Toward a run-free financial system

A new essay, expanding greatly on a previous WSJ oped and illustrated by a great comic. Here's the introduction, follow the link for the whole thing.

Toward a run-free financial system
John H. Cochrane
April 16 2014

Abstract

The financial crisis was a systemic run. Hence, the central regulatory response should be to eliminate run-prone securities from the financial system. By contrast, current regulation guarantees run-prone bank liabilities and instead tries to regulate bank assets and their values. I survey how a much simpler, rule-based, liability regulation could eliminate runs and crises, while allowing inevitable booms and busts. I show how modern communications, computation, and financial technology overcomes traditional arguments against narrow banking. I survey just how hopeless our current regulatory structure has become.

I suggest that Pigouvian taxes provide a better structure to control debt issue than capital ratios; that banks should be 100% funded by equity, allowing downstream easy-to-fail intermediaries to tranche that equity to debt if needed. Fixed-value debt should be provided by or 100% backed by Treasury or Fed securities.  

Weekend Labor Markets

This weekend produced several interesting readings on the state of labor markets.

1. Glenn Hubbard,

In the Wall Street Journal on "The Unemployment Puzzle: Where Have All the Workers Gone?" Like economists of all stripes, the fact that the unemployment rate -- the fraction of people looking for jobs -- is down masks the deeper problem, that so many people are not working and not looking.

Glenn sets out well the basic question:

Krugman on reading

Paul Krugman has a fascinating blog post up. To be fair, I will quote it in its entirety, with my emphasis added in bold. 

I’ve written before about the myth of the stupid progressive economist.Many conservative economists have a fixed idea in their heads — it’s more than just a presumption, because it seems completely impervious to evidence — that progressive economists are dumb guys who don’t understand basic economics. And because of this fixed idea, conservatives appear literally unable to read what my side writes; they criticize the dumb things they’re sure we must have said, without checking to see if that’s what we actually said.

In the linked post I wrote about health reform issues, but you also see this in macro: five years and more into this discussion, freshwater economists still can’t wrap their brains around the notion that modern Keynesians (both New and eclectic) have actually done a lot of hard thinking over the past few decades. I’ve called this a failure of reading comprehension, but it’s actually an unwillingness to read at all, to so much as glance at what the actual argument might be.

And I mean that quite literally. Brad DeLong quotes from a John Cochrane paper (no link) which declares that those stupid Keynesians don’t understand why monetary policy is ineffective. It’s not because of the zero lower bound, it’s because bonds and monetary base are perfect substitutes:

In this analysis, monetary policy is impotent, but not for the usual reason that interest rates are nearly zero. The Fed can arbitrarily exchange Treasury debt for money, and increase the money supply as much as we like. But nobody cares if it does so, since the “flight to liquidity” is equally towards all forms of Government debt. If we want more fruit and less cheese, putting more apples and less oranges in the fruit basket won’t help. 

So, I think I can say without boasting that the modern revival of liquidity-trap economics began with my 1998 Brookings Paper (pdf). Here’s the first sentence of that paper:

THE LIQUIDITY TRAP – that awkward condition in which monetary policy loses its grip because the nominal interest rate is essentially zero, in which the quantity of money becomes irrelevant because money and bonds are essentially perfect substitutes – played a central role in the early years of macroeconomics as a discipline.

That was 16 years ago. Just saying.

It's pretty amazing to write a whole column about people who, and I quote "criticize the dumb things they’re sure we must have said, without checking to see if that’s what we actually said." and then so patently and blatantly not, well, check to see if that's what I actually said.

"no link?" Dear Professor, let me acquaint you with this thing called Google, with which you can check quotes if you are so inclined when Brad doesn't give you the link. (Update: Hilarious "let me google that for you" link from a correspondent.)

If you did, you would find no statement of mine, ever, that says anything like "those stupid Keynesians don’t understand why monetary policy is ineffective." This is slander, pure and simple. I have never used the word "stupid" to describe any economist.  Serious, scholarly, new-Keynesians like Mike Woodford are incredibly smart.

And to write this in the middle of a column complaining that I don't check to see what others have actually said??? Are there no mirrors at the New York Times?

As for my supposed lack of reading skills, I invite the learned professor, if he wishes to join the club of people who check facts, to browse my research webpage and or the page of my monetary economics class. He will find a lifetime of work reading and thinking hard about New, and Old Keynesian models, going back decades. I even got an A in my Keynesian classes at Berkeley in the 1980s.

Since he advocates reading, let me suggest my Determinacy and Identification with Taylor Rules, including the references, or the more recent New Keynesian Liquidity Trap. You can say it's all wrong, but you cannot say I have not read and thought hard about new-Keynesian economics, including all of Woodford's book. But to do that, you have to read past one 2009 blog post, which seems to be the beginning and end of Brad DeLong's reading, and Krugman's passing along of opinions without doing any reading.

Perhaps this is all petulance because I didn't cite Krugman for the idea that at zero rates bonds and money are perfect substitutes. (In, let us remember, a blog post designed to explain to a popular audience how neoclassical models work, with very few citations, not an academic article.) Anyway, Keynes and Friedman (optimum quantity of money) had those ideas long ago. Indeed it did "play a central role in the early years," which is why a citation is not required for every paper that talks about it afterward. And perhaps I should add a little Emily Post etiquette lesson: There is a fine art of fishing for citations. Slander and insults are usually not very effective.

It was April 1. It's so outrageous I did stop to check that it wasn't a parody! Apparently not.

PS: Comments off, for obvious reasons.