The wheel deal

Which is more dangerous – the steering wheel or the driver?


In 2006, Kazakhstan banned the use of cars with the steering wheel on the right-hand side. It argued that such vehicles, designed for countries in which people drive on the left-hand side of the road, lead to accidents here, where we drive on the right-hand side. Banning the cars would lower the rate of accidents per mile driven.

In 1975, a Chicago economist, Sam Peltzman, identified the flaw in this argument: Drivers decide for themselves how much risk to take. They buy cars with a right-hand steering wheel because they cost a few thousand dollars less. They understand that the cars are dangerous on Kazakhstani roads, and so they take precautions. If they are forced to buy cars with a left-hand steering wheel, then they will no longer have reason to drive like the little old lady from Pasadena. They may press the pedal to the metal in order to reach their destination more quickly. This is risky driving, but risk has benefits as well as costs. In short, a ban on right-hand steering wheels might not avert accidents.

Here’s the intuition. A driver will speed a bit more if the benefit to him (getting to the concert on time) exceeds the cost (a possible crash). Requiring him to drive a safer car reduces the cost for every speed. So he will drive faster.

Peltzman was writing about the decision of the United States government in the 1960s to mandate seat belts and other safety features that reduce the chances of injury in a given accident. He pointed out that wearing the seat belt may tempt the driver to speed, making an accident more likely. The overall chance of injury to the driver may not fall. In fact, if speeding endangers pedestrians, then the total number of injuries – to drivers, passengers and pedestrians – may rise.

From his statistical work, Peltzman concluded that requiring seat belts, and steering columns that absorbed energy, had not saved lives.  “The one result of this study that can be put forward most confidently is that auto safety regulation has not affected the highway death rate.”


Building a safer driver


Peltzman’s analysis was sophisticated, but a few technical glitches may be more apparent now than in 1975. The dataset contained observations that varied with time: An accident rate for 1961, another for 1962, and so forth. Some of his estimated models assumed that the relationships between accidents and variables representing potential causes were stable over time. In reality, the relationships might not have been stable, because the underlying variables – e.g., the accident rate, vehicle speed and income – might have been changing over time independently of one another. In addition, the dataset included observations for each state in the U.S. The unique characteristics of a state may affect auto safety on its roads in ways that a statistical model cannot capture explicitly.

These small potential flaws do not blunt Peltzman’s basic point: Regulation too often takes human behavior for granted. Auto regulators viewed safety as an engineering problem. Build a safer car, and fewer people will die in accidents. Peltzman showed that a regulation – such as requiring safer cars – may itself affect the driver’s behavior, and in perverse ways.

If drivers demand more safety, then they may indeed drive the safer car with care. In that case, the regulation may have the desired effects. But it will be superfluous, since the drivers would have wanted to buy safe cars on the market. Regulators would not have had to force automakers to produce them; the profit motive would have seen to that.

At times, regulation benefits us. The driver may not consider that his ill-maintained engine generates air pollution, since he does not suffer most of this pollution himself. Requiring annual inspections of engines may clear the air.

Even here, regulators could borrow a few tricks from the market. They could issue among drivers the number of permits to pollute (by skipping inspections) that corresponds to the level of pollution that they are willing to tolerate. Drivers who find it easy to reduce engine emissions – perhaps because they have new cars – would sell their permits to drivers who cannot afford to clean up. Thus the government would cut pollution to the tolerable level as cheaply as possible. Peltzman’s point – that regulators must consider behavior – holds again.

In 2007, Kazakhstan’s government canceled the ban on right-hand steering wheels just before elections, noted an English newspaper, The Telegraph. The reason was presumably political. But an economic reason exists as well. -- Leon Taylor, tayloralmaty@gmail.com



Good reading

Sam Peltzman. The effects of automobile safety regulation. Journal of Political Economy 83(4): Pages 677-726. August 1975. Online at www.jstor.org. Fun to read.


References

Gethin Chamberlain. Kazakhstan election a 'foregone conclusion'. The Telegraph. August 12, 2007. Online.

Who makes money?

The central bank doesn't print money.  So what?

Conservative critics of the central bank blame it for increasing prices in general, by “printing money.” The usual liberal response – among non-economists – is that the bank doesn’t print dollars and so isn’t responsible for a surfeit of them.

Of course, the bank doesn’t literally have a printing press. Creating coins and paper money is the job of the government mint. Nevertheless, the central bank determines the money supply, especially in the long run, although its influence is indirect.

The simplest way for the bank to affect money is to cut a deal with the public Treasury, the agency that raises the amount of money that the government has decided to spend. If tax revenues don’t suffice, then the Treasury must borrow. It issues I.O.U.'s -- bills, notes and bonds -- through which it usually pays interest periodically in exchange for loans upfront. It would like to borrow as cheaply as possible, by holding down the interest rate that it must pay. A congenial central bank can make the Treasury’s dream come true by buying the government’s bonds. This increases the overall demand for the bonds -- and thus increases their value for their seller, by reducing the interest that it must pay on them.

Where does the central bank get the dollars (or tenge, or whatever) for buying the bonds? Out of its “reserves,” which essentially are safes holding dollars. These reserves are not truly money, since their locked-up dollars are not available for spending. But once the central bank takes the dollars out of reserves and exchanges them for public bonds, the government can spend them on anything.  So they now become money. The central bank has just increased the supply of dollars, even though it didn’t print them. Similarly, if the bank wants to reduce the money supply, then it can sell bonds in exchange for dollars and stash these back in reserves.

The mild, mild West

Most central banks in the West resort to purchases and sales of bonds – “open market operations” – in order to manipulate the money supply. These days, they rarely cut explicit deals with the Treasury. The central bank in the United States, the Federal Reserve, declared its independence of the Treasury Department more than 60 years ago; the charters of some other central banks prevent them from lending directly to their governments. Nevertheless, in a recession, the central bank may buy bonds – and even commercial paper, a form of short-term loans to businesses – in order to give people more spending money, revving up the economy.

The central bank can also increase the money supply by encouraging commercial banks to loan out their reserves. Again, the lent dollars now qualify as money, either as cash or checking accounts. To coax these private banks into lending, the central bank may lower the share of their reserves that it forbids them to lend – the “required reserve ratio.” Or it may lend them its own reserves at a reduced rate of interest, known as the “discount rate.”

The National Bank of Kazakhstan has usually taken this route when it wanted to encourage spending. In recent years, it has increasingly resorted to open market operations. But it faces the same constraint as do central banks in other transition economies – the financial markets in Kazakhstan are still too thin to absorb a lot of bond trades. The consequences of a major bond purchase are not easy to predict.  So the National Bank tended to stick to the tool that it knew best -- the rediscount rate, which has risen slightly to 7.5% in order to contain inflation. 

The Bank's 2011 guidelines identify notes and commercial bank deposits with itself as its "main tools" for stabilizing interest rates.  It has increased slightly the required reserve ratios for commercial banks, which are higher for foreign deposits than domestic ones; but the ratios remain close to zero. 

Even if a central bank did run the mint, it would not control the money supply perfectly, especially in the short run.  The supply depends on the alacrity of private banks in lending and on the share of money that individuals hold as cash rather than as checking accounts.  If banks lend eagerly, and if households prefer bank accounts to fat wallets, then the money supply may increase sharply.  That's because the bank may lend much of Smith's checking deposit to Jones, creating (say) $1.80 for every $1 in the account. 

In Kazakhstan, commercial banks were scorched by the 2008 crisis and remain reluctant to lend today.  Also, Kazakhstanis prefer to pay with cash than with checks.  These facts restrict some factors affecting the tenge supply that are beyond the National Bank's control.  Thus the Bank can manipulate the money supply more precisely than is usual for central banks.  This may help account for its relatively good record of inflation (relative, anyway, to some other countries in the Commonwealth of Independent States, like Georgia): about 9% per year, just outside the Bank's target range of 6-8%.  -- Leon Taylor, tayloralmaty@gmail.com


References

National Bank of Kazakhstan.  Monetary policy guidelines for 2011.  Online.

The charge of the Austrian brigade

Austrian economics and the Real McCoy


Conservative politicians often identify themselves with something that they call “Austrian economics.” This, in their mouths, boils down to the proposition that inflating the money supply will inflate prices.  (One exception is the U.S. presidential candidate Ron Paul, a disciple of Ludwig von Mises; Paul has advocated competition among currencies in order to improve them.)

The link of money supply to inflation is not uniquely Austrian. Most economists accept that when the economy produces at full capacity, attempts to spend additional money will raise only prices since long-run output cannot be increased. They also accept that when the economy is below capacity, a boost in spending may induce producers to hire more workers and reopen factories, increasing output. Competition among these firms will hold down prices. In today’s anemic economies, an increase in the money supply may not hitch up prices right away – but just you wait.

What is Austrian macroeconomics? What does it mean for central Asia?

Austrians -- particularly the late Nobel laureate Friedrich Hayek -- focus on how money affects the structure of the national economy. In principle, any industry should expand to the point that a little more expansion will earn the same rate of return as it would in any other industry. An industry that earns a lower rate of return than others has over-expanded. It should release some men and machines to industries where they would be more valuable.

This process is painful for the bloated industry – and for industries that depend on it. When the faulty industry happens to be finance, its sudden curtailment will slow down the economy in general, since any firm must rely on finance to pay for expansion. (In the United States, firms often pay out of their own pockets – i.e., out of retained earnings – rather than borrow from banks or sell shares of stock. But finance still determines American expansion, since the firm will spend its retained earnings on its own project rather than lend to someone else’s only if it anticipates a higher rate of return to the former.) Austrians want to reduce the corpulent industry as quickly as possible – even if this would trigger a national recession – since delay would distort the economy further and make the inevitable adjustment more painful. Do we want a one-year recession now or a 10-year depression later?

Increasing the money supply may obscure identity of the industries that need to slim down, because the new money does not affect all industries at the same time. The first industries to receive the money may interpret it as an increase in demand for their products – and so may expand. Later, when their input prices rise, they will discover that the supposed increase in “demand” was, in fact, an increase in money supply that will eventually raise all prices. Then they will cut back, laying off workers and padlocking factories.  Inflation leads to mistakes that touch off a business cycle.

Austrian castor oil

To Austrians, the problem with printing dollars is not that it raises all prices. This would increase the household’s income by as much as it did the cost of its groceries (since the wage is also a price), so the household could buy as many goods as before. The problem is that inflation is not general in its early stages. The fact that most prices do not rise immediately after an expansion of money – which seems the case today -- is small comfort; to the contrary, it may lead to mistakes that induce recession.

For example, global oil prices rose 65% from 2009 ($60 per barrel) to early 2011 ($95), according to the United States Energy Information Administration. Does this increase merely signal the rise in demand for oil that one would expect from a recovering world economy? Or is part of it due to the early effects of a monetary expansion that occurred because national governments fought the 2008-9 crisis by printing money?

Conservative politicians are quicker to accept the Austrian mantle than its implications. It’s easy to blame central bankers for “debasing our money.” It’s not so easy to point out that the Austrian medicine – let bad firms fail – may cost millions of voters their jobs.

Nevertheless, the Austrian model may have anticipated correctly the economic twists and turns around the world for the past five years. The current eurocrisis may have arisen in large part because commercial banks lent to profligate governments that today cannot pay them back.

The Austrian model may also pertain to Central Asia in the long run. To what extent are the region’s economies inefficient because of lingering effects of Soviet policy? In Kazakhstan, has the farm sector contracted to its efficient size? To what extent are monetary policies in the region disguised attempts to prop up faltering industries like banking? The Austrians are politically correct; are they therefore wrong? – Leon Taylor, tayloralmaty@gmail.com


Good reading

F. A. Hayek. The collected works of F. A. Hayek. Volume 5: Good money. Part I: The New World. Edited by Stephen Kresge. The University of Chicago Press. 1999.


References

Paul Krugman. G.O.P. monetary madness. The New York Times. December 15, 2011.

Ron Paul.  Mises and Austrian economics: A personal view. Auburn, Alabama: Ludwig von Mises Institute.  1984.  Online.