Monday, 31 October 2011

Fiscal Policy - No Brainers

1. We have a demand shortfall crisis in the economy.
2. We have a long term structural deficit problem.
3. David Cameron says we need to focus on the deficit.

But he also says that we should abolish investment expensing in return for an across the board corporation tax cut.

In other worse, we should increase the marginal cost of investing in machinery and plants in this country (and thereby creating demand) and we should decrease the cost of hoarding profit, which will probably be saved precisely because there is a demand shortfall and so investments have to be more cost effective than ever in order to justify themselves. So the policy in balance does little or nothing to solve the deficit problem (because abolition of investment expensing is offset by corporate tax deductions) whilst worsening the demand shortfall (by increasing the marginal cost of investment decisions).

This is a no brainer.

Monetary Policy

As the Oxford Class of 2010 know, at least partly from the scarring experience of our Macro Paper, there are serious limits to inflation targeting.

Firstly, from an expectations perspective, it leaves us seriously vulnerable to a deflation trap, as when if the interest rate hits the lower bound, we lose monetary policy as a vehicle for boosting the economy. Realizing this, consumers expect low core inflation or deflation and so are encouraged to save - reinforcing the deflation trap. Interest rates can't go low enough to move some of these excess savings into investments and so they effectively just lie around doing nothing -perhaps getting parked into treasury bills- when they could be financing small business investment for the credit constrained etc.

An increasing voice seems to be building from the US Policy Community for Nominal GDP Targeting. From what I can make out, this works a lot like a price level target in so far as, when the economy falls from its intended path, the expectations of future loose monetary policy (and hence inflation) encourage spending now leading ultimately to a lessening of the threat of a deflation trap. The Nominal GDP target is being endorsed now by Krugman and Christina Romer, as well as tacitly perhaps by Mankiw and even Jan Hatzius from Goldman Sachs.

I think its clear, from the appalling Unemployment situation on both sides of the pond (8.1% over here, 9.1% over there -and that's not including those withdrawn from the labour pool or of course those in jail- about 1% of America), that governments have to do more. Moreover, there are two clear reasons to prefer solutions to come from central banks and monetary policy over parliaments and fiscal policy - which is that whilst fiscal policy can certainly restore the 'flexible price equilibrium' income, it cannot create the optimal composition of that income. This is because monetary policy can ultimately leave it to consumers and businesses to choose how to spend their money, whilst fiscal policy in the shape of spending (tax cuts in a depression just get saved, afterall, if the Marginal Propensity to spend is falling and interest rates stuck at 0 are not providing sufficient incentives to invest) must be spent on specific 'pet' projects. Those projects may or may not be societally optimal (there's a standard caveat to this point which is public goods provision as well as a less obvious but important counter argument here about dynamic effects and the possibility that government interference might change the optimal outcome but I honestly don't see it as being enormously important, I'm assuming that the flexible price outcome is the preferred one). The second point is the fiscal issue - whilst inflation would tend to reduce the debt burden, expansionary fiscal policy would do the opposite and so lacks 'political support' in both the UK and US (specifically, it lacks the support of necessary numbers of MP's and Congressmen). Whether it ought to do so or not is another issue, but clearly as long as political power remains distributed as it currently is, large fiscal stimulus seems impossibly optimistic.

If you accept these points, then I think the case for Nominal GDP Targeting becomes hard to refute. It will lead to higher core inflation in the short run most likely, but then, the real costs of inflation come from variability and unpredictability, rather than its level per se. Moreover, a bit higher inflation would be no bad thing.

Incidentally, if the BofE or the Fed moved to an NGDP target, then there remain questions about how it would meet its target. To move the UK out of its current doldrums would require enormous monetary stimulus which would probably have to take the shape of QE. QE is growing unpopular politically, being seen as a sort of backdoor bailout. Perhaps the next round could come with stricter lending regulatory requirements for small businesses?

Sunday, 30 October 2011

European Central Bank - Modelling its Behaviour (wonkish)

As Shakespeare anticipated, sorrows have struck Europe not as single spies but in battalions. Fiscal and Financial woes abound, not to mention the political (not much sign of leadership from Brussels as Sarkozy tells Cameron to "shut up" and that he is "sick of" him whilst Berlusconi, Europe's most famous comedian, denounced Angela Merkel as an "unfuckable lard arse").

I want to interpret the events in Europe through the lens of two different models, to see what each might say the future holds for Europe.

Specifically, I want to look at the issue of the European Central Bank. A new ECB President is imminent, and many in the press are saying that only if the ECB agrees to provide full backing to governments with high yield sovereign debt (essentially via offering to buy their debt by 'printing'* money) can the crisis be averted. Under the previous ECB President, Jean Claude Trichet, such a move was ruled out (JCT is said to be heavily influenced by the German experience of hyperinflation and therefore anything remotely similar to monetizing the debt is a big no-no).

Realist models, like those of Geoffrey Garrett, tend to hold that the institutions of the EU are held on a tight Principal-Agent rope, and so their choices simply reflect the interests of the member states as a unanimous body. Policy change from the ECB, therefore has to be unanimously agreed and Draghi will probably just hold the line his predecessor did - no bailouts for 'bad behaving' governments. Neofunctionalists on the other hand hold that individuals can 'go native'. Mario Draghi, as the President of the ECB, would oversee an enormous expansion of his own power if the Central Bank were to gain the ability to act as a Lender of Last Resort, which is effectively what we are talking about here. So, the Neofunctionalists would tend to see the crisis as being solved by Mario Draghi pushing his own agenda. Of course, in order for that to go from being Draghi's preferred solution to policy, I believe in this case the Germans would in fact have to sign off. That in turn would require approval from the Bundestag/Bundesrat, which is, to understate, a challenging prospect.

Realists like Sebastian Rosato are publishing in recent editions of International Security saying the EU will stagnate or collapse. Of course, realists have always been saying this. Many neofunctionalists on the other hand see this crisis as an opportunity for policy entrepreneurs to push through an expansion of European Institutions' power, including the ECB's power to act as a Lender of Last Resort and also for the EU to jointly offer Eurobonds. The next few months and years will not be a clean cut empirical test of these theories, but it will come close. Whilst I think the case on how the ECJ functions is more or less closed now, what happens over the next few months will give us an important way of thinking about how the ECB functions, and the ability of Europe to handle a crisis that the ECJ cannot solve, with force majeure. If this crisis leads to increased integration in the Euro-zone, Realist models will be discredited and realist theorists of the EU will have to head home, not in single spies, but in battalions.

(Apologies for the likely shortfalls in spelling and grammatical accuracy in the above).
*Obviously no printing is actually done when a central bank engages in 'printing' money.

Unreasonable Protests: Progress at last.

To begin with, two quotations:

"The reasonable man adapts himself to the world; the unreasonable one persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man."
George Bernard Shaw

"It is no measure of health to be well adjusted to a profoundly sick society."
Jiddu Krishnamurti

I have been seriously concerned by the poor quality of press reporting of the Protests outside St Paul's. Those protests are an attempt to bring about a more democratic society - one in which businesses and people align their interests for long term good, rather than short term considerations.

With regards to debunking press myths:

1. St Paul's was forced to close because of the protests.
St Paul's voluntary decision to close has been described as a "hysterical overreaction" by the Bishop of Buckingham and many visitors and indeed Clergy have echoed this decision.

2. 90% of the Tents are empty
Again pure fabrication. Naturally, its quite difficult to spend two weeks in a tent, especially when you have outside commitments, family, girlfriends etc. But people do spend most of their nights in their tents. The 90% figure has been disowned by the City of London Police and the thermal imaging photos have been shown to be nonsense- for which the protesters are now suing the offending papers via the Press Complaints Commission.

3. Occupy London is an anticapitalist protest.
Going to have to rely on primary research to make this point. Some of the protesters see the problem as being capitalism, but they are definitely the minority. In general, the problem is seen as being 'corporatism' - which is to say enormous institutions that have become not just economically but politically powerful, and have used that power to line their own pockets and the expense of ordinary people. I cannot find the words 'Anti-Capitalist' on

There are many, many more, but I don't have time for them. These are the main ones. Some other things worth observing:

1. How many times have I heard "I am for the right to protest but" - and how often is this 'but' something along the lines of: "in this particular case they should be moved on/cleared out etc etc". Its somewhat hypocritical to claim you are for the right to protest but every time someone does, you are for their being removed/kettled etc!

2. I have never, ever, ever met such a diverse group of interesting people. Almost without exception, the people protesting are eager to learn and to listen - much more than can be said for the people desperately eager to dismiss the protesters without so much as spending half an hour listening to their diverse views, beliefs and aspirations for a more democratic country.

3. They have no specific manifesto. True. But then, the movement has existed for a couple of weeks. Other movements have had decades to build their demands and policy making infrastructure. Occupy London is just building that infrastructure now. What comes out may not be a specific list of demands, but may take the form of a set of proposals, or ideas intended to set the agenda rather than define precisely the exact laws that parliament should pass. But this reflects the facts that above everything else the protesters are democrats- and believe that no small group, even one so well meaning as themselves, should be able to define and dictate laws to the rest of us. Unlike parliamentarians, bankers and naysayers, they are at least consistent in this respect.

Thursday, 20 October 2011

Intergenerational Externalities

This is going to be the opener in a general discussion over the extent to which the younger generation of this country - people born from the 1990s to today in particular- are effectively having an economic war waged on them by the powerful political & economic classes.

I want to make a few observations with regards to a disparity between the rhetoric and the actions of today's politicians.
  1. We hear prominent government politician's say that "Racking up 400m of debt in their [our children's] name every day is not right" And yet one of the proposed solutions to this debt problem is to raise tuition fees which of course is a much more direct way of increasing young people's debt! This obvious contradiction is generally totally ignored and worse still, there's no evidence that fees increases will actually decrease young people's liability for public debt and all the while Britain lags behind the average % of GDP spent on higher education (look at the highlighted columns).
  2. At the same time, the biggest threat to young's people's long term security, far from being debt, is of course, the coming climate catastrophe. The significance and impact of Global Climate change cannot be understated, but in the context of a recession, the issue that constitutes the single biggest threat to young people today is totally forgotten in the political discourse.
  3. Moreover, whilst the depression and/or jobless so-called recovery continue, the political classes in this country continue to obsess over one thing: the deficit. Despite the fact that interest rates have hit record lows according to our own prime minister, the economic focus is still on cutting the deficit! In spite of the mounting evidence that even financial institutions see the current approach as wrong, the government continues to obsess about the deficit and not the real crisis of increasing unemployment. Unsurprisingly, this is a policy that hits young people more than anyone else.
It is no wonder really that young people are becoming ever more angry and frustrated with a system that leaves them ever more marginalised and irrelevant. I wouldn't be surprised if the world over, young people started rejecting these systems and ones like it and searching for something new...

Oh... wait ...maybe ... I ... am ... a ... little behind on this.
(I was going to have a link for every word but I got bored because there were so many).

NB: Note that this post is an attempt to chronicle, rather than elucidate or forecast. (That stuff will come later). Specifically, I want to chronicle the disenfranchisement of young people and my views on it.

Tuesday, 4 October 2011

What is Prices and Values?

Hi, I'm Ravin Thambapillai and this is my blog, Prices and Values.

Prices and Values is of course a pun on a famous Oscar Wilde phrase - that cynics are the people that know the price of everything but the value of nothing. Prices and Values is an attempt to assess, realistically, developments in Economics, Politics and the Technology business world.

Sure, there are a lot of blogs out there on all these issues. And whilst I have some experience in all three (I read economics at Oxford, where I also founded the Oxford International Relations Society and I've also worked at Google for a year) I'm no Nobel Prize Laureate, Harvard Professor or World Famous journalist turned Venture Capitalist.

So why write a Blog?

There are three things I want to achieve with this blog:

1. Chronicle
2. Elucidate
3. Forecast

I want to Chronicle the developments in these fields, my thinking on these developments and where relevant, the academic discussion of the issues. Secondly I want to try to elucidate the developments - ie to interpret them through the lens of models. Interpreting events through a variety of different models means we can then test the validity of these models by making forecasts. This approach should, over time (if carefully maintained), help us determine which model of reality has the best fit. With any luck therefore, this blog should be an educative experience for me!

But obviously, any good blog has to be a discussion. Which means I'll be keen to get feedback, commentary, ideas, advice, criticism and even rebukes! So let the dialogue unfold! :-)