- Does the 2010 Dodd-Frank regulatory reform act meaningfully address runs on shadow banking?
- So what do you think is the most promising way to meaningfully end "too big to fail"?
- Do you think there's any reason to believe recessions following financial crises should necessarily be longer and more severe, as Carmen Reinhart and Kenneth Rogoff have famously suggested?
- Many people have asked whether the finance industry has gotten too big. How should we think about that?
- What are your thoughts on quantitative easing (QE) — the Fed's massive purchases of Treasuries and other assets to push down long-term interest rates — both on its effectiveness and on the fear that it's going to lead to hyperinflation?
- Both fiscal and monetary policies have been on extreme courses recently. What are your thoughts on how they might affect each other as they move back to normal levels?
- Switching gears to finance specifically, what do you think are some of the big unanswered questions for research?
- You wrote an op-ed on an "alternative maximum tax." What’s the idea there?
- Can transfers really help the bottom half of the income distribution?
- Which economists have influenced you the most?
Thanks to Aaron Steelman, Lisa Kenney and especially Renee Haltom, who helped a lot with the editing. I'm a lot less coherent in person!
Great stuff, John. You don't seem to love Dodd Frank, and I agree, but do you think the increased capital requirements stemming from it will be beneficial? Wouldn't that reduce the reliance on run prone assets that you mention a being important? More broadly, do you think government intervention is needed to reduce our reliance on run prone assets?
ReplyDeleteIf I may, one of the unintended consequences of increased capital requirements is that the one-size-fits all approach is wiping out small banks in the US. The big guys may carry nationwide, systemic risks that may warrant more capital, but not the mom&pops. One consequence is an even greater concentration of capital in the majors.
DeleteJohn,
ReplyDeleteThese answers intrigued me:
"On the first, the only way to precommit to not conducting bailouts is to remove the legal authority to bail out. Ex post, policymakers will always want to clean up the damage from crises and worry about moral hazard another day. Ulysses understood he had to be tied to the mast if he was going to ignore the sirens. You also have to let people know, loudly. The worst possible system is one in which everyone thinks bailouts are coming, but the government in fact does not have the legal authority to bail out."
Currently:
1. Congress has the legal authority to borrow money.
2. Central bank has the legal authority to lend money.
Which legal authority are you in favor of breaking, or at least curtailing?
John,
ReplyDelete"On the second, if we purge the system of run-prone financial contracts, essentially requiring anything risky to be financed by equity, long-term debt, or contracts that allow suspension of payment without forcing the issuer to bankruptcy, then we won’t have runs, which means we won’t have crises. People will still lose money, as they did in the tech stock crash, but they won’t react by running and forcing needless bankruptcies."
I think you are misconstruing two important issues here. The only way to eliminate "Run prone" financial contracts is to eliminate the marketability / resale ability of financial contracts. Meaning that to totally eliminate runs, financial contracts would need to be structured in such a way that the initial buyer is the owner until such contract has reached the end of duration.
By relying more on equity, you are not advocating fewer "Run prone" financial contracts (equity and even long term debt can still be prone to runs). Instead you are advocating more financial contracts with less legal protection. Which is fine, but it should be acknowledged as such.
Regarding your last post about Krugman and cockroaches (comments were turned off)... You flatter yourself too much. I read the post several times and am convinced it has nothing to do with your name. He defines cockroach and talks about the ideas coming out of Chicago as being a cockroach. Again, it doesn't have anything to do with your name.
ReplyDeleteExcellent!
ReplyDeleteIf you think markets are reacting incorrectly to QE because it's so novel they don't know how, are you putting your money where your mouth is and betting against them?
ReplyDeleteI read the interview. One thing you mentioned that I have not seen you explain in this forum is "the fiscal theory of the price level". Could you please explain it or give a reference to an explanation.
ReplyDeleteFat Man,
DeleteSee:
http://www.minneapolisfed.org/research/qr/qr2342.pdf
http://en.wikipedia.org/wiki/Fiscal_theory_of_the_price_level
"The fiscal theory of the price level is the idea that government fiscal policy affects the price level"
Government fiscal policy can indeed affect the price level.
"For the price level to be stable (to control inflation), government finances must be sustainable: they must run a balanced budget over the course of the business cycle, meaning they must not run a structural deficit."
I don't agree with this part for several reasons:
The government is not limited in the duration of securities that it sells. Faced with perennial deficits the government can extend the duration of securities that it sells.
The government is not limited to selling coupon securities that may put a cash flow pinch on the government. It can instead sell accrual securities where repayment of interest and principle is made at maturity.
The government is not limited to selling securities that offer a guaranteed rate of return (bonds). They can also sell non guaranteed securities (equity).
Fun stuff.
ReplyDeleteQ: If risk premiums are large and fluctuating, it seems likely one should be able to time the market. That is, this implies there should exist beta bets that generate above average absolute returns. All I can think is for credit spreads when they are near their historical extremes (eg, 300 basis points or 900 basis points for B-credits). But the marquee risk premium is the equity risk premium, and aggregate equity returns seem unpredictable in real time (eg, using only data available prior to decision time). Shouldn't the equity risk premium be forecastable, as demonstrated by some sort of market timing rule, if the 'large and variable risk premium' story is true?
Eric,
DeleteThe equity risk premium over the risk free rate of return that investors demand for investing in equity - yes? Typically, that is the interest rate that a sovereign government with the ability to tax offers on its bonds - yes?
Question: What is the equity risk premium if the sovereign government refuses to sell bonds?
"Shouldn't the equity risk premium be forecastable, as demonstrated by some sort of market timing rule." Only if the willingness to sell risk free securities is forecastable - which it is not.
hey john,
ReplyDeletelooking forward to your research on gov debt and inflation. I read peter boettke's blog once and a while. He has always pointed out that the fed and treasury were always linked.
Well, let me ask you the same question again: Have you discovered a new special violation of market efficiency, which only affects responses to QE announcements? If so, what evidence is there for it? What evidence is there that "...Markets are great at correlations and unconditional forecasting, and less so at structural cause and effect for things they have never seen before..."?
ReplyDeleteI am pretty sure there is no evidence for your contention. If there is, you should be forming your own hedge fund to exploit it ASAP.
Consequently the question is why are you rejecting a pretty powerful piece of evidence?
Well...the performance of the economy since QE3---that is, open-ended, results-dependent QE---has not been bad. I don;t know why QE gets a bad rap.
ReplyDeleteMarket Monetarists have argued for a QE3 style program, as opposed to QE 1 and QE 2, when the Fed said it would leave the battlefield regardless of whether victory was in hand. QE1 and QE2 were of limited size and duration, and the Fed said so before ti started. A key error.
So QE3 sends a stronger signal, and being larger and more sustained is more stimulative. And the public know the Fed won't quit too soon (we hope!).
Since QE3 (Sept. 2012) the private sector has been adding almost 200k jobs per month, the auto industry is near all-time record sales, the housing market is back, the S&P 500 is up more than 25 percent, and property prices are up 10-15 percent (lots of variations of course). A bit worrisome is that inflation is actually sinking--but at least there is no sign of over stimulation.
I do not see how John Cochrane and others can say "Oh, QE3 is not working."
Of course, I would prefer supply-side improvements in addition to QE3. We have runaway federal agency and entitlement spending, an ethanol program, and ossified USDA and FDA, and who knows what all at state and local levels.
But, should we suffer and wait for supply-side improvements---which could be a long wait, when do you think ethanol will be dumped?---or stay with QE3 and 200k new jobs a month?
John, will you provide examples of "run prone" financial contracts?
ReplyDeleteEd Livermore,
DeleteI’m 99% certain that the “run prone contract” that Cochrane has in mind is standard deposits at banks. The trouble with those deposits is that when the suspicion arises that the loans or investments backing the deposits are worth less than the deposits (i.e. the bank is insolvent), everyone makes a rush for the door before the door closes and depositors can get nothing out till insolvency proceedings have been completed (which in the case of Lehmans is taking years).
In contrast, if where depositors want interest (i.e. want their money lending on or investing) they have to take the normal risks involved in investing (and there’s no reason they should be excused those risks) then the value of their deposits varies with the value of the underlying loans and investments. That’s much like a mutual fund. And it ‘s impossible for mutual funds to become insolvent.
As to where depositors under that system were determined to get $X back for every $X they deposit, they’d be offered 100% safe 100% reserve deposits. But their money would be doing nothing, so it would earn little or no interest.
Sanjay,
Delete"The trouble with those deposits is that when the suspicion arises that the loans or investments backing the deposits are worth less than the deposits (i.e. the bank is insolvent), everyone makes a rush for the door before the door closes and depositors can get nothing out till insolvency proceedings have been completed (which in the case of Lehmans is taking years)."
Except Lehman wasn't relying on deposits for funding. Instead they were relying on short term credit. You honestly believe that the run in the shadow banking industry had anything to do with deposits or deposit insurance?
"In contrast, if where depositors want interest (i.e. want their money lending on or investing) they have to take the normal risks involved in investing (and there’s no reason they should be excused those risks) then the value of their deposits varies with the value of the underlying loans and investments."
Based upon what value metric? Mark to market? How does that work if a bank chooses to retain the loans it makes - i.e. their loans retained are not marketable securities?
Mark to credit risk? Fairly easy as long as long as markets are well regulated. More difficult when shadow banking removes responsibility for truth in lending (N.I.N.J.A. loans, no doc loans, etc.). Even more difficult with securitized lending where banks are betting on the value of the underlying asset.
Mark to interest rate risk? Seeing that interest rate risk has a political element how do you measure it?
And you do realize that banks in their current incarnation already do this don't you? When they want to offload credit / interest rate risk they sell these things called certificates of deposit - perhaps you have heard of them?
Frank,
DeleteI only quoted Lehmans because it’s an example (an extreme one) of how long it can take to wind up a bank. Also I realise Lehmans was an investment bank, i.e. it didn’t take deposits from households. But it must (by definition) have had what Cochrane calls “run prone contracts” (i.e. it must have owed a SPECIFIC number of dollars to creditors) else it wouldn’t have gone insolvent. Put another way, what you call “short term credit” was to Lehmans as retail deposits are to a retail bank.
Next, you ask “Based on what value metric”. My answer to that is “market forces”. That is, mutual funds have a selection of assets the value of which is determined solely by what the market thinks the assets and hence the mutual fund is worth.
But there are possible variations on that theme. For example in the case of money market mutual funds they could be forbidden to make an absolute promise to depositors not be break the buck, and the authorities in the US are actually trying to stop money market mutual funds making that promise. I.e. if the authorities get their way, MMMFs’ promise to depositors might be along the lines “we’ll try to repay you $X for every $X you deposit, but if the underlying assets drop in value, you’ll get less than $X” back”.
Next, you ask “How does that work if a bank chooses to retain the loans it makes..” The answer to that is that mutual funds often “retain the investments they make” when someone sells mutual fund units. If there is someone willing to buy those units at the existing price, then the value of the units stays the same. If not, the value of the mutual fund drops till a buyer looking for a bargain appears.
Re CDs, they amount to much the same thing as a savings account or term account. That is they are an interest yielding investment which involves a bank promising to repay the relevant bank creditor a specific number of dollars. That would be illegal under Cochrane’s system (if I’ve got him right).
Lawrence Kotlikoff and Milton Friedman actually advocate/d systems much like John Cochrane’s. For Friedman, see Ch.3 of his book “A Program for Monetary Stability”, section headed “How 100% Reserves Would Work”. And for Kotlikoff, see:
http://www.bloomberg.com/news/2013-03-27/the-best-way-to-save-banking-is-to-kill-it.html
Sanjay,
Delete"Next, you ask - based on what value metric. My answer to that is market forces. That is, mutual funds have a selection of assets the value of which is determined solely by what the market thinks the assets and hence the mutual fund is worth."
First, those assets owned by a mutual fund / bank are financial assets that are claims on real goods - for instance a mortgage is a claim on a house. And so the obvious question is which market should determine the value of the mortgage - the house market or the mortgage bond market? And yes, those two markets (mortgage bonds and houses) can diverge.
Second, mutual funds can hold financial assets until those assets reach maturity - they don't have to sell. Markets can become illiquid - bid / ask spreads can go very wide and so which market should mutual funds be valued upon - the bidder's price market or the asker's price market?
"A government that borrows in its own currency will print money rather than default. That will cause inflation."
ReplyDeleteProbably not. As long as the government has positive net worth, it can print any amount of money without causing inflation. Inflation only happens when the government's net worth becomes negative. The same thing is true of bonds.
Inflation? The Bank of Japan cannot even hit a 1 percent target...despite an announced plan to double the monetary base. You are right.
DeleteWhat no one is addressing is the Great Taboo: What if we can monetize debt with no inflation? Well, that is what we have been doing.
So...why not keep doing it?
I just read an old speech Krugman made in Chicago last January where he tries to suggest that debasing the currency this time around is acceptable….oh really. Based on his visceral blogging these days apparently he must have left Chicago that night feeling very defeated.
ReplyDeleteToo bad really, oh I’m not suggesting that’s he’s not smoking crack, I just typically see professional economist agree to disagree helps them work through their research.
I guess he’s just more interested in promoting his opinion, he must have found a payoff.
Why do you support a consumption tax and not an asset tax/income flat tax? It seems odd that you would punish the people that due to limited means spend a high portion of their income...and reward the ultra wealthy who spend tiny bits of their wealth. please help me understand why frugal Warren Buffet should pay less than the average family of 4?
ReplyDeleteVery impressive. Thank you!
ReplyDelete