Archive for October 2014


We’re getting there (not?)

Update:  I’m told the CFTC did not allow US trading in NGDP futures markets, despite this press release.  Can anyone find the actual regulation?

Update 2:  Several commenters linked to a letter from the CFTC that makes it clear that Americans will not be able to trade in the NGDP futures.  Although it is stated in a way that suggests the university made this request in their application, the way the process played out it was clear this was the most they could hope for.  I’m really disappointed with this for two reasons. First, I don’t see any reason why Americans should not be free to set up this market, or any other prediction market.  I don’t see any reason for government regulation.  People can legally lose millions of dollars in Las Vegas, but the government is worried about prediction markets where no one would be allowed to wager more than $850.  And these are markets that (unlike Vegas) have enormous potential benefits to social welfare.  Even worse, this isn’t an American endeaver, it’s New Zealand university doing this project.  Just imagine if Harvard was trying to set this up and the New Zealand government set a letter warning Harvard they could face legal troubles unless betting was restricted to Harvard students and staff.  I’m an American, and I can tell you that Americans would be outraged.  “Who gives the New Zealand government the right to tell Americans what we can or cannot do in our own university! How does this affect them?”  It’s times like this that I feel first hand what foreigners must feel quite often–how the US often acts like a big bully.  I have nothing personal against the individual who sent the letter–presumably he is just following US government policy.  But Americans overall need to think about how they would feel if foreign governments made demands on us that were similar to the demands we are increasingly placing on foreigners. And of course this is just the tip of the iceberg—whole countries are being destroyed by a war on drugs that the US government insists they fight.

Commenter Cthorm pointed me to this new regulation from the CFTC:

RELEASE: PR7047-14

October 29, 2014

CFTC Staff Provides No-Action Relief for Victoria University of Wellington, New Zealand, to Operate a Not-For-Profit Market for Event Contracts and to Offer Event Contracts to U.S. Persons

Washington, DC “” The U.S. Commodity Futures Trading Commission’s (CFTC) Division of Market Oversight (DMO) today announced the issuance of a no-action letter for Victoria University of Wellington, New Zealand (University), to operate a not-for-profit market for event contracts, and to offer event contracts to U.S. persons, without registration as a designated contract market, foreign board of trade, or swap execution facility, and without registration of its operators.

The University’s proposed market for event contracts is similar to the Iowa Electronic Markets (IEM) operated by the University of Iowa. CFTC’s Division of Trading and Markets, which preceded DMO, previously granted no-action relief to the University of Iowa with respect to the operation of the IEM by letters dated February 5, 1992, and June 18, 1993. Like the IEM, Victoria University of Wellington’s proposed market for event contracts consists of submarkets for binary contracts concerning political elections and economic indicators, is operated for academic research purposes only, and its operators, who are faculty at the University, receive no separate compensation.

The University’s main objective for its event contracts market is to determine whether it can aggregate information and predict outcomes of certain events more accurately than through alternative means, such as public opinion polling. The University plans to use the results from its market as teaching tools in its courses on statistical analysis, market theory, and trader psychology, and as supporting data for research papers and analyses.

The University’s market would vary from the IEM model in certain respects, including a larger allowable number of traders in its market, as well as a higher, inflation adjusted cap on investment by any single market participant. DMO believes that each of these variances is intended to promote the educational public interest purpose of the project, while maintaining the market’s small-scale, not-for-profit nature.

I’ve frequently criticized government regulations restricting prediction markets. Although I don’t think there should be any regulatory barriers at all in this area, I applaud the CFTC for allowing this futures market to avoid regulatory sanctions from the US.  It’s an important first step.  If successful, it will offer valuable data on NGDP expectations.

Hopefully with this barrier overcome, Wellington University will be able to provide us with a tax advantaged way of donating money.  I’ll let you know when I hear more.

Meanwhile Hypermind is already running, and will receive a $10,000 infusion of prize money within a few days.

PS.  Cullen Roche has a new post entitled “Scott Sumner Says Silly Things,” where he compares me to a silly and amateurish monkey.  I’ve been called worse, and if I have to be a monkey I guess I’d prefer not to be a sober and boring one. Roche says it’s obvious I was referring to new Keynesianism, whereas I thought it was obvious I was referring to the older variant, the one that took liquidity traps much more seriously.

Oh, and Milton Friedman (the guy who advocated QE for Japan back in 1997, and who pointed out that money in Japan was way too tight despite near-zero interest rates and that the euro would fail) has been “totally discredited.”  Roche admits that much of new Keynesian economics is based on Friedman’s work, so I guess he thinks NK is also completely discredited.  And he suggests that Robert Lucas’s work has also been completely discredited.  I’d guess he also thinks RBC theory has been completely discredited.  And Austrian economics?  All that’s left is circa-1938 Keynesianism, the theory that QE doesn’t cause an exchange rate to depreciate.  Is that Roche’s theory?

Driving to work today the BBC reporter was assuring NPR listeners that QE in Japan had been tried over and over again, and always failed.  Really, when did it fail?  The BOJ got the growth it wanted from 2002 to 2006, and then pulled much of the money out of circulation when it feared high inflation in 2006.  Is that what the BBC reporter meant when he said it failed?  Yet people like Roche get upset when you point out that Keynesians still believe in liquidity traps.

PPS.  This has to be one of the most perplexing sentences I’ve ever read:

In somewhat related snippets, Noah Smith on people who can’t admit that they were wrong about QE

HT:  Marcus Nunes

Three widely held theories discredited in 5 minutes

I woke up this morning to find that my very useful commenters had provided me with information showing that 3 widely held economic theories were discredited last night between 12:45 and 12:50 am.  These theories are Keynesian economics, RBC theory, and the theory of beggar-thy-neighbor policies.  Yes, these theories have been totally discredited dozens of times before over the past few years (or decades if you wish), but piling on is fun!

Here’s the first comment, by Cameron:

BOJ announces it will expand its QE program, Nikkei rises 4.5%!

The liquidity trap theory is dead. Please please please follow in their footsteps ECB.

Of course Keynesian economics predicts the QE announcement would have no effect on stock prices, as the new money would just sit there as excess reserves.  You are just swapping one low interest government asset for another low interest government asset.  (In fairness, I don’t know what the BOJ is buying in this case, but we also see big market effects when central banks just buy government bonds.)

And yet the economic blogosphere is full of people telling us “we just don’t know” if QE has any effect.  Yesterday I saw an article indicating that the “markets” were uncertain whether QE had had any effect.

Of course the real business cycle people will say; “yes, monetary stimulus will raise nominal stock prices, but that effect merely represents inflation.”  On to comment number 2, from Steve:

BOJ expands monetary base to 80T yen per year

The central bank says it will expand annual bond purchases to 80 trillion yen a year, up from the current 50 trillion yen. It will also extend the duration of bonds it holds to about 7-10 years.

The impact on markets was swift: dollar-yen jumped 1 percent to 110.26, while the Nikkei surged over 4 percent to its highest levels since September 25.

So the Japanese stock market also soared in dollar terms, and if you look at the intraday data the huge spike was right after the announcement.  RBC theory says it’s just inflation, and that real values should not be affected.  And yet Noah Smith tells us that RBC theory is alive and well. And I’m sure it is, in the elite journals.

[As an aside, there are people who claim that some RBC models allow for nominal shocks.  Sorry, but the sine qua non of RBC theory is that nominal shocks don’t matter.  If both types of shocks matter it’s not an RBC model, it’s an NK model with both supply and demand shocks being important. When people say they don’t believe that RBC theory is correct, they mean that they think nominal shocks matter.  Everyone believes that real shocks also matter.  After all, the devastating earthquake/tsunami/shutdown of all nuclear power in Japan caused a  . . . oh wait; it didn’t cause a recession, or an increase in unemployment.  OK, everyone agrees that a real shock 10 times bigger than the Japanese tsunami could cause a recession. Say Godzilla destroying Tokyo.]

The last resort of the anti-QE crowd is to admit that it “works,” but only in a beggar-thy-neighbor way.  Stealing growth from other countries via currency depreciation and trade surpluses.  But macro is not a zero sum game.  Commenter Steve also provides this information:

I was wondering why the S&P500 futures abruptly spiked 15 points (0.75%) at 12:45am EDT. TheMoneyIllusion has the answer!

Steve, I’m sure that was a coincidence.  There must have been was lots of other news at 12:45 am that would have caused broad indices to spike sharply higher in the US.  And if it was Japan, it was surely only stocks in US companies with operations in Japan.

Seriously, the extent to which people go to try to deny the obvious is almost comical.  I think it has something to do with Bernanke’s comment that QE works in practice but not in theory.  That’s not true of course, it works in theory by raising the expected future money supply and expected future NGDP, but it gets at reasons why economic bloggers deny the obvious.  They live in a world of theories, of models, not reality.

PS.  Cameron also provides this nugget:

Also debunked is the belief that consensus is more important than policy stance. The vote was 5-4 in favor of expansion.

Make that 4 theories debunked.  Not a bad day’s work for my comment section!  I don’t have links, but all comments are quoted in full, and are listed among the first 8 comments of the previous post. They are easy to find.

PPS.  This is another reason why we need a NGDP futures market.  Hypermind has started one, but it’s still small, and appears inefficient in my view.  The market forecast 3.9% NGDP right before yesterday’s announcement, which seemed too low to me.  The actual figure was 4.9%.  So there are still $100 bills on the sidewalk.  The prizes at Hypermind will grow sharply in a few days, so when I make the announcement get in there and start picking them up.

Maybe the economics profession doesn’t want NGDP and RGDP futures markets because deep down they know that Keynesian and RBC models would be totally discredited almost immediately. I can’t think of any other rational explanation.

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.