## Tuesday, December 29, 2020

### Unintended consequences

The Dec 14 Wall Street Journal amplifies my warnings on the movement to de-fund fossil fuels by financial regulation, citing "climate risks."
"The Senate Democrats’ Special Committee on the Climate Crisis recently issued a report detailing how the Fed and eight other regulatory agencies should penalize investment in fossil fuels and promote green energy. They claim financial institutions are underpricing the risk that carbon-intensive assets will become “stranded.”
Mind you, their worry isn’t about how climate change per se would devalue investments, which financial institutions already account for. They want a warning about the costs of government climate policies. “Because Congress has not advanced any comprehensive climate policies in the last decade, the market has not priced in the possibility of significant federal action,” the report notes."

As reported this is at least a refreshing breath of honesty. In all I have read (not everything, it's a mountain) of the BoE, ECB, BIS, OECD, IMF treatment of "climate risk," there is a vague insinuation that climate itself poses a "risk," which is utter nonsense. Beyond nonsense, it is a directive for banks to make up numbers in order to justify de-funding politically unpopular fossil fuel projects. (In case that's not obvious, climate is not weather. The tails of the weather distribution and their minor effect on the profitability of large corporations are better known than just about any other risk, at horizons where bank supervision and risk management operate.) Here, it is at least clear that the relevant "risk" is the risk that Congress or the administrative state will shut down businesses.

Actually, if taken seriously, honestly and generally, I might be all for it. Yes! Let our financial regulators require that firms and the banks who fund them disclose and account for all of the political risks that future government action might take to harm them -- law, regulation, administrative decisions, and prosecution. Indeed, state every possible nitwit regulation, idiotic tariff (Dec 29 WSJ is a masterpiece of how arbitrary  administrative decisions make or break companies), or ridiculous law or politicized prosecution might harm the company or investment.  Let's make this really tough -- criminal penalties for failing to disclose ahead of time that, say, the government might challenge a decade-old merger, or decide with a secret algorithm that it doesn't like the interest rates you charged or who you hired, or decide (Wal-Mart) to sue you for prescriptions you are legally required to fill. While we're disclosing financial risks, let's disclose the risk that a future Congress might remove the long list of subsidies and protections that your green projects live on. The long lists of well documented potential mischief would be edifying!

OK, I'll stop dreaming. This isn't serious, it isn't about climate in any vaguely sensible cost-benefit way, it's about fossil fuels. It's about de-funding fossil fuels before alternatives are available at scale, by capturing the regulatory system because the people's elected legislators are not about to do it. (In the US.)

## Thursday, December 24, 2020

### Christmas in Quarantine

A merry Christmas -- or whatever you celebrate this time of year -- in quarantine, from a favorite band.

## Wednesday, December 23, 2020

### Techsodus/Techsit politics.

The tech industry is fed up and leaving San Francisco in particular, the valley and California in general. Covid, like a war, speeds things up. If you're a young economist you could do worse than study this latest chapter in the (likely) decline of great cities (SF, NY, LA? Chicago?) and the movement of people and industries to friendlier, safer, and more welcoming climates. If you're a young political economist, whether they bring with them the politics that destroyed the places they left behind -- slash and burn progressivism -- will be equally interesting to watch.

I ran across a great essay on this saga by Mike Solana

The latest fashion is to claim it's immoral for tech founders and companies to leave, after they have "extracted" so much wealth here. Mike skewers this new fashion, pointing out that tech companies and their founders created wealth here.  Microcode is not mined like gold.

I take extreme issue with the notion that industry leaders have taken something from the “community,” ...This is precisely the opposite of reality. ... They are the network. Technology workers do not “extract” value from the region, they are what makes the region valuable.

...the Bay Area’s nativist, anti-immigration political climate has certainly not created the tech community, which is populated largely by immigrants, be they from out of the state or out of the country

But he really digs in on the culture and politics that is going to send this golden goose packing to Austin:

the technology industry has brought tremendous tax revenue to the Bay Area. The budget of San Francisco literally doubled this decade, from around six billion to over twelve billion dollars. With our government’s incredible, historic abundance of wealth, the Board of Supervisors has presided over: a dramatic increase in homelessness, drug abuse, crime — now including home invasion — and a crippling cost of living that can be directly ascribed to the local landed gentry’s obsession with blocking new construction. ...

"Landed gentry." That's really good.

### CBDC in EU

I wrote an oped for Il Sole 24 Ore on central bank digital currency, as part of a series they are doing. It's here in their premium edition (gated) here on their blog, in Italian on top and English below. Thanks much to Luciano Somoza and Tammaro Terracciano for translation and inspiring the project.

THE DIGITAL EURO IS A THREAT TO BANKS AND GOVERNMENTS. AND THAT’S OK.

A central bank digital currency (CBDC) is in principle a very good idea. It offers the possibility of very low-cost transactions to households and businesses, especially in securities and international transactions. More excitingly, CBDC offers us a foundation for an efficient and nimble financial system that is completely insulated from recurrent crises.

But CBDC poses a puzzle, as it undercuts many of governments’ and central banks other questionable objectives. Central banks want to prop up conventional banks, who benefit from taking deposits. And governments are unlikely to want to allow the anonymity that is the great attribute of physical cash.

One vision for CBDC basically gives everyone access to bank reserves. Reserves are interest-paying accounts that banks hold at the central bank. When bank A wishes to pay bank B, it notifies the central bank, which just changes the numbers in each account on the central bank’s computer. The transaction can be accomplished in milliseconds, and costs basically nothing. Why don’t we have that? We should.

## Saturday, December 19, 2020

### Bisin on MMT Rhetoric

Alberto Bisin has written an intriguing short review of Stephanie Kelton's The Deficit Myth. Alberto focuses on the rhetoric of MMT and the book. (My review here FYI.)

MMT's rhetoric is surely its most salient feature. It has been phenomenally successful in terms of gaining attention, and it has eschewed all the traditional rhetoric of economics -- academic articles, conference presentations, monographs full of equations, econometric estimates and tests, or even mountains of charts and graphs, PhD students fanning out to develop it.

[In response to JZ comment, that is not necessarily good or bad, it's just a fact. The conventional economic rhetoric produces a lot of garbage, too.  Bryan Caplan has a point. The major distinction may be engagement with critics, which happens in conventional discourse and so far has been largely absent with MMT.]

Kelton's book is unusual in MMT rhetoric for appearing to be one definitive source that would lay it out, following standard rhetoric. The trouble with writing a book is that sometimes people read it carefully, and are emboldened that they aren't missing something in the usual flurry of blog posts tweets and videos. Then the world finds out the ideas in it are empty, the rhetoric artifice rather than explanatory.

(NB, "rhetoric" has gained an unfortunate pejorative in common usage. I mean no such pejorative. How we structure economic discussion is hugely important. If you have not read Deirdre McCloskey's Rhetoric of Economics article or subsequent books, do so immediately.)

Alberto:

The book should be seen as a rhetorical exercise. Indeed, it is the core of MMT that appears as merely a rhetorical exercise. As such it is interesting, but not a theory in any meaningful sense I can make of the word. The T in MMT is more like a collection of interrelated statements floating in fluid arguments. Never is its logical structure expressed in a direct, clear way, from head to toe.

## Thursday, December 10, 2020

### Goodfellows wrap-up

The wrap-up goodfellows for the year, a great conversation with H.R. McMaster and Niall Ferguson, moderated by Bill Whalen who serves up the questions and keeps us on track. >

The podcast version. You can find all the good fellows videos and podcasts here. We'll be back in January.

## Wednesday, December 9, 2020

### Debt denial

Our national debt denial is a new essay on debt. Yes, it repackages many themes from previous essays, but debt is important, and I'm refining things through many efforts. This one is better, I think, than previous efforts.

This appears in a new biweekly column in National Review Online, "Supply and Demand," which I'll be doing with Casey Mulligan.

In French here

***

Does debt matter? As the Biden administration and its economic cheerleaders prepare ambitious spending plans, a radical new idea is spreading: Maybe debt doesn’t matter. Maybe the U.S. can keep borrowing even after the COVID-19 recession is over, to fund “investments” in renewable energy, electric cars, trains and subways, unionized public schools, housing, health care, child care, “community development” schemes, universal incomes, bailouts of student debt, state and local governments, pensions, and many, many more checks to voters.

The argument is straightforward. Bond investors are willing to lend money to the U.S. at extremely low interest rates. Suppose Washington borrows and spends, say, $10 trillion, raising the debt-to-GDP ratio from the current 100 percent to 150 percent. Suppose Washington just leaves the debt there, borrowing new money to pay interest on the old money. At 1 percent interest rates, the debt then grows by 1 percent per year. But if GDP grows at 2 percent, then the ratio of debt to GDP slowly falls 1 percent per year, and in a few decades it’s back to where it was before the debt binge started. What could go wrong? This scenario requires that interest rates stay low, for decades to come, and remain low even as the U.S. ramps up borrowing. The scenario requires that growth continues to outpace interest rates. Most of all, this scenario requires that big deficits stop. For at best, this is an argument for a one-time borrowing binge or small perpetual deficits, on the order of 1 percent of GDP, or only$200 billion today.

Yet an end to big borrowing is not in the cards. The federal government borrowed nearly $1 trillion in 2019, before the pandemic hit. It borrowed nearly$4 trillion through the third quarter of 2020, with more to come. If we add additional and sustained multi-trillion-dollar borrowing, and \$5 trillion or more in each crisis, the debt-to-GDP ratio will balloon even with zero interest rates. And then in about ten years, the unfunded Social Security, Medicare, and pension promises kick in to really blow up the deficit. The possibility of growing out of a one-time increase in debt simply is irrelevant to the U.S. fiscal position.

Everyone recognizes that the debt-to-GDP ratio cannot grow forever, and that such a fiscal path must end badly.

## Monday, December 7, 2020

### Free Market Vaccines

Part 1: Who should get the vaccine first? Sell to the highest bidder. The disease and recession go away faster.

Part 2: The cost of perfection. The vaccine was invented in a weekend, available in February. In free market land, we would not have had a pandemic, or a recession. 284 thousand people would be alive today. That is the cost of FDA "protection."

Part 1: Who should get the vaccine first?

Absolutely nobody* has mentioned in public the free market answer: Sell to the highest bidder.

(Or just allow some sales to the highest bidder. Don't put people in jail for selling some to the highest bidder,)

It's not as dumb as it sounds. Sure, there is an externality. A good vaccine policy might be to give it to those most likely to spread it to others, with the goal of swiftly reducing the prevalence of the disease. That argues for giving the vaccine in bars.

That is not our public policy. The entire discussion centers around who should be protected first, from a disease whose prevalence is taken as given. Old people, nursing homes, health care workers, essential workers -- the argument is not the externality. The argument is entirely who should get the individual benefit of protection from the vaccine.  Just why "to the highest bidder" is wrong is then much less clear.

The case is stronger than usual, for there is a second way to avoid infection: Stay home. Social distance. Wear protective gear. So the question is not, really, "Who should be protected from the virus?" The question is, really, "Who should get a treatment that allows them to be out and about, risking contact with the virus, rather than protect themselves by traditional means?" It is really mainly an economic benefit, avoidance of the cost of other measures to stay healthy. There is an economic answer: people should be out and about first who generate the most economic benefit from being out. And, therefore, are willing to pay the most to get the vaccine.

## Saturday, December 5, 2020

### Hoover is hiring!

Hoover is hiring in its fellows program! This is roughly analogous to an assistant/associate professor position, aimed at new PhDs or people out a few years as postdoc or assistant professor. Information here. Deadline Dec 11. This is a great position for young economists, historians, or political scientists with policy-relevant interests.

## Friday, December 4, 2020

The Fed wants to control inflation. Now, it targets the nominal interest rate. But to do that it has to guess what the right real interest rate is. Nominal interest rate = real interest rate plus expected inflation.

Guessing the right price is hard for any planner, and guessing the right asset price doubly hard. If the Fed wants to target inflation, why not target the spread between real and indexed bonds, and let the level of interest rates float to wherever they want to go by market forces?

Nominal interest rate - real interest rate = expected inflation. So, if the Fed wants to see 2% expected inflation, why not target the difference between one year TIPS (indexed treasurys) and one year treasurys at 2%? Then expected inflation has to settle down to 2%

Indeed, beyond a target, the Fed could really nail this down with a flat supply curve. The Fed could nail expected inflation at 2% by offering to exchange, say, any amount of one-year zero coupon treasury bonds for 0.98 one-year zero coupon indexed treasurys (TIPS). And leave $$r^\ast$$ and a lot of real rate prognosticating in the dustbin.

Obviously, you worry. If the Fed nails the spread at 2%, will everything else really settle down so that expected inflation is 2%? Or is this like holding the tail and hoping the dog will wag? We need to write down a model.

I just wrote such a model. This is part of the long-running fiscal theory of the price level book project. But it is a short independent point which blog readers may enjoy. And, I'm always nervous that I missed something in wild ideas like this (see the whole Neo-Fisherian business) so I enjoy comments.

I start with a really simple version of the model, \begin{align} x_{t} & =-\sigma\left( i_{t}-E_{t}\pi_{t+1}\right) \label{ISspread}\\ \pi_{t} & =E_{t}\pi_{t+1}+\kappa x_{t}.\label{NKspread}% \end{align} Here I have deleted the $$E_{t}x_{t+1}$$ term in the first equation, so it becomes a static IS curve, in which output is lower for a higher real interest rate. This simplification turns out not to matter for the main point, which I verify by going through the same exercise with the full model. But it shows the logic with much less algebra. Denote the real interest rate $$r_{t}=i_{t}-E_{t}\pi_{t+1}.\label{rdef}%$$ We can view the spread target as a nominal interest rate rule that reacts to the real interest rate, $$i_{t}=\alpha r_{t}+\pi^{e\ast}.\label{iar}%$$ The spread target happens at $$\alpha=1$$, but the logic will be clearer and the connection of an interest rate peg and interest spread peg clearer if we allow $$\alpha\in [0,1]$$ to connect the possibilities.

Eliminating all variables but inflation from \eqref{ISspread}-\eqref{iar}, we obtain $$E_{t}\pi_{t+1}=\frac{1-\alpha}{1-\alpha+\sigma\kappa}\pi_{t}+\frac {\sigma\kappa}{1-\alpha+\sigma\kappa}\pi^{e\ast}.\label{pidynsimple}%$$

For an interest rate peg, $$\alpha=0$$, $$i_{t}=\pi^{e\ast}$$, inflation is stable -- the first coefficient is less than one -- but indeterminate.

We complete the model with the government debt valuation equation, in linearized form $$\Delta E_{t+1}\pi_{t+1}=-\Delta E_{t+1}\sum_{j=0}^{\infty}\rho^{j}% s_{t+1+j}-\Delta E_{t+1}\sum_{j=0}^{\infty}\rho^{j}r_{t+1+j}% ,\label{fiscalclose}%$$ which determines unexpected inflation. We have a simplified version of the standard new-Keynesian fiscal theory model.

(Targeting the spread rather than the level of interest rates does not hinge on active fiscal vs. active monetary policy. In place of \eqref{fiscalclose}, one could determine unexpected inflation from an active monetary policy rule instead. One writes a threat to let the spread diverge explosively for all but one value of unexpected inflation, in classic new-Keynesian style. In place of $$i_{t}=i_{t}^{\ast }+\phi(\pi_{t}-\pi_{t}^{\ast})$$, write $$i_{t}-r_{t}=\pi_{t}^{\ast}+\phi (\pi_{t}-\pi_{t}^{\ast})$$, where $$\pi_{t}^{\ast}$$ is the full inflation target, i.e. obeying $$\pi_{t}^{e\ast}=E_{t}\pi_{t+1}^{\ast}$$ and $$\Delta E_{t+1}\pi_{t+1}^{\ast}$$ the desired unexpected inflation. )

If the interest rate target responds to the real rate $$\alpha\in(0,1)$$, the model solution has the same character. As $$\alpha$$ rises, the dynamics of \eqref{pidynsimple} happen faster, so inflation dynamics behave more and more like the frictionless model, $$\kappa\rightarrow\infty$$.

At $$\alpha=1$$, the spread target $$i-r=\pi^{\ast}$$ nails down expected inflation, as we intuited above. Equation \eqref{pidynsimple} becomes $E_{t}\pi_{t+1}=\pi^{e\ast}.$ Equation \eqref{fiscalclose} is unchanged and determines unexpected inflation, though the character of discount rate variation changes.

Inflation is not zero, but it is an unpredictable process, which in some sense is as close as we can get with an expected inflation target. Output and real and nominal rates then follow \begin{align*} x_{t} & =\frac{1}{\kappa}\left( \pi_{t}-\pi^{e\ast}\right) \\ r_{t} & =-\frac{1}{\sigma\kappa}\left( \pi_{t}-\pi^{e\ast}\right) \\ i_{t} & =\pi^{e\ast}-\frac{1}{\sigma\kappa}\left( \pi_{t}-\pi^{e\ast}\right) \end{align*} A fiscal shock here leads to a one-period inflation, and thus a one-period output increase. Higher output means a lower interest rate in the IS curve, and thus a lower nominal interest rate. The real and nominal interest rate vary due to market forces, while the central bank does nothing more than target the spread.

Of course we may wish for a more variable expected inflation target -- many model suggested it is desirable to let a long smooth inflation accommodate a shock. It's easy enough, say, to follow $$\pi_{t}^{e\ast}% =E_{t}\pi_{t+1}=\pi_{t}$$ and even have a random walk inflation. Or, $$\pi _{t}^{e\ast}=p^{\ast}-p_{t}$$ to implement an expected price level target $$p^{\ast}$$ with one-period reversion to that target. Or $$\pi_{t}^{e\ast }=\theta_{\pi}\pi_{t}+\theta_{x}x_{t}$$ in Taylor rule tradition. The point is not to defend a constant peg, but that a spread target is possible and will not explode in some unexpected way.

The same behavior occurs in the full new-Keynesian model, which is also the sort of framework one would use to think about the desirability of a spread target. I simultaneously allow shocks to the equations and a time-varying spread target. The model is \begin{align} x_{t} & =E_{t}x_{t+1}-\sigma(i_{t}-E_{t}\pi_{t+1})+v_{xt}\label{xspread}\\ \pi_{t} & =\beta E_{t}\pi_{t+1}+\kappa x_{t}+v_{\pi t}\label{pispread} \end{align} Write the spread target as $i_{t}-r_{t}=\pi_{t}^{e\ast}.$ With the definition $r_{t}=i_{t}-E_{t}\pi_{t+1},$ we simply have $E_{t}\pi_{t+1}=\pi_{t}^{e\ast}.$ As in the simple model, the spread target directly controls equilibrium expected inflation. Unexpected inflation is set by the same government debt valuation equation \eqref{fiscalclose}. The other variables given inflation and unexpected inflation follow $x_{t}=\frac{1}{\kappa}\left( \pi_{t}-\beta\pi_{t}^{e\ast}-v_{\pi t}\right)$ $$r_{t}=i_{t}-\pi_{t}^{e\ast}=-\frac{1}{\sigma}\left( \pi_{t}-\pi_{t}^{e\ast }\right) +\frac{\beta}{\sigma}\left( \pi_{t}^{e\ast}-E_{t}\pi_{t+1}^{e\ast }\right) +\frac{1}{\sigma}\left( v_{xt}+v_{\pi t}-E_{t}v_{\pi t+1}\right) \label{rit}$$

Following inflation, output still has i.i.d. deviations from the spread target, plus Phillips curve shocks. The real rate and nominal interest rate also have only i.i.d. deviations from the spread target, plus both IS\ and Phillips curve shocks. Output is not affected by IS shocks. The endogenous real rate variation $$\sigma r_{t}=v_{xt}$$ offsets the IS shock's effect on output in the IS equation $$x_{t}=E_{t}x_{t+1}-\sigma r_{t}+v_{xt}$$. This is an instance of desirable real rate variation that the spread target accomplishes automatically. (To obtain \eqref{rit} first-difference \eqref{pispread} and then substitute $$x_{t}-E_{t}x_{t+1}$$ from \eqref{xspread}.)

I conclude, it could work. The Fed could target the spread between indexed and non-indexed debt. Doing so would nail down expected inflation. The Fed could then let the level of real and nominal rates float according to market forces. If every other price that has ever been set free is any guide, real and nominal interest rates would float around a lot more than anyone expects.

The result is almost, but not quite, a holy grail of monetary economics. The gold standard has a lot of appeal, as the Fed needs only exchange dollars for gold at a set rate and do no other grand financial central planning. Alas, the value of gold relative to everything else varies too much. We would like something like a CPI standard, which automatically stabilizes the price of everything else in terms of dollars. But the Fed can't buy and sell a basket of the CPI. Indexed bonds (or CPI futures) are nearly the same thing. And here the Fed just trades one year nominal debt for one year real debt. But it's not quite a CPI standard since it only sets expected inflation, not actual inflation. We still need fiscal policy, or new-Keynesian off equilibrium threats, to pick unexpected inflation. Still, guaranteeing that long-sought "anchoring" of expectations seems like a first step.

What else could go wrong? Well, this is just the first simple model, but it's a step. Obviously it depends on the forward looking Phillips curve. So in that sense it may be best as a longer run target and a regime, in which rational expectations and forward looking behavior are good assusmptions, rather than trying to set expected inflation at a daily horizon or try to do something one time that surprises markets.

I would advise the Fed to start paying a lot more attention to the spread. Next, work on increasing the liquidity of indexed debt. Ideally the Treasury should fix debt markets, vastly simplifying TIPS. I've argued for tax free indexed and non-indexed perpetuities, which would be ideal. But the Fed could and should start offering indexed and nominal term financing, for many reasons. If the Fed is going to buy a lot of long-dated Treasurys, it shold issue term liabilities not just floating-rate overnight reserves. Issing term indexed liabilites is a good next step, and there's nothing more liquid than Fed liabilities! Then start gently pushing the spread to where the Fed wants the spread to go. Start buying and selling bonds to push the spread around. Get to the point of a flat supply curve slowly. Heavens, the Fed doesn't trust interest rate targets and QE enough yet to offer a flat supply curve!

### Walter Williams and Economics

"For 40 years Walter was the heart and soul of George Mason’s unique Department of Economics. Our department unapologetically resists the trend of teaching economics as if it’s a guide for social engineers. This resistance reflects Walter’s commitment to liberal individualism and his belief that ordinary men and women deserve, as his friend Thomas Sowell puts it, “elbow room for themselves and a refuge from the rampaging presumptions of their ‘betters.’

My emphasis on the two best parts. This paragraph is from Don Boudreaux' WSJ oped for Walter Williams. The highlighted phrases (my emphasis) stuck out to me as a brilliant encapsulation of where economics research and practice has gone, as well as teaching, in the last few decades. A guide for social engineers, indeed. Most papers end up with "policy conclusions" that amount to intensely complex advice for all-powerful (yes) and all-knowing (ha) "policy-makers" aka social engineers. Economics was once more about how people searching for a little elbow room are empowered to help themselves and their neighbors.

Walter Williams passed this week and Ed Lazear passed last week. I am not only saddened by their loss, but that stirring bits of  the Chicago - UCLA - George Mason economic philosophy seems to take place increasingly in obituaries.

One tidbit