Sanders multiplier magic

The critiques of Gerald Friedman's analysis of the Sanders economic plan  continue. The latest and most detailed and careful so far is by David and Christina Romer.

Bottom line:

1. The central idea in Friedman's analysis is that taking $1 from Peter to give to Paul raises overall income by 55 cents.  From this, you get multipliers from raising taxes and spending, from higher minimum wages, more unions, and so forth. 
2. I chuckle a little bit that so many economists who previously liked multipliers now don't like their logical conclusions. 
3. The Romers charge a serious, elementary arithmetic mistake in treating levels vs. growth rates. If they're right Friedman's whole analysis is just wrong on arithmetic.

The analysis

One might have expected that a sympathetic analysis of the Sanders plan would say, look, this is going to cost us a bit of growth, but the fairness and (claimed) better treatment of disadvantaged people are worth it.

Friedman's having none of that. In his analysis, the Sanders plan will also unleash a burst of growth, claims for which would make a fervent supply-sider like Art Laffer blush.

"The Sanders program... will raise the gross domestic product by 37% and per capita income by 33% in 2026; the growth rate of per capita GDP will increase from 1.7% a year to 4.5% a year." And, apparently, raise the growth rate permanently.

Negative rates and FTPL

I've devoted most of my monetary economics research agenda to the Fiscal Theory of the Price Level in the last two decades (collection here). This theory says, fundamentally, that money has value because the government accepts it for taxes, and inflation is fundamentally a fiscal phenomenon over which central banks' conventional tools -- open market operations trading money for government bonds -- have limited power.

Since I grew up in the 1970s, I figured the FTPL would have its day when inflation unexpectedly broke out, again, and central banks were powerless to stop it. I figured that the spread of interest-paying electronic money would so clearly undermine the foundations of MV=PY that its pleasant stories would be quickly abandoned as no longer relevant.

I may have been  exactly wrong on both points: It seems that uncontrolled disinflation or deflation will be the spark for adoption of FTPL ideas; that the equivalence of money and bonds at zero interest rates,  and central banks powerless to create inflation will be the trigger.

These thoughts are prodded by two pieces in the Economist, "Out of Ammo:" and "Unfamiliar Ways Forward" (HT and interesting discussion by Miles Kimball)

If you want inflation (a big if -- I don't, but let's go with the if) how do you get it? Ultra-low rates, huge bond purchases, and lots of talk (forward guidance, higher inflation targets) seem to have no effect. What can governments actually do?

Greece and Taxes

An interview for the Greek Reporter, in English, perhaps cheering the like-minded and sure to infuriate some conventional wisdom.

I agree with the "anti-austerians" on one point: Raising taxes was a bad idea. In my emphasis what counts are marginal tax rates on growth-producing activities, rather than Keynesian pump-priming, however, which is an important distinction.

The article says "A recently released study by the Economics Department at the National Kapodistrian University of Athens revealed that Greece has the third highest taxation rate among 21 European countries." If anyone has a link, especially if it's in English, send it in the comments.

Right Wing NPR

I was listening to NPR this morning over coffee, and nearly spilled it. Host Steve Inskeep was interviewing Mark Surman, Mozilla founder, on the topic of Apple refusing to hand over the keys to the Iphone to the Federal Government (and anyone who might be able to hack the Federal Government. Oh, right, that's never happened!)

INSKEEP: One last thing, coming back to this San Bernardino case, we don't know what's in that iPhone. We don't even know if it's important. But let's spin out the worst case scenario as a prosecutor might. Suppose your side wins, that phone is never opened, and as a result, the government misses a chance to find some other suspect and disrupt some attack. The attack goes forward, and people are killed. Will that have been worth it in order to protect encryption?

Surman, probably flabbergasted that anyone should ask such a question, changed the subject

SURMAN: We need to find ways to really be able to seek communications before they're sent or after they're sent and actually work with law enforcement on doing this well. There are alternative ways to get information, getting access to it before or after it's encrypted. What we want to avoid is creating a precedent where encryption can be broken by an arbitrary third party.

But Inskeep kept at it

INSKEEP: So you're saying, in essence, it may well be harder to catch terrorists, but you can still work at it, and the extra difficulty is worth it.

Remember, this is cloyingly liberal NPR, not some foaming at the mouth right wing program!

Like Surman, I often am too polite to give the right answer to such shocking questions in real time. But with the benefit of hindsight, here's a better answer

COCHRANE: Well, come to think of it, you're right there Steve. And while you're at it, let's keep going. These pesky first and fourth amendments sure get in the way of law enforcement, don't they? I mean all this business about going out and getting warrants, and waiting for a judge is so time consuming. If a terrorist gets away while you're busy getting a warrant, and people are killed, will that really have been worth it to protect some sort of centuries old procedures? If someone stirs up trouble on a Jihadi website, why do we have to allow that? And this annoying business about grand juries, and presenting evidence, and discovery, and Miranda warnings, it's so burdensome. What if some terrorist gets away and kills someone?  The police surely should be allowed to just throw anyone suspicious in jail, to make sure they don't do anything bad. Heck, while you're at it, what's with these prohibitions against torture? Bring back the rack, or start chopping people's fingers off until they talk. If you hold back, and some terrorist kills someone, was your little sense of ethics really worth it?  

There is a reason we have all these protections. There is a reason we need to defend them even in times of turmoil.

Perhaps a President Hillary Clinton will bring a sympathetic ear to the right to digital privacy. She undoubtedly wishes her email had been bullet-proof encrypted, not just from the FBI and NSA, but from the Chinese and Russian hackers likely reading every line.

Update: I realize from some of the comments that the point may not have been clear. This isn't about the Apple decision. It's moot, really, anyway, as even Apple can't open the new Iphones. And one can make cost/benefit arguments either way. My point was about the argument: We will hear quite often in coming years and decades, the argument that even one terrorist caught is worth sacrificing privacy and civil liberty. Be prepared to answer, to point out there are costs as well as benefits, and to list what they are. And, finally, I sound more critical of Inskeep than I should. In fairness, he does not offer an opinion. He asks a question, one commonly asked, and may well have been floating a t-ball in the hope Surman would smash it out of the park as I attempted to do.  Many people will ask that question. It's worth asking, over and over, and rehearsing the answer.

Kashkari on TBTF

Neel Kashkari, the new president of the Minneapolis Fed, is making a splash with a speech about too big to fail, and the need for a deeper and more fundamental reform than Dodd Frank.  I am delighted to hear a Federal Reserve official offering, in public, some of the kinds of thoughts that I and like-minded radicals have been offering for the last few years.

I believe the biggest banks are still too big to fail and continue to pose a significant, ongoing risk to our economy.

Now is the right time for Congress to consider going further than Dodd-Frank with bold, transformational solutions to solve this problem once and for all.

From an economic point of view, now is indeed the right time -- calm before the storm. I'm not so sure now is a great time from a political view! But perhaps anti-Wall Street feelings from both parties can be harnessed to good use.

...When the technology bubble burst in 2000, it was very painful for Silicon Valley and for technology investors, but it did not represent a systemic risk to our economy. Large banks must similarly be able to make mistakes—even very big mistakes—without requiring taxpayer bailouts and without triggering widespread economic damage.

This is a key lesson. As Dodd-Frank spreads to insurance companies, equity mutual funds, and asset managers, we're losing sight of the idea that trying to stop anyone from ever losing money again is not a wise way to prevent a panic. It's the nature of bank liabilities, not their assets, that is the problem.

I learned in the crisis that determining which firms are systemically important—which are TBTF—depends on economic and financial conditions. In a strong, stable economy, the failure of a given bank might not be systemic. The economy and financial firms and markets might be able to withstand a shock from such a failure without much harm to other institutions or to families and businesses. But in a weak economy with skittish markets, policymakers will be very worried about such a bank failure.

In other words, the whole idea of designating an institution that is per se "systemic" is silly.

...there is no simple formula that defines what is systemic. I wish there were. It requires judgment from policymakers to assess conditions at the time.

Here I think Kashkari isn't really learning the lesson. If it's undefinable, even in words, and needs "judgment," then perhaps the idea really is empty.

More deeply, I think we need to apply much the same thinking to regulation that we do to monetary policy. At least in principle, most analysts think some sort of rule is a good idea for monetary policy. Pure discretion leads to volatility, moral hazard, time-inconsistency and so on. We should start talking about good rules for financial crisis management, not just ever greater power and discretion to follow whatever the "judgment" (whim?) of the moment says.

A second lesson for me from the 2008 crisis is that almost by definition, we won’t see the next crisis coming, and it won’t look like what we might be expecting. If we, or markets, recognized an imbalance in the economy, market participants would likely take action to protect themselves. When I first went to Treasury in 2006, Treasury Secretary Henry Paulson directed his staff to work with financial regulators at the Federal Reserve and the Securities and Exchange Commission to look for what might trigger the next crisis... We looked at a number of scenarios, including an individual large bank running into trouble or a hedge fund suffering large losses, among others. We didn’t consider a nationwide housing downturn. It seems so obvious now, but we didn’t see it, and we were looking. We must assume that policymakers will not foresee future crises, either.

This is an unusual and worthy expression of humility. Others advocate loading up the Fed with "macroprudential" regulation and "bubble pricking" tools, on the faith that this time, yes this time, they really will see it coming, and really will do something about it.  Regulators are not wiser, smarter, less behavioral, etc. than traders.

Speaking of the "resolution authority,"

Unfortunately, I am far more skeptical that these tools will be useful to policymakers in the second scenario of a stressed economic environment. Given the massive externalities on Main Street of large bank failures in terms of lost jobs, lost income and lost wealth, no rational policymaker would risk restructuring large firms and forcing losses on creditors and counterparties using the new tools in a risky environment, let alone in a crisis environment like we experienced in 2008. They will be forced to bail out failing institutions—as we were. We were even forced to support large bank mergers, which helped stabilize the immediate crisis, but that we knew would make TBTF worse in the long term.

There are no atheists in foxholes, the saying goes.  Notice "forcing losses on creditors and counterparties." This is exactly right. "Bailouts" are not about saving the institution, they are about saving its creditors. We should always call them "creditor bailouts." And a run is in full swing, and when the hotlines to the Treasury are buzzing "if we lose money on this, then the world will end," anyone in charge will guarantee the debts.

I believe we must begin this work now and give serious consideration to a range of options, including the following:

• Breaking up large banks into smaller, less connected, less important entities.

Here, Kashkari caused a stir in the press. Bernie Sanders voiced approval. Since "breaking up" has no subject -- who is to do this and how? -- and no mechanism, I'll give Kashkari the benefit of the doubt that he had something more sophisticated in mind than brute force.

• Turning large banks into public utilities by forcing them to hold so much capital that they virtually can’t fail (with regulation akin to that of a nuclear power plant).

Aha! My favorite simple solution, more capital!  I'm delighted to hear it. Of course (to whine a bit), banks don't "hold" capital, they "issue" capital -- it's a liability not an asset. And if they have so much capital that they virtually can't fail, what is this business about public utilities? And why in the world do they need regulation akin to that of a nuclear power plant? Given how regulation has spiraled costs, stultified innovation, and stopped expansion of the one scalable carbon-free energy source we have, that's a particularly unfortunate analogy. Or maybe it's an incredibly accurate analogy for just where Dodd-Frank style regulation will lead. The point is the opposite: with "so much capital that they virtually can't fail" they don't need the hopeless project of "systemic" designation, intensive asset risk regulation, and so forth.

• Taxing leverage throughout the financial system to reduce systemic risks wherever they lie.

A Pigouvian tax on short term debt -- after we get rid of all the subsidies for it -- is my other favorite answer.

The financial sector has lobbied hard to preserve its current structure and thrown up endless objections to fundamental change.

Many of the arguments against adoption of a more transformational solution to the problem of TBTF are that the societal benefits of such financial giants somehow justify the exposure to another financial crisis. I find such arguments unpersuasive.

This needs some explanation. Banks produce studies claiming that higher capital requirements or reduced amounts of run-prone short-term funding will cause them to charge more for loans and reduce economic growth. Kashkari is pointing out that these arguments are pretty thin, because the cost of not doing it is immense -- 10 percent or so of GDP lost for nearly a decade and counting is plausible.

Obviously, I don't agree with everything in the speech. Kashkari is a bit too vague about "contagion" "linkages" and so fort for my taste. But the good news is to have this conversation, and not settle in to implementing page 35,427 of Dodd Frank regulations, head in the sand, while we wait for the next crisis.

The rest of the speech outlines his plans to get the Minneapolis Fed working hard on these issues, and to push for them at the larger Fed. This is a project worth watching.

In case I haven't plugged it about 10 times, my agenda for these issues is in Toward a Run-Free Financial System and the many blog posts under the "banking" "financial reform" and "regulation" labels.

Sad CEA Letter

And just as I was getting all weepy about how great and a-political, obejective, non-partisan and all that the CEA is, along comes an open letter from past CEA chairs Alan Krueger, Austan Goolsbee, Chirstina Romer, and Laura D'Andrea Tyson to Senator Sanders, to restore my cynicism.

The heart of the letter is worthy, and commendable: to call out the fact that Senator Sander's campaign is making promises that don't add up, beyond even the usual stretches of campaign rhetoric from both sides.

But read

 When Republicans have proposed large tax cuts for the wealthy..

Hmm. I wonder if Republicans would characterize their proposals that way? How many speeches have you heard saying "we want  large tax cuts for the wealthy!" No, they say they want tax reform to reduce distorting marginal rates and rampant cronyism.

Really, dear colleagues and friends, how would you respond if Republican CEA chairs were to write a similar letter addressing the shortcomings of Trump's plan that started,

When Democrats have proposed incentive-killing growth-killing marginal tax rate increases with lots of exemptions for their donors... 

and goes on to trumpet their sober-minded analysis of the plans, would you be inspired to plaud their "reputation" for objective evidence-based analysis?

So this is just a poke in the eye, a repetition of partisan Democratic campaign rhetoric, stirring up the base by bulverizing the other party.

Why is Washington so polarized? Because even once-respectable academic economists, transported to Washington, cannot stop themselves from this sort of schoolyard taunting, tribalistic attacks, and repetition of their bosses' propaganda.

CEA History

The Council of Economic Advisers has released a history of the CEA on its' 70th anniversary, as  Chapter 7 of the  Economic Report of the President. This piece is very interesting for economists interested in policy.

It's a nice reminder on how much economic policy ideas have changed. In the late 1940s, when the CEA was set up, fiscal policy was everything. Solow's growth model had not been invented, let alone Romer's. Monetary policy was a twinkle in Milton Friedman's eye. Adam Smith had more or less been forgotten. Economic policy was widely thought to consist of just setting the right level of fiscal stimulus, let multipliers work their magic, to achieve "full employment" and economic growth. The piece tracks well the rediscovery of microeconomics and regulation, as well as the shifts in macroeconomic thinking.

It reminds us how much the stage has changed. In the early years there were really no economists working elsewhere in government, and there were no think tanks. Now every agency has a chief economist and a staff, and the CEA isn't (!) the only game in town for producing policy-oriented research. Its role has changed as a consequence.

The CEA has long had many roles,  adviser, calculator of numbers, cheerleader for the Administration's policies, spinner for the Sunday talk shows, and interagency warrior.

One of its most important and least appreciated roles is just to stop silly stuff.

Brooks v. Krugman

I usually try to steer away from Presidential politics, and especially from commentators' habit of analyzing character. But last week's New York Times had two particularly interesting columns that invite breaking the rule: "I Miss Barack Obama" by David Brooks and "How America Was Lost" by Paul Krugman.

As we contemplate a Clinton, Sanders, Trump, or Cruz presidency, we may well continue the pattern that each president's main accomplishment is to burnish nostalgia for his (so far) predecessor. Brooks is feeling that.

And he's right. Say what you will about policy, the Obama Administration has, as Brooks points out,  been staffed by people of basic personal integrity and remarkably scandal-free. (In the conventional sense of "scandal." I'm sure some commenters will contend that the bailouts, Lois Lerner, the EPA, and Dodd-Frank and Obamacare are "scandals," but that's not what we're talking about here.) On economic issues, his main advisers have been thoughtful, credentialed, mainstream Democrats. Obama's speeches on many topics have, as David says, been full of "basic humanity," even if one disagrees with his solutions.

The Libertarian Case for Bernie Sanders

The Libertarian Case for Bernie Sanders, from Will Wilkinson at the Niskanen Center. Yes, Denmark scores much above the US on ease of doing business indices. An interesting case. A welfare state is not necessarily a politicized regulatory state, with strong two-way political-industry capture. The latter may be more dangerous economically.  Those who wish to eat golden eggs have an incentive to let the Goose grow fat.

Update: Megan McArdle brilliantly demolishes the case.  "It's fun, but not convincing." My view as well.

Policy Rules Legislation

Allan Meltzer and John Taylor organized a Statement on Policy Rules Legislation signed by quite a few famous economists. John's blog explains in some detail.

Stating a rule or "strategy" about what things the Fed will react to also will help the Fed to pre-commit to things it will not react to. If the Fed says they react to inflation and unemployment, that means you should not expect it to react to stock prices, oil prices, exchange rates, and so forth.

Ms. Yellen's testimony and monetary policy report happen Feb 10 and 11. It will be interesting to hear the discussion of these issues. I hope that discussion includes not just legislation, but whether the Fed should follow something like this strategy communication on its own, in order to limit pressures for the Fed to do unwise things.