Monthly Archives: October 2011

The Good Old Days of Gold

A frequent rallying cry amongst many contemporary critics of monetary policy is reference to the good old days of gold when money was backed by something and maintained its purchasing power. While I share an affinity for a stable price level and am similarly interested in monetary reform, the yearning for the gold standard often comes in curious forms and ignores the surrounding institutional structure. Take, for example, Robert Sirico’s op-ed in The Wall Street Journal, he commends the Vatican for its recent statement on the role of monetary policy in the last few decades. Specifically, Sirico writes:

People are occupying Wall Street, blaming capitalism, speculation and greed, but rare is the analysis that traces all these problems back to the structural change in money that was brought about in the early 1970s.

We went from a hard-money regime, in which there were restrictions on the power of central banks and financial institutions to create money and credit, to one where money became purely paper. There were no restrictions remaining on the power of governments to finance unlimited debt. Banks could create credit seemingly without limit. Central banks became the real power in the world economy.

None of this was true under a gold standard. That system limits the expansion of credit by an indelible physical fact. There was a limit, a check, a rule that went beyond the whim of financial masters and politicians. The Vatican seems to understand this.

This is an interesting hypothesis, but it begs the question: Why did Nixon close the gold window? The Bretton Woods system collapsed because monetary policy had been too accommodative during that era. As the U.S. saw its gold reserves fall, it had essentially one of two options, significantly contract monetary policy or close the gold window. Not surprisingly, Nixon closed the gold window.

But contrast this reality with Sirico’s argument. According to this argument, the gold standard provides a check on the expansion of money and credit. However, the Bretton Woods agreement clearly did not provide any such check. Therein lies the problem with most contemporary arguments for the gold standard; they lack any reference to the institutional structure in which the system would operate. So long as there is a central bank, there is no reason to believe that a gold peg would provide any check on monetary policy.

A gold standard, like any other monetary standard, has costs and benefits. The main benefit is price stability. The main costs are the resource costs from mining gold for storage and the fluctuations in output that result from relative differences in the productivity of gold mining and the other industries in the economy. The desirability of the gold standard is therefore determined by the magnitudes of the costs and the benefits in and of themselves and in comparison to alternate monetary regimes. However, advocates of a return to the gold standard must be prepared to argue in favor of the abolition of the Federal Reserve and the establishment of a free banking system in which individual banks issue notes backed by gold. Otherwise, the check that a gold standard places on monetary policy is no different than that placed by a price level target — it’s only as good as the central bank’s commitment.

Meaningless Statistics

I don’t know nearly enough about Republican presidential candidate Herman Cain’s 9-9-9 tax plan to offer meaningful commentary — in fact, given the limited information available to the public, I would suggest that many of those commenting on it don’t know enough either, but I digress. In any event, the policy has recently been criticized on the grounds that it is regressive and shifts the tax burden away from the rich and more towards, well, everyone else. Some of these criticisms are ultimately meaningless unless we assume that the status quo is optimal.

For example, The Wall Street Journal summarizes the “tax-shifting” argument based on a recent think tank analysis:

Herman Cain’s “9-9-9” tax plan would boost taxes paid by moderate- and low-income households while cutting taxes for upper-income earners, according to a study released Tuesday by a think tank.


Liberals are sure to seize on the study as further evidence that the plan is too tough on working families, while conservatives said it underscores the need to focus on the “9-9-9” plan’s potential to lift the economy and job growth.


The top 20% of earners would bear 51% of the federal tax burden under the Cain plan, a reduction of almost 17 percentage points, the Tax Policy Center said. The bottom 20% would bear 3.4% of the federal tax burden, up from less than 1% now.

So what? This is a meaningless statistic unless we know the optimal amount of taxation that should come from the top and bottom 20%. In addition, the WSJ article notes that this might be a net positive with Republican primary voters since “almost half of U.S. taxpayers…don’t have to pay federal income tax under current rules.” It is therefore unclear what we are supposed to make of these numbers. Whether this is good or bad seems to depend on who you ask.

Then there is Bruce Bartlett:

As for corporations, Mr. Cain’s proposal is primarily going to benefit those with revenues of more than $1 million a year, because they account for 98.7 percent of all receipts by C corporations. (A C corporation is a legal entity separate and distinct from its owners that is taxed as a corporation; its shareholders pay taxes individually on their gains.) Those companies with receipts over $50 million account for 88.8 percent of total receipts.

Other business entities — sole proprietorships, S corporations (which have between 1 and 100 shareholders and pass through net income or losses to shareholders) and partnerships — would not benefit because they are not taxed on the corporate schedule. But they represent 92 percent of all businesses.

Those are some great statistics, but entirely misleading. The “92 percent of all businesses” that are described do not, in fact, pay the corporate income tax. However, the net income for these firms is paid through the personal income tax. As a result, they would benefit from the lower personal income tax rates. Thus, to say that 92% of all businesses wouldn’t benefit from a reduction in the corporate income tax rate is another meaningless statistic.

What I would like to see is a serious analysis of the policy (any policy for that matter) without the use of meaningless statistics.

On Observational Equivalence

Paul Krugman explains why one should believe in the Keynesian model. There are two main points he emphasizes:

First, we’re talking about a model, not just a prediction about the impact of spending increases. So you can ask about the ancillary predictions of that model as opposed to rival models. Anti-Keynesians assured us that budget deficits would send interest rates soaring; Keynesian analysis said they’d stay low as long as the economy remained far from full employment. Guess who was right?

Ricardian equivalence predicts that policy will not effect the interest rate.

The second point:

Also, there are some features of the approach that can be tested separately. Keynesianism isn’t just about sticky prices, but it does generally assume sticky prices — and there is overwhelming evidence, from a variety of sources, that prices are indeed sticky.

Evidence that prices do not adjust instantaneously does not imply that price stickiness is important in explaining fluctuations. For example, see this recent paper by Allen Head, Lucy Qian Liu, Guido Menzio, and Randy Wright. Here is the abstract:

Why do some sellers set prices in nominal terms that do not respond to changes in the aggregate price level? In many models, prices are sticky by assumption. Here it is a result. We use search theory, with two consequences: prices are set in dollars since money is the medium of exchange; and equilibrium implies a nondegenerate price distribution. When money increases, some sellers keep prices constant, earning less per unit but making it up on volume, so profit is unaffected. The model is consistent with the micro data. But, in contrast with other sticky-price models, money is neutral.

Neither of these observations suggest that Krugman is wrong, but rather to note that there are other views that are observationally equivalent. In other words, his reasons for supporting Keynesian models is confirmation bias.

The Strangest Thing I Read Today

Via Scott Sumner, I find Ezra Klein considering counterfactuals about policy and the recession. However, two sentences stuck out as particularly odd:

The stimulus was a bet that we could get out of this recession through the one path everyone can agree on: growth. The bet was pretty much all-in, and it failed.

The stimulus was about growth? Not the stimulus package that I saw.

The stimulus package was a “gap-closing” policy and the emphasis seemed to be more toward preventing the loss of public sector jobs like teachers, police, and fire service — as evident by the substantial chunk of the package that was devoted to transfers to states. Now we can debate the merits of such policies until we are blue in the fact, but there was very little in the way of growth-producing policies consistent with economic theory (and that remains true if you think that the transfer payments were good policy). What precisely was pro-growth about the stimulus package? Perhaps I missed something.

Thank You, Steve

I remember sometime in 2003, I was still an undergrad and I was working in retail. I showed up for work one day and one of my fellow workers said to me, “I have to show you something really cool.” We walked back to the electronics department, he opened up the case and said, “check this out. It’s from Apple. They call it an iPod.” I played around with the iPod for about 15 minutes, looked at him it said, “this is really cool, but it’s a bit pricey. Is anybody going to buy it?”

That was the genius of Steve Jobs. He didn’t invent the graphical user interface, but he perfected it like no other. I still remember seeing Mac OS X for the first time and it convinced me that I needed to switch back to using Apple’s products. It was so much more fluid and user friendly than Windows, but in quintessential Jobs fashion, it was also elegant and beautiful. And this says nothing about reliability. I have first generation MacBook Pro on my desk at home. First generation means that it’s 5 1/2 years old. It still runs like new and even if it crashed tomorrow (which it won’t), it would still be the longest-lasting and most reliable computer I have ever owned.

The creation of the iPod in an of itself was a remarkable innovation (thousands of songs on one device!), but Steve Jobs did so much more than simply create a new way to listen to music; he revolutionized the way we purchase music. It also revolutionized the way that we access content. Do you want to listen to NPR or ESPN Radio or EconTalk? The iPod and the iTunes store enabled you to listen to many of your favorite radio programs anywhere you want whenever you want. And would programs like EconTalk even exist without the creation of the iPod or iTunes? The iPhone allowed us the same functionality while simultaneously offering the ability to make phone calls, but it was also so much more. In doing so, it revolutionized the way we think about and use our phones.

In my mind, though, perhaps the best creation, and what will turn out to be the most revolutionary, is the iPad. While I do not yet own an iPad (donations are accepted), I really see the iPad and tablets in general as being the new laptop. It is so much more enjoyable to surf the internet, watch digital content, and read journal articles, newspapers and magazines on a tablet. What the iPod did for the way we listen to music, the iPad will do to the way we read and consume other digital content, like movies and television shows.

Steve Jobs had perhaps the most innovative mind of the last century. Since the founding of Apple, Jobs created more value and perhaps did more to improve the everyday lives of individuals than perhaps any other. The world has lost a great mind. Thanks for everything, Steve.