How to think about debt?

I attended Gertjan Vlieghe’s speech yesterday at the Society of Business Economists annual conference in London. The speech had a market impact because it challenged the consensus perception of Vlieghe as an uber-dove. It had an impact on me for another reason.

But first, a bit of context.

Back in May I was reflecting that many people seem to have become either really cross that monetary policy is way too tight (looking at low levels of inflation), or really cross that monetary policy is way too loose (reflecting either historical anchoring, or looking to debt growth). For a sample of this crossness, you could do worse than look at my compendium of tl;dr versions of submissions to the Treasury Select Committee’s inquiry into the effectiveness and impact if post-2008 UK monetary policy.

Anyway, I drew the following chart, to try to understand this bad-temperedness. 


It shows for each calendar year since 1983 the pace of US inflation (y-axis), the change in US private nonfinancial credit to GDP ratio, and then the bubble size relates to the real interest rate (blue is positive, white is negative; large is large, small is small). I can see that the debt folk (I’ve labelled as Austrians, but this is probably unfair) probably reckon that anywhere right of the y-axis means that rates have been too low, while inflation folk see anything below the x-axis as evidence that rates have been too high. In the top right and bottom left quadrants, debt and inflation folk would probably get on okay at a drinks party without coming to blows. The top left and bottom right quadrants are, by contrast, times when these folk are likely to spend most of the time either talking past – or slinging abuse – at one another. You will notice that we’ve spent a good deal of time in the bottom right quadrant in recent years: inflation has been scarce, but real interest rates low and increased leverage forthcoming.

Claudio Borio, Head of the Monetary and Economic Department of the Bank of International Settlements, wrote an interesting paper in 2013 arguing that the idea of the output gap had kind of gone astray. Typically, monetary policymakers seek to identify potential economic growth with reference to non-inflationary economic growth. Borio argued that this is, if not bogus, too restrictive: the pace of economic growth may be unsustainably strong, and the economy operating beyond capacity, if financial imbalances (aka leverage) are building up. In other words, Borio argues that changes in the price level (inflation) and changes in the stock of private nonfinancial credit (leverage) are each important in determining the sustainable pace of economic growth.

I’ve got some sympathy with Borio. If this sounds a bit abstract think of China today: inflation is not a problem, but credit growth is rampant,  perhaps to the extent that it might point to faster growth than is ultimately sustainable. Central bank mandates in many – perhaps most – developed economies are meaningfully oriented towards delivering low levels of price inflation, variously defined. Why? Because inflation is a form of monetary instability. And preventing monetary instability so that people can get on with their lives rather than obsess over the nature of money  – via the creation and execution of an inflation-targeting mandate – seems a pretty reasonable thing for a monetary sovereign to do.

But, as the Global Financial Crisis made baldly evident, inflation is not the only form of monetary instability. During the GFC, Central Banks resurrected their age-old response to this episodic type of monetary instability: by acting as Lenders of Last Resort and clearing up *after the fact* with super-easy monetary policy.

Whether central banks should act *before the fact* and ‘lean against the wind’ so preventing the build up of bubbles has been a live and heated debate probably for as long as they have acted as Lenders of Last Resort. There are good arguments on both sides, simplifying as:

  1. Pro-leaning: bubbles are dumb (aka lead to capital misallocation), and big bubbles bursting hurts (aka deliver large loss of welfare, can be associated with financial and monetary instability etc). If your whole job is to maintain monetary stability, going on and on about how hard it is to lean against the wind is a bad look.
  2. Anti-leaning: By definition, people won’t agree that something is a bubble until after it bursts. Furthermore, while bubbles might hurt a few people a lot, tightening monetary policy more than would otherwise be called for comes at a real cost for many (fewer jobs, slower investment, etc). Better to clear up after the event with some ultra-easy policy response if necessary. In other words, it might be really important to stop bubbles, but it’s also both practically impossible and trying to do do is likely to be pretty damaging. 

The Global Financial Crisis did highlight the arguments of the pro-leaners, but didn’t really challenged the arguments of the anti-leaners. I see Vlieghe’s speech as an elegant take on this debate: maybe even a way to square the circle.

In the speech Vlieghe introduced what he called the Finance Theory of the Equilibrium Real Rate (ERR). At it’s simplest it is an intuition that interest rates are low and the risk premia attached to equities are high when the world is risky. Few would disagree. ‘Risky’ in this context means consumption growth has a lot of volatility, and (importantly) negative skew and kurtosis. The intuition is demonstrated with an historical econometric analysis of a couple of hundred years of UK data, and different regimes are identified – some with a high ERR and some with a low ERR. The different regimes have some shared characteristics of credit growth, realised equity risk premia, realised nominal rates and inflation, as well as distributions of consumption growth (expressed in terms of mean, standard deviation, skewness and kurtosis). I would urge you to read it and make up your own mind whether it says more than real policy rates are very low and equity returns are very strong in periods following economic busts. I think that it does.

How is this linked to thinking about the current state of monetary policy? Importantly, Vlieghe’s Finance Theory of the ERR doesn’t actually help define where the ERR might be, ex ante. But one of the things he associates with high or low ERR regimes is the change in the stock of household credit. If households are deleveraging, chances are that you are in a low ERR regime, and even an ultra-low nominal Bank Rate might not be very far below the ERR. But if households are releveraging, maybe you’re moving *out* of a low ERR regime, and Bank Rate might be very far below the ERR. Over the past year or so, UK households have been releveraging, so a question is introduced as to whether the UK is moving out of a low ERR regime and into a higher ERR. Through this lens monetary policy in the UK may be becoming ever-easier unless Bank Rate is raised. And so Vlieghe argues, without a hint of Austrianism, that the easiness of a given monetary policy becomes defined by changes in the price level (inflation) and changes in the stock of private nonfinancial credit (leverage).

Vlieghe’s Financial Theory of the ERR, like Borio’s Financial Theory of Sustainable Economic Growth (OK, I made up that name), doesn’t argue ‘sure, inflation is important – but there’s this other thing too called financial stability/ leverage to worry about’. It isn’t a new target variable to chuck into your optimisation. Instead, it is a variable that reconfigures other terms in the optimisation process in a potentially unknown and whacky way.

If this understanding is right (and, to be fair, I would be surprised if Vlieghe even recognised it as such) I am left with some questions:

1. The circularity question.

Isn’t inter-temporal substitution supposed to be a pretty major transmission mechanism? And doesn’t this manifest in changes to credit stock? Maybe I should reread James Cloyne’s awesome 2016 paper that finds the transmission mechanism isn’t all about intertemporal transfers, but also about transfers between households. 

2. The reversion to *which* mean question.

But if we target stable debt to GDP, are we stabilising at a level that is above or below equilibrium level of debt at a whole economy level? What is equilibrium level of private non-financial sector debt-to-GDP? Is the equilibrium level of debt conditional upon the term structure of interest rates available to, and the whole shape of the prospective distribution of economic growth as experienced by, each debt-bearing demographically-unique cohort? Do we have confidence that we know what this is for any economy?

3. The FPC question.

The whole point of the FPC was supposed to be to a means of exerting control over stuff like leverage growth. This was a sort of nod to the Leaners (without actually going the whole way and saying that rates should be changed to lean against the wind). Is Vlieghe saying the whole project is just a bit rubbish? Or, to put it as a meme:


4. The globalisation question.

Isn’t the location of all those dots in the bottom right quadrant of the chart more easily explained by the idea that there is global overcapacity in labour owing to a global labour glut that will turn as Chinese governance-adjusted unit labour costs reach developed market governance-adjusted unit labour costs? This dovetails into the @rajakorman question (simply put, is @rajakorman right that the whole thing can be put to bed by adding an international flows dimension).

I didn’t really expect a really impactful speech. I was dead wrong.

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20 years in

It was twenty years ago today that I began working in fund management. 
What advice would I offer someone starting out in the industry, based on my experience? I’ve spent a good few tube journeys pondering this question, and this is my best effort.

1. Treat the job as if you are lucky to have it, because you are.

    There are many wonderful people with brilliant minds who will never get the opportunity to sit in your seat. Somehow, you’re sitting here. This is an amazingly fabulous opportunity. Do something with it, and don’t waste it.

    2. You can never truly *know* the mixture of luck and judgement attached to your results. 

    As @xkcd puts it:

    This is a big big deal, and will likely gnaw away at your insides if you are at all reflective, no matter how successful you are. (If it doesn’t, check that you haven’t got Dunning-Kruger syndrome.) Use this doubt to humble you, especially when things are going very well. Make sure that you do a really good job on the things that are absolutely within your control (the careful implementation of your investment process; well-prepared, respectful and unpatronising interactions with, and attitudes towards, clients; strong risk management, etc). And read this piece by @ericlonners.

    3. Despite #2, learn quickly that Every Job is a Sales Job.

    This was an absolute shock to me on leaving university. Nicely expressed in this thread.

    But also worth recalling one of my boss’s mantras here: 90% of life is about managing expectations. You live with the consequences of your sale (to others and to yourself); by over-selling you raise the bar that you must clear in order to not fail.

    4. Pick a good boss.

    This is hard when you’re starting out and literally know nothing about your boss and know nothing about what makes a good boss. So while your first boss will be a bit pot luck, choose your second carefully. Think about the values you have and how these are reflected in your boss; think about the way your boss succeeds or doesn’t succeed. You absolutely don’t need to share the same political, social or religious views, but you must be able to respect them professionally. If your boss doesn’t get some *core* stuff (personal integrity, centrality of the client etc) then change your boss. 

    5. Don’t (over)-job hop.

    You need a really good reason to not stick out your first job for at least two years. It is possible that you will be given mindlessly basic grunt work for two years. No biggie. You are being paid to learn: take every opportunity to do so.

    You may find an earnings or opportunity jump occurs each time you do change firms, but your ability to jump diminishes over time. No one will want to employ someone who has a history of not sticking around. Try moving internally rather than externally if it’s a role thing. (Once you’ve spent a long stretch with one firm this doesn’t apply so much.)

    6. When you have worked out what you think, make sure that you take enough risk on your view.

    You have the potential to lose your job with every decision* that you make, but it helps no-one if you make good judgements and their impact is insufficient to really make much difference.

    *(Don’t worry, you won’t be allowed to make many decisions until that time when you are competent to make them if you have a half-decent boss.)

    7. There is a part of you that will *become* your job/ profession.

    We don’t come out of the womb as accountants, psychiatrists, fund managers, journalists, etc. And we spend our formative years building an identity which may not ‘fit’ with our target profession. But after years of pretending to be the sort of person who is a finance professional you will find that you aren’t pretending anymore. If you can make peace with this early, you will have a better time of things. Incidentally, Hashi Mohamed did an awesome Radio 4 documentary on social mobility which I thought was a masterclass on extreme adaptability. Listen to it here

    8. Never Ever say that we live in unprecedented times.

    Stuff happens all the time. And the incidence of stuff is no excuse for doing a bad job for your clients; in fact it is the successful navigation of these that will add value to your clients. In my 20 years the following stand out: the Asian crisis, the Russian default, LTCM, Brazilian depeg, Dotcom boom/ bust, Argentina crisis, 9/11 and War on Terror, Brazilian electoral crisis, Worldcom/ Enron/ Anderson client crisis, Gulf War, all that stuff that is generally wrapped up into the Global Financial Crisis, the European sovereign debt crisis, Commodity meltdown/ deflation, Anglo-Saxon populist electoral wave. Each of these (and many others) felt like they could be fairly existential for markets on which I was professionally focused. Each was heralded as unprecedented. And each was. But navigating frequent unprecedented events is … er … the job. I don’t buy that the last twenty years is particularly challenging in the broader sweep of history. If a particular couple of decades further back in time look relatively calm I would suggest that this probably signals a lack of curiosity of the past.

    9. Read books.

    My job involves reading a lot of documents. Downtime consists in reasonable part of reading documents that I don’t have time to read during work time but feel I should read, or think might be useful to read. I could fill every hour of every day doing this and not read all that I think I should read. The idea of squeezing in time to read some professionally irrelevant book is not always appealing. (In fact, there seems to be no time.) But make room for books. Books get inside your head, and great books will touch on themes that are recurrently relevant. There are people way more professionally successful than I will ever be who find time to fit in reading a book or two a week. I read at least twelve a year. It’s a start.

    10. Don’t stop asking silly (but relevant) questions.

    The more you know, the more you know you don’t know, as the saying goes. But try to work out where you can get away with asking them.

    And finally, some advice I would offer, not based on experience? Learn to code.

    Podcast

    A quick post to say that I was lucky enough to be invited onto the Odd Lots podcast by Joe Weisenthal and Tracy Alloway to talk about money and my kids savings.

    Joe and Tracy managed to weave the chat such that we covered the establishment of the Nangle Household Bank, and the evolution of its monetary policy, the basics around inside and outside money, and the complications that target saving poses to monetary policy (where interest rate elasticity of demand has the potential to become small or perversely negative). And they did this in a way that is still fun to listen to, which is quite an achievement! If you are into podcasts and like this blog, it may be of interest.

    We didn’t quite get on to the nature of money Venn that I trialled on Twitter the other day (below), but that’s probably good because I have had to rethink the whole Moon thing (with help from Twitter).

    And if you want a more worky outline of all of the above, here is a document I wrote a while back that tries to pull it together.

    A Bad Week in the UK

    I was shown a really interesting App (Explain Everything) when looking around a school today. The classroom seems to be ahead of the boardroom as far as interactive technology goes.

    I thought I would play around with it on my phone and test it to give my personal view of things going on in the UK this past week.

    This is a corrected version after the first one erroneously said that Marine Le Pen had tweeted in approval of Theresa May’s conference address. Like the Huffington Post, I had been fooled by a supporter’s account.

    ​​

    Still an awesome chart!

    Today the Resolution Foundation released an excellent and fascinating paper looking at data behind Branco Milanovic’s ‘elephant chart’, and asking what conclusions can be realistically drawn from it.

    My tweets may have played some small role in popularising the chart – the reporting of an opinion I tweeted that it is ‘the most important of the last decade’ is footnoted a couple of times in the paper, and it even appeared in a Dutch Trade Minister’s speech a couple of weeks ago.

    Here’s the tweet, which I drew on my iPad of a picture that I snapped while reading Milanovic’s terrific book:

    I have been thrilled to have had a role in drawing attention to the work that Milanovic’s and Lakner have conducted, a summary of which can be read here.

    But judging from my Twitter feed this morning you would think that the Resolution Foundation paper has found major methodological flaws that makes a nonsense of the chart.

    Not so.

    To reiterate, the elephant chart is an amazing chart. It paints in one graphic a picture of the global economy that is (in my opinion) unrivalled. It is so good precisely *because* it combines income changes and demographic changes; it tells the story of recent global history and the degree to which the rise of China (and India) have changed the world. It also illustrates that lower income households in the West have largely not participated in the remarkable global growth over the two decades. The original Milanovic & Lakner paper  dwelt at length on the compositional issues behind the chart, and there was even an animated gif that @MaxCRoser put together using country-specific compositional data contained therein which is pretty stunning, and was widely distributed before inexplicably disappearing from Twitter. Luckily I have been able to find and embed a copy below: global-income

    The Resolution report does the world a service by further drawing out the data behind the chart, discussing what policy implications can and cannot be drawn from the chart, and reminding people of the compositional issues.

    Compositional issues are hard. And this is probably the most striking chart in the report for people interested in the impact of compositional issues. It even makes its way into the FT.

    unknown

    This chart is complicated. As its title suggests, it shows ‘Growth in average per capita household income of each percentile group (rolling average) if there had been no income growth and changes were solely due to uneven population growth’.

    I think that this means that it imagines a situation where:

    1. every worker is put into an country-specific income decile in 1988, and the mean income of the decile is then fixed in real terms;
    2. net new workers per country are distributed evenly across these country-specific deciles;
    3. all countries for which there is data have their country-specific deciles chucked into a spreadsheet in 2008;
    4. the income required to make it into each percentile in 2008 is then compared to the income required to make it into each percentile in 1988.

    The outcome is then charted. (Apologies if I’ve misinterpreted.)

    If this understanding is correct, the chart then shows the impact on the elephant chart of

    1. poorer countries having had faster population growth than richer countries;
    2. starting the exercise in 1988 when the global income distribution had the following shape:

    unknown-1

    Or, as the author of the Resolution report, Adam Corlett, puts it:

    “For example, the poorest decile of people in the US were in the 70-75th percentile range in 1988. But population growth among poorer countries would have pushed those Americans up into the 75th-80th percentile range by 2008. The bottom US decile would be replaced in the 70-75th percentile part of the global distribution by the richest urban Chinese, but the latter’s average income was around $1,500 compared to the former’s $2,600: producing a fall in the average income of those percentiles.”

    And so, when holding constant the country population share the elephant chart looks as follows (red line):

    unknown-2

    Is this a ‘truer’ version of the original elephant chart? Not at all. In fact, holding constant population shares stable is a nonsense: it no longer shows a picture of profound changes that have been experienced across the global economy as a whole. The author both understands this and makes no attempt to conceal it, because he is trying to do something important and useful to which this new chart is particularly well-suited: to correct a misperception as to what the original elephant chart showed.

    Specifically, it issues a corrective to claims that working class developed market incomes have *stagnated* in real terms during the period. And here, despite being one of the people who actually read Milanovic & Lakner, I am at least partly culpable. In a blog for voxeu among other places, I have used the elephant chart and stated “there is a large section of people who are well-off in global terms who have largely not participated in global growth over the past 20 years. That section is populated largely by the Western lower middle and working classes”.  The words may not be technically incorrect, but to say that they fail to draw attention to the compositional issues underlying the chart is more than fair. Furthermore, they mask the fact that while I have looked at US income distribution in some depth, and think myself relatively familiar with the data that is published in the UK, the impact of Japanese income data on the overall chart had passed me by.

    When we look at the constant country population share chart from the Resolution paper we can see that my claim that a large section of Western lower middle and working classes largely not participating in global growth might more accurately (but not massively more accurately) be described as having experienced a cumulative real income growth of c25% (although this will vary *meaningfully* by country – with Japanese lower income deciles experiencing contraction, US lower income deciles experiencing low but positive growth, and Western European lower deciles experiencing c45% cumulative income growth). These levels of cumulative income growth have been lower than the income growth at the top of each of the income distributions for the respective developed market block (leading in many developed countries to higher levels of income inequality), and lower than the income growth of the global median or global poor (leading to lower levels of income inequality across the globe, principally due to the rise of China). And so while real incomes have risen for lower middle and working classes in absolute terms, the bottom 80% labour share of GDP in the UK and US has declined as a proportion of GDP (defined as the labour share of GDP multiplied by the proportion of labour income received by the bottom 80% of the income distribution, see chart below), while the relative cost of labour in the West vs the rest of the world has reduced. (It is also notable that the big decline in the UK occurred in the 1980s, with an evening out thereafter.)

    unknown

    I don’t think that all these things are disconnected, and I’m pretty sure that the Resolution Foundation report isn’t arguing that they are disconnected. Instead, it is seeking to quash a meme that real incomes have stagnated for developed market middle class workers on account of globalisation. It does so with aplomb. As Torsten Bell, also of the Resolution Foundation, blogsboth those saying globalisation automatically benefits everyone and those saying that developed world middle classes have seen no income growth are wrong. Perhaps most crucially, where individual countries lie in between those extreme positions is to a significant degree down to policy choices.”

    Given that I read Milanovic & Lakner’s compositional discussions in the original paper, why did I not major on these compositional discussions? Well, I didn’t think that they change the use to which I put the chart (discussing the global labour glut that came about with China joining the global trading system, the associated substitution of capital for labour, and the loss of labour bargaining power in a variety of developed market economies). Although I was not aware of the contribution the Japan had made to the distribution until reading the report.

    I tend not to be accused of oversimplifying things. But given the reaction to the Resolution Foundation report, I certainly feel complicit in propagating the end-product of a complex piece of analysis without due caveats.

    However, it’s still an awesome chart.

    You break it, you pay for it

    So we’re a month into the post-EU referendum period and the lights have not gone out. Yes, we’ve gone through a pretty shaky political patch for the Conservative Party leadership which was unnerving to say the least. And the Labour Party is either nearing the point of exuberant rebirth or self-immolation depending on your perspective. But things seem somewhat more stable than they did a month ago.
    From an economic data perspective we are still an essentially pre-data period, or at most a period of anecdata, collected/ assembled with various levels of formality. The Economist put together a piece about data it had scraped from the web which was interesting, but really illustrated how little data we really have. 
    We have seen data from a few forward-looking surveys come out, the sort of which market-folk like me digest when trying to understand likely developments at a macro level. They are, by definition, snapshots taken at a point in time. 

    Here is a quick recap of what we have seen:

    • The GfK consumer survey data, which was dire. However, this was taken during the period of peak national political insanity. So perhaps it should be taken with a big pinch of salt.
    • The RICS survey fell sharply, and tends to lead house prices by around six months, a point made by Sam Tombs here:

    • The Bank of England Agents’ summary of business conditions which was widely interpreted as being more positive, painting a picture as it did of firms somewhat in shock but trying to get on with life. This bullet point is a fair summary of the post-Referendum part of the report, but you might as well read the whole report. It is only three pages in total, so shame on you if you discuss it without having bothered to read it.

    • The Markit survey of Purchasing Managers (the UK PMI) released today, which was pretty awful, although contained an important caveat from its chief economist Chris Williamson that signs of confidence began to lift later in the month as the new government took shape.

    • The CBI Business Optimism index fell sharply, although the orders component was decent and the survey was taken between 27th June and 13th July (recall that May became PM on 13th). [This bullet added 25th July.] Here’s Samuel Tombs again:

    But to reiterate. This is not hard data. And without hard data we risk projecting our priors onto the straws in the wind that so far exist, as Tim Harford wrote most eloquently here
    And so it is perhaps natural to see a variety of commentators seizing on individual bits of information that *proves* that the UK is either booming or collapsing. Perhaps the whole thing looks rather emotional to the outside observer, and perhaps it is.
    But the truth is that we simply don’t know. We each have guesses. Furthermore, we can infer from market prices the degree to which our guesses are more or less consensus. But we don’t know and we won’t know (unless the bottom falls immediately out of the economy) for a little while.
    But the reason I’m writing this blog is that I’ve started seeing snippets of commentary from folks who supported Leave that I find somewhat disturbing. I’m happy for them to point to data that they reckon proves a UK boom. I’m happy for them to change their mind and say that they were wrong (although would be surprised if this should happen since we are still in the pre-data period). But I am not happy for them to say that the economy was already broken before the Referendum. And this is what I’ve started to see sneak in.

    Similarly, I’ve seen folks who supported Remain appearing to relish the bad pre-data that we’ve seen, perhaps seeing it as enhancing their reputation for analysis. This is really distasteful. There is nothing to celebrate about a downturn.

    I was one of the 288 signatories of the letter organised by Paul Levine, Tony Yates and Simon Wren-Lewis.  I stand by its wording, but I very much hope that I’ve been wrongly pessimistic on the impact on the UK of voting to leave the EU. The prospect of eating humble pie is wildly attractive because I want the UK economy to blossom. In fact I am working bloody hard to play my part in ensuring that it thrives. Economic recessions are frankly awful. They carry a distinctly human cost.

    But if it does turn out that we have scored an economic own goal by voting to Leave I’m simply not having those who belittled the prospective economic costs of Leaving wash their hands of their responsibility and telling the rest of us that the UK economy was already broken. It wasn’t.

    Brexit and Freedom

    I think that folks who follow me on Twitter will have worked out by now that I plan to vote Remain in the EU Referendum, and furthermore think that calling the whole thing in the first place was something of an economic own goal. The consequences appear to me extremely likely to be economically and financially negative for the country, which is why Remain are so keen to focus on the economics and Leave are so keen to move the debate on to anything but.

    Despite news media saturated with coverage, I listened today to an old podcast (16th March) of Radio 4’s excellent Moral Maze that discussed the morality of Brexit, during which Michael Portillo put the moral case for Brexit as ‘What Price Liberty?’. (He actually asked an American whether there was a price at which Americans would give up independence, but it comes to the same thing.) This is both a really good way to argue for Brexit, and also a really good general question. It asks you to look deep into yourself and decide whether you are sufficiently mercenary as to put your freedom up for sale. Posing this question as a Brexiteer puts you on the side of principle, and I have no doubt that many if not most on the Leave side see themselves as freedom-fighters even if I don’t see them as anything of the sort.

    It is also a wonderful question because it asks us to think about what liberty actually means to each of us. Sounds pretty basic, no? Freedom is the ability to do what you want to do, right? Perhaps, but this is a question with which I have struggled since an undergraduate, despite being lucky enough to attend a lecture course by the awesome Quentin Skinner on the subject and having read many of the texts to which he refers. A couple of years ago I downloaded Skinner’s iTunesU lecture ‘What is Freedom’ which seems like a potted version of the whole course and drew from it the following diagram:

    FullSizeRender

    Starting at the bottom right, we begin with Hobbes, for whom freedom is lack of physical interference. To Hobbes, the Highwayman’s question ‘your money or your life?’ was fair – you were free to choose and as such could never be made unfree in the experience of being robbed (or indeed tortured into confessions etc). Locke then comes along and asked how interference might be extended beyond the physical, and with Bentham we have a more formulated version as to how the will (rather than just the body) might be coerced. At this point liberty is still an interpersonal notion. As we move to the top right bubble we then progress to the idea used by Mill and Marx: that liberty is not necessarily interpersonal and that the agent restricting the self may actually be you (through false consciousness or Mill’s idea of inauthenticity). These echo ideas advanced by Plato, and – away from tracts on liberty – were also worked on by folks like Freud. All this so far describes only what is known as ‘negative liberty’ – aka freedom to do what you want to do – and not its ‘positive’ moment (where freedom consists in essentially fulfilling your mission, however described), outlined on the left hand side of the diagram.

    What is absent from this diagram is Skinner’s rather fascinating third leg of liberty, which comes from neo-Roman understandings of freedom that are based on absence of dependence (eg, you are subject to the arbitrary will of another agent), rather than on any absence of interference. It’s not that you can’t do what you want to do, but rather you know that another agent has the power to arbitrarily interfere if it so sees fit, and as such you self-censor. This neo-Roman understanding of liberty can be deployed extremely powerfully against monarchy, colonialism, gender inequality, and the modern day state’s interception of electronic communication. I may well have misunderstood, but as far as I can tell it is also the most powerful argument in the Brexiteer’s intellectual arsenal.

    What can be said against such a noble argument? Plenty of things, although some are conditional on different understandings of liberty. Folks who appeal to the UK’s EU membership enabling the UK to better collectively combat climate change, international terrorism etc are sort of relying upon an understanding of a collective shared project – kind of leaning on a positive concept of liberty. I can see why this doesn’t wash with them. And folks who talk about economic impact of Leave are perceived to be speaking a utilitarian dialect that is equally impenetrable to intellectual fans of Leave.

    Speaking in neo-Roman terms then, our power to hold the Brexit Referendum proves the lack of dependence. The power to leave existed before the government decided to call the Referendum. The power to leave is precisely what undermines the intellectual underpinnings of the Leave campaign. If we wish to examine whether to exercise this power we should look at the costs of so doing. And the welfare costs of so doing seem great.

    My daughter’s political career is already over

    Unwittingly, I may have killed my 8yo’s prospects of a political career even before she could even say Hard Working Families. How? Well when she was born Gordon Brown was giving out money to babies in the form of Child Trust Funds. I did the paperwork and put the money into the most unimaginative thing possible – a cheap FTSE100 tracker fund, with the idea that I would think more about where it should be invested at a later time.

    What’s the problem? Well, in short, this:

      
    (Just to be clear, the asset line is for the whole fund, not my daughter’s holding.)

    She will never be able to say that she didn’t have a trust fund.

    She will never be able to say that she never benefitted from offshore investments. 

    When the press has a go at her evil financier father who must’ve known what he was doing, she should best not defend me so as not to put me ‘in play’. 

    It would be a real mistake for her to tell the press that commingled investment funds are domiciled offshore typically so that the owners of units don’t get taxed twice for owning underlying shares and that she would be as liable for tax through her offshore holding as she would have been by holding the underlying shares direct. 

    She should by no means tell people that actively choosing to buy a product (like, let’s say, a book over the Internet, or a fancy branded coffee) is probably more ethically dubious than investing in commingled investment funds offshore that are registered with the tax authorities and push all income and capital through the tax system in *exactly the same manner as investing directly onshore* would, but at a fraction of the cost given economies of scale.

    Because that would just be digging herself a deeper hole.

    That’s all too complicated, and she would then undoubtedly have to apologise for a massive and self-inflicted communications failure.

    On the other hand, there is the chance that if she went into politics she possibly might embark upon a programme of government that is premised on economic illiteracy, be overly political in the way she chose to distribute resources, and call periodic imbecilic referenda.

    So perhaps I’ve done the rest of us a favour.

    A Tonic for Millennials’ Pensions Gloom

    It seems that Millenials have been getting rather flustered on Twitter in response to the FT’s suggestion that they should save £800 per month if they want to get a decent pension. With the median gross wage for 22-29 year olds at around £21k pa (translating into a take-home pay of £17,500 pa) you can see why telling them they’re stuffed if they don’t save £9,600 pa might get them annoyed. So I thought I’d try to cheer them up.

    About 12 years ago – when I was 28 – I went to an event in Cambridge hosted by John Eatwell at which a young Ed Balls answered questions about his career etc. Balls was excellent – engaging, articulate, and erudite. I was extremely impressed by this Number 11 SPAD and did what many young folk do in such situations: I sought to show off. So I assembled and delivered a long and pointed question about the forthcoming pensions crisis. I’d read a bunch of papers and books on the subject and so thought I knew my stuff. As such the speech I reeled out was more like a verbally-delivered data-laden op-ed than a question really – you know the type. I was *that* ridiculous idiot.* Anyway, before Balls could respond Eatwell jumped down my throat, basically telling me that I didn’t know what I was talking about and referring me to a paper he’d written. I’m glad that he did because the paper was very good.

    Eatwell’s very short pensions paper contains some very very basic ideas that are so simple that they are frequently lost in plain sight. I would summarise them as follows (although do read as it has a bit more than just this):

    1. A pension pot is an asset;
    2. An asset is a claim on someone else;
    3. That ‘someone else’ – for the cohort as a whole – can only be non-pensioners;
    4. From a macroeconomic perspective that does not incorporate either distributional outcomes across income groups or differing efficiencies of state versus private investment, and implicitly assumes medium -term current account balance, unfunded pay-as-you-go state pensions and pre-funded private defined contribution pensions are identical: they are both just claims on non-pensioners.

    Or to put it another way, pensioners will collectively consume output produced by the young. Money, as always, mediates – and so in place of ‘consume output produced by’, read  ‘receive income from’. Pensioners will receive an income that can come only from non-pensioners. This income could be in the form of rent, dividends, and interest only from the young, or the proceeds of asset sales made only to the young. This income could be in the form of tax transfers only from the young. Or some mixture. It was ever thus and it will ever be thus.

    And so society has a choice as to what level of income pensioners should collectively receive, and how this should be distributed.** Society today includes an ever-swelling portion of pensioners. The two really big variables here that determine aggregate pensioner consumption are: 1) the collective output of the young (of which pensioners consume some slice); 2) the size of said slice. There is the (sizeable) issue of inequality among pensioners of course, but let’s park that for now.

    When we move on to the pensions that millennials might prospectively receive, the two key variables determining their collective pensions will be: 1) the collective output of folks not yet born (that they will have to breed or import); 2) the size of the slice that they can persuade their unborn spawn to part with. Saving £800 per month might be one strategy to build a claim on the millennials’ unborn spawn. It doesn’t seem  bad one if they are to be raised on the inviolability of property rights and the societal necessity of monetary stability, but I’m not sure that millennials have their parenting strategies planned out that far yet.

    For my part, I am doing my best to busily follow the FT’s pointers and accruing claims on millennials’ future economic output so that I can claim a decent slice of it when the time comes to hang up my boots. But I’m hedging my property rights bet by being nice to millennials.

    persons-0008

    UPDATE: Ben Southwood (@bswud) from the Adam Smith Institute has written this reply. Do read it.

    * I groan every time I hear someone do this now, in the shame-filled knowledge that I was once (perhaps a lot more than once) *that* guy.

    ** The choice can manifest in level of state pension, tax treatment of unearned income, capital gains etc.

    Policy making in an Elysium scenario

    On Wednesday evening I was fortunate enough to attend the Annual dinner of the Society of Business Economists. The keynote speaker was the Ignazio Visco, Governor of the Bank of Italy,  who gave a thoughtful and wide-ranging speech covering the whole waterfront of economic challenges. The key points for me of the speech were as follows:

    • Inequality is high and rising (especially when considering the top 0.1%). And this is true in both income terms and wealth terms.
    • Technology is developing that threatens to automate a staggeringly large proportion of jobs (Visco reckons that forecasting 45-50% of total employment will be replaced outlined here would not be outlandish), delivering a rolling disinflationary shock to the economy. The poster image of this view is the chart below that comes from Frey & Orborne‘s work.

    Frey and Osborne 1frey and osborne 2

    • Macroprudential policy can be expected to be increasingly relied on to stop monetary policy stimulus feeding through into reckless misallocation of capital/ poor lending to risky projects that might undermine the stability of the financial system.

    The governor had plenty of other interesting things to say (competing theories of secular stagnation, and a host of other questions), and I would encourage people to read a version of his speech here. But I don’t think I’ve misrepresented the three bullets above as three of the main points.

    Now, I’ve already put my stake in the ground about where I stand on some of this stuff, and it stands in stark contrast to the bullets presented above. (I’m more of the view that there have been waves of concern stretching back pretty much forever about the degree to which technology will deliver mass unemployment and crippling real wage cuts, but these have all so far come to nothing. Meanwhile, there is a massive demographic transition coming through in front of our eyes, the upshot of which appears to me likely to deliver labour some bargaining power.) But what if he’s right and I’m just plain wrong?

    Let’s run the idea ad absurdum (yes, I know, real life has a habit of getting in the way of running ideas to the extreme conclusions). But if we did:

    1. The folks who own the robots will own the means of production (as well as the means of accountancy, the means of lawyering etc etc), and there will be no room for pontificating about labour power: labour power will be kaput. Income from the sales of robot overlord kit and robot overlord output will accrue to these members of the capitalist elite, and they shall have a fine life. But given their microscopic marginal propensities to consume (and the fact that they will have become autarkic with the help of their robots) there would be a big demand problem in the economy, and disinflation (if not deflation) is the norm.
    2. If central banks continue to shy from helicopter money, focussing instead on setting the appropriate rate of interest at the short (and perhaps through QE, the long end), the days of positive nominal, let alone real, interest rates becomes but a halcyon memory. But permanently negative real rates (as set by the economy, and implemented by the central bank) inflate further the net present value of cash flows attached to the firms that own our robot overlords (in turn owned by the ultra-rich), heightening inequality outlined in #1.
    3. Given what might be decent returns to robot overlordship you might think that the sector attracts lots of fresh capital. It does, but in the form of equity finance, given the high risks associated with technology even in the robotic sector, and the macroprudential framework that has been thoughtfully put in place to guard against financial accidents that might result from speculatively financing start-ups that challenge the big players means, on the ground, that entrepreneurs are credit-rationed for the sake of financial stability. The folks that provide this equity finance are typically drawn from #1, although periodically someone does something truly clever and special, is lionised and held up as an example of how the whole system is actually very meritocratic (further buttressed by the fact that all the professional careerists go and work in the big robot overlord firms proving that the return to education is high).

    Okay, I might have stretched the whole thing a little far, but let’s continue for a moment. What, exactly, is the problem that I’ve outlined? After all:

    • The economy is larger (in volume terms) and more efficient than it would have otherwise have been (or the robots wouldn’t have been able to take over). Tick?
    • There is a dynamic form of capital allocation in play (albeit in equity finance only, but that has less financial system risks anyway) to challenge the robot overlord firms, preventing complete monopolist behaviour. Tick again?

    Would policymakers sit back and let this scenario play out? What happens when this sort of plutocracy collides with democracy? Put another way, what is the likely policy response to an Elysium scenario (good Blomkamp sci-fi film, underrated in my view), in which what really matters is ‘who owns the robots?’

    There are some readers who might say “open your eyes, this dystopian future has been developing for decades and the answer is obvious: plutocrats win, democratic institutions are captured, and the cultural zeitgeist is also captured into knowing that the system of the day is both economically optical and morally sound“. I would counter that while it is hard to ever step out of one’s cultural context, a whole host of measures of well-being (life expectancy, health, literacy, etc) suggest that the fruits of economic growth have to a certain extent been widely-shared, and we are nowhere near the Elysium point at a national level (although this is certainly less true at a global level).

    Through the instruments of the state, we collectively have in place a structure that facilitates/ optimises capitalism (contract law, property rights, state monopoly of violence etc) so that the economy can – in aggregate – grow to its potential, and we can then deal ex post with questions of distribution. This is what I understand Lord Mandelson meant when he said he was “intensely relaxed with people getting filthy rich as long as they pay their taxes“. Sort of Rawls, if perhaps not exactly. 

    It seems clear to me that addressing the dim and distant Elysium scenario with a traditional monetary policy response would be problematic (see #2 above). And given that it is a question of ‘who owns the robots’ in this dim and distant scenario, I wonder whether either (a) a wealth tax, (b) a heli-money financed acquisition of robot overlord property rights, or maybe (c) a Guardian campaign to nationalise the robots would gain popularity. Disregarding option (c), I think that option (a) would be fair, but it seems that few others agree. But option (b) rhymes with my understanding as to how assignats came into existence in France in 1789: as a way to finance the acquisition of venal offices off their pre-Revolutionary holders.* (Assignats have ultimately been associated with monetary instability and hyperinflation, although it is not clear to me that this experience serves to support the quantity theory of money as much as a view that money is a microtechnology of daily trust that is ultimately somewhat fragile.) It would be strange if we found ourselves revisiting techniques used in the late eighteenth century to deal with a twenty first or twenty second century problem.

    After I wrote a draft of this blog I saw on Twitter that Andy Haldane spoke this evening on all of these issues in a reasonable amount of depth. Reading the speech I think his views are very interesting, and are of course laid out in a fuller, more eloquent, and well-contextualised manner. (To be fair, he probably spent more than two tube journeys typing them up on an iPhone.) He indicates that he, like Visco, are taking the potential implications of automation seriously as a prospective intermediate disinflationary force. He ends with the idea that there are three public policy solutions that might be put into motion (relax, retrain and redistribute), and this sounds pretty reasonable (actually, Visco did make a big play for retraining now I think about it). I would have loved to have asked Haldane a question on the prospective use of helicopter money for the Elysium scenario. I hope Duncan asked it.

    *Rebecca Sprang outlines in her brilliant book that ‘no one (not even Marat or Robespierre) took the truly revolutionary position of suggesting venal offices might be illegitimate privileges that could be cancelled without payment’ (p87). It seems even in Revolutionary France that radical ideas of wealth tax were considered beyond the Pale.