Month: April 2014

Must-Reads:

1. Samuel G. Hanson et al.: Banks as Patient Fixed Income Investors: “We examine the business model of traditional commercial banks in the context of their co- existence with shadow banks. While both types of intermediaries create safe “money-like” claims, they go about this in very different ways. Traditional banks create safe claims with a combination of costly equity capital and fixed income assets that allows their depositors to remain “sleepy”: they do not have to pay attention to transient fluctuations in the mark-to-market value of bank assets. In contrast, shadow banks create safe claims by giving their investors an early exit option that allows them to seize collateral and liquidate it at the first sign of trouble. Thus traditional banks have a stable source of cheap funding, while shadow banks are subject to runs and fire-sale losses. These different funding models in turn influence the kinds of assets that traditional banks and shadow banks hold in equilibrium: traditional banks have a comparative advantage at holding fixed-income assets that have only modest fundamental risk, but are relatively illiquid and have substantial transitory price volatility.”

2. Barry Eichengreen: It’s Not a Savings Glut, It’s a Tolerance for Holding Risky Investment Shortfall: “The data show little evidence of a savings glut…. It is plausible that the wealthy consume smaller shares of their income…. But to affect global interest rates, these trends have to translate into increased global savings…. A second explanation for low interest rates is a dearth of attractive investment projects. But this does not appear to be the diagnosis of stock markets…. Capital expenditure has been insufficient to prevent rates from trending down for more than three decades…. If the disorder has multiple causes, then there should be multiple treatments… tax incentives for firms to hire the long-term unemployed; more public spending on infrastructure, education, and research to compensate for the shortfall in private capital spending; and still higher capital requirements for banks and strengthened regulation of nonbank financial institutions…. Finally, central banks should set a higher inflation target…”

3. Owen Zidar Weekend Links: “Larry Summers gave a talk at INET (starts at 45 min and goes to 1:38 or so) with some especially interesting hypotheses about the changing structure of investment (from GE’s high capital investment model to Google’s abundance of cash) and reflections on the agriculture transition (around 1:21) and the associated difficulties with large shifts in the industrial composition of employment… http://new.livestream.com/INETeconomics/HumanAfterAll/videos/47888551“

Continue reading “Things to Read on the Morning of April 14, 2014” →

Samuel G. Hanson et al.: Banks as Patient Fixed Income Investors: “We examine the business model of traditional commercial banks…

…in the context of their co- existence with shadow banks. While both types of intermediaries create safe “money-like” claims, they go about this in very different ways. Traditional banks create safe claims with a combination of costly equity capital and fixed income assets that allows their depositors to remain “sleepy”: they do not have to pay attention to transient fluctuations in the mark-to-market value of bank assets. In contrast, shadow banks create safe claims by giving their investors an early exit option that allows them to seize collateral and liquidate it at the first sign of trouble. Thus traditional banks have a stable source of cheap funding, while shadow banks are subject to runs and fire-sale losses. These different funding models in turn influence the kinds of assets that traditional banks and shadow banks hold in equilibrium: traditional banks have a comparative advantage at holding fixed-income assets that have only modest fundamental risk, but are relatively illiquid and have substantial transitory price volatility.

Matthew Yglesias is surprised that most economists favor raising the minimum wage:

Matthew Yglesias: What do economists think about the minimum wage?: “A survey of economists by the Initiative on Global Markets…

…at the University of Chicago’s Booth School of Business found they supported a minimum-wage increase. They weren’t sure, however, whether increases would create unemployment. Most said that, on balance, the benefits exceeded the costs…

But why should he be surprised?

Most economists are card-carrying utilitarians who believe in the declining marginal utility of wealth. Thus pro-poor redistribution is a good thing until the bucket gets sufficiently leaky. And the overwhelming evidence is that at current relative levels of the minimum wage the bucket is not very leaky, and might not even be leaky at all.

So where is the source of his surprise?

One possibility is that Matthew has spent too much time listening to bad right-wing economists who are even worse philosophers–people who say things like: “We are economists, We talk only about efficiency, and so we talk about what maximizes real income per capita. If you want to introduce some other consideration and maximize something other than real income per capita, well then you are introducing interpersonal value comparisons into the problem and you should consult the philosopher or theologian. But we should agree at the start that it is maximizing real income per capita that is the efficient outcome.”

The problem with this, of course, is that maximizing real income per capita does take a stand, and a very fictional your stand, on interpersonal value comparisons. To maximize real income per capita is to assert that each dollar at the margin–no matter how rich is the person that goes to–has the same effect on marginal utility, has the same effect on the greatest good of the greatest number. If we were, instead of maximizing real income per capita, to go about maximizing the geometric mean of real income we would be taking another stand: that utility was logarithmic in real income, so that each doubling of real income had the same effect on the greatest good of the greatest number no matter who that doubling went to or how rich they already were.

Both maximizing real income per capita and maximizing the geometric mean of real income are wrong, are not what we really want to do. We have feelings of desert that enter into the question. Our intuitions about how marginal utility declines with wealth are fuzzy and surely do not follow the same logarithmic curve everywhere. And we do allow for what philosophers parody as “utility monsters”–that some people would enjoy or derive more benefit than others from at least some thing.

But if one wants a neutral place to start, it is surely less obnoxious to start from maximizing the geometric mean of real income than from maximizing real income per capita. And once one starts from there you need a very large disemployment effect–one that we simply see strong evidence against at the current level of the minimum wage–for an increase in the minimum wage to flunk any sensible benefit-cost calculation.

520 words

There Are Four r’s

When I look at Thomas Piketty’s big book, I see one thing that he failed to do that I think he really should have done. A large part of the book is about the contrast between “r”, the rate of return on wealth, and “g” the growth rate of the economy. However, there are four different r’s. And in his book he failed to distinguish between them.

The four different r’s are:

1. The real interest rate at which metropolitan governments can borrow: call this r₁.

2. The real interest rate that is the actual average return on wealthin the society and economy: call this r₂.

3. The real interest rate that is the average risky net rate of accumulation–what capital receives, minus the risk of confiscation or destruction or taxation, plus appreciation in valuation multiples, minus what is spent in order to keep the world in the appropriate social position: call this r₃.

4. A measure of the extent to which capital and wealth serve as an effective claim on income independent of how much capital there is–a standardized measure of what the society and economy’s return on wealth would be at some standardized ratio of wealth to annual income: say, 4: call this ρ.

These four r’s are very different animals.

Continue reading “Notes and Finger Exercises on Thomas Piketty’s “Capital in the Twenty-First Century”: The Honest Broker for the Week of April 19, 2014″ →

In a rational financial market, there are four and only four reasons to trade:

1. Liquidity–moving money into and out of the market because you are saving or dissaving.
2. Rebalancing–you are bearing too much of some kind of idiosyncratic risk that you are not receiving a proper reward for, and should shed.
3. Control/incentives–the trade will produce wealth by better-aligning the incentives of agents with principals.
4. Information–you have done some research, and know something about the current configuration of what asset prices should be that Ms. Market does not (yet) know.

In a “rational” financial market without noise traders in which liquidity, rebalancing, and control/incentive traders can tag their trades, it is impossible to make money via (4). Counterparties to (4) will ask the American question: If this is a good trade for you, how can it be a good trade for me? The answer: it cannot be. And so the economy underestimates in fundamental information, and markets will be inefficient–prices will be away from fundamentals, and so bad real economic decisions will be made based on prices that are not in fact the appropriate Lagrangian-multiplier shadow values–because of free riding on the information contained in informed order flow and visible market prices.

Now comes Streetwise Professor:

Continue reading “Something I Do Not Understand About the Defenders of High-Frequency Trading in the Debate Over HFT: Friday Focus: April 11, 2014” →

Must-Reads:

1. Ezra Klein: Why Won’t Obama Lead?: “Unlike in parliamentary systems, the president is not the leader of the party that wields power in the legislature. Instead, the president often leads the party that is the minority in one or both chambers of Congress. And in those cases the president’s intervention can actually make Congress less cooperative. Elections are zero-sum affairs: for one party to win the other party has to lose. Since elections are typically a referendum on the party in power that sets up a very simple incentive for the minority party: they need the majority party to fail, or at least to be seen to fail, if they’re to regain power. What makes the American political system unusual is that its checks and balances, alongside unusual minority protections like the filibuster, actually give the minority party the power to make the majority party fail. A system that typically requires the minority party’s cooperation to work is nevertheless built to penalize that cooperation. The result is much as you’d expect. When the president takes a position on an issue the opposing party becomes far more likely to take the opposite position…”

2. Daniel Kuehn: Botched Economics of Gender by Mark Perry and Andrew Biggs in the WSJ: “Mark Perry and Andrew Biggs have a really unfortunate op-ed in the Wall Street Journal yesterday perpetuating the idea that the gender pay gap is a ‘myth’…. Why[?]… Because surprise, surprise the conditional difference in means is smaller than the unconditional difference in means! I sent this letter to the editor in. It has not been published at this point: ‘Mark Perry and Andrew Biggs (April 7th, 2014, “The ’77 Cents on the Dollar’ Myth About Women’s Pay”) seem to confuse our ability to attribute the gender pay gap to various factors with the idea that the gap itself is a ‘myth’…. By highlighting the various determinants of pay disparities Perry and Biggs are actually confirming the existence of the gap and presenting evidence on where it originates…. We know… that many occupations are highly segregated by gender, and that large gender disparities exist in the amount of time dedicated to household work. Young women may be nominally free to major in whatever they choose, as Perry and Biggs suggest, but these choices are heavily conditioned by earlier experiences in the home and in primary and secondary school. All of these disparities are closely related to each other and to the pay gap, and they pose a real problem for those of us that value gender equity. Dismissing the gender pay disparity because it is deeply embedded with other disparities does not clarify the issue at all; it confuses the issue.'”

3. Adam Posen: Monetary Policy Normalization: Challenges for Fiscal Policy:

4. Lawrence Summers et al.: We haven’t done it in 15 years and Japan hasn’t done it in a generation:

Continue reading “Things to Read on Thursday Evening: April 10, 2014” →

Lawrence Summers: An agenda for the IMF: “In the face of inadequate demand, the world’s primary strategy is easy money….

All this is better than the kind of tight money that in the 1930s made the Depression great. But it is highly problematic as a dominant growth strategy.We do not have a strong basis for supposing that reductions in interest rates from very low levels have a large impact on spending decisions. We do know that they strongly encourage leverage…. We cannot confidently predict the ultimate impacts of the unwinding of massive central bank balance sheets on markets or on the confidence of investors. Finally, a strategy of indefinitely sustained easy money leaves central banks dangerously short of response capacity when and if the next recession comes. A proper growth strategy would recognize that an era of low real interest rates presents opportunities as well as risks and would focus on the promotion of high-return investments… infrastructure spending… promote private investment, including authorizing oil and natural gas exports, bringing clarity to the future of corporate taxes… moving forward on international trade agreements…. Europe has moved back from the brink… But no strategy for durable growth is yet in place and the slide toward deflation continues…. A global growth strategy framed to resist secular stagnation rather than simply to muddle through with the palliative of easy money should be this week’s agenda.”