## Friday, July 20, 2018

### Nobel Symposium on Money and Banking Day 2

Day 2 of the Nobel Symposium on Money and Banking focused on monetary policy. (My last post covered Day 1 on banking.)

Bernanke

Sadly Ben Bernanke's video and slides are not up on the website. Ben showed some very interesting evidence that the crisis was an unpredictable run, rather than the usual story about predictable defaults resulting from too much credit. Things really did get suddenly a lot worse in September and October 2008. Yes, it's easy to say this is defense against the charge that he should have done more ahead of time. But evidence is evidence, and I find it quite plausible that the relatively small losses in subprime need not have caused such a massive crisis and recession absent a run. Ben says the material is part of a paper he will release soon, so look for it. One can understand that Bernanke is careful about releasing less than perfect drafts of papers and videos.

History

Barry Eichengreen gave a scholarly account of why history matters, especially the great depression, and we should pay more attention to it. (Paper, video.) He aimed squarely at typical economists whose knowledge stopped at Friedman and Schwartz, or perhaps Ben Bernanke's famous non-monetary channels paper, in which bank failures propagated the depression. He emphasized the role of the gold standard and international cooperation or non-cooperation, and warned against facile comparisons of the gold standard experience to today's events and the euro in particular.

Randy Kroszner has a great set of slides and an engaging presentation. He also started on parallels with the great depression, and told well the story of the US default on gold clauses. He closed with a warning about fighting the last war -- particularly apt given the exclusive focus of most of this conference on the events of 2008 -- and on how to start a crisis. In his view when Bank of England Gov Mervyn King said: “We will support Northern Rock." People hear "Northern Rock's in trouble? Run!" Likewise, in my view, speeches by President Bush and Treasury Secretary Paulson did a lot to spark the run in the US.

DSGE

A highlight for me, was the session on DSGE models.

Marty Eichenbaum (video, slides, subsequent paper) gave a nice review of the current status of new Keynesian DSGE models, and how they are developing in reaction to the financial crisis and recession, and the zero bound episode.

Harald Uhlig

Critiques, or more precisely lists of outstanding puzzles and challenges, are often more memorable and novel than positive summaries, and Harald Uhlig delivered a clear and memorable one. (Video, Slides)

Asset prices are a longstanding problem in DSGE models. In typical linearized form, the quantity dynamics are governed by intertemporal substitution, and the asset prices by risk aversion, and neither has much influence on the other. (I learned this from Tom Tallarini.) Rather obviously, our recent recession was all about risk aversion -- people stopped consuming and investing, and tried to move from private to government bonds because they were scared to death, not a sudden attack of thriftiness. There is a lot of current work going on to try to repair this deficiency, but it still lives in the land of extensions of the model rather than the mainstream. Harald also points out a frequently ignored implication of Epstein-Zin utility, the utility index reflects all consumption and anything that enters utility

Financial frictions are blossoming in DSGE models, in two forms: First, HANK or "heterogenous agent" models, which add things like borrowing constraints and uninsurable risks so that the distribution of income matters, and in an eternal quest to make the models work more like static ISLM. Second, in response to the financial crisis (see first day!) stylized models of banking and intermediary finance are showing up. I'm still a little puzzled that the more standard time-varying risk aversion part of macro-finance got ignored, (a plea here) but that is indeed what's going on.

The conundrum, here as elsewhere in DSGE, is that the more people play with the models, the further they get from their founding philosophy: macro models that do talk about monetary policy, (now) financial crises, but that obey the Lucas rules: Optimization, budget constraints, markets, or, more deeply, structures that have some hope of being policy invariant and therefore predictions that will survive the Lucas critique. Already, many ingredients such as Calvo pricing are convenient parables, but questionably realistic as policy-invariant.

Harald points out that since most of the frictions are imposed in a rather ad-hoc manner, neither will they be policy-invariant. This is a deeper and more realistic point than commonly realized. Every time market participants hit a "friction," they tend to innovate a way around that friction so it doesn't hurt them next time. Regulation Q on interest rates was once a "friction," and then the money market fund was invented. The result is too often "chicken papers:"

The understandable trouble is, if you try to microfound every single friction from Deep Theory -- just why it is that credit card companies put a limit on how much you can borrow, in terms of asymmetric information, moral hazard, and so forth -- the audience will be asleep long before you get to the data. Also, as we saw in day 1, there is (to put it charitably) a lot of uncertainty in just how contract or banking theory maps to actual frictions. I think we're stuck with ad-hoc frictions, if you want to go that route.

Harald's next point is, I think, his most devastating, as it describes a huge hole in current models that is not (unlike the last two) a point of immense current research effort. The Phillips curve and inflation are the central point of the New Keynesian DSGE model -- and a disaster.

The Phillips curve is central. The point of the model is for monetary policy to have output effects. Money itself has (rightly) disappeared in the model, so the only channel for monetary policy to work is via the Phillips curve. Interest rates change inflation, and inflation causes output changes. No surprise, it is very hard for that model to produce anything like the last recession out of small changes in inflation. (I have to agree here with the premise of the financial frictions view -- if you want your model to produce the last recession, other than by one huge shock, the model needs something like a financial crisis.)

The Phillips curve in the data is well known

Less well known, but worth lots of attention, is how the now standard DSGE models completely fail to capture inflation. Harald's slide:

The point of the slide, in simpler form: The standard Phillips curve is

inflation today = beta x expected inflation next year - kappa x output gap (unemployment) + shock

Essentially all inflation is accounted for by the shock. The model is basically silent about the source of inflation. Looking at the model as a whole, not just one equation, Neither monetary policy shocks nor changes in rules accounts for any significant amount of inflation.

I made a similar graph recently. Use the standard three equation model
Now, use actual data on output y, inflation pi, and interest rate i, to back out the shocks v. Turn off the monetary policy shock vi = 0. Solve the model and plot the data -- what would have happened if the Fed had exactly followed the Taylor rule?

Answer: Inflation and output would have been virtually the same. The inflation of the 1970s and its conquest in the 1980s had nothing to do with monetary policy mistakes. It is entirely the fault, and then fortunate consequence, of "marginal cost" shocks that come from out of the model. This is a pretty uncomfortable prediction of a model designed to be about monetary policy! Or, as Harald put it

• QDSGE: don’t account for inflation with monetary policy shocks.
• The NK / Phillips-Curve-based NK QDSGE models may thus provide a poor guide for monetary policy.

Wait, you ask, what about Marty Eichenbaum's pretty graphs, such as this one, showing the effects of a monetary policy shock?
The answer: After a lot of work, the effects of a monetary policy shock look (at last) about like what Milton Friedman said they should look like in 1968. But monetary policy shocks don't account for any but a tiny part of output and inflation variation, quite contra Friedman (and Taylor, and many others') view.

Last, standard new Keyensian DSGE models have strong "Fisherian" properties. In response to long lasting or expected interest rate rises, inflation goes up. More on this later.

Ellen McGrattan

Ellen stole the show. (Slides.) Take a break, and watch the video. She manages to be hilarious and incisive. And unlike the rest of us, she didn't try to sheohorn a two hour lecture into her 15 minutes.

Her central points. First, like Harald, she points out that the models are driven by large shocks with less and less plausible structural interpretation, and thus further from the Lucas critique solution than once appeared to be the case. The shocks are really "wedges," deviations from equilibrium conditions of the model with unknown sources

What to do? Focus on rules and institutions. This is a deep point. Even DSGE modelers, in the desire to speak to policy makers, often adopt the static ISLM presumption that policy is about actions, about decisions, whether to raise or lower the funds rate. The other big Lucas point is that we should think about policy in terms of rules and institutions, not just actions.

Monetary policy and ELB

Stephanie Schmitt-Grohé (slidesvideo)  talked about the Fisherian possibility -- that raising interest rates raises inflation. New-Keynesian DSGE models, with rational expectations, have this property, especially for permanent or preannounced interest rate increases, and when at zero interest rates or otherwise in a passive regime where interest rates do not react more than one for one with inflation. She and Martin Uribe have been advocating this possibility as a serious proposal for Europe and Japan that want to raise inflation.

She presented some nice evidence that permanent increases in interest rates do increase inflation -- and right away, not just in the long run.

Mike Woodford. (slides, video)  gave a dense talk (37 slides, 20 minutes) on policy at the lower bound. During the ELB, central banks moved from interest rates to asset purchases and forward guidance. Mike asks,
To what extent does this mean that the entire conceptual framework of monetary stabilization policy needs to be reconsidered, for a world in which ELB might well continue periodically to bind?
In classic form, Mike sets the question up as a Ramsey problem. Given a DSGE model, what is the optimal policy, given that interest rates are occasionally constrained? He derives from that problem a price level target. The price level target works, intuitively, by committing the central bank to a period of extra inflation after the zero bound ends. It is a popular form of forward guidance. The innovation here is to derive that formally as an optimal policy problem.

Mike's price level target is stochastic, changing optimally over time to respond to shocks. I'm a little skeptical that the central bank can observe and understand such shocks, especially given the above Uhlig-McGrattan discussion about the nature of shocks. Also, as I emphasize in comments, I'm dubious about the great power of promises of what the central bank will do in the far future to stimulate output today. I'm a fan of price level targets, but on both sides, not just as stimulus, but for utterly different reasons.

Mike takes on rather skeptically the common alternative -- quantitative easing, asset purchases during the time of the bound. He points out that to work, people have to believe that the increase in money is permanent, and won't be quickly withdrawn when the zero bound is over. As evidence, he points to Japan:

Similarly, he likes the price level target over forward guidance -- speeches in place of action -- as it is a more credible commitment to do things ex-post that the bank may not wish to do ex-post.

Finally, he addresses the puzzles of new Keynesian models at the zero bound -- forward guidance has stronger effects the further in the future is the promise; effects get larger as prices get less sticky, and so on. He argues that models should replace rational expectations with a complex k-step iterated expectations rule.

Me.

Video, slides from Swedenslides from my webpagewritten version. I covered this in a previous blog post, so won't repeat it all. I put a lot of effort in to it, and it summarizes a lot of what I've been doing in 15 minutes flat, so I recommend it (of course). It also offers more perspective on above points by Mike and Stephanie. My favorite line, referring to Mike's push for irrational expectations is something close to
"I never thought we would come to Sweden, that I would be defending the basic new-Keynesian program, and that Mike Woodford would be trying to tear it down. Yet here we are. Promote the fiscal equation from the footnotes and you can save the rest."
Emi Nakamura

Poor Emi had to go last in an exhausting conference of jet-lagged participants. She did a great job (video, slides) covering a century of monetary history and monetary ideas clearly and transparently. These are great slides to use for an undergraduate or MBA class on monetary policy, as well. An abbreviated list:

• Gold standard
• Seasonal variation in interest rates under the gold standard; money demand shocks
• Money demand shocks in the 1980s -- how the supposedly "stable" V in MV=PY fell apart when the Fed pushed on M.
• Instability / indeterminacy of interest rate targets
• The switch to interest rate targets and corridors
• The (near-miraculous) success of inflation targets

• Taylor rules and other theory of determinate inflation under interest rate targets
• How is it "monetary economics" without money?
• Why did immense QE not cause inflation?

Postlude

Monday featured two panels, Macroeconomic research and the financial crisis: A critical assessment, with Annette Vissing-Jørgensen, Luigi Zingales, Nancy Stokey, and  Robert Barro ; and Banking and finance research and the financial crisis: A critical assessment with Kristin Forbes, Ricardo Reis, Amir Sufi, and Antoinette Schoar.

Perhaps it's in the nature of panels, but I found these a disappointment, especially compared to the stellar presentations in the main conference. Also I think it would have been better to allow more (any, really) audience questions; the whole conference was a bit disappointing for lack of general discussion, especially with such a stellar group.

In particular, Luigi led by excoriating the profession for not paying attention to housing problems and financial crises. I thought this a bit unfair and simultaneously short-sighted. He singled out monetary economics textbooks, including Mike Woodford's, for omitting financial crises. Well, Mike omitted asteroid impacts too. It isn't a book about financial crises. And, after lamabasting all of us, he said not one word about events since 2009. What are we missing now? I had to stand up and ask that rude question, again suggesting that perhaps we are all not listening to Ken Rogoff this time. Annette went on to ask something like "don't you Chicago people believe in any regulation at all," and the respondents were too polite to say what an unproductive question that is and just move on.

Again, I offer apologies to authors and discussants I didn't get to. The whole thing was memorable, but there is only so much I can blog! Do go to the site and look at the other sessions, according to your interests.

## Thursday, July 19, 2018

### Nobel Symposium on Money and Banking Day 1

I attended the Nobel Symposium on Money and Banking in May, hosted by the Swedish House of Finance and Stockholm School of Economics.   It was a very interesting event. Follow the link for all the presentations and videos. (Click on "program." )

This review is  idiosyncratic, focusing on presentations that blog readers might find interesting. My apologies to authors I leave out or treat briefly -- all the presentations were action-packed and even my verbose blogging style can't cover everything.

"Nobel" in the title has a great convening power! The list of famous economists attending is impressive. And each presenter put great effort into explaining what they were doing, in part on wise invitation from the organizers to keep it accessible.  As a result I  understood far more than I do from usual 20 minute conference presentations and 15 minute discussions.

The first day was really "banking day," giving a whirlwind tour of the financial economics of banking.

Darrell Duffie gave (as always) a super presentation on the effects regulation is having on arbitrage in markets. (Slides, video)

## Tuesday, July 17, 2018

### Health care competition?

Continuing the health care series, there does come a time in which innovative disruptors can break open a protected market and bring some competition. Think Uber and taxis. In a very nice essay, John Goodman describes one such effort, MedBid, an online marketplace where hospitals (gasp) bid for your business:
[entrepreneur Ralph] Weber says MediBid got about 3,500 requests last year from patients; and providers made 12,000 bids on those requests. ...
The average knee replacement on MediBid costs around $15,000. The normal charge by U.S. hospitals is around$60,000 and the average insurance payment is about $36,500. A similar range exists for hip replacements, with an average Medibid price of about$19,000.
Recall prices of $180,000 per hip in my last post. The most interesting feature of Goodman's essay is the nature of price discrimination hospitals practice. It turns out they will negotiate lower prices for cash customers... Sometimes: ...Canadians can come to the U.S. and pay about half as much as we Americans pay. By taking advantage of Medibid, you and I can do the same thing. So can employer health plans. So which hospitals are giving Canadians and MediBid patients 50% off? It could easily be a hospital right next door to you. Strange as it may seem, hospitals are willing to give traveling patients deals that they won’t give those of us who live nearby. The reasons? Hospitals believe that if you live in their neighborhood, they’re going to get your business, regardless. Also, after your operation, your insurance company might argue over whether the operation should have been done in the first place. They might argue that there was no pre-authorization. They may argue over price. They may argue over many other things. And when the hospital finally gets its money, it might be a year or two after the fact. The “medical tourism market,” as it’s sometimes called, has three requirements: (1) you have to be willing to travel and (2) you have to pay up front, and (3) there can be no insurance company interference after the fact. This last part is really interesting. You have to travel to get the discount. We'll see how long the price discrimination lasts in the face of a market that organizes people around it. More and more people have high copayment policies, ACA policies that have such narrow networks they can't get the treatment they want, health savings accounts and so forth. Employers can steer you to Medbid as well. ## Sunday, July 15, 2018 ### Cross subsidies again -- hip replacement edition From the Wall Street Journal, a familiar story of medical pricing mischief: Michael Frank...had his left hip replaced in 2015. The Manhattan hospital charged roughly$140,000. The insurance company paid a discounted rate of about $76,000, and his share—a 10% copay, plus a couple of uncovered expenses—was a bit more than$8,000.
The author, Steve Cohen
I’d recently had two hips replaced, six months apart, at the same hospital that had treated him....the hospital had charged $175,000 for my right hip and$180,000 for the left. The insurance company had paid discounted rates of $75,000 and$77,000.
The usual picture is a huge sticker price, an "insurance discount" and Medicare and Medicaid paying even less than that. I googled around a bit looking for the latter numbers, which I didn't find but I did find here a nice study of cost variation
The average typical cost for a total knee replacement procedure was $31,124 in 64 markets that were studied. However, it could cost as little as$11,317 in Montgomery, Alabama, and as high as $69,654 in New York, New York. Within a market, extreme cost variation also exists. In Dallas, Texas, a knee replacement could cost between$16,772 and $61,585 (267 percent cost variation) depending on the hospital. Similar trends also were seen for the average typical cost for a total hip replacement procedure, which averaged$30,124. However, it could cost as little as $11,327 in Birmingham, Alabama, and as much as$73,987 in Boston,5 Massachusetts, which had the greatest variance within a given market, with costs as low as $17,910 (313 percent cost variation). These are, I think, insurance costs not the above sticker prices. Also from the LA times, New Medicare data show that Inglewood's Centinela Hospital Medical Center billed the federal program$237,063, on average, for joint replacement surgery in 2013. That was the highest charge nationwide. And it's six times what Kaiser Permanente billed Medicare eight miles away at its West L.A. hospital. Kaiser billed $39,059, on average, and Medicare paid$12,457. The federal program also paid a fraction of Centinela's bill -- an average of $17,609 for these procedures. That does give some sense that Medicare is paying even less than private insurers. Economics What's going on here? Observations: 1) This market is grotesquely uncompetitive. In any competitive market, suppliers bombard you with price information to get you to shop, and prices are driven to something like cost. Airlines don't need a government run nonprofit to disclose how much they charge. There is not just massive price-based competition for flights, there is massive competition for price-shopping services -- google flights vs. orbitz vs. kayay vs. priceline vs. expedia and so on. 2) The insane list price, the insurance discount of about half, and medicare paying about half that is telling. You would expect a cash discount. There are people with$30k to spend, insurance that doesn't cover hip surgery, and hospitals should be jumping to serve them, cash and carry, no paperwork. There are plenty of people with that kind of money to spend on cosmetic surgery.

The clearest sign of pathology in US health care is that the cash market is dead. Even if you have the money, you must have an insurer to negotiate the "insurance discount."

I suspect that in fact if you go to the hospital and say you're paying cash and negotiate, you can get a much better deal. So long as you don't let anyone else know what you're paying. But even that is no defense. You don't have to go visit airline offices and negotiate one on one for a ticket to New York. Competitive businesses chase after their cash customers. And people with $30k to spend on hip replacements don't want to spend weeks negotiating. Why don't they advertise? Hospitals cannot publicly say what the cash price is. If they did, insurance would demand that price too and the cross subsidies would vanish. The quoted price is a fiction. It allows hospitals to declare lots of charity care when they treat uninsured people with no money at all. But more importantly, it gives them a great starting point for a one-on-one ex-post negotiation for the unwary. As in "cross subsidies," we have an immense scheme of cross-subsidies going on, in which private insurance at$70k overpays compared to Medicare, and the hospital is left free to fleece the unwary with outrageous $140k bills. Cross subsidies cannot withstand competition. 3) The huge price variation gives some sense how wasteful the system is. In addition to the obvious variation across hospitals in a given town, variation across cities is telling. Google flights shows$591 for a first class ticket from New York to Birmingham Alabama, and the most expensive hotel I can find there is $177 per night. Why not fly to Alabama? Well, of course, insured patients are insured. And insurance is, per law, state based, so Alabama is out of network! Regulations The government needs to do something about this, right? Steve mentions one apparently failed effort, In 2009, New York’s then-attorney general, Andrew Cuomo, announced the creation of a nonprofit organization called FAIR Health. Its mandate is to provide consumers accurate pricing information for all kinds of medical services. I found the FAIR Health website and queried its database. It reported that the out-of-network price for a hip replacement in Manhattan was$72,656, close to what Mr. Frank’s and my insurance companies had paid. The problem: We were both in-network, and FAIR Health estimated that cost as only $29,162. I never did figure out the reason for the difference in pricing—but somebody ought to. The second natural response, which we hear over and over, is that the government needs to pass rules mandating price disclosure. But what happens when the government forces price disclosure and companies (evidently) don't want to tell customers what the price is? Well, there are rules mandating price disclosure for hotel rooms, which must be posted on the door of the hotel room. Yet on the hotel's website, Well, that regulation is working great isn't it. It's easy to jump to the conclusion that people need more skin in the game, greater copays, greater incentive to shop. But the real problem is lack of supply competition. Incentive to shop is no good if you can't find out what things actually cost. The problem is that hospitals don't want to tell you the price to attract your business. They don't want to because they don't have to, because they are protected from competition. Hotels do want to tell you the real price. Until hospitals do too, they will find their way around disclosure regulations too. It's easy to post phony prices and wink that nobody actually pays that price. Hospitals already do that when forced to disclose by stating huge prices and then offering insurers bundle discounts separated from the individual bill. ## Thursday, July 12, 2018 ### Loss Aversion A frequent email correspondent asked "I’d love to hear your take on “loss aversion.” I just finished listening to Kahneman’s book." My response seems worth sharing with blog readers. Expected Utility Let’s review expected utility first. The utility you get from consumption or wealth is a concave function of consumption or wealth. An extra dollar makes you more happy than it makes Bill Gates. So, compare either getting C for sure, or a 50/50 bet of getting C+Delta or C-Delta, i.e. having C or betting 50/50 on a coin flip. The expected utility of C for sure is just U(C). The expected utility of the bet is EU = prob(loss) * U(consumption if loss) + prob(gain) * U(consumption if gain) EU = 1/2 * U(C - Delta) + 1/2 * U(C + Delta). As the graph shows, this is less than the expected utility of C for sure. So, people should decline fair value bets. They are “risk averse”. Comments. Behavioral fans (New York times has done this often in its economics coverage) criticize “classical economics” by saying it ignores the fact that people fear losses more than they value gains. That’s absolutely false. Look at the utility function. People fear losses more than they value gains. That’s the whole point of expected utility. (You’ll see the confusion in a second). A common mistake: EU( C) is not the same as U [ E(C )]. You do not find the utility of expected consumption, you find the expected utility of consumption. In my graph, C is equal to the expected value of C-Delta and C+Delta, and the whole point is that the utility of C is bigger than the expected utility of (C-Delta) or (C+Delta). You can take E inside a linear function, but you cannot take E inside a nonlinear function. Loss aversion OK, on to loss aversion. In the usual sort of experiments Kahneman found that people seem reluctant to lose money. They have a “reference point” and work hard to avoid bets that might put them below that reference point. He models that as expected utility with a kink in it, as in the second drawing. I was careful to draw the reference point as different than C. People do not necessarily place the reference point at the expected value of the bet. In fact, usually they don’t. If betting on stocks, the expected value of the bet is to gain 7% per year. The “don’t lose money” point would be do not go below 0, not do not go below the mean. Here people are especially afraid only of the very left part of the distribution. Now, really, how are these models different? Expected utility can be any function, and nobody said it doesn’t have a kink in it. The key distinguishing feature of loss aversion – and its Achilles heel – is that the reference point shifts around. If you make some money, and play again, then your kink shifts up to the new amount of money you made. Expected utility is supposed to stay the same function of consumption or wealth. People might change behavior – most likely the utility curve is flatter at high levels of consumption, so rich people are less risk averse. But the curve itself does not shift. The key assumption that distinguishes loss aversion from expected utility is that the kink point shifts around as you gain and lose money. That’s also the Achilles heel. The first problem is how do you handle sequential bets. If I go to the casino, and know I will play twice, how do I think about my strategy? With expected utility this is easy, because the expected utility works backwards. Suppose you win the first bet, then figure out what you do in the second bet. For each of win or loss in the first bet, then, you have an expected utility from taking the second bet. The expected utility of the first bet is then the expected vaule of the expected utilities you would have if you won or lost. ## Thursday, June 14, 2018 ### Different Planets A friend, who reads an unusually diverse set of sources, passed on some interesting pictures suggesting that our media live on different planets. On the Trump-Kim summit On the investigations: ## Tuesday, June 12, 2018 ### Cross-subsidies Cross-subsidies are an under-appreciated original sin of economic stagnation. To transfer money from A to B, it would usually be better to raise taxes on A and to provide vouchers or otherwise pay competitive suppliers on behalf of B. But our political system doesn't like to admit the size of government-induced transfers, so instead we force businesses to undercharge B. Since they have to cover cost, they must overcharge A. It starts as the same thing as a tax on A to subsidize B. But a cross-subsidy cannot withstand competition. Someone else can give A a better price. So our government protects A from that competition. That ruins the underlying markets, and next thing you know everyone is paying more for less. This was the story of airlines and telephones: The government wanted to subsidize airline service to small cities, and residential landlines, especially rural. It forced companies to provide those at a loss and to cross-subsidize those losses from other customers, big city connections and long distance. But then the government had to stop competitors from undercutting the overpriced services. And as those deregulations showed, the result was inefficiency and high prices for everyone. Health care and insurance are the screaming example today. The government wants to provide health care to poor, old, and other groups. It does not want to forthrightly raise taxes and pay for their health care in competitive markets. So it forces providers to pay less to those groups, and make it up by overcharging the rest of us. But overcharging cannot stand competition, so gradually the whole system became bloated and inefficient. A Bloomberg article "Air Ambulances Are Flying More Patients Than Ever, and Leaving Massive Bills Behind" by John Tozzi offers a striking illustration of the phenomenon, and much of the mindset that keeps our country from fixing it. The story starts with the usual human-interest tale, a$45,930 bill for a 70 mile flight for a kid with a 107 degree fever.
At the heart of the dispute is a gap between what insurance will pay for the flight and what Air Methods says it must charge to keep flying. Michael Cox ... had health coverage through a plan for public employees. It paid $6,704—the amount, it says, Medicare would have paid for the trip. The air-ambulance industry says reimbursements from U.S. government health programs, including Medicare and Medicaid, don’t cover their expenses. Operators say they thus must ask others to pay more—and when health plans balk, patients get stuck with the tab. Seth Myers, president of Air Evac, said that his company loses money on patients covered by Medicaid and Medicare, as well as those with no insurance. That's about 75 percent of the people it flies.  Source: Bloomberg.com According to a 2017 report commissioned by the Association of Air Medical Services, an industry trade group, the typical cost per flight was$10,199 in 2015, and Medicare paid only 59 percent that.
So, I knew about cross-subsidies, but $45,950 vs.$6,704 is a lot!

OK, put your economics hats on. How can it persist that people are double and triple charged what it costs to provide any service? Why, when an emergency room puts out a call, "air ambulance needed, paying customer alert" are there not swarms of helicopters battling it out -- and in the process driving the price down to cost?

## Monday, June 11, 2018

### Summer School Suggestion

The Asset Pricing online class is back, now hosted on Canvas. This is a first-year PhD level course in asset pricing. Advanced undergraduates and MBAs with some economics and basic calculus can take it too.  I mention it again as it is well suited as a summer school project, and I realized in talking to colleagues that not everyone who knew about the original class knows it's alive again.  Go here to sign up.

Faculty can also assign it or parts of it, and using the canvas system find out if students have taken the quizzes. This makes it a useful summer school prerequisite for fall classses, or you can use it or parts of it in a flipped classrom -- have the students do an online unit, take the quiz, and then show up to class prepared for more advanced discussion.

More information here on my webpage, along with all the videos and notes, and lots of extra material. If you don't want to take the quizzes, you can see the videos and notes without taking the course.

## Monday, June 4, 2018

### ACA dropouts

Half of the people who sign up for Obamacare (ACA) get a flurry of medical care, then drop out before a year is over. They can always sign up again if they need to. People who stay on insurance tend to be those who have ongoing chronic and expensive conditions that need continual care. The implications for the viability of such insurance are not good.

This is the interesting conclusion of a new paper, "Take-Up, Drop-Out, and Spending in ACA Marketplaces" by Rebecca Diamond, Michael Dickstein, Tim McQuade, and Petra Persson. One good summary graph:

## Tuesday, May 29, 2018

### Lessons of the ELB

I gave a short presentation on monetary policy at the Nobel Symposium run by the Swedish House of Finance. It was an amazing conference, and I'll post a blog review as soon as they get the slides up of the other talks. Offered 15 minutes to summarize what I know about the zero bound, as well as to comment on presentations by Mike Woodford and Stephanie Schmitt-Grohé, here is what I had to say. There is a pdf version here and slides here. Novelty disclaimer: Obviously, this involves a lot of recycling and digesting older material. But simplifying and digesting is a lot of what we do.

Update: video of the presentation here. Or hopefully the following embed works:

Lessons of the long quiet ELB
(effective lower bound)

We just observed a dramatic monetary experiment. In the US, the short-term interest rate rate was stuck at zero for 8 years. Reserves rose from 10 billion to 3,000 billion. Yet inflation behaved in this recession and expansion almost exactly as it did in the previous one. The 10 year bond rate continued its gentle downward trend unperturbed by QE or much of anything else.

Europe's bound is ongoing with the same result.

## Saturday, May 26, 2018

### Jitters

Or, "the beginning of the end, or the end of the beginning?" Or, "from demand to supply?"

An Op-Ed for The Hill with some extras:

The economic expansion and stock market runup have been going on for a decade, and a case of the jitters seems to be spreading. How long can this go on? Is the end around the corner?

After years of quiet, the stock market suddenly became volatile again last March. Volatility is a sign of uncertainty, and often presages a decline. Stock prices are high relative to earnings and dividends, which often precedes a fall. Short term interest rates have risen, and long term rates and short term rates are nearly the same. An inverted yield curve, when short term rates are higher than long term rates, is one of the most reliable warning signs of a recession. The unemployment rate is down to 3.9%, a level that historically has only happened at business cycle peaks — that were soon followed by troughs. House prices and credit are up too, as they were at recent peaks. Is it time to worry?

## Friday, May 18, 2018

### Alexander Hamilton's solar panels

I think I finally have figured out why California is mandating solar panels on top of houses. (WSJ story here.)

As energy, environmental, or housing policy, it borders on the absurd, as pretty much everyone quickly figured out.

Just to recap, remember that most rooftop solar does not power the house underneath it. The energy goes out to the grid. Why not, you ask? Well, the rooftop energy comes at the wrong time, and we don't yet have economical storage, so you have to be connected to the grid anyway. Given that, the costs of switches to let the roof partially power the house at sometimes, power the grid at other times, is not worth the zero benefit. After all, electricity is electricity and your light bulb does not care where it came from.

So rooftops are just a place to put the electric utility's solar panels. Now let's consider, where is the best place to put solar panels that feed the grid?

Option A:

(OK, in reality the Mojave desert, or the vast stretches of wasteland along I-5 pockmarked with angry farmer billboards, but the camels are cute.)

Option B: The roof of a typical northern California house:
 http://www.redwoodhikes.com/Dewitt/Dewitt.html

(OK, I'm having fun with this one, but you get the point. Actually a house off the grid is one place where rooftop solar does make a lot of sense, but you don't have to force people to buy them in that case.)

To belabor the point, people like to build houses near trees. Trees shading roofs are heavily protected in Palo Alto where I live, and you risk massive fines if you cut one down. House roofs don't always pitch to the southwest at the optimum angle.

A house is an expensive and flammable structure for a solar panel. You need to be a lot more careful putting it up there than out in the desert. In California especially, each installation needs a separate design, design review, permits, and so on. Code requirements are stringent. Each installation needs big switches, where the fire department can get at them (and a separate one for the battery). Each house needs a separate set of switches to connect to the grid. All of these fixed costs are spread way out on a commercial solar farm out in the desert.

And so on. We don't operate tiny coal burning generators in each house for the same good reasons.

So why is California doing it? Grumpy free marketers tend to bemoan nitwit liberalism, but economics teaches us to look for rational maximizing actors even in government.

So here is a suggestion. It's actually a brilliant move. Large-scale rooftop solar is only sustained by subsidies -- tax credits for installation and the requirement that homeowners can sell power to their fellow citizens (through the utility) at above-market rates. To put the matter mildly, not everybody thinks these subsidies are a good idea, and moreover you can't count on Washington to maintain subsidies for the 30 year lifespan of solar panels. You never know, someone like, say, Donald Trump might get elected president and start tearing apart energy subsidies.

So, once solar panels are on the rooftops of thousands of registered voters, you have a natural constituency that will vote and otherwise pressure the state, the administration, congress, and agencies to continue solar subsidies.

The Alexander Hamilton story is that he wanted the US federal government to take on the state debts from the revolutionary war, in part to create a class of bondholders who would support the federal government's ability to raise taxes, to pay off that debt. Putting solar panels on houses, though ridiculously inefficient from an energy or environment point of view, achieves the same thing, in a nefarious sort of way.

Too bad they can't just give each of us a solar panel out in the desert, the way some charities show you "your" child in some third-world country. Once a year, you get a card "Happy holidays! I'm your solar panel, number 3457 in the Mojave desert. I've had a great year pumping out electricity! Here is your check for $357.52 in subsidies and power generation. Remember to vote on election day!" ## Tuesday, May 15, 2018 ### Meditation on a trip to the DMV I arrived at the DMV yesterday at 9 AM. My number came up at 5:45 -- you have to wait anxiously all day as you have 10 seconds to respond to your number. At 6:05, 10 hours after arrival. I was informed it was too late to take my written test so I would have to come back. As usual the place was packed, no food, no drink, two filthy restrooms. (California has an appointment system but it takes two months to get an appointment, so if you need something now or can't book a free day two months ahead of time, you wait. 10 hours. Then you still get an appointment to return two weeks later as they won't get to you.) Despite 13.2% top income tax rate, 7.5-9.5% sales tax, gas taxed to$3.80 a gallon, California cannot operate a functional DMV. Even Illinois, good old corrupt, bankrupt, Illinois, can operate a vaguely functional DMV. (Direct election of the secretary of state may have something to do with that.)

Estonia, this is not. Piles of paper flow around. Technology is about 1992 -- there is a number system, so you don't stand in line for 10 hours. But no indication where you are in the queue or when they might get to you.

Rebellion was in the air. Most people do not have my time flexibility. The very nice lady next to me had taken the day off work and had to arrange child care, which was going to end at a finite time. This was her second day of waiting. She was ready to start the revolution.

This is not unusual. It's just a completely normal day down at the DMV.

The joke has been around a long time: Do you really want the people who run the DMV to operate your health care and insurance system? But it is a good joke. The DMV is the main interface most people have  with the functioning or lack thereof of a bureaucracy.

The irony is that the democratic candidates in California are falling all over themselves to be stronger on "single-payer" health -- which does not just mean one fallback, but that all others are banned.

The amazing thing is that citizens of this noble state are all for it, though they must, like me, each take their turn in the 10 hour line at the DMV. (I suspect many high income progressives do not realize that "single payer" means them too. No concierge medicine.)

Republicans: I suggest you set up tables outside the DMV. After all, there is motor voter registration and this might get people in a good frame of mind for your message.

Second thought: Things could be worse. The DMV is  good proxy for the quality of government institutions. In many countries in the world you must pay a bribe to get a driver's license. In many other countries you can pay a bribe to cut through swaths of paperwork. At least in the US you can't do that.

But there are countries where government actually works. When our friends on the left dream of Scandinavian health care, perhaps they should visit a Scandinavian DMV first, and agree that let's see if our government can run a DMV before it tackles health care. And don't go after me with taxes -- the cost of a functional DMV is not that high. This one just needs to expand to match the growth in its population and the complexity of the various laws it has passed.

## Friday, May 11, 2018

### Argentina update and IMF

From Alejandro Rodriguez, my correspondent from the last post
We are ***! People are withdrawing funds from fixed income mututal funds (which hold ARS 300 billion of CB short term debt). Yestedary alone people withdrew 4% from those funds and ran to the dollar today. Peso falls 5% to $24.00 ARS/USD. Next step is a ran against term deposits in banks. Next tuesday the CB has to roll over ARS 680 billion of short term debt. A conservative estimate is that ARS 150 billion will not be rolled over and will ran immediatelly to the dollar. No IMF bailout will stop the crisis but it will definitively help us in the aftermath. PS: If you want to know what interest rates are now (like if anyone cares about them anmore) maturity APR 5 days 81% 41 days 45% PS2: CB trying to control the FX as I write email. Down to$23.00 ARS/USD.
Coincidentally, as Argentina started this spiral, I was at the Hoover conference on "Currencies, Capital, and Central Bank Balances," and thinking about it especially during the session on "Capital Flows, the IMF’s Institutional View and Alternatives" featuring Jonathan Ostry, who bravely came to defend the IMF's Institutional View, Sebastian Edwards, and John Taylor, moderated by George Shultz.

Briefly, in the good old days, the IMF was solidly for the Postwar Order that viewed capital restricitons -- laws stopping people from investing in a country or taking their investments out -- were bad things and to be avoided at all times.

That changed, and the new view, as summarized compactly by John Taylor, is much more friendly toward "capital flow management":
what is new about the Institutional View is that “capital flows require active policy management,” which includes “controlling their volume and composition directly using capital account restrictions.” (p. 8) The Institutional View document (IMF 2012) defines key terms and gives examples. For example,.. CFMs thus include “capital controls” that “discriminate on the basis of residency” and macro-prudential policies that differentiate on the basis of currency (p. 40). ..[The quotes and page numbers in the next two paragraphs are from Ghosh, Ostry, and Qureshi (2017).]
As Ostry explained, the new view also includes a stronger reliant on fiscal stimulus tools to counter domestic difficulties.

My obvious thought, is just how much would Argentina's problems be solved by more capital flow management, currency restrictions, investment restrictions, fiscal stimulus and so forth. And whether the IMF, if it rides to the rescue, will suggest more such dirigisme for its bailout money. The old IMF view -- commit to openness, fix your budget problems, and a somewhat jaundiced view of the ability of even well intentioned central bankers to execute masterstrokes of technocratic "management"  -- might have something to go for it still.

(It's worth remembering that capital cannot flow in aggregate. The only way capital can leave a country is on boats.  You can sell a factory to a local at a low price, and you can sell the foreign currency for dollars at a low price, but you cannot move a factory once built and someone else has to buy the foreign currency and give you dollars. Capital and trade accounts must balance. Capital cannot flow in the short run. Prices can change.

"Flow management" is one of those soothing NGO acronyms for what is in fact property seizure. You can tell I'm not favorably predisposed)

## Friday, May 4, 2018

### Groundhog day in Argentina

My friend and colleague Alejandro Rodriguez, director of the Department of Economics at CEMA in Buenos Aires, wrote me a few emails that Argentina seems to be blowing up again in very interesting and sad ways. I haven't seen any coverage in the US media.
Argentina is going through some fun times (for macroeconomists)... After a two day holiday markets opened yesterday and the peso kept falling (-3%) despite the rate hike (300bps) on friday and the continued drain of reserves. We are trapped with Bill Murray in Groundhog Day. Same thing today... markets open with pressure on the peso. The central bank sold 300 millon of reserves in less than 10 minutes early in the morning when liquidity is at its lowest and it couldn´t sopt the run. Soon after it announced another rate hike of 300bps. Short term debt that expires on may 16 has a yield of 38.7% APR and there are 680 billon pesos of it waiting to mature in less than two weeks. Still the market did not respond and the peso kept falling, more than 8% with respect to yesterday´s close....
Naturally my interest is particularly peaked by a country whose central bank seems powerless to stop inflation and devaluation in a time of fiscal stress. In fact, there are indications that raising interest rates, by making interest costs larger, make the fiscal problem worse and make devaluation worse, not better.

I asked Alejandro for a bit more to share with blog readers since we hear so little about this in the US. Here is his longer story backward:

Groundhog Day: ...Like Phil Connors (Bill Murray) we got trapped in Punxsutawney by the perfect storm. Last year Congress passed a law changing the tax code which included a new tax on Central Bank debt held by non residents. The new tax became effective on April 25th. The new tax initiated a sell off by non residents which was absorbed by the CB which sold USD 2.1 billon between April 23rd and 25th without the dollar moving one cent (20.25 ARS/USD). The new tax coincided with the increase of the 10 year US treasuries yield and the strengthening of the dollar. The CB thought this was an external shock and that no further actions were going to be needed.

## Wednesday, May 2, 2018

### DB warns of US debt crisis.

"A coming debt crisis in the US?" warns a Deutsche Bank report* by Quinn Brody and Torsten Slok.

 Source: DB
This graph is gorgeous. US deficits have, historically, been driven overwhelmingly by the state of the business cycle, and have very little to do with tax policies and spending decisions that dominate press coverage. In booms, income rises, so tax rate times income rises. In busts, the opposite, plus "automatic stabilizer" spending kicks in.

Until now.

There is a good reason past deficits did not really spook markets. They understood the deficit was a temporary phenomenon, due to temporary poor demand-side economic performance. We do not have that excuse now.

In case you thought this was some alarmist crank sheet, the report starts by quoting the latest CBO
report:
the CBO argues that, assuming current policies and trends are not changed, “the likelihood of a fiscal crisis in the United States would increase. There would be a greater risk that investors would become unwilling to finance the government’s borrowing unless they were compensated with very high interest rates.”

## Tuesday, May 1, 2018

### What's worse than tariffs?

Quotas.

This morning's Wall Street Journal "Trump postpones steel tariff decision.." starts optimistic
President Donald Trump eased trade pressure on top U.S. allies Monday, giving the European Union and some nations outside the bloc more time to negotiate deals that would exempt them from U.S. steel and aluminum tariffs..
But it turns out those "deals" are worse than the original
The Trump administration is backing broad restrictions on the trade of metals to limit the direct and indirect effects of Chinese steel and aluminum production on the U.S. market. “In all of these negotiations, the administration is focused on quotas that will restrain imports, prevent transshipment, and protect the national security,” the White House said in a statement.
Quotas are worse than tariffs. With a tariff, you can at least measure and limit the damage. Imported steel pays a tax, and then costs 25% more.  But you can import as much of the stuff as you need, and the damage is limited to a 25% price rise.

(On that word. Free traders should insist on "import tax" rather than "tariff" to remind taxophobic Republicans just what they are doing.)

With a quota, by contrast, the price difference can get as big as it wants and so the damage can grow unbounded. Moreover, it's harder to see -- you have to look at exchange-rate adjusted price indices which people can ignore as one more government statistic. When you pay 25%, you see it.

## Saturday, April 28, 2018

### EPA, the nature of regulation, and democracy

My Hoover colleague Richard Epstein posted a revealing essay on the nature of environmental regulation last week, with environmental regulation as a particular example. The contrast with "Environmental Laws Under Siege: Here is why we have them"  in New York Times  and the New Yorker's  Scott Pruitt's Dirty Politics is instructive

Epstein's point is not about the raw amount of or even what's in the regulation, but the procedure by which regulation is imposed:
As drafted, NEPA [National Environmental Policy Act of 1970 ] contains no provision that allows private parties to challenge agency decisions in court. Instead, the NEPA approval process is a matter for internal agency consultation and deliberation that takes into account comments submitted by any interested parties.
One year after its passage, NEPA was turned upside down in a key decision by Judge J. Skelly Wright of the D.C. Circuit Court of Appeals... Wright read the law as giving private parties the right to challenge government actions. Indeed, Wright welcomed such challenges, writing (admiringly) that the change, “promises to become a flood of new litigation—litigation seeking judicial assistance in protecting our natural environment.”
Giving private parties the right to challenge an agency decision grants enormous leverage to the private parties most opposed to letting projects go forward. In the case of nuclear power, delay became the order of the day, as the D.C. Circuit on which Judge Wright sat arrogated to itself the power to find that any EA or EIS was insufficient in some way, so that the entire project was held up until a new and exhaustively updated EIS was prepared—which could then be duly challenged yet again in court.

## Thursday, April 26, 2018

### Conference on the cross section of returns.

The Fama-Miller Center at Chicago Booth jointly with EDHEC and the Review of Financial Studies will host a conference on September 27–28, 2018 in Chicago, on the theme “New Methods for the Cross Section of Returns.” Conference announcement here and call for papers here.

Papers are invited for submission on this broad theme, including:
• Which characteristics provide incremental information for expected returns?
• How can we tame the factor zoo?
• What are the key factors explaining cross-sectional variation in expected returns?
• How many factors do we need to explain the cross section?
• How can we distinguish between competing factor models?
• Do anomaly returns correspond to new factors?
Why a blog post for this among the hundreds of interesting conferences? Naked self-interest. I agreed to give the keynote talk, so the better the conference papers, the more fun I have!

This is, I think, a hot topic, and lots of people are making good progress on it. It's a great time for a conference, and I look forward to catching up and trying to integrate what has been done and were we have to go.

My sense of the topic and the challenge: (Some of this reprises points in "Discount rates," but not all)

Both expected returns and covariances seem to be stable functions of characteristics, like size and book/market ratio. The expected return and covariance of an individual stock seems to vary a lot over time. So we need to build ER(characteristics) and then see if it lines up with covariance(R, factors | characteristics), where factors are also portfolios formed on the basis of characteristics.

## Sunday, April 22, 2018

### Basecoin

Cryptocurrencies like bitcoin have to solve two and a half important problems if they are to become currencies: 1) Unstable values 2) High transactions costs 2.5) Anonymity.

I recently ran across Basis and its Basecoin, an interesting initiative to avoid unstable values. (White paper here.)

Basecoin's idea is to expand and contract the supply so as to maintain a stable value. If the value of the basecoin starts to rise, more will be issued. If it falls, the number will be reduced.

So far so good. But who gets the seignorage when basecoins are increased? And just what do you get for your basecoins if the algorithm is reducing the numbers? From the white paper:
If Basis is trading for more than $1, the blockchain creates and distributes new Basis. These Basis are given by protocol-determined priority to holders of bond tokens and Base Shares, two separate classes of tokens that we’ll detail later. If Basis is trading for less than$1, the blockchain creates and sells bond tokens in an open auction to take coins out of circulation. Bond tokens cost less than 1 Basis, and they have the potential to be redeemed for exactly 1 Basis when Basis is created to expand supply.
Aha, basecoins get traded for ... claims to future basecoins?

You should be able to see instantly how this will unwind. Suppose the algorithm wants to reduce basecoins. It then trades basecoins for "basecoin bonds" which are first-inline promises to receive future basecoin expansions. But those bonds will only have value during temporary drops of demand. If there is a permanent drop in demand, the bonds will never be redeemed and have no value.  They are at best claims to future seignorage. Any peg collapses in a run, and the run threshold is mighty close here.

But it gets worse.