Sugar Mountain

Last Saturday I got to go to the biannual meeting of the Macro-Finance Society. This is a great new effort spearheaded by outstanding young macro-finance researchers.

(The society is limited to people with PhDs after 1990, occasioning the title of this post, a reference to a song about a bar limited to people under 21, a reference you will not get unless your PhD was granted well before 1990.)

I can't blog all the great papers and discussions, so I'll pick one of particular interest, Itamar Drechsler, Alexi Savov, and Philipp Schnabl's "Model of Monetary Policy and Risk Premia"

This paper addresses a very important issue. The policy and commentary community keeps saying that the Federal Reserve has a big effect on risk premiums by its control of short-term rates. Low interest rates are said to spark a "reach for yield," and encourage investors, and too big to fail banks especially, to take on unwise risks. This story has become a central argument for hawkishness at the moment. The causal channel is just stated as fact. But one should not accept an argument just because one likes the policy result.

Nice story. Except there is about zero economic logic to it. The level of nominal interest rates and the risk premium are two totally different phenomena. Borrowing at 5% and making a risky investment at 8%, or borrowing at 1% and making a risky investment at 4% is exactly the same risk-reward tradeoff.

Taylor rules

Last week I attended a conference at Hoover, "Frameworks for Central Banking in the Next Century." It was very interesting for its mix of academics, Fed people, and media. The Wall Street Journal had an interesting article Monday morning, "BOE's Carney may need to play a fourth card" on BOE governor Mark Carney's struggles with rules. I am left with more questions than answers, which is good.

Rules 

What do we really  mean by "rules?" The clearest version would be mechanical, the Federal Funds rate shall be \[ i_t = 2\% + 1.5 \times (\pi_t - 2\%) + 0.5 \times (y_t-y^*_t ) \] say, with \(i\) = interest rate, \(\pi\) = inflation \(y - y^*\) = output gap. The numbers come in,  the Fed mechanically borrows and lends at that rate. This is something like an idealized gold standard.

That is not what anybody has in mind, obviously.  So what do we really mean by "rules?"

Declining expectations

Philadelphia Fed President Charles Plosser made this nice graph, showing how reduced views of potential GDP are closing the gap, not rises in actual GDP. The source is a nice speech here.  This fits in the recent series of blog posts on forecasts and slump. By contrast, here is the last big recession, where GDP closed the "gap."

In praise of bottom-feeders

A fascinating quote in today's Wall Street Journal: Warren Buffett to Tim Geithner just after the Bear Sterns bailout:

"I was sort of hoping you wouldn't do it, because then everything would have crashed and I would have been first in line to buy."

Buffett continued,

"It would have been terrible for the country, but I would've made a lot more money" 

Amen on number one. A's fire sale is B's buying opportunity. In the end, a lot of finance depends on flexible long-only money to come in and take risks when others are selling.

Absolutely wrong on number 2, Mr. Buffett. There is no more patriotic act an American sitting on a few billion dollars can perform, than to show up at a fire sale with a fat checkbook and a pen.

Forecast Followup

A follow-up to "groundhog day," reflecting some comments and email. Here is a pretty up to date graph of real GDP, the CBO's current assessment of "potential" and the previous trendline, which is a pretty good approximation to what the CBO thought potential was just before the crisis. The surprising thing about this recession is how sadly-diminishing expectations of "potential" are behind the closing of the gap, rather than GDP rising to meet potential.

Groundhog Day

Torsten Slok once again makes a beautiful graph, of the kind I posted at the bottom of Punditonomics, reminding us of the foibles of forecasting.  (I would have connected each projection to the actual value at the time it was made, but should make my own graphs if I want to criticize.)


Torsten views the result as an indication of failure for the Fed's models. I think the message is deeper, and tells us a lot more about the macroeconomic situation.

Plus ça change

Corresponding on the "Run Free Financial System," François Velde at the Chicago Fed sends me an interesting paper, "Early Public Banks" with William Roberds.  François and William document nicely just how long bank runs have been going on, just how long we've been struggling with money-like bank liabilities, and just how long narrow-banking proposals have been around.

AQR on momentum

Cliff Asness, Andrea Frazzini, Ronen Israel and Toby J. Moskowitz have a lovely SSRN paper "`Fact, Fiction and Momentum Investing."

The whole momentum literature is so huge, it's hard to know where to sum up, and this is a great place, especially if you're teaching an MBA class. Since they're obviously a bit conflicted (momentum + value is one of AQR's core strategies), their emphasis on the simple facts, which you (or your students) can replicate from Ken French's databse, is great.

Some "Myths,"

Myth #1: Momentum returns are too “small and sporadic”. Like any factor, it's not an aribtrage opportunity.

The return premium is evident in 212 years (yes, this is not a typo, two hundred and twelve years of data from 1801 to 2012) of U.S. equity data

So, to sum up, who you calling small and sporadic?

A writing style more bold than my own.

Are you SIFI?

"Financial crises are always and everywhere due to problems of short-term debt" quoth Doug Diamond, and wisely. Not so, according to the Office of Financial Research and the Financial Stability Council, which are, apparently, planning to "designate" as "systemically important" asset managers such as BlackRock and Fidelity.

The depths of this silliness are hard to fathom.

Stuff cheap, people expensive

Source: New York Times

This nice graph appeared in the New York Times (link). Of course they had to ruin it with a rant about inequality.

The deeper point is that things are getting cheaper and cheaper, and people -- services provided with their expertise -- are getting more and more expensive.

On the back of my mind: What does the economy look like when goods are essentially free, and all value consists of paying other people for their expertise?

I explored this a little in covering Larry Summers' Martin Feldstein speech.  But it remains, I think, an important question for deep microeconomic research.

In just about any transaction you name, from electronics to fashion to health care, most of the value comes from the expertise of the seller, not the physical good.

The characteristics of the production, value, and sale of expertise are completely different from those of the standard widget.  Just the measurement of GDP and inflation in such a world raise lots of open questions.

The cost of regulation

Gordon Crovitz has a nice piece in the Wall Street Journal, Monday May 5, titled "The end of the permissionless web" which sparks several thoughts.

What has made the Internet revolutionary is that it's permissionless. No one had to get approval from Washington or city hall to offer Google searches, Facebook  profiles or Apple  apps, as Adam Thierer of George Mason University notes in his new book, "Permissionless Innovation." [Available free and ungated here. - JC]  

The central fault line in technology policy debates today can be thought of as 'the permission question,' " Mr. Thierer writes. "Must the creators of new technologies seek the blessing of public officials before they develop and deploy their innovations?" 

Punditonomics

James Surowiecki at The New Yorker had a nice column last month on "Punditonomics," the tendency of much public discussion to focus on individuals who seem to have forecast one or two big events in the past.

The economic incentive is clear:

Experts in a wide range of fields are prone to making daring and confident forecasts, even at the risk of being wrong, because when they're right the rewards are immense. An expert who makes one great prediction can live off the success for a long time; we assume that the feat is repeatable. 

But, being right once is pretty meaningless

Toward a run-free financial system

A new essay, expanding greatly on a previous WSJ oped and illustrated by a great comic. Here's the introduction, follow the link for the whole thing.

Toward a run-free financial system
John H. Cochrane
April 16 2014

Abstract

The financial crisis was a systemic run. Hence, the central regulatory response should be to eliminate run-prone securities from the financial system. By contrast, current regulation guarantees run-prone bank liabilities and instead tries to regulate bank assets and their values. I survey how a much simpler, rule-based, liability regulation could eliminate runs and crises, while allowing inevitable booms and busts. I show how modern communications, computation, and financial technology overcomes traditional arguments against narrow banking. I survey just how hopeless our current regulatory structure has become.

I suggest that Pigouvian taxes provide a better structure to control debt issue than capital ratios; that banks should be 100% funded by equity, allowing downstream easy-to-fail intermediaries to tranche that equity to debt if needed. Fixed-value debt should be provided by or 100% backed by Treasury or Fed securities.  

Weekend Labor Markets

This weekend produced several interesting readings on the state of labor markets.

1. Glenn Hubbard,

In the Wall Street Journal on "The Unemployment Puzzle: Where Have All the Workers Gone?" Like economists of all stripes, the fact that the unemployment rate -- the fraction of people looking for jobs -- is down masks the deeper problem, that so many people are not working and not looking.

Glenn sets out well the basic question:

Krugman on reading

Paul Krugman has a fascinating blog post up. To be fair, I will quote it in its entirety, with my emphasis added in bold. 

I’ve written before about the myth of the stupid progressive economist.Many conservative economists have a fixed idea in their heads — it’s more than just a presumption, because it seems completely impervious to evidence — that progressive economists are dumb guys who don’t understand basic economics. And because of this fixed idea, conservatives appear literally unable to read what my side writes; they criticize the dumb things they’re sure we must have said, without checking to see if that’s what we actually said.

In the linked post I wrote about health reform issues, but you also see this in macro: five years and more into this discussion, freshwater economists still can’t wrap their brains around the notion that modern Keynesians (both New and eclectic) have actually done a lot of hard thinking over the past few decades. I’ve called this a failure of reading comprehension, but it’s actually an unwillingness to read at all, to so much as glance at what the actual argument might be.

And I mean that quite literally. Brad DeLong quotes from a John Cochrane paper (no link) which declares that those stupid Keynesians don’t understand why monetary policy is ineffective. It’s not because of the zero lower bound, it’s because bonds and monetary base are perfect substitutes:

In this analysis, monetary policy is impotent, but not for the usual reason that interest rates are nearly zero. The Fed can arbitrarily exchange Treasury debt for money, and increase the money supply as much as we like. But nobody cares if it does so, since the “flight to liquidity” is equally towards all forms of Government debt. If we want more fruit and less cheese, putting more apples and less oranges in the fruit basket won’t help. 

So, I think I can say without boasting that the modern revival of liquidity-trap economics began with my 1998 Brookings Paper (pdf). Here’s the first sentence of that paper:

THE LIQUIDITY TRAP – that awkward condition in which monetary policy loses its grip because the nominal interest rate is essentially zero, in which the quantity of money becomes irrelevant because money and bonds are essentially perfect substitutes – played a central role in the early years of macroeconomics as a discipline.

That was 16 years ago. Just saying.

It's pretty amazing to write a whole column about people who, and I quote "criticize the dumb things they’re sure we must have said, without checking to see if that’s what we actually said." and then so patently and blatantly not, well, check to see if that's what I actually said.

"no link?" Dear Professor, let me acquaint you with this thing called Google, with which you can check quotes if you are so inclined when Brad doesn't give you the link. (Update: Hilarious "let me google that for you" link from a correspondent.)

If you did, you would find no statement of mine, ever, that says anything like "those stupid Keynesians don’t understand why monetary policy is ineffective." This is slander, pure and simple. I have never used the word "stupid" to describe any economist.  Serious, scholarly, new-Keynesians like Mike Woodford are incredibly smart.

And to write this in the middle of a column complaining that I don't check to see what others have actually said??? Are there no mirrors at the New York Times?

As for my supposed lack of reading skills, I invite the learned professor, if he wishes to join the club of people who check facts, to browse my research webpage and or the page of my monetary economics class. He will find a lifetime of work reading and thinking hard about New, and Old Keynesian models, going back decades. I even got an A in my Keynesian classes at Berkeley in the 1980s.

Since he advocates reading, let me suggest my Determinacy and Identification with Taylor Rules, including the references, or the more recent New Keynesian Liquidity Trap. You can say it's all wrong, but you cannot say I have not read and thought hard about new-Keynesian economics, including all of Woodford's book. But to do that, you have to read past one 2009 blog post, which seems to be the beginning and end of Brad DeLong's reading, and Krugman's passing along of opinions without doing any reading.

Perhaps this is all petulance because I didn't cite Krugman for the idea that at zero rates bonds and money are perfect substitutes. (In, let us remember, a blog post designed to explain to a popular audience how neoclassical models work, with very few citations, not an academic article.) Anyway, Keynes and Friedman (optimum quantity of money) had those ideas long ago. Indeed it did "play a central role in the early years," which is why a citation is not required for every paper that talks about it afterward. And perhaps I should add a little Emily Post etiquette lesson: There is a fine art of fishing for citations. Slander and insults are usually not very effective.

It was April 1. It's so outrageous I did stop to check that it wasn't a parody! Apparently not.

PS: Comments off, for obvious reasons.

EconTalk MOOC Podcast

Russ Roberts

A podcast interview with Russ Roberts on EconTalk about my experience teaching a MOOC and thoughts on the economics of MOOCs. (The interview was based a bit on my last post here.)

Russ is a very good interviewer, and the EconTalk series quite interesting.

The sign of monetary policy, part II

(This blog post uses mathjax to show equations. You should see pretty equations, not ugly LaTex code.)

The ECB is in the news today. They want some inflation, yet the overnight rate is already zero. They're talking about negative interest rates, which leads to a great lunchroom discussion about bags of euros wandering around Europe.  All very interesting.

Yet it brings to mind a heretical thought I explored in an earlier blog post: What if we have the sign wrong on the effect of monetary policy? Could it be that to get more inflation, our central banks should raise rates not lower them? (Leave aside whether you think more inflation is good, which I don't. But suppose you want it, how do you get it?)

It's not as crazy as it sounds.

Interviews

I did two interviews that blog readers might enjoy.


This is an interview with Jeff Garten at Yale, covering financial crises and reform/regulation efforts rather broadly. Source here. It's part of a very interesting series of interviews on the "future of global finance" with lots of superstars. I give Niall Ferguson the prize for most creative  author photo.

This one is a podcast interview on the ACA and how free-market health care can work, with Don Watkins at the Ayn Rand institute's "debt dialogues" series. If you follow the link you get several formats.

Goodman Vs. Emanuel

On the fourth anniversary of the ACA, Saturday's Wall Street Journal had an excellent pair of pro and con OpEds from John Goodman "A costly failed experiment" and Ezekiel Emanuel "Progress, with caveats."

Stein on Financial Stability in Monetary Policy

Fed governor and Harvard Professor Jeremy Stein gave an important speech on March 21, Incorporating Financial Stability Considerations into a Monetary Policy Framework. I have a few minor criticims, specifically on standard errors, causal mechanism, and Lucas critique. But it's great for Jeremy to think out loud this way, and give me occasion to do the same. You should read the whole thing.

Stein's bottom line:

...all else being equal, monetary policy should be less accommodative--by which I mean that it should be willing to tolerate a larger forecast shortfall of the path of the unemployment rate from its full-employment level--when estimates of risk premiums in the bond market are abnormally low.

This view has put Stein a bit in the camps of the hawks, meaning simply those who for one reason or another think the time to raise rates is sooner rather than later.