Saturday, March 7, 2015

On the myopia of macroeconomics

On matters of macroeconomics, I am mostly an agnostic in the classical sense - one who is unsure where everyone else (in the original, stupider people, but that seems presumptuous) seems to be sure.

Of course, the fact that everyone else is sure and manages to come to wildly different conclusions is always puzzling. Should the Greek government be spending more to grow its way out of debt, or spending less to pay off the existing debt? I confess, dear reader, to not being very confident in my answer to this question. Partly this may be because I'm an idiot who didn't learn enough macroeconomics. The latter is certainly true. Although the chances that I know less macroeconomics that half the idiots spouting off about austerity on facebook is also quite slim.

Every now and again, I'm struck by a sense that a lot of macroeconomics seems rather unimaginative, in the sense of focusing only on the current set of institutional arrangements that we have, rather than contemplating very different sets of arrangements and figuring out whether they might be an improvement.

This is fine, if you think that the current arrangements are the product of extended scientific experimentation. But given that a lot of them seem to have come about mostly by historical accident, it's hard to be so confident that we live in the panglossian best macroeconomic world of all macroeconomic worlds.

For example, everyone who's anyone knows that the optimal way to run a money system is to have all currency printed by a central bank on special pieces of paper. These pieces of paper should have a fixed face value, and be backed by nothing but the central bank's presumed desire to avoid too much inflation.

Be honest, how confident are you that all of these assumptions are optimal?

The paper aspect is surely not optimal. As I've said before, we exist on a 'paper standard' - the real money is the electronic dollars recorded at the bank, and people have the notional ability to convert all of these to pieces of paper. Which they do occasionally, for a small amount of their dollars, and over time will do less and less. But already, it would be totally feasible to convert all currency over to electronic forms without too much effort. Should we do it? Should it have already happened?

Once you start doubting, it makes you wonder how sure you are of the rest of it.

What would happen if the US switched to a gold standard? Let's take it as given that the loss of monetary policy would be a problem. But how big, exactly? If you had to forecast the stock returns on the day the policy was announced out of the blue, do you think you could come within +/- 5%? I'm not sure I could. Are you also equally confident that the gold standard wouldn't have any offsetting benefits to at least partly counterbalance the loss of monetary policy?

This ambiguity is especially true when you ponder things like Bitcoin. It's still going merrily along - Stripe now lets you accept it easily as a payment form. Sure, both search volume and price are lower than a few years ago - it seemed like there was probably a bubble at the time.

One way to look at this graph is to think 'Ha, look at how far it's fallen! The increasing scandals and decreasing interest surely herald the end for Bitcoin.'

The other way to look at it, which I think is more relevant, is that Bitcoin is still going after almost 4 years, even though very few academic economists can explain its existence at all.

To wit, the standard requirements for money is that it is a unit of account, a mechanism of exchange, and a store of value. Bitcoin has the first two, but not the third - there's nothing inherently valuable about certain mineable bits of information, hence nobody should be willing to hold it. Yet they are. And in response, few respectable academic theories seemed to have evolved much beyond 'people are idiots' and 'you can't short it'. At some point, this is a bit unsatisfactory. Shouldn't you at least consider the possibility that the third requirement is not actually 'store of value' but rather 'belief that the next guy will accept it'? In which case 'store of value' is just a way of getting there, and Bitcoin seems to be on the way to being accepted without it. And once something becomes widely accepted, this belief becomes self-fulfulling.

The reason that I think it behooves one to have a little modesty in one's own theories here is that I am almost certain that if you took academic economists from 100 years ago and told them that instead of trading gold-backed currencies, people will be entirely comfortable accepting otherwise worthless pieces of paper issued by the government, and nobody will think this odd, they would say you were crazy. And frankly, they'd have a point. After the fact, economists will be around to tell you that the key thing actually is that the bits of paper have a reliable value as a way to pay tax bills. But doesn't this sound like a rationalisation? It's certainly a lot flimsier than 'it's tradable for actual gold', and yet a) here we are, and b) people are now saying that any further decline in the inherent value of currency is absolutely unthinkable, notwithstanding the huge decline we've already made.

There are tons of examples. Central banks themselves were a random populist intervention that economists took decades to even begin to rationalize. So was deposit insurance. These schemes both predated our formal understanding of why they seemed to work.

Given all this, I think it's okay, and probably even desirable, to have pretty darn flat priors about macroeconomic policy. You probably don't want massive deflation, to jack up interest rates to 20% overnight, or to permanently spend more than you earn. But you're a braver man than I if you think our current institutional arrangements are close to optimal.

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