Thursday, April 26, 2012

Economic Theory and Durable Goods

Sexy title, no?

A strict consumable good is one that will be consumed (used up) in this period. A durable is something that will last many periods, although you can think of a fraction of it being used up per period. So a new roof is a durable, you'll need to replace it again in 30 years, but 15 years from now you will not have half a roof, you will just have a roof with 15 years left of life.

Megan's blog runs the standard story on durables:
Normal economics has two pieces of advice about how to buy consumer durables:
1.  Buy them when interest rates are low (cheaper to borrow the money; and you weren't going to earn anything at the bank anyway).  
2.  Don't buy them when your income takes a one-time hit (if the 'crops' have been bad the last few years--like they've been since the Great Recession--it's best to focus on buying things that get used up: food, haircuts, doctor visits; you can keep driving the Corolla). 
Recessions are times when 1 and 2 usually push in opposite directions, but in practice 2 wins the battle: Durable purchases collapse in a recession
 Well, yes and no.

The main durable in the household sector is housing. The price of housing is very much determined by the price of financing -- when financing is cheap housing prices go up, and when financing is expensive, housing prices go down. In other words, housing is an asset for which the levered and unlevered prices are very different.

Therefore, housing, a durable, is a terrible thing to buy when interest rates are low because that means financing is cheap and therefore housing will be expensive. Better to buy a house with a high interest rate loan, for a lower price, and then refinance into lower interest rate loans when rates fall.

But, people buy when money is cheap. If Monetarists want a mechanism by which interest rates impact the economy, this would be it. Low interest rates encourage consumer spending via horizontal credit expansion beacause they use the money to buy housing. That increase in AD then brings the economy into full employment.

However, when the fall in AD is caused by over-consumption of housing due to cheap money, offering more cheap money to buy those assets at their fully leveraged priced is truly pushing on a string. Even more than ZIRP.

Monday, April 16, 2012

Facebook vs Google

It's tough to know what goes on inside of companies. In general, they are much more random, chaotic, and yes, even stupid than thoughts. When you have a lot of people with partial knowledge in a political culture, stuff happens, often for no good reason. So, while I don't agree with what ReadWriteWeb has to say about Facebook vs Google, my own guess is likely wrong as well. Here's RWW:
All that profile information you've filled out over the years on Facebook? That's not just there for your friends and colleagues to see, or for self-expression. Facebook is also able to use much of it to target the advertising you see on Facebook. (And, eventually, potentially all over the Web, the way Google does.) 
Would you rather know who someone is, or what they are interested in right now? If I were starting a business from scratch, I'd much rather have intent than profile information because profile information is what you use to sell something when you don't have intent. It's second best, designed to help in reach, and not the actual moment of closing when the wallet comes out and money moves from A to B.

Brand advertising, disassociated from intent from the inception, has a natural home on Facebook, but I still think Google's ad business is a better one to be in, fundamentally.

I think Google is scared of Facebook because Facebook is successfully competing with the Web, and Google makes money by selling ads on websites, for websites.

Friday, April 06, 2012

Making your nut: MMT is really not Monetarism

A while ago I posted why I thought, contra Interfluidity, that MMT was not monetarism. I stand by this assertion. Interfluidity countered by saying that Sumner (sort of an idiot-savant of the Monetarist school) supported a payroll tax holiday and gave a couple of links in the comments. Here's one.

In actuality, Sumner advocates for an employer side cut after holding his nose and saying it's "far less efficient than monetary stimulus". In my opinion, this is a far cry from the MMT position as a payroll tax holiday immediately as monetary stimulus is a fairy tale, but you can make up your own mind. What's more interesting is the reasoning, which shows why MMT and Monetarism as, in fact, like chalk and cheese.

Monetarist believe that the Fed can control the price level (really -- "The Fed controls the price level") although the mechanism they use for this, controlling the quantity of reserves, has no way to enter the real economy because reserves are used to payment settlement, and bank lending is not reserve constrained.

So, why do Monetarists believe an employer side payroll tax holiday will be helpful at all?
For very complicated reasons it is hard to directly cut the nominal wages of workers. But you can cut the nominal labor costs to companies very easily—just reduce payroll taxes. Now that the Keynesian fiscal stimulus has not worked, the Obama team is looking at new ideas. They are rediscovering the merits of sticky-wage theories of the business cycle, which I am one of the few economists to still adhere to
"Sticky wage theories of the business cycle" means that, since employees will not accept nominal wage cuts, in deflationary environments where real prices are falling, sticky nominal wages means that the real marginal cost of labor goes up, and employers can only respond by firing people -- hence unemployment.

It's true that nominal wages are sticky downwards, but employers fire people when sales fall because demand is not there. There's a straightforward story for why nominal wages are sticky downwards, and it should be obvious to anyone who has taken out a loan -- debt (and interest) is nominal. People carrying debt have to make a nominal nut every month.

If you have a loan which requires a payment every period, that loan balance and monthly nut is nominal, and will not change. In a deflationary environment, the real burden of nominal debt grows, which is what triggers defaults. When loans default, banks write down capital, which constrains their ability to extend further credit as bank lending is capital constrained (not reserve constrained, as Monetarists believe). As credit contracts, prices fall further, as assets that are traditionally bought on margin have a different cash price and leveraged price. Houses would cost less if mortgages were outlawed.

This is the "debt deflation" spiral and Monetarists miss it because they don't, ironically, have debt in their models. The ignore it by thinking it's just a transfer. As MMT gets bank lending right, it understands the horizontal component of money, and thus avoids this mistake.

Monday, April 02, 2012

Keen vs Krugman

In general, I'm not a fan of Steve Keen's work for two reasons:

1. He ignores the vertical component of money which, I think, is important and also necessary in understanding the monetary system.
2. I find his computer models a needlessly complicated way to do something that (to me) is simpler with basic double entry book keeping and t-tables.

However, in his back-and-forth with Paul Krugman, Keen is absolutely right. Paul says
If I decide to cut back on my spending and stash the funds in a bank, which lends them out to someone else, this doesn’t have to represent a net increase in demand.
This used to be my model of banking as well -- what does it matter if people save more by putting more money in the bank? That just gives banks more money to lend out, right? Wrong. Academic macroeconomics does not understand how banks work. Loans create deposits. Bank lending is not reserve constrained.