trolly, as an ingenious way to neutralise friction and study gravity. That prompted Barry to ask the Speed of Gravity, a pretty big leap if you ask me; perhaps it was something that was bothering him.  'H' suggested it was 9.81 m/s, but we quickly persuaded him that his was the acceleration of something due to gravity (in one second), and not of gravity itself. John said he thought it was something to do with the warping of space-time, to which I nodded, but I could not think how to follow that up, so I proposed the experiment of rapidly producing a mass here and seeing how quickly you could feel its effect over there. I remembered the Schiehallion experiment, where someone climbed Mt. Schiehallion with a pendulum, to "weigh the mountain". I suggested that gravity would travel at the speed of light. Wikipedia seemed to concur. 
     I think we were all pretty impressed with ourselves. Someone hoped that Einstein would have been flattered had he dropped in, and another agreed that we seldom reached such philosophical heights in the New Inn.  
     I drained my glass. John offered me another but I declined and picked up my watering can as I made for the door, causing another guffaw from my merry companions: "Why did so few chaps carry watering cans these days?" etc. 
     Good place, the New Inn.

Friday, 3 November 2017

Henry Farrell on ‘Very Serious People’

Henry Farrell has a nice piece on ‘Very Serious People’ in the Crooked Timber blog for 22nd July 2015.

But his second sentence (below) is ludicrous. 
“Tyler Cowen argues that the concept of “Very Serious People” refers to people who “realize that common sense morality must, to a considerable extent, rule politics.” I’m not either the originator nor the popularizer of the term, but I think that’s wrong. As I understand it, the theory underlying the concept of Very Serious People is as follows.”
I think Henry Farrell means: 
“I am neither the originator nor the popularizer of the term, but I think Tyler Cowen is wrong.”
Farrell makes many valuable points in his piece, but I think it is marred by the snide vagueness of the epithet, and the panache of the writing. I suppose I am making a plea for “re-reading before posting”, something Henry Farrell could add to his little essay on ‘Good Writing in Political Science’.

Thursday, 26 October 2017

Shostak on The Importance of Theory

Shostak on 'The Importance of Theory'.

In “Fed confused about what drives inflation?”, Dr. Frank Shostak writes:
“The purpose of a theory is to enable to ascertain the definition of a phenomenon that is subject to investigation.
    The correct definition attempts to identify the essence of the phenomenon i.e. the key parts that drives the phenomenon.
    For instance, the definition of human action is not that people are engaged in all sorts of activities, but that they are engaged in purposeful activities – it is purpose that gives rise to an action.
    So when Tarullo states that Fed policy makers do not know the causes that drive inflation he basically says that Fed policy makers have not as yet established the correct definition of inflation.
    Is it then valid to be practical, as suggested by Tarullo, to focus only on the data to understand what inflation is all about? If Fed policy makers respond to changes in price indices without establishing what drives these changes this runs the risk of making things much worse.”

My literal translation (into English).

The reason for propounding a theory is to make possible the definition of the phenomenon under investigation. A correct definition identifies the essence of the phenomenon, i.e. the forces that drive the phenomenon. For instance, the correct definition of “human action” indicates that activities are purposeful, not merely varied; for it is the purpose that gives rise to the action.

So, when Tarullo states that policy makers at the Federal Reserve do not know the causes that drive inflation, that is tantamount to saying that they have the wrong definition of inflation. Is it then valid to focus only on the data (as a means of understanding the ‘meaning’ of inflation)?  To react to change in the Consumer Price Index without understanding what is causing those changes could make matters worse. 

My Comment

I do not think the reason for propounding a theory is the one given, and I disagree with Shostak’s definition of “definition”, and (in addition) his definition of “human action”. But this nonsense is not germane, and perhaps can be safely ignored. I agree with Shostak that the Federal Reserve should try to understand the cause (or causes) of any current inflation. 

It may be that inflation indicates that something is changing; the volume of money, or of goods. An intelligent Government would try to identify what exactly is changing, and adjust for that. They should not merely obliterate the signal. There is a parallel in healthcare. Pain is a signal of something going wrong. An analgesic like paracetamol obliterates the signal but does nothing to identify precisely what is going wrong, and nothing to rectify the problem.

Dr. Shostak is angry about inflation because it robs value from those with positive bank balances. But there will (presumably) be others who like inflation because it gives value to those with negative balances, and those who create the money. 

But let us get back to the "importance of definition". Dr. Shostak writes:
"However, if we accept that inflation is about rises in money supply and not a rise in prices then all ........ can be easily explained.  It is not the symptoms of a disease but rather the disease itself that causes the physical damage. Likewise it is not a general rise in prices but rises in money supply that inflicts the physical damage on wealth generators."
Once again  I disagree. I believe that the money supply should increase as and when necessary, for example, when there is an increase in goods. 

But there is a quite different, and much more subtle argument in favour of a controlled low level (2%p.a.) of inflation. Is the Keynesian position not generally accepted that, for psychological reasons, an economy is more stable and more easily controlled when there is a constant low level of inflation? Do we throw out the "General Theory" and 8 decades of largely successful government for the sake of simple mathematics? I do not think the case is made, yet.  

Maybe we could agree that, as a type of covert taxation, inflation is a bit underhand. 

Monday, 23 October 2017

Angina — further questions

Angina — further questions

Predictable, effort-related, chest pain is called stable angina The consensus view is that ‘diseased’ (or atherosclerotic) arteries, partly occluded with cholesterol-rich plaques, require raised blood pressure, so more effort is required from the heart. If the coronary arteries supplying the heart muscle are healthy, blood pressure would rise, and in time ventricular hypertrophy would be evident. But if they are themselves partially occluded, part of the heart muscle becomes inadequately oxygenated when under this increased work load; this ischaemia causes pain — in the myocardium (and referred areas such as: neck, jaw, shoulder, or arm).

There are two main coronary arteries, but they branch and fuse, and there is considerable variation between individuals. Occlusion can occur in one, or more limbs, and can, in time, cause the vascular network to adapt. When 130 patients with chest pain syndromes were examined for physical evidence of coronary artery disease 93 patients showed positive, but 37 showed no sign of disease [1].  I understand that ischaemia in a small part of the heart can be as painful as in a large part. So it is possible that the physical tests for occlusion were not sufficiently discriminating. But it is also stressed that not every chest pain shows the effort-induced aetiology of stable angina. A very similar pain can be caused by emotional stress, where the transient cardiac ischaemia presumably results from adrenaline stimulating β1 receptors, which results in increased cardiac effort (and oxygen-demand) by increasing heart rate, conduction velocity, and stroke volume. According to one source [2], in about 2% of people with angina, the closure of the artery (or arteriole) is due to “coronary artery spasm”. According to another source [3] this aetiologiy is 5 times more common in women than men. 

One question that nags me is as follows: Does the pain experienced during exercise coincide with (and thus 'flag') further damage occurring to the coronary vessels? There seem to be two ways in which this might be the case. 
  1. The pain (ex hypothesi) indicates ischaemia, which in turn can cause cell-death (when the cells are unprepared). Dead cells may lead to scar tissue and possible foci for plaque build-up.
  2. Ischaemia can cause cells to generate superoxide radicals, which can modify lipids (including cholesterol), or can react with nitric oxide to form peroxynitrite. Peroxynitrite can nitrate protein tyrosines. The presence of antibodies against nitrotyrosine in patients with  atherosclerosis, myocardial ischemia, have confirmed the occurrence of such nitration. [4] 

This question is important, because the patient will want to know whether to exercise as much as possible, or to avoid (as much as possible) the pain of over-exertion. 

[1]   Cohn et al., (1971) Circulation; 44:196-202
[3]   Bugiardini, et al. (2005) JAMA.; 293:477-84;
[4]   Beckman and Koppenol (1996) Am J Physiol. 1996;271:C1424-37.

Sunday, 15 October 2017

Brexit Negotiations

    I find stressful, and begin to resent, the shilly-shallying on the Brexit negotiations.   
    Here is a simplifying suggestion.  Britain has offered to honour commitments made during membership.  Barnier wants to know how much that is.  Why not everything that we were paying before the brexit referendum? But during the transition period, we receive all the benefits that we received as a full member before the referendum. (No more closed-door stuff.)
    At least we know how much that was, and that we can afford it; and we know that it is regarded as value for money by 48% of Britons.  
    During the transition period we enter no new commitments, and we pull out, one by one, from the costs and the privileges of membership. The transition ends when the negotiations end. They might take decades.
    Yours sincerely, Ian West
Ian West, 9 Thenford road, Middleton Cheney, Banbury, OX17 2NB. (Tel: 01295 713889; mob: 07906 750986)

Friday, 13 October 2017

“Coppola Comment” Comment

“Coppola Comment” Comment

Frances Coppola is always an enjoyable read, enunciating good sense in lucid prose. But she can be teasing, as in her latest blog.


     Like organisms, I believe economies can grow until they approach maturity, when they will enter a ‘steady-state’. It is neither possible nor desirable to grow for ever. By the way, GDP cannot be used as a measure of growth unless corrected for devaluation. True growth (in wealth) would have to involve either an increase in population or productivity (per worker), or both.  I cannot see why anyone should want a mature economy to grow.  No sane Briton could want an increase in the population (of Britain), nor an increase in the ratio of concrete to green-space, in Britain.  There will (in Britain) be even less interest in the growth of economies elsewhere in the world. 


     I suppose inflation is (in essence) the willingness of some people (sufficient people) inside a currency zone to pay more for a standard item (or sufficient basket of items).  And I suppose this could happen if the items become more scarce, or if the currency becomes more plentiful. 
     I assume that the conventional aim of 2% inflation depends entirely on politics and psychology; not on economics. People are unwilling to accept a lowering of money wages. If government wishes to lower real wages (for whatever reason), that can be achieved most easily by fixing money wages and waiting for inflation (devaluation). In Japan, with a mature and stable economy, I cannot see why anyone could possibly want inflation, whether in the form of devaluation, or of growth.  (If Japan wanted inflation, I think that could be achieved, with a printing press.) 

Interest Rates:

     From Cowen, I read “Peter Olson and David Wessel write:
‘The natural rate of interest, also called the long-run equilibrium interest rate or neutral real rate, is the rate that would keep the economy operating at full employment and stable inflation’.”  When base interest rate was the only lever the Central Bank could pull, the Olson and Wessel definition probably made some sense; the central bankers spent their time sliding the lever up and down while watching their two indicators of success. Quantitive easing provides another lever for the Central Bank, and doubtless upsets the theory of ‘natural interest rate’.  Even without the complication of quantitative easing, it seems quite possible that the concept of Natural Interest Rate contains internal contradictions: [a] Full employment may not be ‘natural’. [b] Full employment, when achieved, might not be compatible with the interest rate required for stable inflation (unless stable inflation is used to provide a definition of “full employment”).

Coppola clearly knows all that, and in her blog is not so much dismayed, as laughing at the discomfort of the economists who were armed not with basic principles but with rules of thumb.