Archive for January 2012


Not from the Onion

Imagine a news story like this:

Prejudiced Researchers find Evidence that Stupid People are Prejudiced

Several researchers who have negative views of social conservatives, have found evidence that stupid people are more likely to be prejudiced.

(Alternate headline:  “Study show smart people are more skilled at hiding their prejudice.”)

Or how about:

Students Who Don’t Drop Out are More Likely to Graduate

“We also know that when students don’t walk away from their education, more of them walk the stage to get their diploma. When students are not allowed to drop out, they do better. So tonight, I am proposing that every state — every state — requires that all students stay in high school until they graduate or turn 18. (Applause.)”

Seems like it’s pretty easy to get Congressmen to applaud.

Gingrich calls for the US to annex  the moon

“Gingrich is so confident in his vision in a lunar base that he said if the colony had 13,000 permanent American residents it should be considered for statehood.

He admits the proposal is ‘the weirdest thing [he’s] ever done,’”

Reality is a harsh mistress.

About the GDP numbers

Our GDP numbers are notoriously unreliable, so keep that in mind as you read the following.  There are two ways of estimating GDP; income and expenditure.  The income numbers are considered more reliable, so naturally the press ignores them and reports the expenditure numbers.  The estimated expenditure growth rate fell from 4.4% in the 3rd quarter to 3.2% in the 4th quarter.  The income numbers aren’t in yet, but from preliminary data it looks like GDP growth increased from 2.6% in the 3rd quarter to about 4% in the 4th quarter.

BTW, you notice I don’t specify “real” or “nominal” GDP.  Obviously when people don’t specify an economic variable, they mean nominal.  If you mean real wages or real interest rates, you say so.  That’s how it should be for GDP.  If it was, perhaps the Great Recession would never have happened.

So the mystery of the slow recovery continues to be no mystery at all.  Tight money hasn’t allowed the sort of robust NGDP growth you’d need for a brisk recovery.  Period.  End of story.

Or at least it should be the end.  In the comment section people complain I’m merely stating a tautology, as a fall in NGDP is a recession.  No it’s not.  Zimbabwe had the fastest NGDP growth in the world a few years back, and was deep in recession.

A more sophisticated argument is that the correlation between NGDP and RGDP doesn’t imply causation, and/or the Fed can’t control NGDP.

There have been a variety of natural experiments throughout US economic history that show how NGDP shocks impact RGDP.  A sudden fall in NGDP that is due to a decline in the monetary base (say 1920-21, or 1929-30) will also tend to reduce RGDP.   When an expansionary shock like dollar devaluation raises NGDP, then RGDP also tends to rise.  That does not mean they are always correlated—as we saw in Zimbabwe, supply shocks can also impact the economy.

As far as the Fed’s ability to control NGDP, I don’t see how that can be seriously questioned.  Economic theory says that permanent increases in the (non-interest-bearing) monetary base are inflationary.  And there is no example in all of world history where a fiat money central bank tried to inflate and failed.

To summarize, the Fed can control NGDP, and a more stable path for NGDP will produce a more stable path for RGDP.  The best post showing that link was produced by Marcus Nunes (graphs 11&12).

Marcus also pointed to a recent NGDP targeting endorsement by John Quiggin.  Naturally I agree with him, but at the risk of seeming picky I’m going to contest one small part of Quiggin’s essay:

Last but not least, a nominal GDP target would create room for fiscal policy as well as monetary policy. What is needed now is the abandonment of counterproductive austerity policies as a response to the slump in Europe and the US. Austerity should be replaced by a combination of short-term fiscal stimulus and long-run measures aimed at a sustainable budget balance. That can only be achieved if central banks co-operate with pro-growth fiscal policy, instead of seeking to counteract it in the name of inflation targets.

He’s right that inflation targeting makes fiscal stimulus ineffective.  But I’m afraid the same applies to NGDP targeting.  The good news (as Nunes pointed out) is that fiscal policy is not needed if central banks target NGDP.

Bill Woolsey sent me a very nice NGDP endorsement from Sven Wilson at the website

Eugene White on banking: regulation or incentives?

At a recent economics conference I came across a fascinating paper by Eugene White, which discussed how incentives built into banking during the National Banking Era helped reduce risk taking.  The paper changed my views more than anything else I’ve read in recent years.  Here’s a few excerpts:

The Dodd-Frank Act of 2010 exemplifies this confusion. Few observers believe that the bill will provide a lasting reform of the American financial system, and many suspect that it will sow the seeds of the next financial crisis. By focusing on the regulation of choices made by borrowers, depositors, shareholders, and bankers, the Act repeats the mistakes made by previous reform legislation. Instead, reform should focus on changing the incentives that parties face to insure that they are correctly aligned to induce the development of less fragile institutions.

.   .   .

Perhaps, the most important but least heralded change in the ten years prior to the 2008 crisis was the shift by most major investment banks from partnerships to limited liability corporations.

What is notable about contemporary reform is that there is little effort to change the incentives that caused bank executives to take the big risks and a huge emphasis on regulating their choices. The implicit assumption seems to be that incentives and the assignment of liability plays only a small role so that choices must be regulated—that is, the market cannot be made to adequately discipline banks. Could such a market-based system be devised? In this paper, I offer evidence from the American National Banking Era (1864-1913) for the ability of incentives to successfully limit losses from bank failures.

.  .  .

An essential feature of the National Banking System was double liability for national banks, chartered by the federal government. Concerned that shareholders would not devote the time and resources to adequately monitor banks’ officers, the National Banking Act of 1864 imposed double liability on shareholders. Under this rule, if a bank failed, the receiver could order shareholders to pay an assessment up to the par value of the stock to compensate depositors. This regulation provided a key incentive to shareholders to control the risk-taking activities of bank management. The results of double liability are striking—banks were frequently and voluntarily closed when performing poorly but before they failed, as shareholders sought to avoid assessments. When they did not close a bank soon enough and it became insolvent, it was typically not deeply insolvent; and depositors received a substantial partial payout.

.   .   .

The two senior officer of the bank were the president who was paid a salary of $10,000 and the cashier who received a salary of $7,000.  Some banks required a bond of the president; but Merchants National did not; however, all employees down to the messengers were required to post a bond. The cashier posted a bond of $30,000, while the messengers had to provide bonds of $5,000.

The shareholders delegated the task of monitoring the management to six outside directors (the president was a seventh director).  According to the national bank examiner’s report, they were men of “good character and standing” who met twice a week to review the bank’s discounts and loans and examined the bank twice a year, having “all its operations laid before them.”  The president and the directors all owned stock in the bank, the president 196 shares and the six directors 213, 50, 40, 20, 10 and 10 shares. Altogether, the outside directors owned 343 shares, which while it was not a large portion of the 30,000 shares, represented substantial potential individual losses if they were assessed their double liability in the event of the bank failing. For the directors owning, just 40 or 50 shares, carried a potential assessment of $4,000 or $5,000, very substantial sums in the late nineteenth century. For the president, a loss of $19,600 would have been equal to double one year’s salary. The cashier could have been assessed $6,200 or slightly less than one year’s salary; but then he had to provide a $30,000 bond. These large potential downside losses for the senior bank management (and even junior officials, considering the bonds posted) and the directors charged with monitoring them created substantial inducements to control and reduce risk taking.

It might be objected that supervision by the regulator, the Comptroller of the Currency was a more important factor in insuring the safety of national banks. However, supervision under the pre-1913 Comptroller was relatively light, relying on the market to discipline the banks.

Take the US banking system of 1864-1913, end branching regulation, add NGDP targeting, and we’d be fine.  No need for Dodd-Frank.

Enrich thy neighbor

I could write an entire book on economic myths.  One of the most famous is the idea that devaluing your currency steals business away from neighboring countries.  This idea, sometimes dubbed “beggar-thy-neighbor,” had a grain of truth during the 1930s.  When countries left the gold standard, it led to fears that the remaining countries would devalue.  This caused gold hoarding, which was deflationary for the countries with currencies still pegged to gold.

But this theory has no place in the modern world.  Every time the Fed eases significantly, the dollar drops.  And stock prices rise in our trading partners.  Yesterday was a good example:

European stocks advanced, climbing 20 percent from the September low and entering a bull market, after the U.S. Federal Reserve signaled it may keep interest rates low through 2014 and a report said Greece’s creditors will make a new offer for a debt-swap deal.

More evidence that Bernanke is a dove

More on the endlessly interesting Bernanke press conference:

Robin Harding: Robin Harding from the Financial Times. Mr. Chairman, while I look at these forecasts for 2014, the median of the forecast is I think 0.75 and the mean is 1.12 percent. If I were to draw a line for these–these dots, how should I draw it so I best understand what the FOMC is most likely to do?

I expected Bernanke to dodge the question.  He’d emphasized elsewhere that these were just forecasts, and when the time came the Fed would have to look at current data.  (After someone pointed out that 11 of 17 favored increased rates by late 2014, despite high unemployment.)   And he’d talked about why the names attached to each forecast were being kept secret. But he did answer the question:

I guess my suggestion would be to look at the median, the middle of the–of the distribution because we do have a democratic process in the Committee, and so the median will give you some sense of where the weight balances against the higher–in favor of higher or lower–lower rates. Again, we did note that in support of our assessment of late 2014, which is a Committee decision and of course there was a 9 to 1 vote in favor of that, but that is supported by the observation that 11 of the 17 participants expect the funds rate at the end of 2014 to be 1 percent or less.

Bernanke also mentioned that he wasn’t going to be around forever.  Thus this policy was institutional, and not contingent on whether he remained Fed chairman.

.  .  . at some point there’ll be a new Chairman, but there’s a lot more continuity on the FOMC collectively. The average bank president is on the FOMC for as much as 10 years and governor’s terms are 14 years. So, even as the Chairman changes, much of the FOMC remains continuous. So, as we talk about interest rates in 2014, the fact that there is quite wide ranging agreement that interest rates will be low for a long time, it should give you more confidence that that’s not dependent on a single individual.

Overall, I thought Bernanke went out of his way to suggest that Fed watchers should focus on the more dovish views, the preference for low rates in late 2014.  He also emphasized that the Fed wasn’t an inflation targeter, but rather put equal weight on the dual mandate:

Greg Ip of The Economist. Mr. Chairman, the Fed’s statutory goals are price stability and maximum employment but traditionally, the Fed has interpreted that somewhat flexibly in the sense that if there was a conflict between the two, they would push for price stability rather than for employment on the view that overtime, stable prices was the best contribution monetary policy could make to maximum employment. But today, you went to some pains to say actually, you treat these goals, put them on in equal footing and that there might be circumstances in which you put one above the other. So following up a little bit on Binyamin question, do I take it that if inflation were to move somewhat above your 2 percent preferred level that you would tolerate that in order to make for the progress on unemployment?

Chairman Bernanke: Well the period of time, yes we treat them symmetrically.

At various times Bernanke observed that even if the economy continues on its current path, there is a strong case for additional stimulus:

But I would say that, as I’ve said on several–in several answers, that if recovery continues to be modest and progress on unemployment very slow and if inflation appears to be likely to be below target for a number of years out so the configuration we’re talking about in the projections then I think there would be a very strong case based on our framework for finding different additional tools for expansion–for expansionary policies or to support the economy.

On the question of the fiscal multiplier, his press conference provided support for both views.

1.  On the side of a positive multiplier, Bernanke noted that zero interest rates would still be appropriate with an even stronger economy.  That could be viewed as implying that monetary policy is currently too tight.  He did note that there were some risks associated with unconventional policies.  I inferred that he saw these “risks” (which I don’t see as being real) as being one factor holding the Fed back.  So perhaps the fiscal authorities could do something without triggering a monetary tightening.

2.  However Bernanke also made a number of statements that cut the other way.  He repeatedly emphasized that they’d be watching the economy closely over the coming months, and the Fed would provide additional stimulus if the indicators weren’t satisfactory.  He kept emphasizing that they take their dual mandate seriously, and that unemployment is too high by any reasonable estimate of the natural rate.  Also that inflation is likely to remain low.  The takeaway for me was that Bernanke made it quite clear that he feels the Fed needs to be active, and how much they do depends on the state of the economy.  That implies a near-zero multiplier.  Or at the very least, that the multiplier is considerably lower than the figure implied by Keynesian models.

I suppose in this sort of situation one’s outlook depends on one’s priors.  It seems to me the obvious solution is simple; do a employer-side payroll tax cut.  ( I recall Christy Romer recommended this idea.)  That boosts AS, and forces the Fed to do additional monetary stimulus to prevent the rate of inflation from falling.  Bernanke was quite clear that below 2% inflation was unwelcome.  The employer-side cut is the one form of fiscal stimulus that works in theory, under either of the two interpretations discussed above.

Of course neither party favors an across the board cut in the employer-side payroll tax, so it won’t happen.  Only places like Singapore do that sort of sensible policy.

He also agreed with Milton Friedman that the best way to produce higher interest rates for savers is with an expansionary monetary policy:

So I think what we need to do as, is often is the case, when the economy goes into a very weak situation, then low interest rates are needed to help restore the economy to something closer to full employment and to increase growth and that in turn will lead ultimately to higher return across all assets for savers and investors.

In contrast, the Bank of Japan has tightened policy almost every time inflation rose above zero, and ended up with nearly 2 decades of ultra-low rates.