Tuesday, June 30, 2020

Rethinking production under uncertainty

Even at my age, I get a little tingle when a paper is finally published. "Rethinking production under uncertainty" is now out at RAPS (free access for a while) and on my website.

The basic idea is simple.

Our standard way of writing production technologies under uncertainty tacks a shock on to an intertemporal technology.  We might write \[ y(s) = \varepsilon (s) f(k) \] where  \(k\) is capital invested at time 0, \(s\) indexes the state of nature (rain or shine) \(y(s)\) is output in state \(s\). That production technology does not allow producers to transform output across states at time 1. No matter high the contingent claim pricer for rain vs. shine, the producer can't make more in the rain state at the expense of making less in the shine state.

This is the production set of a farmer, say, with initial wheat that can be eaten providing \(y(0)\) or planted to give \( \{y(h), y(l)\} \) in states \( h, l\).

As a result, marginal rates of transformation are not defined, and you can't write a true production-based asset pricing model, based on marginal rate of transformation = contingent claim price ratio.

So, why don't we write down technologies that do allow producers to transform output across states as well as dates? Our farmer could plant wheat in a field that does better in rainy weather than shiny weather, for example. (You can feel an aggregation theory coming.)  The result is a smooth production technology,

Monday, June 29, 2020

Interview and Goodfellows

I did an interview on Covid-19 and economics last week with Carlos Carvalho who runs the Salem Center for Policy at the McCombs School of Business, UT Austin. Carlos is doing a series of these interviews. I objected that anything on this subject will be out of date in 5 minutes, but Carlos wants to look at broader issues, and also see how well the interviewee's prognostication bears out. We'll see about that. So far, I would score that I underestimated just how much Americans were itching to go to bars and party. (Really, fellow citizens, pub crawling? Are you out of your minds?)

Niall, H.R. and I also did a Goodfellows interview with Hoover's own Condoleezza Rice. This was a really interesting conversation on Russia, China, the place of the US in the world, and inevitably Condi's thoughtful views on race in the US.

All Goodfellows here  Podcast version:

Monday, June 15, 2020

The cancel culture twitter mob comes to economics

Last week we learned  the twitter mob has taken over economics too.

In case you aren't following, here is the short version of the story. Harald Uhlig, a distingushed macroeconomist at the University of Chicago,  sent out a few tweets questioning the wisdom of quickly "defunding the police." The twitter mob, led by Paul Krugman and Justin Wolfers, swiftly attacked. A petition circulated, reportedly gaining 500 signatories, demanding his removal as editor of the Journal of Political Economy.  I saw an astonishing number of tweets from economists that I formerly respected and considered to be level headed, fact-and-logic, cause-and-effect analysts of public policies pile on.   The media piled on, with coverage at  New York TimesWall Street Journal Chicago Tribune and a bit of a counterpoint at Fox NewsBreitbart National Review and others. By Friday, the University of Chicago caved in and threw Harald under the bus.

Start by actually reading Harald's tweets.

Monday, June 8, 2020

Perpetuities, debt crises, and inflation

My brief exchange with Markus Brunnermeier at the end of a Covid-19 talk  attracted some attention, and merits a more detailed intervention. Gavin Davies at FT made some comments (more later) as did the Economist.

My proposal to fund the US with perpetuities comes from a paper, here. (Sorry regular readers for the repeated plug.)  The rest is standard fiscal theory of the price level, spread over too many papers to give one more plug.

There are three main points.  First, inflation is not about money anymore -- the choice of money vs. bonds. Money -- reserves -- pay interest, so reserves are just very short-term government bonds. Inflation is about the the overall demand for government debt. That demand comes from the likelihood of the debt  being repaid, and the rate of return people require to hold debt.

Second, if we have inflation, the mechanism will be very much like a run or debt crisis. Our government rolls over very short term debt. Roughly every two years on average, the government must find new lenders to pay off the old lenders. If new lenders sniff trouble they refuse to roll over the debt and we're suddenly in big trouble. This is what happened to Greece. It's what happened to Lehman Bros. In our case, our government can redeem debt with non-interest-paying reserves, resulting in a large inflation rather than an explicit default.

2a, a run is always unpredictable. If you knew there would be a roll-over crisis next year, you would dump your government bonds this year, and the run would be on. There is a whiff of multiple equilibrium too. Our debt is nicely sustainable at 1% interest. If interest rates go up to 5%, we suddenly have north of $1 trillion additional deficits, which are not sustainable. The government  is like a family who, buying a home, got the 0.1% adjustable rate mortgage rather than the 1% (government debt prices) fixed rate mortgage because it seemed cheaper. Then rates go up. A lot.

Sure demand is high for US government debt, rates are low, and there is no inflation. But don't count on trends to continue just because they are trends. How long does high demand last? Ask Greece. Ask an airline.

Third, for this reason, I argue the US should quickly move its debt to extremely long maturities. The best are perpetuities -- bonds that pay a fixed coupon forever, and have no principal payment. When the day of surpluses arrives, the government repurchases them at market prices. By replacing 300 ore more separate government bonds with three (fixed rate, floating rate, and indexed perpetuities), treasury markets would be much more liquid. Perpetuities never need to be rolled over. As you can imagine the big dealer banks hate the idea, and then wander off to reasons that make MMT sound like bells of clarity. That they would lose the opportunity to earn the bid/ask spread off the entire stock of US treasury debt as it is rolled over might just contribute.

But we don't have to wait for perpetuities. 30 year bonds would be a good start. 50 year bonds better. The treasury could tomorrow swap floating for fixed payments.

Then we would be like the family that got the 30 year fixed mortgage. Rates go up? We don't care. By funding long, the US could eliminate the possibility of a debt crisis, a rollover crisis, a sharp inflation for a generation. 

Friday, June 5, 2020

Magical Monetary Theory

I read Stephanie Kelton's book, The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy,” and wrote this review for the Wall Street Journal. As usual I have to wait 30 days to post the whole thing here.

I approached this task with an open mind. What I had heard of MMT has some overlap with fiscal theory of the price level, on which I work, and I hoped to see some commonality.

I was disappointed. Short version:
"Ms. Kelton...starts with a few correct observations. But when the implications don’t lead to her desired conclusions, her logic, facts and language turn into pretzels." 
Full version in 30 days, if you can't find a way around WSJ paywall.