Daily Archives: April 6, 2012
A gut wrenchingly embarrassing piece at the Guardian on their work with Getty Image to pick out 10 images which sum up sustainability. Or rather some Getty PR pitched them a free advert disguised as a donation.
It like the end result of na Nathan Barley sketch -
‘ok guys, water saving what do we vissssualise that with.
Nathan – putting up hand – how about a photo of 10 people in a bath.
And another idea, why dont we show like unsustainable development is like taking too big a slice of Quice, if your greedy right, there aint nothing left….well crumbs.
Oh metaphorical high fives Nathan, metaphorical high fives.’
Reserves Don’t Constrain Lending – But cash flow, cost of capital and credit risk does – John Carney
John Carney offers important insights as a former banker on the issue of whether reserves constrain lending – worth reading in full. The argument being one made over a century ago – even with endogenous money there will be a cash flow constraint on further lending and this is influenced by the setting of interest rates – but this is a weak means of controlling the money supply.
The idea that banks are not constrained by reserve levels—because they can always borrow required reserves should they fall short—shouldn’t leave anyone with the impression that banks do not face serious constraints on their lending.
The biggest constraint on lending is the basic business model of banking.
When I was a banking lawyer, we usually referred to this as “cost plus lending.” The idea was that the bank’s source of profit was charging more for loans than it cost the bank to make the loan.
This sounds pretty simple until you start thinking about the source of the costs to make a loan. The first cost, of course, is what’s known as “the cost of funding”—the amount the bank must pay to borrow the reserves required to make loans.
But there are a host of non-funding costs as well. The bank must also somehow acquire the regulatory capital to back the loan, and capital can be expensive. The bank faces administrative costs in making the loan. Bankers must be paid. There may also be various taxes and government fees that apply.
Banks also face interest rate risk that they attempt to hedge by either borrowing funds at durations that match the term of the loan they are making—which raises the bank’s cost of funding—or making floating rate loans. But with very large loans, banks will often require floating rate borrowers to hedge against interest rate risk themselves—since you don’t want your borrower defaulting just because rates have increased. The price of interest rate hedging also has to be figured into the borrowers ability to pay the loan.
These aren’t trivial costs. The best estimate is that these add up to almost 300 basis points—the spread between the Fed Funds rate and the Prime Rate.
This means that even if banks can make loans out of thin air, there are plenty of loans that a bank cannot make. Or, to put it differently, if a bank makes too many of these loans it will lose money and eventually fail. A person or business whose free cash flow is too light to support the costs of the loan, for example, is not credit worthy—that is, not eligible to receive a loan under most circumstances.
This is one way that monetary policy works to encourage more lending. When monetary policy brings down the price of banks borrowing reserves—that is, reduces the Feds Funds rate—it brings down the cost of making loans. This means some borrowers will be credit worthy at lower rates that wouldn’t make the cut at higher rates.
The flip side of this is that potential borrowers must also see opportunities to put bank loans to work. If they view potential for future profit as weak, the demand for new loans shrinks. Of course, monetary policy plays a role here too. Low rates can make otherwise uneconomic projects work and, as the Austrians put it, may send a signal that there is more saving in the economy available for future spending. (Although, I would add, that under our current system of Fed manipulated interest rates and endogenous money creation by banks, this is almost certain to be a false signal.)
Banks also must price in the “credit risk” of making a loan—the risk that the borrowers may default, either because the collateral for the loan becomes so undervalued that the borrower “walks away” or because cash flow fall short of what is needed to make the loan.
Credit risk depends both on the individual character of each borrower and the general economic prospects. Rising unemployment, fall in consumer demand, the plausibility of management’s business plans all feed into credit risk.
Evidence indicates that credit risk, interest rate risk and other costs of lending exercise very strong influences over lending. The stuff the Fed tends to influence most directly—the cost of funding—can be overwhelmed by the credit risk and cost of capital.
As Christina and David Romer showed in this 1994 paper, banks have shown that they can maintain high lending levels even when policy is tightening. And, as we’ve seen recently, banks can maintain low lending levels (relative to reserves) even when policy is loosening.
To put it differently, banks are not free to create money willy-nilly. They are subject to restraints imposed by both the markets and regulators. But under current procedures, these restraints do not arise from a hard limit on the amount of reserves in the system. They arise from the costs of lending, which is conditioned by (a) the interest rate targeted by the Fed, (b) regulatory and market capital requirements and the market price for bank capital, (c) by back-office administrative and hedging costs of lending, and (d) the credit-worthiness and credit-hungriness of borrowers.
Is this banking mysticism then – imagining as Krugman asserts that different rules apply to banks than the rest of the economy. No Carneys ‘Cost plus lending’ model is exactly the same ‘cost plus’ balance sheet model of profits that Post-Keynesians have always asserted. Banks are firms whose product is money – they follow the same rules as any other firm – firms produce physical goods, banks and other financial intermediaries produce money.
What is more you will spot we have a missing piece to the jigsaw – a theory of interest rates, cost plus=risk adjusted NPV of loan over period (very similar to Fisher).
To make up for some of the justifiable criticisms one area where Krugman is spot on.
Free Exchange at the Economist
many prominent macroeconomists argue that a small increase in the inflation rate could yield a large improvement in the employment picture. Conversely, when inflation is low, labour-cost adjustments will prove remarkably difficult. This is certainly true of America. Where labour markets (and wages) are less flexible, as in Europe, nominal adjustments are all but impossible. And yet, that is precisely what European leaders are forcing on workers around the European periphery.
Lastly, as Mr Krugman also says, increased labour-market flexibility might actually prove counterproductive in some circumstances. (His sometime co-author, Gauti Eggertson, contributed to a recent paper arguing that flexible wages were destabilising.) In a deflationary environment, flexible wages will fall. That, in turn, will increase the real burden of debt, touching off what Irving Fisher called a debt-deflation theory of depression.
In lay terms if your wages are lowered and you are in debt or are forced into debt then this could suppress demand in the economy and weaken employment. Austerity and ‘internal devaluation’ e.g wage cuts lead to a downward spiral – and in the european periphery this leads to risk of further default and debt contagion that is threatening to collapse the whole eurozone.
And another area where he is only part right
What Mr Krugman doesn’t quite acknowledge here is that sticky wages undercut some of the nastier presumed features of a liquidity trap. Both Mr Krugman and Mr Eggertson have occasionally cautioned against supply-side reforms during liquidity traps on account of the “paradox of toil”. An increase in labour supply, they reckon, produces downward pressure on wages and, therefore, prices. With interest rates at zero, downward inflation pressure corresponds to upward pressure on real interest rates, which are contractionary. The “bizarro world” of the liquidity trap rests in no small part on the assumption that wages aren’t particularly sticky in the downward direction, when in fact they very much are.
Though Free Exchange perhaps should acknowledge that in circumstances where wages are forced to be flexible downwards by law and ‘internal valuation’ policies then the worst aspects of this ‘paradox of toil‘ -and a a ‘paradox of flexibility‘ ; kick in – Where wages fall and cost of living stays broadly fixed – because for example international energy and food prices, this can trigger debt deflation and the kind of austerity death spirals we see in Greece, Portugal and Spain. In the UK wage freezes combined with inflation and spending tax rising have much the same effect. Eggertson together with co authors has recently expanded on the idea that flexible wages can be destabilising.
Now you could argue that this paradox of flexibility is a theoretical construct because at the zero bound we have labour contraction not expansion. This however assumes we simply have a monolithic labour market, as if we had one buyer and one seller. However at any one time except at the direst moment of crisis there will be labour sub markets which are contracting and expanding, and the expanding markets will be the ones where public policy on labour market flexibility will apply most strongly. Proof of this is reduction in hourly rates in contracted staff areas, where of course there is much more flexibility – both up and down – then salaried employees. In my field for example rates have gone down from £35-40 an hour to as low as £15-20. Halving incomes (assuming hours remain the same) at a time of rising prices will therefore have as devastating impact on household expenditure and debt in those segments as those experienced by Greek public sector workers.
Free Exchange concludes:
A general conclusion: I am increasingly sceptical that the benefits of low and stable inflation are all they’re cracked up to be. Low inflation is grand so long as one assumes that critical variables adjust as easily in one direction as in the other. It should be abundantly clear by now that they do not; for all sorts of variables—wages, prices, and interest rates among them—zero is a big, fat economic obstacle. Central bankers don’t seem to mind running the economy repeatedly into this wall—anything to avoid being tarred an inflation dove. But the human cost of ignoring this rather important real world feature is proving to be intolerably high.
So despite the spat about DGSE and the multiplier there is I think a key area of consensus between the two Ks.
- Monetary Policy is not enough at the zero bound, we need fiscal policy too
- Both the paradox of thrift and the paradoxes of flexibility & toil can drive debt deflation
- Reducing wages and labour market ‘flexibility’ in debt burdened nations will be counterproductive
- Modest inflation can erode debt, but it is a double edged sword as it can also drive people into debt when wages don’t rise with inflation.
Buford Wyoming is the worlds smallest town. It is also the highest town on the route between San Francisco and New York. The sign used to say two, and then the owners son moved away, and the owner wanted to sell up and retire. The town used to have a population of 2,000 but now even the ghosts have moved on. 145 ranchers and mountain men living in the wilds get their mail and essentials from here however.
Once a semi-bustling town of about 2,000 residents that started in the 1860s, the rerouting of the Transcontinental Railroad sealed the town’s fate. Buford’s most famous moments all date back to the 1800s. As the second-oldest town in Wyoming, U.S. President Ulysses S. Grant visited in 1869 and outlaw Butch Cassidy robbed a store there about a decade later (he was caught and served time in Laramie). Since Cassidy, Buford hasn’t made the news much.
According to the Wahsington Post
The new owner will get a gas station and convenience store, a schoolhouse from 1905, a cabin, a garage, 10 acres, and a three-bedroom home at 8,000 feet altitude — overlooking the trucks and cars on the nearby interstate on one side and the distant snowcapped mountains in Rocky Mountain National Park in Colorado on the other.
It was sold at auction yesterday for $900,000 dollars to a vietnamese businessman. Lets hope he improves the stock:
We also have some fascinating and unusual items, such as whistles made from elk antlers, and authentic stick pens (it’s a fully functional pen whittled from a western tree!)
Lauren Lyster’s Capital Account covers probably what has been the biggest economists bust up since Hayek v Keynes and has caused something of an internet sensation.
The argument is between Professor Paul Krugman, Noble Prize Winner and undoubtedly the worlds most famous economist through his outspoken NYT column and blog, and Professor Steve Keen – who until recently was a marginalised and little known figure based in Australia. Keen had one major claim to fame though, he was only one of a tiny handful of economists who predicted the great financial crisis of 2007 to today (and Krugman didnt) and the only one to do so with a mathematical model.
Now both figures are progressives and critics of the neo-conservative austerity ‘consensus’ that somehow we will get out of this great depression by austerity which is and will make matters worse. So why have daggers been drawn? Well the reason is that Krugman and some of his more conservative colleagues such as Greg Mankiw and Robert Lucas all share the same underlying theory of economics – the neoclassical synthesis. This approach of course failed to predict the crisis and is used to justify austerity economics. However over a number of years the dissatisfaction with this approach has been growing. Because progressive Neo-Classicals – the so called New Keynesians, have been unable to lend a clear blow on austerity economics, either to show why we had the great depression, to prove that it does not work and present a clear policy alternative, many have concluded that they are an active impediment to a change in thinking about economics. But the austerians can point to progressives supporting the foundations of their own economic theory it must be right mustn’t it. The New Keynsians have become the ideological prop to the status quo. A potemkin village to be pointed at by neo-cons to critics of economics. YankeeFrank on Naked capitalism sums it up
Actually, I would argue that Krugman and his Rubinite sponsors are our worst enemies. They provide many of the theoretical underpinnings for our current lemon socialist/crony capitalist system. Krugman, as far as I recall, has still refused to utter the words “fraud” or “crime” in relation to the misdeeds of our bankster overlords.
To say that debt can be “modeled out”, or banks can be ignored, in our understanding of the financial system is exactly how the devil gets in….
Krugman’s answer to our problems is the typical limousine liberal response, and it amounts to pretty much the same thing as the republican response: charity for the “losers” in our economy. The main difference is who should provide it, the government or private donors.
Sure Krugman wants “money drops”, but insists the current system is sustainable if we just do that. He in no way calls for real reform of finance, banking or industrial policy. But that is because he’s spent his career pushing the policies we now live under. …So yes, Krugman is the enemy. The idea that he is an ally just shows us how far from any real solutions this nation is; which is why we’re going to have another, much more massive and destructive, collapse before the ideas discussed on … truly progressive sites get the airing and support they deserve.
The alternative school has emerged from the ‘post Keynesian’ school. This school grew out of Keynes closest associates and was based on the idea that the key issue in economics is that of disequilibrium. That is when different markets are out of sync with excess/under supply, such as of course lack of demand for labour – unemployment, or excess demand for money, inflation. This group held that what was important about Keynes was that it was a disequilibrium theory. Whereas in America the synthesis in the neoclassical synthesis squeezed Keynes into a more conventional ‘equilibrium’ box where economies are stable and markets stabilising and things tend to settle down except where there are external ‘shocks’, or where prices are ‘sticky’ – like – heaven forfend – when people don’t automatically drop their wages if their is a bad week. The Post Keynsians attacked the foundations of this view, but for many years were a small group. They achieved a few notable victories, notably from economist Piero Sraffa who for a time seemed to shake the whole foundations of economics with results neo-classicism couldn’t explain and which even the giants of the time such as Paul Samuelson admitted defeat on. But it didn’t go anywhere. It was a Pyrrhic victory. The results were dismissed as being abstract and of no practical importance.
Everything carried on as before and heterodox figures were confined to a small club. There was a reason for this – money – or rather lack of a theory and model of money and banking. In the last 20-30 years however to fill that that huge gap, a theory of money, credit and banking, developed. It was known as the French circuitist school. Its ideas were actually very similar to ideas which were dominant before the second world war, that an expansion of money is based on credit, which is founded on profits in the future funding loans and creating monetary expansion today, through profits funding interest on loans, as opposed to investments created through savings, which is not monetary expansion as it is simply spending deferred until the future – the monetary stock does not change. A second breakthrough came with the work of Wyne Godley, who incidentally is the model for the St Michael defeating the Devil on the side of Coventry Cathedral. He took this approach toward money and modelled how it flowed between bank accounts and the economy. This approach became known as stock-flow consistent economics. The other key figure was Hyman Minsky – again a fairly marginal figure in his lifetime but a cult figure now – since who set out a model of financial instability – how a boom in credit could create a financial crash and recession. Steve Keen was the figure who brought these ideas together and more importantly created a dynamic computer economic model – which he used to predict the 2007 crash, and further more the risk of a further ‘double dip’ which we have actually now begun to see.
Although Steve Keen launched frequent attacks on the neo-classical citadel Krugman seemed to ignore Keen. Until last week, and then it all kicked off. Exactly what the issues were and how they were argued will have to wait till another day as it deserves a more through treatment in terms people can understand without jargon and maths. In short though Krugman attacked a paper of Keen’seven though he professed not to really understand the ideas behind it. The reaction on the internet was instant, the comments on Krugman’s blog made it clear that Krugman should learn this stuff and moreover most felt Keen was right. The reaction of Krugman was to lash out accusing Keen and his critics of mysticism. This simply unleashed a torrent of criticisms on the web, which to my eyes were about 20:1 in favour of Keen. The problem was that Krugman seem to express some very naive and out of date ideas on how money works. If you want to follow the arguments here is Krugmans follow up and a third post. To which Keen replied here, and then here.
Keen responded by calling Krugman’s economics ‘ptolomiac’ as outdated as assuming the sun revolved around the earth. I chipped in a short piece explaining how Krugman’s economics weren’t even ptolomiac – as it was timeless so the earth didnt even spin. The piece went through Krugman’s ideas on how investment is funded and how money is created and tried to show some flaws in his approach. To my surprise Keen to whom I am just an acquaintance of and occasional correspondent with posted my piece in support and retweeted some of my more abtuse theoretical points. From his blog.
I’m rather lucky with the calibre of my blog members, and that’s been in evidence in the discussion over Krugman here in the last few days. One comment by Andrew Lainton simply has to be shared more widely…
Gulp. Krugman responding to the Ptolomiac criticism lashed out – but made a critical error, he quoted Keen selectively in order to make him look like some kind of unknowledgeable idiot. The blogoshere spotted this instantly and came down on Krugman like a tonne of bricks, the argument became for a time intemperate. Scott Fullweiller made a slam dunk intervention. Until suddenly, Krugman, seeing that many had considered he had made an idiot of himself withdrew from the field saying im right, the rest of you are wrong and im not taking part in the debate any more – he took his ball home. Though he did come back with the rather limp defence that the New Keynesian theories were somehow different and not the kind of ‘DGSE’ models that Keen has attacked and.
I’m all for listening to heretics when they offer insights I can use, but I’m not finding that at all in this conversation, just word games and continual insistence that the members of the sect have insights denied to us lesser mortals. Time to move on.
Which the blogosophere immediately picked up on as hypocracy as New Kenynsian models are built on the mathematical foundation on DGSE and it was Krugman who was playing word games and refusing to engage with the criticisms of why they were wrong.
Ana -Berlin summed it up
What this latest Krugman post shows is a bad faith, not superior knowledge. I’ve read Keen’s blog and Krugman’s original posts along with all the readers comments and seems to me that 1) Krugman tried to debunk an opposing theory with a couple of coffee table talk remarks which is in itself a massive display of petulance. 2) Krugman constantly appealed to “authority” to disguise is inability to engage the opposing theory on scientific grounds (e.g. cannot go to Berlin due to more important engagements). 3) When hounded by readers who, correctly, point out that his arguments are fallacious and that he fundamentally misunderstands the role of banking, Krugman resorts to some third party opinion who, conveniently, misrepresents Keen’s points completely. 4) it all ends in a nasty tone, with Krugman insulting Keen, and here, one should note, that this is not a symmetric battle, you are talking about a Nobel prize winner, world wide known economist trying to diss and belittle a much lesser known professor out of spite. On a final note i would advise everybody to get acquainted with Keen, Krugman is not going to write economical history
In terms of the argument the overwhelming view of the internet was the Krugman had lost the debate and this was one for the history books – perhaps even a turning point in the dominance of neolassical economics – or neo-con economics as I call it. As I said a few days ago ‘this week will be remembered as the end of the beginning of the end of neo-classical economics’.
Interestingly many of the key theoreticians in this new approach come from a non economics background, such a historians, traders, and engineers, so why should not even a town planner join in. Neo-classical economics had become so degraded that it needed to be torn down from the outside.
Neo-classical economics now has its wagons circled because there have been a number of attacks recently even from outside and inside the corral, from figures such as Eggertson and Kocherlakota which imply that disequilibrium is the norm and that you get this even when prices are fully flexible – so the defence that New Keynsianism is somehow immune to criticisms for its inclusion of ‘stickiness’ falls apart. These results if followed through imply that the foundational principles of neo-classical economics are incoherent and must be replaced by a dynamic disequilibrium alternatives on broadly the lines that Keen and others have suggested.
As Keen Said on Capital Account last night - video at top
Hey, your models didn’t predict the financial crisis, we can ignore your models….
[Y]ou can’t model the economy without including the role of banks, debt, and money. And Krugman’s part of the economic establishment, which for thirty or forty years has got away with arguing that you can model a capitalist economy as if it had no banks in it, no money, and no debt… You just don’t have a model of capitalism if you don’t include those components.
From NPPF para 215
…due weight should be given to relevant policies in existing plans according to their degree of consistency with this framework (the closer the policies in the plan to the policies in the Framework, the greater the weight that may be given).
Lets look at a simple case of a single material consideration/policy.
The case of an infill proposal in a village outside an infill only village boundary in the Green Belt. Before the NPPF it would be refused, now limited infill is allowed. The decision is binary, refuse or approve - you don’t half approve a house. Or another example where a plan zones out nonemployment use on a non employment site, whilst the NPPF now requires ongoing support of evidence. Again the policy either is consistent or it isn’t and if it isn’t you have to go with more up to date national policy.
I have heard it put by a number of people that you apply some kind of bingo card or grocers scales approach of a % compliance, but how could that ever work?
In the cases above applying a % weight is unworkable. Planning is based on an a binary decision arrived at by subjective assessment, not an objective assessment based on analogue weighting. Indeed in applying para 215 I cant think of a single practical use case where an inspector would not feel obliged to apply NPPF policy in the event of a conflict because if they did not JR would be likely because polices are either consistent with the NPPF or not. In the real world there is no such thing as ‘degree of consistency’ – it is either consistent – indicating the same decision as the adopted plan, or it is inconsistent, indicating a different decision. It might work in the fantasy world where a plan says approve 75% of the time and the NPPF says approve 90% of the time and you would average between the two and roll a dice – but back in the land of reality. It is as delusional as Samantha Brick.
If anyone can think of a real world example where you could apply some kind of scale of degree of consistency on a specific policy and split the difference then please let me know, prizes (modest) will be awarded. Now if the NPPF say set parking standards or building heights then yes you could split the difference, but it doesn’t does it.
On to multiple material considerations you then have the problem of how to use multiple weights. Planning theorist Thomas Saaty (author of the Compact City) proved many years ago that in these cases you have to calculate eigenvalues of n dimensional matrices!! (second year undergraduate maths) where you have more than 1 objective of differing importance – err I cant see the profession adopting those in a hurry although there are off the shelf/GIS tools that will do the job for you (I think they are great but I think most planners will run scared at the idea). Similarly it only works if the different weightings can form a simple static decision tree. In most cases they won’t because they will have a logical structure not just one of weight, for example if an area never floods or the use is amended by condition that it is not a vulnerable one flooding is not material to the decision.
Indeed from what I am hearing the head scratching this idea is producing is going down like a tonne of bricks.