tag:blogger.com,1999:blog-5823681527167712382024-03-19T03:48:41.889-05:00The Grumpy EconomistJohn Cochrane's blogJohn H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.comBlogger1360125tag:blogger.com,1999:blog-582368152716771238.post-70280684816395970552024-02-04T21:12:00.004-06:002024-02-04T21:12:32.799-06:00Understanding Trumpers<p> <a href="https://www.grumpy-economist.com/p/understanding-trumpers-c25" target="_blank">WSJ oped and substack post</a>.</p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com0tag:blogger.com,1999:blog-582368152716771238.post-1811613434998464792024-02-01T10:16:00.005-06:002024-02-01T10:16:26.522-06:00Change, demographic and intellectual<p> New post over at <a href="https://www.grumpy-economist.com/p/change-demographic-and-intellectual" target="_blank">grumpy-economist.com substack</a></p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com0tag:blogger.com,1999:blog-582368152716771238.post-64053756727558772432024-01-07T17:35:00.003-06:002024-01-07T17:35:25.515-06:00Aftermath<p> Aftermath. Reflections on the Claudine Gay affair. <a href="https://www.grumpy-economist.com/p/aftermath" target="_blank">Over at Substack.</a> </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com2tag:blogger.com,1999:blog-582368152716771238.post-66497063175469388052024-01-04T22:08:00.006-06:002024-01-04T22:08:42.518-06:00Fiscal Narratives for US Inflation <p><a href="https://www.grumpy-economist.com/p/fiscal-narratives-for-us-inflation" target="_blank">An essay on substack</a>; interpreting US inflation history via fiscal theory, prepared as comments for a session at the AEA meetings. </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com1tag:blogger.com,1999:blog-582368152716771238.post-63356033908593395032023-12-31T23:34:00.004-06:002023-12-31T23:34:26.866-06:00Writing lesson, comment on Tom Friedman<p> Don't piss people off unless you have to. <a href="https://www.grumpy-economist.com/p/writing-lesson-comment-on-tom-friedman" target="_blank">Over at Substack. </a></p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com4tag:blogger.com,1999:blog-582368152716771238.post-36787818185884007552023-12-29T23:04:00.005-06:002023-12-29T23:04:57.999-06:00Argue Honestly in the Claudine Gay Affair<p><a href="https://www.grumpy-economist.com/p/argue-honesty-in-the-claudine-gay" target="_blank"> Post over at Substack</a>. Firing Gay over plagiarism will not fix Harvard. </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com8tag:blogger.com,1999:blog-582368152716771238.post-60895008024626419662023-12-28T13:11:00.004-06:002023-12-28T13:11:50.859-06:00Conti on the future of universities <p> A new <a href="https://www.grumpy-economist.com/p/conti-on-the-future-of-universities" target="_blank">post over at Substack,</a> a nice essay by Greg Conti on the future of universities. </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com5tag:blogger.com,1999:blog-582368152716771238.post-47710275908350835432023-12-27T21:43:00.006-06:002023-12-27T21:43:47.494-06:00A Kind Word for the Fed<p> This is my first post over at Substack. <a href="https://www.grumpy-economist.com" target="_blank">Follow me here</a> and let me know if it isn't working. </p><p>The post is in praise of interest on reserves and abundant reserves, with (of course) some suggestions for improvements. </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com6tag:blogger.com,1999:blog-582368152716771238.post-1718431254393498152023-12-20T21:33:00.001-06:002023-12-22T18:22:54.173-06:00Politics by Law<p><a href="https://www.wsj.com/us-news/law/colorado-ruling-knocking-trump-off-ballot-puts-supreme-court-in-hot-seat-de07e8f5" target="_blank">Colorado's Supreme Court kicks Trump</a> off the ballot (WSJ). <a href="https://johnhcochrane.blogspot.com/2023/10/political-prisoner-dilemma.html" target="_blank">I wrote earlier</a> forecasting constitutional crisis with next election. Legal chaos is starting right on schedule. </p><p>Summary: Both sides are casting their opponents as <i>illegitimate. </i>That justifies profound norm-breaking behavior. Political battles are being fought in the courts, so control of the courts and the judicial system now becomes vital to political success. When you can't afford to lose an election you do anything to win. Scorched earth rules the day. </p><p>This affair offers a catch-22 to the Supreme Court. As a partisan chess move, you can't help but admire it. The case is weak, as even the judges voting for it admit. The election is coming up fast. There are many pending state cases to keep Trump off the ballot. The Supreme Court surely does not want to see elections more and more decided by courts. This will likely force the Court to act.<span></span></p><a name='more'></a><p></p><p>Letting the ruling stand, and having Trump off the ballot in several states, will inflame Trump supporters, and bolster their view that the justice system is hijacked by Democrats. If it is overturned, Democrats will quickly cast it as a "pro-Trump" partisan move, and use it to inflame their campaign to de-legitimize the court. Among other consequences, that will embolden the increasing habit of simply ignoring Supreme Court decisions. The brouhaha may also scare the court over the many election cases that are headed its way like an avalanche in the next year. It is devilishly clever. If it were not so utterly destructive. </p><p>The WSJ on these points. </p><blockquote><p>The ruling ... placed the Supreme Court in a position it likely would have preferred to avoid: having to resolve unprecedented legal issues that also ignite strong political passions among the nation’s electorate. ... </p></blockquote><p>A central legal question: </p><blockquote><p>One point of deep disagreement was whether removing Trump from the ballot violated his due process rights, given that he hasn’t been convicted of a crime and the pending criminal charges against him aren’t for insurrection.</p></blockquote><blockquote><p>... One dissenting justice was particularly vehement in opposition, saying it violated bedrock American principles to remove Trump from the ballot in this fashion. </p></blockquote><blockquote><p>“Even if we are convinced that a candidate committed horrible acts in the past—dare I say, engaged in insurrection—there must be procedural due process before we can declare that individual disqualified from holding public office,” Justice Carlos Samour Jr. wrote.</p></blockquote><blockquote><p>“I could see the Supreme Court worrying about that and saying if you’re going to disqualify someone you need to give them more of an opportunity to make their case because that’s such a momentous deprivation of liberty and rights,” said [David] Orentlicher, an elected Democrat...</p></blockquote><p>Hypocrisy is hardly new in politics. But it is noteworthy that the party bleating most loudly about "threats to democracy" is so distrustful of democracy that it is waging legal battles to keep Mr. Trump from being democratically elected. If it's so self-evident that Trump violated the Constitution and his oath of office, the correct remedy is to simply let voters not vote for him on that basis. The party supposedly of the little person does not trust that little person to make the most basic decisions. </p><p>Pushing political battles into the judicial system really is a threat to democracy. In a lot of semi-autocratic countries, when someone loses an election, the winners go after them on vague charges, impoverish them, family, and supporters, and often put them in jail if not worse. In response, people do everything in their power not to lose elections, no matter how many law and norms get broken along the way. The more political battles end up in court, the closer we come to that state. </p><p>I repeat the warning from my last post. This is the tip of the iceberg. We have not just the 92 (is that the latest number?) charges against Trump. Redistricting will be a battleground. Campaign finance charges will be levied. Republicans are gearing up Hunter Biden charges. Every smudged postmark, every extended deadline will end up in court. The Supreme Court may end up making crucial decisions again. The losers will claim <i>illegitimacy </i>of both the winner and the process, and will spend the following 4 years in resistance. Stop now while you can. </p><p>(I am moving to Substack. I will cross-post everything in both places until the bugs are worked out.) </p><p><i>Update:</i></p><p>Thanks all for the thoughtful and mostly polite comments, on such a sensitive topic. </p><p>I now think the Supreme Court should leave it alone. Let the election come, let Coloradans ponder their Supreme Court banning the candidate of one of our two parties from the ballot, and let Coloradan voters do something about it if they don't like that outcome. I come to this view from reading Nellie Bowles always <a href="https://www.thefp.com/?gclid=CjwKCAiAhJWsBhAaEiwAmrNyq0nuzRlBLTl1SRos4fWVeSWRXHs46b35PcsnOYqZncpDqA0PmbdTbRoCmDEQAvD_BwE" target="_blank">fantastic and humorous commentary over at the Free Press</a>: </p><blockquote><p>The only way to protect democracy is to end democracy: The Colorado Supreme Court decided this week that Trump is disqualified from holding the presidency and so cannot appear on the Republican primary ballot in the state. Meanwhile, California’s lieutenant governor ordered the state Supreme Court to “explore every legal option” to remove Trump from the ballot. In doing so, she said that the rules for the presidency are simple: “The constitution is clear: You must be 40 years old and not an insurrectionist.” Yet even there she is wrong: you only have to be 35. </p></blockquote><blockquote><p>Anyway, for a long time the standard liberal take has been that Democracy Is Under Threat from Republicans. And Trump certainly tried schemes in Georgia and whatnot, like, the man gave it a shot. But I would say that banning the opposition party’s leading candidate. . . is pretty much the biggest threat to democracy you can do. It’s a classic one, really. Timeless. Oldie but Goodie. The American left was so committed to protecting democracy that they had to ban voting. </p></blockquote><blockquote><p>All I’ll say is that once you ban the opposition party’s top candidate, you can no longer, in fact, say you’re for democracy at all. You can say you like other things: power, control, the end of voting, choosing the president you want, rule by technocratic elites chosen by SAT score, all of which I personally agree with. But you can’t say you like democracy per se.</p></blockquote><blockquote><p>So Colorado, listen, I dream every day of being a dictator. I would seize the local golf course and turn it into a park on day one; day two, expand Austin breakfast taco territory to the whole country; day three, invade Canada. Day four, we ban zoos. My fellow fascists, we’re on the same page. Let’s just drop the democracy stuff and call it what it is. </p></blockquote><p>But until courts pick candidates for Colorado Supreme Court, the voters of Colorado can choose if they want democracy. </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com67tag:blogger.com,1999:blog-582368152716771238.post-92022257858697857942023-12-17T22:24:00.000-06:002023-12-17T22:24:45.152-06:00Bond risk premiums -- certainty found and lost again<p>This is a second post from a set of comments I gave at the NBER Asset Pricing conference in early November at Stanford. <a href="https://www.nber.org/conferences/asset-pricing-program-meeting-fall-2023" target="_blank">Conference agenda here</a>. <a href="https://www.johnhcochrane.com/research-all/nber-comments-2023" target="_blank">My full slides here</a>. <a href="https://johnhcochrane.blogspot.com/2023/12/new-keynesian-models-puzzle-of.html" target="_blank">First post here</a>, on new-Keynesian models</p><p>I commented on "Downward Nominal Rigidities and Bond Premia" by François Gourio and Phuong Ngo. The paper was about bond premiums. Commenting made me realize that I thought I understood the issue, and now I realize I don't at all. Understanding term premiums still seems a fruitful area of research after all these years. </p><p><b>I thought I understood risk premiums</b></p><p>The term premium question is, do you earn more money on average holding long term bonds or short-term bonds? Related, is the yield curve on average upward or downward sloping? Should an investor hold long or short term bonds? <span></span></p><a name='more'></a><p></p><p>1. In the beginning there was the mean variance frontier and the CAPM. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjzE3eWL7cU8VBw0XTZEIkeV1D3moAJ4wqV_rhRzYy7wPrTxDle4xZulSkFIJvDGN2CFuE5gi3_akmIm60JJOnYT68mJgyYU1CRD-m9chUFi9zExbKOpapbqG0BTAMZ4RmvH78f-jAjhgPSMad28-bVX8wiicId0QbzLoYiX08F1s07J1GrYVdMqk4NSA/s476/MV_picture.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="452" data-original-width="476" height="304" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjzE3eWL7cU8VBw0XTZEIkeV1D3moAJ4wqV_rhRzYy7wPrTxDle4xZulSkFIJvDGN2CFuE5gi3_akmIm60JJOnYT68mJgyYU1CRD-m9chUFi9zExbKOpapbqG0BTAMZ4RmvH78f-jAjhgPSMad28-bVX8wiicId0QbzLoYiX08F1s07J1GrYVdMqk4NSA/s320/MV_picture.png" width="320" /></a></div>Long term bonds have an almost stock-like standard deviation (around 10%, 16% for stocks) with a mean return barely above that of cash or short term bonds. They look like yucky investments. <div><br /></div><div>(They're not, or not just based on this observation. Bonds are around 40% of the market. Good final exam question: Given the above picture, should a mean-variance investor get out of bonds? Is the market price and quantity irrational? Hint: Individual stocks are also inside the frontier.) </div><div><br /></div><div>More precisely, short-term bonds or the "risk free rate" are the best investment for risk-averse investors. Long term bonds are at best part of the risky portfolio. Less risk averse investors hold some of them for slightly better return and diversification. </div><div><br /></div><div>That leads to the standard presupposition that long-term bonds have higher returns, and the yield curve slopes up, to compensate for their extra risk. That isn't quite right -- average return depends on betas. Long term bonds have higher returns, if their extra risk covaries with stock risk. They could be "negative beta" securities, but that is unlikely. Higher interest rates lower stock prices too. </div><div> </div><div>2. <a href="https://www.aeaweb.org/articles?id=10.1257/aer.91.1.99" target="_blank">Campbell and Viceira</a> neatly reversed this conclusion in a beautiful AER paper. What is the risk-free investment for a <i>long-horizon</i> investor, one who wants a steady stream of consumption? Answer: <i>an indexed perpetuity</i>. A bond that pays (say) $100 per year, indexed for inflation, forever. This is obvious once you look at the payoffs, but not at all obvious from standard portfolio theory. There long-term bonds look like volatile investments whose returns miraculously correlated with innovations to state variables for investment opportunities. In English, long term bonds can have big mark to market losses. But when price goes down yield goes up, you make it back in the long run. Yes, they are risk free for long term investors. <a href="https://www.johnhcochrane.com/research-all/long-term-portfolios" target="_blank">Portfolios for long-term investors</a> is a long riff on this theme. </div><div><br /></div><div>Now, your presupposition is that long term bonds should have the lowest yields, being safest, and short-term bonds should have a higher mean return to compensate for extra risk. </div><div><br /></div><div>But we're talking about nominal bonds, not indexed bonds. The risk-free proposition holds if real interest rates vary, but inflation does not.In that case, short bonds have roll-over risk for long term investors, and long bonds have steady payouts. If inflation varies but real rates are constant, then short-term bonds have less risk for long term investors. </div><div><br /></div><div>That suggests an interesting view: Until 1980, inflation was pretty variable, and we should see upward sloping term structure and risk premium. After 1980, or at least after 1990, inflation was stable and real interest rates varied. The risk premium should turn around. </div><div><br /></div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiVBlBDHUqbnTscO7WgsIuB8AhqHBJicnLOWLqSBX4n3im0-vw6krTFOj4XWtY-wqse87iow2FUSw7Kc0hS3Cu0-7yap9y10BtTRvTcvKyv45AHdT8YxfZtlpS2m-lwL0oEG5AD-qm9qCoDQEa9ErA5_OAKXvnCPKduEM8j9yN_jrkZHij_1pSWf0-Keg/s792/Cochrane_comments_on_Yields-4%20(dragged).tiff" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="612" data-original-width="792" height="494" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiVBlBDHUqbnTscO7WgsIuB8AhqHBJicnLOWLqSBX4n3im0-vw6krTFOj4XWtY-wqse87iow2FUSw7Kc0hS3Cu0-7yap9y10BtTRvTcvKyv45AHdT8YxfZtlpS2m-lwL0oEG5AD-qm9qCoDQEa9ErA5_OAKXvnCPKduEM8j9yN_jrkZHij_1pSWf0-Keg/w640-h494/Cochrane_comments_on_Yields-4%20(dragged).tiff" width="640" /></a></div>3. That too is simplistic, because of course I'm looking again at variance not beta. Now, inflation reliably falls in recessions (see graph). Interest rates also fall in recessions, so bond prices rise. That means bonds are <i>great</i> negative-beta investments. Bonds overall should have very low returns. And this pattern has become much stronger since the 1980s, so bond returns should have gone down. <div><br /></div><div>They did. In all the arguments about "savings glut," "low r*" and so on, I never see this basic mechanism mentioned. Bonds are great negative-beta securities to hold in a recession or financial crisis. </div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaT4JmhhrXWQWMrZ-afMcalP6t48pHbacvfQ2pwnKhUYVXLxwqFtu3qFy81IhmVB54sUOvyGeztlpdfWQjMStksFA0o6D3UvaSBKi-oUJgHUREr7xEbW5EEAD9_ZMoTu6fcGVscrXoe0wEy_3btJOzA5W3A4ITiTab6JmY5VPawOPinfd35pHUxP6r7g/s788/Cochrane_comments_on_Yields-5%20(dragged).tiff" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="468" data-original-width="788" height="382" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjaT4JmhhrXWQWMrZ-afMcalP6t48pHbacvfQ2pwnKhUYVXLxwqFtu3qFy81IhmVB54sUOvyGeztlpdfWQjMStksFA0o6D3UvaSBKi-oUJgHUREr7xEbW5EEAD9_ZMoTu6fcGVscrXoe0wEy_3btJOzA5W3A4ITiTab6JmY5VPawOPinfd35pHUxP6r7g/w640-h382/Cochrane_comments_on_Yields-5%20(dragged).tiff" width="640" /></a></div><br /><div>And, that holds especially for government bonds. Look at 2008, and remember that prices move inversely to yields. Holding 10 year government bonds would have been much better than holding BAA bonds! That saving grace in a severe financial crisis, when the marginal utility of cash was high, might well account for some of the otherwise much higher yield of BAA bonds. </div><div><br /></div><div>But today we're looking at the term premium, long bonds vs short bonds, not the overall value of bonds. Now, short bond yields go down a lot more than long term yields. But price is 1/(1+y)^10, and the short bonds mature and roll over. It's not obvious from the graph which of long or short bonds has a better return after inflation going through the financial crisis. But that is easy enough to settle. </div><div><br /></div><div><b>But I didn't </b></div><div><b><br /></b></div><div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTqAr0l7TTvxT5_covdAY6r6QQL2BSeyOPDy6cVULZPGciHdKr6CTqzz22ekvNv3RZCZz9-5w-_YC1TDPIEa_DrqPrGwLh60KzpgpEn4gpPMQ8o9a9EzP73ttbDF8C5spzpKKAkE_wQIQvV3UyQf4NN-pHR8jEgxqDJviPhBWom0oOv5Wudi94k-2S9A/s792/Cochrane_comments_on_Yields-6%20(dragged).tiff" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="612" data-original-width="792" height="494" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTqAr0l7TTvxT5_covdAY6r6QQL2BSeyOPDy6cVULZPGciHdKr6CTqzz22ekvNv3RZCZz9-5w-_YC1TDPIEa_DrqPrGwLh60KzpgpEn4gpPMQ8o9a9EzP73ttbDF8C5spzpKKAkE_wQIQvV3UyQf4NN-pHR8jEgxqDJviPhBWom0oOv5Wudi94k-2S9A/w640-h494/Cochrane_comments_on_Yields-6%20(dragged).tiff" width="640" /></a></div></div><div>Reading Gourio and Ngo made me realize this cozy view was a bit lazy. I was looking at covariance of return with one-period marginal utility, forgetting the whole long-horizon investor business that brought me here in the first place. The main lesson of Campbell and Vieira's work is that it is <i>nuts</i> to do one-period mean and alpha vs beta analysis of bond returns. More precisely, if you do that you <i>must </i>include "state variables for investment opportunities." When bond prices go down bond yields go up. You will make it all back. That matters. </div><div><br /></div><div>Yet here I was thinking about one-period bond returns and how they covary with instantaneous marginal utility. What matters for the long-horizon investor is how a bad outcome covaries with remaining lifetime consumption, remaining lifetime utility. Returns that fall in a recession shouldn't matter much at all if we know the recession will end. </div><div><br /></div><div>There is, of course, one special case in which consumption today is a sufficient statistic for lifetime utility -- the time-separable power utility case. To use that, though, you really have to look at nondurable consumption, not other measures of stress. And, of course, I'm assuming that long-term investors drive the market. </div><div><br /></div><div>Normally we do not impose the consumption-based model. So it remains true, if you are thinking about expected returns in terms of betas on various factors, it is absolutely nuts not to think about long term bonds with factors such as yields that are state variables for future investment opportunities. </div><div><br /></div><div>Gouio and Ngo use a consumption-based model, but with Epstein Zin utility. (Grumble grumble, habits are better for capturing time-varying risk premeia.) The power utility proposition that today's consumption is a sufficient statistic for information about the future also falls apart with Epstein Zin utility. A lot of the point of Epstein Zin based asset pricing is that expected returns line up with consumption betas, but <i>also</i> and often predominantly with betas on information variables that indicate future consumption. </div><div><br /></div><div>Here, my comment is not critical, but just interpretive. If we want to understand how their or any model of the bond risk premium works, we cannot think as I did above simply in terms of returns and current consumption. We have to think in terms of returns and information variables about future consumption, a set of state-variable betas. Or, following back to Campbell and Viceira's beautiful insight, we should think about returns as increases in the whole stream of consumption. We should think about portfolio theory in terms of streams of payoffs and streams of consumption, not one-period correlations and state variables. </div><div><br /></div><div>What's the answer? Why do Gourio and Ngo find a shifting term premium? Well, I finally know the question, but not really the intuition of the answer. </div><div><br /></div><div>You can see how my attempt to find intuition for bond premiums follows advances in theory, from mean-variance portfolios and CAPM, to ICAPM with time-varying investment opportunities, which bonds have in spades, to a long-term payoff view of asset pricing, to time-varying multi factor models, to the consequences of Epstein Zin utility. </div><div><br /></div><div>But contemporary finance is now exploring a wild new west: "institutional finance" in which leveraged intermediaries are the crucial agents and the rest of us pretty passive; segmented markets, safe asset "shortages" "noise traders" and pure supply and demand curves for individual securities, neither connected across assets by familiar portfolio maximization nor connected over time by standard market efficiency arguments. With this model of markets in mind, obviously, who should (or can!) buy long term bonds, and how we understand term premiums, will be vastly different. </div><div><br /></div><div>So, I go from a very settled view with just a little clarification needed -- long vs short term bond recession betas -- to seeing that the basic story of term premiums really is still out there waiting to be found. </div><div><br /></div><div><br /></div><div><br /></div><div><br /></div><br /><div><br /><div><br /></div><div><br /></div><div><br /></div><div><br /><p><br /></p></div></div>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com16tag:blogger.com,1999:blog-582368152716771238.post-22623961718838926712023-12-15T11:20:00.006-06:002023-12-15T18:10:30.986-06:00Time for a new (?) theory of regulation<p>What's the basic story of economic regulation? </p><p>Econ 101 courses repeat the benevolent dictator theory of regulation: There is a "market failure," natural monopoly, externality, or asymmetric information. Benevolent regulators craft optimal restrictions to restore market order. In political life "consumer protection" is often cited, though it doesn't fit that economic structure. </p><p>Then "Chicago school" scholars such as George Stigler looked at how regulations actually operated. They found "regulatory capture." Businesses get cozy with regulators, and bit by bit regulations end up largely keeping competition down and prices up to benefit existing businesses. </p><p>We are, I think, seeing round three, and an opportunity for a fundamentally new basic view of how regulation operates today. </p><p>The latest news item to prod this thought is <a href="https://docs.fcc.gov/public/attachments/FCC-23-105A2.pdf" target="_blank">FCC Commissioner Brendan Carr's scathing dissent</a> on the FCC's decision to cancel $885 million contract to Starlink. Via <a href="https://twitter.com/BrendanCarrFCC/status/1734696706795778126" target="_blank">twitter/X</a>: <span></span></p><a name='more'></a><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgIXlZz4c58igvZNl3BD4nNaSB2pRSSIciPA4EFc8nIh2umioDsplbieS7VDlKxkm1DK_JxS-aVvSlG1VBfT7TmrQTfICXI40xvqRq2L6tnQx864HGqE6Ti88W1yW-zbnuf5YLfcQ2WSaHC_JJkVI3kwlv0yZDJWh46c5bXzkFkTFCrBphe_-d_po_VdQ/s1198/Screenshot%202023-12-13%20at%208.29.01%E2%80%AFAM.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="546" data-original-width="1198" height="292" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgIXlZz4c58igvZNl3BD4nNaSB2pRSSIciPA4EFc8nIh2umioDsplbieS7VDlKxkm1DK_JxS-aVvSlG1VBfT7TmrQTfICXI40xvqRq2L6tnQx864HGqE6Ti88W1yW-zbnuf5YLfcQ2WSaHC_JJkVI3kwlv0yZDJWh46c5bXzkFkTFCrBphe_-d_po_VdQ/w640-h292/Screenshot%202023-12-13%20at%208.29.01%E2%80%AFAM.png" width="640" /></a></div><p>Quoting from the dissent itself (my emphasis): </p><blockquote><p>Last year, after Elon Musk acquired Twitter and used it to voice his own political and ideological views without a filter, President Biden gave federal agencies a greenlight to go after him. During a press conference at the White House, President Biden stood at a podium adorned with the official seal of the President of the United States, and expressed his view that Elon Musk “is worth being looked at.”<a href="https://www.whitehouse.gov/briefing-room/speeches-remarks/2022/11/09/remarks-by-president-biden-in-press- conference-8/" target="_blank">1</a> When pressed by a reporter to explain how the government would look into Elon Musk, President Biden remarked: “There’s a lot of ways.”<a href="https://www.wsj.com/articles/elon- musk-biden-administration-justice-department-investigations-accdd84a?mod=article_inline" target="_blank">2</a> There certainly are. <i>The Department of Justice, the Federal Aviation Administration, the Federal Trade Commission, the National Labor Relations Board, the U.S. Attorney for the Southern District of New York, and the U.S. Fish and Wildlife Service </i>have all initiated investigations into Elon Musk or his businesses.</p></blockquote><blockquote><p>Today, the Federal Communications Commission adds itself to the growing list of administrative agencies that are taking action against Elon Musk’s businesses. I am not the first to notice a pattern here. Two months ago, The Wall Street Journal editorial board wrote that “the volume of government investigations into his businesses makes us wonder if the Biden Administration is targeting him for regulatory harassment.”<a href="https://www.wsj.com/articles/elon- musk-biden-administration-justice-department-investigations-accdd84a?mod=article_inline" target="_blank">3</a> After all, the editorial board added, Elon Musk has become “Progressive Enemy No. 1.” Today’s decision certainly fits the Biden Administration’s pattern of regulatory harassment. Indeed, the Commission’s decision today to revoke a 2020 award of $885 million to Elon Musk’s Starlink—an award that Starlink secured after agreeing to provide high-speed Internet service to over 640,000 rural homes and businesses across 35 states—is a decision that cannot be explained by any objective application of law, facts, or policy.</p></blockquote><p>When the Biden administration launches an "all of government" initiative, they mean<i> all </i>of government. </p><p>A tweeter queries</p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkgarRw6CuUDnu-LOV1HzTVg2As0TRbd2gn8-CH5W6oSR7qlwQtU7xccxMmUEpi22fOjXCzYc-9HHwRSMbovMM7aNaLpZZymtS45Dlqq2BQsWBTXjeTBxqwnMu_0g5H0Rc3yP6r9wW2ryHEeq6tBX1BoyGG2Wd24LbEgCHb4DH1MluMQO6-f8nHBWinA/s1214/Screenshot%202023-12-13%20at%208.27.44%E2%80%AFAM.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="438" data-original-width="1214" height="232" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhkgarRw6CuUDnu-LOV1HzTVg2As0TRbd2gn8-CH5W6oSR7qlwQtU7xccxMmUEpi22fOjXCzYc-9HHwRSMbovMM7aNaLpZZymtS45Dlqq2BQsWBTXjeTBxqwnMu_0g5H0Rc3yP6r9wW2ryHEeq6tBX1BoyGG2Wd24LbEgCHb4DH1MluMQO6-f8nHBWinA/w640-h232/Screenshot%202023-12-13%20at%208.27.44%E2%80%AFAM.png" width="640" /></a></div><br /><p>Show me the man, and I'll find the crime. Three felonies a day. </p><p>In the same vein, I found most interesting in the twitter files and scathing Missouri V. Biden decision the question, just how did the government force tech companies to censor the government's political opponents? "Nice business you have there. It would be a shame if the alphabet soup agencies had to look into it." </p><p>This doesn't fit either the econ 101, benevolent nanny, or regulatory capture view. Fundamentally, regulators have captured the industry, not the other way around. They hold arbitrary discretionary power to impose huge costs or just shut down companies. They use this power to elicit political support from the companies. There is a bit of old Chicago school capture in the deal. Companies get protected markets. But the regulators now don't just want a few three martini lunches and a cozy revolving door to "consultant" jobs. They demand, political support. The regulators are more political ideologues than gently corruptible insiders. </p><p>Sometimes regulators seem to attack businesses just for fun, like <a href="https://www.wsj.com/economy/jobs/a-moving-company-touts-its-young-chiseled-workers-feds-say-thats-age-discrimination-c50a773c" target="_blank">suing a moving company</a> for age discrimination. But maybe here too they are showing everyone what they can do, or scoring some ideological points so people get the message. </p><p>The increasing arbitrariness of regulation is part of the process. I find myself nostalgic for the good old days of the Administrative Procedures Act, public comment, cost benefit analysis, and formal rule making. Now regulators just write letters or take legal action, which even if unsuccessful can bankrupt a company. Using administrative courts, the regulators are prosecutor, judge, jury, and executioner all rolled in to one. </p><p>Unrelated. $885 million / 640,000 = $1,3825. The federal government apparently thinks it's worthwhile for taxpayers to pay $1,382 to give rural households access to satellite internet. If anyone asked, "would you rather $x in cash or a starlink account?" (which, I think, they also have to pay for) I wonder if x would be much more than $50. </p><p><br /></p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com22tag:blogger.com,1999:blog-582368152716771238.post-27641994402485663522023-12-13T09:27:00.002-06:002023-12-14T08:25:45.883-06:00A Vision for the University of Pennsylvania<p>A group of faculty at Penn have written <a href="https://pennforward.com" target="_blank">A Vision for a New Future of the University of Pennsylvania</a> at <a href="https://pennforward.com/">https://pennforward.com/</a>. They encourage signatures, even if you're not associated with Penn. I signed. </p><p>Big picture: Universities stand at a crossroads. Do universities choose pursuit of knowledge, the robust open and uncomfortable debate that requires; excellence and meritocracy, even if as in the past that has meant admitting socially disfavored groups? Or do universities exist to advance, advocate for, and inculcate a particular political agenda? Choose. </p><p>Returning to the former will require structural changes, and founding documents are an important part of that rebuilding effort. For example, Penn and Stanford are searching for new presidents. A joint statement by board and president that this document will guide rebuilding efforts could be quite useful in guiding that search and the new Presidents' house-cleaning. </p><p>There is some danger in excerpting such a document, but here are a few tasty morsels: </p><p>Principles:</p><blockquote><p>Penn’s sole aim going forward will be to foster excellence in research and education.</p></blockquote><p>Specifics:<span></span></p><a name='more'></a><p></p><blockquote><p>Intellectual diversity and openness of thought. The University of Pennsylvania’s core mission is the pursuit, enhancement, and dissemination of knowledge and of the free exchange of ideas that is necessary to that goal.....</p></blockquote><blockquote><p>Civil discourse. The University of Pennsylvania ... acknowledges that no party possesses the moral authority to monopolize the truth or censor opponents and that incorrect hypotheses are rejected only by argument and persuasion, logic and evidence, not suppression or ad-hominen attacks. </p></blockquote><blockquote><p>Political neutrality at the level of administration. ... In their capacity as university representatives, administrators will abstain from commenting on societal and political events...</p></blockquote><blockquote><p>The University must remain neutral to scientific investigation, respect the scientific method, and strive to include many and varied approaches in its research orientation.</p></blockquote><p>Admissions, hiring, promotion </p><blockquote><p>... No factor such as gender, ethnicity, nationality, political views, sexual orientation, or religious associations shall be considered over merit in any decision related to the appointment, advancement, or reappointment of academic, administrative, or support staff at any level. Excellence in research, teaching, and service shall drive every appointment, advancement, reappointment, or hiring decision.</p></blockquote><blockquote><p>no factor such as gender, ethnicity, nationality, political views, sexual orientation, or religious associations shall be considered in any decision related to student admission and aid. </p></blockquote><blockquote><p>Faculty committed to academic excellence must have a supervisory role in the admission process of undergraduate, graduate, and professional students. Admission policies should prioritize the fair treatment of each individual applicant, and criteria must be objective, transparent, and clearly communicated to all community members. </p></blockquote><p>Faculty have outsourced admissions to bureaucrats. While the cats are away, the mice play. Faculty complain the students are dumb snowflakes. Well, read some files. And no more "bad personality" scores for asians. </p><p>Education:</p><blockquote><p>A central goal of education is to train students to be critical thinkers, virtuous citizens, and ethical participants in free and open but civilized and respectful debate that produces, refines, and transmits knowledge. </p></blockquote><p>Competition:</p><blockquote><p>as Penn’s competitors struggle to define their mission and lose their focus on this manner of excellence, Penn has a unique opportunity to emerge as a globally leading academic institution in an ever more competitive international landscape....</p></blockquote><blockquote><p>An unconditional commitment to academic excellence will become Penn’s key comparative advantage in the decades to come. As many other universities in Europe and the U.S. compromise their hiring decisions by including other non-academic criteria, Penn will be able to hire outstanding talent that otherwise would have been hard to attract. </p></blockquote><p>I have been puzzled that the self-immolation of (formerly) elite universities has not led to a dash for quality in the second ranks. There is a lot of great talent for sale cheap. But many second rank schools seem to have bought in to The Agenda even more strongly than the elite. I guess they used to copy the elite desire for research, and now they copy the elite desire for fashionable politics. Or perhaps donors government, alumni or whatever it is that universities compete for also are more interested in the size of the DEI bureaucracy than the research accomplishments and teaching quality of the faculty or the competence of the students. Clearly, the writers of this document think in the long run competition will return to the production and dissemination of knowledge, and that universities that reform first will win.</p><p> </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com23tag:blogger.com,1999:blog-582368152716771238.post-11938596799307688432023-12-08T23:18:00.001-06:002023-12-08T23:20:31.299-06:00Sociology Meetings<p>When Jukka Savolainen wrote about it in the <a href="https://www.wsj.com/articles/floridas-shunning-of-sociology-should-be-a-wake-up-call-curriculum-higher-education-politics-0fdbd542" target="_blank">Wall Street Journal</a> I couldn't quite believe it, so I had to go look. Indeed, on the website of the <a href="https://www.asanet.org/2024-annual-meeting/annual-meeting-theme/" target="_blank">American Sociological Association describing its 2024 annual meeting</a> we have the official "theme" of the meeting</p><p>"..sociology as a form of liberatory praxis: an effort to not only understand structural inequities, but to intervene in socio-political struggles."</p><p>"To intervene." "Political struggles." <span></span></p><a name='more'></a><p></p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjTRbwLMA5WWbmp41QTO1RxHWTwA0xX0iDcP8nbhRed5N376ECUcuRdlmdJj6Om9dqhZAerSwla0oCdoNwy0Jp6j1app72U050EbKhpavc8-jVSZaeBeeUXeYsIvfFt64e0QShaXAo7W4oGl8yxIXx4bLDLjQGafCPIHMYTFAjqdIjSlnh-XEL2cXX3MQ/s2104/Screenshot%202023-12-08%20at%206.49.37%E2%80%AFPM.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="1232" data-original-width="2104" height="375" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjTRbwLMA5WWbmp41QTO1RxHWTwA0xX0iDcP8nbhRed5N376ECUcuRdlmdJj6Om9dqhZAerSwla0oCdoNwy0Jp6j1app72U050EbKhpavc8-jVSZaeBeeUXeYsIvfFt64e0QShaXAo7W4oGl8yxIXx4bLDLjQGafCPIHMYTFAjqdIjSlnh-XEL2cXX3MQ/w640-h375/Screenshot%202023-12-08%20at%206.49.37%E2%80%AFPM.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">American Sociological Association. My emphasis.</td></tr></tbody></table><p>For a long time, people have made fun of the "social sciences" including economics as pretend sciences. We have "physics envy," they said, but will never really measure up. Well, a lot of social sciences are not pretending to be sciences anymore!</p><p>There is a lot of attention to the political conformity and censorship going on on campuses, but not enough I think to the similar problems of professional societies and journals. Professor Savolainen for example doesn't feel particularly "included" these days. </p><p>Hopefully, the explosion into public consciousness over the last few weeks of just how rotten and politicized academia has become will make this sort of thing look pretty embarrassing by springtime. </p><p> </p><p><br /></p><p><br /></p><p><br /></p><p><br /></p><p><br /></p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com7tag:blogger.com,1999:blog-582368152716771238.post-48746809974859491862023-12-08T17:01:00.002-06:002023-12-08T22:53:42.082-06:00New-Keynesian models, a puzzle of scientific sociology<script src="https://polyfill.io/v3/polyfill.min.js?features=es6"></script>
<script async="" id="MathJax-script" src="https://cdn.jsdelivr.net/npm/mathjax@3/es5/tex-mml-chtml.js"></script><p>This post is from a set of comments I gave at the NBER Asset Pricing conference in early November at Stanford. <a href="https://www.nber.org/conferences/asset-pricing-program-meeting-fall-2023" target="_blank">Conference agenda here</a>. <a href="https://www.johnhcochrane.com/research-all/nber-comments-2023" target="_blank">My full slides here</a>. There was video, but sadly I took too long to write this post and the NBER took down the conference video. </p><p>I was asked to comment on "Downward Nominal Rigidities and Bond Premia" by François Gourio and Phuong Ngo. It's a very nice clean paper, so all I could think to do as discussant is praise it, then move on to bigger issues. These are really comments about whole literatures, not about one paper. One can admire the play but complain about the game. </p><p>The paper implements a version of Bob Lucas' 1973 "<a href="https://www.jstor.org/stable/1914364" target="_blank">International evidence</a>" observation. Prices are less sticky in high inflation countries. The Phillips curve more vertical. Output is less affected by inflation. The Calvo fairy visits every night in Argentina. To Lucas, high inflation comes with variable inflation, so people understand that price changes are mostly aggregate not relative prices, and ignore them. Gourio and Ngo use a new-Keynesian model with downwardly sticky prices and wages to express the idea. When inflation is low, we're more often in the more-sticky regime. They use this idea in a model of bond risk premia. Times of low inflation lead to more correlation of inflation and output, and so a different correlation of nominal bond returns with the discount factor, and a different term premium. </p><p>I made two points, first about bond premiums and second about new-Keynesian models. Only the latter for this post. </p><p>This paper, like hundreds before it, adds a few ingredients on top of a standard textbook new-Keynesian model. But that textbook model has deep structural problems. There are known ways to fix the problems. Yet we continually build on the standard model, rather than incorporate known ways or find new ways to fix its underlying problems. </p><p><b>Problem 1: The sign is "wrong" </b>or at least unconventional.<span></span></p><a name='more'></a><p></p><p></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhMZOItwq8HBa_93nJLBe7kOMx_9IwHzjrIdKlCDs7roqKK1cSRFPErhyphenhyphenr1N8q9mKILYDXg2ZD1-gojG6DiXkl2yOqvZkaJbksIY5WeJIchhrihti8T4FWDi_SyBZK-pkE9uNaYT7yMCPsFLdP6mVlXdgiB059OQzEc5-KpermEj1cyJZVJ_NoQYqTXow/s792/Cochrane_comments_on_Yields-7%20(dragged).tiff" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="612" data-original-width="792" height="494" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhMZOItwq8HBa_93nJLBe7kOMx_9IwHzjrIdKlCDs7roqKK1cSRFPErhyphenhyphenr1N8q9mKILYDXg2ZD1-gojG6DiXkl2yOqvZkaJbksIY5WeJIchhrihti8T4FWDi_SyBZK-pkE9uNaYT7yMCPsFLdP6mVlXdgiB059OQzEc5-KpermEj1cyJZVJ_NoQYqTXow/w640-h494/Cochrane_comments_on_Yields-7%20(dragged).tiff" width="640" /></a></div>The basic sign is wrong -- or at least counter to the standard belief of all policy makers. In the model, higher interest rates cause inflation to jump down immediately, and then <i>rise </i>over time. Everyone at the Fed uniformly believes that higher interest rates cause inflation to go nowhere immediately, and then gently <i>decline</i> over time, with "long and variable lags." <p></p><p>Larry Ball pointed this out 30 years ago. The behavior comes straight from the forward-looking Phillips curve. Lower output goes with lower inflation, <i>relative to future inflation. </i>I.e. inflation rising over time. </p><p>To be clear, maybe the model is right and the beliefs are wrong. It's amazing that so much modeling and empirical work has gone in to massaging theory and data to conform to Milton Friedman's 1968 proclamation of how monetary policy works. The "long and variable lags" in particular are a trouble to modern economics. If you know prices are going up tomorrow, you raise prices today. But that's for another day. This model does not behave the way most people think the economy behaves, so if you're going to use it, at least that needs a major asterisk. </p><p>Well, we know how to fix this. You can see that sneaking lagged inflation into the Phillips curve is going to be a big part of that. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjQ1UkxMjlOQl_yPfdKRc8o1QFYT4J-u5mYT5ZmFQHMTSLXivBjX9Yf8qgzxK1glgxUUIZJWt-mU70yuuUio-Z8mVpWpNuxIUTcwARK2o_5_F8JOP5rftoKezi1yjgVOBZCD28o4hCRK_DUoEPP33Np3db1Rh7ppOAoHWHGMDugmqmLy5iiztYuerGcrg/s792/Cochrane_comments_on_Yields-8%20(dragged).tiff" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="612" data-original-width="792" height="494" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEjQ1UkxMjlOQl_yPfdKRc8o1QFYT4J-u5mYT5ZmFQHMTSLXivBjX9Yf8qgzxK1glgxUUIZJWt-mU70yuuUio-Z8mVpWpNuxIUTcwARK2o_5_F8JOP5rftoKezi1yjgVOBZCD28o4hCRK_DUoEPP33Np3db1Rh7ppOAoHWHGMDugmqmLy5iiztYuerGcrg/w640-h494/Cochrane_comments_on_Yields-8%20(dragged).tiff" width="640" /></a></div>Christiano Eichenbaum and Evans, 20 years ago, produced a widely cited model that "fixes" this problem. It has a lot of ingredients. Most of all, it assumes that wages and prices are indexed. Firms and workers that don't get tapped by the Calvo fairy to change their price or wage nonetheless raise by observed inflation. This gives a Phillips curve with lagged inflation. Moreover, in preferences, investment, and this Phillips curve, CEE modify the model to put growth rates in place of levels. (More review in a <a href="https://johnhcochrane.blogspot.com/2023/08/interest-rates-and-inflation-part-3.html" target="_blank">three part series on new-Keynesian models here</a>.) <div><br /></div><div>The result: If the funds rate goes down (right panel) unexpectedly, inflation goes down just a bit but then turns around and goes up a year later. <br /><div><br /></div><div>(Several other authors get to the same place by abandoning rational expectations. But that has its own problems, and it's going to be hard to incorporate asset pricing that way. Much more in <a href="https://www.johnhcochrane.com/research-all/inflation-neutrality" target="_blank">Expectations and the Neutrality of Interest Rates</a>) </div><div><br /></div><div>Great. But notice that neither Gourio and Pho nor pretty much anyone else builds on this model. We cite it, but don't use it. Instead, 20 more years of NK theorizing studies different extensions of the basic model, that don't solve the central conundrum. </div><div><br /></div><div><b>Problem 2: Fed induced explosions</b></div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj5k06b6pwfMeO3mM0oPD3MOTKjGhBWlLbZVUAwPOEviUHWfDIBQdWR7GLgj96qkYb7-f8_vkE7DfufO9ptA81rhicUkyzhbYKdGLzmHu9JmQeK_pBGwu9ii2KhJgRYexk_l2uo9jmZSxgUFbR4BVKl9IIr29b7JdNq7E4GmnNRgd1DxKmqiafoa8dWTw/s792/Cochrane_comments_on_Yields-9%20(dragged).tiff" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="612" data-original-width="792" height="494" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj5k06b6pwfMeO3mM0oPD3MOTKjGhBWlLbZVUAwPOEviUHWfDIBQdWR7GLgj96qkYb7-f8_vkE7DfufO9ptA81rhicUkyzhbYKdGLzmHu9JmQeK_pBGwu9ii2KhJgRYexk_l2uo9jmZSxgUFbR4BVKl9IIr29b7JdNq7E4GmnNRgd1DxKmqiafoa8dWTw/w640-h494/Cochrane_comments_on_Yields-9%20(dragged).tiff" width="640" /></a></div><br /><div>The standard new-Keynesian model says that if the Fed holds interest rates constant, inflation is stable -- will go away on its own -- but indeterminate. There are multiple equilibria. The standard new-Keynesian model thus assumes that the Fed deliberately destabilizes the economy. If inflation comes out more than the Fed wishes, the Fed will lead the economy to hyperinflation or hyper deflation. Under that threat, people jump to the inflation that the Fed wishes to see. </div><div><br /></div><div>But the Fed does no such thing. Central bankers resolutely state that their job is to <i>stabilize</i> the economy, to bring inflation back from wherever it might go. Despite thousands of papers with new-Keynesian equations written at central banks, if anyone were ever to honestly describe those equations in the introduction, "we assume that the central bank is committed to respond to inflation by hyperinflation or deflation in order to select from multiple equilibria" they would be laughed out of a job. </div><div><br /></div><div>This has been clear, I think, since 2000 or so. I figured it out by reading Bob King's "<a href="https://www.richmondfed.org/publications/research/economic_quarterly/2000/summer/king" target="_blank">Language and Limits</a>." My "<a href="https://www.johnhcochrane.com/research-all/determinacy-and-identification-with-taylor-rules" target="_blank">Determinacy and Identification</a>" in the JPE 2011 was all about this. We've also known at least one way to fix it, as shown: fiscal theory. OK, I'm a broken record on this topic. </div><div><br /></div><div>Instead, we go on with the same model and its underlying widely counterfactual assumption about policy. </div><div><br /></div><div><b>Problem 3: The fit is terrible</b></div><div><b><br /></b></div><div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhNBxcYitQQvMJ2EbV8ooeORjPqM4dVu7WjHCgLP7e8Kg_yYL2qUpLTGW5KZgXNsaQOCP3WENgl1ZEaSwxMhZydYQaq1D_bFDO6EOiibMalQrAVBuLgVYWkmGGu1yan6A4k92IOrE8PnXjkxTESY1KQv-sjtvsqP2cdmcjwWnZV1aF1HX9Um7H18G9ugQ/s761/Cochrane_comments_on_Yields-10%20(dragged).tiff" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="352" data-original-width="761" height="296" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhNBxcYitQQvMJ2EbV8ooeORjPqM4dVu7WjHCgLP7e8Kg_yYL2qUpLTGW5KZgXNsaQOCP3WENgl1ZEaSwxMhZydYQaq1D_bFDO6EOiibMalQrAVBuLgVYWkmGGu1yan6A4k92IOrE8PnXjkxTESY1KQv-sjtvsqP2cdmcjwWnZV1aF1HX9Um7H18G9ugQ/w640-h296/Cochrane_comments_on_Yields-10%20(dragged).tiff" width="640" /></a></div><br />A model consists of a set of equations, with the thing you want to determine (say, inflation) on the left, the economic causes described by the model on the right, plus "shocks," which are things your model can't capture. In the explanation part, there are parameters (\(\sigma, \ \beta, \ \kappa, \ \phi\)), that control how much the things on the right affect the things on the left. </div><div><br /></div><div>The fit of new-Keynesian models is usually terrible. In accounting for economic variables (\(x_t,\) \(\pi_t, \) \(i_t \) here), the error terms (\(\varepsilon\)) are much larger than the model's economic mechanisms (the \(x,\) \(\pi\) on the right hand side). Forecasts -- predicting \(\pi\), \(x\) ahead of time -- is worse. For example, where did inflation come from and why did it go away? Expected inflation hasn't moved much, and the economy just plugged along. Most of the rise and fall of inflation came from inflation shocks. </div><div><br /></div><div>Related, the fit of the models is about the same amount of terrible for different values of the parameters. That means the parameters are "poorly identified" if identified at all. That means that the mechanisms of the model -- say, how much higher interest rates lower output, and then how much lower output affects inflation -- are weak, and poorly understood. </div><div><br /></div><div>In part this isn't often noticed because we got out of the habit of evaluating models by fit in the 1980s. Most models are evaluated, as I showed above for CEE by matching select "identified" impulse response functions. But as those response functions also explain small variances of output and inflation, it's possible to match response functions well, yet still fit the data badly, i.e. fit the data only by adding big shocks to every equation. </div><div><br /></div><div>I don't know of good fixes here. Old fashioned ISLM models had similar problems (See Sims 1980). But it is a fact that we just ignore and go on. </div><div><br /></div><div>The Phillips curve is a central problem, which has only gotten worse lately. Unemployment was high and declining throughout the 2010s, with stable inflation. Inflation came with high unemployment in 2021. And inflation fell with no high real interest rates, no unemployment, and strong growth in 2022-2023. But what will replace it? </div><div><br /></div><div><b>So where are we?</b></div><div><br /></div><div><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiu1s__HDkuy_X9hhH_VVChMHTioltOFVMLGlpDP1YQYQQfqGE2CYBoFd7RQQqaJU6mSKM6ofF1eIu8S4Q-vbgt_ZLFeczGVOxrte49cQW7aKVNq88EoUrXvXaQ3udWWY_3L7BfFuNkM5js_ZGlxgXVVo58W8uYH_tGqdcFiU83s89EtBFi_d1VgoxErg/s792/Cochrane_comments_on_Yields-11%20(dragged).tiff" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="612" data-original-width="792" height="494" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiu1s__HDkuy_X9hhH_VVChMHTioltOFVMLGlpDP1YQYQQfqGE2CYBoFd7RQQqaJU6mSKM6ofF1eIu8S4Q-vbgt_ZLFeczGVOxrte49cQW7aKVNq88EoUrXvXaQ3udWWY_3L7BfFuNkM5js_ZGlxgXVVo58W8uYH_tGqdcFiU83s89EtBFi_d1VgoxErg/w640-h494/Cochrane_comments_on_Yields-11%20(dragged).tiff" width="640" /></a></div><br />Macro is surprisingly un-cumulative. We start with a textbook model. People find some shortcomings and suggest a fix. But rather than incorporate that fix, the next paper adds a different fix to the same textbook model. One would think we would follow the path on the right. We don't. We follow the path on the left. </div><div><br /></div><div>This is common in economics. The real business cycle literature followed much the same path. After the King Plosser Rebelo stochastic growth model became the standard, people spent a decade with one extension after another, each well motivated to fix a stylized fact. But by and large the next paper didn't build on the last one, but instead offered a new variation on the KPR model. </div><div><br /></div><div>Posteriors follow priors according to Bayes' rule, of course. So another way of putting the observation, people seem to put a pretty high prior on the original model, but don't trust the variations at all. </div><div><br /></div><div>I sin too. In <i><a href="https://www.johnhcochrane.com/research-all/the-fiscal-theory-of-the-price-level-1" target="_blank">Fiscal Theory of the Price Level</a></i> I married fiscal theory with the new-Keynsian IS and Phillips curve, exactly as above, despite problems #1 and #3. Well, it makes a lot of sense to change one ingredient at a time to see how a new theory works. I'm unhappy with the result, but I haven't been able to move on to a new and better textbook model, which is what has occasioned several of these related posts. </div><div><br /></div><div><i>Wę need a digestion.</i> Which of the new ingredients are reliable, robust, and belong as part of the new "textbook" model? That's not easy. Reliable and robust is very hard to find, and to persuade people. There are so many to choose from -- CEE's smorgasbord, capital, financial frictions, heterogeneous agents, different expectation formation stories, different pricing frictions, and so on. What's the minimal easy set of these to use? </div><div><br /></div><div>Part of the trouble lies in how publishing works. It's nearly impossible to publish a paper that removes old ingredients, that digests the model down to a new textbook version. The rewards are to publishing papers that add new ingredients. Even if, like CEE, everyone cites them but doesn't use them. </div><div><br /></div><div>I've asked many economists why they build on a model with so many known problems, and why they don't include known fixes. (Not just fiscal theory!) The answer is usually, yes, I know about all these problems, but nobody will bother me about them since every other paper makes the same assumptions, and I need to get papers published. </div><div><br /></div><div>I went on a bit of a tear here as I referee lots of great papers like this one. Every part of the paper is great, except it builds on a model with big flaws we've known about for 30 years. It feels unfair to complain about the underlying model, since the journal has published and will publish a hundred other papers. But at what point can we, collectively, scream "Stop!" </div><div><br /></div><div>The new-Keynesian model has been the standard model for an astonishing 30 years. None of ISLM, monetarism, rational expectations, or real business cycles lasted that long. It's even more amazing that it is so unchanged in all this time. It is definitely time for a better textbook version of the model! Maybe this is a plea for Woodford, Gali or one of the other NK textbook authors, which much better command of all the variations than I have, to bless us a new textbook model. </div><div><br /></div><div>Or, perhaps it's time for something totally new. </div><div><br /></div><div>That's not fiscal theory per se. Fiscal theory is an ingredient, not a model. You can marry it to new-Keynesian models, as I, Leeper, Sims, and others have done. But you can also marry it to old ISLM or anything else you want. Given the above, maybe there isn't an existing modification but a new start. I don't know what that is. </div><div><b><br /></b></div><div>(My comments also have some similar comments about term premiums and how to think about them, but this post is long enough.) </div></div><div><br /></div><div><b><i>Update:</i></b></div><div><b><i><br /></i></b></div><div>Twitter correspondents <a href="https://twitter.com/S_Surprenant/status/1733267649612664860" target="_blank">Stéphane Surprenant</a> and <a href="https://twitter.com/t_holden/status/1556902477630431232" target="_blank">Tom Holden</a> point me to <a href="https://www.aeaweb.org/articles?id=10.1257/mac.20180124" target="_blank">The Transmission of Monetary Policy Shocks</a> by Silvia Miranda-Agrippino Giovanni Ricco in the AEJ Macro, and<a href="https://www.sciencedirect.com/science/article/pii/S0014292118300461?casa_token=CdEDiU7OBo8AAAAA:fDqeu5WReFc9bcuxXnbujMmbqSyZYwgZ23_JZQnreg9upexmv0-QFdKrOPVu8aaigJn515o52AdE" target="_blank"> Inflation, output and markup dynamics with purely forward-looking wage and price setters</a> by Louis Phaneuf, Eric Sims, and Jean Gardy Victor in the European Economic Review. </div><div><br /></div><div>The former is a VAR with high frequency measurement of the monetary policy shock. And..</div><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicmwas5k34jKPsduAii3UoM7TB-ZQJA47CSNcrNqKyCirZJLcKnHACeTMPMrz9EjArUpeWrU6UrnTKDXNLuO6WUrIbiZyTV3RgprSzD5zJ3MBosXzj7kaZZXuWyg9jqddzb_4QiOq_dlXEG1fK3lP4DwlxovO4B3qhLkGtG09Bm21NrK2dHiAFQSZISw/s1138/Screenshot%202023-12-08%20at%208.46.16%E2%80%AFPM.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="760" data-original-width="1138" height="428" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEicmwas5k34jKPsduAii3UoM7TB-ZQJA47CSNcrNqKyCirZJLcKnHACeTMPMrz9EjArUpeWrU6UrnTKDXNLuO6WUrIbiZyTV3RgprSzD5zJ3MBosXzj7kaZZXuWyg9jqddzb_4QiOq_dlXEG1fK3lP4DwlxovO4B3qhLkGtG09Bm21NrK2dHiAFQSZISw/w640-h428/Screenshot%202023-12-08%20at%208.46.16%E2%80%AFPM.png" width="640" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;"><span style="text-align: left;"> Source: Miranda-Agrippino and Ricco</span></td></tr></tbody></table><br /><div><br /></div><div>The <i>price level</i> as well as the inflation rate can jump down immediately when the interest rate rises! (I think the graph plots the level of CPI, not growth rate.) That's even stronger than the baseline model in which the price level, being sticky, does not move, but the inflation rate jumps on the interest rate rise. </div><div><br /></div><div>The latter is a nice theoretical paper. It adds a lot of the CEE assumptions. I overstated a great deal that others have not used these ingredients. They are used in these "medium scale" models, just not in "textbook" models. However, it gets rid of indexed prices and wages with purely forward looking Phillips curves. It adds intermediate goods however. This makes prices changes work through the network of suppliers adding interesting dynamics, which has always struck me as a very important ingredient. And...</div><div><br /></div><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgcDpbWdhjWLNxK0NSOr1XsC1iaER1sQfxxmuim252jPkLOxy8mePmyP3VucKYp-0gOPY5kpu79Be9WXT4vLb_-sNGTKGhgEEnHv-L6IZme5LU0v4BiakKz-pD3BhWIRRzbTSRAPQT_CWn7B-grXNhabMR8823ESCwfsH4YLmQT-aqSCZxUzdoMXGxrJw/s912/Screenshot%202023-12-08%20at%208.37.55%E2%80%AFPM.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="794" data-original-width="912" height="350" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgcDpbWdhjWLNxK0NSOr1XsC1iaER1sQfxxmuim252jPkLOxy8mePmyP3VucKYp-0gOPY5kpu79Be9WXT4vLb_-sNGTKGhgEEnHv-L6IZme5LU0v4BiakKz-pD3BhWIRRzbTSRAPQT_CWn7B-grXNhabMR8823ESCwfsH4YLmQT-aqSCZxUzdoMXGxrJw/w400-h350/Screenshot%202023-12-08%20at%208.37.55%E2%80%AFPM.png" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">Source: <span style="text-align: left;">Phaneuf, Sims ,and Victor</span></td></tr></tbody></table><br /><div>The main estimate is the dark line. Here you see a model with the conventional response: inflation does not move on impact, and increases some time after the interest rate rise. </div><div><br /></div><div>So, we can switch places! Estimates can replicate the conventional model, with an instant inflation response. Models can replicate the conventional estimates, with a slow inflation response. This one is much prettier than CEEs. <br /><div><br /></div></div>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com8tag:blogger.com,1999:blog-582368152716771238.post-17830043520269012792023-12-06T18:08:00.002-06:002023-12-07T08:24:18.788-06:00The Income Tax Paradox <p>The Supreme Court is hearing a case with profound implications for the income tax. <a href="https://www.wsj.com/articles/moore-v-u-s-supreme-court-wealth-tax-elizabeth-prelogar-34f7814f" target="_blank">WSJ editorial here</a> and good <a href="https://www.wsj.com/articles/the-wealth-tax-you-may-already-owe-irs-supreme-court-moore-v-us-b463deeb" target="_blank">commentary from Ilya Shapiro here</a>. </p><p>This issue is naturally contorted into legalisms: What the heck does "apportioned" mean? How is "income" defined legally? I won't wade into that. What are the economic issues? What's the right thing to do here, leaving aside legalisms?<span></span></p><a name='more'></a><p></p><p>Three general principles underlie taxation. The most important is: The government taxes what it can get its hands on. The economists' analysis of incentives comes much later: The government tries to tax in such a way that does not set off a rush to avoidance, either legal (complex structures to avoid taxes) or economic (don't do the thing that gets taxed, like earn income). </p><p>So why does the government tax income? Because, circa 1913, income was easier to measure than sales, value added, consumption, or other economically better concepts. When money changes hands, it's relatively for the government to see what's there and take a share. Tariffs really start from the same concept. It's relatively easy to see what's going through the port and demand a share, Adam Smith, David Ricardo and free trade be damned. But the government wanted more money than tariffs could provide. </p><p>So, even if it were a good idea to tax wealth, the problem is that there is not neceassarily any <i>cash</i> around where there is wealth or unrealized capital gains. When you sell an asset, you get some cash, and it's easy for the government to demand it. When you do not sell an asset, you have no extra cash. It's a "paper profit." What are you going to pay the government with? </p><p>This comes up in practical terms with estate taxes. Yes, we have a 40% top marginal rate wealth tax right now. (If wealth taxes are unconstitutional, why isn't the estate tax number one on the chopping block? OK, I promised not to delve in to law, but I wish someone would answer it.) But private businesses, family farms, and the like don't have 40% of their value sitting around in cash. Unless you carve out a Swiss cheese of loopholes, and complex legal structures, you have to break up or sell the business to get the cash. That's why the estate tax has said Swiss cheese. </p><p>It also has happened in the news lately with internet titans who got big stock grants at the top of the market. The market crashes. They still owe tax on the value of stock when granted. </p><p>Property taxes are another case. Yes, we have wealth taxes, in the form of property taxes. (They are state and local, not federal, and the issue is federal wealth taxes.) People sometimes can own a house but not have the money to pay the tax. </p><p>Wealth and unrealized capital gains are also troublesome because in many cases it's hard to know exactly how much there is. Just what is the value of a house, a building, or a privately held business? Accountants can differ, especially if taxes are at stake. The minute you tax it, accountants also can get creative about corporate structure to game valuation rules -- voting vs. non voting shares, debt with embedded options, options to buy that are never exercised, interlocking trusts, and so forth. See above estate tax Swiss cheese.</p><p>Moreover, market values change. If I pay tax on unrealized appreciation this year, do I get my money back when the value goes down next year?</p><p>So you can see it makes sense: If one wants to include "investment income" as "income." then tax it when there is a definite value -- the market sale price -- and tax it when there is some cash around to grab; when it is realized. </p><p>But now trouble perks up. It's reasonably easy to turn actual income into an unrealized gain. Suppose you have some income stream, and you don't plan to spend it right away. You want to reinvest it. Rather than pay income tax on the income, then additional income tax on the interest or dividends over time, and then more income tax on the appreciation of the final sale, create a corporation or other entity; let the income flow into the corporation which reinvests it. The "corporation" could just be a shell to receive income and put it in a mutual fund. Yes, you'll still pay capital gains tax when you sell, but that's a lot less. And delay is always great. </p><p>Now you know why we have a corporate income tax at all. There is no economic point to corporate taxes, and "corporations pay their fair share" is nonsense. Every cent of corporate income tax comes from higher prices, lower wages, or lower payouts to stock and bondholders. We should tax those <i>people</i>. And if you want redistribution, taxing the "right" people, that's a lot easier to do when you tax people. But if there is no corporate tax, lots of people will incorporate to avoid income taxes. So, we tax corporate income and then your payout. Thousands of pages of tax law and regulation follow to plug one hole after another. After 100 years of patchwork, including some taxing of unrealized gains, it sort of kept a balance, but people keep inventing new ideas. The case before the court involves domestic owners of a foreign corporation and the treatment of the income received into that corporation abroad. </p><p>So, as revealed by the pro-tax arguments before the court, we have already stepped over the grab-it-while-it's-hot line and taxed a good deal of unrealized income. There was some sort of equilibrium of not overdoing it. </p><p>But not overdoing it, obeying norms and gentlepersons's agreements, is going out of style these days. From WSJ:</p><blockquote><p>The Ninth Circuit’s opinion opened up a freeway to tax wealth and property. And wouldn’t you know, President Biden’s budget this year includes a 25% tax on the appreciation of assets of Americans with more than $100 million in wealth....</p></blockquote><blockquote><p>Justice Samuel Alito asked: “What about the appreciation of holdings in securities by millions and millions of Americans, holdings in mutual funds over a period of time without selling the shares in those mutual funds?” Ms. Prelogar replied: “I think if Congress actually enacted a tax like that, and it never has, that we would likely defend it as an income tax.”</p></blockquote><p>Well, it's also called an estate tax, and we have it now! </p><blockquote><p>There you have it. The Biden Administration believes the Sixteenth Amendment lets Congress tax the unrealized appreciation of assets. As Justice Neil Gorsuch noted, when the Supreme Court opens a door, “Congress tends to walk through it.” The Justices should close the wealth-tax door. </p></blockquote><p>But it is also true that would upset the delicate balance above that allows the government to collect a lot of taxes. Someone has to pay taxes, so other rates would have to go up a lot. When one side overdoes it, the gentleperson's agreement explodes. </p><p>Like corporate income, taxing investment income also makes no sense. You earn money, pay taxes on it, and invest it. If you choose to consume later rather than now, why pay additional tax on it? One of the main don't-distort-the-economy propositions is that we should give people the full incentive to save, by refraining from taxing investment income.</p><p>So why take investment income? Again, because once you tax income, many people can shift labor income to investment income. If you run a business, don't take a salary, but pay yourself a dividend. If you're a consultant, incorporate yourself and call it all business income. In the 1980s even cab drivers incorporated to get lower corporate tax rates. </p><p>The <i>income </i>tax is the original sin. Taxing <i>income</i> made no sense on an economic basis. The government only did it because it was easy to measure and grab, at least before people started inventing a century's worth of clever schemes to redefine "income." It leads inescapably to more sins, the corporate tax and the tax on investment income. And now the repatriation tax on accumulated foreign earnings. </p><p>What's the solution? Well, duh. Tax <i>consumption</i>, not income or wealth. Get the rich down at the Porsche dealer. Leave alone any money reinvested in a company that is employing people and producing products. Now we can do it. And we can then throw out the income tax, corporate tax, and estate tax. </p><p>Income is really meaningless. You earn a lot of income in your middle years, but little early and late. The year you sell a house, you're a millionaire, but then back to low income the rest of the time. Yet our government hands out more and more benefits based on income as if it were an immutable characteristic. It is not. Consumption is a lot more meaningful! </p><p>The case brings up another uncomfortable question. The couple invested their money, and then the IRS changed the rules and told them to pay taxes now on decades worth of past earnings. While we're playing lawyer, laws generally cannot penalize <i>past</i> behavior. Surely if they knew this rule, the couple would have arranged their business differently. </p><p>Here there is an uncomfortable principle of taxation. Unexpected, just this once and we'll never do it again wealth taxes are economically efficient. The problem of taxation is disincentives. If you announce a wealth tax in the future, people respond by not accumulating wealth. Go on round the world private jet tours instead. (I hear UAE is nice this time of year, and all the smart people are there.) But if you tax existing wealth, and nobody knew it was coming, there is no disincentive. </p><p>This is, however, one of the most misused propositions in economics. That promise never to do it again isn't credible. If the government did it once, why not again? And it feels horribly unfair, doesn't it? Grabbing wealth willy nilly unpredictably is not something responsive rule-of-law democracies can or should do. (This issue came up with the corporate tax cut. There was a lot of effort not to reward past investment. That's the same principle as trying to tax that past investment now that it is made. I prefer stable rules.) </p><p>Thus, I actually hope that the Supreme Court does blow up the tax system. It's a bloated crony-capitalist mess. Most people suspect that others with clever lawyers are getting away with murder, which is corrosive to democracy. If the friends of the court are right that the tax system will not survive a narrow definition of income, that might force a fundamental reckoning. We need a ground up reform. Not every decision taken in 1913 has to last forever. Let the income tax implode, and bring on a consumption tax. (Instead, not as well as!) </p><p>I doubt it will happen though. The court is really good at constitutional law, but not at first-principles economics. With the continued political assault on their legitimacy, they will surely find a way to decide this narrowly, and wait to strike down the wealth tax when and if it is enacted. But who knows, it's interesting that they took it in the first place. </p><p><br /></p><p><br /></p><p><br /></p><p><br /></p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com44tag:blogger.com,1999:blog-582368152716771238.post-15330556384701955602023-12-04T10:22:00.002-06:002023-12-04T10:22:16.011-06:00FTPL news: discount and Economist list <p> </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5ZK637ckJa9C3rgTngKKnKTcLbKAerPzuPYkfpnKI6RDxFCUfFOrLH_owbxQwZUMzwIMnQqN880SHuwvCCYM_MYM1PCJo_zcMMND3tRlwZq82J7xusHgZOLqn8FKG-1-y9fqJOo5_F9e_PiDZi53Htf9S6o1L2eS5X87yKMeO00P51bFhZ1zTw5XqkA/s960/discount_2023.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="540" data-original-width="960" height="362" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg5ZK637ckJa9C3rgTngKKnKTcLbKAerPzuPYkfpnKI6RDxFCUfFOrLH_owbxQwZUMzwIMnQqN880SHuwvCCYM_MYM1PCJo_zcMMND3tRlwZq82J7xusHgZOLqn8FKG-1-y9fqJOo5_F9e_PiDZi53Htf9S6o1L2eS5X87yKMeO00P51bFhZ1zTw5XqkA/w640-h362/discount_2023.png" width="640" /></a></div><br /><p></p><p>Just in time for the holidays, the perfect stocking stuffer -- if you have really big stockings. 30% discount on <i><a href="https://press.princeton.edu/books/hardcover/9780691242248/the-fiscal-theory-of-the-price-level" target="_blank">Fiscal Theory of the Price Level</a></i> until June 30 2024. </p><p>And Fiscal Theory makes the <i>Economist's</i> <a href="https://www.economist.com/culture/2023/12/01/the-best-books-of-2023-as-chosen-by-the-economist" target="_blank">list of best books for 2023</a>. </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgz9M98gs30UvUVWFdMf4PpFjI3VPP5yTujxrWx1t3jGUz8gniwyHVHHBeqWHr9txgE_1XyVX3OU-fgoGZSe8bJKaRNFE4ChfA3ttqeg-cj166frNj4yJ_MxrXxfo8A3A746mzeqtClpifCO4uHJNxgPW_0YOFYHpLVhL3YQuge3vekXOFHGaKAqUwXaA/s1430/Screenshot%202023-12-04%20at%208.19.43%E2%80%AFAM.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="1430" data-original-width="1348" height="400" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgz9M98gs30UvUVWFdMf4PpFjI3VPP5yTujxrWx1t3jGUz8gniwyHVHHBeqWHr9txgE_1XyVX3OU-fgoGZSe8bJKaRNFE4ChfA3ttqeg-cj166frNj4yJ_MxrXxfo8A3A746mzeqtClpifCO4uHJNxgPW_0YOFYHpLVhL3YQuge3vekXOFHGaKAqUwXaA/w378-h400/Screenshot%202023-12-04%20at%208.19.43%E2%80%AFAM.png" width="378" /></a></div><br /><p><br /></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhqx0WUoQLDyZA63NJVpxskjOZGAyBPNS_eeJVr1xqjkwYZ5ehiS_871cb2FB29AzHur2z19QUCiC8VQ-PRLPUZhIejTK_40sotIGI8Jsj3Zbevexm1NntwhjoBUhERYKVczsblKbG-o_5-I1SX6lBs5EgV7drgnD85g8FZqJb4VW-0xTg0V9OSaptncg/s1232/Screenshot%202023-12-04%20at%208.19.55%E2%80%AFAM.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="438" data-original-width="1232" height="143" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhqx0WUoQLDyZA63NJVpxskjOZGAyBPNS_eeJVr1xqjkwYZ5ehiS_871cb2FB29AzHur2z19QUCiC8VQ-PRLPUZhIejTK_40sotIGI8Jsj3Zbevexm1NntwhjoBUhERYKVczsblKbG-o_5-I1SX6lBs5EgV7drgnD85g8FZqJb4VW-0xTg0V9OSaptncg/w400-h143/Screenshot%202023-12-04%20at%208.19.55%E2%80%AFAM.png" width="400" /></a></div><br /><p><br /></p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com2tag:blogger.com,1999:blog-582368152716771238.post-73990319588612130252023-11-24T21:24:00.012-06:002023-12-12T10:57:27.966-06:00Pro Dollarization<p>With President Milei's election in Argentina, dollarization is suddenly on the table. I'm for it. Here's why. <span></span></p><a name='more'></a><p></p><p><b>Why not? A standard of value</b></p><p>Start with "why not?'' Dollarization, not a national currency, is actually a sensible default. The dollar is the US standard of value. We measure length in feet, weight in pounds, and the value of goods in dollars. Why should different countries use different measures of value? Wouldn't it make sense to use a common standard of value? Once upon a time every country, and often every city, had its own weights and measures. That made trade difficult, so we eventually converged on international weights and measures. (Feet and pounds are actually a US anachronism since everyone else uses meters and kilograms. Clearly if we had to start over we'd use SI units, as science and engineering already do.) </p><p>Moreover, nobody thinks it's a good idea to periodically shorten the meter in order to stimulate the economy, say by making the sale of cloth more profitable. As soon as people figure out they need to buy more cloth to make the same jeans, the profit goes away. </p><p><b>Precommitment</b></p><p><i>Precommitment </i>is, I think, the most powerful argument for dollarization (as for euorization of, say, Greece): A country that dollarizes cannot print money to spend more than it receives in taxes. A country that dollarizes must also borrow entirely in dollars, and must endure costly default rather than relatively less costly inflation if it doesn't want to repay debts. </p><p>Ex post inflation and devaluation is always tempting, to pay deficits, to avoid paying debt, to transfer money from savers to borrowers, to advantage exporters, or to goose the economy ahead of elections. If a government can precommit itself to eschew inflation and devaluation, then it can borrow a lot more money on better terms, and its economy will be far better off in the long run. </p><p>An independent central bank is often advocated for precommitment value. Well, locating the central bank 5,000 miles away in a country that doesn't care about your economy is as independent as you can get!</p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgc51PQGJZNty4D_1xE10gq1K1AME-SUk0TRpyNXO14N_q3AG9ePxssYq5HSLzFARTT8_do4V1tU-t2feKavYYZneUmVJyHSDBEucWaJ8iQpWUHv3xGDFXCRC22jc8WdM8g_ZMYPiA046eS7uHn6yt5EZQxpWhQbHzdOHKtTRuR93QrofII0PX5D7m20Q/s1200/F_oXvQrWsAA3k38.jpeg" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="1172" data-original-width="1200" height="391" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgc51PQGJZNty4D_1xE10gq1K1AME-SUk0TRpyNXO14N_q3AG9ePxssYq5HSLzFARTT8_do4V1tU-t2feKavYYZneUmVJyHSDBEucWaJ8iQpWUHv3xGDFXCRC22jc8WdM8g_ZMYPiA046eS7uHn6yt5EZQxpWhQbHzdOHKtTRuR93QrofII0PX5D7m20Q/w400-h391/F_oXvQrWsAA3k38.jpeg" width="400" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">The Siren Vase. Greek 480-470 BC. Source: <a href="https://twitter.com/Culture_Crit/status/1727719512856789358" target="_blank">The Culture Critic</a></td></tr></tbody></table><p>Precommitment is an old idea. See picture. It's hard. A country must set things up so that it <i>cannot</i> give in to temptation ex post, and it will regret and try to wriggle out of that commitment when the time comes. A lot of the structure of our laws and government amount to a set of precommitments. An independent central bank with a price-level mandate is a precommitment not to inflate. A constitution and property rights are precommitments not to expropriate electoral minorities. </p><p>Especially in Argentina's case, precommitment is why full dollarization is better than an exchange rate peg or a currency board. A true exchange rate peg -- one dollar for one peso, as much as you like -- would seem to solve the temptation-to-inflate problem. But the country can always abrogate the peg, reinstitute currency controls, and inflate. An exchange rate peg is ultimately a fiscal promise; the country will raise enough taxes so that it can get the dollars necessary to back its currency. When that seems too hard, countries devalue the peg or abandon it altogether. </p><p>A currency board is tougher. Under a currency board, every peso issued by the government is backed by a dollar. That seems to ensure adequate reserves to handle any conceivable run. But a strapped government eyes the great Uncle-Scrooge swimming pool full of dollars at the currency board, and is tempted to abrogate the board, grab the assets and spend them. That's exactly how Argentina's currency board ended. Dollarization is a burn the ships strategy. There is no return. Reserves are neither necessary nor sufficient for an exchange rate peg. The peg is a fiscal promise and stands and falls with fiscal policy. </p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEionYAK410nhq_68hNTSmrQAVaXfeMp8NDp5adHez7VEPFl7BCDYhMo5l4EFbaGK6KeGDm6jyF3aleWATyHIcVIrPYF3ngvrM7-ob8pmDrW53-CM627XBX5zaQWOH7EhZzdzn_BdZVlRttPBV6Y6GYDOCuL_zJlJztX_buPAO7JbfsLe3IgExHBrx0kUQ/s602/main-qimg-60a9fe6ee03f809241347fe75769b0bd-lq.jpeg" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="339" data-original-width="602" height="180" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEionYAK410nhq_68hNTSmrQAVaXfeMp8NDp5adHez7VEPFl7BCDYhMo5l4EFbaGK6KeGDm6jyF3aleWATyHIcVIrPYF3ngvrM7-ob8pmDrW53-CM627XBX5zaQWOH7EhZzdzn_BdZVlRttPBV6Y6GYDOCuL_zJlJztX_buPAO7JbfsLe3IgExHBrx0kUQ/s320/main-qimg-60a9fe6ee03f809241347fe75769b0bd-lq.jpeg" width="320" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">A currency board, to the government</td></tr></tbody></table><p>Full dollarization -- the country uses actual dollars, and abandons its currency -- cannot be so swiftly undone. The country would have to pass laws to reinstitute the peso, declare all dollar contracts to be Peso contracts, ban the use of dollars and try to confiscate them. Dollars pervading the country would make that hard. People who understand their wealth is being confiscated and replaced by monopoly money would make it harder -- harder than some technical change in the amount of backing at the central bank for the same peso notes and bank accounts underlying a devalued peg or even an abrogated currency board. </p><p>The design of dollarization should make it harder to undo. The point is precommitment, to make it as costly as possible for a following government to de-dollarize, after all. It's hard to confiscate physical cash, but if domestic Argentine banks have dollar accounts and dollar assets, it is relatively easy to pronounce the accounts in pesos and grab the assets. It would be better if dollarization were accompanied by full financial, capital, and trade liberalization, including allowing foreign banks to operate freely and Argentinian banks to become subsidiaries of foreign banks. Absence of a central bank and domestic deposit insurance will make that even more desirable. Then Argentinian bank "accounts" could be claims to dollar assets held offshore, that remain intact no matter what a future Peronist government does. </p><p>Governments in fiscal stress that print up money, like Argentina, also impose an array of economy-killing policies to try to prop up the value of their currency, so the money printing generates more revenue. They restrict imports with tariffs, quotas, and red tape; they can restrict exports to try to steer supply to home markets at lower prices; they restrict currency conversion and do so at manipulated rates; they restrict capital markets, stopping people from investing abroad or borrowing abroad; they force people to hold money in oligopolized bank accounts at artificially low interest rates. Dollarization is also a precommitment to avoid or at least reduce all these harmful policies, as generating a demand for a country's currency doesn't do any good to the government budget when there isn't a currency. </p><p>Zimbabwe dollarized in 2009, giving up on its currency after the greatest hyperinflation ever seen. The argument for Argentina is similar. Ecuador dollarized successfully in much less trying circumstances. It's not a new idea, and unilateral dollarization is possible. In both cases there was a period in which both currencies circulated. (Sadly, Zimbabwe ended dollarization in 2019, with a re-introduction of the domestic currency and redenomination of dollar deposits at a very unfavorable exchange rate. It is possible to undo, and the security of dollar bank accounts in face of such appropriation is an important part of the dollarization precommitment.) </p><p><b>The limits of precommitment</b></p><p>Dollarization is no panacea. It will work if it is accompanied by fiscal and microeconomic reform. It will be of limited value otherwise. I'll declare a motto:<i> All successful inflation stabilizations have come from a combination of fiscal, monetary and microeconomic reform. </i></p><p>Dollarization does not magically solve intractable budget deficits. Under dollarization, if the government cannot repay debt or borrow, it must default. And Argentina has plenty of experience with sovereign default. Argentina already borrows abroad in dollars, because nobody abroad wants peso debt, and has repeatedly defaulted on dollar debt. </p><p>The idea of dollar debt is that explicit default is more costly than inflation, so the country will work harder to repay debt. Bond purchasers, aware of the temptation to default, will put clauses in debt contracts that make default more costly still. For you to borrow, you have to give the bank the title to the house. Sovereign debt issued under foreign law, with rights to grab assets abroad works similarly. </p><p>But sovereign default is not infinitely costly and countries like Argentina sometimes choose default anyway. Where inflation may represent simply hugging the mast and promising not to let go, default is a set of loose handcuffs that you can wriggle out of painfully. </p><p>Countries are like corporations. Debt denominated in the country's own currency is like corporate equity (stock): If the government can't or won't pay it back the price can fall, via inflation and currency devaluation. Debt denominated in foreign currency is like debt: If the government can't or won't pay it back, it must default. (Most often, default is partial. You get back some of what is promised, or you are forced to convert maturing debt into new debt at a lower interest rate.) </p><p>The standard ideas of corporate finance tell us who issues debt and who issues equity. Small businesses, new businesses, businesses that don't have easily valuable assets, businesses where it is too easy for the managers to hide cash, are forced to borrow, to issue debt. You have to borrow to start a restaurant. Businesses issue equity when they have good corporate governance, good accounting, and stockholders can be sure they're getting their share. </p><p>These ideas apply to countries, and the choice between borrowing in their own currency and borrowing in foreign currency. Countries with poor governance, poor accounting, out of control fiscal policies, poor institutions for repayment, have to borrow in foreign currency if they are going to borrow at all, with intrusive conditions making default even more expensive. Issuing and borrowing in your own currency, with the option to inflate, is the privilege of countries with good institutions, and democracies where voters get really mad about inflation in particular. </p><p>Of course, when things get really bad, the country can't borrow in either domestic or foreign currency. Then it prints money, forcing its citizens to take it. That's where Argentina is. In personal finance, you start with no credit at all; then you can borrow; finally you can issue equity. On the scale of healthier economies, dollarizing is the next step up for Argentina. </p><p>Dollarization and foreign currency debt have another advantage. If a country inflates its way out of a fiscal mess, that benefits the government but also benefits all private borrowers at the expense of private savers. Private borrowing inherits the inflation premium of government borrowing, as the effective government default induces a widespread private default. Dollarization and sovereign default can allow the sovereign to default without messing up private contracts, and all prices and wages in the economy. It is possible for sovereigns to pay higher interest rates than good companies, and the sovereign to be more likely to default than those companies. It doesn't always happen, because sovereigns about to default usually grab all the wealth they can find on the way down, but the separation of sovereign default from inflationary chaos is also an advantage. </p><p>Greece is a good example, and a bit Italy as well, both in the advantages and the cautionary tale about the limitations of dollarization. Greece and Italy used to have their own currencies. They also had borders, trade controls, and capital controls. They had regular inflation and devaluation. Every day seemed to be another "crisis" demanding another "just this once" splurge. As a result, they paid quite high interest rates to borrow, since savvy bondholders wanted insurance against another "just this once."</p><p>They joined the EU and the eurozone. This step<i> precommitted</i> them to free trade, relatively free capital markets, and no national currency. Sovereign default was possible, but regarded as very costly. Having banks stuffed with sovereign debt made it more costly. Leaving the euro was possible, but even more costly. Deliberately having no plan to do so made it more costly still. The ropes tying hands to the mast were pretty strong. </p><p>The result: borrowing costs plummeted. Governments, people and businesses were able to borrow at unheard of low rates. And they did so, with aplomb. The borrowing could have financed public and private investment to take advantage of the new business opportunities the EU allowed. Sadly it did not. Greece soon experienced the higher ex-post costs of default that the precommitment imposed. Dollarizaton -- euroization -- is a precommitment, not a panacea. Recommitments impose costs on yourself ex post. Those costs are real. </p><p><i>A successful dollarization for Argentina has to be part of a joint monetary, fiscal, and microeconomic reform.</i> (Did I say that already? :) ) If public finances aren't sorted out, a default will come eventually. And public finances don't need a sharp bout of "austerity" to please the IMF. They need decades of small primary surpluses, tax <i>revenues</i> slightly higher than spending, to credibly pay down any debt. To get decades of revenue, the best answer is growth. Tax revenue equals tax rate times income. More income is a lot easier than higher tax rate, which at least partially lowers income. Greece and Italy did not accomplish the microeconomic reform part. </p><p>Fortunately, for Argentina, microeconomic reform is low-hanging fruit, especially for a Libertarian president. </p><p><b>Transition</b></p><p>Well, so much for the Promised Land, they may have asked of Moses, how do we get there? And let's not spend 40 years wandering the Sinai on the way. </p><p>Transition isn't necessarily hard. On 1 January 1999, Italy switched from Lira to Euro. Every price changed overnight, every bank account redenominated, every contract reinterpreted, all instantly and seamlessly. People turned in Lira banknotes for Euro banknotes. The biggest complaint is that stores might have rounded up converted prices. If only Argentina could have such problems. </p><p>Why is Argentina not the same? </p><p>Well, for a lot of reasons. Before getting to the euro, Italy had adopted the EU open market. Exchange rates had been successfully pegged at the conversion rate, and no funny business about multiple rates. The ECB (really the Italian central bank) could simply print up euros to hand out in exchange for lira. The assets of the Italian central bank and other national central banks were also redenominated in euro, so printing up euros to soak up national currencies was not inflationary -- assets still equal liabilities. Banks with lira deposits that convert to Euro also have lira assets that convert to euro. And there was no sovereign debt crisis, bank crisis, or big inflation going on. Italian government debt was trading freely on an open market. Italy would spend and receive taxes in euros, so if the debt was worth its current price in lira as the present value of surpluses, it was worth exactly the same price, at the conversion rate, in euro. </p><p>None of this is true in Argentina. The central problem, of course, is that the government is broke. The government does not have dollars to exchange for Pesos. Normally, this would not be a problem. Reserves don't matter, the fiscal capacity to get reserves matters. The government could simply borrow dollars internationally, give the dollars out in exchange for pesos, and slowly pay off the resulting debt. If Argentina redenominated interest-bearing peso debt to dollars at a market exchange rate, that would have no effect on the value of the debt. </p><p>Obviously, borrowing additional dollars would likely be difficult for Argentina right now. To the extent that its remaining debt is a claim to future inflationary seigniorage revenues, its debt is also worth less once converted to dollars, even at a free market rate, because without seigniorage or fiscal reforms, budget deficits will increase. </p><p>And that leads to the primary argument against dollarization I hear these days. Yes it might be the promised land, but it's too hard to get there. </p><p>I don't hear loudly enough, though, what is the alternative? One more muddle of currency boards, central bank rules, promises to the IMF and so forth? How do you suddenly create the kind of stable institutions that Argentina has lacked for a century to justify a respectable currency? </p><p>One might say this is a problem of price, not of quantity. Pick the right exchange rate, and conversion is possible. But that is not even clearly true. If the state is truly broke, if pesos are only worth anything because of the legal restrictions forcing people to hold them, then pesos and peso debt are genuinely worthless. The only route to dollarization would be essentially a complete collapse of the currency and debt. They are worth nothing. We start over. You can use dollars, but you'll have to export something to the US -- either goods or capital, i.e. stock and bonds in private companies -- to get them. (Well, to get any more of them. Lots of dollars line Argentine mattresses already.) That is enough economic chaos to really put people off. </p><p>In reality, I think the fear is not a completely worthless currency, but that a move to quick dollarization would make peso and peso claims worth very little, and people would rebel against seeing their money holdings and bank accounts even more suddenly worthless than they are now. Maybe, maybe not. Just who is left in Argentina counting on a robust value of pesos? </p><p>But the state is not worth nothing. It may be worth little in mark to market, or current dollar borrowing capacity. But a reformed, growing Argentina, with tax, spending, and microeconomic reform, could be a great place for investment, and for tax revenue above costs. Once international lenders are convinced those reform efforts are locked in, and Argentina will grow to anything like its amazing potential, they'll be stumbling over themselves to lend. </p><p>So a better dollarization plan redeems pesos at the new greater value of the post-reform Argentine state. The question is a bit of chicken and egg: Dollarization has to be part of the reform, but only reform allows dollarization with a decent value of peso exchange. So there is a genuine question of sequencing of reforms. </p><p>This question reminds me of the totally fruitless discussion when the Soviet Union broke up. American economists amused themselves with clever optimal sequencing of liberalization schemes. But if competent benevolent dictators (sorry, "policy-makers") were running the show, the Soviet Union wouldn't have failed in the first place. </p><table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto;"><tbody><tr><td style="text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTuR0zQycCPkFzUotcmLM6Xxldb9eHJ0FIkB7bJRWOqVBGwq1BKhfIC00kbQfCYEad_csPcfdg87ScudQVBvsCoTNsCV9M9wYiH4tB1QETjc3Fj0telHVSeskJ6qXqRZOhN5AvStR2lP7a5p0TwbcOEn_6hyqgYcvkNj_90Egz4xqIrdQ1t9HVQhyTbA/s876/Sargent_Germany.png" style="margin-left: auto; margin-right: auto;"><img border="0" data-original-height="818" data-original-width="876" height="299" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEiTuR0zQycCPkFzUotcmLM6Xxldb9eHJ0FIkB7bJRWOqVBGwq1BKhfIC00kbQfCYEad_csPcfdg87ScudQVBvsCoTNsCV9M9wYiH4tB1QETjc3Fj0telHVSeskJ6qXqRZOhN5AvStR2lP7a5p0TwbcOEn_6hyqgYcvkNj_90Egz4xqIrdQ1t9HVQhyTbA/s320/Sargent_Germany.png" width="320" /></a></td></tr><tr><td class="tr-caption" style="text-align: center;">The end of hyperinflation in Germany. Price level 1919-1924. Note left-axis scale. Source: Sargent (1982) "The ends of four big inflations." </td></tr></tbody></table><p>A better historical analogy is, I think, the ends of hyperinflation after WWI, so beautifully described by Tom Sargent in 1982. The inflations were stopped by a sudden, simultaneous, fiscal, monetary, and (to some extent) microeconomic reform. The fiscal problem was solved by renegotiating reparations under the Versailles treaty, along with severe cuts in domestic spending, for example firing a lot of government and (nationalized) railroad workers. There were monetary reforms, including an independent central bank forbidden to buy government debt. There were some microeconomic reforms as well. Stopping inflation took no monetary stringency or high interest rates: Interest rates <i>fell</i>, and the governments printed <i>more</i> money, as real money demand increased. There was no Phillips curve of high unemployment. Employment and the economies boomed. </p><p>So I'm for almost-simultaneous and fast reforms. </p><p>1) <i>Allow</i> the use of dollars everywhere. Dollars and pesos can coexist. Yes, this will put downward pressure on the value of the peso, but that might be crucial to maintain interest in the other reforms, which will raise the value of the peso. </p><p>2) Instant unilateral free trade and capital opening. Argentina will have to export goods and capital to get dollars. Get out of the way. Freeing imports will lower their prices and make the economy more efficient. Capital will only come in, which it should do quickly, if it knows it can get out again. Float the peso. </p><p>3) Long list of growth - oriented microeconomic reforms. That's why you elected a Libertarian president. </p><p>4) Slash spending. Reform taxes. Low marginal rates, broad base. Subsidies in particular distort prices to transfer income. Eliminate. </p><p>5) Once reforms are in place, and Argentina has some borrowing capacity, redenominate debt to dollars, and borrow additional dollars to exchange pesos for dollars. All existing peso contracts including bank accounts change on the date. </p><p>Basically, you want people to hold peso bills and peso debt in the interim as claims on the post-reform government. Peso holders have an incentive to push for reforms that will raise the eventual exchange value of the peso. </p><p>6) Find an interim lender. The central problem is who will lend to Argentina in mid stream in order to retire pesos. This is like debtor in possession financing but for a bankrupt country. </p><p>This could be a job for the IMF. The IMF could lend Argentina dollars for the purpose of retiring pesos. One couldn't ask for much better "conditionality" than a robust Libertarian pro-growth program. Having the IMF along for the ride might also help to commit Argentina to the program. (The IMF can force conditionality better than private lenders.) When things have settled down, Argentina should be able to borrow dollars privately to pay back the IMF. The IMF might charge a decent interest rate to encourage that. </p><p>How much borrowing is needed? Less than you think. Interest-paying debt can simply be redenominated in dollars once you pick a rate. That might be hard to pay off, but that's a problem for later. So Argentina really only needs to borrow enough dollars to retire cash pesos. I can't find numbers, but hyper inflationary countries typically don't have much real value of cash outstanding. The US has 8% of GDP in currency outstanding. If Argentina has half that, then it needs to borrow only 4% of GDP in dollars to buy back all its currency. That's not a lot. If the peso really collapses, borrowing a little bit more (against great future growth of the reform program) to give everyone $100, the sort of fresh start that Germany did after WWII and after unification, is worth considering. </p><p>Most of the worry about Argentina's borrowing ability envisions continued primary deficits with slow fiscal adjustment. Make the fiscal adjustment tomorrow.</p><p>"You never want a serious crisis to go to waste," said Rahm Emanuel wisely. "Sequencing" reforms means that everything promised tomorrow is up for constant renegotiation. Especially when parts of the reform depend on other parts, I'm for doing it all as fast as possible, and then adding refinements later if need be. Roosevelt had his famous 100 days, not a 8 year sequenced program. </p><p>The Argentine reform program is going to hurt a lot of people, or at least recognize losses that had long been papered over in the hope they would go away. Politically, one wants to make the case "We're all in this, we're all hurting. You give up your special deal, preferential exchange rate, special subsidy or whatever, but so will everyone else. Hang with me to make sure they don't get theirs, and in a year we'll all be better off." If reforms are in a long sequence, which means long renegotiation, it's much harder to get buy in from people who are hurt earlier on that the ones who come later will also do their part. </p><p><b>The standard answers</b></p><p>One standard critique of dollarization is monetary policy and "optimal currency areas." By having a national currency, the country's wise central bankers can artfully inflate and devalue the currency on occasion to adapt to negative shocks, without the inconvenience and potential dislocation of everyone in the country lowering prices and wages. </p><p>Suppose, say, the country produces beef, and exports it in order to import cars. If world demand for beef declines, the dollar price of beef declines. The country is going to have to import fewer cars. In a dollarized country, or with a pegged exchange rate, the internal price of beef and wages go down. With its own country and a floating rate, the value of the currency could go down, leaving beef and wages the same inside the country, but the price of imported cars goes up. If lowering prices and wages causes more recession and dislocation than raising import prices, then the artful devaluation is the better idea. (To think about this question more carefully you need traded and non-traded goods; beef, cars, and haircuts. The relative price of beef, cars, and haircuts along with demand for haircuts is also different under the two regimes). </p><p>Similarly, suppose there is a "lack of demand'' recession and deflation. (90 years later, economists are still struggling to say exactly where that comes from.) With its own central bank and currency, the country can artfully inflate just enough to offset the recession. A country that dollarizes also has to import not-always-optimal US inflation. Switzerland did a lot better than the US and EU once again in the covid era. </p><p>This line of thinking answers the question, "OK, if Argentina ($847 bn GDP, beef exports) should have its own currency in order to artfully offset shocks, why shouldn't Colorado ($484 bn GDP, beef exports)?'' Colorado is more dependent on trade with the rest of the US than is Argentina. But, the story goes, people can more easily move across states. A common federal government shoves "fiscal stimulus" to states in trouble. Most of all, "lack of demand" recessions seem to be national, in part because of the high integration of states, so recessions are fought by national policy and don't need state-specific monetary stimulus. </p><p>This is the standard "optimal currency area" line of thinking, which recommends a common currency in an integrated free trade zone such as US, small Latin American countries that trade a lot with the US, and Europe. Standard thinking especially likes a common currency in a fiscal union. Some commenters felt Greece should keep or revert to the Drachma because the EU didn't have enough common countercyclical fiscal policy. It likes independent currencies elsewhere.</p><p>I hope you're laughing out loud by now. A wise central bank, coupled with a thrifty national government, that artfully inflates and devalues just enough to technocratically exploit price stickiness and financial frictions, offsetting national "shocks" with minimum disruption, is a laughable description of Argentina's fiscal and monetary policies. Periodic inflation, hyperinflation and default, together with a wildly overregulated economy with far too much capital and trade controls is more like it. </p><p>The lure of technocratic stabilization policy in the face of Argentina's fiscal and monetary chaos is like fantasizing whether you want the tan or black leather on your new Porsche while you're on the bus to Carmax to see if you can afford a 10-year old Toyota. </p><p>Another reason people argue that even small countries should have their own currencies is to keep the seigniorage. Actual cash pays no interest. Thus, a government that issues cash earns the interest spread between government bonds and interest. Equivalently, if demand for cash is proportional to GDP, then as GDP grows, say 2% per year, then the government can let cash grow 2% per year as well, i.e. it can print up that much cash and spend it. </p><p>But this sort of seigniorage is small for modern economies that don't have inflation. Without inflation, a well run economy might pay 2% for its debt, so save 2% by issuing currency. 2% interest times cash which is 10% of GDP is 0.2% of GDP. On the scale of Argentinian (or US) debt and deficits, that's couch change. </p><p>When inflation is higher, interest rates are higher, and seigniorage or the "inflation tax" is higher. Argentina is living off that now. But the point is not to inflate forever and to forswear bigger inflation taxes. </p><p>Keeping this small seigniorage is one reason for countries to keep their currency and peg to the dollar or run a currency board. The currency board holds interest-bearing dollar assets, and the government gets the interest. Nice. But as I judge above, the extra precommitment value of total dollarization is worth the small lost seigniorage. Facing Argentina's crisis, plus its catastrophic century of lost growth, lost seigniorage is a cost that I judge far below the benefit. </p><p>Other countries dollarize, but agree with the US Fed to rebate them some money for the seigniorage. Indeed, if Argentina dollarizes and holds 10% of its GDP in non-interest-bearing US dollars, that's a nice little present to the US. A dollarization agreement with Argentina to give them back the seignorage would be the least we can do. But I don't think Argentina should hold off waiting for Jay Powell to answer the phone. The Fed has other fires to put out. If Argentina unilaterally dollarizes, they can work this sort of thing out later. </p><p>Dollarization would obviously be a lot easier if it is worked out together with the US government and US banks. Getting cash sent to Argentina, getting banks to have easy payment systems in dollars and links to US banks would make it all easier. If Argentina gets rid of its central bank it still needs a payment system to settle claims in dollars. Accounts at, say, Chase could function as a central bank. But it would all be easier if the US cooperates. </p><p><b>Updates:</b></p><p>Some commenters point out that Argentina may be importing US monetary policy just as the US imports Argentine fiscal policy. That would lead to importing a big inflation. They suggest a Latin American Monetary Union, like the euro, or using a third country's currency. The Swiss franc is pretty good. Maybe the Swiss can set the world standard of value. </p><p>Both are good theoretical ideas but a lot harder to achieve in the short run. Dollarization will be hard enough. Argentines have a lot of dollars already, most trade is invoiced in dollars so getting dollars via trade is relatively easy, the Swiss have not built out a banking infrastructure capable of being a global currency. The EMU lives on top of the EU, and has its own fiscal/monetary problems. Building a new currency before solving Argentina's problems sounds like a long road. The question asked was dollarization, so I stuck to that for now. </p><p>I imagined here unilateral dollarization. But I didn't emphasize enough: The US should encourage dollarization! China has figured this out and desperately wants anyone to use its currency. Why should we not want more people to use our currency? Not just for the seigniorage revenue, but for the ease of trade and international linkages it promotes. The Treasury and Fed should have a "how to dollarize your economy" package ready to go for anyone who wants it. Full integration is not trivial, including access to currency, getting bank access to the Fed's clearing systems, instituting cyber and money laundering protocols, and so forth. </p><p><b>Important update: </b></p><p>Daniel Raisbeck and Gabriela Calderon de Burgos at CATO have <a href="https://www.cato.org/blog/economist-gets-it-wrong-dollarization-argentina" target="_blank">a lovely essay</a> on Argentinian dollarization, also debunking an earlier Economist article that proclaimed it impossible. They include facts and comparison with other dollarization experiences, not just theory as I did. (Thanks to the correspondent who pointed me to the essay.) </p><p>Some quotes:</p><blockquote><p>At the end of 2022, Argentines held over $246 billion in foreign bank accounts, safe deposit boxes, and mostly undeclared cash, according to Argentina’s National Institute of Statistics and Census. This amounts to over 50 percent of Argentina’s GDP in current dollars for 2021 ($487 billion). Hence, the dollar scarcity pertains only to the Argentine state....</p></blockquote><blockquote><p>The last two dollarization processes in Latin American countries prove that “purchasing” the entire monetary base with U.S. dollars from one moment to the next is not only impractical, but it is also unnecessary. </p></blockquote><blockquote><p>In both Ecuador and El Salvador, which dollarized in 2000 and 2001 respectively, dollarization involved parallel processes. In both countries, the most straightforward process was the dollarization of all existing deposits, which can be converted into dollars at the determined exchange rate instantly.</p></blockquote><blockquote><p>in both Ecuador and El Salvador, dollarization not only did not lead to bank runs; it led to a rapid and sharp increase in deposits, even amid economic and political turmoil in Ecuador’s case....</p></blockquote><p>There is a general feature of ending hyperinflation: People hold more money. In this case, people hold more bank accounts once they know those accounts are safe. </p><p>Short summary of the rest, all those dollar deposits (out of mattresses into the banking system) allowed the central bank to retire its local currency liabilities. </p><blockquote><p>Emilio Ocampo, the Argentine economist whom Milei has put in charge of plans for Argentina’s dollarization should he win the presidency, summarizes Ecuador’s experience thus:</p></blockquote><blockquote><blockquote><p>People exchanged their dollars through the banks and a large part of those dollars were deposited in the same banks. The central bank had virtually no need to disburse reserves. This was not by design but was a spontaneous result.</p></blockquote></blockquote><p>In El Salvador also, </p><blockquote><p>Dollar deposits also increased spontaneously in El Salvador, a country that dollarized in 2001. By the end of 2022, the country’s deposits amounted to 49.6 percent of GDP—in Panama, another dollarized peer, deposits stood at 117 percent of GDP.</p></blockquote><blockquote><p>El Salvador’s banking system was dollarized immediately, but the conversion of the circulating currency was voluntary, with citizens allowed to decide if and when to exchange their colones for dollars. Ocampo notes that, in both Ecuador and El Salvador, only 30 percent of the circulating currency had been exchanged for dollars four months after dollarization was announced so that both currencies circulated simultaneously. In the latter country, it took over two years for 90 percent of the monetary base to be dollar‐based.</p></blockquote><blockquote><p>Cachanosky explains that, in an El Salvador‐type, voluntary dollarization scenario, the circulating national currency can be dollarized as it is deposited or used to pay taxes, in which case the sums are converted to dollars once they enter a state‐owned bank account. Hence, “there is no need for the central bank to buy the circulating currency” at a moment’s notice.</p></blockquote><p>Dollarization starts with both currencies and a peg. As long as people trust that dollarization will happen at the peg, the conversion can take a while. You do not need dollars to soak up every peso on day 1. Dollarization is, above, a commitment that the peg will last for years, not a necessary commitment that the peg will last a day. </p><p>I speculated about private borrowing at lower rates than the sovereign, once default rather than inflation is the only way out for the sovereign. This happened: </p><blockquote><p>... as Manuel Hinds, a former finance minister in El Salvador, has explained, solvent Salvadorans in the private sector can borrow at rates of around 7 percent on their mortgages while international sovereign bond markets will only lend to the Salvadoran government at far higher rates. As Hinds writes, under dollarization, “the government cannot transfer its financial costs to the private sector by printing domestic money and devaluing it.”</p></blockquote><p>A nice bottom line: Ask people in Ecuador, El Salvador, and Panama what they think:</p><blockquote><p>This is yet another lesson of dollarization’s actual experience in Latin American countries. It is also a reason why the vast majority of the population in the dollarized nations has no desire for a return to a national currency. The monetary experiences of daily life have taught them that dollarization’s palpable benefits far outweigh its theoretical drawbacks. </p></blockquote><p><b>Even more important update:</b></p><p>From Nicolás Cachonosky <a href="https://economicorder.substack.com/p/a-guide-to-dollarization-in-argentina" target="_blank">How to Dollarize Argentina</a> The central problem is non-money liabilities of the central bank. A detailed plan. Many other blog posts at the link. See his comment below. </p><p>Tyler Cowen on dollarization in <a href="https://www.bloomberg.com/opinion/articles/2023-11-28/there-s-only-one-way-for-argentina-to-dollarize-messily" target="_blank">Bloomberg</a>. Great quote: </p><blockquote><p>The question is not how to adopt a new currency, it is how to adopt a new currency and retain a reasonable value for the old one. </p></blockquote><p>Dollarization is easy. Hyperinflate the Peso to zero a la Zimbabwe. Repeat quote. </p><p>Emilio Ocampo on <a href="https://ucema.edu.ar/sites/default/files/2023-06/848.pdf" target="_blank">dollarization as a commitment device</a>. </p><blockquote><p>One of the main reasons to dollarize is to eliminate high, persistent, and volatile inflation. However, to be effective, dollarization must generate sufficient credibility, which in turn depends critically on whether its expected probability of reversal is low.... </p></blockquote><blockquote><p>The evidence suggests that, in the long-run, the strongest insurance against reversal is the support of the electorate, but in the short-run, institutional design [dollarization] can play a critical role.</p></blockquote><blockquote><p>Fifty years ago, in testimony to U.S. Congress, Milton Friedman argued that “the whole reason why it is an advantage for a developing country to tie to a major country is that, historically speaking, the internal policies of developing countries have been very bad. U.S. policy has been bad, but their policies have been far worse. ... (1973, p.127).”</p></blockquote><blockquote><p>In this respect, not much has changed in Argentina since. </p></blockquote><p>Craig Richardson explains <a href="https://www.aier.org/article/why-dollarization-doesnt-work-in-zimbabwe/" target="_blank">how dollarization failed in Zimbabwe</a>, a wonderful cautionary tale. Deficits did not stop, the government issued "bonds" and forced banks to buy them, bank accounts became de linked from currency. Gresham's law prevailed, the government "bonds" circulating at half face value drove out cash dollars. With persistent government and trade deficits there was a "dollar shortage." </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com24tag:blogger.com,1999:blog-582368152716771238.post-47717777718753456782023-11-21T22:31:00.001-06:002023-11-24T10:06:45.198-06:00Sunstein redefines "Liberal"<p>Cass Sunstein has a lovely <a href="https://www.nytimes.com/2023/11/20/opinion/cass-sunstein-why-liberal.html" target="_blank">New York Times essay</a> that tries to give us back the word "Liberal." I hope it works. <span></span></p><a name='more'></a><p></p><p>"Liberal" from "Libertas" means, at bottom, freedom. In the 19th century, "liberals" were devoted to personal, economic, and increasing social freedom from government restraint. "Conservatives" wanted to maintain aristocratic privileges, and government interventions in the traditional way of doing things. The debate was not so obvious. Conservatives defended their view of aristocratic power in a noblesse-oblige concern for little people that the unfettered free market might leave behind, in a way quite reminiscent of today's elites who think they should run the government in the name of the downtrodden (or "nudge" them, if I can poke a little fun at Sunstein's earlier work). </p><p>But by the 1970s, the labels had flipped. "Liberals" were advocates of big-state interventionism, in a big tent that included communists and marxists. It became a synonym of "left." "Conservatives" became a strange alliance of free market economics and social conservatism. The word "classical liberal" or "libertarian" started to be used to refer to heirs of the enlightenment "liberal" tradition, broadly emphasizing individual liberty and limited rule of law government in both economic and social spheres. </p><p>But broadly, "liberal" came to mean more government intervention and Democrat, while "conservative" came to mean less state intervention and Republican, at least in rhetoric. </p><p>But a new force has come to the fore. The heirs of the far-left marxists and communists are now, .. what shall we call them.. perhaps "censorious totalitarian progressives." Sunstein calls them "post liberals." The old alliance between center-left and far left is tearing apart, and Oct 7 was a wake up call for many who had skated over the division. </p><p>Largely, then, I read Sunstein's article as a declaration of divorce. They are not us, they are not "liberals." And many of you who call yourselves "conservatives," "free marketers" or even "libertarians" should join us to fight the forces of illiberalism left and right, even if by now you probably completely gave up on the <i>New York Times </i>and read<i> the Free Press</i> instead. </p><p>Rhetoric: Sunstein is brilliantly misleading. He writes what liberalism "is" or what liberals "believe," as if the word were already defined his way. It is not, and the second part of this post quotes another NYT essay with a quite different conception of "liberal." This is an essay about what liberal <i>should</i> mean. I salute that. </p><p>It's interesting that Sunstein wants to rescue the traditional meaning of "liberal," rather than shade words in current use. "Classical liberal," is mostly the same thing, but currently shades a bit more free market than he'd like. "Neoliberal" is an insult but really describes most of his views. People have turned insults around to proud self-identifiers before. "Libertarian," probably has less room for the state and conservativism than Sunstein, and most people confuse "libertarian" with "anarchist." It's interesting he never mentions the word. </p><p>Well, let's rescue "liberal." </p><p>Here are some excerpts of Sunstein's 37 theses. I reorganized into topics. </p><p><i>What is "liberalism"? </i></p><blockquote><p>1. Liberals believe in six things: freedom, human rights, pluralism, security, the rule of law and democracy....</p></blockquote><blockquote><p>6. The rule of law is central to liberalism. ...It calls for law that is prospective, allowing people to plan, rather than retroactive, defeating people’s expectations. It requires conformity between law on the books and law in the world. It calls for rights to a hearing (due process of law)....</p></blockquote><p>Liberalism requires law evenly applied, not "show me the man, and I'll find the crime." It requires a legal system in which each of us is not guilty of "<a href="https://www.amazon.com/Three-Felonies-Day-Target-Innocent/dp/1594035229" target="_blank">Three Felonies a Day</a>," unprotected unless we are trouble to those in power. </p><blockquote><p>10. Liberals believe that freedom of speech is essential to self-government....</p></blockquote><blockquote><p>11. Liberals connect their opposition to censorship to their commitment to free and fair elections, which cannot exist if people are unable to speak as they wish. ...They agree with ... “the principle of free thought — not free thought for those who agree with us but freedom for the thought that we hate.” </p></blockquote><p>It's freedom, individual dignity, equality before the law and the state. </p><p><i>Economics </i></p><p>On economic matters, "liberalism" starts with the basic values of the laissez-faire tradition, because the right to transact freely is one of the most basic freedoms there is:</p><blockquote><p>15. Liberals prize free markets, insisting that they provide an important means by which people exercise their agency. Liberals abhor monopolies, public or private, on the ground that they are highly likely to compromise freedom and reduce economic growth. At the same time, liberals know that unregulated markets can fail, such as when workers or consumers lack information or when consumption of energy produces environmental harm.</p></blockquote><p>On the latter point, Sunstein later acknowledges room for a variety of opinion on just how effective government remedies are for such "failures" of "unregulated markets." I'm a free marketer not because markets are perfect but because governments are usually worse. A point we can respectfully debate with fact and logic.</p><blockquote><p>16. Liberals believe in the right to private property. But nothing in liberalism forbids a progressive income tax or is inconsistent with large-scale redistribution from rich to poor. Liberals can and do disagree about the progressive income tax and on whether and when redistribution is a good idea. Many liberals admire Lyndon Johnson’s Great Society; many liberals do not.</p></blockquote><p>I endorse this as well, which you may find surprising. Economics really has nothing to say about non-distorting transfers. Economists can only point out incentives, and disincentives. Redistribution tends to come with bad incentives. "Liberals" can and do argue about how bad the disincentives are, and if the purported benefits of redistribution are worth it. Cass allows liberals (formerly "conservatives") who "do not" admire extensive federal government social programs, because of their disincentives. Me.</p><blockquote><p>17. Many liberals are enthusiastic about the contemporary administrative state; many liberals reject it</p></blockquote><p>I also agree. I'm one of those who largely rejects it, but it's a matter of degree on disincentives, government competence, and the severity of the problems being addressed. "Liberals" can productively debate this matter of degree. Liberalism is a framework for debate, not an answer to these economic questions. </p><p><i>Integrating Conservativism</i></p><p>Integrating "conservative" into "liberal" is one of Sunstein's charms, and I agree. He is also trying to find a common ground in the "center," that tussles gently on the size of government while respecting America's founding enlightenment values, and unites many across the current partisan divide. </p><blockquote><p>2...Those who consider themselves to be leftists may or may not qualify as liberals. You can be, at once, a liberal, as understood here, and a conservative; you can be a leftist and illiberal. </p></blockquote><blockquote><p>22. A liberal might think that Ronald Reagan was a great president and that Franklin Delano Roosevelt was an abomination; a liberal might think that Roosevelt was a great president and that Reagan was an abomination. </p></blockquote><p>"Conserativism" properly means conserving many of the traditions of our society, rather than burning it down once a generation striving for utopia, and having it dissolve into tyranny. Sunstein's "liberalism" is conservative</p><blockquote><p> 24. Liberals favor and recognize the need for a robust civil society, including a wide range of private associations that may include people who do not embrace liberalism. They believe in the importance of social norms, including norms of civility, considerateness, charity and self-restraint. They do not want to censor any antiliberals or postliberals, even though some antiliberals or postliberals would not return the favor. On this count, they turn the other cheek. Liberals have antiliberal and postliberal friends.</p></blockquote><blockquote><p>26. .. if people want the government to act in illiberal ways — by, for example, censoring speech, violating the rights of religious believers, preventing certain people from voting, entrenching racial inequality, taking private property without just compensation, mandating a particular kind of prayer in schools or endorsing a particular set of religious convictions — liberals will stand in opposition.</p></blockquote><p>The latter includes, finally, a bit of trends on the right that "liberals" do not approve of, and they don't. </p><blockquote><p>28. Some people (mostly on the right) think that liberals oppose traditions or treat traditions cavalierly and that liberalism should be rejected for that reason. In their view, liberals are disrespectful of traditions and want to destroy them. Nothing could be further from the truth. Consider just a few inherited ideals, norms and concepts that liberals have defended, often successfully, in the face of focused attack for decades: republican self-government; checks and balances; freedom of speech; freedom of religion; freedom from unreasonable searches and seizures; due process of law; equal protection; private property.</p></blockquote><blockquote><p>29. Liberals do not think it adequate to say that an ideal has been in place for a long time. As Oliver Wendell Holmes Jr. put it: “It is revolting to have no better reason for a rule of law than that so it was laid down in the time of Henry IV. It is still more revolting if the grounds upon which it was laid down have vanished long since and the rule simply persists from blind imitation of the past.” Still, liberals agree that if an ideal has been with us for a long time, there might be a lot to say in its favor.</p></blockquote><p>A lover of freedom can also admire rule of law, tradition, and custom. Why do we have private property? A illiberal, like many college students fresh to the world, might start from basic philosophical principles, and state that all of the earth's bounty should be shared equally, and head out to the ramparts to seize power. As a philosophical principle, it can sound reasonable. </p><p>But our society and its laws, traditions, and customs, has thousands of years of experience built up. A village had common fields. People over-grazed them. Putting up fences and allocating rights led to a more prosperous village. The tradition of property rights, and their quite detailed specification and limitation that evolved in our common law, responding to this experience, along with well-educated citizens' conception of right and virtue, the moral sense of property right that they learn from their forebears, can summarize thousands of years of history, without us needing to remember each case. </p><p>This thought is what led me in the past to characterize myself as an empirical, conservative, rule-of-law, constitutional and pax-Americana (save that one for later) libertarian, back when the word "liberal" meant something else. </p><p>But, as Holmes points out, a vibrant society must see that some of this laws and traditions are wrong, or ineffective, and thoughtfully reform them. Property rights once extended to people, after all. </p><p>Most of all, the 1970s "liberal" but now "illiberal" view has been that government defines the purpose and meaning of life and society, be it religious purity, socialist utopia, or now the vanguard of the elite ruling on behalf of the pyramid of intersectional victimization. The role of the government is to mold society to that quest. "Conservatives" have thought that the purpose of life and society is defined by individuals, families, churches, communities, scholars, arts, culture, private institutions of civil society, via lively reasoned debate; society can accommodate great variety in these views, and the government's purpose is just to enforce simple rules, and keep the debate peaceful, not to define and lead us to the promised land. I read Sunstein, correctly, to restore the word "liberal" to this later view, though it had largely drifted to the former. </p><p><i>Who isn't liberal? The progressive left</i></p><p>Who isn't a "liberal," to Sunstein? If you've been around university campuses lately, you know how much today's "progressives" ("post-liberals") have turned politics into a tribal, warlike affair. This is who Sunstein is really unhappy with, and to whom this essay is a declaration of divorce: </p><blockquote><p>5. ...liberals ... do not like tribalism. ... They are uncomfortable with discussions that start, “I am an X, and you are a Y,”... Skeptical of identity politics, liberals insist that each of us has many different identities and that it is usually best to focus on the merits of issues, not on one or another identity.</p></blockquote><p>I would add, liberals evaluate arguments by logic and evidence, not who makes the argument. Liberals accept an enlightenment idea that anything true can be discovered and understood by anyone. Truth is not just listening to "lived experience." </p><blockquote><p>18. Liberals abhor the idea that life or politics is a conflict between friends and enemies.</p></blockquote><blockquote><p>23. Liberals think that those on the left are illiberal if they are not (for example) committed to freedom of speech and viewpoint diversity. They do not like the idea of orthodoxy, including on university campuses or social media platforms. </p></blockquote><p>Ad of course, </p><blockquote><p>30. Liberals like laughter. They are anti-anti-laughter.</p></blockquote><p>Old joke from my graduate school days: "How many Berkeley marxist progressives does it take to screw in a light bulb?" Answer: "I don't think that kind of humor is appropriate." </p><p>****</p><p>In case you think everyone agrees on this new definition of "liberal," the essay has a link below it to another one by Pamela Paul, "<a href="https://www.nytimes.com/2023/11/16/opinion/liberals-and-progressives.html" target="_blank">Progressives aren't liberal</a>." Paul's essay also covers some of the history of how the word was used, but in the end uses it in a quite different way from Sunstein. </p><p>In the 1960s and 70s, the left proudly used the word in self-description. </p><blockquote><p>In the 1980s, Ronald Reagan, who often prefaced [liberal] with a damning “tax and spend,” may have been the most effective of bashers. ...Newt Gingrich’s political organization GOPAC sent out a memo, “Language: A Key Mechanism of Control,” urging fellow Republicans to use the word as a slur.</p></blockquote><blockquote><p>It worked. Even Democrats began avoiding the dread label. In a presidential primary debate in 2007, Hillary Clinton called herself instead a “modern progressive.” She avoided the term “liberal” again in 2016.</p></blockquote><p>I think Clinton was trying to position herself to the <i>right </i>of what "liberal" had become by 2016. "Progressive" has come to mean something else. But I may be wrong. </p><blockquote><p>Never Trump conservatives tout their bona fides as liberals in the classical, 19th century sense of the word, in part to distinguish themselves from hard-right Trumpists. Others use “liberal” and “progressive” interchangeably, even as what progressivism means in practice today is often anything but liberal — or even progressive, for that matter.</p></blockquote><p>In the last sentence she is right. Sunstein is not, as he appears, describing a word as it is widely used today, but a word as it is slowly becoming used, and as he would like it to be used. </p><blockquote><p>liberal values, many of them products of the Enlightenment, include individual liberty, freedom of speech, scientific inquiry, separation of church and state, due process, racial equality, women’s rights, human rights and democracy.</p></blockquote><p>Here you start to think she's got the same basic big tent as Sunstein. But not so -- this essay is testament to the enduring sense of the "liberal" word as describing the big-government left, just please not quite so insane as the campus progressives: </p><blockquote><p>Unlike “classical liberals” (i.e., usually conservatives), liberals do not see government as the problem, but rather as a means to help the people it serves. Liberals fiercely defend Social Security, Medicare, Medicaid, Obamacare, the Voting Rights Act and the National Labor Relations Act. They believe government has a duty to regulate commerce for the benefit of its citizens. They tend to be suspicious of large corporations and their tendency to thwart the interests of workers and consumers.</p></blockquote><p>Sunstein had room for disagreement on these "fierce" defenses, or at least room for reasoned argument rather than profession of essential belief before you can enter the debate. "Tout their bona fides" above also does not have quite the reach-across-the aisle non partisan flair of Sunstein's essay. I don't think Paul welcomes never-Trump classical liberals in her tent. </p><p>For Paul, the divorce between "liberal" and "progressive" is real, as for many other "liberals" since the October 7 wake up: </p><blockquote><p>Whereas liberals hold to a vision of racial integration, progressives have increasingly supported forms of racial distinction and separation, and demanded equity in outcome rather than equality of opportunity. Whereas most liberals want to advance equality between the sexes, many progressives seem fixated on reframing gender stereotypes as “gender identity” and denying sex differences wherever they confer rights or protections expressly for women. And whereas liberals tend to aspire toward a universalist ideal, in which diverse people come together across shared interests, progressives seem increasingly wedded to an identitarian approach that emphasizes tribalism over the attainment of common ground.</p></blockquote><blockquote><p>It is progressives — not liberals — who argue that “speech is violence” and that words cause harm. These values are the driving force behind progressive efforts to shut down public discourse, disrupt speeches, tear down posters, censor students and deplatform those with whom they disagree.</p></blockquote><blockquote><p>Divisions became sharper after the Oct. 7 Hamas attack, when many progressives did not just express support for the Palestinian cause but, in some cases, even defended the attacks as a response to colonialism, and opposed retaliation as a form of genocide. </p></blockquote><blockquote><p>This brings us to the most troubling characteristic of contemporary progressivism. Whereas liberals tend to pride themselves on acceptance, many progressives have applied various purity tests to others on the left, and according to one recent study on the schism between progressives and liberals, are more likely than liberals to apply public censure to divergent views. This intolerance manifests as a professed preference for avoiding others with different values, a stance entirely antithetical to liberal values.</p></blockquote><p>Yes. But no Republicans, please. Unlike Sunstein, Paul's "Liberalism" remains unabashedly partisan. </p><p>I hope Sunstein's version of the word prevails. </p><p>In any case, it is nice to see the division between the Woodstock Liberals, previously fellow travelers, from the extreme progressive left, and it is nice to see this word drift back to where it belongs. </p><p>This is an optimistic post for the future of our country. Happy Thanksgiving. </p><p><i>Update: </i>I just ran across Tyler Cowen's <a href="https://marginalrevolution.com/marginalrevolution/2022/10/classical-liberalism-vs-the-new-right.html" target="_blank">Classical Liberals vs. The New Right</a>. Excellent. And I forgot to plug my own "<a href="https://www.johnhcochrane.com/news-op-eds-all/understanding-the-left" target="_blank">Understanding the Left</a>," which I still think is a great essay though nobody seems to have read it. </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com37tag:blogger.com,1999:blog-582368152716771238.post-60326307036138899672023-11-16T22:39:00.002-06:002023-11-16T22:39:20.607-06:00FTPL at SEA<p>Sunday Nov 19 6-7 PM I will be giving the "Association Lecture" at the <a href="https://www.southerneconomic.org/event/7662b305-ad92-474d-8f2c-bce1240b9858/websitePage:16b82361-8a57-42ff-ae16-61b95fe42d68" target="_blank">Southern Economics Association conference</a> in New Orleans. The topic naturally is "The Fiscal Theory of the Price Level." If you're curious, and will be at the conference, stop by. I now have a pretty good condensed talk about fiscal theory! </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgu2h87PxTrj-rAdHixWd8r1DY8H7qEG5fZ1h_ipvs9LRf3BhBgpXx6pXSFEdvwyNwbB6h5hX-3PCIxNskZYkBthbwCO4iXxgubYbky2DpqOsULeFqrqKHS5i2aKEvqBkr-hk4Nr47tcrpBCKL2hp1MhXUX40Ydlh44BqghAB5XAfeymQIf_pQcR7MIDg/s2034/Screenshot%202023-11-16%20at%208.34.47%E2%80%AFPM.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="670" data-original-width="2034" height="213" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgu2h87PxTrj-rAdHixWd8r1DY8H7qEG5fZ1h_ipvs9LRf3BhBgpXx6pXSFEdvwyNwbB6h5hX-3PCIxNskZYkBthbwCO4iXxgubYbky2DpqOsULeFqrqKHS5i2aKEvqBkr-hk4Nr47tcrpBCKL2hp1MhXUX40Ydlh44BqghAB5XAfeymQIf_pQcR7MIDg/w640-h213/Screenshot%202023-11-16%20at%208.34.47%E2%80%AFPM.png" width="640" /></a></div><br /><p><br /></p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com1tag:blogger.com,1999:blog-582368152716771238.post-3988063431461871332023-11-05T12:49:00.000-06:002023-11-05T12:49:15.504-06:00Lukianoff and Schlott on Cancellation<p><iframe allow="accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share" allowfullscreen="" frameborder="0" height="516" src="https://www.youtube.com/embed/tI1P1KGGPxI" title="Greg Lukianoff and Rikki Schlott: The Canceling of the American Mind" width="918"></iframe></p><p>Last week I was honored to be moderator for a discussion with Greg Lukianoff and Rikki Schlott on their new book "<a href="https://www.amazon.com/Canceling-American-Mind-Undermines-Institutions" target="_blank">Canceling the American Mind</a>" at the <a href="https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=&ved=2ahUKEwiu97erwq2CAxW9K0QIHdY5AnQQFnoECBMQAQ&url=https%3A%2F%2Fwww.commonwealthclub.org%2Fevents%2F2023-11-02%2Fgreg-lukianoff-and-rikki-schlott-canceling-american-mind" target="_blank">Commonwealth Club</a> of San Francisco. <a href="https://www.youtube.com/watch?v=tI1P1KGGPxI" target="_blank">Link here</a>, if the embed above doesn't work </p><p>Here are my questions. I shared them with Greg and Rickki ahead of time, so the actual questions are a bit shorter. But this may give you some interesting background, and I think they're good questions to ponder in general.<span></span></p><a name='more'></a> <p></p><p>1) The book is full of great stories. Perhaps you can help everyone get a sense of the book with one or two of the most informative cancellation stories. </p><p>2) I notice a progression in your work. “Coddling” has moved to “canceling” and is moving to “censorship.” People think of “canceling” as a social phenomenon, twitter pile-ons. But, as you show in the book, it has now moved on to organized institutional censorship, in universities, scientific societies and publications, medicine and medical schools, journalism, media and tech, publishing, psychotherapy, law schools, and corporations, which not only punish transgressors but enforce ideological conformity. I’d like you to choose a few stories, explain some of these mechanisms,— for example “DEI” bureaucracies, speech surveillance, curriculum mandates, and so on. </p><p>3) There is an important distinction between free speech and academic freedom. It is one thing to censor and fire people for political tweets, but entirely another that whole lines of research are censored — covid, sex and biology, race and policing are examples. And the spread of censorship to the formerly hard sciences seems more damaging than just how much of a lost cause the humanities are. </p><p>Yet academic freedom in research and teaching is not absolute. If you’re hired to research and teach cosmology, the university is right to say you can’t do lots of creationism, and the right to invest in what it thinks are promising fields. I don’t like “where do you draw the line” discussions, but I would like your thoughts on academic freedom. </p><p>It also strikes me that we find your stories so compelling simply because the things people are censored for seem so reasonable, and their censorship so ridiculous. Yet the ideologues think we’re ridiculous. It’s not clear that academic freedom is the central issue, rather than just how ridiculous and politicized most universities have become in their teaching and research priorities. Perhaps free speech and academic freedom are necessary but not sufficient to fix universities.</p><p>4) A softball: Free speech is all well and good but surely “hate speech and disinformation must be regulated.” —usually stated in that maddening subject-free passive voice, leaving who and how unsaid.</p><p>5) Censorship now infects the government. Since you wrote the book, the twitter files and the savage <i>Missouri V. Biden</i> injunction have come out, detailing how the government got tech companies to silence its political critics. A notable example includes the Great Barrington declaration signatories who turned out to be right about masks, vaccine mandates, lockdowns, and school closures. I fear that social media and AI regulation are really all about censoring political speech, which now includes scientific discourse. Are you?</p><p>6) You also wrote the book before the Hamas terrorist attack in Israel. Campuses and much of Europe exploded with pro-Hamas protests. University leaders, used to denouncing every small injustice in the world, issued muddles. Long-time donors are rebelling. </p><p>Well, they say, don’t you believe in freedom of speech and academic freedom? If we want to go on a campus rampage with “kill the jews” signs, that’s freedom of speech. If we want to run an exercise in class where we make Jewish students stand apart, that’s academic freedom. </p><p>Follow up: In my view, the main lesson is not the hilarious hypocrisy, or a pointless “where do you draw the line” on free speech. The real question is why universities have chosen to admit, hire, and promote so many people who, given free speech, choose to use it on murderous anti-semitism? How do you process these events?</p><p>7) Your book valiantly tries to balance “left" and “right.” I want to push us to a more nuanced view, which may help to defuse partisan sentiments. It’s not really “left” and “right,” as most people on each side still support free speech. [Greg pushed back hard on that, which was very interesting.] Rather there is a small, but influential minority of each that is the enemy of free speech. And let’s get past whose “fault” it is.</p><p>a) Let’s start with the left. I think of the free speech enemies as the totalitarian progressives, sometimes called “woke,” but I try to avoid that charged term. Who do you see the as enemies of free speech on the left, what do they want, and what dangers they pose? </p><p>b) Now on the right. I was surprised to learn how much cancellation is coming from the right. Who are they? In your book, I count some ham handed anti-woke politicians, some traditional book-banning social conservatives, a smattering of “national conservatives,” “common good conservatives” and a vortex of Trump supporters rallying around his peccadillos. But I shouldn’t put words in your mouth. Who are they and what do they want?</p><p>c) You try to be even handed, but I want to push you on that. The anti-speech forces on the left have won the long march through the institutions. You describe a string of selection mechanisms starting in grade school to enforce left-wing ideological conformity. They’re on the advance. On the right you describe have ham-handed “anti-woke” legislators, and what you call a “fringe theory from the Opus Dei wing of the conservative movement.” The the left has Harvard, Yale, Princeton, and Stanford. You cite right-wing cancellations at Collin College, University of Rhode Island, Montana State and University of Kentucky. Is not the present danger to freedom really mostly from the small minority of left-wing activists, and the crowd of bien-pensants who go along with them?</p><p>8) I have to admit I’m a bit disappointed about your “cures.” Maybe depressed is the right word — if you two don’t have magic bullets, we’re in real trouble. You outline a radical restructuring of universities, which is great, but not who is going to take over universities to do it. You emphasize nice rules for a better rhetoric: free speech, logic and evidence, ignore what someone said about another topic, no ad-hominem attacks, and so on. But the opponents of free speech ignore traditional enlightenment rhetoric for a reason. The far left says that logic and evidence are colonialist white supremacist racist thinking; we don’t have to listen to evil people. And faced with their latest ideological word salad, it’s hard to see what there is to discuss on a factual basis anyway. The far right says, we are faced with a Maoist / Bolshevik cultural revolution, aimed at seizing power. There’s no free speech in a war. Voluntarily abiding by better rhetoric doesn't seem likely. Neither side likes your “free speech culture.” </p><p>9) Let’s close with another softball. As you note, free speech is a rare and recent idea. Censorship for political or religious reasons has been the norm in human societies. In your words, why is freedom of speech and thought so crucial? </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com8tag:blogger.com,1999:blog-582368152716771238.post-45512876095703702172023-10-27T11:26:00.007-05:002023-11-02T08:59:28.201-05:00Prices vs. inflation and a mortgage puzzle<p>Mickey Levy's<a href="https://www.wsj.com/articles/were-still-paying-for-the-federal-reserves-blunders-bb42cc5f" target="_blank"> excellent WSJ oped</a> leaves some thoughts. </p><p><i>Inflation</i> has fallen, though I still suspect it may get stuck around 3-4%. But <i>prices</i> "are 18.9% higher than its [their] pre-pandemic level." And some important prices have risen even more. "Rental costs continue to rise in lagged response to the 46.1% surge in home prices." Those who are taking a victory lap about the end of <i>inflation</i> (the rate of change of prices) are befuddled by continuing consumer (and voter) anger. </p><p>Well, prices are not the same thing as inflation. <span></span></p><a name='more'></a>Our current monetary policy has, for decades, forgotten past mistakes. If inflation surges to 10%, and prices rise 10%, it is considered a victory, and battle over when inflation gets back to 2%, though prices are still 12% higher than they were. It wasn't always this way. Under the gold standard, <i>prices</i> were stable for long periods, which means that bouts of inflation were quickly followed by bouts of deflation. I'm absolutely not advocating for the gold standard, but it's worth remembering that price stability rather than inflation stability is possible. <p></p><p>Why the fuss? As Mickey points out, not all prices rose the same amount. In particular, "Increases in wage and salaries ... haven’t kept pace with the CPI and have resulted in a decline in real wages." No wonder "the public isn’t pleased." </p><p>This offers an interesting moment to rethink the basic idea of bygones will be bygones in monetary policy. Wages are, by common agreement, a lot more sticky than prices. Eventually wages will catch up, but it will be a long and contentious process. Wouldn't it be better, after a bout of inflation, for prices to come down quickly, to match the current level of nominal wages? "Real wage restoration" has a nice ring to it that even Fed doves and inequality worriers might appreciate. </p><p><i>Mortgages</i></p><p>Mickey also points to a fascinating puzzle of our mortgage markets: </p><blockquote><p>Tens of millions of homeowners who locked in mortgages at rates below 3% between 2020 and 2021 are now unwilling to sell. The result is a shortage of homes on the market and higher prices. ..That in turn has impaired labor mobility, historically an important factor for production and labor-market efficiencies.</p></blockquote><p>In the US, if you wish to protect yourself against rising mortgage interest rates by buying a fixed rate mortgage, you can only do it bundled with <i>one particular house.</i> You cannot easily say, "I don't want to get hit by interest rate rises, but I might want to move and still be able to afford a big house." So we are stuck with this interesting puzzle, that higher interest rates to combat inflation lead to people staying parked in houses they really don't want, unwilling to move to take a better job somewhere else, to downsize, to cash out of a house-poor expensive area (Palo Alto), to upsize for more children or elderly parents, and so on. </p><p>30 year fixed rate non-transferrable mortgages with a complex option to prepay and refinance when interest rates go down, and little consequence for default (whew) are not a law of nature. It is not this way around the world, and I've been fascinated to talk to economists at other central banks about their very different worries. </p><p>In many countries almost all mortgages have floating rates, that quickly catch up to any rise in short term interest rates. In many of these countries, it is not easy to default. If interest rates rise from 2% to 6% and you can't afford to triple your monthly payment, you can't just give the bank the keys as you typically can in the US. In Sweden, I was told, if you default on a mortgage, the bank will grab all your other assets, and also garnish your wages for several years. You will live on their minimum social assistance income, about $15,000 at the time of this conversation, for several years. </p><p>As a result, central banks in these countries have a completely different set of worries about raising interest rates. Rather than worry about defaults that will imperil banks, they worry that people will stop spending on everything else before defaulting on their mortgage. So monetary policy (raising interest rates), surprisingly ineffective right now in the US, can be dramatically more "effective" with that sort of mortgage market. (Yes, inducing a fall in consumption is the point of raising interest rates.) I don't know of mainstream models that include this distinction but it seems first order for the effect of interest rates on the economy. Central bankers also worry a lot more about public backlash when mortgage costs for the whole population can swiftly double or more. </p><p>Back to the US. Why can you not keep your mortgage when you change houses? Why must protection against interest rate rises -- a form of insurance, really -- be tied to staying in one house? </p><p>Put that way, you can come up with a dozen legal, regulatory, and perhaps even economic reasons. The 30 year fixed rate itself is an invention of 1930s federal housing policy. Banks hold very few mortgages. Pretty much the whole mortgage market gets securitized with a credit guarantee by federal housing agencies (Fannie, Freddy, etc.). So if their rules for acceptable mortgage says you can't change houses, well, you can't change houses, no matter what demand. Subsidies for a particular version of a product kill product innovation. One real estate economist I asked this of suggested that the mortgage originators like it this way, as it forces you to pay fees to move. And one can speculate that lenders don't want you to substitute a worse house as collateral. I don't think that holds, because acceptability of the house follows simple rules, but it's possible. </p><p>So, today's bright idea: Why don't banks also routinely sell retail fixed for floating swaps? These are standard financial contracts that have been around for decades. Here's how it works: You take out a floating rate mortgage, at say 2%. Fixed rate mortgages are, say, 3%. So along with your mortgage, you agree with the bank that you will pay the bank 3% a year, fixed for 30 years, and the bank will pay the floating mortgage rate. That's 2% now, but if interest rates rise, the bank has to pay 5% and you keep paying 3%. Now you can sell the house. When you get a new house, you use the floating rate (5%) to pay the new higher mortgage on the house, while you keep paying 3% out of pocket. We have synthesized a portable mortgage. </p><p>Why doesn't this happen? I await your speculation in the comments. Banks trade fixed for floating swaps among themselves all the time, so laying off the risk is not hard. </p><p>As usual, I am drawn to wonder what tax or regulation is in the way. I can think of a few. First, you will get the mortgage interest tax deduction only on the actual mortgage. The actual 3% fixed mortgage lets you deduct the whole 3%. You will pay income tax on fixed for floating payments. This is really an insurance payment, like fire insurance, which shouldn't be taxable, but the IRS will likely treat it as such. Perhaps if insurance companies sold the product they could lobby Washington for rules to extend the tax exemption, but then you lose some of the efficiency of banks doing what is properly the business of banks. </p><p>Heaven knows how bank regulators and consumer financial protection regulators will do to tangle up a perfectly sensible product. The Fed finally<a href="https://www.wsj.com/articles/federal-reserve-climate-banks-regulation-jerome-powell-michelle-bowman-7857f0d9" target="_blank"> caved in to political pressure</a> to put climate in financial regulation: </p><blockquote><p> banks must manage their balance sheets for physical risks from climate change, such as flooding or drought, as well as the “stresses to institutions or sectors arising from the shifts in policy, consumer and business sentiment, or technologies associated with the changes that would be part of a transition to a lower carbon economy.”...</p></blockquote><p>Shifts in policy? OK Citi, what will happen to your balance sheet if a Republican gets elected and cancels electric vehicle mandates? Oh, maybe that's not the "change in policy" banks are supposed to anticipate. </p><blockquote><p>Banks will also have to conduct a “climate-related scenario analysis”—don’t call them stress tests—that extend “beyond the financial institution’s typical strategic planning horizon” and account for potential losses in “extreme but plausible scenarios.” </p></blockquote><p>Well, if anvils fall from the sky... But I digress. With this sort of thing coming from regulators, who has the time to create and get approval for a new product that might actually serve homeowners and help to unlock housing supply in places where it's scarce? </p><p>If you can think of other regulatory (or economic) barriers, comment away. Or maybe, just maybe, we're waiting for a sharp fintech company to figure out that floating + swap is a product consumers would want. </p><p>(Swaps also require counterparties to post collateral, i.e. put in enough cash that the other side can be sure the payment stream keeps going, and in the event of default come out even. On the household side, equity in the house should serve as it does for mortgages; it would be like a second mortgage claim on home equity. That's a reason to bundle retail swaps with the mortgage issuance. One could have banks post collateral too, though enough priority in bankruptcy should do the trick as these are retail contracts. ) </p><p>(The madness of refinancing fixed mortgages is also puzzling. I know a lot of very good financial economists, and not one can figure out the optimal time to refinance a fixed rate mortgage. Why not just sell mortgages that adjust down but not up? Sure, you'll pay a few basis points extra, but we save a lot of complexity and the costs of getting that option wrong. The same answers as above may apply.) </p><p><i>Update:</i></p><p>I long ago proposed "health status insurance," which is insurance against health insurance premium increases. If you get sick and your health insurance increases, the premium insurance pays the higher health insurance, or a lump sum so you can do it. </p><p>What I'm suggesting here is also "mortgage rate rise insurance." Get a floating rate mortgage and separate mortgage rate insurance. If the mortgage rate rises, the insurance pays the higher rate, or a lump sum so you can do it. </p><p>While we're at it, the major difference between buying and renting is that buying allows you to stay in the house no matter if rents go up, where renters bear the risk of higher rents. It's puzzling that you can get long-term commercial leases, but residential leases allow the rent to rise each year. Rent increase insurance could work the same way. Rent for a year, buy rent increase insurance, and if the rent goes up, rent increase insurance pays the difference or pays a lump sum so you can do it. (Renters synthesize this somewhat by renting and then voting in rent control!) </p><p><i>Update 2:</i></p><p>As many commenters point out, another way to handle the problem is for borrowers to be able to buy their own mortgage back, as is done in Denmark. </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com38tag:blogger.com,1999:blog-582368152716771238.post-82209759029825084962023-10-27T10:17:00.001-05:002023-10-27T10:17:26.055-05:00Evergreen expectations<p> </p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhjC7kXeOHb6rHMClD2zhZpE9e60PS6ckkTfsStD9UqGUDA6tzy9Oyd6DVoouzS8cpYAPrYdPktKb8vgU7hDbLJ662Th7yzTo2bQXnkw4Ao2_w7gFz2E52_JeU-KJxvXzOCv1KKfuG69Lvmyed2cf1VZXii6bNtLbyFmavB4LB5JmpjEiq67rrrA7W4RA/s1896/Screenshot%202023-10-27%20at%205.48.22%E2%80%AFAM.png" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="828" data-original-width="1896" height="280" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEhjC7kXeOHb6rHMClD2zhZpE9e60PS6ckkTfsStD9UqGUDA6tzy9Oyd6DVoouzS8cpYAPrYdPktKb8vgU7hDbLJ662Th7yzTo2bQXnkw4Ao2_w7gFz2E52_JeU-KJxvXzOCv1KKfuG69Lvmyed2cf1VZXii6bNtLbyFmavB4LB5JmpjEiq67rrrA7W4RA/w640-h280/Screenshot%202023-10-27%20at%205.48.22%E2%80%AFAM.png" width="640" /></a></div>A lovely plot from the always interesting Torsten Slok. The graph shows the actual federal funds rate, together with the path of "expected" funds rate implicit in fed funds futures market prices. (Roughly speaking the futures contract is a bet on where the Fed funds rate will be at various dates in the future. If you want to bloviate about what the Fed will do, it's easy to put your money where your mouth is!) <p></p><p>A lot of graphs look like this, including the Fed's "dot plot" projections of where interest rates will go, inflation forecasts, and longer term interest rate forecasts based on the yield curve (yields on 10 year bonds imply a forecast of one year bonds over the 10 year period.) Just change the labels. <span></span></p><a name='more'></a><p></p><p>In words, throughout the 2010 zero bound era, markets "expected" interest rates to lift off soon, year after year. It was sort of like spring in Chicago -- this week, 35 degrees and raining. Next week will be sunny and 70! Rinse and repeat. Once rates started rising in 2016, markets actually thought the rise would be slower than it was, but then did not see the end of the rise. Of course they did not see the sudden drop in 2020, because they didn't see covid. </p><p>I find it fascinating that for the first full year of inflation, 2021-20222, markets did not price in any interest rate rise at all. The Taylor rule (raise interest rates promptly when inflation rises) wasn't that forgotten at the Fed! The one time when it made abundant sense to forecast the Fed would raise rates, markets did not reflect that forecast. </p><p>When the Fed finally did start to raise rates, amid raging inflation, the market even more curiously thought the rate rises would stop quickly. This being a pasted graph, I can't easily add inflation to it, but with the federal funds rate substantially below inflation until June 2022, it's interesting the markets thought the Fed would stop. The story of "transitory" inflation that would go away on its own without a repeat of the early 1980s -- without interest rates substantially below inflation -- was strong. </p><p>The market forecast seems to me still remarkably dovish. GDP just grew like gangbusters last quarter, and the Fed believes in the Phillips curve (strong growth causes inflation). We're running a historic budget deficit for an economy at full steam. The Taylor rule (interest rates react to inflation and output) is still a pretty good description of what the Fed does, sooner or later. So, if you were to trade on the historical pattern, you would bet on rates falling much more quickly than forecast. Hmm. </p><p>This is an old phenomenon. The "expectations" in market forecasts don't seem right. Don't jump to fast to "irrational," finance always has a way out. We call it the "risk premium." There is money to be made here, but not without risk. If you always bet that the funds rate will be below the futures rate, you'll make money most of the time, but you will lose money on occasion. First, in many such bets the occasional losses are larger than the small regular gains. That is important, because the pattern of constant misses in the same direction suggests irrational forecasts, but that's not true. If you play roulette and bet on anything but 00, you win most of the time, but lose big on occasion and come out even overall, More plausibly, when you lose you lose at times when it is particularly inconvenient to lose money. </p><p>Economists often use the federal funds future to establish the "expected" federal funds rate, and then any movement including no movement at all counts as an "unexpected" shock. By that measure the early 2010s were one series of "unexpected" negative monetary policy shocks, month after month. The graph makes it clear that's a reading of history that needs some nuance in its interpretation.</p><p><br /></p><p><br /></p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com10tag:blogger.com,1999:blog-582368152716771238.post-30266152789408120292023-10-22T14:09:00.001-05:002023-10-22T23:40:29.946-05:00Leonhardt on investment<p> David Leonhardt's <a href="https://www.nytimes.com/2023/10/17/magazine/us-public-investment.html" target="_blank">pean to investment in the Sunday NY Times Magazine </a>starts well:</p><blockquote><p>A cross-country trip today typically takes more time than it did in the 1970s. The same is true of many trips within a region or a metropolitan area....Door to door, cross-country journeys often last 10 or even 12 hours.<span></span></p><a name='more'></a><p></p></blockquote><blockquote><p>Compare this stagnation with the progress of the previous century. The first transcontinental railroad was completed in 1869... revolutionizing a journey that had taken months. People could suddenly cross the country in a week. Next came commercial flight... Finally, the jet age arrived: The first regularly scheduled nonstop transcontinental flight occurred on Jan. 25, 1959, from Los Angeles to New York, on a new long-range Boeing jet, the 707....</p></blockquote><blockquote><p>In the more than 60 years since then, there has been no progress. Instead, the scheduled flight time between Los Angeles and New York has become about 30 minutes longer. Aviation technology has not advanced in ways that speed the trip, and the skies have become so crowded that pilots reroute planes to avoid traffic. Nearly every other part of a cross-country trip, in airports and on local roads, also lasts longer. All told, a trip across the United States can take a few more hours today than in the 1970s</p></blockquote><p>(If you want to skip to the snark, it's in "review" below. You may wonder why I bother fussing about a New York Times piece. I do because it starts so unusually well, but then falls apart at taking obvious inferences from useful facts. ) </p><p>On the surface too, </p><blockquote><p>In 1969, Metroliner trains made two-and-a-half-hour nonstop trips between Washington and New York. Today, there are no nonstop trains on that route, and the fastest trip, on Acela trains, takes about 20 minutes longer than the Metroliner once did. Commuter railroads and subway lines in many places have also failed to become faster. When I ride the New York City subway, I don’t go from Point A to Point B much faster than my grandparents did in the 1940s. For drivers — a majority of American travelers — trip times have increased, because traffic has worsened. In the California metropolitan area that includes Silicon Valley, a typical rush-hour drive that would have taken 45 minutes in the early 1980s took nearly 60 minutes by 2019. </p></blockquote><p>Why?</p><blockquote><p>Why has this happened? A central reason is that the United States, for all that we spend as a nation on transportation, has stopped meaningfully investing in it.... Historically, the most successful economic growth strategy has revolved around investment. It was true in ancient Rome, with its roads and aqueducts, and in 19th-century Britain, with its railroads. During the 20th century, it was true in the United States as well as Japan and Europe. </p></blockquote><p>The latter is not quite true. The most successful economic growth strategy is productivity, gained from new ideas embodied in new products and new companies. But it would be quite useful to get from place to place faster. </p><p>Leonhardt makes a decent case for government investment in basic research and public goods: </p><blockquote><p>Investments are expensive for a private company, and only a fraction of the returns typically flows to the original investors and inventors. Despite patents, other people find ways to mimic the invention. Often, these imitators build on the original in ways that are perfectly legal but would not have been possible without the initial breakthrough. Johannes Gutenberg did not get rich from inventing the printing press, and neither did Tim Berners-Lee from creating the World Wide Web in 1989....</p></blockquote><blockquote><p>The earliest stages of scientific research are difficult for the private sector to support. In these stages, the commercial possibilities are often unclear. An automobile company, for example, will struggle to justify spending money on basic engineering research that may end up being useful only to an aerospace company. Yet such basic scientific research can bring enormous benefits for a society. It can allow people to live longer and better lives and can lay the groundwork for unforeseen commercial applications that are indeed profitable.</p></blockquote><p>True but overstated. We might see a lot more private investment if we didn't tax its returns after all. A perfectly logical case for eliminating corporate income taxes and individual taxes on investment returns follows, but of course you won't hear it in the pages of the NYT.</p><p>He goes on to laud military spending for its speeding of technical progress. A perfectly logical case for much larger military spending also follows. </p><p>Yes, </p><blockquote><p>Without a doubt, government officials make plenty of mistakes when choosing which projects to fund. They misjudge an idea’s potential or allow political considerations to influence decisions..</p></blockquote><p>He excuses these, a bit too quickly I think:</p><blockquote><p>Yet these failures tend to be cheap relative to the size of the federal budget, at least in the United States. (The risks of overinvestment are more serious in an authoritarian system like the old Soviet Union or contemporary China.) Even more important, a few big investment successes can produce returns, in economic growth and the resulting tax revenue, that cover the costs for dozens of failures. IBM and Google can pay for a lot of Solyndras.</p></blockquote><p>Without a Cold War it is easy to throw immense down ratholes. More on that coming. </p><blockquote><p>Just as important, government can reduce its involvement as an industry matures and allow the market system to take over. After the government creates the initial demand for a new product, the sprawling private sector — with its reliance on market feedback and the wisdom of crowds — often does a better job allocating resources than any bureaucratic agency.</p></blockquote><p>I'm grateful for the acknowledgement, but though the government can, will it do so? Car companies are headed down an infernal abyss of crony-capitalism. Energy subsides do not seem headed for free market Nirvana. Tech companies are becoming government controlled. </p><blockquote><p>Education also fits the definition of a program that requires spending money today mostly to improve the quality of life tomorrow. In the middle of the 20th century, education was the investment that turbocharged many other investments.</p></blockquote><p>Yes. An eloquent case for education follows. And education seems the poster child for how the government can send endless money down larger and larger ratholes to no effect. </p><blockquote><p>The stagnation of investment does not stem only from the size of government. It also reflects the priorities of modern government, as set by both Republicans and Democrats. The federal government has grown — but not the parts oriented toward the future and economic growth. Spending has surged on health care, Social Security, antipoverty programs, police and prisons. (Military spending has declined as a share of G.D.P. in recent decades.) All these programs are important. A decent society needs to care for its vulnerable and prevent disorder. But the United States has effectively starved programs focused on the future at the expense of those focused on the present. ...</p></blockquote><blockquote><p>This great American stagnation has many causes, but the withering of investment is a major one. </p></blockquote><p>Yes. </p><p><i>Review:</i></p><p>At this point, the essay could easily have segued straight in to a techno-optimist manifesto, like the <a href="https://a16z.com/the-techno-optimist-manifesto/" target="_blank">eloquent one posted by Mark Andreesen</a>. Certify supersonic planes! Hyperloop. A rapid push for self-driving cars. Repeal Davis-Bacon, and other measures that drive up costs. Reform zoning laws and environmental review. Sure, increase federal research and R&D spending, but reform it as well. Driving it all, get back to energy abundance with a vastly deregulated nuclear regulatory commission. Focus transportation on speed. (It's a tragedy that we build light rail and subway lines with no express trains, so they take longer than totally jammed freeways. Could it all be just for show?) </p><p>It did not. Instead, too predictably for The New York Times, it went on to cheer "Bidenomics," </p><blockquote><p>President Biden has made investment the centerpiece of his economic strategy — even if that isn’t always obvious to outsiders. He has signed legislation authorizing hundreds of billions of dollars to rebuild the transportation system, subsidize semiconductor manufacturing and expand clean energy. These are precisely the kinds of programs the private sector tends not to do on its own. All told, Biden has overseen the largest increase in federal investment since the Eisenhower era. Notably, the infrastructure and semiconductor bill both passed with bipartisan support, a sign that parts of the Republican Party are coming to question the neoliberal consensus. As was the case during the 1950s, the threat from a foreign rival — China, this time — is focusing some policymakers on the value of government investment.</p></blockquote><p>Just about every word of this epitomizes why we are in the sorry state we are. The Biden Administration's Federal Highway Administration declared (<a href="https://johnhcochrane.blogspot.com/2022/01/infrastructure-does-not-mean-roads-and.html" target="_blank">see previous blog post</a>) that none of the "infrastructure'' money would be used to expand road capacity, or, most scandalously, "have significant impacts to travel patterns!" Rebuild, perhaps, but not if it solves any of the problems in the first paragraph. No, the private sector will not "subsidize semiconductor manufacturing." Wasn't that exactly the sort of activity that Leonhardt just said is best for the private sector to do? Semiconductor manufacturing is doing just fine abroad. The massive money is earmarked to bring it to the US, where we will do it more expensively. This is simple protectionism on steroids; do to chip manufacturing what the Jones Act did for the Merchant Marine and sugar subsidies do to them. "Expand clean energy" with mind-boggling subsidies and protection -- on the order of a Trillion dollars, largely for current generation battery powered electric cars, which save no carbon, and which China can also make more cheaply if you care about the environment. </p><p>And most deeply, US chips and green energy subsidies don't make anything cheaper, faster, or better. They just do what we already do in the US, at vastly greater cost, and in a different way. Even if electric cars did save carbon, they would not get you to the airport any faster. </p><p>The problem with US public investment is not just lack of money. It is that the money we do spend goes down ratholes, so not spending is wise. Public teacher unions that deliver generations of children, mostly already disadvantaged, who cannot read or count. $4 billion dollar per mile subways. Leonhardt mentions other countries' success with high speed trains, without mentioning the poster child for all that is wrong with US public investment: the California railroad. 15 years and counting, $100+ billion dollars, not a mile of track laid yet. SNCF, the French state railroad company smelled so much rot it wouldn't touch the project. </p><p>If it were not so perfectly obvious to voters that money will be wasted, they might support a lot more investment. </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com21tag:blogger.com,1999:blog-582368152716771238.post-3370577675479547422023-10-20T09:52:00.009-05:002023-10-20T09:54:09.191-05:00Bhattacharya on Covid censorship<iframe allow="accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share" allowfullscreen="" frameborder="0" height="492" src="https://www.youtube.com/embed/VyzEB3ZybGA" title="Stanford Classical Liberalism Seminar - Jayanta Bhattacharya - October 12, 2023." width="875"></iframe><p>A week ago Jay Bhattacharya gave a great talk at the weekly <a href="https://cli.stanford.edu" target="_blank">Stanford Classical Liberalism</a> workshop. (<a href="https://www.youtube.com/watch?v=VyzEB3ZybGA" target="_blank">Link</a> in case the embed doesn't work.) He detailed the story of government+media Covid censorship, along with the dramatic injunction in the <i>Missouri v. Biden</i> case. The discovery in that case alone, detailing how the administration used the threat of arbitrary regulatory retaliation to get tech companies to censor covid information -- along with other matters, including the Hunter Biden laptop -- is astonishing. We now know what they did, no matter what judges say about its technical legality. <span></span></p><a name='more'></a><p></p><p>Toward the end, it came out that Stanford hosts an "internet observatory," specifically named in the injunction for colluding with the government to find and censor people on the internet. Internal matters always drawing attention, there was a longish discussion about that. It does matter. Using (tax exempt) universities and other "nonprofits" to do things that are illegal for the government to do is, at least, not very pretty. As with all matters Israel, academic freedom and free speech seem to be pretty selectively applied. </p><p>Another example of university efforts on "disinformation" came up in later discussion, at <a href="https://www.jbs.cam.ac.uk/faculty-research/centres/cfra/conferences-events/cambridge-disinformation-summit/" target="_blank">Cambridge</a>. It has an interesting mandate: </p><blockquote><p>"Strategic disinformation is an accelerant for major societal problems such as climate change,.... "</p></blockquote><p>Yes, I thought, channeling Bjorn Lomborg and Steve Koonin. The climate-catastrophe, climate-justice, degrowth, anti-capitalism, let-them-stay-poor, get-back-to-the-farm-and-set-my-soul-free crowd has spread immense disinformation about actual climate science. Oh wait, somehow I don't think that's what they have in mind. Orwell would be proud. (I would be delighted to be wrong in this case. Let me know.) </p><p>But these internal matters are minor, really. The story of government, using threat of regulatory attack, to censor the internet is the real shocker. It also reveals a lot about our regulatory state. Can't internet companies say "well, regulation follows rules and procedures; you can't hurt us with regulation when we haven't done anything wrong and there is no provable case?" Ha Ha. Give us the company, and we'll find the regulation. </p>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com3tag:blogger.com,1999:blog-582368152716771238.post-66106563630065338732023-10-18T20:09:00.007-05:002023-10-18T22:38:59.884-05:00Political prisoner dilemma<p>This is a draft oped. It didn't make it as events in Israel are now consuming attention. But sooner or later we need to elect a president and live with the results. I went light on the economics, but you can see the basic game theory of the analysis. It amplifies some comments I made on Goodfellows. </p><p>****</p><p> If, as it appears, the election will come down to Trump vs. Biden, the US is headed for a constitutional crisis, and the social, and political chaos that implies. Like prisoners of the economists’ dilemma, there seems no easy way out. </p><p>Whichever wins, the others’ partisans will pronounce the president to be fundamentally illegitimate. In turn, Illegitimacy justifies and emboldens scorched-earth tactics, more norm-busting and institution-destruction.<span></span></p><a name='more'></a><p></p><p>If Biden wins, Trump supporters will see an official Washington, especially its justice system, enmeshed in presidential politics. They remember Hilary Clinton’s laptop, the Russia collusion hoax, and endless investigations. Now they see sprawling indictments for process and paperwork crimes, that nobody else would be charged for. They see a Washington-media-intelligence cabal censoring news, from censorship of Covid policy dissenters — who turned out to be largely right — to the Hunter Biden laptop story just before the last election. See the scathing Missouri V. Biden. And they see the Family Business. Sure, Biden, like so many in public office who somehow end up with millions in family wealth, likely has enough lawyers and shell companies to avoid provable illegality. But illegality is not the issue. Trump supporters will see the stench of the swamp, secret email accounts, the reins of power covering up the embarrassing facts. </p><p>If Trump wins, Democrats will go ballistic. Democrats have refined de-legitimization for decades. Trump’s denialism was almost comical in its incompetent emulation. Recall Bush derangement syndrome, continuing claims that the 2000 election was stolen or decided by a corrupt court; Stacey Abrams, the #resistance, #not my president. But it’s all worse now. Though Democrats express themselves in legalisms, in the end they feel that Trump’s actions after the last election amount to a nearly treasonous violation of his oath of office to defend the Constitution.</p><p>(Before you start yelling your side's spin, take a breath. Yes, you see things differently, but how will they see things, no matter you loud you yell? How will they act? That's what matters.)</p><p>Our next election is likely to be chaos, enhancing the voices claiming illegitimacy. The election will be close. There will surely be a nationwide legal battle. Every questionable vote, every smudged postmark, every local decision to stretch a ballot deadline, every change in procedures will end up in court. Losing Democrats will cry “racist voter suppression.” Losing Republicans have gotten good at even more fanciful stolen election claims. </p><p>If the election is decided by courts, heaven help us. The Democrat’s efforts to de-legitimize the Supreme Court are already well under way. Media now routinely refer to every federal judge by the president that appointed him or her, not, say, by the school they went to or their most famous decisions. Large swaths of the population will tell themselves that the election was stolen. </p><p>With No Labels and Kennedy in the fray, it is possible that the election will come down to many ballots in the electoral college. Having tried to de-legitimize Trump for losing the popular vote in 2016, will democrats accept an electoral college result if the popular vote is 40-30-30? Will Republicans? It is possible that the electoral college fails, and the Presidency is decided by the House of Representatives, itself chaotic and under a razor-thin majority. Our Constitution brilliantly prescribes fail-safe procedures to produce a decision. But it only works only if people accept that decision. With so many already opining that the electoral college is an illegitimate anachronism, and with the House in such chaos and low esteem, will losers calmly accept the results of the Constitutional mechanism?</p><p>Widely believed, and more widely spun illegitimacy justifies horrendous behavior. You can tell the Jan 6 rioters were play-acting by how unserious they were. People who really believe an election was stolen bring tanks. Widespread violent protests are easy to foresee. </p><p>Widely perceived illegitimacy leads to constitutional crisis and chaos. People will simply disregard presidential actions, action by his appointees, and court orders. They will violently resist attempts to enforce government actions. </p><p>How do we avoid this mess? There is a lot of hope that one or the other party will blink, and choose a vaguely sensible candidate who will then sweep the general election. But candidates are chosen by primaries, a “democratic” reform we may wish to rethink. (Old men in smoke filled rooms, desiring to win a general election, would never have picked these two.) It’s not so easy. </p><p>And even a reasonable candidate will only postpone the deeper question: Why is attacking the legitimacy of elections, institutions, and the courts gaining in strength? It is a scorched earth policy — ruin the institution to gain temporary advantage. </p><p>The answer seems clear: The rewards of winning and the costs of losing are now too great. Narrowly, each of Trump and Biden could well end up in jail if he loses, a situation familiar in, say, Pakistan, but so far undreamt of in the US. Avoiding that is worth a lot of scorched earth. More broadly, winning an election now confers the power to rule by executive order. It confers power over administrative fiat, the power to shower billions on supporters, control of the regulatory machine that lines up corporate support, the power to censor the internet, and the power to hound your opponents and their supporters through the intelligence and judicial system. Losing graciously is a less and less viable option. </p><p>Democracy isn’t so much about who wins elections. Democracy requires the ability to lose elections, admit the legitimacy of the loss, but live on to regroup and win another day. Only when the power of the winners to impose immense changes with narrow majorities is constrained can losers do that.</p><div><br /></div>John H. Cochranehttp://www.blogger.com/profile/04842601651429471525noreply@blogger.com39