crescet: waste and pine

"..man in short that man in brief in spite of the strides of alimentation and defecation is seen to waste and pine waste and pine.."  Lucky

The relationship between wealth and income is clearly strong.  There's an argument in economics that we do in fact consume based on our expectation on our lifetime income (under either a simplifying assumption of untrammelled friction-less borrowing from one time period to another or given a borrowing constraint as a function of wealth).  A (real) wealth process is in general replenished by the remnants of income minus consumption, per unit time.  It is also replenished by a rate of return on savings, and there's probably a jump process (in the sense quants use when modelling price action in derivatives pricing) on wealth - unexpected increases and decreases in wealth due to either an inheritance, an unexpected and large cost, etc.

In practice, the relative proportion of wealth over income (or expected income, or average income, smoothed over a lifetime) determines how much one can borrow, and one's consumption response function during times of economic hardship.  In other words, crescet drives your current (and expected future personal credit spread). If the amount you can borrow is always expressed to you as a percentage of your wealth,  then the associated borrowing cap and associated credit spread for loans are both functions of crescet.  Clearly it works well in a theorist's modelling of crescet if one can reasonably assume that there's a stable pattern of consumption based on a lifetime income  model.  It takes the variance out of the expected income process and allows for the possibility for doing a simpler lifetime crescet model.

The natural initial assumption, I think, is that consumption is based on a lifetime wealth process (which has embedded in it a lifetime income model).  It is also natural to assume that lending to consumers will always have a budget constraint based on some simple measurable proxy for the lifetime wealth process.  Current income appears to be the provable, easy to calculate proxy of choice, certainly in the western world.  

In the western world, it is a decent first approximation certainly for the last 70 years, to assume that the average person's wealth is held jointly in the property they live in, and in their pension.  However, when you look at this closely in the context of consumption smoothing and lifetime income, it becomes harder to make a distinction between wealth and sensible foregone consumption for future times.

Needless to say, the general flow of theory on consumption modelling goes like this: classical period economists model consumption largely as a function of interest rates.  Fisher introduces inter-temporal consumption and a budget constraint. Keynes in effect operates on the assumption that the average consumer is very much bound by the limit to borrow (i.e. he theoretically honours a real constraint on borrowing not present in theoretically pure models with frictionless borrowing).  He also, like lenders, approximates income as this year's income, and has no model for income to be shifted from one time to another (saving).  Modigliani added this element in the 1950s.  By far the biggest discontinuity in the lifetime income model is the fact of retirement, so in a sense, Modigliani introduces retirement to the model, and brings with that an ability to save and borrow.  I think this probably is a sign of the times.  In the early 20th century of Keynes, only about 10% of homes were privately owned.  By the 1950s of Modigliani's time, the US already had 50% home ownership.  So having a model which accounted for this significant fact of lumpy consumption in a person's life was an advance.

Friedman further made a sub-distinction between that fraction of 'reliable' and 'windfall' income, and considered the former more determinant in the consumer's life.  Windfall income adjustments (a legacy from a rich relative, a lottery win, a sudden hospital bill, a windfall tax) ought to have a net effect on one's wealth, depending on how that is consumed or saved.

One final chronological piece of background - the 1930s of course foregrounded the problem of persistent unemployment - a phenomenon not 'solved' by adjusting the real interest rate.  This leads Keynes to pursue aggregate consumption, including the less controversial personal consumption function (my current focus) and the much more variable investment function.

Lastly the rational expectations mob arrive on the scene to point out that if the consumer is doing all this good modelling and smoothing of lifetime consumption, then any actual changes to consumption would therefore have to be random (meaning unpredictable).  There's something quite beautiful about that step, even though the assumption made in it is initially hard to believe.

Keynes via Machievelli, Hobbes and Nietzsche

Neoclassical economists at core prefer macro-economic explanations which cash out at the micro-level.  As I mentioned in a previous post some of the roots of the story Keynes tells about the actor known as leviathan can be traced back to Thomas Hobbes.  But I'd like to throw in a religious dimension to all of this, which points even further back to Machiavelli and forward to Nietzsche.

Hobbes's construct was a macro actor, a personification of the state, onto which desires, intentions, actions are imposed.  Collections of these actors interacting at the state level are the genesis of macro-economics.  This is Keynes's root.  No assumption is made about any evolution from individual actors to state actors.  They're just different beasts.  Understanding this allows him to question simplifying projections of homespun metaphors which make sense at the individual level but which might not work at all in the same way at the state level.

But a generation or two before Hobbes, Machiavelli tried to develop a book of etiquette  for the only figure who could span the individual and the state - and that is the king or prince.  This is an amazing point of connection here between two entire schools of thought which have been struggling to maintain a friendly dialogue ever since.  In the embodiment of the prince, here you have a flesh and blood man who's being given a new rulebook for behaviour vis-a-vis his role as sovereign.  It is no wonder that rulebook seemed so alien.  The context behind this was I think an implicit understanding that the tenets of living - the rules of behaviour  - embodied in Christianity (and by extension to several of the other major world religions) were insufficient for the emerging nation state post the Christian empire's dominance.  Driving a state with rules which applied to individual Christians became inadequate.  Machiavelli's was an early attempt to make a new rulebook for the sovereign.  Nietzsche likewise took this breakdown of the homogeneous and unquestioned presence of Christianity in Western life and tried to apply it to individuals themselves.  Both thinkers take the same inspiration but write their rulebooks for the national-sovereign and the personal-sovereign.  The evolution of the discourse on the rulebook for the national-sovereign becomes increasingly hermetically sealed, less immoral-seeming, still alien, more amoral, formalised even.  This is, in a sense Catholic to Nietzsche's more Protestant radical individualist pursuit. which has echoes in the work of J.S. Mill, through Samuelson, Friedman and the mainstream neoclassical approach.  The Catholic state-as-actor/institution-as-actor approach has echoes in Adam Smith, Veblen, institutional analysis, Keynes.  

The rejection of the project of Keynes's aggregates based approach in favour of the micro-based approach is in a sense a rejection of the power of the state to write its own rule book, as the rule book is too detached from the individuals within it.  It is a rejection of an elite tradition of technocratic statecraft, talking in riddles among themselves, preferring to see individuals as effaced details.  

So much for the history of these ideas.  That explains to me some of the mutual cultural hostility when you hear the modern day intellectual combatants face off in the media.  Their positions may be deeply connected anyway.  The science of emergence is still in its infancy.  I can well imagine that the creative act of invention behind Machiavelli, Nietzsche, Hobbes, Keynes will not be the end of the story.  I marvel at their inventiveness but suspect in time that strong complex connections will be found between the micro and the macro level across many social sciences.  So perhaps the best way to bring Keynes together with Buchanan and Lucas is to think of them as  providing joint inspiration to new generations of political economists as they recognise the gap - but also try to bridge it, with increasing levels of success - between the rulebooks of individuals and the rulebooks of the various institutions which they produce.

neo = classical + Keynes + Fisher

An interesting short cut way of thinking about neoclassical economics and how it derives form classical economics is to imagine the following formula:

necoclassical = classical + Keynes + Fisher

The classical story is one where a market's supply and demand characteristics drive the equilibrium price of a good (including commodities, manufactured goods, services, and the price of labour, namely average wages).

Keynes pointed out that there are nominal price rigidities which prevent certain markets form clearing, a point in case being the labour market.  Nominal prices are sticky upwards - they don't like down adjustments.

Fisher pointed out that debt was also a rigidity in certain points during the economic cycle.  The debt is expressed in nominal terms, but during deflationary periods, for example, the borrower may find it increasingly hard to make their debt payments.  

They're both therefore, pushing forward the classical economic view by highlighting the need for more structure in the too simplistic classical view of a market driven economy.

I think that some time in the next one hundred years, real (as opposed to nominal) debt contracts will be  the norm.  This will take the sting out of so-called debt-driven deflationary periods.  I.e. the nominal rigidity of debt will become a solvable economic problem.

Whether the inflexibility of labour to deflationary periods has a rational expectations description (e.g. it is fairer for the average employee to take an inflation-induced wage cut rather than some subset of struggling companies going to the wall) or a behavioural economics one (we find thinking about real economic variables a system 2, slow brain activity and prefer the 'what you see is all there is' fast brain fallacy), or an unintended side effect of the historical fact of  'great moderation' hastened  by the arrival of semi-apolitical effective central banks (an institutional explanation) will help determine the prognosis of this current economic reality.


In today's highly politicised world of academic economics, I'd be obliged to refer to the classical + Keynes + Fisher as 'post-Keynesian'.