Stumbling and Mumbling

Policy fetishism

Are we making a fetish out of economic policy?
I ask because of an omission from today’s newspapers. None, AFAIK, reported that the Bank of England said yesterday that the cash holdings of non-financial companies have risen at an annualized rate of 22.8% in the last three months, having fallen sharply for most of last year.
But this turnaround is great reason for optimism; the more cash firms have, the less likely they are to cut spending on jobs and inventories.
And yet, whilst omitting this fact, the dead trees are full of talk about the G20 meeting, even though most sensible observers doubt it will produce anything other than banalities.
It seems that newspapers - aided of course by Brown - believe the fate of the economy hangs upon the actions of policy-makers, but are ignoring evidence of whether it might recover anyway, even if fiscal or  monetary policy do little to help.
Which raises the question. Why do they pay so much attention to policy, and so little to the underlying economy? Here are three possibilities:
1. The availability bias. Policy is big and obvious - more so than Bank of England statistics - and it’s natural to think that things that leap easily to mind must be important.
2. The leadership illusion. Newspapers are hugely hierarchical organizations. This contributes to a faith in the power of leaders to affect things. This faith might be exaggerated.
3.  The glamour bias. From a distance, policy looks exciting: all that power! All that testosterone! And it’s easy to think that this matters. But in fact, the question of when the economy will recover rests upon deeply unglamorous and downright dull evidence - about such things as the inventory cycle and monetary growth.

Economics 2.0: a review

Economics 2.0 by Handelsblatt journalists Norbert Haring and Olaf Storbeck is a Freakonomics-style book translated from the original German. If that makes your heart sink, it shouldn’t. This is a lovely book, beautifully translated by Jutta Scherer.
Like Freakonomics, it is a series of anecdotes, a whizz around new economic research. This makes the book ideal for dipping into, as well as reading cover to cover. We learn, for example, that: good managers can be worse than bad ones; children are more like homo economicus than adults are; investors who research shares earn lower returns than ones who don’t (I’ll not mention this in my day job!); customers are slow to respond to changes in product quality; and the success rate of particular heart surgeons varies according to the hospital they work in.
However, whereas Freakonomics dealt to a large extent with trivia - who gives a damn if sumo wrestlers cheat? - Haring and Storbeck focus upon important matters. There are fine chapters on the economics of happiness (with I think the right tone of scepticism), the gender pay gap, company management and the role of culture in economic success. And there’s a beautiful discussion of how sports economists have shown that competition does not necessarily lead to fully optimizing behaviour; Haring and Storbeck are (perhaps?) the first Germans to write intelligently about cricket. 
There is, however, a drawback to this approach.  Occasionally - and this struck me whilst reading their account of the sub-prime crisis - Economics 2.0 can be like a collection of artistic photographs. You come away thinking: “what an interesting perspective; I hadn’t looked at it that way before” rather than getting an full accurate picture of things. In this sense, the book is best regarded as a companion to other reading.
Two groups of people, in particular, should benefit enormously from this. Students who are  depressed by the weight of arid and futile maths - DSGE models are economics with the economics taken out - can turn to this book as a light reminder that our subject really can illuminate the real world.
And those know-alls who doubt whether economics is a genuine science should learn from this that the answer is -yes, it is. 

Not paying MPs

The Times’ Carl Mortished wants to abolish MPs’ pay.  The interesting thing about this is that the traditional argument against it - that it would debar working class people from entering parliament - is no longer as strong as it once was, as politicians seem increasingly to be drawn from richer backgrounds anyway.
The strength of this idea arises from the fact that, if MPs we unpaid, people could only enter parliament after they had amassed private means, which would in most cases not be until their late 40s. And this would give them two advantages.
These aren’t that they would be more independent of parties; party machinery would still be necessary to get elected. Instead, they would be more independent of the media and civil service. One thing that age gives us, along with a bad back and gout, is a bullshit detector. Older people know that the media aren’t as important as folk pretend, and know better how to cope with recalcitrant employees.
Better still, age brings scepticism. Older parliamentarians, with experience outside SW1,  are more likely to appreciate that social problems can’t be solved by laws,  initiatives and the strangulation of freedom.
There is, though, a counter-argument. The reason for paying MPs is much the same reason for paying chief executives a fortune. It’s not to provide incentives or - God help us - attract “talent”. It’s to bribe them not to plunder the joint. If MPs and ministers were unpaid, they’d  just try to make money in other ways. If we’re lucky they’d just fiddle their expenses. It’s no accident that two ministers to have, in effect, done this - McNulty and Smith - have such low majorities that they are likely to be out of work after the next election anyway; they’re making money whilst they can. If we’re unlucky, they’d do so by making policy in the interests of those companies that promise them well-paid work after they leave parliament.
MPs, like the rest of us, will sell themselves to the highest bidder. As that bidder is unlikely to be their conscience, isn’t it better that it be the tax-payer?

The Orwell prize: worthless trash

Justin is troubled by the possibility that Iain Dale might win the Orwell prize for blogging. He shouldn’t be. The prize is worthless.
The judges have invited bloggers to nominate 10 of their best posts; I had better things to do, such as pick my nose. This is a moronic way of assessing them. Over a 12 month period any serious blogger will make over 200 posts. 10 is less than 5% of their output. The only people who think you can judge something on the basis of a small and biased sample are statistically illiterate idiots.
And not just idiots, but lazy ones. Anyone who really wants to know the best blogs (if this phrase has any meaning at all) will already have their favourites. The only people who need to ask others to nominate blogs, and then a handful of their posts, are those who just haven’t bothered to discover the blogosphere, and don’t want the trouble of following whole blogs.
So who are these imbeciles doing the judging? They seem to be precisely the sort of superannuated old ponces that blogging is a reaction against. Their belief that anyone of merit gives a damn about their opinion can only be a triumph of ego over evidence.
So, far from fearing that some semi-literate gossipmonger will win the prize, we should hope he does so. The award won’t elevate Iain Dale, but merely show the prize to be the meaningless trash it is.

Brown: the market's verdict

I'll not pick apart everything Dan Hannan said in that speech. But there’s one point to question. He said:

Britain is worse off than any other country as we go into these hard times. The IMF has said so. The European Commission has said so. The markets have said so, which is why our currency has devalued by 30%.

But not all markets have said this. The stock market hasn’t. According to MSCI, the UK’s has been one of the best performing markets in the last 12 months in local currency terms. Among developed countries, only Australia, Canada and Sweden have out-performed the UK, and this only by a couple of percentage points. The UK has out-performed the world index by  almost six percentage points, and the euro zone by almost 11 percentage points.
Stock markets, then, have faith in Gordon Brown.
Well, no. There are countless reasons why the UK has out-performed. For example, it’s benefited from uncovered equity return parity (a weak currency can be good for shares sometimes) and the market has a defensive bias - lots of utilities, brewers and pharmaceuticals firms and few industrials.
Only a fool would read the stock market’s verdict as support for Brown. But why, then, regard sterling’s fall as an indictment of him, when there are other reasons (the closing of carry trades for example) for that too?
Financial markets have much better things to do than pass judgment upon politicians.
A question: why has no politician articulated what the left believes about the economy as well as Hannan has expressed the right’s views?

Money growth & inflation

Alice Cook claims that the fact that monetary growth is accelerating is the “most difficult” fact for forecasters of deflation. It’s not. The link between growth in M4 - which is currently running at 18.8%  - and inflation is very weak.
Just look at my chart. Can you see a strong link between the two? Granted, the acceleration in M4 growth in the mid-00s led to a rise in inflation last year. But if you wait long enough, you can get that sort of link between any two data series.
Over the last 20 years, M4 has risen 450% whilst the  RPIX index has risen just 90%. Which suggests the long-run relationship between the two isn’t any better than the short-run link.
If you want a more sophisticated take, try this paper by David Hendry and Jennifer Castle, which models inflation with little role for M4 growth.
This is not to say M4 has zero impact on inflation. This paper by Costas Milas estimates that, when monetary growth is above 10%, “a 1 percentage point increase in the annual growth rate of M4 increases annual inflation by only 0.09 percentage points.”
But this effect is small. The M4 stock is currently £2 trillion. So the first £75bn of quantitative easing will increase it by just 3.75%. On Milas’ calculation, this would add just over 0.3 percentage points to inflation. Which isn’t much.
Now, a lot of what you read on this blog is eccentric and out-of-consensus. But on this point, I’m with the mainstream. Breakeven inflation rates for gilts of less than eight years maturity are under 2 per cent, suggesting markets aren’t worrying about money-fuelled inflation. And the Treasury’s survey (pdf) of economists shows that the average forecast for CPI inflation at the end of 2010 is just 1.6%, with the highest forecast, from Citigroup’s Michael Saunders, at 3.7%.
Let’s be clear. I’m not sure inflation will fall very sharply, except for mathematical reasons - not least because the UK’s Phillips curve is a queer shape; some of Alice's other points are reasonable. But to expect it to rise a lot because M4 is growing a lot is to lose touch with the facts.

End of world not nigh

The failure of the DMO’s auction (pdf) of 4.25% 2049 gilts - bids fell 7% short of the £1.75bn offered - has led to some hysteria, such as some of the comments here.
I fear, however, that the truth is rather more mundane.
The thing is, gilts are in normal times near-substitutes for each other: 2049 stock is very similar to 2048 stock, which is similar to 2047 stock and so forth. However, quantitative easing has changed this.  The Bank will buy gilts (pdf) in the 5-25 year range. Ceteris paribus, this gives gilts in the 2014-34 year maturity range a liquidity premium over other issues.
Now, in principle this new premium should have been embedded in prices immediately, when the policy was announced earlier this month.
However, because QE is a new policy, we can’t be sure how a big this premium should be. All that’s happened with this auction is that we’ve discovered that it should be bigger than the market thought yesterday. It’s just part of the price discovery process.
You might wonder why the DMO is issuing long-dated gilts at all, when it could be supplying the more-demanded medium maturities.
This question speaks to an ancient issue in debt funding - the trade-off between opportunistically supplying whatever‘s in demand on the one hand, versus a fixed calendar of auctions on the other. The DMO has been following the latter policy - hence today’s problem. The argument for doing this is that it reduces the risk market-makers face; if these know what supply is coming, they can run their books accordingly, and this reduces the risk premium in gilts and hence funding costs for the tax-payer.
But it could well be that the size of debt issues required, plus QE, mean that this policy should change, and the DMO should have more flexibility to issue as and when it can. 
Whatever, markets are not spooked. Yes, some cash prices fell, especially at the longer end. But the June long gilt future has had a decent day in the end. Whose opinion would you trust - that of informed traders, or the semi-literate commenters on some blog?

Yes, inflation will fall

Yesterday’s rise in inflation (pdf) has led several people to claim that our problem is inflation, not deflation. I disagree. Insofar as we can be sure of anything in economic forecasting, inflation will fall. I say so for three reasons.
1) A big chunk of inflation is the legacy of last spring’s rise in utility bills. Gas and electricity prices have risen 22.6% in the last 12 months, contributing 1.05 points to the 3.2% CPI inflation rate. But these price rises will fall out of the annual inflation rate in the next few months. This alone would take inflation down close to its 2% target.
2) Some of the stubbornness of inflation reflects a rise in import prices as a result of sterling’s fall in the autumn. But unless sterling falls again - and anyone who’s certain it will is just mentally ill - this is a one-off effect that’ll drop out of the annual inflation rate next winter.
3) As I’ve been saying for some time in my day job, the first effect of recession can be to raise inflation by reducing firms’ willingness to cut prices. The reason for this was spelt out in a paper (pdf) by Garth Saloner and Julio Rotemberg back in 1986. Quite simply, if there are few potential customers to be won, there’s no point cutting prices. Firms are more likely to engage in price wars in booms than in slumps. Why do you think new car prices have held up as demand has collapsed?  
It’s only as the recession creates spare capacity - forcing firms to scramble to win orders to keep in business - that it leads to prices coming down. But this take time. As Mervyn King wrote (pdf):

The outlook for global activity will constrain UK demand prospects and, as a result, the margin of spare capacity is likely to build in the coming quarters, pulling down on CPI inflation.

The key phrase there is “coming quarters.” The thing about macroeconomics - and I’ve learned this the hard way - is that things are slow. Booms go on  longer than you expect, inflation is slow to rise and slow to fall, and so on. And, crucially, monetary policy - be it conventional or unconventional - is slow to affect inflation. Life is lived through time lags - a point which semi-economists, obsessed only with comparative statics, tend to forget.
So yes, inflation will fall and the Bank is right to act now to take measures to raise inflation. Why does something as bland as this need saying?

Returns to good universities

New research confirms what we’ve long suspected but not quantified - that it does matter what university you attend.
This paper shows that there are significant differences in graduate earnings, depending upon the quality of university. For example, if a university has an RAE score one standard deviation above-average, its graduates earn, on average, 4% more than the average graduate. And a graduate of a top quartile university earns 10-16% more (depending on which measure of quality is used*) than a graduate of a bottom quartile institution.
These differences control for students’ A level scores and other things, and so try to correct for the fact that better universities attract better applicants.
There seems to have been a rise in these returns over time, which suggests that as university numbers have expanded, so too has the premium upon attending a better one.
The paper is, however, silent on the question of whether good universities raise graduate earnings by giving them more skills, or merely by signalling their higher quality. 
This suggests there might be a case for lifting the cap on university tuition fees. The current ceiling, of £3145 a year, has the effect of suggesting that all universities are the same, as almost all charge the maximum. But this is not so.
* There is, however, a negative correlation between the pay of teaching staff and graduate earnings.

The Rotten State of Britain: a review

Eamonn Butler’s The Rotten State of Britain aspires to be The State We’re In for the 00s. It’s not - and not just because it is a much easier read than Hutton’s tome.
Whereas his was a narrative about our economy and society, most of The Rotten State of Britain is a series of attacks upon New Labour’s failures, with chapters such as “spin“, “snoopers“ and “nannies“. Naturally, some of these hit their targets better than others.  Butler is good on civil liberties and the absurdities of red tape. And I think he‘s wise to not pin the blame for the banking crisis (which he scarcely mentions) upon the government. However, his whinges about “multicturalism” and “Winterval” suggest he’s overdosed on the Daily Mail.
There are, however, a couple of problems here.
First, Butler gives the impression that New Labour is an alien government imposed upon us from outside. The common theme uniting Butler’s complaints about the government is its top-down centralizing managerialism, though he doesn’t use that word.  As he says:

[New Labour] seem to believe that their own narrow wisdom is better than that of millions  of individuals whose ideas and values and conventions are tested every day.

But what he doesn’t ask is: if Labour’s so bad, why did millions of these individuals vote for it in three elections? What is the appeal of illiberal centralism? Why is that the alternative narrative - of liberty, self-determination and the wisdom of crowds - has not won much public support?
 What Butler misses here is that the ideology of centralism is not confined to New Labour, but is in fact wired into companies and the media. Butler complains:

Everyone is expected to fit in, to conform, and to rejoice in their conformity. Those who do not conform are thought immoral, scorned and vilified.

But government on its own does not have the power to do this. Pressures to conform come also from HR departments and from the media. It’s here too that we find the ideology of hierarchy, centralism and distrust of true diversity.
And yet Butler pretends that this ideology is New Labour’s alone. He never asks: where did New Labour get it from?
I fear this mistake is not a mere intellectual error on Butler’s part, but rather the natural result of that vulgar libertarianism which sees only government as the enemy of freedom, whilst failing to see that its enemies can also exist in the private sector.
My second problem is that Butler is too sketchy about remedies. He calls for a flat tax and for education vouchers, but provides next to no evidence for their effectiveness. And he says:

Until we replace our rotten, means-tested, rights-driven welfare system, we will never stop the steady growth of social dysfunction.

This fails to address Joseph Schumpeter’s famous quip - that if a man has been run over by a bus, you do not restore him to health merely by reversing the bus.
Granted, institutions determine character in the long-run. But it is surely just wishful thinking to suppose they do so quickly. The idea that reform of the welfare state will swiftly abolish the underclass and create a society of imaginative self-reliant hard workers is surely doubtful - and Butler gives us no reason not to doubt it.
Again, I fear this is not his error alone. Free marketeers often pay too much attention to comparative statics, and not enough to dynamics - to the difficulties of getting from one equilibrium to another.
And herein lies a paradox. Butler and New Labour have something in common. Both are optimists. It’s just that New Labour is optimistic about centralized control, and Butler optimistic about decentralization.