Tuesday, October 20, 2020

Challenges for central banks.

On October 20, I was graciously invited to give a talk at the  ECB Conference on Monetary Policy: bridging science and practice. 

I survey six challenges facing central banks: 1. Interest rates and inflation; 2. Policy reviews; 3. Financial reform post 2008 4. New challenges to finance post covid; 5. The many risks ahead; 6. Central banks and climate.  

For the whole thing, go here for a pdf. A video of my presentation is here. (The conference website will have all videso soon.) Items 1-5 are mostly interesting for monetary economists, though general readers might find my summary and distillation of the Fed policy review of some interest. 

Here, I post the section on climate change and conclusion, which are the most novel. And if you like the general approach and want to see it applied to the rest of what central banks are up to, that's another advertisement to read the whole talk pdf. 

In the section leading up to this, I describe risks to the financial system from widespread defaults, sovereign defaults, a US debt and currency crisis, another bigger pandemic, war, political chaos, cyber disaster and a few other unpleasant possibilities. But covid has taught us to prepare for the unexpected.  

....Which brings me to a great puzzle. In this context why are the ECB, BoE, BIS, IMF consumed with one and only one “risk”… climate? 

Challenge 6. Climate, Mission creep, and Politicization risk. 

I think this adventure is a dangerous mistake. 

Disclaimer: I do not argue that climate change is fake or unimportant. None of my comments reflect any argument with scientific fact. (I favor a uniform carbon tax in return for essentially no regulation.) 

The question is whether the ECB, other central banks, and international institutions such as the IMF, BIS, and OECD should appoint themselves to take on climate policy, or other important social, environmental or political causes, without a clear mandate to do so from politically accountable leaders. 

Moreover, the ECB and others are not just embarking on climate policy in general. They are embarking on the enforcement of one particular set of climate policies — policies to force banks and private companies to de-fund fossil fuel industries, even while alternatives are not available at scale, and to provide subsidized funding to an ill-defined set of “green” projects. 

To be concrete, I quote from Executive Board Member Isabel Schnabel’s recent speech. I don’t mean to pick on her, but she expresses the climate agenda very well, and her speech bears the ECB imprimatur. She recommends

"First, as prudential supervisor, we have an obligation to protect the safety and soundness of the banking sector. This includes making sure that banks properly assess the risks from carbon-intensive exposures…"

Let me speak out loud the unclothed emperor fact: Climate change does not pose any financial risk, at the 1, 5 or even 10 year horizon at which one can conceivably assess the risk to bank assets.

“Risk” means variance, unforeseen events. We know exactly where the climate is going in the next 5 to 10 years. Hurricanes and floods, though influenced by climate change, are well modeled for the next 5 to 10 years. Advanced economies and financial systems are remarkably impervious to weather. Relative market demand for fossil vs. alternative energy is as easy or hard to forecast as anything else in the economy. Exxon bonds are factually safer, financially, than Tesla bonds, and easier to value. The main risk to fossil fuel companies is that regulators will destroy them, as the ECB proposes to do, a risk regulators themselves control. And political risk is a standard part of bond valuation. 

That banks are risky because of exposure to carbon-emitting companies, that carbon-emitting company debt is financially risky because of unexpected changes in climate, in ways that conventional risk measures do not capture, that banks need to be regulated away from that exposure because of risk to the financial system is nonsense. (And if it were not nonsense, regulating bank liabilities away from short term debt and towards more equity would be a more effective solution to the financial problem.) 

Next, a pervasive regime essentially of shame, boycott, divest and sanction

"linking the eligibility of securities as collateral in our refinancing operations to the disclosure regime of the issuing firms. …"

We know where “disclosure” leads. Now all companies that issue debt will be pressured to cut off disparaged investments and make whatever “green” investments the ECB is blessing. 

Last, the ECB should print money directly to fund green projects:

"reassessing the benchmark allocation of our private asset purchase programmes. In the presence of market failures, …the market by itself is not achieving efficient outcomes."

Now you may say, “climate is a crisis. Central banks must pitch in and help the cause. They should just tell banks to stop lending to the evil fossil fuel companies, and print money and hand it out to worthy green projects.”

But central banks are not allowed to do this, and for very good reasons. A central bank in a democracy is not an all-purpose do-good agency, with authority to subsidize what it decides to be worthy, de-fund what it dislikes, and to force banks and companies to do the same. A central bank, whose leaders do not regularly face voters, lives by an iron contract: freedom and independence so long as it stays within its limited and mandated powers. 

The ECB in particular lives by a particularly delineated and limited mandate. For very good reasons the ECB was not set up to decide what industries or regions need subsidizing and which should be scaled back, accordingly to direct bank investment across Europe, to set the price of bonds, and and to print money to subsidize direct lending. These are intensely political acts. In a democracy only elected representatives can take or commission such intensely political activities. If I take out the words “green,” you, EU member states, and EU voters would properly react with shock and outrage at this proposal.

That’s why this movement goes through the convolutions of pretending that defunding fossil fuels and subsidizing green projects — however desirable — has something to do with systemic risk, which it patently does not. 

That’s why one must pretend to diagnose “market failures” to justify buying bonds at too high prices. By what objective measure are green bonds “mispriced” and markets “failing?”  Why only green bonds? The ECB does not scan all asset markets for “mispriced” securities to buy and sell after determining the “right” prices. 

Here is another way to put the observation. There are two interpretations of the proposal: 

a) We looked evenhandedly at all the risks to the financial system, like those listed on the last slide, and the most important financial risk we came up with just happens to be climate. 

b) We want to get involved with climate policy. How can we shoehorn that desire into our limited mandate to pay attention to financial stability?  

How do you interpret the proposal? I think it’s pretty obvious that the answer is the latter — or at least that the vast majority of people reading it will interpret it as the latter which is what counts to my point. 

Feeding this perception is the central omission of this speech, and everything else I have read on the subject: any concrete description of just how carbon sins will be measured.

At face value, “carbon emitting” does not just mean fossil fuel companies, but cement manufacturers, aluminum producers, construction, agriculture, transport, and everything else that emits carbon. Will the carbon risk and de-funding project really extend that far, in any sort of honest quantitative way? Or is “carbon-emitting” just a code word to hound the politically unpopular fossil fuel companies? 

In the disclosure and bond buying project, who will decide what is a green project? Already, cost-benefit analysis— Euros spent per ton of carbon, per degrees of temperature reduced, per Euros of 2100 GDP increased, is pretty shoddy in this area.  By what process will the ECB avoid switchgrass, corn ethanol, high speed trains to nowhere, and other past follies? How will it allow politically unpopular projects such as nuclear power, carbon capture, natural gas via fracking, residential zoning reform, or geo-engineering ventures, which all, undeniably, scientifically, lower carbon and global temperatures; or adaptation projects which undeniably, scientifically lowers its GDP cost? 

Actually, where is this analysis for the whole program? Before embarking, I challenge the ECB to calculate  how many degrees this plan will lower global temperatures, and how many euros of global 2100 GDP it will raise in any sort of transparent verifiable and credible way. Never mind the costs, just quantify  the benefits. 

How then will the ECB resist political pressure to subsidize all sorts of boondoggles? If the central bank does not have and reveal neutral technical competence at making this sort of calculation, the project will be perceived as simply made up numbers to advance a political cause. And all of the central bank’s activities will be then tainted by association. 

This will end badly. Not because these policies are wrong, but because they are intensely political, and they make a mockery of the central bank’s limited mandates. If this continues, the next ECB presidential appointment will be all about climate policy, who gets the subsidized green lending, and who got de-funded, what the next set of causes is to be, not interest rates and financial stability. Board appointments will become champions for each country’s desired subsidies.  Watch US Supreme Court appointments for a preview. Countries and industries that lose out will object. This is just the sort of institutional aggrandisement that prompted Brexit. 

If the ECB crosses this second Rubicon — buying sovereign and corporate debt was the first — be ready for more. The IMF is already pushing redistribution. The US Fed, though it has so far stayed away from climate, is rushing to “inclusive” employment and racial justice. There lots of problems in the world. Once you start climate policy, and so obviously break all the rules to do it, how can you resist the clamor to de-fund, disclose, and subsidize the rest? How will you resist demands to take up regional development, prop up dying industries, subsidize politician’s pet projects, and all the other sins that the ECB is explicitly enjoined from committing?

A central bank that so blatantly breaks its mandates must lose its independence, its authority, and people’s trust in its objectivity and technical competence to fight inflation and deflation, regulate banks, and stop financial crises.

A positive piece of advice: Go ask for an expanded mandate. If the EU explicitly tasks the ECB with implementing carbon policies via defunding, bank regulation, and subsidized investment, all of my objections vanish. An explicit mandate to address climate, and only climate, would also help the ECB to defend against the coming demand that it move on to every other problem.


The western world faces a crisis of trust in our institutions. And that crisis is fed by a not inaccurate perception that the elites who run our institutions don’t know what they are doing, are politicized, are expanding actions beyond the authority granted by  accountable representatives. 

Trust and independence must be earned, by evident competence and institutional restraint.

Yet central banks, not obviously competent to target inflation with interest rates, floundering to stop financial crisis by means other than wanton bailouts, not beginning to address obvious risks lying ahead, now want to determine and implement their own climate change policy? (And, next to move into inequality and social justice?)  [note: the previous comments are the subject of the just-as-fiery first 2/3 of the talk, here.]

We don’t want the agency that delivers drinking water to make its list of socially and environmentally favored businesses, and start turning off the water to disfavored companies. Nor should central banks. Provide liquidity, period. 

Yes, there is a popular movement that wants all institutions of society to jump in to the pressing social and political goals of the moment, and the heck with boring legalities. But I hope everyone in this room understands those constraints are essential for a functioning democratic society, for functioning independent technocratic institutions, and incidentally for making durable progress on the important social and political goals.

Working for a central bank is a bit boring, I admit. One may feel a longing to do something that feels more important, help the world on its big causes. One may feel longing for the approval of the Davos smart set. How does Greta Thunberg get all the attention? But a central bank is not the Gates foundation, which can spend its money any way it likes. This is taxpayers' money, and regulations use force to transfer wealth between very unwilling people. A central bank is a government agency, not a philanthropic fund. Central bankers are public servants, just like the people who run the DMV. If it's too boring and does not feel fulfilling, get another job.  

Central banks must be competent, trusted, narrow, independent, and boring. A good strategy review should refocus central banks on their core narrow mission, and let the other institutions of society address big political causes. Boring as that may be.  


Update. A correspondent educates me on the actual legal foundations of the ECB. We know the ECB has an inflation mandate, but on what basis does it regulate banks, engage in "macro prudential" policy, buy (perpetually, it seems) sovereign bonds and corporate bonds? Does it have authority to start a climate project? 

"The ECB has a mandate regarding the use of macroprudential policy instruments, which comes in the scope of its banking supervision mandate as laid down in the SSM regulation (“Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions”).

In particular, the ECB has the responsibility to assess macroprudential measures adopted by the national authorities in the countries within the ECB’s Banking Supervision (currently = euro area countries) and it has the power to apply, more stringent capital measures aimed at addressing risks to financial stability (e.g. countercyclical capital buffer rates). So, it’s asymmetric w.r.t. macroprudential policy.

The ECB Governing Council delegated the preparation of macroprudential policy decisions to the “Directorate General Macroprudential Policy and Financial Stability”, which belongs to monetary policy part of the bank. The Governing Council always has the last say, also on decisions by the SSM Supervisory Board.

Overall, one could say that it is a financial stability mandate related to risks in the banking sector. And then there is the price stability mandate (Article 127 (1) of the Treaty)  that can have a broad interpretation: 'Without prejudice to the objective of price stability', the Eurosystem shall also 'support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union.'"

Those last few lines open a door. But it does not seem the ECB can come up with its own climate policy, it would have to follow EU climate policy, i.e. the list of favored and unfavored industries. 

But my point goes beyond legalities. Do the majority of EU taxpayers, and member states, believe and agree the ECB has authority to start up its own independent climate policy,  force banks do de-fund the ECB's choice of unpopular industries, force "disclosure" on corporate bond issuers, and pick and choose green projects to subsidize with printed money? If not, even that last sentence is thin ice. 

Later, my correspondent adds

Article Art 127 (1) also states

“The ECB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources, and in compliance with the principles set out in Article 119.”

 Art 119 (3) includes 

“These activities of the Member States and the Union shall entail compliance with the following guiding principles: stable prices, sound public finances and monetary conditions and a sustainable balance of payments.”

Hmm. Maybe in the current environment such lovely language is best left alone! 

PS: Similar unasked for advice to the OECD, in a previous blog post.



In a series of tweets, Nathan de Arriba-Sellier argues that in fact the EU has passed climate legislation, that in his view, authorizes what the ECB is doing. His article.  The ECB is interestingly not making a big deal that they are only following directive. I don't want to delve into EU legalities, because of course I don't know a lot about it. But perhaps EU voters need to know a bit more what the EU is up to! 

Update 2: 

Of course taking on a policy mantle that might be justified somewhere in vague EU language is one thing, but the ECB clearly is not embarking kicking and screaming on climate because the EU is making it do so. 

Yvan Langwiler and Athanasious Orphanides have an extensive Options for the ECB’s Monetary Policy Strategy Review. Its climate section makes a lovely point: 

The ECB could apply a CO2 criterion not only to the assets it purchases, but also to the collateral framework, excluding bonds from companies that do not meet its CO2 standards as acceptable collateral in refinancing operations. This would make such bonds significantly less attractive and increase the financing cost of such corporations.
In principle, the ECB could go even further and apply such a criterion also to government debt. For example, it could allocate its purchases of sovereign debt not just on the basis of the capital key of each Member State but on the basis of a capital-and-ecological key. It could also raise haircuts on sovereign debt of Member States with high CO2 emissions. This would ease financial conditions in countries that are the best in terms of CO2 emissions, and worsen it for countries that are particularly harmful in this respect. The heterogeneity of the carbon footprint of member countries of the euro area is considerable, as can be seen from Figure 14.
Such a policy could provide an incentive for Member States to improve their carbon footprint. It is also quite obvious that the ECB could easily be accused of overstepping its mandate by doing this, that it would be ultra vires.


  1. "lives by an iron contact"?

    don't you mean iron contract?

  2. by an iron contact. little typo, think u mean contract?
    As Western Civ. continues to fall down the rabbit hole, things seem to become curiouser and curiouser.
    When i started to read the post, i thought to myself: hope he speaks about time frames.
    Will now go read the PDF. Glad to hear someone speaking out re the nonsense, but hope it not falling upon deaf ears.

  3. One of the things mask deniers (I'm not sure what to call them? The selfish people who refuse to wear masks) will point to is the CDC's original guidance for people to NOT wear masks because they wouldn't necessarily be effective. This was a transparent lie the CDC chose to promote in an effort to ensure masks were not hoarded by the public so that they would be available to medical practitioners. In lying, they allowed trust in them to be eroded at the start of a pandemic. Not a good idea.

    I assume they did this because if they'd gone out and said "we don't have masks for everyone so please don't hoard them so that our doctors/nurses have them", it would have caused hoarding. It should be noted if economists had not urged cutthroat efficiency-pursuing globalized supply chains, a mask shortage would not have been an issue as America's factories could have just produced more (in factory-heavy countries masks did not run out).

    Like the CDC, central banks run a tremendous risk of encouraging the opposite of good behavior by trying to manipulate the public with mind games rather than straightforward, honest, and direct communication. Ironically, the Fed has been moving more towards direct communication over the last decade, so maybe that is emboldening them to start communicating about things beyond their purview.

    Ultimately, the ends do not justify the means and these institutions need to be more honest and transparent to restore confidence and faith in institutions and authority as a whole. I fear the opposite is going to be the prime narrative theme of the 21st century.

  4. Good post. IMHO simple fuel taxes, rising slowly but steadily, are the best way to handle potential CO2-induced climate warming, and could be used to reduce taxes on employee incomes.

    Central banks have nothing to do with it.

    1. And when a government that collects fuel taxes is a large emitter of CO2, how do those taxes dissuade that government from continued emissions?

    2. Exactly right.
      It is a double sided trade, emitter and damaged. When looking for the correct model look at tort as the assumption is a tort judge is a small, negligible player.

  5. Isabel Schnabel is referring to regulatory risk--the risk that petroleum and natural gas, propane, ethane, natural gasolines, napthas, etc., will be rendered obsolete as fuel sources by legislation in the EU. A commercial bank having "exposure" to firms that rely on those fuels or process inputs could see, in her view, a decline, perhaps a dramatic decline, in the value of its portfolio of loans (assets). To the extent that the ECB has exposure as a lender of last resort, her concern is well validated. It is doubtful that the ECB itself would regulate against a specific sector or an energy type. But, as a 'straw man', the ECB is an easy target to set up and then knock down.

    1. Most commercial banks don't retain a lot of the loans that they make. Instead they are sold off to pension funds, insurance companies, and other investment vehicles. And so I don't believe the risk is to commercial banks themselves - they can always adjust their lending terms to accommodate regulatory risk. The risk is to the second hand buyers of those loans. A large regulatory change could put those existing debt contracts at risk.

    2. This is a great point -- banks largely originate and distribute, especially large corporate bond holdings, e.g. fossil fuel companies. But, aha, now central banks are widening their mandate to look for "risks" throughout the financial system outside banks. Hedge funds might hold such bonds, for example. Under the expanded look for risk everywhere mandate, they can start making everyone "disclose" climate risks, or stop banks from handling loans because they might be distributed elsewhere.

    3. Gosh John, do you think allowing commercial banking, investment banking, and insurance to be all run out of the same shop is still a good idea? If so, then why not just throw some green energy companies (solar, wind, etc.) under the same umbrella?

      You say, central bank mission creep begins with a central bank getting off it's core duties. I say, central bank mission creep began when some central banker who will remain nameless decided to team up with some former Wall Street Treasury Secretary who will remain nameless and combined commercial banking, investment banking, and insurance.

      You tell me when Glass Steagal is going to be reinstated in full, and then you will know when the U. S. central bank will go back to it's core function.

    4. The ECB embarked on a programme of purchasing corporate debt of european companies in the secondary market during the pandemic downturn this year. Private power utility corporation debt has been acquired by the ECB through that programme. Many of those corporations rely on petroleum (oil and/or natural gas) or coal for their primary energy. The ECB also purchased the corporate bonds of oil and gas producers and distributors, e.g., Shell, through this programme. The argument from the 'green' lobbyists' faction is that these purchases go against the 2015 Paris Agreement proposal to limit overall global atmospheric temperature increase to 1.5 Celsius degrees by the year 2100, and as such the ECB is funding the very companies that the 'green' lobbyists should not be supported by public investment. That is one argument.

      A second argument arises from commercial banking loan syndications which are a principal means of funding corporate operations through the banking sector. To the extent that syndicated loans are to corporations whose operations and profits are petroleum-dependent and coal-dependent and hence subject to 'asset stranding' risk, the systematic risk of the commercial banking sector is increased, and this should be a concern of the ECB relative to its price-stability mandate. Naturally, one would want to evaluate the actual prospects of 'asset stranding' within the term horizon of such syndicated loans--if the prospect is small to negligible, then the effect on systematic risk is likely to be correspondingly small. Conversely, if the risk of 'stranding' is moderate to high, then the effect on systematic risk is commensurably higher and not negligible. It is to the advantage of 'green' lobbyists to play up the risk, if it is truly small or negligible, in order to advance their social agendas; conversely, it is to the advantage of bank borrowers, and perhaps the banks themselves, to play down the risk, if the risk is non-negligible or high, in order to give themselve time to adjust their operations or sell those assets off at a price acceptable to their owners.

      The EU and USA differ in their banking systems, and it would be an error to conflate the two and say that the EU banking sector operates in the same way that the US banking sector does. The remarks by "FRestly" should be viewed as coming from a US banking system perspective.

  6. I agree with your message about the appropriateness of central banks fighting climate change. But what about the gillet jaunes? We are coming on two years now of a protest started by raising fuel taxes. I doubt the political will of democracies in support of carbon taxes. Or do i need to think harder about the incidence on the consumer classes?

    1. So if the deplorables vote against it, unaccountable international institutions should shove it down their throats? I have read a lot about "eco-authoritarianism" but it is a dangerous idea.

    2. i said I agree with you on the unaccountable institutions. But your preferred solution wont happen without huge political pain. What are the third+ options?

  7. To be frank, in order to make clear that taxes are not rising but shifting from income to negative externatities politicians ought to bundle an increase in taxes on fuels with a decrease in taxes for income. The question is whether the politicians want to do so as they might, due to a type of agency problems, prefer to spend the new cashflows on prestige projects, entrenchment (by solely benefiting their likely voters with new expenditures.) etc.

  8. Excellent post. A brief comment on the attached ECB conference paper. You mention that it might be better to target the TIPS spread rather than the nominal interest rate. I agree. As an aside, ever since the 1980s, a group of us have been advocating that central banks target market expectations of inflation (or NGDP growth). There are of course a variety of ways of doing so, including TIPS spreads.

    The fact that economists can't even agree as to whether raising interest rates is expansionary or contractionary is reason enough not to use rates as the policy instrument. Imagine if a driver didn't know which way the car moved when you turned the wheel to the right!

    I also agree that price level targeting is superior to inflation targeting (partly because it allows for less discretionary mischief.)

    1. Scott,

      TIPs have an element of legislative risk that must be recognized - they were not voted into existence by Congress (see U. S. federal register, circa 1996-1997), but remain as a liability of the government. As such, it is fully within the power of Congress (facing a budget constraint) to define the inflation component any way they see fit (for instance 0%) or in the very least redefine the CPI once again (see 1983 elimination of houses, see 1996 Boskin Commission).

      My own opinion is that if a government needs to rely on post-hoc inflation to eat away at the value of it's debt, then it shouldn't be borrowing. Instead, it should be selling equity where the buyer is aware of the risk before purchasing the security (see Social Security as example). The only problem with Social Security is the mandate.

    2. Inflation doesn't actually reduce the debt burden, because inflation is factored into nominal interest rates. A surge in inflation would reduce the debt burden, but in recent decades inflation has actually been trending downward, it's been less than anticipated, so it's made the debt burden worse.

    3. Scott,

      Future inflation is not factored into existing loans. For instance the 15%+ post-hoc inflation of the late 1970's in the U.S. was not factored into loans made in the late 1960's.

      As far as the "debt burden" goes, the easiest way to reduce the debt burden is to rely on the sale of equity rather than debt (bonds). For whatever reason unknown to me - economists, policy makers, and politicians have yet to figure this out.

    4. Scott,

      Future inflation is not factored into existing loans. For instance the 15%+ post-hoc inflation of the late 1970's in the U.S. was not factored into loans made in the late 1960's.

      As far as the "debt burden" goes, the easiest way to reduce the debt burden is to rely on the sale of equity rather than debt (bonds). For whatever reason unknown to me - economists, policy makers, and politicians have yet to figure this out.

  9. The central bank's concern with climate change is one half of the macroeconomic equation. Taxes are the other half. The democrat's plan to lower carbon emissions means electricity and transportation inputs will have to be increased to produce the same outputs. Coupled with increased marginal tax rates, capital intensity will be reduced. This translates to reduced employment. A decline in capital stock. A decline in real GDP and real HH consumption. The CBO's 2030 projections for employment, capital stock, real GDP and HH consumption puts the central bank in a real bind. Tax more? Print more? Choose inflation, another tax, more? Finally, If one is interested see: Oct 20 Hoover Daily-Report, An Analysis Of Vice President Biden's Agenda. The Long Run Impacts of Regulations, Taxes and Spending. It ain't pretty!

  10. How was this talk received?

  11. Question for David Seltzer ... October 21, 2020 at 5:04 PM ....
    "electricity and transportation inputs will have to be increased to produce the same outputs"
    What do you mean by that phrase? I'm not asking about money flow. I am asking about real resource inputs.

    1. I'll answer for David. Suppose you can keep the lights on for 10 c / kWh by burning natural gas, or 20 c / kWh from solar cells. Ignoring the production, installation, etc. the solar cells don't make carbon, of course. Leaving out the anti-carbon benefits, the economy is using more resources to do the same thing. The resources making solar cells could be making iPhones, which you essentially get for free if you burn the gas rather than make use and install the solar cells. Now the solar cells don't make carbon, which is good. But the value of carbon saved had better be 10 c / kWh.

    2. E5 and John,

      There are life span issues to consider. Solar panels are generally guaranteed optimum electrical output for 30 years while gas wells run dry in about 10-11 years. And they (solar panels) are a technology that will improve over time (iPhone #1, #2, #3, etc.).

      And so how many real resources are used to locate, drill, and extract gas from a new well 3 times over 30 years?


      The problem with solar isn't the cost per se.
      It is it the intermittent nature of solar energy.
      Obviously you want your lights and heat turned on at night when there is no sun.
      Battery and other storage technologies are the big hiccup, but the technology behind them is improving as well.

    3. The cited article (https://news.energysage.com/solar-energy-vs-fossil-fuels/) is a poor source of information for a discussion such as this one.

      Comparing a simple cycle natural gas turbine driven electrical generation plant against a distributed roof-top solar photovoltaic panel installation on a commercial building or on a single-family residential housing unit ('house') is fraught with difficulties. The SCNG turbine generating plant is 'dispatchable', i.e., it produces electricity on demand. The solar photovoltaic panel output is 'non-dispatchable', i.e., it cannot produce electricity on demand (e.g., during non-daylight hours, or during the daylight hours under over-cast skies). The two different and distinct technologies serve different markets and different regions of the country.

      The cost of green-house gas emissions from stationary plants (coal or natural gas electrical generating plants) at a carbon tax rate of $30 per metric ton of CO₂-equivalent ("per mt-CO₂-eq.") is $0.022 per kilowatt-hour for a simple cycle turbine operating on natural gas (1,000 Btu/cu.ft.) at an efficiency rate of 25%.

      A solar photovoltaic panel offering electricity at $0.20 per kWh couldn't compete with a simple cycle gas turbine plant producing electricity for $0.10 per kWh ex carbon tax or $0.122 per kWh cum carbon tax. If we're talking about marginal costs for the next 1 kWh, then the cost of fuel for the solar PV panel is effectively zero, but the fuel cost for the simple cycle gas turbine is positive. For short periods of time during the peak afternoon demand period on days with clear skies, the solar PV panel beats the simple cycle gas turbine generating plant. But would you build a solar PV electrical generating plant on the off-chance that you could sell electricity only during sunny periods of the day? Perhaps in California you might consider it.

      Perhaps, like the author of the cited on-line article, you might suggest that "If only the government would stop 'subsidizing' fossil fuels...", solar and wind would become predominant sources of primary energy in the USA. One would then have to define what one means by 'subsidizing' fossil fuels and subsequently prove that fossil fuels are in fact subsidized--it's easier said than done. The author of the cited on-line article doesn't even try, which must tell us something.

  12. Mr Cochrane, I found your video very interesting. Especially the first part about the correlation between inflation and interest rates. Why is it that central banks have been getting this wrong for so long, while overwhelming evidence is staring them in the face?

    1. YuShan,

      Correlation is not causation (as any good statistician will tell you).

      A central banker will only know the effect of the money that he lends after he lends it. Whether that borrowed money is used for productive purposes or for consumption or destructive purposes (wars), is completely out of their (central banker) hands.

      It's not that central banks have been "getting it wrong". It is that borrowers have been "getting it wrong" - they are the ones that deploy the borrowed money into the economy.

    2. "The borrowers have been getting it wrong"

      That is a weird thing to write. The theory that underlies the central bank monetary policy is supposed to understand how the mechanics work. That includes the behaviour of borrowers.

      If the opposite happens from what your theory tells you, your theory is simply wrong! It keeps surprising me that central bankers keep sticking to the same dogmas. It is not just stupid, it is very harmful, because the bad "medicine" blows up ever bigger asset bubbles that undermine stability, require even bigger policy response, etc. It's truly scary.

    3. YuShan,

      "The borrowers have been getting it wrong. That is a weird thing to write."

      Not really. First let us dispense with the moralistic "right/wrong" notation. The core function of a central bank is to act as lender of last resort. They are not given the power to selectively decide which loans will result in higher real growth and which will lead to higher inflation - that is what the private banking industry (for personal / business loans) and for Congress (for government loans) are left to decide.

      The central bank is tasked by Congress to maintain price stability. And so how do they do that when they don't get to pick and choose which loans to accept / reject?

      On a first order level, they do that by adjusting the nominal interest rate based upon loan demand. The graph in John's paper fails (and most Taylor rules) fail to take that into account - how does the interest rate affect the demand for loans?
      As the demand for loans / credit rises, the central bank can raise the interest rate in response.

      On a second order level, the central bank can look at trends in productivity, inflation / credit defaults, and other indicators to gauge how that previously borrowed money is being used. And so even in the face of high loan demand, a central bank may refrain from raising the interest rate if those loans are resulting in higher real economic growth.

      So "the borrowers have been getting it wrong" is absolutely the right way to describe central bank policy of the 1970's. If the borrowers had got it right in the 1970's, the central bank could have maintained a stable interest rate policy (see Greenspan Fed about 1992 through 2000).

    4. YuShan,

      Think of central banking as process control.

      The input is the interest rate the central bank is willing to lend at.

      The immediate feedback loop is the willingness of borrowers at that interest rate.

      The output and delayed feedback loop is how much real GDP and inflation you get at the interest rate being offered.

  13. John H. Cochrane; October 23, 2020 at 9:30 AM
    Different resources consumed.
    1. Consumption of a certain amount of natural gas drawn from a well (that will run dry), and use of the transportation and generating equipment involved, and the losses along the way, and all the efforts of people to make that happen.
    2. Consumption of a certain amount of the output of a device that has been constructed from certain resources, that will need to be replaced after a certain time, and all the efforts of people to make that happen.
    Comparing those two, in terms of resources consumed, is not so easy. Some of the resources have a superficial similarity, if you are willing to equate an hour of roughneck work drilling a well with an hour of maintenance technician work in a silicon foundry. Others bear no comparison. What resource in #2 would you consider equivalent to fossil hydrocarbon reservoir depletion?
    The money-based comparison only looks at the matrix of people's willingnesses to exchange a multiplicity of commodities, for other commodities, right now. And it makes no allowance for the value of preparing for a time in the not-too-distant future when the money-based comparison will yield the opposite answer.

  14. I understand your point about creating mandates or not, but really it just seems like the wrong tool. Carbon tax. Okay. Maybe there's a tax on all fossil fuel related business (sort of like a Tobin tax to throw sand in the wheels of international capital markets to slow capital flows) so that it generally is taxed on the output and input side, all to discourage fossil fuels. But still that's not the role of a monetary authority.
    Your deeper economic point is that these institutions and so, so many economists fought for so long for central bank independence so they could focus on the one thing we THINK just maybe they can control in the long run: inflation. Then we all worried about the best instruments to achieve that: monetary aggregates, Taylor-type rules or pure rules vs discretion, etc. and the opinion is solidly on the side of rules of some form. After all that work. After all the apparent success of the great moderation. After most countries around the world adopt some sort of CB independence and maybe formal inflation targeting ... after all that, the "developed" economy central banks sneak in through the back door political objectives and erode their own central bank independence (read John's comments on MMT which is all about mixing monetary and political/social justice objectives). Once the ECB, FED, Bank of England, of Canada, etc. do this and the IMF etc push for it globally, central bank independence is going to crumble as every EM's bank follows suit.
    That's the danger. And then... what happens? The economy is in the toilet and there are no funds to finance green projects :-) (Sorry, I had to end a little extreme).

  15. To be pedantic, the chastity prayer comes from St. Augustine.

    More relevant, let's go back to M Friedman. If the Fed targets the money supply and forgets about interest rates, do we have any of those tiresome neo-Fisher stories?

    1. Fixed! Yes of course. Thanks. Neo-Fisher is really about rational vs. adaptive expectations, not about money vs. other methods for raising interest rates, so yes. But remember it only works for widely anticipated, slow, steady, persistent interest rate rises, so most of your intuition about sudden, unexpected, temporary monetary shocks does not apply.

    2. Anonymous,

      Also, remember that the neo-Fisher story does not address how interest rates affect the demand for credit or how that borrowed money is used.

      If the Fed raises the interest rate it is willing to lend at and credit growth slows or contracts, then inflation is likely to either remain stable or fall.

      If the fed raises the interest rate it is willing to lend at, credit growth remains steady, and productivity increases, again inflation is going to remain stable or fall.

      I don't know if economists are just terrible at mulitiple variable math (productivity, inflation, credit growth, interest rate) or if they just like simple stories to tell policy makers.


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