Thursday , February 21 2019
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David Andolfatto

David Andolfatto

The views and opinions expressed by me in this blog are my own and should in no way be attributed to the Federal Reserve Bank of St. Louis, or to the Federal Reserve System.

Articles by David Andolfatto

Is Neo-Fisherism Nuts?

3 days ago

According to my friend and former colleague Steve Williamson, inflation is low in Japan because of the Bank of Japan’s policy of keeping its policy rate low. Accordingly, if the BOJ wants to hit its 2% inflation target, it should raise its policy rate and keep it persistently higher. This is what I’ve called the NeoFisherian proposition. It’s a provocative idea because it flies in the face of conventional wisdom. But is it correct? Does it serve as a practical guide for monetary policy? My feeling is that the answers to these questions are "no" and "no." In what follows, I explain why.At some point in their undergraduate career, students of macroeconomics are introduced to the Fisher equation. The Fisher equation usually stated as R = r + π or, in words:
Nominal Rate of Interest = Real

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When is more competition bad?

January 11, 2019

Contrary to popular belief, standard economic theory does not provide a theoretical foundation for the notion that "competition is everywhere and always good." It turns out that legislation that promotes competition among producers may improve consumer welfare. Or it may not. As so many things in economics (and in life), it all depends.I recently came across an interesting paper demonstrating this idea by Ben Lester, Ali Shourideh, Venky Venkateswaran, and Ariel Zetlin-Jones with the title "Screening and Adverse Selection in Frictional Markets," forthcoming in the Journal of Political Economy.The paper is written in the standard trade language. Like any trade language, it’s difficult to understand if you’re not in the trade! But I thought the idea sufficiently important that I asked Ben

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Racial Diversity in the Supply of U.S. Econ PhDs

December 25, 2018

This post is motivated by Eshe Nelson’s column "The Dismal Cost of Economics’ Lack of Racial Diversity." I was especially struck by this data — out of the 539 economics doctorates awarded to U.S. citizens and permanent residents (by U.S. institutions), only 18 of the recipients were African-American.

I thought it would be of some interest to see what the data looks like more broadly over other groups and over a longer period of time. I thank my research assistant, Andrew Spewak, for gathering this data (from the National Science Foundation). Let’s start with the raw numbers first. The data is aggregated into 5-year bins beginning in 1965 and up to 2014. The orange bars represent the number of econ PhDs awarded to U.S. citizens and permanent residents (by U.S. institutions) over a

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Does the Fed have a symmetric inflation target?

December 23, 2018

It’s well-known that the Fed has been undershooting its inflation 2% target every year since 2012 (ironically, the year it formally adopted a 2% inflation target). This has led some to speculate whether 2% is being viewed more as a ceiling, rather than a target, as it is with the ECB. The Fed, however, continues to insist that not only is 2% a target, it is a symmetric target.  But what does this mean, exactly? And how can we judge whether the Fed has a symmetric inflation target or not?These questions came to me while listening to Jay Powell’s recent press conference following the FOMC’s decision to follow through with a widely anticipated rate hike. At the 16:15 mark, reporter Binyamin Appelbaum (NY Times) asked Powell the following question:
BA: You’re about to undershoot your

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Working More for Less

December 6, 2018

I had an interested chat with a colleague of mine the other day about the labor market. In the course of conversation, he mentioned that he used to teach a class in labor economics. Naturally, an important lesson included the theory of labor supply. Pretty much the first question asked is how the supply of labor can be expected to change in response to a change in the return to labor (the real wage). My colleague said that for years he would preface the theoretical discussion with a poll. He would turn to the class and ask them to imagine themselves employed at some job. Then imagine having your wage doubled for a short period of time. How many of you would work more? (The majority of the class would raise their hands.) How many of you would not change your hours worked? (A minority of

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Does the Floor System Discourage Bank Lending?

December 3, 2018

David Beckworth has a new post up suggesting that the Fed’s floor system has discouraged bank lending by making interest-bearing reserves a relatively more attractive investment; see here. I’ve been hearing this story a lot lately, but I can’t say it makes a whole lot of sense to me.Here’s how I think about it. Consider the pre-2008 "corridor" system where the Fed targeted the federal funds rate. The effective federal funds rate (FFR) traded between the upper and lower bounds of the corridor–the upper bound given by the discount rate and the lower bound given by the zero interest-on-reserves (IOR) rate. The Fed achieved its target FFR by managing the supply of reserves through open-market operations involving short-term treasury debt.Consider a given target interest rate equal to (say)

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Smart Contracts and Asset Tokenization

November 8, 2018

Book of Smart Contracts 1959
In his 1959 classic Theory of Value, Gerard Debreu takes a deep dive into general (Walrasian) equilibrium theory. (Yes, I know, but please try to stay awake for at least a few more paragraphs.)He studies a very stark hypothetical scenario where people are imagined to gather at the beginning of time and formulate trading plans for a given vector of market prices (called out by some mysterious auctioneer). Commodities can take the form of different goods, like apples and oranges. But they can also be made time-contingent and state-contingent. An apple delivered tomorrow is different commodity than an apple delivered today. An orange delivered tomorrow in the event of rain is different commodity than an orange delivered tomorrow in the event of sunshine. And so

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What is the yield curve forecasting?

September 24, 2018

It’s well-known that in the United States, recessions are often preceded by an inversion of the yield curve. Is there any economic rationale for why this should be the case? Most yield curve analysis makes reference to nominal interest rates. Economic theory, however, stresses the relevance of real (inflation-adjusted) interest rates. (The distinction does not matter much for the U.S in recent decades, as inflation has remained low and stable). According to standard asset-pricing theory (which, unfortunately for present purposes, abstracts from liquidity premia), the real interest rate measures the rate at which consumption (a broad measure of material living standards) is expected to grow over a given horizon. A high 1-year yield signals that growth is expected to be high over a

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The Trust Machine: The Story of Bitcoin

July 7, 2018

I came across a presentation of Bitcoin the other day called The Trust Machine: The Story of Bitcoin.  I thought it was very nice and I encourage anyone who’s interested in Bitcoin to view it (less than 25 minutes). What I offer below are questions and comments that came to my mind as I listened to the narrative. I’d recommend listening to the entire presentation first and then reading my comments below. The bold numbers represent the corresponding time in the video to which the remark pertains.
1:04 Before Bitcoin, the only way to make electronic payments over the Internet was via your bank. However, over 2 billion people in the world do not have access to a bank account.  
Sure, but why is Bitcoin the best solution for this problem? Nobody was connected to their bank accounts

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Inflation and Unemployment (Part 2)

March 29, 2018

In my previous post (Inflation and Unemployment), I reviewed what I thought was a fair characterization of the way the Federal Reserve Board staff organize their thinking about inflation and unemployment, as well as how this view of the world was at least partly responsible for the "hawkish" overtone of current Fed policy. I also suggested that the inflation and unemployment dynamic might be better understood through the lens of an alternative theory that emphasized the supply and demand for money (broadly defined to include U.S. treasury debt).I want to thank Paul Krugman for taking the time to critique my post and draw attention to an important issue that concerns U.S. monetary policy makers today (see: Immaculate Inflation Strikes Again). I was only a little disappointed to learn that

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Inflation and unemployment

March 26, 2018

The FOMC decided on March 21 to increase the target band for the federal funds rate by 25 basis points, to a range of 1.50-1.75%. This despite inflation running persistently below the Fed’s 2% target, only moderate wage growth, and inflation expectations firmly anchored.

What is the FOMC thinking here? To be more precise, what is the dominant view within the FOMC that is driving the present tightening cycle? Remember, the FOMC is made up of 12 regional bank presidents plus 7 board of governors (at full strength) possessing a variety of views which are somehow aggregated into a policy rate decision. I think it’s fair to say that the dominant view, especially among Board members, is heavily influenced by the Board’s staff economists. So, maybe what I’m really asking is: what is the Board

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What anchors inflation?

March 19, 2018

Conventional wisdom is that a central bank can anchor the long-run rate of inflation to a target of its own choosing. This belief is evident where ever a government has charged its central bank with a "price stability" mandate (commonly interpreted nowadays as keeping a consumer price index growing on average at around 2% per annum over long periods of time).
What exactly is the mechanism by which a central bank is supposed to control the long-run rate of inflation (the growth rate of the price-level)? And is it really the case that a central bank can defend its preferred inflation target without any degree of fiscal support?
Asking these questions reminds me of the old joke of an economist as someone who sees something work in practice and then asks whether it might also work in theory.

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The recession of 2012-13 and the taper tantrum

February 22, 2018

I admit this is a rather strange title for a post, but bear with me. Every once in a while I reflect back on the so-called "taper tantrum" event in the summer of 2013 when Fed Chair Ben Bernanke made an off-the-cuff remark that the FOMC was thinking of maybe slowing down the pace QE3 asset purchases (see here). The stock market had a temporary sell-off, which turned out to be no big deal. What I find more interesting is how long bond yields rose sharply and persistently. Even more interesting, real bond yields behaved in this manner–see the figure below.

OK, so maybe the initial sell-off of bonds could be interpreted as the market being surprised that QE3 (an open-ended program) might terminate earlier than expected. But I just can’t believe that QE programs can have such persistent

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U.S. GDP Expenditure Components

February 19, 2018

One way to decompose the GDP is in terms of its expenditure components, Y ≡ C + I + G + NX. I like to write "≡" instead of "=" to remind myself that this decomposition is measurement, not theory.
 

In what follows, consumption is measured in terms of nondurables and services only–I add consumer durables with private investment. The data is inflation-adjusted, quarterly, and I report year-over-year percent changes. I’ll start with recent history (since 2010) and then later look at a longer sample (beginning in 1960).

 

Let me begin with GDP and consumption. I like to study consumption dynamics because I have some notion of Milton Friedman’s "permanent income hypothesis" in the back of my mind. The idea is that individuals base their expenditures on nondurable goods and services more

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Fiscal theories of the price-level

February 9, 2018

This post is me thinking out loud about how fiscal considerations may influence the price-level.  The question of what determines the price-level is an old one. It’s a question that economists struggle with to this day.

To begin, what do we mean by the price-level? Loosely, the price-level refers to the "cost-of-living," where cost is measured in units of money. Living refers to the flow of services consumed (destroyed) for the purpose of survival/enjoyment. (Note that the cost-of-living might alternatively be measured as the amount of labor one must expend per unit of consumption, but this would require a separate discussion.)
Measuring aggregate material living standards is challenging for two reasons. First, people consume a variety of goods and services. Suppose that the price of

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Blockchain: what it is, what it does, and why you probably don’t need one

January 21, 2018

Dilbert – by Scott AdamsInterest in blockchain is at a fever pitch lately. This is in large part due to the eye-popping price dynamics of Bitcoin–the original bad-boy cryptocurrency–which everyone knows is powered by blockchain…whatever that is. But no matter. Given that even big players like Goldman Sachs are getting into the act (check out their super slick presentation here: Blockchain–The New Technology of Trust) maybe it’s time to figure out what all the fuss is about. What follows is based on my slide deck which I recently presented at the Olin School of Business at a Blockchain Panel (I will link up to video as soon as it becomes available) Things are a little confusing out there I think in part because not enough care is taken in defining terms before assessing pros and

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Lowflation: Then and Now

January 10, 2018

The term "lowflation" was initially coined by economists at the IMF in 2014 (see here). It refers to an inflation rate that is persistently low (relative to some target) but positive. Here is what lowflation looks like in the United States:

How should we think about lowflation? I’ve written a bit on the subject here and here. Is the phenomenon unusual? Is it something we should worry about?As it turns out, the phenomenon is not unusual even in recent U.S. monetary history. The following diagram plots the PCE core inflation rate for the United States since 1960. The shaded areas represent "lowflation" episodes–periods in which PCE core inflation is below 2%.

The early 1960s was also an era of lowflation. So was the more recent period 1996-2003. The period 2004-2008 pf (slightly

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Fedcoin and blockchain

December 27, 2017

I see Campbell Harvey promoting the idea of Fedcoin here: "Bitcoin is Big. But Fedcoin is Bigger." I’m not sure I agree with his pitch for the idea.Let’s start with Harvey’s claim that
"Bitcoin and other cryptocurrencies are based on a complicated technology known as blockchain, which acts like a digital ledger of all transactions completed with the currency."
Complicated? Well, yes and no. As I explain here "Why the blockchain should be familiar to you," there’s a sense in which blockchain technology–a growing record of communal history existing on a distributed virtual ledger updated via a communal consensus algorithm–is an ancient innovation. Indeed, I claim that most of our small-group social interactions today still make extensive use of blockchain technology. Of course, the

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My perspective on the Bitcoin Project (collected works)

December 21, 2017

It’s true, I really did say that.It’s Christmas time and I’m in a giving mood. So I thought I’d collect all my writings and talks related to Bitcoin and blockchain in one easy-to-access spot.
Like many people, I first took notice of Bitcoin in 2013, after its price soared to over $1000, before plummeting significantly. Thank goodness I didn’t buy any back then (D’oh!). Many economists dismissed the phenomenon as just another bubble/scam. This was my initial instinct as well, but after checking under the hood, I discovered something intriguing and worth learning more about.

Bitcoin/blockchain is generally much better understood today than it was back then, although an air of mystery persists. But the concept is not very complicated at all, even if the underlying mechanics

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The Great American Slump (update)

December 18, 2017

I detect some chatter out there concerning the recent "unexpected" rise in the U.S. labor force participation rate. The discussion is related mainly to the question of whether the labor market has fully recovered from the effects of the Great Recession. I suggested back in 2010 (here) that American recovery dynamic might be a prolonged one, at least, taking the Great Canadian Slump as a model. I updated that analysis here in 2016. In light of the recent discussion, I thought I’d see where we stand today.Here is EPOP (employment-to-population ratio) for Canada (beginning in 1990) and the United States (beginning in 2008).  
The two series bear a striking resemblance 40 quarters (10 years) out. Here is what the picture looks like when we restrict attention to the prime-age (15-54)

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Interpreting the yield curve

November 27, 2017

There’s been a lot of talk lately about the flattening of the yield curve, what’s causing it, and what it portends. In this post, I describe a simple "neoclassical" theory of the yield curve and ask to what extent it serves as a useful guide for our thinking on the matter.
 
Let’s start by defining terms. Let I(m) denote the yield (market interest rate) on (say) a U.S. treasury bond with maturity m. So, I(1) denotes the yield on a one-year bond and I(10) denotes the yield on a ten-year bond. The slope (S) of the yield curve is given by the difference in yields between long and short bonds. In this example, S = I(10) – I(1). Here’s what the yield curve looks like for the U.S. since 1961.

Normally, the slope of the yield curve is positive. But occasionally, it turns negative — an

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Tyler Cowen on Central Bank Cryptocurrencies

November 25, 2017

I enjoy reading Tyler Cowen and have learned a lot from his columns. So before I criticize his most recent effort, I want to thank him for all his fine contributions! Unfortunately, I think he drops the ball a little bit on his most recent effort. No worries–we all do sooner or later. What follows are some thoughts that came to my mind as I read his most recent article entitled "Cryptocurrencies Don’t Belong in Central Banks." My (unedited/uncensored thoughts are recorded in blue…Tyler, take note: "uncensored"= risk-taking central banker!) 

Should central banks embrace cryptocurrencies, or even pioneer their own? In a nutshell, no. Crypto assets are an unusual innovation, still in flux and often poorly understood. Trying to centralize them in a bureaucracy is exactly the wrong way

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A monetary-fiscal theory of inflation

August 6, 2017

On December 17, 2015, the FOMC has raised its policy rate (IOER) from 25bp to 50bp. It has since raised the IOER rate three more times to 1.25%. Many on the committee seem convinced that further rate hikes are needed (in addition to actions designed to shrink the Fed’s balance sheet, which is already shrinking relative to the size of the economy). What is the source of this enthusiasm for monetary policy tightening, given that the unemployment rate is close to target, and given a PCE inflation rate that has been undershooting the Fed’s 2% inflation target for several years now? The short answer is the Phillips curve. Or, to be more precise, a belief in the Phillips curve theory of inflation. The basic idea is that at very low rates of unemployment, competition for workers will lead to

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Where’s the inflation?

August 3, 2017

The PCE inflation rate in the United States has been consistently below the Fed’s official 2% target for many years now. Equally persistent are the forecast errors of those who have expected inflation to rise to its target level (and possibly beyond). What accounts for the missing inflation? In a recent NYT article, Binyamin Appelbaum mentions four theories of inflation: (1) Monetarist, (2) Phillips Curve, (3) Expectations, and (4) Internationalist. Let me briefly describe and comment on these four views.Monetarist. The price-level is determined by the supply of money relative to the demand for money. Inflation (the rate of change in the price-level) is therefore determined by the rate of growth of the money supply net of the rate of growth in the demand for money (often proxied by the

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The St. Louis Fed’s Macroeconomic Outlook

April 19, 2017

St. Louis Fed president James Bullard recently gave this speech on the U.S. macroeconomic outlook. The key themes of his talk were:The U.S. economy has converged to a low-growth, low-safe-real-interest-rate regime, a situation that is unlikely to change dramatically over the near future;
The Fed can afford to take a wait-and-see posture in regard to possible changes in U.S. fiscal and regulatory policies;
The U.S. policy rate can remain relatively low for now and that doing so is consistent with the dual mandate;
Now may be a good time for the FOMC to consider allowing the balance sheet to shrink in nominal terms.

What does Bullard have in mind when he speaks of a low-growth "regime?" The usual way of interpreting development dynamics is that long-run growth is more or less stable and that deviations from this stable trend represent "cyclical" mean-reverting departures from trend. And if it’s "cyclical," then it’s temporary–we should be forecasting reversion to the mean in the near future–like the red forecasting lines in the picture below.

This view of the world can lead to a series of embarrassing forecast errors. Since the end of the Great Recession, for example, you would have forecast several recoveries, none of which have materialized. But what if that’s not the way growth happens? Suppose instead that growth occurs in decade-long spurts? Something like this.

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Sectoral and Occupational Trends in the U.S. Labor Market

April 15, 2017

The labor market is back to normal. Or so we are told. Here’s the prime-age unemployment rate for the United States beginning in 1960.

Above we see the familiar cyclical asymmetry, in which the unemployment rate spikes up sharply at the onset of a recession and declines gradually during the recovery. As of today, the prime-age unemployment rate is at 4%, close to its recent historical norm. 

Other measures of labor market activity, however, tell a slightly different story. Here is the prime-age employment-to-population ratio. Employment took a big tumble during the recession–especially for males–and its taken a lot longer to recover than unemployment. In fact, we’re not quite back to pre-recession average of about 80%. 

The reason employment has recovered more slowly than unemployment is because significant numbers of prime-age workers left the labor force in the aftermath of the Great Recession. This pattern has reversed only recently.

By these standard measures of aggregate labor market activity, the U.S. labor market appears close to "full employment." Nevertheless, there is still much anxiety concerning the present state and future course of the U.S. labor market. Much of this anxiety stems from the perennial concerns regarding the impact of international trade and technology on future employment opportunities.

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Fiscal over monetary policy?

April 8, 2017

The Economy May Be Stuck in a Near-Zero World (Justin Wolfers).Justin does a good job describing how many economists view the role of monetary and fiscal policy in the post Great Recession world of low interest rates and low inflation. I am curious to know where I agree and disagree with what he says. So, here goes.[T]he real (inflation-adjusted) interest rate consistent with the economy operating at its full potential has fallen…from around 2.5 percent to 1 percent, or lower.I think this is true. I also do not think it’s surprising that the "natural rate of interest" (r*) fluctuates and that its trend path may shift over time. Indeed, I’d be surprised to learn this was not the case. According to standard macroeconomic theory, r* should follow the trend in consumption growth. The basic idea is simple. If the economy is expected to grow rapidly, people will want to save less (or borrow against their higher future income) in order to smooth their consumption. Collectively, their efforts to consume more and save less puts upward pressure on the real interest rate. The converse holds true if pessimism reigns: people will want to save more, to make provisions against a bleak future. Collectively, the effect is to depress the real interest rate.Of course, we cannot observe r*. But theory suggests it should be roughly proportional to consumption growth.

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A reply to Lawrence White

March 1, 2017

People are generally not accustomed to the idea of a central bank altering the maturity structure of outstanding government debt in a manner that might confer a financial benefit to the government (and by extension, to the citizens it represents). The purpose of my previous post was to make people aware of this possibility, using the recent experience of the Federal Reserve’s quantitative easing (QE) program as an example.The gist of my story went something like this. Suppose that the Fed makes a one-time purchase of a 10-year treasury bond yielding a risk-free 2.5% annual nominal coupon. Suppose that the purchase is financed by "printing" reserves. (Note, this asset purchase and method of finance describes the basic nature of QE). Suppose further that the interest paid on reserves remains below 2.5% for the duration of the bond. Then the Fed makes a profit off the rate of return differential in each of the 10 years it holds the bond on its books. If I understand my critics correctly, none would dispute the financial benefit associated with this Fed intervention as far as the public purse is concerned; at least, as long as it is somehow known ex ante that the short rate will remain below the long rate in the manner assumed.

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A public finance case for keeping the Fed’s balance sheet large

February 15, 2017

Former Fed Chair Ben Bernanke recently asked a question concerning the optimal long-run size of the Fed’s balance sheet (Should the Fed keep its balance sheet large?). Bernanke comes down on the side of "keeping the balance sheet close to its current size in the long run." While he does not explicitly say how "size" is defined, I think it’s clear he means the size of the balance sheet measured relative to the size of the economy (say, as measured by nominal GDP). According to this measure of size, the Fed would have to grow its balance at the rate of nominal GDP growth. In addition to the reasons reported by Bernanke, I think there’s a public finance argument to be made for keeping the Fed’s balance sheet large–at least, under certain conditions–like ensuring that the inflation mandate is met. Let me explain. Let’s begin with a picture that most people are familiar with. 

Prior to 2008, the Fed’s balance sheet was under one trillion dollars in size. Prior to 2008, it grew roughly at the same rate as the economy. Most of these assets consisted of short-term U.S. treasury securities. Most of these asset acquisitions were financed with zero-interest money (currency in circulation). Since 2008, the Fed’s balance sheet has grown to 4.5 trillion dollars. The composition of assets has moved away from short-term government debt to longer-term debt and mortgage-backed securities.

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Can the blockchain kill fake news?

December 30, 2016

Bloomberg View columnist Megan McArdle has an interesting article on fake news: Fact-Checking’s Infinite Regress Problem. Fake news constitutes blocks of information fabricated either wholly or in part from falsehoods to serve a political end. It is an act of commission, as opposed to a related act of omission: reporting blocks of true information chosen selectively to serve a political end.

A natural response to the problem of fake news is the emergence of fact-checkers. But on what basis are these elected or self-appointed fact-checkers to be trusted? Who will guard the guardians? The solution cannot be to appoint another layer of super-fact-checkers, since this process results in an infinite regress. Ultimately, the solution will have to reside in an answer like: "The guarded must guard the guardians." Fake news–or fake history, for that matter–is not something new. Every society is built on a store of publicly accessible information–a shared history–that evolves over time. But who is assigned write-privileges to this public ledger and how can they be trusted? How can we be sure that Caesar, for example, didn’t fabricate much of what is recorded in his Commentaries? This the problem with public ledgers where everyone has a write-privilege, as we do with the Internet. But the problem is an ancient one.

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