Wednesday, 31 August 2011

The expansionary effects of balanced budget increases in expenditure

I saw an article by Robert Shiller in the NYT in July: "How to make the case for a new stimulus" and was reminded of this by another article by Shiller that I saw yesterday.

The mechanism relies on expenditures all being on consumption or investment, but matched taxes coming from a mixture of consumption and savings. The higher the proportion that comes from savings, the higher the boost to national income, and that's before multiplier effects.

Go back to my previous post but now add in private savings (firms still own all capital and produce all the output, so that gross profits, P = Y - W, and it's firms that make investments in capital stock K) so:

P = Sf + d = Y - W = C + G + I - W = W + d - Sa - T + G + I - W
i.e. Y = d + W + I + G - T - Sa

(the only difference now is that savings by firms are labelled Sf and savings by agents are labelled Sa). Therefore, assuming wages, dividends, investment all constant in short run, and assuming that raising T by 1 lowers Sa by 0.5 (i.e. 50% of taxes raised come from income that would otherwise have been saved), then raising government expenditure and taxes by same amount (i.e. balance budget expansion in government expenditure) would raise national income by 50% of the increase in the government budget. This would then be subject to multiplier effects since wages, dividends and investment are not constant in the slightly longer run.

Obviously fully deficit financed expansion in government expenditure would be even more expansionary (100% of the increase rather than 50% as above). Ideally you'd set tax rates and expenditure such the goverment was running a small surplus at full employment, so that it could afford to engage in this counter-cyclical policy during downturns. Also, just need debt levels not to grow as a percentage of GDP over the cycle - you don't need to balance the budget in pounds and pence over the cycle if there's economic growth.

However, maybe there won't be economic growth in future?

Monday, 29 August 2011

The evolutionary roots of the morals of 1001 Nights

Went to see 1001 Nights at the Festival last week. Excellent. The main theme though seems to be sexual jealousy from husband towards apparently adulterous wives. The moral message from some of the stories is that it's OK to brutally murder such a wife, but make sure you have your facts correct first!

With honour killings, Sharia law, and, maybe to a lesser extent, everyday attitudes, this moral code clearly persists. Why? A simple model of investment costs towards the next generation might explain this:

Suppose both parents invest the same (in terms of effort, resources etc) in the children that they bring up within the family unit that they live in. Clearly, pre-birth, men and women both have an incentive to seek the highest quality genes in their partner, but the costs of infidelity at this point are perhaps assymmetric.

The evolutionary cost to women of male infidelity is that the man chooses to live with someone else and make this investment elsewhere. The infidelity may change the ex-ante probability of the man choosing another partner, but despite the infidelity there is still some probabilty that there will be zero cost to to woman (i.e. the man stays).

The evolutionary cost to men of female infidelity is that the child is not theirs. Their investment will therefore be, from the point of view of their own genes, wasted. There is no probability one way or the other (there may be uncertainty that looks like a probability distribution, but the die has already been cast). Women never have a reason to doubt where to make their investment since they always have proof that the child is theirs.

It may be (game theory's not my game so I'm not going to attempt to construct a full model of this strategic interaction) that the evolutionary costs of female infidelity to men are higher than the evolutionary costs of male infidelity to women, and if so then maybe there's a biological basis for the moral code expressed in 1001 Nights.

This could be sorted in these modern times by genetic testing and putting the biological father on the birth certificate. This is perhaps not the best social policy from a child-centred point of view and maybe feels wrong from some sense of fundamental morals. But morals are not fundamental: they have a biological basis that is embedded in a cultural framework. Choosing social policy on a child-centred basis is not playing evolution's game: if we want to change morality so that sexual jealousy and sexual violence are less of a problem then we need to change the evolutionary biological incentives.

Joseph Stiglitz on New Directions For Economics

I enjoyed the Joseph Stiglitz lecture at Lindau. He presented two main areas as a research agenda in macroeconomics: networks and contagion; and structural transformations in the economy.

I'm very interested in possible structural transformations, but it seems Stiglitz has in mind productivity improvements in one sector exceeding growth in demand and causing an economy wide slump as labour gets trapped in the declining sector. The example is agricultural productivity improvements prior to the great depression only sorting itself once this surplus labour had managed to move to manufacturing.

The hypothesis is perhaps this is happening now and we are seeing manufacturing productivity gains outstripping demand, and causing a slump that will be righted only once enough formerly manufacturing labour has made its way to services.

This doesn't seem right to me and I'm concentrating on the structural transformation implied by a reduction in the energy flux to the economy. Stiglitz's idea and model will be worth keeping in mind and/or following up though.

Saturday, 20 August 2011

Corporate savings are the inverse of government deficits: implications

At the moment both government deficits and corporate savings are high. It is non-obvious but there is a close relationship between these quantities:

Let corporate profits, P = corporate savings, S + dividends, d
These profits are generated by paying wages to the labour force, W, using the capital stock owned by the corporate sector, K, and producing the economic output of the economy, Y i.e. P = Y - W
Households income is wages, W + dividends, d, less taxes, T, and is spent entirely on consumption, C (i.e. we assume all saving is done by the corporate sector).
The government raises taxes, T and buys government purchases, G from the corporate sector, running a deficit, D = G - T.
The corporate sector can also 'buy' some output from themselves to augment the capital stock, i.e. investment, I is used to increase K.

These relationships can be combined:

P = S + d = Y - W = C + G + I - W = W + d - T + G + I - W = d + D + I
i.e. S = D + I

Therefore, corporate savings is, under some assumptions, equal to government deficits + corporate investment. So when we see corporate savings as the mirror image of government deficits then all we're really seeing is constant (and very low) corporate investment.

This is just accounting, so there's no consideration of incentives or causality here. A freshwater/conservative reading of the current situation might be something like: we take corporate savings as given and governments choose the level of deficit that they run. Therefore government deficits cause the lack of corporate investment by providing an alternative home for these savings.

My reading of the situation is more like, governments choose the level of their spending, G, and they choose the tax rate - but the level of economic activity ultimately determines the tax revenue, T and so deficit, D is endogenous. Expectations of demand determine corporate investment I. Therefore low demand expectations means low investment and is strongly suggestive of low tax take and so high deficits. Corporate savings is still the sum of D and I, but these are driven in opposite directions by demand expectations. If larger government spending now was such that demand expectations were boosted to a level that raised investment, then any inertia in corporate savings would require that the deficit was actually reduced by the increased government spending. Chris Dillow has a post on this too: I don't completely agree with his take on Labour's fiscal policies during the 00's since, given global imbalances it must have been possible to realise that government revenues from the financial sector were not sustainable. If this income had been spent on capital investment rather than revenue spending then his argument is fine though.

Of course it could be that there is no inertia in corporate savings, and so the increase in investment could be accompanied by an increase in corporate savings. This could be achieved by a reduction in dividends - probably reducing tax take and increasing the deficit - and so a reduction in private consumption i.e. higher government consumption merely crowds out private consumption. However, this implies that an economy with unemployed resources chooses to meet an increase in demand from the government by reducing private demand. Quite possible that unemployed resources are used to meet the increase in demand which would allow investment to increase without corporate savings increasing, requiring that the deficit falls.

Again, if we want the investment, required to mitigate resource constraints and climate change, to actually be made, we need to ensure demand is maintained. 

Monday, 15 August 2011

Statement of Investment Principles

Idea: get pension fund trustees to explicitly state their investment views on savings that fund consumption now (and in return you get an IOU which says that the consumer will pay you back essentially from future growth), against savings that fund investment now - and actually generate the productive infrastructure for that future growth.

It should be possible for people to invest their pensions in e.g. solar panels, rather putting money into the stock market where corporations are supposedly already sitting on a huge cash pile that they don't know what to do with. Especially at the moment when attitudes must be fairly dead set against such investment ("some of that investment will be in the big bad banks wooooo")

Basically interested in generalising something like this to pre-retirement savings as well as lump sum cash.

Tuesday, 9 August 2011


The media coverage of the S&P downgrade was utterly dreadful. Markets did not fall on fears over US debt. If they had then the price of this debt would have fallen. It rose. Instead markets fell because the S&P downgrade makes the political case for more austerity seem stronger (hand in hand with the dreadful media coverage), this makes expected growth (even) lower which hits stock markets and makes government debt seem like a good investment.

The best commentary on the subject can be found at:
Exactly, exactly & exactly.

Thursday, 4 August 2011

A semantic dispute about the reasons behind the financial crisis?

Steve Randy Waldman provides a convincing explanation of how bank and sovereign behaviour interacted to cause the financial crisis. But he seems to be writing this as a critique of Tyler Cowan's theory that the crisis was caused by the “we thought we were wealthier than we were” mechanism. I think perhaps this could be resolved simply by accepting that Waldman's story is what lead to aggregate behaviour that was equivalent to "us" (or to our "representative agent") behaving as if we thought we were wealthier than we actually were. See also Chris Dillow .

My view is that there was a lot of (effective) "we thought we were wealthier than we were" behaviour over the 00's - for whatever reason. This imagined wealth increase lead to households making a portfolio rebalancing decision to lever up against this higher value for our assets (houses), and so to collectively borrow to consume. The financial crisis was caused when commodity supply constraints (a small supply shock) lead to price pressures (eventually $140 oil) which lead to an effective re-evaluation of our wealth and a consequent massive retrenchment (large demand shock). The appropriate policy now is Keynesian demand creation, as per Krugman, to maintain employment and allow households to repair their balance sheets. This provides a tremendous opportunity for public direction of investment whilst the state is taking up the slack and it should be 100% piled into energy investments since that relatively small supply constraint is only going to grow.

Austerity is completely the wrong response.