Things I Wish Everyone Understood About Macroeconomics

Given some recent nonsense I have seen bandied about I thought I would do a quick write up of what I think is important for normal people to know about macro.

-More spending is not some magic expand the economy juice. More money does not equal more significantly more production under normal conditions, or else Zimbabwe would have become a paradise. More spending is really only useful if the economy is demand constrained which occurs when current prices are too high for the amount of money circulating. This leads to many resources(like labor) going unused, so the extra spending instead of diverting resources instead brings unused resources back on line. If all the resources are currently being employed than extra spending can only divert resources from some uses towards others.

-Price level is determined in long run by the money to stuff ratio, that is how much money is circulating next to how many real things are produced.

-Monetary policy should be judged by its output (inflation or NGDP growth take your pick) if these numbers don’t change enough, monetary policy is being too tight, if these numbers are changing too much change and it is being too loose period. Monetary policy is functionally infinite in power, unless your country has a fixed exchange rate or an incompetent central bank anything else that might affect the amount of spending doesn’t really matter. If your central bank is incompetent it probably also won’t matter what else you do anyway. Standard monetary policy runs out of steam when interest rates hit zero(liquidity trap), but there are many many other non standard tools that look scary and are hard for a layman to comprehend. Keep calm and look at projected inflation/NGDP growth.

-The typical nominal recession is a dumb thing which is really just an artifact of the fact we use money and prices are sticky, not some great judgment from above to repent for our sinful ways. The solution is to try to bring spending back to what will allow for full employment of resources. Recessions that occur for structural reasons are a different story. But your typical recession is best understood with the following story, you go to the grocery store with $100 picture the basket of goods you could buy, now go back to the same store with roughly the same prices but only $80, it is impossible to buy the same basket. It is impossible to buy the same output with similar prices and less spending. Since wages are especially hard to lower in nominal terms, labor tends to be hit disproportionality hard. But it doesn’t really matter what your price level is, only that the amount of spending can facilitate full employment of resources at whatever the current price level.

-All government spending is the result of a tax, current taxes are obvious, borrowing and spending is a tax on the future, printing money and spending is an inflationary tax on money holders, defaulting on the debt is a tax on holders of the debt(also an insane idea). Government spending is important, but it isn’t magic, those resources need to come from somewhere so they are going to come from other uses of those resources. Treat anyone who claims otherwise as someone who claims to actually be a wizard.

Learning Economics as a Way to Curb Resentment

I think one of the most important reasons to learn economics is that if it is done properly, it can help you extend your empathy. Also knowledge of economics, specifically that other’s gain is not your loss, consistently helps me curb my natural feelings of resentment.
I was standing in line to pay for my insulin, usually the lines are short because I could just pay at endocrinology, but policy change due to new ownership (PLA) everyone now had to stand in line together. I had debated bringing my cane as for me standing in line is… unpleasant and now faced with a snaking line I regretted being cane-less. About half way through, after putting in 15 or so minutes of grinding my teeth, suddenly there was a flurry of movement. A new line had opened up, but I had missed my chance. Surveying the victors of this sudden disequilibrium event, I noticed that a lot of the people now well ahead of me in line used to be behind me. My first instinct was to be upset at the perceived unfairness, but then I snapped myself out it, and realized that, those people who now have to wait less don’t make me have to wait more and in fact, the line in front of me had also appreciably shortened in the melee, besides how would a fairer way even work? The new line was actually beneficial for everyone, it would be silly to be mad about it. With this realization I felt better, thanking economic insights that make it easier to carry less resentment I slowly worked my way through the line, really regretting the absence of my cane.
After another 15 minutes of waiting in line, my legs nearing their threshold of endurance, it was my turn in line and… a Chinese man from far away came charging at me in the cashier booth, I am, I should mention the only foreigner that was at the hospital. My Chinese is far from perfect, very far in fact, but in this instance it proved ample enough to understand what he was saying. He was Chinese, he had been waiting in line, his legs hurt, and they were going to serve a foreigner before him? It was an uncomfortable situation for all involved, while at first the lady at the register tried her best to just ignore him, his mounting anger, his shrill piercing screaming were too much, she took his documents and started to process him. Anger was my first response, I had waited in line just like everyone else after all, my legs didn’t feel great either, and his characterization of me wasn’t overly kind. But soon the anger turned to pity: what must it be like to be such a man, so filled with resentment, lashing out, not even thinking of the discomfort of all of his fellow citizens whom he had just cut in line in front of. Even though he got his way, I couldn’t help imagine just how painful such an existence must be.
And once again I thanked economics.

Maybe Not Meddle with Meddling Externalities

To begin, a meddling externality is where others would be willing to pay in order to change or outlaw the behavior of others, essentially people are willing to pay in order to meddle in the lives of others. In practice this kind of externality is no different than being willing to pay for breathing less polluted air. You might say, yes but that is just in your head, but isn’t all value? What is the difference between being willing to pay $20 dollars for cleaner air, for coffee, for making is so others don’t watch pornagraphy, or that people can’t date outside a narrow set of criteria. These are all psychic harms and benefits when you get down to it. While I accepted this logically, in my heart I was never able to care about them the same as a regular externality.
I finally put my finger on why I tend to think differently about meddling externalities than other externalities. In economics we take preferences as a given, but in actuality they can change and be influenced in fairly predictable ways. I really doubt that in 50 years there will still be a lot of people upset by gay marriage. For civil rights at one point in time there were very large meddling externalities by bigoted whites about people of color being in their “proper place”, but even in the areas where such bigotry used to thrive, such meddling externalities have probably if anything reversed direction. I think if marijuana became legal in 50 years people would largely stop caring about others using it, indeed we are already seeing this. Allowing people freedom tends to result in meddlers changing their preferences, since often these preferences are not founded on anything aside from feelings about outgroups. And since this is the case, I would probably often permit behaviors that at the time might be inefficient due to factors of current taste if such tastes are likely to change due to ingroup outgroup dynamics.

On Bears and the Perils of Modern Life

Economics is a powerful tool, but it does possess its blind spots. We assume that the choices people make are rational ones, and to a large degree this is likely true. But I fear that the modern world often lays before us an easy path, a path that our instincts compel us to follow and yet if we heed their call, we will find ourselves living an empty existence. The following is the tale of an anthropomorphized bear named Gordon that encapsulates the treachery of following the easy path. A similar situation has been observed in nature with baboon colonies near eco tourism resorts, the baboons breaking apart their social structures maladaptivly clinging to the easy nourishment found in bounty of human refuse.

Gordon awoke in his cave, hangover piecing his skull. He shuddered as he became filled with self loathing. Instinctively he reaches his paw to the bottles laying next to him to numb the aching chasm, but finds them woefully empty. Licking at an empty bottle he is forced into an uncomfortable clarity, at this point all he is empty, living each day as pointless as the last. He thinks back to his childhood as a young bear. Hunting, fishing for salmon, foraging for berries with his mother, playing with his brother. Those difficult times, those happy times.
Life had changed ever since the humans had built a campsite near him. He had discovered at first by accident what a simple thing it was, walking into an occupied campsite, watching as the humans fled before him, leaving behind their camping provisions. No chase, no frigid water, no gnawing at bushes, just food. He ate until sated reveling in the ease of acquiring the bounty before him. It was later that he would discover the fiery water they so often brought with them. That was the beginning of the end he reflected, that is what had transformed him from a noble beast into what he was now, alive, fat, miserable.
He reflected, he knew. He vowed, he vowed he would go back on the path, the path bears should follow. Rising from his cave to drink from a nearby stream he planned it all out, he would no longer take from the humans, he would once again hunt, once again fish, once again forage. As he thought this, he plucked up his massive shoulders and headed to a nearby river that he recalled from his youth. It had been a long time since he had walked this far, he could feel his limited endurance, but determined he pressed on. There were voices he heard, in the strange high pitch tone of man. He disregarded them and walked on, his legs growing ever more tired supporting his girth. “I must press on!” Gordon the bear vowed to himself.
A vow which started to decrease and decrease in volume, as it was drowned out by all of the justifications that began to flood his mind. It was okay he told himself, just once more, tomorrow would be another day. He turned around and headed for the voices.
He woke up, this time instead of childhood he thought of Guindalin.
She was a female, she was his mate, they had gotten along, but who would want what he had become? His heart surged, beating uncontrollably, he tried his best to suppress it, managing to do so only for a few scant minutes at a time. Today is his day to reform, he can’t give in, he lay there like that for an hour or two and then Gordon the bear could bear it no more.
Reaching for the bottles next to him he found there were a few left from yesterdays raid, he bit their tops off, desperately consuming them. It is okay he said, tomorrow will be a another day.
Another morning another drunken haze, what is the point of this life? To follow the easy path was spiritual suicide. Today is the day, Gordon steeled his resolve. He headed for the stream again. This time, undeterred by the voices coming from the forest. He arrived at the glade on the way to the fishing spot, it was just as beautiful just as pristine as ever, but was it always so hot, where there always so many flies and mosquitoes? Pausing he listened for deer, remembering they were once prevalent there, but his dulled senses picked up nothing. He carried onward to the river and waded in, he did it, he made it, he was going to be a real bear once again. The water robbed him of his warmth more rapidly than he remembered, the fish moved faster than he remembered, his paws responded slower than he remembered. He decided to take a break from the cold water, just a break. He heard those familiar voices in the distance.
Tomorrow is another day.
continued here

What Does More Mean?

Economic efficiency has some potential flaws, flaws I will certainly discuss but unfortunately most of the critiques of efficiency are not grounded on any real understanding. I still remember reading an article against “economic efficiency” that argued we should focus on higher quality rather than more which is… Anyway without further ado a crash course in what economic efficiency really is.

The essential idea of economic efficiency is that a more efficient state is a world with more, but this concept might be harder to fully understand than it first appears. Ten apples might be more than five apples, but which is more: a chair, or five chickens? Three ergonomic office chairs or one extravagant throne? In prior examples, we talked about how trade creates wealth even when we are just moving one object around with nothing being produced, but how can the same amount of stuff possibly be more? This concept is essential to an understanding of economic efficiency and its importance.

We tend to talk in terms of money: consumer surplus is willingness to pay in contrast to that which is actually paid, producer surplus is what the producer would accept for their sacrifices in contrast to what is actually paid to them. This though, can lead to several misleading thoughts such as a misunderstanding surrounding the importance of money. If a women who graduated from the top of her class at *insert high status university here* got a job offer to work in Wall Street for $200,000 dollars a year, but instead she decides to instead become a hermit meditating in the woods, the world in which she is a hermit is a world with “more”. Yes such wealth will not show up in any sort of economic measurement, but that reflects an impoverishment in our ability to measure, not a repudiation of the concept. Measurements, after all, are forced to focus on only that which may be easily observed and reliably quantified.

Remember money itself is just a means that allows for an easier exchange of resources. We measure everything in terms of money, not because of money’s importance, but instead because of the real goods and services that the money represents. Remember we actually assume that money itself has no value; a giant pile of money that cannot be traded for real goods would be worthless. In the case of the woman, we can imagine what real goods she would purchase with that 200k as well as any discomfort from the work that would be required of her to do in order to earn it. She has the option between that real basket of goods and living a quiet life in the woods. It is impossible for us as outside observers to know which is set of goods is more. Her choice is the only way we can determine which set of real goods is more valuable to her and thus can be considered to be “more”. Though it is true that as a hermit she is exceedingly unlikely to create benefit for others, it is also true that her being unwilling to work in finance reflects that those who would benefit from her labors are themselves not willing to sacrifice enough of their own resources to compensate her for the difference between the two lives.

So let us try to run through an efficiency example using this idea and only real goods to hopefully get a clearer understanding of what “more” means and how trade can create more even when it is merely shuffling goods. Let’s say that we have a vastly oversimplified two-good economy with rice and meat, with two people about to make a trade. There is Jesse who wants to have more rice and is willing to trade some meat for it, and there is Stella who (conveniently enough for this example) wants to have more meat and is willing to trade some of her rice for it. For Jesse, he would value 5 kg of rice equally to 1kg of meat. That is, if offered those two sets of real goods he would be indifferent, if offered a little more rice or a little less meat he would certainly choose the rice and vice versa. Stella’s tastes are a little more carnivorous, she values 1kg of meat at a whopping 20kg of rice. As we should know from chapter three, the different set of preferences means they could potentially trade with 1kg of meat being valued anywhere between 5 and 20kg. Let’s say the bargain is struck where Stella will provide 10kg of rice to Jesse in exchange for 1kg of meat[1]. What is the surplus in this case, and why?

Stella would have been willing to give an extra 10kg of rice to Jesse. So now, she has something she values at 20kg of rice, but she only had to trade away 10kg. She therefore went from having 20kg of rice value to having 30kg of rice value (or 1.5 kg of meat value if you prefer), so her surplus is then equal to 10kg of rice (.5kg meat). For Jesse, he gets the rice he so coveted, sacrificing only half the meat he would have been willing to give up, so his surplus is 5kg of rice (or 1kg meat). We can then say that total surplus from this trade is equal to 15kg of rice or equivalently 1.5kg meat. To really understand why this is, imagine that instead the two could not trade, and that you were responsible for making sure that they had a collection of real goods that they would value the same amount as the one trade gave them. You would have to either create 15kg of rice, giving Jesse 5kg and Stella 10kg, or you would have to create 1.5kg of meat and give .5kg to Stella and 1 kg to Jesse. In either case, you would need to make more by the amount of surplus we calculated, in order to come up with a scenario that is equally satisfying to both parties as that which was arrived about merely by moving meat and rice between the two. So even though trade in this case does not alter the amount of rice in the economy, for this reason we can say the economy grew in wealth by the equivalence of 15kg of rice or 1.5kg of meat. It is in this way that we can say there is “more”.

Money makes all this easier because each person can only value a dollar as a dollar. Essentially anytime we transact for money, we are actually exchanging real goods for real goods with the world becoming wealthier each time by the difference between the sacrifice you would have been willing to make and the one you actually made. The benefit of money is that we don’t actually need to receive our goods from the person that we gave our resources to. Thus I can give economics lessons to students intent on learning it, and get my meat from ranchers, rather than scouring the world looking for a rancher desperate to turn meat into knowledge of demand curves and economic efficiency. It is really not very intuitive at all, but always try to look past money into the flow of real goods.

[1] The actual price is unimportant so long as it falls within the range of trade, as it just changes who gets what surplus but not the amount of surplus to be gained, if meat traded for an extra bag of rice it would just mean Jesse gets 1 more bag worth of surplus, and Stella one less.

King Midas and the True Nature of Money

I am going to tell you a famous story from Greek mythology that helps illuminate the truth of money.

King Midas one day saved the son of Dionysus, one of the major gods[1]. In order to show his thanks to the King, Dionysus offered to grant Midas a single wish. Midas, being covetous by nature, paused little before deciding that what he wanted to wish for was a golden touch. He asked the god to have everything he touches turn to gold. Dionysus warned the King to think twice before making the wish, but Midas was certain.  After a deep sigh Dionysus laid the boon upon the King and then departed. Overjoyed, Midas touched a flower in his vast garden and marveled as it became solid gold. He went around his mansion touching all that he could think of, transmuting all within his touch instantly from their plain materials into lustrous shimmering gold.

He called a great feast in order to celebrate his new found power. Before him on the table there laid the finest wines, meats, fruits, and assorted specialties from all around the kingdom. He touched his wine goblet which became golden, and with a beaming smile he made a toast to the immense fortune both he and his kingdom had to look forward to. Placing the goblet to his lips, however, revealed a horrible surprise: the second the wine touched his lips, it too, became transmuted into gold. Gold would not slake his thirst. He quickly grabbed for food, but anything that he laid his hands on became solid gold. Desperately he had a servant try to feed him directly, though to no avail—the second any substance touched his mouth, whether it be the sweetest grapes or the juiciest meat, it instantly became cold, tasteless gold. Gold would not satisfy his hunger.

He ran out into his garden to his favorite bench and sat down amongst the lifeless golden flowers, cursing his fate, thinking again and again of Dionysus’ warning. His daughter came to comfort her father, laying her hand on his shoulder in order to give him solace. In that moment she was transformed from a lovely sweet girl into an unspeaking, unfeeling golden statue.

At this, Midas broke down, and in between his sobs he implored Dionysus to come again and take away his golden burden. As the god had initially wished to bestow a blessing on King Midas, not a curse, he came to the King and told him to wash his hands in a nearby river to take away his power. Midas, following Dionysus’s instructions, immediately set off, and after finding the river, washed his hands. Gold came shimmering from his skin as he made contact with the flowing water, and once it had stopped, he ran back to his palace as fast as his legs would carry him. Much to his relief, his daughter was there to greet him when he returned, with the flowers of his garden once again swaying in the breeze.

There are many lessons that can be taken from this story. When I first learned it as a child, the morals of the story that were emphasized were about being careful what you wish for as well as the hazards of greed. These are good lessons to be sure, however, unfortunately, they are not very pertinent to this chapter. I did promise to relate the story to the true nature of money after all, didn’t I?

Let’s relate this story to the 5th point of thinking like an economist: “People Don’t Care about Money”. What is the use of the gold to Midas? Nothing. If you can only have money and nothing else, you will have a very poor life indeed. It is instead the things that money can buy, like the wine and the food that are of value. Having money without goods is like having the poker chips from a bankrupt casino.

But what if Midas had been a little wiser in his wish? For the below story, let us assume that like modern currency, gold is only used as money to avoid unnecessary complications.

Dionysus offers him a wish of his choice. Midas quickly says: “I want everything I touch to turn to gold!” Dionysus gives the king a skeptical look and replies: “everything?”
Midas, instantly realizing his mistake, he says: “oh no, that would be horrible, I couldn’t eat or drink! I might even accidently turn my lovely daughter into gold! How terrible that would have been! Instead, how about you grant me the ability to turn anything I desire into gold?”.
The god says: “sure, glad you caught that error!” Under his breath he mumbles: “though you still might consider taking an economics class.” “What was that last part?” The king asked, to which the God replied: “nothing, never mind, poof it is done.” Midas turned many things into gold and enjoyed a fine banquet of only the best food and wine with the company of his daughter that day.

This version of the story might at first look like a happy ending, but let us analyze it further. Question: how does the gold speed the craftsman’s work? The farmers’ growing of food? It is true that more gold will allow Midas to purchase more things, but where do those more things come from? Since the gold does not actually make it so that more can be produced, it must mean that, instead of changing how much is produced, it is changing who gets what is produced. In this case, Midas is getting more, which means less for people who are not Midas. Money is a claim to goods and services, an increase in the claims without a corresponding increase in goods and services means each of the claims are worth less. So in this instance, the new flood of gold will make it so that a given amount of gold will be able to exchange for less real products than from before. He is taking the real value he receives from the gold holders in his kingdom, and could have achieved the same result by taxing them without using magic wishes.

Midas is actually acting precisely in the same way as someone who counterfeits money. One might imagine as a result, silver might become a more valuable metal. Perhaps then he might think that he should have asked for the silver touch instead. Hopefully you understand why this would also be folly.

Imagine we go far back in time to when humans first started farming and we dropped several tons of gold onto the early farming villages. What would it have allowed them to do? Now imagine instead that we instead gave them the wheel thousands of years before its invention. Money may be what makes an individual rich, but real things are what make a society rich. Money is just a claim to some of societies real goods.

[1] Specifically the god of wine, revelry, and … well many other things.

Fun Trade Facts

The US gets only 8% of its oil from the Middle East

(consume about 2/5s from our own production)

The US imports only 2% of its steel from China.

(consume 2/3rds from our own production)

China only has a .7% trade “surplus” overall

The EU has the world’s highest trade surplus, and 8.4% unemployment

Imports are not actually subtracted from GDP, instead they are mistakenly counted in consumption or investment but since GDP stands for gross domestic product, they shouldn’t, so they are removed just to prevent GDP from being overstated.

Imports are the benefits of trade and exports are how you pay for them.

Trade deficits are basically like getting a loan, and don’t indicate robbery anymore than you borrowing money indicates robbery

Historically tariffs increase the trade deficit because demand for foreign currency falls(as it becomes less useful) appreciating the currency

Tariffs on raw productive inputs tend to hit employment of those working in industries using those inputs harder than it benefits makers of the input.

Since exports are linked to imports, and restriction on importing will lead to less exported as well.