Wrap Up for October 2022

Three takeaways from the UK market meltdown.

Some observations on David Ricardo's letters.

Fiscal dominance, or financial dominance?

Considering the downsides of divisions of labour.

An explanation how QE communication broke down at the BoE.

Tim Harford explains what we keep getting wrong about inflation.

Roger Farmer reflects on the life of Axel Leijonhufvud.

How can the U.S. economy be worse and better at the same time?

NGDP would be a simpler way to do monetary policy.

When it comes to cutting the costs of expensive skill sets, some cutbacks are more dangerous than others.

This year's Nobel explains why banks exist in their present form.

Edible cities are planting fruit trees and vegetable gardens in their public places.

What if the Fed hasn't even tightened yet?

Scott Sumner reflects on Slouching Towards Utopia.

Ordinary workers hold little importance in the health and progress of today's economy.

Michael Mandel discusses productivity (and more) with James Pethokoukis.

The Fed's battle with inflation is far from over.

Where Britain led the U.S. is likely to follow.

Michael Spence notes a changing global equilibrium.

"We can't afford the state we want and voters don't want the alternative."

Some takeaways from the September CPI report.

Perhaps the Fed's FAIT framework could be salvaged.

Greg Mankiw thinks the fed might be overdoing monetary tightening.

"Classical liberalism vs. the New Right"

Many medications were reclassified as OTC because of the wealth of information consumers now have at their fingertips.

American debt-ceiling standoffs may become more risky now.

Wages have risen at the bottom in the last decade.

Some economics history book ideas for the holidays.

Noah Smith feels that a "critical point has been reached." And, Chris Blattman is worried about the chances of WWIII with China.

The global natural interest rate may have fallen from 1.9 percentage points between 1985 and 2015. Plus, it's the least tangible capital that tend to the lowest productivity levels.

Hospital policies should also "do no harm".

In some respects political violence is all too familiar.

Might Good Deflation Counter Excess Monetary Demand?

What makes good deflation so desirable? It all starts when increased output is possible with fewer resources overall. Once price reductions per unit come into play, they in turn lead to real wage gains and higher productivity levels. I believe that good deflation could become a services sector response to counteract high inflation and rising interest rates. Given the many positives of good deflation, what accounts for such resistance to its potential in housing and time based services?

Even though both areas must deal with the natural scarcities of time and place, much of the bias against good deflation potential is inadvertent and political in nature. Not only are such biases protectionist, they discourage adaptive evolution in time and place based product - evolution which could otherwise augment their capacity despite their natural limitations. While time based skill and land as real estate are certainly not exponential in nature, they could still add additional output through flexible coordination of knowledge and land use potential.

Bias characteristics also differ depending on the markets and sectors in question. For instance, progressives and conservatives increasingly prefer a restoration of local manufacturing over global free trade. Fortunately - even though this anti free market bias will increase manufacturing costs to some degree - globalized manufacture should continue benefiting nations in the foreseeable future. At the very least, it's reasonable to expect good deflation to ultimately be restored in global markets. Once tradable sector resource access is more stable and predictable, it should become more cost effective as well.  

Societies are fortunate indeed, that tradable sector activity is often managed for full production efficiencies. Still, during times of high inflation, we're reminded of the dangers of taking good deflation in tradable sectors for granted. Indeed, relying on the serendipity of long term good deflation (along with the more recent low inflation pattern) made it easy to disregard the long term inefficiencies of non tradable sectors. These inefficiencies remain in place due to countless quality requirements, many of which have been exacerbated by government subsidies. 

Recall however, that these requirements end up as ever more inputs in relation to aggregate output. Even when quality gains are worth additional costs for some, other groups suffer efficiency losses which in turn require additional personal labour for non discretionary needs. Consequently when it comes to quality of life, some income groups are actually moving backwards. Again, constant calls for higher wages occur because lower income groups need to work more hours than is sometimes feasible to meet their financial responsibilities.

Fortunately there are already better production methods which could establish disinflation in housing - methods which could eventually lead to good deflation as well. Just the same, a considerable amount of social and political bias has prevented the majority of flexible housing options. In this restrictive environment, progressives tend to focus on time based constraints for meeting financial obligations. Whereas conservatives are more concerned about place based constraints, such as immigrants who are seen as competing for already scarce housing. 

Despite the protectionism that stands in the way of production reform, housing is still a simpler issue to solve than markets based on time and personal skill. Hence countering excess monetary demand could begin with more flexible interpretations of housing for all income levels. Otherwise, many individuals will remain subject to the first mover problem of providing valuable services for others by more accessible means, only to be locked out of the housing necessary for this to happen. For that matter, one of the main reasons wages recently increased for the lowest income levels, is that employers were faced with the fact no housing existed nearby which their employees could afford. 

Societies need to focus on non tradable sector production issues, since they are at the heart of recent inflation which is proving difficult to eradicate. However, there's something else important about productivity expectations which needs to be noted here. When productivity involves final product which is independent of personal labour, these areas do have capacity for exponential output. Since our economic time is not exponential, it often demands a higher price as a fixed quantity. In these instances, people rely on investments in knowledge and skill to increase their time value. Alas, institutions then tend to respond by substituting away from time based input, in order to meet their financial obligations! Despite the obvious drawbacks of this effect, our current understanding of productivity gains makes it a rational approach, especially if institutional budgets are already in jeopardy. 

How, then, could good deflation be achieved in skills use without having to substitute away from time based input? One way is to make mutual time commitments, or time arbitrage, a valid and measurable economic unit. Skill sets would be voluntarily chosen and independent of monetary value. However, group effort would also utilize monetary compensation as a base to keep the process in motion. Time arbitrage might help societies maintain and preserve what they build and create, plus the knowledge and skills involved would be simultaneously measured as cumulative gains. Time as an economic unit of value is also one way to overcome the Baumol effect and ultimately, achieve good deflation in time based services. Again, production gains would transpire on completely different terms in these settings. Once housing production reform begins in earnest, economic validity for mutual time commitments would be the logical next step.

Use Markets to Help the Marginalized (Before It's Too Late)

In a time of rising inflation and interest rates, governments have to come to terms not only with fiscal limitations, but also limits on their ability to assist the marginalized - at least through monetary means. As national budgets become ever more unwieldy, many protective roles for lower income groups might ultimately have to be set aside.

Some would argue, isn't this a positive, since governmental support often tends to cause more harm than good? It depends on whether the domestic markets of housing and services can evolve for a full range of income levels. In the meantime, consider the harsh realities faced by low income groups when it comes to living normal lives. These circumstance are largely due to environments which were put in place by public and private interests alike. As governments increasingly find their hands tied in terms of public assistance, will private sectors become more willing to live up to promises about free market potential? Or will private interests - along with the political left and right - instead pretend that economic and social freedoms are no longer possible?

Questions such as this are in need of valid answers, not vague posturing and excuses. In particular, when people struggle to maintain their financial responsibilities, they become ever more vulnerable to government overreach. It has seldom been difficult to correlate poorly functioning markets with authoritative and restrictive governments. Worse, it's as if societies have forgotten what market freedoms consist of. For one thing, inclusive markets are certainly not a matter of coercing lower prices from existing markets. Rather, market freedoms are about encouraging the design of new patterns and production systems which function alongside what already exists, but with simpler resource requirements and system inputs. Indeed, previously existing markets could in many instances just be recognized as market participants with preferences for serving higher income levels, for whatever reasons. 

When I think about production reform possibilities which have yet to see the light of day, sometimes I can't help but be angry such options never got the chance. If there had been good deflation in our domestic markets here in the U.S. we could have been better prepared for the extreme uncertainties of a transitioning global economy. In the past nine and a half years of this blog I've often highlighted people who've touched on these issues. Just the same, it's not easy to find individuals who are willing to commit to adaptive market evolution. Meanwhile I often find myself unable to tolerate the hypocrisy of left and right thinkers who always pretend someone else bears responsibility for what we've lost.

Instead of being cognizant of their own responsibility for free market evolution, many libertarians have stepped away from adaptive market patterns to take part in cultural battles. Small wonder that few really expect this to change anytime soon. Is it already too late to use markets to help the marginalized? Will libertarians stay focused on divisive rows and/or inconsequential details in the years to come? Why and how did we imagine libertarianism to have a ghost of a chance, if it was only about free markets for society's most powerful? As much as I wish for a better ending to this unfolding reality, alas, there are days I fear there might not be one. 

"Political" Equilibrium is Not the Same as Natural Equilibrium

When might politically motivated budgets create too much confusion for general equilibrium conditions? Even though there's no clear answer, economic dynamism and long term growth potential may depend on how these matters are ultimately approached. It's now apparent that the fiscal dominance of today's service centered economies, could hinder progress in the near future.

Until recently, ultra-low interest rates were becoming taken for granted as inevitable. And not only did this prompt national governments to borrow in excess of earlier norms, it discouraged a rational general equilibrium framing as output driven. This loss of a quantitative understanding, has made it even more difficult to create productivity improvements in domestic markets. Instead, the fiscal "freedoms" of late are fueling the ambitions of multiple political parties. Alas, the results aren't encouraging, since fiscal policies tend to reward specific group preferences instead of positive market outcomes.

However, does fiscal irresponsibility account for a rising equilibrium rate, and might this impact equilibrium stability? Scott Sumner considers equilibrium effects, and notes: 

The "natural" or equilibrium interest rate also has multiple meanings, but generally refers to the interest rate that provides for some sort of macroeconomics equilibrium, such as stable prices. Throughout most of the world, the equilibrium interest rate has been trending lower since the early 1980s. Until now...

He continues:

A more complete model of the equilibrium interest rate might also account for the political economy of fiscal policy. Suppose that the natural interest rate falls so low that politicians become tempted to run larger budget deficits. Eventually, the deficits become so large that the equilibrium interest rate begins rising again. 

In retrospect, the new UK Prime Minister also went too far with the extensive tax cuts of her fiscal package.

All of this makes me wonder whether ultra-low interest rates are not a stable equilibrium, at least in most places. I still believe that low rates are a technically feasible equilibrium, but perhaps it is inevitable that politicians in many countries will abuse the privilege of almost costless borrowing - right up to the point where that privilege is removed.

Indeed, the Washington Post notes the new Prime Minister's predicament and adds

Across the supposedly advanced economies, the return of inflation has magnified the riskiness of extravagant political gestures. For the most part, however, politicians have not gotten the message.

How to think about all this? For one thing, I'm inclined to believe that fiscal policy (rather than monetary and supply side circumstance) would not be responsible for a rising natural interest rate, whether or not a government "crosses the line" in this regard. Especially since fiscal policy correlates with credit dominant outcomes which substantially differ from the time correlated aggregate output of natural equilibrium. 

In terms of aggregate output potential, total hours worked are an important part of the equation. Specifically, when considering equilibrium potential, one might ask: How much aggregate output is defined by exponential representation, versus the linear representation of (naturally scarce) time and place dominated output? Especially since fiscal dominance could eventually be undermined by expectations in the secondary markets of applied knowledge. And if service sector output doesn't presently appear linear, it's because areas of exponential gain are not being adequately defined in relation to the scarce resources of time and place defined product. In all of this, the fiscal dominance of political equilibrium is not well suited for the creation of a better defined and stable general equilibrium.