More Interest-Rate Graphs

For a talk I gave a week or so ago, I made some more interest-rate graphs. This extends the last post on the subject. It also might be useful if you're teaching forward rates and expectations hypothesis. 

The question: Are interest rates going up or down, especially long term rates?  Investors obviously care, they want to know whether they should put money in long term bonds vs. short term bonds.  As one who worries about debt and inflation, I'm also sensitive to the criticism that market rates are very low, forecasting apparently low rates for a long time. Yes, markets never see bad times coming, and markets 3 years ago got it way wrong thinking rates would be much higher than they are today (see last post) but still, markets don't seem to worry.

But rather than talk, let's look at the numbers. I start with the forward curve. The forward rate is the "market expectation" of interest rates, in that it is the rate you can contract today to borrow in the future. If you know better than the forward rate, you can make a lot of money.

Here, I unite the recent history of interest rates together with forecasts made from today's forward curve. The one year rate (red) is just today's forward curve. I find the longer rates as the average of the forward curves on those dates. Today's forward curve is the market forceast of the future forward curve too, so to find the forecast 5 year bond yield in 2020, I take the average of today's forward rates for 2020, 2021,..2024.

I found it rather surprising just how much, and how fast, markets still think interest rates will rise. (Or, perhaps, how large the risk premium is. If you know enough to ask about Q measure or P measure, you know enough to answer your own question.)

Doctor-owned hospitals

In writing about the ACA and our health-care problems, I started to think more and more about supply restrictions. In every other industry, costs come down when new suppliers come in and compete. Yet our health-care system is full of restrictions and protections to keep new suppliers out, and competition down. Then we wonder why hospitals won't tell you how much care will cost, and send you bills with $100 band aids on them.

In that context, I was interested to learn this week about the ACA's limits on expansion of doctor-owned hospitals. The Wall Street Journal article is here, and I found interesting coverage in American Medical News. The text and analysis of the amazing section 6001 of the ACA is here

In astouding (to me) news, the ACA prohibits doctor-owned hospitals from expanding, and prevents new doctor-owned hospitals at all, if they are going to serve Medicare or Medicaid patients. From WSJ

Solar Panel Tariffs

It's time to start a new series on "energy idiocy." You just can't make this stuff up... From today's WSJ:

BRUSSELS—Chinese solar-panel manufacturers will face import tariffs of up to 67.9% at European Union borders under a plan from the 27-nation bloc's executive body...

Europe, like the US, subsidizes the installation of solar panels. So, we subsidize things to make the prices to consumers go down and encourage the industry. Then when the industry is encouraged and prices do go down, we pass tariffs to make prices go up.  This is almost as fun as oil, which we subsidize to make prices go down, then pass regulations to try to stop people from using it.

Finance: Function Matters, not Size

"Finance: Function Matters, not Size" This is the new title of the published version of "The Size of Finance," which I posted on this blog here as a working paper. If you enjoyed the original, here is the better final version. If you didn't, here it is all fresh and new.

Published version (my webpage)
Published version (Journal of Economic Perspectives)
Growth of the Financial Sector" symposium (Journal of Economic Perspectives)

Cyprus and Resolution Authority

Holman Jenkins has a revealing Cyprus update in today's Wall Street Jounal. For those of you who haven't been following the news, Cyprus' banks failed, borrowing huge amounts of money and investing it in Greek debt (yes).  Cyprus was bailed out by the EU after a chaotic week, including an agreement that large depositors would lose some money, called a "bail-in."

Floating-rate Treasury debt

Last week the Treasury announced that is it going ahead with floating-rate debt, and gave some details how it will work. The Wall Street Journal coverage is here and the Treasury announcement is here. I wrote about the issue at some length last fall, here (And freely admit some of today's essay repeats points made there.)

Right now, the Treasury rolls over a lot of debt. For example, about one and a half trillion dollars is in the form of Treasury bills, which mature in less than a year. So, every year, the Treasury sells one and a half trillion dollars of new bills, which it uses to pay off one and a half trillion dollars of old bills.

With floating-rate debt, all the buying and selling is avoided. Instead, the Treasury periodically sets a new rate, so that the floating rate security has value one dollar (just as the maturing bill would have). It's the same thing, except the bill sits in the investor's pocket.

Small monetary policy question

A small monetary policy question has been bugging me this morning.

The Fed is buying long term bonds and agency debt, with stated desire to drive down long term Treasury and mortgage-backed security rates.

Why does the Fed not simply say "We are going to peg the 10 year Treasury rate at 1.5%. We buy and sell at that price." If the Fed wants the 10 year rate to be, say, 1.5%, then this seems a lot simpler than setting a quantity ($80 billion a month), and then enduring endless arguments with academics like me whether it's having any effect at all, or commissioning complex staff studies to determine whether the impact is 10 or 15 basis points and how long it lasts.

The answers I can come up with are not pretty. Perhaps the Fed understands that any "segmentation" is smaller than it thinks, and doesn't last that long. So, the required bond purchases would rapidly explode in size. If that's the answer, then the Fed isn't doing it so that it can continue to seem powerful when in fact it really is not.

Perhaps it's political. If the Fed can say "we're buying $80 billion a month. This is helping, but we don't know exactly how much," then it avoids responsibility for what the rate actually is. If it says 1.5%, then every car dealer and mortgage broker in the country wants to know, why not 1.4%? This is even more cleverly Macchiavellian. But such deeply political decisions are a long way from the benevolent independent central bank we write about in papers.

Any ideas anyone?  

While we're here, two great quotes from Fed economists (obviously un-named) I've talked to recently.

Me: Aren't you worried about big banks borrowing short and lending long? What happens when, inevitably, interest rates rise?

Economist A: "Don't worry, we'll let them know ahead of time."

This was some time ago. I think last week's announcements that the "stress tests" were (at last) going to include plain - vanilla interest rate risk might count as such warning.

Economist B: "Inflation is just not a concern. The Fed now is balancing growth against financial stability."

A new dual mandate, and a fascinating can of worms. I'd love to see that Phillips curve.

 

Taylor on monetary policy

John Taylor has a lovely little blog post, encapsulating so much in a few sentences. An excerpt with comments (emphasis mine)

...there is a crucial issue which explains much of the enormous difference of opinion between critics and supporters of the Fed’s current policy. Critics such as me and Allan Meltzer ... argue that monetary policy should focus on a clear strategy for the instruments of policy. A goal for inflation or other measures of macro performance is not enough if it is simply part of a whatever-it-takes approach to the instruments. Such an approach results in highly discretionary and unpredictable changes in policy instruments with unintended adverse consequences, as we have been seeing in recent years.

Supporters such as Adam Posen... are just fine with the Fed using, even year after year, a whatever-it-takes approach to the instruments of policy as long as there is an overall goal. With such a goal in mind, so their argument goes, the central bank can and should always intervene in any market, by any amount, over any time frame, with any instrument or program (old or new), and with little concern for unintended consequences in the long run or collateral damage in the short run (say on certain groups of people or markets) as long as it furthers that goal.

Critics are very concerned about those unintended consequences and collateral damage; they are also concerned about an independent government agency wielding such a great deal of power as it carries out a year-after-year whatever-it-takes approach. Supporters are much less concerned.

I have always had this problem with nominal GDP targets, inflation targets, and so forth. Ok, the Fed adopts your target. Now what? If nominal GDP doesn't do what the Fed wants it to do, what should the Fed do about it? Talk more? (Monetary policy is starting to look more and more like foreign policy here).

Taylor points out a deeper danger. The Fed's "mandate," the list of its "goals," keeps expanding. Beyond just inflation and unemployment, now the Fed is in charge of "financial stability," managing "systemic risks," the health of specific markets (mortgages, exports), the health of specific institutions (too big to fail banks), the diagnosis and pricking of bubbles (when not the deliberate stoking of such bubbles), management of the details of every part of financial system (how swaps get traded, for example) and surely coming soon a federal anti-crabgrass mandate.  The list of things the Fed can do in pursuit of these goals is getting bigger and bigger too, while the power of its conventional instruments (setting short rates, quantiative easing) is diminishing.  If the Fed doesn't think banks are lending enough, and to the right people, in pursuit of one of its many goals, what stops them from using their regulatory power to just go tell the banks who they should lend to?

We have told the Fed to attain unattainable goals, and given it great power to do "whatever it takes" in their pursuit.  The Fed seems to go along. It's fun to be given so much power, in the short run at least.  But in a democracy, the price of great independence must be limited power, and the Fed will soon have to choose. Congress already limited some of the Fed's powers after some "whatever it takes" of the financial crisis.

Taylor, of course, would like the Fed limited to the instrument of short-term rates, and to follow the Taylor "rule" for setting them. But the principle is larger than that instance.

Alternative Maximum Tax

This is an Op-Ed for the Wall Street Journal, original here on April 15 2013

Source: Wall Street Jouirnal

They keep coming back, like the villains of a good zombie movie, chanting "more taxes, more taxes." Long ago, Congress passed the alternative minimum tax, or AMT—a simple flat rate to ensure that in an insanely complex tax code, no one escapes paying something. Now we need an alternative maximum tax as a simple, rough-and-ready way to limit the tax zombies' economic damage. Call it the AMaxT.

With Monday's deadline for filing tax returns looming, let's start a national conversation: How much is the most anyone should have to pay? When do taxes indisputably start to harm the economy and produce less revenue—when government takes 50% of people's income? 60%? 70%?

I like half, but the principle matters more than the number. Once the country settles on a number, each of us gets to add up everything we pay to government at every level: federal income taxes, yes, but also payroll (Social Security, Medicare, etc.) taxes, state, city and county taxes, estate taxes, property taxes, sales taxes, payroll taxes and unemployment insurance for nannies, household workers, or other employees, excise taxes, real-estate transfer taxes, and so on and on, right down to your vehicle stickers and those annoying extra taxes on your airline tickets.

On April 15, once this total hits the alternative maximum tax, you've done your bit and federal income taxes can take no more. You compute federal income taxes as usual, but then you get to reduce the "tax due" that the total is less than the alternative maximum.

What the IMF consideres macro

Via Greg Mankiw's blog, I learned about the IMF conference on "Rethinking Macro Policy." See the announcement and program here. I reproduce the program below.

I find this most striking as a reflection on what the IMF considers "macro." Yes, they have the whole spectrum, indeed, all the way from  Geroge Akerlof and Joe Stiglitz on the far left end of traditional Keynesian economics, to... Olivier Blanchard and David Romer on the pretty-far left end of somewhat new-Keynesian economics?

Debt and growth in 10 minutes

This is a short video from last year. I only just found out it exists. It still seems pretty topical, and (for once) condensed because Lars Hansen really forced me to obey the 10 minute time limit!

There is a better link here from the BFI page here that covers the whole event, but I couldn't figure out how to embed those.

Energy Idiocy

What is it about energy that send all sides of the political spectrum into spasms of babbling idiocy? Here are two items heard on my jog yesterday, courtesy of NPR, one from the right, one from the left, with the NPR interviewers mindlessly accepting idiocy in the middle.

Start with NPR's coverage of Gina McCarthy's Senate confirmation hearings. The issue is the EPAs efforts to close down coal-fired power plants to reduce carbon emissions

Interest rate graphs

Where are interest rates going? Here are two fun graphs I made, for a talk I gave Tuesday at Grant's spring conference, on this question. (Full slide deck here or from link on my webpage here)

Here is a graph of the recent history of interest rates. (These are constant maturity Treasury yields from the Fed)  You can see the pattern:

Fun debt graphs

I was having a bit of fun making graphs for a talk. Are we all fine and debt is no longer a problem? I went back for a closer look at the CBO's long term budget outlook and The budget and economic outlook 2013 to 2023. All numbers from these sources.

Growth in the UK?

I thought European "austerity," meaning mostly large increases in marginal tax rates on anyone daring  to work, save, invest, start a company or hire people, while spending stays north of 50% of GDP, was a pretty bad idea.

So I was glad to read the tiltle, when a friend sent me a link to the Telegraph, announcing Osborne to unleash raft of policies to kick-start growth. Great, I thought, after trying everything else, the British will finally try the one thing that will work.

The fair price of catfish in Vietnam

Source: Wikipedia

Another fish story.  In recent news, our Federal Government is now taking on the "fair price" of catfish in Vietnam, and imposing large "anti-dumping" tariffs. Can the price of tea in China be far away?

Lovers of free markets and free trade, this is for you. Fry it with a little hot sauce.

Capital not a lost cause?

Admati and Hellwig (my review here) (and fellow travelers) may be having some effect! From today's WSJ "Heard on the Street":

There is growing talk among regulators, for example, of forcing banks to issue a minimum amount of long-term debt, cap the size of their short-term liabilities or restrict activities that can be conducted within regulated bank subsidiaries.

At the same time, regulators seem to be focusing more on the need to pre-emptively address potential systemic risks.

Any such moves could further constrain banks' ability to juice returns through leverage while also limiting lucrative activities that fall outside a traditional lending function. That could subdue earnings growth already hampered by the superlow interest-rate environment.

The danger isn't lost on banks themselves. A number of banking groups recently joined together in a public attempt to rebut notions of a big-bank borrowing subsidy.”

OK, 3 out of 4 ain't bad. Admati and Hellwig (and I) take a dim view of asset risk regulation and the chance that regulators have any hope of seeing bubbles emerge. But more capital, and more people understanding that leverage and TBTF is a subsidy to banks, so banks are forced to fight about it... that's progress.

GMO Salmon

Source: http://www.aquabounty.com

This weekend's New York Times brought the interesting story of AquaBounty's genetically modified salmon, which are genetically engineered to grow twice as fast as normal Salmon. A few choice bits:

"In 1993, the company approached the Food and Drug Administration about selling a genetically modified salmon that grew faster than normal fish. In 1995, AquaBounty formally applied for approval. Last month, more than 17 years later, the public comment period...was finally supposed to conclude. But the F.D.A. has extended the deadline...

Appropriately, it has been subjected to rigorous reviews... scientists, including the F.D.A.’s experts, have concluded that the fish is just as safe to eat as conventional salmon and that, raised in isolated tanks, it poses little risk to wild populations.

Why the delay?

Taxation of capital and labor

"Redistributing from Capital to Workers: An Impossibility Theorem" is a fine post by Garrett Jones on Econlog, explaining the theorem that the optimal tax on capital is zero. It's the best blog-post length, evenhanded, accessible summary I've seen. It includes all sorts of links where you can see arguments in detail, an unusually scholarly approach for a blog post.

His one-sentence summary

 Under standard, pretty flexible assumptions, it's impossible to tax capitalists, give the money to workers, and raise the total long-run income of workers. Not, hard, not inefficient, not socially wasteful, not immoral: Impossible.

Crunch time

David Greenalw, Jim Hamilton, Peter Hooper and Rick Mishkin have a nice op-ed in the Wall Street Journal summarizing their recent paper, Crunch Time: Fiscal Crises and the Role of Monetary Policy, (The link goes to from Jim's website there is also an executive summary.)

David, Jim, Peter and Rick are after the same question in my last WSJ oped and Blog post: Suppose the Fed wants to raise interest rates with a huge debt outstanding. With, say, $18 trillion outstanding, raising interest rates to 5% means raising the deficit by $900 billion a year. That's real fiscal resources. In a present value sense, monetary tightening costs someone $900 billion a year of taxes.  There is no chance that current tax revenues can go up that much, or current spending can go down that much. So, raising interest rates to 5% with a lot of debt outstanding means we will borrow it, the debt will grow $900 billion a year faster, and the larger taxes /lower spending will come someday in the far off future.

Or maybe not. David,  Jim, Peter and Rick delve in to the "tipping point" I alluded to.

Countries with high debt loads are vulnerable to an adverse feedback loop in which doubts by lenders about fiscal sustainability lead to higher government bond rates, which in turn make debt problems more severe.