Sunday, June 16, 2019

Real estate ups and downs

In a delightfully YIMBY "Americans Need More Neighbors" the New York times gets it almost all right.
Housing is one area of American life where government really is the problem. The United States is suffering from an acute shortage of affordable places to live, particularly in the urban areas where economic opportunity increasingly is concentrated. And perhaps the most important reason is that local governments are preventing construction.

It goes on, even noting flagrant progressive hypocrisy
Increasing the supply of urban housing would help to address a number of the problems plaguing the United States. Construction could increase economic growth and create blue-collar jobs. Allowing more people to live in cities could mitigate inequality and reduce carbon emissions. Yet in most places, housing construction remains wildly unpopular. People who think of themselves as progressives, environmentalists and egalitarians fight fiercely against urban development, complaining about traffic and shadows and the sanctity of lawns. 

It noticed the sordid racial past of zoning restrictions
... many residents said they were surprised to learn that single-family zoning in Minneapolis, as in other cities, had deep roots in efforts to enforce racial segregation. Cities found that banning apartment construction in white neighborhoods was an effective proxy for racial discrimination, and the practice spread after it was validated by the Supreme Court in 1926. 
Heavens, it even allows for the freedom to spend money, as long as it's not subsidized
People should be free to live in a prairie-style house on a quarter-acre lot in the middle of Minneapolis, so long as they can afford the land and taxes. But zoning subsidizes that extravagance by prohibiting better, more concentrated use of the land. 
Usually I would expect the NYT to jump on the opposite bandwagon and prohibit such houses.  The NYT even realizes that more market-rate apartments is the best way to provide more low priced housing

OK, the Times being the Times, it has to argue for some vast new subsidy,

 Governments need to provide subsidized housing for people who cannot afford market-rate housing. 
But here too, it gets a lot right. The bulk of the long oped is not about repeating the disaster of public housing projects, or more "affordable housing" mandates. It's just about build -- move the supply curve to the right. Berating its own a little more, it recognizes substitution and depreciation
...advocates for affordable housing should be jumping up and down and screaming for the construction of more high-end apartment buildings to ease demand for existing homes. Those new buildings are filled with people who would otherwise be spending Saturdays touring fixer-uppers in neighborhoods newly named something like SoFa, with rapidly dwindling populations of longtime residents.
Today’s market-rate apartments will gradually become more affordable, just as new cars become used cars. 
Meanwhile, in progressive political reality, and lest you get too optimistic, the Wall Street Journal, in a spectacularly mis-titled article, covers New York State's new rent control law. The title is "New York Passes Overhaul of Rent Laws, Buoying Wider Movement to Tackle Housing Crunch"  It's not an overhaul, it's a massive expansion, and it will not tackle the housing crunch, but it will make it spectacularly worse.
The New York legislation brings increased power to tenants in roughly one million rent-regulated apartments in New York City. It makes it more difficult for the owners of those apartments to increase rents, while enabling more tenants to sue landlords for rent overcharges. Also, tenants around the state will have more protections against eviction.
Proposals to limit rents are advancing in a number of state legislatures, including in California, where a statewide cap on rent passed the California Assembly in May, and in Oregon, which passed the nation’s first statewide rent control in February, limiting annual rent increases to 7% plus local inflation.
The times will probably get its way on housing subsidies, already a popular idea here in California. Imagine a subsidy for any house or rent above 30 percent of your income, plus a continued block on new construction.

It's interesting that economists spend a lot of attention on the minimum wage, and less on rent control plus housing supply restrictions. I guess nobody has made a big stir with a diff in diff regression claiming that rent control doesn't shrink housing supply. Perhaps someone should, just to ge the outrage going.

And, if you're wondering about the wealth tax, it's here. A limit on rents is a pure tax on the landlord's  property, transferring its value to the current renter, but destroying much of that value along the way.

Friday, June 7, 2019

Futures forecasts


Torsten Slok at DB updates this lovely graph on occasion. Here's what it means. Fed fund futures are essentially bets on where the Federal funds rate will be at various points in the future. Thus, you can read from the dashed lines the market's guess about where the federal funds rate will go -- assuming that the bets are priced to have an even chance of winning or losing.

Reading it that way, the market was systematically wrong from 2009 to 2016. It's something like springtime in Chicago -- this week, 40 degrees and raining. Next week, 75 and sunny. Week after week after week. In 2017, the market finally changed expectations to say, no, fed funds rates are not rising -- just in time to miss the actual rise in federal funds. Now, as in the blue line, market forecasts say there will be a big decline. But, as Torsten points out, why would the market be right today?

So what does this graph mean? Are market practitioners really that dumb? After all, there is a lot of money to be made here. When the graph is upward sloping -- as the entire yield curve was upward sloping from 2009-2016 -- and so long as rates don't rise, you can make a fortune borrowing short and lending long. And vice versa. In short, the difference between forward rate (right end of dashed lines) and spot rate (current fed funds rate) does a lousy job of forecasting where the spot rate will go -- and thus, mechanically, is a good signal of the extra return, positive or  (lately) negative you will get by holding long-term bonds.

The pattern is actually widespread and longstanding. Starting in the late 70s and early 1980s, Gene Fama wrote a series of papers on it, short term bonds, money markets, foreign exchange,  and (a favorite of mine) long term bonds (with Rob Bliss). Campbell and Shiller also found it in long term bonds, which Monika Piazzesi and I extended.  Piazzesi and Swanson show the pattern in federal funds futures.

There are three potential stories:

One: the market is dumb. People are dumb. Well, that's a nice story that can "explain" just about anything. But if you're so smart why are you not rich. Behavioral finance isn't that empty, and searches for common patterns in dumbness. However this graph is the opposite of the usual behavioral claim, extrapolative expectations, excess belief in momentum.  If there is a rejectable hypothesis in behavioral finance, this graph seems to reject it. (I welcome corrections to that statement in the comments.)

Two: there is a risk premium and it varies over time. For most of 2009-2015, the economy was depressed. People needed a good promised return, a coin more than 50/50, to hold the risk of long term bonds.  Once we exit the recession, the opposite pattern holds. Long term bonds should pay less than short term bonds, and maybe now the yield curve is finally waking up to that pattern. Naturally, I'm attracted to this story, but I admit it's a bit strained late in the upslope period.

Three: exit and entry to recessions is something like a rare event, a Poisson process. Such a process is like computer failure. The chance of the event is always the same, and does not increase as the length of time goes by. Recovery could happen any time. In a second paper that's what Piazzesi and I seemed to find for this pattern in bond markets. The market forecasts are right, in fact, and we just got 7 tails in a row. That is a speculative idea, and needs quantification.

Whatever the story, here is the fact: futures prices are not good forecasts (true-measure conditional means) of where interest rates are going. That fact is true not just of Fed Funds futures, but interest rates in general.

Update:

Torsten sends along an updated chart, going further back in history.


Thursday, June 6, 2019

Institutionalized nonsense

When, last week, the Treasury issued its currency manipulation report, I thought it was a joke. Treasury put Germany and Italy on its "monitoring list" of countries suspected of "currency manipulation."

Germany and Italy are, of course, part of the Euro, the whole point of which is that they cannot, individually, "manipulate" their currencies, whatever that means. It is precisely this inability to devalue -- to "manipulate" the Drachma to regain "competitiveness" (another meaningless term) -- that conventional wisdom bemoaned of Greece.

I had a little chuckle, envisioning some frustrated mid-level Treasury economist bemoaning the trade and currency idiocy floating around Washington, putting this little message in a bottle to see if anyone noticed the reductio ad absurdum.  If so, hello there, somebody noticed.

But then  read the report.

Thursday, May 30, 2019

Fed Nixes Narrow Banks Redux

J. P. Koning at AEIR writes well on the Fed's efforts to quash narrow banks, more clearly than my previous efforts here here and here

As a quick review: Narrow banks take your money and invest it 100% in interest-paying reserves at the Fed. They are completely immune from runs, failures, and financial crises. You would get a lot higher interest than the big banks currently pay.  The Fed should be giving them a non-systemic medal. Instead, the Fed is fighting them tooth and nail.
the Fed is floating the idea of destroying the narrow-bank business model before it can ever be tested in the market.
J.P. clearly goes through the Fed's proffered objections, demolishing each in turn.  The financial stability concern makes no sense -- after all, they can buy treasury bills directly or buy treasury - backed money market funds. Reserves are that, with instant rather than one day settlement, or money market funds that now are allowed to invest in reserves.

J.P is, I think, a little too polite. He writes,

An Apocalyptic View of Central Banks

In the department of genuinely terrible, and terrifying, ideas, I just got the a request from Simon Youel, the Media and Policy Officer at Positive Money, regarding the appointment of Mark Carney's successor as Governor of the Bank of England.  Positive money is organizing a "joint letter to the Financial Times, calling on the Chancellor to appoint someone who’ll foster a pluralistic policy-making culture at the central bank."

The proposed letter:
Applicants to be the next Governor of the Bank of England are asked to commit to an eight year term lasting until 2028. By then the world will be a very different place.  
Three key trends will shape their time in post. Firstly, environmental breakdown is the biggest threat facing the planet. The next Governor must build on Mark Carney’s legacy, and go even further to act on the Bank’s warnings by accelerating the transition of finance away from risky fossil fuels.  
Secondly, rising inequality, fuelled to a significant extent by monetary policy, has contributed to a crisis of trust in our institutions. The next Governor must be open and honest about the trade-offs the Bank is forced to make, and take a critical view of how its policies impact on wider society. 
Thirdly, the UK economy is increasingly unbalanced and skewed towards asset price inflation. Banks pour money into bidding up the value of pre-existing assets, with only £1 in every £10 they lend supporting non-financial firms. The next Governor must seriously consider introducing measures to guide credit away from speculation towards productive activities.  
As the world around it changes, the function of the Bank itself must evolve. Its current mandate and tools are increasingly coming into question, and a future government may assign the bank with a new mission. The next Governor must meet this with an open mind, not seek to preserve the status quo. 
To equip the Bank to meet the challenges of the future, the new Governor will also need to ensure it benefits from a greater diversity of backgrounds, experience and perspectives throughout the organisation. 
The Bank of England’s own stated purpose is to promote the good of the people. We need a Governor genuinely committed to serving the whole of society, not just financial markets.

Tuesday, May 28, 2019

Cost divergence

Source: Marginal Revolution
This lovely picture is from Why are the prices so D*mn High? by Eric Helland and Alex Tabarrok. (It's covered in Marginal Revolution: The Initial post,  Bloat does not explain the rising cost of education, and an upcoming summary on health care.)

Bottom line: objects got cheap, people got expensive. Technology, automation, globalization (thank you China), and quality improvement made goods cheaper. People, especially skilled people, got more expensive. All of which should make you feel good if you're a person and especially a skilled person.

The source of the relative rise in the cost of education and health care is less clear. Looking around at  a typical university,  school system, or hospital suggests massive bloat and inefficiency. Alex suggests  not:
I assumed that regulation, bloat and bureaucracy, monopoly power and the Baumol effect would each explain some of what is going on. After looking at this in depth, however, my conclusion is that it’s almost all Baumol effect. 

Thursday, May 23, 2019

Refreshing YIMBY at NYT

Farhad Manjoo writes an excellent YIMBY (yes in my back yard) essay in the New York Times, remarkably placing the blame squarely where it belongs -- progressive politics.
Across my home state [California], traffic and transportation is a developing-world nightmare. Child care and education seem impossible for all but the wealthiest. The problems of affordable housing and homelessness have surpassed all superlatives — what was a crisis is now an emergency that feels like a dystopian showcase of American inequality. 
Just look at San Francisco, Nancy Pelosi’s city. One of every 11,600 residents is a billionaire, and the annual household income necessary to buy a median-priced home now tops $320,000. Yet the streets there are a plague of garbage and needles and feces, and every morning brings fresh horror stories from a “Black Mirror” hellscape: Homeless veterans are surviving on an economy of trash from billionaires’ mansions. Wealthy homeowners are crowdfunding a legal effort arguing that a proposed homeless shelter is an environmental hazard. A public-school teacher suffering from cancer is forced to pay for her own substitute. 
At every level of government, our representatives, nearly all of them Democrats, prove inadequate and unresponsive to the challenges at hand. Witness last week’s embarrassment, when California lawmakers used a sketchy parliamentary maneuver to knife Senate Bill 50, an ambitious effort to undo restrictive local zoning rules and increase the supply of housing.
He notices the same hypocrisy that struck me walking past the "all are welcome here" signs in Palo Alto:
Then there is the refusal on the part of wealthy progressives to live by the values they profess to support at the national level. Creating dense, economically and socially diverse urban environments ought to be a paramount goal of progressivism... Urban areas are the most environmentally friendly way we know of housing lots of people. We can’t solve the climate crisis without vastly improving public transportation and increasing urban density. ... 
Yet where progressives argue for openness and inclusion as a cudgel against President Trump, they abandon it on Nob Hill and in Beverly Hills. This explains the opposition to SB 50, which aimed to address the housing shortage in a very straightforward way: by building more housing. ... 
Reading opposition to SB 50 and other efforts at increasing density, I’m struck by an unsettling thought: What Republicans want to do with I.C.E. and border walls, wealthy progressive Democrats are doing with zoning and Nimbyism. Preserving “local character,” maintaining “local control,” keeping housing scarce and inaccessible — the goals of both sides are really the same: to keep people out. 
“We’re saying we welcome immigration, we welcome refugees, we welcome outsiders — but you’ve got to have a $2 million entrance fee to live here, otherwise you can use this part of a sidewalk for a tent,” said Brian Hanlon, president of the pro-density group California Yimby. 
It's an obvious point. But it's great to hear this point in the New York Times. An internal reflection on hypocrisy is much more effective than an outside charge.

I don't agree with everything. He starts with a good point,
One continuing tragedy is the decimation of local media and the rise of nationalized politics in its place.
Yes, everyone here in California is so consumed with Trump Apolexy that they don't even notice what the city council is doing. But Manjoo chalks the fundamental problem up to larger representation for rural states in the Senate. Hmm. If the same people who vote for San Francisco zoning have more power to push their agenda on the whole country, I don't see how that makes it better.

Still I see hope. California is a one party state, and the one party is slowly waking up to the fact that it must govern too. Slogans about the great progressive future are fine in opposition, but once you've been in total charge for a while, you do start to own it.  After trying everything else, California is slowly waking up to the fact that we have found the problem and it is us. Subsidies, vouchers, "affordable housing" mandates will never make a dent. Just Let Them Build some housing. It took Nixon to go to China. I was very happy to see the Obama administration recognize the havoc caused by occupational licensing restrictions. The YIMBY self-reflection is not over yet. 



Tuesday, May 21, 2019

Clemens on minimum wage

Jeff Clemens offers a "roadmap for navigating recent research" on minimum wages in a nice CATO policy analysis.  A review and a doubt.

He discusses the recent claims that minimum wages don't hurt low-skilled people. This is an impressive and readable account of a vast literature. It's not as easy as it seems to evaluate cause and effect in economics.  Evidence from small increases in the minimum wage over short time intervals in some locations in good economic times may not tell you the effects of large increases over longer time intervals in all locations in bad economic times.

The "new conventional wisdom," of small effects, Jeff reports, ignores a lot of the more recent work, and especially work that  uses "data from individual-level administrative records" rather than "aggregate data and survey data," work that runs "experiments whenever possible," and work that "transparently analyzes compact historical episodes in the U.S. experience" (P. 8)

Thursday, May 16, 2019

Two Videos

My Hoover colleague Russ Roberts just finished a nice video on inequality:


Among other takeaways, he stresses that the people who were rich in 1980 are not the same people or even families who are rich now. It is not true that "the rich got richer." He also tracks individuals through time, and poor individuals got richer to.  There is a lot more economic mobility in the US than the standard talking points.

The video is part of Hoover's Policy Ed initiative, and comes with lots of background information. I'll be curious to hear your comments.

A few months ago I went to the Friedberg Economic Institute to give an evolving talk I call "Free to grow" bringing together various themes of this blog and other writing. It's not nearly as polished as Russ's, and I'm still struggling to keep it under 10 hours!


(Click here to see the video.) The Friedberg Institute is a nascent free-market oriented organization in Israel. It mostly sponsors talks and classes for undergraduates, and for alumni of their program. As a result it is forming a club of sorts of talented and interesting young Israelis interested in economic freedom. If you're in Israel, check it out, and if you're invited to talk there, accept!

Tuesday, May 14, 2019

Almost sane housing supply

California, despite being a one-party state, is actively debating SB50 that would over-ride local zoning laws and allow construction of apartment buildings, especially near transit areas.

This is almost a remarkable outbreak of sanity. In a divided government, one can keep touting slogans. But when one party takes over, apparently permanently, they do have to actually govern, and eventually some reality must sink in.

Housing in California is ridiculously expensive. After California tried everything else -- "affordable housing" mandates on developers, subsidies, rent controls, public housing, and so forth -- it is finally facing the fact -- we need to just let people build. Given that California will not allow more land to be devoted to housing -- wisely, in my view -- and given that the first generation housing stock was built cheaply, using a lot of land for little house, the natural place to allow people to build is up: replace small single family houses on large lots with apartments, townhouses, or even single family houses on smaller lots.

The problem here is local zoning laws, building laws and various impeding regulations, which are more or less designed to preserve enormously expensive museums of 1950s suburbia. So SB50 overrides local laws.

The end result, though is saddled by a trip through the progressive sausage factory. I recommend Joe DiStephano's analysis with beautiful maps.

The first stop was rather clever: wrap it in green. "You can build" was never going to fly in California. So the original effort, SB25, restricted the effort to areas near transit. Who can object to allowing apartments near transit, so people can get out of their cars? Moreover, with this twist, SB25 put the kibosh on one standard local trick for restricting construction, requirements for lots of onsite parking.

The transit clause extends to "high quality bus corridors." Now in one sense that's great. Other than nostalgia and cuteness, and outside places like New York City, buses are much better transit options.  But one of the main reasons buses are great is that it is much easier to move a bus line than to move a rail line. You can be on a "high quality bus corridor" tomorrow.

"Jobs rich areas" are now included. Allowing people to live nearer where they work is better than any "transit" idea. That too is a little strange though. If people were allowed to build housing, jobs would locate there quickly. Housing first redevelopment is not too hard an idea.

Alas, the bus and jobs exemption only waive density and parking, and allow cities to keep height limits and other zoning restrictions. Which they will do.  

Then it descends into madness, and an invitation to endless litigation.

"Sensitive communities" are exempt. That means (still quoting Joe), "‘High Segregation & Poverty’ or ‘Low Resource’ in TCAC Opportunity Maps," "Other local areas determined by each regional government through a collaborative process," and "Tenant-Occupied and Rent Controlled parcels."

California will write a law allowing the construction of apartment buildings, and conversion of houses to multifamily units, yet will specifically exempt the areas most obviously in need of redevelopment. Once upon a time governments granted subsidies and tax breaks for redeveloping such places. Minorities and poor people will instead be condemned to live in rotten housing and rotten neighborhoods. Heaven forbid a few apartments get built near transit stops, some yuppies move in, grocery stores and coffee shops grow to serve them, and the rest of the neighborhood. 

Joe's maps tell the story. Where in LA will California allow apartments? Not in the places that need redevelopment! Perhaps if people could build apartments, these might become "jobs rich areas!"   



As its local governments are devoted to maintaining museums of suburbia, the state government is devoted to preserving museums of poverty, racial segregation, and lack of businesses and services. 

(To be fair, the state law only over rides local zoning laws. There is nothing that stops the city of LA from allowing development with or without SB50.)

As a classic example of how we got in to this mess, consider the instant reaction on the Menlo Park nextdoor.com 


Now, if we do a little Bayesian Improved Surname Geocoding -- not perfect, but good enough for the Justice Department to sue auto dealers -- we can conclude that the author is white, wealthy, lives in a house worth at least $3 million dollars, and a reliable progressive Democrat, bleeding hearts over climate change and inequality. Yet this post is worthy of the darkest anti-immigrant keep-the-poor-out    climate-denying right-winger. All the people who rehab the $3 million single family houses to $6 million single-family houses in Menlo Park drive in from 50 miles away, as do those who mow the lawns, wait the tables and so on. The young bright kid from Fresno who might get his break working here has little hope of finding a place to live. I guess there is a lot of hypocrisy going around these days, but this is pretty glaring.

Also echoing the local zeitgeist and how-did-we-get-in-to-this-mess thoughts is the ongoing saga of the Flintstone House. NYT here, and a good article at the Guardian If you've ever driven down 280, you've seen this cool house. It was recently sold, and the new owner took up the Flintstones theme:

Before:
After:
More great pictures at SF Curbed. How utterly cool, you undoubtedly think. What did the city do, make it a historic landmark to preserve it? No, the city is suing Ms. Fang, the owner, for landscaping without permits and "community input."

From the Guardian
... the tastemakers of Hillsborough have not extended their favor to the experimental stylings of William Nicholson, the architect...It was in response to the Nicholson’s construction of the Flintstone house in 1976 that the town first established its Architecture and Design Review Board (ADRB), ... established “so there would never be another home like that built in Hillsborough”.
...Mrs Fang claims that she attempted to work with town of Hillsborough to obtain the proper permits for her landscaping work, ..she says she feels like the town is playing with her like a cat with a mouse – “play, play, play, bite, until I die” – and claims she has interacted with the town 44 times while attempting to comply. At one point, the town lawyer pressured her to paint all the mushrooms a single color, she says. “Every time I complied with their request, they moved the goalpost,” she says.
"Design review," which produces Disneyland replicas of craftsman houses and bland identical French farmhouses, allows its executors to stymie permits with endless arbitrary whimsical requests for esthetic changes.

Bottom line, any residual meaning of "private property" is vanishing in California.

(I received a few comments from fellow libertarians last time I wrote about these issues. Shouldn't communities have the right to pass whatever restrictions they want? If they want to preserve a $5 million per house replica of 1950s suburbia, and wall out the unwashed masses, hypocrisy aside, why should the state stop them? I counter, this is not libertarianism, the defense of private rights, this is untrammeled majoritarianism, by which your neighbors via the city strip you of your right to sell your house to the highest bidder, do what you want with it, and strip the ambitious kid from Fresno who wants to move here of his right to be supplied by a competitive marketplace. It's also a monstrous inefficiency. A neighbor who is hurt by $500 from his dislike of looking at your property can destroy millions of value to you. Anyway, it's a longer discussion which I acknowledge here without getting in to it. )

Monday, May 13, 2019

Free Solo and Economic Growth

We recently watched "Free Solo", the great movie about Alex Honnold's free (no aids, no ropes) solo climb of El Capitan. Among many other things, it got me thinking about economic growth.

The abilities of modern day rock climbers are far beyond those of just a generation ago. The Wikipedia history of El Capitan starts with a 47 day climb in 1958, using pitons, ropes, and all sorts of equipment, and continues through development of routes and techniques to Alex's three hour romp up the face. 

Why wasn't it done long before? There is essentially no technology involved. Ok, a bit. Alex is wearing modern climbing boots, which have very sticky rubber. But that's it. And reasonably sticky rubber has been around for a few hundred years. There is nothing technological that stopped human beings from climbing much like this thousands of years ago. Alex, transported to 1890, might not have free soloed El Capitan without his current boots, but he would have climbed a lot more big walls than anyone else.

Clearly, there has been an explosion in human ability to climb rocks, just as there has been in human productivity, our knowledge of how to do things, in more prosaic and more economic activities. And, reading the history, the rate of improvement has grown over time. 

Friday, May 10, 2019

Financial Inflation?

Torsten Slok sends this lovely picture of the S&P500 and the price index for portfolio management and investment advice services. Torsten explains that "50% of the decline in core PCE inflation since the peak in July has been driven by financial services, and with the stock market rebounding, we should expect to see the financial services component move higher again."

What's going on? I think it's this: Most portfolio management payments are a percent of value -- you pay a fee, say 1%, of the total value of the portfolio. When the stock market goes down 10%, you pay 10% less in fees. Now, the BEA's job is to figure out, did you get 10% less quantity -- did you get 10% less "valuable advice" for that fee? You're not an idiot, so you're paying 1% off the top of your wealth annually, a third of Senator Warren's dreaded wealth tax, for something of value, the BEA figures. Or did the "price" of financial services go down 10%? Evidently, the BEA assumes the price, not the quantity changed, so the "price" of financial services tracks the stock market.

This is of course nonsense. On the other hand, I have no better idea how to separate 1% management fees into a "price" or a "quantity" (or, heaven forbid, a "quality improvement"). The number of people working to provide you financial advice didn't change 10%. Though, in the long run, it will if the market stays down. How should, or does, the PCE handle rents, or dividend payments? I don't know.

I went back to the documentation for how the PCE is constructed to try to understand these questions and see if my hunch is correct, but I failed to understand anything in there. (I got lost in the "commodity flow method," see p. 5-27.) I would value comments from people who understand this stuff.

Overall, I think the lesson is that our measures of inflation are pretty noisy. First we throw out food and energy. Now it looks to me that "core" should throw out management-fee based financial services, or at least assume that the price is fixed (1% sounds like a fixed price) rather than the quantity. Do real estate and other commissions do the same thing and the price index rises and falls with the price of housing? What's next?

(The point of throwing out food and fuel is not that they don't matter but a feeling that the core CPI today is a better guide of where the overall CPI will be in the future. A more thorough analysis of which components are better forecasters of overall CPI would be welcome.)

Maybe an inflation measure that is less comprehensive but better measured isn't such a terrible idea. Maybe the Fed worrying about 1.8% vs. 2% inflation is not such a good idea.

Thursday, May 9, 2019

Rent Control Poem

"kevinsch" posts an remarkable essay on rent control on a  Seattle city council blog (HT Marginal Revolution).
I’m not an economist, not a landlord, nor a renter. But since we’re having this debate, I went to the UW Library and pulled the literature on rent control so I could understand the issues, the studies, and what the experts conclude.  Here’s what I found. 
1. Within the community of economists there is broad consensus that rent control is a bad idea. The consensus is on par with the scientific community on climate change, and the medical community on the safety of vaccinations. 
Given the widespread move to introduce rent controls on the left coast, savor that.
2. There are two documented benefits of rent control: it decreases economic displacement for people living in rent-controlled housing, and it can reduce the volatility of rental pricing in cities where there is sufficient stock of rental housing. 
3.  There is a very long list of documented harms that rent control causes. It provides a strong disincentive to build more rental housing. It drives landlords to reduce spending on maintaining their units until the quality of the housing has drawn down to the point where it matches the allowed rent. And thus by reducing property values, it reduces property tax revenues. It reduces mobility for renters, causing them to stay in their rent-controlled housing rather than move when a better job or the needs of their family require it. It misallocates the total housing stock by encouraging people to stay in housing that doesn’t match their needs.  It encourages rental property owners to convert apartments to condominiums, thereby reducing the rental housing stock. It inevitably leads to a “cluster” of regulations piled on top to try to legislate away all of rent control’s problems. And it doesn’t help the people with the greatest need, but rather the people most capable of gaming the system. 
It's remarkable that someone who is not an economist could so quickly find all these subtle effects. Yes, most people quickly get that landlords will not keep up apartments, and builders won't build them. But most people don't quickly get the disincentives for renters not to "move when a better job or the needs of their housing require it." Or that it leads not to nirvana for the low income renter, but helps "the people most capable of gaming the system." I would only add that it really hurts the young ambitious person of limited means who wants to move to town to get that upward-mobility job.

4.  In many cities with rent control, tenants see annual rent increases at the maximum amount allowed, because landlords understand that if they skip a year they will never catch up. 
5.  Rent control’s harms can be mitigated in part through an aggressive public/social housing program that creates a large quantity of units using public funds. However, in those places it’s unclear that rent control itself is adding much value beyond the significant value that the public housing program alone delivers. 
OK, Kevinsch is not an economist so I'll let this pass. The history of aggressive public/social housing programs in US cities are an absolute disaster.

More deeply, he missed the underlying cause of the problem -- building, zoning, and land-use restrictions. Supply meets demand. If builders were allowed to build cheap apartments for modest renters, they would do so. If builders were allowed to build expensive apartments for high-income renters, who then would move out of buildings suitable for low rent apartments, they would do so.
6.  As this paper says, rent control “confers its benefits early, and extracts its costs late.” That’s one of the reasons it’s such an attractive policy idea. 
Well, it confers benefits to renters early. The loss of property value to landlords is instant, but apparently nobody cares about them. The "one time" capital tax is always tempting.
7.  As this article puts so well, among rent control advocates there are no rent control failures; there are only bad implementations. 
Ditto, say, Socialism and Venezuela.
8. And finally, as this research paper suggests, economists have been thorough at convincing themselves that rent control is a bad idea, and inept at convincing anyone else.
This is a gem. And so true. Like, say, tariffs. I wish I knew just how to fix that despite the immense effort and millions of dollars going in to better dissemination of economic ideas.

The essay goes on, and it's worth reading the whole thing. 

There is a lesson here. Why do our governments, and especially local governments, so often wander into terrible economic policies? The "education" theory says they just don't know basic economics, and don't have any competent policy advice. If they and their staff could just be "educated" things would get better. (And if we could break through all the competing parties who also want to "educate" politicians.) The "interest" theory, more typical among public choice economists, views political outcomes as the result of power, not ideas. Rent control wins when incumbent renters who want to stay put win the political battle over landlords, mobile renters, and potential newcomers, and invoke whatever ideas butter the toast of their cause.

That the city council of Seattle has available such amazingly good policy advice speaks to the latter, sad to say for those of us in the "education" business.

The third view is that ideas still matter at the larger level.  A bad idea like rent control requires the asset of the general voter. Yes, incumbent renters who know how to work the system may win the political battle over landlords, property owners, people who want to move to the city and rent, and mobile renters or those not good at working the system, who will lose.  But the larger mass of homeowners, condo owners, and non-controlled renters must go along. They don't have a personal interest, other than a general desire to feel good by helping those who face higher rents, so they don't have much reason to study the issue. If the general electorate understood how bad rent control is for their city, and most of the people they want to help, perhaps economic policy would be better. There is hope for ideas. 


Wednesday, May 8, 2019

Jenkins on ACA

Holman Jenkins "Obamacare is popular because it failed" from a week ago is worth savoring and has an interesting new idea.

On Obamacare's failure:
ObamaCare’s user cohort now consists almost entirely of willing “buyers” who receive their coverage entirely or largely at taxpayer expense. It also consists of certain users who take advantage of the coverage for pre-existing conditions and stop paying once their condition has been treated.... 
...For a family of four not benefiting from a subsidy, notes insurance industry veteran Bob Laszewski, a policy can cost $15,000 with a $7,000 deductible. In other words, “they have to pay $22,000 before they get anything.” 
In every larger aim, the Affordable Care Act has predictably failed. It was supposed to ramrod efficiency through the health-care marketplace. Instead, it has become just another inefficient program bringing subsidized medicine to one more arbitrarily defined subset of the population.
(On "stop paying," see the excellent paper by Rebecca Diamond, Michael J. Dickstein, Timothy McQuade and Petra Persson. They document that many people sign up for ACA insurance, get a flurry of health care, and then quit. Half of new ACA enrollees in California quit by the end of the year. This number includes everyone, even those getting subsidized premiums, so it is likely that people paying full premiums quit even sooner.

Tuesday, May 7, 2019

Ip on carbon tax

Over the weekend, Greg Ip at WSJ wrote a  nice piece on the carbon tax.

Greg addresses some common objections.
This urge to stop at nothing to find an effective solution is understandable. How can you put a price tag on the future of the planet?
..Green New Deal backers make another powerful argument: Global emissions levels are still rising, and to reverse them, carbon prices would have to be so high they’d be politically toxic. Better, the activists argue, to simply go straight to a massive, government-directed transition. 
This attitude is common. But there is no evading economics. Either you have visible economic damage (carbon tax) of $1,000 per ton or invisible economic damage of $10,000 per ton.  Prices are better than restrictions because you can see where you're wasting $10,000 per ton, which money could reduce 9 times as much carbon properly deployed.

There is also a political judgment here that people will not stand for a visible tax, but will stand politically, or perhaps be too stupid to notice, the much larger shadow price of direct controls. They won't pay $5 at the pump for gas, but will stand for banning cars. I don't think that's true. I don't think the left thinks it's true either. The way the Green New Deal and even the IPCC reports now bundle carbon reduction with a vast left-wing political agenda, and a rather Orwellian drive to silence criticism confirms it.

Sunday, May 5, 2019

Smith, MMT, and science in economics

Many blog readers have asked for my opinions of "Modern Monetary Theory." I haven't written yet, because I try to read about things in some detail, ideally from original sources, before reviewing them, which I have not done. Life is short.

From the summaries I have read, some of the central propositions of MMT draw a false conclusion from two sensible premises. 1) Countries that print their own currencies do not have to default on excessive debts. They can always print money to pay off debts. True. 2) Inflation in the end can and must be controlled by raising taxes or cutting spending, sufficiently to soak up such printed (non-interest-bearing) money. True. The latter proposition is the heart of the fiscal theory of the price level, so I would have an especially tough time objecting.

It does not follow that the US need not worry about deficits, and may happily borrow tens of trillions to finance all sorts of spending. Borrow $50 trillion or so. When bondholders revolt, print money to pay off the bonds. When this results in inflation, raise taxes to soak up the money. OK, but this latter step is exactly raising taxes to pay off the bonds. Moreover, if bondholders see that the plan is to pay off bonds with printed money, they refuse to buy or roll over bonds in the first place and the inflation can happen right away.

This may reflect a common confusion between today's money with the new money that pays off debt. It would only take $1.5 trillion in extra taxes or lower spending to retire current currency (non-interest bearing government debt) outstanding. But  that's not the task after the great bond bailout. Then we have to raise taxes or cut spending by, in my example,  the $50 trillion printed to pay off the bonds. Large debts are either paid or defaulted, and inflation is the same thing economically as default. Period. (Currency boards run in to some of the same problem. Backing today's currency is not enough to avoid devaluation, if one does not back all the debt which promises to pay currency.)

I must admit some amusement that Keynesian commentators, having urged fiscal stimulus and decried evil "Austerians" for years, are apoplectic to be passed on the left. But that does not make the ideas of those passing on the left any more right.  There is also a different and interesting strain of thought, exemplified by recent writings by Larry Summers and Olivier Blanchard, that the current low interest rate environment might allow for somewhat, but not unlimited, extra borrowing. Those ideas are completely different analytically. I hope to cover them in a later blog post.

Noah Smith and guru-based theory

But, as I said, I have not studied MMT, so perhaps I'm missing something. Enter Noah Smith, who has delved in to figure out just what MMT is and whether or how it hangs together.

Noah interestingly characterizes MMT as  "Guru-based theory." Noah:

Friday, April 12, 2019

Perpetually wrong forecasts

Torsten Slok of Deutsche Bank sends along the following fascinating graphs

The titles seem a little off. Yes, the market is expecting rate cuts (forward rate) but the market has been exactly wrong about everything for 10 years (and longer) first forecasting the recovery that never came, then forecasting much slower interest rate rises than actually happened.  Survey expectations seem to match the forward curves well except perhaps at the very end.

Mechanically, a rising forward curve and rates that never rise means you earn a lot of money in long term bonds. It's a "risk premium" Monika Piazzesi and Eric Swanson point out this pattern is common. The same pattern holds in longer term bonds, as well known since Fama and Bliss. An upward sloping term structure indicates higher expected returns on long term bonds, and vice versa. And it makes some sense. In recessions, people don't want to hold risks, so we expect a premium for riskier assets. In booms, as interest rates rise, people are more willing to take risks.

Still it's unsettling for lots of reasons. Why did the forward curve suddenly flatten exactly when interest rates finally took off? Another interpretation is something like a Poisson process in the end of recessions, in which the chance of fast recovery is independent of how long you've been in a recession, rather than arriving slowly and predictably. That makes it rational to continue these expectations persist despite continual disappointment, and to change forecast quickly once the long-awaited fast growth arrives.

Monday, April 8, 2019

Meer On Minimum Wage

David Henderson posts a thoughtful draft op-ed by Jonathan Meer on minimum wages. Two talents of  great economists are to recognize that averages hide big differences among people, and to imagine all the avenues of substitution and unintended effects of a regulation. The oped excels:

Substitution:
when the minimum wage is raised, employers offset increased labor costs by reducing benefits like the generosity of health insurance. Other benefits, like free parking or flexibility in scheduling, are more difficult to measure but are also likely to be cut back. Employers will likely expect more work effort when they are forced to pay more, changing the nature of jobs. And in the longer run, economists have found that employers shift towards automation and expecting customers to do more things themselves– reducing job growth in ways that aren’t always obvious. This damage takes time to be seen, which is one reason minimum wage hikes, like rent control, often seem appealing. 
Who gets jobs?
When debate focuses on the total number of jobs lost or gained, it hides this potentially nasty distribution of the benefits: a recent college graduate with a barista job may get a few more dollars an hour, but the high school dropout finds it harder to get and keep a job. ...
The teenage children of well-off families, earning money to buy video games, are treated the same as single moms struggling to get by. When wages are set at an artificially high rate, why should an employer take a risk on the single mother who needs the occasional shift off to take her kids to the doctor? The kid from a disadvantaged background who needs some direction on how to treat customers appropriately? Or the recently released felon trying to work his way back into the community? Why should employers bother with them when there are plenty of lower-risk people who are willing to work at those artificially high wages? 
Assorted comments, especially to dispel the usual you-just-don't-care-you-want-profits-for-big-business calumnies:
It will get much worse in the next recession...Those at the margins of the workforce will be left further behind. Low-wage jobs aren’t easy, don’t pay well, and are rarely fun. But not being able to find work at all is far worse.
Despite the lowest unemployment rates in decades, only 39% of adults without a high school degree had a full-time job in 2018 – and among young African-Americans dropouts, it’s a shocking 26%. It’s hard to believe that the best way to help them find work and start climbing the job ladder is to put the first rung out of reach, making it difficult for them to find work and driving them to illegal employment with few protections.
 We should never minimize the struggles of low-income families to get ahead. But good intentions are no substitute for good policy. Minimum wage proponents mean well, but the unintended consequences hurt the worst-off the most.
Jonathan isn't just making this up as us bloggers tend to do. He points to "The Minimum Wage, Fringe Benefits, and Worker Welfare, with Jeffrey Clemens and Lisa B. Kahn
...state-level minimum wage changes decreased the likelihood that individuals report having employer-sponsored health insurance. Effects are largest among workers in very low-paying occupations, 
and Dropouts Need Not Apply: The Minimum Wage and Skill Upgrading
workers employed in low-paying jobs are older and less likely to be high school dropouts following a minimum wage hike.... job ads in low-wage occupations are more likely to require a high school diploma following a minimum wage hike,
Related, Zachary S. Fone, Joseph J. Sabia, Resul Cesur find exactly the predicted substitution into criminal activity
find that raising the minimum wage increases property crime arrests among those ages 16-to-24, with an estimated elasticity of 0.2. This result is strongest in counties with over 100,000 residents and persists when we use longitudinal data to isolate workers for whom minimum wages bind. Our estimates suggest that a $15 Federal minimum wage could generate criminal externality costs of nearly $2.4 billion. 
Hat tip to David Henderson, who posted the draft oped and a link to the excellent Jonathan Meer - James Galbraith debate, and to the indefatigable Marginal Revolution. I saw an early draft of the oped, and hoped Meer would be able to publish it, at least somewhere like WSJ. It's not too late!

Update: 

Jonathan passed on this tidbit from Obenauer & von der Nienburg, “Effect of Minimum-Wage Determinations in Oregon,” July 1915, yes 1915
“The belief was very prevalent among store women that the minimum wage had wrought only harm to them as a whole. The experienced women contended that formerly they had gotten through the day without any hurry or strain. If it was necessary to work a few minutes overtime, they did so willingly. Now, they said, they are under constant pressure from their supervisors to work harder; they are told the sales of their departments must increase to make up for the extra amount the firm must pay in wages.”
Plus ├ža change...

Overall, it's a shame that economists have bought the popular discourse that all that matters are "jobs," as if it were 1933, not the vast range of the terms of employment -- how hard you have to work, hours, tasks, flexibility, side benefits, overtime, and so forth.


Friday, March 29, 2019

Operating Procedures

The Fed sets interests rates. But how does the Fed set interest rates? The Fed is undergoing a big review of this question. We had a little workshop at Hoover, in preparation for the larger May 3 Strategies for Monetary Policy conference, which provokes the following thoughts.

Issue

Here is the issue.



The graph plots the demand for reserves, as a function of the interest rate on other short-term assets such as overnight federal funds, Libor, money market rates, and so on.

(Reserves are accounts that banks have at the Fed. The Fed sets the interest rates on such accounts.)

The lower horizontal line is the rate the Fed pays on reserves.

If the interest rate on other similar assets (overnight federal funds, Libor, repo rates) is above the interest rate on reserves, then banks should want to get rid of reserves. However, reserves are useful, as money is useful, so banks are willing to hold some even when they lose interest on reserves by doing so. The greater the interest costs -- the greater the difference between the rate banks can lend at and the rate they get on reserves -- the more they work hard to avoid holding reserves. At the end, there are legal and regulatory requirements to hold reserves.

In the flat zone, banks are satiated in reserves. Reserves don't have any marginal liquidity value. But banks are happy to hold arbitrary quantities as an asset so long as the interest on reserves is above or equal to what they can get elsewhere.

If banks can borrow at less than the interest on reserves, they would do so and demand infinite amounts. Therefore, competition among banks should drive those rates up to the interest on reserves.  Similarly, if rates banks can lend at are higher than interest on reserves then banks should compete to lend, driving other rates down to the interest on reserves. Therefore, the Fed by setting the interest on reserves sets the overall level of overnight interest rates.

Questions

Here are the questions:

1) Where should the supply of reserves be? This is the biggest question the Fed is asking right now. The three vertical lines in the graph are three possibilities.

The Fed currently fixes the supply of reserves, which is referred to as the "size of the balance sheet," so the lines are vertical. The Fed raises the supply of reserves by buying assets such as treasuries or other assets, "printing money," i.e. creating reserves, in return for the assets. The balance sheet shows the assets (e.g. Treasuries) against liabilities (reserves and cash). Yes, the Fed is nothing more than an enormous money market fund, offering fixed value floating rate accounts which it backs by treasury and other securities.

The debated is couched as "floor system" vs. "corridor system."  A "floor system" refers to the two supplies on the right, where there are so many reserves that the other interest rates will equal the rate on reserves.

There are two floor-system variants: abundant reserves, with the supply well to the right, and minimalist reserves, with the supply of reserves set to the smallest possible level, where the demand curve just hits the lower bound, "satiation" in reserves. The latter seems to be where the Fed is heading -- a minimal-reserves floor system.

In a "corridor system," the Fed has an upper and lower band for the market interest rates it wants to target. Historically this was the Federal funds rate, which is the rate at which banks lend reserves to each other overnight. It tries to place that interest in the middle of the band, by artfully putting the supply of reserves in the downward sloping component. This is how the Fed operated before 2008.

The rate at which the Fed is willing to lend reserves also provides an upper bound, which I'll get to in a minute.

2) If there is going to be a corridor, which rate should the Fed care about? The (justly) moribund federal funds rate? The overnight general collateral repo rate? Libor? One advantage of the abundant floor, is that the Fed can stay quiet about all this and let the market sort out just what kind of overnight lending it prefers.

3) If there is a band, how wide should the range between the upper and lower bound be?  1%? 0.5? 0.25%? 0.01%?

3) How free should lending and borrowing be? Who gets access to interest paying reserves, and how much interest do they get? Who can borrow reserves, and on what therms -- what collateral is acceptable, is it overnight or term borrowing, does such borrowing incur formal regulatory attention or informal "stigma"?

4) What assets should the Fed buy on the other side of the balance sheet, or accept as collateral if it lends reserves?  Just short-term treasuries? (My favorite) The current mix of long term treasuries and mortgage-backed securities? Or, perhaps, follow the ECB and BOJ and buy corporate bonds and stocks, many countries debts, or lend newly created reserves to banks and count the loans as assets?

The motivations here are, I think, as much political as economic, and it's better to acknowledge that. (We should understand the Fed can't do that in writing, but we can!) Having touted QE as extraordinary accommodation the Fed is under big pressure to stop stimulating. It's too late to say that QE was mostly symbolic. Having seen the Fed buy all sorts of securities, congresspeople are coming up with dandy ideas for new things the Fed can "invest" in by printing money. Having paid banks about a quarter point more than they can get anywhere else, and indeed allowed a pleasant little arbitrage to go on, the Fed is under pressure to pay other investors the same. Congress is even more full of ideas for who the Fed should lend to, and how the Fed should use its expanded regulatory powers to channel credit here and deny credit there.

"Normalization" is a pretty meaningless economic term to me -- why is whatever the Fed was doing in 2007 "normal," why is it good? But "normalization" is a tremendously useful marketing banner. We're going back to "normal," so leave us alone with your bright ideas. Well, fine, but let us quietly  go to a new normal that incorporates all the interesting things we've learned in the last 10 years.

My answer

My (radical as usual) answers:

I like the "floor" system, with abundant reserves. The great lesson of the last 10 years is, we can live the Friedman rule. We can have money that pays full interest, so that holding money has no opportunity cost, and this will not cause inflation. This is genuinely new knowledge. Liquidity is free! There is no need for people to waste time and effort on cash management. Liquidity is good for financial stability too: Banks holding huge reserves don't fail.

I go beyond the abundant floor: The Fed should not target the supply of reserves at all. The supply curve of reserves should be horizontal.  The Fed should just say, "bring us your treasuries, and we'll give you reserves and pay the IOER rate." Or, "Bring us your reserves and you can have treasuries."

Why? Well, if you want to target a price, you offer to buy and sell freely at that price. If you want to target an interest rate, target an interest rate. We have seen limited arbitrage between reserves and other assets due to lack of competition in banking and Fed restrictions, who can hold reserves, and the fixed supply.

I see no economic or financial harm whatever from arbitrary expansion of the Fed's balance sheet, if the assets are all short-term Treasuries. Reserves are just overnight, electronically transferable government debt. If the banking system wants more overnight debt and less three week to six month debt, let them have what they want. I see no reason to artificially starve the economy of overnight debt.  The Fed offers free exchange between cash and reserves; the government as a whole should offer free exchange between short term treasuries and overnight treasuries, i.e., reserves.

To accommodate the economy's desire for ample reserves, and the Fed's desire not to provide them, the Treasury should offer the same asset, and the Fed should encourage this and work with the Treasury to make it happen. 

Specifically, the treasury should issue overnight, fixed-value ($1), floating-rate, electronically-transferable debt. Let's call it treasury electronic money. Legally, this is treasury debt that any individual or financial institution can hold, just as they can hold treasury bills or treasury coins. Functionally, these are interest-paying reserves. Like reserves, but not even like T bills, these can be bought or sold immediately: Owners can transfer their ownership of $1 worth of treasury money to someone else on the treasury website, and owners can sell $1 worth of treasury money and have the money wired (i.e. the treasury sends $1 of reserves to the owner's bank) instantly. (Details here.)

Given the Fed's resistance to narrow banking, and the potential of treasury electronic money to undercut bank's (subsidized) deposit financing, I suspect the Fed's first instinct would be to fight such an innovation. The Fed should overcome that instinct and welcome a solution to the problem of providing lots of liquid assets without the (genuine, below) downsides the Fed feels about a large balance sheet.

I agree with critics that the composition of the Fed's assets should return quickly to short-term treasuries only, and in my ideal world to just this treasury electronic money. That is mostly for political economy reasons outlined below. Other assets should be on the balance sheet in emergencies only.

If the Fed feels the need to buy long-term treasurys or take them as collateral, issuing reserves in return, because of a shortage of safe assets, that means the Treasury has not issued enough short-term liquid treasurys. There are simpler ways to fix that problem. 

Other answers

Tuesday, March 26, 2019

Central Bank Independence

I'm on a panel at the "ECB and its watchers" conference Wednesday, to discuss central bank independence. Here are my comments. Yes, there is a lot more to say, but I get exactly 15 minutes. I hope I'm not scurrying back tomorrow to retract something stupid here.

Central Bank Independence
John H. Cochrane
Hoover Institution, Stanford University
Remarks presented at the “ECB And its Watchers” conference, March 27 2019. 

I believe central bank independence is a good thing, and that it is in increasing danger. I don’t think that’s a controversial view, or we would not be here.

I sense that our mission today is to decry politicians that wish to influence the central banks’ good works, especially by pressing for low interest rates.

But I’ll argue instead that much of the threat to central bank independence stems ultimately from how central banks are behaving, and has little to do with interest rates.

Principles

What is, can and should be independent? Let me suggest three principles.

1) In a democracy, independence must come with limited powers, and a limited scope of authority.

2) An independent agency must follow rules, norms, and traditions, not act arbitrarily, with lots of discretion.

3) To be independent, an agency must be, and be perceived to be, competent at its task.

What cannot be independent? A lot of government activity transfers wealth from one person to another, or fights for political power. Those activities must be politically accountable.

Limited powers: Central banks operate within legal restrictions. For example, it seems puzzling that central banks struggle to raise inflation. We all know how to stoke inflation: drop money from helicopters. To stop inflation, soak up the money supply with heavy taxes.

Yet central banks are legally prohibited from this one, most effective action for stoking or stopping inflation.  Why? Well, in a democracy, writing checks to voters or confiscating their hard-earned cash must be reserved for politically accountable institutions.

Rules and norms: Most restraints on central bank actions are rules, norms, and traditions, not legal limitations. Central banking remains something of a black art, so central bankers must sometimes use judgement and discretion, especially in crises, and let the rules or norms evolve with experience. But if they are to stay independent, they must quickly return to or re-form rule, norm, or traditional limitations on their power.

From this perspective, the ECB was set up as an almost perfect central bank. It followed an inflation target. It only acted on the short-term interest rate. Its assets were uncontroversial.  And it was not to finance deficits or bail out sovereigns.

The inflation target and Taylor rule are most important here for their implied list of things that the central bank should not, is not expected to, and pre-ccommits not to pay attention to or control directly: stock prices, housing prices, sectoral and industry health, regional imbalances (especially in Europe), credit for small businesses, income and wealth inequality, infrastructure investment, decarbonization, bad schools, and so on.

An independent central bank should say often, “that’s a terrible problem, but it’s not our job to fix it.” It loses power and prestige in the moment, but gains independence in the long run.

Actions:

So what are central banks doing to invite challenges to their independence?

Interest rates get a lot of attention, but they are not, I think, the core of the problem. Yes, President Trump is violating established norms by complaining publicly about interest rates. But most people in both parties understand this is a violation, and a norm worth keeping, so for the moment I think the norm against interest-rate jawboning will hold in the future.

The big threat to independence comes from the expansion of activities and responsibilities that central banks have taken on, on an apparently permanent basis, in the years since the financial crisis: Asset purchases, regulatory expansion, a much larger set of goals, and a marriage of regulatory and macroeconomic policy.

Purchasing assets in dysfunctional markets, as in 2008, is what central banks traditionally do in a crisis. (We can argue whether they should, but that’s for another day.) But once markets returned to normal, continuing to buy large portfolios of long-term bonds, mortgage backed securities, corporate bonds, imperiled European sovereign debt, and even stocks, for years on end, was a different choice.

We can argue the benefits. Maybe QE lowered some rates, a bit, for a while, and maybe that stimulated a bit.

But we have ignored the costs. Central banks took on a new, and apparently permanent power, formerly foresworn: to buy assets directly, to control asset prices, not just short term interest rates.

It is harder to say to a politician, who complains that mortgage rates are too high, that this is not our problem; we set the short term rate to stabilize inflation; we don’t pay direct attention to other assets, or to directing credit to mortgages rather than big business.

It will get worse. The US Congress has noticed the Fed’s balance sheet. Under the mantra of “modern monetary theory,” a swath of congresspeople want the Fed to print trillions of dollars to finance the Green New Deal.

The ECB and euro were set up with a clear rule that the ECB does not bail out sovereigns. In the crisis, President Draghi rather brilliantly stemmed the first debt crisis with a “do what it takes” promise, that did not have to be executed, along with a warning that this could not be permanent.

But in response, Italy took the St. Augustinian approach — Lord, give me structural reform, but not quite yet. The ECB continues to repo government debt and Italian banks are still stuffed with Italian government bonds. The doom loop looms still, and markets still expect a bailout.

The ECB has lost the long run game of chicken. It will likely have to actually do what it takes when the next crisis comes.

But there is little that is more political, little that cannot stay independent more clearly, than bailing out insolvent sovereigns, with euros that must either inflate or be backed up by taxes on the rest of Europe.

The ECB is still directly financing questionable banks and questionable corporations. These are also activities that will invite political scrutiny.

The crisis spawned a vast expansion of regulation. The US Fed is now using an immense,confusing, and constantly changing set of rules to act with great discretion on telling banks what to do.

Moreover such regulation changed from “micro,” somewhat rules-based regulation, to more nebulous and discretionary “macro prudential” regulation that directs the activities of “systemic” institutions — something nobody can define other than “we know it when we see it.” The Fed wanted to include large insurance companies, until courts struck that down, and tried for a while to systemically regulate equity asset managers, on the theory that the managers might sell in a behavioral herd and send prices down.

But telling banks and other institutions what to do, who to lend to, when to buy and sell assets, with billions on the line, using a high degree of judgment and discretion, is a political act that invites loss of independence. Your “bubble” is my “boom,” your “fire sale” my “buying opportunity.”

More than current actions, the ideas swirling around central banks seem to me even more dangerous for their future independence.

It is taken for granted that central banks should embrace the task of managing and directing the entire financial system. This only starts with managing bank assets to try to manage “systemic” risks. It goes on to managing asset prices and housing prices, I guess so that nobody ever loses money again, and directing the “credit cycle.” And central banks should go beyond short rates and asset purchases, and use regulatory tools to direct the macroeconomy and asset markets.

Nobody even seems to stop and think that such actions are intensely political, and will invite strong attacks on central bank independence.

Moreover, faith that we economists and the central banks we populate have any actual technical competence to implement such grandiose schemes is evaporating, and rightly so. That the already vast regulatory system failed to stop the last crisis eroded a lot of trust. In many ways the revelation that elites didn’t know what they were doing led to today’s populism. That once this horse was out of the barn, Europe’s regulators nonetheless kept sovereign debt risk free, inviting a second sovereign debt crisis, eroded more trust. If the next crisis blindsides larger, and much more pretentious grand plans, that trust and the independence it grants will vanish.

Even monetary policy is becoming more dangerous to independence. Much of the post-crisis analysis hinges on how monetary policy effects income transfers, for example from investors to mortgage borrowers or from all of us to bank balance sheets. Well, if the point of monetary policy is to take money from Peter, and give it to Paul, on the grounds that Paul has a higher marginal propensity to consume, Peter is going to call his congressman.

I sense that a lot of this expansion of tools, scope, and discretion comes from a natural human and institutional tendency towards aggrandizement.  It’s fun to become the grand macro-financial planner, always in the news. It’s boring to be a limited, technical institution that says “not my job.”

For example, I think a lot of QE was simply done to be seen to be “doing something” in the face of slow supply-side growth. Remember, monetary problems, especially any ill effects of 1% rather than 2% inflation, do not last 10 years. Long run growth comes from productivity, and structural reform, not stimulus, and not money.

But in the language of central bankers, “growth” and “demand” seem to be synonyms. This morning, describing a decline in growth with no decline in consumption, President Draghi used the word “demand” many times, and “supply” never. Like helicopter parents, central banks want always to be in charge.

Maybe you disagree, but think of the costs. For sure, the promise of endless QE, and reiterating the promise that central-bank provided demand stimulus is the vital answer, lessened the pressure for structural reform.

More generally, imagine that about 5 years ago, central banks had said, “We’ve done our job. The crisis is over. ‘Demand’ is no longer the problem. If you think growth is too low, get on with structural reform. Low inflation and interest rates are fine. Welcome to the Friedman rule. QE is over, and we are no longer intervening in asset markets. In place of intrusive bank regulation, countercyclical buffers, stress tests, and asset price management, we are going to insist on lots and lots of capital so there can’t be crises in the first place. We’ll be taking a long vacation.”

Just how much worse would the overall economy be? We can argue. How much better would the threats to central bank independence be? A lot.

Well, it’s not too late.

Suggestions

Let me offer some practical suggestions:

1) Separate monetary policy and regulation. Regulation is much more intrusive, and much harder to resist political pressure. Using regulatory tools for macroeconomic direction is inherently going to threaten independence. The ECB’s Chinese wall between regulation and monetary policy is a good start.

2) Transfer, or swap, all balance sheet assets other than short term treasuries to a “bad bank,” controlled by fiscal authorities.

3) Solve the sovereign debt problem. Stop the doom loop: get own country sovereign debt out of banks, or backed by capital. Create a mutual fund with a diversified portfolio of government debts, and force banks to hold that if they don't want big risk weights. Allow pan-europeans banks that hold diversified portfolios. Then insolvent sovereigns can default without shooting their hostage.

4) Abandon the pretense that risk regulation, asset price management, and credit allocation policy will stop another crisis. Move to narrow deposit taking and equity financed banking, or at least allow these to emerge rather than fighting them tooth and nail.

The US Fed is clearly perceived to be defending monopoly profits of large banks, a big threat to its independence. If you don’t like President Trump’s tweets, wait for President Elizabeth Warren’s. And she knows where the regulatory bodies are buried.

5) Europe needs structural financial reform more than continued bank support from the ECB. For example, corporate bonds should be held in mutual funds marketed directly to investors.

6) Be quiet. Federal Reserve officials should not give speeches about inequality or other hot-button partisan political issues, no matter how passionately they feel about them.

7) But don’t throw away the bad with the good. In the face of political criticism, I sense central banks, rushing to apply the label “normalization.” The Fed is rushing to reduce the quantity of reserves and go back to older reserve management schemes, losing the lessons of how well an abundant reserves system can work.

Independence is not ours to claim. Central banks are government agencies, not private institutions with rights. Governments grant them independence when it is useful for government to pre-commit not to use some of its vast powers for political ends. Independence must be earned by, well, not using power in ways that must be politically accountable.

Central banks need to answer, What economic problems, are not your job to worry about? What tools will you not use? Central banks need to choose the power and allure of trying to fix everything, and thus acting politically, vs. the limitations that allow independence. They can’t have both. And we voters need to tell our politicians which kind of central bank we want. We can’t have both either.

Having laid out the options, it seems clear to me that nobody wants a limited, and hence independent central bank. The trend to central banks as the large, integrated, monetary-financial-and macroeconomic planners, integrating broad control of financial markets and their participants, is desired by central banks, politicians, and not contested by voters. So they shall be, but not independent.