Thursday, January 27, 2022

The cost of crying wolf

Why do so many Americans believe crazy things? Maybe not "crazy," but beliefs that wildly get wrong factual costs and benefits, such as those of vaccines? 

It does not help that they have been lied to, over and over again. Why should they believe anything now? Our elites, and in particular our public health bureaucrats, though invoking the holy name of "science," have been trying to massage public psychology via deliberate obfuscation for a few years now. There is little science of managing public psychology, and if there is, epidemiologists don't have it. There is some good ancient wisdom, as codified in the story of the boy who cried wolf.  We do know that when lies are exposed, when elites are shown to be disparaging and trying to manipulate average people, trust erodes. 

This thought is boosted by Marty Makary's WSJ Oped "The High Cost of Disparaging Natural Immunity to Covid."

For most of last year, many of us called for the Centers for Disease Control and Prevention to release its data on reinfection rates, but the agency refused. Finally last week, the CDC released data from New York and California, which demonstrated natural immunity was 2.8 times as effective in preventing hospitalization and 3.3 to 4.7 times as effective in preventing Covid infection compared with vaccination.

Yet the CDC spun the report to fit its narrative, bannering the conclusion “vaccination remains the safest strategy.” 

Why? Well, both facts can be true. It can be true that immunity from previous exposure is very powerful, and even more powerful than vaccination, but that vaccination rather than let-it-rip, lockdowns, or masks, remains the safest public health strategy.  Why not say so? Because the CDC thinks we're morons and can't understand that, so it must suppress evidence of natural immunity to scare people into vaccination. Then the word gets out, and people trust the CDC even less. (The rest of the article is great on facts of natural immunity.) 

It's worse.

Monday, January 24, 2022

Stock market fall and long-term investors

 

Having just plugged "portfolios for long-term investors" again, I really should opine on its message about the recent stock market decline. If you didn't see this coming and get out ahead of time, or if it was perfectly obvious to you that this was coming but you didn't get off your butt and do anything about it, preferring to pontificate at the dinner table, just how bad should you feel about it? 

Not as bad as you might think. 

Sunday, January 23, 2022

Portfolios for long-term investors

"Portfolios for long-term investors" is published, Review of Finance 26(1), 1-42. (2022). This standard link works if you have institutional or individual access. I am not allowed to post a free access link here, but I am allowed to post one on my webpage where you will find it. 


The theme: How do we account for the vast gulf between portfolio practice and portfolio theory? How do we make portfolio theory useful given that the world has time-varying expected returns and time-varying returns and correlations? I argue for a view more focuses on prices and payouts, as a long-term bond investor should buy an indexed perpetuity and ignore one-period returns. I advise one to think about the market and equilibrium. The average investor must hold the market portfolio. Anything else is a zero sum game. So figure out why you are different than average. (If you think you're smarter than average, note that they think they're smarter than you.) The result encapsulates some ancient advice: Buy stocks for the dividends, broadly interpreted. Take risk you are well-positioned to take. If stocks have great value to other investors for reasons either technical (liquidity, short-sales constraints, etc.) or behavioral, avoid them. 

The paper grows out of the summary I used to give for MBA and PhD students. There aren't any equations, but there are lots of suggestions about how academic portfolio theory might be done better, and connect better to its intended audience. Thanks especially to Monika Piazzesi and Luis Viceira, who invited me to give the talk on which it is based, and Alex Edmans who shepherded it to publication. 

******

Update: I just found that the NBER has posted the original lecture video


Friday, January 21, 2022

Institute for progress

We need to be reminded occasionally that nothing matters but long-run growth, and long-run growth all comes from productivity, better knowledge of how to better serve human needs and desires.  Yet economic policy is almost all not about growth, but rather about redistribution, and in particular propping up old ways of doing things and the rents associated with them. 

Courtesy Marginal Revolution, the Institute for Progress is a noteworthy new effort to produce growth-oriented policy. Institutions are important, to spread the word and create a constituency for tending the golden goose. 

..productivity growth has been in long-term decline since the 1970s. This is supposed to be the age of ambitious infrastructure investments in the battle to fight climate change, but we can’t even build new solar plants without being vetoed by conservation groups. Hyperloops and supersonic airplanes promise to revolutionize transportation, but building a simple subway extension in NYC costs up to 15 times more per kilometer than it does in other cities around the world. ...The pace of scientific progress has been slowing.... 

(Here and elsewhere see the original for links.) Why? 

Over the last 50 years, we’ve increased the number of veto points at nearly every governmental level, failed to invest in state capacity, and raised the stakes of the debate through polarization. So it perhaps shouldn’t be a surprise that the federal government that went to the moon in 1969 botched production of simple diagnostic tests during a once-in-a-century pandemic.

But the potential is there. Maybe we are not running out of ideas after all, but merely on the edge of technical revolutions, like changing from rail to airplanes:    

...there are genuinely exciting — potentially game-changing — discoveries on the horizon. 

Wednesday, January 19, 2022

Accounting for the blowout / Project Syndicate

A Project Syndicate Essay. Before it moves on to climate change, inequality, and racial issues, the Fed should have to think just a little bit about the evident failure of its existing financial regulation. 

Why Isn't the Fed Doing its Job?

The nomination of new members to the US Federal Reserve Board offers an opportunity for Americans – and Congress – to reflect on the world’s most important central bank and where it is going. 

The obvious question to ask first is how the Fed blew its main mandate, which is to ensure price stability. That the Fed was totally surprised by today’s inflation indicates a fundamental failure. Surely, some institutional soul searching is called for. 

Yet, while interest-rate policies get headlines, the Fed is now most consequential as a financial regulator. Another big question, then, is whether it will use its awesome power to advance climate or social policies. For example, it could deny credit to fossil-fuel companies, demand that banks lend only to companies with certified net-zero emissions plans, or steer credit to favored alternatives. It also could decide that it will start regulating explicitly in the name of equality or racial justice, by telling banks where and to whom to lend, whom to hire and fire, and so forth. 

But before considering where the Fed’s regulation will or should go, we first need to account for the Fed’s grand failure. In 2008, the US government made a consequential decision: Financial institutions could continue to get the money they use to make risky investments largely by selling run-prone short-term debt, but a new army of regulators would judge the riskiness of the institutions’ assets. The hope was that regulators would not miss any more subprime-mortgage-size elephants on banks’ balance sheets. Yet in the ensuing decade of detailed regulation and regular scenario-based “stress tests,” the Fed’s regulatory army did not once consider, “What if there is a pandemic?” 

Tuesday, January 18, 2022

Fed Nominees

I salute President Biden's nominations for the Federal Reserve Board, especially Sarah Bloom Raskin and Lisa Cook. (Philip Jefferson seems straightforward and uncontroversial, but other than reading a CV I haven't looked that hard.)

 We can now have an honest conversation about where the Fed is going, and whether and how the Fed should use its tools, primarily regulation, to advance the Administration's agenda on climate, race, and inequality. 

The Wall Street Journal nicely assembled crucial quotes on Ms. Raskin and climate. In 2020,   

The Fed established broad-based lending programs to prevent businesses that were otherwise sound from failing due to the shutdowns. 

Writing in the New York Times in May 2020, 

Ms. Raskin wanted the Fed to exclude fossil-fuel companies from these facilities. “The Fed is ignoring clear warning signs about the economic repercussions of the impending climate crisis by taking action that will lead to increases in greenhouse gas emissions at a time when even in the short term, fossil fuels are a terrible investment,” she wrote. ...

“The Fed’s unique independence affords it a powerful role,” Ms. Raskin added. “The decisions the Fed makes on our behalf should build toward a stronger economy with more jobs in innovative industries—not prop up and enrich dying ones.”  

Monday, January 3, 2022

Fiscal Inflation.

This is an essay, prepared for the CATO 39th annual monetary policy conference.  It will appear in a CATO book edited by Jim Dorn. This is a longer and more academic piece underlying "The ghost of Christmas inflation.Video of the conference presentation. This essay in pdf form. 

FISCAL INFLATION 

John H. Cochrane

From its inflection point in February 2021 to November 2021, the CPI rose 6 percent (278.88/263.161), an 8 percent annualized rate.  Why? 

Starting in March 2020, in response to the disruptions of Covid-19, the U.S. government created about $3 trillion of new bank reserves, equivalent to cash, and sent checks to people and businesses. (Mechanically, the Treasury issued $3 trillion of new debt, which the Fed quickly bought in return for $3 trillion of new reserves. The Treasury sent out checks, transferring the reserves to people’s banks. See Table 1.)  The Treasury then borrowed another $2 trillion or so, and sent more checks. Overall federal debt rose nearly 30 percent. Is it at all a surprise that a year later inflation breaks out?  It is hard to ask for a clearer demonstration of fiscal inflation, an immense fiscal helicopter drop, exhibit A for the fiscal theory of the price level (Cochrane 2022a, 2022b).  

What Dropped from the Helicopter? 

From December 2019 to September 2021, the M2 money stock also increased by $5.6 trillion.  This looks like a monetary, not a fiscal intervention, Milton Friedman’s (1969) classic tale that if you want inflation, drop money from helicopters. But is it monetary or fiscal policy? Ask yourself: Suppose the expansion of M2 had been entirely financed by purchasing Treasury securities. Imagine Treasury debt had declined $5 trillion while M2 and reserves rose $5 trillion. Imagine that there had been no deficit at all, or even a surplus during this period. The monetary theory of inflation, MV=PY, states that we would see the same inflation. Really? Similarly, ask yourself: Suppose that the Federal Reserve had refused to go along. Suppose that the Treasury had sent people Treasury bills directly, accounts at Treasury.gov, along with directions how to sell them if people wished to do so. Better, suppose that the Treasury had created new mutual funds that hold Treasury securities, and sent people mutual fund shares. (I write mutual fund as money market funds are counted in M2.) The monetary theory of inflation says again that this would have had no effect. These would be a debt issue, causing no inflation, not a monetary expansion. Really? 

Sunday, January 2, 2022

Weekend reads on the state of America -- and China

Two pieces stood out from some weekend internet meandering. 

Marginal Revolution points to an excellent long letter from Dan Wang on China.

A trenchant part of Dan's essay is, curiously, a few reflections on America. Not bad for living in Shanghai: 

The US, for starters, should get better at reform. The federal government has found itself unable to build simple infrastructure or coordinate an effective pandemic response. Somehow the US has evolved to become a political system in which people can dream up a hundred reasons not to do things like “build housing in growing areas” or “admit people with skills into the country.” If the US wants to win a decades-long challenge against a peer competitor, it needs to be able to improve state capacity. ...

Since the US government is incapable of structural reform, companies now employ algorithm geniuses to help people navigate the healthcare system. This sort of seventh-best solution is typical of a vetocracy. I don’t see that the US government is trying hard to reform institutions; its response is usually to make things more complex (like its healthcare legislation) or throw money at the problem. The proposed bill to increase domestic competitiveness against China, for example, doesn’t substantially fix the science funding agencies that are more concerned with style guides than science; and the infrastructure bill doesn’t seem to address root causes that make American infrastructure the most costly in the world. Congress is sending more money through bad channels.

 Stop and savor. 

Thursday, December 23, 2021

The Ghost of Christmas Inflation

This is part of an ongoing series of essays on inflation.  This one is at Project Syndicate. The next post is somewhat longer and more academic with the same themes. 

The Ghost of Christmas Inflation

Inflation continues to surge. From its inflection point in February 2021 to last month, the US consumer price index has grown 6% – an 8% annualized rate. 

The underlying cause is no mystery. Starting in March 2020, the US government created about $3 trillion of new bank reserves (an equivalent to cash) and sent checks to people and businesses. The Treasury then borrowed another $2 trillion or so and sent even more checks. The total stimulus comes to about 25% of GDP, and to around 30% of the original federal debt. While much of the money went to help people and businesses severely hurt by the pandemic, much of it was also sent regardless of need, intended as stimulus (or “accommodation”) to stoke demand. The goal was to induce people to spend, and that is what they are now doing. 

Milton Friedman once said that if you want inflation, you can just drop money from helicopters. That is basically what the US government has done. But this US inflation is ultimately fiscal, not monetary. People do not have an excess of money relative to bonds; rather, people have extra savings and extra apparent wealth to spend. Had the government borrowed the entire $5 trillion to write the same checks, we likely would have the same inflation. 

Thursday, December 16, 2021

Fiscal theory update

Whew. The penultimate draft of The Fiscal Theory of the Price Level is now done, and in the hands of the copy-editors at Princeton. There is still time to send me typos, thinkos, wrong equations, excessive repetition and more! 



Do we live in China?

Google/Youtube's "misinformation" policy. 

You may not "contradict... local health authorities' (LHA) or the World Health Organization."  But read the note, they might change their mind, so watch truth/misinformation change in real time.  

Really? Scientific discussion never contradicts the edicts of "authorities?" Political discussion never does so? 

HT Martin Bazant's six foot rule lecture 

Sunday, December 12, 2021

The ECB's dilemma

I have been emphasizing the Fed's dilemma: If it raises interest rates, that raises the U.S. debt-service costs. 100% debt to GDP means that 5% interest rates translate to 5% of GDP extra deficit, $1 trillion for every year of high interest rates. If the government does not tighten by that amount, either immediately or credibly in the future, then the higher interest rates must ultimately raise, rather than lower, inflation. 

Jesper Rangvid points out that the problem is worse for the ECB. Recall there was a euro crisis in which Italy appeared that it might not be able to roll over its debt and default. Mario Draghi pledged to do "whatever it takes" including buying Italian debt to stop it and did so. But Italian debt is now 160% of GDP, and the ECB is still buying Italian bonds. What happens if the ECB raises interest rates to try to slow down inflation? Well, Italian debt service skyrockets. 5% interest rates mean 8% of GDP to debt service. 

Friday, December 10, 2021

FTPL article

I wrote a short-ish article for the Journal of Economic Perspectives on Fiscal Theory of the Price Level. It tries to summarize the 700 page book in a readable article with no equations. Let me know how I'm doing -- comments most welcome. 




Wednesday, December 8, 2021

Debt Video

 

This is a short video summarizing papers r<g? and (better) section 6.4 of Fiscal Theory of the Price Level. Do low interest costs on the debt mean the government never has to pay it back? If the government doesn't have to repay debts, why do any of us citizens have to repay debts? Let the government borrow, pay off our student, mortgage, and auto debt. Let it send us checks and we can all stop working, paying taxes, and just order things from Amazon. Hmm. Something is wrong here...

The main point. We have 5% of GDP primary deficits, and bigger coming. A r<g of 1% is a fun possibility for  government with 1% of GDP deficits and 100% debt to GDP. But it still leaves us 4% in the hole, and then the next crisis, pandemic, war, or social security and medicare come along.  

Kudos to the Hoover Policy-Ed team (This video on their website, with additional material) and especially Shana Farley and Tom Church, who managed to boil down a complex subject to an understandable video. The animations are impressive. Yes, the guy talking needs acting lessons (it's a lot better at 1.25 speed) and a haircut. Next time... 

Wednesday, December 1, 2021

Inflation speculation

I'm working madly to finish The Fiscal Theory of the Price Level. This is a draft of Chapter 21, on how to think about today's emerging inflation and what lies ahead, through the lens of fiscal theory. (Also available as pdf). I post it here as it may be interesting, but also to solicit input on a very speculative chapter. Help me not to say silly things, in a book that hopefully will last longer than a blog post! Feel free to send comments by email too. 

Chapter 21. The Covid inflation 

As I finish this book's manuscript in Fall 2021, inflation has suddenly revived. You will know more about this event by the time you read this book, in particular whether inflation turned out to be ``transitory,'' as the Fed and Administration currently insist, or longer lasting. This section must be speculative, and I hope rigorous analysis will follow once the facts are known. Still, fiscal theory is supposed to be a framework for thinking about monetary policy, so I would be remiss not to try. 

Figure 1. CPI through the Covid-19 recession.

Figure 1 presents the CPI through the covid recession. Everything looks normal until February 2021. From that point to October 2021 the CPI rose  5.15% (263.161 to 276.724), a 7.8% annual rate.

What happened, at least through the lens of the simple fiscal theory models in this book? Well, from March 2020 through early 2021, the U.S. government -- Treasury and Fed acting together -- created about $3 trillion new money and sent people checks. The Treasury borrowed an additional $2 trillion, and sent people more checks. M2, including checking and savings accounts, went up $5.5 trillion dollars. $5 trillion is a nearly 30% increase in the $17 trillion of debt outstanding at the beginning of the Covid recession. Table 21.1 and Figure 2 summarize. ($3 trillion is the amount of Treasury debt purchased by the Fed, and also the sum of larger reserves and currency.  Federal debt held by the public includes debt held by the Federal Reserve.)

M2, debt, and monetary base (currency + reserves) through the Covid-19 recession.

Some examples: In March 2020, December 2020, and again in March 2021, in response to the deep recession induced by the Covid-19 pandemic, the government sent ``stimulus'' checks, totaling $3,200 to each adult and $2,500 per child. The government added a refundable child tax credit, now up to $3,600per child, and started sending checks immediately. Unemployment compensation, rental assistance, food stamps and so forth sent checks to people. The ``paycheck protection program'' authorized $659 billion to small businesses. And more. The payments were partly designed as economic insurance, transfers from people doing well during covid to those who had lost jobs or businesses, and efforts to keep businesses from failing. But they were also in large part, intentionally, designed as fiscal-monetary stimulus to boost aggregate demand and keep the economy going. The  massive ``infrastructure'' and ``reconciliation'' spending plans occupied the Congress through 2021, adding expectations of more deficits to come.  

From a fiscal-theory perspective, the episode looks like a classic fiscal helicopter drop. There is a large increase in government debt, transferred to people, who do not expect that debt to be repaid. It is a``fiscal shock,'' a decline in surpluses s_t, with no expectation of larger subsequent surpluses. Of course it led to inflation! 

Sunday, November 28, 2021

Inflation Explainer

Bari Weiss asked me to write a short post for her substack offering some inflation explanations on the occasion of post-Thanksgiving shopping.  

It’s Black Friday, ‘70s-Style

Black Friday begins tonight, and Americans, after emerging from our collective turkey coma, will dive into our sacred, national ritual: shopping. 

Those who haven’t shopped lately are in for a rude awakening: Many items will be out of stock, delayed or cost a lot more than they used to. Welcome to inflation, back from the 1970s!  

As you look for a deal on a Peloton to work off your pandemic paunch, here is a brief explanation about what’s going on with our economy, why so many things are becoming more expensive, why this hurts all of us, and why the government can’t spend its way out of this mess.

Why are prices rising? 

The news is full of “supply chain” problems. Shipping containers can’t get through our ports. Car-makers can’t get chips to make cars. Railroads look like the 405 at rush hour. 

What’s underlying many of these problems is the fact that businesses can’t find enough workers. There aren’t enough truck drivers, airline pilots, construction workers and warehouse workers in the “supply chain.” Restaurants can’t find waiters and cooks. There are 10 million job openings and only seven million people looking for work. About three million people who were working in March 2020 are no longer working or looking for work.

But supply chains wouldn’t be clogged if people weren’t trying to buy a lot. The fundamental issue is that demand is outstripping supply.

Tuesday, November 23, 2021

Grumpy on inflation at CATO

I had a great time at the CATO monetary policy conference last week. A brief view on why we're having inflation and the chance it will continue:  


Briefly, a helicopter dropped. The Fed fell flat. And here we go. Grumpy got steamed up on this one. 

If the embed doesn't work, try the direct link or the above conference link. Greg Ip moderated well, and stick around for insightful comments from Fernando Martin, Mark Sobel, and David Beckworth.

Friday, November 19, 2021

A convenient myth: Climate risk and the financial system

A Convenient Myth: Climate risk and the financial system. At National Review Online. 

In an October 21 press release, Janet Yellen — Treasury secretary and head of the Financial Stability Oversight Council (FSOC), the umbrella group that unites all U.S. financial regulators — eloquently summarized a vast program to implement climate policy via financial regulation:

"FSOC is recognizing that climate change is an emerging and increasing threat to U.S. financial stability. This report puts climate change squarely at the forefront of the agenda of its member agencies and is a critical first step forward in addressing the threat of climate change."

You do not have to disagree with one iota of climate science — and I will not do so in this essay — to find this program outrageous, an affront to effective financial regulation, to effective climate policy, and to our system of government.

Thursday, November 18, 2021

Inflation meditation

The discussion about inflation is pretty confused. There is a lot of confusion about aggregate demand vs. individual demand, aggregate supply vs. supply, and about relative prices vs. inflation. 

My theme: Inflation is entirely about "demand," not "supply." Fixing the ports, the chips, the pipelines, the labor disincentives, the regulations, are all great and good, and the key to economic growth. But they will not on their own do much to slow inflation. We are having inflation because the government printed up a few trillion dollars, and borrowed a few trillion more, and wrote people checks. People are spending the checks. 

At a superficial level this is obvious. If people weren't spending a lot of money, the ports would not be clogged. But it's deeper than that. 

Inflation is all prices and wages going up at the same time. Relative price changes are when one price goes up and other prices go down. Reality combines the two, but let's use terms correctly for each element. 

Supply shocks cause relative price changes, not inflation. Suppose the ports clog up, and you can't get TVs off the boat from China. Then the price of TVs has to rise relative to other prices. The price of TVs has to go up relative to restaurant food, for example, so people buy fewer TVs and go out to eat more. Or the price of TVs has to go up relative to wages, so people buy less overall. 

Now the world is a bit more complex. If prices and wages moved instantly, the price of restaurant food, or wages, would go down, the price of TVs would go up, and the overall price level would not change. In reality the other prices go down slowly. So the price of TVs goes up, and other prices and wages only slowly go down. We measure a little bit of inflation, followed by a slow period of lower measured inflation. 

This is one of the mechanisms people have in mind when they refer to supply shocks, and say inflation will be transitory. But that's clearly not what's happening now. Everything is going up, though some things more than others. 

Likewise what happens if people decide in a pandemic that they want to buy more TVs and go out to dinner less? That's a relative demand shock. It drives up the price of TVs, and down the price of restaurant food with no inflation. But restaurant prices go down more slowly than TV prices go up, so we measure a bit of inflation and then less inflation. But that's not what's happening now. Restaurant prices are going up too. 

"Aggregate supply" is the question, how much more does the economy produce when all prices and wages are moving up at the same rate -- true, pure, inflation? That's a tricky and slippery concept! Sure, if wages rise more than prices, workers might work harder and produce more. If prices rise more than wages, companies might produce more in pursuit of higher profits. Since I told the same story both ways, you can see even this is slippery. But these stories are still about relative prices and wages, not both prices and wages rising together. If prices rise 10% and wages rise 10%, why does anybody do anything different? Welcome to the mysteries of "aggregate supply." 

It only makes sense if you think prices or wages were sticky and one or the other was stuck at too low a level. Then a bit of inflation can unstick one of the two, getting the economy back to a more productive level. Aggregate supply is about sticky prices and wages, not about the actual productive capacity of the economy. Another way to see it: Why was the economy not already producing as much as it could, so that money raises output rather than immediately raising inflation? Well, something had to be wrong that inflation could fix, and in macro theory that's "sticky prices." 

Yes, this is slippery, but let's not get too far down the rabbit hole. The central point, as intuitive as it sounds, it is not true that unclogging the ports will soak up demand and stop pure inflation. It will lower the relative price of TVs, but that "more supply" doesn't do much about all prices and wages rising together. 

All prices and wages rising together means that one thing is falling in value -- money, and government debt. Inflation is a change in the relative price of money and government debt relative to everything else. Inflation comes thus, fundamentally, from the overall supply vs. demand for money and government debt. 

We seem, sadly, to be repeating all the confusion on these affairs that prevailed in the 1970s. Oil price "supply" shocks will surely be "transitory." President Biden is sending the FTC to hound the oil companies to lower prices.  Can "guideposts" be far behind? For a thousand years, inflation has led to a witch hunt after "speculators" and "middlemen" and price rising conspiracies. Here we go. 




Tuesday, November 16, 2021

Academic Freedom at Stanford -- commentary

This is a follow up to a post on the Stanford faculty petition on free speech. I place my comments here, in a separate post. I want to be super-clear that the signatories signed the letter of the last post, and endorse nothing else. 

What does it say? Free speech, free inquiry, academic freedom. Period. Not free speech so long as nobody feels hurt. Not free speech so long as you don't disagree with or are viewed as not fully supporting Stanford's policy on Diversity,  Equity, and Inclusion. Not free speech except if you disagree with Stanford's or the County of Santa Clara's covid policies, or Stanford's "sustainability" principles. Not free speech, but limited to your domain of academic expertise, determined by some bureaucratic process. There are other faculty groups and committees working on all these "free-speech but" policies. This group endorsed free speech, period.