Tuesday, July 15, 2014

Trying To Understand Inflation

Scott Sumner makes the case that economists generally can’t agree on what inflation is, and even when they do, their understanding is at odds with the general population. Let’s explore this a little:

Imagine an economy with one laborer, me, one capital owner, you, two consumers, you and me, and two kinds of goods, apples and oranges. It takes me one hour to produce one apple and one hour to produce one orange. I can only work a maximum of 500 hours in total per year. I get paid one dollar an hour, but you get half of my wages (this makes it easier to introduce a monetary system into this fictional economy rather than having the capital owner retain the product--just assume after production the fruit is co-owned by you and me hence we "buy" it from the coop). Let's start with the price of apples at $1 and the price of oranges at $1. Another way of looking at it is to say the price of an orange is one apple and the price of an apple is one orange.

Fast forward to one year later where apples and oranges begin the year at the same price of $1 each (sticky prices) but then rise to $1.17 for apples and $1.05 for oranges (details how are below), my wage rate is still $1 per hour (sticky wages), but my productivity has increased whereby it only takes me 45 minutes to produce either fruit. In this story how can we meaningfully talk about "inflation"? Prices have risen, but so has productivity. In fact, productivity has potentially increased 33%. And wages are flat for the time being. None of these variables alone really tells the story. John Cochrane might say we’re on to something.

And if a monetary authority (an entity that controls the supply of money such as a central bank) targets "inflation", we start to see big problems. David Beckworth tells it better and more thoroughly than I can.

Picking up on one of Beckworth’s claims, we can see from our hypothetical apples and oranges economy that it will look like the supply of money needs to be loosened when in fact it needs to be tightened to allow total spending in the economy (nominal GDP) to be maintained.

Let's assume in the first year I produce 300 apples and 200 oranges, and then you and I each separately purchase/consume 150 apples and 100 oranges. Total spending in year 1 is $500 (500 fruits at $1 each). 

[here comes the yada, yada, yada...]
In the second year I produce 360 apples and 240 oranges taking just 450 hours to do so thanks to my enhanced productivity which leaves time every day to pretend I'm Rip Van Winkle while on the clock (you'll see below why I would stop working at some point short of maximum output--360 and 240 are somewhat arbitrary numbers). My total wages are $500 still since I'm still getting $1 per hour for 450 hours of labor and 50 hours of napping. You still get half of my wages, but additionally the central bank gives you $100 and me $75 (out of thin air) so as to maintain the monetary authority's desired ~2% inflation target in the face of a 33% rise in productivity* ($175 is about a 35% increase over the $500 monetary base). I have $325 and you have $350. As we attempt to make our purchases of apples and oranges presumably to get at a similar consumption arrangement as before (half of each type of fruit for each of us), we bid up the price of each good somewhat so that the market can clear and in the process we change the consumption arrangement some. Your greater purchasing power allows you to bid up your slightly preferred fruit, apples, a little relative to oranges. The prices settle at $1.17 for apples and $1.05 for oranges (these prices are arbitrary in the example—just one of many ways the math will work out). You walk away with 190 apples and 121 oranges while I get 170 apples and 119 oranges (just one of many possible outcomes). This makes total spending in period 2 $675 [$1.17 x (190+170) + $1.05 x (121+119)].

We can summarize the economic situation: Total spending, "nominal GDP", is up dramatically (35%) while the "real GDP" is only up 20%. The monetary authority wanted only about 2% price inflation but got a 15% level. The economy could potentially be producing 11% more fruit than it is actually producing. The Cantillon Effects of you getting $100 and me only $75 from the central bank may be unrealistic and are not central to the story. I believe there is something to it and it can have distributional effects as it does here (both in the price change and ultimately the quantities of apples and oranges we each get to enjoy). Don’t get lost in this, though; it is not the central theme—rather understand that inflation is a murky subject and policy based on it can have severely adverse consequences.

It was my expectation of the central bank's inflation targeting which led me to shirt instead of producing more--I happened to stop at 360 apples and 240 oranges. The high rate of money supply growth was a negative shock to my purchasing power. I should have seen my $1 per hour going further as the price of apples and oranges came down in nominal-dollar terms, labor-hour terms, and substitute-good terms (apples for oranges and vice versa). If instead of targeting inflation the central-bank targets nominal GDP to rise about 5% such that nominal GDP should be about $525 in year 2, prices will be allowed to fall and my purchasing power because my wages are sticky will be rising; hence I will be incentivized to produce closer to the the economy's full potential. In which case I will be doing a lot less shirking. Year 2 would look more like this: I produce close to 667 total fruit, the money supply increases about 5% rather than 35%, the prices of apples and oranges each fall about 25% (a 33% productivity increase implies a 25% price decrease) but is offset some with the 5% increase in money supply, and the economic distortions are minimized. Happily ever after . . .


*The key here is that the central bank doesn’t completely understand the increase in productivity, and it realistically wouldn’t. In a more realistic, fluid economy what they would see would be falling prices or at least downward price pressure for apples and oranges. Productivity gains would equally be disguised as underemployment (after all, I am napping). The feedback loop keeps telling them to fight deflation—i.e., increase the money supply.

Monday, July 14, 2014

Highly Linkable

America is under attack. Literally thousands of people are invading from our exposed southern flank. We must summon great courage to repel this threatening force of . . . oh, wait. It's children. This is perhaps a tipping point in the clustered calamity that is our xenophobic immigration policy, our lack of coherence in dealing with people in need (you can't cry "amnesty creates moral hazard" when the moral hazard is an economic boon), and our inhumane and uneconomic and tyrannical drug war. Luckily, one Grumpy Old Man is here to provide wisdom.

What's the worst low-carbon energy alternative? The answer, my friend, is blowing in the wind . . .

Russ Roberts and Mike Munger discuss many steps forward, while Megan McArdle laments one step back.

This is a subtle, (should be) obvious, and great point by Art Carden on the minimum wage debate. If you don't get this, you are truly living in economic, ivory tower fantasy land.

Sticking with Art, here is his attempt at Bryan Caplan's challenge to pen how conservatives are often quite authoritarian. Sex, drugs, rock & roll, war, and so much more. Bryan made the case that liberals (more appropriately named progressives) are quite authoritarian. I strongly agree with both, and one thing that stands out to me is how much more blatant conservatives tend to be in their acts of authoritarianism.

Sticking with art of a different sort, Sumner makes two excellent points about the city of Detroit's apparent art wealth--namely that Detroit can dig out some by selling some assets and that it is the reasonable thing we should expect but some find it hard to apply this logic when dealing with a government entity.

Sunday, July 13, 2014

Investing Is Not A Sport

Investing using the sports mindset will leave you saying, "I've made a huge mistake." And it doesn't just take something as colossal as buying real estate in Iraq circa 2002. It is little decisions made all along the way. Examples:
  • Buying a stock and then watching its day-by-day or even minute-by-minute performance. This includes trying to explain every fluctuation in price. Most of what goes on over short periods is random noise. This is actually true of sports as well, but it is part of the allure of sports. However, following your investments' gyrations will lead to poor decision making and potentially heart failure.
  • Falling in love with a stock. You aren't a fan, you're an investor. You're making an educated evaluation of the asset's value. She's a beauty, but don't fall in love. She's one in a million and there are bound to be plenty better. 
  • Thinking that you "obviously" should have purchased some asset that recently had a great run. There is nothing obvious before the fact in investing. That "couldn't miss" real estate deal undoubtedly had tremendous downside risk that just didn't happen to play out. Remember, the reason you're even thinking about it is because it happened to be a winner. "If only I'd had money back circa 2002-03, I would have gobbled up Apple stock." Yeah, Apple's comeback was about as obvious back then as the 2004 Red Sox's comeback against the Yankees in the ALCS right before Big Papi stepped up to the plate in the bottom of the 12th. In hindsight the winning outcome seems logical and likely because it is the winner. We don't have to fully create the narrative as to how it could come to be. Reality has done that for us, but there were many, many other possible outcomes. Often some of these were individually more likely than the actual outcome. 
  • Getting wrapped up in performance rather than process. We choose teams and individuals to root for based on a lot of reasons many of which are based on past performance. But successful past performance in investing means buying yesterday's winners--a strategy that doesn't correlate very well with future investing success. Good investing is about finding a good process. That process should generate future investing success.
  • Talking yourself into taking a lot more risk than you should simply because the risk started small. Remember this amazing lucky break cum colossal mistake? You are never "playing with house money". 
  • As a related point, if you find yourself playing in the equivalent of the championship game, realize that you are mistaken. Investing doesn't work that way. You don't accrue your way into a large reward/low risk situation. Investing is about choosing a risk/reward mix over the long term.
  • Sitting a turbulent/uncertain/rough period out on the sidelines. There are no sidelines in investing. Cash is an asset. The mattress, safe deposit box, and interest-free checking account are all examples of investments--albeit, very poorly performing ones. The game is still going on whether you are playing a highly active role or trying to avoid all volatility. Inflation is constantly trying to eat away at the value of your net worth. And ALL periods are turbulent, uncertain, and rough. 
Perhaps golf offers the closest analogy to investing: your performance is largely independent of others' performances, your choices imply the risk/reward mixture (laying up versus going for the green), there is a cumulative effect between actions, the course you choose to play should be dictated by your abilities and your knowledge of the course will affect your performance, about the best you can hope for is a little better than "par", discipline is more rewarded than ability, etc. But even this analogy runs into strong limitations. Investing is always continuously cumulative. You never get to start a new round or new hole. Knowing how to successfully invest relies more heavily on learned skill than raw ability. 

Sunday, July 6, 2014

Highly Linkable

Terry Anderson is thinking sensibly about climate change. (HT: Don Boudreaux)

Speaking of Don Boudreaux, he has a fantastic new series of videos out as part of MRUniversity's "Everyday Economics" series. I highly recommend these short, extremely well-made videos.

Steve Landsburg points out an amazing physical-world derivation of pi. Here is the full paper. I don't suggest you pull this little nugget out the next time you're gambling, Eddie, gambling money on pool games, but it is pretty cool. Aside from being impressed by this myself, I think it demonstrates something about political economy. It is understandable that because brilliant people can discover truths like this other people believe brilliant people can discover the truths about how to govern other (not-so-brilliant) people's lives.

Two from Megan McArdle: In the first she offers an explanation as to why so many people are saving too little (AKA, building too much personal debt). In the second she talks about the social media frenzy surrounding the Supreme Courts' Hobby Lobby decision and how the calls of BOYCOTT! are very unlikely to actually succeed. This supports a thesis I have had about how the world has changed. To wit: Cults and cult leaders are less likely today while riots are more likely. Negative, tipping-point events can be blown out of portion and escalated more easily today, but they're not as long-lasting and sustainable as they were in the past. In the past information restriction, a critical tool of the cult, was much more easily accomplished. Hence, it is easier to incite a mob, but harder to inspire a movement.

I plan on reading the new book The Frackers: The Outrageous Inside Story of the New Billionaire Wildcatters and this recent EconTalk encouraged my excitement for it. But John Tamny at Forbes raises a few negatively critical points that are worth considering.

Vintage Photos:
Moscow in 1968
Street scenes of NYC in the 60s and 70s
More street scenes of NYC in the 70s
Other color photos of NYC in the 70s
Besides being very cool to look back at these places and people in the past, there is something I notice--more evidence against the Great Stagnation theory. For one we can see some stark differences between life back then and modern life in these cities. The second is a bit more subtle. In the previous era the USSR could appear to compete with the USA economically (e.g., having a large number of cars, the world's biggest X, etc.). In the current era the shortcomings are too obvious. Life today in the USA is filled with so many creature comforts available to so many of us, that in the comparison we rightfully consider Moscow as the capital of a undeveloped economy.

Saturday, July 5, 2014

Communication Breakdown

I have been thinking lately about steps one can take to advance the cause of liberty. Early July is an appropriate time for this type of thinking, but there is never a wrong time. I'm thinking about small steps rather than a stairway to heaven, and it probably has to begin with how we converse with those we seek or should be seeking to win over.

With a nod to Arnold Kling's Three Languages of Politics, most of our efforts to communicate with our ideological adversaries float like a lead balloon. Libertarian arguments often strike conservatives and progressives as poison by reinforcing their respective fears of barbarism and oppression. Allow me to propose some antidotes. Please note that these are antidotes with limitations. The conservative so afflicted as to be a moral crusader and the progressive so burdened as to be against private property are beyond this proposal's reach.

For conservatives the narrative needs to focus on responsibility. We should show how people should be treated as responsible to make decisions for themselves regarding issues like drug use, gambling, and marriage. The responsibility angle already works for conservatives when considering issues like welfare--an able-bodied person should be ultimately responsible for his own well being and individuals should be responsible for charity. We can extend that framework to include other issues. An adult should have the responsibility to decide for himself what chemicals to put in his body, when to engage in games of chance, and who to partner with in marriage.

For progressives the narrative needs to focus on empowerment. We should show how people should be empowered to have more choice in where to send their kids to school, greater flexibility in the terms of their employment, and more options in how to save for retirement. Specifically, we need to show how our favored policy responses will help the most vulnerable.

While these techniques will not work on all issues (at least not in isolation), they may well advance the effort on many important issues.

cross posted at Liberty.me

Wednesday, July 2, 2014

WWCF: 3-D Immersion TV or Live Wallpaper?

Which will come first?

3-D Immersion TV

or

"Live" Wallpaper

Let me start by defining some terms. 3-D immersion TV means a television experience that transcends the current "I am watching something projected before me" to be more "I am in the middle of something occurring around me". I don't know exactly what it would look like other than think of the difference between watching a stage performance of Les Miserables on television versus actually being at the performance seated down front. Now imagine stepping on stage. 

The 3-D immersion experience (3-D I-TV) would have the action truly happening about you rather than just with depth in front of you. Perhaps it would be holographic from a device(s) located on the ceiling and floor. I think it will start with sports and then reality shows with scripted programs in large part to follow. I imagine multiple camera locations/angles such that watching the football game from home will be much like having the best seats in the house where your perspective changes as the action dictates. Imagine multiple Skycams where perhaps you choose your vantage point following the action as best suits you. There would be little worry about an important part of the play going out of screenshot--just turn your head, and you can watch the quarterback getting late-hit as the ball sails down field. 

As for "live" wallpaper (Live-Walls), this is a combination of two ideas I've had for a very long time. When I was young, I dreamed of a spherical room you could step into and suddenly be looking at a 360' x 360' view of some impressive landscape like the Grand Canyon. The camera system driving this video would be mounted on a tall, thin tower. Holding onto this dream, I was then influenced from the early Web's webcams. Molding my concept into a more practical form, I now want walls that will project whatever desirable vista I would like to surround myself with: the beach in Hawaii, Broadway in NYC, the Champs-Élysées, etc. 

Imagine what this technology does for the elderly trapped in their hospital/nursing home/prisons. Imagine how this can transform schools. Imagine how much more enjoyable your current, drab office would be. Sure this will put Big Picture Frame out of business, but the rest of us will be Soarin' Over California from our living rooms. 

The limiting factor for 3-D I-TV is probably technological, but we are getting closer and closer to holograms. The limiting factor for Live-Walls is probably more economical related to the business plan--getting to a critical mass to make the investment using existing technology worthwhile (e.g., using just flat-screen HDTVs). The ultimate desire to have entire walls that act as video screens puts technology as an additional hurdle for Live-Walls. 

I think the critical point for which has come first will be once one of these technologies is common in middle-class homes. The first may seem to face more obstacles, but this might be what "saves" TV. Imagine shopping from your home in a 3-D environment. Imagine the demand for sports and hence sports advertising. The business case for 3-D I-TV may drive its advancement. Of course there is a third possibility: that these two ideas converge in one large step toward Nozick's Experience Machine.

My guess is Live-Walls is coming first and will be within the next 10 years. 3-D I-TV follows within 5 years of Live-Walls' critical mass achievement.

Tuesday, July 1, 2014

What's On My DVR And On My Netflix List:

I've made a lot of progress against the ever-rising tide of television programming that beckons, but so much more work remains to be done.

If you remember from my previous post, I was ranking the comedic shows I was watching. Not much changed in the rankings as this past season progressed. "HIMYM" disappointingly but expectantly continued its slumping trend right up to the bitter end. I was an early predictor that the mother was dead. I was wrong about Ted and Robin getting together for good. I was right that it was evident the skill of the writers had run out preventing them from pulling off that ending.

On a bright note Jeff Winger did indeed right the ship of "Community"--another prediction I nailed. I think this show is basically back to original form even with the cast changes. That is an impressive feat.

"New Girl" is still probably my top show. I am equally impressed at how this show is integrating new characters.

"Louie" is amazing. This show is arguably one of the best dramas on TV as well as best comedies. Charles Grodin's appearances are apropos the quality of this show. This scene in particular was great writing--"Misery is wasted on the miserable".

Now, to the point of the post. My current to-watch list includes in no particular order:

  • "Comedians in Cars Getting Coffee" - I could watch these conversations go on for hours. Each episode is too short.
  • "The Middle" - Kept passing by this one. Need a marathon to catch up.
  • "The Simpsons" & "Family Guy" & "Futurama"- I list these together since I have to watch them on my own sans wife. 
  • "The Americans" - Still on the list. Still not started.
  • "The Goldbergs
  • "Breaking Bad" - If nothing else, doing it to keep up with the rest of society.
  • "House of Cards" - Ditto
  • "Mad Men" - Going back to fill in the gaps in my viewership. 
Notably off the list is "Downton Abbey". Remember, I found religion (seventh item down).