Results for “interest rates risk fed” 63 found
Interest on reserves, continued
I was intrigued by this passage, from Interfluidity:
Interest rates are, for the moment, excruciatingly low. But a subsidy
to the banking system, once put into place, will be quite hard to
dislodge. So, let’s imagine that the Fed will pay interest on bank
reserves in perpetuity, that it will pay such interest at or near the
risk-free short-term interest rate, and that the expansion of the Fed’s
balance sheet is more or less permanent. How large a subsidy to the
banking system do the interest payments on reserves represent? Some
problems are arithmetically challenging, but not this one. The present
value of a perpetual stream of market-rate interest payments is
precisely the amount of the principal. Therefore, the present value of
the Fed’s de facto commitment to pay interest to banks on $800B
of freshly created reserves is $800B. We fought and wailed and gnashed
our teeth over potentially overpaying for TARP assets. Meanwhile, we
are quietly allowing the Fed give away, as a direct, literal subsidy,
more than the entire $700B that Paulson was allowed to play with. Note
there is no question about this being an "investment": The interest
payments that the Fed is now making to banks on its suddenly expanded
balance sheet are not loans. The banks owe taxpayers absolutely nothing
in return for this windfall.
I take that calculation to be a very rough one, and possibly an overstatement, but the point remains of interest. It also can be argued that interest on reserves is a bad signal for at least two reasons:
1. It signals the Fed fears being left holding the intra-day Fedwire bag if a major bank goes under, and
2. It signals the Fed thinks major banks need such a subsidy.
The cited post is interesting throughout.
Can the Fed in fact pop bubbles?
Megan McArdle wonders:
Prospectively, if you want to do it effectively, you probably need to intervene in the very early stages. The Fed raised interest rates in the late 1920s, to no effect–indeed, it encouraged foreign capital to flow in. Iceland’s central bank, too, tried to quiet its financial bubble, but borrowers simply ignored them–borrowed at the higher rate, or stupidly took on currency risk by getting auto loans and mortgages from abroad. Meanwhile, more lenders were attracted by the higher rates. If you think house prices will go up 10% every year, a 1% increase in mortgage interest rates is not really that worrying.
Do you know any good pieces on this topic? Daniel Gross also says it is hard to do. Here is one article on Bernanke’s bubble laboratory.
My excellent Conversation with Marc Rowan
Here is the video, audio, and transcript, taped in his Apollo office in NYC. Here is the episode summary:
Marc Rowan, co-founder and CEO of Apollo Global Management, joined Tyler to discuss why rising interest rates won’t hurt Apollo’s profitability, why liabilities have traditionally been the weak spot in insurance, why the concept of liquidity needs a rethink, the meaninglessness of the term “private credit”, what role crypto will play in American finance, why Marc bought a brutalist apartment, which country has beautiful new neighborhoods, what motivated Apollo’s office redesign, what he looks for in young hires, the different kind of decision-making required in debt versus private equity, the biggest obstacle to doing business in India, how university governance can be improved, what he’s learned from running restaurants, the next thing he’ll learn, and more.
And an excerpt:
COWEN: Now, how stable is all this as a political equilibrium? If you think about the four major banks, as you well know, there are very serious stress tests applied to them, capital requirements. The Fed is a major regulator. At least for insurance, it tends to be at the state level. One can reinsure through Bermuda. Capital requirements are very different. Competence of the state regulators arguably is lower than that of the Fed. Whether or not one wants more regulation — and generally, I don’t — but is this a stable situation? How’s it going to evolve?
ROWAN: First, I would have to correct almost everything you’ve said along the way to set the table for what I’m going to talk about. First, the difference between not so much the banking system and insurance, but the banking system and the investment marketplace. Let’s start with this — there are plenty of ways for investors to lose money. Investors can buy speculative stocks. They could buy the S&P. They can speculate in almost anything.
The making or losing of money is not, in and of itself, a systemically risky activity because, for good reason, we allow speculative investing every single day. Things go up, things go down. You can lose money in credit as well as in equity.
Now we come to mutual funds. If a mutual fund, which is daily liquid, owns credit, and investors want to get their money back, you’re right, price just adjusts. Mutual funds are not price guarantors. Are they regulated? Mutual funds are regulated. Are they disclosed and transparent? Yes, they’re disclosed and transparent. The holdings of a mutual fund are completely visible and they’re de-levered. Is that a risky activity because it moved out of the banking system and into a mutual fund? I don’t think so; I actually think it has de-risked. It’s made our economy and our financial system more resilient.
Now I’ll come to your question on political equilibrium. Insurance — if you just focus on insurance — has no federal guarantee, does not borrow short and lend long, has no access to the Fed, and does not do liquidity transformation or maturity mismatch, and they are forced to hold amounts of capital.
If you look — and I’ll give you a comparison just for us, not for the whole industry — who holds more capital, Athene our insurer as a percentage of assets or the typical bank? You would think the typical bank, but you would be wrong. We hold more capital per dollar of assets than anyone else. Who holds more investment-grade assets? Ninety percent of our book is investment-grade, the typical bank is two-thirds investment-grade.
COWEN: Sure, but that’s all time-sliced—
ROWAN: Let’s keep going.
COWEN: Money market funds have been a source of systemic risk, AIG has been —
ROWAN: I can’t tell you there’s not risks in the economy. We have a choice. We can have risk dispersed among lots of institutions, or we can have it concentrated in the government-backed, borrow-short, lend-long, government-guaranteed banking system.
Every time we disperse that risk, we make the system more resilient. If you want to focus on insurance, which is your question on political equilibrium, there’s more capital, there’s no ALM mismatch, there’s more investment-grade, and there is appropriate state-based regulation for institutions that do not have government guarantees or borrow from the Fed or do anything else.
Insurance is very slow-moving. We’re talking about, on average, 10-year assets. This is a very slow-moving process. Again, most of the issues that have happened in the insurance industry have not been asset issues. They’ve been liability issues, exactly the kind of thing that insurance-specialist regulation is designed to detect.
Recommended, and of course we talk about Marc’s higher ed campaign as well.
Regulation Can’t Prevent the Next Financial Crisis
That is the topic of my latest Bloomberg column, here is one piece of it:
For another, an effort to make banks safer can effectively push risk into other sectors of finance. It can move into money market funds, commercial credit lenders, fintech, insurance companies, trade credit, and elsewhere. These institutions are generally less regulated than are banks and don’t have the same kind of direct access to the Federal Reserve’s discount window.
This is no mere hypothetical: In the 2008 crisis there were major problems with both money market funds and insurance companies.
There is a temptation, in light of recent events, to greatly stiffen bank capital requirements — to raise them to, say, 40%. Again, that would make banks safer, but it would not necessarily make the financial system as a whole safer.
And so policymakers allow banks to continue along their potentially precarious path. Whatever their reasons, the fact remains that bank regulations can get only so tough before financial risk starts spreading to other, possibly more dangerous, corners of the system.
And:
During the 2008 financial crisis, for example, there was an excess concentration of derivatives activity in AIG, later necessitating a bailout. Financial derivatives acquired a bad name in many quarters, and government securities were viewed as a safe haven. With Silicon Valley Bank, the problem was the inverse: Its portfolio was insufficiently hedged with derivatives and interest-rate swaps, leaving it vulnerable to major swings in interest rates. It should have used derivatives more.
It is easy enough to say, “We can write regulations so this won’t happen again.” But those regulations won’t prevent new kinds of mistakes from happening.
Classical liberalism vs. The New Right
It has become increasingly clear that the political Right in America is not what it used to be. In particular, my own preferred slant of classical liberalism is being replaced. In its stead are rising alternatives that don’t yet have a common name. Some are called “national conservatism,” and some (by no means all) strands are pro-Trump, but I will refer to the New Right. My use of the term covers a broad range of sources, from Curtis Yarvin to J.D. Vance to Adrian Vermeule to Sohrab Ahmari to Rod Dreher to Tucker Carlson, and also a lot of anonymous internet discourse. Most of all I am thinking of the smart young people I meet who in the 1980s might have become libertarians, but these days absorb some mix of these other influences.
I would like to consider where the older classical liberal view differs from these more recent innovations. I don’t so much intend a cataloguing of policy positions as a quest to find the most fundamental difference, at a conceptual level, between the classical liberal views and their New Right competitors. That main difference – to cut to the chase — is how much faith each group puts in the possibility of trustworthy, well-functioning elites.
A common version of the standard classical liberal view stresses the benefits of capitalism, democracy, civil liberties, free trade (with national security exceptions), and a generally cosmopolitan outlook, which in turn brings sympathy for immigration. The role of government is to provide basic public goods, such as national defense, a non-exorbitant safety net, and protection against pandemics.
In the classical liberal view, elites usually fall short of what we would like. They end up captured by some mix of special interest groups and poorly informed voters. There is thus a certain disillusionment with democratic government, while recognizing it is the best of available alternatives and far superior to autocracy for basic civil liberties.
That said, classical liberals do not consider the elites to be totally hopeless. After all, someone has to steer the ship and to this day we do indeed have a ship to steer. Most elites are intelligent and also they are as well-meaning as the rest of us, even if the bureaucratic nature of politics hinders their performance. We can entrust them with supplying basic public goods, and indeed we have little choice. Those truths hold even if the DMV will never be as efficient as Amazon, and even if sometimes our elites commit grave errors, for instance when the Johnson administration escalated the Vietnam War, to cite one example of many.
In the classical liberal view, the great failing of elites is that they do not keep society as free as it ought to be.
The New Right thinkers are far more skeptical of elites. They are more likely to see elites as evil and pernicious, and sometimes they (implicitly) see these evil elites as competent enough to actually wreck society. The classical liberals see checks and balances as strong enough to limit the worst outcomes, whereas the New Right sees ideological conformity and indeed collusion within the Establishment. Checks and balances are a paper tiger.
Once you start seeing elites as so bad and also so collusive, many other changes in your views might follow. You might become more skeptical about free speech, because you view it as a recipe for putting a lot of power in the hands of (often Democratic-led) major tech companies. And is there de facto free speech if a conservative sociologist cannot get hired at Yale? You also might become more skeptical about immigration, not because you are racist (though of course there are racists), but because you see it as a plot of the Democratic Party to remake America in a new image and with a new set of voters (“you will not replace us!”). Free trade becomes seen as a line peddled by the elite, and that is an elite unconcerned with the social and national security costs of a deindustrialized America. Globalization more generally becomes a failed project of the previous elite.
The New Right doesn’t entirely reject the basic principles of free market economics, but it does try to transcend libertarian views with a deeper understanding of the current power structure. In each case there are sociological forces operating that are seen as more important than “mere” free market economics. In this regard the New Right has a more interdisciplinary worldview than do many of the classical liberals. The New Right thinkers regard most power as cultural in nature, rather than rooted in coercive government alone.
Using this kind of contrast, just about every classical liberal view can be redone along New Right lines. The policy emphasis then becomes learning how to use the government to constrain the Left and its cultural agenda, rather than ensuring basic liberties for everyone. The New Right view is that this obsession with basic liberties leads, in reality, to the hegemony of a statist Left, and a Left that will use its power centers of government, media and academia to crush and cancel the New Right.
There is also a self-validating structure to New Right arguments over time. You can’t easily persuade New Right advocates by pointing to mainstream media reports that contradict their main narrative. Mainstream media is one of the least trusted sources. Academic research also has fallen under increasing mistrust, as the academy predominantly hires individuals who support the Democratic Party.
Most classical liberals are uncomfortable with the New Right approaches, and seek to disavow them. I share those concerns, and yet I also recognize that hard and fast lines are not so easy to draw. The New Right is in essence accepting the original classical liberal critique of the state and pushing it a few steps further, adding further skepticism of elites, a greater emphasis on culture, and a belief in elite collusion rather than checks and balances. You may or may not agree with those intellectual moves, but many common premises still are shared between the classical liberals and the New Right, even if neither side is fully comfortable admitting this.
The New Right also tends to see the classical liberals as naïve about power (the same charge classical liberals fling at the establishment), and as standing on the losing side of history. Those aren’t the easiest arguments to refute. Furthermore, the last twenty years have seen 9/11, a failed Iraq War, a major financial crisis and recession, and a major pandemic, mishandled in some critical regards. It doesn’t seem that wrong to become additionally skeptical about American elites, and the New Right wields these points effectively.
While I try my best to understand the New Right, I am far from being persuaded. One worry I have is about how it initially negative emphasis feeds upon itself. Successful societies are based on trust, including trust in leaders, and the New Right doesn’t offer resources for forming that trust or any kind of comparable substitute. As a nation-building project it seems like a dead end. If anything, it may hasten the Brazilianification of the United States rather than avoiding it, Brazil being a paradigmatic example of a low trust society and government.
I also do not see how the New Right stance avoids the risks from an extremely corrupt and self-seeking power elite. Let’s say the New Right description of the rottenness of elites were true – would we really solve that problem by electing more New Right-oriented individuals to government? Under a New Right worldview, there is all the more reason to be cynical about New Right leaders, no matter which ideological side they start on. If elites are so corrupt right now, the force corrupting elites are likely to be truly fundamental.
The New Right also overrates the collusive nature of mainstream elites. Many New Right adherents see a world ever more dominated by “The Woke.” In contrast, I see an America where Virginia elected a Republican governor, Louis C.K. won a 2022 Grammy award on a secret ballot and some trans issues are falling in popularity. Wokism likely has peaked. Similarly, the New Right places great stress on corruption and groupthink in American universities. I don’t like the status quo either, but I also see a world where the most left-wing majors – humanities majors – are losing enrollments and influence. Furthermore, the internet is gaining in intellectual influence, relative to university professors.
The New Right also seems bad at coalition building, most of all because it is so polarizing about the elites on the other side. Many of the most beneficial changes in American history have come about through broad coalitions, not just from one political side or the other. Libertarians such as William Lloyd Garrison played a key role an anti-slavery debates, but they would not have gotten very far without support from the more statist Republicans, including Abraham Lincoln. If you so demonize the elites that do not belong to your side, it is more likely we will end up in situations where all elites have to preside over a morally unacceptable status quo.
The New Right (and the classical liberals I might add) also seem to neglect the many cases where American governance has improved over time. My DMV really is many times better than it was thirty years ago. New York City is currently seeing some trying times, due to the pandemic aftermath, but the city is significant better run today than it was in the 1970s. Social Security, for all of its flaws, remains one of the world’s better-functioning retirement systems. The weapons the U.S. military is supplying to Ukraine seem remarkably effective. The Fed and Treasury, for all their initial oversights, did forestall a great depression in 2008-2009. Operation Warp Speed was a major success and saved millions of lives.
It is missing the point to provide a counter-narrative of all of our government’s major and numerous screw-ups. The point is that good or at least satisfactory elite performance is by no means entirely out of our reach. We then have to ask the question – which philosophy of governance is most likely to get us there next time around? I can see that some New Right ideas might contribute to useful reform, but it is not my number one wish to have New Right leaders firmly in charge or to have New Right ideology primary in our nation’s youth.
Finally, I worry about excess negativism in New Right thinking. Negative thoughts tend to breed further negative thoughts. If the choice is a bit of naivete and excess optimism, or excess pessimism, I for one will opt for the former.
Perhaps most of all, it is dangerous when “how much can we trust elites?” becomes a major dividing line in society. We’ve already seen the unfairness and cascading negativism of cancel culture. To apply cancel culture to our own elites, as in essence the New Right is proposing to do, is not likely to lead to higher trust and better reputations for those in power, even for those who deserve decent reputations.
Very recently we have seen low trust lead to easily induced skepticism about the 2020 election results, and also easily induced skepticism about vaccines. The best New Right thinkers will avoid those mistakes, but still every political philosophy has to be willing to live with “the stupider version” of its core tenets. I fear that the stupider version of some of the New Right views are very hard to make compatible with political stability or for that matter with public health.
I would readily grant that my opinion of our mainstream elites has fallen over the last five to ten years, and in part from consuming intellectual outputs from the New Right. But I don’t long for tearing down the entire edifice as quickly as possible. That would break the remaining bonds of trust and competence we do have, and lead to reconstituted governments, bureaucracies, and media elites with lower competence yet and even less worthy of trust. If you yank out a tooth, you cannot automatically expect a new and better tooth to grow back.
The polarizing nature of much of New Right thought means it is often derided rather than taken seriously. That is a mistake, as the New Right has been at least partially correct about many of the failings of the modern world. But it is an even bigger mistake to think New Right ideology is ready to step into the space long occupied by classical liberal ideals.
The Diamond and Dybvig model
The Diamond and Dybvig model was first outlined in a seminal paper from Douglas W. Diamond and Philip H. Dybvig in 1983 in a famous Journal of Political Economy piece, “Bank Runs, Deposit Insurance, and Liquidity.” You can think of this model as our most fundamental understanding, in modeled form, of how financial intermediation works. It is a foundation for how economists think about deposit insurance and also the lender of last resort functions of the Fed.
Here is a 2007 exposition of the model by Diamond. You can start with the basic insight that bank assets often are illiquid, yet depositors wish to be liquid. If you are a depositor, and you owned 1/2000 of a loan to the local Chinese restaurant, you could not very readily write a check or make a credit card transaction based upon that loan. The loan would be costly to sell and the bid-ask spread would be high.
Now enter banks. Banks hold and make the loans and bear the risk of fluctuations in those asset values. At the same time, banks issue liquid demand deposits to their customers. The customers have liquidity, and the banks hold the assets. Obviously for this to work, the banks will (on average) earn more on their loans than they are paying out on deposits. Nonetheless the customers prefer this arrangement because they have transferred the risk and liquidity issues to the bank.
This arrangement works out because (usually) not all the customers wish to withdraw their money from the bank at the same time. Of course we call that a bank run.
If a bank run occurs, the bank can reimburse the customers only by selling off a significant percentage of the loans, perhaps all of them. But we’ve already noted those loans are illiquid and they cannot be readily sold off at a good price, especially if the banks is trying to sell them all at the same time.
Note that in this model there are multiple equilibria. In one equilibrium, the customers expect that the other customers have faith in the bank and there is no massive run to withdraw all the deposits. In another equilibrium, everyone expects a bank run and that becomes a self-fulfilling prophecy. After all, if you know the bank will have trouble meeting its commitments, you will try to get your money out sooner rather than later.
In the simplest form of this model, the bank is a mutual, owned by the customers. So there is not an independent shareholder decision to put up capital to limit the chance of the bad outcome. Some economists have seen the Diamond-Dybvig model as limited for this reason, but over time the model has been enriched with a wider variety of assumptions, including by Diamond himself (with Rajan). It has given rise to a whole literature on the microeconomics of financial intermediation, spawning thousands of pieces in a similar theoretical vein.
The model also embodies what is known as a “sequential service constraint.” That is, the initial bank is constrained to follow a “first come, first serve’ approach to serving customers. If we relax the sequential service constraint, it is possible to stop the bank runs by a richer set of contracts. For instance, the bank might reserve the right to limit or suspend or delay convertibility, possibly with a bonus then sent to customers for waiting. Those incentives, or other contracts along similar lines, might be able to stop the bank run.
In this model the bank run does not happen because the bank is insolvent. Rather the bank run happens because of “sunspots” — a run occurs because a run is expected. If the bank is insolvent, simply postponing convertibility will not solve the basic problem.
It is easy enough to see how either deposit insurance or a Fed lender of last resort can improve on the basic outcome. If customers start an incipient run on the bank, the FDIC or Fed simply guarantees the deposits. There is then no reason for the run to continue, and the economy continues to move along in the Pareto-superior manner. Of course either deposit insurance or the Fed can create moral hazard problems for banks — they might take too many risks given these guarantees — and those problems have been studied further in the subsequent literature.
Along related (but quite different!) lines, Diamond (solo) has a 1984 Review of Economic Studies piece “Financial Intermediation and Delegated Monitoring.” This piece models the benefits of financial intermediation in a quite different manner. It is necessary to monitor the quality of loans, and banks have a comparative advantage in doing this, relative to depositors. Furthermore, the bank can monitor loan quality in a diversified fashion, since it holds many loans in its portfolio. Bank monitoring involves lower risk than depositor monitoring, in addition to being lower cost. This piece also has been a major influence on the subsequent literature.
Here is Diamond on google.scholar.com — you can see he is a very focused economist. Here is Dybvig on scholar.google.com, most of his other articles in the area of finance more narrowly, but he won the prize for this work on banking and intermediation. His piece on asset pricing and the term structure of interest rates is well known.
Here is all the Swedish information on the researchers and their work. I haven’t read these yet, but they are usually very well done.
Overall these prize picks were not at all surprising and they have been expected for quite a few years.
The Minimum Wage, Rent Control, and Vacancies or Who Searches?
In an interesting new paper Federal Reserve economists Marianna Kudlyak, Murat Tasci and Didem Tüzemen look at what happens to job vacancy postings when the minimum wage increases.
The vacancy data in our analysis come from the job openings data from the Conference Board as a part of its Help Wanted OnLine (HWOL) data series. HWOL provides monthly data on vacancies at detailed geographical (state, metropolitan statistical area, and county) and occupational (six-digit SOC and eight-digit O*Net) levels starting from May 2005. HWOL covers around 16,000 online job boards.
…Our identification strategy exploits the idea that different occupations can be differently impacted by minimum wage hikes due to differential mass of occupation-specific wage distributions concentrated around the prevailing minimum wage. We formalize this idea by analyzing wage distributions by occupation at the state level using micro data from the Current Population Survey (CPS). We identify occupations with large shares of employed workers at or near the state-level effective minimum wage and we refer to these occupations as “at-risk occupations.” We then estimate vacancy growth in at-risk occupations relative to vacancy growth in other occupations around the time when minimum wage increase takes place in the state, and relative to growth in vacancies in at-risk occupations at the national level.
…We find a statistically significant and economically sizeable negative effect of the minimum wage increase on vacancies. Specifically, a 10 percent increase in the level of the effective minimum wage reduces the stock of vacancies in at-risk occupations by 2.4 percent and reduces the flow of vacancies in at-risk occupations by about 2.2 percent.
…We find that firms cut vacancies up to three quarters in advance of the actual minimum wage increase. This finding is consistent with the firms’ desire to cut employment and vacancies being a forward-looking tool to achieve it. This finding is also consistent with a typical announcement effect of a policy change. Formally testing for the parallel trends assumption in our triple-difference identification, we find that at-risk and not-at-risk occupations do not have statistically significant differences in their vacancy trends prior to the typical announcement period. But the negative effect persists even four quarters after the minimum wage increase. The cumulative negative effect of a 10 percent increase in the minimum wage on total vacancies is as large as 4.5 percent a year later.
…We find that vacancies in occupations that typically employ workers with lower educational attainment (high school or less) are affected more negatively than vacancies in other occupations. The negative effect on vacancy posting is exacerbated in counties with higher poverty rates, which highlights another trade-off that policymakers might want to take into account.
This reminded me of a similar paper on rent controls (ungated) by Are Oust that Tyler and I mention in the forthcoming edition of Modern Principles of Economics.
Are Oust studied rent controls in Oslo, Norway and found that during the rent control era it was common for landlords to require their tenants to be of a certain gender, age, occupation and even religion (which would be illegal in the United States). Landlords would also find ways to charge extra by asking renters for extra services such as baby-sitting, garden work or snow-clearing. When rent control was eliminated, however, the number of apartments increased and landlords no longer advertised these kinds of requirements. Perhaps most telling, in the rent-control era it was common for renters to advertise “Apartment Wanted” but when rent controls were lifted it became much more common for landlords to advertise “Apartments for Rent!”
In other words, in a free market firms search for employees and landlords search for renters but under the minimum wage and rent control, workers must search for jobs and renters must search for apartments to a much greater extent.
Nellie Bowles interviews me on inflation
So I called someone smart (Tyler Cowen, an economist, author, and professor at George Mason University) to explain the dynamics to me.
“Inflation right now is still transitory in that we can choose to end it,” Cowen told me. The Federal Reserve could disinflate and raise interest rates—mortgage interest rates today remain well below 3%—though that risks starting a recession.
Cowen explained that the reason the inflation-wary are still pretty quiet is that all the anti-Obama Republicans were so wrong in 2008. After the Obama-era bailout during the Great Recession, Republicans were convinced inflation would run rampant. And they said so. A lot. But inflation stayed mostly in control. “They all got egg on their faces after that,” Cowen said. “So the crowd that would complain now, they’re whispering about it but not shouting yet.” (Larry Summers and Steve Rattner have sounded the alarm.)
“I think the inflation will last two to three years, and it will be bad,” Cowen said. But really grim hyper-inflation à la Carter-era, he thinks is unlikely. It could only happen if the Federal Reserve decides it’s too risky to trim the sails of cheap money. “I’d put it at 20% chance that the Fed will think, ‘Trump might run again, and we don’t want Biden to lose . . . history’s in our hands, so we’ll wait to tighten.’ And then it just goes on, and then it’s very bad.”
But a recession is also bad. It’s hard to sort it all out. “As the saying goes, ‘If you’re not confused, you don’t know what’s going on,’” Cowen told me.
That is from the Bari Weiss Substack, other topics are considerd (not by me) at the link.
The wisdom of Scott Sumner
Meanwhile, young tweeters seem to forget the Great Inflation happened, or perhaps that it was caused by some sort of oil shock. How oil shocks cause double digit NGDP growth has never been explained. Everything we learned about unreliable Phillips Curves and shifting inflation expectations seems to have been forgotten. You simply can’t have too much stimulus.
I suppose their ignorance is understandable. If parents expertly adjust the thermostat to keep the house temperature at 71 to 73 degrees for 20 years, with a 72 degree target, can you blame the kids who grew up in that house for thinking that thermostats don’t have much impact on temps? (Let’s hope Powell knows!)
My views are orthogonal to this intra-Keynesian debate. I don’t think the fiscal stimulus is a good idea, but not because I expect much inflation. The inflation rate will be determined by the Fed. Rather it’s a reckless policy because it will lead to higher tax rates in the future and won’t do much to generate growth beyond Q3. (Deficits do cause higher interest rates, but only slightly higher in a country like the US.)
For 250 years of American history, politicians have held the peacetime budget deficit in check because of fears of either inflation or higher interest rates (or perhaps a loss of confidence in the gold standard.) What would happen if they begin to sniff out that the actual risk is not inflation or much higher interest rates next year, rather the risk is higher taxes in 20 years, after they’ve safely retired? How would they respond to this information?
I fear that we are about to find out.
There is more at the link. As an aside, I am amazed how much “but the job market recovered so slowly last time” is considered a relevant argument here.
Why bitcoin will not take over the world
Yes it is here to stay, and it is not a bubble, but…here is one part of the argument:
If you hold or trade with a stablecoin, you incur several risks. First, the stablecoin peg to the dollar may someday be broken, an old problem with pegged exchange rates that Milton Friedman often warned about. Second, to the extent stablecoins and other crypto assets become a major part of the financial system, they will attract more regulatory interest. That in turn will limit many of their advantages over the traditional bank sector. The U.S. government does not want a financial system that evolves outside the purview of the Federal Reserve, FDIC and other regulatory institutions.
Third, the formal banking sector will improve, for instance by moving to more rapid clearing, or by introducing electronic reserve currencies. With the latter, you could transfer your electronically-based dollars within the accounting system of the central bank, and achieve a non-intermediated transfer without resorting to crypto. It is not obvious that crypto will be the market winner once more mainstream institutions learn some lessons from the success of crypto.
And in sum:
The more utopian scenarios for crypto, whether proponents realize it or not, rely on the notion that crypto remains simultaneously fringe and mainstream. That will be a hard trick to pull off.
Your rebuttals, and more, are considered at the link to my latest Bloomberg column.
Robert B. Wilson, Nobel Laureate
Here is his home page. He has been at Stanford Business School since 1964, and born in Geneva, Nebraska. Here is his personal website. Here is his Wikipedia page. He has a doctorate in business administration from Harvard, but actually no economics Ph.D. (bravo!) Here is the Nobel designation.
Most of all Wilson is an economic theorist, doing much of his most influential work in or around the 1980s. He is a little hard to google (no, he did not work with Philip Glass), but here are his best-cited papers. To be clear, he won mainly for his work in auction theory and practice, covered by Alex here. But here is some information about the rest of his highly illustrious career.
He and David Kreps wrote a very famous paper about deterrence. Basically an incumbent wishes to develop a reputation for being tough with potential entrants, so as to keep them out of the market. This was one of the most influential papers of the 1980s, and it also helped to revive some of the potential intellectual case for antitrust activism. Here is Wilson’s survey article on strategic approaches to entry deterrence.
Wilson has a famous paper with Kreps, Milgrom, and Roberts. They show how a multi-period prisoner’s dilemma might sustain cooperating rather than “Finking” if there is asymmetric information about types and behavior. This paper increased estimates of the stability of tit-for-tat strategies, if only because with uncertainty you might end up in a highly rewarding loop of ongoing cooperation. This combination of authors is referred to as the “Gang of Four,” given their common interests at the time and some common ties to Stanford.
His 1982 piece with David Kreps on “sequential equilibria” was oh so influential on game theory, here is the abstract:
We propose a new criterion for equilibria of extensive games, in the spirit of Selten’s perfectness criteria. This criterion requires that players’ strategies be sequentially rational: Every decision must be part of an optimal strategy for the remainder of the game. This entails specification of players’ beliefs concerning how the game has evolved for each information set, including information sets off the equilibrium path. The properties of sequential equilibria are developed; in particular, we study the topological structure of the set of sequential equilibria. The connections with Selten’s trembling-hand perfect equilibria are given.
Here is a more readable exposition of the idea. This was part of a major effort to figure out how people actually would play in games, and which kinds of solution concepts economists should put into their models. I don’t think the matter ever was settled, and arguably it has been superseded by behavioral and computational and evolutionary approaches, but Wilson was part of the peak period of applying pure theory to this problem and this might have been the most important theory piece in that whole tradition.
From Wikipedia:
Wilson’s paper “The Theory of the Syndicates,”JSTOR 1909607 which was published in Econometrica in 1968 influenced a whole generation of students from economics, finance, and accounting. The paper poses a fundamental question: Under what conditions does the expected utility representation describe the behavior of a group of individuals who choose lotteries and share risk in a Pareto-optimal way?
Link here, this was a contribution to social choice theory and fed into Oliver Hart’s later work on when shareholder unanimity for a corporation would hold. It also connects to the later Milgrom work, some of it with Wilson, on when people will agree about the value of assets.
Here is Wilson’s book on non-linear pricing: “What do phone rates, frequent flyer programs, and railroad tariffs all have in common? They are all examples of nonlinear pricing. Pricing is nonlinear when it is not strictly proportional to the quantity purchased. The Electric Power Research Institute has commissioned Robert Wilson to review the various facets of nonlinear pricing.” Yes, he is a business school guy. Here is his survey article on electric power pricing, a whole separate direction of his research.
Here is his 1989 law review article about Pennzoil vs. Texaco, with Robert H. Mnookin.
Wilson also did a piece with Gul and Sonnenschein, laying out the different implications of various game-theoretic conjectures for the Coase conjecture, namely the claim that a durable goods monopolist will end up having to sell at competitive prices, due to the patience of consumers and their unwillingness to buy at higher prices.
Wilson was the dissertation advisor of Alvin E. Roth, Nobel Laureate, and here the two interview each other, recommended. Excerpt:
Wilson: As an MBA student in 1960, I wrote a class report on how to bid in an auction that got a failing grade because it was not “managerial.”
And here is an Alvin Roth blog post on the prize and the intellectual lineage.
The bottom line? If you are a theorist, Stockholm is telling you to build up some practical applications — at the very least pull something out of your closet and sell it on eBay! A lot of people thought Roberts and maybe Kreps would be in on this Prize, but they are not. The selections themselves are clearly deserving and have been “in play” for many years in the Nobel discussions. But again, we see the committee drawing clear and distinct lines.
Let’s see what they do next year!
Are central banks manipulating asset prices?
That case still needs to be made, here is Cullen Roche:
1) Are Central Banks “pushing money” on people?
The whole premise of the first paragraph is that Central Banks have implemented QE and forced money onto people which has resulted in a lot of asset chasing.¹ I’ve never understood this mentality to be honest. When the Fed engages in QE they expand their balance sheet and buy a bond from the private sector. In a low inflation environment bonds become increasingly similar to cash so these sellers of bonds are selling one cash-like instrument for another. As a result, the private sector ends up holding more low interest bearing cash-like instruments and the Fed holds higher interest bearing cash-like instruments. So the whole basis of this theory is that if someone who was already holding a risk averse asset then sells that risk averse asset for something very similar then they will suddenly become less risk averse and run out and drive up stocks? That doesn’t even make sense. If I have a moderate risk tolerance and hold a portfolio of 50% bonds and 50% stocks and I want to sell my bonds because I read a scary article about how bonds are super risky because interest rates are going to rise (more on this later) then I will swap out some part of my 50% bonds for cash or something else that’s relatively low risk (to maintain my moderate risk profile). I don’t swap out my whole bond position for a stock position or a role of the dice at the roulette wheel.
Anyhow, the evidence doesn’t even mesh with this. Global Central Banks have been implementing QE for 10 years now. The average annual return of the Vanguard Total World Index is 8.9% per year over that period. That is 0.02% higher than the average 35 year return. So, if investors are acting crazy today then they’ve been crazy for 35 years. Which might be true. It’s probably true. I actually think investors are usually kind of crazy. But they’re not any crazier today than they were 35 years ago.
Sensible throughout.
The Nanny Tax and the Miracle of Government Loaves
Before it descends into utter madness, Leslie Forde’s Slate article on Nanny pay opens with a good story:
“I’m sorry … but I can’t,” she told me over the phone. My heart sank. I was confident she’d take the job. Quickly, I went into negotiation mode, “But wait, can we talk about the pay? Do you need more to … ” She said no before I could finish. “I just can’t take a job (that pays) over the table. It’ll mess up my housing. I won’t be able to stay in my apartment. I’m sorry. I’ve already taken another job.” I ended the call. …my entire career was at risk because I couldn’t find a nanny—at least, one willing to be paid legally.
It’s estimated that less than 10 percent of 2 million domestic workers and the families who employ them pay employment taxes.
From that opening I was expecting the author to explain that nannies aren’t willing to work on the books because at the bottom of the income scale income is taxed twice–first by Federal and State direct taxes and second indirectly because higher income causes workers to lose benefits. As a result of this double taxation, in some states it’s possible for poor workers to face effective marginal tax rates above 100 percent. If you had to pay to work, would you work?
High marginal taxes rates on the poor are a problem. We ought to be able to agree on that, even if we disagree on proposals to address the problem such as a universal basic income or a negative income tax. But in Forde’s magical world, up is down and down is up and the problem is that taxes on the poor are too low. But not to worry because this presents a hidden opportunity!
There is, however, a hidden opportunity to provide help to our caregivers and the families who employ them. Right now, these under-the-table arrangements are creating a “tax gap”—billions of dollars in additional funding that would be available to support caregivers, if the majority of families and their caregivers paid into the system.
Did you get that? If nannies were taxed the government would have more money to provide nannies with benefits. Wait, it gets worse. According to Forde, we can make both families and nannies better off by giving them back the money the government takes and still have money left over!
The estimated “gap” from the lost tax revenue is a combination of the federal and state employment taxes typically paid by employees (Social Security, Medicare, and income taxes) and employers (in addition to Social Security and Medicare, they must pay federal and state unemployment taxes.) Imagine if just a portion of this revenue were used to reimburse families for more of their child care expenses and to provide caregivers access to better benefits than they get currently with their under-the-table jobs. (italics added, AT)
Indeed, wouldn’t it be nice to live in a world of pure imagination? One without tradeoffs. Where we could rely on the miracle of government loaves to solve all problems?
How tight is monetary policy now?, and some remarks on ngdp and market monetarism
I say “not that tight,” while leaving room open for the possibility that it should be looser.
What metrics might we look at? Federal funds futures no longer expect imminent further rate hikes from the Fed. Expected rates of price inflation have been very close to two percent. No matter what you think about the structural component of labor supply, cyclical unemployment has recovered a great deal over the last few years. And that is through the period of “taper talk” of almost two years ago. Consumer spending is doing OK, not spectacular but not cut off at the knees. And while in very recent times price expectations are headed downwards away from two percent, this seems to stem from negative real shocks, to which the Fed has responded passively (perhaps unwisely). That’s different than the Fed tightening. There was a quarter point rate hike from December, which is a small tightening for sure, but I don’t see much more than that.
So in sum, those data do not suggest severe monetary tightness, though again I am open to the argument that monetary policy should be looser.
By the way, I agree with Scott Sumner that we should not equate low interest rates with loose money. Tight and loose money are multi-dimensional, cluster concepts, especially post-2008, and require reference to a variety of variables. And if you are wondering, from this list of Lars Christensen monetary policy indicators I accept only #2, at least in a 2016 global setting where other real economies are volatile.
Given that I don’t see monetary policy as so tight right now, I suggested that if we have a recession it was likely to be a risk premium recession. The big uptick in gold prices is consistent with this view, though hardly proof of it.
So what is the context here? I am worried that if the United States has a recession this year (still unlikely, in my view, but maybe 20%?), that recession will be blamed on “tight money.”
To get more specific yet, I am very much a fan of the ngdp rule approach to monetary policy, but I am uncomfortable with one strand in market monetarist thought. I worry when low ngdp growth is blamed for low growth rates of real gdp.
Ngdp is an accounting summation, so I still want to know the real cause of the slower growth in real gdp. Let’s unpack at the most basic level whether the active cause was Fed tightening on the nominal side, or instead a negative real shock, followed perhaps by excess Fed passivity. That is one reason why I think of it as information-destroying to cite ngdp as a cause of developments in rgdp.
More fundamentally, if a central bank is doing anything close to price inflation targeting, mentioning low ngdp and low real gdp growth rates is simply citing the same fact twice, or almost so, rather than explaining one variable with the other. Angus once called the ngdp invocation a tautology; I’m not sure that is the right terminology, but still I wish to look for independent, non-ngdp measures of monetary policy when deciding how to allocate the blame for a recession, to real or nominal factors.
For further context, I was disquieted by some recent Lars Christensen posts on monetary policy and the American economy. I read him as “revving up” to blame a possible recession on tight U.S. monetary policy. I don’t think he provides much evidence that money is tight enough to cause a recession, other than citing the deterioration of some real variables.
I would encourage market monetarists to define — now — how tight or loose monetary policy really is. Then stick with that assessment, based on whatever variables you consulted.
A year from now, I won’t count it if you say a) “well, ngdp growth is down, money was tight, therefore real gdp growth rates fell. Tight money must have been the problem because low rates of ngdp growth are tight money.”
I would count it if you say something like b): “the dollar shock [or some other factor] was worse than the Fed had thought. That started to push us into recession. The Fed should have loosened, but they didn’t, and so the slide into recession continued, when the Fed could have moderated it somewhat by pursuing an ngdp target.” (By the way, read Gavyn Davies on the strong dollar issue. Alternatively, here is a Marcus Nunes take which I think is citing ngdp in exactly the way I am worried about.)
I also would count it if you said “I see the Fed tightening a lot right now, a recession is likely coming,” although I might dispute your evidence for that tightening.
Here is a recent Scott Sumner post, mostly about me. It’s basically taking the other side of what I have been arguing, and I would suggest simply disaggregating the ngdp terminology into a more causal language of nominal and real shocks. Surely there are other independent, ex ante signs for judging the tightness of monetary policy, rather than waiting for ngdp figures to come in, which again is citing a transform of the real gdp growth rate as a way of explaining real gdp.
I find these issues come up many, many times in market monetarist writings. I think they have basically the right policy prescription, and could provide the world with billions or maybe even trillions of dollars of value, if only policymakers would listen. But I also think they are foisting a language of causality on the business cycle problem which the rest of economic discourse does not easily absorb, and which smushes together real and nominal shocks into a lower-information accounting variable, namely ngdp, and then elevating that variable into a not entirely deserved causal role. We ought to talk in terms of ex ante, independent measures of monetary policy looseness, not ex post measures which closely resemble indirect transforms of real gdp itself.
That, in a nutshell is why, although I usually agree with the market monetarists on policy, and their desire to lower the status of “hard money” doctrine within liberalism, and while I have long applauded and supported their efforts, I don’t call myself a market monetarist per se.
Addendum: Nick Rowe comments. And Marcus Nunes comments.
What is the anti-austerity recommendation for Brazil?
At 70% of GDP, public debt is worryingly large for a middle-income country and rising fast. Because of high interest rates, the cost of servicing it is a crushing 7% of GDP. The Central Bank cannot easily use monetary policy to fight inflation, currently 10.5%, as higher rates risk destabilising the public finances even more by adding to the interest bill. Brazil therefore has little choice but to raise taxes and cut spending.
Too often, at the popular level, there is a confusion between “austerity is bad” and “the consequences of running out of money are bad.”
Sophisticated analysts of fiscal policy do not make this mistake.
By the way, here is a long study of how Brazilian fiscal policy has been excessively pro-cyclical (pdf).
And how is Brazilian output doing you may wonder?:
By the end of 2016 Brazil’s economy may be 8% smaller than it was in the first quarter of 2014, when it last saw growth; GDP per person could be down by a fifth since its peak in 2010, which is not as bad as the situation in Greece, but not far off. Two ratings agencies have demoted Brazilian debt to junk status. Joaquim Levy, who was appointed as finance minister last January with a mandate to cut the deficit, quit in December. Any country where it is hard to tell the difference between the inflation rate—which has edged into double digits—and the president’s approval rating—currently 12%, having dipped into single figures—has serious problems.
Don’t forget this:
Since the constitution’s enactment, federal outlays have nearly doubled to 18% of GDP; total public spending is over 40%. Some 90% of the federal budget is ring-fenced either by the constitution or by legislation. Constitutionally protected pensions alone now swallow 11.6% of GDP, a higher proportion than in Japan, whose citizens are a great deal older. By 2014 the government was running a primary deficit (ie, before interest payments) of 32.5 billion reais ($13.9 billion) (see chart).
Brazilian commodity prices have fallen 41% since their 2011 peak, so I say Ed Prescott has earned his Nobel Prize right there.
The first underlying article/op-Ed also is from The Economist. Without intending any slight to their other recent issues, the January 2-8 issue is one of their best in a long time. I am very pleased to have bought it in advance at the airport rather than waiting to get to my copy back at home.