Saturday, May 25, 2013


My daughter Sally is at the Grand Central Academy of Art in New York. This is one of her still lives (yes, it's a painting). See if you can figure out what it means. Then click on the figure for an explanation. Don't miss "ceci n’est pas une mol├ęcule d’histamine." 

Yes, this has nothing to do with economics. It's just cool.

Thursday, May 23, 2013

The Fed and Shadow Banking

The WSJ has a fascinating Op-Ed by Andy Kessler, "The Fed Squeezes the Shadow-Banking System" Andy thinks that Quantiative Easing has the opposite, contractionary effect.

QE is just a huge open market operation. The Fed buys Treasury securities and issues bank reserves instead. Why does this do anything? Why isn't this like trading some red M&Ms for some green M&Ms and expecting it to affect your weight?  (M&M of course stands for "Modigliani Miller" if you didn't get the joke.)

The usual thinking is that bank reserves are "special." They are connected to GDP in a way that Treasuries are not.  In the conventional monetary view, MV = PY.  Bank reserves, through a multiplier, control M. The bank or credit channel view says that bank reserves control lending and lending affects PY. The red M&Ms, though superficially identical, have more calories.

In Andy's view (my interpretation), that is turned around now. Now, Treasuries supply more "liquidity" needs than bank reserves, and (more importantly) the supply of treasuries is more connected to nominal GDP than is the supply of bank reserves.

Wednesday, May 22, 2013

Epstein on the IRS and more

Richard Epstein has a lovely essay, "The Real Lesson of the IRS Scandal" As lots of commentators left and right are realizing, this kind of outcome is baked in to our regulatory system. A small excerpt:
The dismal performance of the IRS is but a symptom of a much larger disease which has taken root in the charters of many of the major administrative agencies in the United States today: the permit power. Private individuals are not allowed to engage in certain activities or to claim certain benefits without the approval of some major government agency. The standards for approval are nebulous at best, which makes it hard for any outside reviewer to overturn the agency’s decision on a particular application.

Local Austerity

The Wall Street Journal had a really heart-warming article, Europe's Recession Sparks Grass-Roots Political Push  about groups taking over local governments in southern Europe, and cleaning out years of mismanagement. An excerpt
At her inauguration Ms. Biurrun [the new mayor of Torroledones, Spain] choked up before a jubilant crowd.

Then she began slashing away. She lowered the mayor's salary by 21%, to €49,500 a year, trimmed council members' salaries and eliminated four paid advisory positions.

She got rid of the police escort and the leased car, and gave the chauffeur a different job. She returned a carpet, emblazoned with the town seal, that had cost nearly €300 a month to clean. She ordered council members to pay for their own meals at work events instead of billing the town.

Saturday, May 18, 2013

The Role of Monetary Policy, Revisited

I am giving a talk Thursday May 30, titled  "The Role of Monetary Policy, Revisited."  The event is at Booth's Gleacher Center in downtown Chicago, reception 4:30 and talk 5:15. It's part of a series of talks sponsored by the Becker-Friedman Institute.

The talk is based on  an essay I'm working on, and will be presenting at a few central banks this summer. Once per generation we re-think what central banks do, can't do, should do, and shouldn't do. Milton Friedman's famous 1968 address marked the last big transition. I think, we are in a similar moment. I will look at the big picture in the same spirit. I'm aiming at a serious talk, grounded in academic research, but accessible.

Blog followers, students, colleagues, friends, and even glider pilots are most welcome. Please rsvp so they know how many people to plan for.

The event announcement invitation and rsvp links are here on the BFI webpage

There is also an event announcement and rsvp link on the Booth Alumni events webpage here.

Problems viewing this e-mail? View it in a browser.
Becker Friedman Institute
The Becker Friedman Institute for Research in Economics of the University of Chicago cordially invites you to
The Role of Monetary Policy Revisited
A talk by John H. Cochrane, AQR Capital Management Distinguished Service Professor of Finance at the University of Chicago Booth School of Business
Thursday, May 30, 2013
4:30 p.m. Reception
5:15 p.m. Talk and Q&A
Executive Dining Room, Sixth Floor
University of Chicago Gleacher Center
450 North Cityfront Plaza Drive
Chicago, Illinois (map and directions)
Please join us as University of Chicago Booth School of Business Professor John Cochrane reexamines Milton Friedman's 1968 presidential address to the American Economic Association. In this famous speech on the role of monetary policy, Friedman argued, "There is always a temporary trade-off between inflation and unemployment; there is no permanent trade-off."
Starting from this perspective, Cochrane will reevaluate the role of monetary policy 45 years later. Is it effective? Can it fill all the roles people expect of it? How should monetary policy be conducted going forward?
Please respond online by
May 23.
Please extend this invitation to others who might find the program of particular interest.
Complimentary valet parking will be available at the Gleacher Center entrance.
If you have questions or require advance assistance, please contact Maria Bardo-Colon at 773.834.1898 or
John H. Cochrane
The AQR Capital Management distinguished service professor of finance at the University of Chicago Booth School of Business, Cochrane's scholarly work focuses on finance, monetary economics, macroeconomics, health insurance, time-series econometrics, and other topics. He is the author of
Asset Pricing, a coauthor of The Squam Lake Report, a research associate of the National Bureau of Economic Research, a senior fellow of the Hoover Institution at Stanford University, and an adjunct scholar of the CATO Institute. He blogs as The Grumpy Economist. Cochrane earned a bachelor's degree in physics at Massachusetts Institute of Technology and PhD in economics at the University of California, Berkeley. He was a member of the University of Chicago Department of Economics before joining Chicago Booth.

Friday, May 17, 2013

More Interest-Rate Graphs

For a talk I gave a week or so ago, I made some more interest-rate graphs. This extends the last post on the subject. It also might be useful if you're teaching forward rates and expectations hypothesis. 

The question: Are interest rates going up or down, especially long term rates?  Investors obviously care, they want to know whether they should put money in long term bonds vs. short term bonds.  As one who worries about debt and inflation, I'm also sensitive to the criticism that market rates are very low, forecasting apparently low rates for a long time. Yes, markets never see bad times coming, and markets 3 years ago got it way wrong thinking rates would be much higher than they are today (see last post) but still, markets don't seem to worry.

But rather than talk, let's look at the numbers. I start with the forward curve. The forward rate is the "market expectation" of interest rates, in that it is the rate you can contract today to borrow in the future. If you know better than the forward rate, you can make a lot of money.

Here, I unite the recent history of interest rates together with forecasts made from today's forward curve. The one year rate (red) is just today's forward curve. I find the longer rates as the average of the forward curves on those dates. Today's forward curve is the market forceast of the future forward curve too, so to find the forecast 5 year bond yield in 2020, I take the average of today's forward rates for 2020, 2021,..2024.

I found it rather surprising just how much, and how fast, markets still think interest rates will rise. (Or, perhaps, how large the risk premium is. If you know enough to ask about Q measure or P measure, you know enough to answer your own question.)

Doctor-owned hospitals

In writing about the ACA and our health-care problems, I started to think more and more about supply restrictions. In every other industry, costs come down when new suppliers come in and compete. Yet our health-care system is full of restrictions and protections to keep new suppliers out, and competition down. Then we wonder why hospitals won't tell you how much care will cost, and send you bills with $100 band aids on them.

In that context, I was interested to learn this week about the ACA's limits on expansion of doctor-owned hospitals. The Wall Street Journal article is here, and I found interesting coverage in American Medical News. The text and analysis of the amazing section 6001 of the ACA is here

In astouding (to me) news, the ACA prohibits doctor-owned hospitals from expanding, and prevents new doctor-owned hospitals at all, if they are going to serve Medicare or Medicaid patients. From WSJ

Thursday, May 9, 2013

Solar Panel Tariffs

It's time to start a new series on "energy idiocy." You just can't make this stuff up... From today's WSJ:
BRUSSELS—Chinese solar-panel manufacturers will face import tariffs of up to 67.9% at European Union borders under a plan from the 27-nation bloc's executive body...
Europe, like the US, subsidizes the installation of solar panels. So, we subsidize things to make the prices to consumers go down and encourage the industry. Then when the industry is encouraged and prices do go down, we pass tariffs to make prices go up.  This is almost as fun as oil, which we subsidize to make prices go down, then pass regulations to try to stop people from using it.

Wednesday, May 8, 2013

Finance: Function Matters, not Size

"Finance: Function Matters, not Size" This is the new title of the published version of "The Size of Finance," which I posted on this blog here as a working paper. If you enjoyed the original, here is the better final version. If you didn't, here it is all fresh and new.

Published version (my webpage)
Published version (Journal of Economic Perspectives)
Growth of the Financial Sector" symposium (Journal of Economic Perspectives)

Cyprus and Resolution Authority

Holman Jenkins has a revealing Cyprus update in today's Wall Street Jounal. For those of you who haven't been following the news, Cyprus' banks failed, borrowing huge amounts of money and investing it in Greek debt (yes).  Cyprus was bailed out by the EU after a chaotic week, including an agreement that large depositors would lose some money, called a "bail-in."

Saturday, May 4, 2013

Floating-rate Treasury debt

Last week the Treasury announced that is it going ahead with floating-rate debt, and gave some details how it will work. The Wall Street Journal coverage is here and the Treasury announcement is here. I wrote about the issue at some length last fall, here (And freely admit some of today's essay repeats points made there.)

Right now, the Treasury rolls over a lot of debt. For example, about one and a half trillion dollars is in the form of Treasury bills, which mature in less than a year. So, every year, the Treasury sells one and a half trillion dollars of new bills, which it uses to pay off one and a half trillion dollars of old bills.

With floating-rate debt, all the buying and selling is avoided. Instead, the Treasury periodically sets a new rate, so that the floating rate security has value one dollar (just as the maturing bill would have). It's the same thing, except the bill sits in the investor's pocket.

Wednesday, May 1, 2013

Small monetary policy question

A small monetary policy question has been bugging me this morning.

The Fed is buying long term bonds and agency debt, with stated desire to drive down long term Treasury and mortgage-backed security rates.

Why does the Fed not simply say "We are going to peg the 10 year Treasury rate at 1.5%. We buy and sell at that price." If the Fed wants the 10 year rate to be, say, 1.5%, then this seems a lot simpler than setting a quantity ($80 billion a month), and then enduring endless arguments with academics like me whether it's having any effect at all, or commissioning complex staff studies to determine whether the impact is 10 or 15 basis points and how long it lasts.

The answers I can come up with are not pretty. Perhaps the Fed understands that any "segmentation" is smaller than it thinks, and doesn't last that long. So, the required bond purchases would rapidly explode in size. If that's the answer, then the Fed isn't doing it so that it can continue to seem powerful when in fact it really is not.

Perhaps it's political. If the Fed can say "we're buying $80 billion a month. This is helping, but we don't know exactly how much," then it avoids responsibility for what the rate actually is. If it says 1.5%, then every car dealer and mortgage broker in the country wants to know, why not 1.4%? This is even more cleverly Macchiavellian. But such deeply political decisions are a long way from the benevolent independent central bank we write about in papers.

Any ideas anyone?  

While we're here, two great quotes from Fed economists (obviously un-named) I've talked to recently.

Me: Aren't you worried about big banks borrowing short and lending long? What happens when, inevitably, interest rates rise?

Economist A: "Don't worry, we'll let them know ahead of time."

This was some time ago. I think last week's announcements that the "stress tests" were (at last) going to include plain - vanilla interest rate risk might count as such warning.

Economist B: "Inflation is just not a concern. The Fed now is balancing growth against financial stability."

A new dual mandate, and a fascinating can of worms. I'd love to see that Phillips curve.