Wednesday, July 24, 2019

Notes from a nameless conference

Martin Gurri at the fifth wave writes a very intresting "notes from a nameless conference." (HT Marginal Revolution). A few choice quotes, but do read the whole thing.
..In their hundreds if not thousands, I was swarmed by people of good will who were also smart, articulate, and hyper-educated.  They craved, sincerely, to help the disadvantaged and save the earth.  The words “science” and “reason” were perpetually on their lips, as if they held the copyright for these terms – which, in a sense, they did.  And if they were a bit defensive, a tad obtuse, their intentions were the purest I could imagine. 
So why, by their own admission, do they no longer inspire trust? 
I have met their kindred before, in other glittering places.  They run the institutions that hold center stage in our society, but look on the world as if from a walled mountain fortress, where every loud noise from beyond is interpreted as risk and threat.  They disagree about minutia, but mostly move in lockstep, like synchronized swimmers, with word and thought.  They are earnest but extraordinarily narrow.  In a typical complaint, one speaker blamed the public for hiding in an “information bubble” – yet it occurred to me, as I sat through the conference, that the bubble-dwellers controlled the microphones there. 
The same unmodulated whine about present conditions circled around and around, without even the ambition to achieve wit, depth, or originality: 
The internet is the enemy:  of rationality, of democracy, of truth.  It must be regulated by enlightened minds. 
The public resembles an eight-year-old who is always fooled by tricks and lies.  For its own protection, it must be constrained by a Guardian class. 
Populism is the spawn of lies.  Even if it wins elections, it is never legitimate, and must be swept away by a higher authority. 
Climate change is a scientific mandate for torturous economic and political experiments, implemented by experts.  To deny this is worse than error – it’s a crime against humanity. 
Hate speech, offensive words, fake news, deep fakes, privacy violations, information bubbles, bitcoin, Facebook, Silicon Valley, Vladimir Putin, Donald Trump, Brexit:  all must be controlled, criminalized, exploded, broken up, exposed, deposed, or repeated until the right answer is obtained. 
None of this was up for discussion.  None of it was uttered with the least semblance of self-awareness.  In the same breath, a speaker called for the regulation of the web and the education of children in “tolerance.”  If I had pointed out the contradiction, the speaker, I’m certain, would have denied it.  Tolerance, for her, meant the obliteration of opinions she disliked.
In fact, each narrative loop I listed above ends with the elites happily in charge, and the obliteration of the wretched present.  If we wish to understand why trust evaporated in the first place, consider the moral and political assumptions behind this rhetorical posture
Martin does not really strike home the central contradiction here. Though "threat to democracy" is also a constant mantra, this movement is in fact profoundly anti-democratic. Us the self appointed aristocracy, must run things in the interest of the little people -- and we must change the rules of the game so the benighted little people never vote wrong and replace us.

Every era’s monetary and financial institutions are unimaginable until they’re real

Every era’s monetary and financial institutions are unimaginable until they’re real, writes Tyler Cowen in an excellent essay on the anniversary of Bretton Woods. (MR link)

Our ancestors' experience with paper money leading quickly to massive inflation would leave them agape at our completely unbacked fiat money and floating exchange rates which has led only to mild inflation. forward [from the gold standard] to the current day. Currencies are fiat, the ties to gold are gone, and most exchange rates for the major currencies are freely floating, with periodic central bank intervention to manipulate exchange rates. For all the criticism it receives, this arrangement has also proved to be a viable global monetary order, and it has been accompanied by an excellent overall record for global growth. 
Yet this fiat monetary order might also have seemed, to previous generations of economists, unlikely to succeed. Fiat currencies were associated with the assignat hyperinflations of the French Revolution, the floating exchange rates and competitive devaluations of the 1920s were not a success, and it was hardly obvious that most of the world’s major central banks would pursue inflation targets of below 2%. Until recent times, the record of floating fiat currencies was mostly disastrous.
As Tyler points out, even 20 years ago the standard opinion was that the euro would not work.
Another surprising monetary innovation would be the euro. Both Milton Friedman and Paul Krugman warned that the euro was unlikely to succeed and persist. Yet it has proven more durable than many people expected, and there does not seem to be an end in sight. This kind of a common fiat currency, spread across so many nations, is without precedent in world history.
(I quibble with that one: Gold coins were an international currency, and throughout history coins have been shared among countries. Our own "dollar" comes from the common colonial use of a Spanish coin.)

The sovereign default issue remains, but that less-than-desired  inflation remains the euros' problem would have been a big surprise. That countries like Greece and Italy would, so far, choose the hard path of staying on the euro rather than take the sugar high of another devaluation is indeed a political if not an economic surprise.

Bretton Woods' system, including fixed exchange rates, the IMF, a dollar sort of pegged to gold but you can't have gold, dollar reserves, and extensive capital controls is as archaic to us as it was radical to pre WWII thinking.

Tyler only hints at the main message:
 Looking forward, don’t assume the status quo will hold forever, but rather prepare to be shocked....
So as you consider the legacy of Bretton Woods this week, remember that core lesson: There will be major changes in monetary and institutional arrangements that no one can even imagine right now. Assume the permanency of the status quo at your peril.
My main point is to underline that hint.

We forget how recent our own monetary certainties are,. Well into the 1970s, mainstream Keynesian economists thought that inflation came from "wage price spirals" and administered prices, and that central banks were pretty irrelevant. Milton Friedman was a radical upstart. He won, dramatically, on the importance of central banks. Yet too his focus on money growth rates died out with the 1980s. The current consensus view that central banks have the power to control inflation, and the power, ability, and duty to stabilize the economy, all by setting short term rates, is an idea that only took shape in the late 1980s and 1990s.

And that is falling to pieces all around us. That no "deflation spiral" breaks out at the zero bound undermines that view entirely. The death of the Phillips curve, the antithesis of the 1970s -- strong output and employment with puzzlingly low inflation -- the endless inflation below central bank targets, all stand witness. (And be careful what you wish for! Strong growth with low inflation is pretty darn nice!)

Intellectually, we grope to maintain the illusion of an all-powerful central bank, whose asset purchases and Delphic pronouncements about its future actions powerfully steer the economy. But the feeling that perhaps Friedman won too much, and that central banks are not nearly as powerful as they seem (other the power to screw things up, which they retain!)  is getting stronger and stronger.

The only thing that is sure is that our current doctrines will look as archaic 20 years from now as Bretton Woods, and the 1950s-60s Keynesian consensus, do today. That humility -- and the hard and and critical thinking it ought to provoke -- are indeed great lessons of this anniversary.

Every era’s monetary and financial institutions are unimaginable until they’re real. And so will be the next era's institutions.

Monday, July 22, 2019

Everything is f***d

The most hilarious course syllabus I've seen in a while, from Professor Sanjay Srivastava at the University of Oregon.



The point is serious,  going well beyond the replication problem. Meta-analyses just repeat the same mistakes a hundred times.

"Office hours: Held on Twitter at your convenience." I love it.

Saturday, July 20, 2019

New Papers

I've been remiss about blogging lately while I finished two new papers, "The Fiscal Roots of Inflation," and "The Value of Government Debt." I'm posting here for those who might  be interested, and I appreciate  comments.

Both papers apply asset pricing variance decompositions to questions of government finance and inflation. The inflation paper is  part of the long-running fiscal theory of the price level project. (Note: this post uses MathJax which may not show properly on all devices.)

I start by deriving an analogue to the Campbell-Shiller linearization of the return identity:
\[ \beta v_{t+1}=v_{t}+r_{t+1}^{n}-\pi_{t+1}-g_{t+1}-s_{t+1}. \] The log debt to GDP ratio at the end of period \(t+1\), \(v_{t+1}\), is equal to its value at the end of period t, \(v_{t}\), increased by the log nominal return on the portfolio of government bonds \(r_{t+1}^{n}\) less inflation \(\pi_{t+1}\), less log GDP growth \(g_{t+1}\), and less the primary surplus \(s_{t+1}\). The "surplus" in this linearization is the surplus to GDP ratio, divided by the steady state debt to GDP ratio. It's not a log, so it can be negative. \(\beta = e^{-(r-g)}\) is a discount rate corresponding to the steady state real rate \(r\) less GDP growth rate \(g\).

Iterating forward, the present value identity is \begin{equation} v_{t}=\sum_{j=1}^{\infty}\beta^{j-1}\left[ s_{t+j}-\left( r_{t+j}^{n}-\pi_{t+j}+g_{t+j}\right) \right] .\label{pvsy}% \end{equation} I simplify by using \(\beta=1\) as the point of linearization. 1 vs. 0.99 doesn't make any significant difference for empirical purposes.

Now apply standard asset pricing ideas. To focus on inflation, in "Fiscal Roots" I take the time \(t+1\) innovation of the present value identity, \(\Delta E_{t+1}\equiv E_{t+1}-E_{t}\). Rearranging, we have the unexpected inflation identity, \begin{align} & \Delta E_{t+1}\pi_{t+1}-\Delta E_{t+1}\left( r_{t+1}^{n}-g_{t+1}\right) \label{Epiintro}\\ & =-\sum_{j=0}^{\infty}\Delta E_{t+1}s_{t+1+j}+\sum_{j=1}^{\infty}\Delta E_{t+1}\left( r_{t+1+j}^{n}-\pi_{t+1+j}-g_{t+1+j}\right) .\nonumber \end{align} A decline in the present value of surpluses, coming either from a change in expected surpluses or a rise in their discount rates, must result in a lower real value of the debt. This reduction can come about by unexpected inflation, or by a decline in nominal long-term bond prices. The value of debt drops out, which is handy and simplifies matters.

Thursday, July 18, 2019

All that glitters is not gold

I wrote a Wall Street  Journal Oped on the gold standard, partly in response to last week's Oped by James Grant (whose "PhD standard" is a great quip) and Greg Yp's excellent column on Judy Shelton and gold.

Pegging the dollar to gold won't  stop inflation or deflation.  Inflation was already quite volatile in the 19th  century, and it would be worse today:
What determines the value of gold relative to all goods and services? In the 19th century, gold coins were used for many transactions. People and businesses had to keep an inventory of gold coins in proportion to their expenditures. If the value of gold rose relative to everything else (deflation), people gained an incentive to spend them, and thereby drive up the prices of everything else. If the value of gold fell (inflation), people needed more of it, so they spent less and drove down other prices. This crucial mechanism linked the price of gold to all other prices. 
That link is now completely gone. Other than jewelry and some minor industrial uses, there is nothing special about gold, and little linking the price of gold to all other prices. If the Fed pegged the price of gold today, the price of everything else would just wander away. The Fed might just as effectively peg the price of chewing gum. A monetary anchor is a good thing, but the anchor must be tied to the ship. Gold no longer is. 
Broader commodity standards face the same problem. Traded commodities are such a small part of the economy that the relative price of commodities can swing widely with little effect on inflation.
In particular, if the value of gold goes up, you have deflation, which many people are  worried about today. The gold standard did nothing to stop the sharp  deflation  of the 1930s.

Gold is not really a monetary promise, it's a fiscal promise:
If people demanded more gold from the government than it had in reserve, the government had to raise taxes or cut spending to buy more gold. More often, the government would borrow to get gold, but governments must credibly promise to raise taxes or cut spending to borrow. This fiscal commitment ultimately gave money its value, not the sometimes-empty promise to exchange money for gold. Taxes ultimately back all government money. The gold standard made this fiscal commitment visible and testable. 
It is possible, though, to answer gold standard advocates critiques of current affairs without a return to gold
..the U.S. could enact a policy today that emulates the good features of the gold standard. I call it the CPI standard. First, Congress and the Fed would agree that “price stability” in the Fed’s mandate means precisely that, not perpetual 2% inflation. The Fed’s mandate would be to keep the consumer-price index (or a suitably improved index) as close as possible to a stated value. 
Second, the CPI target would bind fiscal policy (Congress and the Treasury) as well as monetary policy (the Fed). Inflation would require automatic fiscal tightening and deflation would trigger loosening, just as a gold-standard government trying to defend its currency must tighten fiscally to raise its gold reserves. 
Third, the government would emulate the promise to trade gold for notes in modern financial markets. There are many ways to do this, but the simplest is to commit to trade regular debt for inflation-indexed debt at the same price. Under this system, inflation would cost the government money and force a fiscal tightening in the same way gold once did. And vice versa—the system would forestall deflation as well. 
 I conclude
Gold-standard advocates offer a cogent critique of current monetary policy, but a return to gold is unfeasible. A stable CPI, immune from both inflation and deflation, backed by the same fiscal commitments that underlay gold, is worth taking seriously.
As usual, I have to wait 30 days to post the whole thing.