NGDP targeting, rapid growth, and the Balassa-Samuelson effect

Sometimes I’m asked whether the 5% NGDP target is also appropriate for countries like China.  I’m not certain, but my hunch is that it is not.  However it’s not easy to explain why a different rate would be needed.  Yes, 5% NGDP growth would imply 5% deflation in a country with 10% RGDP growth—but so what?  As long as productivity was rising fast enough to generate 10% RGDP growth, a little deflation shouldn’t cause any problems.

Instead, I think the problem lies elsewhere.  Let’s suppose China went for 5% NGDP growth, and experienced 5% deflation as a result.  If PPP held, then the Chinese yuan should rise by about 7% a year against the dollar (assuming we had 2% inflation.)  And if the interest parity condition held, then Chinese nominal interest rates should be 7% lower than in the US.  Since the interest rate on US T-bills (and currency) is 0%, you’d expect the interest rate on Chinese T-bills (and currency) to be negative 7%.

Now I know what you are thinking; “PPP doesn’t hold between the US and China, because of factors like the Balassa-Samuelson effect.”  I agree, and initially I assumed that would somehow “fix” the problem.  Unfortunately it doesn’t.

Let’s assume that the real exchange rate for the Chinese yuan rises by 4% a year due to China’s fast productivity growth.  That seems like a reasonable estimate.  In that case if China has minus 5% inflation and the US has 2% inflation, then the Chinese yuan should be expected to appreciate by 11% per year against the dollar.  And according to the interest parity condition Chinese interest rates should be 11% lower than US rates.  If the yield on US T-bills and currency is 0%, then the yield on Chinese currency should be negative 11%.

Houston, we’ve got a problem.  Macro economics is full of beautiful symmetries that revolve around relationships like the quantity theory of money, the Fisher effect, and purchasing power parity.  This isn’t one of them.  This is ugly.

I’m guessing that one reason the Chinese don’t want negative 5% inflation is that they don’t want massive hoarding of their currency.  Higher inflation solves that problem.  But it doesn’t solve a more fundamental problem; Chinese real interest rates need to be 4% lower than US real interest rates.  But you’d expect real interest rates to be much higher in a fast growing economy like China.  That’s where capital controls and financial repression come in.  China (or I should say the Chinese government) doesn’t want a flood of foreign capital pouring into their country, so they put up all sorts of barriers, and then force Chinese savers to accept very low real interest rates–despite China’s fast growth.  In addition, the SOEs earn lower than expected rates of return because . . . well because they are state-owned and hence somewhat inefficient. Of course this breeds corruption, and also a black market in money-lending—especially in the more market-oriented provinces like Zhejiang.

I can think of one other reason not to have 5% NGDP target in a country with a trend rate of RGDP growth equal to 10%.  You’d have lots of individual people making the jump from the rural to the urban economy, and getting 200% nominal wage increases, and then you’d have to balance that with others getting nominal wage cuts.  In other words, there’s a lot of wage growth variation in a country like China, and thus if you want to avoid the money illusion problem associated with nominal wage cuts, you might want to have a higher trend rate of NGDP growth than in a more stable economy like the US.  I’m sure the Chinese have figured that out at some intuitive level, even if they haven’t worked through the problem in exactly the way I described.


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62 Responses to “NGDP targeting, rapid growth, and the Balassa-Samuelson effect”

  1. Gravatar of Major_Freedom Major_Freedom
    20. June 2012 at 05:24

    The Balassa-Samuelson “effect” should really be called “hypothesis”:

    http://membres.multimania.fr/drineimed/hpbimg/papier12.pdf

    The empirical results of the BS-effect are mixed. Sometimes it holds, sometimes it does not hold.

    Let’s assume that the real exchange rate for the Chinese yuan rises by 4% a year due to China’s fast productivity growth. That seems like a reasonable estimate. In that case if China has minus 5% inflation and the US has 2% inflation, then the Chinese yuan should be expected to appreciate by 11% per year against the dollar. And according to the interest parity condition Chinese interest rates should be 11% lower than US rates. If the yield on US T-bills and currency is 0%, then the yield on Chinese currency should be negative 11%.

    Houston, we’ve got a problem. Macro economics is full of beautiful symmetries that revolve around relationships like the quantity theory of money, the Fisher effect, and purchasing power parity. This isn’t one of them. This is ugly.

    China has exchange rate controls. The Chinese Yuan should not be expected to rise 11% per year against the dollar.

  2. Gravatar of John John
    20. June 2012 at 05:28

    So that’s the drawback to setting an NGDP target below RGDP. What’s the drawback to setting NGDP ridiculously high like 50%? Since you don’t think inflation is a real issue, you think too low NGDP growth is the bigger danger (see your post on 0% NGDP growth in Japan), and stability is the most important thing, I’m not sure what you think the drawbacks are to high NGDP; especially since your recent post defending stagflation.

  3. Gravatar of Major_Freedom Major_Freedom
    20. June 2012 at 05:32

    I can think of one other reason not to have 5% NGDP target in a country with a trend rate of RGDP growth equal to 10%. You’d have lots of individual people making the jump from the rural to the urban economy, and getting 200% nominal wage increases, and then you’d have to balance that with others getting nominal wage cuts.

    Nominal wage cuts means business costs equivalently fall. With lower costs, businesses can sell at lower prices. With lower prices, real wages need not fall.

    You’re conflating nominal wages with real wages.

  4. Gravatar of Ritwik Ritwik
    20. June 2012 at 05:57

    Scott

    Assume no capital controls. Assume no P/E dislocations, at t=0 or at t=1. Assume there’s a Chinese ETF and corresponding USD ETF.

    Since NGDP growth is 5%, the nominal yield on both ETFs, in their currency of denomination, should be 5%. However, the CNY itself appreciates by 11% vs. the USD, so while I only make 5% in USD ETYF, I make 16% in CNY ETF.

    The other way to frame this is that the equity risk premium in China is 16%, while in the US it is 5%. Why would this be so?

    Interest rate parity is an absurd assumption in the face of differential RGDP growth rates. And vice versa.

    Interest rate parity says that an increase in the real exchange rate must be exactly counterbalanced by a difference in the real interest rates. The moment you say that a fast growing economy with greater productivity increases like China must have a higher real rate as well as an appreciating real exchange rate, you’ve contradicted interest rate parity.

    There are reasons for capital controls, high savings corruption, inflation management etc. But viewing them through the lens of interest rate parity doesn’t help.

  5. Gravatar of ssumner ssumner
    20. June 2012 at 07:11

    MR, You said;

    “China has exchange rate controls. The Chinese Yuan should not be expected to rise 11% per year against the dollar.”

    I used to say “did you even read my post?!?!” Now I know that you did–which makes these comments even worse.

    John, It’s not necessarily a bad idea to set the NGDP target below the RGDP trend rate. My point was that it might be a bad idea in a country like China. In a more stable country it might work.

    In my view the main drawback from a high NGDP targeting is the excess taxation of saving and investment. But there are some other costs as well (menu costs, etc.)

    MR, You said;

    “Nominal wage cuts means business costs equivalently fall. With lower costs, businesses can sell at lower prices. With lower prices, real wages need not fall.”

    I was talking about variation in nominal wage growth, so your comment makes no sense.

    Ritwik, I don’t understand where you are going with that, but let me emphasize that the IPC applies where capital markets are open, and doesn’t require equal RGDP growth rates. As long as arbitragers are free to move money around, the IPC will hold.

  6. Gravatar of Jim Jim
    20. June 2012 at 07:33

    Dumb question: Why is the real exchange rate expected to increase with faster productivity growth?

  7. Gravatar of OGT OGT
    20. June 2012 at 07:49

    Given the ZLB and downward nominal rigidity it seems like a bit of a no brainer to set your Nominal target above real growth. And if real growth is less stable than a developed country it would also seem to be logical to give more ‘headroom’ on your NGDP target.

  8. Gravatar of StatsGuy StatsGuy
    20. June 2012 at 08:22

    Scott – the problem (leaving aside the zero bound and political issues, which are probably the real problem) is past expectations. If current asset allocation decisions were based on past expectations of 10% NGDP growth (say, 5% inflation and 5% real), changing this target to 5% NGDP growth creates a massive shift in resources. In the presence of leverage, this is amplified, and firms go bankrupt, with counterparty risk issues. More specifically, the financial system (credit channel) needs direct support.

    Any change to the NGDP target needs to be made with a HUGE lead time to avoid a shock (on the order of 30 years).

  9. Gravatar of Saturos Saturos
    20. June 2012 at 08:46

    Jim, export growth. Use the supply-and-demand model.

    Scott, as you say, China’s real interest rate will have to be lower anyway – capital controls just cut the quantity of investment at that rate. How is that in China’s interest? How is that in the Chinese governments interest? The USA is the favorite destination of global capital, yet neither the US nor its government has lost its economic clout, for all that. And you’d think a smart government would preserve its power by cutting the incentive to have a black market in the first place – kind of like the argument for legalizing and taxing marijuana. Or for that matter, Deng’s revolution.

  10. Gravatar of Major_Freedom Major_Freedom
    20. June 2012 at 08:48

    Jim:

    Dumb question: Why is the real exchange rate expected to increase with faster productivity growth?

    Because with any given nominal exchange rate, an increase in productivity and thus appreciation of the local currency will enable the buyer of that currency to purchase more goods and services in the local country.

    Every time you see the word “real”, it (usually) means the quantity of goods and services that can be bought. So if we say the real exchange rate increased, it means we can buy more goods and services using a currency that is bought at a given nominal exchange rate.

    For example, suppose the exchange rate between Euros and US dollars is 1 Euro to 1.5 US dollars (ignore spread).

    If we assume an initial equality in productivity in the two economies, then should productivity in the US increase relative to Europe, then the real exchange rate for US dollars will go up, despite the nominal rate remaining unchanged.

  11. Gravatar of Major_Freedom Major_Freedom
    20. June 2012 at 09:59

    ssumner:

    “China has exchange rate controls. The Chinese Yuan should not be expected to rise 11% per year against the dollar.”

    I used to say “did you even read my post?!?!” Now I know that you did-which makes these comments even worse.

    I did read your entire post, as I always do when I address anything in them. I didn’t see any mention of currency pegging.

    “Nominal wage cuts means business costs equivalently fall. With lower costs, businesses can sell at lower prices. With lower prices, real wages need not fall.”

    I was talking about variation in nominal wage growth, so your comment makes no sense.

    I realize you were talking about nominal wages.

    I was talking about real wages, so your comment about alleged “problems” with falling nominal wages in isolated areas is incomplete. You say it’s a problem, but it’s not necessarily a problem in terms of standards of living.

    Plus there is the fact that rising wages in one location does not necessarily mean falling wages elsewhere, if the overall demand for labor rises. Increased real savings can do this with sound money, and in the case of a fiat money regime like China, it is almost certainly going to be the case anyway because of inflation.

  12. Gravatar of Ron Ronson Ron Ronson
    20. June 2012 at 11:17

    In a country with a high and quite possibly a variable rate of RGDP growth would not an inflation target be better ? With NGDPLT there would be large variations in the inflation rate which sound like it would be disruptive, especially if it occasionally went negative,

    I know the usual arguments about IT and supply-side shocks but isn’t stable inflation and occasional unnecessary money tightening better that large variations in inflation with occasional deflation ?

  13. Gravatar of Gregor Schubert Gregor Schubert
    20. June 2012 at 15:50

    Scott,
    aren’t you making a mistake by conflating the nominal analysis based on inflation with the real link between productivity and real exchange rates?
    Yes, higher productivity should lead to a higher real exchange rate, GIVEN a nominal exchange rate, but isn’t the mechanism for this to happen that my given nominal amount of money will be able to buy more of the now more abundant domestically produced goods, that is, buy them at a cheaper price? Thus, the higher productivity effect on the real exchange rate of 4% would already entail 4% deflation and does thus not add add to your initial purely nominal analysis but is rather orthogonal to it.

    If what I just said is not correct, I would appreciate a clearer explanation of how productivity growth should effect the nominal exchange rate.

    Incidentally, I don’t think what you are naming as such is actually related to what is commonly called the “Balassa-Samuelson effect” which I always thought refers to price levels differing between rich and poor countries with the real exchange rate being an exogenous input not an output of that effect.

  14. Gravatar of ssumner ssumner
    20. June 2012 at 17:31

    Jim, It’s complicated, but the basic idea is that poor countries have a comparative advantage in non-tradable goods like haircuts. As productivity rises the increase occurs disproportionately in traded goods, like cars.

    The real exchange rate is nothing more than the ratio of price levels. Poor countries tend to have lower overall price levels because they have a comparative advantage in nontraded goods like haircuts, and the prices of traded goods like cars tends to equalize.

    And don’t pay any attention to Major Freeman, he has no idea what the Balassa-Samuelson effect is. He’ll just confuse you.

    OGT, To some extent it depends on whether the rigidity is in wages or prices.

    Statsguy, True, but that doesn’t explain why countries let NGDP growth rates rise higher as RGDP rises.

    Saturos, I actually don’t know the current Chinese real interest rate, but it’s obviously higher than predicted by the IPC. I’m sure politics explains a lot of this.

    Ron, I can’t emphasize enough that people should just stop thinking about inflation. It doesn’t matter, indeed it doesn’t even exist except in the minds of government bureaucrats. It’s NGDP instability that causes problems, not inflation instability.

    Gregor, I’m afraid I don’t understand all of your comment, but what I do understand seems wrong. The change in the real exchange rate is not dependent on any assumptions about the nominal rate.

    The B-S effect says China’s real exchange rate should rise at a few percent per year. The change in China’s nominal exchange rate is the increase in the REE plus the US inflation rate minus China’s inflation–assumed to be 4% plus 7% in my example.

    Maybe if you used specific numbers I could better follow your argument.

    The ratio of price levels (measured in the same currency) is the real exchange rate, so I don’t follow your last comment.

  15. Gravatar of Ron Ronson Ron Ronson
    20. June 2012 at 18:44

    (With my Bob Murphy hat on)

    Why not just go for 1000% NGDP growth ?

  16. Gravatar of Ron Ronson Ron Ronson
    20. June 2012 at 18:46

    (and without it on)

    If neither inflation not deflation matter what different does it make what level of NGDP you set , or if you set one at all ?

  17. Gravatar of Ron Ronson Ron Ronson
    20. June 2012 at 19:00

    (and thinking about it more fully)

    I suppose you will say that as long as business knows that sales will hold up then they will be able to make the necessary price adjustments (up or down). Is that true though ? Excessive Inflation will cause relative pricing to move out of kilter and deflation will presumably be worse due to price stickiness.

  18. Gravatar of Paul Andrews Paul Andrews
    20. June 2012 at 20:57

    Scott,

    Some quotes from you recently:

    June 11: “I deny the existence of the price level.”

    June 14: “”Maybe I shouldn’t have said “non-existent.” What I meant was that there was no correct price level “out there” waiting to be measured. Perhaps I should have said it is not useful.””

    June 20: “(inflation) doesn’t matter, indeed it doesn’t even exist except in the minds of government bureaucrats.”

    Which is it to be?

  19. Gravatar of J.V. Dubois J.V. Dubois
    21. June 2012 at 00:37

    This article totally messed me up, I feel that I cannot think straight. Let me explain how I think about is. If we assume that real interest rate expected in China is a natural rate that is long-term real GDP growth we know that this has to be 10%. So if they would target 5% NGDP growth that would mean that nominal interest rate in line with expected real interest rate should be 5%. It is calculated as expected real interest rate + inflation. So basically agents in economy expect to have their share from whatever money expansion happens (assuming that velocity is stable in the long run) and they rely on growth in productivity for their real returns.

    Now about that 4% productivity growth in export sectors + currency appreciation: I think you kind of assume the result. The point here being that if there are vast differences in interest rates, it should be solved by capital inflow into China. I would say that this is the natural way how difference in real growth stemming from undercapitalisation in one country should be balanced. So in short, productivity and export can have very strong growth but it could be “sterilized” by strong growth in import of capital goods.

    But then I am not very good at this so it is quite liklely that I have it wrong.

  20. Gravatar of nickik nickik
    21. June 2012 at 01:55

    Scott,

    This is confusing to me. Why is 5% so optimal? Are not all the things you said about productiv norm in america true for 5% NGDP growth for China?

    Can you make any argument why 5% and not something else. The Free Banker Productivy Norm people kind of avoid this problem by just making MV stable whatever the situation.

  21. Gravatar of Gregor Schubert Gregor Schubert
    21. June 2012 at 02:01

    Let me try and clarify what I was wondering about:
    The B-S effect assumes PPP holding only for tradables. Thus, we know that the (nominal) exchange rate will only reflect differences in inflation between tradables in China and the US. Therefore, to what extent CPI inflation gets reflected in the exchange ratewill depend on the extent to which it stems from inflation in tradables prices. However, the B-S effect also tells us that a productivity increase in tradables will lead to a shift in relative prices between T and NT goods which will mean that NT prices rise faster in the short term than T prices.

    The result should be that an increase in T productivity of, say, 4%, in China, means that NT inflation is above the CPI inflation and T inflation below CPI inflation to achieve the necessary adjustment of relative prices. Thus, to return to your example, CPI inflation of negative 5%in China with concurrent T productivity growth should mean that tradables inflation is even lower and that the appreciation should be correspondingly even higher than 11%.

  22. Gravatar of Major_Freedom Major_Freedom
    21. June 2012 at 02:24

    By the way, the -7% or -11% interest rate you inferred has to exist in China, based on the various contingencies of productivity and PPP and so on, that tells you 5% NGDP targeting at the country level is untenable, is what Hayek was talking about when he said countries should not engage in targeting money and spending lest it lead to international instability.

    Instead of accepting that -11% interest rate is enough to reject 5% NGDP targeting at the country level, you write another blog post suggesting the use of a “virtual fed funds target” that can go negative, so that if rates have to be -11% in China, they can de facto accomplish this by keeping nominal rates at zero, and pretending that a virtual fed funds negative rate can be used as if it exists by monetizing the kitchen sink.

    Imagine rates being at zero for a generation in China, while they maintain a 5% NGDP target by way of utilizing a negative virtual policy rate! Imagine the local and international instability that would result!

    ——

    I know the answer, but what if NGDP targeting carries with it a supply-side causation for correction? What if NGDP targeting can avoid a correction caused by a collapse in aggregate money and spending, but itself brings about supply-side correction by way of what inflation does to economic calculation and the capital structure of the economy? I think it takes a leap of faith to believe that in the long run, any such causation of supply side problems would “reverse”, or “correct”, in a constant growth NGDP world.

    Just look at Australia. They had roughly stable NGDP growth 1990-2008. Why then did the central bank have to engage in an accelerating aggregate money supply growth program? Why didn’t the stable NGDP growth require stable money supply growth?

    The answer of course is that the monetary inflation itself morphs into supply side problems that only accelerated inflation can postpone from correction, because division of labor entrepreneurs who have made errors due to distortions caused by inflation, can only be deluded into continuing their investment and spending patterns by the same nominal means that made them make those errors in the first place. So the inflation that is needed to postpone correction, itself creates new problems that need even more money to maintain.

    The ultimate reason why this is taking place is because the law of scarcity is asserting itself. Sure, if resources were infinite, then inflation would be able to bring about unlimited prosperity. But we are not living in the Garden of Eden. We live in a world of scarcity. This has the effect of forcing upon a division of labor society the requirement that production be coordinated in the physical sense. Projects started that are not sustainable to completion, cannot be sustained by the same thing that caused them to arise in the first place, which is a given nominal dose of inflation. No, they require INCREASING doses of inflation, because the inflation itself is the very cause of the past unsustainable configuration.

    The more that physical reality asserts itself, the more the central bank finds that it has to print more money to maintain spending and to avoid correction. So the aggregate money supply that is needed to maintain spending growth for unsustainable investments, has to accelerate over time.

    —–

    The biggest lesson that all market monetarists need to learn, and learn well, is that because inflation distorts economic calculation, a constant money supply growth is INSUFFICIENT for bringing about constant NGDP growth. A constant NGDP growth, in a world of scarcity, in a world where inflation distorts economic calculation, this requires accelerating money supply growth.

    Inflation CHANGES people and CHANGES the capital structure of the economy. It doesn’t just affect prices and spending. It affects the real side of the economy in such a way that the real economy becomes addicted, so to speak, to inflation, and requires ever more to continue being an inflation economy.

    It is very much like a drug addict, despite Sumner’s scoffing at the analogy. A drug can make a person feel good for a time, but because the drug itself changes the person, because the same dose rate has less and less of an effect, it means in order to bring about the same effect, an ACCELERATING dose rate is required. If the same dose rate is applied, then the effect (NGDP) will be reduced. People CHANGE with inflation. Again, only Austrians grasp the importance of people changing over time. NGDP theory presupposes humans are automaton robots. They say de facto NGDP has worked in the past, de jure NGDP targeting will work forever in the future. It violates Goodhart’s Law.

    Sure, there won’t be problems associated with 90% of the money supply and spending disappearing overnight. But the cost is problems associated with 90%, then 900%, then 9000%, etc increases in the money supply.

    Sumner has said don’t worry, we can just shave off zeroes from the currency and rename the money. But he doesn’t understand that even these renaming events will tend to accelerate too. A monetary system cannot function if the currency is renamed and redenominated every year, then every hour, then every minute, then every second. The monetary system will completely breakdown because it can no longer function as a tool for economic calculation. If the state is relentless, they might be able to force the people to keep using the new editions over time, but civilization would collapse because the division of labor would break down.

    Market monetarism is a long term path to the collapse of civilization. It’s not a permanent solution. It’s just another flavor of the month, ad hoc, central planning IDIOCY that no amount of sophisticated analysis, posturing, and scoffing can hide.

    I write this because I want to make it clear that market monetarists had no excuse in advocating the things they do. They were told MANY times. Since Sumner’s baby boomer generation has damaged the world to a huge degree, I want historians to look back and realize just how muddle headed and dogmatic they were. They don’t listen to reason because reason refutes their entire program, the same way Marx did not listen to reason because reason refuted his program. He introduced polylogism in an attempt to safeguard his beliefs from the critiques of the rationalists. Market monetarists are doing something similar. They are re-introducing the assumption of constancy in human action in an attempt to safeguard their beliefs.

  23. Gravatar of Major_Freedom Major_Freedom
    21. June 2012 at 02:31

    ssumner:

    Jim, It’s complicated, but the basic idea is that poor countries have a comparative advantage in non-tradable goods like haircuts.

    Good lord someone doesn’t understand basic economic concepts.

    Comparative advantage presupposes trade between the parties compared. It explains how gains can be made for all parties through exchange, despite one party being absolutely more productive in all goods and services. It is the trading itself that enables us to learn the contents of comparative advantage.

    Comparative advantage in non-tradable goods is like saying you are a better hamburger eater than I am a runner.

  24. Gravatar of Saturos Saturos
    21. June 2012 at 02:32

    Ron Ronson, non-indexed taxes (especially on capital), shoeleather costs, and the almost inevitable descent into unpredictable price levels, with the associated debtor-creditor redistribution and calculation failure.

    Paul Andrews, the price level plainly is out there as that which can be calculated by the chain-weighted base prices method. Whether Scott Sumner finds it useful for whatever particular purpose he has in his head is another matter.

    Scott, so you’re saying repression forces up real rates from the parity equilibrium. But that means higher returns for savers than otherwise. And I still don’t see how the Chinese government profits from holding back investment.

  25. Gravatar of Saturos Saturos
    21. June 2012 at 02:40

    Oh wait, never mind, it must be this sort of thing: http://whynationsfail.com/blog/2012/3/12/whos-afraid-of-development.html
    http://whynationsfail.com/blog/2012/2/28/the-cow-eats-where-it-is-tethered.html

  26. Gravatar of Bill Woolsey Bill Woolsey
    21. June 2012 at 05:21

    I think the problem with the analysis is the “if the T-bill rate is zero….”

    And then trying to come up with an equilibrium where investors get the same real return on Chinese debt as on T-bills.

    What market process would drive down the interest rate on Chinese debt to zero (and below, leaving aside the possibility of storing Chinese currency notes in safes.)

    Well, it would involve people selling Tbills and using the proceeds to buy Chinese securities.

    This tends to raise the yield on T-bills, which breaks the starting assumption.

    If this process is blocked by capital controls (people can’t really buy Chinese securities) or the Chinese state is holding the T-bills and is willing to take a loss on them, then there is no equilibration process.

    In the trully long run, capital flows into China until the marginal product of capital falls, and the growth of output and the implied high real natural rate of interest falls.

    Now, I would suggest that China have a more rapid growth rate for nominal GDP. And I also think shifting to a slower one some time in the future would also be wise.

    But I don’t think that trading with countries with slower growing real output means that slower trend growth of nominal GDP and rapid deflation of final goods prices creates some puzzle regarding equating real interest rates.

    If you have trully open capital markets, then it just is the same reality that the greater returns to investment in the rapidly growing economy should involve capital flows. It is those capital flows that brings the interest rates into equilibirum.

  27. Gravatar of Bill Woolsey Bill Woolsey
    21. June 2012 at 05:21

    I think the problem with the analysis is the “if the T-bill rate is zero….”

    And then trying to come up with an equilibrium where investors get the same real return on Chinese debt as on T-bills.

    What market process would drive down the interest rate on Chinese debt to zero (and below, leaving aside the possibility of storing Chinese currency notes in safes.)

    Well, it would involve people selling Tbills and using the proceeds to buy Chinese securities.

    This tends to raise the yield on T-bills, which breaks the starting assumption.

    If this process is blocked by capital controls (people can’t really buy Chinese securities) or the Chinese state is holding the T-bills and is willing to take a loss on them, then there is no equilibration process.

    In the trully long run, capital flows into China until the marginal product of capital falls, and the growth of output and the implied high real natural rate of interest falls.

    Now, I would suggest that China have a more rapid growth rate for nominal GDP. And I also think shifting to a slower one some time in the future would also be wise.

    But I don’t think that trading with countries with slower growing real output means that slower trend growth of nominal GDP and rapid deflation of final goods prices creates some puzzle regarding equating real interest rates.

    If you have trully open capital markets, then it just is the same reality that the greater returns to investment in the rapidly growing economy should involve capital flows. It is those capital flows that brings the interest rates into equilibirum.

  28. Gravatar of Mike Sax Mike Sax
    21. June 2012 at 05:51

    Saturos-thank you. You’re a welcome reality check

  29. Gravatar of Becky Hargrove Becky Hargrove
    21. June 2012 at 06:43

    Saturos, the first link: also a good reminder why governments risk destroying their own budgets by keeping knowledge use artificially scarce, which means struggling to pay the way for people who cannot use knowledge to help themselves.

  30. Gravatar of Saturos Saturos
    21. June 2012 at 07:10

    Becky, you are a deep and mysterious thinker. I hope to understand what on earth you are on about someday.

    Mike, not sure what you’re referring to either, but thanks.

    Scott, I think Bill’s got you there.

  31. Gravatar of Ritwik Ritwik
    21. June 2012 at 09:55

    Bill Woolsey

    How does 0 matter? Assume that the rate on t-bills is 11%. So the real interest rate is 9%. Chinese short term rates should then be 0% in the example that Scott gives.

    Plus, the rate on t-bills as being discussed here is the stable equilibrium rate that the market settles to AFTER the process of arbitrage.

    Scott

    I’m not sure why you find my example confusing. r(china) = r(US)- REER appreciation. A country that has an appreciating real exchange rate is required to have a lower equilibrium real rate if interest rate parity holds. You cannot simultaneously say the following three things :

    1) China has an appreciating REER.
    2) China has higher real interest rates.
    3) Interest rate parity holds.

    You’re looking to explain the contradiction by the means of capital controls. But if you move away from China you will find that even with an open capital account IPC does not hold. IPC is a risk-neutral condition.

    But even if you assume away risk for a moment, the equivalence of real risk free rates in two different economies implies that the equity risk premia in these two economies should be *vastly* different if their growth rates differ vastly. Indeed, the difference in the equity risk premia will be exactly equal to the difference in the nominally safe interest rates, so long as the total return on equity is equal to the economy wide growth rate (a fairly straight=forward assumption).

  32. Gravatar of Mike Sax Mike Sax
    21. June 2012 at 09:59

    Saturos just in general there’s a lot of information put out by certain commentators-who ever could they be?-and often it’s you who seem to clear up the errors

  33. Gravatar of Mike Sax Mike Sax
    21. June 2012 at 09:59

    I should say “misinformation” that is put out there

  34. Gravatar of Major_Freedom Major_Freedom
    21. June 2012 at 10:01

    Bill Woolsey:

    This tends to raise the yield on T-bills, which breaks the starting assumption.

    Not if the Fed reacts and buys t-bills to keep the t-bill rates at zero.

  35. Gravatar of Major_Freedom Major_Freedom
    21. June 2012 at 10:10

    Saturos:

    Becky, you are a deep and mysterious thinker. I hope to understand what on earth you are on about someday.

    Becky is dealing with the philosophical question/dilemma of limitations to human knowledge, and such limitations being used as a weapon of denial/exclusion against the weak, similar to how some people believe the limits of wealth allegedly created by the institution of private property can be used as a weapon of denial/exclusion against the weak.

    She is trying to come to terms with her own limitations, and she uses “the weak” as an ideal abstract type to defend whatever policies of force are necessary to minimize the effects of wealth and information scarcity.

    The mind is to be unshackled from the fetters that external physical reality imposes. Release the binding constraints on knowledge – of information – and weak/poor people will be empowered, and the state will not need to spend so much money on themselves releasing, TEACHING, such information.

    Becky: What you are thinking requires lifting the ban on inside information, so that weak and poor people who DO acquire such information, can earn gains by trading off of it. You OK with that?

  36. Gravatar of Saturos Saturos
    21. June 2012 at 10:18

    Well there will always be genetic inequality*, and inequalities of innumerable idiosyncratic circumstance which flow together to make an individual’s life. But doesn’t Becky think that once every human has access to an Ipad with the internet and Wikipedia, you have all the information you need? No one can ever have all the productive knowledge, that’s what the market is for (and why Hayek favored some redistribution), but is she talking about an inequality which is closable yet not closing with the years? Or is she talking about some Assange type stuff? Or is figuring out what she really means going to be like reading Heidegger or Hegel (lord help me)?

    *we can construct the appropriate S/F scenario where this doesn’t hold, but I fail to imagine it in a way that isn’t dystopian.

  37. Gravatar of Major_Freedom Major_Freedom
    21. June 2012 at 10:35

    Saturos:

    But doesn’t Becky think that once every human has access to an Ipad with the internet and Wikipedia, you have all the information you need?

    All information on the internet and Wikipedia is (obviously) historical and public. There is also information that is non-public and non-historical. For example, what I plan to do next week. Yes, I guess it becomes historical as soon as I think it, but it is always subject to revision and replanning, so it’s not historical in that sense.

    Hayek spoke about the dispersed nature of knowledge in human society. Even with wikipedia and the internet, knowledge is still dispersed. No one person knows all the information that resided in “the internet.” It’s available in principle, but each individual much economize their time. Whatever they do, whatever they learn, they cannot learn anything else during that time, and their time is scarce. This is why central planning doesn’t work according to Hayek.

    I think Becky’s thinking is not so much technical as it is philosophical. It is a question that cannot be definitively answered by proposing new technology that can only ever minimize, but never reconcile, the issue.

    I also got the impression that she was talking Assange type stuff, of how power centers depend on hierarchical information structures, which can be broken down by the reaction of those power centers tightening up their communication in response to information leaks, thus making the power center ineffective.

    Yes, I think it will be something along the lines of reading Hegel, lord help you.

  38. Gravatar of Becky Hargrove Becky Hargrove
    21. June 2012 at 12:20

    Lord help me because I’ve never taken the time to learn philosophy – too many other books beckoned first! It makes me nuts framing this in philosophical terms but I have little choice because I have to explain why this stuff matters. Mine is the learning from real life how people use assets and resources of all kinds to gridlock the lives of others, and knowledge is just the most important example. While I’m also not well read historically, who can miss the long segments of history where widespread knowledge use pretty much disappears. That’s what worries me most and so gets my main attention.

    The idea is to use knowledge incrementally in a stairstep fashion. Learn something, turn around and find an immediate way to apply it even if that means talking to someone about it, so as to commit it to long term memory. Most importantly for wealth capture of knowledge at local levels, start with basic healthcare work/educaton that keeps most people out of emergency rooms and allows people in rural areas to stay there instead of seeking out cities unless they need surgeries. Take virtual knowledge and make it real at local levels so that in the event of catastrophe, widespread knowledge use is anywhere and everywhere in the world, not just strategic cities as is happening now, unfortunately.

  39. Gravatar of Major_Freedom Major_Freedom
    21. June 2012 at 13:11

    Becky:

    Mine is the learning from real life how people use assets and resources of all kinds to gridlock the lives of others, and knowledge is just the most important example. While I’m also not well read historically, who can miss the long segments of history where widespread knowledge use pretty much disappears. That’s what worries me most and so gets my main attention.

    In other words, if I get what you are saying, the more dispersed and specialized knowledge becomes, the more “alienated” people become in terms of knowledge and resources, the worse off “humanity” will get? I agree. But let me explain before you say AHA!

    The more individuals become specialized in their knowledge, the more “individualistic” they become mentally, the less any given individual is “human” in the sense of having common knowledge with other individuals. “Human” is what is common between all of us. Our individual desires, knowledge, and wealth, are what makes each of us unique.

    You say that such knowledge and resource specialization is being used by some to “gridlock” the lives of others. But is that really people being gridlocked? Or is it other people becoming more specialized in the individual unique ways, in terms of knowledge and wealth, that it only APPEARS as though the relatively weak and poor are being MADE to be that way by the actions of others?

    For example, if there is a race, and there are certain faster people, then as the “distance inequality” increases, as their individual spacetime locations become more and more “alienated” relative each other, is this a case of the faster CAUSING relative slowness in the others? Or is the relative slowness of the others their own individual realities being manifested, which are then compared with the faster in a misguided way?

    You have to realize that gains can be made for even the weak and poor, the relatively weaker and poorer they become due to the efforts of the strong and wealthier! This might seem counter-intuitive, but it can be summed up in the expression that it is better to be poor in a rich country, than to be equivalently poor in a poor country, because one can make more gains living among wealthy people, who have more to trade and give through charity.

    Of course you have backwards thinking people who believe all wealth is ill-gotten exploitation of the poor, so the poor are justified in stealing from the rich through government force (what is called wealth redistribution).

    The poor are best off not in a country where private property rights are attacked, but where they are most protected. Read the book “The Mystery of Capital” to see a good explanation of this.

    The more private property rights are protected, meaning the less chance the rich have an opportunity to steal from the poor, and the less chance the poor have an opportunity to steal from the rich, either privately or through government, the more wealth that can be produced for the mass market and the better off both rich and poor will be. The reason why Wal-Mart is able to cater to millions of poor people in the US, but not in Afghanistan, is because private property rights are better protected here than there. Wealth redistribution taken to its maximum is communism, no price system for the means of production, and economic chaos.

    Knowledge is increased along with wealth increase. A person on a desert island will learn less about science and technology, than they would in a modern industrial economy where there is access to wealth that is itself required to learn science and technology.

    Most people believe science and technology only bring about more wealth, but it is also true that more wealth brings about more science and technology.

    Poor areas of the world can be helped the most by maximally protecting property rights, which encourages saving and investment, and thus wealth formation, and thus further science and technological progress.

  40. Gravatar of Becky Hargrove Becky Hargrove
    21. June 2012 at 14:46

    MF,
    Hernando de Soto is one of my biggest heroes. I want to do for knowledge use rights, what he has worked to do for property rights. And he has done it the way it sometimes has to happen: locally, up close and personal. Wealth capture of knowledge use rights can bring small towns and forgotten cities everywhere back into the global economy.

  41. Gravatar of Major_Freedom Major_Freedom
    21. June 2012 at 16:31

    Becky:

    Hernando de Soto is one of my biggest heroes. I want to do for knowledge use rights, what he has worked to do for property rights. And he has done it the way it sometimes has to happen: locally, up close and personal. Wealth capture of knowledge use rights can bring small towns and forgotten cities everywhere back into the global economy.

    I’m with you.

    My position is that private property applied to knowledge requires that all intellectual property laws should be abolished.

    I hold information and knowledge to really be the brain states of individuals, and so should an individual change in such a way that their own brains are in a particular pattern that would manifest a particular thought, then that thought becomes their property, even if a duplicate brain pattern exists in another individual, i.e. even if another individual has the thought.

    So if in a small community of relatively poor people, some of them change in such a way that their brain states are consistent with having an idea that is “patented” by another individual somewhere else, then that small community of people should be able to utilize their own brains and their own property to produce, sell and earn profits using their own brains, despite the fact that their brains match another person’s brains who wants to monopolize it.

    Intellectual property laws are fascist attempts for some businessmen to claim unjust ownership rights over the minds and resources of other businessmen. I think IP laws are holding poor and weak people down by the state forcing them not to utilize their own knowledge, not to utilize their own brains, their own property, to improve their standard of living.

  42. Gravatar of Major_Freedom Major_Freedom
    21. June 2012 at 16:34

    In China, where IP law “violations” are rampant, I argue it has helped millions of people to rise out of poverty.

  43. Gravatar of Becky Hargrove Becky Hargrove
    21. June 2012 at 17:18

    I’m not attacking IP laws per se, although I do believe the pharmaceutical industry should give the right back to individuals to use natural remedies for healing, remedies which are often confiscated for the use of the corporation, while the public is told the remedy was either useless or outlawed for direct use. You have to remember that simply outlawing IP laws is in its own way as extreme as outlawing property, and doing so would not necessarily guarantee that value would remain for the IP that was ‘freed’ overnight. What matters is the context in which knowledge is used and held in common for it to have value in the first place. While we speak of a free market, a lot of societal coordination had to happen for private property to have meaning, and so social coordination needs to happen again before knowledge is freed for use in individual to community (non tradable goods) settings. All that is being done in such a setting is recreating societal norms (time measured services activity) to provide a better support system for capitalism than now exists. Capitalism largely escaped the developed world when the old societal norms disappeared. We need new coordinated norms to bring it back, and knowledge/skills based services is the perfect way to make that happen. The best of knowledge in such local settings eventually is compensated just as higher income is now, but capitalism can provide a sustainable base (affordable living patterns through better technology) so that knowledge need not be randomly mined or devalued, as in the present.

  44. Gravatar of Major_Freedom Major_Freedom
    22. June 2012 at 09:12

    Becky:

    It is the state that is stopping people from using natural remedies. Some corporations are opportunists, and some even write the laws and lobby to have passed, but at the end of the day, it’s the state that is stopping people. Remove that state’s power, and corporations would be powerless to stop you directly and indirectly.

    I think abolishing IP laws is as extreme as protecting property, since I consider IP laws to be violations of property.

    I don’t want a guarantee of value of IP protected ideas. It’s the value individuals attach to the ideas and knowledge that matters to me. If an individual does not value it, that’s their choice, and if they do, that’s their choice.

    I don’t fully agree that a lot of societal coordination had to happen for private property to have meaning. Private property derives from the common perception that what one produces, ought to be disposed of by the producer, rather than a non-producer. There are property systems all over the world, and have been since the dawn of humanity. Even Olstrom-ite communities have property rules, of only allowing members of the community rights of possession/usage vis a vis outsiders, etc. Very few if any humans have ever acted as if there really was no such thing as property. Evolution would have killed them off if there were, since resources are scarce. In the Garden of Eden, sure, maybe propertyless thinking could be naturally selected.

    I think there is social coordination now, enough to enable the spread of these ideas now.

    All that is being done in such a setting is recreating societal norms (time measured services activity) to provide a better support system for capitalism than now exists.

    Time measured service activity? You mean the labor theory of value?

    Capitalism largely escaped the developed world when the old societal norms disappeared. We need new coordinated norms to bring it back, and knowledge/skills based services is the perfect way to make that happen.

    Does this not presuppose private property rights?

  45. Gravatar of Saturos Saturos
    22. June 2012 at 10:37

    Becky, knowledge is scarce like everything else. You have to pay for access to it, one way or another. You have to make a rigorous externalities/public goods case to justify government spending to improve “capture of knowledge”.

  46. Gravatar of Major_Freedom Major_Freedom
    22. June 2012 at 10:42

    Saturos:

    Becky, knowledge is scarce like everything else.

    Ideas are not scarce. They can be in principle copied an infinite number of times. They need not ever run out. An idea discovered 10,000 years ago can be duplicated and used a limitless number of times a million years henceforth.

    This isn’t true for things like oil, animals, and plants. They cannot be duplicated in this way.

    This is one of the reasons why I believe attempts to “own” ideas are unjustified. It would be like people trying to monopolize the idea of “existence of self.”

  47. Gravatar of Becky Hargrove Becky Hargrove
    22. June 2012 at 13:02

    Saturos,
    In part, I am asking for greater freedom in the knowledge which is ‘allowed’ to be captured. For instance, Tyler Cowen just posted about John Goodman’s “Priceless: Curing the Healthcare Crisis.” The reviewer said, “In my work I am constantly struck by how many great healthcare delivery ideas are illegal…” And Goodman says “we have forgotten how to let process innovators test solutions and chip away at problems the way they do…in other industries.”

    In the early eighties I was fortunate enough to experience innovative medicine that was quickly run out of the U.S. and only now do doctors talk about those same ideas on daytime TV. This is one reason why I suggest a coordinated and voluntary environment for ongoing research and development in non-monetary ways, because there is so much now that is not allowed in a monetary framework.

  48. Gravatar of Mike Sax Mike Sax
    22. June 2012 at 13:09

    “This is one reason why I suggest a coordinated and voluntary environment for ongoing research and development in non-monetary ways, because there is so much now that is not allowed in a monetary framework.”

    Hey Becky! I wonder what you mean in this context by “non-monetary ways” I’m not sure how you’re using the world monetary here

  49. Gravatar of Becky Hargrove Becky Hargrove
    22. June 2012 at 13:34

    Mike,
    I’m using ‘non-monetary’ in a context I refer to as a ‘knowledge prior’, in which activities are coordinated around approximately parallel time use, which does not face the limitations of normal production efficiencies. You only need to recall that production efficiency residuals are putting the big squeeze on knowledge services in the present. (of course Morgan would express that differently!) While time use could be converted to monetary units it would be far better if people knew the difference between production efficiencies first so that they would not have to be worked out mathmatically, such as the differences between countries which have different estimations on services in general.

  50. Gravatar of ssumner ssumner
    22. June 2012 at 15:47

    Paul, The June 14 and June 20th comments reflect my current views. And no, they aren’t inconsistent.

    JV, I agree that things should get resolved through capital flows, and that would make Chinese interest rates strongly negative. But you can’t have negative nominal rates, and of course capital is not allowed to flow freely.

    nickik, I picked 5% partly because that was the trend rate the Fed was aiming at, so contracts were signed on that expectation. And partly because I’ve never seen a persuasive argument for another rate–so if it ain’t broke, why fix it?

    Gregor, Now I see where your mistake is. My assumption that the real exchange rate would rise at a 4% rate does not mean that tradeables prices rise 4% less than nontradeable prices, but something greater. I’m pretty sure my math is right on this, as my assumptions were very simple. If you assume a 4% RER change, and a seven percent inflation differential, then the nominal rate must rise by 11%–that’s just using definitions.

    MF, You just keep offering one blooper after another. Comparative advantage assumes trade?? Hayek was thinking about the B-S effect when he said gold standard countries couldn’t target NGDP?? What next??

    Bill, I think you misunderstood my comment (my fault.) I agree that with open capital markets everything gets resolved via arbitrage. US interest rates would be 11% higher than Chinese interest rates of equal risk. That means a lot of capital would pour from the US to China to make that happen. I was discussing the current situation, where there are capital barriers that prevent that from occurring.

    Ritwik, I still don’t follow, The IPC has nothing to do with real interest rates, it’s all about nominal rates and exchange rate changes. If you have open markets and arbitrage it will hold for risk free assets, regardless of what’s going on with real interest rates. The B-S effect doesn’t cause the IPC to not hold.

  51. Gravatar of Becky Hargrove Becky Hargrove
    22. June 2012 at 16:42

    Saturos,
    You’re right that knowledge as used within monetary priors always has to be treated as a scarce commodity, especially in timeframes where primary resource use (as in present day fossil fuels) has continued along an equilibrium that is already mature.

  52. Gravatar of Major_Freedom Major_Freedom
    23. June 2012 at 14:34

    ssumner:

    MF, You just keep offering one blooper after another.

    You just keep saying that, without ever proving it. You just want everyone to take you on faith, the way you have accepted central banking on faith.

    Comparative advantage assumes trade??

    Of course! It’s what the originator Ricardo assumed, it’s what every economist since has assumed. The whole point of comparative advantage is to explain how even the least productive members of society can still create gains for both himself and others, if he (and others) focus on what they are each relatively best at.

    It is not a theory that just assumes something like “Scott in America is better at comedy than Yichuan in China, and Yichuan in China is better at haircuts than Scott in America.”

    No, it assumes that Scott and Yichuan can each make gains if Scott devotes his time to comedy, and Yichuan devotes his time to haircuts, and then they exchange with each other, thereby consuming more comedy and haircuts in total.

    Hayek was thinking about the B-S effect when he said gold standard countries couldn’t target NGDP??

    Hayek said countries should refrain from doing what you call NGDP targeting. (Then he said he would do everything he could to prevent nominal incomes from falling. Then he said it would be very harmful to maintain country spending at an appropriate level. In other words, Hayek was inconsistent on this score).

  53. Gravatar of Paul Andrews Paul Andrews
    24. June 2012 at 22:10

    Scott,

    June 11: “I deny the existence of the price level.”

    June 14: “”Maybe I shouldn’t have said “non-existent.” What I meant was that there was no correct price level “out there” waiting to be measured. Perhaps I should have said it is not useful.””

    June 20: “(inflation) doesn’t matter, indeed it doesn’t even exist except in the minds of government bureaucrats.”

    June 23: “The June 14 and June 20th comments reflect my current views. And no, they aren’t inconsistent.”

    So inflation does not exist outside the minds of government bureaucrats, but the price level does?

  54. Gravatar of Major_Freedom Major_Freedom
    26. June 2012 at 12:21

    Paul:

    You seem like a logical thinker.

    —–

    I think the June 14th and June 20th comments are inconsistent.

    If one argues that the price level exists in reality, but just can’t be accurately measured, and they also argue that price inflation does not exist in reality but is only in people’s minds, then those are inconsistent statements.

    This is because if we accept that price levels exist, then so too does price inflation exist, since price inflation is just the percentage change between two subsequent price levels both of which exist! Sure, you can debate the weakness of this, by asking someone to compare the evolution of price of “a Dell personal computer”, but this is not an argument against the existence of price inflation, it is an argument concerning how one should define a good whose price is to be “tracked”.

    ——-

    Most people understand what you mean when you say “The prices of most things have gone up over the years.” The intuition is not silly. It does have meaning.

    ——-

    My own solution to reconciling people’s intuition, with reality, is not to try and track the evolution of prices for universal concept,or class of goods, which contain many different sub-concepts, such as “a Dell personal computer”, but rather, to track the evolution of prices for what are called existants. These are the building blocks of universal concepts such as “Dell personal computers”.

    Existence is a universal attribute common to all goods. Indeed, it is the UNIQUE attribute common to all goods. Every good is an “existant”, because they each have the common attribute of…existing. No other attribute is common to all objects, and so this can provide us with a foundation for understanding price levels and price inflation.

    Thus,

    Instead of tracking the prices of:

    1. Dell personal computers; and

    2. 4 door sedans; and

    3. 2000 square foot apartment rents.

    Which will lead to problems of quality adjustments, and so on,

    We instead track the prices of:

    1. Number of existants sold that qualify as “Dell personal computer”; and

    2. Number of existants sold that qualify as “4 door sedans”; and

    3. Number of existants sold that qualify as “2000 square foot apartment rents.”

    and so on.

    Doing this, we end up with the following:

    AD = 10 trillion dollars.

    AS = 100 billion existants (i.e. the total number of computers, cars, apartments, etc).

    Price level = AD / AS = $10 trillion / 100 billion = $100.

    Thus, the price level at this time is $100.

    ——

    Now, suppose we move forward in time one year. Suppose these are the new values:

    AD = 10.5 trillion dollars.

    AS = 103 billion existants.

    Price level = AD / AS = $10.5 trillion / 103 billion = $101.94.

    Thus, the price level one year later is $101.94. We can say “price inflation was 1.94% over the course of last year.”

    ——

    Notice how we don’t even have the problem of how to track a specific class of goods like “Dell personal computer” over time because their component existants have changed. We can just track existants themselves which are sold, and how may dollars were used to buy them!

    This is my solution, and I think it is what people are talking about when they say “things are getting more expensive over time.”

  55. Gravatar of Major_Freedom Major_Freedom
    26. June 2012 at 13:08

    This method also prevents any econometric shenanigans from those who have an incentive to over or under-estimate the price level and price inflation for political or other agenda driven reasons. This method is unadulterable.

    Even if technology changes, even if some classes of old goods disappear from the market, even if some classes of new goods enter the market, it doesn’t matter. We don’t need to look at classes of goods. We just need to look at the number of existants sold.

    Of course, to the supply of “goods” we should add existants that are scarce services as well, such as existants satisfying “1 hour massages” and existants satisfying “3 months of consulting” and so on. The method is the same no matter what is sold for money. Every exchange against money contains a definite, delimited supply of scarce existants associated with it.

    —–

    The existants method has the seeming weakness of allowing people to break goods and services down into components that themselves become existants, which makes price levels and price inflation estimates moot. But this is not so, because economic science is the science of human action, not atoms or molecules. So the totality of existants in the economy, which at the subatomic scale can become so enormous as to lose all mathematical usefulness, is actually constrained to objects of human action. When we buy a car, we don’t buy a car because we value the trillions of iron atoms. We buy the car because we value the direct and indirect utility the car provides. So the existant is the one car, not the trillions of iron atoms. However, there are caveats to this, because it may be the case that someone bought the car because of the individual components they intend to use, or sell later on. These complications however are not problematic for the reality of price levels and price inflation constrained to individual action. They are only problematic for observation purposes, for central planning purposes, but then who cares about that? The free market economy can function without anyone tracking aggregate price levels or aggregate price inflation. Individuals can track the price evolution of whatever existants are relevant to their own lives. Nobody pays less or more for a car on the basis that the prices of mansions they can’t afford increased in supply and dropped in price somewhat. Each person only cares about a portion of the totality of all existants. Indeed it is physically impossible for anyone to have knowledge of the totality of all existants and prices!

  56. Gravatar of Paul Andrews Paul Andrews
    26. June 2012 at 19:34

    MF,

    The way I look at it is we each have our own concept of the price level. The vast majority of us have a hazy concept of it, that hits us when we become aware that the things we regularly buy are increasing in price. The fact it is hazy does not make it less real. There is a real phenomenon in the world that we are each hazily aware of in our own way.

    The fact that we have a hazy impression of it does not make it conveniently ignoreable. This is easy to see by looking at histories of countries that experienced general and persistent price increases. In each case it caused real problems in the real world.

    Is there one unique correct measure of “the price level”? No!

    Does that mean it can be ignored? No.

    Do we all have the same concept in mind when we say “inflation”? No!

    Does that mean it exists only in the minds of government bureaucrats? No.

    We don’t all mean the same thing when we say inflation, but we usually mean something similar to one another, and we are describing some aspect of the real world, however imperfectly. And a very important aspect at that.

    Your suggestion may have some advantages over other techniques, and some disadvantages. I’m not particularly interested in finding the “one true measure” as I don’t think it exists. I think we can do better than CPI or PCE, but then again we can do a lot worse (e.g. by ignoring inflation altogether and looking only at NGDP).

  57. Gravatar of Major_Freedom Major_Freedom
    27. June 2012 at 05:31

    Paul:

    If you accept the notion that the price level exists (you do accept that, right?), then it is imperative on me for the sake of matching my mind to reality, to accept that there is in fact one true price level.

    That which exists “outside of me” is not subjective. It is objective and unique. The obligation is on me to figure out the “one true price level”, namely, the one that myself, and you (I think!), accept exists.

    The hazy conception you refer to I don’t believe implies the price level is itself hazy in reality. It means our minds are hazy. But that can be rectified through practical activity.

    ——

    I agree that there is no one correct measure of the current price level, but that’s because I hold that it is not even measurable. Any attempt to measure it can only ever be partial and historical. The measurement can never be complete and current.

    If we have different conceptions of what “price inflation” means, then again the obligation is on me to find out what you mean and what others means when they mention it. Each person’s conception will either be in line with reality, or a deviation away from reality.

    Even if we can’t have a “one true measure” for the price level or inflation, we can still agree as to what they are in reality, and accept that this particular reality can never be known by a single individual. Yes, this may “violate” the framework of empirical induction, but then again, I hold it to be a self-contradictory epistemology anyway.

    ——

    I am interested in your thoughts on any disadvantages my method of “existants” might have.

  58. Gravatar of Paul Andrews Paul Andrews
    27. June 2012 at 20:07

    MF,

    I think our epistemological beliefs differ here. Not sure we can resolve, or need to resolve, but to state simply:

    You hold that the “one true price level” exists in the real world but is not measurable.

    I hold that the “one true price level” exists only as an imaginary concept. There are many possible measures of overall price levels, and these are useful. Some are more useful than other. Some are more useful for some purposes and less useful for others. They tend to have common features which make them not unrelated to one another.

    So when I say the “price level exists” that is shorthand for saying that there are prices, and they do fluctuate, and there tend to be trends in overall prices – i.e. there is a tendency for them to fluctuate in the same direction. I do not mean by the statement “the price level exists” that there is “one true price level”.

    I agree that what exists outside of me is not subjective, and it is objective and unique. However concepts are subjective. A concept in my mind may or may not correspond to an objective unique thing. What it does correspond to is a perceived pattern. The concept “price level” existing in my mind refers to a pattern that I have perceived when observing real events. I believe most people who use the term “price level” are referring to perceived patterns that are similar to mine, but not exactly the same. Therefore it is useful to discuss the price level, and it is useful to take it into account in our behaviour, because there is enough similarity in our concepts for that to lead to useful outcomes. It is not required that we try to match our concepts exactly to do that.

  59. Gravatar of Major_Freedom Major_Freedom
    28. June 2012 at 04:51

    Paul:

    You hold that the “one true price level” exists in the real world but is not measurable.

    I hold that the “one true price level” exists only as an imaginary concept. There are many possible measures of overall price levels, and these are useful. Some are more useful than other. Some are more useful for some purposes and less useful for others. They tend to have common features which make them not unrelated to one another.

    How can an imaginary concept be measured at all? Does the act of measurement not presuppose that one is measuring something?

    So when I say the “price level exists” that is shorthand for saying that there are prices, and they do fluctuate, and there tend to be trends in overall prices – i.e. there is a tendency for them to fluctuate in the same direction. I do not mean by the statement “the price level exists” that there is “one true price level”.

    When I read you writing that, I understand you to be thinking that the price level exists, it just can’t be measured.

    I agree that what exists outside of me is not subjective, and it is objective and unique. However concepts are subjective. A concept in my mind may or may not correspond to an objective unique thing. What it does correspond to is a perceived pattern. The concept “price level” existing in my mind refers to a pattern that I have perceived when observing real events. I believe most people who use the term “price level” are referring to perceived patterns that are similar to mine, but not exactly the same. Therefore it is useful to discuss the price level, and it is useful to take it into account in our behaviour, because there is enough similarity in our concepts for that to lead to useful outcomes. It is not required that we try to match our concepts exactly to do that.

    How do you even know if another person is even talking about the same type of “pattern” you are talking about, other than, of course, using the same terminology of “price level”, if it weren’t for you and that other person presupposing an identical common ground from which you each know?

    For example, if we both look at the same cat, we may think of slightly different things when looking at it. You might think it is a midnight black cat that is healthy looking, I might think it is a skinny cat that is smoky black. But if we were to communicate with each other on what we are observing, what we are talking about, then I argue there is in fact a matching of a common grounding from which we can even know that the other person is referring to this thing in front of us, rather than something else, and that they think it is a cat, rather than a dog or zebra or brontosaurus.

    ——-

    In other words, I think you adhere to a sort of epistemological anarchism, at least when it comes to the price level, whereby even though you accept that there is a unique reality, such that a unique reality contains a unique price level, it is nevertheless impossible for two or more people to agree on thinking the unique thing as it is in reality, where we are all compelled, by some limitation or another, by some fact of separate individual minds, to have mutually exclusive conceptions of it, where no two are alike.

    If this is correct, then I must ask you if you are sure about that. If it is not correct, then where is it not correct?

  60. Gravatar of Paul Andrews Paul Andrews
    28. June 2012 at 16:22

    MF:

    “How can an imaginary concept be measured at all? Does the act of measurement not presuppose that one is measuring something?”

    I said that “one true price level” is an imaginary concept. This cannot be measured. The “price level” refers to various perceived patterns of prices, many of which can be measured.

    “How do you even know if another person is even talking about the same type of “pattern” you are talking about, other than, of course, using the same terminology of “price level”, if it weren’t for you and that other person presupposing an identical common ground from which you each know?”

    We can have similar common grounds. They don’t need to be identical. I am confident that when I talk about “price level” I mean something close to what you mean by “price level”, because the statements you make about the “price level” concur in general with statements I make about the “price level”. i.e. My confidence in the concept evolves over time through conversation.

    “For example, if we both look at the same cat, we may think of slightly different things when looking at it. You might think it is a midnight black cat that is healthy looking, I might think it is a skinny cat that is smoky black. But if we were to communicate with each other on what we are observing, what we are talking about, then I argue there is in fact a matching of a common grounding from which we can even know that the other person is referring to this thing in front of us, rather than something else, and that they think it is a cat, rather than a dog or zebra or brontosaurus.”

    Yes we can easily agree that a particular cat is a cat. However this does not mean our concept of cat is exactly the same. If we both saw a creature that had some dog features and some cat features, you might think it is a dog and I might think it is a cat. For practical purposes that doesn’t matter. We don’t need to agree on that to be able to have meaningful conversations about cats. It is futile to argue over the “essence” of cathood, when there are real cat problems to be solved.

    “In other words, I think you adhere to a sort of epistemological anarchism, at least when it comes to the price level, whereby even though you accept that there is a unique reality, such that a unique reality contains a unique price level, it is nevertheless impossible for two or more people to agree on thinking the unique thing as it is in reality, where we are all compelled, by some limitation or another, by some fact of separate individual minds, to have mutually exclusive conceptions of it, where no two are alike.”

    I accept that there is a unique reality but I do not believe it contains a unique price level. We conceive of a “price level” concept, which actually manifests as many measureable price levels in the real world.

  61. Gravatar of Major_Freedom Major_Freedom
    30. June 2012 at 19:56

    Paul:

    “How can an imaginary concept be measured at all? Does the act of measurement not presuppose that one is measuring something?”

    I said that “one true price level” is an imaginary concept. This cannot be measured. The “price level” refers to various perceived patterns of prices, many of which can be measured.

    I think we’re talking past each other.

    If you say reality exists, and is unique, and you say the price level exists in reality, then the price level must be unique. There must then be “one true price level.” The problem arises on account of whether or not people can agree on what it consists of, how it is to be measured, and what they think it means.

    “How do you even know if another person is even talking about the same type of “pattern” you are talking about, other than, of course, using the same terminology of “price level”, if it weren’t for you and that other person presupposing an identical common ground from which you each know?”

    We can have similar common grounds. They don’t need to be identical.

    Similarity implies SOMETHING is identical. Some attribute, some common description.

    I am confident that when I talk about “price level” I mean something close to what you mean by “price level”, because the statements you make about the “price level” concur in general with statements I make about the “price level”. i.e. My confidence in the concept evolves over time through conversation.

    How do you our statements are consistent with each other, unless we are comparing our statements to some standard in reality? We cannot just be talking about words.

    “For example, if we both look at the same cat, we may think of slightly different things when looking at it. You might think it is a midnight black cat that is healthy looking, I might think it is a skinny cat that is smoky black. But if we were to communicate with each other on what we are observing, what we are talking about, then I argue there is in fact a matching of a common grounding from which we can even know that the other person is referring to this thing in front of us, rather than something else, and that they think it is a cat, rather than a dog or zebra or brontosaurus.”

    Yes we can easily agree that a particular cat is a cat. However this does not mean our concept of cat is exactly the same. If we both saw a creature that had some dog features and some cat features, you might think it is a dog and I might think it is a cat. For practical purposes that doesn’t matter. We don’t need to agree on that to be able to have meaningful conversations about cats. It is futile to argue over the “essence” of cathood, when there are real cat problems to be solved.

    How can we distinguish between merely agreeing that a cat is a cat, and know that we are not talking about the same thing in reality?

    “In other words, I think you adhere to a sort of epistemological anarchism, at least when it comes to the price level, whereby even though you accept that there is a unique reality, such that a unique reality contains a unique price level, it is nevertheless impossible for two or more people to agree on thinking the unique thing as it is in reality, where we are all compelled, by some limitation or another, by some fact of separate individual minds, to have mutually exclusive conceptions of it, where no two are alike.”

    I accept that there is a unique reality but I do not believe it contains a unique price level. We conceive of a “price level” concept, which actually manifests as many measureable price levels in the real world.

    There may be different ways of measuring the price level, but is that the same thing as there being more than one price level in reality? If so, how? If not, where are you getting the notion that reality, which is unique, does not contain a unique price level?

  62. Gravatar of Paul Andrews Paul Andrews
    30. June 2012 at 22:24

    MF,

    Reality doesn’t contain a unique unicorn, but it doesn’t stop us talking about unicorns.

    It seems we won’t be able to agree – you are right we are probably talking past one another. That’s fine, I agree with most of the stuff you write and enjoy your contributions. It would be good to sit down and chew the fat on these deep philiosophical issues, I don’t think it’s going to work on a thread like this.

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