Will it matter when the Fed has “traction?”

People have made all sorts of arguments against “monetary offset,” but there’s only one that actually makes much sense.  The argument is that the Fed does not like doing “unconventional policies” like QE, because they feel “uncomfortable” with a large balance sheet.  (Put aside the fact that QE is perfectly conventional monetary policy–open market operations—and that there is no reason at all to feel uncomfortable with a large balance sheet.  The Fed is effectively part of the Federal government.)

Nonetheless, there is a sort of plausibility to the theory; Fed officials will occasionally say they would cut interest rates further if they could.  But what is the implication of this theory?  It seems to me that this theory implies that Fed policy should become much more aggressive when the Fed is no longer hamstrung by the zero bound.  When they can stimulate without adding to the balance sheet.  But this raises an interesting paradox—the Fed is conventionally viewed as being “stimulative” when they cut rates.  Thus the Fed should want to cut rates as soon as they can do so, which means right after they raise them!

Of course I’m half-kidding.  More realistically the implication is that once the Fed stops doing the “uncomfortable” QE, there will be a long period of zero rates before they raise them.  And perhaps there will be, but right now the Fed suggests it will be raising interest rates in less than a year.

Here’s a graph from a Marcus Nunes post:

Screen Shot 2014-10-30 at 6.15.21 PMNGDP had been rising at about 5% per year in the 17 years before the recession, and it’s been rising about 4% per year in the “recovery.”  Because wages and prices are flexible in the long run, the real economy has been recovering despite the lack of any demand stimulus.  We have fallen from 10% to 5.9% unemployment.  But most people think the economy is still in the doldrums, and needs more stimulus.  President Obama just instructed the Department of Labor to increase unemployment compensation benefits (without any authorization from Congress of course–why do you think would Congress be involved in spending decisions?) This was done because unemployment is at emergency levels, requiring extra-legal remedies.

Fortunately the Fed is no longer doing the “uncomfortable” QE policy, which adds to the balance sheet.  So if you believe the fiscal policy advocates, the Fed should be raring to go with stimulus. How do they do that?  By promising to hold rates near zero for a really long time, or until the labor market is really strong.  But instead, they are suggesting that they will probably raise interest rates soon.  There will be no attempt to get back to the old trend line; the new one seems just fine.

Let’s consider an analogy.  A bicycle rider has a “policy” of maintaining a steady speed of 15 miles per hour.  Then he hits a long patch of ice, and slows to 10 miles per hour, perhaps due to a lack of traction, perhaps because he decided to go slower.  How can we tell the reason?  How about this, let’s put a strong headwind in his face, and see if the speed slows even more.  But now he petals harder and keeps maintaining the 10 miles per hour speed.  That suggests it’s not a lack of traction. But the pessimists insist it must be a lack of traction, why else would he have slowed right when he hit the ice?  Then the bicycle final comes to the end of the ice.  The lack of traction proponents expect him to suddenly speed up, exhilarated by the sudden traction of rubber on asphalt.  Oddly, however, the bike keeps plodding along at 10 miles an hour.  Nothing seems to have changed even though the ice patch is long past.

[In case it's not clear, the headwinds were the 2013 austerity, and the end of the asphalt was the end of the liquidity trap.]

Here’s my claim.  The Fed promise to raise rates soon is not the sort of statement you’d expect from a central bank that for the past 5 years had been frustrated by an inability to cut rates.  (Nor is their other behavior consistent—such as the on and off QE.)  Rather it’s the behavior of a central bank that has resigned itself to pedaling along at a slower speed.  Ten miles per hour is the new normal.

I don’t want to sound dogmatic here.  Obviously monetary offset is not “true” in the sense that Newton’s laws of mechanics are true; the concept only applies in certain times and places.  Oh wait, that’s true of Newton’s laws too .  .  .

Opponents of monetary offset face two big problems.  In theory, the central bank should target some sort of nominal aggregate, and offset changes in demand shocks caused by fiscal stimulus. And in practice it seems like they do, as we saw in 2013, even at the zero bound.  So if monetary offset is not precisely true, surely it should be the default baseline assumption.  Instead, as far as I can tell 90% of economists have never even considered the idea.

PS. Totally off topic, I love this sentence from an article on why a million dollars no longer makes you rich:

Although it sounds like a lot of cash, $1 million of today’s money is only worth $42,011.33 of 1914 dollars, which is less than today’s median household income.

Someone should collect all these amusing claims in the media.  They could have added that today’s median income of $42,011 is only equal to $1764 in 1914 dollars, roughly equal to the per capita GDP (PPP) of Haiti.  I guess I was wrong, the American middle class really is struggling.

Svensson, vindicated.

I once read a book where Richard Rorty debated another philosopher on the nature of “truth.” Rorty claimed something to the effect that; “Truth was what your colleagues let you get way with.”

The other philosopher countered with a hypothetical.  Suppose someone says: “Most people believe X is true, but I believe that Y is actually true.”  Clearly they’d have in mind a different conception of truth.  Rorty countered that claiming something not widely believed is “actually true” is implicitly a prediction that it will be accepted as the truth at some point in the future.  That doesn’t always work, but it’s an interesting way of thinking about truth.

In any case, it can now be said that Lars Svensson’s critique of Riksbank policy has been proven “true” in the sense that his opponents have now recognized it as true (the following is from the excellent Ambrose Evans-Pritchard):

Sweden’s Riksbank has torn up the rulebook of global central banking, cutting interest rates to zero even though the economy is in the grip of a credit boom.

The extraordinary step is intended to stave off deflation but it comes at a time when the Swedish economy is growing at almost 2pc and property prices are rising briskly. The bank has abandoned earlier efforts to curb asset bubbles by “leaning against the wind”.

The Riksbank cut the deposit rate to -0.75pc in what looks like a preparatory move to drive down the krona. Governor Stefan Ingves said the bank has a toolkit of extreme measures in reserve, including use of the exchange rate.

If the Riksbank was caught off guard, it’s because they weren’t paying attention to the only world class monetary expert on their committee.

The Riksbank has in effect washed its hands of the credit boom, leaving it to government regulators to control household debt with mortgage curbs, liquidity limits for banks and other “macro-prudential” tools as best they can.

You mean regulators should deal with specific problems in a specific sector of the economy with a scalpel?  I thought the central bank needed to deal with the housing market with a sledgehammer, smashing the entire economy.

“What the Riksbank is doing is something that a lot of central banks around the world are going to have to do: once interest rates approach zero, they are forced to think about far more radical instruments,” said Lars Christensen, from Danske Bank.

The Riksbank – arguably the world’s oldest central bank, with a tradition of bold monetary experiments – carried out a dramatic volte-face in July when it slashed rates and gave up trying to restrain asset prices. Governor Ingves was outvoted in what amounted to a policy mutiny.

The shift over recent months is a triumph for Mr Svensson, who resigned last year in a stormy dispute. He said the bank made a mistake by tightening before the economy had fully recovered, and then compounding the error by allowing itself to be distracted by the noise of asset bubbles. “Low inflation has actually increased the households’ real debt burden. Riksbank policy has been counterproductive,” he said.

Svensson, vindicated.

The Riksbank is now fully aligned with the Yellen Fed in Washington, which argues that raising rates to stop asset bubbles merely destroys jobs for little useful purpose. Both are pitted against the Bank for International Settlements. The BIS says radical monetary stimulus may help individual countries but only by displacing the problem onto others, leading to a “Pareto sub-optimal” for the world as a whole. It warns that speculative excess is reaching pre-Lehman levels, and calls on global central banks to take pre-emptive action before the bubbles becomes unmanageable.

What is far from clear is whether the Riksbank can get away with such policies. It may run into harsh criticism from rest of the world if it is seen to engage in “beggar-thy-neighbour” stealth devaluation at a time when the Swedish economy is expected to grow 2.7pc next year, and has a current account surplus above 7pc of GDP.

Does the BIS think the eurozone is a bubble?  How much tighter should ECB policy be?  As an aside, Sweden’s a good example of why people should never, ever reason from a current account surplus.  It tells us nothing interesting about the business cycle.

Sweden was one of the first central banks to adopt price level targeting, in the early 1930s. In an intellectual sense, the ECB is at least 80 years behind Sweden:

The institution enjoys a prestige beyond its size, a legacy of the great Swedish economists of the early 20th century: Knut Wicksell, Gustav Cassel, Bertil Ohlin and Gunnar Myrdal. It is watched closely as a pioneer in central bank theory.

The bank famously began “price targeting” in the early 1930s after breaking free from the Gold Standard. The revolutionary policy was the precursor of today’s inflation targeting. It enabled Sweden to escape deflation early in the Great Depression, suffering far less damage than countries that stuck doggedly to failed orthodoxies.

And speaking of monetary innovators, the intellectual leader of market monetarism was recently interviewed by Erin Ade on Boom/Bust (at about the 3 minute mark.)  He is just as good at explaining ideas verbally as in print. But he looks slightly different from what I expected.

HT:  TravisV, Saturos

What’s the matter with Kansas? (big government)

Kansas elected a governor named Sam Brownback in 2010.  He cut income tax rates, promising faster economic growth.  It didn’t work out, and now he’s in a close race for re-election.  Last summer over at Econlog I focused on the absurd claim that these income tax cuts should be expected to raise revenue.  (Not sure who made them, either actual supply-siders, or liberals like Paul Krugman fantasizing about nutty supply-siders.)  In any case, there is virtually no way a state income tax cut cut could boost state income tax revenue, given how low state MTRs are compared to federal MTRs.  Indeed in my Econlog piece I pointed out that the total top MTR in Kansas rose dramatically under Brownback, due to the Obama tax increases.

But the top rates rose even more in other states, so why didn’t Kansas do a bit less bad?  I’m not certain, but I think people tend to expect too much from slight tinkering with taxes and spending. Supply-siders have no one but themselves to blame when they oversell a policy.  I wouldn’t blame the Kansas voters for dumping their governor.

To get a better perspective on what’s wrong with Kansas, let’s compare it to the other 5 states in the center of the country.  Foreign readers know about Texas, but stacked on top are 5 boring, anonymous, rectangular-shaped states.  These cover the Great Plains, a desolate windswept prairie with cold winters and hot summers.  Nothing like the south of France.  Basically there is no reason that any sane person would want to live in any of those 5 states.

[I can cop a superior attitude because I grew up in more sophisticated Wisconsin.  Which has trees. And lakes.  Even as we midwesterners resent the condescension of the coastal elites, we develop our own pecking orders, our own prejudices.]

Here is data I found for state government spending as a share of gross state product in fiscal 2015, for the Great Plains states (north to south):

North Dakota:  16.6%

South Dakota:  13.9%

Nebraska:  17.7%

Kansas:  18.3%

Oklahoma:  16.9%

Texas:  15.2%

Notice that Kansas is the big spender, even after Brownback.  By comparison, California is 18.1%. (Is this data accurate?)

It’s hard to know which of America’s states is the least well known.  Texas is famous.  Oklahoma was a musical.  Kansas had The Wizard of Oz.  Nebraska has Warren Buffett. And North Dakota is newly famous for “the Bakken.”  The only thing marring South Dakota’s prefect blandness is Mt Rushmore.

I would also say that South Dakota has the least going for it.  Three of those states have oil, and Kansas has some affluent suburbs of Kansas city, without the inner city poverty.  Nebraska has slightly better farmland.  And yet by some miracle, South Dakota is booming.  Here’s The Economist, in an article titled “Quietly Booming:  How a neglected state is succeeding”:

Quiet success might be South Dakota’s motto. It has no oil industry; its neighbour North Dakota, with its shale-oil boom, gets all the notice. It has no large military base. There is not even an influential university. Yet South Dakota’s 3.7% jobless rate is the third-lowest in America. The rate is even lower in Sioux Falls, which has the fourth-fastest-growing economy in the country.

The state economy used to rest on farming, but today hospitals and financial companies are among the chief employers. The change began in 1980 when the state enacted financial reforms, prompting Citibank to move its credit-card business there. So many banks followed that the state now has more bank assets, $2.76 trillion, than any other, including New York.

Manufacturing and biotech are thriving, too. Last year Marmen, a French-Canadian wind-turbine manufacturer, opened its first American plant not far from Sioux Falls. Bel Brands, the American arm of a French dairy company, has also invested in the state. South Dakota sits usefully in a nexus of north-south and east-west interstate highways. There is also a decent labour pool. Many workers are little more than a generation from the farm: absenteeism is low, and the unions insignificant.

Taxes are attractively low. South Dakota has no state income tax, personal-property tax, inventory tax or inheritance tax (which has led to a growing trust industry). The regulatory climate is also benign. Dennis Daugaard, the Republican governor, believes in keeping government out of business’s way. “When it comes to laws,” he says, “more isn’t always better.” Since 2011, when he came to office, he has repealed 3,724 regulations.

While people have been looking at Kansas, South Dakota is the real supply-side miracle.  In my view the key is the lack of a state income tax.  While Brownback did cut the top rate in Kansas, it was merely to 4.8%, only slightly below the 5.3% rate in Massachusetts.  In contrast, the top rate is 0% in South Dakota (and Texas.)  Personally, I wouldn’t move to South Dakota if it was negative 10%.  (I plan to retire in California.)  But the zero rate is probably low enough to draw in a few hardy midwesterners.  But a 4.8% rate?  Sorry Brownback, that’s not going to produce any miracles, not when you are sandwiched between Texas and South Dakota.

PS.  The Economist mentions that the Indian reservations in western South Dakota are very poor, as firms don’t want to invest in a place where they would not be able to have any property rights.  I don’t recall seeing that issue discussed in the blogosphere.

PPS.  Matt Yglesias and Ryan Avent and Paul Krugman are right; the coastal areas need to build much more housing.  People want to live in California despite the horrible state government. That’s why their housing prices are so high.  Instead people are forced into places like the Great Plains. And that’s a crying shame.  (Did I mention that I plan to retire in CA?)

PPPS.  Koch Industries is based in Wichita, Kansas, and uses a Thomas Piketty-like egalitarian management approach:

The system is highly democratic. Koch has an unusually “flat” organisational structure for a company its size. Workers can earn more than their bosses. High-school-educated farm boys from Kansas can rise faster than Ivy League MBAs and end up running multibillion-dollar divisions.

PPPPS.  After doing this post I came across an article in the WSJ on the new rankings by the Tax Foundation:

Fast-growing Wyoming [#1 tax climate] has no corporate or individual income tax, but it can’t rest on its laurels. Wyoming is facing new competition from states seeking to modernize their tax systems to compete for jobs and opportunities. Kansas fell three spots to 22nd despite its income-tax cuts because other states didn’t stand still.

Matt Yglesias’ recent posts

Why do I like Matt Yglesias’s posts?  Consider 5 done in the past few days:

Car dealers are awful. It’s time to kill the dumb laws that keep them in business.

BTW, Has anyone asked Warren Buffett if he plans to advocate ending the horrible laws that protect car dealers from competition?  (Like those car dealers he just bought.)  Or whether he intends to support the dealers so he can accumulate even more billions of dollars by ripping off ordinary Americans?  He seems more honest and idealistic than the average Ukrainian oligarch, but it’d be nice to know for sure.  And don’t even ask about the “free market loving” GOP.

DC’s streetcar isn’t even running and it’s already making buses slower

But streetcars look neat . . . kinda European.

Amazon is doing the world a favor by crushing book publishers

I really, really, really dislike publishers.

Democrats are using Ferguson to drive black turnout. But they’re in charge in Missouri.

Surely the Dems would not incite racial fears for selfish electoral reasons?

Obama’s latest plan to boost the economy? Bring back subprime mortgages

After the 2008 crisis just about everyone on the left blamed it on “deregulation.”  (Wait, if banking was deregulated then why did I have to sign 20 consumer protection forms every time I refinanced in the early 2000s?)  I pointed out that the regulators also missed the crisis, so what makes us think they would do any better the second time around?  My liberal friends replied that we now know the evils flowing from unrestrained lending to people who couldn’t possibly repay their mortgages.  But that seemed like too low a bar to me, closing the barn door after the horse had left.

Sure, now it’s obvious that subprime loans were a disaster.  But if the banks had known that in 2004-06 they obviously wouldn’t have made those bad loans, and they would have also refrained from investing in MBSs MSEs.  Yes, regulators have learned their lesson, but so have banks!  Banks are also tightening up on their standards.  So I ask again, what makes us think regulators could do any better next time? And isn’t it setting an excessively low bar to merely have regulators prevent an exact repeat of what went wrong in the 2006 housing bubble?  Anybody could do that!

Well I should have saved my breath, for as Yglesias points out the bar might have been set way too low, but the regulators still couldn’t clear it.  While banks have tightened their standards, regulators have returned to encouraging subprime mortgages.  And this occurred under a supposedly pre-regulation pro-regulation liberal Democratic president.  If regulation doesn’t work now, how is it supposed to work under the next GOP president?  Maybe Paul Krugman can tell us.

Krugman mocks conservatives who predicted inflation, and still insist the real problem is easy money.  And rightly so.  But I’d say the same about any liberal blogger who still thinks “deregulation” was the cause of the 2006 bubble.  If they haven’t learned by now that our regulators are utterly incompetent, then they never will.  Those progressives should be mocked in exactly the same way Krugman mocks conservatives who still insist the Fed’s “easy money” policy will soon create inflation.

PS.  I like the way Reason.com defined the new policy:  ”Insanity defined.”

PPS.  I wish Kevin Drum the best.  I’ve never met him, but based on his writing he seems like a great guy.

Bayesian updating

Here are some interesting articles that I ran across.  First one from the Economist on the real (actual) minimum wage—zero:

Perhaps not coincidentally, the number of unpaid internships has grown just as hiring has become riskier, pricier and more complex. In recent years anti-discrimination and unfair-dismissal rules have been tightened, and minimum wages raised, in many rich countries. The growing cost of benefits such as pensions, health care and maternity leave makes employees more expensive. Interns have therefore become an appealing alternative.

I’ve recently argued that CEOs should be paid far more than they were paid in the 1960s, because their jobs are much more consequential.  Here’s evidence that they are not overpaid:

So, if the shares rise on an executive’s death, that means he was overpaid; if they fall, he was not. By this measure only 42% of the bosses studied were overpaid; furthermore, those with the most eye-popping rewards were found to be giving the best value for money, as measured by the share-price slump when they passed away.

The study also reckons that of the increase in value that results from a firm hiring an executive, he gets 71% and the shareholders therefore get 29%. In the sense that investors at least get some positive reward from the relationship, executives as a whole are not overpaid.

Followers of Mr Piketty are unlikely to be convinced. They would say that even when bosses add more value than the amount by which their pay exceeds the average, they are still overpaid because the average is itself excessive; and that it is inherently indecent for bosses to get such a big share of the gains from their relationship with their firms.

Yeah, they would say that, wouldn’t they?

Recently I did a long post at Econlog saying education wasn’t very important (at the margin in developed countries) and that spending more money wouldn’t have much impact.  I did point to one strong counterargument, a study showed that having a single good teacher at a young age can substantially impact a person’s life outcome.  I found that result quite surprising, but now it looks false:

Estimates that adjust for changes in students’ prior achievement find evidence of moderate bias in VA scores, in the middle of the range suggested by Rothstein (2009). The association between VA and long-run outcomes is not robust and quite sensitive to controls.

Also check out Bryan Caplan’s excellent post on the dubious merits of compulsory attendance laws.

Update:  Tyler Cowen cites a study that conflicts with my prior belief.  But is it scalable? And does it go beyond improving test scores, to improving life outcomes?

I’ve also argued that most anomaly studies in finance are merely data mining, and hence are essentially worthless.  Look at the last sentence in this abstract:

Hundreds of papers and hundreds of factors attempt to explain the cross-section of expected returns. Given this extensive data mining, it does not make any economic or statistical sense to use the usual significance criteria for a newly discovered factor, e.g., a t-ratio greater than 2.0. However, what hurdle should be used for current research? Our paper introduces a multiple testing framework and provides a time series of historical significance cutoffs from the first empirical tests in 1967 to today. Our new method allows for correlation among the tests as well as missing data. We also project forward 20 years assuming the rate of factor production remains similar to the experience of the last few years. The estimation of our model suggests that a newly discovered factor needs to clear a much higher hurdle, with a t-ratio greater than 3.0. Echoing a recent disturbing conclusion in the medical literature, we argue that most claimed research findings in financial economics are likely false.

I’m skeptical of proposals to “regulate” the financial system.  Here’s one example:

“DON’T bail out the big banks on Wall Street another time,” thundered Richard Durbin, an American senator, “Once in a political lifetime is enough!” His amendment to the Dodd-Frank financial reform of 2010 capped the fees banks can charge merchants to process debit-card transactions, on the grounds that banks were gouging businesses and their customers. But the limits on “interchange fees”, as the financial jargon has it, have not worked out as planned. They have resulted, by one calculation, in the transfer of between $1 billion and $3 billion annually from poor households to big retailers and their shareholders. These were not the beneficiaries Mr Durbin had in mind when the amendment came into effect three years ago this week.  .  .  .

Meanwhile the banks, which are in even worse shape, have tried to make up for the lost revenue with higher charges for other things, including monthly fees for having a debit card, or even a current account. In 2009 banks provided 76% of America’s current accounts free of charge; last year the figure was only 38%. The higher charges in turn, have pushed 1m Americans out of the formal financial system—not the result Mr Durbin was aiming for.

I predicted that Hollande’s socialist policies would fail, and he’d do a U-turn just like Mitterrand:

The new team is engineering a shift in economic policy not unlike that under Mitterrand, who made a sharp U-turn in 1983, also after two years in office. Like Mitterrand, Mr Hollande has so far spent most of his time making matters worse. Having declared during his campaign that the “world of finance” was his enemy, and promised his 75% top tax rate, Mr Hollande increased taxes by €30 billion ($40 billion) in his first year. He reversed some of Mr Sarkozy’s popular work-friendly policies, such as tax-free overtime. He sent out mixed messages to foreign investors and entrepreneurs. He failed to curb public spending. And he brought in new rules that choked growth in sectors such as construction.

On Mr Hollande’s watch, the overall tax take grew from 43.7% of GDP in 2011 to 46% in 2013. Annual income growth in 2012-14 has averaged a mere 0.4%. Unemployment, which Mr Hollande had promised to bring down, edged up to over 10%. Confidence collapsed, investment was put on hold, and many of the rich left for Brussels or London. To take but one example of the damage Mr Hollande has wrought, new rent-control rules designed by Ms Duflot (who refused to serve under Mr Valls because she considered him too right-wing) have battered the construction industry. In the two years to January 2014, new housing starts fell by nearly a quarter.

Now the government has gone into reverse. It has embraced a business-friendly mix of policies in a bid to revive the private sector. This may stop short of what the economy needs to get back on its feet, but it contains a decent dose of common sense. In 2015 a cut in the hefty social charges paid by employers will come into full effect, in an attempt to encourage hiring. Savings of €21 billion will be squeezed out of public spending, including €9.5 billion from the social-security system. Perhaps most symbolic of all, the 75% top tax rate, set up initially as a temporary two-year measure, will be quietly allowed to die.

If the Piketty/Krugman soak the rich policies won’t work under a socialist government in France, when and where will they work?

In other posts, I’ve expressed concern over eco-terrorists (think unibomber) who believe the world is overpopulated. Soon they’ll have a weapon:

Nearly 50 cities, mostly in America and Europe, are now home to groups of biohackers or amateur laboratories where they can meet and experiment. Besides Open Wetlab, these include Biocurious in Sunnyvale, California, Genspace in New York and La Paillasse in Paris. The number of biohackers around the world is anybody’s guess, but the movement’s main online-mailing list boasts nearly 4,000 members and is growing rapidly.

What drives the movement is the belief that “biology is technology” (to quote the title of a book by Rob Carlson, a DIYbio pioneer): that DNA is a form of software that can be manipulated to design biological processes and devices. But some people worry that amateur laboratories could create killer bugs or provide training for bio terrorists. For the moment, at least, such fears seem premature.

For the moment . . .

Someday I’ll change my mind, and stop being so dismissive of new theories that challenge my prior beliefs.  But not today.

HT:  Tyler Cowen