Janet Yellen

Bravo to Janet Yellen

Speaking on Capitol Hill Thursday, Federal Reserve Board Chair Janet Yellen warned lawmakers that as they consider such spending, they should keep an eye on the national debt. Yellen also said that while the economy needed a big boost with fiscal stimulus after the financial crisis, that’s not the case now.

“The economy is operating relatively close to full employment at this point,” she said, “so in contrast to where the economy was after the financial crisis when a large demand boost was needed to lower unemployment, we’re no longer in that state.”

Yellen cautioned lawmakers that if they spend a lot on infrastructure and run up the debt, and then down the road the economy gets into trouble, “there is not a lot of fiscal space should a shock to the economy occur, an adverse shock, that should require fiscal stimulus.”

In other words, lawmakers should consider keeping their powder dry so they have more options whenever the next economic downturn comes along.

Here is the full story.  Here is my earlier post on which macroeconomic theories will rise and fall in status because of Donald Trump.  She and the Fed were less wise but a mere month ago.

Larry Summers vs. Janet Yellen

Read Paul Krugman, Scott Sumner, Ezra Klein, and others on this.  My thinking is simple.  Public choice considerations constrain a looser monetary policy with either candidate.  Otherwise, it is easier for me to imagine Summers having credibility with a Republican administration, and having a real voice, relative to Yellen.  He simply has more right-wing street cred, keeping in mind that Yellen is a former Professor from Berkeley who has never really taken heat from the left, unlike Summers.  I think that overall the voice of the Fed within government is a clear positive.  The chance of a Republican administration, come the next election, is probably at least forty percent.  Thus I would prefer Summers.

Women in Economics

Tyler and I are very pleased to announce a new series at MRU, Women in Economics.

Women in Economics highlights the groundbreaking and inspiring work of female economists – not only to recognize the important work they’ve done but to also share their inspirational journeys.

Our first major video on Elinor Ostrom will be released on February 12 followed by videos on Janet Yellen (featuring Christina Romer and Ben Bernanke), Anna Schwartz (featuring Claudia Goldin), Joan Robinson and more. We also have some more informal “mini-testimonials” discussing the work of some major contemporary economists who have been inspirational. In the video below I discuss the work of Petra Moser. (I should have cleaned my office.)

Tyler and I also want to take a moment to thank the fantastic team at MRU for a huge amount of creativity, inspiration and hard work in putting this series together. Lots of thanks and appreciation to Roman Hardgrave, Alexandra Tooley, Mary Clare Peate, Brandon Davis, Justin Dile, Lindsay Moss and William Nava. You too can join the team!

More here.

Is China recovering?

The new gdp figure came in at 6.7%.  No matter what you believe “the real number” to be, this is probably more important:

Chen Xingdong, China chief economist at BNP Paribas, notes that first quarter growth was bolstered by industrial production, fixed-asset investment and an “astonishing” acceleration in construction starts while service sector growth moderated. That is exactly the opposite of what is supposed to be happening. “The pick-up in SOE investment and slowdown in private sector investment will cause problems for structural change,” Mr Chen said.

The first quarter this year also saw record credit expansion in China, even though most economists believe the country needs to be deleveraging. Here is David Keohane citing Wei Yao:

In Q1, increases in total credit exploded to CNY7.5tn, up 58% yoy and equivalent to 46.5% of nominal GDP – one of the highest ratios ever. Credit growth accelerated to 15.8% yoy to end-March, the quickest pace in 20 months.

Also from the FT (see the first link) is this:

Meanwhile, the “Mr Li got lucky” argument suggests that the most powerful player is not the country’s much feared president, Xi Jinping, but rather Janet Yellen, chair of the US Federal Reserve. According to this theory, Ms Yellen’s pause on US rate rises saved China from what looked like the beginning of run on the renminbi and Beijing’s foreign exchange reserves, which fell precipitously in January and February.

These falls moderated only after the Fed suggested it would not raise interest rates as aggressively as it had indicated late last year.

“The Fed’s reversal has taken a lot of pressure off the renminbi and without the currency looking like it’s going to collapse, people are feeling better,” said one Asian investment strategist, who asked not to be named.

The simplest China model for 2016 is this.  Due to the prevalence of SOEs and state influence in the economy, the country can in fact (for now) achieve almost any gdp target it wishes, at least within reason.  But it trades off the quantity of gdp for the quality of gdp, and this time — again — the Party opted for the relatively high growth figure.  That is bad news, not good news.

Here is an unpacking of some parts of the gdp number.  Here is Nerys Avery.

Should the Fed tighten?

1. I do not know what the Fed should do, and I do not know what the Fed will do.  I don’t even like that phrase “should the Fed tighten?,” but the superior “what kind of multi-dimensional expectational monetary path should the Fed indicate?” is awkward.

2. Starting in 2008, I thought money was too tight during 2007-2011, and in general I am not afraid of upping the dose of inflation, ngdp, however you wish to express it.  I have never had “tight money” in my blood, so to speak.

3. There is good evidence from vacancies and the like that labor markets are fairly tight right now, equities are high and apparently China-robust, and we just had a gdp report of 3.8%.  So something other than more monetary loosening ought not to be out of the question.  Those variables simply cannot be irrelevant for the Fed’s current choice.

4. There is not a stable Phillips curve.  So the lack of strong price inflation does not carry clear labor market implications, nor does it mean we can boost employment through looser money.

5. Often I buy the “asymmetry argument.”  That suggests more price inflation probably won’t hurt us much, but monetary tightening could damage labor markets, so why tighten?  Paul Krugman among others makes this argument.

6. Now the risks look fairly symmetric.  The first reason is that zero short rates for so long might be encouraging excess risk-taking in the financial sector.  This can be the “reach for yield” argument, which in spite of its lack of replicable econometric support commands a lot of loyalty from serious observers within the financial sector itself.

7. The second reason for symmetric risks is that zero short rates for so long might be encouraging zombie companies:

The end of ultra-low interest rates may bode ill for the productivity of British businesses, which is already poor. Output per hour is still lower than before the crisis of 2007, whereas in America and even France it has grown. Tight monetary policy should be bad for productivity, since it makes business investment more expensive. As the cost to businesses of borrowing has fallen by more than half since 2008, investment by firms has risen by 20%. The worry now is that dearer borrowing will curb the investment binge, making productivity even more dismal.

Yet there is another side to the productivity equation. Kristin Forbes, a member of the MPC, points out that, as in Japan in the 1990s, cheap borrowing may allow inefficient “zombie firms” to survive for longer than they normally would. In Britain interest payments as a share of profits have fallen from about 25% in 2009 to 10% today, bringing down company liquidations with them. As they stagger on, zombie firms hold down average productivity levels in their industry and, as a result, put a lid on wage growth. Rising interest rates could slowly start to sort the wheat from the chaff.

That is from from The Economist and of course you can adapt it for an American context.

8. Those two arguments might be meaningful with only a chance of say fifteen percent each, but that still would put the risks in a broadly symmetric position.  I don’t see that the critics have made the case that a mere quarter point rate increase should be so damaging.

9. The contrarian in me rebels when I see article after article, blog post after blog post, consider the monetary policy problem in only two dimensions, namely as would be expressed by a Phillips curve.  See #4.  The “nice view” of monetary policy, as Faust and Leeper suggest (pdf), is probably wrong.

10. If I were at the Fed, I would consider a “dare” quarter point increase just to show the world that zero short rates are not considered necessary for prosperity and stability.  Arguably that could lower the risk premium and boost confidence by signaling some private information from the Fed.  But it’s a risk too — what if the zero rates are necessary?

11. The prospect of a stronger dollar, and the subsequent hit on American exports, remains a domestic reason not to let rates rise.  I doubt if it is a global Benthamite reason, but it is probably a reason held by some within the Fed.

12. The biggest piece of information here is that both Janet Yellen and Stanley Fischer both seem genuinely uncertain as to what the Fed should do.  No, they haven’t been absorbed by the hard money Borg.  They have their own version of these arguments and it seems they see the risks as being relatively symmetric, and thus the correct monetary policy choice is far from obvious.  No one has yet said anything that is smarter or more potent in Bayesian terms than what they probably are thinking.

13. Let’s say the Fed did decide to allow rates to rise.  How exactly would they make that happen?  How hard would it prove to accomplish?  That’s an under-discussed angle to all of this.  And the Fed might either wish to postpone this curiosity or get it over with, another set of symmetric risks.

We’ll know more soon.

The False Prophets of Efficiency Wages

One of the least-convincing tropes of financial journalism is the article explaining how business firms can increase profits and at the same time engage in some conventional, culturally-approved, do-good activity such as improving the environment, saving energy, or helping the poor. The latest version is how to increase profits by increasing wages.

Here is James Surowiecki writing in the New Yorker:

A substantial body of research suggests that it can make sense to pay above-market wages—economists call them “efficiency wages.” If you pay people better, they are more likely to stay, which saves money; job turnover was costing Aetna a hundred and twenty million dollars a year. Better-paid employees tend to work harder, too. The most famous example in business history is Henry Ford’s decision, in 1914, to start paying his workers the then handsome sum of five dollars a day. Working on the Model T assembly line was an unpleasant job. Workers had been quitting in huge numbers or simply not showing up for work. Once Ford started paying better, job turnover and absenteeism plummeted, and productivity and profits rose.

Walter Frick writing in the Harvard Business Review agrees:

The theory of efficiency wages…suggests that firms sometimes have an incentive to pay workers more than the going rate because doing so attracts better candidates, motivates them to work harder, and encourages them to stay at the company longer.

(Similar kinds of stories are offered by Justin Wolfers and Jan Zilinksy and also Paul Krugman).

There are two problems with this story, one obvious and one not-so obvious. The not so-obvious problem is that the economists who developed the theory of efficiency wages (including Shapiro and Stiglitz, Akerlof and Yellen and Yellen) had no illusions that they were helping business firms to discover a new way to increase profits. The economists who developed efficiency wage theory were trying to explain persistent unemployment. Hence the title of Janet Yellen’s famous survey, Efficiency Wage Models of Unemployment.

The question that motivated efficiency wage theory was not why firms should raise wages but why firms don’t cut wages when they should. The answer they gave was that firms don’t cut wages despite unemployment because they fear that workers will respond to lower wages with reduced productivity. Thus, here is Akerlof and Yellen explaining that when workers demand “fair” wages they create unemployment.

…according to the fair wage-effort hypothesis, workers proportionately withdraw effort as their actual wage falls short of their fair wage. Such behavior causes unemployment…

In the original efficiency wage literature there is no wishful thinking–no idea that we can have more of everything that we want without tradeoffs. Instead of being desirable, the efficiency wage is a problem because lower wages would reduce unemployment and be better for the economy as a whole.

Instead of letting us bask in wishful thinking the real efficiency wage theory suggests unpleasant tradeoffs. Yellen, for example, suggests that if it were cheap, greater monitoring of workers would lower unemployment as would allowing workers to take low-pay or no-pay internships for trial periods. In our paper on asymmetric information, Tyler and I make such unpleasant tradeoffs clear:

When employers do not easily observe workers, for example, employers may pay workers unusually high wages, generating a rent. Workers will then work at high levels despite infrequent employer observation, to maintain their future rents (Shapiro and Stiglitz 1984). But those higher wages involved a cost, namely that fewer workers were hired, and the hires that were made often were directed to people who were already known to the firm. Better monitoring of workers will mean that employers will hire more people and furthermore they may be more willing to take chances on risky outsiders, rather than those applicants who come with impeccable pedigree. If the outsider does not work out and produce at an acceptable level, it is easy enough to figure this out and fire them later on.

Notice that the efficiency wage theorists took it for granted that to the extent that firms can increase profits by raising wages they have already done so (hence the persistent unemployment). Firms don’t typically leave $100 bills lying on the ground so the Stiglitz, Akerlof, Yellen assumption makes perfect sense. Thus the more obvious problem with the journalistic account of efficiency wages is that it makes it sound as if the idea that productivity might increase with wages is a revelation that firms have never considered. (See Frick for some implausible stories of why firms might not raise wages even when it is profitable to do so.) In fact, firms routinely track turnover and productivity and they are well aware that higher wages are a possible means to reduce turnover and increase productivity although, as it turns out, not necessarily the most effective means. Indeed, the whole field of workforce science deals with retention, turnover and job satisfaction and the relationship of these to productivity and it does so with more nuance than do most economists. Thus, it’s simply not plausible that large numbers of firms on the existing margin can increase wages, profits and productivity. TANSTAAFL.

In summary, the real theory of efficiency wages is an important and useful theory of persistent unemployment–one that helped earn Stiglitz and Aklerof Nobel prizes and Yellen a plum government job–but the journalistic proponents of “efficiency wages” are false prophets peddling false profits.

Assorted links

What would Fedcoin look like?

JW,  a loyal MR reader, writes to me:

It’s 2018, Janet Yellen has been renominated to be Fed Chair by President Walker having served a successful first term of solid growth and low inflation.  However, to achieve such growth Yellen has had to maintain very low interest rates.  Then, disaster strikes.  France leaves the Euro unexpectedly and causes a world wide credit crunch.  It’s 2008 all over again.  President Walker is unwilling to do any stimulus.  Yellen decides that a regime change is necessary at the Fed.

Taking to heart MMT, Keynes, Bernanke, Yellen merges Keynes’ idea of burying money in jars with Helicopter Ben’s idea of dropping money from the sky.  The Fed announces that the United States is going to create its own cryptocurrency, which can be exchanged for US dollars at any US regulated depository institution.  No or minimal fees can be charged by the banks for this exchange.  They will be created just like Bitcoin, decentralized and according to a mining algorithm.  American citizens can mine them, create businesses to do so, and put people to work.  Unlike Bitcoin, the supply of DollarCoin will not be finite, capped at 21 million.  Instead, DollarCoin will be targeted to grow at an inflation rate consistent with an NGDPLT of 20 trillion US dollars.  Liquidity is restored.  No QE is necessary.  CNBC starts cheerfully referring to DollarCoin as YellenCoin.

Meanwhile, Bitcoin plummets in value.  With the US Government now accepting a cryptocurrency, its advantages vanish.  People’s belief in its value goes away, and looking down, it crashes.  Remittances are now sent to relatives in Africa and Latin America by YellenCoin, just as people once did briefly in Bitcoin.

It is interesting to think about why this is so implausible.  There are a few reasons:

1. YellenCoin would be a means of payment but not the medium of account.  This would move the economy into a currency substitution model, a’la Girton and Roper, but would not have the effects of a straightforward monetary expansion.

2. Cryptocurrencies are much more likely to be used for some kinds of transactions than others.  So this act of “monetary policy” would be very much non-neutral.

3. Central banks are not supposed to be seen as taking major risks or overturning the established order of things.  They are highly risk-averse when it comes to their public reputations, and their very much prefer sins of omission to sins of commission.  If the Fed established Fedcoin and something went wrong with the idea, they would be subject to especially heavy blame.  In the meantime, few people (are there exceptions?) are blaming them for not establishing a cryptocurrency.

Assorted links

Inequality and the Masters of Money

This post isn’t about inequality and money it’s about inequality and the masters of monetary policy. Consider Janet Yellen, her recent confirmation to chair the Fed has made her the most powerful woman in the world, the most powerful woman in world history, the world’s second most powerful person, or the world’s most Yellenpowerful person depending on who you believe. In anycase, Yellen is powerful. Moreover, Yellen is married to Nobel prize winner George Akerlof. The fact that two such outstanding individuals should be married to one another is an illustration of assortative mating. Yellen-Akerlof are the 1% of the 1% and all that political and cultural achievement concentrated in one family is an example of the growth of inequality. Tellingly, one of the drivers of this inequality was greater equality of opportunity for women.

Now consider, President Obama’s nomination for Fed vice-chairman, Stanley Fischer. Fischer was born in Zambia, holds dual Israeli-American citizenship and was most recently the governor of the Bank of Israel. In all of US history there is almost no precedent for a former major official of a foreign country to become a major official of the United States. Given all the economists in the United States one might have thought that a suitable candidate could be found without this peculiar history and yet it’s not hard to understand why President Obama has nominated Fischer–to wit, I wouldn’t be surprised if everyone President Obama asked for advice on this question to told him that Fischer would be one of the best people in the entire world for the job.

Bernanke-Fisher

Indeed, many of the people Obama spoke to, including Ben Bernanke, would have been Fischer’s students, themselves a large subset of the tiny elite of the world’s top monetary economists. Perhaps the world of monetary economics is an inbred clique, a supplier-controlled cartel. Maybe so, but I see this as part of a larger story. Stanley Fischer, rather than thousands of other nearly equally-qualified people, is being nominated to the U.S. Federal Reserve for the same reasons that large firms, compete madly for a handful of CEO’s (in the process bidding up their wages to stratospheric levels).

Consider that even in the rarefied world of monetary policy Fischer’s appointment isn’t unique. In 2012, the British appointed Mark Carney, a Canadian, to be the Governor of the Bank of England, the first non-Briton to ever hold the role. When even Great Britain and the United States find that their home-grown talent isn’t good enough that tells you that the demand for talent is immense. My favorite example of this from the business world is Sergio Marchionne. Marchionne is the CEO of Italy’s Fiat and the Chairman and CEO of Chrysler, among several other positions. He commutes between Italy and the United States, lives in Switzerland, and has dual Italian and Canadian (!) citizenship. Appointments and potential appointments like those of Carney and Fischer illustrate that the demand for talent and the winner-take-all phenomena of a globalized world are not limited to the business world.

Small differences in quality at the top have a greater impact the larger the firm, the market, or the economy. How many truly great decisions did Bill Gates make at Microsoft (compared to another plausible CEO)? I would guess that fewer than 10 decisions made billions of dollars of difference. And if Yellen-Fischer make just a few better calls than their next best counterparts, well that could easily be worth hundreds of billions.

It’s also notable that the Federal Reserve is trying to create the highest-quality team. O-ring production tells us that you maximize the value of production by matching high-quality workers with other high quality workers. In the private sector, O-ring production magnifies inequalities of talent into even larger inequalities of income. In the public-sector, O-ring production magnifies inequality of talent into even larger inequalities of power.

The bottom line is this, a common set of factors is driving inequality: equality of opportunity,  assortative mating, O-ring production, increases in the demand for talent driven by the leveraging of talent through technology. The forces are similar and so are the results, the money elite, the monetary elite, the power elite.

Assorted links

Peter A. Diamond

Here is Diamond's home page, here is Diamond on Wikipedia.  Diamond has been at MIT since 1970 and he is considered one of the bulwarks there, having produced many excellent students, including Bernanke and Andrei Shleifer.  Here is the bit of most current interest:

On April 29, 2010, Diamond was announced by Barack Obama as one of three nominees to fill the three vacancies then present on the Federal Reserve Board, along with Janet Yellen and Sarah Bloom Raskin.[5] On August 5 the Senate returned Diamond's nomination to the White House, effectively rejecting his nomination. Ben Bernanke, the current Chairman of the Fed, was once a student of Diamond.

Some of Diamond's early work was in capital theory, as he outlined the conditions under which, in dynamic growth models, the level of capital could be inefficient.  Read this paper, from 1965, which is still his most frequently cited work.  It helped produce a standard framework for thinking about national debt and economic growth.

Diamond has contributed plenty to the theory of optimal taxation, in particular when linear commodity taxes are optimal and how to use the tax system for redistribution.  See this paper with James Mirrlees (also a Nobel Laureate) and also this one.  One implication is that taxing inputs often leads to more distortion than taxing outputs and you can think of this as one possible motivation for a consumption tax.

Here is Diamond's 1982 paper on macro and search theory, which I think of as his most influential.  The abstract is classic Diamond:

Equilibrium is analyzed by a simple barter model with identical risk-neutral agents where trade is coordinated by a stochastic matching process.  It is shown that there are multiple rational expectations equilibria, with all non-corner solution equilibria inefficient.  This implies that an economy with this type of trade friction does not have a unique rate of natural unemployment.

The relationship to the current day U.S. is striking.  One point he stresses is that subsidization of production can make sense and also that there can be real costs of converging to the lowest possible rate of unemployment too quickly.  This remains an important "framework" paper for analyzing the interaction of search and aggregate demand.  His other 1982 search paper implies that labor mobility will be less than is socially optimal.  This paper on search theory shows that unemployment compensation can lead to better job matches, by limiting crowding externalities in the job market.

He and Olivier Blanchard wrote a classic piece on the Beveridge Curve, which is about the relationship between job vacacies and the unemployment rate.  Some commentators cite the Beveridge Curve as evidence for structural unemployment, although this is controversial.

Diamond has written a great deal on social security, often at the applied level.  Here is his paper criticizing social security privatization in Chile for its high costs.  Here is his survey on social security reform proposals.  Here is his paper on macro and social security reform.  Here is a very good European talk he gave on pension issues.  Diamond wrote a book with Peter Orszag on social security and he has been a major influence on Democratic Party thinking on this issue; the book looks closely at progressive price indexing rather than wage indexing of benefits.  Here is a CBO summary and analysis of the plan.  Much of Diamond's more formal social security analysis stresses risk-sharing issues and in general he often points out that social security proposals, including Bush's privatization idea, are not well-grounded in rigorous analysis.

Here Diamond tells us not to expect 7 percent stock returns for the ongoing future.

Diamond has many interests, here is his survey on contingent valuation and whether some number is better to use than no number at all.  He and Stiglitz wrote a famous paper on risk and risk aversion.

Personally, my favorite Diamond paper is this short gem on the evaluation of infiinite utlity streams; it will make your head spin, as it asks whether we have coherent means of thinking about prospects with infinite utility and in general how intertemporal utility streams should be ordered.  See also his related paper on stationary utility, co-authored with T.J. Koopmans.

Here is his short introduction on behavioral economics.

I think of Diamond as the classic MIT economist, especially of the earlier, pre-Acemoglu generation.  Lots of theoretical rigor, though sometimes his theory pieces don't have a simple or simply analytic punchline.  There is greater concern with risk, and stability conditions, and dynamic and border conditions, than you would see in a Chicago theory paper.  There is a strong emphasis on the ability of government to implement welfare-improving schemes of the sort found in social democracies.  The approach is quite technocratic — solve and advise.  Public choice and political economy considerations take a back seat.  High IQ.  Of the MIT economists, he has done the most to pursue the Samuelson tradition of having a universal method and very broad interests.  His papers remain central to public finance, welfare economic, intertemporal choice, search theory, macroeconomics, and other areas.  His policy impact on social security has been significant.

Addendum: Levitt comments on Diamond.