Lessons of the ELB

I gave a short presentation on monetary policy at the Nobel Symposium run by the Swedish House of Finance. It was an amazing conference, and I'll post a blog review as soon as they get the slides up of the other talks. Offered 15 minutes to summarize what I know about the zero bound, as well as to comment on presentations by Mike Woodford and Stephanie Schmitt-Grohé, here is what I had to say. There is a pdf version here and slides here. Novelty disclaimer: Obviously, this involves a lot of recycling and digesting older material. But simplifying and digesting is a lot of what we do.

Update: video of the presentation here. Or hopefully the following embed works:

Lessons of the long quiet ELB
(effective lower bound) 

We just observed a dramatic monetary experiment. In the US, the short-term interest rate rate was stuck at zero for 8 years. Reserves rose from 10 billion to 3,000 billion. Yet inflation behaved in this recession and expansion almost exactly as it did in the previous one. The 10 year bond rate continued its gentle downward trend unperturbed by QE or much of anything else.

Europe's bound is ongoing with the same result.

Jitters

Or, "the beginning of the end, or the end of the beginning?" Or, "from demand to supply?"

An Op-Ed for The Hill with some extras:


The economic expansion and stock market runup have been going on for a decade, and a case of the jitters seems to be spreading. How long can this go on? Is the end around the corner?

After years of quiet, the stock market suddenly became volatile again last March. Volatility is a sign of uncertainty, and often presages a decline. Stock prices are high relative to earnings and dividends, which often precedes a fall. Short term interest rates have risen, and long term rates and short term rates are nearly the same. An inverted yield curve, when short term rates are higher than long term rates, is one of the most reliable warning signs of a recession. The unemployment rate is down to 3.9%, a level that historically has only happened at business cycle peaks — that were soon followed by troughs. House prices and credit are up too, as they were at recent peaks. Is it time to worry?

Alexander Hamilton's solar panels

I think I finally have figured out why California is mandating solar panels on top of houses. (WSJ story here.)

As energy, environmental, or housing policy, it borders on the absurd, as pretty much everyone quickly figured out.

Just to recap, remember that most rooftop solar does not power the house underneath it. The energy goes out to the grid. Why not, you ask? Well, the rooftop energy comes at the wrong time, and we don't yet have economical storage, so you have to be connected to the grid anyway. Given that, the costs of switches to let the roof partially power the house at sometimes, power the grid at other times, is not worth the zero benefit. After all, electricity is electricity and your light bulb does not care where it came from.

So rooftops are just a place to put the electric utility's solar panels. Now let's consider, where is the best place to put solar panels that feed the grid?

Option A:

(OK, in reality the Mojave desert, or the vast stretches of wasteland along I-5 pockmarked with angry farmer billboards, but the camels are cute.)

Option B: The roof of a typical northern California house:

http://www.redwoodhikes.com/Dewitt/Dewitt.html

(OK, I'm having fun with this one, but you get the point. Actually a house off the grid is one place where rooftop solar does make a lot of sense, but you don't have to force people to buy them in that case.)

To belabor the point, people like to build houses near trees. Trees shading roofs are heavily protected in Palo Alto where I live, and you risk massive fines if you cut one down. House roofs don't always pitch to the southwest at the optimum angle.

A house is an expensive and flammable structure for a solar panel. You need to be a lot more careful putting it up there than out in the desert. In California especially, each installation needs a separate design, design review, permits, and so on. Code requirements are stringent. Each installation needs big switches, where the fire department can get at them (and a separate one for the battery). Each house needs a separate set of switches to connect to the grid. All of these fixed costs are spread way out on a commercial solar farm out in the desert.

And so on. We don't operate tiny coal burning generators in each house for the same good reasons.

So why is California doing it? Grumpy free marketers tend to bemoan nitwit liberalism, but economics teaches us to look for rational maximizing actors even in government.

So here is a suggestion. It's actually a brilliant move. Large-scale rooftop solar is only sustained by subsidies -- tax credits for installation and the requirement that homeowners can sell power to their fellow citizens (through the utility) at above-market rates. To put the matter mildly, not everybody thinks these subsidies are a good idea, and moreover you can't count on Washington to maintain subsidies for the 30 year lifespan of solar panels. You never know, someone like, say, Donald Trump might get elected president and start tearing apart energy subsidies.

So, once solar panels are on the rooftops of thousands of registered voters, you have a natural constituency that will vote and otherwise pressure the state, the administration, congress, and agencies to continue solar subsidies. 

The Alexander Hamilton story is that he wanted the US federal government to take on the state debts from the revolutionary war, in part to create a class of bondholders who would support the federal government's ability to raise taxes, to pay off that debt. Putting solar panels on houses, though ridiculously inefficient from an energy or environment point of view, achieves the same thing, in a nefarious sort of way.

Too bad they can't just give each of us a solar panel out in the desert, the way some charities show you "your" child in some third-world country. Once a year, you get a card "Happy holidays! I'm your solar panel, number 3457 in the Mojave desert. I've had a great year pumping out electricity! Here is your check for $357.52 in subsidies and power generation. Remember to vote on election day!"

Meditation on a trip to the DMV

I arrived at the DMV yesterday at 9 AM. My number came up at 5:45 -- you have to wait anxiously all day as you have 10 seconds to respond to your number. At 6:05, 10 hours after arrival. I was informed it was too late to take my written test so I would have to come back. As usual the place was packed, no food, no drink, two filthy restrooms.

(California has an appointment system but it takes two months to get an appointment, so if you need something now or can't book a free day two months ahead of time, you wait. 10 hours. Then you still get an appointment to return two weeks later as they won't get to you.)

Despite 13.2% top income tax rate, 7.5-9.5% sales tax, gas taxed to $3.80 a gallon, California cannot operate a functional DMV. Even Illinois, good old corrupt, bankrupt, Illinois, can operate a vaguely functional DMV. (Direct election of the secretary of state may have something to do with that.)

Estonia, this is not. Piles of paper flow around. Technology is about 1992 -- there is a number system, so you don't stand in line for 10 hours. But no indication where you are in the queue or when they might get to you.

Rebellion was in the air. Most people do not have my time flexibility. The very nice lady next to me had taken the day off work and had to arrange child care, which was going to end at a finite time. This was her second day of waiting. She was ready to start the revolution.

This is not unusual. It's just a completely normal day down at the DMV.

The joke has been around a long time: Do you really want the people who run the DMV to operate your health care and insurance system? But it is a good joke. The DMV is the main interface most people have  with the functioning or lack thereof of a bureaucracy.

The irony is that the democratic candidates in California are falling all over themselves to be stronger on "single-payer" health -- which does not just mean one fallback, but that all others are banned.

The amazing thing is that citizens of this noble state are all for it, though they must, like me, each take their turn in the 10 hour line at the DMV. (I suspect many high income progressives do not realize that "single payer" means them too. No concierge medicine.)

Republicans: I suggest you set up tables outside the DMV. After all, there is motor voter registration and this might get people in a good frame of mind for your message.

Second thought: Things could be worse. The DMV is  good proxy for the quality of government institutions. In many countries in the world you must pay a bribe to get a driver's license. In many other countries you can pay a bribe to cut through swaths of paperwork. At least in the US you can't do that.

But there are countries where government actually works. When our friends on the left dream of Scandinavian health care, perhaps they should visit a Scandinavian DMV first, and agree that let's see if our government can run a DMV before it tackles health care. And don't go after me with taxes -- the cost of a functional DMV is not that high. This one just needs to expand to match the growth in its population and the complexity of the various laws it has passed.

Update:

There is a special DMV office for legislators only, reports the Sacramento Bee.  In the meantime, the first appointment at Redwood City is 4 months out, the last time I looked.

Argentina update and IMF

From Alejandro Rodriguez, my correspondent from the last post

We are ***! People are withdrawing funds from fixed income mututal funds (which hold ARS 300 billion of CB short term debt). Yestedary alone people withdrew 4% from those funds and ran to the dollar today. Peso falls 5% to $24.00 ARS/USD. Next step is a ran against term deposits in banks. Next tuesday the CB has to roll over ARS 680 billion of short term debt. A conservative estimate is that ARS 150 billion will not be rolled over and will ran immediatelly to the dollar. No IMF bailout will stop the crisis but it will definitively help us in the aftermath.

PS: If you want to know what interest rates are now (like if anyone cares about them anmore)

maturity APR 5 days 81% 41 days 45%

PS2: CB trying to control the FX as I write email. Down to $23.00 ARS/USD.

Coincidentally, as Argentina started this spiral, I was at the Hoover conference on "Currencies, Capital, and Central Bank Balances," and thinking about it especially during the session on "Capital Flows, the IMF’s Institutional View and Alternatives" featuring Jonathan Ostry, who bravely came to defend the IMF's Institutional View, Sebastian Edwards, and John Taylor, moderated by George Shultz.

Briefly, in the good old days, the IMF was solidly for the Postwar Order that viewed capital restricitons -- laws stopping people from investing in a country or taking their investments out -- were bad things and to be avoided at all times.

That changed, and the new view, as summarized compactly by John Taylor, is much more friendly toward "capital flow management":

what is new about the Institutional View is that “capital flows require active policy management,” which includes “controlling their volume and composition directly using capital account restrictions.” (p. 8) The Institutional View document (IMF 2012) defines key terms and gives examples. For example,.. CFMs thus include “capital controls” that “discriminate on the basis of residency” and macro-prudential policies that differentiate on the basis of currency (p. 40). ..[The quotes and page numbers in the next two paragraphs are from Ghosh, Ostry, and Qureshi (2017).]

As Ostry explained, the new view also includes a stronger reliant on fiscal stimulus tools to counter domestic difficulties.

My obvious thought, is just how much would Argentina's problems be solved by more capital flow management, currency restrictions, investment restrictions, fiscal stimulus and so forth. And whether the IMF, if it rides to the rescue, will suggest more such dirigisme for its bailout money. The old IMF view -- commit to openness, fix your budget problems, and a somewhat jaundiced view of the ability of even well intentioned central bankers to execute masterstrokes of technocratic "management"  -- might have something to go for it still.

(It's worth remembering that capital cannot flow in aggregate. The only way capital can leave a country is on boats.  You can sell a factory to a local at a low price, and you can sell the foreign currency for dollars at a low price, but you cannot move a factory once built and someone else has to buy the foreign currency and give you dollars. Capital and trade accounts must balance. Capital cannot flow in the short run. Prices can change.

"Flow management" is one of those soothing NGO acronyms for what is in fact property seizure. You can tell I'm not favorably predisposed)

Groundhog day in Argentina

My friend and colleague Alejandro Rodriguez, director of the Department of Economics at CEMA in Buenos Aires, wrote me a few emails that Argentina seems to be blowing up again in very interesting and sad ways. I haven't seen any coverage in the US media.

Argentina is going through some fun times (for macroeconomists)... After a two day holiday markets opened yesterday and the peso kept falling (-3%) despite the rate hike (300bps) on friday and the continued drain of reserves. We are trapped with Bill Murray in Groundhog Day. Same thing today... markets open with pressure on the peso. The central bank sold 300 millon of reserves in less than 10 minutes early in the morning when liquidity is at its lowest and it couldn´t sopt the run. Soon after it announced another rate hike of 300bps. Short term debt that expires on may 16 has a yield of 38.7% APR and there are 680 billon pesos of it waiting to mature in less than two weeks. Still the market did not respond and the peso kept falling, more than 8% with respect to yesterday´s close....

Naturally my interest is particularly peaked by a country whose central bank seems powerless to stop inflation and devaluation in a time of fiscal stress. In fact, there are indications that raising interest rates, by making interest costs larger, make the fiscal problem worse and make devaluation worse, not better.

I asked Alejandro for a bit more to share with blog readers since we hear so little about this in the US. Here is his longer story backward:

Groundhog Day: ...Like Phil Connors (Bill Murray) we got trapped in Punxsutawney by the perfect storm. Last year Congress passed a law changing the tax code which included a new tax on Central Bank debt held by non residents. The new tax became effective on April 25th. The new tax initiated a sell off by non residents which was absorbed by the CB which sold USD 2.1 billon between April 23rd and 25th without the dollar moving one cent (20.25 ARS/USD). The new tax coincided with the increase of the 10 year US treasuries yield and the strengthening of the dollar. The CB thought this was an external shock and that no further actions were going to be needed.

DB warns of US debt crisis.

"A coming debt crisis in the US?" warns a Deutsche Bank report* by Quinn Brody and Torsten Slok.

Source: DB

This graph is gorgeous. US deficits have, historically, been driven overwhelmingly by the state of the business cycle, and have very little to do with tax policies and spending decisions that dominate press coverage. In booms, income rises, so tax rate times income rises. In busts, the opposite, plus "automatic stabilizer" spending kicks in.

Until now.

There is a good reason past deficits did not really spook markets. They understood the deficit was a temporary phenomenon, due to temporary poor demand-side economic performance. We do not have that excuse now.

In case you thought this was some alarmist crank sheet, the report starts by quoting the latest CBO
report:

the CBO argues that, assuming current policies and trends are not changed, “the likelihood of a fiscal crisis in the United States would increase. There would be a greater risk that investors would become unwilling to finance the government’s borrowing unless they were compensated with very high interest rates.” 

What's worse than tariffs?

Quotas.

This morning's Wall Street Journal "Trump postpones steel tariff decision.." starts optimistic

President Donald Trump eased trade pressure on top U.S. allies Monday, giving the European Union and some nations outside the bloc more time to negotiate deals that would exempt them from U.S. steel and aluminum tariffs..

But it turns out those "deals" are worse than the original

The Trump administration is backing broad restrictions on the trade of metals to limit the direct and indirect effects of Chinese steel and aluminum production on the U.S. market. “In all of these negotiations, the administration is focused on quotas that will restrain imports, prevent transshipment, and protect the national security,” the White House said in a statement. 

Quotas are worse than tariffs. With a tariff, you can at least measure and limit the damage. Imported steel pays a tax, and then costs 25% more.  But you can import as much of the stuff as you need, and the damage is limited to a 25% price rise.

(On that word. Free traders should insist on "import tax" rather than "tariff" to remind taxophobic Republicans just what they are doing.)

With a quota, by contrast, the price difference can get as big as it wants and so the damage can grow unbounded. Moreover, it's harder to see -- you have to look at exchange-rate adjusted price indices which people can ignore as one more government statistic. When you pay 25%, you see it.