Wednesday, February 15, 2012

For Friday, 2.17 (and my own weekly post)

We'll be meeting again in room 041 to start research on our papers. Don't worry about bringing a rough draft for this week. We'll do peer editing next week after people have had some more time to conduct some research.

Thanks for the fun discussion today. After thinking about the two topics in tandem, it occurred to me that monetary policy--see here for more information on what Japan did today--is also a good example of framing bias in action: using phrases like "printing money" or "inflating the money supply" sends people from all over the political spectrum into a tizzy. Marxists see an attempt by the central bank to pump money into the hands of rich people without creating any jobs (see here and here); a certain strain of libertarian sees the government trying to steal the hard earned dollars of savers (see here and here).

However, in other contexts, the very same Marxists, as well as a different stripe of libertarian, are perfectly willing to see increasing aggregate demand as the solution to recessions caused by declines in spending. So while these individuals may be all against "printing money" and will decry the tyranny of the Federal Reserve--either for stealing wealth or for concentrating it in the hands of the rich--they are all for increasing aggregate demand. (By the way, the Fed does not actually print money, but rather uses open market operations to increase the money supply by purchasing government bonds, which are credited instantly and electronically to the bank account of the seller--doing it this way ensures the Fed is not just creating money recklessly as they now have an asset, and they can sell those same bonds in the future and withdraw the same money from circulation when the time comes).

The problem is that in a monetary economy--that is, in all modern advanced economies--these are one and the same thing. Increasing the money supply is how the level of aggregate demand adjusts.

Indeed, the very scary prospect of "printing money" is at the same time the rather dry and straightforward concept of controlling demand to produce full employment. This is symbolized by Y* in the graph below, the point after which more demand produces higher prices rather than more output because the economy simply can't produce more goods--thus additional demand just bids up the price of the current supply. (Think of it this way: Let's say there's a town where everyone is working half as hard as they woud like to be working. Businesses are only doing half the business they could be doing. Factories are only producing half the products they could be making. One day, a bunch of rich people from out of town moves in and starts buying more things. Suddenly everyone is working as much as they can. Factories are producing as much as they can. Restaurants are filled at all hours of the day. But then suddenly more rich people move in and start spending money. Until new factories and new businesses open up (which does not happen overnight), all that extra spending will do is drive up the prices of current output as more rich people compete for the same number of things--tables at restaurants, goods produced by factories, labor for their homes, etc.)

Right now almost everyone is for more aggregate demand (although they may disagree over why there is a shortfall); and yet many people who consider themselves mainstream and possessed of sensible and temperate views on economics are publicly falling into dyspeptic rages denouncing the madmen at the Fed. 

As one economist has pointed out, something about money just drives people batty. Ultimately, perhaps it is Marx who best explains why this is: even when it is in the form of gold, money somehow symbolizes the great trust that we have to put in our fellow humans in a complex modern society with an intricate economic system. This makes radical individualist types nervous. On the other hand, just as for some it symbolizes the inherently social nature of value--Robinson Crusoe found that money was useless on his island--it also symbolizes the seemingly unfortunate need to alienate and reify this underlying social cooperation in the form of a financial instrument--something that makes radical communitarian types nervous. 

But money is necessary because some general store of value is necessary for the economy--otherwise, we fall back into the inefficiencies of a barter economy. Indeed, Barter is so inefficient that some have even challenged the notion that there was a stage of human development before money, claiming instead that bartering never existed on a mass scale--people may fall into barter during certain times of economic necessity like hyperinflation or in places like prison, but it's never been widespread according to this view (and indeed, even in such circumstances a money-like object will often come into existence--think of the role of cigarettes in films about prison). 

As for the evolution of the monetary system itself, both Marxist and libertarians are often convinced that the Federal Reserve is some evil plot on the part of a shadowy, plutocratic elite. However, it turns out that there are good reasons why we first developed gold as the primary form of money and then moved on past it, and they are anything but conspiratorial. Rather, it is chemistry and basic macroeconomics that explains this evolution. Money has to be stable, compact and solid, and rare in order to serve its social function as a store of value, a medium of exchange, and a unit of account--if it quickly degenerated, was too bulky or heavy, or was extremely common, it would be difficult to carry about or to control the supply and thus fix its value. Most elements are either unstable, bulky, or hard to handle (in some cases because they are gases), even some modern precious metals like platinum have such high melting points that they are difficult to refine. So gold became money (for more on this, check out this podcast). This was a fine arrangement as long as the gold supply was expanding at a quick enough rate to support economic development. Once that stopped being the case, gold was no longer convenient. For an economy in which output was expanding at a faster rate than gold to remain on the gold standard, the price of everything at once would have to fall. The problem is that this is difficult for an economy. So instead of this happening, some prices fall, while there is just less demand for other things, leading to reduced output and unemployment. 

To counteract this problem, we just invented our own synthetic money--people were used to the government issuing certificates for gold, so why not just have them issue certificates that were very elaborate and hard to copy. These certificates met the same requirements as gold itself. They were stable and compact, but most importantly, the exact scarcity of these things could be controlled so that prices for stuff keep rising at a minimal but steady rate. This avoids periods of deflation and the recessions related thereto. Of course, then we have to trust the government not to make too much of the stuff. But even under the gold standard, we had to trust the government when it said that it had gold in its vaults. We have to trust the government to keep the price of gold stable. Indeed, in a manner of speaking we might think of this as a form of government intervention into the market--the ideal price system lets the cost of everything fluctuate rather than fixing the cost of some items. Again, this is framing bias in action: most libertarians would vociferously denounce a government plan to set the price of milk, and yet some trust the government to set the price of gold! 

So if we are going to have to trust the government no matter what currency system we adopt, shouldn't we at least pick the system that allows markets to operate freely and efficiently while avoiding periodic severe depressions? Under a gold standard--or a milk standard, or a gasoline standard, or a platinum standard, or a college tuition standard, or a yoga lessons standard, or any standard in which the government guarantees the value of money in terms of one particular good or service--we not only have to trust the government to keep enough gold around, but we still have to trust them not to print too much money relative to the amount of gold they are holding. Is having to trust the government to do two things instead of just one really worth a less efficient price system and the threat of depressions? Once again it's the problem of framing bias: everyone wants full employment and everyone wants stable prices. And while a gold standard sounds like the best way to do this, and while inflation targeting sounds like a terrible way to do this, it is really only with the advent of the latter system that we have been able to maintain stable prices and full employment for any significant period of time



    Here's a brief explanation of Steve Miller's entrepreneurial endeavors. In general it seems leftist to me to leave things up to the government and right-winged to take things in to your own hands. This program exists because its education is of a higher quality than the surrounding public schools. The charity aspect makes it appeal to the left, but the innovative, competitive business model just screams Stossel to me.
    I think it's a good mix between the two, like the charity in Denver I mentioned in class.
    Step Thirteen -

  2. Great links, both of which show the problem of public goods--things that everyone benefits from but which it is hard to make everyone pay for since you cannot exclude them from those benefits. Everyone benefits from an educated population, and from safer streets, but it's hard to get each person to pay for it because others will just be excluded. Education and charity care are good examples.

    One good example is the homeless: it turns out that just giving them homes, as opposed to seeing it as some social problem, makes economic sense. This prevents costs that affect everyone, so someone just needs to step up and pay for their care.

    Here are examples: