Worthwhile Canadian Initiative

The (mis-)coordination of monetary and fiscal policy

Suppose the monetary authority says "We already have interest rates at zero, so monetary policy can do no more to increase aggregate demand. But fiscal policy can do more..."

Suppose the fiscal authority says "We already have very high deficits and debt, so we are scared of future insolvency, so fiscal policy can do no more to increase aggregate demand. But monetary policy can do more..."

No one individual admits to a loss of faith that monetary or fiscal policy can increase aggregate demand as much as is needed. But policy is the same as it would be if there were such a loss of faith.

Are we hard-wired for capitalism?

When I get back from the Canadian Economics Association meetings this evening, my dog will throw himself on me in a paroxysm of joy. But if, two minutes later, I were to try to take a bone away from him, he would bare his teeth and growl.

Animals – including humans – are instinctively possessive. Economists have names for the human equivalent of growling when someone takes away your bone. Loss aversion theory says that the pain from losing $10 is greater than the happiness from gaining $10. The sunk costs fallacy is (bad) reasoning along the lines of "I paid $500 for these pants that make me look like a hippo, there's no way I'm going to throw them out." I suspect that a typical economist considers these manifestations of possessiveness irrational -- but recognizes that loss aversion and other theories are useful when it comes to explaining the real world.

At the CEA meetings, Mukesh Eswaran and Hugh Neary presented a fascinating paper explaining why, from an evolutionary perspective, it makes sense to be possessive, and to respect others' possessiveness. Unfortunately I can't find a copy of their paper on-line, but this is my interpretation of the basic intuition behind their results.

How is model-based macroeconomic forecasting possible?

I can figure out how some things work. I can't figure out how other things work. But there are some things I can't figure out how it's even possible for them to work. Using macroeconomic models to make macroeconomic forecasts falls into that third category of things. I can't see how it's even possible to do it. And yet people claim to do it all the time.

This is a follow-up to Scott Sumner's post, which is in turn a follow-up to Mark Thoma's post. They gave me the inspiration to write about something that has puzzled me for years.

Trends in OECD corporate income tax rates

From the OECD's Tax Database (Table II.1):

The last few decades has seen extensive work documenting the deleterious effects of corporate income taxes - especially for small open economies. These lessons seem to have been taken to heart by policy-makers.

Corporate income taxes: a reading list

Like many Canadians, I am dreading the prospect of a federal election. We all have our own reasons for doing so, and here's mine. Now that the Liberals have announced that they - along with the NDP - will oppose the reduction in the corporate income tax rate that is planned for next year's budget, there is the very real possibility that corporate taxes will be an election issue.

Ban the penny! And the nickel, while we're at it

Deputy Governor Pierre Duguay provides us with one of the more interesting trial balloons to come out of the Bank of Canada in a very long while:

[T]he Bank views the possible elimination of the penny in terms of the potential impact on inflation, and has conducted some preliminary research on this issue. The findings, which have been made available to other researchers, show that any impact on inflation would be insignificant and more likely non-existent...

Since the coin was first produced by the Royal Canadian Mint in 1908, the penny has lost 95 per cent of its purchasing power. In other words, the penny then had the same purchasing power as 20 cents would today. Indeed, in 1908, you could buy your daily newspaper for two cents, and a loaf of bread cost five cents.

According to the Bank of Canada's inflation calculator, the buying power of a penny in 1948 is about the same as a dime in 2010. Pennies and nickels are literally worthless: I defy you to enter any store, anywhere, armed with only 9 cents to buy something.

Ban the penny, and ban the nickel. They're worse than useless.

Eta: Full credit to John Palmer, who started banging this drum some twenty years ago.

The CPI and other asset prices

Returning from a long weekend's canoeing, I remembered one of the main reasons I am a sticky-price macroeconomist. I checked to see if the economy had imploded while I was not worrying about it. April CPI up 0.1% from March; CAD/USD down about 2%; CAD/EUR up about 2%; TSX down around 3%; S&P500 down around 6%; oil down around 3%, etc.

You get the picture. The exact numbers don't matter. The CPI moved less in one whole month than all the other numbers moved in my 4-day weekend. A whole order of magnitude less. The CPI is a boring number. Anybody can predict next month's CPI within a 1% range; nobody can predict next month's exchange rates, oil prices, or stock prices with that degree of accuracy.

But what does this tell us?

An update on the concentration of income in Canada

Yesterday saw an odd coincidence:

• The Globe and Mail ran a bunch of articles about the 10-figure salaries earned by a small number of people ([1],[2],[3]).
• McMaster University's Mike Veall passed along updated data (preliminary paper and data files [1], [2], [3]) confirming the trend in which income is increasingly concentrated among a small number of people.

Three years ago, I blogged about the results that Mike published with Berkeley's Emmanuel Saez on the evolution of top income shares in Canada up to 2000. The updated numbers are not directly comparable to the ones in the AER study, but they show the same trends over the periods in which the two data sets overlap. Even better, they show what has happened to the concentration of after-tax income.

How Game Theory Made Me a Better Businessman

Anyone who has taught microeconomics has, at one time, had to deal with the question, That's all very nice, professor, but how am I supposed to use any of this in the real world? If I'm running a business, I'm not going to know the demand curve for the product and I'm not going to be in a perfectly competitive or a monopoly market. What's the point?

From my own personal experiences as an economist and a business person, there are a number of useful lessons the business world can learn from microeconomics. The first is from the world of game theory.

Quick warning: I'll try not to let this get too 'preachy', but it is Sunday and my full first name is Michael Patrick so I hope you'll forgive any accidental sermonizing.

Does internet access promote marriage?

Next week at the Canadian Economics Association meetings I'm discussing a provocative paper by Andriana Bellou on the The Impact of Internet Diffusion on Age at First Marriage.

The theory behind the model is straight from the e-harmony ads: "I decided to give eHarmony a try after several frustrating attempts to find someone to love, admire, cherish and respect for the rest of my life." People delay marriage because it takes time to find Mr. Right. The internet means women can find Mr. Right faster, so they marry younger.

Maybe the Bank of Canada won't raise interest rates on June 1

The April CPI release is out; here is the updated graph of core inflation rates over various horizons:

Core inflation started trending above the 2% target in November, and this trend explains why the Bank felt it necessary to use its April 20 interest rate decision to release itself from the conditional commitment to hold the overnight target at 0.25% until July.

But since then, two things have happened:

• The eurozone crisis has rattled financial markets.
• Inflation has slowed.

On April 20, there was a pretty strong argument for increasing interest rates on June 1. That case is looking much weaker now.

The bank tax: more reasons for Canada to resist

Germany promises to keep pushing for a bank tax:

Merkel to push financial reform at G20: German Chancellor Angela Merkel on Thursday called for a global levy on banks, a new European rating agency and a co-ordinated exit from stimulus measures as Germany stepped up efforts to drive financial regulatory reform...

She said Germany would push its partners to introduce taxes on banks. “Accountability is what is required in every state and I don’t think it will ruin financial markets if we could agree on an international taxation."

To put this into context, here's an interesting article dredged up by Tyler Cowen at Marginal Revolution:

German banks take aim at Basel III leverage cap: A planned cap on bank leverage would not make the sector safer, said a German banking lobby on Friday, adding heavyweight support to a growing campaign.

Tyler Cowan continues:

Might I go out on a limb and suggest that some of these European banks are...excessively leveraged?  In theory the Basel III reforms will adjust the leverage restrictions for the risk of bank assets.  It's been the case for a long time that many German banks have higher measured degrees of leverage.  But are they more leveraged, all things considered?  If they're worried about Basel III, maybe the answer is yes.

It would appear that the Europeans are more interested in finding people to pay for their bank bailouts than in preventing them from happening in the first place.

Connecting the eurozone crisis to the Canadian economy

This looks tricky.

We should perhaps start with Tim Duy's suggestion that the eurozone crisis could be a net positive for the US:

The European crisis, by keeping US interest rates in check and oil prices low, may do more to help the US recovery than hurt it.

It makes sense to think of lower prices for oil and other commodities as a plus for the US, but it's a mixed bag for us. A stronger US recovery is a plus for Canada, but lower commodity prices are a negative: the net effect may be close to a wash.

What is a "reserve currency" anyway?

I just realised I don't really know; that's why I'm asking.

With the Eurozone troubles, the US dollar has been rising against the Euro. That's not so surprising. But the US dollar is rising not just against the Euro; it seems to be rising against other currencies as well, like the Canadian dollar. And gold is rising too, even against the US dollar. As Scott Sumner notes, it's looking a bit like a replay of late 2008. On a much smaller scale so far, but it's still worrying.

I can understand this at one level. In a financial crisis, there's a rush into money. And at a global level, the US dollar is the most "moneyish" of all moneys, so there's a rush into US dollars. But what does it really mean to say that the US dollar is the most "moneyish" of all monies?

The orthodox loss of faith

I think we are witnessing the biggest silent shift in macroeconomic thought since the Second World War. For 70 years we have taught, and believed, that we would never again need to suffer a persistent shortage of demand. We promised ourselves the 1930's were behind us. We knew how to increase demand, and would do it if we needed to.

The orthodox have lost faith in that promise; only the heterodox still believe it. And the heterodox have nothing in common, except for keeping the faith.

The orthodox haven't lost hope. They hope that monetary and fiscal policy will be enough to get us out of this recession, and that the limits on monetary and fiscal policy will not be binding this time around. And they are probably right. But they have lost faith that monetary and/or fiscal policy will always be enough - that there are no limits.

And if the Eurozone too turns Japanese, they may start to lose even that hope.

The Economics of the NHL: Collector's Edition

It was the Winter of '69. Canadians were still smarting from the refusal of the National Hockey League to grant expansion franchises to Vancouver and Quebec City. Attempts were made to prosecute the NHL under the Combines Act for anticompetitive behaviour. The NHL owners claimed they were motivated by "the love of the game". But in Canadian Journal of Economics, J.C.H. Jones argued the owners were maximizing profits.

The beer and pizza theory of the Canadian recession revisited

Philip Cross at StatsCan summarises the recent recession:

[T]he 2008-2009 recession in GDP was driven more by prices than volume in Canada, while in the US it was driven more by volume than by prices.

Should teaching evaluations be public?

Every economics undergraduate learns that competitive markets are efficient.

But efficiency requires information. In a competitive market, a store that sells rotten apples for $2.00/lb will likely go out of business. Yet if people do not have information about the quality of apples they are buying, a store can sell bad produce and make a profit.

Universities are in the teaching business. Every semester students diligently fill out forms evaluating their professors. Why don't more universities make the information gathered through teaching evaluations public?

Centre for Monetary and Financial Economics Conference at Carleton

This is where I will be today and tomorrow: "Economic and Financial Crisis: Lessons from the Past, and Reforms for the Future". I will see how much sinks into my brain, and probably post about it on the weekend.

Fiscal Federalism revisited

A French, German, and Canadian student were asked to write an essay on elephants......And the Canadian student titled his essay "Elephants: a Federal or Provincial responsibility?"

The Eurozone is what Canada would be if we abolished the Federal government, leaving only the Bank of Canada. The 16 Eurozone countries are the 10 Canadian provinces. Americans could draw a similar analogy.

What are the lessons for Canada from the Eurozone crisis?

1. A currency union with the US and Mexico? Forget it.

2. If Quebec separates, should it keep using the Canadian dollar? Forget it.

That's the easy bit.