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Almagest

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PostSubject: Stuff   Mon Dec 08, 2008 7:57 am

Stuff.

So I didn't necessarily post this to be all preachy. I mainly wanted to ask Kamma if he had any insight into a viable way in which America could change its entire economy to work on a system that doesn't sustain itself through dangerous amounts of over-consumption.

Also interested in what other people think of the video, obviously.
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Shelarahn

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PostSubject: Re: Stuff   Mon Dec 08, 2008 11:13 am

The chick who made the video is fugly
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grak

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PostSubject: Re: Stuff   Mon Dec 08, 2008 1:56 pm

Funny how the consumption that built our economy is now derided as the great moral evil of our time.
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Dimidréas

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PostSubject: Re: Stuff   Mon Dec 08, 2008 2:35 pm

grak wrote:
Funny how the consumption that built our economy is now derided as the great moral evil of our time.

Now I want to drink, thanks...
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Kamma

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PostSubject: Re: Stuff   Tue Dec 09, 2008 12:38 pm

Alma,

First off, good motivational video, even if it does use overtly populist appeals at times which ignore the tough questions. Generally speaking, even those tools have value in making people aware of the full costs of their actions.

Second, sorry to take so long to reply. I began writing a response and then realized that it is a bit like Alice falling down the rabbit hole. Unfortunately, I have not studied environmental economics at all so I cannot wave my hand at some general conclusions from that field. However, concepts from the fields of development econ, growth econ, and general macro theory can be used to help understand the human framework in which a solution has to be formulated.

The hardest part of the issue is its complexity. There are so many factors that go into it; talking about it qualitatively inevitably faces significant diminishing returns. To put together my thoughts, I have been putting together a macro model with the salient structural elements so that I can be rigorous about my understanding of the problem. Not only is this a perfect application of a good deal of the theory I've been working with lately, but a proper DSGE growth model with well formulated resource constraints (all growth models that I am aware of have abstracted away from such constraints) could potentially be a paper topic. (edit: there is some literature out there)

I'm going to start by discussing the permanent income hypothesis qualitatively (although I will use a few equations), and I will report back when I feel more confident with the ways that the various institutional/social/physical frictions interact.

Understanding the way that people form their intertemporal preferences is a huge part of the problem. Taking a standard instantaneous utility function, and then assuming that societies seek to maximize their total future-discounted expected utility, the first order maximization condition gives what is called the consumption euler equation:

U'(c_t)=beta*E_t[(1+r)*U'(c_t+1)]

where U'(c) is marginal utility, beta is the discount factor (0<beta<1), E_t is the expectations operator conditioned on time t information, and r is the expected real interest rate: 1 + r = (1 + nominal interest rate)/(1 + expected inflation).

The consumption euler equation expresses the hypothesis of rational expectations, people make their decisions about the future using all available current period information. If rational expectations holds, then to the extent that people are informed and we have enough information consumption should be smoothed over time. That is, consumption should approximate a stecady state. This idea (credited to Milton Friedman) is called the permanent income hypothesis.

What the video you posted in fact does is to help society converge our consumption stream to a new (more correct, fully informed) sustainable steady state. The problem is that information is often costly to obtain (and there may be more social norm and institutional factors at play too retarding the spread of information). The way I see it is, people do hold close to rational expectations (approximately, artificial neural networks are a way to simulate approximate rational expectations). With the proper information, consumption should trend around the steady state growth path as postulated by the permanent income hypothesis.

Unfortunately, consumption in itself is an abstract phenomenon, as is utility. However, one way to try to see if this holds true is in the dual variables -- the price variables (the interest rate). Suppose that at some time t we are at the steady state. Then, the euler equation reduces to

U'(c)=beta*r*U'(c) meaning that 1 + r=1/beta

values of beta between .96 and .99 (~4.1% and ~1.2% respectively) are often used in calibrations of models and tends to fit data well (note, not in short run situations of hyperbolic preferences -- a topic which potential relevance, but I'll ignore it for now). If the interest rate is higher than 1/beta, what does this mean? Then, U'(c_t)>E_t[U'(c_t+1)] which implies (due to diminishing returns to consumption, ie concavity) that c_t<E_t c_t+1. people expect to consume more in the future. If the interest rate is lower, then just the opposite holds and people expect to consume less.

Look at the following data on interest on US bonds (blue) and interest on inflation indexed bonds (red). The spread is a measure of expected inflation, and so in theory (to the extent that lending to the federal gov't is risk free) the red line measures the expected real interest rate:



First notice that at the beginning of the data series, this measure suggest that the real interest rate was at about 4%. However, with the onset of the recent slowdown, the real interest rate has fallen. Arguably, people are realizing that they can't afford their current mode of consumption and are expecting to cut back.

Now, I'm not arguing that this necessarily directly has to do with living on a finite planet. It does, however, suggest that we have tools to indirectly observe people's preferences and expectations. Interest rates are a potential insight into understanding how people will behave with respect to their future consumption.

Note that this doesn't imply that permanently low interest rates will CREATE a better future. In fact, if one used policy to put downward pressure on interest rates you would in fact encourage consumption (the opportunity cost of consumption today is the interest rate). BUT, in the transition from a over consuming steady state growth path to sustainable level of consumption, you would expect to see a fall in interest rates as people updated their expectations to information about the future and then a rise again in interest rates as we approach the new steady state growth path.

Ok. I need to get some work done and I've probably bored the shit out of everyone. There is plenty more to be said, and I'm going to create a more formal model of how a complex macro economy with imperfect product markets would react over time to running up against its resource constraint.


Last edited by Kamma on Tue Dec 09, 2008 6:03 pm; edited 1 time in total
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Almagest

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PostSubject: Re: Stuff   Tue Dec 09, 2008 3:40 pm

All right, so basically you're saying Americans do have the capacity to be influenced by non-standard market forces into consuming less, which is a good start, but wouldn't such an event have negative impacts on the economy? If everyone in America woke up and was, like, "Crap, there are finite resources on this planet. Maybe I should consume less shit so that my great-grandchildren will have something when I'm gone," wouldn't that spell some sort of economic collapse? Or if it happened gradually, would the economy be able to adjust?

Also, at the end of the video, populism may have been hinted at, but really nothing substantial was said. There was a pretty green circle and she mentioned a couple ideas like closed loop production and green living economies - stuff that goes beyond just consuming less - which might be effective on a small scale, but is there anyway they could work as major part of the ridiculously complex U.S. economy?
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Kamma

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PostSubject: Re: Stuff   Tue Dec 09, 2008 5:58 pm

Actually, by populism I meant the worker exploitation and anti-corporation rhetoric (which isnt necessarily wrong but framing it in the way that she did can turn off people who otherwise might be sympathetic/convinced -- ultimately hurting the cause).

I'm not sure what you mean by standard market forces. There is a grand confusion between the terms 'free market' and 'competitive market.' Competitive markets are unambiguously good. Unfortunately they don't exist. However with the right institutions, they can be approximated. Conservatives have a notion that 'free markets' create institutions that do the best job of this approximation.

So if by 'standard' market forces, you mean market forces that prevail in 'free' markets. Then, (although what I am about to say technically opens up a can of worms that is largely ideologically based...) yes. By saying yes I am implicitly assuming that free markets allow for large externalities. (The externalization of costs talked about in the video, more or less).

No economist will argue that when people internalize their external costs, it is welfare decreasing. On a theoretical basis this is absolute. But it is not a question of theory. It is a question of empiricism. It is a question of having complete information.

So I return to my main point: with complete information about the real effects of x, y, and z (meaning that people realize the costs they will face in the future) people will choose to reduce their consumption. People will do exactly what you are doing.

Maybe the best way to imagine it is via an intertemporal externality. That is just a fancy way of saying the obvious: by over consuming today, you are making it more costly to consume tomorrow. You shift the true cost of consumption into the future period because your expectation about the future is based off of incomplete information.

It makes no sense to me that people would sign a contract for more money today to allow someone to kill them tomorrow if they sincerely believe that tomorrow they will be killed. However, it makes complete sense to accept money today in exchange for death tomorrow if you believe that there is no way that the counter-party will follow through on their promise. Unfortunately, conservation of mass/energy doesn't break its contract. <insert indicator of terrible math/science education in America>

So, yes any society is capable of being influenced by anything. It is simply a question of incentives. If the incentives are there to consume in a sustainable way, people will.

On the negative impacts on the economy: a reduction in 'consumption' (abstract idea) means less demand for 'things' (ideas, goods, services, etc) meaning less production, meaning lower real incomes for workers. If lower steady state income means less massive variability of income, this is welfare improving (relative risk aversion). Now, if we lived in a world of perfectly competitive markets, we could make this transformation instantaneously there would be no bizarre chaotic spin-off effects and everyone would be happy (instant welfare would be lower, but the sum of all future welfare would be higher). Reality is that we live in a world of frictions and inertia. Frictions and inertia are what create 'unemployment' and explain why people dislike 'inflation.' In a general sense, rapid changes in aggregate variables such as a massive decline in housing prices (although absolutely necessary) cause distortions to the relative incentives, contracts, valuations etc... that people make decisions over. Often the effects of these distortions can create feedback effects.

In this sense, it is essential that a transition is gradual and fully expected by people. Again referring to the Euler equation above and the idea of rational expectations: if people come to expect change, they will start adjusting for the change before it actually arrives, muting the potential distortionary dynamics. Informing people of the true consequences of their actions (especially when those consequences are explained in real, incentive generating ways) is probably the single most important way to mute the adverse transitional effects of a massive decline in consumption.
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