A Mater of Truthiness

I’ve been doing some research on lying lately. There’s a wealth of really interesting literature out there, but most of it is (IMHO) flawed. The main method of collecting data is based on surveys. Basically, this means the researchers are asking people to honestly tell them about instances of dishonest behaviour. I’d be counting on you to tell me the truth about lying.

I’ve been using a different technique. I give subjects an opportunity to lie to another subject for money. Depending on the situation, a little more than half the people I had as subjects (about 200) lied. Not all that surprising. What surprised me is the types of things that seem to influence a person’s likelihood of lying.

I designed the experiment to see if there was a difference in lying based on if the subject faced a potential gain or a potential loss. An asymmetric value function, like the one I’ve written about here before, predicts that people are more likely to lie when facing a loss. This is actually what I discover. So pay extra attention when dealing with someone who has something to lose.

The common perception is that women are more trustworthy than men. Well, not in this experiment. Men and women were equally likely to lie. Some other researchers using similar environments found that women were actually less likely to lie for monetary gain. These experiments were done in Sweden and the US. Canadian women,it seems, are more like males than their Swedish or American sisters. Score one for Canadian equality?

Having divorced parents is known to mess kids up. I found that people who’s parents are divorced are more likely to lie than others. What I found really interesting though was that people who reported being raised by a single parent were a lot less likely to lie. I’m not sure why that might be. Keep in mind that I’ve got a sample selection problem in that the people I’m talking about are all university students. So it might be that only the most well adjusted/honest kids raised by a single parent make it that far.

One of my favourite results of this work is that the faculty of the student seems to make a difference. In particular, business students lie a lot more than others. There are a couple of interesting possibilities. First, business students may be more sensitive to monetary reward and are therefore more likely to lie for cash. It could also be that business students have a lower “cost” of lying and are more likely to do it. These are similar, but not quite the same thing. It could also be that business students are more competitive. Lying meant you ended up with more money than the other person in this environment. That could have been a key motivating factor.

In short, we don’t really have a handle on why and when people lie. We’re getting better at catching them in the act, but predicting when it will happen? Not really sure.

Building silos

This is about something I've noticed on and off over my years in the alternate universe that is the academy.  A great many faculty and other people bemoan the formation of discipline silos, and yet nobody seems to have a grasp on how and why they form.  I'm starting to think they are the inevitable result of a number of forces that aren't going to disappear soon.

Let's start with one that's near and dear to every economist's heart; specialization.  There are huge gains to be made in almost every field of human endeavor by having different people focus on different things.  Knowledge creation is no different than any other human endeavor in this regard.  We can delve more deeply into things through specialization.  As our body of knowledge increases, the number of things someone needs to know to be able to make a meaningful contribution increases.  The number of academic articles published across disciplines every month is more than a life time's reading, never mind an entire discipline's worth of background material.  So the silos are in part a natural part of the growing body of knowledge.

Specialized methods of analysis:  An increasing number of disciplines have moved away from the ancient philosophy mode of figuring out how things work, namely words and thought experiments.  The use of formal mathematic models can create a barrier to entry that is hard for many to overcome.  This division between disciplines, even when studying the same problems, makes cross understanding difficult.  A small, but growing, number of academics are able to translate complex mathematical concepts into something more accessible.  It's a long between theoretical physics and postmodern art.

Resources:  This is the dirty little secret of universities in developed countries.  A growing share of a university's budget is not devoted to academic staff.  Instead it is being spent on a variety of other things, some legitimate, others ...  let's just say I'm not convinced yet.  The resulting fights for resources tend to make interdisciplinary cooperation difficult.  In order get new positions or often to even replace retiring faculty, a remarkable battle with highly uncertain rules and potential outcomes ensues.  Often, but not consistently enough to make it truly workable, resource allocations come down to the number of students who have declared a discipline as their major.

Confirmation bias:  Now we focus on students.  People choose disciplines and view disciplines based on their own preconceptions.  How could they not?  Which discipline will someone who believes poverty is the result of an oppressive system choose?  It likely isn't evolutionary biology.  It isn't likely to be economics, though it does happen.  By the same token someone who believes in self determination isn't likely to pursue a degree in sociology. This self selection reenforces the things that make the disciplines different.  Thus a difference between disciplines that starts out small will be continually reenforced until the gulf between the disciplines becomes almost impossible to cross.  

All of these processes combine to make the gulf between disciplines hard to transcend.  Maybe, just maybe, the gains of these silos out weigh the costs.

Failing for Freedom

Freedom may cost a little more and in a different way than we generally think. In order to be free our actions have to have meaningful consequences. These consequences have to include at least some possibility of failure. Without the possibility of failure, choices are meaningless and no one can be free.

What do I really mean by freedom in this context? I mean the ability to determine where we end up; I'm talking about outcomes. Freedom is the ability to make choices that you care about.

The best way I can think of to make this clear is an analogy. Pretend you're a contestant on the classic game show "Let's Make a Deal". You've made it to the end of the show and have to choose 1 of 3 doors. If all 3 doors have "zonk" (joke prizes like a toy car instead of a real car) prizes behind them, it won't matter which one you choose. The outcome will always be the same. In this deterministic setting, you can't really say you exercised any meaningful freedom as nothing you could have done would have changed the outcome. The same logic applies if all the doors had a major prize behind them. Once again your actions have no influence on the outcome, therefore, you weren't free.

In order for your actions to matter, in order to be free, there must be a variety of possible outcomes. Once different outcomes are possible , choices you make can have an impact on outcomes and you can reasonably be said to enjoy some degree of freedom.

The unfortunate reality of freedom is that sometimes "zonk" prizes will be chosen.

Economists do it with models

This is for RY.

In a comment left here about a month or so ago – I’ve been swamped with my real job – someone complained about the use of models in economics. I get these complaints all the time. Economics uses too many models, the models in economics are unrealistic, the models in economics are too complicated (this amounts to being too realistic), and so on.

All of these complaints have some merit. The models that students encounter in their first economics courses are painfully simple. It’s hard to get into a meaningful discussion about the ideas behind these stripped down models.

Many of the models used, even at higher levels, are unrealistic. There are entire classes of models (rational expectations, perfect information, etc) that I really, really don’t like. We often make heroic assumptions about people that don’t have a lot to do with real live human beings. I cringe whenever I here a job candidate defend a particular model by saying, “this assumption was made for tractability”. That just means they assumed something to make the math easier to solve.

Finally, many of the models used in economics (particularly at the higher levels) are quite complex. It’s easy to lose track of what’s going on if you’re dealing with a system of 6 or 7, never mind 20 equations. Some of this problem is the way the models are sometimes presented. All the equations can usually be reduced to just one or two, but all are shown with the idea that it’s important to know where they come from. The other source of complexity is the math required to solve the models, but more on that later.

So, on its face the indictment has merit. Now we turn to the defense.

A model is just a simplification of the real world so that we can focus on a small part of what’s going on. The models that first year students see are extremely stripped down versions of more robust models. Why strip them down? To allow students to focus on what many in the discipline feel are the fundamental relationships. Everybody knows that price isn’t the only thing that influences how much of something people want to buy, but it is almost always a factor. We ignore all the other stuff in an effort to make sure we get that part right. More complex relationships are added later, not as quickly as I would like, but you can’t have everything.

The unrealism has very little defense in my mind. Assuming that people are always right, except for some small error term bugs the crap out of me. The only defense to unrealism I can buy into so far is we’re slowly working in the direction of realism. So the models maybe unrealistic now, but they’re more realistic than they were. This is progress, of a sort.

Finally we turn to complexity. I get this at all levels, right from intro to graduate. At the lower levels, I’m sorry to say the blame has to fall on the public education system (this is the more on that later issue). A frightening number of students arrive at university illiterate and even more are innumerate. At the undergrad level the models we’re talking about aren’t that complicated (they’re even linear), but many students lack the background preparation to simple algebra. At the upper levels, most economists (including me) aren’t trained in enough mathematics. We all need more. There are few economists who have the ability to invent the math required to solve a problem and translate the math into something accessible. Hell, there aren’t many in physics either. The advantage of using mathematics is precision and the fact that if you’ve done the math correctly, you can’t have made an error in logic.

So given all of these issues, why use models at all? To further our understanding of real world phenomena! Every discipline uses models. All a model is, at its core, as a way of organizing facts and ideas. A model is anything that describes the interconnectedness of two or more things. All the humanities use models and just the sciences and pretenders to science. Economists do it with models, and so does everybody else. Economics is just a little more explicit about it than others.

Alternatives to the BoC’s inflation target

This post comes from something a former student shared with me. The link they shared is here
The Bank of Canada’s policy target (currently 2% inflation as measured by the CPI) is up for review/renewal this year. This is a good time to look at other options. Let’s examine a few.

1% - this is just silly, the BoJ and Fed have been engaged in a huge experiment in monetary policy with zero or near zero interest rates. The results from the US are not in yet, but I’m not optimistic and there isn’t a lot to suggest it’s been successful in the Japan. I’m more likely to side with raising targets (a la Olivier Blanchard) rather than reducing them.

NGDP targeting – this is a little more interesting. The idea is the central bank targets a combination of price level and output (essentially P*Y), this is sort of what the Fed does in the US. A reasonable target for this might be something like 5 or so, given past growth rates and inflation.

Problem: what happens if you have a wildly good year? Deflation? Ouch. Say we get a year of growth 6% in real GDP, in order to meet the target we’d have to have deflation. If this were only a one way target, it’d be pretty pointless. So I don’t really see this working out.

Status Quo - We’ve got the U.K. which has overshot its inflation target yet again, despite poor performance in terms of output. Canada, on the other hand, has done quite well in terms of meeting its inflation target and having the needs of meeting the inflation target matching the needs of the real economy. In short when inflation has been below its target the real economy has generally been in need of stimulus.

Why is Canada different? I’m pretty sure it has to do with the mix of what we produce and what we consume, and the resulting impact on the exchange rate. Given that we import finished goods a drop in the exchange rate means an increase in the CPI. We tend to export raw materials and import finished goods. The U.K., on the other hand tends to export services (particularly financial services) and import finished goods. When the demand for the financial services they produce fell dramatically output followed suit. The drop in demand for the financial services (their key export) also caused the value of the pound to fall and inflation, as measured by changes in the CPI, rose. Result: The needs of inflation targeting are contrary to the needs of the real economy, increasing the interest rate would likely increase the value of the pound and decrease the inflation rate – but this would hurt exports and output (or at least not help). This makes sense; the U.K.’s export industry is exceptionally pro-cyclical with respect to the current economic crisis.

Canada is in a slightly different situation. While on the surface it looks a lot like what’s going on in the U.K., there might be something a little different about what drives Canada’s exchange rate. Global demand for the kind of raw materials Canada exports tends to be pretty stable. The stability of demand for our raw materials isn’t the only the reason why Canada’s different. When the price of raw materials falls, say due to a lack of demand, the price of finished products tends to fall too. Thus, a drop in the demand for Canadian exports tends to be matched with a drop in the price of the finished products we import. This means that unless the types of goods that are considered key inputs changes radically (this could happen if hydrogen or other alternate transportation fuels work out) Inflation targeting is a good match for Canada.

Of course this is based on a Keynesian interpretation of monetary policy, if you're a follower of Hayek, things are a little different.

A Dangerous Narrative

In my research I work mostly with raw statistics. That means data (generally secondary) based on observations of hundreds if not thousands of people. Thanks to desktop computing I have a myriad of ways analyzing, reducing, organizing, and presenting this data, all in the name of trying to find some consistent relationships between variables. All of these fancy techniques are designed to make sure I identify relationships between things that actually exist and can be used to predict what relationships will emerge when I’m using a different data set. Get this right and, ideally, we can predict what is going to happen before we collect the data. This is the whole point.

When I’m getting ready to lecture in a class, I’m engaged in an entirely different exercise. Most of the students in lower level classes that I run aren’t ready or able to deal with the kind of statistical arguments that the theories require. The symbolic logic that underpins the theories does no better. Instead, I go looking for stories – narratives. Students at lower levels (ie before they’re indoctrin… – I mean properly educated) tend to find narratives more convincing anyways.
So what’s the problem – students become convinced of the “right” things and I don’t have to figure out how to explain a probit or fixed effects panel model to first year students, wins all around, right?

Well, things get a little more complicated when you start to think about how people form expectations. From experimental work in both economics and behavioural psychology we can identify some of the consistent mistakes people make when forming their beliefs about how likely something is. Let’s start with why narratives work.
The effectiveness of a narrative is based on the fact that most people are able to project themselves into someone else’s position if they invest a little energy. This is easier, the more like you the person is seen to be. As a result the best narratives are those that feature people as close to how the audience sees themselves as possible. For those who want to explore this further consult Adam Smith’s Theory of Moral Sentiments.

OK, so we can make a story more compelling by choosing someone as like the audience as possible – big deal. This introduces to proximity. This is the idea that events you can relate to are seen as more likely than they actually are. If your friend’s house is robbed you’re more likely to worry about your house, even if you live across the city. Somebody you don’t know in the next neighborhood – not much effect. The more like you the person in the story seems, the bigger the impact on probability.

Here’s another way things can get weird, some of the some things that make for an interesting story generally screw with our perceptions. For example, more extreme events are more interesting and a lot easier to recall. This taps into what is called availability; the easier it is for you to recall an event the more likely you believe it to. A good narrative will increase availability in both these ways, even when the event is incredibly unlikely.

We also have to worry about issues like representativeness and conservatism. Representativeness just means we assign probabilities based on a prior belief and how well any new data represents the conditional event. If 85% of cars are blue and somebody who is wrong 20% of the time tells you a car is blue, you’ll generally go with an 80% chance the car was blue. This, for those who have studied stats, is dead wrong, the correct answer is 41%. Conservatism means you start with a prior and resist updating your beliefs by giving little weight to new data. So a good narrative can entrench an incorrect belief very easily.

We also have to deal with the so called, law of small numbers. The idea here is that a remarkably small sample should be representative of the population that generated the sample. This really comes out when you ask people to generate a small set of random numbers. The numbers they come up with tend to have negative autocorrelation (a big number is followed by a small one), which means the series isn’t random. What this means is that a small number of narratives are often assumed to be representative of an entire population, particularly if those few narrative agree. This just isn’t the case.

Don’t get me wrong, I’m not saying there is no place for narrative in research or teaching, they’re a great place to start, but a horrible place to stop. If all we consider are narratives, however, we’re going to get it wrong.

Relative Poverty or Consumerism: Choose your evil.

I recently spent a day in a room with public school teachers, education experts, and humanities types. I was the only one there with any experience in empirical data or the kind of formal logic commonly used in empirical disciplines. My time with this group (I get to do it again for 2 days in May) will form the basis of a number of posts, but here’s the first.

One of the things that gets this group worked is consumerism (they often use the label capitalism but consumerism is more accurate). “Consumerism is the capitalist system trying to keep the worker down.” “Consumerism is destroying the planet.” “Consumerism is nothing but lies designed to keep us all unhappy.” If you’re reading this I’m sure you are familiar with this type of statement. I’m not going to discuss the veracity of these statements here (there is some truth here). I want to focus on a glaring hypocrisy.

Shortly after the outpourings affirmation of anti-consumerist ideology the discussion moved onto relative poverty, specifically decrying the unequal distribution of income for people identified as indigenous. (To be honest there was some actual discussion education related topics in between, but nobody want to hear about that).

I want to be clear – there are some people in this country living in deplorable conditions, many of them on reserves. In many cases, these living conditions count as absolute poverty and need to be addressed. Not tomorrow, but now! (Yes, I do have a suggestion, but it definitely isn’t politically correct and would likely piss off a number of people who were in that room to no end). Absolute poverty isn’t what they were talking about so I won’t either.

The concern was that some people are getting richer faster than others, as it always is with relative poverty. It isn’t about the fact that some people don’t have enough to meet a standard of living we would consider basic in this country (living high off the hog in most of the world).

So what does an increase in relative poverty without an increase in absolute poverty mean? It means that some are getting richer faster than others. So what does becoming richer really mean? It means you have more consumption opportunities than before. Consider your stereotypical working class joe. They are in no danger of starving to death, generally have a decent roof over their head, and can even afford some luxuries. So why would anyone be worried that other people are becoming relatively richer? The only possible reason is that consumption and *gasp* consumerism yields benefits. For the argument to make any sense it must be that the group getting richer is gaining happiness and those not getting richer are not. Remember that the only meaningful difference is consumption opportunities. If consumer is so “bad” we should be celebrating any reduction in consumption opportunities of any group. The worry about relative poverty is the worst form of keeping up with the Joneses.

So which is it, is consumerism bad or is relative poverty bad?

Happy Shiny People (for academics)

I recently visited a number of universities in the Maritimes. For those not in the know there are a lot of very small universities in the region. These universities tend to have small student bodies and a similarly small faculty compliment. In talking to these people something became very clear.

The happiest and most productive of departments I visited was at the smallest of the universities I visited. This of course got me thinking. What makes university faculty most likely to be productive? (BTW this is an issue I’m personally concerned about.)

The university in question has had a stable student population for decades (about between 2250 and 2500) and does have a fairly large endowment. On the down side it does have something of a history of labour unrest, with a potential for faculty strikes every few years.

What has always amazed me about this group is how much pleasure they take from their work and how much research they actually get done despite an onerous teaching load. Thinking about it for the last couple of weeks, I’ve spotted a few things to consider.

1) Few layers of administration. This is a small university with relatively few AVP’s DAVP’s, ADAVP’s, associate dean’s, coordinators, etc. This means there is a hope of influencing the outcome of administrative decisions. Despite this it is possible for a department head to devote comparatively little time to admin busy work. Unlike larger schools in which most faculty members don’t know who is making administrative decisions this week and don’t feel they have any meaningful say in the direction the university takes or have to spent countless hours in meetings that accomplish nothing.

2) The group legitimately respects each other and gets along. When hiring, attention was paid to how different people appeared to “fit”. In a small group this is exceptionally important. You need someone who is going to be of a complimentary temperament. Many academic units ignore this to their detriment. Ideally, you need someone who agrees with just enough not to make you insane. I’ve seen this group subject their own (and my work when I visit) to intense thoughtful scrutiny. It isn’t always the velvet glove sort either, but it is always done in a way that lets you know it’s about making it “right”.

3) Really bright, engaged, students. I’m not even talking about graduate students, though they offer fill this role. The students I have encountered there are genuinely engaged, willing to challenge, and capable of putting up a really good intellectual fight. There is accordingly a great atmosphere of academic debate and thought.

Considering all these factors, it really makes me wonder if Universities in Western Canada have taken a wrong turn in pursuing size. Would a larger number of smaller universities better achieve the stated objectives?

Paying for "IT"

There is an ongoing debate about prostitution in many countries around the world. The question is whether or not it should be legal. An interesting quirk of Canadian law is that prostitution isn’t illegal but solicitation is. You can pay for sex, but cannot talk about paying for sex and mean it.

On the legalization side there are a lot of positive arguments. Places from Amsterdam to New Zealand have legalized prostitution. There hasn’t been an explosion of drugs, violence, family break up, or any of the expected maladies that you might think would go along with legalization.

On the plus side, many places with legal regulated prostitution have less trouble with violence toward sex workers (police are now actually called), fewer sex workers addicted to drugs, and a better chance of controlling STD’s through regular health checks.

So why not just accept it legalize the open and honest exchange of sex for money? There are the usual moral objections and I can wrap my head around some of those.

But let’s put on our cynic hats for a moment. Let’s say we legalize prostitution. Who loses? In general it would mean a transfer of relationship power from people who withhold or limit sex. Think about this; you’re in a bar trying to woo someone and aren’t getting anywhere. If prostitutes are legal, safe, and not entirely shunned you aren’t going to put that much effort in at the bar. You likely won’t be buying drinks for somebody else all night, you’ll give up and go for the open exchange.

You likely won’t put up with a partner withholding sex to get what they want either – again you’ll just opt out. This means a significant reduction in power for anybody who holds out the possibility of sex as leverage. Makes you wonder about the true motives of some who object to legalization.

The unfairness of fair trade

I’m intrigued by the idea of so called fair trade as a development mechanism. Two of the most developed countries in the world (Canada and the U.S.) were initially heavily exploited and saddled with “unfair” terms of trade and yet here we are, near the top of the list in term of standard of living. Thus it can’t be a simple fact that unfair trade prevents development.

Let’s take a closer look at “fair” trade. In many cases fair trade involves the purchase of a product at a premium, if there were no premium it wouldn’t have to be marketed differently from plain old trade (I’m always amused when people tell me having to pay more is a good thing). The basis for the premium is that the trade is fair and the consumer gets to feel good about giving extra money to someone deserving (read less well off than they are themselves). So you’re really buying two goods, the coffee, knick knack, or what have you, and the belief you’re a good person. A large part of what you’re purchasing when you buy fair trade coffee is the warm feeling of doing good while getting your daily caffeination. So far no harm, no foul.

Here’s the catch, you only get the good feeling of helping someone who’s worse off. This means you’ll only be willing to pay the premium so long as the people on the other side of the exchange are poorer than you are. Think about it, have you ever seen anything promoting “fair trade” with the U.S. or France?

What’s the result? The people producing the good generally make just enough to keep them producing but not much more. With coffee you keep people working small plots using expensive (inefficient) techniques with little or no hope of improving their lot in life beyond what it is now.

Lots of people who promote fair trade argue that it improves the lives of the people actually producing the good compared to the opportunities offered by the heartless multinational corporations. And in general they’re right, in the short run. In the long run the people producing the fair trade good will remain stuck at a low level of absolute and relative income – they can’t change their techniques or increase the size of their operation to capture more of the value of their good – they won’t qualify for fair trade any more. Further they will always be dependent on the good will of those of us in the rich world. So keep buying your “fair” trade goods if you like the idea of making sure there’s somebody in the world less well off in the long run than you are.

But hey, in the long run we’re all dead anyways, right?

The Hurtful Helicopter

I’ve been doing a lot of reading about prospect theory lately. This theory is likely become taught in most microeconomics courses over the next 10 to 20 years (things move slowly in the academy). There are a lot of important details in the theory, but one that sticks out in my mind is the idea of reference points.

The idea is that when considering options (prospects) people compare the possibilities to what they have now. What you have now is a reference point and what you might get is a prospect. It doesn’t take much of a stretch to see that what you expect about something or someone can be a reference point. This is one of the reasons why expectations are so important.

Having established a reference point, the next interesting piece of the theory is that gains are treated very differently from losses. While gains improve your happiness, the effect is moderate. Losses, on the other hand, cause dramatic reductions in happiness. Estimates show a loss as having almost twice the impact of a gain. So gaining $5 bucks, keeping it for a while, and then losing it is worse than never having it at all.

What does this have to do with helicopter parents and happiness? Think about what your average overbearing parent does to a child’s expectations in life. The child has never experienced failure, has been told they are super, special, and just the bestest at everything. These expectations are going to be impossible to meet once you grow up and get out into the world. This means that something that would be a forgone gain (a minor discomfort) for most of us, becomes a crushing loss for the pampered kid. The impact on the happiness of the child will be dramatic. I haven't met a sheltered kid that seemed happy to me, and this might be part of the explanation.

Trying to make your child happy all the time, might just be making them unhappy in the long run.

You Can't Say That

I wonder if anybody else is getting tired of censorship. We’ve just seen two major incidences of censorship in the name of correct thinking; the release of Mark Twain’s Huck Finn and the banning from Canadian air waves of Dire Straits’ Money for Nothing.

The edited release of Huck Finn, is being led by an “academic” in Alabama. Twain’s use of the word “nigger” is to be replaced with the word “slave”, the term injun is also to be removed. The thinking is that schools are more likely to use the book if they can avoid the discomfort of loaded words. Never mind that a discussion of the place of offensive language would benefit all students, we wouldn’t anyone to have to deal with something they found unpleasant.

In a related story, the Canadian Broadcast Standards Council has shown it’s willingness to kowtow to people demanding censorship. After an individual in Newfoundland complained, a Dire Straits song, Money For Nothing, has been pulled from Canadian airwaves; for an ironic use of the word “faggot”.

Have we all gotten so weak that we can’t even tolerate words written years or centuries ago from people we’ve never met and never will meet? Have all the years of self-esteem building failed? Has all the affirmative action been in vain? Are we allowing the frailty of a few to govern what is available to all?

From where I sit our society has not progressed, it has actually reverted into something less robust, weaker, and less healthy. If can’t stand the occasional use of unpleasant words, how are we going to cope with the real challenges of the 21st century?

Monetary Cure?

This comes out of a question I asked when the Parliamentary Budget Office was giving a seminar here. In one set of forecasts, the PBO is projecting that interest rates will remain low for the next several years. Given the lack of inflationary pressures we’re seeing and speed of the recovery south of the border, this makes a lot of sense to me. In a different forecast, they were predicting that Canadian labour productivity wouldn’t be rising very quickly in the foreseeable future. Again, I can believe this.

The problem arises when you put the two together and this was basically the question I asked. What I was initially intrigued by was the apparent contradictory nature of these two predictions. Of course it was the last question and I didn’t get to ask a follow up, so you get to suffer.

Start with the idea behind a monetary stimulus. The whole point of reducing interest rates is to encourage consumers to buy (on finance) durables and firms to engage in more investment spending. This is a pretty textbook story so far. Reduce interest rates, increase consumption and investment, and presto the economy recovers.

Investment in economics isn’t quite the same as what most people think of as investment. When we talk about investment, we’re talking about the purchase of new physical capital not financial capital. We’re talking about the stuff that tends to make people more productive like machinery, computers, and so on. So a monetary stimulus should be followed by a period of increased productivity as new capital comes “online” and increases labour productivity.

The problem with the story so far is that it ignores the excess capacity many measures show in the Canadian economy. If there is a lot of excess capacity in the economy, we aren’t likely to see a lot of investment in new capital. Why buy more capital when you aren’t using what you’ve already got? So, for the monetary stimulus to have any impact on the Canadian economy, all the heavy lifting has to be done by consumers. This is actually what’s happening. Consumer debt is on the rise in Canada and is now reported to be higher than (relative to income)in the U.S. It is possible we’re setting ourselves up for a debt driven bubble in consumer spending.

There’s another catch. Consumer spending generally doesn’t go to stuff made in Canada. Look at almost all your consumer goods, electronics, appliances, etc. Not very much of it is made in Canada. A lot of it is made in places like China or Korea. So a spike in consumer spending doesn’t do a whole lot for the Canadian economy.

So the follow up question remains. Is the monetary stimulus of low interest rates likely to do us any good or is the cure likely to be worse than the disease?

The Deadweight Loss of Christmas

There’s been a lot done about the deadweight loss of Christmas over the years (It really starts with Waldfogel in the 1993). We’ve all received those gives that, well, suck. You know what I’m talking about; the dancing/singing gorilla, the hideous sweater, any “executive” gift, etc. The economic argument is really simple, people would get more utility (happiness) out of the whole exercise if we gave cash and let them pick what they wanted for themselves. We could even go one step further and just do net transfers and save ourselves a lot of hassle.

Well, I got a phone call from somebody this year very apologetically saying they were sending a cheque for Christmas. This suited me just fine. I can buy whatever I want, and assuming I know myself better than they do, I can come closer to maximizing my utility. Combine this with the fact that they avoid the insanity of shopping at Christmas, and wins all around right?

If it is wins all round, and this person knows I’m a weird breed (an economist) why apologize? Why should we be embarrassed to send money as a gift? Might there be something important going on?

A gift is often an expression of how you feel about them and how well you know them. This works for somebody you know really well, but not for people you don’t know that well. This is also high risk. If you get it wrong, you reveal you don’t really know them that well. Not exactly the message you want to send.

Once upon a time, if you lived in a different city or had more free time than somebody else, gift giving would have made sense. You’d have access to different goods at different prices. Or you would have been able to devote more time to shopping than the person on the other end of the exchange. With internet shopping and research, this doesn’t hold up any more.

One of the things I’ve heard people saying about shopping for somebody (and I’ve done it myself) is you want to buy them something they wouldn’t normally get for themselves. There are two ways to interpret this. One, you’re asserting the person you’re buying for is a moron and you know better than they do what will make them happy. While this is certainly a possibility, the sentiment isn’t really a match for that ol’ Christmas spirit. While I generally think that humans aren’t the best at knowing what will lead to happiness, I’d at least like to think I have a better idea of what will make me happy than you do.

The other side of buying something for someone they wouldn’t normally get for themselves is one aspect of gift giving that does make a lot of sense, particularly for those with children or other responsibilities. Money given as a gift often (in my experience) gets spent on something boring and practical, paying down the mortgage, fixing the car, toilet paper, etc. By giving someone a gift that is purely about their own enjoyment (a day at the spa for example) is actually giving them permission to enjoy a pure luxury or to be a little bit selfish and not feel guilty about it. This can have value above and beyond the purchase price.

So instead of us exchanging gifts this next year, maybe we should just give each other permission to be selfish for a day without guilt. Just don’t ask me to wrap it.

The Fight Over Happiness

There’s some interesting debate concerning happiness going on out there. There have been a number of studies that show self-reported happiness hasn’t increased much when a country’s GDP grows (Easterlin’s work is key in this regard). Then we look at the chart above (reproduced from the Economist’s magazine’s daily charts and at Justin Wolfers’ work) we see a pretty clear relationship between GDP per capita and happiness. So what’s going on here? Why such conflicting results?


There are, of course, the usual arguments about econometric technique and data sources and the like. This, unfortunately, is standard with results that run counter to somebody’s religiously held opinion. But let's be a little less cynical.

There could be a prospect theory style reference point problem with the time series work. People continually reset their happiness based on the income or lifestyle they are used to. While gains are adjusted to very quickly, losses may have a much greater impact on reported happiness. Having running hot water once a week would have made somebody deliriously happy 100 years ago, but now we get grumpy if we have to cut our 20 minute soak under the shower head short. I’d like to see some of these happiness studies done right about now or a year ago in the US. I’m guessing you’ll see a fall in happiness compared to when things were going great. Having the benefits of economic growth may not make us report greater happiness over time, but not having them definitely makes us unhappy.

But there’s another possible problem with both approaches. It could be that most of the people talking about this issue have got the supposed causation backward. The hypothesis being tested is that more income (GDP per capita) makes people happier. If the causation runs this way we would expect an increase in income to increase happiness within a country over time and countries with higher incomes to have higher levels of happiness, hence no conflict about what the data is saying. But what if the causation actually runs the other way?

What if what we’re actually seeing in this data is the idea that people who are happier are more productive and can generate greater levels of output, all else being equal? This would explain why we see a relationship between levels of happiness and a relationship between growth and happiness over time without showing increased levels of happiness when an economy grows.

This is a definite possibility, but I still think economic opportunity (money) is central to happiness. If you disagree, I’d be happy to accept your money. It would make me happy just to help you out.

The Up Side of Food Prices

Taken from the Economist’s Daily Charts

Paying more for food might be good for Saskatchewan and Canada as a whole. The price of food is on the rise again. The obvious reason why this is likely to be good for the “great flatness” is a lot of wheat and other food crops are grown here. The higher the price of agricultural output, the better the Saskatchewan economy tends to do. It also helps the price of potash (a key input into many fertilizers), again the higher the price of potash the better things tend to go for the province. The price of potash also has a major impact on the health of the government finances as potash royalties make up a huge portion of government revenue.

While both these things clearly suggest that higher food prices are good for the GDP of Saskatchewan I’m thinking about something a little less obvious. More than 1 in 5 adults in Saskatchewan rate as obese on the BMI, and more than half of Canadians are overweight, with almost 1 in 4 self-reporting obese. (And this is self-reported!). Generally, speaking an increase in the price of something reduces the amount people buy.

Now before we get too excited, the demand price elasticity of food (the sensitivity of how much people buy to the changes in the price) is fairly small. For example the Agriculture and Agri-food Canada estimate of the price elasticity of eggs is -0.35, meaning a 1% increase in price decreases the amount people purchase by 0.35%. On the plus side there is an effect. Increases in the price of food reduce consumption. An increase in the price of food generally has the potential to reduce our consumption. Remember we aren’t talking about a developing country in which people are in danger of starving to death if they eat less. A reduction in calories in developed countries like Canada is likely to improve health.

A downside might be people making a quantity for quality trade off. If this happens we might actually see an increase in obesity in response to an increase in the price of food. I don’t think this is too likely to happen for most Canadians, as other forms of entertainment will likely be substituted. Also countries with exceptionally high food prices (Japan and France for example) have relatively low rates of obesity.

Rising food prices. That’s a good thing?

I May Need To Change My Mind

I went to a presentation by the Office of the Parliamentary Budget Officer (PBO) yesterday. (The name needs a little work, but it was likely named by committee.) I went expecting to leave annoyed by their incompetence and political hackishness, but left pleasantly surprised. This subgroup of the PBO seems to know what they’re doing.

For those not subjected to this level of minutia, the PBO was started an attempt to create a non-partisan organization to generate predictions about the Canadian economy, the federal budget, and the likely cost of government programs. It was created by the current Tory government under Steven Harper, with the stated goal of improving the transparency.

Something really interesting came up during the discussion, that didn’t really have a lot to do with their main forecasting duties. Someone, probably looking to stir things up a bit, asked how they were being treated by Finance Canada. The short answer – they weren’t getting much help from that direction. The assumption on the part of most of the audience is that this lack of help was a result of a lack of enthusiasm on the part of the Harper government. This may or not be the case, but for now let’s assume it is and try and figure out why you’d create something like the PBO and then not help it achieve its stated goal.

A former student of mine is heavily involved with the NDP in the Maritimes. When they won the Nova Scotia election he was super excited and emailed me with his good news. I congratulated him, but also warned the governing is a lot harder than winning an election. He told me a while ago that, damn it, I was right. The point is new governments don’t really know what’s involved in governing and can’t until they’re in power. The PBO was formed early in the Conservative mandate, likely when the party leadership still believed in things. The subsequent lack of cooperation maybe part of the realization that some of the things they initially believed in may be incompatible with actually running the government.

The nature of the government in its current form can make governing even more of a challenge. Minority government often means resorting to a number of tricks and stunts that would otherwise be avoided. This is done by virtually every party around the world when they are in a minority government situation. Not having the parliamentary strength to over ride objections makes you less likely to support something that can create objections.

A third possibility is that there is a severe personality conflict between the budget officer and a politician and/or high ranking civil servant. Having met the current budget officer and watched how he engages with the media, I can definitely see this happening. The PBO has no place making policy recommendations, but should be providing analysis of recommendations being generated else where.

A cynical possibility is that the current government is just giving lip service to the idea. In this case they want to do as little as possible while being able to claim to improve transparency.

Of course the assumption that the lack of cooperation is coming from the sitting government ignores another possibility. Those who’ve tried to work with the civil service will likely have identified another possible origin of resistance. The civil servants in Finance may resist working with the PBO if they believe they are going to be subjected to extra PUBLIC scrutiny or suffer a loss of authority/power. This would be particularly true if those in Finance had nothing to gain by cooperating. A quick thought about the incentives of the situation make it pretty clear that full cooperation was unlikely.

Whatever the source of the lack of cooperation, the PBO is a good idea. I fan, but I’m starting to think there’s hope for this incarnation of it.

The Dubious Morality of Crown Corporations

I’ve always been concerned by arguments for doing something that involve morality. The argument if often made that if profits were going to be made by providing something, it is only moral that government should capture those profits. This of course got me thinking about the moral issues associated with crown corporations. There are at least a couple of big holes in using morality as an argument in support of crown corporations.

One of the key public goods that governments provide is a common set of rules and their enforcement. This includes the rules that govern how businesses operate. An unbiased set of rules and equitable enforcement are a central part of what makes effective states like Canada so wealthy. Thus it isn’t entirely unreasonable to think of government as a referee in sports. The system only works when we can trust the ref to be impartial.

Crown corporations are like the referees deciding they wanted to play, not ref. Another way of thinking about it would be if you’ve been at a game in which the referees were closely related to one of the players. Sometimes it works out OK, but a lot of the time it doesn’t. If we can’t trust the referee to be impartial, the system starts to break down. Crown corporations may thus be more damaging to the entire system than most of us realize. Were all investors treated fairly when GM become an American “crown corp.”? Nope, some were more equal than others.

Another consideration is the nature of business itself. Most businesses don’t workout and close. Many crown corps don’t work so well either. The difference is often the scale of the failure and who loses. When we’re talking about scale, governments don’t tend to think small and have access to an incredible amount of start up capital. In case there are some that don’t recall a crown corporation of size failing I’ve got a few examples. Bricklin Motors in New Brunswick was one example, yep that’s the same guy who was responsible for North American introduction of the Yugo. Spudco in Saskatchewan (a place generally known for pretty good government) provides another example. Of course many people tend to forget that FANNIE MAE and FREDDIE MAC (a big part problem of the boom and subsequent collapse of the American housing market) were the American version of crown corps.

Private businesses fail and so do crown corps. What’s the big deal? The big deal is where the money comes from. Private firms collect money from investors voluntarily, government collect money from citizens involuntarily. Nobody (well, there are some odd folk out there) pays taxes because they want to. People pay taxes because if they don’t the government will take their stuff and possibly throw them in jail. When I think a private firm is going to do something dumb, I can choose not to invest, in many cases I can even bet against the success of the firm. If my government decides to do something dumb, as a tax payer I’m on the hook and there isn’t much I can do about it. If we were talking about public goods, I wouldn’t be as bothered by this, but we’re talking about the provision of private goods here, things like cars, potatoes, and such.

The final point I’ll make is that government activity does tend to reduce private sector activity. Crowding has a long history in economics. There are two recent papers that provide important empirical data on the topic (Furceri and Sousa 2010 www.eeg.umminho.pt/economica/nipe and Cohen, Coval, and Malloy 2010 http://ssrn.com/abstract=1426106 ). Given that government spending crowds out private sector activity we might want to think really carefully about launching more crown corporations.

There are at least 3 reasons why crown corporations aren’t necessarily moral. I’m not even talking about the effectiveness of crowns. I’m talking just about the moral implications. When governments launch crown corporations they become referees choosing to play the game they’re supposed to supervise using money collected involuntarily to supplant other economic activity. Sounds morally dubious to me.

Spectator Sports, Pornography, and Why Society Works

While watching football on the weekend (GO RIDERS!)I found myself getting pretty intense, even though I was watching the game by myself. I haven’t actually felt like that since I quit playing competitive sports. Why am I so worked up? What’s going on? I started trying to come up with other things which elicit a physical reaction even though you aren’t even remotely involved and are unlikely to be involved any time soon. After a little thought and a smart ass comment by a student I realized pornography works pretty much the same way.

What makes these two things so interesting? The fact that we get wrapped up in watching them as if we were actually doing it ourselves. Some would say that this indicates a great flaw in our current society. We’re constantly indulging base pleasures and not doing important things.

I’d argue the exact opposite. The fact that we have a physical response to something we see other people doing says something pretty amazing about human beings. It says we have the ability to project ourselves into different situations and feel what other people feel - in short it says we have empathy. Think about it. We choose to empathize with a sports team and feel some of the highs and lows of competition. We watch physical intimacy between other people and feel aroused ourselves.

Empathy is what makes society possible. The fact that we can feel what someone else feels serves as a check on our greed and selfishness. Without empathy, we’d have to work a lot harder to get people to pay attention to those among us who need help. We’d also have to spend a lot more time and energy on controlling people’s behaviour to limit the damage we could do to each other. In fact, without empathy it’s unlikely that we would have been able to achieve anything like the standard of living we have now. Without empathy life truly would be “nasty, brutish, and short”.

Spectator sports and pornography are not base, low brow, or pathetic. They are examples of empathy in action. They are realizations of exactly what it is that makes us truly human – the ability to feel what others feel. It isn’t a football stadium or an adult theater, it’s a shrine to empathy.

The Canadian Mint: Coining Extra Business

Recently the Canadian Mint has been producing what seems like an extraordinary number of “collectible” circulation coins. This summer it was the Saskatchewan Roughrider looney and more recently a Remembrance Day quarter and many, many others. It’s getting rarer and rarer to get a quarter with a caribou on it as change.

Of course this gets me thinking, why go through all the cost and effort of designing, producing, and advertising these coins? I suspect, but haven’t been able to track down, that the Mint is receiving money from Canadian Heritage or some other government department for such coins. But I think there might be something else a little more subtle going on here as well.

Let’s start by a little review of some basic monetary theory. The idea is the relationship between the monetary base and the money supply. According to basic theory the relationship is

Money Supply = ((1+Currency Drain)/(Reserve Ratio + Currency Drain)) times Money Base.

Currency drain is technically money that doesn’t get deposited in banks for whatever reason. For our purposes here, this means people are hanging on to it because it looks pretty. The reserve ratio is the ratio of deposits that commercial banks keep on hand in case you want to take some money out your account.

As people choose to hold onto more cash, the money supply shrinks. When the money supply shrinks, we tend to see really low inflation or even deflation. Given that the Bank of Canada has an inflation target of 2%. It has two ways to react to an increase in the amount of cash people want to hang on to. One way to respond is to reduce the overnight rate in an effort to get banks to reduce their reserve ratio. Another solution would be to increase the monetary base by printing or minting more money. Both of these will lead to an offsetting increase in money supply.

Let’s focus on the second option, as it actually relates to the Mint. By minting “collectible” coins, the Mint encourages (if not forces) the Bank of Canada to increase the monetary base. Of course when the monetary base is increased what is needed? More currency produced by the Mint. In short by producing successful “collectibles” the Mint creates more business for itself. Not a bad deal for them, eh?

Now give me back my lucky Riders looney.