Archive for August 2012


Six degrees of separation from reality

Tyler Cowen linked to a Christopher Balding post that made the following claim:

I find that implausible, and looked in his post for documentation.  He linked to a Tyler Durden post that never made any such claim.  Instead Durden claimed:

Beijing Alone Has 50% More Vacant Housing Than The US

And where did Durden get that information?  He linked to a google translation of a Beijing news report:

Beijing Public Security Bureau population administration division, said yesterday that have checked 725.5 million floating population information marked rental housing 1390000 3812000 check vacant houses.

Durden actually misquoted the google translation slightly, to make it seem less “gobblety-gook-like.”  I asked my wife to read the original Chinese text, and she couldn’t make heads or tails out if it–even in the original!  But we did establish that google mistranslated the original.  For instance the 725 million figure was actually 7.25 million in the Chinese version.  But what’s a factor of 100 between friends?  So you have one blogger citing another blogger who claims a third blogger made a claim he never made, and that third blogger’s actual claim involved misquoting a google translation, that was itself a mistranslation of the original.  And the original is incomprehensible to a native Chinese reader. And later Balding says only a fool would trust Chinese government data anyway.  So why does he cite it?

Update:  Commenter Philemon verifies that in China the term “vacant” includes apartments where no one was home when the surveyor happened to show up.

Beijing’s population has been soaring in recent years, and now tops 20 million.  Here is a Reuter’s article that describes the housing market:

They sleep in boxy rooms crammed into dingy low-rises and spend hours commuting to work on crowded buses as part of a trend of poorer white-collar workers being forced to the fringes of China’s wealthiest cities.

Some say these struggling college graduates who swarm out of their cramped accommodations and head to work in the urban sprawl each morning are reminiscent of worker insects in a colony. Not surprisingly, they are often referred to as China’s ant tribe.

The growing ranks of ‘worker ants’ poses a policy challenge for Beijing’s Communist Party leaders as high property prices and dim career prospects thwart the ambitions of many graduates for a comfortable middle-class lifestyle.

In Tangjialing, a dusty suburban Beijing village laced with dirt roads, college-educated software technician Kong Chao typifies the spartan existence of many such graduates.

“This is hard, but there’s no other way,” said Kong, 24, who is relatively fortunate as he has a toilet and cooking area in his cramped room and doesn’t have to share with other tenants.

Kong pays 550 yuan ($81) a month in rent, about 10 percent of his monthly wage. A similar room in a central area of Beijing would eat up most of his salary.

“You see what a crowded city Beijing is,” he said. “We younger people all come to seek work. But we can take it.”

Does China have too much housing?  Perhaps by some criteria.  But I don’t see any evidence in that google mistranslation to change my prior belief that China will need far more housing in the future.

Christopher Balding also has this to say:

When Scott Sumner asks “what do you want them to build more of?” and Lulu responds “that Scott can get a haircut for $4 or an ice cream cone for 50 cents shows how low productivity and wages are in China” demonstrates how far removed from reality both are.

.  .   .

Living in China I can attest first hand to the fact that China has easily the highest price level of any country I have visited in the past two years.  An ice cream cone for 50 cents?  Lulu obviously has spent too much time in Michigan and not in China. 

This is one of the most comical statements I have read in 3 years of blogging.  Balding must be in some sort of cocoon, like the Chaoyang district of Beijing where all the foreigners live, where they charge five times as much as in the real China.  He should get out more.  I just had (an admittedly basic) dinner in a nice hotel in Anhui for $2, including tax and tip.  And I was the one that had the 50 cent ice cream cone from a Beijing McDonalds, not Lulu.  Has he visited Switzerland?

If you priced China’s service sector at US prices it would be huge.  And it’s growing extremely fast, with stores, restaurants, hotels, hair salons, etc, opening up all over China.  But I suppose that’s also a “bubble” because it involves building, which is that awful “investment.”  I guess the investment-phobes want the Chinese to serve meals and cut hair out in the middle of the street, as they used to a few years ago.

China’s gradually building a modern high income economy.  Because they are still part communist, they are doing so clumsily, and with lots of resource mis-allocation.  But the glass is still half full, and the water level is gradually rising.

PS.  The snark was aimed at Balding, who’s an expert on “how far removed from reality” Yichuan and I are.  Apologies if Tyler Cowen got caught in the crossfire.

Reply to Yichuan Wang

[I just noticed that Matt Yglesias did a reply that is superior to mine, so I suggest you read his instead.   But I hate to throw away my own typing . . . ]

A few days ago I asked the following:

So here’s my question for all of you China skeptics that insist they are building way too much housing, infrastructure, heavy industry, etc.  What precisely do you want them to build more of?  And what are the 100s of millions of Chinese living in tiny ramshackle homes to do?  Sit tight for a few more decades while resources pour into nice urban services for the pampered elite?

And then Yichuan Wang replied as follows:

I want them to start building leaf blowers, so we don’t have so many Chinese people in the low productivity position of sweeping streets. I want them to start building farm equipment, so we don’t have so many Chinese farmers tending the fields. I want them to build more laundry machines, to free the rural Chinese from scrubbing clothes on washboards. I want them to build electric stoves, so my Grandpa can put away the coal fired outside oven. I want them to build computers that can deliver cheaper education to the masses.

Instead of just focusing on “building,” I want them to invest in human capital, so productivity can be at a level that we don’t need “make work” jobs. I want them to build more schools and hire better teachers, so classes aren’t as large and you’re not damned if you can’t make it in a top elementary school. I want productivity to be high enough that high end stores don’t need more clerks than actual customers.

I want these things among many others that will only be more obvious in a freer market.

First a bit of context.  Despite my sloppy wording, I was actually pushing back against two claims; that China is devoting too few resources to consumption, and too much to housing.  Although Yichuan’s answer is certainly more persuasive than my post, I’m still not fully convinced:

1.  Several of the items mentioned are investment, not consumption.  These include schools and farm equipment.  No argument there.

2.  Why not go beyond leaf blowers and buy US-style machines to clean streets?  China’s already much too dusty and Beijing now has these machines.  Of course that would be investment as well.  Yichuan wants higher productivity.  So do I.  You get that via investment (and market reforms.)

3.  I noticed that almost the entire Yangtze River delta is covered in new homes.  As far as I know the homes built by those millions of farmers are not subsidized.  They are purchased by farmers from local private sector contractors.  Applying the doctrine of revealed preference, it seems that almost every farmer in that part of China wants a new house at fair market prices. 

4.  Yangtze River delta farmers are rich by the standards of rural China, but less so relative to urban China.  Thus as more and more Chinese are moving into the income levels seen in the rural Yangtze delta, I’d expect an explosion of housing construction, even if China had a 100% free housing market.  The hard truth is that the Chinese people are currently willing to pay very high prices for houses, relative to the cost of production, and realtive to their incomes.  Are the Chinese people “wrong” to be willing to pay so much?  Yes, other investment opportunities are limited.  But it’s not at all obvious to me that these distortions are the main factor pushing up home prices.

5.  I’m not sure the more ramshackle rural homes in the poorer parts of China are set up to take modern home appliances, but that’s just speculation.  In general, new home construction tends to trigger demand for more home appliances.

6.  Like Yichuan, I’d like to see the market allocate resources in China.  In fact, to a surprisingly large extent it already does so.  But I share his concern that the government is probably mis-allocating a lot of capital on showy projects (like manned space flight) that are less useful than new schools.  I was not trying to argue that the Chinese government allocates resources efficiently.  That’s a different question from whether China invests too much, or from the question of whether China builds too many houses.

7.  Chinese car and motorcycle ownership rates are soaring, and yet highway accident deaths are plunging (from 81,000 in 2007 to 62,000 in 2011.)  Could that be due to their massive highway building program, involving lots of divided highways?

8.  Subways are extremely crowded in China.  In a few decades China will have dozens of cities that “need” subways just as much as New York, Tokyo, London and Paris “need” subways.  I can’t even imagine those four cities without subways.  But here’s one problem; today New York is too rich to build a subway system–wages are too high.  If China doesn’t build subways when it’s a developing country, it might later find itself too rich to build the system when it is desperately needed.  Global real interest rates on long term bonds are near zero (think in terms of the opportunity cost of all the capital tied up in China’s holdings of US T-bonds.)  One could argue that it’s a good time for China to build lots of subways, and also borrow lots of money from the West to build lots of schools.  But maybe not, there is that looming demographic/pension/health care nightmare.  In other words, I have little confidence in my opinion of what China’s government should be doing in the area of investment, and I have only slightly more confidence in Yichuan’s opinion.

PS.  I am not able to access Yichuan’s blog in China, so I linked to a Tyler Cowen post where I found the above quotation.

PPS.  I am reading Ronald Coase’s excellent book on China, and hope to do a post soon.

The fallacy of composition lies at the very heart of monetary economics

Most people try to visualize monetary economics at the micro level.  What would I do if the Fed gave me some money?  What would I do if the Fed sold me some money for a T-bond?  But that approach simply won’t work, as these thought experiments are subject to the fallacy of composition:

1.  We all think that we control our own personal quantity of base money.  And we do.

2.  We think the Fed controls the total monetary base.  And it does.

3.  So what if the Fed increases the base, and we don’t want to hold any more money?  What happens?  The answer is that our attempt to get rid of this money causes a change in the macroeconomy (higher NGDP), which eventually causes us to want to hold on to the extra money created by the Fed.  That is the essence of monetary theory, the very core of (non-MMT) monetary economics, not changes in interest rates that may or may not make people want to invest more.

Len Rosenthal and Brito sent me a New York Fed piece by Antinolfi and Keister that seems to fall prey to the fallacy of composition:

In other words, the size of the monetary base is determined by the amount of assets held by the Fed, which is decided by the Federal Open Market Committee as part of its monetary policy.

    It’s now becoming clear where our story’s going. Because lowering the interest rate paid on reserves wouldn’t change the quantity of assets held by the Fed, it must not change the total size of the monetary base either. Moreover, lowering this interest rate to zero (or even slightly below zero) is unlikely to induce banks, firms, or households to start holding large quantities of currency. It follows, therefore, that lowering the interest rate paid on excess reserves will not have any meaningful effect on the quantity of balances banks hold on deposit at the Fed.

The passage is literally true, but in a deeper sense is misleading in a very revealing way.  It relies on a “micro approach” to monetary economics, ignoring the fallacy of composition.

A lower IOER will obviously reduce the total bank demand for ERs.  That’s supply and demand 101.  And Antinolfi and Keister are correct that it will not change the size of the monetary base.  Nor will it directly make people want to hold a single dollar more in currency.  So what gives? 

This attempt to get rid of ERs is essentially a OMO by the banking system.  When they reduce their collective demand for ERs, the money will literally be forced out into the economy.  There are several ways this might occur.  A pessimistic Keynesian would say that interest rates on bank deposits would fall until people wanted to hoard more cash.  An optimistic monetarist would say that the monetary injection would boost NGDP enough so that people would want to hold more cash, in order to make a larger volume of purchases.  In practice, it depends on all sorts of things, most importantly on expectations of future monetary policy.  What sort of signal would be sent by the lower IOER?

Even in the optimistic case, the effect on the stock of ERs would be tiny.  Thus suppose ERs are $2 trillion and cash is $1 trillion.  Also suppose the lower IOER boosts NGDP by 2% (an optimistic assumption.)  In that case currency demand might (and I emphasize might) rise by 2%, to $1.02 trillion.  And that means ERs would fall by $20 billion, to $1.98 trillion.  So they are right that ERs are not significantly affected.  But the macroeconomy might nonetheless be very strongly affected.

Later on they indicate that the lowering of IOER might have macroeconomic effects.  So I’m not trying to say their article is factually incorrect, or that they don’t understand the fallacy of composition.  Rather I’m claiming that 99% of readers would interpret the passage I cited in exactly the same way that I did.  That is, they’d assume that Antinolfi and Keister were trying to show that lower IOER would not do much good, because the level of ERs would not be significantly affected.  They are right that the level of ERs would not be greatly affected, but they are wrong if they are trying to imply that this means the policy would not do much good.  That question can only be answered by evaluating the signalling aspect of lower IOER.

PS.  Later they speculate that a negative IOER would cause banks to hoard currency.  Despite the fact that I was the first to publish a paper advocating negative IOER, I’m not really a big fan of the idea.  But if the Fed did go ahead with negative IOER, it would be absolutely idiotic to exempt ERs held in the form of currency.

An imaginary conversation

The Zen Master:  Money is too tight.

Exasperated Fed official:  But what do you want us to do?

The Zen Master:  First tell me where you want to go?

Exasperated Fed official:  What do you mean?

The Zen Master:  Provide an observable metric for the path of AD over time, and then tell us all the preferred trajectory of that indicator.

Exasperated Fed official:  OK, we’d like to see total spending rise by 6% a year for two years, then 4.5% per year thereafter.  But what do you want us to actually do?

The Zen Master:  You’ve just done it.

PS.  The master of monetary metaphors (Nick Rowe) has a couple highly recommended posts on the implication of various forms of price (and wage?) stickiness.  (Here and here.)

Reply to David Altig

Commenter 123 sent me the following list of questions by David Altig, of the Atlanta Fed:

The questions about the costs and benefits of any particular policy intervention are abundant, and for virtually every potential pro there is a potential con. Here is my personal, certainly incomplete list of pros/cons or benefits/costs associated with another round of large-scale asset purchases:

Pro:  Lower interest rates (and perhaps a lower dollar) will on balance spur spending.
Con:  The expectation of low interest rates for a longer period of time will reduce the urgency to borrow and spend.
Pro:  Expanded asset purchases and lower rates will preserve needed liquidity in financial markets.
Con:  Expanded asset purchases and lower rates will create or exacerbate financial market distortions.
Pro:  More monetary stimulus reduces the probability of an undesirable disinflation in the near term.
Con:  More monetary stimulus increases the probability of undesirable inflationary pressures in the longer term.
Pro:  Lower Treasury and MBS rates will induce an appetite for risk taking that is needed to get productive resources “off the sidelines.”
Con:  Lower Treasury and MBS rates will induce an appetite for risk taking that sets us up for the next bubble.
Pro:  Monetary policy is the only channel of support for the economy, absent new fiscal policies.
Con:  Monetary policy support is relieving the pressure to make needed fiscal reforms that would be much more effective than monetary stimulus.
Pro:  With additional monetary stimulus, GDP growth will be higher and unemployment lower than they would otherwise be, and outcomes may be more consistent with the FOMC’s mandate to promote maximum employment.
Con:  With additional monetary stimulus, the exit from monetary stimulus once the economy improves will be more difficult than it would otherwise be, and outcomes may be inconsistent with the FOMC’s mandate to achieve price stability.
Pro:  The performance of the economy has not been consistent with the FOMC’s mandated objectives.
Con:  The economy is slowly moving in the direction of the FOMC’s mandated objectives, and the Fed should “keep its powder dry” in case of further deterioration of the economy.

[Note: The rest of this post is aimed at the Fed as a whole, not at Altig personally.] 

I am not going to answer Altig’s specific questions.  Instead I’d like to suggest that the Fed as a whole is thinking about the entire issue in the wrong way.  Let’s start with the term ‘intervention,’ which Altig uses in his opening paragraph.  Suppose you went up to the front of the Greyhound bus, and started chatting with the driver.  Suddenly he asked whether you’d like him to continue “intervening” with the direction of the bus.  Most people would be taken aback, indeed that sort of “intervention” is pretty much the be-all-and-end-all of being a bus driver.  You steer the bus.

The Fed essentially steers the nominal economy.  But it has a very ambiguous attitude toward this responsibility.  In real time, it sees movements in NGDP as being caused by factors beyond its control.  Thus banking panics and hoarding caused NGDP to fall in half during the early 1930s, not the Fed.  A private sector wage/price spiral drove NGDP up at an 11% rate from 1972 to 1981, creating high inflation.  And (the BOJ) argued that the bursting of a credit bubble and banking distress drove NGDP lower in  the late 1990s.  And of course the Fed argues that banking distress and a bursting housing bubble drove NGDP 10% below trend in the 2007-2010 period. 

On the other hand when things go well, as when NGDP grew at relatively stable rates from the mid-1980s to 2007, the Fed takes credit for the resulting “Great Moderation.”  It attributes these gains to technical improvements such as the Taylor Principle.  So it doesn’t entirely deny that it drives the nominal economy, rather it only denies responsibility when things go poorly.

Academics see things very differently.  Milton Friedman (and later Ben Bernanke) argued that the Fed caused the collapse in NGDP in 1929-33, and that the Fed was responsible for the Great Inflation.  And they both argued that the BOJ was responsible for the fall in Japanese NGDP in the late 1990s. 

And although Fed officials won’t take the blame for contemporaneous policy failures, they are happy to blame their predecessors, as it makes their current actions seem more enlightened.  Thus the semi-official Fed view is now that Friedman and Bernanke were right, that the Fed did cause the Great Contraction, and that the Fed did cause the Great Inflation.

But this creates a problem, as the arguments used by Friedman, Bernanke, et al, in blaming the Fed for previous errors, also would suggest that they are to blame for the 2007-2010 plunge in NGDP growth.  Consider two important Bernanke arguments from the early 2000s:

1.  Financial distress is no excuse; the BOJ had the resources to boost NGDP growth, it failed to show “Rooseveltian resolve.”

2.  Both interest rates (real and nominal) and the money supply are poor indicators of the stance of monetary policy.  In the end only NGDP growth and inflation are reliable indicators of the stance of policy. 

Of course if you average those two “reliable” indicators, since mid-2008 America’s had the slowest growth in AD, and hence the tightest money, since Herbert Hoover was president.  How does Bernanke reconcile these views?

Bernanke claims money has been “extraordinarily accommodative,” based on the low interest rates and fast money supply growth.  Thus he simply walks away from his 2003 definition of the stance of monetary policy.  And no one in the press has called him on this inconsistency.

He has not walked away from his much more well known denial of “liquidity traps” as preventing monetary stimulus, as that would make him look like a fool.  Instead he’s consistently argued that the Fed could do more, but is held back by certain unspecified “risks and costs” of further stimulus.

This approach to the problem is wrong on all sorts of levels.  There are no costs and risks of keeping expected NGDP growing along a 5% track, level targeting, all the “costs and risks” come from missing the target.  To take just one example, the ultra-slow NGDP growth after mid-2008 drove nominal rates to zero, and greatly boosted the demand for base money.  This forced the Fed to buy lots of assets, exposing them (allegedly) to risk of capital losses on those assets.  But that “risk” is caused by tight money, not monetary stimulus.  Even worse, it’s not really a risk at all, as the Fed is part of the Federal government.  Any losses to the Fed from falling T-bond prices are more than offset by gains to the Treasury.  Indeed that’s why inflation has traditionally been viewed as a boon to government coffers.

But all this minutia about costs and risks misses the bigger picture.  The Fed does not face a difficult choice about whether to intervene or not, it is already steering the bus, it just doesn’t understand that fact.  The Fed needs to decide which direction it wants to take.  There is no “non-intervention” policy by the Fed, as it has a monopoly on the supply of base money.  Admittedly at zero rates there is a lot of slack in the market response to temporary currency injections, but the Fed also has the ability to steer expectations about its longer term goals for NGDP.  I don’t know if Fed officials realize this, but the markets have basically decided that the Fed is happy with no return to the old NGDP trend line, and indeed a downshift to a lower rate of NGDP growth, probably about 4%.  If the Fed doesn’t want that to happen, they need to use different language when talking about their longer term policy goals.  Where will they push NGDP once they’ve exited the zero bound?   Right now they are signalling 4% NGDP growth as far as the eye can see, which means a slow recovery.

I’m not arguing the Fed should “intervene” to “fix problems.”  I oppose discretion.  I want them to clearly set out a path for NGDP (or some other nominal indicator like a weighted average of inflation and output gaps) and set policy at a position where they expect to hit their target.  Just as I’d want a bus driver to set the steering wheel at a position where he expected the bus to remain on the road.

Like Brad DeLong, I thought they had basically decided to do that in the decades before 2007, keeping NGDP growth close to 5%.  And like Brad DeLong I was shocked to find out (in late 2008) that they had no such policy intention.  That they were still like the old Fed of the 1930s, willing to blame the naughty market economy for any deviations of NGDP from a stable path.

I’m sure most readers are much less naive than I am, and understand that big institutions cannot accept blame (in real time) for costly mistakes that screw up the macroeconomy and cause millions to lose their jobs.  Such as failing to cut the fed funds target much more aggressively in 2008, when rates were still 2%.

PS.  Altig links to a John Cochrane piece that seems to take the view that monetary policy is ineffective when nominal rates are zero.  How ironic would it be if Chicago became known as a “liquidity trap” school.  Friedman must be spinning in his grave.

PPS.  Several commenters sent me an excellent piece by James Pethokoukis.  For the record I like Paul Ryan, but not as VP.  Too ideological.  And don’t worry about Romney, I assure you he has zero interest in gold.  It’s all about getting the Ron Paul voters enthused.  Readers from other countries should understand that in America these campaign promises mean nothing.

PPPS.  Very said to hear that Arnold Kling has given up blogging.  I disagreed with is views on macro, but was in awe of his skill in analyzing regulation and the interaction of government and markets.  He was one of my favorite bloggers.