Author Archives: Arnold Kling

Scott S. on my inflation views

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Scott Sumner writes,

I do think the Fed is more agile, but the decisive factor is that the Fed is much stronger. If you want a metaphor. . .imagine I’m driving my car and my 6-year old daughter pushes the steering wheel to try to change direction. I’d simply push back more strongly.

Read the whole thing.

Also, you should read Scott’s post on bond market vigilantes.

The 1990s were a successful period for monetary policy. . .We can infer from stable 2% inflation that the actual interest rate stayed pretty close to the natural interest rate during the 1990s.

Scott is fond of saying “Never reason from a price change.” In Fantasy Intellectual Teams, if other players use that, his owner will score M points.

The way I understand this maxim is that prices are an endogenous variable that can be affected by many things. So you cannot safely draw inferences from a price change without knowing more about what went on.

If we generalize the rule to say that you cannot safely draw inferences from changes to endogenous variables, then Scott violates his own rule promiscuously. Take the quoted passage, for example. Can we safely infer that because inflation was stable that the interest rate stayed pretty close to the natural rate?

It sounds like Scott is providing an explanation for the low inflation of the 1990s, based on a concept called the “natural rate of interest.” But the natural rate of interest is something that we cannot observe. It plays a role in macroeconomics that is analogous to the role played by “systemic racism” in Critical Race Theory.

For Scott to convince me of monetary dominance, I would like to see him reason from an observable definition of loose money or tight money. Saying that an episode of slow growth in nominal GDP proves that monetary policy was tight is convincing to someone who already believes in monetary dominance, but not to a skeptic.

A few more remarks:

1. I think of inflation as determined by the behavior of paper wealth relative to real output. If wealth grows rapidly and persistently relative to real output, then eventually consumer prices will increase markedly. The sort of deficit spending we have undertaken in 2020 and 2021 has added a lot to paper wealth and nothing to output. So watch out.

2. I think that most of the time neither fiscal policy nor monetary policy has much effect on paper wealth.

3. My story for Japan is that before the government started creating lots of paper wealth, a lot of paper wealth got destroyed in the collapse of Japanese real estate and equity prices. So Japanese consumers were not flooded with wealth on net.

4. I think that the government can monetize a fair amount of debt and get away with it, as long as it looks as though it will collect enough future taxes to pay off bondholders. It’s when the government has no choice but to monetize that things get ugly. And it’s up to bond investors to calculate when the government is going to have no choice, and to try to sell their holdings before that perception becomes widespread. That is the sort of sovereign debt crisis that you really don’t want to go through.

Status and power

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Gertjan Steede writes,

status is, first and foremost, something that we claim, give and receive in everyday interaction. As a result, a status hierarchy develops in society and in every group within society. Depending on the group’s activities, that hierarchy could be more or less obvious. It will simultaneously be expressed in all kinds of currency: kindness, power, beauty, skill, daring, money – to name a few. I am claiming status by writing this blog, and if you read it to the end, you are giving me status.

While status is about voluntary acts, power is about everything that people coerce one another into. We use power when we receive status insults, or if we have learned that this is a good way of obtaining what we want.

. . .In fact, we people play the status-power game all our lives. If something “gives us energy”, it means it gives us status. We like those whom we can count on to give status to us. In contrast, we long to give status to those we love. We claim status, by being nice or showing off. The status-power game is our life. We do nothing else.

Read the whole post. I think his concepts of status and power map to the distinction between a prestige hierarchy and a dominance hierarchy that I learned from Joseph Henrich.

The post also supports my intuition that people turn to dominance moves when they cannot attain status through prestige. Regulating other people’s speech is an example.

Q&A on my inflation views

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For context, read Tyler (and Scott S.) vs. me on inflation.

1. What if the Fed chairperson explained monetary dominance out loud?

That would mean telling Republicans that tax cuts don’t stimulate and telling Democrats that more government spending doesn’t stimulate. So the Fed chairperson would alienate Congress. Retaliation would likely follow.

How could we distinguish empirically the dose-response model from the autocatalytic model of inflation?

A big challenge is to pin somebody down on how to measure the dose. There are many measures of the money supply to choose from, ranging from a narrow definition of Fedcoin plus currency to a broad definition that includes all financial assets. The current fad is to measure the dose as the difference between the interest rate and “r-star,” which is a mythical interest rate at which the economy is in perfect balance. And here, the choice of which interest rate to compare to “r-star” could vary. Finally, Scott Sumner says to heck with all of these indicators–just look at nominal income as the measure of monetary policy. That threatens to be circular. To be fair, Scott wants to use a market measure of expected future nominal GDP, which removes the circularity. But it also makes it hard to do an empirical study, since we do not have direct measures of market forecasts for nominal GDP–it is up to the investigator to try to find a proxy.

We need to agree on a way to measure dose. I want the dose to be something that the Fed controls pretty directly, as opposed to the measure of money that includes all financial assets or even Scott’s preferred measure of market expectations for nominal GDP. But then you run into the problem that the Fed’s operating procedures have changed periodically, especially with paying interest on Fedcoin.

But if you could agree on a dose measurement a priori (meaning you don’t cheat and look at historical data to try to pick a measure that best correlates with response), then in principle you could look at past experience. What you would be looking for is cases of modest but significant changes in dose. If the conventional wisdom is correct, you should see significant response. If the autocatalytic view is correct, you should see no significant response.

Do you really believe that there is nothing the Fed can do to affect the economy?

Of course I don’t go that far. The Fed could sell $400 billion on bonds tomorrow. Or Janet Yellen could walk into the New York Stock Exchange with a bomb strapped to her waist and blow the whole place up.

But if we stick to normal Fed operations, which are small and gradual, I believe that those are easily absorbed by financial markets without affecting anything important. Obviously, this is an outlier view.

Note that the fact that people believe that the Fed affects things gives it the ability to affect things, just as the fact that people believe that Elon Musk’s tweets matter gives Elon Musk the power to affect stock prices with his tweets. But I don’t think that those effects are very long-lasting in either case.

Null hypothesis watch

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Gregory Clark and Neil Cummins wrote,

we measure the consequence of extending compulsory schooling in England to ages 14, 15 and 16 in the years 1919-22, 1947 and 1972. From administrative data these increases in compulsory schooling added 0.43, 0.60 and 0.43 years of education to the affected cohorts. We estimate the effects of these increases in schooling for each cohort on measures of adult longevity, on dwelling values in 1999 (an index of lifetime incomes), and on the the social characteristics of the places where the affected cohorts died. Since we have access to all the vital registration records, and a nearly complete sample of the 1999 electoral register, we find with high precision that all the schooling extensions failed to increase adult longevity (as had been found previously for the 1947 and 1972 extensions), dwelling values, or the social status of the communities people die in. Compulsory schooling ages 14-16 had no effect, at the cohort level, on social outcomes in England.

Pointer from Jeffrey Miron.

Tyler (and Scott S.) vs. me on inflation

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Tyler Cowen writes,

To see why the huge increase in bank reserves did not result in inflation, consider that there has been a considerable decrease in U.S. excess bank reserves over the last five years. No one claims that this has been accompanied by a massive deflation, whether in securities markets or elsewhere. Once that point is conceded, it’s possible to see why higher levels of reserves are not necessarily inflationary.

Let me stress that his views are fairly mainstream. It is my views that you should especially doubt. I hold outlier views in two ways. Rather than argue against Tyler, I will argue against what I think Scott Sumner would say. I hope this deals with Tyler en passant.

1. Fiscal dominance vs. monetary dominance. The government tries to control the level of nominal income using fiscal and monetary policy. If you are a worker, your nominal income is your salary. If you are a self-employed yogurt maker, your nominal income is the revenue from your yogurt sales, less the cost of inputs.

If the government wants to use fiscal policy to raise nominal income, it can run a larger deficit. Congress votes to send Paul a stimulus check for $1000 by borrowing the money from Peter, giving Peter a Treasury bill. Paul feels $1000 richer, and Peter does not feel poorer, because he expects to be paid back. (As academic economists will tell you, there is actually a longstanding dispute on this point. Just Google “Barro are government bonds net wealth” or “Ricardian equivalence.”)

If the government wants to use monetary policy to raise nominal income, the Fed obtains Peter’s Treasury bill, paying for it using a digital asset, called bank reserves, or Fedcoin, if you will. The more Fedcoin that banks have, the more freely they will lend, and the more freely the public will spend.

Scott’s argument for monetary dominance is that the Fed, which sets monetary policy, is way more agile than Congress, which sets fiscal policy. It’s like a game of rock, paper, scissors in which if Congress shows rock, the Fed shows paper. Or if Congress shows scissors, the Fed shows rock. The Fed can always win.

Consider the $1.9 trillion stimulus Congress is debating. Even though it would be an adverse supply shock, as quantified by Casey B. Mulligan and Stephen Moore, it would tend to raise nominal income. If it passes, the Fed can decide to be less expansionary in order to keep nominal income on target. If it fails, the Fed can be more expansionary and still hit the target. Note that no Fed chairperson would ever say this out loud; instead, the Fed chairperson is obligated to tell Congress that whatever it plans to do is exactly what the economy needs and thank heaven for Congress, because the Fed could never do the job all by itself.

I believe in fiscal dominance. That is because I do not think that Peter cares all that much whether he hangs on to his T-bill or exchanges it for money. Scott thinks that Peter will spend more in the latter case. I am skeptical.

In this regard, my views coincide with the Modern Monetary Theory of Stephanie Kelton. (Rest assured that her views and mine differ in many other respects). She would say that Fedcoin is merely non-interest-bearing government debt (although since the financial crisis of 2008 the Fed has paid interest on Fedcoin). I might prefer to say that T-bills are interest-bearing money.

2. Inflation as an autocatalytic process

Scott, like almost all mainstream economists, sees inflation as having a continuous dose-response pattern. Give the economy a higher dose of money and it will respond with higher inflation. Other economists measure the “dose” as the employment rate.

I think of inflation as an autocatalytic process. Inflation is naturally low and stable. But it can be jarred loose from that regime and become high and variable. Then it takes a lot of force to bring it back to the low and stable regime.

Another example of an autocatalytic process is a social media platform. If you want to try to build the next Facebook, it is really hard to get started. But once enough people join, then their friends will want to join, so growth becomes automatic.

When inflation picks up to an annual rate of 8-10 percent, it changes your behavior. I know, because I remember the 1970s. When you run a business and you see your suppliers and workers demanding 10 percent more than they did a year ago, you cannot ignore that when you set your price. When you are a worker and see the cost of the stuff you buy going up 10 percent per year, you need to demand a raise just to keep up.

The real take-off point for inflation in the 1970s was the New Economic Policy of President Richard Nixon, announced in August of 1971. He let the dollar “float,” meaning that it depreciated in world markets. In a misguided attempt to stifle inflation, he imposed wage and price controls. In order to work properly, a capitalist economy must have freely moving prices. The controls were a self-inflicted adverse supply shock. Adverse supply shocks raise prices (and recall that the latest “stimulus” is an adverse supply shock on steroids). Although for a little while the price controls repressed inflation, the more enduring effect–the supply shock–went in the other direction. Note, too, that inflation itself is a supply shock, because a lot of the steps that households and businesses take to protect against inflation are steps that detract from productive activity.

Once inflation gets going, the only way to stop it is to slam on the economic brakes. Usually, this means drastically cutting government spending. But in the U.S. in the early 1980s, we slowed the economy without cutting government spending. Instead, the foreign exchange market put on the brakes by raising the value of the dollar, stimulating imports and making our exports non-competitive. And the bond market put on the brakes by raising interest rates, so that nobody could afford the monthly payment on an amortizing mortgage. After a few years of high unemployment, inflation receded.

Most economists attribute these developments to Fed policy under the sainted Paul Volcker. Scott could say that this was exhibit A for monetary dominance. The economic consensus may be right, but I would raise the possibility that the financial markets were the main drivers.

What about more recent experience? As I see it, since the 2008 crisis Congress has been undertaking ever-more-reckless deficit spending, throwing match after match on the firewood, without starting an inflation fire. Maybe that pattern will persist. But if an inflation fire does get going, I will be less surprised than the markets.

Lost his Waze

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Noam Bardin writes,

When Waze was acquired by Google, most of the people who know me did not believe I would last 7 weeks, let alone 7 years

When the web site I founded was acquired by Homestore.com, I lasted about 7 weeks. I wrote an email to the CEO of Homestore saying that I thought he was trying to make the company seem much more valuable than it was. I was immediately fired. He was eventually convicted of securities fraud and sentenced to prison.

I view Bardin’s tale as quite different. The way I see it, he went from a sub-Dunbar organization to a super-Dunbar organization. The latter needs many more formal processes and controls. As he puts it,

Working as an independent start-up is fundamentally different from a corporation and it is much more nuanced and deep than I had understood.

If you strongly prefer informal processes and fewer controls, stick with start-ups.

Is prestige a danger sign?

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Paul Graham writes,

the most important thing I learned, and which I used in both Viaweb and Y Combinator, is that the low end eats the high end: that it’s good to be the “entry level” option, even though that will be less prestigious, because if you’re not, someone else will be, and will squash you against the ceiling. Which in turn means that prestige is a danger sign.

He worked at Interleaf, which produced high-end publishing software. I think that if A serves the high end of the market and B serves the low end of the market, if one of them takes over the other’s market, it is more likely that B will move into the high end.

But prestige brands still have value.

Pointer from Tyler Cowen. Reading Graham’s whole essay is worth your time.

Rationalist epistemology

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Tom Chivers writes,

According to Paul [Crowley], the thing that distinguishes a cause from a cult is when it becomes taboo to criticise the cult.

From The Rationalist’s Guide to the Galaxy, p. 191

This leads to the following train of thought.

1. Good thinkers engage with ideas that question their beliefs. Bad thinkers instead engage in emotional blackmail against those who would question their beliefs.

2. Of course (1) is an instance of emotional blackmail. The terms “good” and “bad” are emotionally loaded. This is reminiscent of Quine’s point that the claim that “propositions that cannot be tested against logic or observation are dogma” is itself a dogma. I am willing to say that “there is one example of emotional blackmail that is acceptable, and that is the insinuation that it is bad to otherwise use emotional blackmail.”

3. I am not against emotions. You should pay attention to your emotions and choose an appropriate response. Many years ago, I was playing a game in an Othello tournament and noticed myself feeling frustrated that the game was not quickly resolving itself in my favor. Your natural reaction is to become impatient. But instead you need to do the opposite. I noticed my emotions, stopped, thought a long time, and made a course-correcting move.

4. More deeply, I do not believe that we can rationally calculate our daily lives. This point is expressed very well by Moshe Koppel in his book Judaism Straight Up. You can find out more about the book here or here, although I don’t think either article gets quite to the heart of what Koppel is saying.

The way I put it is this: We engage in behaviors and hold beliefs without understanding why we behave the way we behave or why we believe what we believe. This is not a failure of rationality. It is the human condition.

5. If I were asked to reduce the criteria for a fantasy intellectual to just one, it would be something like “the ability to constructively deal with criticism of one’s beliefs.” Part of doing that is anticipating what a critic might say.

6. Unfortunately, colleges nowadays seem to teach the opposite. Countering criticism with rational arguments seems to be “out,” and emotional blackmail seems to be “in.”

The inflation outlook

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Jon Hilsenrath writes,

It is easy to find reasons for discomfort. Tesla’s stock price is up more than 300% in the past year. Copper prices are up 56%. The S&P Case-Shiller Home price index is up 9.5%. Freight prices are up 215%; soybeans, 54%, lumber, 117%.

John Greenwood and Steve H. Hanke write,

Speculative manias are in the air, as evidenced by the recent price surges for bitcoin, a digital asset with a fundamental value of zero, and GameStop, a declining retailer. Along with the other economic trends—a strong recovery, surging commodity prices and an uptick in inflation—those asset bubbles have a clear cause: the massive expansion of money and credit.

My picture of the situation right now is that the paper wealth created by various tranches of “stimulus” is flying around the asset markets, chasing Elon Musk tweets (ht Matt Levine). It is like airplanes stacked up over LaGuardia, flying in circles waiting for permission to land. At some point, people will resume spending their wealth on consumption. That is when the inflation will shift out of asset markets and into the prices of goods and services.

What will be the average annual rate of inflation between now and February 2027? I would give the following probabilities:

less than 2 percent: p = .5
between 2 and 4 percent: p = .2
between 4 and 6 percent: p = .1
over 6 percent: p = .2

Am I willing to bet? If my goal were to get rich, I would be buying an ETF that shorts long-term Treasuries. But my goal is to try to maintain what I have. I am trying as hard as I can to have a portfolio that is defensive against a high-inflation scenario. I probably should be investing in commodities.

The most likely reason that my view differs from the market’s is that I am much less confident that the Fed can stifle inflation when fiscal policy is so loose. The standard Fed response to inflation would be to buy less government debt. That would allow interest rates to rise. That causes government spending to rise by (change in interest rate)x(amount of debt to be rolled over). Because there is so much debt to be rolled over, this is a big deal. Other things equal, it puts more paper wealth into the hands of the public, so that it is less anti-inflationary than would be the case if we were starting with less outstanding debt.

And I predict intense political resistance to allowing interest rates to rise.

Number One Pick going for W, M

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Scott Alexander writes about Freddy DeBoer’s The Cult of Smart.

If the season had started, and if DeBoer were on someone’s team, Alexander would get a Win. In response to DeBoer’s case for the Null Hypothesis that successful school reform is not scalable, Alexander writes

These are good points, and I would accept them from anyone other than DeBoer, who will go on to say in a few chapters that the solution to our education issues is a Marxist revolution that overthrows capitalism and dispenses with the very concept of economic value. If he’s willing to accept a massive overhaul of everything, that’s failed every time it’s tried, why not accept a much smaller overhaul-of-everything, that’s succeeded at least once?

Later in the essay, Alexander creates a candidate to score a Meme.

School is child prison. It’s forcing kids to spend their childhood – a happy time! a time of natural curiosity and exploration and wonder – sitting in un-air-conditioned blocky buildings, cramped into identical desks, listening to someone drone on about the difference between alliteration and assonance, desperate to even be able to fidget but knowing that if they do their teacher will yell at them, and maybe they’ll get a detention that extends their sentence even longer without parole. The anti-psychiatric-abuse community has invented the “Burrito Test” – if a place won’t let you microwave a burrito without asking permission, it’s an institution. Doesn’t matter if the name is “Center For Flourishing” or whatever and the aides are social workers in street clothes instead of nurses in scrubs – if it doesn’t pass the Burrito Test, it’s an institution. There is no way school will let you microwave a burrito without permission. THEY WILL NOT EVEN LET YOU GO TO THE BATHROOM WITHOUT PERMISSION. YOU HAVE TO RAISE YOUR HAND AND ASK YOUR TEACHER FOR SOMETHING CALLED “THE BATHROOM PASS” IN FRONT OF YOUR ENTIRE CLASS, AND IF SHE DOESN’T LIKE YOU, SHE CAN JUST SAY NO.

Incidentally, I have decided to simplify Meme scoring. A player scores a Meme point if a Meme is used (by someone other than the player) three or more times during the season. So if “child prison” gets used by three other writers to mean school, Scott’s owner gets a Meme point.