The Fed Looks Increasingly Concerned About Liquidity and Growth — Even If it Says Otherwise

The Fed Looks Increasingly Concerned About Liquidity and Growth — Even If it Says Otherwise

11/02/2019Ryan McMaken

The Federal Reserve lowered its benchmark interest rate on Wednesday, cutting the target federal funds rate by 0.25 percent to a range of 0.5 to 0.75 percent.

The Fed's rate-setting committee, the FOMC, has now cut rates three times this year. The committee's rhetoric around the rate cut was the usual routine. The committee's statement indicated that " labor market remains strong and that economic activity has been rising at a moderate rate." But the official statement says something similar nearly every time the committee meets. So, there is no information here to suggests why the committee is cutting now versus all the other times the labor market is "strong" and economic strength is "moderate."


Two members of the committee voted against the cut: Esther L. George and Eric S. Rosengren.

Rosengren voted against the measure because he wanted a bigger ate cut. George, like her predecessor Thomas Hoenig at the Kansas City Fed, is relatively hawkish — although not the extent Hoenig was.

Thus, George noted in response to the rate cut: “While weakness in manufacturing and business investment is evident, it is not clear that monetary policy is the appropriate tool to offset the risks faced by businesses in those sectors when weighted against the costs that could be associated with such action.”

In other words, George recognizes that, yes, there are downsides to expansionary monetary policy.

Although the Fed statements offer no insights, the fact the Fed continues to cut rates suggests it is working from a position of fear about the true strength of the economy. Although jobs data continues to point to expansion, a number of other indicators look less rosy. The Case-Shiller index, for example, has fallen to 2-percent growth, and appears to be headed toward zero. We have seen a similar dynamic since 2006. Moreover, new housing permit growth has been negative (year-over-year) in six of the last ten months. Tax receipt data has also been weak, with seven out of the last ten reported periods showing negative year-over-year growth.

It's true that other indicators point to strength, but if things are going so well, why cut rates?

After all, the target rate is already remarkably low even by the standards of the most recent expansion, when the Fed Funds rate was allowed to rise to over five percent.


The Fed has justified this ultra-low-rate policy with theories about the natural interest rate, and about the alleged need to keep prices at or above two-percent inflation.

The problem is that the Fed cannot actually observe the natural interest rate and the two-percent inflation standard is a completely arbitrary standard invented in recent years.

Nonetheless, the Fed continues to look relatively restrained compared to other central banks, to which its policies are in part a reaction. Other central banks have set a very low bar, to be sure, but the Fred nonetheless looks almost hawkish compared to the ECB and the Bank of Japan. Both are pursuing a negative-interest-rate policy, and even with the latest rate cut, the Fed's target rate also remains above that of the Bank of England, and equal with the Bank of Canada.

But the target rate is, of course, not the Fed's only policy tool. To address liquidity problems observed during the recent repo crisis, the Fed has stepped up purchases and added to its balance sheet.

And then there is the interest the Fed pays on reserves. On Wednesday, the FOMC also announced a cut to the interest rate "paid on required and excess reserve balances," dropping the rate from 1.8 percent to 1.55 percent, mirroring the drop in the fed funds rate. 

This keeps the interest paid on reserves at 0.2 percent below the fed funds rate. That's the biggest gap we've seen since 2008, and it suggests the Fed wants more lending in the real economy, even though it's also apparently concerned about liquidity for banks.


This makes sense if we're in a late phase of the boom which brings increased demand for loans, but without sufficient savings and earnings at the street level to assure liquidity for banks through the marketplace. This is only a problem one encounters in an economy built on central-bank credit expansion. Central bankers no doubt are sure they can navigate these waters, but its unclear how long they can keep the current boom going.

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The Pre-Marriage Blood Test In America Is Now Gone

10/17/2019Ryan McMaken

2019 was the year that the blood-test requirement for marriage was finally abolished in all 50 US states.

This past March, the governor of Montana signed the legislature's bill abolishing the state's requirement that women submit to blood tests to be screened for rubella prior to the granting of a marriage license.

Technically, Montana had removed the absolute mandate in 2007, but the change would only "allow brides to opt out after signing an acknowledgement of the pregnancy risks related to rubella, and only if the groom signs too. Otherwise, the female applicant must provide a medical certificate signed by a physician stating that she has been tested or is exempt for medical reasons."

The 2019 legislation now completely removes the requirement.

Montana was the only remaining state with a blood test requirement. As recently as 1980, though, 34 states still had laws on the books requiring blood tests before marriage. Kasey S. Buckles, Melanie Guldi, and Joseph Price provide a concise summary of the legislative trend:

Of these 34, 19 states repealed their law in the 1980s, 7 repealed in the 1990s, and 7 more repealed between 2000 and 2008, leaving only Mississippi with a BTR in 2009.

(Buckles, et al,counted the Montana "opt out" as abolition, leaving only Mississippi.)

Mississippi ended its requirement in 2012.

But why was there ever a requirement at all?

Like so many invasive procedures mandated by governments, mandatory blood tests for couples seeking marriage licenses were a product of the age of eugenics and Progressive politics — two things that often go together.

As Ruth C. Engs notes in The Progressive Era's Health Reform Movement : "'Racial improvement' through positive eugenics, such as marriage to a healthy individual, [and] blood tests for syphilis prior to marriage ... were promoted for improving the 'race,' thus leading to a healthier nation."

The rights of individuals to marry whom they wished was thus swept aside in the name of "hygiene" and public health. Blood tests took their place along with prohibitions on interracial marriage as a means of "racial improvement."

Between 1980 and 2008, abolition was more a function of medical treatment options rather than any commitment to medical freedom or marriage freedom.

Buckles, et al note:

Historically, many states have required applicants for a marriage license to obtain a blood test. These tests were for venereal diseases (most commonly syphilis), for genetic disorders (such as sickle-cell anemia), or for rubella. The tests for syphilis were part of a broad public health campaign enacted in the late 1930s by U.S. Surgeon General Thomas Parran. Parran argued that premarital testing was necessary to inform the potential marriage partner of the risk of contracting a communicable disease, and to reduce the risk of birth defects associated with syphilis. According to Brandt (1985), "by the end of 1938, twenty-six states had enacted provisions prohibiting the marriage of infected individuals." Screenings for genetic disorders and for rubella were also implemented in the interest of minimizing the risk of genetic disease or birth defects in the couple's offspring.

Buckles, et al., note that it soon became apparent that the cost of the mandate was very high and benefits were quite low:

In the case of syphilis, however, it was soon recognized that premarital blood testing was not a cost-effective way to screen for the disease. Despite reports that 10% of Americans were infected, only 1.34% of applicants in New York City's first year of testing were found to have the disease. Brandt (1985) notes that a premarital exam was "not the optimal locus for screening," since couples seeking to marry were not likely to be in the most at-risk groups, and individuals who knew they were infected could wait until the infection cleared to apply for a license. ... Nationwide, couples spent over $80 million to reveal 456 cases.

By the 1980s, sexually-transmitted diseases were far more treatable than was the case in the 1930s. This lessened the importance of alerting future sex partners about one's health status. (This theory, of course, relies partly on an assumption people rarely have sex outside marriage — a view that was rather fanciful even in the 1930s.)

Nonetheless, abolition was not just a matter of deliberation over the medical efficacy of the laws. Ordinary people never appeared to be enthusiastic about the mandates, and many resented the additional hoops they needed to jump through to carry on with their personal lives.

It should surprise no one, then, that couples actively sought to avoid the costly and time-consuming test requirements.

Blood test requirements led to couples choosing to marry in states that did not have the mandates: "it appears that about one-third of the decrease in licenses is due to couples marrying out of state, while about two-thirds choose not to marry at all."

So, it turns out the mandated blood tests worked to discourage marriage while doing little to actually identify people with disease or improve public health.

The mandate was great for the medical industry, however, since it required the payment of many millions of dollars for otherwise unnecessary medical procedures.

You'll Marry Your Sister!

Another source of confusion over mandated blood tests has been a belief held by some that blood tests were used to screen for the "marry-your-sister" problem. That is, some think that blood-test mandates exist for purposes of genetic testing.

Unlike tests for venereal disease, however, genetic testing for consanguinity is very expensive, and has never been generally mandated by states. The issue could much more cheaply and pragmatically be addressed by granting people the legal right to know who their biological parents are, when the information is available. Cases of consanguinity are generally tied to cases when a marriage partner has been adopted, abandoned, or otherwise is unaware of his or her biological parents.

Conflicting Messages on Medical Freedom

It may be, however, that the abolition of one violation of medical freedom could be replaced by another.

After all, Montana's blood-test requirement was justified on the grounds that it prevented health problems for a third party. That is, if a woman with rubella becomes pregnant, this can have devastating effects on the developing fetus. Functionally, it was more a pre-pregnancy requirement than a pre-marriage requirement.

Just as modern treatments for STD lessened the need to test for syphilis ahead of time, the need for pre-pregnancy testing for rubella was largely supplanted by the prevalence of vaccines against rubella.  Will the repeal of the rubella blood test signal a renewed drive toward mandatory rubella vaccination in Montana? For now, efforts to remove all non-medical exemptions for vaccines are concentrated in states like New York and California. But the issue is certainly not confined only to these places.

It should not be assumed the movement toward abolishing blood tests was motivated by libertarian impulses.

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Remembering The Road to Serfdom: Collectivism and Morality

10/17/2019Gary Galles

In addition to providing crucial insights into the cleavages between social organization based on freedom and social organization based on coercion, Friedrich Hayek’s The Road to Serfdom provided many other insights. Many of them dealt with the morality of collectivism. In honor of the books 75th anniversary this year, please consider Part 2 of our considerations— Collectivism and Morality. (See Part I here.)

  • Is there a greater tragedy imaginable than that, in our endeavor consciously to shape our future in accordance with high ideals, we should in fact unwillingly produce the very opposite of what we have been striving for?
  • It seems almost as if we did not want to understand the development which has produced totalitarianism because such an understanding might destroy some of the dearest illusions to which we are determined to cling.
  • Democratic socialism…is not only unachievable, but…produces something so utterly different that few of those who now wish it would be prepared to accept the consequences.
  • [Beyond] the power to make general rules…delegation means that some authority is given power to make…arbitrary decisions.
  • Any policy aiming directly at a substantive ideal of distributive justice must lead to the destruction of the Rule of Law.
  • The question raised by economic planning is…whether it shall be we who decide what is more, and what is less, important, or whether this is to be decided by the planner.
  • The kind of state action which really would increase opportunity is almost precisely the opposite of the “planning” which is now generally advocated and practiced.
  • Although the professed aim of planning would be that man should cease to be a mere means, in fact—since it would be impossible to take account in the plan of individual likes and dislikes—the individual would more than ever become a mere means, to be used by the authority in the service of such abstractions as the “social welfare” or the “good of the community.”
  • Planning…consists essentially in depriving us of choice, in order to give us whatever fits best into the plan.
  • It soon becomes the one burning question which of the different sets of ideals shall be imposed upon all by making the whole resources of the country serve it.
  • The more we try to provide full security by interfering with the market system, the greater the insecurity becomes; and…the greater becomes the contrast between the security of those to whom it is granted as a privilege and the ever increasing insecurity of the under-privileged.
  • The democratic statesman who sets out to plan economic life will soon be confronted with the alternative of either assuming dictatorial powers or abandoning his plans.
  • The ethics produced by collectivism will be altogether different from the moral ideals that lead to the demand for collectivism.
  • Socialism can be put into practice only by methods of which most socialists disapprove.
  • The practice of socialism is everywhere totalitarian.
  • The principle that the end justifies the means in individualist ethics is regarded as the denial of all morals. In collectivist ethics it becomes necessarily the supreme rule.
  • Once you admit that the individual is merely a means to serve the ends of the higher entity called society or the nation…the pursuit of the common end of society can know no limits in any rights or values of any individual.
  • Since it is the supreme leader who alone determines the ends, his instruments must have no moral convictions of their own…no ideas about right or wrong which might interfere with the intentions of the leader.
  • Even the striving for equality by means of a directed economy can result only in an officially enforced inequality—an authoritarian determination of the status of each individual in the new hierarchical order.
  • Morals are of necessity a phenomenon of individual conduct…they can exist only in the sphere in which the individual is free to decide for himself...Only where we ourselves are responsible for our own interests…has our decision moral value.
  • In this sphere of individual conduct, the effect of collectivism has been almost entirely destructive.
  • A movement whose main promise is the relief from responsibility cannot but be antimoral in its effect, however lofty the ideals to which it owes its birth.
  • Injustices inflicted on individuals by government action in the interest of a group are disregarded with an indifference hardly distinguishable from callousness…the grossest violations of the most elementary rights of the individual...more and more often are countenanced.
  • Almost all the traditions and institutions in which democratic moral genius has found its most characteristic expression…are those which the progress of collectivism and its inherently centralistic tendencies are progressively destroying.
  • Neither good intentions nor efficiency of organization can preserve decency in a system in which personal freedom and individual responsibility are destroyed.
  • To imagine that the economic life of a vast area…can be directed or planned by democratic procedure betrays a complete lack of awareness of the problems such planning would raise…To undertake the direction of the economic life of people with widely divergent ideals and values is to assume responsibilities which commit one to the use of force; it is to assume a position where the best intentions cannot prevent one from being forced to act in a way which to some of those affected must appear highly immoral.
  • We shall never prevent the abuse of power if we are not prepared to limit power.

The Road to Serfdom made a powerful case that collectivism, by its nature, produced moral decline, and that it remains true even for collectivism supported out of desires for moral improvement. Since the direction that a system of social organization actually changes our morality is far more important than the direction one might hope it would lead, Hayek’s insights into the dystopian results of utopian collectivist thinking still merit careful consideration, three-quarters of a century later, at a time when support for socialist government interventions is again on an upswing.

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Hustlers' High Time Preference Does Them In

10/16/2019Doug French

The movie “Hustlers” is generating Oscar buzz and box office cash.  Words like “empowering” and “so much effing fun” are describing the JLo vehicle, based on the 2015 New York Magazine article “The Hustlers at Scores,” penned by Jessica Pressler.  Ramona (Lopez) and Destiny (Constance Wu) have been described as entrepreneurial for their client fishing, drugging, and stealing exploits.    

The critics are koo koo for JLo, with Nigel Smith writing in People, “In a tweet following the premiere, Vulture‘s Hunter Harris praised the film as ‘perfect’ while predicting that Lopez will be nominated for her first Oscar for her performance.”   

“Hustlers” cost $20 million to make and is closing in on $100 million in box office receipts world-wide after only a couple weeks of showings.  There was a healthy Friday night crowd at a local theater when I saw the film, with the audience 80-90 percent female. It was a girls' night out to see JLo and company drain the credit cards of Wall Street A-holes--pre and post 2008 financial meltdown.  

While much of the movie is set in a strip club, there is little nudity.  The film, at 110 minutes is larded up with scenes of high-end shopping and champagne corks popping. The screenplay directly lifts passages from Ms. Pressler’s article, but filler was needed to make it a full-length feature.  Multiple entrances, Magnificent 7-style, are provided by JLo and co-stars, along with celebrations of big scores. Eventually, hearing Ramona call someone (everyone) “BaayyBee!” might touch your last nerve.  

The story does connect with the 2008 financial crash, but you won’t mistake it for “The Big Short” or “Margin Call.”  Ramona takes Destiny under her wing and explains the three levels of Wall Street guys--low level, honest, but no money; mid-level, somewhat dishonest, some money; those at the top who cheat people all day and have lots of money to spend at strip clubs.      

After the crash and Wall Street layoffs, strip clubs go dead in the city and the enterprising, let’s call them performers, work their old money contacts to get guys into the club.  After Ramona has a customer pass out drunk and she swipes his credit card for five grand, she has a Hayekian discovery inspiration, believing she can perfect the process. Pressler writes, 

Of course, it didn’t always work. Sometimes they’d go through the whole performance and the guy would be too tired to go out; they would offer him drugs for extra energy, but he would be too lame to take them. In the face of such situations, Samantha had come up with the innovation that was making her rich: a special drink spiked with MDMA and ketamine.

Samantha is the real life Ramona.  

This is where the entrepreneurship turned to fraud.  While these women showed some entrepreneurial can-do spirit, their high time preferences did them in.  They spent everything they made and when Ramona learns a certain customer has $50,000 available credit on his card, instead of drawing only some of it as Destiny suggests, Ramona takes all 50k.  “That’s the problem with these girls,” Rosie (the real Destiny) told (Pressler) of her cohort (Ramona/Samantha), shaking her head. “I see the forest. They just wanted a $50,000 tree.”  

The movie portrays most men as stupid or worse.  Ramona tells Destiny, while doing a lap dance, “Drain the clock, not the c--k.” The occasional good guy is viewed as a hopeless sap, who can be strung along for money as needed.  

JLo is, no doubt, extraordinary at age 50.  However, her performance is not anymore Oscar Worthy than the acting of any aging stripper hustling at any club in America.  In fact, after seeing “Hustlers” you will leave feeling the same as leaving any strip joint--cheap and sleazy.    

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Not All Indian Reservations Are Alike

10/16/2019Ryan McMaken

Back when I taught political science, a phrase I used when preparing students for the tests was "he who makes distinctions well, teaches well."

That is, if we're talking about regime types, dear student, you better know the difference between a totalitarian regime, and a regime that is merely authoritarian. If we're talking about eighteenth-century American ideologies, you better know the difference between Alexander Hamilton and Thomas Jefferson. If we're talking economic policy, know the difference between fiscal policy and monetary policy.

And when it comes to different groups of Americans often considered to be homogeneous, it is often helpful to dig a little deeper to see some of the differences.

One such group is indigenous Americans. Or in the common parlance: "Indians."

Often, whenever one reads a news-media article about Indians, it usually begins with a few sentences about how poor they are, and how terrible the reservations are in terms of their standards of living. Usually, the Pine Ridge reservation in South Dakota is mentioned.

But at all reservations equally poor?

After all, some reservations have forests and ample access to water. Others are in the middle of deserts with few natural resources. Some relatively near metro areas and all the services they provide. Some reservations are hours from good healthcare and good shopping.

Well, it turns out that all reservations certainly aren't all the same.

Looking at the top-25 most populous reservations, we find that the median income among people who self-identify as Indians varies from $18,890 on the Gila River reservation (AZ) to $79,167 on the Agua Caliente reservation (CA). That's for the period from 2013 to 2017.

The overall US median income during the period was about $57,000, which means the median income for Indians on the Isabella and Tulalip reservations were about equal to everyone else.

Indeed, given that many reservations are in rural areas, it's helpful to compare incomes not to the US overall, but to the incomes of Rural Americans. The rural median income for the same period is $44,020. That means income for the median household on the Agua Caliente, Isabella, Tulalip, Uintah and Ouray, Osage, Wind River, and Puyallup reservations are all higher than the median household in rural America.

A the lower end, however, we do indeed find grinding poverty and remarkably low median incomes that are less than half of the national median income.

Even on the reservations with higher median incomes, poverty rates at the lower end remain elevated. The overall US poverty rate of 14.6 percent (against, from 2013-2017) was lower than all of the 25-largest reservations. The US rural poverty rate of 17.2 percent was lower than all but two (Osage and Tulalip) of the reservations.



One aspect of reservation populations that is often ignored, however, is the fact that on many reservations, people who self-identify as Indian are in the minority.

Among the 25-most populous reservations, the portion of the resident population that was Indian ranged from 1.7 percent on the Agua Caliente reservation to 96.8 percent on the San Carlos reservation.1



Reservations with lower proportions of non-Indian residents tend to be poorer. This may reflect several factors:

  • Residents on reservations that are more geographically isolated tend to encounter fewer non-Indian residents, thus leading to less intermarriage, and fewer residents who are not Indians.
  • Geographically isolated reservations tend to be poorer, and poorer reservations tend to attract fewer non-Indians engaged in commerce and employment on or near a reservation.
  • In many cases, reservations with more laissez-faire economic policies have more "checkerboarding," or mixing of privately owned and tribally-owned lands within this reservation. Checkerboarding may correlate with higher incomes.

In general, rural reservations are often affected by many of the same problems that rural communities in general encounter. There are fewer jobs, and the jobs that do exist often pay lower wages than in metropolitan areas. The US rural median income, for instance is approximately $44,000, while the urban median income is approximately $59,900.

Geographic isolation tends to be a clear factor in cases where the tribe owns a casino. When the casino is near a metropolitan area, it attracts large numbers of visitors to the reservation who spend freely. The most extreme case of this, perhaps, is the Mdewakanton Sioux of Minnesota (a group of under 1,000 people) which owns two casinos within the Minneapolis metro area. Members of the tribe receive nearly one million dollars per year in payments from tribal business organizations.

Another extreme case is the Agua Caliente reservation which is adjacent to Palm Springs, California. The tribe and is one of the city's largest land owners. Only a tiny percentage of residents are actually enrolled in the tribe.

Less-extreme examples of relatively prosperous reservations include the Southern Ute reservation — near the college and resort town of Durango Colorado — and the Tulalip reservation, which owns a casino and business park near I-5 in Washington State, near the Seattle-Tacoma metro area.

[A note on the data: In the first and second graphs, I've used median incomes that correspond to the group labeled  "AIANa," which according to the Minneapolis Fed's report on reservation incomes, "includes only individuals who self-identify racially as American Indian or Alaska Native alone." In the third graph, the Indian population corresponds to "AIANac" which "includes AIANa individuals and also those who self-identify as American Indian or Alaska Native in combination with other races." See report here:]

Photo credit: I-5 Design & Manufacture via Flickr (image cropped)

  • 1. The number of residents who are members of the tribe governing the reservation is lower than the number of residents who self-identify as Indian.
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The Nobel Prize in Economic Science Awarded to Silly, Politically Correct, Technocrats

10/14/2019Robert Wenzel

The Royal Swedish Academy of Sciences has awarded the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2019 to Abhijit Banerjee (Massachusetts Institute of Technology) and to his wife Esther Duflo (Massachusetts Institute of Technology) and to Michael Kremer (Harvard University).

From the Nobel committee:

Despite recent dramatic improvements, one of humanity’s most urgent issues is the reduction of global poverty, in all its forms. More than 700 million people still subsist on extremely low incomes. Every year, around five million children under the age of five still die of diseases that could often have been prevented or cured with inexpensive treatments. Half of the world’s children still leave school without basic literacy and numeracy skills.

This year’s Laureates have introduced a new approach to obtaining reliable answers about the best ways to fight global poverty. In brief, it involves dividing this issue into smaller, more manageable, questions – for example, the most effective interventions for improving educational outcomes or child health. They have shown that these smaller, more precise, questions are often best answered via carefully designed experiments among the people who are most affected.

In fact, these laureates are government technocrats who think at the government level rather than at the foundational level where an appreciation for free markets would make their work useless.

The Nobel committee:

As a direct result of one of their studies, more than five million Indian children have benefitted from effective programmes of remedial tutoring in schools. Another example is the heavy subsidies for preventive healthcare that have been introduced in many countries.

One has to ask, do these three seriously believe they have the answer for five million Indian children rather than leaving things up to the free market where multiple options would develop (without political interference)?

And political interference is not a theoretical question.

Alex Tabarrok reports on one type of interference (one of potentially many kinds):

[W]hen they tried to institute a similar program for nurses in Putting a Band-Aid on A Corpse the program was soon undermined by local politicians and “Eighteen months after its inception, the program had become completely ineffective.” 

And government subsidies for preventive healthcare? That is the government, deciding what is proper preventative healthcare, is taken seriously. In other words, the vegans, ketos and paleos get to battle it out to see who gets influence over health policies rather than leaving options?

How confused are these three?

Naturally, they are concerned with politically correct questions.

Tabarrok writes:

Duflo and Banerjee have conducted many of their field experiments in India and have looked at not just conventional questions of development economics but also at politics. In 1993, India introduced a constitutional rule that said that each state had to reserve a third of all positions as chair of village councils for women. In a series of papers, Duflo studies this natural experiment which involved randomization of villages with women chairs. In Women as Policy Makers (with Chattopadhyay) she finds that female politicians change the allocation of resources towards infrastructure of relevance to women. In Powerful Women (Beaman et al.) she finds that having once had a female village leader increases the prospects of future female leaders, i.e. exposure reduces bias.

Then there are just silly, poorly constructed models.

Tabarrok again:

Before Banerjee became a randomistas he was a theorist. His A Simple Model of Herd Behavior is also a favorite. The essence of the model can be explained in a simple example (from the paper). Suppose there are two restaurants A and B. The prior probability is that A is slightly more likely to a better restaurant than B but in fact B is the better restaurant. People arrive at the restaurant in sequence and as they do they get a signal of which restaurant is better and they also see what choice the person in front of them made. Suppose the first person in line gets a signal that the better restaurant is A (contrary to fact). They choose A. The second person then gets a signal that the better restaurant is B. The second person in line also sees that the first person chose A so they now know one signal is for A and one for B and the prior is A so the weight of the evidence is for A and the second person also chooses restaurant A. The next person in line also gets the B signal but for the same reasons they choose A. In fact, everyone chooses A even if 99 out of 100 signals are B. We get a herd. The sequential information structure means that the information is wasted. Thus, how information is distributed can make a huge difference to what happens.

Does Banerjee seriously think that restaurants are just signal takers subject to the herd? That they will do nothing to signal the benefits of their restaurants? This model has nothing to do with reality.

The Prize awarded for this silly work is 9 million Swedish krona ($916,000), to be shared equally between the three.

Originally published at Economic Policy Journal
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Why the Number of Firms Doesn't Matter for Innovation

10/10/2019Per Bylund

Consumers do not gain because there are many producers of the same good, the number is irrelevant. They also do not gain from firms competing with each other, their strategies matter little. Consumers gain from production directed toward value creation.

We have been taught that competition "is" many actors trying to do exactly the same thing, which "forces" them to outdo each other. But it is a simplification that gets very close to being a lie.

The reason is that  the competitive pressure that makes a business continue to innovate and even reinvent itself is not that there "are others." What matters is that others may beat them in the future. This is more than hairsplitting. 

Consider a runner who is so fast that nobody in that sport can beat her/him. Does that mean s/he stops training or just works to maintain that skill? No. Because there is no guarantee that others, who have trained differently and developed a new set of skills, won't enter. So to stay on top, the runner needs to continue to get better. For business, it is more difficult, since those who judge the outcome -- consumers -- might change their minds and develop new wants. 

The same thing holds true though, it is not enough to "simply" beat the existing competition, because there may be new entrants with innovations that undermine the value of your offering. And competitors may reinvent themselves to do the same. 

True competition, which any business needs to deal with, is the possibility of better offerings in the future.

More importantly: this pressure exists regardless of how many are currently producing a certain good. Competitors in the flip phone market were not disrupted by a better/cheaper flip phone, but a different type of device: the smart phone. 

In other words, what really matters is the value proposition, how well one satisfies consumers -- not the number of competitors in the present market.

While firms in the existing market try to keep prices lower and quality higher than the existing competition, and try to position their offering with respect to competitors' similar offering, this "dance" is not what creates value. Innovative, imaginative, entrepreneurship is what facilitates value for consumers and creates, reshapes, and destroys industries. 

In other words, all that is needed for a competitive product offering is *one* producer -- as long as others are not hindered from entering. There is this mistaken belief that what matters to consumers is the number of firms already busy producing a good, preferably almost the same good, which has made us think of competition not in terms of entrepreneurship but "how many." It often is true that more firms competing for limited demand will therefore engage in innovation, but it is not the fact that there are other firms that benefits consumers--it is the innovation. 

And what drives innovation is the pursuit of future profitability. You can have a market with hundreds of similar firms producing, which is disrupted by one innovative entrepreneur, and that one entrepreneur is much more important than any of the hundreds of competitors. 

The entrepreneur creates the valued new offering that satisfies consumers; s/he destroys the old by creating the new. That's what matters, not the number of firms. 

Formatted from Twitter @PerBylund

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Powell Lied: Quantitative Easing Is Back

10/09/2019Daniel Lacalle

The Federal Reserve, through its president Jerome Powell, has indicated that it is preparing to increase its balance “organically”. The effort to separate this latest monetary policy change of course from a full-blown new QE (quantitative easing) is, at the very least, amusing. If we look at what is being discussed, it has nothing to do with organic expansion and looks a lot like a new repurchase program.

Why has this announcement not affected the US dollar? The DXY Index is almost at highs of 99.02 at the close of this article. The main reason is that the dollar is appreciating not because the monetary policy of the Federal Reserve is hawkish, but because the central banks of other economies are much more reckless. The US dollar seems to strengthen as a safe-haven currency against other countries’ larger and worse financial repression actions. As such, the US dollar, gold and silver act as the best stores of value into a global slowdown where tother countries implement worse monetary policies as well as negative nominal rates.

The repo market crisis shows something that we have mentioned in this column several times. Central banks have created a monetary tsunami and thought they could manage the magnitude of the waves. The need to inject more than 270 billion US dollars into the short-term money market teaches us that liquidity is much lower than the Federal Reserve estimated and the agents’ debt much greater. If this happens in a dynamic economy and financial sector like the US and with huge liquidity providers, imagine when it happens in Europe, where those mechanisms do not exist with the scale of the US counterparts.

What the Fed proposes has very little to do with organic expansion. The Quantitative Easing programs repurchased between 60 to 85 billion dollars in assets per month. If we look at the organic growth of the Federal Reserve balance sheet prior to quantitative easing, it barely reached 3 billion dollars in a month. The Federal Reserve is discussing between 200 and 300 billion per quarter. That is not organic expansion but it is neither the type of measure that would trigger a surge in risk appetite from financial agents. So it is quite a lot more than organic expansion and also a lot less than what beta-chasing investors may require to keep their negative dollar carry-trade on cyclical assets.

This is a measure that will not satisfy those who need more excess liquidity and more stimuli to continue playing against the dollar but, at the same time, it further distances the Federal Reserve from normalization. If we assume the figures mentioned in different sources, the Federal Reserve balance sheet is unlikely to go below 25% of GDP in the next years.

The average investor may find contradictory messages in the Fed statements. Powell confirms that the economy is growing at a good pace, that unemployment is at the lowest level in 50 years and that core inflation remains above the Federal Reserve threshold, yet they also tell us that they have to cut rates and expand the balance sheet. Something does not match, and the explanation may lie in the need to keep an excessively leveraged market afloat and prevent the chain of bubbles in financial assets from bursting.

To me, these apparent contradictions in communication mean that the Federal Reserve is looking to prevent a financial asset meltdown while at the same time trying to avoid a higher concentration of risk. It may be, again, trying to manage the waves in the tsunami.

Originally published at
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Mark Thornton Inspires BBC Radio Episode on Prohibition

10/09/2019Tho Bishop

Recently, the BBC produced a radio series on "50 Things That Made the Modern Economy". One episode focused on the economics of prohibition, crediting the work of Mark Thornton's Economics of Prohibition for helping write the script for the show.

The episode is available here.

Dr. Thornton's book is available here.

(Thanks to Bob Broadfoot for letting us know!)

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Greece Never Really Recovered from Its Financial Crisis

Now that Greece’s bailout program has ended, what are the prospects for economic growth and development in Greece? These two definitions are different, as economic growth is the increase of income while economic development includes factors as increased schooling, life expectancy etc. However, economic growth is mandatory for economic development. There are many theories in the international literature about economic growth. The fundamental theory is  Robert Solow’s that combines two variables — capital and labor — but there are many other such as the theories of Romer and Lucas which focus on human capital and innovation. I am going to examine investment, savings and labor as variables of economic growth in Greece scrutinizing data of Greece from the latest years before I reach a conclusion.

Greece has made numerous efforts to attract foreign investment. While the benefits of foreign direct investment are controversial, as they depend on the kind of investment, this effort seems not to have had significant results in Greece. The first graph depicts the foreign direct investment per year. The straight line shows the trend of foreign direct investment that is almost a horizontal line, there is no sizable increase.


The second graph shows the Foreign Direct Investment as a percentage of GDP from the World Bank. Over the last two years, the FDI does not exceed 2% of GDP:


From my point of view, there are three main factors that have led to this failure. First, it is worth mentioning that Greece has the fifth-highest corporate tax rate in Europe (29%). This reduces the profit margin of a potential investor. It is 5.7 percentage points higher than corporate tax rate in Euro area (23.3%) while the rate of the neighboring countries is on average 14.2%.

Another drawback is the public bureaucracy. It is a problem that governments have tried to solve in recent decades, but little has been done. In any case, the facilitation of potential investors is crucial in order to attract investments.

Finally, political instability undermine investment and growth. The World Bank provides data from which an index has been created that depicts political stability. 2.5 points of the index indicates strength political stability and -2.5 points indicates political instability. The picture below proves the political instability of Greece.


Savings are vital in economic growth according to economic theory as an increase in savings increases the capital stock which is one of the two variables in Solow’s model. A simple way to understand the importance of savings is that someone’s saving could be someone else’s funds for investment. Financial institutions play the role of closing the gap between them. The following graph depicts the savings in Greece per year. Domestic savings have been reduced from 2008 to date dramatically due to consumption needs as Greeks’ income has decreased.


This reduction has a negative effect on economic growth and it is a necessity the savings start to increase again.

The last variable we'll examine is labor. Labor force participation has decreased over the last ten years. An explanation behind this may be the frustration that unemployed citizens feel from the high unemployment rate that the Hellenic Statistical Authority has approximately calculated at 19.9%. This increased by 12.1 percentage points from 2008. But the quantity of the labor force is not the only important factor. One must also consider the quality.

Unfortunately, the quality of workers may be getting worse: approximately 400.000 Greeks have emigrated the last eight years in order to work abroad, the majority of them not only graduates of universities but also holders of a master’s degree. This brain drain has a huge impact on economic growth as affects productivity and innovation, both significant for economic growth. There are many factors that affect productivity but surely education is one of them. Also, according with the European Commission, the innovation performance of Greece from 2010 to 2017 has decreased by 0.9% and Greece is considered as modest innovator. Needless to say, it is the same period that brain drain was more intense. The next graph depicts the trend of labor force participation rate.


Greece still faces many headwinds. Investments have not increased sufficiently, savings are going down, and the labor force is not only reduced compared to previous years, but highly educated Greeks have emigrated. Taking everything into consideration, it seems that Greece will have to change course to improve capital stock (via investment and savings), and labor, in order to achieve higher levels of productivity and actual production. Both are key in improving economic growth — and thus the Greek standard of living.

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American Politics Has Too Many "Party Animals"

10/03/2019Gary Galles

As hard as it is to believe after the 2016 election, attempts to bend, fold, spindle and mutilate public opinion have become even more intense and partisan since. Attacks, accusations, misrepresentations, leaks, innuendo, “gotcha” questions, ad hominem attacks and more follow one another on an accelerating merry-go-round of political abuse.

While many decry this overheated partisanship, few have analyzed the issue better than James Fenimore Cooper, in The American Democrat, an 1838 primer on Americans’ political responsibilities, written in reaction to the political excesses of his era.

America’s first great writer recognized that “in a democracy, the delusion that would elsewhere be poured into the ears of the prince is poured into those of the people.” He also saw that citizens needed the vigilance to see through those delusions, to maintain a democracy that did not eviscerate liberty: “The elector who gives his vote, on any grounds, party or personal, to an unworthy candidate, violates a sacred public duty, and is unfit to be a freeman.” As we wade through the mountain of muck that is accumulating in anticipation of the 2020 election, Cooper’s analysis appears very prescient:

  • In a democracy, as a matter of course, every effort is made to seize upon and create public opinion, which is, substantially, securing power.
  • Failing of the means of obtaining power more honestly, the fraudulent and ambitious find a motive to mislead, and even to corrupt the common sentiment, to attain their ends. This is the greatest and most pervading danger of all large democracies...We see the effects of this baneful influence in the openness and audacity with which men avow improper motives and improper acts, trusting to find support in a popular feeling.
  • The people are peculiarly exposed to become the dupes of demagogues and political schemers, most of the crimes of democracies arising from the faults and designs of men of this character.
  • Party misleads the public mind.
  • Opinion can be so perverted as to cause the false to seem to be true; the enemy, a friend, and the friend, an enemy; the best interests of a nation to appear insignificant, and trifles of moment; in a word, the right the wrong and the wrong the right.
  • Party, by feeding the passions and exciting personal interests, overshadows truth, justice, patriotism and every other public virtue…by putting unworthy motives in the place of reason.
  • Party feeling...induces men to adopt in gross, the prejudices, notions and judgments of the particular faction to which they belong, often without examination, and generally without candor.
  • Thus it is we see half the nation extolling those that the other half condemns, and condemning those that the other half extols. Both cannot be right, and as passions, interests and prejudices are enlisted on such occasions, it would be nearer the truth to say both are wrong.
  • The discipline and organization of party are…putting managers in the place of the people.
  • When party rules, the people do not rule, but merely such a portion of the people as can manage to get control of party.
  • Party pledges the representative...right or wrong, when the institutions intend that he shall be pledged only to justice, expediency and the right, under the restrictions of the constitution.
  • No freeman who really loves liberty...will ever become a mere party will be his earnest endeavor to hold himself a free agent, and most of all keep his mind untrammeled by the prejudices, frauds, and tyranny of factions.

Given how many Americans are now acting as if they were mere “party men,” Cooper’s warnings against putting party before serious thought were never more necessary. Unfortunately, those who most need to heed it show little inclination of doing so.

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