Archive for August 2018


What does it mean to ask “Is money too loose?”

Is money too loose?  That might seem like a simple question, calling for a yes or no answer.  But it isn’t, because people wrongly think of monetary policy is a series of gestures, not a regime.

Our current regime has multiple goals, including an average inflation rate of 2%, and cyclical stability.  Often the two goals do not conflict, as in 2009.  But sometimes they do, like right now.

For example, monetary policy in Japan became more expansionary under Prime Minister Abe, producing slightly higher inflation and substantially higher NGDP growth.  I’ve argued that it’s still too contractionary because Japan remains well below its 2% inflation target.  Others say the labor market is now very strong (which is true) and that no further monetary stimulus is needed.  That’s also true, if you are focusing on the “stabilization” part of monetary policy.  But I believe Japan would still benefit from raising trend inflation high enough to escape the zero rate bound.

Recent Fed policy has given the US economy exactly the same sort of sugar rush as the Japanese felt after 2013.  Both NGDP growth and inflation are accelerating modestly.  From a “stabilization” perspective, policy may be too expansionary.  On the other hand, core PCE inflation is right at 2%, after a long period of underperformance.  From this perspective, policy is finally getting right on track.

Here’s another way of thinking about the dilemma.  The Fed’s dual mandate calls for above 2% inflation when unemployment is high, and below 2% inflation when unemployment is low.  The average rate should be 2%.  Unemployment is currently low, and hence the Fed should shoot for below 2% inflation.  But the Fed ran a tight monetary policy during the Great Recession and slow recovery, so if they run below 2% inflation right now they may lose credibility.  If you run below 2% inflation during both recessions and booms, then the average rate will obviously fall below 2%.

Right now, the Fed can either try to make its 2% long run inflation target credible at the expense of cyclical instability, or it can try to smooth out the business cycle at the expense of its long run 2% inflation target.  It cannot do both.

Or the Fed can adopt NGDPLT and do its best to run a countercyclical inflation rate.  Under NGDPLT, there are no “dilemmas”, just a clear target to shoot for, each and every day.

PS.  Demand-side fiscal policy is quite expansionary, but that doesn’t change anything I said here.  RGDP growth has been raised by supply-side reforms like the corporate tax cut, and that does interact with monetary policy by boosting NGDP growth (assuming the Fed targets inflation at 2%.)  In retrospect, Obama’s biggest policy mistake was not cutting the corporate income tax sharply in early 2009, instead of enacting the actual stimulus bill.  Of course if he’d had that ideology then he never would have gotten the Democratic Party nomination.

Japan: Is life getting better?

I’m choosing Japan for this post, but it could refer to almost any developed country.

I would argue that the answer to the question in the title depends on how you define “life”:

Definition A:  The total utility of the typical life.

Definition B:  The average flow of human utility in a typical year.

Economists usually think in terms of definition A, even though one could argue that strict application of our widely used utilitarian framework implies definition B is more appropriate.  (Or even another definition, total flow of utility.)

Below is a typical picture of Japanese Screen Shot 2018-08-28 at 1.15.54 PMlife in the 1950s, along with a more recent picture, which shows what a typical day in Japan might look like during the 2050s.  In which of these two pictures are “living standards” higher?

Now you may complain that I’m comparing apples and oranges, that of course life is more fun when you are young than when you are elderly.  And that’s true, but I’d also argue that these two pictures fit my definition B of “life”.  In each case, I’m showing the typical experience of Japanese life during a given day, or even a given year.

Consider the population distributions, by age for Japan in 1960, 2020 and 2050:

Screen Shot 2018-08-28 at 1.30.47 PMYou can see that during the 1950s, life in Japan was mostly young life.  During the 2050s, life in Japan will be mostly old life.  In my previous post I argued that I’d gladly accept a much lower income to have the health and energy I had at age 31, rather than my current 62.

Just to be clear, I’m not a nihilist arguing that Japan’s amazing economic progress since the 1950s has been of no value.  Living standards in material terms really are vastly higher.  Not only are the Japanese much richer, they also live much longer.  Nor am I arguing for a natalist policy to boost birthrates—I see no obvious market failure that calls for government interference.  On the other hand, I’m not denying that a natalist policy might be beneficial, just that I haven’t yet seen any convincing arguments for interfering with people’s personal decisions on having children.  So I don’t have any sort of agenda here, other than to make people think about what it means for life to be “better” than in the past.

Of course all this hinges on my preference for definition B of “life”.  Most people probably think in terms of definition A, and hence would not be at all bothered by these trends, as long as the average complete life is better than before.  My “flow approach” partly fits in with my denial of personal identity.  I think of life as a series of experiences, and I think of “me” as being a completely different person from the “me” at age 8.  Japan in the 1950s had a big flow of “young life”.

I’m so agnostic about all of this that I’m not even sure younger people really are happier. Happiness research doesn’t necessarily support this claim, even though we almost all instinctively feel that we’d like to be younger.  Think about the vast industry for beauty products to make people look younger.  Or “health clubs”.  But maybe our worship of youth is all just looking through rose-tinted glasses.

BTW, the Japanese population pyramid from 1960 is roughly how things looked throughout most of human history, almost everywhere in the world.  It’s the new distribution that is uncharted territory.  If youth really does equate with happiness, how do we compare life in Mali and Niger, with life in Japan?  Also, because poor countries typically have higher birth rates, and because birth rates fall as countries get richer, Japan’s birthrate cannot be increased by economic growth, no matter how many stories you read about modern East Asian families being unable to “afford” more than one child.  Singapore is twice as rich as Japan, and has an even lower birth rate.  Crazy rich Asians!

PS.  The little girl on the left didn’t have an iPhone.  I’m old enough to remember just how sad life was back then.  Young people today can’t even imagine.

GOP banking policy bleg

For millennials, the 2008 financial crisis was the defining economic shock of their lifetime.  I believe I know how the Democrats think about his issue.  But what about the GOP?  For some bizarre reason, I have no idea what policy stance the GOP favors as a way of avoiding a repeat of 2008.  If a student asked me to describe the GOP position, I’d wouldn’t know what to say.  That’s not true of any other major public policy issue.  I may not always agree, but at least I know where the GOP stands on abortion, tax cuts, coal burning, etc.  I know they are split on trade.  But I know nothing of their views on banking reform.

The Dems seem to favor something like Dodd-Frank.  I don’t like that approach, as it’s overly complex and avoids most of the key problems (subprime loans, FDIC, the GSEs etc.)  But what about the GOP?  It would be nice if they favored a more sensible approach, which might include higher capital requirements for banks (or convertible debt), abolishing the GSEs, reforming or abolishing FDIC, more expansionary monetary policy during periods such as the Great Recession.  Another option is to adopt the Canadian (big bank) system, which doesn’t have crises every few decades.  But I never see any evidence for GOP support of any of those options.  They favored tighter money during the Great Recession.  (Oddly many Republicans are now calling for easier money, even as inflation is much higher than in 2009.)  I see no evidence that the GOP has any interest in abolishing the GSEs or reforming FDIC.  They seem to favor small banks, which are the biggest flaw in our financial system.  The FT says the GOP is opposed to higher capital requirements, an option that seems greatly preferable to Dodd-Frank.

So what does the GOP actually favor?  The 2008 financial crisis happened during a Republican administration.  What lessons has the GOP learned?

I’m not being sarcastic, I’d actually like to know the GOP position on banking crises.

PS.  The Mexico trade deal is good news, despite being a very slight net negative.  There is a tiny bit more protection for industries, as well as tighter IP rules.  I see those as small negatives.  There will be freer trade in digital goods. The stock market hates protectionism and is rallying on the (good) news that Trump only cares about symbolic “wins”, not content (something I’ve been arguing for quite some time.)  Let’s hope there is a similar agreement with Canada and China.

As far as the “downtrodden workers” in the Rust Belt—this agreement says the administration doesn’t care about you.  The steel and aluminum tariffs will hurt manufacturing by more than the rules of origin changes will help.

PPS.  Hopefully the Dems will take the House and refuse to ratify the agreement.  But I suspect they’ll cave.

What do we mean by meaning?

A commenter named Ted asked me some interesting questions:

Topics/prompts that I’d be interesting in reading your thoughts on:

-What determines the risk-free rate?
-Where have you found meaning in life?
-How do you think historians will look back on this period?
-What will money look like in 100 years? In 1,000 years? In 10,000 years?
-What’s a book or TV show or movie or podcast you liked? Why?
-How do you fight against selection bias as you consume information about the world?
-What are topics we should be talking about more?
-Maybe a high-level tour through periods in history that illustrate something about monetary policy (aimed at people like me who are too lazy to read books where this already written down)
-What are topics you wish you knew more about?
-What are questions that are both important and difficult to answer?
-What constitutes your information diet? What sources of information do you strongly recommend?
-More posts on how public opinion isn’t real (for me, this was a big takeaway from your writing)
-Thoughts on macro hedge funds
-How you have thought about death and how you wish you thought about death
-Questions that you have for your readers

That gives me ammunition for a number of “Ted talks”.  I’ll start with meaning, as I’ve recently been reading a book on psychedelics that touches on that subject.

Let me begin by noting that I often have a sort of “inside view” and an “outside view”.  Thus my inside view is, “of course I have free will” and my outside view is, “of course free will doesn’t exist.”  Similarly, my inside view of meaning is probably not too dissimilar from the views of others, while my outside view is that meaning doesn’t exit.  Life is just one damn mental state after another.

With free will, my outside view is not just that free will doesn’t happen to exist, but that something like that can’t possibly exist.  Similarly, my outside view is that meaning can’t possibly exist.  Since my outside view is uninteresting, and a bit depressing, I’ll focus the rest of my post on my inside view.

Because of my outside view, I prefer not to talk about “finding meaning”, as if there is something out there to me found. Rather I’d prefer to say “seeing meaning”, which implies meaning occurs in our minds.  I’ve long believed that the very young see more meaning in life than older people, and that meaning gradually drains away as you age.  Meaning is also more likely to be visible in dreams, and (I’m told) in psychedelic trips on LSD or mushrooms.

This quote from a book by Karl Knausgaard nicely captures the way meaning drains away from life as one ages:

You could still buy Slazenger tennis rackets, Tretorn balls, and Rossignol skis, Tyrolia bindings and Koflach boots. The houses where we lived were still standing, all of them. The sole difference, which is the difference between a child’s reality and an adult’s, was that they were no longer laden with meaning. A pair of Le Coq soccer boots was just a pair of soccer boots. If I felt anything when I held a pair in my hands now it was only a hangover from my childhood, nothing else, nothing in itself. The same with the sea, the same with the rocks, the same with the taste of salt that could fill your summer days to saturation, now it was just salt, end of story. The world was the same, yet it wasn’t, for its meaning had been displaced, and was still being displaced, approaching closer and closer to meaninglessness.

Of course there are also some consolations that come with age.

Compared to most people, I probably find less meaning in success and fame, and more in art.  At least that’s how it seems to me.  I’m probably about average for seeing meaning in friends and family (although given my Northern European cultural heritage, perhaps a bit less than average for family.)

During my career, I noticed that some colleagues cared a lot about things like promotions, whereas I didn’t care at all.  I did get some satisfaction from the positive press I got in September 2012, but probably less than most people would.  I’m not ambitious in a career sense.  If given the opportunity to be Fed chair, or a senator from California, or CEO of Goldman Sachs, I’d immediately turn down the opportunity.  If not for this Mercatus position, I’d already be retired—at age 62.  I’d rather make $20,000/year and have the health I had at age 31, than $200,000/year and have the health I have today—and I don’t even have any serious health problems, just chronic annoyances. That’s why the income inequality debate doesn’t really resonate with me; it just doesn’t seem that important.  (That’s my impression; I’m not trying to defend it.) On the other hand, extreme poverty in developing nations such as North Korea seems like by far the most important problem in the world.

I also find much less meaning that usual in ceremonies such as funerals, weddings, graduations and other such events. I’m not a social person.

When I was a young academic, my research was meaningful to me.  As I got older, I realized that people simply didn’t care and it lost meaning.  What made my depression book so hard to write is that I did it after I’d become disenchanted, after I realized the book would be ignored.  Fortunately, the hardest part (all the research) was done by the time I reached that view, but it was still an agonizing process to write the book.

Conversely, I got a lot of meaning out of a brief summer course I taught at Cato this summer.  I was great seeing younger students from really good schools that were interested in market monetarist ideas.  My blog also gave me meaning, especially during the early years when I still had new things to say and the readership was larger and more engaged.  I still have modest hopes for my blog book, but I don’t think book length projects are my forte.  If I were actually able to influence Fed policy, that would seem meaningful to me.

For me, the greatest meaning in life comes from art, broadly defined to include aesthetically beautiful experiences with nature, old cities, and scientific fields like astronomy and physics.  The most meaningful experience in my life might have been seeing the film 2001 at age 13.  I’ve never tried LSD, but after reading about the experience it reminds me of this film, and indeed the director was someone who experimented with acid.  (It might also be the only “psychedelic” work of visual art that’s actually any good.  Whereas pop music from the 60s is full of good examples.)

To me, art is “real life” and things such as careers are simply ways of making money in order to have the ability to experience that real life.  After art, I’d put great conversation second on the list.  And the part of economics that most interests me is the ability to converse with like-minded people (such as at the Cato summer course.)

I’m sort of like a satellite dish, receptive to ideas and sounds and images.  My ideal is Borges, who regarded himself more as a great reader than a great writer (of course he was both, and a great conversationalist.)  I’d rather be a great reader than a great writer.  I’d rather be able to appreciate great music than be able to produce it.

I’m not at all like Trump.

PS.  I’ll answer some other Ted questions in later posts, here and at Econlog.

Monetary policy is boring. That’s good.

You’ve probably noticed that I no longer do as many posts on monetary policy.  That’s partly because I put my better posts over at Econlog and partly because there’s currently not much to talk about.  NGDP growth has been in the 3% to 5% range for 9 years, and I see no sign of anything changing in the near future (except perhaps a bit slower NGDP growth after this year, which is currently featuring above 4% growth.)  While boring is bad for me, it’s good for the economy.

Today, interest has turned to the question of when the next recession will occur.  The short answer is the same as always—no one can predict recessions.  But I’d like to talk about the issue anyway, since everyone seems interested in the question.

I’ve recently been catching up on David Beckworth’s podcasts, and listened to a very interesting discussion he had with Michael Darda.  Michael is a market monetarist who works in the investment area, and is known for having an excellent grasp of macroeconomics.  He knows the data quite well and he has a rare ability to interpret macro data correctly.  Lots of people are good at one, but he’s extremely good at both—no doubt partly due to his upbringing in Madison, Wisconsin.
Screen Shot 2018-08-25 at 3.48.02 PMAt one point they began discussing the yield spread, which has been one of the better recession forecasting tools.  I’d like to put in my two cents worth.

As you can see from the following graph, the yield curve often inverts before a recession.  Here it’s important not to over interpret the correlation, as US expansions never last more than 10 years, and yield curves typically don’t invert until well into an expansion, and the lag between inversion and recession varies somewhat over time.  Furthermore, yield curves did not invert before recessions in the 1933-58 period.  Still it’s one of our most reliable forecasting tools.

Screen Shot 2018-08-25 at 2.34.50 PMHere are a few observations:

1.  Over at Econlog, I argued that while the yield spread is pretty good at predicting recessions, it’s much less good at indicating when money is too tight.

2.  It’s possible that the yield spread is reacting to changes in the unemployment rate.  Consider the following hypothesis.  The yield spread gets relatively flat whenever the unemployment rate falls to a level close to the natural rate of unemployment.  Let’s also assume that the unemployment rate falling close to the natural rate is a good predictor of recessions:

Screen Shot 2018-08-25 at 2.32.30 PMIn that case we should be worried, as the unemployment rate has recently fallen to a level that is probably close to the natural rate.

Interestingly, there is one notable case when unemployment falling close to the natural rate did not lead to a recession.  In 1966, unemployment fell to 3.8% and there was no recession until 1970.  But that false signal is equally true of the yield spread, which also inverted in 1966.  Coincidence?

[On the other hand, the natural rate of unemployment is time varying (higher during 1975-95) and hard to measure, which makes the yield spread a better forecasting tool.]

When the unemployment rate is trending lower, it’s rational to expect the expansion to continue.  It may not always continue (consider 1981) but it’s a rational forecast.  And when unemployment is trending lower, the yield spread tends to be positive.  That’s because investors expect the future economy to be stronger than the current economy, and interest rates are highly correlated with the strength of the economy.

Conversely, when unemployment has fallen close to the natural rate, it’s no longer rational to expect lower unemployment in the future.  Indeed it’s quite likely that we’ll soon enter a recession.  That’s why the yield curve gets flat, and sometimes inverts.  In plain English, we never seem to achieve soft landings.  But Australia frequently does, and thus it’s not impossible.  The UK achieved a soft landing in 2001, and hence their 1990s expansion lasted until 2008.  If they can do it, so can we.

Memo to Jerome Powell:  Your mission, should you decide to accept it, is to avoid the hard landings that so often occur, but also avoid the 1966 scenario, where the Fed pulled up too soon, never landed at all, and instead soared off into the Great Inflation.  To do this, you need to avoid an excessively expansionary policy, which sometime triggers the inflation that later causes overly tight policy, and also avoid overly tight policy, which can directly cause a recession.  Let’s see . . . how about 4% expected NGDP growth?

Given that we’ve never had an expansion last for more that 10 years, you might wonder why I expect this one to go beyond a decade.  Well, until 2006-12 we’d never had a housing crash.  Until 2016, we’d never elected a lunatic as President.  Until 2018, we’d never adopted a wildly expansionary fiscal policy during a period of peace and prosperity.  None of those examples have any bearing on how long this expansion will last, rather they show that it’s really common for things to happen that have never happened before in the US.  And notice that other countries have had housing crashes before 2006, and lunatic presidents, and reckless fiscal policies during peace and prosperity.  That’s why I mentioned Australia and the UK (and there are many other such examples.) They provide an important clue that there is no inherent age limit on expansions.

Inductive reasoning can be useful, but must be handled with care.

PS.  The Hypermind NGDP prediction market is currently forecasting 4.8% NGDP growth from 2018:Q1 to 2019:Q1.  However, since the 2nd quarter is already in and growth was quite strong, this implies (annualized) 3.9% NGDP growth from 2018:Q2 to 2019:Q1.  Monetary policy is right on course.

PPS.  Because money is now boring, and my Trump posts are always stupid, please feel free to recommend other topics.  On the other hand, money is the only topic on which I have anything interesting to say.