## Sunday, June 19, 2022

### Economic Freedom in the Alito Draft

I read the draft Supreme Court decision on Roe v. Wade. I was surprised that the draft so quickly prejudges economic liberty, which I thought of as a topic still open for debate. I wrote the essay below. I haven't been able to interest any of the usual places that publish my op-eds, so, with the decision likely to come next week, here it is.

***

Dear Justices: As you overturn Roe, don’t prejudge economic liberty! Economic, social and political freedom are intertwined. Reform of the administrative state is America’s next great challenge. Leave us the chance to argue for liberty and privacy to transact, communicate, and work as we wish.

Justice Alito’s draft opinion affirms that the Constitution includes privacy and liberty among unenumerated rights. Good. To counter hysteria that other precedents would soon fall, he explicitly affirms them. Good. Of “the right to marry a person of a different race, … the right to marry while in prison,… the right to obtain contraceptives, … the right to reside with relatives, …the right to make decisions about the education of one’s children, … the right not to be sterilized ,… to undergo involuntary surgery, forced administration of drugs,…[the] right to engage in private consensual sex acts,…the right to marry a person of the same sex,’’ Justice Alito writes that overturning Roe, “…does not undermine them in any way”  (p.32).

And then he—or perhaps overenthusiastic clerks—takes a step too far. The draft also reassures the left that their economic agenda is not at risk, by explicitly affirming the radical jurisprudence of the late New Deal.

The draft opinion savages  Lochner v. New York as  “Freewheeling judicial policymaking,” a “discredited decision,” (p. 14) and an “erroneous decision’’ on the scale of the infamous Plessy v. Ferguson (p.64). Lochner examined whether the state of New York could restrict hours of work. The 1905 court found such limitations interfere “with the right and liberty of the individual to contract.” (George Will's Conservative Sensibility tells the story well.)  The draft praises West Coast Hotel (1937), which overruled an earlier case “which had held that a law setting minimum wages for women violated the “liberty” protected by the fifth amendment.” Economic liberty gets sarcastic scare quotes. Piling on, “West Coast Hotel signaled the demise of an entire line of important precedents that had protected an individual liberty rights against state and federal health and welfare legislation,” including decisions “holding invalid a law banning contracts forbidding employees to join union,” or “holding invalid laws fixing the weight of loaves of bread,” (p. 36) and more.

The separation between social and sexual liberty and privacy and extensive government intrusion into the most minute economic affairs makes no logical sense. The draft tries and fails. The draft claims that “appeals to a broader right to autonomy…could license fundamental rights to illicit drug use, prostitution, and the like.” But we can talk about Uber drivers’ right to set their own hours without demanding legal prostitution. We might not even want to prejudge a fundamental right to "illicit" drug use, which in that phrasing includes violating the FDA's latest diktats. The draft states that “what sharply distinguishes” other rights from abortion is the “life of an unborn human being.” But even drug use and prostitution do not involve unborn life.

The draft denies unenumerated rights not “deeply rooted in history and tradition.” (p. 11) That is an interesting addition to the Constitution’s text, and I imagine legal scholars might want to debate that limitation. The framers could have added it, but did not do so. This is its central argument. It extensively describes legal restrictions on abortion in the 19th century, when the 14th amendment was written, to document that an individual right to abortion is not "deeply rooted in history and tradition."

But by that standard, the Court must then allow that history and tradition, our “scheme of ordered liberty,” long favored economic liberty and privacy. The same history of 19th century law would not find an inkling of the Department of Labor’s intrusive regulations or the FDA’s baby formula fiasco. Economic regulation was novel, not economic liberty. And many people today believe that political and social liberty cannot exist without economic liberty. Start with Friedman's Capitalism and Freedom.

The draft proclaims that economic liberty is subject to majoritarian rule, where personal and sexual liberty is an individual right. Again citing West Coast Hotel, “the court .. overruled decisions that wrongly removed an issue from the people and the democratic process.” (p. 40.) But economic liberty must be an individual right, protected from the whims of the majority, which is even more inclined to use law to enrich one at the expense of the other than it is to force sexual conformity. We don’t vote whether a city should grab a house and turn it in to a mall or a homeless shelter. Well, we do, but we shouldn’t. To function, property rights must be an individual right.

In needlessly asserting one narrative history of economic rights while making a decision on abortion, the draft gratuitously denies the possibility of another history: The Lochner-era court did hold to the Constitution’s protections and the country’s history and traditions, until the political pressure and Roosevelt’s court-packing threats caused the court to back down, and to write constitutional gibberish, rather than wait for the consensus that constitutional amendment would bring.

I support an individual Constitutional right to abortion. But I also support the court overturning Roe v. Wade. Many thoughtful people on the left agree (for example, Yale Law's Akhil Reed Amar on Common Sese). My policy preferences should not matter in any of my arguments today, but I think they do. If more of us were able to separate our policy preferences from judgement whether the court or state legislatures should decide an issue, as a matter of practicality and keeping the country together, we might have a healthier debate.

Abortion needs to go back to the states. The court never considered a clear right, instead trying to write the compromises only legislatures can broker. How about trading some abortion restrictions for greater funding for contraceptives, adoption, child care and so forth? Only a legislature can do that, and produce the buy-in that such compromises produce. I won't be totally happy, you won't be totally happy, but we can stop tearing the country apart. Yes, “far from bringing about a national settlement of the abortion issue, Roe and Casey have enflamed debate and deepened division” (p. 6) because  “Those on the losing side…could no longer seek to persuade their elected representatives to adopt policies consistent with their views.” (p. 40) More importantly, after Roe, they must try to persuade their fellow citizens to elect different representatives, and politicians will have to recalibrate their positions. It's easy to be extreme when we know nothing can happen. Both parties are now the dog that caught the car.

Most of all, abortion has poisoned Court politics and public debate for 50 years. The Court, and we who argue about what the court should do, and what kind of justices to appoint, can finally move on to languishing great questions of our government.

Prime among those is how to reform our dysfunctional government by executive order and imperious bureaucracy. Wickard v. Filburn could be the new Roe v. Wade. Filburn grew wheat on his own farm to feed his own animals. The 1942 Court held that the federal government’s power to regulate interstate commerce extended to forcibly stopping Filburn from doing so, in order to drive up the price of wheat. The Court affirmed it in Gonzalez v. Raich (2005), with even Antonin Scalia concurring. The Court decided that growing pot in your own backyard for your own private medicinal purposes, legal in a state, can be banned by the federal government as interstate commerce. This case lies at the foundation of the administrative state. Really? Is this beyond dispute?

For years, Justices before the Senate loudly said they would not prejudge Roe v. Wade, so as not to prejudge cases before hearing them. Yes, it is wise for the Court to say loudly that this decision does not imperil to contraception and interracial marriage, if only to reveal how many critics don’t bother to read decisions. But please, don’t needlessly prejudge economic freedom. Sometimes, silence is golden.

***

Update: The ruling is out, and most of the economic rights trashing is gone! Economic liberty is still in quotes, and West Coast Hotel still reverses a "wrong" precedent, but it's a lot better.

I heard over and over again on NPR yesterday how the court has never taken away rights before. Uh, hello? The right to contract, to decide your own hours and nature of work, to build whatever you want on your property no matter what the planning, historical, zoning commission say; the right to grow wheat in your own back yard and feed it to your horse.

## Thursday, June 16, 2022

### Fiscal Histories

Fiscal Histories  is a new paper, a second try at an essay on fiscal theory for the Journal of Economic Perspectives.

The basic concept is to explain the fiscal theory of the price level with no equations by applying it, by seeing how it might be able to explain and interpret a wide variety of historical episodes. Abstract:

The fiscal theory states that the price level adjusts so that the real value of government debt equals the present value of real primary surpluses. Monetary policy remains important. The central bank can set an interest rate target, which determines expected inflation, and news about the present value of surpluses drives unexpected inflation. I exposit fiscal theory by offering an interpretation of historical episodes, including the gold standard, currency pegs, the ends of hyperinflations, the success of inflation targets, the rise and fall of inflation in the 1970s and 1980s, the long quiet zero bound of the 2010s, and the 2021-2022 inflation. Going forward, fiscal theory warns that inflation will have to be tamed by coordinated monetary and fiscal policy.

I thank Erik Hurst and Tim Taylor for the concept. Most of the stories are summarized from the Fiscal Theory of the Price Level, but pulling them out, putting them in one place and simplifying them is a great idea. The key idea

I think through how fiscal theory can account for important episodes. A first purpose is expositional: by this method we can understand how fiscal theory works, and what elaborations it might need. A second purpose is more serious: analyzing episodes is the crucial way we evaluate all macroeconomic models.

I mostly tell plausible stories, rather than summarize well-worked out and published economic history or quantitative analysis. Fiscal theory is new, and that work is just beginning. But stories rightly come first. Formal analysis always builds on plausible stories. Moreover, that there are such plausible stories, that it provides a framework that can possibly account for history as MV=PY and IS-LM do, is news, since many people opine that fiscal theory can be quickly dismissed by well-known episodes. I also hope to inspire detailed analysis.

The paper also shows the results of a nice model, and sneaks the model in a footnote, that gets at the basics of fiscal theory with sticky prices more simply than I did in FTPL. The graph:

Figure 1: Responses of inflation and output in a simple fiscal-theory sticky-price model. Top: 1% deficit shock with constant interest rate. Bottom: Interest rate shock with constant surpluses

You can think through a lot of fiscal theory with these graphs. The first graph is a fiscal shock with no change in interest rate, which is roughly what I think we saw in 2021. It leads to protracted inflation, and devalues outstanding bonds with a period of negative real interest rates. The second graph is an interest rate rise with no change in surpluses. It gives a temporary inflation decline. Reality combines the two graphs. The Fed's rate rises will add the second graph on the first, which will help. A bit. For a while.

Yes, repackaging the same ideas in a lot of different ways. I hope to find one that works, or at least to offer different packages for different tastes.

I'm not sure of the title yet. Fiscal Fables? Fiscal Bedtime Stories? ; )

## Tuesday, June 14, 2022

### ECB word salad hubris

The  Speech by the ECB's Isabel Schnabel, advertised on the official ECB twitter stream

caused a characteristically grumpy outburst from me. Savor the ECB's tweet in all of its glory:

We will not tolerate changes in financing conditions that go beyond fundamental factors and that threaten monetary policy transmission.

Also,

In December of last year, we made clear that we would not tolerate price adjustments that would undermine the transmission of our monetary policy

So now central bankers know what "fundamentals" are in all asset prices, and "will not tolerate" bond prices (aka "changes in financing conditions") that deviate from their idea of "fundamentals." And I thought they had an inflation mandate, and a short-term interest rate "tool."

The contrast between the vision of detailed machinery that central bankers think they know how to control and any actual scientific knowledge of the monetary and financial system is gaping. The one thing I actually know as an "expert" is how little anyone else actually knows. Nobody really knows what the "monetary transmission mechanism" is to start with, let alone how "financing" conditions affect it. And if Ms. Schnabel knows reliably how to distinguish prices from "fundamentals" I know a lot of hedge funds that would pay her a whole lot more than the ECB does!

As one way to see that gap, I compiled the following list of central-bankerese from her speech. At a minimum, if you want to be a central banker, learn to talk like this. As a human, ask yourself if anybody actually knows what any of this word salad actually means, let alone if the ECB has the technical knowledge to control it. (Some, of course, is just complex euphemism.) If I knew more computers it would be great fun to program up an AI that can replicate a central banker. It shouldn't be that hard, because nobody knows what any of this means!

Your central banker word-salad vocabulary list:

vulnerability to fragmentation risks

disruptive and self-fulfilling price spirals

financing conditions

wedge

national borrowing conditions

fragmentation

## Monday, June 13, 2022

### AEA P&P, a measure of an organization

The American Economics Association papers and proceedings are out. This is a selection of the selection of papers presented at the AEA annual meetings. It tells you a lot about where the economics profession is--what papers are submitted--and also where the AEA as our (so far) premier professional organization is--what papers got included -- and perhaps more interestingly, where it isn't.

Here are the papers. The AEA put the sessions in random order; I reorganized by rough topic. Of course many of the topics have intersectional elements so this isn't perfect either. Comments below, but you should read the raw data first and find your own inferences.

AEA DISTINGUISHED LECTURE

On the Dynamics of Human Behavior: The Past, Present, and Future of Culture, Conflict, and Cooperation

Race

RACE, GENDER, AND FINANCIAL WELL-BEING

• Black Land Loss: 1920−1997
• Intersectionality and Financial Inclusion in the United States
• At the Intersection of Race, Occupational Status, and Middle-Class Attainment in Young Adulthood
• Child-to-Parent Intergenerational Transfers, Social Security, and Child Wealth Building

RACISM IN THE UNITED STATES: EVIDENCE FROM ECONOMIC HISTORY

• Media Access and Consumption in the Civil Rights Era
• On the Impact of Federal Housing Policies on Racial Inequality
• Sundown Towns and Racial Exclusion: The Southern White Diaspora and the "Great Retreat"
• Discrimination, Segregation, Integration, and Expropriation

## Thursday, June 9, 2022

### Climate finance emperor update

I wrote a review of Stuart Kirk's climate finance speech, which among other things criticized the Dutch Central Bank for putting fingers on the scale in order to make "climate financial risk" look bigger than it is.

Remember where we are. Here we are not talking about the fantasy that in the next 5 years or so, on the scale of actual bank investments and regulatory horizon, some physical "climate" event will destroy the financial system. We are talking about "transition risk," the chance that our legislators take such extreme action that their carbon policies cause a financial meltdown of systemic proportions. And here, whether a carbon tax could do that.

Robert Vermeulen of the Dutch Central Bank wrote (in personal capacity, and with extraordinary politeness given the circumstances) to defend their calculations:

In the Dutch Central Bank scenario Kirk refers to we model the impact of a US$100 increase in the carbon price. On whether this is low, high or outrageous we can debate, but if fully passed on to consumers it would make a round trip Amsterdam – New York US$ 200 more expensive.

The GDP numbers in the table need to be interpreted as relative to the baseline. So, let us assume a baseline GDP growth of 2% per year. Suppose the economy has size 100 in year 0, then the size of the economy is 110 in year 5. So, this baseline economy has a GDP level of 102 in year 1, 104 in year 2, etcetera. Since the scenario needs to be read as relative to the baseline, the GDP level in the scenario is 100.7 in year 1, 100.8 in year 2, 103.2 in year 3, 106.7 in year 4 and 109.5 in year 5. So, the carbon price we model by no means destroys the economy.

With respect to the interest rate shock, this variable is not assumed but follows endogenously from the model. Note that the long-term interest rate increases by 1 percentage point. As the economy grows slower compared to the baseline, the interest rate converges again to the baseline interest rate and is about equal to it in year 5. To put things into perspective, the US 10-year gov’t bond yield increased from 1.72% on March 1st to 3.12% on May 6th this year. Since a carbon price has a very similar effect on fossil fuel energy prices, the increase in long-term interest rates is not something strange and fully in line with what we observed this year.

The main point "the interest rate shock...is not assumed but follows endogenously from the model" Kirk is not correct  in alleging that the high interest rates are a separate assumption plugged in to the model to make GDP fall.

I have not read the appendix, nor studied the model. However, this being a blog, that won't stop me from a few speculations.

I am still a little bit puzzled. That a 2% of GDP tax increase should lower GDP makes a lot of sense, as it adds distortions (not counting externalities) to the economy. But real interest rates usually fall in recessions. Perhaps this is a nominal interest rate rise?

It is also puzzling that a carbon tax is so damaging. In response I needled Robert a bit: Why don't you simulate a decline in Europe's already prodigious fuel taxes? If a rise in the carbon tax lowers GDP this much, a decline in fuel taxes should raise GDP and lower interest rates by similar amounts!

In response to a few queries from me, Robert adds:

Please note that we investigate tail risk scenarios and how banks would be affected in case of a sharp increase in carbon prices. In case the policymaker wants to meet the Paris Agreement carbon emission targets we would argue that you ideally present companies with a predictable policy path until 2050. This allows gradual adjustment in the economy, but it requires action soon. However, when governments wait too long and still want to meet the emission targets the economy will receive a bigger shock.

This is interesting. I presume this means the economic model has very large "adjustment costs." Usually taxes have a "level effect" so the speed of implementation doesn't matter that much. Kirk might have a thing to say about a model in which putting in the carbon tax suddenly has much larger effect than spreading it over a few years.

Perhaps interesting, in the study we also analyze the effects of technological shocks which make solar power much cheaper and easier to store. Basically this is a deflationary price shock and due to the adjustments in the economy it still leads to some temporary lower GDP growth relative to the baseline growth. In this case you indeed see interest rate decreases because the shock of the source is deflationary, i.e. energy becomes cheaper.

No matter what you do GDP goes down? Usually cost-reducing supply shocks are good for GDP. It seems that this model has a very strong Phillips curve, so that lower inflation (which we now all might think of as a good thing) lowers GDP? Good thing our ancestors who built power plants, highways, and dikes, didn't think that supply improvements lower GDP! The last comment leads to my question whether we're looking at real vs. nominal interest rates.

Saving the best for last:

Please note that carbon price increases, at least of the magnitude we modeled, should not lead to financial crises. For the Dutch economy a US\$100 carbon price increase amount to a little less than 2% of Dutch GDP at face value. We modeled it as a quota (e.g. similar to OPEC production limits), so the benefits of the higher prices fall on to the fossil fuel producers. In case you would model it as a tax levied by the governments and would assume that the tax is redistributed e.g. as a decrease in the VAT, you would find (much) smaller GDP impacts. Therefore, with appropriate policies you can ideally achieve simultaneously lower carbon emissions and minimize negative short-term impacts on the economy.

"Carbon price increases, at least of the [big] magnitude we modeled, should not lead to financial crises." Well, the game is up right there. As for the topic of Kirk's whole speech, is there a financial system risk from climate, or is this all a smokescreen to get central banks to de-fund fossil fuels where legislators will not go, the game is up. (And, I would add, it is even more contradictory for regulators to say they have to step in to de fund fossil fuels before legislators impose the big carbon tax because legislators will never impose the big carbon tax.)

The last part is important as we think about the actual issue: What you do with  carbon tax revenue matters a lot to its impact on its economic effect. If the carbon tax revenue is used to offset other distorting taxes,  I can easily imagine that GDP rises, a win-win. There are other taxes with far higher marginal rates and far worse distortions.

We are of course witnessing an experimental version of the calculation, courtesy of Vladimir Putin. Others such as Ben Moll are making more microeconomic calculations that the effect of this large and sudden price hike and quantity reduction will be much smaller. We shall see. We shall also see if there is any stress at all on the banking system as a result of higher oil prices. For now, higher prices are causing dramatic increases in profits of legacy oil, not the collapse that climate financial risk advocates predicted. Econ 101 works.  But it is worth pointing out that the carbon tax and "Putin's price hike" are economically identical, so experience of one can inform the other, and complaining about one is a bit silly if one enthusiastically endorses the other.

## Wednesday, June 8, 2022

### The Phillips Curve

Behold the Phillips curve, one more statistical correlation treated as an eternal verity that our inflationary era has just undermined.

From 2007 to 2019, the standard observation was "The Phillips curve has become flat." Large changes in unemployment correspond to very little change in inflation, or small changes in inflation correspond to huge changes in unemployment, depending on which causal (mis) reading of the correlation you choose. To the optimist, allowing a tiny bit of inflation could dramatically reduce unemployment. To the pessimist, it would take immense unemployment to do anything about inflation, should we have to.

Then came the pandemic. Unemployment shot up with no change in inflation, right on the curve.

Then came the inflation. The Phillips curve woke up. It's almost vertical! (The scales of the two axes are different).

Much Fed and commentator thinking relies on the Phillips curve. It's the central way interest rates affect inflation, in conventional thinking. High interest rates raise real interest rates lower aggregate demand cause unemployment which causes via the Phillips curve, lower inflation.

Clearly, something is very wrong here. Maybe expectations shift. Maybe supply shocks do matter after all. Surely one should start with a serious dynamic Phillips curve, as most macro literature does. Maybe the Phillips curve is flexible up but sticky down, and the natural rate shifts around.  Maybe prices are sticky until they aren't. As Bob Lucas showed long ago, the slope of the Phillips curve depends on the volatility of inflation. Countries with volatile inflation get no output boost from additional inflation. Thousands of epicycles can be added, and this post is a bit of an invitation to do so. Or maybe the Phillips curve was just a correlation after all, hiding a deeper reality. (My view, but for another blog post).

In the meantime, it's another good warning not to take statistical correlations too seriously, and certainly not as causally as we tend to do. Such as inflation will always be 2%. Such as real interest rates are on a permanent downward trend?

This time of inflation will lead us to rewrite an awful lot of macroeconomics.