Rethinking production under uncertainty

Even at my age, I get a little tingle when a paper is finally published. "Rethinking production under uncertainty" is now out at RAPS (free access for a while) and on my website.

The basic idea is simple.

Our standard way of writing production technologies under uncertainty tacks a shock on to an intertemporal technology.  We might write \[ y(s) = \varepsilon (s) f(k) \] where  \(k\) is capital invested at time 0, \(s\) indexes the state of nature (rain or shine) \(y(s)\) is output in state \(s\). That production technology does not allow producers to transform output across states at time 1. No matter high the contingent claim pricer for rain vs. shine, the producer can't make more in the rain state at the expense of making less in the shine state.

This is the production set of a farmer, say, with initial wheat that can be eaten providing \(y(0)\) or planted to give \( \{y(h), y(l)\} \) in states \( h, l\).

As a result, marginal rates of transformation are not defined, and you can't write a true production-based asset pricing model, based on marginal rate of transformation = contingent claim price ratio.

So, why don't we write down technologies that do allow producers to transform output across states as well as dates? Our farmer could plant wheat in a field that does better in rainy weather than shiny weather, for example. (You can feel an aggregation theory coming.)  The result is a smooth production technology,

Interview and Goodfellows

I did an interview on Covid-19 and economics last week with Carlos Carvalho who runs the Salem Center for Policy at the McCombs School of Business, UT Austin. Carlos is doing a series of these interviews. I objected that anything on this subject will be out of date in 5 minutes, but Carlos wants to look at broader issues, and also see how well the interviewee's prognostication bears out. We'll see about that. So far, I would score that I underestimated just how much Americans were itching to go to bars and party. (Really, fellow citizens, pub crawling? Are you out of your minds?)

Niall, H.R. and I also did a Goodfellows interview with Hoover's own Condoleezza Rice. This was a really interesting conversation on Russia, China, the place of the US in the world, and inevitably Condi's thoughtful views on race in the US.




All Goodfellows here  Podcast version:

The cancel culture twitter mob comes to economics

Last week we learned  the twitter mob has taken over economics too.

In case you aren't following, here is the short version of the story. Harald Uhlig, a distingushed macroeconomist at the University of Chicago,  sent out a few tweets questioning the wisdom of quickly "defunding the police." The twitter mob, led by Paul Krugman and Justin Wolfers, swiftly attacked. A petition circulated, reportedly gaining 500 signatories, demanding his removal as editor of the Journal of Political Economy.  I saw an astonishing number of tweets from economists that I formerly respected and considered to be level headed, fact-and-logic, cause-and-effect analysts of public policies pile on.   The media piled on, with coverage at  New York Times, Wall Street Journal Chicago Tribune and a bit of a counterpoint at Fox News, Breitbart National Review and others. By Friday, the University of Chicago caved in and threw Harald under the bus.

Start by actually reading Harald's tweets.

Grumpy podcast: MMT, debt, and perpetuities

A podcast on this week's topics, MMT and debt.

Perpetuities, debt crises, and inflation

My brief exchange with Markus Brunnermeier at the end of a Covid-19 talk  attracted some attention, and merits a more detailed intervention. Gavin Davies at FT made some comments (more later) as did the Economist.

My proposal to fund the US with perpetuities comes from a paper, here. (Sorry regular readers for the repeated plug.)  The rest is standard fiscal theory of the price level, spread over too many papers to give one more plug.

There are three main points.  First, inflation is not about money anymore -- the choice of money vs. bonds. Money -- reserves -- pay interest, so reserves are just very short-term government bonds. Inflation is about the the overall demand for government debt. That demand comes from the likelihood of the debt  being repaid, and the rate of return people require to hold debt.

Second, if we have inflation, the mechanism will be very much like a run or debt crisis. Our government rolls over very short term debt. Roughly every two years on average, the government must find new lenders to pay off the old lenders. If new lenders sniff trouble they refuse to roll over the debt and we're suddenly in big trouble. This is what happened to Greece. It's what happened to Lehman Bros. In our case, our government can redeem debt with non-interest-paying reserves, resulting in a large inflation rather than an explicit default.

2a, a run is always unpredictable. If you knew there would be a roll-over crisis next year, you would dump your government bonds this year, and the run would be on. There is a whiff of multiple equilibrium too. Our debt is nicely sustainable at 1% interest. If interest rates go up to 5%, we suddenly have north of $1 trillion additional deficits, which are not sustainable. The government  is like a family who, buying a home, got the 0.1% adjustable rate mortgage rather than the 1% (government debt prices) fixed rate mortgage because it seemed cheaper. Then rates go up. A lot.

Sure demand is high for US government debt, rates are low, and there is no inflation. But don't count on trends to continue just because they are trends. How long does high demand last? Ask Greece. Ask an airline.

Third, for this reason, I argue the US should quickly move its debt to extremely long maturities. The best are perpetuities -- bonds that pay a fixed coupon forever, and have no principal payment. When the day of surpluses arrives, the government repurchases them at market prices. By replacing 300 ore more separate government bonds with three (fixed rate, floating rate, and indexed perpetuities), treasury markets would be much more liquid. Perpetuities never need to be rolled over. As you can imagine the big dealer banks hate the idea, and then wander off to reasons that make MMT sound like bells of clarity. That they would lose the opportunity to earn the bid/ask spread off the entire stock of US treasury debt as it is rolled over might just contribute.

But we don't have to wait for perpetuities. 30 year bonds would be a good start. 50 year bonds better. The treasury could tomorrow swap floating for fixed payments.

Then we would be like the family that got the 30 year fixed mortgage. Rates go up? We don't care. By funding long, the US could eliminate the possibility of a debt crisis, a rollover crisis, a sharp inflation for a generation. 

Magical Monetary Theory

I read Stephanie Kelton's book, The Deficit Myth: Modern Monetary Theory and the Birth of the People’s Economy,” and wrote this review for the Wall Street Journal. As usual I have to wait 30 days to post the whole thing here.

I approached this task with an open mind. What I had heard of MMT has some overlap with fiscal theory of the price level, on which I work, and I hoped to see some commonality.

I was disappointed. Short version:

"Ms. Kelton...starts with a few correct observations. But when the implications don’t lead to her desired conclusions, her logic, facts and language turn into pretzels." 

Full version in 30 days, if you can't find a way around WSJ paywall.

Podcast and Goodfellows

Here are links to this week's grumpy economist podcast, and Goodfellows discussion with Niall Ferguson and H.R.  McMaster. Grumpy on the careful reopening and debt. Goodfellows on Europe.



Carnivorous Moose (?)
 

Unemployment insurance weaning

As the economy recovers, public policy faces an inevitable dilemma. How do we wean the economy from support?

This comes to the head with federal support for unemployment insurance -- $600 per week, set to expire at the end of July. The unemployment rate will still be high in July. Congress seems to have largely given up, in public, of thinking clearly about the economic purpose of policies, and now the discussion is entirely in terms of who deserves additional "help," often in moral terms -- "people" vs "corporations," various regions, sizes of business, "communities," and so on.  How can we reduce "help" while unemployment surely ravages the land?

On the other hand, for many workers right now, unemployment benefits pay more than working. Unemployment pays more than going back to their old job as it opens, and it pays more than taking one of the many new jobs that are available now -- Amazon, Wal-Mart are hiring, and there is surely going to be demand for contact tracers, temperature takers, building disinfecters, social distance monitors, and so on.

So, the age old question of economic policy emerges. How do we balance help -- insurance -- with incentives -- the need to get people back to work ASAP when jobs are available?

Lost in the policy discussion, let us not forget the hard fact of life. Work is not fun. People in the real world (not economics bloggers!) don't work because it's fulfilling or enjoyable. They work because they need the money and the health insurance. Work is a necessary evil for our economy to produce the things we all need and want to consume. People don't take lower paying jobs willingly, no matter how much society needs you, right now, to stop binging Netflix and go spend 8 hours wiping down carts at the local Safeway.

With that, here are some clever ideas.

1) Pay anyway.  If you take a job, you can keep the unemployment benefit, at least for a period of time. Or, better, you can get a nice cash check, $1200 (two weeks of federal, another stimulus check) or even $2400 (a month). In return, you can't get unemployment again for, say, 4 or 6 months.

2) Community service. If you stay on unemployment past July 31, you have to do (say) 20 hours a week of community service. What will they do? Well, I've been reading Stephanie Kelton's book (review coming), and she has a proposal for a federal jobs program. Apparently, she thinks there was an immense amount of good work that governments and communities needed done before the pandemic, WPA style. There is much more now -- trace contacts, disinfect playgrounds, take temperatures in public buildings, you name it.  Workers could be rented out to monitor temperatures in front of struggling businesses. So, put Kelton and company -- Bernie Sanders, AOC --  in charge of the community service part.

I offer this latter suggestion only half-jokingly. Obviously there is a political divide on what to do about unemployment. If the government is already paying people, there isn't much damage to letting the left try out its jobs program. If like me you're a little cynical about government jobs programs, well, we'll find out, and we'll save money to boot as the prospect of working for local government might just scare a lot of people back to work. And I love an offer they can't refuse. Imagine the Trump Administration calling the left's bluff on this one -- how can they say no?

(A response to a commenter: It doesn't matter for this purpose if there is any value to the work. I'm looking for a disincentive to stay on unemployment when there are jobs available, that will be politically palatable.)

3) Jobs board. Sweden has (had?) an interesting system that combined a carrot with a stick. Generous unemployment, but a national job registry and you had to take a job offer. I doubt the bureaucratic competence of the US, especially in the month or so we have to get it going, but something similar could happen. To get Federal unemployment top-up after July 31, you have to fill out a one page form with work experience that reads like a job application. Employers can search and offer you a job. If you get the job offer, you take it or  lose unemployment.

4) Just who? Obviously it's time to restrict just a little bit who gets generous unemployment. If your old company is still in business and wants to hire you back, the gig is up. If it's hiring at all, even lesser job categories, you have to apply. If there are more than X job vacancies in your county, the extra unemployment insurance dries up.

A currently popular idea is temporarily cutting or eliminating payroll taxes. This is a nice inducement to work, but even I am a little behavioralist and I wonder just how many people who earn $20 an hour are really clear on how much extra they will get by returning to their old jobs if there is a payroll tax reduction. My $2400 check seems like a more salient incentive.

Airlines and information

Airlines are in big trouble. Even after reopening, nobody wants to fly, perceiving them as dangerous.

But are airline flights dangerous? As I read the super-spreading literature, I have not seen a single case of an airline flight charged with spreading the virus. (Please chime in if you have seen any documented cases of virus spread on airline flights.) That's remarkable. From January to March, people were flying all over the world. People were flying from Wuhan to all over the world. But while we have seen super spreading events in restaurants, bars, cruise ships, aircraft carriers, nursing homes, jails, beach parties, Mardi Gras, choir practice, and more, I have not seen one from an airline flight. Even though people are cooped up for hours in close quarters.

One can speculate why. Airliners actually have very good ventilation systems and hospital grade HEPA filters. Except for the occasional chatty seat mate with cat videos to show, people are usually completely silent. Talking loudly seems to be a big part of spreading the virus. An airline with reasonable extra precautions, such as taking temperatures, certifying no symptoms (and you get your money back if you say you have symptoms, please), masks, wipe downs, is likely safer still. The worry may be for nothing.

But how will we know? Now I get to the point. In the tens, and probably eventually hundred or more billion dollars our government is spending to prop up airlines, how about 1 billion for research on the question, is an airline flight safe? For a billion dollars we ought to be able to answer this question definitively in about a week. Actually 10 million -- 1/1,000 of the money our government will shovel out to boost airlines -- ought to do the trick. If I'm right, that would do more good than an MMTers dream of stimulus.

Jones and Fernández-Villaverde update

Chad Jones and Jesús Fernández-Villaverde have updated their SIR model with social distancing. A part I find very intriguing is that they impute the infection rate and the reproduction rate from death rate data. The infection rate \(I_t\)  is given by \[I_t = \frac{1}{\delta \gamma} \left( \frac{d_{t+2}-d_{t+1}}{\theta} - d_{t+1} \right)\] where the greek letters are parameters they estimate by fitting the path of deaths over time, and \(d_t\) is the daily death rate. Though deaths only happen a few weeks after infection, you can reverse the model dynamics to figure out how many are infected today from how many are dying today. (Well, tomorrow and the day after). They similarly infer today's reproduction rate \(R_0\) from the next three days death rates.

Now, there is clearly some inaccuracy here, and I've been pestering them to provide standard errors. There is some noise in daily deaths and once you start double and triple differencing them, the noise is larger.

But as I think about behavioral and policy responses, these are the numbers we need. How many people in this state, city, zip code, grocery store, bar, are infectious right now? 1 in 10? 1 in 100? 1 in 1000? 1 in 10,000? Is the virus spreading or slowly decaying, with reproduction rate below one? Just how careful do we need to be? Is wiping down,  surfaces or spraying luggage with disinfectant remotely cost-effective? Where are hot spots?

Good Fellows -- International Man of History

A new lively Good Fellows discussion video

and podcast





Direct links here if the above embed codes don't work.

Get Ready for the Careful Economy

Source: Wall Street Journal

Ready or not—mostly not—the reopening is at hand. The economic carnage of a continued lockdown is simply too great to sustain. But the virus is still with us, so the carefully reopened economy will be less efficient than the pre-pandemic economy.....

A Wall Street Journal Oped on where we are and peering in to the muck. Much is inspired by my "dumb reopening" blog post of a week or so ago.

I must say my faith in human wisdom is a bit shaken by the videos of massive crowds on Memorial Day. Spring break and Mardi Gras were super-spreader events, and being outdoors is good but not perfect. On the other hand, in many parts of the country maybe 1/1000 people are infected at most. And the media has been known on occasion to pick one or two sensational stories and let them stand in.

The oped is cut to the bone, as there things are. I did not emphasize enough that isolating the vulnerable and making sure they don't get it -- testing anyone who wants to walk in to a nursing home -- is a much more effective tool than a blanket business lockdown. This disease is very concentrated

Also I wanted to hammer home that parties are dangerous, business per se is not. Locking down all business will likely be seen as a huge waste. We will see if Americans are able to refrain from partying. Indeed I worry that by focusing attention on business closings as the main policy tool, people get the idea that business is dangerous, staying at home is not. Let's party.

One worry on regulation is that it will provide a recipe  for a wave of lawsuits. That may have been a reason the Administration tried to hold back CDC guidance. A long, expensive, and impractical list of things you must do to reopen is catnip when someone gets sick and wants to blame a business. Show us the records that you wiped down the bathrooms every half hour. A legal system that can sue over talcum powder is not above this.

School of sustainability

In a few recent posts, I was critical of university endowment practices. Why build up a stock of investment, rather than invest in faculty, research, or other core activities? Why wall that pile of assets from being spent, especially when budgets are cratering in a pandemic? When we see businesses with piles of cash, we infer they don't have any good investment projects, and the piles are ripe for diversion to bad ideas.

But universities are non-profits, and one major piece of being a non-profit is that the business is protected from the market for corporate control. If you see a business wasting money on bad investments, buy up the stock, fire management, and run it right. Repurchases were part of an earlier reform effort, to stop management from wasting money on aggrandizing projects.

Perhaps restrictions on endowment spending serve a somewhat parallel function for universities. Perhaps I was wrong to criticize so harshly.

These thoughts are brought to mind by Stanford's announcement of a new school "focused on climate and sustainability." A "school" is bigger than a center, an institute, a department, a division. Stanford has seven "schools," Business, Education, Engineering, Humanities & Sciences, Law, Medicine, and, yes, Earth, Energy & Environmental Sciences.

Why a new school? It will

"amplify our contributions in education, research and impact further by aligning people and resources more effectively.

Says university President Tessier-Lavigne. Vice Provost Kathryn Moller will

"lead an inclusive process designing the school’s structure....consult with key internal and external stakeholders to develop a school organization that amplifies faculty and student contributions to address the most urgent climate and sustainability challenges." 

creating an

"impact-focused community, with new opportunities to enhance the impact of their work on the issues they deeply care about,” 

"Impact" and "amplify" repeat quite a few times.

Reopening the economy, and aftermath, now on Youtube

My Bendheim Center talk and discussion with Markus Brunnermeier on all things Covid-19 and economics is now on YouTube, direct link here. I start at 14:08.

If you like the paintings behind me and you're getting bored, more info here. (Shameless nepotism disclaimer.)

Endowment humor

Steven Wood writes a wonderful letter from a university president, responding to suggestions that a university dip in to its endowment,

As president of this University, there is nothing more important to me than the health and safety of our community. Though I’m currently away from campus, summering on my private island off of Maine, my thoughts are almost always with you, and my secretary is literally always available to field your questions and hear your concerns.

...a number of you have reached out to provide us with valuable feedback regarding our recently announced budget adjustments. Specifically, many of you have asked why an institution with a $46 billion endowment is freezing salaries, rescinding job offers, refusing to adjust tenure tracks, and laying off staff instead of using an endowment the size of Iceland’s GDP to keep our community afloat.

Let me say this: We hear you. You are valid. You. Matter. Secondly, and no less importantly, let me make something clear: The. Endowment. Is. Not. For. You. 

...the first rule of the endowment was “Never talk about the endowment.” At the end of every quarter, they blindfold me, take me to an undisclosed location which I suspect is the Chairman of the Board’s rumpus room, show me the quarterly returns, rough me up a little, then blindfold me again, and dump me on the lawn of my University-owned home. This is as close as I’ve ever gotten to the endowment, so good luck getting anywhere near that money.

Oh, I give up, just go read the whole (short) thing and have a nice chuckle.

Thanks to a colleague for the pointer.

Schmitz on monopoly

Jim Schmitz has released the first salvo in what promises to be a monumental work on monopoly, titled Monopolies Inflict Great Harm on Low- and Middle-Income Americans. (I love titles with answers and no colons.)

Today, monopolies inflict great harm on low- and middle-income Americans. One particularly pernicious way they harm them is by sabotaging low-cost products that are substitutes for the monopoly products. I'll argue that the U.S. housing crisis, legal crisis, and oral health crisis facing the low- and middle-income Americans are, in large part, the result of monopolies destroying low-cost alternatives in these industries that the poor would purchase.

He promises more to come

Legal Services, Residential Construction, Hearing Aids, Eyecare and ...Repair, Pharmaceutals, Credit Cards, Public Education...

There is a huge one right there.

To Jim the main characteristics of monopoly are

A. Monopolies sabotage and destroy markets. They typically destroy substitutes for their products, those that would be purchased by low-income Americans.

B. Monopolies also use their weapons to manipulate and sabotage public institutions for their own gains...

Reopening the economy -- and the aftermath

I'm doing a Zoom talk at the Bendheim Center, Princeton, with Markus Brunnermeier, 12:30 Eastern today (Monday May 18) on this, tune in if you're interested. It's mostly based on recent blogs and opeds. Sign up here. I'll post a link to the video when it's over.

Strategies for Monetary Policy

Strategies for Monetary Policy is a new book from the Hoover Press based on the conference by that name John Taylor and I ran last May. (John Taylor gets most of the credit.) This year's conference is sadly postponed due to Covid-19. We'll have lots to talk about May 2021.

At that link, you can see the table of contents and read Chapter pdfs for free. You can buy the book for $14.95 or get a free ebook.

The conference program and videos are still up.

Much of the conference was about the question, what will the Fed do during the next downturn? Here we are, and I think it is a valuable snapshot. Of course I have some self interest in that view.

As long as I'm shamelessly promoting, I'll put in another plug for my related Homer Jones Lecture at the St. Louis Fed, video here and the article Strategic Review and Beyond: Rethinking Monetary Policy and Independence here. That was written and delivered in early March, about 5 minutes before the lookouts said "Iceberg ahead." John and I don't put a lot of our own work into the conference books, but it sparked a lot of thoughts.  I am grateful to Jim Bullard and the St. Louis Fed for the chance to put those together.

Monetary policy is back to "forget about moral hazard, rules, strategies and the rest, the world is ending." This is a philosophy that happens quite regularly and now has become the rule and strategy. So strategic thinking about monetary policy is more important than ever.  This is a philosophy very much due to John Taylor.

The last part of my Homer Jones paper delves into just what risks the big thinkers of central banking were worried about on the eve of the pandemic. Pandemic was not in any stress test.  BIS, BoE, FSB and IMF  wanted everyone to start stress testing ... climate change and inequality. This is a story that needs more telling.    

Comment apology

To my commenters: I hit the wrong button this morning while cleaning up the huge amount of spam that comes in the comments, and many good comments got deleted. I appreciate your thoughts and I apologize for inadvertently deleting them.

Friday podcasts

Direct link Grumpy podcast page



Direct link  Goodfellows page