Monday, January 31, 2022

Infrastructure does not mean roads and bridges, apparently

Congress passed a much-ballyhooed "infrastructure" bill. "Roads and bridges." Well, not much of it went to roads and bridges in the first place, only $110 billion out of $1.2 Trillion went to roads, bridges "and investments in other major transportation programs." 

But the The Federal Highway Administration (FHWA) decides where to spend the money. The The Wall Street Journal reports  

...Deputy Administrator Stephanie Pollack advised staff on the types of projects they should give the red light.

According to the memo, proposals should be sent to the bottom of the pile if they “add new general purpose travel lanes serving single occupancy vehicles.” She means cars. That includes construction of new roads and highways, or expansions of existing ones. 

In short, how many roads and bridges do you get in the $1.2 trillion dollar bill? Zero. 

The infrastructure bill also included provisions to limit the endless environmental review that is used to block projects. The FHWA undercut that neatly, 

The policy imposes a 90-day limit on approval for projects reviewed under the National Environmental Policy Act (NEPA).

But the FHWA is doubling down on other green restrictions. Its memo declares that any project requiring a new right of way is ineligible for a fast-tracked NEPA review. States planning to widen clogged highways using federal funds could face months or years of scrutiny. 

The WSJ continues on how this memo undermines the clear intent of Congress, an interesting political story. 

I found the original memo here. (WSJ, why do you not link to sources?) 

FHWA will implement policies and undertake actions to encourage -- and where permitted by law, require -- recipients of Federal highway funding to select projects that improve the condition and safety of existing transportation infrastructure within the right-of-way before advancing projects that add new general purpose travel lanes serving single occupancy vehicles. 

Saturday, January 29, 2022

Interest-rate surveys


Torsten Slok, chief economist at Apollo Global Management, passes along the above gorgeous graph. Fed forecasts of interest rates behave similarly. So does the "market forecast" embedded in the yield curve, which usually slopes upward. 

Torsten's conclusion: 

The forecasting track record of the economics profession when it comes to 10-year interest rates is not particularly impressive, see chart [above]. Since the Philadelphia Fed started their Survey of Professional Forecasters twenty years ago, the economists and strategists participating have been systematically wrong, predicting that long rates would move higher. Their latest release has the same prediction.

Well. Like the famous broken clock that is right twice a day, note the forecasts are "right" in times of higher rates. So don't necessarily run out and buy bonds today. 

Can it possibly be true that professional forecasters are simply behaviorally dumb, refuse to learn, and the institutions that hire them refuse to hire more rational ones? 

My favorite alternative (which, I admit, I've advanced a few times on this blog): When a survey asks people "what do you 'expect'?" people do not answer with the true-measure conditional mean. By giving an answer pretty close to the actual yield curve, these forecasters are reporting a number close to the risk-neutral conditional mean, i.e. not \(\sum_s\pi(s)x(s)\) but \(\sum_s u'[c(s)]\pi(s)x(s)\). The risk-neutral mean is a better sufficient statistic for decisions. Pay attention not only to how likely events are but how painful it is to lose money in those events. Don't be wrong on the day the firm loses a lot of money. The weather service also tends to overstate wind forecasts. I interpret the forecast of 30 mph winds as "if you go out and capsize your boat in a 30 mph gust, don't blame us." "If you buy bonds and they tank, don't blame us" surely has to be part of a finance industry "forecast." 

If the risk-neutral mean equals the market price, do nothing. And do nothing has to be the advice to the average investor. Reporting the forecast implied by the yield curve directly has a certain logic to it. 

Economists rush too quickly, I think, from surveys where people are asked "what do you expect?" to bemoaning that the answers do not represent true-measure conditional means, and blaming that on stupidity. As if anyone who answers the question has the vaguest idea what the definitions of mean, median, mode, conditional and true vs. risk-neutral measure are. We might have a bit more humility: They're giving us a sensible answer, to a question posed in English, but since we asked the question in a  foreign language, it is an answer to a different question. 

(Teaching is good for you. Most of my students did not understand that "risk" can mean you earn more money than you "expected," at the beginning of the class. I hope they got it by the end! But they were not wrong. In English, "risk" means downside risk. In portfolio analysis, it means variance. Know what words mean.) 

But that also means, do not interpret the answers as true-measure conditional means! 

This graph is particularly challenging since it concerns the 10 year rate only. Similar graphs of short-term rates also show consistent bias toward forecasting higher rates that don't happen. But that is more excusable as a risk-neutral mean, since the yield curve slopes up in the first few years. A rising forecast of 10 year yields corresponds to slope from 10 years to longer maturities, which is typically smaller. Torsten, if you're listening, a comparison to the forecast implied by the forward curve at each date would be really interesting! 


Update: The same students who used the English meaning of "risk" to be "downside risk" also used the English meaning of "expected" to be "what happens if nothing goes wrong," somewhere in the 90th percentile. The two meanings do make some sense, properly understood, especially in a world with skewed distributions -- the lion gets you or does not, the plan crashes or does not, the bomb explodes or does not. Many important distributions are not normal, so mean and variance aren't appropriate! 

I don't mean to say that surveys are useless. They are very important data, that can be very useful for forecasting events. If the survey forecast points up, that tells you something. A forecasting regression that includes survey data can be very useful. Just don't interpret it directly as conditional mean and blather about irrationality if it isn't. 

The variation across people in survey forecasts is the really interesting and under-studied part of all this. The graph is the average forecast across forecasters. But individual forecasters say wildly different things. Even these, who are professional forecasters. Why do survey forecasts vary across people so much, though the people have the same information? Why do trading positions not vary over time or across people anything like the difference between survey forecasts and market prices says they should? I think we're missing the interesting part of surveys -- their heterogeneity, with little heterogeneity of actions. 


Thursday, January 27, 2022

The cost of crying wolf

Why do so many Americans believe crazy things? Maybe not "crazy," but beliefs that wildly get wrong factual costs and benefits, such as those of vaccines? 

It does not help that they have been lied to, over and over again. Why should they believe anything now? Our elites, and in particular our public health bureaucrats, though invoking the holy name of "science," have been trying to massage public psychology via deliberate obfuscation for a few years now. There is little science of managing public psychology, and if there is, epidemiologists don't have it. There is some good ancient wisdom, as codified in the story of the boy who cried wolf.  We do know that when lies are exposed, when elites are shown to be disparaging and trying to manipulate average people, trust erodes. 

This thought is boosted by Marty Makary's WSJ Oped "The High Cost of Disparaging Natural Immunity to Covid."

For most of last year, many of us called for the Centers for Disease Control and Prevention to release its data on reinfection rates, but the agency refused. Finally last week, the CDC released data from New York and California, which demonstrated natural immunity was 2.8 times as effective in preventing hospitalization and 3.3 to 4.7 times as effective in preventing Covid infection compared with vaccination.

Yet the CDC spun the report to fit its narrative, bannering the conclusion “vaccination remains the safest strategy.” 

Why? Well, both facts can be true. It can be true that immunity from previous exposure is very powerful, and even more powerful than vaccination, but that vaccination rather than let-it-rip, lockdowns, or masks, remains the safest public health strategy.  Why not say so? Because the CDC thinks we're morons and can't understand that, so it must suppress evidence of natural immunity to scare people into vaccination. Then the word gets out, and people trust the CDC even less. (The rest of the article is great on facts of natural immunity.) 

It's worse.

Monday, January 24, 2022

Stock market fall and long-term investors


Having just plugged "portfolios for long-term investors" again, I really should opine on its message about the recent stock market decline. If you didn't see this coming and get out ahead of time, or if it was perfectly obvious to you that this was coming but you didn't get off your butt and do anything about it, preferring to pontificate at the dinner table, just how bad should you feel about it? 

Not as bad as you might think. 

Sunday, January 23, 2022

Portfolios for long-term investors

"Portfolios for long-term investors" is published, Review of Finance 26(1), 1-42. (2022). This standard link works if you have institutional or individual access. I am not allowed to post a free access link here, but I am allowed to post one on my webpage where you will find it. 

The theme: How do we account for the vast gulf between portfolio practice and portfolio theory? How do we make portfolio theory useful given that the world has time-varying expected returns and time-varying returns and correlations? I argue for a view more focuses on prices and payouts, as a long-term bond investor should buy an indexed perpetuity and ignore one-period returns. I advise one to think about the market and equilibrium. The average investor must hold the market portfolio. Anything else is a zero sum game. So figure out why you are different than average. (If you think you're smarter than average, note that they think they're smarter than you.) The result encapsulates some ancient advice: Buy stocks for the dividends, broadly interpreted. Take risk you are well-positioned to take. If stocks have great value to other investors for reasons either technical (liquidity, short-sales constraints, etc.) or behavioral, avoid them. 

The paper grows out of the summary I used to give for MBA and PhD students. There aren't any equations, but there are lots of suggestions about how academic portfolio theory might be done better, and connect better to its intended audience. Thanks especially to Monika Piazzesi and Luis Viceira, who invited me to give the talk on which it is based, and Alex Edmans who shepherded it to publication. 


Update: I just found that the NBER has posted the original lecture video

Friday, January 21, 2022

Institute for progress

We need to be reminded occasionally that nothing matters but long-run growth, and long-run growth all comes from productivity, better knowledge of how to better serve human needs and desires.  Yet economic policy is almost all not about growth, but rather about redistribution, and in particular propping up old ways of doing things and the rents associated with them. 

Courtesy Marginal Revolution, the Institute for Progress is a noteworthy new effort to produce growth-oriented policy. Institutions are important, to spread the word and create a constituency for tending the golden goose. 

..productivity growth has been in long-term decline since the 1970s. This is supposed to be the age of ambitious infrastructure investments in the battle to fight climate change, but we can’t even build new solar plants without being vetoed by conservation groups. Hyperloops and supersonic airplanes promise to revolutionize transportation, but building a simple subway extension in NYC costs up to 15 times more per kilometer than it does in other cities around the world. ...The pace of scientific progress has been slowing.... 

(Here and elsewhere see the original for links.) Why? 

Over the last 50 years, we’ve increased the number of veto points at nearly every governmental level, failed to invest in state capacity, and raised the stakes of the debate through polarization. So it perhaps shouldn’t be a surprise that the federal government that went to the moon in 1969 botched production of simple diagnostic tests during a once-in-a-century pandemic.

But the potential is there. Maybe we are not running out of ideas after all, but merely on the edge of technical revolutions, like changing from rail to airplanes:    

...there are genuinely exciting — potentially game-changing — discoveries on the horizon. 

Wednesday, January 19, 2022

Accounting for the blowout / Project Syndicate

A Project Syndicate Essay. Before it moves on to climate change, inequality, and racial issues, the Fed should have to think just a little bit about the evident failure of its existing financial regulation. 

Why Isn't the Fed Doing its Job?

The nomination of new members to the US Federal Reserve Board offers an opportunity for Americans – and Congress – to reflect on the world’s most important central bank and where it is going. 

The obvious question to ask first is how the Fed blew its main mandate, which is to ensure price stability. That the Fed was totally surprised by today’s inflation indicates a fundamental failure. Surely, some institutional soul searching is called for. 

Yet, while interest-rate policies get headlines, the Fed is now most consequential as a financial regulator. Another big question, then, is whether it will use its awesome power to advance climate or social policies. For example, it could deny credit to fossil-fuel companies, demand that banks lend only to companies with certified net-zero emissions plans, or steer credit to favored alternatives. It also could decide that it will start regulating explicitly in the name of equality or racial justice, by telling banks where and to whom to lend, whom to hire and fire, and so forth. 

But before considering where the Fed’s regulation will or should go, we first need to account for the Fed’s grand failure. In 2008, the US government made a consequential decision: Financial institutions could continue to get the money they use to make risky investments largely by selling run-prone short-term debt, but a new army of regulators would judge the riskiness of the institutions’ assets. The hope was that regulators would not miss any more subprime-mortgage-size elephants on banks’ balance sheets. Yet in the ensuing decade of detailed regulation and regular scenario-based “stress tests,” the Fed’s regulatory army did not once consider, “What if there is a pandemic?” 

Tuesday, January 18, 2022

Fed Nominees

I salute President Biden's nominations for the Federal Reserve Board, especially Sarah Bloom Raskin and Lisa Cook. (Philip Jefferson seems straightforward and uncontroversial, but other than reading a CV I haven't looked that hard.)

 We can now have an honest conversation about where the Fed is going, and whether and how the Fed should use its tools, primarily regulation, to advance the Administration's agenda on climate, race, and inequality. 

The Wall Street Journal nicely assembled crucial quotes on Ms. Raskin and climate. In 2020,   

The Fed established broad-based lending programs to prevent businesses that were otherwise sound from failing due to the shutdowns. 

Writing in the New York Times in May 2020, 

Ms. Raskin wanted the Fed to exclude fossil-fuel companies from these facilities. “The Fed is ignoring clear warning signs about the economic repercussions of the impending climate crisis by taking action that will lead to increases in greenhouse gas emissions at a time when even in the short term, fossil fuels are a terrible investment,” she wrote. ...

“The Fed’s unique independence affords it a powerful role,” Ms. Raskin added. “The decisions the Fed makes on our behalf should build toward a stronger economy with more jobs in innovative industries—not prop up and enrich dying ones.”  

Monday, January 3, 2022

Fiscal Inflation.

This is an essay, prepared for the CATO 39th annual monetary policy conference.  It will appear in a CATO book edited by Jim Dorn. This is a longer and more academic piece underlying "The ghost of Christmas inflation.Video of the conference presentation. This essay in pdf form. 


John H. Cochrane

From its inflection point in February 2021 to November 2021, the CPI rose 6 percent (278.88/263.161), an 8 percent annualized rate.  Why? 

Starting in March 2020, in response to the disruptions of Covid-19, the U.S. government created about $3 trillion of new bank reserves, equivalent to cash, and sent checks to people and businesses. (Mechanically, the Treasury issued $3 trillion of new debt, which the Fed quickly bought in return for $3 trillion of new reserves. The Treasury sent out checks, transferring the reserves to people’s banks. See Table 1.)  The Treasury then borrowed another $2 trillion or so, and sent more checks. Overall federal debt rose nearly 30 percent. Is it at all a surprise that a year later inflation breaks out?  It is hard to ask for a clearer demonstration of fiscal inflation, an immense fiscal helicopter drop, exhibit A for the fiscal theory of the price level (Cochrane 2022a, 2022b).  

What Dropped from the Helicopter? 

From December 2019 to September 2021, the M2 money stock also increased by $5.6 trillion.  This looks like a monetary, not a fiscal intervention, Milton Friedman’s (1969) classic tale that if you want inflation, drop money from helicopters. But is it monetary or fiscal policy? Ask yourself: Suppose the expansion of M2 had been entirely financed by purchasing Treasury securities. Imagine Treasury debt had declined $5 trillion while M2 and reserves rose $5 trillion. Imagine that there had been no deficit at all, or even a surplus during this period. The monetary theory of inflation, MV=PY, states that we would see the same inflation. Really? Similarly, ask yourself: Suppose that the Federal Reserve had refused to go along. Suppose that the Treasury had sent people Treasury bills directly, accounts at, along with directions how to sell them if people wished to do so. Better, suppose that the Treasury had created new mutual funds that hold Treasury securities, and sent people mutual fund shares. (I write mutual fund as money market funds are counted in M2.) The monetary theory of inflation says again that this would have had no effect. These would be a debt issue, causing no inflation, not a monetary expansion. Really? 

Sunday, January 2, 2022

Weekend reads on the state of America -- and China

Two pieces stood out from some weekend internet meandering. 

Marginal Revolution points to an excellent long letter from Dan Wang on China.

A trenchant part of Dan's essay is, curiously, a few reflections on America. Not bad for living in Shanghai: 

The US, for starters, should get better at reform. The federal government has found itself unable to build simple infrastructure or coordinate an effective pandemic response. Somehow the US has evolved to become a political system in which people can dream up a hundred reasons not to do things like “build housing in growing areas” or “admit people with skills into the country.” If the US wants to win a decades-long challenge against a peer competitor, it needs to be able to improve state capacity. ...

Since the US government is incapable of structural reform, companies now employ algorithm geniuses to help people navigate the healthcare system. This sort of seventh-best solution is typical of a vetocracy. I don’t see that the US government is trying hard to reform institutions; its response is usually to make things more complex (like its healthcare legislation) or throw money at the problem. The proposed bill to increase domestic competitiveness against China, for example, doesn’t substantially fix the science funding agencies that are more concerned with style guides than science; and the infrastructure bill doesn’t seem to address root causes that make American infrastructure the most costly in the world. Congress is sending more money through bad channels.

 Stop and savor.