Raise interest rates to raise inflation? Lower interest rates to lower inflation? It's not that simple.
A correspondent from an emerging market wrote enthusiastically. His country has somewhat too high inflation, currency depreciation and slightly negative real rates. A discussion is going on about raising rates to combat inflation. Do I think that lowering rates in this circumstance is instead the way to go about it?
As you can tell, posing the question this way makes me very uncomfortable! So, thinking out loud, why might one pause at jumping this far, this fast?
Fiscal policy. Fiscal policy deeply underlies monetary policy. In my own "Fisherian" explorations, the fiscal theory of price level is a deep foundation. If the government is printing up money to pay its bills, the central bank can do what it wants with interest rates, inflation is coming anyway.
Thursday, March 31, 2016
Tuesday, March 29, 2016
A very simple neo-Fisherian model
A sharp colleague recently pushed me to write down a really simple model that
can clarify the intuition of how raising interest rates might raise, rather than lower, inflation.
Here is an answer.
(This follows the last post on the question, which links to a paper. Warning: this post uses mathjax and has graphs. If you don't see them, come back to the original. I have to hit shift-reload twice to see math in Safari. )
I'll use the standard intertemporal-substitution relation, that higher real interest rates induce you to postpone consumption, \[ c_t = E_t c_{t+1} - \sigma(i_t - E_t \pi_{t+1}) \] I'll pair it here with the simplest possible Phillips curve, that inflation is higher when output is higher. \[ \pi_t = \kappa c_t \] I'll also assume that people know about the interest rate rise ahead of time, so \(\pi_{t+1}=E_t\pi_{t+1}\).
Now substitute \(\pi_t\) for \(c_t\), \[ \pi_t = \pi_{t+1} - \sigma \kappa(i_t - \pi_{t+1})\] So the solution is \[ E_t \pi_{t+1} = \frac{1}{1+\sigma\kappa} \pi_t + \frac{\sigma \kappa}{1+\sigma\kappa}i_t \]
Inflation is stable. You can solve this backwards to \[ \pi_{t} = \frac{\sigma \kappa}{1+\sigma\kappa} \sum_{j=0}^\infty \left( \frac{1}{1+\sigma\kappa}\right)^j i_{t-j} \]
Here is a plot of what happens when the Fed raises nominal interest rates, using \(\sigma=1, \kappa=1\):
When interest rates rise, inflation rises steadily.
Now, intuition. (In economics intuition describes equations. If you have intuition but can't quite come up with the equations, you have a hunch not a result.) During the time of high real interest rates -- when the nominal rate has risen, but inflation has not yet caught up -- consumption must grow faster.
People consume less ahead of the time of high real interest rates, so they have more savings, and earn more interest on those savings. Afterwards, they can consume more. Since more consumption pushes up prices, giving more inflation, inflation must also rise during the period of high consumption growth.
One way to look at this is that consumption and inflation was depressed before the rise, because people knew the rise was going to happen. In that sense, higher interest rates do lower consumption, but rational expectations reverses the arrow of time: higher future interest rates lower consumption and inflation today.
(The case of a surprise rise in interest rates is a bit more subtle. It's possible in that case that \(\pi_t\) and \(c_t\) jump down unexpectedly at time \(t\) when \(i_t\) jumps up. Analyzing that case, like all the other complications, takes a paper not a blog post. The point here was to show a simple model that illustrates the possibility of a neo-Fisherian result, not to argue that the result is general. My skeptical colleauge wanted to see how it's even possible.)
I really like that the Phillips curve here is so completely old fashioned. This is Phillips' Phillips curve, with a permanent inflation-output tradeoff. That fact shows squarely where the neo-Fisherian result comes from. The forward-looking intertemporal-substitution IS equation is the central ingredient.
Model 2:
You might object that with this static Phillips curve, there is a permanent inflation-output tradeoff. Maybe we're getting the permanent rise in inflation from the permanent rise in output? No, but let's see it. Here's the same model with an accelerationist Phillips curve, with slowly adaptive expectations. Change the Phillips curve to \[ c_{t} = \kappa(\pi_{t}-\pi_{t-1}^{e}) \] \[ \pi_{t}^{e} = \lambda\pi_{t-1}^{e}+(1-\lambda)\pi_{t} \] or, equivalently, \[ \pi_{t}^{e}=(1-\lambda)\sum_{j=0}^{\infty}\lambda^{j}\pi_{t-j}. \]
Substituting out consumption again, \[ (\pi_{t}-\pi_{t-1}^{e})=(\pi_{t+1}-\pi_{t}^{e})-\sigma\kappa(i_{t}-\pi_{t+1}) \] \[ (1+\sigma\kappa)\pi_{t+1}=\pi_{t}+\pi_{t}^{e}-\pi_{t-1}^{e}+\sigma\kappa i_{t} \] \[ \pi_{t+1}=\frac{1}{1+\sigma\kappa}\left( \pi_{t}+\pi_{t}^{e}-\pi_{t-1} ^{e}\right) +\frac{\sigma\kappa}{1+\sigma\kappa}i_{t}. \] Explicitly, \[ (1+\sigma\kappa)\pi_{t+1}=\pi_{t}+\gamma(1-\lambda)\left[ \sum_{j=0}^{\infty }\lambda^{j}\Delta\pi_{t-j}\right] +\sigma\kappa i_{t} \]
Simulating this model, with \(\lambda=0.9\).
As you can see, we still have a completely positive response. Inflation ends up moving one for one with the rate change. Consumption booms and then slowly reverts to zero. The words are really about the same.
The positive consumption response does not survive with more realistic or better grounded Phillips curves. With the standard forward looking new Keynesian Phillips curve inflation looks about the same, but output goes down throughout the episode: you get stagflation.
The absolutely simplest model is, of course, just \[i_t = r + E_t \pi_{t+1}\]. Then if the Fed raises
the nominal interest rate, inflation must follow. But my challenge was to spell out the market forces
that push inflation up. I'm less able to tell the corresponding story in very simple terms.
(This follows the last post on the question, which links to a paper. Warning: this post uses mathjax and has graphs. If you don't see them, come back to the original. I have to hit shift-reload twice to see math in Safari. )
I'll use the standard intertemporal-substitution relation, that higher real interest rates induce you to postpone consumption, \[ c_t = E_t c_{t+1} - \sigma(i_t - E_t \pi_{t+1}) \] I'll pair it here with the simplest possible Phillips curve, that inflation is higher when output is higher. \[ \pi_t = \kappa c_t \] I'll also assume that people know about the interest rate rise ahead of time, so \(\pi_{t+1}=E_t\pi_{t+1}\).
Now substitute \(\pi_t\) for \(c_t\), \[ \pi_t = \pi_{t+1} - \sigma \kappa(i_t - \pi_{t+1})\] So the solution is \[ E_t \pi_{t+1} = \frac{1}{1+\sigma\kappa} \pi_t + \frac{\sigma \kappa}{1+\sigma\kappa}i_t \]
Inflation is stable. You can solve this backwards to \[ \pi_{t} = \frac{\sigma \kappa}{1+\sigma\kappa} \sum_{j=0}^\infty \left( \frac{1}{1+\sigma\kappa}\right)^j i_{t-j} \]
Here is a plot of what happens when the Fed raises nominal interest rates, using \(\sigma=1, \kappa=1\):
Now, intuition. (In economics intuition describes equations. If you have intuition but can't quite come up with the equations, you have a hunch not a result.) During the time of high real interest rates -- when the nominal rate has risen, but inflation has not yet caught up -- consumption must grow faster.
People consume less ahead of the time of high real interest rates, so they have more savings, and earn more interest on those savings. Afterwards, they can consume more. Since more consumption pushes up prices, giving more inflation, inflation must also rise during the period of high consumption growth.
One way to look at this is that consumption and inflation was depressed before the rise, because people knew the rise was going to happen. In that sense, higher interest rates do lower consumption, but rational expectations reverses the arrow of time: higher future interest rates lower consumption and inflation today.
(The case of a surprise rise in interest rates is a bit more subtle. It's possible in that case that \(\pi_t\) and \(c_t\) jump down unexpectedly at time \(t\) when \(i_t\) jumps up. Analyzing that case, like all the other complications, takes a paper not a blog post. The point here was to show a simple model that illustrates the possibility of a neo-Fisherian result, not to argue that the result is general. My skeptical colleauge wanted to see how it's even possible.)
I really like that the Phillips curve here is so completely old fashioned. This is Phillips' Phillips curve, with a permanent inflation-output tradeoff. That fact shows squarely where the neo-Fisherian result comes from. The forward-looking intertemporal-substitution IS equation is the central ingredient.
Model 2:
You might object that with this static Phillips curve, there is a permanent inflation-output tradeoff. Maybe we're getting the permanent rise in inflation from the permanent rise in output? No, but let's see it. Here's the same model with an accelerationist Phillips curve, with slowly adaptive expectations. Change the Phillips curve to \[ c_{t} = \kappa(\pi_{t}-\pi_{t-1}^{e}) \] \[ \pi_{t}^{e} = \lambda\pi_{t-1}^{e}+(1-\lambda)\pi_{t} \] or, equivalently, \[ \pi_{t}^{e}=(1-\lambda)\sum_{j=0}^{\infty}\lambda^{j}\pi_{t-j}. \]
Substituting out consumption again, \[ (\pi_{t}-\pi_{t-1}^{e})=(\pi_{t+1}-\pi_{t}^{e})-\sigma\kappa(i_{t}-\pi_{t+1}) \] \[ (1+\sigma\kappa)\pi_{t+1}=\pi_{t}+\pi_{t}^{e}-\pi_{t-1}^{e}+\sigma\kappa i_{t} \] \[ \pi_{t+1}=\frac{1}{1+\sigma\kappa}\left( \pi_{t}+\pi_{t}^{e}-\pi_{t-1} ^{e}\right) +\frac{\sigma\kappa}{1+\sigma\kappa}i_{t}. \] Explicitly, \[ (1+\sigma\kappa)\pi_{t+1}=\pi_{t}+\gamma(1-\lambda)\left[ \sum_{j=0}^{\infty }\lambda^{j}\Delta\pi_{t-j}\right] +\sigma\kappa i_{t} \]
Simulating this model, with \(\lambda=0.9\).
As you can see, we still have a completely positive response. Inflation ends up moving one for one with the rate change. Consumption booms and then slowly reverts to zero. The words are really about the same.
The positive consumption response does not survive with more realistic or better grounded Phillips curves. With the standard forward looking new Keynesian Phillips curve inflation looks about the same, but output goes down throughout the episode: you get stagflation.
The absolutely simplest model is, of course, just \[i_t = r + E_t \pi_{t+1}\]. Then if the Fed raises
the nominal interest rate, inflation must follow. But my challenge was to spell out the market forces
that push inflation up. I'm less able to tell the corresponding story in very simple terms.
Friday, March 25, 2016
Central banks as central planners
Two news items cropped up this week on the general topic of central banks as emergent central planers.: a nice WSJ editorial by James Mackintosh on QE extended to buying corporate debt, and the Fed's proposed rule governing "Macroprudential" countercyclical capital buffers. The ECB also has a new Macroprudential Bulletin with similar ideas that I will not cover because the post is already too long. (Some earlier thoughts on the issue here. As usual, if the quotes aren't showing right, come back to the original of this post here.)
The WSJ editorial:
The WSJ editorial:
..as the central banks become more desperate to boost inflation and growth, they are starting to break one of the modern tenets of the profession by funneling that cash directly to what they regard as “good” uses.The Bank of Japan’s conditions for companies to qualify for central bank funding include
offering an "improving working environment, providing child-care support, or expanding employee-training programs".... increasing capital spending, expanding spending on research and development or boosting what the Bank of Japan calls “human capital.” The latter means pay raises for staff, taking on more people or improving human resources.
Monday, March 21, 2016
The Habit Habit
The Habit Habit. This is an essay expanding slightly on a talk I gave at the University of Melbourne's excellent "Finance Down Under" conference. The slides
(Note: This post uses mathjax for equations and has embedded graphs. Some places that pick up the post don't show these elements. If you can't see them or links come back to the original. Two shift-refreshes seem to cure Safari showing "math processing error".)
Habit past: I start with a quick review of the habit model. I highlight some successes as well as areas where the model needs improvement, that I think would be productive to address.
Habit present: I survey of many current parallel approaches including long run risks, idiosyncratic risks, heterogenous preferences, rare disasters, probability mistakes -- both behavioral and from ambiguity aversion -- and debt or institutional finance. I stress how all these approaches produce quite similar results and mechanisms. They all introduce a business-cycle state variable into the discount factor, so they all give rise to more risk aversion in bad times. The habit model, though less popular than some alternatives, is at least still a contender, and more parsimonious in many ways,
Habits future: I speculate with some simple models that time-varying risk premiums as captured by the habit model can produce a theory of risk-averse recessions, produced by varying risk aversion and precautionary saving, as an alternative to Keynesian flow constraints or new Keynesian intertemporal substitution. People stopped consuming and investing in 2008 because they were scared to death, not because they wanted less consumption today in return for more consumption tomorrow.
Throughout, the essay focuses on challenges for future research, in many cases that seem like low hanging fruit. PhD students seeking advice on thesis topics: I'll tell you to read this. It also may be useful to colleagues as a teaching note on macro-asset pricing models. (Note, the parallel sections of my coursera class "Asset Pricing" cover some of the same material.)
I'll tempt you with one little exercise taken from late in the essay.
(Note: This post uses mathjax for equations and has embedded graphs. Some places that pick up the post don't show these elements. If you can't see them or links come back to the original. Two shift-refreshes seem to cure Safari showing "math processing error".)
Habit past: I start with a quick review of the habit model. I highlight some successes as well as areas where the model needs improvement, that I think would be productive to address.
Habit present: I survey of many current parallel approaches including long run risks, idiosyncratic risks, heterogenous preferences, rare disasters, probability mistakes -- both behavioral and from ambiguity aversion -- and debt or institutional finance. I stress how all these approaches produce quite similar results and mechanisms. They all introduce a business-cycle state variable into the discount factor, so they all give rise to more risk aversion in bad times. The habit model, though less popular than some alternatives, is at least still a contender, and more parsimonious in many ways,
Habits future: I speculate with some simple models that time-varying risk premiums as captured by the habit model can produce a theory of risk-averse recessions, produced by varying risk aversion and precautionary saving, as an alternative to Keynesian flow constraints or new Keynesian intertemporal substitution. People stopped consuming and investing in 2008 because they were scared to death, not because they wanted less consumption today in return for more consumption tomorrow.
Throughout, the essay focuses on challenges for future research, in many cases that seem like low hanging fruit. PhD students seeking advice on thesis topics: I'll tell you to read this. It also may be useful to colleagues as a teaching note on macro-asset pricing models. (Note, the parallel sections of my coursera class "Asset Pricing" cover some of the same material.)
I'll tempt you with one little exercise taken from late in the essay.
Tuesday, March 8, 2016
Deflation Puzzle
Larry Summers writes an eloquent FT column "A world stumped by stubbornly low inflation"
So why is inflation slowly declining despite our central banks' best efforts? Here is a stab at an answer. I emphasize the central logical points with bullets.
Market measures of inflation expectations have been collapsing and on the Fed’s preferred inflation measure are now in the range of 1-1.25 per cent over the next decade.
Inflation expectations are even lower in Europe and Japan. Survey measures have shown sharp declines in recent months. Commodity prices are at multi-decade lows and the dollar has only risen as rapidly as in the past 18 months twice during the past 40 years when it has fluctuated widely
And the Fed is forecasting a return to its 2 per cent inflation target on the basis of models that are not convincing to most outside observers.
Central bankers [at the G20 meeting] communicated a sense that there was relatively little left that they can do to strengthen growth or even to raise inflation. This message was reinforced by the highly negative market reaction to Japan’s move to negative interest rates.
So why is inflation slowly declining despite our central banks' best efforts? Here is a stab at an answer. I emphasize the central logical points with bullets.
- Interest rates have two effects on inflation: a short-run "liquidity" effect, and a long-run "expected inflation" or "Fisher" effect.
Wednesday, March 2, 2016
Premium increase insurance
Marginal Revolution and the Wall Street Journal both pass on a great quote from Warren Buffett:
You may say BH doesn't want the risk, but in a previous letter Buffett explained that BH was selling 99 year put options. And being hugely diversified is precisely what allows a company like this to take some risk.
If it doesn't want to hold the risk it could sell it. Surely there are lots of investors who are skeptics of climate change -- not warming, but the claim that warming will give rise to more extreme weather and higher insurance payouts; people who cheered at that quote in the WSG -- and would be happy to put their money where their mouths are in the reinsurance market.
(These thoughts are obviously related to health insurance, premium increase insurance and long-term guaranteed renewable contracts that solve the preexisting conditions problem.)
It’s understandable that the sponsor of the proxy proposal believes Berkshire is especially threatened by climate change because we are a huge insurer, covering all sorts of risks. The sponsor may worry that property losses will skyrocket because of weather changes. And such worries might, in fact, be warranted if we wrote ten- or twenty-year policies at fixed prices. But insurance policies are customarily written for one year and repriced annually to reflect changing exposures. Increased possibilities of loss translate promptly into increased premiums. . . .
Up to now, climate change has not produced more frequent nor more costly hurricanes nor other weather-related events covered by insurance. As a consequence, U.S. super-cat rates have fallen steadily in recent years, which is why we have backed away from that business. If super-cats become costlier and more frequent, the likely—though far from certain—effect on Berkshire’s insurance business would be to make it larger and more profitable.
As a citizen, you may understandably find climate change keeping you up nights. As a homeowner in a low-lying area, you may wish to consider moving. But when you are thinking only as a shareholder of a major insurer, climate change should not be on your list of worries.The puzzle to me is, why doesn't Berkshire Hathaway write ten- or twenty-year policies at fixed prices? Or, better, why does it not offer a second contract, that ensures you against the event that your regular insurance will be repriced every six months? If people are worried about it, and nobody else is doing it, it would seem they could charge a huge premium.
You may say BH doesn't want the risk, but in a previous letter Buffett explained that BH was selling 99 year put options. And being hugely diversified is precisely what allows a company like this to take some risk.
If it doesn't want to hold the risk it could sell it. Surely there are lots of investors who are skeptics of climate change -- not warming, but the claim that warming will give rise to more extreme weather and higher insurance payouts; people who cheered at that quote in the WSG -- and would be happy to put their money where their mouths are in the reinsurance market.
(These thoughts are obviously related to health insurance, premium increase insurance and long-term guaranteed renewable contracts that solve the preexisting conditions problem.)
Friday, February 26, 2016
Sanders multiplier magic
The critiques of Gerald Friedman's analysis of the Sanders economic plan continue. The latest and most detailed and careful so far is by David and Christina Romer.
Bottom line:
The analysis
One might have expected that a sympathetic analysis of the Sanders plan would say, look, this is going to cost us a bit of growth, but the fairness and (claimed) better treatment of disadvantaged people are worth it.
Friedman's having none of that. In his analysis, the Sanders plan will also unleash a burst of growth, claims for which would make a fervent supply-sider like Art Laffer blush.
"The Sanders program... will raise the gross domestic product by 37% and per capita income by 33% in 2026; the growth rate of per capita GDP will increase from 1.7% a year to 4.5% a year." And, apparently, raise the growth rate permanently.
Bottom line:
- The central idea in Friedman's analysis is that taking $1 from Peter to give to Paul raises overall income by 55 cents. From this, you get multipliers from raising taxes and spending, from higher minimum wages, more unions, and so forth.
- I chuckle a little bit that so many economists who previously liked multipliers now don't like their logical conclusions.
- The Romers charge a serious, elementary arithmetic mistake in treating levels vs. growth rates. If they're right Friedman's whole analysis is just wrong on arithmetic.
The analysis
One might have expected that a sympathetic analysis of the Sanders plan would say, look, this is going to cost us a bit of growth, but the fairness and (claimed) better treatment of disadvantaged people are worth it.
Friedman's having none of that. In his analysis, the Sanders plan will also unleash a burst of growth, claims for which would make a fervent supply-sider like Art Laffer blush.
"The Sanders program... will raise the gross domestic product by 37% and per capita income by 33% in 2026; the growth rate of per capita GDP will increase from 1.7% a year to 4.5% a year." And, apparently, raise the growth rate permanently.
Thursday, February 25, 2016
Negative rates and FTPL
I've devoted most of my monetary economics research agenda to the Fiscal Theory of the Price Level in the last two decades (collection here). This theory says, fundamentally, that money has value because the government accepts it for taxes, and inflation is fundamentally a fiscal phenomenon over which central banks' conventional tools -- open market operations trading money for government bonds -- have limited power.
Since I grew up in the 1970s, I figured the FTPL would have its day when inflation unexpectedly broke out, again, and central banks were powerless to stop it. I figured that the spread of interest-paying electronic money would so clearly undermine the foundations of MV=PY that its pleasant stories would be quickly abandoned as no longer relevant.
I may have been exactly wrong on both points: It seems that uncontrolled disinflation or deflation will be the spark for adoption of FTPL ideas; that the equivalence of money and bonds at zero interest rates, and central banks powerless to create inflation will be the trigger.
These thoughts are prodded by two pieces in the Economist, "Out of Ammo:" and "Unfamiliar Ways Forward" (HT and interesting discussion by Miles Kimball)
If you want inflation (a big if -- I don't, but let's go with the if) how do you get it? Ultra-low rates, huge bond purchases, and lots of talk (forward guidance, higher inflation targets) seem to have no effect. What can governments actually do?
Since I grew up in the 1970s, I figured the FTPL would have its day when inflation unexpectedly broke out, again, and central banks were powerless to stop it. I figured that the spread of interest-paying electronic money would so clearly undermine the foundations of MV=PY that its pleasant stories would be quickly abandoned as no longer relevant.
I may have been exactly wrong on both points: It seems that uncontrolled disinflation or deflation will be the spark for adoption of FTPL ideas; that the equivalence of money and bonds at zero interest rates, and central banks powerless to create inflation will be the trigger.
These thoughts are prodded by two pieces in the Economist, "Out of Ammo:" and "Unfamiliar Ways Forward" (HT and interesting discussion by Miles Kimball)
If you want inflation (a big if -- I don't, but let's go with the if) how do you get it? Ultra-low rates, huge bond purchases, and lots of talk (forward guidance, higher inflation targets) seem to have no effect. What can governments actually do?
Monday, February 22, 2016
Greece and Taxes
An interview for the Greek Reporter, in English, perhaps cheering the like-minded and sure to infuriate some conventional wisdom.
I agree with the "anti-austerians" on one point: Raising taxes was a bad idea. In my emphasis what counts are marginal tax rates on growth-producing activities, rather than Keynesian pump-priming, however, which is an important distinction.
The article says "A recently released study by the Economics Department at the National Kapodistrian University of Athens revealed that Greece has the third highest taxation rate among 21 European countries." If anyone has a link, especially if it's in English, send it in the comments.
I agree with the "anti-austerians" on one point: Raising taxes was a bad idea. In my emphasis what counts are marginal tax rates on growth-producing activities, rather than Keynesian pump-priming, however, which is an important distinction.
The article says "A recently released study by the Economics Department at the National Kapodistrian University of Athens revealed that Greece has the third highest taxation rate among 21 European countries." If anyone has a link, especially if it's in English, send it in the comments.
Friday, February 19, 2016
Right Wing NPR
I was listening to NPR this morning over coffee, and nearly spilled it. Host Steve Inskeep was interviewing Mark Surman, Mozilla founder, on the topic of Apple refusing to hand over the keys to the Iphone to the Federal Government (and anyone who might be able to hack the Federal Government. Oh, right, that's never happened!)
Like Surman, I often am too polite to give the right answer to such shocking questions in real time. But with the benefit of hindsight, here's a better answer
Perhaps a President Hillary Clinton will bring a sympathetic ear to the right to digital privacy. She undoubtedly wishes her email had been bullet-proof encrypted, not just from the FBI and NSA, but from the Chinese and Russian hackers likely reading every line.
Update: I realize from some of the comments that the point may not have been clear. This isn't about the Apple decision. It's moot, really, anyway, as even Apple can't open the new Iphones. And one can make cost/benefit arguments either way. My point was about the argument: We will hear quite often in coming years and decades, the argument that even one terrorist caught is worth sacrificing privacy and civil liberty. Be prepared to answer, to point out there are costs as well as benefits, and to list what they are. And, finally, I sound more critical of Inskeep than I should. In fairness, he does not offer an opinion. He asks a question, one commonly asked, and may well have been floating a t-ball in the hope Surman would smash it out of the park as I attempted to do. Many people will ask that question. It's worth asking, over and over, and rehearsing the answer.
INSKEEP: One last thing, coming back to this San Bernardino case, we don't know what's in that iPhone. We don't even know if it's important. But let's spin out the worst case scenario as a prosecutor might. Suppose your side wins, that phone is never opened, and as a result, the government misses a chance to find some other suspect and disrupt some attack. The attack goes forward, and people are killed. Will that have been worth it in order to protect encryption?Surman, probably flabbergasted that anyone should ask such a question, changed the subject
SURMAN: We need to find ways to really be able to seek communications before they're sent or after they're sent and actually work with law enforcement on doing this well. There are alternative ways to get information, getting access to it before or after it's encrypted. What we want to avoid is creating a precedent where encryption can be broken by an arbitrary third party.But Inskeep kept at it
INSKEEP: So you're saying, in essence, it may well be harder to catch terrorists, but you can still work at it, and the extra difficulty is worth it.Remember, this is cloyingly liberal NPR, not some foaming at the mouth right wing program!
Like Surman, I often am too polite to give the right answer to such shocking questions in real time. But with the benefit of hindsight, here's a better answer
COCHRANE: Well, come to think of it, you're right there Steve. And while you're at it, let's keep going. These pesky first and fourth amendments sure get in the way of law enforcement, don't they? I mean all this business about going out and getting warrants, and waiting for a judge is so time consuming. If a terrorist gets away while you're busy getting a warrant, and people are killed, will that really have been worth it to protect some sort of centuries old procedures? If someone stirs up trouble on a Jihadi website, why do we have to allow that? And this annoying business about grand juries, and presenting evidence, and discovery, and Miranda warnings, it's so burdensome. What if some terrorist gets away and kills someone? The police surely should be allowed to just throw anyone suspicious in jail, to make sure they don't do anything bad. Heck, while you're at it, what's with these prohibitions against torture? Bring back the rack, or start chopping people's fingers off until they talk. If you hold back, and some terrorist kills someone, was your little sense of ethics really worth it?There is a reason we have all these protections. There is a reason we need to defend them even in times of turmoil.
Perhaps a President Hillary Clinton will bring a sympathetic ear to the right to digital privacy. She undoubtedly wishes her email had been bullet-proof encrypted, not just from the FBI and NSA, but from the Chinese and Russian hackers likely reading every line.
Update: I realize from some of the comments that the point may not have been clear. This isn't about the Apple decision. It's moot, really, anyway, as even Apple can't open the new Iphones. And one can make cost/benefit arguments either way. My point was about the argument: We will hear quite often in coming years and decades, the argument that even one terrorist caught is worth sacrificing privacy and civil liberty. Be prepared to answer, to point out there are costs as well as benefits, and to list what they are. And, finally, I sound more critical of Inskeep than I should. In fairness, he does not offer an opinion. He asks a question, one commonly asked, and may well have been floating a t-ball in the hope Surman would smash it out of the park as I attempted to do. Many people will ask that question. It's worth asking, over and over, and rehearsing the answer.
Kashkari on TBTF
Neel Kashkari, the new president of the Minneapolis Fed, is making a splash with a speech about too big to fail, and the need for a deeper and more fundamental reform than Dodd Frank. I am delighted to hear a Federal Reserve official offering, in public, some of the kinds of thoughts that I and like-minded radicals have been offering for the last few years.
More deeply, I think we need to apply much the same thinking to regulation that we do to monetary policy. At least in principle, most analysts think some sort of rule is a good idea for monetary policy. Pure discretion leads to volatility, moral hazard, time-inconsistency and so on. We should start talking about good rules for financial crisis management, not just ever greater power and discretion to follow whatever the "judgment" (whim?) of the moment says.
Speaking of the "resolution authority,"
Obviously, I don't agree with everything in the speech. Kashkari is a bit too vague about "contagion" "linkages" and so fort for my taste. But the good news is to have this conversation, and not settle in to implementing page 35,427 of Dodd Frank regulations, head in the sand, while we wait for the next crisis.
The rest of the speech outlines his plans to get the Minneapolis Fed working hard on these issues, and to push for them at the larger Fed. This is a project worth watching.
In case I haven't plugged it about 10 times, my agenda for these issues is in Toward a Run-Free Financial System and the many blog posts under the "banking" "financial reform" and "regulation" labels.
I believe the biggest banks are still too big to fail and continue to pose a significant, ongoing risk to our economy.
Now is the right time for Congress to consider going further than Dodd-Frank with bold, transformational solutions to solve this problem once and for all.From an economic point of view, now is indeed the right time -- calm before the storm. I'm not so sure now is a great time from a political view! But perhaps anti-Wall Street feelings from both parties can be harnessed to good use.
...When the technology bubble burst in 2000, it was very painful for Silicon Valley and for technology investors, but it did not represent a systemic risk to our economy. Large banks must similarly be able to make mistakes—even very big mistakes—without requiring taxpayer bailouts and without triggering widespread economic damage.This is a key lesson. As Dodd-Frank spreads to insurance companies, equity mutual funds, and asset managers, we're losing sight of the idea that trying to stop anyone from ever losing money again is not a wise way to prevent a panic. It's the nature of bank liabilities, not their assets, that is the problem.
I learned in the crisis that determining which firms are systemically important—which are TBTF—depends on economic and financial conditions. In a strong, stable economy, the failure of a given bank might not be systemic. The economy and financial firms and markets might be able to withstand a shock from such a failure without much harm to other institutions or to families and businesses. But in a weak economy with skittish markets, policymakers will be very worried about such a bank failure.In other words, the whole idea of designating an institution that is per se "systemic" is silly.
...there is no simple formula that defines what is systemic. I wish there were. It requires judgment from policymakers to assess conditions at the time.Here I think Kashkari isn't really learning the lesson. If it's undefinable, even in words, and needs "judgment," then perhaps the idea really is empty.
More deeply, I think we need to apply much the same thinking to regulation that we do to monetary policy. At least in principle, most analysts think some sort of rule is a good idea for monetary policy. Pure discretion leads to volatility, moral hazard, time-inconsistency and so on. We should start talking about good rules for financial crisis management, not just ever greater power and discretion to follow whatever the "judgment" (whim?) of the moment says.
A second lesson for me from the 2008 crisis is that almost by definition, we won’t see the next crisis coming, and it won’t look like what we might be expecting. If we, or markets, recognized an imbalance in the economy, market participants would likely take action to protect themselves. When I first went to Treasury in 2006, Treasury Secretary Henry Paulson directed his staff to work with financial regulators at the Federal Reserve and the Securities and Exchange Commission to look for what might trigger the next crisis... We looked at a number of scenarios, including an individual large bank running into trouble or a hedge fund suffering large losses, among others. We didn’t consider a nationwide housing downturn. It seems so obvious now, but we didn’t see it, and we were looking. We must assume that policymakers will not foresee future crises, either.This is an unusual and worthy expression of humility. Others advocate loading up the Fed with "macroprudential" regulation and "bubble pricking" tools, on the faith that this time, yes this time, they really will see it coming, and really will do something about it. Regulators are not wiser, smarter, less behavioral, etc. than traders.
Speaking of the "resolution authority,"
Unfortunately, I am far more skeptical that these tools will be useful to policymakers in the second scenario of a stressed economic environment. Given the massive externalities on Main Street of large bank failures in terms of lost jobs, lost income and lost wealth, no rational policymaker would risk restructuring large firms and forcing losses on creditors and counterparties using the new tools in a risky environment, let alone in a crisis environment like we experienced in 2008. They will be forced to bail out failing institutions—as we were. We were even forced to support large bank mergers, which helped stabilize the immediate crisis, but that we knew would make TBTF worse in the long term.There are no atheists in foxholes, the saying goes. Notice "forcing losses on creditors and counterparties." This is exactly right. "Bailouts" are not about saving the institution, they are about saving its creditors. We should always call them "creditor bailouts." And a run is in full swing, and when the hotlines to the Treasury are buzzing "if we lose money on this, then the world will end," anyone in charge will guarantee the debts.
I believe we must begin this work now and give serious consideration to a range of options, including the following:
Here, Kashkari caused a stir in the press. Bernie Sanders voiced approval. Since "breaking up" has no subject -- who is to do this and how? -- and no mechanism, I'll give Kashkari the benefit of the doubt that he had something more sophisticated in mind than brute force.
- Breaking up large banks into smaller, less connected, less important entities.
- Turning large banks into public utilities by forcing them to hold so much capital that they virtually can’t fail (with regulation akin to that of a nuclear power plant).
- Taxing leverage throughout the financial system to reduce systemic risks wherever they lie.
The financial sector has lobbied hard to preserve its current structure and thrown up endless objections to fundamental change.
Many of the arguments against adoption of a more transformational solution to the problem of TBTF are that the societal benefits of such financial giants somehow justify the exposure to another financial crisis. I find such arguments unpersuasive.This needs some explanation. Banks produce studies claiming that higher capital requirements or reduced amounts of run-prone short-term funding will cause them to charge more for loans and reduce economic growth. Kashkari is pointing out that these arguments are pretty thin, because the cost of not doing it is immense -- 10 percent or so of GDP lost for nearly a decade and counting is plausible.
Obviously, I don't agree with everything in the speech. Kashkari is a bit too vague about "contagion" "linkages" and so fort for my taste. But the good news is to have this conversation, and not settle in to implementing page 35,427 of Dodd Frank regulations, head in the sand, while we wait for the next crisis.
The rest of the speech outlines his plans to get the Minneapolis Fed working hard on these issues, and to push for them at the larger Fed. This is a project worth watching.
In case I haven't plugged it about 10 times, my agenda for these issues is in Toward a Run-Free Financial System and the many blog posts under the "banking" "financial reform" and "regulation" labels.
Wednesday, February 17, 2016
Sad CEA Letter
And just as I was getting all weepy about how great and a-political, obejective, non-partisan and all that the CEA is, along comes an open letter from past CEA chairs Alan Krueger, Austan Goolsbee, Chirstina Romer, and Laura D'Andrea Tyson to Senator Sanders, to restore my cynicism.
The heart of the letter is worthy, and commendable: to call out the fact that Senator Sander's campaign is making promises that don't add up, beyond even the usual stretches of campaign rhetoric from both sides.
But read
Really, dear colleagues and friends, how would you respond if Republican CEA chairs were to write a similar letter addressing the shortcomings of Trump's plan that started,
So this is just a poke in the eye, a repetition of partisan Democratic campaign rhetoric, stirring up the base by bulverizing the other party.
Why is Washington so polarized? Because even once-respectable academic economists, transported to Washington, cannot stop themselves from this sort of schoolyard taunting, tribalistic attacks, and repetition of their bosses' propaganda.
The heart of the letter is worthy, and commendable: to call out the fact that Senator Sander's campaign is making promises that don't add up, beyond even the usual stretches of campaign rhetoric from both sides.
But read
When Republicans have proposed large tax cuts for the wealthy..Hmm. I wonder if Republicans would characterize their proposals that way? How many speeches have you heard saying "we want large tax cuts for the wealthy!" No, they say they want tax reform to reduce distorting marginal rates and rampant cronyism.
Really, dear colleagues and friends, how would you respond if Republican CEA chairs were to write a similar letter addressing the shortcomings of Trump's plan that started,
When Democrats have proposed incentive-killing growth-killing marginal tax rate increases with lots of exemptions for their donors...and goes on to trumpet their sober-minded analysis of the plans, would you be inspired to plaud their "reputation" for objective evidence-based analysis?
So this is just a poke in the eye, a repetition of partisan Democratic campaign rhetoric, stirring up the base by bulverizing the other party.
Why is Washington so polarized? Because even once-respectable academic economists, transported to Washington, cannot stop themselves from this sort of schoolyard taunting, tribalistic attacks, and repetition of their bosses' propaganda.
Tuesday, February 16, 2016
CEA History
The Council of Economic Advisers has released a history of the CEA on its' 70th anniversary, as Chapter 7 of the Economic Report of the President. This piece is very interesting for economists interested in policy.
It's a nice reminder on how much economic policy ideas have changed. In the late 1940s, when the CEA was set up, fiscal policy was everything. Solow's growth model had not been invented, let alone Romer's. Monetary policy was a twinkle in Milton Friedman's eye. Adam Smith had more or less been forgotten. Economic policy was widely thought to consist of just setting the right level of fiscal stimulus, let multipliers work their magic, to achieve "full employment" and economic growth. The piece tracks well the rediscovery of microeconomics and regulation, as well as the shifts in macroeconomic thinking.
It reminds us how much the stage has changed. In the early years there were really no economists working elsewhere in government, and there were no think tanks. Now every agency has a chief economist and a staff, and the CEA isn't (!) the only game in town for producing policy-oriented research. Its role has changed as a consequence.
The CEA has long had many roles, adviser, calculator of numbers, cheerleader for the Administration's policies, spinner for the Sunday talk shows, and interagency warrior.
One of its most important and least appreciated roles is just to stop silly stuff.
It's a nice reminder on how much economic policy ideas have changed. In the late 1940s, when the CEA was set up, fiscal policy was everything. Solow's growth model had not been invented, let alone Romer's. Monetary policy was a twinkle in Milton Friedman's eye. Adam Smith had more or less been forgotten. Economic policy was widely thought to consist of just setting the right level of fiscal stimulus, let multipliers work their magic, to achieve "full employment" and economic growth. The piece tracks well the rediscovery of microeconomics and regulation, as well as the shifts in macroeconomic thinking.
It reminds us how much the stage has changed. In the early years there were really no economists working elsewhere in government, and there were no think tanks. Now every agency has a chief economist and a staff, and the CEA isn't (!) the only game in town for producing policy-oriented research. Its role has changed as a consequence.
The CEA has long had many roles, adviser, calculator of numbers, cheerleader for the Administration's policies, spinner for the Sunday talk shows, and interagency warrior.
One of its most important and least appreciated roles is just to stop silly stuff.
Monday, February 15, 2016
Brooks v. Krugman
I usually try to steer away from Presidential politics, and especially from commentators' habit of analyzing character. But last week's New York Times had two particularly interesting columns that invite breaking the rule: "I Miss Barack Obama" by David Brooks and "How America Was Lost" by Paul Krugman.
As we contemplate a Clinton, Sanders, Trump, or Cruz presidency, we may well continue the pattern that each president's main accomplishment is to burnish nostalgia for his (so far) predecessor. Brooks is feeling that.
And he's right. Say what you will about policy, the Obama Administration has, as Brooks points out, been staffed by people of basic personal integrity and remarkably scandal-free. (In the conventional sense of "scandal." I'm sure some commenters will contend that the bailouts, Lois Lerner, the EPA, and Dodd-Frank and Obamacare are "scandals," but that's not what we're talking about here.) On economic issues, his main advisers have been thoughtful, credentialed, mainstream Democrats. Obama's speeches on many topics have, as David says, been full of "basic humanity," even if one disagrees with his solutions.
As we contemplate a Clinton, Sanders, Trump, or Cruz presidency, we may well continue the pattern that each president's main accomplishment is to burnish nostalgia for his (so far) predecessor. Brooks is feeling that.
And he's right. Say what you will about policy, the Obama Administration has, as Brooks points out, been staffed by people of basic personal integrity and remarkably scandal-free. (In the conventional sense of "scandal." I'm sure some commenters will contend that the bailouts, Lois Lerner, the EPA, and Dodd-Frank and Obamacare are "scandals," but that's not what we're talking about here.) On economic issues, his main advisers have been thoughtful, credentialed, mainstream Democrats. Obama's speeches on many topics have, as David says, been full of "basic humanity," even if one disagrees with his solutions.
Friday, February 12, 2016
The Libertarian Case for Bernie Sanders
The Libertarian Case for Bernie Sanders, from Will Wilkinson at the Niskanen Center. Yes, Denmark scores much above the US on ease of doing business indices. An interesting case. A welfare state is not necessarily a politicized regulatory state, with strong two-way political-industry capture. The latter may be more dangerous economically. Those who wish to eat golden eggs have an incentive to let the Goose grow fat.
Update: Megan McArdle brilliantly demolishes the case. "It's fun, but not convincing." My view as well.
Update: Megan McArdle brilliantly demolishes the case. "It's fun, but not convincing." My view as well.
Tuesday, February 9, 2016
Policy Rules Legislation
Allan Meltzer and John Taylor organized a Statement on Policy Rules Legislation signed by quite a few famous economists. John's blog explains in some detail.
Stating a rule or "strategy" about what things the Fed will react to also will help the Fed to pre-commit to things it will not react to. If the Fed says they react to inflation and unemployment, that means you should not expect it to react to stock prices, oil prices, exchange rates, and so forth.
Ms. Yellen's testimony and monetary policy report happen Feb 10 and 11. It will be interesting to hear the discussion of these issues. I hope that discussion includes not just legislation, but whether the Fed should follow something like this strategy communication on its own, in order to limit pressures for the Fed to do unwise things.
Stating a rule or "strategy" about what things the Fed will react to also will help the Fed to pre-commit to things it will not react to. If the Fed says they react to inflation and unemployment, that means you should not expect it to react to stock prices, oil prices, exchange rates, and so forth.
Ms. Yellen's testimony and monetary policy report happen Feb 10 and 11. It will be interesting to hear the discussion of these issues. I hope that discussion includes not just legislation, but whether the Fed should follow something like this strategy communication on its own, in order to limit pressures for the Fed to do unwise things.
Friday, January 29, 2016
Gordon on growth 2
PBS covers Bob Gordon's The Rise and Fall of American Growth.
[Embedded video. These aren't picked up when other sources pick up the blog, so come back to the original if you don't see the video.]
PBS and Paul Solman did a great job, especially relative to the usual standards of economics coverage in the media. OK, not perfect -- they livened it up by tying it to partisan politics a bit more than they should have, though far less than usual.
I don't (yet, maybe) agree with Bob. I still hope that the mastery of information and biology can produce results like the mastery of electromagnetism and fossil fuels did earlier. I still suspect that slow growth is resulting from government-induced sclerosis rather than an absence of good ideas in a smoothly functioning economy. But Bob has us talking about The Crucial Issue: long term growth, and its source in productivity. The 1870-1970 miracle was not about whether the federal funds rate was 0.25% higher or lower. And the issue is not about opinions, like the ones I just offered, but facts and research, which Bob offers.
The issue of future long-term growth is tied with the issue of measurement, something else that Bob has championed over the years. GDP is well designed to measure steel per worker. Information, health and lifespan increases are much more poorly measured. This is already a problem in long-term comparisons. In the video, Bob points to light as the greatest invention. The price of light has fallen by a factor of thousands since the age of candles, to the point where light consumption is a trivial part of GDP. It's a worse problem as all the great stuff becomes free. I suspect that we'll have to try to measure consumer surplus not just the market value of goods and services.
And congratulations to Bob. The economics profession tends to focus on the young rising stars, but he offers inspiration that economists can produce magnum opuses of deep impact at any point in a career.
Disclosure: I haven't read the book yet, but it is on top of the pile. More when I finish. Ed Glaeser has an excellent review.
Update: Tyler Cowen's review, in Foreign Affairs
[Embedded video. These aren't picked up when other sources pick up the blog, so come back to the original if you don't see the video.]
PBS and Paul Solman did a great job, especially relative to the usual standards of economics coverage in the media. OK, not perfect -- they livened it up by tying it to partisan politics a bit more than they should have, though far less than usual.
I don't (yet, maybe) agree with Bob. I still hope that the mastery of information and biology can produce results like the mastery of electromagnetism and fossil fuels did earlier. I still suspect that slow growth is resulting from government-induced sclerosis rather than an absence of good ideas in a smoothly functioning economy. But Bob has us talking about The Crucial Issue: long term growth, and its source in productivity. The 1870-1970 miracle was not about whether the federal funds rate was 0.25% higher or lower. And the issue is not about opinions, like the ones I just offered, but facts and research, which Bob offers.
The issue of future long-term growth is tied with the issue of measurement, something else that Bob has championed over the years. GDP is well designed to measure steel per worker. Information, health and lifespan increases are much more poorly measured. This is already a problem in long-term comparisons. In the video, Bob points to light as the greatest invention. The price of light has fallen by a factor of thousands since the age of candles, to the point where light consumption is a trivial part of GDP. It's a worse problem as all the great stuff becomes free. I suspect that we'll have to try to measure consumer surplus not just the market value of goods and services.
And congratulations to Bob. The economics profession tends to focus on the young rising stars, but he offers inspiration that economists can produce magnum opuses of deep impact at any point in a career.
Disclosure: I haven't read the book yet, but it is on top of the pile. More when I finish. Ed Glaeser has an excellent review.
Update: Tyler Cowen's review, in Foreign Affairs
Friday, January 22, 2016
Tax Oped -- full version
 |
| Source: Wall Street Journal |
Left and right agree that the U.S. tax code is a mess. The men and women running for president in 2016 are offering reform plans, and proposals to fix the code regularly surface in Congress. But these plans are, and should be, political documents, designed to attract votes. To prevent today’s ugly bargains from becoming tomorrow’s conventional wisdom, we should more frequently discuss the ideal tax structure.
The first goal of taxation is to raise needed government revenue with minimum economic damage. That means lower marginal rates—the additional tax people pay for each extra dollar earned—and a broader base of income subject to tax. It also means a massively simpler tax code.
Friday, January 15, 2016
MacDonell on QE
Gerard MacDonell has a lovely noahpinion guest post "So Much for the QE Stimulus" (HT Marginal Revolution). Some good bits here, with my bold on noteworthy zingers.
The post is unusual, because practitioners tend to regard the Fed and QE as very powerful. But here he expresses nicely the skeptical view of many academics such as myself.
The post is unusual, because practitioners tend to regard the Fed and QE as very powerful. But here he expresses nicely the skeptical view of many academics such as myself.
the Fed leadership has now abandoned its original story about how QE affects the economy and has conceded that the tool is weak
It has long been obvious that QE operated mainly through signaling and confidence channels, which wore off on their own without any adjustment in the size or composition of the Fed’s balance sheet....Obvious to us skeptics, not to the Fed or to the many academic papers written trying to explain the supposed powers of QE
The story initially told by the Fed leadership starts with the claim that large scale asset purchases (LSAPs) [lower interest rates]... by removing default-free interest rate duration from the capital markets. ...Translation: buying bonds to drive up bond prices
That story does not hold much water.
Tuesday, January 5, 2016
Secret Data Encore
My post "Secret data" on replication provoked a lot of comment and emails, more reflection, and some additional links.
This isn't about rules
Many of my correspondents missed my main point -- I am not advocating more and tighter rules by journals! This is not about what you are "allowed to do," how to "get published" and so forth.
In fact, this extra rumination points me even more strongly to the view that rules and censorship by themselves will not work. How to make research transparent, replicable, extendable, and so forth varies by the kind of work, the kind of data, and is subject like everything else to creativity and technical improvement. Most of all, it will not work if nobody cares; if nobody takes the kind of actions in bullet points of my last post, and it's just an issue about rules at journals. Already, (more below) rules are not that well followed.
This isn't just about "replication."
"Replication" is much too narrow a word. Yes, many papers have not documented transparently what they actually did, so that even armed with the data it's hard to produce the same numbers. Other papers are based on secret data, the problem with which I started.
But in the end, most important results are not simply due to outright errors in data or coding. (I hope!)
The important issue is whether small changes in instruments, controls, data sample, measurement error handling, and so forth produce different results, whether results hold out of sample, or whether collecting or recoding data produces the same conclusions. "Robustness" is a better overall descriptor for the problem that many of us suspect pervades empirical economic research.
This isn't about rules
Many of my correspondents missed my main point -- I am not advocating more and tighter rules by journals! This is not about what you are "allowed to do," how to "get published" and so forth.
In fact, this extra rumination points me even more strongly to the view that rules and censorship by themselves will not work. How to make research transparent, replicable, extendable, and so forth varies by the kind of work, the kind of data, and is subject like everything else to creativity and technical improvement. Most of all, it will not work if nobody cares; if nobody takes the kind of actions in bullet points of my last post, and it's just an issue about rules at journals. Already, (more below) rules are not that well followed.
This isn't just about "replication."
"Replication" is much too narrow a word. Yes, many papers have not documented transparently what they actually did, so that even armed with the data it's hard to produce the same numbers. Other papers are based on secret data, the problem with which I started.
But in the end, most important results are not simply due to outright errors in data or coding. (I hope!)
The important issue is whether small changes in instruments, controls, data sample, measurement error handling, and so forth produce different results, whether results hold out of sample, or whether collecting or recoding data produces the same conclusions. "Robustness" is a better overall descriptor for the problem that many of us suspect pervades empirical economic research.
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