Litterman on carbon finance

I just read a very nice article by Bob Litterman in CATO's "Regulation" on the finance of carbon taxes. It includes a review of some of the recent academic calculations.

(Related, Ronald Bailey at Reason.com takes on the Administration's latest cost of carbon estimates, and reviews Robert Pindyk's recent NBER working paper "What do the models tell us?" also covered by Bob.)

Like just about every economist, Bob favors a carbon tax or tradeable emissions right over the vast network of regulatory controls on which we are now embarked. I might add that getting rid of the large subsidies for carbon emissions implicit in many country's policies would help before we start taxing.

But let's get to business, how big should the carbon tax be?

Rajan to run the central bank of India

My colleague Raghu Rajan has just been appointed governor of the central bank of India. See Financial Times and Reuters. Congratulations Raghu!

Let me add two little notes to the songs of praise for this decision.

Traditionally, academic central bank governors come from the world of monetary policy, people who think about interest rates and inflation and all that. Raghu comes from the academic world that studies finance and banking. Look at his vita and you'll see great article after great article thinking about how banks work.

Just in time. Central banks are now all scrambling to understand banking and financial markets, regulating the financial system, avoiding crises, and so on. This is their central new task. (Or you might say, a return to their age-old task after a short interlude.) You can't ask for a person on the planet who has thought more clearly and productively about these issues.

His popular book “Saving capitalism from the capitalists” with Luigi Zingales is also revealing. Yes, he sees how over regulation and corruption are at the heart of India’s problems (and many of our own). But he also sees the strong political forces that keep the dysfunctional system in place. If anyone can understand and resist the political pressures that central bank governors face, it will be Raghu. And he won’t be tempted to think that any monetary magic or financial dirigisme from a central bank can fix all of India's problems.

He is also about the most polite person I know, while never shying away from standing for what's right. That means he will be far more effective than typical bull-in-a-china-shop academics like myself would ever be in steering a ponderous bureacracy.

Good luck, Raghu. I think you'll need it.

Reuters already expreses the view that it's too bad he's out of the running for the US Fed job.

The Republic of Paperwork

Mark Steyn, while writing on other matters, came up with this gem:

40 percent of Americans perform minimal-skilled service jobs about to be rendered obsolete by technology, and almost as many pass their productive years shuffling paperwork from one corner of the land to another in various “professional services” jobs that exist to in order to facilitate compliance with the unceasing demands of the microregulatory state. The daily Obamacare fixes — which are nothing to do with “health” “care” but only with navigating an impenetrable bureaucracy — are the perfect embodiment of the Republic of Paperwork.

Immigration

WSJ Op-Ed on immigration, with extra comments.  Original here.

Think Government Is Intrusive Now? Wait Until E-Verify Kicks In

Source: Wall Street Journal

Massive border security and E-Verify are central provisions of the Senate immigration bill, and they are supported by many in the House. Both provisions signal how wrong-headed much of the immigration-reform effort has become.

E-Verify is the real monster. If this part of the bill passes, all employers will be forced to use the government-run, Web-based system that checks potential employees' immigration status. That means, every American will have to obtain the federal government's prior approval in order to earn a living.

Et tu, Brute?

Politico's Byron Tau has a hilarious story:

Pot legalization activists are running into an unexpected and ironic opponent in their efforts to make cannabis legal: Big Marijuana...

On Au

Greg Mankiw has a cool New York Times article and blog post, "On Au" analyzing the case to be made for gold in a portfolio, including a cute problem set. (Picture at left from Greg's website. I need to get Sally painting some gold pictures!)

I think Greg made two basic mistakes in analysis.

From Livestock to the Stock Exchange

From Livestock to the Stock Exchange. © Sally Cochrane All Rights Reserved

Artist's description: This is a brief visual history of trade, reading left to right. The first "money" was cattle, represented by the cheese. Ancient Mesopotamians kept track of their cattle exchanges on cuneiform tablets like receipts (we have some at the Oriental institute of Chicago!). The root of the word "pecuniary" comes from the root "pecu" meaning "cattle." Cowrie shells were another early form of currency for trade, and beaver fur, which was very valuable, was used in barter when Europeans discovered the New World. The coins and stock ticker tape represent the modern end of the history. July 2013. 8"x 16" oil on canvas.

Original here with many other sizes.

Sally says the beaver fur was inspired by a Russ Roberts EconTalk podcast, interviewing Timothy Brook on his book Vermeer's Hat. "Part of the book talked about how valuable beaver fur was for making hats that ended up in the Netherlands during Vermeer's lifetime." I don't know how many other artists listen to EconTalk while painting...

The Value of Public Sector Pensions

The unfunded promises of public sector pensions are in the news, with the Detroit bankruptcy. Josh Rauh at Stanford and Hoover has a nice blog post on the subject titled "Public Sector Pensions are a National Issue''. (Josh and Robert Novy-Marx wrote a very influential paper (ssrn manuscript) alerting us to the size of the state and local pension bomb.)

Josh's baseline number for the value of underfunded pensions: $4 trillion. Why so big, and why is this a surprise? Because many governments calculate their funding by assuming they will earn 8% per year. Discounting a riskless liability (pensions) at a risky rate is a basic error in finance. It's made all the time. University presidents are notorious for demanding their endowments "reach for yield" in order to "make our rate of return targets."

Reading this piece sparks a few thoughts about the risks posed by pensions and other unfunded liabilities.

Are we prepared for the next financial crisis?

This is the title of a very well-prepared video made by Hal Weitzman, Dustin Whitehead and the Booth "Capital Ideas" team, based on interviews with many of our faculty. Direct link here (Youtube)

Health Insurance and Labor Supply

I just ran across an interesting paper, "Public Health Insurance, Labor Supply, and Employment Lock" by  Craig Garthwaite,  Tal Gross and my Booth colleague Matthew Notowidigdo.

They study an interesting event

... In 2005, Tennessee discontinued its expansion of TennCare, the state’s Medicaid system. ... Approximately 170,000 adults (roughly 4 percent of the state’s non-elderly, adult population) abruptly lost public health insurance coverage over a three-month period.

The result was

a large and immediate labor supply increase....we find an immediate increase in job search behavior and a steady rise in both employment and health insurance coverage. 

A Ray of Hope? Hospitals Post Prices

I was intrigued by news stories of an Oklahoma hospital posting prices for surgery -- prices far below those offered by its competitors. Here is the article and the surprisingly low price list.  Several competitors felt the pressure to slash and post prices.

Stopping Bank Crises Before They Start

This is a Wall Street Journal Oped 6/24/2013

Regulating the riskiness of bank assets is a dead end. Instead, fix the run-prone nature of bank liabilities.

In recent months the realization has sunk in across the country that the 2010 Dodd-Frank financial-reform legislation is a colossal mess. Yet we obviously can't go back to the status quo that produced a financial catastrophe in 2007-08. Fortunately, there is an alternative.

At its core, the recent financial crisis was a run. The run was concentrated in the "shadow banking system" of overnight repurchase agreements, asset-backed securities, broker-dealers and investment banks, but it was a classic run nonetheless.

Mankiw on the 1%

Greg Mankiw has an intereting new article draft, titled "Defending the 1%"  It's mistitled really, as the main point I got out of it is the more interesting question, "Can transfers really help the bottom 50%?"

It's a very well written (as one would expect) and survey of economic issues surrounding the idea of greatly expanded taxation of upper income people to fund transfers. Go read it, I won't do it justice in a summary.

As Greg notes, much of the success of the 1% is not rent-seeking, nor inherited wealth, but entrepreneurs who innovated and got spectacularly wealthy in the process.

Two seconds

The weekend wall street journal had an interesting article about high speed trading, Traders Pay for an Early Peek at Key Data. Through Thompson-Reuters, traders can get the University of Michigan consumer confidence survey results two seconds ahead of everyone else. They then trade S&P500 ETFs on the information.


Source: Wall Street Journal

Naturally, the article was about whether this is fair and ethical, with a pretty strong sense of no (and surely pressure on the University of Michigan not to offer the service.)
It didn't ask the obvious question: Traders need willing counterparties. Knowing that this is going on, who in their right mind is leaving limit orders on the books in the two seconds before the confidence surveys come out?

OK, you say, mom and pop are too unsophisticated to know what's going on. But even mom and pop place their orders through institutions which use trading algorithms to minimize price impact. It takes one line of code to add "do not leave limit orders in place during the two seconds before the consumer confidence surveys come out."

In short, the article leaves this impression that investors are getting taken. But it's so easy to avoid being taken, so it seems a bit of a puzzle that anyone can make money at this game. 

I hope readers with more market experience than I can answer the puzzle: Who is it out there that is dumb enough to leave limit orders for S&P500 ETFs outstanding in the 2 seconds before the consumer confidence surveys come out?

Job market doldrums

Three recent views on the dismal labor market pose an interesting contrast.

Alan Blinder wrote a provocative WSJ piece on 6/11, Fiscal Fixes for the Jobless Recovery. A week prviously, 6/5, Ed Lazear wrote about The Hidden Jobless Disaster. And John Taylor has a good short blog post Job Growth–Barely Keeping Pace with Population

All three authors emphasize that the unemployment rate is a poor measure of the labor market. Unemployment counts people who don't have a job but are actively looking for one. People who give up and leave the labor force don't count. Employment is a more interesting number, and the employment-population ratio a better summary statistic than the unemployment rate. After all, if unemployment falls because everyone who is looking for a job gives up, I don't think we'd see that as a good sign.

Source: Wall Street Journal

Ed Lazear made this interesting chart. As he explains,

Two on financial reform

I recently read two interesting items in the long-running financial regulation saga.

First, a very thoughtful, clear, and succinct speech by Philadelphia Fed President Charles Plosser titled "Reducing Financial Fragility by Ending Too Big to Fail." It's interesting to see a (another?) Fed President basically say that the whole Dodd-Frank / Basel structure is wrong-headed. Two little gems:

 There is probably no better example of rule writing that violates the basic principles of simple, robust regulation than risk-weighted capital calculations.
...
Remember that Title II resolution is available only when there are concerns about systemic risk. Just imagine the highly political issue of determining whether a firm is systemically important, especially if it has not been designated so by the Financial Stability Oversight Committee beforehand....

...Creditors will perceive that their payoffs will be determined through a regulatory resolution process, which could be influenced through political pressure rather than subject to the rule of law

No surprise, I agree.

Second, Anat Admati and Martin Hellwig have an addition to their "Banker's new clothes" book (my review),  23 Flawed Claims Debunked.  Don't miss the fun footnotes.  Anat and Martin get some sort of medal for patience in wading through dreck.

Bipartisan Mercantilism

From the press release here and here

Wednesday, June 5, 2013 WASHINGTON, D.C. — Following new figures that show a 34 percent jump over last month’s [my emphasis] U.S.-China trade deficit, U.S. Sens. Sherrod Brown (D-OH), Jeff Sessions (R-AL), Chuck Schumer (D-NY), Lindsey Graham (R-SC), Debbie Stabenow (D-MI), Richard Burr (R-NC), Susan Collins (R-ME), and Robert Casey (D-PA), today introduced the Currency Exchange Rate Oversight Reform Act of 2013... 

 ...the bill would use U.S. trade law to counter the economic harm to U.S. manufacturers caused by currency manipulation, and provide consequences for countries that fail to adopt appropriate policies to eliminate currency misalignment. The senators’ introduction comes in advance of upcoming talks between President Obama and Chinese President Xi.

Obviously, this is a political shot across the bow to the Obama Administration to press mercantilist trade restrictions in the upcoming discussions with China. Still, why cloak it in such nonsense as

“It is universally accepted that China and other major countries intentionally manipulate their currency to create an advantage for themselves in the marketplace” [Senator] Graham said.

Well, not "universally."

The "complete summary" continues,

"the bill specifies the applicable investigation initiation standard, which will require Commerce to investigate whether currency undervaluation by a government provides a countervailable subsidy if a U.S. industry requests investigation... 

I'm glad to see that industries which don't like to compete with Chinese manufacturers will become experts in monetary policy.

The legislation requires Treasury to develop a biannual report to Congress that identifies... "fundamentally misaligned currencies" based on observed objective criteria...

I cannot find what those "objective criteria are." Let us know, guys and gals, a Nobel Prize in economics awaits you.

If they don't like the Chinese peg, maybe next they can target Texas for its 1-1 peg to the Ohio dollar, which is obviously sucking business to Texas.

When they're done with "currency manipulation" perhaps they can get to the serious business of impeaching the Easter Bunny.


(Thanks to Alex Walsh at the Birmingham News for pointing me to the link.)

Immigration

I wrote a short essay on immigration for Hoover's "Advancing A Free Society" series. It's here, and reproduced below.  The whole set of essays in Hoover's Immigration Reform series is worth perusing.

Since writing it, and also reading Steve Chapman's good editorial on the subject (Chicago Tribune, Townhall) the e-verify system seems like an even bigger nightmare. Every employer in the country must check that every applicant has the Federal Government's permission to work before employing him or her.

Beyond the points raised in the essay below, it's an interesting coincidence that this e-verify is in the news at the same time as the IRS scandal. Congressional Republicans get the cognitive-dissonance award of the year for this one.

Monetary Policy Puzzle

Might raising interest rates, but not paying interest on reserves, actually be "stimulative," inducing banks to lend out reserves?

Last week, I gave a talk on monetary policy at a forum organized by the Becker-Friedman institute.  I explained my view, that as long as reserves pay the same interest rate as very short-term Treasuries, and as long as banks are holding huge amounts of excess reserves, that monetary policy and pure quantitative easing -- buy short-term treasuries, give the banks more reserves -- has absolutely no effect on anything. Interest-paying excess reserves are exactly the same thing as short-term treasuries.

When the time comes to tighten, I said, I hope dearly that the Fed continues to pay a market interest rate on reserves and allow huge amounts of excess reserves to continue. (I had lots of financial-stability reasons, which will wait for another day here.)   But that means that conventional open market operations and quantitative easing -- more reserves, less Treasuries -- will continue to have no effect whatsoever.

An audience member asked a very sharp question: Suppose the Fed raises interest rates but does not raise the rate on reserves? Now, banks do have an incentive to lend them out instead of sitting on them. Wouldn't velocity pick up, MV=PY start to work again, and the Fed get all the "stimulus" it wants and then some?

It's a particularly sharp question, because it gives sensible-sounding mechanism why the conventional sign might be wrong: why raising rates now might give monetary "stimulus" that is otherwise so conspicuously lacking. There are a few other of these stories wandering around. One: Low rates are said to discourage retirees and other savers, who now "can't afford to spend."  (Quotes around things that don't make much economic sense.)   John Taylor, wrote a very provocative WSJ oped, (too subtle to summarize in one sentence here) and also came close to saying the sign is wrong and higher rates would be more stimulative.

But is the suggestion right? I sort of stammered, and needed the weekend to think it through. (Giving talks like this is a great way to clarify one's ideas. Or maybe this just reveals my shocking ignorance. In any case, it makes a good exam question.) Think about it, and then click the "read more."

Forward Guidance vs. Commitment

He: "Honey, I'm getting tickets for Sunday's football game. Do you want to come?"

Forward guidance.  She: "As things look now, I think I'll feel like coming when Sunday rolls around. Of course that might change. If my mother calls and wants to go shopping I might well feel differently."

Commitment. She: "Sure, honey, that sounds like fun. Get the tickets. I know my mom might call, and I'll regret it later, but we have to get the tickets now, so count me in."