Tuesday, September 29, 2020

Belgian Doctors' open letter on covid-19

A correspondent sent me a link to the Belgian Doctors' open letter on covid-19. I found it original, documented, and worth reading and thinking about. It is at least an important contribution to a debate -- and one of its big points, we should be having a debate. Science is still quite uncertain about much regarding this disease, and science never did know much about economic and public policy. I'm not totally convinced, but it has several interesting ideas that I had not considered before. 

The headline

We ask for an open debate, where all experts are represented without any form of censorship. After the initial panic surrounding covid-19, the objective facts now show a completely different picture – there is no medical justification for any emergency policy anymore.

The current crisis management has become totally disproportionate and causes more damage than it does any good.

We call for an end to all measures and ask for an immediate restoration of our normal democratic governance and legal structures and of all our civil liberties.

A history 

Monday, September 28, 2020

Fifty shades of QE. Research in the bubble.

It always struck me that research inside the Fed seems to produce answers closer to the views of Fed officials than does research outside of the Fed. Perhaps my experience of reading a speech by Ben Bernanke one morning and attending a workshop by a Fed economist that found exactly his guess of the (implausibly large, to me) effects of QE that afternoon colored my views. 

In "Fifty Shades of QE:" Brian Fabo, Martina Jančoková, Elisabeth Kempf,  and Luboš Pástor quantify this tendency:

...central bank papers report larger effects of QE on output and inflation. Central bankers are also more likely to report significant effects of QE on output and to use more positive language in the abstract. Central bankers who report larger QE effects on output experience more favorable career outcomes. A survey of central banks reveals substantial involvement of bank management in research production.

Figure 5 gives some sense of the result:

Saturday, September 26, 2020

"You're hired" Mulligan review

"You're Hired!" is Casey Mulligan's memoir of a year spent as Chief Economist of the Council of Economic Advisers. 

The book is pitched as an analysis of President Trump, "riveting first-hand accounts of President Trump’s engagement with policy and politics." I read it in part for that reason. Opinions on the current occupant generally reflect either kool-aid drinking, never-Trump disdain, or foaming-at-the-mouth derangement. Casey, one of the few remaining true-blue Chicago School economists, and an outstanding one who combines analysis and policy, is none of the above. I know him as a clear thinker and a straight talker.  With an election coming,  I wanted to see what he had to say. 

Casey delivers some important insights about this President. But the book is really not that much about Trump. It is much more about how the CEA works, how policy is formed in the Trump administration, which is much more like other administrations than you'd think, and a record of some great successes of the Trump-era CEA. (Kevin Hassett, the CEA chair, really deserves more pride of place in this story.) Trump shows up to make the big decisions, but usually on issues the CEA has spearheaded. 

For this story, and all the 90% that is not about Trump,  I strongly recommend the book to economists, of all political leanings. If you are an academic, interested in economic policy and in serving your country but without joining the permanent federal bureaucracy, the CEA is the most likely place you will land. If you want a voice for serious economic analysis in the government, the CEA is it. Casey also tells you how the CEA relies on academic research.  

Thursday, September 24, 2020

Growth and regulation

Is economic growth inexorably slowing down? Such is the depressing conclusion of Nick Bloom, Chad Jones, John Van Reenen, and Michael Webb, who showed in a very important paper that it is taking more and more effort to find new ideas. It is also the conclusion of Robert Gordon's Rise and Fall of American Growth. They promised us flying cars, and all we get tweets. The marshaling of facts in these and related works is impressive and depressing. 

I'm attracted to the other much more hopeful (maybe) possibility: growth, really the continued betterment of the human condition, is possible, but it is just stymied by the ever-increasing web of law and regulation. 

Along today come two interesting posts courtesy Marginal Revolution (always must-read). The first is narrow, on nuclear power, the second much broader on how bad regulation spreads around the world. 

Monday, September 21, 2020

Romer on testing

As part of an email conversation about testing, Paul Romer sent the following message. He so beautifully encapsulated the case for testing, I asked for permission to post his email. Here it is. 

Here is a short summary of the case for testing.

1. A program of "test and isolate" will reduce the effective reproduction number, R.

2. A combined policy of (i) more "test and isolate" which reduces R and (ii) more social interaction and more economic activity which increases R can be designed so that the net effect on R is zero.

3. The ratio of the cost of the additional testing to the additional economic activity that this combined policy will allow offers one way to estimate of the "rate or return" to spending on tests. My rough estimate is that this rate of return lies in the range of 10x to 100x so there is no doubt that test and isolate would be cost effective. To reach the higher end of the range, the cost of the test would have to be relatively low, say  $10.

4. The combined plan under #2 will lead to more total cases. If the main measure of policy success or failure were deaths, an increase in the number of cases would not matter. Under the current circumstances, an increase in the number of cases is likely to be interpreted as a sign of a policy failure. This increases the political cost to the administration of increasing the number of tests. A second-best solution that avoids this cost might be to use at home tests and encourage people to self-isolate. This way, the results from the tests need not generate any new confirmed cases.

[JC Comment: one reluctance that the president or governors may have is that more testing naturally produces more measured cases, and the media don't seem all that good about recognizing this fact.] 

Details on Targeting, Timing, and Compliance:

- Under the program in #3, the benefit created when more infectious people are isolated is received by unknown others who are free to resume normal activities. This is a classic case of an external effect. As a result, it makes sense for the government to pay for the tests and perhaps even to pay for "supported isolation" to increase the compliance rate. Because the fraction of the population that is infected is relatively small and because the required period of isolation is short, it would be relatively inexpensive to pay the few people who are in isolation, for example by making up any lost wages. Because transmission in the household is likely, it would make sense to offer a choice of isolation in a hotel or isolating the entire family at home. However, implementing this would require some way to confirm that someone is infectious, which precludes its use in the at-home approach noted under #4 above.

- For purposes of calculating the rate of return in the combined program described in #3, it is useful to consider a thought experiment of testing people at random. But in any practical program, the efficient way to use more tests is to start by targeting populations that have high ex ante probability of being infected. This could be done by concentrating the tests in high prevalence geographical regions, in high exposure populations, or on people identified by contact tracing. I am skeptical that contact tracing is the cost effective way to identify a large number of people who have a higher ex ante probability of being infected.

- For reducing R, what matters is the average number of infectious-person-days in isolation per test. This depends on (a) the number of true positives that are isolated and (b) when in the course of their infection they are isolated. The way to increase (a) is to target populations with a high ex ante probability of infection. The way to increase (b) is to use tests with a shorter time from sample to result.

- The choice between centralized lab testing and POC tests depends in part on an easily quantified tradeoff between a reduction in the sample-to-result time of most POC tests and a reduction in their sensitivity. But in the early months of any program for expanding the number of tests, the most important differentiator is likely to be the supply response. Many people are convinced that there is a large amount of lab capacity on university campuses that could rapidly be mobilized so that this path probably offers the lowest-cost path of expansion until manufacturing capacity increases for the POC or at home tests.

- There is a synergy between the frequency of testing in a population and the use of pooling to increase lab capacity. As the frequency increases, the frequency of positives will go down so that pooling becomes more cost effective.

-  A large fraction of the total cost of a test comes from the discomfort experienced by the person who gives the sample and the time it takes for a healthcare professional to collect the sample. On both grounds, saliva samples will almost surely have the lowest cost.

- To reduce the cost from isolating false positives, any initial positives could be retested. Because the number of positive results will be a small fraction of the number of tests, retesting adds only a small amount to the cost of the program.

- As long as any true positives are isolated, the net effect of the combined program described in #2 will be to increase the total amount of social interaction by people who are not infectious, even if there are some false positives.

I hope this is helpful. 



Jacobin pandemic

Casey Mulligan tweeted an interesting report on the coronavirus from Jacobin online magazine as "makes the most sense." Given that the Jacobins were 

"the most radical and ruthless of the political groups formed in the wake of the French Revolution, and in association with Robespierre they instituted the Terror of 1793–4."

(google dictionary) the link attracted my eye. (Do these people know history? Or is this intentional? And they're all upset about Trump and "authoritarianism?")  

Indeed, after the predictable throat-clearing editorializing about "disparate impact" and inequality, and despite idiotic question preambles like this one

"Under capitalism, we have become a species that increasingly exploits other creatures and their habitats, and moves in large numbers and with great speed around the globe, making us ripe for a pandemic like this one."

(China is.. capitalist? The plague, cholera, yellow fever, smallpox were... what?) Jacobin editorial board member Nicole Aschoff spurs Harvard professors Katherine Yih  and Martin Kulldorff to interesting, sensible and useful answers. The extreme source of this commonsense gives me some hope. However, read though or skip to my critical comments, as it's not as totally wise as Casey suggests. 

KY: ... I don’t think it’s wise or warranted to keep society locked down until vaccines become available. ..Instead of a medically oriented approach that focuses on the individual patient and seeks (unrealistically) to prevent new infections across the board, we need a public health–oriented approach that focuses on the population  and seeks to use patterns, or epidemiologic features, of the disease to minimize the number of cases of severe disease and death over the long run, as herd immunity builds up.

NA: Like Dr Yih, I am very concerned about the collateral damage of lockdowns. In public health policy, we cannot just consider the present consequences of one single disease. We must think more broadly, considering all short- and long-term health outcomes.

...Another example is school closings. Good education is not only important for academic achievement and financial well-being; it is also critical for the mental and physical health of children and into their subsequent adulthood. Kids have minimal risk from this virus, and it is sad that we are sacrificing our children instead of properly protecting the elderly and other high-risk groups.

(I hate to break it to modern-day Jacobins, but the Trump Administration is basically following this approach. And the disparate impact is precisely brought on by economic lockdown.  ) 

Read on for much common sense. 

However, I don't think this is totally right, and "damn the torpedoes, protect the old folks and let's sail on to herd immunity" is not, I think the right or at least complete answer.  

1) Herd immunity, on its own, is a meaningless concept.  Most people think herd immunity happens when everyone has gotten it, which is false.  A virus stops spreading when the reproduction rate is below one. The reproduction rate combines frequency of contact and fraction of immune in the population. Only that combination matters.

If each infected person meets 3 people and 67% of the population has immunity, the virus stops.  If each infected person meets two people and 51% the population has immunity, the virus stops. If each infected person meets 0.99 people and nobody is immune, the virus stops.  The fraction with immunity on its own is meaningless.

So we need to work on both parts of the equation -- reduce the contact rate and minimum economic and social cost, as well as wait for greater numbers to become immune. 

2) Long term consequences.  The article acknowledges these and moves on. This strikes me as a great unknown. The view that it’s like the flu, just let people get it until immunity rises, while keeping old and sick people safe, is predicated on the idea that there are few long term consequences other than death. 

 If 20% are getting long term important debilitation, that skews the treadeoff to less contact.  If this were the plague or cholera, with 50% death, we would not be talking about herd immunity.

3) Testing. The article is missing the one great opportunity we have to reduce the spread and reduce the social and economic cost of the disease, until a vaccine becomes available. "Test" only appears in the article in the section on protecting the elderly and nursing homes. This is the great unexploited opportunity. We can cheaply reduce the contact rate with next to no business or social cost.

Why in the world are we not embarking on widespread public-health testing? Why is the FDA still regulating tests, saying they may only be performed in a medical setting?  By what possible right or common sense can the FDA tell me that I cannot send samples of my body to a lab, and the lab cannot tell me what’s in them? Read Alex Tabarrok "our antigens, ourselves" to get really grumpy about this. You have to be astoundingly paternalistic about the stupid deplorable to believe that people need to be protected from simple information about what is in their body. There is zero medical danger from a saliva test. 

This thing could be over in  weeks if the FDA allowed cheap, fast, relatively inaccurate, cash-and-carry, completely unregulated tests. Go to CVS, get the test kit, find out if you have it. No referral, no doctor visit, no prescription, no insurance, no faxed paperwork. Let private decisions figure out what to do with the results. Businesses, restaurants, schools could all demand it. With a cheap test, the contact rate can go below one and we need no immunity. Of course, the government has every interest in paying for and subsidizing tests too. 

Frankly I do not understand this Administration. If President Trump simply tweeted, "FDA: Free the tests!" and "CDC: tell people to get tested" this thing could be over in weeks. We could reach herd immunity with a low contact rate alone, and reastaurants, schools, universities, airlines, could require test results and reopen quickly. Trump could go into the election with the number of cases and deaths crashing. He could campaign in empty hospitals. 

Saturday, September 19, 2020

Storm coming

I am very worried about how the next election will play out. I am more worried than most commenters, hence this post, because as an economist I predict people's behavior by asking what is natural given their incentives and the rules of the game as they are. That thinking leads to a dark place.  

Our democracy has one essential function: a peaceful transfer of power. There are rules of the game. A winner is determined even in a close race. Both sides agree who won, and that the winner is a legitimate office holder. 

We seem inexorably headed to the most divisive election since 1860, in which this mantle of legitimacy is sure to vanish, to horrendous result. 

Ruth Bader Gisberg's death adds both distraction from the task of fixing election machinery -- really, agreement by both sides what the rules of the game will be, and to abide by the results -- and one more pathway to disaster. 

Imagine, as seems quite possible, that  Trump scores an early lead in the days after the election, with a narrow electoral college majority, though losing the popular vote, with 90% - 10% losses in the deep blue cities. Trump declares victory. Blue cities erupt in  protest. 

As mail in votes come in and are tabulated, Biden gets closer and closer and by his party's count has won.

Thursday, September 17, 2020

Muni haircuts

"Municipal bond investors have to share the burden in state bailouts" writes my colleague Josh Rauh, and he is exactly right.

Background: State and local governments borrowed a lot of money and blew it. They borrowed further by not funding their pensions. Now covid comes along, people are fleeing cities, and they don't have tax revenue to fund ongoing expenses. 

The big question hanging over Washington: If we are going to help state and local governments weather the storm of their current expenses, does that mean federal taxpayers bail out the bondholders who lent state and local governments all this money? 

As in the Greek crisis, bond investors and their allies like to clam "contagion," that any losses will spark a financial crisis.  

Whether that argument has any merit in other cases, as Josh points out it does not hold for municipal bonds in the current financial environment. Municipal bonds are illiquid and tax-exempt and thus well targeted at very wealthy high-income individuals who face high tax rates, and whose saving is thus beyond IRA, 401(k) and other tax-free investment possibilities. And we are not in a systemic financial crisis.  

...as of this spring, around 12 percent of municipal bonds were owned by banks. This implies only about $130 billion of total exposure to all general obligation municipal debt by the banking sector, compared to well above $1 trillion of tier one bank capital. Similar amounts of general obligation municipal debt reside on the balance sheets of the insurance companies, where municipal bonds are 7 percent of assets.

The remaining municipal bonds are directly owned by individuals, or in mutual funds and exchange traded funds largely owned by individuals. Municipal bond defaults would primarily affect individual investors, and especially individuals who buy tax exempt municipal debt because they are looking for tax free income.

Of a piece with the effort to restore the state and local tax deduction, the effort to bail largely blue states and cities out of their debts to largely blue high income taxpayers is just a little bit inconsistent with tax the rich and tax their wealth rhetoric.  

Daniel Bergstresser and Randolph Cohen presented a paper a while ago at a Brookings conference, measuring that 42% of municipal bond value was held by the top 0.5% of the income distribution. Now that so many including the Fed are interested in racial justice, similar breakdowns of who holds municipal bonds would be interesting. Given the racial disparity in wealth, it would be astounding if the disparity in municipal bond holding were not very large as well.   

Josh's solution is straightforward: 

Congress has to therefore condition any further bailout funds on shared losses by municipal bond investors. For instance, the law can mandate that state governments pass legislation that would write off a dollar of municipal bond debt for every dollar of additional grants given to a state or local government.

If we ever are to have any sort of market discipline, if a Fed put is not going to protect all large and politically potent issuers and all large and politically potent investors, who got outsized returns for many years by holding risky assets,  from actually taking those losses when it counts, rather than one more taxpayer bailout, this seems like the time and place. 

Municipal bonds are already highly subsidized, by their tax deduction. State and local governments have responded predictably by borrowing a lot. (Universities also get to borrow at municipal bond rates, and effectively use the money to invest in their hedge-fund endowments.) If municipal bonds now enter the too big to fail regime, the subsidy and incentive to over borrow explodes. 

This situation is part of a general conundrum. The government and the Fed has taken on forestalling bankruptcies of large businesses and governments in the covid recession. (Restaurants, small landlords, and other small businesses no. But AAA bond issuers, and municipal bond issuers yes.) 

To forestall a bankruptcy, you do not just lend money for current operations -- you end up taking on past debts.  

Fortunately the recession seems to be ending quickly, because the magnitude of debt that might end up in federal hands under the no-bondholder-may-lose-money regime is pretty frightening. 


French Translation at Vox-fi

Tuesday, September 15, 2020

Atlas agonistes

A group of Stanford faculty recently circulated, and then posted, an open letter objecting to my Hoover colleague Scott Atlas, who serves as a senior adviser to the Administration on health policy. 

Read the letter. Then come back for a little reading comprehension test.


Q1: What specific "falsehoods and misrepresentations" do they accuse Scott of making?

Q2: Which of the following do they claim Scott is publicly denying, contrary to scientific evidence? 

  1. Face masks, social distancing, handwashing and hygiene can help to reduce the spread of Covid-19. 
  2. Crowded indoor spaces are dangerous. 
  3. Asymptomatic people can spread covid-19
  4. Testing asymptomatic people can help to slow the spread. 
  5. Children can get Covid-19
  6. Pandemics can end via herd immunity. Vaccines work, by conferring herd immunity.
  7. Letting people get sick is better than a vaccine. 
  8. All of the above  

Q3: What specific documented evidence of statements that contravene contemporary scientific consensus do the signatories provide? 

Q4: What role in the Administration do they cite that Scott has, and misuses? 

(Note present tense. Scott is an adviser. We all get to change our minds -- even Dr. Fauci once said face masks were not worth the bother, but the signatories don't seem to feel an "ethical obligation" to play gotcha on that one. What matters is, what is Scott currently advocating in the Administration?) 


Debt podcast and reconciliation


The Grumpy Economist podcast is back, with some thought on the debt issues from my last posts here and here.

David Andofatto had some final thoughts at macro mania, with which I mostly agree. Yes a twitter/blog debate in macroeconomics produces agreement! Central points: 

1) For these purposes a large sharp inflation and a default are not much different. In fact, the event I have in mind is most likely an inflation, as the US is likely to choose inflation over default. I don't think I made this equivalence clear in the debt posts. Also, the Fed is just another issuer of interest-paying debt. 

However, I don't think the chance of default or haircut is as remote as everyone else seems to think. They are also related events. Remember, my scenario for a debt crisis posits an economic and political crisis at the same time -- pandemic, recession, war, huge demands on the US treasury. Just how sacrosanct will full repayment of debt be to the US political system? When Chinese central bankers and Wall Street fat-cats are pressing for debt repayment but ordinary Americans are hurting, will our political system really take hard measures to repay the former in full, while throwing everyone's lives into misery via inflation? Maybe, and maybe inflation can still be blamed on speculators and middle-people and the usual bogey-people but maybe not. A haircut on Treasurys is not inconceivable. It could also come via refusal to raise the debt limit, or via a sharp wealth tax. And if people start to fear a haircut coming, they will certainly dump debt immediately, so fear of even technical defaults can spark the inflation.  

2) Yes, a good part of current r<g may well be a liquidity premium for US government debt due to its usefulness in transactions. But the big questions for r<g remain how reliable and how scaleable. Liquidity demand is not very scaleable. For example, if a government is financed only by money and no debt, and money demand MV=PY, then the government can run perpetual small deficits as the real economy Y and hence money demand grow. But if the government sees this situation, says "great, r<g, let's blow $10 trillion bucks," it will soon discover this opportunity does not scale at all. 

In the more reasonable MV(i)=PY that money demand is interest elastic, as the government exploits the opportunity and supplies more M it must pay greater interest on money (interest on reserves, interest on money-like treasurys), eating away quickly at r<g. 

The sensible r<g advocates like Blanchard recognize that r<g does not scale infinitely, and that a rise in r captures its limit. However, the discussion usually goes quickly to crowding out and the marginal product of capital rising. The liquidity effect that depresses US government bond yields is likely much less scaleable than crowding out of the whole US capital stock. 

When you read estimates of how much r rises as debt/GDP rises, pay attention to which mechanism they have in mind. 

Liquidity demand is also more fickle. Money demand can rise and fall quickly. The portion of treasury demand that comes from its use in financial transactions can be undone by different payment and clearing technology. Relying on this poorly understood mechanism for 30 years of r<g to pay off our debt seems a bit risky. US sanctions and regulations are creating a big incentive for others to create such alternative mechanisms. 

3) The government should borrow longer. The Fed can help.  

One of my policy conclusions is that the US government should borrow long-term as households who fear a big rise in interest rates should get 30 year mortgages not adjustable rate mortgages. Currently the Fed is actively undoing the Treasury's meager efforts to borrow long term, by buying up long-term treasury and guaranteed agency debt and issuing overnight reserves in return, and by issuing new debt in the form of overnight debt. 

The Fed could easily introduce term deposits -- reserves that carry a fixed interest rate, rather than a floating rate, and whose principal value varies. The Fed could also engage in fixed-for-floating swap contracts to eliminate the government's exposure to interest rate risk. (Such swap contracts should be collateralized of course, since you don't buy insurance from someone you will bail out if they lose money!) If interest rates rise the Fed will not just rescue the US government from a crisis, but will look like bloody geniuses. Which would you rather as a central banker in a crisis: a huge rise in net worth with which you can bail out the Treasury, or to fight an immense mark-to-market loss? 

Fintech in chains

"Fintech can come out of the shadows" is the title that Wall Street Journal editors gave to  Brian Brooks and Charles Calomiris' oped last week. I have not in a long time seen a title that more utterly contradicts the content of the essay.  For what they advocate is exactly the opposite: Fintech in chains, hemmed in by  the sort of regulatory stranglehold that fintech was created to escape. 

What is fintech? Basically companies that offer  

services—consumer loans, credit cards or payment processing—that banks have traditionally offered.

but, crucially, fintech does not accept deposits. 

The issue? 

The Office of the Comptroller of the Currency determines which companies qualify for charters as national banks or federal savings associations and supervises the activities of those banks.

But not fintech companies, because fintech companies don't take deposits. And that is the legal issue prompting the oped -- Brooks and Calomiris, coincidentally acting comptroller of the currency and chief economist of the OCC, want the OCC to regulate fintech just like banks. (Calomiris is a topnotch economist who normally writes very good papers. ) 

So what's so awful about fintech? 

Monday, September 14, 2020



For another purpose, I had reason to look up TIPS yields. 

The current Treasury Inflation-Protected Security (TIPS) yields are -1.27% (5 years) -0.98% (10 years) and, amazingly, -0.35% (30 years). You pay them 0.35% per year for a stable real value. I did not realize it was this low. 

The context. I serve on the advisory board of a small nonprofit that has an endowment. The endowment is intended to be perpetual. We're discussing the equity vs. fixed income allocation. I wanted to lay out the options. If they want absolute safety of principal and payout, under a perpetual constraint, they can pay out... -0.35% of the principal every year! I advised they accept some risk in the payout stream. 

It is not common for foundations to link the payout rate to the portfolio beta or composition. On economic grounds it should be. If you want a perpetual investment, the payout rate has to relate to the average portfolio return. Fixed income should have a lower payout rate than equity. 

Of course, some payouts are set by IRS rules or by a conflict between managers and donors, and there apparent illogic can serve other purposes.

Latest Goodfellows

The latest Goodfellows discussion. Embedded, hopefully, here: 

or direct link here. (Try that if the embed fails. Youtube has started censoring Hoover.) 


Wednesday, September 9, 2020

Smoke and Nukes

 I was driving in Northern California on Labor Day, contemplating the 1-2 mile visibility in thick smoke through the Central Valley, and listening to NPR, when an enticing story came along

Amna Nawaz:

For a closer look at what's behind that heat wave and what's fueling these fires, I'm joined by Leah Stokes, she's a professor and researcher on climate, energy and political policy at the University of California, Santa Barbara

Great, I thought. We're going to hear some real science and policy. What's the role of forest floor cleaning? Climate warming isn't the issue per se -- it's hot in Arizona but Arizona doesn't burn. It's a complex of moisture, growth human activity. And policy. Great. What do we do about the fact that so much burning land is federal, and the federal government isn't cleaning up its forest floor either. What's the budget history of fire fighters? Just what are the air quality numbers? 

I was, to put it mildly, disappointed. 

Sunday, September 6, 2020

More on debt

Following my last post on debt I've thought a bit more, and received some very useful emails from colleagues. 

A central clarifying thought emerges. 

The main worry I have about US debt is the possibility of a debt crisis. I outlined that in my last post, and (thanks again to correspondents) I'll try to draw out the scenario later. The event combines difficulty in rolling over debt, the lack of fiscal space to borrow massively in the next crisis. The bedrock and firehouse of the financial system evaporates when it's needed most. 

To the issue of a debt crisis, the whole debate about r<g, dynamic inefficiency, sustainability, transversality conditions and so forth is largely irrelevant. 

We agree that there is some upper limit on the debt to GDP ratio, and that a rollover crisis becomes more likely the larger the debt to GDP ratio.  Given that fact, over the next 20-30 years and more, the size of debt to GDP and the likelihood of a debt crisis is going to be far more influenced by fiscal policy than by r-g dynamics. 

In equations with D = debt, Y = GDP, r = rate of return on government debt, s = primary surplus, we have* \[\frac{d}{dt}\frac{D}{Y} = (r-g)\frac{D}{Y} - \frac{s}{Y}.\] In words, growth in the debt to GDP ratio equals the difference between rate of return and GDP growth rate, less the ratio of primary surplus (or deficit) to GDP. 

Now suppose, the standard number, r>g, say r-g = 1% or so. That means to keep long run average 100% debt/GDP ratio, the government must run a long run average primary surplus of 1% of GDP, or $200 billion dollars. The controversial promise r<g, say r-g = -1%, offers a delicious possibility: the government can keep the debt/GPD ratio at 100% forever, while still running a $200 billion a year primary deficit! 

But this is couch change! Here are current deficits from the CBO September 2 budget update

We were running $1 trillion deficits before the pandemic. Each crisis seems to bring greater stimulus.  

I especially like this view because it doesn't make sense that an interest rate 0.1% above the growth rate vs. an interest rate 0.1% below the growth rate should make a dramatic difference to the economy. Once you recognize some limit on the debt/GDP ratio, and desirability of some long-run stable debt/GDP, there is no big difference between these two values. The surplus required to stabilize debt to GDP smoothly runs from negative couch change to positive couch change. 

I find this a liberating proposition. I find the whole sustainability, long run limits, dynamic inefficiency, transversality condition and so forth a big headache. For the question at hand it doesn't matter! (There are other questions for which it does matter, of course.) 

As we look forward,  debt/GDP dynamics for the next 20 years are going to be dominated by the primary surplus/deficit, not plausible variation in r-g. The CBO's 10 years of 6-8% of GDP overwhelm 1-2% of r-g. If each crisis continues to ratchet up 10% of GDP deficits per year, more so. The Green New Deal, and large federal assumption of student debts, state and local debts, pension obligations, and so forth would add far more to debt/GDP than decades of r vs. g.  


Now that this is clear, I realize I did not emphasize enough that Olivier Blanchard's AEA Presidential Address  acknowledges well the possibility of a debt crisis: 

Fourth, I discuss a number of arguments against high public debt, and in particular the existence of multiple equilibria where investors believe debt to be risky and, by requiring a risk premium, increase the fiscal burden and make debt effectively more risky. This is a very relevant argument, but it does not have straightforward implications for the appropriate level of debt.

See more on p. 1226. Blanchard's concise summary

there can be multiple equilibria: a good equilibrium where investors believe that debt is safe and the interest rate is low and a bad equilibrium where investors believe that debt is risky and the spread they require on debt increases interest payments to the point that debt becomes effectively risky, leading the worries of investors to become self-fulfilling.

Let me put this observation in simpler terms. Let's grow the debt / GDP ratio to 200%, $40 trillion relative to today's GDP. If interest rates are 1%, then debt service is $400 billion. But if investors get worried about the US commitment to repaying its debt without inflation, they might charge 5% interest as a risk premium. That's $2 trillion in debt service, 2/3 of all federal revenue. Borrowing even more to pay the interest on the outstanding debt may not work. So, 1% interest is sustainable, but fear of a crisis produces 5% interest that produces the crisis. 

Brian Riedi at the Manhattan Institute has an excellent exposition of debt fears. On this point, 

... there are reasons rates could rise. ...

market psychology is always a factor. A sudden, Greece-like debt spike—resulting from the normal budget baseline growth combined with a deep recession—could cause investors to see U.S. debt as a less stable asset, leading to a sell-off and an interest-rate spike. Additionally, rising interest rates would cause the national debt to further increase (due to higher interest costs), which could, in turn, push rates even higher.


So how far can we go? When does the crisis come?  There is no firm debt/GDP limit. 

Countries can borrow a huge amount when they have a decent plan for paying it back. Countries have had debt crises at quite low debt/GDP ratios when they did not have a decent plan for paying it back. Debt crises come when bond holders want to get out before the other bond holders get out. If they see default, haircuts, default via taxation, or inflation on the horizon, they get out. r<g contributes a bit, but the size of perpetual surplus/deficit is, for the US, the larger issue. Again, r<g of 1% will not help if s/Y is 6%. Sound long-term financial strategy matters. 

From the CBO's 2019 long term budget outlook (latest available) the outlook is not good. And that's before we add the new habit of massive spending. 

Here though, I admit to a big hole in my understanding, echoed in Blanchard and other's writing on the issue. Just how does a crisis happen? "Multiple equilibria" is not very encouraging. Historical analysis suggests that debt crises are sparked by economic and political crises in the shadow of large debts, not just sunspots.  We all need to understand this better.  



As Blanchard points out, small changes do not make much of a difference.  

 a limited decrease in debt—say, from 100 to 90 percent of GDP, a decrease that requires a strong and sustained fiscal consolidation—does not eliminate the bad equilibrium. ...

Now I disagree a bit. Borrowing 10% of GDP wasn't that hard! And the key to this comment is that a temporary consolidation does not help much. Lowering the permanent structural deficit 2% of GDP would make a big difference! But the general point is right. The debt/GDP ratio is only a poor indicator of the fiscal danger. 5% interest rate times 90% debt/GDP ratio is not much less debt service than 5% interest rate times 100% debt/GDP ratio. Confidence in the country's fiscal institutions going forward much more important. 

At this point the discussion usually devolves to "Reform entitlements" "No, you heartless stooge, raise taxes on the rich." I emphasize tax reform, more revenue at lower marginal rates. But let's move on to unusual policy answers. 

Borrow long. Debt crises typically involve trouble rolling over short-term debt. When, in addition to crisis borrowing, the government has to find $10 trillion new dollars just to pay off $10 trillion of maturing debt, the crisis comes to its head faster. 

As blog readers know, I've been pushing the idea for a long time that especially at today's absurdly low rates, the US government should lock in long-term financing. Then if rates go up either for economic reasons or a "risk premium" in a crisis, government finances are much less affected. I'm delighted to see that Blanchard agrees: 

to the extent that the US government can finance itself through inflation-indexed bonds, it can actually lock in a real rate of 1.1 percent over the next 30 years, a rate below even pessimistic forecasts of growth over the same period

It's not a total guarantee. A debt crisis can break out when the country needs to borrow new money, even absent a roll over problem. But avoiding the roll-over aspect would help a lot! Greece got in trouble because it could not roll over debts, not because it could not borrow for one year's spending. 

Contingent plans? Blanchard's concise summary adds another interesting option 
 contingent increases in primary surpluses when interest rates increase. 

I'm not quite sure how that works. Interest rates would increase in a crisis precisely because the government is out of its ability or willingness to tax people to pay off bondholders. Does this mean an explicit contingent spending rule? Social security benefits are cut if interest rates exceed 5%? That's an interesting concept. 

Or it could mean interest rate derivatives. The government can say to Wall Street (and via Wall Street to wealthy investors) "if interest rates exceed 5%, you send us a trillion dollars." That's a whole lot more pleasant than an ex-post wealth tax or default, though it accomplishes the same thing. Alas, Wall Street and wealthy bondholders have lately been bailed out by the Fed at the slightest sign of trouble so it's hard to say if such options would be paid. 

Growth. Really, the best option in my view is to work on the g part of r-g. Policies that raise economic growth over the next decades raise the Y in D/Y, lowering the debt to GDP ratio; they raise tax revenue at the same tax rates; and they lower expenditures. It's a trifecta. In my view, long-term growth comes from the supply side, deregulation, tax reform, etc. Why don't we do it? Because it's painful and upsets entrenched interests. For today's tour of logical possibilities if you think demand side stimulus raises long term growth, or if you think that infrastructure can be constructed without wasting it all on boondoggles, logically, those help to raise g as well. 


*Start with \(\frac{dD}{dt} = rD - s.\) Then \( \frac{d}{dt}\frac{D}{Y} =  \frac{1}{Y}\frac{dD}{dt}-\frac{D}{Y^2}\frac{dY}{dt}.\)


Update: David Andolfatto writes, among other things, 

"Should we be worried about hyperinflation? Evidently not, as John does not mention it"

For these purposes, hyperinflation is equivalent to default. In fact, a large inflation is my main worry, as I think the US will likely choose default via inflation to explicit default. This series of posts is all about inflation. Sorry if that was not clear. 


Is there a danger of "bond vigilantes" sending the yields on USTs skyward? Not if the Fed stands ready to keep yields low.

All the Fed can do is offer overnight interest-paying government debt in exchange for longer-term government debt. If treasury markets don't want to roll over 1 year bonds at less, than, say, 10%, why would they want to hold Fed reserves at less than 10%? If the Fed buys all the treasurys in exchange for reserves that do not pay interest, that is exactly how we get inflation. And mind the size. The US rolls over close to $10 trillion of debt a year. Is the Fed going to buy $10 trillion of debt? Who is going to hold $10 trillion of reserves, who did not want to hold $10 trillion of debt. 

In a crisis, even the Fed loses control of interest rates. 



Chris Pullman and Richard Reeves at Brookings write opposing a reinstatement of the deduction for state and local taxes on the federal income tax. Jonathan Parker, a great economics tweeter, tweets approvingly

I offer a little more guarded approval. Yes, it's praiseworthy when any organization in our politicized times criticizes the favored narrative of the party they are perceived to be associated with. And the SALT deduction should, in my view, not be reinstated. 

But though they are right, but they are not right for the central reasons. And the reasons they give are a lot less non-partisan than Jonathan makes it sound. 

Friday, September 4, 2020

Debt Matters

Debt Matters

(This is a draft of an oped. I got done and saw it's 1500 words, so I'm posting it for your enjoyment rather than go through a painful 600 word diet. Diet later. Maybe. ) 

Last week, the U.S. passed a milestone — US federal debt in private hands exceeded 100% of GDP. But does all this debt matter, or is worrying about debt passé?

This debate has been going on among economists for a while. One does not need to go to the incoherence of "modern monetary theory" to find support for the view that debt has few consequences. Olivier Blanchard, of MIT and the IMF, in his Presidential Address to the American Economic Association, (excellent summary here) declared that “there may be no fiscal costs” of additional debt. The core of his argument is that the interest rate on government debt may be lower than the growth rate of the economy so the US can roll over debt forever. 

Larry Summers, ex treasury secretary, President of Harvard, and adviser to presidents, surely the preeminent policy economist of our generation, has advocated that additional debt-financed spending may have so strong a multiplier as to pay for itself. (Paper here) As a result “expansionary fiscal policies may well reduce long-run debt-financing burdens," a super-Keynesian version of the Laffer curve

(I don’t mean to pick on Blanchard and Summers — they are only superbly distinguished representatives of widely held views.) 

Unlike MMT, these are logically consistent possibilities. But are they right? 

The interest rate on government debt is indeed slightly lower than good guesses of the economy’s growth rate, as sadly low as the latter is, so that if we roll over debt with no additional deficits, the debt to GDP ratio will slowly decline and the US can indeed run this slow-rolling Ponzi scheme. 

But how long will this happy circumstance of ultra-low interest rates continue? More to the point, how scaleable is this opportunity? Bond market investors lend 100% of GDP to the US government at 1% interest. Will they lend 200% of GDP at the same low interest rate, or will they start to require higher interest rates? A government that finances itself only with money and no debt need not pay back the money -- but, obviously, cannot double the opportunity. 

What happens when, rather than grow out of a given debt, the US piles on larger and larger debt to GDP ratios each year? The analysis is about sustainability of a large, but steady debt to GDP ratio. It does not justify a debt to GDP ratio that grows 10 percentage points per year.  At what debt to GDP ratio must the party stop and the growing out of it begin? 

Blanchard recognizes these limits are out there somewhere, and that debt crowds out private investment. But just where the limits are is less clear. That finding the limits will be unpleasant is clear. 

Summers’ view is likewise limited to a period of “secular stagnation” with perennially deficient demand, sticky prices and wages, and the other requirements of extreme Keynesianism.  Are we in such a period, or is covid a supply shock? Was the economy really suffering lack of demand when unemployment hit 50 year lows last February? 

Washington knows no such sophistication, but our politicians have grasped the logical implications of the proposition that debt does not matter with more clarity than have economists. 

The notion that debt matters, that spending must be financed sooner or later by taxes on someone, and that those taxes will be economically destructive, has vanished from Washington discourse on both sides of the aisle. The covid response resembles a sequence of million-dollar bets by non-socially distanced drunks at a secretly reopened bar: I’ll spend a trillion dollars! No, I’ll spend two trillion dollars! That anyone has to pay for this is un-mentioned. Well, perhaps nobody does have to pay. 

And who is to blame them, really? Markets offer 1% long-term interest rates. Blowout spending  financed by the Fed printing money — which is no different from debt — has resulted in no inflation so far. Faced with the deep concerns of current voters, worry that our children and grandchildren might have to pay off debt is not particularly salient. They’re either in the basement playing video games or out protesting for the end of capitalism anyway.  Politicians will take the cheap money as long as markets are happy to provide it. 

The economists, even the modern monetary theorists, envision debt issued to finance worthy investments, or valuable spending, all undertaken with a careful green eyeshade approach. Washington has figured out the logical conclusion of the idea that Federal debt doesn’t matter, in a way these economists have not: If debt and money printing have no fiscal cost, why be careful about how you spend money? Send checks to voters. Why not? It’s costless. No boondoggle project is objectionable. Send billions to prop up dying businesses. Why not? It’s costless. Why bother fixing the post office? Send them another $25 billion. Or $100. 

Deeper: Why should citizens have to pay back debts if the Federal government does not have to do so? Bail out student loans. Bail out bankrupt states and locals and their pensions. Cancel the rent. Cancel the mortgage. Why should anyone have to pay any debt if the Federal government has access to a money machine? Why work? Why should the federal government not just keep printing money and sending it to us? Other countries are not so lucky as we are. Why should emerging markets pay back debt if the US does not have to? Bail them out. 

Why indeed should anyone pay taxes? Here Stephanie Kelton, MMT proponent, has followed the logic. The only reason to charge taxes at all, in her view, is to expropriate the wealthy to rob them of political power. 

These are inescapable logical conclusions of the view that federal debt has no fiscal cost. If you’re uncomfortable with the end of the trip, perhaps you should revisit the assumption from which it inexorably follows. At least, you recognize that the opportunity to borrow with little fiscal cost is limited, so should be preserved. 

Advocates point to WWII. It is true, that the US exited an even greater debt to GDP ratio. It was not painless. Growth higher than interest rates was part of it, but not all. Two bouts of inflation, in the late 1940s and in the 1970s devalued much debt. The US ran steady primary (excluding interest costs) surpluses from the 1940s through the mid 1970s. Spending was low in the pre-entitlement economy, and nobody was totting up hundreds of trillions in unfunded promises. The war, and its spending, was over. Statutory personal taxes and actual corporate taxes were high. Financial repression and closed international capital markets kept interest rates on government bonds low, and deprived Americans of better investment opportunities and our and the world’s economies much needed investment capital. And we had an international debt crisis in the early 1970s, prompting the abandonment of Bretton woods and depreciation of the dollar. 

In short, the US grew out of WWII debt by not borrowing any more, by decades of fiscal probity, and by strong supply-side growth in a deregulated economy. We have none of these reassurances going forward. And this, and the UK exit from Napoleonic War debt in the 1800s by starting the industrial revolution are about the only historical examples of a semi-successful repayment of this much debt. Otherwise, the history of large sovereign debts is one long sorry tale of default, inflation, devaluation, and consequent financial chaos. The UK did not exit WWII debt successfully, leading to crisis after crisis, and everyone else did worse. 

Still, what should we be afraid of? The vision of grandchildren saddled with taxes, or even just unable to borrow more while the economy sits at its limit, of, say, 200% debt to GDP, is indeed not a salient brake to spending. 

That is not the danger. The danger the US faces, the danger we should repeat and keep in mind, is a debt crisis. We print our own money, so the result may be a sharp inflation that wipes away the value of debt rather than an even more disruptive default, but the consequences will be almost as dire. 

Imagine that 5 or even 10 years from now we have another crisis, which we surely will. It might be another, worse, pandemic; a war involving china, Russia or the Middle East. Imagine the US follows its present trends of partisan government dysfunction, so an impeachment is going on, a contested election, and even militias roaming the streets of still boarded up cities. Add a huge economic recession, but unreformed spending promises. 

At this point, the US has, say, 150% debt to GDP.  It needs to borrow another $5 - $10 trillion, or get people to hold that much more newly-printed money, to bail out once again, and pay everyone’s bills for a while. It will need another $10 trillion or so to roll over maturity debt. At some point bond investors see the end coming, as they did for Greece, and refuse. Not only must the US then inflate or default, but the firehouse of debt relief, bailout and stimulus that everyone expects is absent, together with our capacity for military or public health spending to meet the shock that sparks the crisis. 

Yes, I've warned about this before, and no, it hasn't happened yet. Well, if you live in California you live on an earthquake fault. That the big one hasn't happened yet doesn't mean it never will.  

No, interest rates do not signal such problems. (Alan Blinder, covering such matters in the Wall Street Journal, "if the U.S. Treasury starts to supply more bonds than the world's investors demand, the markets will warn us with higher interest rates and a sagging dollar. No such yellow lights are flashing.) They never do. Greek interest rates were low right up until they weren’t. Interest rates did not signal the inflation of the 1970s, or the disinflation of the 1980s. Lehman borrowed at low rates until it didn’t. Nobody expects a debt crisis, or it would have already happened. 

We cannot tell when the conflagration will come. But we can remove the kindling and gasoline lying around. Reform long-term spending promises in line with long run revenues. Reform the tax code to raise money with less damage to the economy. And today, spend only as if someone has to pay it back. Because someone will have to pay it back. 

Blanchard concludes with “public debt.. can be used but it should be used right.” I agree. We are in a crisis, and thoughtful spending with borrowed or printed money is necessary. (How about a test a week for every American?) But keep constantly in mind, it will be paid back, steadily or chaotically. There really is no argument. Most of these points are in Blachard's Presidential Address. 

Whether a steady debt/GDP ratio can life with small steady primary deficits, rather than small steady primary surpluses is not the interesting question. There is a limit, a debt/GDP beyond which markets will not lend. On  this, I think, we all agree. There is a finite fiscal capacity. Even though in theory the r<g argument would allow a 1,000% debt to GDP ratio, or 10,000%, at some point the party stops. The closer we are to that limit, the closer we are to a real crisis when we need that fiscal capacity and it is no longer there. 


And now, dear fellow Americans, enjoy your Labor Day. Please listen to Dr. Fauci and don't run out to party like you did on Memorial Day. Let's be sensible and get this thing over with. 

Update: A new and better post More on Debt follows. 

Thursday, September 3, 2020

On looting

A good read: Graeme Wood's Atlantic essay covering Vicky Osterweil, her popular book In Defense of Looting, and NPR interview. (HT Niall Ferguson

NPR summarizes the book as an argument that “looting is a powerful tool to bring about real, lasting change in society.” If the real, lasting change you wish to effect is burning society to cinders and crippling for a generation its ability to serve its poorest citizens, then I suppose I am forced to agree. 

That's as nice a topic sentence as you could ask for.  

Looting is good, she [Osterweil] says, because it exposes a deep truth about the great American confidence game, which is that “without police and without state oppression, we can have things for free.” 

Just who is going to produce those things and work hard to sell them in a looting society? Wood essentially asks that gaping question. 

Osterweil’s argument is simple. The “so-called” United States was founded in “cisheteropatriarchal racial capitalist” violence. That violence produced our current system, particularly its property relations, and looting is a remedy for that sickness. “Looting rejects the legitimacy of ownership rights and property, the moral injunction to work for a living, and the ‘justice’ of law and order,” she writes. Ownership of things—not just people—is “innately, structurally white supremacist.”

This quote, I think, provides a deep understanding of our current far left. 

Wednesday, September 2, 2020

Abbott Labs to the rescue? Free the tests!

Context: Cheap, fast, tests can stop this pandemic quickly, even if they are not very accurate.

Last week, Abbott Labs announced (more info here) that (finally)
the U.S. Food and Drug Administration (FDA) has issued Emergency Use Authorization (EUA) for its BinaxNOW™ COVID-19 Ag Card rapid test for detection of COVID-19 infection. Abbott will sell this test for $5. It is highly portable (about the size of a credit card), affordable and provides results in 15 minutes. BinaxNOW uses proven Abbott lateral flow technology, making it a reliable and familiar format for frequent mass testing through their healthcare provider. With no equipment required, the device will be an important tool to manage risk by quickly identifying infectious people so they don't spread the disease to others.  
Note the last sentence. Abbott gets it -- the point of this test is not to diagnose sick people, it is to keep most sick people from spreading the disease.  If every American got this test once a week for a month ($5 x $350 million = $7 billion = one drop in bucket of the fiscal and economic cost of this pandemic) it would be over in a month.
Abbott will also launch a complementary mobile app for iPhone and Android devices named NAVICA™. This first-of-its-kind app, available at no charge, will allow people who test negative to display a temporary digital health pass that is renewed each time a person is tested through their healthcare provider together with the date of the test result. Organizations will be able to view and verify the information on a mobile device to facilitate entry into facilities along with hand-washing, social distancing, enhanced cleaning and mask-wearing.
"We intentionally designed the BinaxNOW test and NAVICA app so we could offer a comprehensive testing solution to help Americans feel more confident about their health and lives," said Robert B. Ford, president and chief executive officer...
Even better. (It does not say who the app reports data to, which could make it better yet. For example, it could automatically notify your employer.)
"With lab-based tests, you get excellent sensitivity but might have to wait days or longer to get the results. With a rapid antigen test, you get a result right away, getting infectious people off the streets and into quarantine so they don't spread the virus."
Again, Abbott gets it.

But, what's this business about "through their healthcare provider?"
Under FDA EUA, the BinaxNOW COVID-19 Ag Card is for use by healthcare professionals and can be used in point-of-care settings that are qualified to have the test performed and are operating under a CLIA (Clinical Laboratory Improvement Amendments) Certificate of Waiver, Certificate of Compliance, or Certificate of Accreditation. Within these settings, the test can be performed by doctors, nurses, school nurses, medical assistants and technicians, pharmacists, employer occupational health specialists, and more with minimal training and a patient prescription.   
What is wrong with these people? (FDA) If most of us call our health care providers, you get  non-urgent appointment in about 3 weeks, insurance gets billed about $400, we pay $150, to get the necessary referral, and prescription (!) and on for more delays and costs to get the test.

What possible reason is there for all these restrictions? How can anybody be hurt by taking this test, and how will all these layers of bureaucracy help that anyway? Yes, a huge employer like Stanford can probably obtain a CLIA CoW, CoC, etc. and hire a "occupational health specialist" to administer tests, but how is a restaurant going to do it?

There is a pandemic on, folks. Regulators gotta regulate, I guess, to justify their existence. But not now.

Free the tests!