Secret Data

On replication in economics. Just in time for bar-room discussions at the annual meetings.

"I have a truly marvelous demonstration of this proposition which this margin is too narrow to contain." -Fermat

"I have a truly marvelous regression result, but I can't show you the data and won't even show you the computer program that produced the result" - Typical paper in economics and finance.

The problem 

Science demands transparency. Yet much research in economics and finance uses secret data. The journals publish results and conclusions, but the data and sometimes even the programs are not available for review or inspection.  Replication, even just checking what the author(s) did given their data, is getting harder.

Quite often, when one digs in, empirical results are nowhere near as strong as the papers make them out to be.

Tax Oped

Source: Wall Street Journal

An Oped at the Wall Street Journal, "Here's what genuine tax reform looks like." With a new art style by WSJ. (Ungated via Hoover. I have to wait 30 days to post the whole thing.)

 I buried the lead, which I'll excerpt here:

"...Why is tax reform paralyzed? Because political debate mixes the goal of efficiently raising revenue with so many other objectives. Some want more progressivity or more revenue. Others defend subsidies and transfers for specific activities, groups or businesses. They hold reform hostage.

Wise politicians often bundle dissimilar goals to attract a majority. But when bundling leads to paralysis, progress comes by separating the issues. 

Thus, we should agree to first reform the structure of the tax code, leaving the rates blank. We will then separately debate rates, and the consequent overall revenue and progressivity.... we can agree on an efficient, simple and fair tax, and debate revenues and progressivity separately.

We should also agree to separate the tax code from the subsidy code. We agree to debate subsidies for mortgage-interest payments, electric cars and the like—transparent and on-budget—but separately from tax reform.

Negotiating such an agreement will be hard. But the ability to achieve grand bargains is the most important characteristic of great political leaders."

This is, I think, the most novel idea in the oped. All tax reform packages mix changes to the structure of the tax code with specific rates. Then, the wonkosphere goes on a witch hunt of who pays more and who pays less, and the attempt to fix pathological problems in the structure falls apart.

I think our politicians really could negotiate a tax code in which all the rates are left blank. Then, we have a separate debate about what those rates will be.  In fact, tax rates ought to change a lot more often than the tax code itself.

Similarly,  the key to removing the pernicious subsidies in the tax code is again to separate the issues. Taxes are for taxing, then we can debate subsidies.

We need to move from the equilibrium of, I have my subsidy/deduction/credit/special deal, so I won't complain about yours, to the equilibrium of, I gave up my subsidy/deduction/credit special deal, so I'll make darn sure you give up yours too.

Institutions and experience

These are remarks I prepared for a symposium at Hoover in honor of George Shultz on his 95th birthday. Willie Brown was the star of the symposium, I think, preceded by a provocative and thoughtful speech by Bill Bradley.

Institutions and Experience

Our theme is “learning from experience.” I want to reflect on how we as a society learn from experience, with special focus on economic affairs. Most of these thoughts reflect things I learned from George, directly or indirectly, but in the interest of time I won’t bore you with the stories.

An English baron in 1342 tramples his farmers’ lands while hunting. The farmers starve. Then, insecure in their land, they don’t keep it up, they move away, and soon both baron and farmers are poor.

How does our society remember thousands of years of lessons like these? When, say, the EPA decides the puddle in your backyard is a wetland, or — I choose a tiny example just to emphasize how pervasive the issues are — when the City of Palo Alto wants to grab a trailer park, how does our society remember the hunter baron’s experience?

The answer: Experience is encoded in our institutions. We live on a thousand years of slow development of the rule of law, rights of individuals, property rights, contracts, limited government, checks and balances. By operating within this great institutional machinery, these “structures” as senator Bradley called them last night, these “guardrails” as Kim Strassel called them in this morning’s Wall Street Journal, our society remembers Baron hunter’s experience in 1342, though each individual has forgotten it.

Tilting at Bubbles

Source: Wall Street Journal

The Wall Street Journal reports on the "Fed's Unsolved Puzzle: How to Deflate Bubbles" (That's the print version headline, much pithier than online.)

I thought I was reading The Onion. There it is, a graph marked "Asset Bubbles," measured, apparently, with interferometer precision.

Luke Skywalker and ISIS

Via Marginal Revolution, I found "The Radicalization of Luke Skywalker" interesting.

Despised people -- terrorists; slaveholders; Republicans, to the New York Times -- think of themselves as good and worthy, though they do things we find unfathomably evil. Understanding how they see themselves is the first step to any sort of progress in world affairs. Understanding need not mean agreeing or condoning. The language we use -- "terrorist," "radicalize" -- puts them beyond comprehension; useful for ordering drone strikes but not for understanding why people sign up and how they might be turned. The analogy is admittedly strained, but seeing that we might have felt the same feelings that attract terrorists is an unsettling and useful experience.  Even if it's only a movie.

Smith meet Jones

A while ago I wrote up a smorgasbord of policies that I thought could increase US economic growth, at least for a few decades, in "Economic Growth" (pdf, html here.) Noah Smith took me to task in a Bloomberg View column, complaining that I confused growth with levels,

...I want to focus on one bad argument that Cochrane uses. Most of the so-called growth policies Cochrane and other conservatives propose don't really target growth at all, just short-term efficiency. By pretending that one-shot efficiency boosts will increase long-term sustainable growth, Cochrane effectively executes a bait-and-switch.

As it turns out, the difference between "growth" and "level" effects in growth theory and facts is not so strong. Many economists remember vaguely something from grad school about permanent "growth" effects being different and much larger than "level" effects.  It turns out that the distinction is no longer so clear cut; "growth" is smaller and less permanent than you may have thought, and levels are bigger and longer lasting than you may have thought.

Along the way, I offer one quantitative exercise to help think just how much additional growth the US could get from the sort of free-market policies I outlined in the essay.

Part I Growth and Levels 

A quick reply: China.

Zoning and inequality

I am always pleased when economists normally thought of on different ends of the political spectrum come to the same conclusions. So it is with zoning laws; traditionally a target of free-market and libertarian thinkers. Now joined by Jason Furman, Obama administration CEA chair. From a recent speech,

..excessive or unnecessary land use or zoning regulations... impede mobility and thus contribute to rising inequality and declining productivity growth.

How?

...zoning regulations and other local barriers to housing development allow a small number of individuals to capture the economic benefits of living in a community, thus limiting diversity and mobility. ...

Zoning and other land use regulations, by restricting the supply of housing and so increasing its cost, may make it difficult for individuals to move to areas with better-paying jobs and higher-quality schools. Barriers to geographic mobility reduce the productive use of our resources and entrench economic inequality.

and later

High-productivity cities—like Boston and San Francisco—have higher-income jobs relative to low-productivity cities. Normally, these higher wages would encourage workers to move to these high-productivity cities—a dynamic that brings more resources to productive areas of the country, allows workers in low-productivity areas to earn more, improves job matches and competes away any above-market wages (another type of economic rents) in the high-productivity cities. But when zoning restricts the supply of housing and renders housing more expensive—even relative to the higher wages in the high productivity cities—then workers are less able to move, particularly those who are low income to begin with and who would benefit most from moving. As a result, existing income inequality across cities remains entrenched and may even be exacerbated, while productivity does not grow as fast it normally would.

Fixed-income comments

A month ago,  I attended the SF Fed/Bank of Canada conference on fixed income. I had the chance to comment on Michael Bauer and Jim Hamilton's "Robust Bond Risk Premia.” My comments here.

As usual when faced with a really nice paper, I used most of my discussion time to survey the field and give my views on current facts and challenges, which is why my comments might be interesting to blog readers.

Some highlights: I reran regressions of bond returns in the style of Joslin, Priebsch, and Singleton, forecasting returns with the first  three principal components of yields, and growth and inflation. Here are the results:

A wise comment

Scott Sumner passes on a wise comment from his blog:

...the main problem in America is that the public, including its highly educated members, is social-scientifically ignorant. Most people I talk to about policy do not even realize that there is anything non-trivial about policy analysis. They want the government to make sure that four phases of rigorously designed RCTs be performed before drugs are made available to the public, for fear of unintended consequences of intervening on a complex system like the human body, yet they think they understand the consequences of highly complex interventions on human societies by introspection alone. Not only do they think they understand the consequences of alternative policy choices, but they're so confident that their understanding is right and that its truth is so obvious that the only explanation for disagreement is evil intentions.  

When I point out that on virtually every policy issue, at least somewhat compelling arguments for many conflicting points of view have been made by relevant experts, people usually react in disbelief or denial, or immediately retreat to questioning the motives of these experts ("of course they say that, they're on the payroll of Big Business" or whatever). These patterns of speech and behavior are uniformly distributed across the political spectrum, even if intelligence and knowledge of well-established facts is not. Even many experts in particular areas of social science evince no awareness of the lack of expert consensus on almost anything in their field, and give the impression of unanimity to an unknowing public.

(Emphasis in the original.) The rush to bulverism (evil intentions or corruption of people who disagree) is particularly noticeable in economic commentary.  Uncertainty about policy is especially strong in macroeconomics and finance.  That doesn't mean anything goes. Many arguments do violate basic budget constraints or suffer other obvious logical flaws.

How do you know economists have a sense of humor? We use decimal points.

Hounded out of business II

Nathaniel Popper at the New York Times Dealbook, writes "Dream of New Kind of Credit Union Is Extinguished by Bureaucracy" It's a worthy addition to the series of anecdotes on how regulation, especially discretionary actions of regulators, are killing investment and businesses.

Again, we collect anecdotes as a challenge to measurement. There is no data series on numbers of businesses driven away by regulation. Yet.

This is a good anecdote, as it illustrates a too little reported underbelly of financial regulation.

Mr. Kahle saw how hard it was for the employees at his firm to obtain loans, and more broadly, how the existing financial system had helped contribute to the financial crisis. He thought he could do things differently, and he aimed to prove it when he began applying to open a credit union in early 2011.

Since then, the credit union has faced a barrage of regulatory audits and limitations on its operations, ...Now, Mr. Kahle is giving up on his dream of creating a new kind of bank, ...

...the troubles faced by his Internet Archive Federal Credit Union point to how difficult it can be to try out anything new in the heavily regulated industry.

Spot insurance markets

Obamacare/ ACA was in the news last week. Some relevant summaries, and comment below.

United Health pulling out of the Obamacare exchange market

UnitedHealth reported one problem after another: An expensive risk pool that lacks the younger and healthier consumers who are supposed to buy overpriced plans to cross-subsidize everyone else....People join the exchanges before they incur large medical expenses—insurers are required under ObamaCare to cover anyone who applies—and then drop out after they receive care. The collapse of the ObamaCare co-ops is recoiling through the market.

... Commercial insurers are being displaced by Medicaid managed-care HMOs, with their ultra-narrow physician networks and closed drug formularies.

From the WSJ blog,

...Health plans say they have had more sick people, and fewer healthy people, sign up under the new rules than they need to keep prices stable. ...It’s also cited as a factor in some insurers’ decisions to withdraw products from the market or offer more limited choices of providers this year. Health Care Service Corp., which owns Blue Cross and Blue Shield plans in five states, already has pulled out in selling through HealthCare.gov in New Mexico, and yanked its preferred-provider organization offerings in Texas.

From Rising rates pose challenge to health law

Federal officials are pushing people to evaluate their options and consider switching plans to try to keep costs in check, in a message regularly summarized as “shop and save.”

In about half of the states using HealthCare.gov, people in popular plans can pay lower premiums in 2016 than they did in 2015—as long as they are willing to switch to a plan with a different insurer, usually with a narrower network of doctors and a higher deductible. 

A story:

Kimono England...said... Their health plan’s decision to withdraw its “preferred provider organization” product this year tipped her over the edge.

She said she now has only a narrow provider-network option that doesn’t include her local doctors,...she decided to enroll in a Christian health-care sharing ministry, in which members agree to pay each other’s health bills... since the ministry won’t pay for an expensive specialty shot her husband needs four times a year they are thinking of buying a health plan just to cover him.

The move by the England family would mean that five people with relatively low medical costs exit the insurance risk pool, and one person with large expenses remains—bad news for the insurance industry.

Also,  Mary Kissel interview of Holman Jenkins (video)

Comments:

Let's beyond the standard headlines -- "Millions more covered!" "But they're all medicaid or high subsidy!" (For example here.) "Premiums going up!" "Not if you shop!" and so forth.

Health "insurance" seems to be moving to a spot market, in which large numbers of people change plans, sign up, or leave every year, and in which large numbers of companies change their plans and coverage every year.

The churn on the individual side and its spiraling costs was a predictable (and widely predicted) response to the ACA, which addressed preexisting conditions by mandating insurers to cover anyone at the same price. The joke around the passage of the ACA was that health insurance would consist of a cell phone, which you use to buy coverage on the way to the hospital.

Yes, open enrollment is only once a year, but it's not really a constraint. Most conditions involve years of care, and you can wait six months to ramp up big expenses. A binding non-insurance penalty close to the cost of insurance was never going to pass.

Moreover, the problem is not so much insurance vs. no insurance, it's the right to move around between plans. Buy a bronze high deductible policy one year. If you get sick, move to a gold low deductible big network policy the next year.

The tragedy here is what was lost. Yes, individual insurance had big problems. But before the ACA, there were millions of people who bought insurance when they were healthy; that paid guaranteed-renewable premiums in a large stable health insurance companies, so that when they got sick, they would still have good affordable health insurance. Sure, it didn't work for people who moved across state lines, who got jobs with employer-provided group plans, and many suffered various snafus. But for many self-employed people and small business owners outside the big company - big government nexus, it actually worked ok.

Those relationships are all gone now. If ever we do move back to long-lasting, individual insurance, that you buy when healthy so that it covers you when sick, the millions of people who did the right thing and bought in to the system are now gone.

It's more surprising, at least to me, that annual chaos is breaking out on both sides.  Plans are discontinued, companies leave the market, coops come and go bankrupt, networks change, and many of us have the pleasure of annually sorting through health insurance policies, trying to figure out which ones cover the doctors, hospitals, and medications we are using or might need next year, all likely to do it again in the next year.

Our "federal officials" are not only not bemoaning this chaos -- they're encouraging it! "Shop and save." Shop because your plan got canceled, they changed your network, they vastly raised your premiums, and so forth. Save because they won't pay your claims.

I guess Americans need something to do between Thanksgiving and New Years. Together with shopping for cell phone contracts, cable and internet bundles, and figuring out our frequent flyer programs, this should keep us all plenty busy. Winter in the Republic of Paperwork.

Will the supply churn continue? One view of this is simply that companies need time to adapt. They made optimistic assumptions about their pools, find they're losing money and have to adjust. In time, we will again see stable offerings by stable companies.

Maybe, but I doubt it. If people keep playing games, moving to high cost policies when they get sick, health insurance for those of us not getting subsidies will be astronomically expensive. It ceases being insurance.

A different view is that the supply churn is the industry's way of solving the problem. By changing networks and coverage each year, by canceling policies frequently, by companies forming, dissolving, entering and leaving markets,  they keep us on our toes. A stable wide network plan with reasonable cost will attract too many sick people. So, the answer is, keep it unstable.  The same kind of price discrimination by complexity that pervades airlines, cell phones, and credit card contracts, might pull in healthy people who don't have time to spend three weeks a year finding out what doctors are covered by what plan.

Related, I suspect the industry is finding a way to segment the market. There are really four separate health insurance systems: 1) Expanded Medicaid. 2) Highly subsidized premiums based on income. 3) Non-subsidized individual policies. 4) Employer provided insurance for high income people with full time jobs. The first three were supposed to be parts of the same market, but it's fragmenting, with medicaid and subsidized plans giving out low cost low quality care.

This is not a grand conspiracy theory. Like most outcomes in economics, it's not obvious any of the participants understand what's going on, and an evolutionary process settles on outcomes that "work" in the regulatory environment and don't lose catastrophic amounts of money.

Health insurance really does not work as a spot market, of course.

The answer? For those who haven't been reading this blog very long (collections here and here), it is straightforward: Lifelong, deregulated, guaranteed-renewable, individual insurance, bought when you're healthy, carried along from state to state and job to job, with employers contributing premiums rather than setting up group plans. Deregulation of supply, so that for most procedures you can just pay cash and not be rooked by made up prices.

Early Fisherism

John Taylor has an interesting blog post with a great title, "Staggering Neo-Fisherian Ideas and Staggered Contracts." John goes back to a paper he wrote in 1982 for the Jackson Hole conference, on the issue of that time, how to lower inflation. He presented simulations of a model with staggered wage setting, which I reproduce below.

So as far back as 1982, here is a model in which lower interest rates correspond with lower inflation, both in the short run and the long run.  John's model has money in it, so the mechanics are a pre-announced monetary contraction.

Sargent's famous "Ends of four big inflations"  tells an even more radical story.

Hounded out of business

The Wall Street Journal had a nice oped, "Hounded out of business by regulators" by Dan Epstein who was, well, hounded out of business by regulators. Excerpts:

Last Friday, the FTC’s chief administrative-law judge dismissed the agency’s complaint. But it was too late. The reputational damage and expense of a six-year federal investigation forced LabMD to close last year.

...the commission opened an investigation into LabMD in January 2010. ...the FTC refused to detail LabMD’s data-security deficiencies.... Eventually, the FTC demanded that LabMD sign an onerous consent order admitting wrongdoing and agreeing to 20 years of compliance reporting.

Unlike many other companies in similar situations, however, LabMD refused to cave and in 2012 went public with the ordeal. In what appeared to be retaliation, the FTC sued LabMD in 2013, alleging that the company engaged in “unreasonable” data-security practices that amounted to an “unfair” trade practice.... FTC officials publicly attacked LabMD and imposed arduous demands on the doctors who used the company’s diagnostic services. In just one example, the FTC subpoenaed a Florida oncology lab to produce documents and appear for depositions before government lawyers—all at the doctors’ expense.

Inflation Drumbeat

Noah Smith has an interesting Bloomberg View piece on Japanese inflation. Three crucial paragraph struck me

... Japanese unemployment is very low, and the economy is expanding at or above its long-term potential growth rate of around 0.5 percent to 1 percent. So according to mainstream theory, inflation would be an unnecessary and pointless negative for Japan’s economy. Why, then, are there always voices calling for Japan to raise its inflation rate?

Actually, there are several reasons. The main one is that inflation reduces the burden of debt. Japan’s enormous government debt represents the government’s promise to transfer resources from young people (who work and pay taxes) to old people (who own government bonds). Since Japan is an aging society, there are more old people than young people. That makes the burden especially difficult to bear. Young people also tend to have mortgages, the repayment of which is another burden.

Sustained higher inflation would represent a net transfer of resources from the old to the young. That would increase optimism, and hopefully raise the fertility rate, helping with demographic stabilization. It would also decrease the risk that the Japanese government will eventually have to take extreme measures to stabilize the debt.

I like these paragraphs because they so neatly distill the language used by the standard policy establishment to advocate inflation. Noah clearly separates the usual "stimulus" arguments from the new "debt" argument, which helps greatly.

Debt is a "burden." Sort of like snow on your roof, debt appears from the sky somehow and then represents a "burden" requiring "lifting," which would be beneficial to all.

Debt "represents the government’s promise to transfer resources from young people ... to old people.." Apparently, the government woke up one morning, and said "we promise to grab about two and a half years worth of income from young people and give it to old people." Undoing such an ill-advised promise does indeed sound worthy.

But, lest these soothing words lull you into idiocy, let us remember where debt actually comes from. The Japanese government borrowed a lot of money from people who are now old, when they were young. Those people consumed less -- they lived in small houses, made do with fewer and smaller cars, ate simply, lived frugally -- to give the government this money. The promise they received was that their money would be returned, with interest, to fund their retirements, and to fund their estates which young people will inherit.

Noah is advocating nothing more or less than a massive government default on this promise, engineered by inflation. The words "default,"  "theft," "seizure of life savings," apply as well as the anodyne "transfer." I guess Stalin just "transferred resources."

Open Letter on Economic Data

I joined a large number of economists signing an open letter supporting funding for economic data. The letter is here, twitter #SaveTheData, Financial Times story here, press release here.

Few public goods are as cheap or important as good economic data.  Much of our national policy discussion is based on government-collected data. Changes in inequality, wage growth or stagnation, employment and unemployment, growth, inflation... none of these are readily visible walking down the street.

Free, openly accessible, well-documented data, allowing comparisons over long periods of time, such as provided by the Bureau of Labor Statistics, is especially valuable.

Already, much of the data we get is based on decades-old measurement concepts. Perhaps someday internet big data will bring us alternatives. But that day is a long way away. Let's not fly blind in the meantime.

Permazero

St. Louis Fed President Jim Bullard gave a very interesting paper at the Cato monetary conference, with this great title.

Jim starts with this great picture. It's a simulation of the standard three equation new Keynesian model as we go from 2% interest rate to zero. This is an upside down version of the first graph in my "Do higher interest rates raise or lower inflation." (Blog post) But Jim makes a new and insightful point with it, that had not occurred to me.

Jim reads this as an account of what happened in 2008, not (my) tentative prediction for what might happen in 2016 in the other direction. It's compelling: The Fed lowers rates. This boosts output (black line) over what it would otherwise be, overcoming the horrendous negative shocks to the economy from a financial crisis. Inflation gently declines, which is also what inflation did after a one time shock in 2009, related to the output shock which the Fed was offsetting.

Taylor Truman Medal Speech

John Taylor's speech  on receiving the Truman medal for economic policy is noteworthy. John thinks about the institutions that govern monetary and financial policy. We spend too much time on the will-she-raise-rates-or-won't-she sort of decisions that we forget how important this institutional structure is to good, predictable and (as John might put it) rule-based policy.

John reflects on the institutions of postwar policy:

Seventy years ago Harry Truman signed the Bretton Woods Agreements Act of 1945. It officially created two new economic institutions: the International Monetary Fund and the World Bank. A year later he signed the Employment Act of 1946. It created two more new institutions: the President’s Council of Economic Advisers (CEA) and the Congress’s Joint Economic Committee (JEC). And in 1947 came the General Agreement on Tariffs and Trade (GATT) and the Truman Doctrine, and in 1948 the Marshall Plan.

The 13 Trillion Dollar Question

On Tuesday Nov 10 there will be a conference in Chicago on "The $13 Trillion Question: Managing the U.S. Government’s Debt" hosted by the Initiative on Global Markets at Chicago Booth, and the Hutchins Center on Fiscal and Monetary Policy at Brookings. (The Brookings announcement here.)

Robin Greenwood will present "The Optimal Maturity of Government Debt and Debt Management Conflicts between the U.S. Treasury and the Federal Reserve" arguing that the Fed and Treasury are working to cross-purposes -- the Fed buys what the Treasury sells -- and that the government  should go after low rates on long term bonds rather than the budget insurance of issuing long term bonds.

(The government faces the same decision a homeowner does: borrow at near-zero floating rates,  but maybe rates shoot up and so do your payments, or borrow long at 2% rates, and pay more if rates don't go up. Robin and Larry favor the former. I'm more risk averse. Maybe living in California has sensitized me  that just because you haven't seen an earthquake recently doesn't mean you shouldn't buy earthquake insurance. But it's a good argument to have qualitatively -- what's the risk, and what's the reward.)

I will present "A new structure for Federal Debt," arguing for an overhaul of which instruments the Treasury issues, to make them more useful for financial markets and financial stability as well as for government borrowing and risk management. (Earlier blog post about this paper here.)

There will be extensive discussion and broader issues, and (the big draw) a panel of Seth  Carpenter, Charles Evans, and Sara Sprung, moderated by David Wessel.

The conference is by invitation, but you can still sign up here until they run out of room, or email Jennifer (dot) Williams at chicagobooth (dot) edu. It will also be viewable by live webcast, link here, starting 1:30 central.

Update: Video of the event here.

Inequality and Economic Policy Published

The Hoover Press put up for free the chapters of Inequality and Economic Policy: Essays In Memory of Gary Becker, edited by Tom Church, John Taylor, and Christopher Miller. You can of course still buy the book for a reasonable $14.95.

This includes the published version of my essay Why and How We Care about Inequality, also available on my webpage.  Bryan Caplan was kind enough to cover it positively last week, now you can read the original. I put a draft up on this blog last year, so I won't repeat it all today. As usual, the published version is better.

The rest of the contents:

Chapter 1: Background Facts By James Piereson

Chapter 2: The Broad-Based Rise in the Return to Top Talent By Joshua D. Rauh

Chapter 3: The Economic Determinants of Top Income Inequality By Charles I. Jones

Chapter 4: Intergenerational Mobility and Income Inequality By Jörg L. Spenkuch

Chapter 5: The Effects of Redistribution Policies on Growth and Employment By Casey B. Mulligan

Chapter 6: Income and Wealth in America By Kevin M. Murphy and Emmanuel Saez

Chapter 7: Conclusions and Solutions By John H. Cochrane, Lee E. Ohanian, and George P. Shultz

Chapter 8: Contents by Edward P. Lazear adn George P. Shultz

Davis on Regulation and More

Steve Davis has a thoughtful speech on regulation, policy uncertainty, and above all the need for simplicity.  (On the policy uncertainty website).  A few excerpts:

... the Code of Federal Regulations (CFR), which compiles all federal regulations in effect each year...grew nearly eight-fold over the past 55 years, reflecting tremendous growth in the scale and complexity of federal regulations. At 175,000 pages, the CFR contains as many words as 130 copies of the King James Bible.  While Ten Commandments sufficed for the Hebrew God of the Old Testament, the CFR contains about one million commandments in the form of “shall,” “must,” “may not,” “prohibited,” and “required.”...

The size and complexity of the U.S. tax code also grew dramatically in recent decades. As of 2011, it takes 70,000 pages of instructions to explain the federal tax code (McCaherty, 2014). The code has about four million words and 67,000 sections, subsections and cross-references. It’s all crystal clear if you read the instructions carefully. ...

And the best paragraph:

The good Catholic Sisters who saw to my moral instruction in primary school devoted many hours to the Ten Commandments. They wanted my classmates and me to avoid sins. Their success in that regard is in doubt. But at least the Sisters could be confident that we did not sin out of ignorance or uncertainty. How they would have instructed us on one million commandments, I do not know. The delinquents in my school found it hard to absorb a mere ten....

An essay. It's an overview of what a growth-oriented policy program might look like. Regulation, finance, health, energy and environment, taxes, debt social security and medicare, social programs, labor law, immigration, education, and more. There is a more permanent version here and pdf version here. This version shows on blogger, but if your reader mangles it, the version on my blog or one of the above will work better.

I wrote it the Focusing the presidential debates initiative. The freedom of authors in that initiative to disagree is clear.

Economic Growth

Growth is central

Sclerotic growth is the overriding economic issue of our time. From 1950 to 2000 the US economy grew at an average rate of 3.5% per year. Since 2000, it has grown at half that rate, 1.7%. From the bottom of the great recession in 2009, usually a time of super-fast catch-up growth, it has only grown at two percent per year.² Two percent, or less, is starting to look like the new normal.

Small percentages hide a large reality. The average American is more than three times better off than his or her counterpart in 1950. Real GDP per person has risen from $16,000 in 1952 to over $50,000 today, both measured in 2009 dollars. Many pundits seem to remember the 1950s fondly, but $16,000 per person is a lot less than $50,000!

If the US economy had grown at 2% rather than 3.5% since 1950, income per person by 2000 would have been $23,000 not $50,000. That’s a huge difference. Nowhere in economic policy are we even talking about events that will double, or halve, the average American’s living standards in the next generation.

Even these large numbers understate reality.

Open-Mouth Operations

(Note: This post uses mathjax and has embedded pictures. When posts are reposted elsewhere these often get mangled. If it's not displaying well, come to the original at johnhcochrane.blogspot.com)

Our central banks have done nothing but talk for several years now. Interest rates are stuck at zero, and even QE has stopped in its tracks. Yet, people still ascribe big powers to these statements. Ms. Yellen sneezes, someone thinks they hear "December" and markets move.

Buried deep in the paper I posted earlier this week is a potential model of "open mouth" operations, that might of interest to blog readers.

Use the standard "new-Keynesian" model \[ x_{t} = E_{t}x_{t+1}-\sigma(i_{t}-E_{t}\pi_{t+1}) \] \[ \pi_{t} = \beta E_{t}\pi_{t+1}+\kappa x_{t} \] Add a Taylor rule, and suppose the Fed follows an inflation-target shock with no interest rate change \[ i_t = i^\ast_t + \phi_\pi ( \pi_t - \pi^\ast_t). \] \[ i^\ast_t = 0 \] \[ \pi^\ast_t = \delta_0 \lambda_1^{-t} \] Equivalently express the Taylor rule with a ``Wicksellian'' shock, \[ i_t = \hat{i}_t + \phi_\pi \pi_t \] \[ \hat{i}_t = - \delta_0 \phi_\pi \lambda_1^{-t}. \] In both cases, \[ \lambda_{1} =\frac{\left( 1+\beta+\kappa\sigma\right) +\sqrt{\left( 1+\beta+\kappa\sigma\right) ^{2}-4\beta}}{2} \gt 1 \] Yes, this is a special case. The persistence of the shocks is just equal to one of the roots of the model. Here \(\delta_0\) is just a parameter describing how big the monetary policy shock is.

Now, solve the model by any standard method for the unique locally bounded solution. The answer is \[ \pi_{t} = \delta_0 \lambda_1^{-t}, \] \[ \kappa x_{t} = \delta_0 (1-\beta \lambda_1^{-1}) \lambda_1^{-t} \] \[ i_t = 0 \]

Here is the equilibrium path of inflation and interest rates (flat red line at zero).

Swiss Deflation

The Wall Street Journal Monday Oct 19 offers a reflection on deflation in Switzerland.

"It’s as close to an economic consensus as you can get: Deflation is bad for an economy, and central bankers should avoid it at all costs."

I differ, as does Milton Friedman's "Optimum quantity of money." And my "who's afraid of a little deflation" in... The Wall Street Journal.

"Then there’s Switzerland, whose steady growth and rock-bottom unemployment is chipping away at that wisdom."

"At a time of lively global debate about low inflation and its ill effects, tiny Switzerland—with an economy 4% the size of the U.S.—offers a fascinating counterpoint, with some even pointing to what they call 'good deflation.' ”

Indeed. The 1970s had stagflation. Now we have the opposite, "good deflation."  The Phillips curve lives on in "consensus."

Switzerland also is a good case for just how powerless central banks are to do much about it.

Do higher interest rates raise or lower inflation?

A new working paper by that title (pdf).  Some of the main ideas are in a longish post from last August.

The fact that inflation is so stable when interest rates are stuck at zero has profound implications. If inflation is stable at a zero peg, it must be stable at a higher peg as well, which means raising interest rates must sooner or later raise inflation. The open question, which this paper goes after, is whether inflation can temporarily decline when interest rates rise. (Graphs from an earlier blog post here.)

Classical "Keynesian" or "Monetarist" models say that inflation is unstable in a peg. They must be wrong. "New-Keynesian" models say that inflation is stable in a peg, a good point in their favor. The important difference is rational expectations. If people drive a car looking in the rear view mirror, cars are unstable and veer off the road. If people look forward, then cars are stable and get back on the road on their own.

But the standard new-Keynesian model also predicts that inflation goes up if interest rates rise, as shown in the graph.  Interest rates are blue, inflation is red, output is black. The dashed line is when people know the rise is coming, the solid line for when it's a surprise.  Raising rates does lower output, just as you thought.

The paper tries everything to revive the idea that higher interest rates lower inflation, without luck.

Abstract:

The standard new-Keynesian model accounts well for the fact that inflation has been stable at a zero interest rate peg. However, If the Fed raises nominal interest rates, the same model model predicts that inflation will smoothly rise, both in the short run and long run. This paper presents a series of failed attempts to escape this prediction. Sticky prices, money, backward-looking Phillips curves, alternative equilibrium selection rules, and active Taylor rules do not convincingly overturn the result. The evidence for lower inflation is weak. Perhaps both theory and data are trying to tell us that, when conditions including adequate fiscal-monetary coordination operate, pegs can be stable and inflation responds positively to nominal interest rate increases.

Open Borders

Alex Tabarrok has a very nice and very short piece at the Atlantic, The Case for Getting Rid of Borders—Completely. (HT Marginal Revolution)

In the Soviet era, there were walls and guards with guns, and we deplored that people were not allowed to cross the border. Is it that different that the guards with guns are on the other side of the walls?

If you're a liberal, you should cheer the policy with the greatest chance of elevating the world's poor and reducing global inequality. If you're a conservative, believe in the rights of individuals and freedom, don't like minimum wages, unions, protectionism, and government control, it makes little sense to switch sides on this one issue.

Lazear on Dodd-Frank and Capital

Ed Lazear has a nice WSJ oped, "How not to prevent the next financial meltdown." (Also available here via Hoover.) The main points will not be new to readers of this blog, or my much longer essay but the piece is admirable for putting the basic points so clearly and concisely.

The core problem of focusing on institutions not activities:

The theory behind so-called systemically important financial institutions, or SIFIs, is fundamentally flawed. Financial crises are pathologies of an entire system, not of a few key firms. Reducing the likelihood of another panic requires treating the system as a whole, which will provide greater safety than having the government micromanage a number of private companies.

A crisis is a run:

The risks to a system are most pronounced when financial institutions borrow heavily to finance investments. If the value of the assets falls or becomes highly uncertain, creditors—who include depositors—will rush to pull out their money. The institution fails when it is unable to find a new source of funds to meet these obligations.

Uncle Sam Spam

I talked a bit to Binyamin Applebaum about his article in the New York Times, Behaviorists Show the U.S. How to Improve Government Operations. As preparation, I read the Social and Behavioral sciences team annual report which he was covering.

Applebaum's article reflects much of the usual New York Times cheerleading for behaviorism and nudge/nanny programs.

Reading the report, I came away more approving of some aspects than blog readers might think, but a little more skeptical of some aspects than Applebaum's article.

• The bottom line is spam. The government wants to send you letters, email, and text messages to sell its programs.  The limits and objections to the program are pretty obvious once you recognize that fact. Spam gets ineffective pretty quickly, and once we start getting spam from 150 different programs nudging us to do different things, spam will get even more ineffective even more quickly. 
• If it's a good idea for the government to send us spam email and text messages, why are academic behavioral scientists the ones to do it, not professional spammers (sorry, "direct marketers")? The actual end result of this is more employment and consulting contracts for academic behavioral economics. 
• The numbers in the report are surprisingly small. Sending spam raises the number of people taking advantage of some program from 2% to 2.2%, which can be sold as a 10 percent increase.  Even I, somewhat of a skeptic to start, am amazed how low the effects are. And both before and after numbers are incredibly small. The big news in this report is that we're full of government programs that only a few percent of the available people are taking advantage of! That might be great news for the budget, but shocking news of effectiveness.  

Japan Deflation

Deflation returns to Japan. Tyler Cowen has a thoughtful Marginal Revolution post, expressing puzzlment. Scott Sumner discussion here, and Financial Times coverage.

Let's look at the bigger picture. Here is the discount rate, 10 year government bond rate and core CPI for Japan. (CPI data here if you want to dig.)

If you parachute down from Mars and all you remember from economics is the Fisher equation, this looks utterly sensible. Expected inflation = nominal interest rate - real interest rate. So, if you peg the nominal interest rate, inflation shocks will slowly melt away. Most inflation shocks are individual prices that go up or down, and then it takes some time for the overall price level to work itself out.

After the ACA

After the ACA, a longish essay on what to do instead of Obamacare. Relative to the policy obsession with health insurance, it focuses more on the market for health care, and relative to the usual focus on demand -- people paying with other people's money -- it focuses on supply restrictions. Paying with your own money doesn't manifest a cab on a rainy Friday afternoon, if you face supply restrictions.

Long time blog readers saw the first drafts. Polished up, it is published at last in the volume  The Future of Healthcare Reform in the United States edited by Anup Malani and Michael H. Schill, just published by the University of Chicago Press.

The rest of the volume is interesting, and the conference was enlightening to me, a part-timer in the massive health-policy area. As the U of C press puts it with perhaps unintentional wry wit: "By turns thought-provoking, counterintuitive, and even contradictory, the essays together cover the landscape of positions on the PPACA's prospects."

Who is walking who?

Click here for the rest

It's a graphic novel treatment of Gene Fama's Does the Fed Control Interest Rates? paper, from the Booth school's Capital Ideas magazine, by Eric Cochrane (yes, we're related). If it appears squished, use a wide browser window. The art is better in the printed form. 

Eric captured cointegration and error correction, and Gene's regressions of short and long-term interest rates, cleverly with the story. Does Sally take Lucy for a walk, or is Lucy really leading Sally around?  Well, when Lucy goes off hunting for a squirrel, who then moves to catch up?  

Is the Fed Pulling or Pushing?

I did a little interview with Mary Kissel of the Wall Street Journal, following up on thursday's oped. Mary is, as you can tell, a well-informed interviewer and asks some tough questions. She did a great job of pushing hard on the usual Wall Street wisdom about how the Fed, though it has not done anything but talk in years, is secretly behind every gyration of stock or housing prices.

The central point came to me hours later, as it usually does. Is the Fed in fact "holding down" interest rates? Is there some sort of natural market equilibrium that features higher rates now, but the Fed is pushing down rates? That's the conventional view, clearly expressed in Mary's questions.

5 million thanks

OK, it's not Marginal Revolution. It's not even tops in my own family -- My kids' high-school animation videos do better (8 million here, 5.8 million here). But this blog has worked out far better than I hoped when I started, and I appreciate all of you who read, comment, or otherwise participate.

WSJ oped, director's cut

WSJ Oped, The Fed Needn’t Rush to ‘Normalize’ An ungated version here via Hoover.

Teaser:

The outcomes we desire from monetary policy are about as good as one could hope. Inflation is low and steady. Interest rates are lower than Americans have seen in generations. Unemployment, at 5.1%, has recovered to near normal. And banks and businesses sitting on huge piles of cash don’t go bust, a boon to financial stability.

Yes, economic growth is too slow, too many Americans have dropped out of the workforce, earnings are stagnant, and the country faces other serious challenges. But monetary policy can’t solve long-term structural problems.

Opeds are real Haikus -- 950 words is torture for me. So lots of good stuff got left on the cutting room floor, especially acknowledgement of objections and criticisms.

Yes, I'm aware of recent empirical work that QE has some effect:

Conundrum Redux

FT's Alphaville has an excellent post by Matthew Klein on long-term interest rates, organized around Greenspan's "conundrum." The "conundrum" was that Greenspan couldn't control long term rates as he wished. Long rates do not always track short rates or Fed pronouncements.  As the post nicely shows, it was ever thus.

The following graph from the post struck me as very useful, especially as so much bond discussion tends to have short memories.

If the 10 year rate had followed the pink line,  you would not have made any more buying 10 year bonds than buying short term bonds. (The pink line is the forward-looking moving average of the one year rates.)

What the graph shows beautifully, then,  is this: Until 1981, long-term bonds were awful. You routinely lost money buying 10 year bonds relative to buying one year bonds. It goes on year in and year out and starts to look like a constant of nature.

From 1981 until today, the actual 10 year rate has been well above this ex-post breakeven rate. It's been a great 35 years for long-term bond investors. That too seems like a constant of nature now.

Of course, inflation going down was good for long term bonds. But we usually don't think there can be surprises in the same direction 35 years in a row.

Two for growth

I saw two very nice, short views on growth: John Taylor Can We Restart This Recovery All Over Again? and Andy Atkeson, Lee Ohanian, and William E. Simon, Jr., 4% Economic Growth? Yes, We Can Achieve That.

John gets the art prize

Andy, Lee and William get the boil-it-down-to-basics prose prize

 Safety-net policies should not discourage work through high implicit tax rates resulting from means-tested programs. Regulatory policies should not erect barriers to competition and raise costs. Education policies should expand competition and reward the most successful teachers. Immigration policies should expand the number of skilled workers and immigrant entrepreneurs. And tax policies should simplify the tax code, reduce business and personal marginal income tax rates and broaden the tax base.

Sargent on Friedman

I ran across a little gem by Tom Sargent, "The Evolution of Monetary Policy Rules." Alas, it's gated in the JEDC so you'll need a university IP address to read it, and I haven't found a free copy. It's a transcript of a talk, so doesn't have Tom's usual prose polish, but insightful nonetheless.

Milton Friedman, like the rest of us, changed his mind over the course of a lifetime.

Coordinating monetary and fiscal policy:

...At different times, Friedman advocated two apparently polar opposite recommendations. In Friedman (1948), he proposed the following rule. He recommended to the fiscal authorities that they run a balanced budget over the business cycle. And he said what the monetary authorities should do, whatever the fiscal authority does, is to monetize 100% of government debt. That monetary rule implies that the entire government deficit is going to be financed with money creation. That is it.

It is interesting to contemplate what Friedman׳s monetary policy rule would imply if the fiscal authority chooses to deviate from Friedman׳s fiscal recommendation by running sustained deficits over the business cycle. Friedman׳s monetary rule then throws responsibility for inflation control immediately at the foot of the fiscal authority. Friedman׳s (1948) monetary rule tells the fiscal authority that if it wants stable money, then it better do the right things. If you want a stable price level, you had better recognize that you need a sound fiscal policy, period.  The division of responsibilities between monetary and fiscal authorities is clearly and unambiguously delineated. It is a completely clean set of rules. And this is what Friedman advocated until 1960.

Friedman (1960) advocated what looks to be exactly an opposite set of rules for coordinating monetary and fiscal policy. Friedman now advocated that the Federal Reserve, come hell or high water – it is not a Taylor Rule (for technical reasons) – should increase high-powered money, or something close to it, at k-percent a year, where k is the growth rate of the economy. The Fed is told to stick to the k-percent rule no matter what, recession or no recession. Under this rule, the arithmetic of the government budget constraint will force the fiscal authority to balance its budget in a present value sense.

Cheaper sugar

A nice trade epigram from David Henderson

I don't think Trump understands that when we open trade to other countries, we gain not just as exporters but as consumers. But then, what U.S. politician running for president does? Marco Rubio? Rubio argued a few years ago that he would favour getting rid of quotas on sugar imports if we got something in return. But we do get something in return: it's called cheaper sugar. And getting cheaper sugar, by the way, might have caused LifeSavers not to move from Michigan to Quebec.

David might have added, we also get more exports automatically without political deals. When other countries sell us sugar, they get dollars, of every single one ends up buying US exports or invested in the US.

Nothing new. It's in Adam Smith. But nicely expressed. Economics needs good stories.

Greece and Banking, the oped

Source: Wall Street Journal; Getty Images

A Wall Street Journal Oped with Andy Atkeson, summarizing many points already made on this blog. This was published August 5, so today I'm allowed to post it in its entirety. You've probably seen it already, but this blog is in part an archive. If not, here is the whole thing, with my preferred first paragraph.
Local pdf here.

Greece's Ills [and, more importantly, the Euro's] Require a Banking Fix 

Greece suffered a run on its banks, closing them on June 29. Payments froze and the economy was paralyzed. Greek banks reopened on July 20 with the help of the European Central Bank. But many restrictions, including those on cash withdrawals and international money transfers, remain. The crash in the Greek stock market when it reopened Aug. 3 reminds us that Greece’s economy and financial system are still in awful shape. 

Historical Fiction

Steve Williamson has a very nice post "Historical Fiction", rebutting the claim, largely by Paul Krugman, that the late 1970s Keynesian macroeconomics with adaptive expectations was vindicated in describing the Reagan-Volker era disinflation.

The claims were startling, to say the least, as they sharply contradict received wisdom in just about every macro textbook: The Keynesian IS-LM model, whatever its other virtues or faults, failed to predict how quickly inflation would take off in the 1970, as the expectations-adjusted Phillips curve shifted up. It then failed to predict just how quickly inflation would be beaten in the 1980s. It predicted agonizing decades of unemployment. Instead, expectations adjusted down again, the inflation battle ended quickly. The intellectual battle ended with rational expectations and forward-looking models at the center of macroeconomics for 30 years.

Just who said what in memos or opeds 40 years ago is somewhat of a fodder for a big blog debate, which I won't cover here.

Steve posted a graph from an interesting 1980 James Tobin paper simulating what would happen. This is a nicer source than old memos or opeds from the early 1980s warning of impeding doom. Memos and opeds are opinions. Simulations capture models.

The graph:

Source: James Tobin, BPEA. 

I thought it would be more effective to contrast this graph with the actual data, rather than rely on your memories of what happened.

The black lines are the Tobin simulation. The blue lines are what actually happened. (I'm not good enough with photoshop to superimpose the graphs, so I read Tobin's data off his chart.)

The two curves parallel in 81 to 83, with reality moving much faster. But In 1984 it all falls apart. You can see the "Phillips curve shift" in the classic rational expectations story; the booming recovery that followed the 82 recession.

And you can see the crucial Keynesian prediction error: After the monetary tightening is over in 1986, no, we do not need years and years of grinding 10% unemployment.

So, conventional history is, it turns out, right after all. Adaptive-expectations ISLM models and their interpreters were predicting years and years of unemployment to quash inflation, and it didn't happen.

Whither inflation?

(Note: This post uses mathjax to display equations and has several graphs. I've noticed that the blog gets picked up here and there and mangled along the way. If you can't read it or see the graphs, come back to the original .)

The news reports from Jackson Hole are very interesting. Fed officials are grappling with a tough question: what will happen to inflation? Why is there so little inflation now? How will a rate rise affect inflation? How can we trust models of the latter that are so wrong on the former?

Well, why don't we turn to the most utterly standard model for the answers to this question -- the sticky-price intertemporal substitution model. (It's often called "new-Keynesian" but I'm trying to avoid that word since its operation and predictions turn out to be diametrically opposed to anything "Keyneisan," as we'll see.)

Here is the model's answer:

Response of inflation (red) and output (black) to a permanent rise in interest rates (blue). 

The blue line supposes a step function rise in nominal interest rates. The red line plots the response of inflation and the black line plots output.  The solid lines plot the answer to the standard question, what if the Fed suddenly and unexpectedly raises rates? But the Fed is not suddenly and unexpectedly doing anything, so the dashed lines plot answers to the much more relevant question: what if the Fed tells us long in advance that the rate rise is coming?

According to this standard model, the answer is clear: Inflation rises throughout the episode, smoothly joining the higher nominal interest rate. Output declines.

Phillips art

The Wall Street Journal gets a prize for Art in Economics for their Phillips curve article. Abstract expressionist division, not contemporary realism, alas.

Source: Wall Street Journal

(For the uninitiated: There is supposed to be a stable negatively sloped curve here by which higher inflation comes with lower unemployment. Beyond that correlation, most policy economists read it as cause and effect, higher unemployment begets lower inflation and vice versa. The point of the article is how little reality conforms to that bedrock belief.)

Too much debt, part II

"China to flood economy with cash" reads today's WSJ headline. When you read the article, however, you find it's not quite true. China to flood economy with debt is more accurate.

The expected move to free up more funds for lending—by reducing the deposits banks must hold in reserve—is directly aimed at countering the effects of a weaker currency,

The People’s Bank of China’s latest planned move, which could come before the end of this month or early next month, would involve a half-percentage-point reduction in banks’ reserve-requirement ratio, potentially releasing 678 billion yuan ($106.2 billion) in funds for banks to make loans.

I had hoped the world learned this lesson in the financial crisis. Equity is great. When things go bad, shareholders lose value by prices falling, but they cannot run and the firm cannot fail if it does not pay equity holders.

Financial crises are always and everywhere about debt, especially short term debt. Lending more, encouraging more bank leverage, reducing reserves and margin requirements, means that when the downturn comes a needless wave of runs and defaults follows.

Inevitably, it seems, another downturn will come, another set of books will have been found to have been cooked, and then we will find out who lent too much money to whom. US investment banks, 2008, strike one. Greece, 2010, strike 2. China, 2015, strike 3? Do we no longer bother closing the barn doors even after the horse leaves?

This story should also give one pause about the wisdom of "macro-prudential" policy, by which wise central bankers are supposed to presciently open and close the spigots of leverage to manage asset prices.

Europa hat die Banken missbraucht

An editorial in Süddeutche Zeitung, on Greece, banks and the Euro, summarizing some recent blog posts.

I don't speak German, so I don't know how the translation went, but it sounds great to me:

Die jüngste Griechenland-Krise rückt das größte Strukturproblem des Euro in den Vordergrund: Unter dem Dach einer gemeinsamen Währung müssen Staaten genauso wie Firmen pleitegehen können. Banken müssen international offen sein, sie dürfen nicht vollgepackt sein mit den Schuldtiteln lokaler Regierungen. So war der Euro ursprünglich konzipiert. Leider haben Europas Politiker die erste Prämisse vergessen und sind zur zweiten gar nicht erst vorgedrungen. Jetzt ist es Zeit, beides in Angriff zu nehmen.... 

The English version:

Greek Lessons for a Healthy Euro

The most recent Greek crisis brings to the foreground the main structural problem of the euro: Under a common currency sovereigns must default just like corporations default. And banks must be open internationally, not stuffed with local governments’ debts.

This is how the euro was initially conceived. Alas, europe’s leaders forgot about the first and never got around to the second. It’s time to fix both.

Greenspan for Capital

Alan Greenspan joins the high-capital banking club, in an intriguing FT editorial

If average bank capital in 2008 had been, say, 20 or even 30 per cent of assets (instead of the recent levels of 10 to 11 per cent), serial debt default contagion would arguably never have been triggered. Had Bear Stearns and Lehman Brothers continued as capital-conscious partnerships, a paradigm under which both thrived, they would probably still be in business. The objection to a capital requirement of 20 per cent or more, even when phased in over a series of years, is that it will suppress bank earnings and lending. History, however, suggests otherwise.

20 to 30 percent used to be the sort of thing one could not say in public without being branded some sort of nut.

Alan also echoes the main point. Banks need lots of regulators micromanaging their investment decisions, because taxpayers pick up the bag for their too-high debts. Banks with lots of capital do not need asset micro-regulation:

...An important collateral pay-off for higher equity in the years ahead could be a significant reduction in bank supervision and regulation.

Lawmakers and regulators, given elevated capital buffers, need to be far less concerned about the quality of the banks’ loan and securities portfolios since any losses would be absorbed by shareholders, not taxpayers. This would enable the Dodd-Frank Act on financial regulation of 2010 to be shelved, ending its potential to distort the markets — a potential seen in the recent decline in market liquidity and flexibility.

A double bravo.

However, to be honest, I have to nitpick a bit on what seems like the right answer for some of the wrong reasons.

The decline in long-term interest rates

Source: Council of Economic Advisers

Long term interest rates are trending down around the world. And it's not just since the great recession and financial crisis. The same trend has been going on for decades.

The Council of Economic Advisers just issued an excellent report surveying our understanding of this question. A blog post summary by Maury Obstfeld and Linda Tesar.

(Many other interesting CEA reports here. Occupational licensing is next on my in box.)

The report is really well done, for explaining the economic issues in clear simple terms, but without hesitating to use a model and an equation when necessary. If you're wondering how to keep your undergraduate or MBA class (heck, your PhD class) busy this week, this report will do the trick.

There is some grumbling in economics circles about the CEA and what role it should play, between Sunday morning talk show cheerleader for the Administration's policies vs. providing dispassionate  economic analysis to the Administration and country. This kind of report is the kind of CEA I cheer for.

I won't summarize the whole thing. Maury and Linda's blog post blog post does a great job of that, and you should just go read it. A few comments however.

Low Hanging Fruit Guarded By Dragons

A nice essay by Brink Lindsey at Cato, analyzing some regulations that are strangling economic growth, with an explicitly bipartisan (multipartisan) appeal.

It's nice because of the unusual focus, not just health, banking, environment, and labor regulation but regulation we don't hear about often enough,

(a) excessive monopoly privileges granted under copyright and patent law; (b) protection of incumbent service providers under occupational licensing; (c) restrictions on high-skilled immigration; and (d) artificial scarcity created by land-use regulation

It takes a while to get going, so skip to p. 7 where the real analysis starts.

I liked especially the analysis of zoning laws, which are the central force behind rising housing prices. They are also curiously damaging to the environment, by forcing people to live far from where they work, and regressive. I say curiously, because tight zoning is so beloved by supposedly green and liberal places, such as Palo Alto.

The wrong austerity

Bailout deal brings wave of tax hikes - Ekathimerini.com

A barrage of new tax measures are contained in the new bill presented to Greece’s Parliament

...diesel fuel tax for farmers going from 66 euros per 1,000 liters to 200 euros/1,000 liters from October 1, 2015, and to 330 euros by October 1, 2016. Farmers’ income tax to be paid in advance will rise from 27.5 percent to 55 percent. Income tax for farmers is set to rise from 13 to 20 percent for 2016 and to 26 percent for 2017.

Freelancers will be subject to a gradual increase from 55 to 75 percent in advanced tax payments for income earned in 2015, increasing to 100 percent in 2016. The 2 percent tax break for single payments on income tax is also being abolished from January 1, 2015.

Private education, previously untaxed, will be taxed at 23 percent, including the tutoring schools (frontistiria) that most Greeks send their children to but excluding preschools.

Greece’s vital shipping industry will also be subject to new tax rises. Among other measures, tonnage tax is to increase by 4 percent annually between 2016 and 2020. A special contribution by foreign cargo carriers will remain in place until 2019.

"Austerity" has been a contentious and vague word, descending to an all-purpose insult from the pen of Krugman et al.

But on one point I think we can agree. Steep tax increases, especially steep increases in marginal tax rates on people likely to work, save, invest, start new businesses, and hire others, are an especially bad idea right now. The only hope to pay back debt is growth, and this sort of thing just kills growth. Part of growth is also keeping smart young Greeks in the country, which they are leaving in droves.

For better or worse?

Three recent news items and blog posts make a provocative contrast:

Paul Krugman, New York Times,  "The MIT Gang"

It’s actually surprising how little media attention has been given to the dominance of M.I.T.-trained economists in policy positions and policy discourse.... 

James Bartholomew, The Spectator, "British economics graduates have left a trail of misery around the world"

"... the trendy doctrines of our universities have much to answer for" 

(A list that in terms of needless human suffering, is pretty astounding)

Yannis Palaiologos, Politico, Beware of American econ professors!  

World-famous economists — men of Nobel prizes and stellar academic accomplishment — have provided intellectual cover to radicals who appeared at best to be willing to take a stupendously reckless gamble with Greece’s financial, political and geopolitical future, 

To belabor the obvious: Be careful what you wish for.

Summers and the nature of policy advice

Larry Summers has a fascinating editorial in the Financial Times titled "Corporate long-termism is no panacea — but it is a start" You really should read the whole thing and come back for commentary.

The three paragraphs in the heart of the editorial are a tour de force:

Businesses will raise wages to a point where the cost is just balanced by the reduced bill for recruiting and motivating workers. At that point, a further increase in wages does not appreciably change their total costs but higher wages certainly makes their workers better off. So there is a strong case for robust minimum wages.

Never mind centuries of supply and demand, centuries of experience with minimum wages and other price controls, or even the current controversies. Never mind that who works for what business and how many do so is a little bit endogenous. Larry has a new and very clever theory about monopsonistic wage setting in the presence of recruitment and motivation costs.  (One that apparently only holds at the lower end of the wage scale where minimum wages bite?)

Greece and Banking

Source: Wall Street Journal; Getty Images

A Wall Street Journal Oped with Andy Atkeson, summarizing many points already made on this blog.

Greece suffered a run on its banks, closing them on June 29. Payments froze and the economy was paralyzed. Greek banks reopened on July 20 with the help of the European Central Bank. But many restrictions, including those on cash withdrawals and international money transfers, remain. The crash in the Greek stock market when it reopened Aug. 3 reminds us that Greece’s economy and financial system are still in awful shape. 

Greece’s banking crisis revealed the main structural problem of the eurozone: A currency union must isolate banks from sovereign debt. To fix this central structural problem, Europe must open its nation-based banking system, recognize that sovereign debt is risky and stop letting countries use national banks to fund national deficits.

If Detroit, Puerto Rico or even Illinois defaults on its debts, there is no run on the banks. Why? Because nobody dreams that defaulting U.S. states or cities must secede from the dollar zone and invent a new currency. Also, U.S. state and city governments cannot force state or local banks to lend them money, and cannot grab or redenominate deposits. Americans can easily put money in federally chartered, nationally diversified banks that are immune from state and local government defaults.

Depositors in the eurozone don’t share this privilege....

For the rest, you have to go to WSJ, Hoover (ungated) or wait 30 days until I'm allowed to post it here.

Lucrezia Reichlin and Luis Garicano have an excellent Project Syndicate piece on the same topic.

Writing contest: This is our first paragraph. The Journal's editors thought it was better with latest news first. Which works better?