John Cochrane on the safe asset shortage

I gave some comments on “Global Imbalances and Currency Wars at the ZLB,” by Ricardo J. Caballero, Emmanuel Farhi, and Pierre-Olivier Gourinchas at the conference, “International Monetary Stability: Past, Present and Future”, Hoover Institution, May 5 2016. My comments are here, the paper is here

The paper is a very clever and detailed model of “Global Imbalances,” “Safe asset shortages” and the zero bound. A country’s inability to “produce safe assets” spills, at the zero bound, across to output fluctuations around the world. I disagree with just about everything, and outline an alternative world view.

A quick overview:

Why are interest rates so low? Pierre-Olivier & Co.: countries can’t  “produce safe stores of value”
This is entirely a financial friction. Real investment opportunities are unchanged. Economies can’t “produce” enough pieces of paper. Me: Productivity is low, so marginal product of capital is low.

Why is growth so low? Pierre-Olivier: The Zero Lower Bound is a “tipping point.” Above the ZLB, things are fine. Below ZLB, the extra saving from above drives output gaps. It’s all gaps, demand. Me: Productivity is low, interest rates are low, so output and output growth are low.

Data: I Don’t see a big change in dynamics at and before the ZLB. If anything, things are more stable now that central banks are stuck at zero. Too slow, but stable.  Gaps and unemployment are down. It’s not “demand” anymore.

Exchange rates. Pierre-Olivier  “indeterminacy when at the ZLB” induces extra volatility. Central banks can try to “coordinate expectations.” Me: FTPL gives determinacy, but volatility in exchange rates. There is no big difference at the ZLB.

Safe asset Shortages. Pierre-Olivier: driven by a large mass of infinitely risk averse agents. Risk premia are therefore just as high as in the crisis. Me: Risk premia seem low. And doesn’t everyone complain about “reach for yield” and low risk premia?

Observation. These ingredients are plausible about fall 2008. But that’s nearly 8 years ago! At some point we have to get past financial crisis theory to not-enough-growth theory.

I agree, here is the rest.


I wish he would expand a bit on how FTPL predicts determinacy. I haven't seen him post anything about a nominal anchor, and his price stabilization proposal only stabilizations expectations of inflation, whereas others are writing about ways to stabilize the path of CPI.

"At some point we have to get past financial crisis theory to not-enough-growth theory."
-- Except not-enough-growth theory doesn't explain the financial crisis. Which happened, and was real. The "now more than ever" supply side-only explanation is no explanation at all.

Not-enough-growth theory does explain the financial crisis, which was mediated by a global shortage of assets. People tried to compensate temporarily by investing in housing, but this equilibrium collapsed when enough people understood the arguments in Robert Shiller's book.

Note enough assets means too little capitalism and way way too much rent seeking and pillage and plunder of capital, focusing in increasing the shortage of capital assets to increase the rents on scarce capital.

Think of cash like oil in the ground. The pillage and plundering oil industry wants the oil to stay in the ground to create scarcity of capital sold for burning, or for government to force increased burning of capital to shovel cash to the pillage and plunder who will conspire to keep it in the ground to maximize rents on selling capital for burning.

The last thing the oil industry wants is anything that builds capital like wind and solar harvesting and storage that creates an excess of substitutes for burning capital.

And they oppose a hike in the gas tax to pay for better transportation because that will be paid out of their desired rents and might actually reduce demand by creating higher productivity in transportation. Better to have congestion limit miles but force the mpg to be half as much as better roads that increase miles by 20%. But a carbon tax that eliminates all rents and makes tax dodging reap higher rents for a time would be long term devastating - once productive assets replace pillage, plunder, and burning of capital, they become self sustaining.

Or take housing. The cost of building housing is extremely high because existing asset owners who benefited from government paying for infrastructure benefit from capital scarcity so they shift all the costs of building infrastructure onto the new capital which forces new capital prices higher, which as we all know forces prices of old capital high.

If government enacted a rent aka tax on existing capital aka property to pay for infrastructure to make building new capital cheaper aka building cheap housing, the prices of existing scarce capital wold fall. Aka, government policy to create affordable housing would destroy wealth, picking losers, existing owners of inflated price property, and winners, those new buyers of housing paying less than their old neighbors because prices equal cost, not inflated prices from scarcity.

Re: "Me: Productivity is low, interest rates are low, so output and output growth are low."

Current Capital productivity is low because we subsidize, through the tax code, investment in capital, and at some point you reach diminishing returns.

Let's look at investing in human capital.

Can we do accelerated depreciation on that?

Have you looked at the student debt numbers recently? What is that if not investment in human capital?

As far as I know the student debt is owned by the student and is non-dischargeable.

Some assistance.

You can't repossess knowledge and signal value.

Owned, in this example, is used improperly- was that a typo for "owed"?

However, I get the point you are trying to make, but it is is flawed. Someone still has to pay for the productivity-enhancing capital, that is almost always going to be the person who owns the actual capital- in this case the students themselves (though I am willing to entertain the the notion that their debts are not really worth what they used it for). In other words, we have already been on a binge of investing in human capital the last 10 years, and have a shitty economy to show for it. Perhaps it is time to rethink this idea, at least as it applies to higher education.

However, if the student is the one who must pay off the loan, than the investment in human capital makes sense only if the student reaps the gains of that capital. Of course, higher wage growth is the way it's expected to be paid back, but there are plenty of situations where the value of the human capital accrues to the business owner and not the employee.

You end up with the situation that you're investing in human capital, but the return on that human capital goes to a different party entirely, and employee and debt holder are kept out of luck.

Sell, you do expense labour expenses, which are tax deductible on the pnl, so I don't see what the problem is there. I do see, however,va problem with tax deductability of interest expenses, driving corporations (and households where it applies) to take on excessive debt, but this time s changing albeit slowly.


What's the tax deductibility of student loans again as opposed to buying a computer, deducting the interest for purchase and depreciating it? Obviously, I should have been clearer as you did not understand that if you treat a person as capital, and educational improvement as an improvement of capital, you would have to treat depreciation and other capital accumulation assistance devices we have in the tax code differently. Your point re labor expenses is just looking at it from the perspective of the employer, not from the perspective of the employee which receives no assistance in improving its own human capital.

Isn't much of the demand for treasuries driven by Chinese and German mercantilism? They are willing to accept lower, even negative, interest rates, but my understanding is that the fed wants to get away from the ZLB for fear of blowing more bubbles.

If it doesn't fit, you must acquit (the ZLB)!

I think I agree with Cochrane mostly, but I also think there is a great deal of confusion about 'risk premia'. I think people use contradictory definitions of this term.

To me, the 'risk premium' is the increase in expected return associated with absorbing more risk. Right now, I see a kind of complicated story.

1. Guarantees are expensive right now, which suggests that at low levels of risk, premia are high. For example, returns on cash are lower than expected inflation. If you want to buy 'insurance' against currency debasement (inflation), you can lock in a negative 0.28% annual "real" return on a five-year TIP. That's right- you can sleep quietly knowing that your assets will only lose 0.28% in purchasing power over the next five years. Expensive.

2. Reaching for yield. Investors can do better by going farther out on the yield curve (locking up money for longer) and/or underwriting credit risk (corporate bonds). Here, it appears that premia are pretty damn low now. the 30-year TIP yields a real return of just 0.86% per year. The "real" yield curve is about as flat as it's ever been right now. That's a long time to lock money up for a paltry return.

Meanwhile, corporate bond spreads were elevated during most of 2015, but in recent months, they have snapped back to near their historic averages.

At this point on the risk continuum, incremental premia look pretty low.

3. Equity, real estate, etc. This is much more speculative ground, but given yields on bonds compared to corporate earnings yields plus a guess about the path of future profitability, the risk premium here seems pretty high to me right now. I know lots of people disagree- that's what makes stock markets and real estate markets fun. We'll see...

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