Tag: economics

The Fifth Definition

Paul Krugman explains why Keynesian economists have now begun to switch to a fifth definition of inflation, “core inflation”, that is distinct and increasingly distant from the Keynesian school’s theoretical, official, textbook, and practical definitions.

Since I’m taking a break from shoveling, I thought I might take a few minutes to address an issue that seems to confuse many people: the idea of core inflation. Why do we need such a concept, and how should it be measured? So: core inflation is usually measured by taking food and energy out of the price index; but there are alternative measures, like trimmed-mean and median inflation, which are getting increasing attention.

First, let me clear up a couple of misconceptions. Core inflation is not used for things like calculating cost-of-living adjustments for Social Security; those use the regular CPI.  And people who say things like “That’s a stupid concept — people have to spend money on food and gas, so they should be in your inflation measures” are missing the point. Core inflation isn’t supposed to measure the cost of living, it’s supposed to measure something else: inflation inertia….

The standard [core inflation] measure tries to do this by excluding the obviously non-inertial prices: food and energy. But are they the whole story? Of course not — and standard core measures have been behaving a bit erratically lately. Hence the growing preference among many economists for measures like medians and trimmed means, which exclude prices that move by a lot in any given month, presumably therefore isolating the prices that move sluggishly, which is what we want.

And then these great minds of the dismal science wonder why their models don’t work in either a predictive or an explanatory manner. Of course, the reason they need to keep coming up with these additional “definitions” is because not because the “measures have been behaving a bit erratically” but because the conclusions that are based on the definitions don’t line up with what is visibly taking place in the actual economy.

The red line is the standard “core inflation” CPI-FLENS measure that Krugman is citing in his second “Core Logic” post; the blue line is the standard CPI-U.  However CPI-FLENS cannot possibly measure the inflation inertia because the practical application of the various Keynesian definitions of inflation requires something to measure those price changes against.  Simply removing some of the more volatile (and generally higher) prices from the price index only smooths out the price index while tending to reduce it.  Since inflation – and therefore its inertia – depends upon the comparison of those price changes with changes in the production of goods and services, (in practical terms, with GDP minus the price increase of one’s preferred index, be it CPI-U or CPI-FLENS), anything that leaves GDP out of the equation cannot be considered the inflation inertia anymore than the mere change in prices can be considered inflation if it does not take the change in production into account.

So much for inflation

Apparently QE III is in the cards:

In an effort to thwart counterfeiting, the US Government has implemented a $100 bill design so difficult to print even the U.S. Treasury cannot print them. The government needs to burn $110 billion in flawed $100 bills, more than 10% of all existing cash. The cost of printing the flawed bills was a mere $120 million.

If inflation is derived from the money supply, then burning 10% of the the entire currency stock should cause prices to fall, right? Given the current M2 figure of $8,767 billion, this bonfire of the Franklins should result in an immediate 1.3% reduction in the rate of inflation.

Voxiversity 5.2: Inflation and Keynesian Economics

This should be an interesting discussion. The conclusion will initially strike some as a priori insane, but I encourage everyone to consider the empirical evidence before issuing a diagnosis. I may need to revisit this one after the critics have shared their presumably constructive input, so I look forward to hearing everyone’s take on it.

In case you’re wondering why these esoteric and pedantic debates over definitions are of interest to me or why they are important, consider this recent interview with Ben Bernanke. The relevant statement is highlighted in bold.

Pelley: Some people think the $600 billion is a terrible idea.

Bernanke: Well, I know some people think that but what they are doing is they’re looking at some of the risks and uncertainties with doing this policy action but what I think they’re not doing is looking at the risk of not acting.

Pelley: Many people believe that could be highly inflationary. That it’s a dangerous thing to try.

Bernanke: Well, this fear of inflation, I think is way overstated. We’ve looked at it very, very carefully. We’ve analyzed it every which way. One myth that’s out there is that what we’re doing is printing money. We’re not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we’re doing is lowing interest rates by buying Treasury securities. And by lowering interest rates, we hope to stimulate the economy to grow faster. So, the trick is to find the appropriate moment when to begin to unwind this policy. And that’s what we’re gonna do.”

It should be clear that the Fed Chairman does not define inflation in any of the Keynesian manners described in this video. But is his definition correct? That is the $600 billion question.

Let the women work

Calculated Risk presents a chart showing that the percentage of men aged 25-54 participating in the labor force declined to a record low of 88.8% in November.  And that was BEFORE the release of the new World of Warcraft expansion.  The chart goes back to 1948 and shows that the idea women first entered the workforce en masse after WWII or in the 1970s simply isn’t true; about one-third of women have always had to work.  The increase in the percentage of women participating in the workforce is predominantly the result of young women who previously got married and had children while being supported by a husband now working instead of or in addition to having a family.  The chart is also a little misleading in that it only measures to age 54.  One of the chief impacts of more women entering the workforce is that men over the age of 60, who had previously been much more inclined to work, exited the workforce en masse thanks to the establishment of Social Security and Medicare.

So, as I have often said, the primary benefit to society from employing young women is to pay for old men collecting retirement.  In return for which the societal costs include declining marriage rates, skyrocketing illegitimacy rates, lower average wages for both men and women, reduced productivity, and demographic decline.  This would not appear to be either a rational or sustainable policy for any nation, especially considering that the first attempted solution, importing third-world workers to replace the missing children, has not worked out well for any nation that has adopted it.  The choice is as stark as it is simple.  Either abandon the notion of sexual equality and return to the traditional model where 70% of women are occupied with raising families or experience complete societal collapse.

On a tangential note, I saw this in the comment’s at CR’s place.  I don’t see it as a positive indicator: A friend picked up a hitch-hiker in the National Park last week and gave him a ride, and it turned out he was a marine that had done 3 tours in the sandbox, but apparently our military is getting picky about who they allow to re-up, and he told my friend, “I hope something happens in Korea, so I can go back to work.”  It is a time-honored fact of history that when men cannot find jobs, the rulers of society attempt to keep them occupied killing people somewhere else.

Low hurdles

I was bemused when I checked Channel Vox this morning preparatory to uploading the next video in the inflation series and saw that it had won a YouTube award. It appears Voxiversity was #3 Most Subscribed Channel in Italia this week. Of course, I would have needed 360x more to have reached the same ranking in the USA. Clearly the next video should be entitled Victoria’s Secret Economics: Alessandra Ambrosio Explains Inflation.

But since I’m on the subject, I should mention there is a slight change of plans with regards to the 5.2 video. I am extremely loathe to make a case that depends upon anyone accepting my assertions undemonstrated, so the second video will not concern the credit-money definition of inflation as I’d originally planned, but will instead demonstrate the inutility of the four – yes, four – primary Keynesian definitions of inflation. The third video will examine the Monetarist definition, and only then, once the case against the various mainstream definitions is concluded, will I explain and defend my contention that the correct definition of inflation is an increase in the money supply plus outstanding debt.

Anyhow, I’m planning to do the recording tonight and upload it sometime this weekend, in case you’re interested.

Let’s try this again

I think it’s better this time. I’m getting more familiar with Camtasia, which tends to help, and the volume is significantly louder. I also managed to utilize the full screen this time instead of inadvertantly leaving a black rectangle around the perimeter. I also introduced minor errors into two of the graphs; the CPI recalculated for the 0.6% annual error only shows a line including a recalculation for the last ten years and the labels for the dollar devaluation chart were cut off, but I’ve decided to leave it as is so that I can move on to the next one. I found a better font to use for the pop-up notes as well, or “call-outs” as Camtasia calls them.

As before, suggestions for improvement would be welcome. The next video will address why inflation has to include outstanding debt; after that I plan to do videos examining the two conventional definitions of inflation. If you’re interested in being notified when new videos are uploaded, you can subscribe to the Voxiversity Channel.

And the media is right on time

You may recall that in RGD, I wrote that the mainstream media would begin seriously throwing around references to the Great Depression before the end of 2010:

This is starting to throw off more echoes of the Great Depression, where you have a sequence of crises, each touched off by the ones that came before, like dominos falling into some diabolic design. Europe and America thought they’d seen the worst of things by the end of 1930, only to be knocked back down even harder by the contagion of the Creditanstalt crisis. In the US, the crisis ultimately triggered a string of bank failures worse than those sparked by the initial stock market crash, and the worst two years of the Great Depression were 1932-3.

I don’t want to lean too hard on this, as economic commentators (maybe including me) have started seeing Creditanstalt everywhere–in Dubai, in Greece, now in Ireland and maybe Spain. It’s entirely possible that we’ll eventually muddle through without a second major event. But it’s worth remembering that these things take a long time to unfold, and that we are often most vulnerable just when we think we have time for a breather.

The difference, of course, is that the Great Depression 2.0 is going to be much wider, and probably somewhat deeper, than its predecessor. The main reason is that the last time, only the USA attempted to fight it with major government intervention. This time, practically all the governments around the world are doing so. I’m a little off in terms of the timeline since the depression has not been publicly recognized yet, but I have no doubts that we are in it already.

The opportunity cost of sex

Since Spacebunny mentioned that the previous post was of the sort to cause most people to feign death rather than risk inadvertantly entering into the discussion, I thought I’d post Susan Walsh’s rather different take on the opportunity cost study. I suspect it is much more likely to prove interesting to the non-economists in our midst. Not that pedantic debates over opportunity cost versus net utility calculations aren’t stone cold sexy, you understand.

One of the most valuable key economic concepts is that of opportunity cost. It’s the cost of not choosing something, the benefits left behind on the road not taken, and it’s an important component of any choice you make. Sometimes the tradeoff is obvious – if you choose to date Brad, you’re giving up the opportunity to date Jonathan, for example. Often times, though, opportunity costs can be hidden, which can lead to making irrational decisions….

Women often figure they have nothing to lose by staying in a disappointing arrangement until something better comes along. This is a terrible strategy for three reasons:

It’s not just women who make this mistake. As I’ve told some of my male friends time and time again, women should not be confused with jobs. While the best way to find a new job is to have a job, the best way to find a wife is not to have a wife. If you want to meet women, you are much better off being out, about and unattached than caught up in a half-hearted relationship with a girl that you plan to trade in for someone better on the off-chance that you happen to meet them on one of the nights that you’re not sitting at home watching re-runs of Sex in the City with a woman you don’t even particularly like. It’s not fair to her and it’s not utility maximizing for you.

UPDATE: We’re not talking about pre-selection here. We’re talking about the sort of man who is in a “serious relationship” but doesn’t want to be and is simply waiting around for someone else to come along before he can break it off with her.

An incompetent economist at the NYT

It’s little wonder they can’t figure out that we’re in a depression.

Virtually all economists consider opportunity cost a central concept. Yet a recent study by Paul J. Ferraro and Laura O. Taylor of Georgia State University suggests that most professional economists may not really understand it. At the 2005 annual meetings of the American Economic Association, the researchers asked almost 200 professional economists to answer this question:

“You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton? (a) $0, (b) $10, (c) $40, or (d) $50.”

The opportunity cost of seeing Clapton is the total value of everything you must sacrifice to attend his concert – namely, the value to you of attending the Dylan concert. That value is $10 – the difference between the $50 that seeing his concert would be worth to you and the $40 you would have to pay for a ticket. So the unambiguously correct answer to the question is $10. Yet only 21.6 percent of the professional economists surveyed chose that answer, a smaller percentage than if they had chosen randomly.

This is completely wrong and the 27.6 percent of economists who answered (d) $50 were correct. Remember, the question posed states that the opportunity cost is the total value of everything you must sacrifice to attend the Clapton concert. The total value of the Dylan concert to you is $50. In attending the Clapton concert, you do not attend the Dylan concert which you valued at $50. Therefore, the opportunity cost to you is $50 even though not going to see Dylan meant that you didn’t have to pay the $40 you would have otherwise had to pay for a ticket. Opportunity cost is a cost, it is not the net of cost minus implied savings.

In order to incorrectly claiming the correct answer is $10, Robert Frank has to change his definition of opportunity cost from “the total value of everything you must sacrifice” to a nonsensical one that factors in things that you might have otherwise had to sacrifice but didn’t. Based on the example given, it doesn’t matter what the cost of the Dylan ticket is. Whether the Dylan ticket costs $5 or $500, the opportunity cost of going to see Clapton for free is still $50 because that is the value that you place on seeing Dylan and you did not see him. The fact that you didn’t spend $40 on a Dylan ticket is irrelevant; why not throw in $5 for the pizza you didn’t buy and another $150,000 for the Lamborghini you didn’t buy either as well: by Frank’s bizarre reckoning, the opportunity cost of seeing Clapton will leave you with a profit of $150,015!

To put it in terms that even non-economists should be able to understand, let us consider Archie’s Dilemma. When contemplating choosing Veronica (who is on the pill) over Betty (who isn’t), the opportunity cost of nailing the brunette is NOT not banging the blonde less the price of a condom, it is simply not banging the blonde.

Like most Keynesians and monetarists, (and most mainstream economists are one or the other), neither Frank nor the authors of the study understand that value is subjective, not objective, and so they make their usual mistake of running arbitrary numbers through meaningless formulas and ending up with a result that is not so much inaccurate as indefensible and irrelevant. I strongly suspect that a basic mistake was made in formulating the question, since a more meaningful way of structuring the question would be to attach a price to the Clapton ticket.

If, for example, both concert tickets cost $40, then the opportunity cost of going to the Clapton concert would have been $90, $40 for the Clapton ticket and $50 for the sacrificed value of the unattended Dylan concert. Either the study’s authors meant to trick the AEA economists by posing an incredibly simple question or they made a rather stupid mistake. Regardless, Tyler Cowen of Marginal Revolution ends up with the right answer although I don’t think he quite grasped the precise problem with the question and Mr. Frank, the study’s authors, and 21.6 percent of the AEA economists are wrong.

If Paul Krugman had posted this conundrum, the correct answer would have been (e) opportunity cost and the limits of the space-time continuum are barbarous right-wing relics so borrow $40 and attend both concerts.

UPDATE: Since various people are tripping all over their various attempts to define “opportunity cost” instead of paying attention to how it was defined in the question, I will highlight the relevant portion of the question posed by Frank here.

“The opportunity cost of seeing Clapton” is the total value of everything you must sacrifice to attend his concert – namely, the value to you of attending the Dylan concert.”

The value of attending the Dylan concert to you is $50. This means the value of the discount on the ticket is $10. Now, it’s vital to note that Frank assigns TWO distinctly different definitions to “the opportunity cost of seeing Clapton” in his question, thus conclusively proving his point that economists, especially economists writing in the New York Times, don’t understand opportunity cost. Naturally, there are two different answers to the two different questions-in-the-question. The answer to question (A) the “total value of everything you must sacrifice”, is $60 since you’re giving up both the value of the Dylan concert and the value of the discount in order to see Clapton. The answer to question (B) the “value to you of attending the Dylan concert” is $50. However, the four multiple choices provided make it clear that Frank is looking for an answer to question (B) rather than question (A), which is why the correct answer is (d) $50.

A first whack

Don’t expect too much out of this little video on inflation and the CPI. It’s a first effort and I’m not shooting for professional quality or auditioning for a radio show here. The point is simply to transmit information in an alternative medium to the written text. I made a mistake in setting the screen capture size too low and I think I also neglected to spend enough time discussing what the CPI-U is; anyhow, I would welcome suggestions for improvement.

The Voxiversity YouTube channel is located here.