When Eric Crampton first suggested the idea of creating an NGDP futures market in New Zealand, I was intrigued. It would be outside the oppressive regulatory regime of the SEC. When Robert Quigley-McBride said it could be set up for $1500, I was pleasantly surprised. I might be able to raise those funds from readers. Hell, I could pay that myself, except my wife would probably (quite reasonably) ask why I had to do so, when I’d already devoted six years to this project, mostly unpaid. So I didn’t ask her.
Then Robert said it would cost an extra $30,000 to set up the accounting infrastructure to handle all the interest-bearing margin accounts, if we adopted my complete proposal. When I read that I thought to myself “fat chance of raising that kind of money.” And in fact we did not raise $31,500, we raised more than twice that sum, in less than 2 days. Approaching $70,000. And without even asking for small donations. I’m stunned. (Special thanks to Ken Duda and Gabe Newell for huge donations, but the others were also very generous.)
But as all good philosophers know, every success just creates new problems. Now I started to worry about liquidity. There is no NGDP futures market in the US, precisely because there is very little demand for NGDP futures contracts. And this market would be in New Zealand. Who would trade? My initial proposal in academic papers was to have the Fed run the market, and the interest rate on margin accounts would be raised high enough to assure liquidity. The Fed could easily afford to do that for a market with several $100 million in margin accounts. But this current proposal would merely pay market rates (now quite low); the funding would be to set up the complex accounting system. The more money we raised, the more guilty I felt about the prospect of wasting the money of idealistic donors.
I have some ideas on how the trading volume concern can be addressed, which I will present below. But I am also looking for your ideas. Before rushing in, however, try to remember two things:
1. Don’t look at the donations thus far as a big pot of money to spend. I am determined to do this as cheaply as possible, given that we can be confident of succeeding. I am determined to rethink the plan in such a way as to come in well under the promised donations thus far, so I can present the donors with a plan that has a high likelihood of success, and also tell them we only need X% of their promised donations. Where X is well under 100.
2. This is not a normal futures market, and hence normal rules don’t apply. Normal futures markets are trying to meet customer demand for hedging and speculation. There is little such demand for NGDP futures. We are trying for a demonstration project showing that it would be possible to create a public good that is highly useful in policy analysis, by leveraging the “wisdom of crowds.” So don’t rush in and tell me it must be done “this way” because pork bellies are traded this way.
I’ll get the ball rolling, but in the end this isn’t just my project. You must also convince both the experts at iPredict and the donors that your proposal is feasible. So even if you convince me it may not happen. Here’s one thought I have:
Robert told me that a direct subsidy might be much cheaper to administer than a complex set of interest-bearing margin accounts. Other accounts at iPredict do not earn interest. So perhaps we could do something like the following:
Let’s suppose our budget ends up being $41,500. The $1500 sets up the market, and $40,000 is used to subsidize trading.
Instead of investing margin account money, let’s think of direct subsidies to traders. We could plan on a 5 year horizon for the project (then raise extra funds later if we are successful.) That’s 20 quarters of operation to fund. In that case we can afford a $2,000 subsidy each quarter.
One way of doing the subsidy is to have each winning contract equally share the $2000. That would guarantee some trading, as if only one person bought contracts they would be guaranteed to win the entire $2000! Overall I’m strongly interested in a subsidy scheme that does not allow for a complete failure of the market.
Say what you will about Paul Krugman, he’s a genius at intuition. He once remarked (I’m over-simplifying) that all of economics boils down to two jokes:
1. That can’t be a $100 bill, someone would have picked it up already (the EMH)
2. No one goes there anymore, it’s too crowded. (S&D)
My plan is a subsidy not a price, so it sort of reverses #2. ”Lots of people buy NGDP futures, as the market is so uncrowded that they have a good chance of winning the subsidy.” Of course that’s nonsense, but it’s a way of thinking about why my proposal would be a sort of foolproof plan for insuring at least some trading. Low volume is hard to conceive as an equilibrium outcome. That’s what I’m aiming for.
Some commenters prefer a plan with a contract linked to the specific future NGDP, not just a range of values. I like that better too, as it provides precise point estimates. But iPredict found that people much prefer to trade things like win/loss in elections, rather than vote share. Again, we need volume for success. Vote share contracts are boring because the vote share rarely diverges more than a couple percent from public opinion polls. Then I thought about tying the contract price to the growth rate of NGDP, which is more volatile than the NGDP level. But the starting point can undergo revisions, which makes the growth rate more ambiguous. So we didn’t end up there, but I suppose the contract price could be the percentage difference between the actual initial announcement of NGDP, and the estimate of 4 quarter previous NGDP on the very same day (if we were dealing with a one year contract.) It’s something to at least consider.
Other proposals would subsidize the market maker to assure more liquidity, but I worry that while it’s a good idea, that might still not overcome a lack of interest in US NGDP (outside the US). Recall the goal is to derive a public good—the public’s expectations of US NGDP growth, even if they have no interest in trading without a subsidy. Did I mention that volume is the problem?
Because I did not ask small contributors to help out, I am going to ask my non-American readers to give this market a shot, if only for the fun of it. It will be set up to be either a zero or positive sum game; what casino offers those odds? American readers can recommend this to their foreign friends and colleagues. Eventually I will also ask other bloggers to point out the value of the experiment, if it succeeds.
We are also working on issues of how best to deliver the donor funds to NZ, hopefully in a way that earns a tax deduction.
I suppose it’s slightly embarrassing to be rethinking things this late in the game, but I’ve never much cared about losing face, and do care a lot about getting this done right.
And finally, on a personal note, the last few days have been very gratifying. A few hours after the initial post I had not gotten any donations, then for another hour only one. I flashed back to my Cub scout days where I only sold one box of cookies, because I was too shy to approach people. I’ve never been good at asking people to do me favors, and would have been a horrible salesman. “You actually don’t need these encyclopedias, to be honest it’s all on Wikipedia.” The wonderful thing about the anonymity of the internet is that it allows a loser like me to actually have some small moments of success. The downside is that it also allows me to be somewhat more of a jerk than I am when actually meeting people face to face.