"When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.
We shall be able to rid ourselves of many of the pseudo-moral principles which have hag-ridden us for two hundred years, by which we have exalted some of the most distasteful of human qualities into the position of the highest virtues"

( JM Keynes, "Economic Possibilities for our Granchildren" 1930 )

Wednesday, September 15, 2010

The Economics of the Schnitzel*

Everyone can surely remember from his/her own past those unique moments in which a phrase, sight or a comment turned a complicated set of ideas into a simple, clear, concept (“How I did Not Think About It Before?” moment…). That personal Eureka experience may be the outcome of an individual “masterstroke” but it is more commonplace to find the origin of such experiences in our immediate environment.

I had many Eureka moments in my life, one of them dates to my early days as an Economics student. During a Micro Economics class , Prof. U.R. tried to explain what “Revealed Preference” is all about ( Note : R.P. is a method to analyze the consumers´ wants and needs from her actual behavior). A student suddenly asked the lecturer why to bother with complicated calculations as it is much easier to ask the consumer directly about her preferences. The Prof. replied with a simple example: A smart grandmother ( in my case the typical Jewish Grandmother, guess it is the same in other cultures) will never ask her grandchildren if they like the Schnitzel she bothered to prepare. She would prefer to know the “real” answer by having a look at the empty/not empty plates when the meal is over….. That is the essence of Revealed Preference, the understanding that even with kids actual behavior can be a better signal than words as people are prone to answer according to prior strategies and interests, ( in less polite words, to manipulate) That lesson remained in my head as “The Schnitzel Theory”.

Back to the present, I´ve got the feeling that the actual economic conjecture is a perfect candidate to apply the old “Schnitzel Theory”. Listen to what Governments, Central Bankers, the Media (with rare exceptions) and other interested parts have to say about the economy and you will hear an optimistic and sweet melody. Does the economic real “plate” ( i.e. actual decisions ) fit with these calm messages?

Lets have a look on the following graph (Evolution of Interest Rates and Inflation in US)

Source : Treasury Yields in Perspective Doug Short August 16, 2010

What does the graph tell us? First of all the official interest rate is being maintained at record low levels (the red line), practically zero. The market rates (Blue Line) which is heavily influenced by the monetary policy and market expectations is also very low. On real terms (the difference between inflation and interest rates) the official short term rate is in negative territory, i.e. Central Banks are running an ultra expansionary policy (app. negative 2-3%). The last time we had a similar experiment, (2001 -2005) the party eventually ended in tears including the prick of a major real estate bubble and a major economic crisis. That is not a secret, even to policy makers.

The most convincing explanation for such unorthodox and risky policy (with possible assets bubbles or inflation) is that reality is still very unpleasant and the economy requires high doses of cheap money in order to maintain asset prices and employment. In other words, the real and concrete policy measures tell us a different story from the official narrative.

To whom should we believe? My answer to that question as an adept of the "Schnitzel Theory" is that we are still far away from a real and sustainable recovery and a lot of problems lie ahead. Policy makers can say whatever they want, but as long as facts tell us a different story I prefer to believe to the later.

In that context I will ask you a favor : Please let me know when the facts fit with words or when you see a clear return to normal macroeconomic policies. That day it will be possible to say that the plate is empty and the time for the sweet dessert arrived… as Granma taught me : Dessert only for those who emptied their plates ... ( Or "The Wall" version : If you don´t eat your meat, you can´t have any pudding ....")

*Schnitzel : Typical Centre European , a thin meat cutlet (usually breaded and fried), Milanesa in Italy

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