The November election has split the Senate, which the Democrats won by a very small majority, from the House, which the Republicans won, also by a very small majority (according to AP’s call yesterday). The result of divided government will be gridlock, that is, as the late Justice Antonin Scalia explained, “power contradicting power.” There is a seven-minute YouTube video where he adds that Americans should “learn to love the gridlock,” because it prevents an excess of legislation. It is a feature, not a bug, of the American system of government. That divided government would protect individuals is an old (classical) liberal idea. It was echoed in Montesquieu’s 1748 book The Spirit of the Laws: To prevent this abuse, it is necessary [that], from the very [arrangement] of things, power should be a check to power. [French original] Pour qu’on ne puisse abuser du pouvoir, il faut que, par la disposition des choses, le pouvoir arrête le pouvoir. More to the point, James Madison wrote in Federalist No. 51: This policy of supplying by opposite and rival interests, the defect of better motives, might be traced through the whole system of human affairs, private as well as public. We see it particularly displayed in all the subordinate distributions of power; where the constant aim is to divide and arrange the several offices in such a manner as that each may be a check on the other. … In republican government the legislative authority, necessarily, predominates. The remedy for this inconveniency is, to divide the legislature into different branches; and to render them by different modes of election, and different principles of action, as little connected with each other, as the nature of their common functions, and their common dependence on the society, will admit. What does this have to do with economics? Although economists have always been interested in the workings of politics, as suggested by the old term “political economy,” the contemporary school of Public Choice has provided enhanced analysis of how democratic government works in practice and how it can or cannot efficiently promote the interests of the several individuals in society (assuming that government is necessary). Two especially important books in that regard are Geoffrey Brennan and James Buchanan, The Reason of Rules (Cambridge University Press, 1985; Liberty Fund, 2000); and the older classic of James Buchanan and Gordon Tullock, The Calculus of Consent (University of Chicago Press, 1962; Liberty Fund, 1999). A central idea is that rational individuals will want to constrain government power with constitutional rules. Gridlock hopefully happens when a government wants to impose bans or obligations that don’t meet the consent of most citizens. It is true that gridlock may prevent the adoption of potentially good legislation or the repeal of bad legislation, but this is still better than tyranny or, as Montesquieu said, Since a despotic government is productive of the most dreadful calamities to human nature, the very evil that restrains it is beneficial to the subject. [French original] Comme le despotisme cause à la nature humaine des maux effroyables, le mal même qui le limite est un bien. (0 COMMENTS)

As part of its constitution, Massachusetts has a flat-rate income tax. Since 2020, that rate has been 5.0 percent and was actually higher in some previous years. Various interest groups have tried over the years to change the constitution so that the state government could impose a higher income tax rate on high-income people. Other people successfully and valiantly succeeded in fighting off those attempts. This month, there was, yet again, a measure on the Massachusetts ballot to change the constitution and impose a higher tax rate on people with high incomes. Specifically, the measure called for a 4-percentage point surtax on the portion of people’s income in excess of $1 million. I had hoped to report that this measure failed. Alas, I cannot. With 99 percent of the votes counted, 52.0 percent voted Yes, with 48.0 percent voting No. That means that it’s mathematically impossible for the measure to be voted down. If every single remaining vote were a No, that would mean that 51.5 percent are Yes votes and 48.5 percent are No votes. These are the opening paragraphs of my “The Bad News from Taxachusetts,” IPI, TaxBytes, November 16, 2022. And the last paragraph: The requirement that everyone pay the same tax rate on income restrained politicians from raising the tax rate substantially because they knew it would hit everyone. Indeed, sometimes that constraint led politicians to actually cut Massachusetts’ income tax rates. In 1992, for example, the tax rate was 5.95 percent. It fell in steps to 5.0 percent. Sadly, the constraint that led to that happy result is now gone. Read the whole thing, which is quite short.   (1 COMMENTS)

Following the crash of cryptocurrency exchange FTX, Senator Bob Menendez (D-New Jersey) declared (“US Lawmakers Call for More Crypto Regulation After FTX Collapse,” Financial Times, November 15, 2022): This should be a renewed call for Congress to take a serious look at crypto exchanges and lending platforms, many of which engage in risky behaviours, while marketing themselves as safe for consumers. We could say something similar with much more evidence and theory to back up our claim: “It’s time to take a serious look at government, which engages in risky behaviors while marketing themselves as safe for citizens.” Just think about of federal power and the public debt, which increase with every emergency and in between, and very seldom recede. The naïve conceit expressed by state rulers is not limited to one side of the aisle. The Financial Times continues: Cynthia Lummis — the Republican senator from Wyoming, who has co-written a bipartisan bill that sketches out a complete regulatory framework for digital assets in the US — described the FTX turbulence as “awful and simultaneously not all that surprising”. “It’s obvious that Congress needs to regulate digital assets,” she added. That Sam Bankman-Fried, the entrepreneur who founded and ran FTX, was a big donor to the Democratic Party and allied groups does not make the episode less revealing (“Sam Bankman-Fried’s Fall Cuts Off Big Source of Funds for US Democrats,” Financial Times, November 13, 2022): Before the fall of Bankman-Fried’s cryptocurrency exchange FTX, the entrepreneur had emerged as the second-largest donor to Democrats after George Soros. … The entrepreneur was the second-largest donor to Democratic-leaning groups during the latest midterm elections, spending $36mn. He did hedge his rent-seeking bets, but apparently only with small amounts: During the 2022 cycle, Bankman-Fried donated $155,000 to rightwing Pacs: the Alabama Conservatives Fund, which backed Republican Alabama Senator-elect Katie Britt, a crypto supporter; and Heartland Resurgence, which backed Senator John Boozman of Arkansas, the top Republican on the Senate agriculture committee that oversees crypto. That the Senate Committee on Agriculture, Nutrition, and Forestry “oversees” cryptocurrencies is rather hilarious feature of the story. (0 COMMENTS)

Commenter Jeff asked an interesting question: Thought experiment: What if the trajectory of policy were such that everyone—all market participants: buyers and sellers, creditors and debtors, producers and consumers—woke up one day and realized that money is worth exactly half what they thought it was worth the day before?How would this inflation be categorized by the knowledgeable with regard to dividing up demand vs. supply effects? 100% demand-driven inflation? 50-50 demand/supply? 100% supply shock?I imagine there should be a well-defined answer for a well-posed question? I’m going to address this in a roundabout way, which I believe will shed light on what’s wrong with much of modern macro.  I’ll begin with some thought experiments relating to currency reform events, and then discuss how these examples relate to ordinary demand shocks. Developing countries that have previously suffered from high inflation will occasionally do a currency reform, such as exchanging 100 old pesos for 1 new peso, with the goal of making mathematical calculations easier for shoppers.  It’s sort of like a stock split, but in the opposite direction.  On the day these reforms are made, all nominal values immediately adjust in the same 100 to 1 ratio.  Thus 100 million (old) peso bonds become 1 million (new) peso bonds.  A 600 peso/hour wage contract becomes 6 peso/hour.  Prices also fall by 99%.  There is a sense in which this price decline might be viewed as a severe “deflation”, but almost no one views it that way.  Is it actually 99% deflation? Two reasons might be offered as to why this is not truly deflation.  First, deflation means falling prices as measured in the same currency.  Under a currency reform, the new peso is a different currency from the old peso.  (Europe’s adoption of the euro provides another example of this phenomenon.)  Second, the currency reform is in some sense “neutral”, like changing the length of a measuring stick, it doesn’t affect any real quantities. To see which reason is the more essential, I’d like to consider a thought experiment where only one of these two objections applies, and then consider how we would view that event.  To make things easier, let’s look at an inflationary currency reform, say 1 old peso for 100 new ones.  And let’s make one further adjustment—the new pesos will be identical to the old pesos—the exact same money.  This is tricky to accomplish, but it’s just a thought experiment and we are trying to work through what’s really going on here. Normally, if you swapped 1 peso for 100 of the same peso, people would immediately turn around and do this over and over again.  To prevent that outcome, assume that everyone exchanging money must line up at a bank or government office at 12 noon on January 1st, at which time each of their old pesos will be exchange for 100 of the exact same type of money.  No double dipping.  As with any other currency reform, nominal contracts such as bonds and labor agreements are automatically adjusted in the same ratio of 1 to 100.  Thus as with any other currency reform, there should be absolutely no real effects, we are merely changing the length of the measuring stick. And yet even in this case, I don’t think the public would view the event as some sort of hyperinflation, as it doesn’t have any of the real effects (on output and wealth redistribution) normally associated with hyperinflation.  The effects of this action are essentially the same as a traditional currency reform where one old peso is exchange for 100 new and different pesos.  And yet in a technical sense it really is hyperinflation—as we are measuring prices in the exact same currency. The point of this thought experiment is to try to convince you that while one can cite two reasons why currency reforms are usually not view as hyper-deflation or hyperinflation, only one of the reasons is truly essential.  The essential reason is that currency reforms are completely neutral, they don’t have real effects. That’s why they are viewed as non-events.  After all, in a technical sense the thought experiment I just gave you really is a 100-fold increase in the price level, it really is hyperinflation, as the currency type has not changed, just the quantity of money.  It is what I would call a pure nominal shock. This thought experiment also helps us to understand why most real world nominal shocks do have real effects.  In most cases, a change in the money supply or demand is not accompanied by a government fiat automatically adjusting all contracts.  This real world nominal contract stickiness means that nominal shocks cause swings in real variables such as employment, output and bankruptcies, effects that would not occur in a pure currency reform with no nominal contract stickiness. In my view, the best way to think about the business cycle is that there are a series of nominal (demand) shocks that would be completely neutral in a world of 100% contract flexibility, but end up having important real effects due to the existence of nominal contracts (plus firms being slow to adjust prices.) But that’s not how most economists look at phenomena such as inflation. It is much more common for economists to describe inflation (a nominal process) as being caused by real shocks.  Thus they might argue that a booming economy—i.e., excessively rapid growth in GDP beyond the economy’s potential—causes inflation.  Or excessively low unemployment causes inflation (the Phillips Curve model.)  To me, this confuses cause and effect. Of course even in my view of causality, nominal and real variables are positively correlated over the business cycle.  So does it really matter how we view causation?   Here’s why I believe it does matter.  A few months back I recall seeing people argue that inflation wasn’t being caused by demand side factors, because “demand” wasn’t even back to the pre-Covid trend line.  I use scare quotes for demand, as they were not defining demand as nominal spending (which would be appropriate), but rather as real spending, which is wildly inappropriate. If the natural rate of output were 100% knowable in real time, the two approaches would end up giving similar answers.  But let’s say that the natural rate of output moves around in hard to forecast ways.  For instance, suppose that Covid depressed the natural rate of output in 2022 by 2%, by reducing labor force growth (sharply lower immigration, people with long Covid, people fearful of getting Covid, etc.)  In that case, if RGDP were to return to 1% below the pre-Covid trend line, it would actually be 1% above the (depressed) natural rate of output.  An economy that looked “depressed” would actually be overheated. I want pull my hair out when I see economists define “demand” as real output.  That’s an EC101 error.  Real output is a quantity, it’s just as much “supply” as it is demand.  In fact, it is neither demand nor supply, it is quantity demanded and quantity supplied.  The appropriate way to measure aggregate demand is to look at nominal spending—NGDP.  And NGDP was far above trend in 2022.  Any shortfall of RGDP was not due to weak demand, it was due to capacity constraints induced by the Covid shock. The same mistake occurs when people argue that low unemployment (a real variable) causes inflation.  Unemployment is a real variable, whereas demand is a nominal variable.  It makes more sense to say that positive nominal shocks (more money demand or less supply) causes low unemployment due to sticky wages.  And because the natural rate of unemployment is hard to estimate, Phillips curve models of inflation are not reliable.  You need to focus on NGDP. The same mistake occurs when economists argue that low real interest rates are an easy money policy.  The natural real interest rate moves around a great deal.  The Fed often finds itself in a situation where it is raising rates but money is getting easier (the 1960s and 1970s) or it is cutting rates but money is getting tighter (the 1930s, 2008.)  To ascertain the stance of monetary policy, you need to look at . . . you guessed it . . . NGDP. So while many economists would scoff at Jeff’s suggestion that a sudden and neutral 2 for 1 change in the price level is a “demand shock”, because they don’t see any change in real demand, I believe Jeff is exactly right.  It’s an unusual demand shock, as it seems to posit a smooth adjustment because everyone has 100% rational expectations and there is no discussion of sticky prices, but it’s still a 100% increase in the price level, and 100% increase in NGDP. When doing macro, don’t start with changes in real variables.  Start with the nominal shocks, such as the change in NGDP.  Then derive the real effects, which will be greater in an economy with lots of wage stickiness (1930 and 2009) and smaller but still quite meaningful in economies with less wage stickiness (1921.)  All economies have some stickiness, except in the unusual case of a pure currency reform.   A currency reform is like a lab experiment, showing us what nominal shocks would look like in a world without any nominal contract stickiness.  They help us to understand why we do see real effects in the real world.  But the real effects (on RGDP or employment) are not the ultimate cause of the business cycle, they are an effect produced by nominal shocks in a world with wage/price stickiness. (0 COMMENTS)

David Beckworth has a new podcast with Ethan Ilzetzki, and it’s one of my favorites. At one point, David asks Ilzetzki about the stance of monetary policy.  A long answer is provided—well worth reading—but this part caught my eye: My best guess of what we will see is that, for the most part, the shocks to monetary policy this past year will be for the most part dovish shocks, they will be negative declines in the fed funds rate.Ilzetzki: And this is a little mind boggling because the actual interest rate has gone up this whole time. But our measures of monetary policy shocks, I suspect, will say the opposite. Just to give you an example, I didn’t look at futures for today’s meeting yet, but last FOMC meeting, the markets were pricing in, I think it was an 82 basis point increase. What does that mean, because the Fed never moves by 82 basis points. So what does that mean? That means that some people were betting on a 75 basis point increase. Some were betting, taking a contrarian view and saying, I think that Fed’s going to go even harder on the economy. So the monetary policy shock that occurred on the day of the announcement was actually a decrease, a very, very slight one, but a decrease in the interest rate because that was the new news that they went for the expected 75, and not for the contrarian, shocking 100 basis points. David Beckworth then points out that these things are tricky to measure: Beckworth: And this is the eternal challenge of macroeconomics identification. How do you truly isolate something caused by monetary policy that wasn’t itself a derivative of some other development in the economy or caused by something else. So macro economists have their work cut out for them, no doubt. . . . Quickly, the monetarist theory says the nominal quantity of money relative to its real demand. Now, the key hang up in the monetarist model is we don’t observe the real money demand, we have to estimate it. It’s an unobservable. New Keynesian model, it’s the Phillips curve. And in the Phillips curve you have this thing called the output gap, which is also, we don’t observe, you have to estimate it. Beckworth: Now for the fiscal theory of the price level, they also have this problem. They’ve got to know the net present value or the discounted present value of future real primary surpluses. So all three theories have these unobservables. It’s hard to falsify them in some extent. Like Ilzetzki, I believe that monetary policy has been pretty dovish in 2022, although I focus more on NGDP growth than event studies.  One thing we both agree on is that interest rates are a highly unreliable indicator of the stance of policy. I’ve argued that the fiscal theory of the price level (which argues that fiscal policy is the dog and monetary policy is the tail), does not explain events in developed countries like the US.  Ilzetzki points out that the model also fails to explain the UK.  Here he discusses the mini-crisis after Liz Truss took over as Prime Minister: Ilzetzki: And so if this was sort of an event of bond markets fearing that the government would strong arm the Bank of England into submission, we would not see what we saw. And coming to the policy recommendations, the UK also provides an excellent counter example or a counter-argument to the bank should just roll over and allow a more expansionary policy. I think what that ignores is the strategic game between the Treasury and the central bank. We saw the Bank of England sticking to its guns saying we’re going to have to raise interest rates more because this fiscal expansion is leading to more inflation. And it took about three weeks for the prime minister to resign. So fiscal policy responds to reality and blinked first in this case. So at least 1-0 here in the UK for monetary dominance and I hope it stays that way. Monetary dominance is both a desirable state of affairs and the way the (developed) world actually works.  God help us if we ever end up with the sort of fiscal dominance that you see in Argentina, Venezuela, and Zimbabwe.  Just imagine what would happen if we asked Congress to target inflation at 2%! (0 COMMENTS)

Language has enormous benefits. It dramatically reduces the transaction costs in exchange, taken both in the narrow sense of trade and in the larger sense of interindividual interaction. It allows the development of literature, philosophy, and science. It opens the road to prosperity. The more complex a language, the larger these possibilities. Language is a standard case of what Friedrich Hayek calls a spontaneous or autoregulated order, and its very complexity is a product of unplanned social evolution. Newspeak was imagined by novelist George Orwell as a language manufactured by the state and meant to replace English. This would be the exact opposite of a spontaneous order. In the Appendix to his dystopian novel Nineteen Eighty-Four, Orwell explained: Newspeak was the official language of Oceania and had been devised to meet the ideological needs of Ingsoc, or English Socialism. … The purpose of Newspeak was not only to provide a medium of expression for the world-view and mental habits proper to the devotees of Ingsoc, but to make all other modes of thought impossible. … Newspeak was designed not to extend but to diminish the range of thought, Except for dead languages, any language of course changes as it adapts to new knowledge, technology, institutions, and general opinion. Contrarily to what the Big Brother of Nineteen Eighty Four was doing, however, changes are typically slow. We would, for example, expect changing opinion about sex and gender to bring linguistic changes, but slowly. Given the relative youth of the woke movement, not more than half a century if we include its postmodernist predecessor, we would not expect it to have already had a widespread impact on common language. So it is surprising to read in the Wall Street Journal (Alexa Corse, Suzanne Vranica, and Sarah E. Needleman, “Elon Musk Raises Specter of Twitter Bankruptcy Amid Executive Turmoil,” November 10, 2022) the following sentences: “I’ve made the hard decision to leave Twitter,” Mx. Kissner, the chief information security officer—who uses the gender-neutral honorific—tweeted early Thursday. Mx. Kissner resigned Wednesday after a disagreement … Of course, Lea Kissner is free to call herself whatever she wants, but why would the Wall Street Journal echo the eccentric title she has chosen? Although most of us would agree that her sex should be of no import in our evaluation of her job performance or opinions on Twitter, why should anybody else change the way he talks about her just because she says so? Who has the power to change language everybody speaks like Big Brother fictionally did in Nineteen Eighty-Four? The Mx. title, gender and racial obsessions, the multiplication of pronouns, and group-identity cages are just some elements of the linguistic innovations that have been pushed by the same fringe over the past few decades. It looks a bit like Orwell’s Newspeak. For sure, today’s Newspeak in the making is a bit more elaborate. Let me give three examples. The first one, already quoted in my post “′Ice is not Ice′ and the Limits of Conversation,” is an excerpt from a 2018 article by Professor Donna Riley in Engineering Studies and emphasizes identity groupism against intellectual rigor: For those of us who work on engineering identity development, rigor may be a defining tool, revealing how structural forces of power and privilege operate to exclude men of color and women, students with disabilities, LGBTQ+ people, first-generation and low-income students, and non-traditionally aged students. The second example comes from an article by UC Berkeley philosopher Judith Butler in the journal Diacritics, and won the 1998 first prize awarded by Philosophy and Literature for the world’s worst writing —for “the most stylistically lamentable [passage] found in scholarly books and articles.” But I am not sure it’s a question of bad writing or of scientifically-looking obfuscation. I suspect Newspeak: The theoretical rearticulation of structure as hegemony marked the work of Laclau and Mouffe as consequentially poststructuralist and offered perhaps the most important link between politics and poststructuralism in recent years (along with the work of Gayatri Chakravorty Spivak). The move from a structuralist account in which capital is understood to structure social relations in relatively homologous ways to a view of hegemony in which power relations are subject to repetition, convergence, and rearticulation brought the question of temporality into the thinking of structure, and marked a shift from a form of Althusserian theory that takes structural totalities as theoretical objects to one in which the insights into the contingent possibility of structure inaugurate a renewed conception of hegemony as bound up with the contingent sites and strategies of the rearticulation of power. The third quote is from a 1989 University of Chicago Law Forum article by Kimberle Crenshaw, a critical race theorist, and mentions the development of a new language (thanks to Alan Kors for having pointed out this article to me, as well as the previous one): It is not necessary to believe that a political consensus to focus on the lives of the most disadvantaged will happen tomorrow in order to recenter discrimination discourse at the intersection. It is enough, for now, that such an effort would encourage us to look beneath the prevailing conceptions of discrimination and to challenge the complacency that accompanies belief in the effectiveness of this framework. By so doing, we may develop language which is critical of the dominant view and which provides some basis for unifying activity. I grant that this Newspeak lacks the conciseness of the Nineteen Eighty-Four variety. Perhaps it is because the easiest (least costly) entry point of today’s Newspeak in public discourse was in scientific-looking but alchemist journals. And remember that Orwell’s Newspeak did have different forms and levels of vocabulary. I have an hypothesis: the real function of current Newspeak—that is, why its promotion is so easily embraced, consciously or not—is to make sure that anything written before the woke liberation becomes so awkward, outdated, and difficult to read that fewer and fewer people will read it. Orwell would have been prescient when he wrote: In practice, this meant that no book written before approximately 1960 could be translated as a whole. Two pages before, he explained that the Newspeak word duckspeak, meant “to quack like a duck.” (Doubleplus was a standardized prefix for an accentuated superlative.) The word duckspeak was was ambivalent in meaning. Provided that the opinions which were quacked out were orthodox ones, it implied nothing but praise, and when The Times referred to one of the orators of the Party as a doubleplusgood duckspeaker it was paying a warm and valued compliment. How can a fringe group of intellectuals and rich college kids push today’s Newspeak’s so effectively? Hypothesis: it has to do with government subsidization of colleges and universities, and indirectly of the “academic” journals who benefit from professors’ free time for writing duckspeak. (0 COMMENTS)

Now that the 30 days are up, I’m posting my whole WSJ op/ed on the latest winners of the Nobel Prize in economics, written the morning the prize was announced. An Economics Nobel for and by Central Bankers The winners hold views on dealing with financial crises that many monetary economists find strange.  By David R. Henderson Oct. 10, 2022 6:34 pm ET The committee that awards the Nobel Prize in economics announced Monday it has chosen three U.S. economists for the 2022 prize: former Federal Reserve Chairman Ben S. Bernanke, Douglas W. Diamond of the University of Chicago and Philip H. Dybvig of Washington University in St. Louis. The award is for “research on banks and financial crises.” The committee praised the winners for doing work “of great practical importance in regulating financial markets and dealing with financial crises.” Many monetary economists would disagree. A careless reader of Mr. Bernanke’s prize-winning work might have seen it as adding a few details to Milton Friedman and Anna J. Schwartz’s 1963 book, “A Monetary History of the United States, 1867-1960.” In fact, it was quite different. “I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again,” said Mr. Bernanke, then a member of the Fed’s board of governors, at Friedman’s 90th birthday party in 2002. Unfortunately, as Fed chairman, Mr. Bernanke, with his fellow Fed governors, did do it again. The main conclusion that Friedman and Schwartz reached in their analysis of the Depression is that the Fed, by failing to act as the lender of last resort, let the money supply contract by 30% between 1929 and 1933. Yet, in explaining its choice for this year’s award, the Nobel committee writes, “Prior to Bernanke’s [1983] study, the general perception was that the banking crisis was a consequence of a declining economy, rather than the cause of it.” That would probably surprise even Mr. Bernanke, who, as noted, put great weight on the Friedman/Schwartz insight. The difference between the Bernanke and Friedman/Schwartz views was that Mr. Bernanke thought providing more liquidity during a crisis wasn’t enough; he emphasized the importance of salvaging particular financial intermediaries, even if some of them arguably should have gone bankrupt. While his academic work on this issue was deep and impressive, it unfortunately caused him, as Fed chairman, not to focus on liquidity during the financial crisis. Many monetary economists at the time, including Jeffrey Hummel, then of San Jose State University, and Scott Sumner, a Bentley University economist who had studied under Friedman, recognized that the key was expanding the money supply rather than choosing specific firms to help. As Mr. Hummel pointed out in 2011, Mr. Bernanke didn’t expand the money supply enough. Quantitative easing, which expanded the money supply, got all the press. Less discussed were two Bernanke initiatives that choked off the increase in the money supply. One was the sale of Treasury securities, which removed from the economy much of the money the Fed had injected in 2008 via the Bear Stearns bailout and the Term Auction Facility. Economists call this “sterilization.” The result was that in the year ending August 2008, the monetary base (currency plus bank reserves) had increased by less than $20 billion, or 2.24%. Had Mr. Bernanke simply increased the money supply substantially, as Alan Greenspan had done in response to the 1987 market crash, the 2007-09 recession would have been shorter and shallower. The second measure restraining liquidity was Mr. Bernanke’s 2008 choice to pay interest on bank reserves, which caused banks to sit on reserves rather than lend them out. As for Messrs. Diamond and Dybvig, their 1983 model purports to give a theoretical explanation of how bank runs occur, but what it calls “banks” are like no banks we know of. As Lawrence H. White of George Mason University points out in his 1999 book, “The Theory of Monetary Institutions,” the model imagines an economy with a single bank that doesn’t make loans and doesn’t issue checking accounts. The reason for bank runs, according to the model, is that investors (not account holders, since there are none) get nervous and try to cash in their investments. The Diamond/Dybvig model uses this bank-run potential to justify deposit insurance. Mr. White points out that there are ways to make actual banks “run-proof.” One is to make checking accounts more like money-market funds. While the Fed, mistakenly in my view, opposed “breaking the buck” during the financial crisis, allowing money market funds to be redeemed at 97 or 98 cents on the dollar would have stopped a run. Another way to prevent runs is for banks to stipulate that depositors can’t access their deposits until they mature. Yet another, which happened before the Federal Reserve was founded in 1913, is to suspend convertibility of deposits into currency. That way, people could still write checks, but the bank, if simply illiquid but not insolvent, wouldn’t suffer a loss. The Nobel Prize in economics is funded not by the Nobel Foundation but by Sweden’s central bank. I don’t usually think that matters, but in this case I wonder if it does. The 2022 award seems to be an affirmation by central bankers of the value of central banking. Mr. Henderson is a research fellow with Stanford University’s Hoover Institution and editor of the Concise Encyclopedia of Economics.  (0 COMMENTS)

Over the past few years, I have noticed a discourse on the left that highlights the socially constructed nature of markets. These commentators argue that markets are mere social conventions and are therefore unreal and easily malleable. They claim that it is only due to greed, insufficient empathy, and/or the pernicious influence of pro-market forces that socialism or similar ideas have yet to be implemented, and that any inequities persist. Commentators may also conflate being pro-business with being pro-market.  While they insist on capitalism as an arbitrary construct, many advocates adhere to an objective theory of economic value (particularly of labour). In their view, the “real value” of goods and services are being denied and exploited by the capitalist system, which in contrary to justice, invents and imposes artificial scarcities and does not reward people fairly or recognize their “objective” worth (whether moral or economic). Such leftists often also argue that the socially constructed nature of gender and race make these social categories malleable for experimentation and expression, and that the right overlooks their inherent fluidity. This discourse has a contrasting parallel on the political right. Many conservatives and libertarians (and most economists) argue that economics is “real” and markets are necessary due to the fact of material scarcity and the presence of costs and tradeoffs. They insist that the laws of economics are non-negotiable, and place “parameters on our utopias”. At the same time, they emphasize that economic value is a subjective, constructed product of the human mind, and not an inherent part of the natural world. Further, they argue that markets do not need to account for desert or “objective” worth, only effective applications of capital (and that such an accounting is impossible). However, such commentators are sometimes skeptical of arguments about gender or race, arguing that these social categories have an objective nature that is not a function of society or culture.  These perspectives are an interesting study in contrasts. Where one admits the presence of constructs, the other denies it. Where one insists that the laws of economics and the need for markets is unavoidable, the other sees it as a totally arbitrary product of power relations or a failure of will. Where one sees value as subjective, the other sees value as inherent. Where one sees gender as fluid, the other sees a binary. Where one sees constraints, the other sees malleability. Ultimately, neither view has a complete picture of the social world. This is because neither side is willing to acknowledge the depth and breadth of social construction. The “right” is correct to say that economic value is subjective. The “left” is correct to say that gender and race are a product of culture. The right is correct to say that the economy is shaped by real constraints. The left is correct to say that the economy is a constructed entity. As I’ve argued elsewhere, all social institutions are constructs and products of the human mind. This does not make constructs arbitrary or “unreal”. Rather, it means that their reality is composed of our beliefs and values. As Virgil Storr writes (referencing Hayek): “The Facts of Social Sciences are What People Believe and Think”. The fact that value is subjective is one reason why there will always be competing uses for (and thus scarcity of) resources. This both creates and constrains what is institutionally feasible. Similarly, the fact that gender (as opposed to sex) and perhaps sex itself are created by people does not mean that conceptions of gender are infinite. What we understand gender or race to be is influenced by our cultural context, and our rejection or acceptance of gender or race categories are responses to the norms and ideas already in place. In A Conflict of Visions, Thomas Sowell argues that political ideologies should be understood as competing visions of humanity. Those on “the right” hold to a “constrained vision” of costs, eternal truths, and a fixed view of human nature, and those on “the left” whole adhere to an “unconstrained vision” without costs and eternal truths and a belief in human perfectibility. While Sowell’s discussion captures a great deal of our political divides, he misses how what counts as real or fixed versus what is malleable or dynamic is often ideologically determined. Further, Sowell fails to see how something can be socially constructed, and thus subject to change and alteration, but also exist as a constraint, in that what other people believe affects the way that a construct operates, and on what costs and choices individuals will face. (1 COMMENTS)

Suppose all of humanity was infected by a virus that left us all infertile–no one will come along after us. How would you react to such a world? Agnes Callard of the University of Chicago says she would be filled with despair. But why does this seem worse than our own inevitable deaths? Callard speaks […] The post Agnes Callard on Meaning, the Human Quest, and the Aims of Education appeared first on Econlib.

The standard textbook approach to regulation is that free markets are generally best except for cases of “market failure”.  Frequently cited examples of market failure include externalities and monopoly.  Now there is a call to regulate the crypto industry: The White House said Friday it was closely monitoring the collapse of digital-asset empire FTX, citing its bankruptcy filing as proof the cryptocurrency industry required strong regulation. The White House and other agencies were monitoring the situation, an administration official said, adding that Americans risked getting harmed without proper oversight of cryptocurrencies. I’m wondering if this is just a knee jerk reaction, or if there is some market failure that I missed.  A few comments: 1. It’s perfectly legal for Americans to invest in all sorts of extremely risky ventures, such as biotech start-ups.  Most of these firms fail, while a few achieve great success.  To use the terminology of administration officials, “Americans get harmed” when risky biotech start-ups fail.  Yes, investors understand that biotech is risky, but I’d say the same about crypto. 2. It’s perfectly legal to lend money to high-risk businesses, where the loans may not be repaid.  Remember junk bonds? 3. Fraud is already illegal. So what’s the argument for new regulations of crypto?  Surely not the fact that Bitcoin prices have plunged by 75%?  Surely not the fact that creditors to FTX are going to lose their money?  Surely not that fact that there are accusations of fraud in the recent FTX collapse?  These are all either normal parts of our financial system, or are already outlawed by regulation.  So what is the specific argument for additional regulation of crypto?  To “protect crypto investors”?   Why would we want to do that?  To protect the banking system?  I’ve seen no evidence that crypto threatens the banking system. Do we really want to make people who invest in crypto feel safer about their investments? Wouldn’t that make “bubbles” even more likely? Isn’t it healthy for crypto investors to fear they might lose their investment?  Wouldn’t it make them more careful? And what is the social value of crypto?  Why should social policy encourage investment in that area? Here I need to walk a fine line between crypto critics and fans, as I’m in neither camp.  I don’t see where crypto has produced much value to society, and it’s a fairly costly industry (if only in energy consumption).  So I don’t see any reason to encourage the growth of crypto through government policy.  I don’t wish to protect crypto investors.  At the same time, I see no reason to inhibit the growth of crypto.  Just because it doesn’t seem very useful to me, doesn’t mean the industry is of no value.  The whole point of free markets is for people to explore new ideas and profit from them if they prove to be useful.  Why would we wish to inhibit a new and innovative industry that might pay great dividends in the future? Again, there may be market failure arguments of which I am unaware.  But “bankruptcy and fraud” are not textbook examples of market failure that require regulation.  One is a part of any well functioning market, while the other is already illegal.  It may seem obvious to you that “something must be done”, but it is not at all obvious to me. (1 COMMENTS)