What are taxes for since law forbids printing of money? This question bothers me for a long time: why government keeps up with the taxes instead of with printing money? This would decrease its operating costs, simplify law and generally raise comfort of existence of all people. Why I don't hear nobody speaking about such idea?

"Why I don't hear nobody speaking about such idea?"

Because historical experience says it won't work.

By printing money instead of collecting taxes, what increases is the nominal disposable income. The "value of work" is certainly not increased. And the important question is, does this increased nominal income lead to higher consumption?

Consider a static society that produces food using labor $L_p$. This society wants also the government to offer some services, say law and order. So the government will also employ some of the available labor in the society, $L_g$ to offer these services. Now, policemen and judges must also eat to survive, so the food produced by the private sector must be enough also for them.

Say it is and part of it must be transferred to $L_g$ somehow. Initially, the government collects taxes for this purpose.
The private sector faces

$$P_c\cdot Q = P_c\cdot w_p\cdot L_p =P_c\cdot C_p + P_c\cdot T$$

where $P_c$ is the price level, $C_p$ is private-sector consumption in food units, $w_p$ is the wage per unit of labor in food units, and $T$ is taxes in food units The left-hand side is production the middle term is pre-tax nominal income of the private sector, the right-hand side is how this income is split between own consumption and taxes. The government looks at

$$P_c\cdot T=P_c\cdot w_g\cdot L_g $$

The government collects that tax, gives it to public servants as pay for their services and they in turn go to the private sector and purchase the food they need.

The economy uses money, and the current quantity of money printed is $M$, which is fully used to facilitate the transactions in a production-consumption cycle.

Then somebody comes up with the OP's idea: why collect taxes which nobody likes, and not print the money needed to pay the government employees?

So the government prints new money $M_n = P_c \cdot T$, stops collecting taxes and pays its employees with $M_n$.

Since taxes are not collected anymore, once production is finished and before consumption, the private sector has in its hands
a) Real quantity of food $C=C_p+T$
b) Money holdings $M = P_c \cdot C$

Government employees appear and show the new money quantity $M_n$ asking to buy the same quantity of food as before. The private sector complies. After the transaction, government employees have no money but they have food. On the other hand, the private sector has

a) Real food quantity $C - T=C_p$ as before
b) Increased money holdings equal to $M + M_n$

And the question is : how does the private sector experience its new situation? What does it mean for the private sector to have more money holdings than before? Well, the private sector accepted the new money brought by the government employees, so it must be the case that this new money is considered to bear the same value, the same credibility as the pre-existing money. This in turn means that all money bills are thought to have purchasing power. It follows that the private sector has in its hands more purchasing power than previously, $M+M_n$, but the same amount of output, $C - T$.

From here on, the standard story is that people will try to use $M+M_n$ to buy more food and consume more, but since available output is the same, $C-T$, this will increase prices (imagining a "bid war" to buy the output). This story is "standard", because it has been observed too many times around the world. Although governments have not eliminated taxes, they have on occasion printed additional money in an attempt to reduce the tax burden or increase government expenses without increasing taxes.

I will describe now two conceivable scenarios (alternatives or in sequel) that do not lead to increased prices:

Α) People do not attempt to increase their consumption with their newly increased purchasing power. They just stash away $M_n$.
Next year, the same cycle happens, the government prints an additional $M_n$ quantity of money to pay its employees, the private sector save this new money on top of its previous savings etc,: the price level stays the same, while the private sector has stashed $2M_n$ away. After $k$ years, the private sector will have saved $k\cdot M_n$ in paper money... To do what with it? Look at it and "feel rich" but never actually use it?

Well, historical experience tells us that people will tend to use this additional money, exactly because they accept that it carries purchasing power. It appears that people are not content to just look at stacks of money bills and rejoice. I mean, initially they do, but then they want to go out there and translate these stacks of money bills into increased consumption (the Scrooge McDuck type of person is, alas, a negligible minority).

B) People are not Scrooge McDucks and try to buy more than before with their increased money holdings. But sellers do not increase their prices, they even resist any attempts by the buyers to offer a higher amount of money,  and sell at the old prices until they run out of stock. Result: at the end of the day, people realize that their increased money holdings were not good enough to bring them higher consumption. But this will make them question and re-assess how valuable, after all, is this money. Which leads us to the exact same consequences with a price increase: all money will lose part of its carrying value in both cases.

People will enjoy the same consumption level as before, but they will feel happier now that they don't pay taxes. But since the government keeps printing new money year after year, prices will go to heaven. Again, historical experience says that people appear to dislike high inflation, probably because in the real world with millions of products the price system plays an important signalling role, which appears to be understood and be valued by the people. High inflation impairs this function, increasing the transactional costs of the people. So one should offset the gain in happiness from the feeling of not paying taxes, to the problems that will be created by high inflation... since recorded episodes of hyperinflation as well as high inflation were time and again ended by government action, it seems that people support such measures, which implies that even though they don't like paying taxes, they dislike more living in high inflation.

ADDENDUM
The OP seems particularly concerned about the tax collection costs, as he indicated in a comment to this answer, putting the matter "at the core" of its question. Here are estimates of the tax collection costs for many countries for three recent years, from OECD. OECD-30 mean value is at $1\%$ of revenue collected.

An excel file with the data series and the diagram can be downloaded here.

More info from OECD on the matter of tax collection efficiency, here.

Printing new money instead of collecting taxes means everyone will be effectively giving away the same amount of their savings every year, which is equal to the inflation rate. This will be bad for two reasons:

it will be impossible to tax people progressively, depending on their income. Instead of lowering taxes for poorer people you'll have to support them by giving some of that printed money back. This will result in the same administrative burden you wanted to avoid in the first place.
you will be taxing money rather than income. This will discourage behaviors that the government typically wants to encourage, like saving money for your own house or filling up a retirement account.


Does migration exacerbate (albeit delay) the problem of aging, economically-inactive populations in Western societies? As a layman, I've always understood that there is a general consensus amongst economists that "immigration is economically beneficial" to rich Western countries (like Britain) who have aging populations because the influx of young economically active workers contributes to the economy (and tax coffers) and thereby supports the old economically inactive population.

But this seems quite obviously short-sighted.  Those immigrants will themselves grow old—and assuming that they remain in their new host countries, they will add to the economic burden of the elderly populations for future generations.

Is such immigration therefore not just kicking today's problems into the future, where it will have compounded and be exponentially worse?

I don’t really see the connection you are drawing. As @Fizz has pointed out, immigration usually happens over time and maybe when immigrants grow old there will be more immigrants to support all of the new old. Likewise, in many countries immigrants tend to have more children than non-immigrants, so that will attenuate the aging problem.

If anything it should be something to check case-by-case, but I don’t see any causal relationship between immigration and the “aging problem”. I see how just mechanically these two are related, but I don’t expect the relationship to have any particular systematic pattern.

It feels to me like you are saying that taking more exams is bound to lower your average grade. Of course more exams will impact your average grade, but it really can go up or down depending on many other factors.

Immigration in this context is best seen as the outsourcing of reproduction to the underdeveloped world. This is often a form of free riding on the investments that other societies make in rearing and the conveyance of skills.

It also allows the ruling class to select the best fruits, and typically to deny them any political power, whereas with native reproduction they must deal with all fruits of whatever character and quality. And it acts as a dose of discipline upon the settled working class too, denying them political power.

I can't see that immigrants tend to exacerbate the problem of an ageing population. In fact, they are often amongst the most fecund groups in their first generation, as they import cultures which value and support reproduction more highly and which have not yet internalised the difficulties their children will face in Western societies.

Arguably, their presence does assault reproductive forces amongst the settled population (including amongst the descendants of the same immigrants), but provided this continues to be compensated for by outsourcing reproduction, then there is no skew towards the elderly (although there is a skew away from young children). It does effectively make Western society parasitic rather than reproductive.


Is "$f(k,l)$ is decreasing return to scale $\Leftrightarrow f_{ll}f_{kk}-f_{kl}^2>0$" always true? For the productions $f(k,l) $ that are continuously differentiable, is the proposition  that

"$f(k,l)$ is decreasing return to scale $\Leftrightarrow f_{ll}f_{kk}-f_{kl}^2>0$"

always true, I have checked for Cobb-Douglas functions and believe it will also hold for all Constant-Elasticity fuction, can someone give me some hints or show some counter-examples?

Here we define $f(k,l)$ to be decreasing return to scale if $ f(tk,tl)<tf(k,l)$ for $t>1$ for all $(k,l)$ in the domain.

In general the statement is wrong. Here is a counterexample:

Suppose you have $f(k,l) = -k l^\beta$ with $\beta >0$ and $(k,l)\in\mathbb{R}^2_{++}$ (you can interpret $f$ as a production function for a "bad" commodity). Then you have:
$$f(tk,tl) = - t^{1+\beta} k l^\beta = t^{1+\beta} f(k,l) < t f(k,l)$$
so that $f(k,l)$ is decreasing returns to scale.

Now let's evaluate $ f_{ll}f_{kk} - f^2_{kl} $. Since $f$ is linear in $k$ we have that $f_{kk}$ is zero, so it is $ f_{ll}f_{kk}$.  On the other hand, we have $f_{kl} = -\beta l^{\beta-1}$ so that overall we have:
\begin{equation}
f_{ll}f_{kk} - f^2_{kl} = 0 - \left[ -\beta l^{\beta-1} \right]^2 = - \beta^2 l^{2(\beta -1)} <0
\end{equation}

So then, where is the trick?

The fact is that $ f_{ll}f_{kk} - f^2_{kl} > 0$ is not a sufficient condition to conclude that the hessian of $f(k,l)$ is negative semi-definite and so $f$ is concave because you also have to impose restrictions on the sign of the principal minor of order 1 of the hessian matrix.

However, provided the hessian matrix is indeed negative semi-defintie than you conclude $f$ is concave and decreasing returns to scale will follow, the statement then holds.

For a single output production function, decreasing returns to scale does imply concavity of $f$. I believe you can find this result in Ch5 of MWG, either as a proposition or an exercise. The condition you have comes from considering the Hessian of $f$, and showing that the determinant is positive. For more on the Hessian Conditions, this is a handy reference: https://mjo.osborne.economics.utoronto.ca/index.php/tutorial/index/1/cvn/t


Neoclassical economic profit and growth theory versus marxian Marxists have a very specific "profit" and "economic growth" theory. According to marxists, profit doesn't come from technology, whose cost will be reflected in the price of whatever commodity the technology owning businessman is selling. Instead, the businessman profits by paying workers low enough for their labor so that they can squeeze a profit (e.g. profit comes from living labor not dead labor (technology)). Some of this profit will in turn be used to invest in more technology which will cause capital growth (capital valorization in marxist speak).

What's the neoclassical parallel to this? It seems in neoclassical models, the market is in equilibrium so the prices reflect marginal costs and there's no "economic profit". What seems to happen is that technological advancement "happens" and this in turn creates economic growth and a new steady state/equilibrium. However, is technological innovation here merely an accident, or does it have a logic in the same way marxian "growth" has (e.g. capitalists accrue profit through living labor and then invest it in technology)?

If there is perfect competition, then yes, you will get zero economic profit, but even then, technology does no poof out of nowhere. Otherwise, you might find very different results.

Let's think of the nature of competition through product differentiation. (We'll get into technology later.) Imagine two firms making their own widgets in Cournot competition, but instead of the normal price function $P = X - q_1 - q_2$, we have

$$P = X - q_i - d\cdot q_{-i}$$ where $-i$ denotes the other firm that is not firm $i$, and $d \in (0,1)$, $1$ being no product differentiation, and $0$ being completely different products sold by the two companies.

If $d = 0$, then the firms aren't really competing since their products are completely different and are acting as monopolists, making economic profit. If $d = 1$, then the firms are competing through regular Cournot and still making profit (probably).

In Bertrand, we can consider product differentiation as part of determining how much of the market you will steal away by undercutting price. The way a normal Bertrand model works is that you set price and then produce (as opposed to Cournot, where you set production, which affects the price). If you have a lower price, and there is no product differentiation, you steal away the whole market, so each firm will push price down to the price under perfect competition, where both firms split the market.

With product differentiation though, you don't lose the whole market when you are undercut, since your product is still a bit different. With full differentiation $(d=0)$ then you get the same result where each firm act as monopolists.

Under each of these models, technology doesn't "just happen", but is reflected through lowering the marginal costs of the firm, which is essential for the firm to be competitive against its rivals. The less technologically advanced the firm is, the more of the market they will lose out on. Economic profit here can be used to invest into research and development or just straight up "technology" to reduce the cost of capital usage over time or other such things like that.

Even in perfect competition with no economic profit, the reason there is no economic profit will partly be because firms have to constantly update their technology to remain competitive, regardless of how differentiated the products are (as long as $d > 0$).

This is an interesting question that I believe involves, of all things, the second law of thermodynamics.

Both marxist and neoliberal perspectives would accept that the so-called "capitalist" must innovate and adopt new technology due to the anarchic force of competition in a market system. The machine enables the firm to reduce labor costs relative to its competitors.

For marxists this is simply a temporary, relative advantage that allows a "window of opportunity." The innovating firm can for a time underprice and capture a higher market share. Of course, competitors can adopt the same machines, no matter how long they are delayed by patents and other defensive tactics. So the unending adoption of new technology is a Sisyphean task or zero sum game, from the standpoint of any set of competitors. Though, of course, many competitors cannot keep up and must "fold their hand" as the investment stakes get higher.

The point of the marxist model is that machines in themselves do not produce value. They only shift the flow of labor so as to produce temporary advantage. Obviously, labor somewhere must make the "machines" and feed, educate, etc., those who make the machines. So in terms of profit the "machine" is only a way of displacing labor to other markets, where the relative costs of producing labor are lower. The idea that "new technology produces value" is not entirely wrong, but simplified and inaccurate.

The reason I bring the second law of thermodynamics into it is this. Marxism retained certain essentialist-materialist values from the 19th century, but these do in fact reflect some more basic laws of physics. Machines are subject to the laws of entropy. They cannot interact, maintain, and reproduce themselves. There are no "perpetual motion" machines. All machines go dead within hours if all humans die. Life is the only "perpetual motion" machine. So what appears to be "value" produced by machines is actually a deferral, displacement, and mediation of hidden labor, living humans.

Thus, for marxism, the simple-minded replacement of workers by machines is necessary under market competition. But is a kind of a "death wish" in which life is channeling itself into dumb matter.The neoliberal perspective has answers to this in the calculus, but simply does not involve itself in such "meta-macroeconomic" concerns. In keeping with the empiricist tradition, it distrusts such metaphysical or speculative analyses.


Has income inequality ever been solved in societies in the past in terms of what people make to cost of living? One thing I've seen many on here whether life style is increasing or poor's wealth is, income inequality in terms of things like food, water, healthcare keep going up, but wages aren't keeping up.  This includes education sadly since if someone can't afford schooling, they can't escape poverty likely?

Have countries in the past ever faced these issues and solved them?  Is it possible for places like America these days?

America has faced staggering income inequality during the Great Depression.

http://thinkprogress.org/economy/2014/03/31/3420998/wealth-inequality/

In 1933 unemployment was 25%. President FDR's "New Deal" policies of fiscal stimulus, massive government spending on infrastructure, increased financial regulation and the creation of a social safety net (welfare, unemployment, pension) helped millions of people out of poverty and minimized the wealth gap.

Whether such a "New Deal" is politically feasible in today's America is debatable. We have to wait until November 3 to see who wins the election.

Inequality is a vague and meaningless concept. Although it's possible to measure reported income and construct gini indices and so forth, these are mathematical abstractions orthogonal to reality.

Thus, it's impossible to answer your question. I'm sure that there have been times in the past were some measure of wages increased slower than inflation and this was resolved through various means. However, ultimately its impossible to say what constitutes inequality and good solutions to address it.

Edit: In case you're curious here is the top 1% income share in the great depression. As you can see income inequality went up after the new deal. It also began increasing after welfare in 1965.

https://www.minnpost.com/sites/default/files/asset/1/1005sk/1005sk.gif


What would happen if the US defaults on its debt? As has been widely discussed already, the situation in Greece is considered more serious than in the US, as they have dollar-denominated debt and can only print Greek currency. The US, has the benefit of World Reserve Currency status. All of that does make sense, but I'm thinking there might be more to the story. So I would like to invite speculation on the consequences if the US one day defaulted on its debt.

A country going bankrupt is hardly a novel event, but few countries of the wealth and influence of the US are can be found in historical precedent. One of the only examples that came to mind is when Russia defaulted in 1998. That had global repercussions to North and South America and beyond. Also it destroyed the business model of Long Term Capital Management, an investment fund headed by a team of nobel-prize winning economists and mathematicians.

World Reserve Currency aside, is the Russian default a fair comparison? What different things might we expect if it were the US to default in the coming years?

The Russian default was an extraordinarily insignificant event compared with a current-day US default on all treasury securities.  There are no remotely similar events to compare it to.  This makes it hard to make guesses about all the ramifications.  Still, speculating is fun.

My guesses, based on a complete default (no money recovered) on all treasury securities:

Massive failure of important financial institutions all across the world.  LTCM was a hedge fund: a type of institution the is specifically expected to have significant failure risk.  On the other hand, treasury securities are held by institutions that are not well-equipped to bear risk.  Pension funds, banks, central banks, possibly whole governments would immediately fail.  There would be ripple effects as other institutions linked to them (or who they owe money to) faced an uncertain future.
Total freezing of most important financial transactions and many markets.  Treasury securities are used as currency and margin in many large and important financial transactions.  We witnessed a great deal of hobbling of financial institutions and markets when a few CDS's and mortgage-backed securities failed.  The loss of confidence in financial institutions and markets would be incomparably greater.
Drastic increases in all interest rates and a sharp decline in all stock prices.  The Russian default had consequences because it caused investors to dump risky investments in favor of safe ones.  A failure of the safest investment (treasuries) would cause utter loss of confidence in all investments and investors wouldn't know where to put money.  Cash maybe?  They would pull money out of both safe and risky investments, driving down both stock and bond prices.
Widespread unemployment. Cash available for lending would dry up.  Firms would be unable to borrow and have to forgo projects and lay people off.  These people would reduce their spending and default on some loans, causing amplified effects on interest rates and economic activity.  I would not be surprised if starvation and loss of social order ensued.
Irreparable harm to confidence in the US government.  The government would never again be able to borrow at low rates, it may not be able to borrow to fund its usual deficit.  This would be problematic since the depression and economic turmoil would require expanding the deficit.  It would be my guess that the US government as we know it would not continue.

I know this sounds a little alarmist, but wholesale default on all US government debt is truly an end-of-the-world-as-we-know-it scale event.    The world truly would change dramatically. Probably future generations would read about the golden age of humanity that ended with the great default.

Realistically, the US is not going to completely default on its debt any time soon.  If there was even a bit of worry about it, people and institutions would stop using it as such a critical component of their transactions and saving.  This would also be a dramatic change, but it would happen over time and reduce the effects, should a default ever happen.  I'm not sure what people would use as a substitute.  It would be uncharted territory.

A more likely, but still apocalyptic, scenario would be some partial default or sustained high inflation.  See the above consequences, but scaled down and including loss of confidence in the dollar.

I would put it that the US have already defaulted on their debt. They just keep kicking the stone down the road just like PIIGS did in the last decade before the "crisis".

The deficits have not gone down which is indicative that there is no real will to adjust the deficit spending. It is therefore easier to treat them as de facto defaulted instead of default in theory. Once you have jumped over that cliff, you can start adjusting positions accordingly instead of diving in illusions.

The dollar is no longer a reserve currency, it is a reserve currency among others. All the large central banks are in the same predicament issuing new debt and money. The business and speculative banks keeps lending irresponsibly and the central banks keeps bailing them out.

Look at how the central banks balance sheets have expanded in the last decade. Amazing.

ECB balance sheet

FED balance sheet

You asked: What would be the consequences? Look at how Argentina was handled. Part of the debt was written down, while a vulture fund wanted to be paid in full with the support of a US court. So a US court would also have to apply that common law practice on the US government and request it to pay in full. As the US government could not pay in full (otherwise it would have done it in the first place) it would have to ask the Federal Reserve to print even more money (just like they have been doing in the last decade).

Therefore I conclude they have already defaulted, they are just pretending they have not.

Put it in other words. I work today on the promise you will work tomorrow to balance things out. I build your house, you say you will mow my lawn.
But instead you print money and watch videos of cats instead. I have to mow my own lawn and work in a coffee shop while you print money. You say there is not enough money to go around, but speculate on the Housing Futures market in Las Vegas, Chicago and London. The moral dilemma game can only be played until those who are being fooled gets wiser.


Limits to Growth: Is environmental collapse by 2030 a likely scenerio? According to a simulation from 1972, the results of which were published in 'The Limits to Growth' environmental collapse is due mid 21st century. The Guardian reports that Dr. Graham Turner reran the simulations using recent data and the collapse is actually due sooner. Here is the referred paper by Dr. Graham Turner:
Quoting from his profile by the Guardian:

Dr. Graham Turner is principal research fellow at the University of Melbourne's Melbourne Sustainable Society Institute. He has a background in applied physics and his current work involves whole-of-system analysis on the long-term physical sustainability of the environment and economy.

As economists do you think Dr. Turner is right?

We know one core element of the Guardian article is nonsense - the discussion of Peak Oil.

The Peak Oil lament, fashionable a decade ago, was that we didn't have enough oil, and that was going to become a major problem very soon.

However, we know from climate science that the reverse is true - we have far too much fossil fuel reserves (disclosure - that's a paper by my colleagues). Our challenge isn't that we won't extract enough to continue economic growth - it's that we'll extract too much and cause a major environmental collapse. Turner's report makes a significant show about the age of cheap and easy oil being over (pp 11,12) - and that's a prediction that was made to look very silly, quickly, as the report's publication in August 2014 happened just as the 18-month oil-price crash caused by huge global over-supply was beginning.

Is environmental collapse possible? Yes.

Are we causing huge ongoing damage to the environment? Yes.

Were all of the significant predictions of the Club of Rome correct? No. Not only has geometric population growth stopped, but even arithmetic growth is in decline - and the growth wasn't capped by disaster, but by better healthcare, better access to contraception, and more education and emancipation of women. Food production per capita has way exceeded predictions. And the renewable alternatives to fossil-fuel energy are already economic and scalable for static applications, and becoming so for transport too.

Are we still on a trajectory of yesterday's brown economy, that will require a trajectory change if we are to avoid environmental collapse?
Yes.
Do we have enough evidence to say that the date for that collapse is 2030?
No.
Do we have the technical means to transition to a modern, clean economy and avoid that collapse?
Yes.

I just want to add one important but neglected fact about the compound growth and doubling time.  The frightening fact is that it will take a very short period of time to consume an enormous amount of resource in the later years of compound growth.  The doubling time is 72 divided by the growth rate.

For example, if we assume 3% annual growth in resource consumption (thus 24 years is the doubling time), it will take only the next 48 years (two doubling times) to consume the remaining 64% of the total resource.  At year 120, 64% of resources are available and we are happy (because we still have plenty of resources remaining).  However, it will take an additional 48 years to consume the remaining 64%.  See Dr. Albert Bartlett: Arithmetic, Population, and Energy in Wiki.

Sangdon Lee

dX/dt = 0.03*X  (X is the cumulative resource consumed)

dY/dt = - 0.03*X  (Y is the remaining resources),

X(0)=1, Y(0)=100.


How to find interest rates with fractional reserve banking? As I understand it, interest rates are set by supply and demand, like any price. Money can be thought of like any other finite commodity. Lenders are willing to supply a certain amount of money at each interest rate, and borrowers are willing to borrow a certain amount at each interest rate. The rate can be calculated by setting supply equal to demand.

However, with fractional reserve banking, this picture seems to fall apart. While the demand curve can still be found, the supply of money is not so easy to quantify. If the reserve requirement were low enough, banks could loan out an arbitrarily large finite amount of money. The only limit to the money supply is the reserve requirement. It doesn't make as much sense to say here that the interest rate is set by supply and demand.

I see a two possibilities:
1) There is a supply curve that depends on the reserve requirement. This means that the interest rate would be a function of the reserve requirement.

2) There is no supply curve. As far as I know, no one sets interest rates (the Fed included, since they only influence rates via open market operations: if they didn't do anything there would still be an interest rate). How can interest rates be calculated in this case?

This question is sufficiently confused about basic concepts that I'm reluctant to go through the effort of clarifying everything enough to provide a meaningful answer, but here is a quick stab...

First, you need to understand that interest rates are not set by the supply of cash provided by banks and the demand from borrowers. They're set in money markets, which is the other side of the credit intermediation that banks perform. Banks lend to borrowers and borrow in money markets (if they didn't borrow, then it wouldn't be fractional reserve banking) to fund a significant portion of their lending.

Second, reserve requirements are far from the only constraint on bank money creation, and I frankly cannot think of a single bank for which they're the binding constraint. Banks are more likely to be constrained by risk-weighted capital requirements, the liquidity coverage ratio, or stress test scenarios than by reserve requirements.

So to answer your question as to how interest rates are determined under fractional reserve banking: bank demand for funds is determined by their set of profitable lending opportunities under a set of constraints including capital requirements (and they face some competition for these funds from firms that have direct access to capital markets and which issue short-term liabilities), while the supply of funds is determined by the amount of uncommitted cash held by firms (and to a much lesser extent, households). These intersect at some point, which determines the interest rate. The Fed affects the risk-free rate by engaging in transactions which swap safe, usually interest-bearing collateral for cash, affecting the relative supply of each.

Finding interest rates with fractional banking is very difficult because it is governed by quantifiable and unquantifiable factors.

Regulatory requirements (like reserve ratios and capital requirements) are objective and quantifiable and play a role (but it varies from bank to bank).

The supply of base money is only limited and is another objective quantifiable component.

But...a major component of banking is trust.  If I create a new money "exchangepesos" and nobody wants it, then any quantifiable math equation would be useless.  Banks create money.  They create "deposit dollars" that of course exceed government dollars (base money).  For this to work, there must be trust.  If I as a depositor or as another bank don't trust say "Bank A", we won't trust in turn their deposit money which will ruin their credit rating and result in the destruction of their deposit money.

Another way of putting this is that banks operate by maturity mismatching.  Matching short term debt to long term assets.  This is naturally exceedingly risk and depends on those lending short term to the bank to consistently roll over such debt.  Because long term assets are long term they will not get the principal in time to satisfy a redemption run by short term debt holders (many of which could be called depositors).

The extent to which a bank can create money and buy interest bearing assets (which affects interest rates) is a function largely of the trust the individuals (but mostly other banks) have in the bank that does the money creation.  This is of course non-quantifiable.

The best solution IMO is to at least quantify the extent to which a bank mismatches debt to asset maturities.  This is an obscure but growing measurement sometimes referred to as the liquidity mismatch index.

A most practical manifestation of this equation would be to have a graph with the horizontal access being maturity times (say 1 second 'aka demand deposits), 1 month, 1 year, 5 years, 10 years, 25 years, etc...).  Then the vertical axis quantify be amounts in dollars.  Two lines would be drawn...one for bank debt stratified by maturity time and another for bank assets stratified by maturity time.  Measuring the area of the difference of the two lines would give you a relatively interesting idea of where the banking system is at and where it could go (especially when compared to historic norms).  But ultimately an exact equation to find interest rates is not possible because trust is so important to banking yet is not quantifiable.


How does a central bank create the money used for quantitative easing or lowering the value of their currency? Up until last week, the Swiss central bank used Francs to buy Euros, in an effort to lower the value of the Franc; today the European central bank announced that it would use Euros to  buy bonds in order to fight deflation.

I assume that the central banks "create" the money used for these programs electronically. I would like to understand how this works. Can a central bank simply by fiat change its holdings of its own currency, and then use this new money in any way they please? Do they later have to "pay back" this money to balance the books, or can they simply forget about it?

Or more concretely: if the ECB buys bonds with newly created electronic money, and these bonds later default, would that be a problem for the ECB or could they laugh it off?

Short Answer

  Can a central bank simply by fiat change its holdings of its own currency, and then use this new money in any way they please?

Theoretically it can, if you don't mind destroying credibility and the economy in the process. In modern economies there are regulations in place that make this impossible. So no.

  Do they later have to "pay back" this money to balance the books, or can they simply forget about it?

If they keep "printing" new money and keep paying back old money in perpetual, the net effect is not having to pay back. So the US government can afford US\$19T of debt. But technically they have to pay back. See long answer below.

  Or more concretely: if the ECB buys bonds with newly created electronic money, and these bonds later default, would that be a problem for the ECB or could they laugh it off?

ECB can laugh it off, but Draghi can't, and certainly Eurozone can't either.

Long Answer

First you have to look into the process of money creation. Let's say you provide an ounce of gold bar (asset) to the Fed, in exchange the Fed will pay you an equivalent sum for your gold,  the current market price, say US\$35. The gold is now in the Fed's reserve (it is called Federal Reserve for a reason). Archaically, you can redeem your gold bar with US\$35.

However, note that debt instruments (i.e. bonds) are also assets. Therefore the government can issue short-term bonds to the Fed that the Fed will put in its reserve, and hand the cash to the government. The book is still balanced because the bonds in reserve are now "disabled", just like you cannot use your gold bar anymore when it's in reserve. But there will be more liquid cash in the market, cash that can be used to do other things, such as investment. When the bonds mature, the process is reversed. Furthermore, the interest (profit) earned from the government bonds will also be remitted back to the government, so the book is still balanced even when interest is taken into consideration.

Quantitative easing is similar. In addition to government bonds, the central bank is now allowed to buy a set quantity of financial instruments that it normally wouldn't have access to, in the same exchange mechanism as stated above. QE allows central banks to (directly) influence interest yield of other instruments, in addition to the usual interbank interest rate which is already close to zero. A lower interest rate makes investment more attractive, which drives the economy. Now that there is more cash in circulation, exchange rate falls, which makes foreign direct investment attractive because US assets cost less in foreign currencies's perspective.

Now, what if the bonds default? Let's suppose there are US\$100 out in circulation, backed by US\$100-equivalent of reserves. If US\$20 of the bonds default, the value of the US currency in circulation will drop in value accordingly in terms of exchange rate. i.e. nominally the dollar notes still say US\$100, but the actual purchasing power will drop to only US\$80.

Suppose that initially US\$20 of reserve is in bond and US\$80 is in gold. When you reason further, had it been a fixed exchange rate system, once the bonds default, if the owners of the US\$40 of gold rush to redeem their gold at a fixed rate, the reserve will now be worth US\$40. The remaining US\$60 in circulation will now have only \$40/\$60 (= 2/3) of its initial purchasing power (compare with 80% purchasing power right after the default). If all US\$80 of gold reserves is redeemed, the remaining US\$20 in the market will worth US\$0. This is one of the reasons why fixed exchange rate won't work: Once there has been a default and people rush to redeem the reserves, hyperinflation follows.)

They have a procedure to make it look like it isn't what it actualy is - dictat.

The problem is that if we accept the reality we may all clammer for more money creation and eventually destroy the value of it, as happened many times in the past.


If I don't pay a debt, then the creditor takes my goods. Why, then, do Greek creditors not take Greece? Normally, when you don't pay a debt, your creditors take your goods (house, car, etc).

If Greece cannot pay its debt, can its creditors take Greek goods (structures, cities, industries, lands, etc)? Can Germany, or other organizations, become owners of Greece?

Maybe that's a silly question, but for a non-expert it sounds logical.

In general, there are three kinds of debt:

Secured debt, like a mortgage or a repurchase agreement. With a mortgage, for example, the debt is secured by a lien on the home, and if the debtor does not pay, the creditor can seize the home.
Unsecured debt, like a credit card or corporate bond. Governments will generally allow creditors to liquidate many of the assets of an insolvent individual or firm to meet unsecured obligations, subject to (often significant) limits. For individuals, things like retirement accounts and primary residences are often off-limits for debt collection.
Sovereign debt. Sovereigns typically issue debt under their own law, and countries generally don't set up their legal systems in such a way as to allow other countries to take their things. However, when sovereigns issue debt under foreign countries' law, as Greece has done with some UK-law bonds, payouts tend to be higher, and overseas property is in fact occasionally seized. However, seizing the domestic property of a defaulted sovereign is effectively impossible, as one of the benefits of being a sovereign is that you control your own territory— attempting to seize another nation's "structures, cities, industries, lands, etc." (setting aside the fact that most structures, cities, industries, and land in Greece are not owned by the government) is what is known as an act of war.

In short, Greece has already been taken.

The key point to note is that money does not have any value until it gets exchanged for either goods or services. Until that exchange happens money does not have any value whatsoever; it is merely a promise and creating promises costs literally nothing. Every country (except for those in currency unions, yes, Greece) can create endless money supplies at no cost because money as we use it today does not have any value.

Goods and services have value, not money. For anybody that happened to live through hyperinflation times or even quantitative easing periods which is happening as I am writing these words as ECB launched 1 trillion (!) QE program, it's obvious how burning money can be.

ECB is not after money as it can easily create endless money supplies, just to mention, quantitative easing.

What ECB is after is control.
ECB wants to control country's domestic matters and make sure that ECB, or wider, the whole banking sector, maintains its supreme position in the country's economy.

Both Lucas Papademos and Mario Monti (yes, Italy) have strong ties to the biggest banks, yet they were supposed to represent their country's interest. Whose interest do you think they were defending? And these two guys aren't even an exception.

So for ECB, the main player in the Euro currency union, it makes sense to keep buying Greek bonds because it costs them nothing and, most importantly, assures Greece stays in Euro Zone which in turn means that ECB essentially controls the country.
The only challenge is how long other countries who are not directly the lenders, will tolerate such a scenario because they are the real losers.

Update

As predicted in my answer, ECB just confirmed that it will step in and provide liquidity for Greek lenders. ECB did so because it is in its own interest to keep Greece in Euro zone regardless of how much money they require to maintain liquidity as creating money does not cost anything. Greece will only leave Euro zone if 1) decides to do so 2) other Euro zones countries will kick Greece out.

https://en.wikipedia.org/wiki/Lucas_Papademos

http://uk.reuters.com/article/2015/03/31/uk-markets-bonds-qe-idUKKBN0MR0FG20150331

http://www.wsj.com/articles/eurozone-leaders-reach-unanimous-agreement-on-greece-says-eus-tusk-1436771076


Is money mostly created (out of nothing) by banks making loans? In the Bank of England's Quarterly Bulletin, 2014 Q1, McLeay, Radia, & Thomas write a pair of articles titled:

"Money in the modern economy: an introduction" and
"Money creation in the modern economy".

I believe they subscribe to what Werner (2014) calls the credit creation theory of banking. From their Overview:

In the modern economy, most money takes the form of bank deposits. But how those bank deposits are created is often misunderstood: the principal way is through commercial banks making loans. Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money.
The reality of how money is created today differs from the description found in some economics textbooks:
• Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits.
• In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money ‘multiplied up’ into more loans and deposits.

These two articles were published in the BoE's Quarterly Bulletin, so I had initially assumed that what they were saying was the mainstream/widely-accepted/orthodox view. On further reading (e.g. of Werner, 2014), I discovered though that this might not be so and am now slightly confused as to what, if any, the mainstream view is.
My main question is this: Is the above description of money creation largely accurate?
Follow-up questions: Does this description differ from what is written in most textbooks and academic papers and books? (And if so, why? Is it because the above description is a relatively recent development? Or the above description has been true for a long time now, but has simply not been incorporated into textbooks and economists' models?)

The monetary base (MB) contains what might be called "public money creation", Notes and coins in circulation (outside Federal Reserve Banks and the vaults of depository institutions), Notes and coins in bank vaults (vault cash), and Federal Reserve Bank credit (required reserves and excess reserves not physically present in banks). The broadest available government measured US monetary measure is M2, which does not contain all the elements of MB, but still is an approximation of the total of private and public money creation, which includes currency, plus time, savings, and demand deposit accounts. So, what is MB/M2? What fraction of money is created by the government of the total?

FRED: (Monetary Base; Total)/(M2 Money Stock*1000)
The answer is less than half. Crudely, money is mostly privately created in the US. The "out of nothing" aspect of your question is more complex. In my personal view, and I guess that's only an opinion, is that because banks are government regulated and insured institutions, forced to back each loan with reserves, and regulated to have capital for each of those loans, they cannot really be said to make this private money out of nothing.

I disagree with some aspects. Firstly money abstractly can be several different things. I consider this as axiom to modern economics until convinced otherwise. The central bank in most economy only actually "prints" new money via its bond coupon payment. This is never balanced and only net credit to money supply.

Actually it may be slightly more complicated. But I assume as key axiom that when a bond is issued, the coupon payment or interest is net credit to the money supply. This is different then special, inter government bonds used by the government and these special bonds are not subject to a open market. These are ideally paid back from tax revenue.

So the bond coupon say 2.9% over 30 years on the principal barrowed is new money. The original principal is actually short term debit from the money supply until it is paid back. And the interest finally, a net addition to the money supply.

The primary area of disagreement I have is this. Under normal circumstances you have steady growth. For example consider China's and worlds use of the usd. Each year new entities enter the global exchange of goods and services using the dollar. Theoretically at some point the integral amount of dollars is not enough, an extreme example would be say you had 20 cars and I have 1000 computers, we each have 2 dollars, now John, born yesterday would like to sell his fathers supply of apples but has no dollars. I want apples, have too many computers and could use a car. But at todays prices I can only buy two apples. Clearly now the currency is no longer a useful tool in the real economic situation in which people can create value out of virtually nothing, improve their poor situation, and all in a beneficial, cooperative economic strategy.

Ideally the money is a tool which must be periodically maintenance to serve the natural economic trade, which transcends the money supply. If it is not there becomes a very natural economic force to bypass it. This is generally seen as the money losing its integrity, forcing, alternative money (oh hey there bitcoin), stealing and things perceived as crime, but are really just attempts to bypass problems with a broken tool, and proceed freely and economically.

Additionally governments have admitted to tightening the money supply in what the call monetary policy. So that if the real, underlying economics get tight, like computers, cars, and apples drying up, they can create a perceived relief from such recessions and prevent depressions.

So we can see that under these assumptions the money supply is one factor in the big economic picture the others are typically much more important, like education levels, natural resources, carrying capacities, energy, population and what not.

Now inside this big complex real economy, you have a the ability to net produce money in very small window where a non government loan is created inside your window, and paid back outside of it. This is then virtually creation of money. Examples of this might be taking on debt as a ceo then retiring.

There are many obvious problems with this. Typically there is more interest then can be repaid, and default OR essentially freely giving money back becomes necessary, also is coupled with economic forces for currency to lose integrity, or a shift to alternate currency. This is interesting economic phenomena in its own right, a general breakdown in cooperative strategy and move to non cooperative. It is not clear which is the cause or effect. But it appears to happen naturally with out choice.

This is a good picture of todays money usd which is mostly created by debt from private banks instead of by the government. It essentially relegates private and corperate banks to do what fed has done in the past. Several things are clear, the debt levels and unwillingness of the central banks to print money, instead turning to corporate bank lending- is unprecedented. Oddly enough while democratic presidents have typically been seen as progressive, modern thinkers, they have set the precedence of extremely tight monetary policy, often operating on the money supply produced under republican administrations. One can argue about the humane effects of monetary policy on the poor. Prisons overflow, homelessness rises, and apparently all at the cost of choking the economy incase of recession. If then, the let off has any real effects is debatable as well.

There are some negative effects of regulation of money supplies. This is primarily inflation. In many economic models inflation does occur, as a result of growing economy. An example of this is the Euro. With Brexit the E.U. would experience a shrinking number of economic players using the euro for trade, as such we have seen negative bond rates over there to prevent inflation, possibly literally learning Euros if that is the method used to destroy bills removed from circulation.

In today's times it is in my opinion we are heading to tougher times and uncertainty in the big economic picture. We have climate change, end of Moores Law, which has fueled the boom of the 90s. But even coming from the Reagan/Vulcan era 14% bond coupons, there were still problems. I view it as testing the waters and the powers which make such decisions thought, (from a long term 100 year outlook) they weren't impressed by semiconductors and that we were shakey in the knees. And quickly pulled back.

It is difficult to know and interpret the vast economic signs and clues but here today after a modest pop up to 3-4% the 30 year declines ounce again towards 2% remaining flat, among the blatant debt, poverty we just have to keep in mind how complex the world is and realize we probably don't understand everything.


Is there an economic rationale for wanting to know the gender of a child before it is born? [Rewritten to express issues in economics terms:]

In terms of the classic economic rational actor (Aka homo economicus) is there some rationale to want to know the child's gender before it is born.

Potential  economic advantages of knowing ahead of time:

Smaller decisions space for choosing a name
Can purchase items in advance

Potential disadvantages of knowing ahead of time:

Is there a utility of surprise?
Are excess purchasing impulses easier to control if you don't know the gender?

I would like to understand this in the framework of the classic rational actor (Assuming they would ever want to have a child)

One typical story people tell is that in some countries there are strict population control policies and if families have a large economic incentive to have either a son or a daughter, they might neglect their pregnancy or terminate it if the child is not the gender they want it to be. In some societies the economic incentives to have sons or daughters are very different: typically sons are expected to bring in a working wife into the family, with a dowry, but daughters are expected to leave to the husband's family and take a dowry with them.

In essence the actual reference cannot be considered rational or irrational on its own. Consider the below definition from wikipedia in the context of the options given in the quesiton.

  At its most basic level, behavior is rational if it is goal-oriented,
  reflective (evaluative), and consistent (across time and different
  choice situations). This contrasts with behavior that is random,
  impulsive, conditioned, or adopted by (unevaluative) imitation.

The first three reasons would be consistent with a rational choice, but the last bay not be consistent with the rational actor because its driven by impulse e.g. potentially buying unwanted items even though the expressed preference is not to buy them

en.wikipedia.org/wiki/Rational_choice_theory#Formal_statement


loanable funds theory: why is the supply of loanable funds equal to saving (+ dishoarding + new money)? It seems that the loanable funds theory suggests that all that is saved is supplied in the market for loanable funds. This makes sense when we are talking about 'household saving' (i.e. household income minus consumption). This money will be put on a savings account (or used to buy bonds), and if not, counts as hoarding per definition. I have a hard time grasping why it would be true for 'firm saving'. Let me explain what I mean by that: Assume a production volume of 1 million $ in a given period. Assume further that 800.000 are paid out as wages and that 500.000 of those are consumed. Overall saving is 500.000, household saving is 300.000. It's obvious that the households will want to loan out those 300.000 (and in the case that they hoard some of this money, it constitutes hoarding, i.e. negative dishoarding, and gets subtracted from the supply of loanable funds = saving + dishoarding + newly created money). But I don't understand why the firms would supply the remaining 200.000 as loanable funds. Is there some assumption that profits are rules out in principle, i.e. that production has to equal household income? I'd be very grateful for some clarification, thx in advance.

Does saving increase the supply of credit? Critique of loanable funds theory.
http://wer.worldeconomicsassociation.org/files/WEA-WER-4-Lindner.pdf

In the first step, the concepts of “saving” and “credit” will be clearly distinguished using simple accounting. It will be shown that credit is not limited by anybody’s saving and that no one has to abstain from consumption in order for a credit to be provided. Also, it will be shown that financial saving (an increase in net financial assets) through a reduction in expenditures reduces other economic units’ revenues and thus their ability to spend and save. Using the concept of excess demand and supply, it will be shown that excess saving does not lead to an excess supply of credit − which would lower interest rates − but to an excess supply of goods, services and/or labor which will lower prices and production. How interest rates change is not determined by excess saving: They could increase, stay the same or decrease. Finally, it will be argued that the identification of saving with the  provision  of  credit  is  likely  to  stem  from  the  invalid  application  of neoclassical growth models to a monetary economy.

The  present  paper  shows  that  the  underlying  view  of  the  “saving  finances  investment”  doctrine implies that the amount of loans that can be lent in a period is limited by the amount of saving in the same period and that, consequently,an abstention from consumption (and other spending) is necessary for more credit to be available for investors. This view is the basis of loanable funds theory (Robertson, 1936;Ohlin, 1937a,c,b;Tsiang, 1956). It will be argued that this view is deeply flawed. Using simple accounting rules in the vein of Stützel (1978;1979) and Lavoie and Godley(2012), the paper will first clarify the difference between saving and the provision of credit: saving changes an economic unit’s net worth which the provision of credit does not. The provision  of  a  credit  only  changes  either  the  composition  of a unit’s  financial  assets or the length of its balance sheet, but not its net worth. Second, it will be shown that loanable funds theorists commit a fallacy of composition  when  they claim  that household financial saving  increases aggregate investment  in tangible assets.

In recent history Paul Krugman defends the use of loanable funds model in online debates with other economists. The statistical measures in the United States have two components called national income and product accounts (NIPA) and flow of funds accounts (FFA). These debates seem to revolve around what role the interest rate(s) play in the dynamic increase or decrease of production, income, and financial instruments. There does not seem to be any deterministic role for interest rates and the financial accounts are not directly linked to the NIPA accounts because there are accounting methods to re-value assets, to depreciate assets, to recognize casualty losses, and introduce other discontinuities in the financial sectors. In short there is no simple deterministic mechanism to link financial saving and investment in a complex credit-driven economy.


Economic schools of thought VS Econometrics From  Wikipedia:

  In the history of economic thought, a school of economic thought is a group of economic thinkers who share or shared a common perspective on the way economies work

Why is it that different economic schools of thought are  still taught in spite of the fact that we now have data to test their ideas and philosophies of the economy and see if they really line up with reality?

I think I can explain the problem as to why the schools persist.  For simplicity we will limit ourselves to the Marxist, Austrian, Neoclassical and Neo Keynsian schools.  I am not sure where to put the Feminist school except under the broad heading of heterodox with Marxists and Austrians as I don't think of it as a school so much as an attitude or direction of thinking.  The same thing would be true for Green economics, it isn't so much a school as a domain.  There are many small groups out there.

For starters, economics is a broad umbrella that prefers dissent and maybe even vocal and extensive dissent.  Part of economics is part of the humanities and part of economics is in the sciences.

Austrian economics as thought through by von Mises argues that there can be no way to measure what they are saying and so they are part of the humanities.  The neoclassical and the neo Keynesian school say any claim that is stated should be measurable and falsifiable, so it is in the sciences.

That said, any serious review of von Mises and related writers would tend to drive one down the path well laid by Leonard Jimmie Savage and his personalistic statistics and in doing so would have a complete empirical methodology.  I believe the branch of the Austrian school that says things cannot be measured simply hasn't read enough statistics.

The two primary schools, the modern Keynesian and Classical forms, are empirical and the reason you cannot rule one out is that both are empirically supported even though they are contradictory.  This is similar to the problem between quantum physics and relativistic physics.  They make contradictory assertions.  It is impossible that both are true, except where they don't overlap.  Yet they both work everywhere else.

The best tool for model selection in that it is both disciplined and founded on well understood mathematical principles is Bayesian model selection.  Non-Bayesian methods assume that you know the null model and you assert the model is true.  This works great for binary problems but is terrible for non-binary problems.

If we define a model space as indexed on the set $I$, with $i\in{I}$ and a set of models, $M$, so that $\mathcal{M_i}\in{M}$ and with vectors of parameters $\theta_i\in\Theta_i$ in a parameter space $(\theta_i,\mathcal{M}_i)\in\Theta\times{M}$ then we can solve the problem of the best model.  Best in this case being understood as being most probably close to the data generating function.

The probability that a model is the true model, from a set of models and given a data set, $X$, is $$\Pr(\mathcal{M_i}|X)=\int_{\theta_i\in\Theta_i}\frac{\Pr(X|\theta_i;\mathcal{M}_i)\Pr(\theta_i;\mathcal{M}_i)}{\sum_{\mathcal{M}_i\in{M}}\int_{\theta_i\in\Theta_i}\Pr(X|\theta_i;\mathcal{M}_i)\Pr(\theta_i;\mathcal{M}_i)\mathrm{d}\theta_i}\mathrm{d}\theta_i$$.

While this methodology works generally and works especially well on a problem by problem basis it won't answer which school is best since it will provide contradictory solutions across specific problems.

What is really needed is a better, overarching explanation of what triggers Keynesian-like effects and what triggers Classical-like effects.  My suspicion is that it is stochastic shocks in the planetary budget constraint compared to where that constraint is expected to be at by the individual actors.

Why is it that different economic schools of thought are still taught

There is really on two kinds...

The Nature of Economics

It is well-known that Austrians disagree strongly with other schools of economic thought, such as the Keynesians, the Monetarists, the Public Choicers, Historicists, Institutionalists, and Marxists… The ultimate difference from which all disagreements at the levels of economic theory and economic policy stem… concerns the answer to the very first question that any economist must raise: What is the subject matter of economics, and what kind of propositions are economic theorems?

Mises’s answer is that economics is the science of human action… It is this assessment of economics as an a priori science, a science whose propositions can be given a rigorous logical justification, which distinguishes Austrians, or more precisely Misesians, from all other current economic schools. All the others conceive of economics as an empirical science, as a science like physics, which develops hypotheses that require continual empirical testing.

The views of Mises’s predecessors, Menger, Böhm-Bawerk, and Wieser, are the same: They, too, describe economics as a discipline whose propositions can in contrast to those of the natural sciences be given some ultimate justification.

But Mises by no means merely notices this rather obvious difference between economics and the empirical sciences. He makes us understand the nature of this difference and explains how and why a unique discipline like economics, which teaches something about reality without requiring observations, can possibly exist. It is this achievement of Mises’s which can hardly be overrated.

— Hans Hermann-Hoppe, ESAM.

Now why is this school of thought (what used to be indistinguishable from the orthodox) no longer so mainstream?

Why Academics Hate A priori

University instruction in an a priori science presents special problems if we are to adhere to the principle that an instructor ought to be a researcher as well. In every field there are very few who can make actual contributions to its intellectual treasury. In the a posteriori sciences, however, pioneers and followers work together with the same told, and there exists no outward distinction between them. In his laboratory, every professor of chemistry can compare himself with the great pioneer. Although his contribution may be modest, his research methods are the same.

Things are different in philosophy, in economics, and in a certain sense, in mathematics. If academic positions were contingent upon independent contributions to economics, barely a dozen professors could be found throughout the world. If positions are awarded only to those researchers who had made original contributions, care must be taken to take into account research done in related areas. In effect, this makes the appointment to academic positions dependent upon scholarly activity in other areas: the history of ideas and doctrine, history of economics, and especially the economic history of the most recent past, which is often erroneously labeled economic problems of the present.

The fiction perpetrated in scholarly circles that all professors are equal does not permit professors of economics to be divided into two classes: those who work independently as theorists, and those whose work consists of economic history and description. The inferiority complex of these “empiricists” has led to a campaign against theory.
          —  Ludwig von Mises, Memoirs

  in spite of the fact that we now have data to test their ideas and
  philosophies of the economy and see if they really line up with
  reality?

Mises’s great insight was that economic reasoning has its foundation in just this understanding of action; and that the status of economics as a sort of applied logic derives from the status of the action-axiom as an a priori-true synthetic proposition.

The laws of exchange, the law of diminishing marginal utility, the Ricardian law of association, the law of price controls, and the quantity theory of money—all the examples of economic propositions which I have mentioned—can be logically derived from this axiom. And this is why it strikes one as ridiculous to think of such propositions as being of the same epistemological type as those of the natural sciences.

To think that they are, and accordingly to require testing for their validation, is like supposing that we had to engage in some fact-finding process without knowing the possible outcome in order to establish the fact that one is indeed an actor. In a word: It is absurd.

— Hans Hermann Hoppe

To use an analogy; it is as if one wanted to establish the theorem of Pythagoras by actually measuring sides and angles of triangles. Just as anyone would have to comment on such an endeavor, mustn’t we say that to think economic propositions would have to be empirically tested is a sign of outright intellectual confusion?

But Mises by no means merely notices this rather obvious difference between economics and the empirical sciences. He makes us understand the nature of this difference and explains how and why a unique discipline like economics, which teaches something about reality without requiring observations, can possibly exist. It is this achievement of Mises’s which can hardly be overrated.

— Hans Hermann Hoppe


Is there an externality if someone buys all stock of some merchandise? Is there an externality if someone buys all stock of some merchandise? On one hand, if they buy all of everything and there's still demand then they've taken it away from other people. On the other hand, it kind of feels like that should be accounted for in the supply curve, and it's not an externality so much as the producers not having known the correct supply curve?

From the Oxford dictionary: (emphasis added by me)

  externality (noun)

  A consequence of an industrial or commercial activity which affects other parties without this being reflected in market prices...

Another way to put this is that externalities are not the results of market rivalry. So if you and I are bidding on the same item on e-Bay, and you are buying it, I kind of suffer, but this is within the market context, this is not abnormal. Whereas if you buy a new stereo system on e-Bay and then keep me up all night by listening to loud music, this happens outside of the market context (unless I sold you the right to listen to loud music) and is an externality.

In case of a Cournot-oligopolies one firm's increased production would also harm other firms by lowering the price. But this is not an externality either, as it is the result of normal market rivalry for the consumers.

It seems like in the situation you are describing you are not facing an externality, as it everything happens in a market context. Perhaps there is information asymmetry, as the store was understocked. (This would require additional assumptions and is not the only possible explanation.)

You can try drawing up an Edgeworth box for a two-person, two-good economy to see this more clearly. It should be easy to show that overall utility is maximized for equilibria near the center of the diagram, where the two agents share both goods equally.

Since you're talking about externalities, this implies that you're looking at maximizing social welfare.  You can certainly construct heterogenous preferences such that one agent hoarding 100% of a good is optimal, but they are probably not that realistic.


What are the known / alleged problems against using energy as currency? What are the known (and alleged) problems of using Joules (i.e. a measure of energy/work) as a currency? I tried to find such idea in Google (searched terms like "technocracy", since someone told me that technocracy had such idea), but I'm not clear about where to search in.

(Edit : asked in contrast to fiduciary/trust/faith-based currencies)

(Edit 2 : found this link, but i'm not quite an expert in eco to judge the possible problems, not exposed in the article)

(Edit 3 : This one is my fault since I asked a not-so-clear question, becuase my lack of knowledge. I have to clarify that this proposal is not mine, and I want to just study the concept. In this way, many principles I should enumerate are:

Energy taken into account is the "seizable" energy, like solar or fossil.
Fossil energy can be stored. Fossil industry would be credited for that.
Solar energy can be captured, transformed, and injected into the power network to be credited for that [as currently is, in many countries, right now], and have such energy redeemed later; the only difference with the current situation is that [the modern proposals support that] the economy could be based in such energy, instead the vice-versa case.
The exchange act would not involve energy directly, since a wallet of that type could be quite dangerous to carry in the ... ¿pocket?.

In this sense, I think useful answers have already been provided to cover the expressed points, althought I don't want to consider the answer as just-closed, but narrow the extent of the issues I want to understand about).

tl;dr: Energy is one of the worst ideas for a currency that anyone's had.
It's not fungible, it's not a store of value, and has absolutely no scarcity. Let's look at the details.
Commodity currencies are problematic
jmbjera has listed core problems with the gold standard, and with commodity currencies generally: its supply is managed not by a democratically-elected government, but by one industry, so you remove a hugely useful tool from the policy-makers' toolbox; and you expose yourself to very high short-term volatility.
But even amongst commodities, energy has unique issues that make it worse than useless as a currency.
Energy is ubiquitous and bountiful
There's absolutely enormous quantities of it lying around everywhere. One kilogramme of anything contains mind-boggling amounts of energy - $E=mc^2$, right? c, the speed of light, is huge. Squaring it makes it a lot bigger (when we're in SI units). $3\times10^8m/s$ squared becomes $9\times10^{16}$ - that's how many joules of energy in 1kg of matter. Any matter. Soil, platinum, flesh and blood, it doesn't matter, it's all the same amount of energy: 90 Petajoules; aka 25 Terawatt-hours. That's a few weeks worth of electricity supply in Britain. So an energy currency means one kilogramme of sand is equivalent value to sufficient electricity to power that G7 country for a few weeks.
Additional energy arrives on Earth every second of the day
So not only is there immense quantities of energy lying around for free, but vast amounts arrive every second from our friendly neighbourhood fusion reactor, the sun. Irradiation on the earth is about 130 Petawatts. That's about four orders of magnitude more than human energy consumption. Or, to put it another way, sunlight on one ten-thousandth of the Earth's surface brings energy in at about the same average rate as global energy demand.
Energy's value varies hugely in time and space
But it gets worse, as far as currencies are concerned. See, energy's value differs constantly in time, in space and in form. You must have noticed that wind and sunlight are free - no one's charging you for them - and they're energy. Whereas you have to pay for natural gas. You probably pay even more, joule for joule, for diesel or petrol (gasoline). And you will pay a lot more for electricity. On top of that, one unit of electricity has a very different price depending on where and when you buy it, and the quantity you're buying it in.
Energy's form drives its economic value. 1 Joule is rarely worth 1 Joule
Electricity is a really high quality vector of energy: it can do huge amounts of work. But you can only use it in the instant it's generated (ok, you can store it briefly in a capacitor, but that will cost you, too). Heat is a really low quality vector of energy: and the closer the temperature is to ambient temperature, the less work it can do. i.e. the less economic value it has. Now, we've got enough problems with variable marginal values of money as it is, without this scale of problem. The other thing is, if you're storing your currency of energy as heat, it's losing its value every second as it cools off. Yet, at the same time, cooling has economic value, in aircon and in refrigeration. So that's a lack of energy that has economic value.
Many energy transformations add economic value but consume energy
Refining crude oil costs you energy and other resources. And the end product is more valuable, which is why people do it, and make a profit at it. But that would be absurd if energy were the currency.
On sophistry
I've seen the argument for an energy currency before. Usually, when you dig deeper, they're not really talking about an energy currency. They're actually trying to sell something. Typically, but not always, fossil gas. So their proposed energy currency turns out to be something very like gas futures contracts (which have the usual commodity-currency problems: control of supply lies with one industry, not democratically-elected governments; and the whole economy is exposed to high short-term volatility). Now, as we know, we've got far more gas than we can possibly burn (see my colleagues' paper in Nature on this), and the gas industry is starting to get nervous. And so it should. This desparate bid for a "gas currency" is just one more bit of special pleading and rent-seeking from what must become a dying industry.

https://www.youtube.com/watch?v=H7QlOTi86Nk The best answer gives Patrick Wood: Technocracy Rising


The purpose of advertising for Pepsi What is the purpose of advertising for companies like Pepsi who advertise the same product and every person in the modern world knows about it? Why waste money?

Advertising is hard to understand if you take classroom economics models too literally.  I highly recommend diving into the literature on behavioural economics if you are truly interested. But for the purposes of your question, Pepsi runs advertising because it operates in a market in which consumer choice is primarily driven by two sources of cognitive bias: the anchoring and the availability heuristic.

On the one hand, new customers are born every day, and if Pepsi doesn't run advertising then those new customers will see a Coke ad first.  On the other, since existing customers don't actually make purchasing decisions based on a careful weighting of product merit, they need to be reminded that Pepsi exists and that there are warm, fuzzy feelings associated with the brand. This way, when they find themselves craving something to drink, Pepsi might be the brand that comes most readily to mind, because it's the last soft drink ad they saw.

This is just my opinion (built on some of the theory, but by no means do I claim it is the Complete Truth), but the anchoring heuristic in particular seems to explain brand loyalty in the cola market.  I grew up in the era of the "blind taste test" and my takeaway from those social experiments is that when the most significant product differentiation is along branding lines, consumers will tend to just stick with whatever product they encounter first, because absent labeling and the social utility that comes from a trite form of tribalism, the consumer is indifferent to the choice.

As an economist, I think, Pepsi Co would want their product to have inelastic demand.


What is the interpretation of the output matrix of pivoting? I have the following matrix:
$$A=  \begin{bmatrix}
    1 & 2 & 3 \\
    2 & 3 & 4
  \end{bmatrix}$$

After pivoting, I got this matrix:
$$B=  \begin{bmatrix}
    1 & 2 & 3 \\
    0 & -1 & -2
  \end{bmatrix}$$

It's very embarrassing, but I know how to pivot, but I don't understand the interpretation of this matrix operation. What is pivoting and why is it important for linear optimization in economics? I only found resources on the mathematical intuition of pivot operation.

In the meantime, thank you so much for your attention and participation.

Pivoting helps solving linear system of equations. Imagine you want to solve for X that satisfies :

\begin{equation}A\cdot X = Y\end{equation}

where
\begin{equation}X = \begin{bmatrix}x_1\\x_2\end{bmatrix}\end{equation} and \begin{equation}Y = \begin{bmatrix}y_1\\y_2\end{bmatrix}=\begin{bmatrix}3\\4\end{bmatrix}\end{equation} and \begin{equation}A = \begin{bmatrix}1&2\\2&3\end{bmatrix}\end{equation}

Then if applying Gauss' Pivot to A' (concatenation of A and Y) with
\begin{equation}A' = \begin{bmatrix}1&2&3\\2&3&4\end{bmatrix}\end{equation}

yields
\begin{equation}B' = \begin{bmatrix}1&2&3\\0&1&2\end{bmatrix}\end{equation}

you instantly have that $x_2=2$ and $x_1=3-2x_2=-1$. On large linear system it is very fast to solve them that way.


Is evolutionary game theory a useful modelling tool? Has evolutionary game theory ever been used to successfully describe an ecosystem or a reasonably closed subsystem of the economy? A frequently used example is about side-blotched lizards but I don't know of any others. And has it ever been proven that in this case the main factor is really relative fitness of strategies and not some other factor, such as the dynamics of gene recombination?

You're looking at it from a particularly biological point of view. I know nothing of side-blotched lizards, but I can say that evolutionary game theory is often used for equilibrium selection. In games with more than one equilibrium (whether it be Nash or otherwise), evolutionary game theory can allow us to select a particular equilibrium that is a better prediction than others in that a population is, in some sense, more likely to reach it and stay there than it is to reach and stay at other equilibria. Have a look at Population Games and Evolutionary Dynamics by William H. Sandholm if you want to see more of how economists use evolutionary game theory. What your question gets at is really more about creating a model with evolution to describe an ecosystem rather than evolutionary game theory, though the two are not unrelated.

Didnt Prof Robert Auman win the Knoble Prize for Game Theory in 2005? I think that he used it in an economic scenario. Look him up.


Does Medicaid or Medicare represent a higher risk to the Federal Government Solvency and Debt going forward? I'm trying to understand not only which program is expected to be larger in terms of costs, but which one has the least capacity to adjust (reduce benefits if revenues for the program fall).

Yes, both presents higher fiscal risks up to the future, as they imply in a higher Federal deficit. The hability to adjust depends, unfortunately, not only on the program itself, but in a political risk as the congress could refuse to reduce the revenue to these programs as this would be not appealing for voters. At least USA does not have something like "free healthcare for everyone" written in it's constituition like countries such as Brazil have.
The broader the extent of the program itself determines it's costs.


Effect of minimum wage on higher levels of pay Suppose the minimum wage increases to \$$x$. Is there any evidence on the effect (if any) this is likely to have upon the wage profile of workers higher in the hierarchy, who are already paid more than \$$x$?

My question is inspired by the following comment from the Financial Times (paywalled link):

  As an employer with an annual payroll of around £650k pa the impact of the introduction of the minimum wage in 1997 led us to pay our lowest paid staff ( casual bar staff back then on about £3ph ) the increased minimum wage so they at least benefited. Everyone else higher in the hierachy ( full timers, supervisors, asst managers, managers) all suffered because at every opportunity ( as people left and needed to be replaced) we tried to replace these higher paid staff with the same caliber person but on lower wages. And we were successful at dong this; and we had to be because we could not afford our overall wage bill to increase. So in 2000 I was paying a General Manager 35k a year. Now I can find and pay a general manager 25k pa and thats a massive nominal decline over 15 years. So the real impact of the minimum wage introduction in the real world of small husiness was to pay the lowest casual staff a little more but most of the higher paid staff ended up being paid less .

Is there any evidence to support the claim that the described response is a widespread phenomenon?

This phenomenon is sometimes called "wage compression" because the range of wages is compressed by the minimum wage laws.
One paper on this subject is The Impact of the Minimum Wage on Other Wages

From employer's perspective minimum wage, in most cases, is simply an overpayment. There wouldn't be any point for minimum wage if it was not an overpayment.

The work done by minimum wage workers can potentially be worth a lot less than the cost of employing them, thus the value of work performed by other workers need to balance this gap. Workers earning above minimum wage need to make up for those earning minimum wage and whose work is worth less than that, so that the employer still makes a profit.

Let's consider a simple scenario.

Before minimum wage

Suppose we don't have a minimum wage regulations and the following scenario happens.
We have two workers, one skilled, one unskilled. The difference in their work efficiency is x2, that is work of the skilled worker is worth twice as much as the work of unskilled. The workers are rewarded accordingly to their work performance, so gross salary of the more efficient one is twice as big as the unskilled worker's salary.

Now, minimum wage gets introduced.

Minimum wage

The initial value of minimum wage is set to 150% of unskilled worker's salary.

Clearly, unskilled worker's work is not worth that much, so at least one of two things must happen now:

Skilled worker needs to agree to be paid less or
If no skilled worker with x2 efficiency agrees to be paid less then the skilled worker will be replaced with even more skilled worker whose efficiency is higher than x2, so that the employer can maintain the same profit margin.

Yes, I have made a lot of assumptions along the way but still this could be a likely explanation why minimum wage causes drop in the salary of higher paid workers.

Update

Upon receiving the feedback for this answer I am adding references to sources that back up my arguments.

  enacting a higher minimum wage clearly benefi ts low-skilled workers.
  By contrast, if one’s initial premise is that there are alternative
  means to produce a product, and employers will seek the least-cost
  method of doing so, then raising the minimum wage will cause employers
  to seek substitutes such as automation or relocation overseas, thereby
  reducing the amount of workers they hire.

Demand for workers falls, clearly.

The Road to Serfdom with the Intellectuals and Socialism F. Hayek, p.15

  Legislative bodies have the power to legislate a wage increase, but
  unfortunately, they have not found a way to legislate a worker
  productivity increase. Further, while Congress can legislate the price
  of a labor transaction, it cannot require that the transaction
  actually be made. To the extent that the minimum wage law raises
  the pay level to that which may exceed the productivity of some
  workers, employers will predictably make adjustments in their use of
  labor. Such an adjustment will produce gains for some workers at the
  expense of other workers. Those workers who retain their jobs and
  receive a higher wage clearly gain. The adverse effects are borne by
  those workers who are lost disadvantaged in terms of marketable
  skills, who lose their jobs and their income or who are not hired in
  the first place.

Again, demand for workers drops, thus by supply-demand law we expect salaries to drop.

Youth and minority unemployment, Dr. Walter E. Williams, p.7


What is the effect of Quantitative Easing on the US budget deficit? Is the deficit getting larger because of QE?

No, the deficit is not getting larger due to QE. Certainly not directly, because that's impossible, and also not indirectly, either.

Quantitative easing is a policy of purchasing government bonds with the intent of decreasing yields while injecting cash into the economy. It affects only the demand for government bonds, not the supply of bonds created by government borrowing.

This shouldn't be a surprise, as the monetary authority (the central bank) and the fiscal authority (Congress) are independent of one another. Congress cannot (without rewriting the Federal Reserve Act) directly control monetary policy, nor can the Fed force the government to borrow more.

Indirectly, Congress could choose to borrow more as a result of QE, due to lower yields on government debt, as the lower debt payments make it cheaper to do so. However, there's not much evidence that this is the case.

The deficit has fallen since 2009 (when it significantly increased due to passage of a large-scale stimulus program consisting primarily of tax cuts but also including direct federal spending, in response to the financial crisis and recession), both in nominal terms and as a percent of GDP. As a percentage of GDP (which is the appropriate long-term comparison, as taxable income is the best indication of a nation's ability to repay a debt), the deficit returned to a normal historical range by 2014.

So it's difficult to conclude even that QE encouraged spending, thereby increasing the deficit indirectly. Given two facts— that the Federal Reserve's QE programs started in earnest in 2009 and continued until late 2014, and that the federal deficit steadily fell during this time— it would be very strange indeed to conclude that QE had increased the deficit.

The US Federal debt has only been increasing year on year... from 2009 - 2014 it increased from $10 trillion to $18 trillion. I don't know why you believe it steadily fell over this time.


Why does an increase in money in circulation increases price levels? I'm a physics student who likes economics very much. I'm trying to get a simple explanation for inflation. I hope that there is one that doesn't involve people willingly rising prices. Thank you very much!

new money is created; it belongs to somebody.
that somebody can either save/invest the money, or spend it on consumption.
provided at least some of the money is spent on consumption, the demand for consumer goods increases.
in a competitive market, this increase in demand results in an increase in the price level. (Note that the sellers are not "willingly rising prices" because, in this simple model of competition, sellers take the price a given natural consequence of the interaction of supply and demand).

You might also find it interesting to read about the quantity theory of money.

When people buy more, when Government invests more, when companies invest more and when exports are bigger than imports, some other people will gain profit. If they have more money, they will also buy more and so on. The GDP for that country will increase to a level called supraproduction. The economy is overheated and the prices will increase as a psychological response of community and as a need to increase the prices for sustaining a supraproduction. You know that when a company produces more, they will gain economy of scales until a certain point when their production costs will increase. That's why they need to increase the price. Of course, everything is far more complicated than that.


Effects of Decentralized Currency What effects could the growing use (and abuse) of Decentralized crypto-currency have on the rest of the world economy? For example, one cause for concern is the simplicity of laundering the currency. Is there any comparable event in history that could help forecast what might be in store? Is there even any cause for worry?

I want to get some outside opinions on this thought experiment.

I agree that cryptocurrency can be used to launder illicit gains, but I think this question needs to consider a broader societal context. It is estimated that there is at least $20 trillion hidden within tax havens around the world. Much of this is laundered by the very institutions (banks) now claiming that cryptocurrency is a potential space for criminal activity.

I think a good example of this is China's recent clampdown on Bitcoin within the context of capital outflows. Although it was speculated that Bitcoin trading within China could be used to avoid capital controls, the comparative amount of Bitcoin was a fraction of the overall amount. Bitcoins entire market cap is about USD18 billion, whereas Chinas capital outflows were USD220 billion in 2016.

I suppose my answer is that cryptocurrency will only ever be a cog within a broader illicit machine. Reducing criminal activities like laundering will require systemic and governance changes within our societies, starting tax avoidance and effective regulation on those who are most likely to carry it out - the super rich.


Criticism of "Modern Political Economics" by Varoufakis, Halevi, Theocarakis The book "Modern Political Economics" is quite critical about "neoclassical economics", the basic claim being, if I understand correctly, that the models which "neoclassical economics" (armed with mathematical insights starting from John F. Nash Jr, Gerard Debreu and Kenneth Arrow) investigate, are not simplifications of some realistic models, but that they (the models) are just wrong (because of what the authors call "Inherent Error").

Is there a serious criticism of the views such as the ones exposed in this book?

added after a comment asking for citations:

maybe not a successful choice, but nevertheless (the following two citations are short descriptions of chapter 3 and chapter 8 of the book):

"Chapter 3 The odd couple: The struggle to square a theory of value with
a theory of growth

The odd couple of the title are value and growth. From the very start, political economics found it difficult to square the two; to create models or accounts of how the exchange value of things was determined in a growing economy. The chapter begins at the beginning, with the French Physiocrats, before moving to Adam Smith and David Ricardo’s attempts to tackle this conundrum. The Inherent Error makes its first fonnal appearance in these works, before it returns again and again in the following chapters. The essence of the Inherent Error is the impossibility of telling a credible story about how values and prices are formed in complex (multi-sector) economies that grow through time."

"Chapter 8 A fatal triumph: 2008’s ancestry in the stirrings of the Cold War

During the Second World War, economic policy was in the hands of the New Dealers, who ran the economy on a trial and error basis and in the light of the accumulated experience of trying, not with great success, to kick-start the ailing US economy during the traumatic 1930s. Meanwhile, a group of scientists (mostly of Central European origin) were manning the agencies, laboratories and divisions of the civilian and military authorities whose job it was to solve practical problems (e.g. logistics, planning of transportation systems, price setting) by means of advanced mathematical methods. However, after the war ended, and the Cold War began to take hold, both the New Dealers and the Scientists lost out in the struggle for the hearts and minds of academic economics. The winners of that ‘game’ were a small group of Formalists, with John F. Nash, Jr, Gerard Debreu and Kenneth Arrow at the helm. The chapter tells the story of that triumph, which gave neoclassical economics a whole new
push, by focusing on the person that the book portrays as the era’s most tragic figure: John von Neumann. His ‘fate’, the chapter argues, was an omen for the type of economics that would prove instrumental in the run up to the Crash o f2008."

and yet another citation:

"The rest, as they say, is history. Debreu and Arrow emerged from Nash’s seminar and in a few short months applied what they had heard to hammer out their own existence proof in the context of a multiple-sector model economy: one that effectively brought back from the dead Walras’ (fully neoclassical) idea of a General Equilibrium complete with determinate prices for everything, including labour input and capital goods (recall Chapter 6). This they accomplished by procuring General Equilibrium’s ultimate mathematical proof; an existence proof that showed under which conditions a set of relative prices exists such that all
markets (including that for labour) are in equilibrium.
This existence proof was to mark a new neoclassical turn in political economics; a turn that altered the discipline’s course and returned neoclassical obscurantism to the throne from which it had been removed by the combined forces of the fall of 1929, the analysis of John Maynard Keynes, the engineering brilliance of von Neumann and, last but not least, the experiences of economic policy during the New Deal and the Second World War."

Neoclassical economics or rational analysis should always be a starting point for an analysis of how a given system or model works.

However, that is all it is - a starting point. You cannot use a model that is solely rational to predict or infer much about how the real world works, because humans are not rational. That is why rational economics are critized, but do not match up with observed behavior.

Therefore, any real critique has to show how rational economics do match up with observed behavior.