Worthwhile Canadian Initiative

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?

That's not shadow banking, that's the stock and bond markets

Paul Krugman has a flow chart showing flows of savings from ultimate lenders to ultimate borrowers. One arrow goes via the banks. Paul labels it "traditional banking"; that's fine. People deposit their savings in banks, and the banks lend those savings to other people or firms. But a second arrow goes directly from "the public" to "borrowers", and Paul labels it "shadow banking". Nope.

Does CMHC have big enough reserves?

This post is more of a bleg; because I'm sure someone reading this knows more about the answer than I do.

An insurance company doesn't need reserves if it is insuring a large number of short term uncorrelated risks. The Law of Large Numbers ensures that its annual claims will equal its annual premiums, if it prices its insurance correctly. Every year exactly 5% of all cars insured will crash, so if you price the insurance at 5% of the claim, plus admin costs, you will break even every year.

But suppose there is the same 5% annual risk of a car crashing, but the risks are perfectly correlated. Once every 20 years, on average, all the cars crash. Then you need reserves. If you price the insurance at 5% of the claim, plus admin costs, you would need to keep at least 20 years' worth of premiums, net of admin costs, in reserve. (That's a minimum, because you might get 2 or more crash years in a row.)

A "proof" of Say's Law; and why money is weird

For a whole economy, does planned expenditure on newly-produced goods necessarily equal planned income from the sale of newly-produced goods? That's what I mean by "Say's Law" in this context.

Say's Law is wrong, and the fact that it is wrong is really important for macroeconomics. But it's not obvious why Say's Law is wrong. And you have to get right inside the minds of those who think Say's Law is right if you want to change their minds. That's what I'm trying to do here.

It is money (qua medium of exchange) and only money, that makes Say's Law wrong. And those Keynesians who reject Say's Law but who also reject the uniqueness of money are as wrong as those who accept Say's Law.

John Cochrane, Paul Krugman, and Say's Law, again

Via Casey Mulligan and Karl Smith, here is John Cochrane's response to Paul Krugman. It's a very good response. But there is one part where John Cochrane is definitely wrong. It's small, but important. And it's all about Say's Law, and the crucial difference between a monetary exchange and a barter economy.

Who is increasing their spending - debtors or creditors?

That's the question we ought to be asking right now, but I haven't seen anyone ask it, let alone answer it. I don't know the answer, but I do know it's the right question to ask.

The grain of truth in the Junker Fallacy

I saw an example of the Junker Fallacy recently (it doesn't matter where). You have probably seen it too somewhere.

"Investment is low because people (or firms) spend all their savings on speculation rather than investment -- bidding up the price of houses, shares, land, or in corporate takeovers; there is no money left over for real investment that could increase future productivity".

It is indeed a fallacy, in that the argument makes no logical sense. It's an example of a fallacy of composition: what is true for each individual is not true for the whole. But there can be a grain of truth in it, in some circumstances, if it's re-stated correctly.

Banks, Money, and Debt

"You and I can only lend money if we've got some to lend; but banks can create money and debt simultaneously at the stroke of a pen". Might commercial banks be the cause of the increase in debt over the last few years?

Maybe partly, but basically no. You can't just look at one side of the market for debt; you have to consider both supply and demand. And when you are talking about macroeconomic things, like total amounts of debt and money, you cannot just do partial equilibrium analysis; you have to do general (dis)equilibrium analysis and look at the economy as a whole. It's the only way to avoid fallacies of composition.

Money and debt

Could monetary policy have caused the recent rise in levels of debt?

The obvious answer is that loose monetary policy lowers interest rates, which causes people to want to borrow and spend more, and so go deeper into debt. That answer is both obvious and wrong, as I explained in a previous post. Low interest rates make people want to borrow more, but they won't be able actually to borrow more unless someone wants to lend more. There is both a demand and a supply curve of debt.

Why did debt increase?

Updated below.

I have heard the argument so many times: "Low interest rates caused people to want to borrow and spend, and that's what caused debt to increase". It's such a simple and obvious explanation; only someone with a PhD in economics could fail to understand it. Unfortunately it's also an explanation that makes no sense at all. You don't need a PhD to see what's wrong with it; you just need to understand ECON 1000's supply and demand properly. But that begs the question: if that explanation makes no sense, what did cause debt to increase?