Comment on Menzie Chinn's recent Econobrowser post

Menzie preset the LM/IS model for the banking sector under some asymmetric information shocks. I leave my comments here.

The post related to the general problem of restartig the baks to restart the economy. I will just give a quick analyisis using the natural yield curgve.

Investment houses need to operate at all the important term points in the natural yield curve, to minimize risk and volatility. When the consumer model unexpectedly changes, the new production model is not yet a complete market. Hence, the investors need to await stronger market signals. During this adjustment period volatility and risk are high because the lack of investment houses operating near the new production cannot smooth the risk function between short and long term investments. All economic sectors would respond the same to consumer equilibrium shifts.

In particular, a deflationary spiral occurs when the new consumption model is restricted by some government restrictions on a critical public good. This is the case in which underground economic production increases. The deflation continues and government revenue reduces until the resource restriction beomes obvious and government must general deregulate the resource.

Take a drive in a Robocar

Which was shown at the Consumer Electronics Show last year. Here is a video and article on the demo.

IS/LM curves, how confusing

I use the following simpler method:

When the real yield curve is smooth we are classical and moving smoothly about equilibrium.. When the yield curve has jaggedness then we have inventory shortages and gluts with opportunities for stimulus.

Closely aligned is the concept of minimum phase, where phase is the alignment between inventory supply flows and demand flows. Linear estimation theory tells us that we are not minimum phase if the yield curve is jagged. An inverted yield cure is one where inventory flows, in the aggregate, have negative feedback.

Linear estimation theory applies because economies are built on the expectation operator.

Caterpillar to sell robotrucks, next year

Caterpillar is not waiting for for the rest of us, mining is in need of Robotic trucks, and they will get them.
Nor is this vendor waiting for anything, they allow you to convert an existing car into a Robocar.

Even Lockheed-Martin can build one. And this European defense contractor. Iowa State not be be outdone, is buildig the driverless agricultural tractor.

Sentience software

New driving software can save up to 20% in mileage.

HT NextBigFuture

A GDP/Debt calculator from Political Calculation

This is a great tool from Political Calculations, a good as the Dynamic Yield Chart.

New Economic Research

Mark Thoma (Economists View)references this paper:

Well, Wow, what an astonishing paper! I read the whole thing, but will be reading this two or three more times.

What is the implication? If fiscal and monetary authorities misinterpret a structural change as animal spirits, then their efforts are likely to be counterproductive. Another implication is that households will willingly undergo a deflationary restructuring if their view of the future is a better equilibrium.

The consumer's model of production is more sophisticated than macroeconomists have assumed. The caveat if that there are more than one set of important consumer groups.

Bloggers doing their job

Great article on bloggers, worldwide, and their effect.

HT. Instapundit

Krugman's Fiscal Stimulus model

Paul had written a two factor model to explain fiscal stimulus in the face of a liquidity trap, and Robert Waldman suggested I go over this paper, which I do now.

Without damaging Paul's reputation too much, I will start with the summary of his paper. Paul is dealing with the situation in which consumer demand today suddenly drops from yesterday, and goods and services are mis-priced from what the producers expected. In this case, the equilibrium condition, ( using Paul's terms) when the utility of all goods and services match, will result in an economy smaller today than the economy yesterday. That is, equilibrium is forcing the economy to shrink with the interest rate being computed to a negative value.

If we ignored government, for the moment, then the natural policy for the monetary authority would be to remove money from the system thus removing the liquidity trap, and settling for the lower equilibrium output. If this were possible, then the IS/LM curves would shift to represent the lower equilibrium and we have the liquidationist approach.

If we will not or cannot move the economy to a lower equilibrium, then what would be a optimal fiscal response? Paul points to the reduced marginal cost of moving government projects forward in time, or possibly starting new government projects, with the expectation that government projects have lower marginal cost today than they would have tomorrow. The drop in consumer demand releases resources and lowers the cost of government projects.

Should the optimum fiscal policy bring us to a new and better equilibrium or smooth over the transition to a lower equilibrium or try to restore the prior, stable equilibrium? To smooth over an equilibrium change, either up or down, the government need simply write an insurance policy for the producers, call it the dis-equilibrium insurance policy, like unemployment insurance or Hank Paulson's large payments to banks. Hiring people in this case makes no sense if they are well covered by dis-equilibrium insurance.

Then there is the possibility that government has projects that increase the utility of public goods and restores equilibrium to a higher output level. If a constraint of some public good is well known, then we are not, by definition, in a liquidity trap, consumers and government economists would be jointly deploying the new public goods and interest rates would not indicate a contraction.

That leaves one possibility, government economists knows what the future equilibrium points are and the consumer does not. In this case, fiscal policy can be expansionary.

The sequence of events in this recession

In response to a number of blogs, such as Econobrowser and Gjerstad and Smith's outline, I give my view:


We were still buying oil like crazy when oil peaked in mid 2008 but Gjerstad and Smith have the banking index declining in mid 2007 and the DOW peaked at mid 2007. Jim Hamilton is good at dating recessions, and he has the GDP dropping in mid 2008, with the oil peak. Unemployment starts to rise in mid 2007 but is still at 5.5% in mid-2008.

The Fed was responding to the fall in house prices when it began lowering rates in late 2007 even as oil prices continued to rise. The dollar hit its low in early 2008. Then came the crash.

The Fed lowered rates in response to the bankers panic about defaults, but ignored the other shoe, rising oil imports and rising prices for oil. The rise in oil prices accelerated as interest rates lowered until the consumer panicked.

Let's put some numbers behind this.

USA oil consumption is about 20 million barrels/day. Gjerstad and Smith put the housing bubble loss at 3 trillion, amoritized out at 5% interest rate, this is 150 billion/year. The $60 drop in oil prices come to 60*20 million * 365 or $438 billion/year. The loss in transportation sales is about 5 million units * $30,000/unit or $150 billion/year.

It appears that the consumer sacrificed much more in transportatio than housing.