More on inflation, violence and identification

Chris has responded to my previous post, which he frames as a criticism of his research. I should state upfront that this does not strike me as entirely accurate, since I emphasized at various points that my concerns lay in the possible journalistic interpretation of his work. Some email correspondence between the two of us suggests that I am not alone in expressing such trepidations, but I digress. On then, to Chris’s response…

1) He begins by taking issue with my decision to focus on food prices, politely suggesting that I “may have missed” the fact that his non-discretionary index of living costs includes various other components (including rent, electricity, water, etc).

As it happens, I don’t think that I missed this at all. My reasons for focusing on food prices are quite simple. First, they provide relevant context to the real effects that I highlight in my post, i.e. agricultural shocks stemming from massive drought. This was done deliberately with the aim of illustrating the overriding message of my post: Attributing causation to any particular event is often very difficult, and we certainly have to bear real effects in the front of our minds when discussing the sources of inflation. (To reiterate, this is something that the Business Day article failed to do entirely.) Second, food prices provide an obvious segue to the other article that I discuss in my post, which concerns the role that monetary expansion had in driving up food prices and thus precipitating the Arab Spring. Such matters notwithstanding, however, I did happen to include the following passage in my original post:

To be clear, South Africans have also experienced sharp increases in the cost of amenities like electricity and water provision due to some boneheaded policy decisions and as a legacy of inefficient parastatal monopolies.

Chris may have missed that, though. (wink)

2) His second objection is that I am unfairly interpreting his research as a suggestion that food hikes are the only cause of violence. He quotes his references to “political grievances” as evidence that I haven’t read the article properly.

Again, however, this seems to be a misunderstanding of what I have written and the major point of my post. In the passage that he quotes, I'm not concerned with alternative causes of violence, but rather the underlying drivers of one particular cause, i.e. inflation. At the risk of repeating myself: To the extent that inflation does act as a trigger for social unrest and violence – and irrespective of whether that occurs alongside other factors such as political grievances or not – we need to understand what the underlying forces behind that inflation are. Any analysis that focuses only on the nominal effects of (quote unquote) “delinquent” monetary policy is simply misleading. Why? Well, because there may be very significant real price drivers occurring at the same time! This is something that the Business Day article completely failed to mention, and the same is true for The Telegraph article that I quoted in the second half of my post. I see nothing wrong with taking exception to such slipshod analysis.

3) Next issue: On my suggestion that one might baulk at the definitive description of this research as “proof” of the relationship between inflation and violence...  Well, I don’t have much to add here, since – again – this is a criticism of how the journalist chose to frame his article. “Proof” is simply too strong and simplistic a word to use given all this issues that I have raised. (Note: I see that this has happened elsewhere.)

4) The penultimate point that Chris makes in his reply extends beyond the article featured in Business Day.  I will summarize his argument as saying that the South African Reserve Bank (SARB) should abandon its focus on the headline CPI, because a) Non-discretionary inflation has been rising much faster, b) It cannot control which specific goods rise and fall in price, and c) It would better facilitate an environment of civil harmony by stabilizing the Rand against a basket of commodities.

Now, interestingly enough, subsequent to yesterday’s post I found this column that Chris has penned himself. (I’ll take it that we can safely assume away possibility of incorrect interpretation by a third party here.) He produces the below graph and proceeds to write: 

Seeing as Non-Discretionary goods price inflation has averaged well above the SARB’s price inflation target of 6% for most of the past seven years, low income groups’ standards of living are falling at a compounded rate relative to high income earners. [Emphasis mine.]

I don’t have the raw data to hand, but eye-balling the chart it doesn't seem at all obvious to me that non-discretionary goods have “averaged well above” the 6% inflation target. (Does it seem obvious to anyone else?) In fact, I’d hazard a guess that it averages a shade below the 6% mark. Certainly, the strongest statement that we can probably make about this series is that it fluctuates around that general level.

We all agree that no single measure of price changes is perfect. Indeed, it is precisely for this reason that we have constructed so many different indices in the hopes of getting a better sense of how “inflation” is playing out in the economy. Central banks like the SARB choose to follow a preferred metric – like the CPI – for a number of reasons, most of them very sensible. As it happens, the sheer volatility of commodities is a key reason why some CBs prefer “core” to “headline” inflation measures. Trying to conduct monetary policy in response to a simple basket of commodity prices would not only be incredibly difficult due to the inherent volatility (and the fact that the CB is more or less powerless to  stop these short-run swings), but potentially counterproductive because of the amplifying effect that it could have on consumption cycles. (For more discussion, see Matt Rognlie’s excellent posts on this subject: here, here, and here.)

5) As for his final point, that peer review is not superior to insights that bring in paying clients… Well, clearly that is not what I meant by “cracking” the problems of identifying a causal link between price increases and the uprisings in the Arab world. (Mind you, if he did accurately predict these events in advance of them happening then I certainly am impressed.) So, while I regard the profit mechanism as essential as the next economist, that has nothing to do with my concerns about getting to grips with some very obvious identification problems. That said, allow me to make a broader concluding remark: Just as no-one should suggest that peer-review is infallible, we should never confuse profitability with validity. Even psychics have been doing a roaring trade for centuries. It doesn't make them right.

Did monetary expansion cause the Arab Spring?

South Africa's top economic and financial daily, Business Day, ran an article yesterday referring to research conducted in part by my old school friend and occasional commentator on this blog, Chris Becker.

Proof that high inflation leads to more public violence 

NEW research appears to show a direct link between inflation and social violence. In the months before the Marikana massacre, in which more than 30 miners died, there was a spike in nondiscretionary inflation — the inflation the poor experience — from 3% to more than 10%. The same is true of the xenophobic attacks in 2008. Just before these attacks, nondiscretionary inflation surged to 20%. The recent violence in Sasolburg was also preceded by an acceleration in inflation.

One might blanch at the definitive description (i.e. "proof") given to an in-house research document that, as far as I can tell, is unscrutinised by outside review. Certainly, I can immediately think of a host of problems that would need to be accounted for before we even begin to talk about proper causation.

That said, I don't doubt that food shortages and price hikes can, and do, trigger civil unrest and social upheaval. The idea is eminently plausible and there have been many attempts to quantify this relationship (more on this below). I commend Chris for trying to establish a more systematic understanding of the issue in the South African context.

However, I find it striking that this particular article makes no mention whatsoever of the real factors that have been driving high food prices in recent years. You know, massive crop failures due to historic droughts in the former Soviet Union, North America, and elsewhere... That kind of thing. In fact, here's a timely case study on South Africa that pinpoints these exact issues, which is itself part of a broader research programme linking food riots and political instability to agricultural supply-side shocks (in particular, those related to climate).

In contrast, the singular premise of the above BD article seems to be that food hikes -- and subsequent violence -- are entirely the fault of "delinquent" monetary policy.[*] I'm certainly not suggesting that loose monetary policy can't lead to inflation. Rather, the failure to acknowledge these severe real shocks makes any kind of simple analysis very misleading. (I should say that I am going strictly on the article here; Chris and his co-authors may well try to account for real factors in their actual research. At least, I sincerely hope so.) 

However, my faith in journalistic competence is somewhat shaken by the inevitable reference to -- you guessed it -- Shadowstats, the preferred purveyor of hyperinflation statistics for conspiracy theorists freedom lovers everywhere!™ Furthermore, statements like "The conclusion[...] is inescapable: inflation leads to violence" are more or less misleading in the same sense as the suggestion that increasing the temperature of your bath water will lead to you being boiled alive. There may may a kernel of truth therein, but it is clearly important to recognise that this is a matter of degree.

The passage that really caught my eye, however, was the following.

Becker conducted similar research internationally and found that countries experiencing the highest levels of social upheaval, such as Syria, Tunisia, Egypt and Algeria, embarked on huge monetary expansion in the months before the outbreak of violence. This monetary expansion translated into sharp increases in inflation just before the outbreak of violence. In Egypt and Tunisia, the violence culminated in the overthrow of the previous governments.

Woah. Let's just back up there a bit. We are now treading very dangerous territory as far as correctly identifying causation goes. It strikes me as as borderline irresponsible to intimate that the proximate cause of the "Arab Spring" was loose monetary policy. There are a myriad, interwoven factors at play and it would take a highly skilled statistician, armed with reams of data, to tease out the underlying drivers from concurrent symptoms. The fact is I've yet to see a paper on this subject make it through the peer-review process to journal publication... and I'm pretty certain that this is precisely due to the difficulties in attributing causation. With respect to my friend, I'm not convinced that he has managed to crack the problem that has stymied so many others.

I'll leave you with a final thought on this question of monetary expansion and the Arab Spring. A quick Google search on the topic throws up an article by Andrew Lilico that appeared in The Telegraph: How the Fed triggered the Arab Spring uprisings in two easy graphs (4 May 2011).  After demurely suggesting that most analysts are simply too afraid or short-sighted to "join the dots between the Federal Reserve’s second phase of quantitative easing and these revolutions [in the Middle East and North Africa]", Lilico bravely plunges forth to do exactly that. True to his word, he also produces two graphs, the most important of which appears below.

Now, I don't know about you, but that graph seems to show a rise in food prices that precedes the Fed's sharp increase in asset purchases... by several months. I am glad to report that this discrepancy wasn't lost on readers at the time. One commentator sardonically observes: "In my experience causes occur before effects."

It is a matter of some debate among economists how inflation manifests itself in the economy during times of monetary expansion. (E.g. Some of you may recall the rather heated discussions on Cantillon Effects that occurred in the blogosphere only recently.)  Well, it is a relief to know that the issue has been resolved thanks to the careful work of Mr Lilico. It turns out that expansionary U.S. monetary policy is so potent that it can positively impact the price of global commodities with a negative lag of several months!

Note (13/02/13): Follow-up here.

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[*] To be clear, South Africans have also experienced sharp increases in the cost of amenities like electricity and water provision due to some boneheaded policy decisions and as a legacy of inefficient parastatal monopolies. I've covered these issues numerous times before on this blog and elsewhere.

Quote of the Week - Schadenfreude

"[T]he British are the only people who indulge in schadenfreude – pleasure derived from another’s misery – about themselves."

An oldie, admittedly, but nicely recycled in this Vox EU article by Tim Besley and John van Reenen.

A question for Nassim Taleb fans

I read an interesting article last night, detailing a public exchange between Daniel Kahneman and Nassim Taleb.

[E]ach man was asked to write a biography of seven words or less. Taleb described himself as: “Convexity. Mental probabilistic heuristics approach to uncertainty.” Kahneman apparently pleaded with the moderator to only use five words, which were: “Endlessly amused by people’s minds.” Not surprisingly these two autobiographies are descriptive of the two men’s bodies of work. Much of the discussion at this event, however, was not about making decisions under uncertainty, but a sort of tit for tat, with Kahneman asking probing questions and making pointed observations of Taleb. Little of the Nobel laureate’s [i.e. Kahneman's] work was discussed.

It would seem that Kahneman had Taleb on the back foot at various times during the exchange, pointing out (among other things) that the latter's framing of situations suffered from a clear "anchoring" bias. 

The above article also reminded me of a lingering question that I have about Taleb's work -- not least of all because it relates to the type of research that made Kahneman famous (i.e. the limits of heuristics in the face of statistical problems). Having failed to get any responses to my query on Twitter, I'd like to try and flesh it out here.

Let me state up front that I have yet to read, in full, any of Taleb's books. (They are patiently waiting on my kindle.) However, I have read several chapters from them and, moreover, a number of the articles that Taleb has penned in different media outlets. For instance, this essay for Edge magazine which seems to nicely sum up his position. 

So, I'm reasonably confident that I know where Taleb is coming from. I should also say that I think some of his points are very well made. Such as the "inverse problem of rare events" -- basically, that it is incredibly difficult to gauge the impact of extremely rare events exactly because they occur so infrequently. We lack the very observations that are needed to build up a decent idea of the probability distribution of their associated impact. As Taleb explains in the Edge essay: "If small probability events carry large impacts, and (at the same time) these small probability events are more difficult to compute from past data itself, then: our empirical knowledge about the potential contribution -- or role -- of rare events (probability × consequence) is inversely proportional to their impact."[*]

My reading of Taleb also leads me to think that he that he more or less regards everyone as blind to "black swan" (low probability, high impact) events. If that is true, however, I'm wondering how he squares that notion with the consistent empirical finding that people tend to overestimate the likelihood of low probability, high impact events. (And vice versa for more common, low impact events.) Consider the following chart, for example, which was originally produced in a seminal study by Lichtenstein et al. (1978):

Relationship between judged frequency and actual number of fatalities per year for 41 causes of death.

What we see here is that people have a clear tendency to overstate -- by an order of several magnitudes -- the relative likelihood of death arising due to "unusual and sensational" causes (tornadoes, floods, etc). The opposite is true for more mundane causes of death like degenerative disease (diabetes, stomach cancer, etc).

Similarly, have a look at Table 2 (p. 19) in this follow-up study by the same authors, where various groups of people were asked to rank the relative risks of different technologies. We clearly see a incompatibility between the opinions of experts and those expressed by laymen. For example, nuclear power is perceived to be far more risky by members of the general public than by those familiar with the actual number of fatalities and diseases brought on by this technology.

Now, Taleb might respond by that saying these are the exactly the type of misleading comparisons that he is talking about! He could argue that the "actual" observed fatalities are not necessarily an accurate representation of the underlying risks. After all, a single major event could significantly alter the average number of deaths of any particular cause (e.g. nuclear meltdown)... 

Well, perhaps, but I'm not totally convinced. For one thing, that says very little about the flipside of this problem, which is the degree to which "normal" causes of death are underestimated -- both in absolute terms and relative to more sensational outcomes. Second, by now we have accumulated decent data on numerous low-probability events that have occurred (rare as they are), from the outbreak of plague to massive natural disasters. Third, even disregarding my previous points, it doesn't seem at all obvious to me that the public is guilty of consistently underplaying the role of black swan events. Indeed, if anything they appear to be using a heuristic which causes them to significantly overestimate the likelihood of rare events.... Perhaps as a way of adjusting for the -- unquantifiable? -- impact that these outcomes could have if they do occur?

To restate my question then to those of you that know Taleb better than myself: Does he ever integrate (or reconcile) his theory about the ignorance of black swan events with the empirical evidence that people consistently overestimate the likelihood of low probability, dramatic outcomes?

UPDATE: This post appears to invoked Taleb's ire in somewhat amusing fashion. See follow-up here.
UPDATE 2: Second follow-up and some big name support of my basic point here.

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[*] This type of unquantifiable uncertainty happens to be a big area of research in the climate change literature. In particular, the 'dismal theorem' proposed by Marty Weitzman, whom I have mentioned numerous times before on this blog. See here for more.

Backyard (royal) skulls

People seem to be pretty excited by the discovery of Richard III's skeleton underneath a Leicestershire car park. I suppose this would be quite interesting in of itself, but a personal development has elevated these events to a profound significance which is altogether unexpected. That is: Me getting my grubby little paws on Frightened Rabbit's new album, Pedestrian Verse, and the subsequent non-stop playing of "Backyard Skulls" (amongst others).

Let me put that into plainer words: I read about Richard III's skeleton being discovered under a parking lot at the precise moment that I was listening to a tune called "Backyard Skulls".

Coincidence?
I think not!

So, while some may call it serendipity, I think my listening efforts clearly played some kind of cosmic role in unearthing the ancient regent's bony remains. And, guided as I am here by the divine hand of blogging fate, I feel it is only fitting to share with you:

All our secrets are smothered in dirt, underneath paving stones

Lying waiting to be told

Some stay hidden, whilst some get found

Like our long lost soul, like a skull beneath the ground

Backyard skulls, deep beneath the ground

All those backyard skulls, not deep enough to never be found

Fear lies the first time that I was wrong

But there is still no sign, no X's mark the spot

The ancient encounters with foreign skin

All but perish by now, guess you can't erase the grin 
From those...

Backyard skulls, deep beneath the ground

All those backyard skulls, not deep enough to never be found

Through the patio doors, lies century upon century

The scars untold, has hushed the suburban adultery

And below our homes, and underneath the worms we feed

Like silent skulls, are smiling at the hypocrisy

Backyard skulls, deep beneath the ground

All those backyard skulls, not deep enough to never be found

Backyard skulls, deep beneath the ground

All those backyard skulls, not deep enough to never be found

Deep enough to never be found

Deep enough to never be found

PS - On the subject of Pedestrian Verse, I might put out a sneaky album review later in the week. (Short review: It's brilliant. Buy it.)