Back door free banking.

Could a few hedge funds decide to begin issuing debt denominated in the hedge fund's own debt?  If the funds became known for stability and their debt was highly rated, it would then function as a free bank.

Hrm, is an ETF functionally similar?

Update:  I don't know what I was thinking, an ETF is obviously not similar, because it pays creditors in currency not in its shares.

The two schools of economic thought.

There are really two big schools of modern economic though, the bottom-up and the top-down.  The bottom up school is made up of the Austrians and the New Institutional Economists.  The top-down school is made of the Monetarists and the new Keynesians.

A New Institutional Macroeconomics?

We had Keynsianism which was based on fiscal policy.  We have Monetarism which was based on monetary policy.  Will we have a new macro paradigm which is based on legal and institutional policy?

I was inspired by Scott Sumner's response to a comment about Japan's massive underground cash economy that I made on his blog.

Doc Merlin, I did my dissertation on currency hoarding and the underground economy.  The ratio of the tax rate to the interest rate is the number of years you can hoard income in cash before you would have been better off paying taxes. In the US that ratio correlates with the cash/GDP ratio over time. That ratio is high in Japan for two reasons; high taxes and low interest. So hoarding cash to evade taxes is profitable. Ironically, the liquidity trap may make their underground economy bigger.

... and also from De Soto's work.
If interest rates are low and taxes are high and if regulation is too onerous people on the whole will avoid the open economy and hide their activities. This will cause GDP will shrink. Transactions rates will slow in the formal economy, and go into the less efficient informal economy.  Formalness is not binary; it is a continuum.  For example if a company would like to go public to gain access to capital, but can't because of the expense of SarOx, it is being less efficient than it could be.  If chooses to avoid going public because the cost of complying with regulation is more than not complying, the entire future economy fails to realize the gains it would have had.

Also, now we have a good way out of a liquidity trap: tax cuts and economic deregulation.  (If the multiplier of fiscal stimulus is less than one as some studies are saying, its also a good idea to cut spending along with the taxes.)

Anything this gives me some examples of things that would help the US get out of a liquidity trap if we were to find ourselves in one:

• Lowering minimum wage
  
  
• Removing regressive taxes (Social security tax and medicare in the US, for example.)
  
  
• Suspending Sarbane-Oxley
  
  

I wonder when this new macro will come about and what it will look like.

More observations from De Soto.

Hernando De Soto observes referring to the informal sector, "Whether you are inside the bell jar or outside, you will be taxed.  What determines whether you remain outside is the relative cost of being legal."

This is extremely important to a functioning government.  This means for a tax/regulation to function for revenue collection, it must be lower than the costs of succeeding in tax/regulation evasion plus the risks of punishment.

$$Functioning Tax or Regulation < costs of evading tax or regulation + subjective cost of the risk of punishment$$

Here we have the private benefits of the individual becoming a public bad under bad legal structure.  They hide their labor and pay bribes (which fund anti-productive activities).  Also the fact that they hide their labor means that the results of their labor are less accessible.

The Mystery of Capital

I just started reading the book, "The Mystery of Capital" by Hernando de Soto, and it occurred to me that one of the functions of private property was to mostly concentrate risk and reward to the persons who were responsible for the action.   It seems obvious now that I think about it.

Definition: Expectations

I have to further define 'Expectations.' An expectation is something that an economic actor acts upon based on perception of the future. For example, a doomsday cult believes that the there is a UFO in the tail of the comet Hale-Bop. This UFO will take their spirits away to a better place when they die if they die while Hale-Bop is near earth. They then rationally proceed to commit mass suicide. They weren't insane or irrational, just horribly wrong.

I think I will change the name of this blog to 'Expectations Matter.'

Definitions:

I need a new word for "model" when referring to the ideas in the economic actors' heads that cause them to act certain ways. "Model" causes to much confusion because it seems to refer to more formal and academic types of thinking. Maybe "expectations" is better?

Ok, here goes:

Economic actors have expectations, when they act on their expectations and they turn out to be correct, these expectations are rewarded. When they are wrong they are punished.

Ok, I like this better.

Re:Does macro need a paradigm shift

This is in response to Scott Sumner's post on his blog, which I recommend reading.


1.

a. First of all, I agree that we need a common, more formal definition of what it means for money to be "tight" or "loose." I think it will be impossible to define what we mean by 'tight/loose money' because of the basic differences in paradigm between the different economic views. Its not that we are all on separate pages; we are reading out of different books.

b. I disagree that your views are that far from the norm, you are fairly standard for a monetarist school economist. Its rather that the econ-blogosphere tends towards the heterodox.

2. This plot suggests that the money supply wasn't that different than normal. AMB was same as normal at the start of the recession M1 and M2 were also.


3. CPI saw a small bump, but PPI had a massive spike.

So, I guess, yes, wrt actual commodities, money was tight, but in an absolute sense, money was not tight (M2 didn't drop appreciably).
That makes me think the 'tight money' story isn't true, because 'tight money' would cause deflation not huge PPI inflation.

4. M2 grew at a much faster rate than M1 (as would be expected) and AMB grew much faster than either of those. To me this looks like a huge push to de-leverage and get out of certain types of assets and get into cash. Also this fits the story of the Fed buying up bank assets.

5. I don't buy the TIPS story, precisely because there was a global push to get out of securities and into cash to avoid bankruptcies.

6. There is no six.

7. I think the 'recalculation' story explains this recession better than a 'tight money' story. Businesses made bad bets, their income was too low for their assets and then they had to de-lever, and switch to more profitable/less expensive business plans. This also somewhat fits John Geanakoplos's theory.

8. It seems to me that the Fed's basic problem is that it is ignoring markets in an attempt to fix them. It can't properly price interest rates which results in either gluts or shortages of money/credit.

Steps In the Model

Ok, at first glance, we have a lot of random people. They all have a model in their head of something they want to do.

1. First step, they have to overcome the initial difficulties in starting up this means clearing regulatory hurdles or finding ways of avoiding detection and getting funding.
   
2. Then comes the phase where they try to get more money to find the idea.
   
3. If the model matches a good way to keep functioning they stay functioning.
   
4. People modify and slightly randomise their model; also, more successful models are copied.
   
5. The entrepreneurs do business for a while.
   
6. The ones who have bad models lose.
   
7. The cycle repeats.
   

Now, this cycle happens all the time, for each entrepreneur. However step 4 means that when they go out of business (step 6) there is some tendency to do so in clusters. This explains how the .com crash and similar crashes happen.

Also, this model predicts says that if temporary methods are used to keep things afloat, the crash will be far worse in the future. This is because as long as entrepreneurial models seem successful they will be copied.

How to use TeX on this blog

Type your TeX math expression, in $$$$...$$$$.
For example $$$$\sqrt{a^2+b^2}$$$$
Looks like $$\sqrt{a^2+b^2}$$
If you need for some reason to type a double dollar sign, instead type four of them together

DO NOT UNDER ANY CIRCUMSTANCES LEAVE AN OPEN DOUBLE DOLLAR SIGN IN THE COMMENTS.

If you need.
This is thanks to:
http://www.forkosh.com/mimetex.html

I hope to install this on my own server eventually, so I don't tax their resources too heavily.

Entrepreneurial Model

• If you provide an idea that I haven't already thought of, i'll add it, and add your name to the list with a short description of what you helped with.
  
  
• Same goes for any contributions that I deem worthy.
  
  
• I tend to think in lists, if this is a problem, tough.
  
  

Some ideas:

• No perfect foreknowledge by entrepreneurs.
  
  
• Not even perfect statistical foreknowledge
  
  
• Failure must be a part of the model, simply because a lot of entrepreneurs fail.
  
  
• Entrepreneurs must not be directly profit seeking, but its ok if profits determine whether they succeed or fail.
  
  
• It seems to me that some variation of a genetic algorithm would be useful here possibly combined with predator-prey.