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Advanced Economics

ALL THINGS BEING EQUAL

The declared intention of the authors of the paper is to "gauge the degree of fiscal prudence or profligacy for each country over the past several decades".

Their method

In order to do so, they use advanced economic methodologies but with a few twists. The data:

  • Excludes periods of defaults
  • Excludes wars
  • Excludes the 2008 economic debacle
  • Hinges on Primary Balances (not Overall Balances)

But nevermind because the results speak by themselves clearly and explicitly. One such example (USA) can be seen below.

USA Prudency and Profilgacy

As you can see dear reader, it is absolutely clear and unquestionably obvious what it is that the authors intended to express. Not only that, but it is clear that with the exception of the default years, the USA has been neither too prudent nor too profligate, just about right. As you can see this evaluation is spot on because the USA has almost never engaged in bottomless borrowing. Hence, sleep thigh our friends, eeeeeverything is under control.

OK.OK. We get it. The graph is too complex. Not to worry. Luckily enough the authors provided a clear explanation.

Definition: "we will define a country-year as “profligate” if it is a non-war, non-default year that is (i) not part of any 25-year window with a positive and significant debt coefficient, (ii) in which the actual primary balance is lower than the forward-looking debt-stabilizing primary balance, and (iii) in which at least one of the following is true: a) the year in question is part of at least one 25-year window with a negative and significant debt response coefficient, or b) the year is influentially profligate according to the influential observations routine."

There, much better right? All clear? Goooood!

Our method

We do recognize that we are not economists, but nevertheless we are people with common sense. As economics is the so-called "science" of human behaviour, it should at least respond to common sense. Any person with common sense will tell you that:

  • Having a lot of debts is bad
  • Getting rapidly into debts is incredibly bad

This is valid for people, business and corporations and there is no reason why this should not also be valid for governments. And so if we take their data (which they have provided) and do some basic calculations, we can arrive at much better conclusions without the hocus-pocus, mumbo-jumbo and shazam of their paper.

It so happens that mathematically speaking there is a simple tool that allows the conversion of any measurement of position over time into speed. This tool was developed by Sir Isaac Newton and every last-year high school student knows about it: it is called Calculus. More specifically, the first derivative.

If we now use the first derivative to calculate the speed at which debt increased over time, voila! We have an automated method to measure how fast are governments getting into debt. Furthermore, this tool does not need to make any assumptions nor does it need to exclude data or make use of highly dubious financial calculations. Not only that but thanks to Excel, this is exceedingly easy to calculate. The result can be seen below.

USA Prudency and Profilgacy

As you can see, the areas in bluish indicate the time period when the debt was decreasing. The areas in redish indicate the opposite. Presto! Prudence in blue, profligacy in red.

Too simple, right?

Of course! Let's say that you are of the opinion that some borrowing is good while too much is bad. OK. That can be arranged very easily. It so happens that the derivative has units. In this case the units are fraction of GDP per year. Let's say that you consider a speed of indebtment higher than 0.75 GDP/year as the upper limit you are willing to tolerate. Far enough, all we need to do is to highlight the areas where the value of the first derivative is higher than 0.75. The result can be seen below.

USA Profilgacy - custom

Magic, right!?

Not only it is clear what it means but it is actually easy to calculate by yourself using Excel (from Microsoft) and a tiny algorithm called Savitzky-Golay (if you are interested, search for it in Wikipedia). Actually, it took us 5 times more effort to make the graph pretty than the time it took us to calculate the values. So much for "cutting edge" economics.

Ahhh… but we are not sophisticated enough, you say. We do not understand the economic conditions, you say. Fair enough, if it is statistics what you want, we can take all the values of the first derivative, calculate the standard deviation (SD) and define as "Profligate" any speed of debt increase higher than one SD. That would highlight all the debt increase periods lying beyond 68% of "closeness" to the average. Or let's take 2SDs for a 95%. Or let's take 2SD for the entire world as "Profligate". Presto! A "neutral" baseline.

We can play these statistical games all day with no end in sight. The point of all this is that economics must not be cosmological science when it comes to explain to people what is going on. Not even when using statistics, which are basically a subjective science since no matter what you calculate and how you calculate it, in the end you must determine what is acceptable or unacceptable according to you. Yet, bureaucrats and politicians make it as complex as possible. Why?

WHY INDEED?

What is there to gain by making all these calculations complex and utterly incomprehensible? Simple: confusion. For politicians -who must lie at all times- (see Government Morality), confusion is the absolute best state of affairs there could possibly exist. It is for this very reason that all governments hire economic bureaucrats by the cord (as in firewood). It is for this very reason that all governments sponsor mainstream economic schools by the gross (i.e. 12 dozens). Because they need their "expertise" to confuse the hell out of everybody. Do you honestly believe that any politician actually knows what it is that they are doing, economically speaking? Of course not. They rely on economic "expert" bureaucrats who in term rely on "standard" and "mainstream" (as in obsolete and non-working) economic theories. The only "tiny" problem in all this expertise is that it is flat in error! But that's OK. Politicians don't mind since the primary purpose is to confuse people, not to enlighten them. Whether an economic theory works or it does not is irrelevant as long as the politician is popular. It is this very process which explains the strange preference of people for governments that "spend" on "social justice". This is, for governments that borrow and spend. For as long as the going is good, politicians are popular. Once the inevitable economic tsunami appears on the horizon, politicians simply declare that they will be "fighting" the problem hence making them popular again. You see, dear reader, politicians are all for "the little guy". No matter that almost all the extreme ups and downs are self-inflicted political wounds. But that's OK since politicians will always have their golden parachutes, salaries and retirement pensions. Don't you worry, they will be OK.

CONCLUSION

Economic bureaucrats use statistics to demonstrate anything that they want to demonstrate using statistics. What that may be is irrelevant…for them. Not for you. While they are playing those silly games your life is flushed down the toilet because what they are playing with is your wealth and believe it or not, you need that wealth to…oh…live perhaps? Just a thought…

Next time you are faced with a seemingly inscrutable economic explanation, there is something very simple you can do. Tell them to explain it to you as if you were a 5 years old child. If they can't you will automatically know that they are making this stuff up. Feel free to get up and leave the room. You are not missing anything.

But perhaps you are an economist or a quant who enjoys the complexities of higher mathematics. That's OK. Nobody is saying that you should not have a hobby. Just one thing; whatever you do make sure you are employed by the government because if your models will actually be implemented, we will be far, far worse than we are today.

Reference: Paolo Mauro, Rafael Romeu, Ariel Binder and Asad Zaman, 2013, "A Modern History of Fiscal Prudence and Profligacy," IMF Working Paper No. 13/5, International Monetary Fund, Washington, DC.

Note: please see the Glossary if you are unfamiliar with certain words.

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