Wednesday, July 22, 2015

Monetary Testimony

I was invited to testify at the Subcommittee on Monetary Policy and Trade of the House Financial Services Committee on Wednesday. I had only done this once before and it was a very interesting experience.

The proposed bills my fellow panelists (John Taylor, Don Kohn, and Paul Kupiec) and I were testifying on  were the Centennial Monetary Commission Act of 2015 and the Federal Reserve Reform Act of 2015. The bills, transcripts, and all testimony are here.

Needless to say, the Taylor Rule was the star of the show, and proposals to restructure the Fed a close second. I let the experts, John Taylor and Don Kohn, talk about those issues. I emphasized that the Fed is a lot more than pushing interest rates around these days, and worries about a lot more than inflation and unemployment. So the whole rules, discretion, independence, etc. debate should encompass financial regulation and macro-prudential policy.

I also think the view that this is an attack on the Fed is wrong. The Fed should welcome limits on its responsibilities, and a clear and happy arrangement with Congress.

I found the level of discussion from the congresspeople overall remarkably thoughtful. And I found the bills themselves quite interesting. Obviously I don't agree with every word of the bills, but this is all a work in progress but an interesting and important work.

Some surprises in the Federal Reserve Reform Act,
‘‘(1) IN GENERAL.—Before issuing any regulation, the Board of Governors of the Federal Reserve System shall—
  • (A) clearly identify the nature and source of the problem that the proposed regulation is designed to address and assess the significance of that problem;

  • (B) assess whether any new regulation is warranted or, with respect to a proposed regulation that the Board of Governors is required to issue by statute and with respect to which the Board has the authority to exempt certain persons from the application of such regulation, compare—

    • (i) the costs and benefits of the pro- posed regulation; and

    • (ii) the costs and benefits of a regulation under which the Board exempts all persons from the application of the proposed regulation, to the extent the Board is able;...

  • (E) ensure that any proposed regulation is accessible, consistent, written in plain language, and easy to understand and shall measure, and seek to improve, the actual results of regulatory requirements.
So, the Fed is allowed and encouraged to say, The Dodd Frank act requires regulation xyz, but, after analysis, we think the whole rule is silly so we'll pass it for show and then exempt everyone from it.

Plain language is great. I wonder if one can challenge a regulation in court because it was required to be written in plain language?

That last clause is important. The Fed must keep track of regulations and retrospectively evaluate them.

In the big picture, there is a lot of discussion of how to unwind the tangle of regulation. This is a fascinating new (to me) approach.

The Monetary Commission bill is likewise a good read. If this gets off the ground, it will be a fascinating debate.  Two excerpts
(11) The Federal Open Market Committee has engaged in multiple rounds of quantitative easing, providing unprecedented liquidity to financial markets, while committing to holding short-term interest rates low for a seemingly indefinite period, and pursuing a policy of credit allocation by purchasing Federal agency debt and mortgage-backed securities. 
(12) In the wake of the recent extraordinary actions of the Federal Reserve System, Congress—consistent with its constitutional responsibilities and as it has done periodically throughout the history of the United States—has once again renewed its examination of monetary policy.
I was pretty crestfallen when I read that, as it is pretty much exactly what I had to say in my testimony (below). But repeating the point in different language seemed useful.

(a) STUDY OF MONETARY POLICY.—The Commission shall—

(1) examine how United States monetary policy since the creation of the Board of Governors of the Federal Reserve System in 1913 has affected the performance of the United States economy in terms of output, employment, prices, and financial stability over time;

(2) evaluate various operational regimes under which the Board of Governors of the Federal Reserve System and the Federal Open Market Committee may conduct monetary policy in terms achieving the maximum sustainable level of output and employment and price stability over the long term, including—

(A) discretion in determining monetary policy without an operational regime;
(B) price level targeting;
(C) inflation rate targeting;
(D) nominal gross domestic product targeting (both level and growth rate);
(E) the use of monetary policy rules; and
(F) the gold standard;

(3) evaluate the use of macro-prudential supervision and regulation as a tool of monetary policy in terms of achieving the maximum sustainable level of output and employment and price stability over the long term;

(4) evaluate the use of the lender-of-last-resort function of the Board of Governors of the Federal Reserve System as a tool of monetary policy in terms of achieving the maximum sustainable level of output and employment and price stability over the long term; and

(5) recommend a course for United States monetary policy going forward, including—

(A) the legislative mandate;
(B) the operational regime;
(C) the securities used in open market operations; and
(D) transparency issues.
This is a pretty sophisticated list. Ok, they didn't add "determinacy in new-Keynesian models," but that's a small shortcoming!  It also includes my call to think of macro-prudential policy in the same breath as interest rates.

The discussion on this one centered on the structure of the committee, with more Republicans than Democrats. One of my proudest moments was to refuse to answer questions about that political makeup. We're economists, you're politicians, don't ask us to opine on political questions. I did say I thought it needed more economists, but everybody laughed.

My verbal remarks and longer written testimony follow. The final thoughts on monetary policy may be provocative enough to keep you going that far.


Verbal Summary

Chairman Huizenga, Ranking Member Moore, and members of the subcommittee: I thank you for the opportunity to testify.

It is wise for Congress to rethink the fundamental structures under which the Federal Reserve operates. I think the Fed wants guidance as much as you want clarity.

The Federal Reserve enjoys great independence, which is widely viewed as a good thing. However, in our democracy, independence must be paired with limited powers. For example, the Fed cannot and does not print up money and give it out, no matter how stimulative such action could be. That is fiscal policy, which you must authorize and the Treasury execute.

Independent agencies should also, as much as possible, implement laws and rules, or at least traditions and precedents. The more an agency operates with wide discretion and sweeping powers, the more it must be supervised by the imperfect, but accountable, political process.

Your hard task is to rethink the limits, rules, and consequent independence vs. accountabilty of the Federal Reserve.

Conventional monetary policy consists of setting short-term interest rates, in response to, and to stabilize, inflation and unemployment. But the Federal Reserve has taken on a wide range of new powers and responsibilities. Even more are being contemplated. My main point today is to encourage you to look beyond conventional monetary policy, and to consider these newly expanded activities, as this pair of bills begin to do.

Even interest rate policy now goes far beyond inflation and unemployment. For example, should the Fed raise rates to offset perceived “bubbles” in stock, bond, or home prices, or to move the exchange rate? I think not. But I have come to stress the question, not to offer my answers.

A rule implies a list of things that the Fed should not respond to, not try to control, and for which you will not blame the Fed in the event of trouble. A rule based on inflation and unemployment says, implicitly, don’t manipulate stock prices. This may be a useful interpretation for you to emphasize.

But the Fed goes far beyond setting short-term interest rates. To address the extreme events of the financial crisis and deep recession, the Fed has bought long-term Treasuries, mortgage-backed securities, and commercial paper, in order to raise their prices directly. Should the Fed continue to try to directly manipulate asset prices? If so, when, under what circumstances, under what rules, or with what supervision and loss of independence?

Since 2008 the Fed’s regulatory role has expanded enormously.  Two examples:

The Fed invented “stress tests” in the financial crisis. They have now become a ritual. The Fed makes up new scenarios to test banks each time.

The Fed now exercises “enhanced supervision” of the “systemically designated” banks, exchanges, and insurance companies. Dozens of Fed staff live full-time at these institutions, reviewing details of their operation.

These operations follow few rules, they involve great discretion, little reporting or supervision from you, and billions of dollars hang on the results. That is not a good long-run combination.

The Fed now contemplates “macro-prudential” policy, combining regulatory and monetary policy tools and objectives.  The Fed will vary capital ratios, loan to value ratios, or other regulatory tools over time, along with interest rates, if it sees emerging “bubbles,” or “imbalances,” or to “stimulate.”  Well, the Fed’s “bubble” is the home-builder’s boom, and builders will will be calling you when the Fed restricts credit. Do you want the Fed to do this? If so with what rules, what limits, and what accountability?

The Reform Act’s  requirements for stress-test transparency, language simplicity, and for cost-benefit analysis are important steps in managing the regulatory explosion. The authorization in Section 8 for the Federal Reserve to exempt all persons from even  Congressionally mandated regulation, if the Fed finds such regulation unwise, is a landmark. But this must be a tool in your oversight. Filling out more mountains of paper will not mechanically improve the process.

These are just a few examples. The Federal Reserve’s scope and powers have expanded dramatically since the financial crisis. That’s understandable. New powers and policies, adopted in crisis, always involve great experimentation and discretion. Now is the time to look forward, and to consider their limits, rules, mandates, goals, and accountability.

And these bills are important first steps.


Written (slightly edited)

Testimony before the Subcommittee on Monetary Policy and Trade of the Committee on Financial Services of the U.S. House of Representatives
Re the Centennial Monetary Policy Commission Act and The Federal Reserve Reform Act

John H. Cochrane
Hoover Institution, Stanford University
July 22 2015

Chairman Huizenga, Ranking Member Moore, and members of the subcommittee: I thank you for the opportunity to testify on these important pieces of legislation.

I am John Cochrane. I am a Senior Fellow of the Hoover Institution, a nonpartisan research institute at Stanford University. I represent my own views only.

It is wise for Congress and the Federal Reserve to rethink the fundamental structures under which the Fed operates. I think that the Fed wants guidance, and a settled relationship with Congress, as much as you want clarity. I view this legislation as an important first step in that process.


Two great principles underlie this effort: Independence and rules.

The Federal Reserve enjoys great independence.  This independence is almost universally  viewed as a good thing.

However, in our democracy, independence must be paired with clearly limited powers. And to the extent the Fed is granted or assumes larger powers, it must lose some of its independence.

For example, the Federal Reserve does not and cannot print money and hand it out, or drop money  by helicopters in Milton Friedman’s famous story.  This kind of “stimulus” would be very powerful. In the depths of the recession, Federal Reserve officials surely would have wanted to do it. Many economists advocated “helicopter drops.” But  the power to write checks to voters in our democracy resides with the Treasury department and Congress. And for obvious reasons. Just who gets the checks and how much are deeply political decisions, and only an Administration and Congress which regularly face the wrath of voters can make them.

We also believe in rules, laws, and rule of law. We believe that independent agencies and their officials should, as much as possible, implement laws and rules, or at least traditions and precedents. They should not issue decrees at their discretion. And the more an agency follows rules, the more limited its powers, the more independent it can be.

Your task, and the Fed’s, is to rethink the limits on Federal Reserve powers, to develop rules, to preserve its independence. And where such limits and rules are not possible, to limit that independence and oversee its decisions in the name of citizens, voters, and taxpayers.


Conventional monetary policy consists of setting short term interest rates, in response to, and with an eye to stabilizing, inflation and unemployment.  Conventional monetary policy was limited to buying and selling short-term Treasuries to affect short-term rates, but will likely consist in the future of simply offering banks higher or lower interest rates on reserves and in loans from the Fed.  You have heard much about rules in this context, and I think the bill before you does a good job of encouraging a fruitful framework for discussion between yourselves and the Federal Reserve.

But that is the tip of the iceberg. In the wake of the financial crisis and deep recession, the Federal Reserve has been given (by the Dodd-Frank act) and has taken on a wide range of new powers and responsibilities. Even more is being hotly discussed, under the label of “macro-prudential” policy. The Fed’s perceived mandates — the central outcomes it should try to control — and its tools — what levers it can pull — have each expanded.

As natural with anything new, this has been a period of great experimentation and thus discretion. But as these experiments merge into regular policy, it is time to bring them in to the usual framework.

My main point today, is to encourage you to look beyond conventional monetary policy, and to consider what rules, mandates, limits, and oversight the Fed will follow in these newly expanded roles, or which of these mandates and tools you wish the Fed to stop pursuing and using.

Interest rate policy now goes beyond inflation and unemployment. The Fed is accused of stoking a housing “bubble” with too low rates in the early 2000s. Now, the big discussion concerns whether the Fed should raise rates to offset a perceived “reach for yield,” high home prices, stock prices and bond prices.

Well, should the Fed be reacting to, or manipulating mortgage rates, exchange rates, and stock, bond, and housing prices? Is it even appropriate for Fed officials to offer opinions on whether stocks are too high or too low?

I think not. There is really no solid economic understanding of any link between the level of short term rates and these other assets. The Fed is as likely to do harm than good, to induce instability in prices from intense speculation about its actions. And manipulating asset prices is an intensely political decision, as the Chinese central bank is finding out, requiring a loss of independence. But I have come to pose the question, not to offer my answers

Perhaps the most important implication of a rule, say linking interest rates to inflation and unemployment, or a mandate, instructing the Fed to stabilize inflation and unemployment, is the long list of things that by implication the Fed should, at least in normal times, not respond, not try to control, and for which you, the Congress, will not hold the Fed responsible. This may be a useful interpretation for you to emphasize.

The Fed’s arsenal of tools now goes far beyond setting overnight rates between banks.

In the recession, the Fed tried to manipulate long-term Treasury rates and mortgage-backed security rates, directly by buying lots of those securities. In the crisis, the Fed also bought commercial paper, to raise those prices. Some central banks buy stocks.

Should the Fed try to manipulate asset prices directly, by buying and selling assets? If so, under what conditions; i.e. with what rules, or with what supervision and loss of independence? Again, I think not. But again, you have to think about it.

Here, the Fed-Treasury separation I praised over fiscal policy has broken a bit. The Treasury’s Office of Debt Management traditionally manages the maturity of government debt in private hands, and thus the Treasury’s exposure to interest rate risk. In the period that the Fed was buying up long-term debt, trying to reduce the amount in public hands, the Treasury was issuing lots of long-term debt, trying to increase it. They each undid the other’s actions. Clearly, some accord is needed over who has responsibility for the maturity structure of the debt.(1)

The Fed is also the prime financial regulator. Since 2008, under the Dodd Frank act, and of its own volition, the Fed’s regulatory role has expanded enormously. “Systemic  stability” is an implicit third or fourth mandate. And the Fed is contemplating “macro-prudential policy,” combining regulatory and expanded monetary policy tools to achieve both macroeconomic and financial goals. What rules and limits will this effort respect?

The Fed now exercises “enhanced supervision” of the “systemically designated” banks, exchanges, and insurance companies. Dozens of Fed staff live full time at these institutions, reviewing details of their operation. This exercise follows few rules, great discretion, and little accountability to you.

The “stress tests” are one example, which this bill begins to address. The Fed made up this procedure in the financial crisis, and it seemed to give confidence in the banks. But this temporary expedient has now become a permanent ritual. The stress tests follow no preset rules. The Fed deliberately tries to surprise the banks with novel tests each time.  The thinking goes, I suppose, that if the banks knew the rules ahead of time, as they know their capital requirements or leverage ratios, they would jigger the books to pass the tests. But the result is a highly discretionary decision by Fed officials, on which billions of dollars and the competitive fortunes of banks rest. That is not a good basis for a permanent policy. I am glad that your bill brings some structure to this enterprise. But not totally glad, as the bill then institutionalizes stress tests and perhaps we should get rid of them instead.

An earlier example is starker. In the robosigning affair, the Federal Reserve joined with the US and states Attorneys General, and used its “safety and soundness” regulatory power to force banks to write down mortgage principal — not on the robosigned homeowners, but on completely unrelated homeowners — and to give money to “nonprofit housing counseling organizations.” Writing down prinicipal — a transfer from bank shareholders to homeowners —  is a fiscal and macroeconomic policy. Whatever its wisdom, it clearly detracts from bank safety and soundness. Though the example is small, I think it provides a clear case of compromised independence, and the use of regulatory powers to effect macroeconomic and fiscal policy interventions. You may or may not approve; you may or may not want the Fed to do such things with complete independence. (2)

The heart of “macroprudential” proposals is the idea that central banks will vary capital ratios, lending standards (loan to value ratios) or other regulatory tools over time, along with interest rates, to stop emerging “bubbles,” or to “stimulate” as need be. The Fed may even try to constrain bank lending in regions of the country, such as those with high housing prices, or to encourage others. Well, your bubble is my boom, and home buyers and builders will be calling you when the Fed restricts credit.  These are political decisions. Do they rise to the writing-checks-to voters standard that an independent agency should not perform? You must decide the limits on this sort of power you wish to impose, and what rules you wish the Fed to follow.

This bill’s requirements for cost benefit analysis are an important step in managing the regulatory explosion. The costs of regulatory compliance and the costs to competitiveness, innovation, and entry into financial services strike me as quite large. But one should not expect the filling out of more mountains of paper to mechanically stop the juggernaut, or more importantly to produce better and clearer regulation, especially when so much rule-making is mandated by Congress itself under the Dodd-Frank act.

The Reform Act’s requirements for stress-test transparency, language simplicity, and for cost-benefit analysis are important steps in managing the regulatory explosion. The authorization in Section 8 for the Federal Reserve to exempt all persons from even Congressionally mandated regulation, if the Fed finds such regulation unwise, is a landmark. But this must be a tool in your oversight. Filling out more mountains of paper will not mechanically improve the process.

The Fed is hotly debating other important changes. Will it maintain a large balance sheet and pay interest on reserves, or revert to the previous rationing of reserves? I prefer the former, for its great financial stability benefits. Will it allow people and non-banks to access interest-paying reserves, the most safe, liquid, and run-free asset imaginable? People will like that, banks will not like being undercut.

The Task

These are all examples of the momentous changes underway in our central bank, as in other central banks around the world. Just how the Fed should approach these issues, which tools and goals it can follow while remaining independent, what rules and legal constraints it can follow in its decisions, what the structures of oversight will be, and how independent it can remain are important issues for you, and the Federal Reserve, to decide.

My main message for you today is to use this bill as a first step in that much broader discussion, and to think beyond conventional monetary policy.

Final thoughts on monetary policy

In part, monetary policy is not, now, obviously broken. The outcomes we desire from monetary policy are, one must admit, about as good as one could hope. Inflation is basically non-existent. Short term rates are as low as we have seen in two generations. The labor market is functioning normally. Economic growth has been steady and bond markets quiet.

Yes, growth is far too slow, not enough people participate or participate fully in the labor force, wages are stagnant, and we face many other economic problems. But these are problems that the monetary policy really can’t do much about.  Congress asked for price stability ([which somehow the Fed interpreted to mean 2% inflation), maximum employment, and low interest rates, and we got them. The Fed has limited powers and limited responsibilities, and the purpose of this bill is to define such limits. Each of us has our own opinions whether the Fed should raise rates or not, but there is no strong professional consensus that the Fed is, right now, doing something dramatically wrong.

This benign outcome is, one must also admit, a bit of a puzzle. When interest rates hit zero, traditional Keynesians predicted a deflationary vortex. When the Fed bought nearly 3 trillion dollars of bonds, creating new money in exchange, traditional monetarists predicted hyperinflation. The Fed’s own forecasts — along with everyone else’s — have been wrong 7 years in a row.  With interest rates stuck at zero, conventional monetary policy has obviously nothing to do with this outcome. We all have our theories - I’ll be glad to fill you in on mine, if you‘d like — but there is no professional consensus on how this remarkably benign state of affairs was reached.

Monetary policy is also much less powerful than most commentators — and most Fed officials — will admit. Money is like oil in the car. Not enough, and the car will stop. But once you have enough oil, adding more does not help the car to go faster. Controlling the car’s speed by slightly starving it of oil is not wise. And more oil will not substitute for clogged fuel injectors.

Like most commentators, I feel that the Fed’s discretionary monetary policy is damaging, as evidenced by financial markets that hang on every sneeze by Fed officials. A more predictable policy may add some stability to financial markets, and enable people who are investing in businesses to do so with more confidence. At least they could be paying more attention to fundamentals and less to parsing Fed officials’ pronouncements. But the combined facts of a benign outcome, at least so far, limited scientific understanding of just how monetary policy works, and limited power of conventional monetary policy, lead me to recommend that this not be the main focus of your efforts.

The massive expansion of Fed responsibilities, the many new tools it is now using, and in particular the temptation to use direct regulatory control to achieve nearly unlimited economic objectives, strike me as the most important topics for a discussion about rules, independence, mandates, and accountability.



(1) See  Robin Greenwood, Samuel G. Hanson, Joshua S. Rudolph, and Lawrence Summers, "Government Debt Management at the Zero Lower Bound." Hutchins Center Working Paper, No. 5, September 2014, for details.

(2) My source here is the Federal Reserve website, and I applaud the Fed’s transparency in making these materials public.


  1. John,

    The interesting passage I find is here:

    "In the period that the Fed was buying up long-term debt, trying to reduce the amount in public hands, the Treasury was issuing lots of long-term debt, trying to increase it. They each undid the other’s actions. Clearly, some accord is needed over who has responsibility for the maturity structure of the debt."

    Where do markets for Treasury debt fall into the determination of it's maturity structure?

    Presuming that the federal government should rely exclusively on debt to finance it's deficits (government equity is another question), the Treasury should allow the maturity structure to fluctuate based upon the bids that it receives.

    In evaluating those bids, bidders should be required to submit both an interest rate and a timeframe over which the debt is redeemed. The Treasury should issue zero coupon debt only and evaluate bids based not upon the absolute interest rate, but rather, the term premium implied by the bid.

    For instance, if the short term interest rate (set by the central bank) is 1% and someone submits a bid of 6% for 40 years, the term premium is calculated as follows:

    SInt = 1%
    LInt = 6%
    Dur = 40 years
    TP = Term Premium

    Lint = Sint + TP * ln (Dur)
    TP = (Lint - Sint) / ln (Dur) = (6% - 1%) / ln (40) = 0.0136

    Compare that to an offer of 2% for 2 years with a short term interest rate of 1%.
    TP = (Lint - Sint) / ln (Dur) = (2% - 1%) / ln (2) = 0.0144

    By evaluating bids for Treasury Debt based upon the term premium, it is clear that 6% over 40 years is a better deal for the government than 2% over 2 years.

  2. John, this is really scary:

    > Plain language is great. I wonder if one can
    > challenge a regulation in court because it was
    > required to be written in plain language?

    That's the problem right there. Placing additional requirements on a regulator, such as its regulations have to be written in "plain language", places tools in the hands of the regulated industries. The lobbyist goes to the Fed staffers and says, "look, if you guys pass this regulation the way it is, we're going to spend the next five years fighting in court about it, so you better make it sweeter for us along the lines of X, Y, and Z, and then we promise not to challenge it."

    These sorts of laws are a bad idea. They put leverage in the wrong place. We should be supporting our regulators, and replacing them if they are doing a bad job, not piling on additional requirements that make their jobs harder and promote regulatory capture.


    Kenneth Duda
    Menlo Park, CA

    1. Kenneth

      Your comment assumes that regulators are noble and selfless while the bankers are selfish and greedy. Regulators with discretion pursue their own interests, the principal-agent problem. Your solution is to hire monitors (Congress?) to replace bad agents but that just adds another layer to the same problem. What is really needed is a banking system structured such that the incentives of the bankers are aligned as much as possible with those of the public. I think John's suggestion of 100% equity banking is a step in that direction. It might not take 100%, maybe 30% would be enough "collateral", but the idea is to make the owners of the financial institutions incentive compatible. Then we could structure regulator behavior much more narrowly, like requiring clear language. Imposing rules (as opposed to self-interested voluntary cooperation) just leads to (inefficient) loophole mining and rent-seeking.


    2. The bit in the bill about "plain language" is basically unenforceable nudging. With or without that language, a regulation, or a statute, could be held invalid if it is so incomprehensible or ambiguous as to violate the Due Process Clause of the Constitution. "Plain language" is itself too ambiguous and subjective to be anything other than a precatory suggestion.

      That said, the requirements set forth in 1(A) and (B) are useful, constructive and ultimately enforceable. To the extent that regulators indicate the purpose of the regulation they are proposing to enact, it helps those regulated (and eventually courts) interpret language that may otherwise be difficult to understand. Drafting statutes and regulations that combine accuracy with simplicity on difficult regulatory subjects isn't at all easy. You should try it sometime! But, clearly stating your purpose is very helpful in the process.

      I'm not an economist, but my experience has been that, economists, more than nearly any other profession, lack the ability to write clearly and concisely, particularly to those outside the profession. Because the Federal Reserve is comprised mainly of economists, perhaps the sponsors of that bill had that particular problem in mind.

  3. John, do you think an open borders immigration policy would help us achieve a 4% growth target? Was there an opportunity to discuss that during the testimony?

  4. "Easy to understand" by who? A high school grad? Someone with a law degree? An MBA? An economics Ph.D.? Your median freshman congressman? The stupidest person in Congress?

    The concept that Congress could pass a law that gave a Federal board the power to exempt EVERYONE from the operation of another law passed by Congress if the Board thinks the law was unwise makes me shake my head. I want to start shouting really, really rude things about the people putting this legislation forward but out of deference to our host I won't try to post them here.

  5. This is a great quote regarding "understanding":

    "It is difficult to get a man to understand something, when his salary depends on his not understanding it." - Upton Sinclair

    1. It's a terrible quote. It's a prime bulverism. Ignore facts and logic, attack your opponent's motivations. We have far too much of that these days.

    2. Professor Cochrane: I am sorry at your reaction. I agree that, in general, arguments ad hominem are too common in the courts and in public discourse. The proposed legislation would require that regulations be "easy to understand". As my earlier post asked: who is to be the test subject who has to be able to understand the regulation? I expect that any organization who did not like a regulation will argue that it is not easy to understand and should therefor be struck down. Hence my reaching for that quote.

      There is, however, a proper place for arguments ad homenim. If someone puts forward an assertion that you cannot prove is wrong or which is complicated and would take lengthy study or analysis or extensive evidence to show is wrong it is legitimate to show either that the propounder has a prior history of putting forward false assertions or has a motivation to put forward a false assertion. We have to prioritize what we spend intellectual energy on: if someone was talking obvious nonsense yesterday, why should I invest time and energy in trying to follow what he is saying today?

      Bear in mind that I am a lawyer and find myself trying to convince judges that clever (deceitful) witnesses are lying.

    3. Absalon, I agree that conflict of interest and confirmation bias are real problems. One of the main functions of the process of science is to help to keep a person from fooling themselves. This is accomplished through the process of peer review and full disclosure of experimental methods so replication of experiments by other independent teams can be easily undertaken and by bending over backwards to think of all possible problems that might exist, and being honest about what those are. When we want something to be true (for example, C. S. Lewis, who coined the term "Bulverism," badly wanted god to exist), it's exactly the time when we should ramp up hyper-skepticism of our own ideas, so we don't color the evidence with our own biases. The best quote that applies that I'm aware of is from the later physicist Richard Feynman:

      "It's a kind of scientific integrity, a principle of scientific thought that corresponds to a kind of utter honesty--a kind of leaning over backwards. For example, if you're doing an experiment, you should report everything that you think might make it invalid--not only what you think is right about it: other causes that could possibly explain your results; and things you thought of that you've eliminated by some other experiment, and how they worked--to make sure the other fellow can tell they have been eliminated.

      Details that could throw doubt on your interpretation must be given, if you know them. You must do the best you can--if you know anything at all wrong, or possibly wrong--to explain it."

      Imagine economists behaving like that! Lol.

    4. ... or this one line quote from Feynman more succinctly characterizes the best method to reliably know something about reality (i.e. engage in science):

      "The first principle is that you must not fool yourself — and you are the easiest person to fool."

      It's also from the "Cargo Cult Science" link I give above. So it's not that a person with a conflict of interest necessarily fools themselves, but it's a sign that we should ALL be especially skeptical, especially the person with the conflict. If they're not, that's a reason to be suspicious: it's an indication that they're ignorant of the first principle of science, as expressed here by Feynman, and thus possibly self deluded. It's a real danger, and I think that's what Sinclair was getting at.

    5. John:

      Surprised you think so. It seems to me that it reflects an important problem in regulatory/bureaucratic behavior. I certainly didn't read it as an ad hominem attack. I agree that questioning motives is a popular way for some to attack the ideas of those they disagree with, but the quote itself (to me at least) is just pointing out that incentives matter.


    6. Tom: I did a physics degree in the 1970s so I was taught to view Feynman as a god. Feynman's talk "Plenty of Room at the Bottom" reminds us of just how great he was. That said, I thought the first quote you give is rambling and the second is much better. I like Thomas Huxley's line, one version of which is: "The great tragedy of Science — the slaying of a beautiful hypothesis by an ugly fact."

  6. I notice your testimony only lists you as "John H. Cochrane, Senior Fellow, Hoover Institution." Are you no longer at U of Chicago?

  7. 'Macro-prudential policy' is all the buzz in Asia with Singapore, HK and China having adopted significant restrictions on the residential property market. Singapore has been the most aggressive, imposing an 18% stamp duty (transfer tax) on foreigners and locals second property's, as well as borrowing limits as a proportion of income (defined as salary, interest and dividends). The latter, dubbed the Total Debt Service Ratio (TDSR) is a particularly lethal form of credit rationing since it effectively estopps an entrepreneur from using his property as collateral to support real investment.

    I count the term 'Macro-Prudential policy' as one of the great mis-nomers in Economics akin to 'Progressive taxation'. Central Bankers seize upon the word 'Prudent' since that is the image they want to project - however in practice they are imposing liquidity restrictions and rationing credit. Let's call these policies something else, like 'Rationing', and please don't let this take root...

  8. Well, I am big fan of KISS in democracy and government so yes, regs and powers should be simple.

    If I have a complaint it is that John Cochrane continues to discuss inflation and central banks when perhaps the discussion should be deflation and central banks. We see now deflation in Europe, we see deflation and recession in Singapore.

    We see Japan and the Bank of Japan struggling to exit 20 years of deflation.

    The United States may in fact now be in deflation with the exception of housing costs---a market in which the supply is constrained in any neighborhood anyone wants to live. You can't put up 60-story condo towers in the City of Newport Beach.

    I think the challenge for central banks today is to beat deflation, obtain moderate inflation and robust growth. The example of Singapore is extremely daunting--the city state is regarded as haven from structural impediments, yet even there a central bank has suffocated and then extinquished growth.

    Robust growth should be the target. Forget about inflation.

    1. "I think the challenge for central banks today is to beat deflation"

      I think first the Fed, and everyone else, need to understand why there is a global savings glut and deflation. Then the Fed can talk about what can be done to address the causes. I don't think that low inflation is the panacea that Krugman and De Long seem to think it is but deflation that manifests itself in falling wages (not just falling consumer prices) would be a problem.

    2. Absalon, this guy has a framework for answering why some in some economies the quantity theory of money seems to apply and in others it doesn't, and why many other economies seems to lie somewhere in between. His thinking is not very mainstream, yet he's willing to put his model / framework on the line by making concrete predictions which, if they don't work out, he says would falsify his model / framework. Try getting most economist bloggers to say particular concrete future scenarios would falsifies their claims: from my experience economists on blogs avoid making concrete statements about what conceivable future observations would falsify their ideas, which perhaps is why economic ideas/claims/models seem to multiply but never be discarded.

    3. The assertion that inflation would stimulate an economy by working around wage downward stickiness seems to me to be fundamentally unsatisfactory. For inflation to be able to work that magic it seems to me that there would have to be a body of workers whose real wages are too high, there have to enough of such workers and the wage misalignment has to be large enough to have macro economic consequences, and those workers must not have the bargaining leverage to protect themselves from inflation.

      So I ask the advocates of inflation: who are these over paid workers, who exist in material numbers, and are currently substantially overpaid, but lack the bargaining power to protect themselves from inflation?

  9. Add on: I think central banks can in fact print (digitize) money when they engage in QE. The second step of QE is the placement of reserves into the commercial bank accounts of the primary dealers, when the Fed buys bonds from those primary dealers.

    However, the first step is the primary dealers buying bonds and placing cash into the hands of bond sellers. This becomes even more office obvious when one considers the Fed's Primary Dealer Credit Facility, which was it initially established to help QE on its way.

    At the end of $4 trillion in QE, you get $4 trillion in the commercial bank accounts of the primary dealers and another $4 trillion in cash in the hands of people who sold bonds to the primary dealers. That $4 trillion in cash was stimulative.

    QE is much more than just a swap of bonds for reserves.

  10. It would take a God conscience to figure that problem.


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