Worthwhile Canadian Initiative

Today's GDI release: both GDP and the terms of trade are improving

There's been a certain amount of commentary on today's GDP release. An annualised growth rate of 0.4% for 2009Q3 is better than zero - and it's at the 80th percentile of the predictive density generated by my toy predictor - but it's not what you'd call a strong recovery.

Happily, there's better news about GDI. The rebound in commodity prices has generated in a recovery in our terms of trade, resulting in an increase of our buying power of 3.3% at annual rates.

(See this post for an explanation of the difference between GDP and GDI).

With any luck, this will be the last post filed under the 'current recession' category.

Money, banks, loans, reserves, capital, and loan officers

Anyone who has taken ECON1000 has probably seen the simple model of how banks create money in a fractional-reserve banking system, and how an increase in reserves creates a multiple expansion of loans and the money supply. An alternative approach, cogently argued in comments here by JKH, says that it is bank capital, not reserves, that plays the crucial role. I think there may be some truth in what JKH says, especially at present, but it is not the whole truth. I'm going to lay out what i believe. Others can either learn from what I say, or try to help me learn where I might be wrong (or maybe even both).

In praise of (a little bit of) fiscal dominance

Who makes sure the long run consolidated government-central bank budget constraint balances? Is it the government? Or is it the central bank? The former gives us a Ricardian regime; the latter gives us fiscal dominance.

Most macroeconomists take a Ricardian regime as their unspoken assumption; and, if pressed, would recommend a Ricardian regime, as is required, in the long run, by central bank independence. If the central bank is to have the independence to pursue its own objectives (be it inflation targeting or whatever), the government must take long run responsibility for its own deficits, grateful for whatever profits from seigniorage revenues the central bank deigns to hand over. Worries about the "coordination of monetary and fiscal policies", heard often in Canada until the mid-1990's, were code for the desire for a Ricardian regime.

"Presentation of the Liberal position on climate change and the environment" - cont'd

I went. And apparently it's being sold as a Big Deal; here's the speech. Here are the points I was curious about last week:

• Is this a real policy proposal, or a recital of Conservative failures? A healthy dose of the latter, and some generalities. No details, though.
• Cap-and-trade, or a carbon tax? Cap-and-trade it is. But none of the details that make this more than a catch-phrase. What is the cap? Will be permits be auctioned or given to existing emitters? Any estimates for the effects on prices? Any measures to protect low-income households from the costs? These are the sorts of questions that Stéphane Dion went to a lot of effort to answer.
• How much material can he cover in 45 minutes? Not a lot, especially since he only spoke for 20 minutes.
• Will he answer questions? No.
• Just how good is Michael Ignatieff's French, anyway? Better than I had been led to believe, although he did seem to lean heavily on his printed text.

As a point of electoral politics, there's nothing wrong with replacing a carbon tax policy with cap-and-trade, as long as we all remember that in almost every way that matters, the two models are equivalent: consumers will be faced with higher prices. In the last election, the Liberals and the Greens were the only parties that had the intellectual integrity to accept this fact, and they made an effort to deal with it. I will be very, very disappointed with Michael Ignatieff if his Liberals join the Conservative-NDP Axis of Climate Change Dimwits.

Oh, and I must scold Ms Taber for this throwaway paragraph in the Globe story I linked to:

The Liberals lost badly in the last election, partly as a result of Mr. Dion’s complicated Green Shift plan that would put a tax on carbon. It was not communicated well; Canadians did not understand it.

The Green Shift was NOT complicated: carbon taxes up, other taxes down. What's so hard to understand? Indeed, it was a model of clarity and precision when compared to the muddled schemes that the Conservatives and the NDP were selling.

Revisiting Robin Hood's agenda: Be less concerned about taking from the rich and focus on giving to the poor

Ed Broadbent had an op-ed in Tuesday's Globe on a plan to reduce child poverty, and he offers this proposal:

In the next budget, let's impose a six-point increase in income tax on those earning more than $250,000 a year (whose average taxable income is $600,000). While leaving them with very high incomes, this would provide $3.7-billion in additional revenue. All of this should be used to increase the National Child Benefit Supplement and thus help our poorest children. With this single act, we would significantly make up for two decades of neglect and make a major dent in child poverty.

I'm happy to endorse the $3.7b increase to the National Child Benefit Supplement - the costs are small (less than 2% of federal spending), and the gains are huge. But for reasons I'll explain shortly, the tax proposal is not particularly persuasive.

In his article, Broadbent asks

Why is it that Finland, Sweden and Denmark have almost wiped out child poverty, and we have not?

Below the fold, I'll try to provide a partial answer to that question. And I'll explain why the conventional Canadian Left's preoccupation with using the tax system as a way of dealing with inequality and poverty should be rethought.

Macroeconomics and Climate Science: compare and contrast

Similarities:

S1. Both do general equilibrium analysis, trying to understand the interaction between parts of a whole system, with lots of positive and/or negative feedback loops.

Milking consumers

It's hard to believe that I've managed to run a blog on the Canadian economy for more than four years without having a go at what is Canada's most fragrant example of bad economic policy. Happily, the Conference Board has just published a paper summarising the sorry state of affairs in the market for dairy products, so I have an excuse to repeat the points economists have been making for generations:

Administered milk prices provide dairy producers with a high return and substantial protection. The prices Canadian producers receive for their milk and butter, for example, are consistently double or triple world prices. As well, profit margins for dairy farmers are consistently and dramatically higher than for other Canadian farmers...

[Q]uotas give farmers the right to produce and sell their milk. Quota values are astronomical, reflecting current and future above-normal profits. The average dairy farm holds quota valued at a minimum of $2 million (or $28,000 per cow), for a total quota value of at least $28 billion...

The system unfairly distributes huge benefits to producers at the expense of some processors, consumers, and restaurants, among others. On average, this subsidy - provided to dairy producers by some dairy processors and consumers - works out to about one-half of the average dairy farmer’s income, according to the Organisation for Economic Co-operation and Development (OECD). Dairy farmers are among the most well-off farmers and well-off Canadians. In contrast to other farmers, over 90 per cent of dairy farms had revenues over $100,000 in 2007, and the average dairy farm in 2007 had net cash income of over $97,000. Subsidizing dairy producers at the expense of less well-off Canadians is therefore a regressive policy...

How can Canada’s 13,600 dairy farms have so much political influence?

Beats me. This is an absolutely disgraceful example of a small group of people using the power of the state to extract huge rents from all Canadians. There's no excuse for it.

On some unconvincing arguments against the need for an effective Parliamentary Budget Office

MM Veldhuis and Lammam respond to my post on their op-ed in the National Post last week, and Kevin Milligan summarises a couple of their points:

1. The PBO would not be exactly like the CBO therefore no parallels to the CBO may be drawn.

2. Canada's Parliamentary system has the advantage that the executive is directly accountable in Parliament--The Finance Minister has to stand up and defend his/her policies.

Go read why these are not convincing arguments.

Some context for the Parliamentary Budget Office's funding woes

Some points to consider:

• The PBO has a budget of $1.8m and 15 employees. (source)
• The US Congressional Budget Office has a budget of $45.2m and 250 employees. (source)
• Policy analysis does not scale well; the cost of putting together a model for evaluating a given policy is pretty much the same in both countries.

The PBO simply doesn't have the resources to be effective.

Maybe the Bank of Canada won't have to intervene in the forex market after all

When we last left this story, inflation was drifting further and further below the Bank of Canada's inflation target, and the CAD was up to 0.97 USD. The case for intervening in the forex market to slow the appreciation of the CAD - and hence slow the drift to deflation - was starting to look pretty strong.

The case looks less strong now. The CAD has stayed in the 0.94 range for several weeks now, and the October CPI release suggests that inflation might be moving back up to the Bank's 2% target:

 

The increase in the October core CPI over September was a bit over 2%.

This looks a bit like what happened last spring. When inflation fell off a cliff during the worst of the recession, the Bank started preparing the ground for quantitative easing, but ended up not having to implement it.

Of course, this is only one month. It'll take two or three more like this before the Bank will stop thinking about intervening in the forex markets.

More reasons to support the PBO

Today's National Post has an op-ed written by a couple of Fraser Institute types entitled "Scrap the Parliamentary Budget Office". It's a remarkable piece of rhetoric. Although its stated purpose is to make the case for eliminating the PBO, it ends up demonstrating once again why an effective PBO is so desperately needed.

Accounting and Economics; and Money

To paraphrase Churchill, accountants and economists are divided by a common language. We seem to be using the same words to talk about the same things, but we don't understand what the other is saying. This is my attempt to provide an economist's perspective on the relation between accounting and economics.

What I say here will not I think be new or controversial for economists (until I start talking about money). Accountants may find it hilariously wrong, like locals hearing tales from a traveller who can't speak the local dialect and gets everything muddled. Let's see.

"Presentation of the Liberal position on climate change and the environment"

It's not often that the internal Laval e-mail listserve grabs my attention. I guess I have to go, if only to satisfy my curiosity about the following points:

• Is this a real policy proposal, or a recital of Conservative failures?
• Cap-and-trade, or a carbon tax?
• How much material can he cover in 45 minutes?
• Will he answer questions?
• Just how good is Michael Ignatieff's French, anyway?

Maybe I'll live-blog it.

Yes, the federal government has a structural deficit. But let's keep it in perspective, shall we?

Don Martin loses it in today's National Post:

Clock tallies IOU to next generation: Stephen Harper will join Jean Chretien as only the second prime minister in history to enroll Canada in the half-trillion-dollar national debt club.

This is silly. Nominal debt figures from 1995 - when the federal debt first went above $500b - should not be directly compared to current nominal debt figures; you have to take into account inflation (a dollar in 1995 was worth more) and economic growth (our ability to pay debts has increased). Here is a graph of the federal debt, expressed as a percentage of GDP and in terms of per capita 2009 dollars:

When the nominal federal debt hit $500b in 1995, that was the equivalent of 59% of GDP. Fourteen years later, $500b works out to about to something like 39% of GDP. In order to reach debt levels that are truly comparable to 1995, the federal government would have to run $50b deficits for at least six years in a row. And no-one is forecasting that.

Yes, the federal government has a structural deficit, and something will have to be done. Panicking isn't it.

Promising to keep nominal interest rates low for too long

I was lucky enough to be invited to a Bank of Canada conference on Thursday and Friday. The topic was "New Frontiers in Monetary Policy Design". One recurring theme in particular has stuck in my mind: that a credible promise to keep interest rates low for too long can help an economy escape a liquidity trap. (I apologise for not remembering which presenter or commenter expressed the point so clearly in this way that it stuck in my mind.)

Deflationary death-spirals and the social construction of monetary policy

I present a simple macro model and use it as a vehicle to explore the idea that it matters how monetary policy is framed. One framing leads to a deflationary spiral, which an alternate framing can avoid or escape. The model is an otherwise bog-standard New Keynesian/Neo-Wicksellian model, but with a minor modification in the financial sector.

Why academic economists aren't (announced) Bayesians

Bryan Caplan asks the question of why more academic economists don't use Bayesian methods. It's a question academic Bayesian economists ask ourselves pretty often.

One part of the answer is that many already are informal Bayesians. For example, the whole DSGE literature would be uninteresting (or even more uninteresting, depending on how you feel about it) if there were not a broad consensus about what the plausible range of certain key parameters is.

But the main answer surely involves hysteresis in the teaching of econometrics. Before 1985 or so, anyone who wanted to make use of Bayesian methods was limited to simple models (eg: linear normal regression) for which analytical expressions for certain key integrals are available. Anyone who wanted to apply Bayesian methods to more sophisticated models had to evaluate those integrals using existing numerical techniques; the 'curse of dimensionality' limited Bayesian econometricians to low-dimension problems.

Even if econometricians could be convinced about the soundness of Bayesian methodology (and it's pretty easy to convince them of that; the usual classical story of repeated, infinite samples makes little sense for the analysis of the finite non-experimental data sets that economists are invariably obliged to work with), they could quite sensibly make the point that classical methods were at least able to provide estimates for models more complex than the linear normal model. It didn't make much sense to spend valuable class time on a methodology that could be applied to a proper subset of models that could be estimated by classical methods. And when those students became teachers of econometrics, they would teach what they knew. And they didn't know anything about Bayesian methods.

So when the curse of dimensionality was lifted by the development of Monte Carlo techniques and computers that could run them quickly and cheaply, there were very, very few teachers of econometrics who realised that Bayesian methods could be now applied to a much wider class of models. There are many important cases (multinomial probit, stochastic volatility, and indeed many if not most latent variable models) where classical estimation is much more costly than Bayesian estimation.

Econometrics syllabuses are path-dependent: academic econometricians who didn't see Bayesian methods as students don't teach them to their students. But the original reason for marginalising Bayesian methodology was that its applicability was too limited for most practitioners - and this is no longer the case. Economists are familiar with the notion of hysteresis - the persistence of a phenomenon after its cause has been removed - and it would appear that the teaching of econometrics is another good example.

On the federal government's structural deficit

The Department of Finance publishes monthly data for expenditures, revenues and the deficit. These numbers don't necessarily correspond to the annual numbers (for example, various items are sometimes booked to a fiscal year after it's over), but it gives us a good idea of where the government's finances are going. The monthly numbers are pretty choppy and have some significant seasonal factors, so I'm going to work with 12-month moving sums.

We all know that the federal government will be running a deficit this year, but it's still pretty impressive just how fast the situation has deteriorated. Here is a plot of the 12-month moving sum of monthly deficits through to August, 2009:

 

What's the optimum net worth of a charitable organisation/university?

Last night I was chatting with someone who works for a think-tank. I work for Carleton University. We both work for charities. Like households, firms, and governments, charities have income and expenses, and a net worth. Consumer choice theory tells us, at least in principle, how much people should save, and what the optimum net worth of a household should be. Finance theory tells us, at least in principle, what the optimum net worth of a firm should be. Public finance theory tells us, at least in principle, what the optimum net worth of a government should be. (Well, that last statement is actually debatable, but let it pass). I don't know of any theory that tells us, even in principle, what the optimum net worth of a charity should be. What is the net worth, below which it should be saving, and above which it should be dissaving?

An updated history of the federal government surplus deficit

In an upcoming post, I'm going to try to thrash out some of the details about the origins of the federal budget deficit, with an idea to figuring out how to make it go whence it came. But first, I'm going to set out some historical background, now that the data from the 2008-9 fiscal year have been added to the Department of Finance's Fiscal Reference Tables.