James Alexander directed me to a recent post by Basil Halperin, which is one of the best blog posts that I have read in years.  (I was actually sent this material before Christmas, but it sort of fell between the cracks.)

Basil starts off discussing a program for distributing excess food production from manufacturers to food banks.

The problem was one of distributed versus centralized knowledge. While Feeding America had very good knowledge of poverty rates around the country, and thus could measure need in different areas, it was not as good at dealing with idiosyncratic local issues.

Food banks in Idaho don’t need a truckload of potatoes, for example, and Feeding America might fail to take this into account. Or maybe the Chicago regional food bank just this week received a large direct donation of peanut butter from a local food drive, and then Feeding America comes along and says that it has two tons of peanut butter that it is sending to Chicago.

To an economist, this problem screams of the Hayekian knowledge problem. Even a benevolent central planner will be hard-pressed to efficiently allocate resources in a society since it is simply too difficult for a centralized system to collect information on all local variation in needs, preferences, and abilities.

One option would simply be to arbitrarily distribute the food according to some sort of central planning criterion.  But there is a better way:

This knowledge problem leads to option two: market capitalism. Unlike poorly informed central planners, the decentralized price system – i.e., the free market – can (often but not always) do an extremely good job of aggregating local information to efficiently allocate scarce resources. This result is known as the First Welfare Theorem.

Such a system was created for Feeding America with the help of four Chicago Booth economists in 2005. Instead of centralized allocation, food banks were given fake money – with needier food banks being given more – and allowed to bid for different types of food in online auctions. Prices are thus determined by supply and demand. . . .

By all accounts, the system has worked brilliantly. Food banks are happier with their allocations; donations have gone up as donors have more confidence that their donations will actually be used. Chalk one up for economic theory.

Basil points out that while that solves one problem, there is still the issue of determining “monetary policy”, i.e. how much fake money should be distributed each day?

Here’s the problem for Feeding America when thinking about optimal monetary policy. Feeding America wants to ensure that changes in prices are informative for food banks when they bid. In the words of one of the Booth economists who helped design the system:

“Suppose I am a small food bank; I really want a truckload of cereal. I haven’t bid on cereal for, like, a year and a half, so I’m not really sure I should be paying for it. But what you can do on the website, you basically click a link and when you click that link it says: This is what the history of prices is for cereal over the last 5 years. And what we wanted to do is set up a system whereby by observing that history of prices, it gave you a reasonable instinct for what you should be bidding.”

That is, food banks face information frictions: individual food banks are not completely aware of economic conditions and only occasionally update their knowledge of the state of the world. This is because obtaining such information is time-consuming and costly.

Relating this to our question of optimal monetary policy for the food bank economy: How should the fake money supply be set, taking into consideration this friction?

Obviously, if Feeding America were to randomly double the supply of (fake) money, then all prices would double, and this would be confusing for food banks. A food bank might go online to bid for peanut butter, see that the price has doubled, and mistakenly think that demand specifically for peanut butter has surged.

This “monetary misperception” would distort decision making: the food bank wants peanut butter, but might bid for a cheaper good like chicken noodle soup, thinking that peanut butter is really scarce at the moment.

Clearly, random variation in the money supply is not a good idea. More generally, how should Feeding America set the money supply?

One natural idea is to copy what real-world central banks do: target inflation.

Basil then explains why NGDP targeting is likely to be superior to inflation targeting, using a Lucas-type monetary misperceptions model.

III. Monetary misperceptions
I demonstrate the following argument rigorously in a formal mathematical model in a paper, “Monetary Misperceptions: Optimal Monetary Policy under Incomplete Information,” using a microfounded Lucas Islands model. The intuition for why inflation targeting is problematic is as follows.

Suppose the total quantity of all donations doubles.

You’re a food bank and go to bid on cheerios, and find that there are twice as many boxes of cheerios available today as yesterday. You’re going to want to bid at a price something like half as much as yesterday.

Every other food bank looking at every other item will have the same thought. Aggregate inflation thus would be something like -50%, as all prices would drop by half.

As a result, under inflation targeting, the money supply would simultaneously have to double to keep inflation at zero. But this would be confusing: Seeing the quantity of cheerios double but the price remain the same, you won’t be able to tell if the price has remained the same because
(a) The central bank has doubled the money supply
or
(b) Demand specifically for cheerios has jumped up quite a bit

It’s a signal extraction problem, and rationally you’re going to put some weight on both of these possibilities. However, only the first possibility actually occurred.

This problem leads to all sorts of monetary misperceptions, as money supply growth creates confusions, hence the title of my paper.

Inflation targeting, in this case, is very suboptimal. Price level variation provides useful information to agents.

IV. Optimal monetary policy
As I work out formally in the paper, optimal policy is instead something close to a nominal income (NGDP) target. Under log utility, it is exactly a nominal income target. (I’ve written about nominal income targeting before more critically here.)

. . .  Feeding America, by the way, does not target constant inflation. They instead target “zero inflation for a given good if demand and supply conditions are unchanged.” This alternative is a move in the direction of a nominal income target.

V. Real-world macroeconomic implications
I want to claim that the information frictions facing food banks also apply to the real economy, and as a result, the Federal Reserve and other central banks should consider adopting a nominal income target. Let me tell a story to illustrate the point.

Consider the owner of an isolated bakery. Suppose one day, all of the customers seen by the baker spend twice as much money as the customers from the day before.

The baker has two options. She can interpret this increased demand as customers having come to appreciate the superior quality of her baked goods, and thus increase her production to match the new demand. Alternatively, she could interpret this increased spending as evidence that there is simply more money in the economy as a whole, and that she should merely increase her prices proportionally to account for inflation.

Economic agents confounding these two effects is the source of economic booms and busts, according to this model. This is exactly analogous to the problem faced by food banks trying to decide how much to bid at auction.

To the extent that these frictions are quantitatively important in the real world, central banks like the Fed and ECB should consider moving away from their inflation targeting regimes and toward something like a nominal income target, as Feeding America has.

The paper he links to contains a rigorous mathematical model that shows the advantages of NGDP targeting. He doesn’t claim NGDP targeting is always optimal, but any paper that did would actually be less persuasive, as it would mean the model was explicitly constructed to generate that result. Instead the result flows naturally from the Lucas-style archipelago model, where each trader is on their own little island observing local demand conditions before aggregate (NGDP conditions). This is the sort of approach I used in my first NGDP futures targeting paper, where futures markets aggregated all of this local demand (i.e. velocity) information. However Basil’s paper is light years ahead of where I was in 1989.

I can’t recommend him highly enough.  I’m told he recently got a BA from Chicago, which suggests he may be another Soltas, Wang or Rognlie, one of those people who makes a mark at a very young age.  He seems to combine George Selgin-type economic intuition (even citing a lovely Selgin metaphor at the end of his post) with the sort of highly technical skills required in modern macroeconomics.

Commenters often ask (taunt?) me with the question, “Where is the rigorous model for market monetarism”.  I don’t believe any single model can incorporate all of the insights from any half decent school of thought, but Basil’s model certainly provides the sort of rigorous explanation of NGDP targeting that people seem to demand.

Basil has lots of other excellent posts, and over the next few weeks and months I will have more posts responding to some of the points he makes (which to his credit, include criticism of NGDP targeting–he’s no ideologue.)

Some people argue that the 4.7% unemployment rate is misleading.  In fact, our PEOTUS makes that argument, citing figures as high as 30% or 40%. There are tens of millions of workers who are not even trying to find work (so we are told) because they are so “discouraged” by 4.7% unemployment and the Obama record of 200,000 new jobs a month for the past 7 years.  And they lack the education to do work like computer coding. But then I read articles like this:

The development boom that’s changing downtowns across the country—and adding new units in hyper-competitive markets—has also led to an acute shortage of qualified construction workers, which is starting to weigh heavily on future projects and planning. As of April 2016, there were over 200,000 unfilled job openings in building construction, according to the Bureau of Labor Statistics Job Openings and Labor Turnover Survey(JOLTS).

Wait, aren’t construction jobs supposed to be the sort of work that is appropriate for non-college educated workers?  What am I missing?  Yes, some construction jobs are highly skilled, but not all.  Heck, even I have done painting, drywall and roofing.

There simply is not much “slack” left.  Many of the long-term unemployed will never work again, even if we have a 1969 or 1999-style economic boom. 

Trump loves big projects, and wants to spend a lot on infrastructure:

“There isn’t much capacity left in the construction industry,” says Julian Anderson, President of Rider Levett Bucknall, North America, a property and construction firm. “There’s a big labor shortage, and construction unemployment is down to 4 percent. It’s so nuts in LA and San Francisco, it’s gotten to the point where it’s probably turning off development.” Anderson says that proposals to deport undocumented immigrants, who make up a sizable portion of the construction workforce in some markets, may severely exacerbate the issue.

Confused?  Join the club.

How about a career in law enforcement?

Economic and social changes have made it harder for police departments to keep their forces fully staffed, and lead to increasingly desperate recruitment.

The Los Angeles Police Department was short of nearly 100 officers as of mid-December—only 1% of its total workforce, but still enough to be felt on the ground, says Captain Alan Hamilton, who runs recruitment for the department. Philadelphia had 350 vacancies, largely due to a spate of retirements. Last spring, Dallas cancelled two academy classes for lack of applicants; its preliminary applications dropped by over 30% between 2010 and 2015. In 2012, the ratio of police officers to population hit its lowest level since 1997, according to Uniform Crime Reporting Programme data published by the FBI.

The dynamics underpinning the shortages vary by department, but there are national trends making it harder for police forces to attract applicants. The first is a strong economy. Nelson Lim, a researcher at the RAND Corporation, a think-tank, says this is nothing new. When plenty of jobs are available, people are usually less motivated to enter dangerous professions. Police forces as well as the armed forces tend to field less interest in boom times.

(The article mentions a slight uptick last year in police fatalities, but they are still down sharply from 10 years ago.)  You see similar stories in manufacturing. Yesterday I heard on CNBC that there is a severe shortage of welders in manufacturing, with 300,000 positions unfilled.  This contributes to manufacturing going to places like China.  Companies in all sorts of “working class” sectors are having trouble finding qualified employees at current wage rates.  Is the problem a tight labor market, or a lack of technical education?  I’m not sure, but I don’t see much evidence for the “robots stealing our jobs” claim.

The implications are clear, if America wants to create substantially more jobs, we don’t need monetary and fiscal stimulus—we need deregulation, supply-side tax reform, better technical education, and most importantly we need to boost the rate of immigration.

PS.  I recall that a substantial share of police officers are now college grads, so I don’t mean to suggest they are all low-skilled jobs.

PPS.  Off topic, but people wonder why I have such a low opinion of Trump on foreign policy.  Here’s his pick for Secretary of State:

At his confirmation hearing before the US Senate Foreign Relations Committee on Wednesday, Mr Tillerson said China’s construction of artificial islands in the contested sea was “akin to Russia’s taking Crimea” from Ukraine in 2014.

“We’re going to have to send China a clear signal that, first, the island-building stops and, second, your access to those islands also is not going to be allowed,” he said.

Yeah, dumping some gravel on an uninhabited reef is sort of like invading a European country of 40 million people and annexing a part of its territory.

And is Russia’s access to the Crimea also “not going to be allowed”?  These people are truly evil—their worldview boils down to “Russia good, China bad”.

I feel like I fell asleep for 20 years and woke up in a country I don’t even recognize. I gather Marco Rubio feels the same way, given his exasperated tone when questioning Tillerson.

PPPS.  My grandmother’s surname was “Van Winkle.”  Seriously.

America’s (very gradual) descent in banana republicanism continues.  Here’s CNBC:

CNBC compiled a list of CEOs who have held one-on-one meetings with the president elect, and we found a distinct pattern. When a CEO visits Trump, the company’s stock usually rises that day and almost always does better than the overall market. Our data focuses on CEOs who had one-on-one meetings with Trump and excluded large group meetings such as the tech sector gathering in mid-December.

On average, we found that stocks tended to beat the S&P 500 by nearly a full percentage point, just for a single day. That’s a lot of monetary value seemingly for simply meeting the president-elect. It suggests that Trump has the power to move markets, and that it builds confidence for investors to know a company is on his good side.

While it’s impossible to say whether it was the meetings specifically that led to strong performances on the days the CEOs visited, the trend is clearly discernible.

The data they report doesn’t seem all that significant to me, but there’s definitely a perception out there that CEOs need to meet with Trump and make some token promises. (I just saw an analyst on CNBC suggest that Amgen’s CEO visit Trump and promise to build a factory in America with a few hundred jobs.)  But I would encourage people to focus less on the specifics than the trends.  I’m actually not that concerned about Trump’s occasionally forays into CEO bashing having all that much impact on a $20 trillion dollar economy.  Nor do I worry all that much about his conflicts of interest, or yesterday’s repudiation of his earlier promise to release his tax returns.  Rather I think what people should focus on is that all these snippets are symptoms of the fact hat we are in a new political world, more akin to southern Italy than the sort of country the Founding Fathers had in mind.  Here’s the Economist:

AT THE height of Silvio Berlusconi’s power, as the billionaire-politician brushed scandals and lawsuits aside with the ease of a crocodile gliding through duckweed, a professor at an Italian university described to Lexington how the terms furbo and fesso helped explain the then-prime minister’s survival. In those bits of Italian society from which Mr Berlusconi drew his strongest support, it is a high compliment to be deemed a furbo, or a sly, worldly wise-guy. The furbo knows how to jump queues, dodge taxes and play systems of nepotism and patronage like a Stradivarius. In contrast the fesso is the chump who waits his turn and fails to grasp how badly the system is rigged, or how much of his taxes will be stolen. The fesso might cheer a new clean-air law in his city, naively taking an announcement by the elites at face value. The furbo wonders who in the environment department may have a brother-in-law with a fat contract to supply chimney scrubbers. Mr Berlusconi’s fans saw him as the furbo to end all furbi. He showed that he heard them, offering them crude appeals to wise-guy cynicism, as when he asserted that any Italians who backed his centre-left opponents were not just mistaken, but were coglioni or, to translate loosely, “dickheads”, who would be voting “against their own interests”. . . .

If Mr Trump’s policies are a mystery, his approach to politics is not. The Republican won office by systematically undermining trust in any figure or institution that seemed to stand in his way, from Republican rivals to his Democratic opponent, leaders of Congress, business bosses, the news media, fact-checkers or simply those fessi who believe in paying taxes. Accused of avoiding federal income taxes during a debate with Hillary Clinton, he growled: “That makes me smart.”

Mr Trump will not be able to stop that destructive mission to make America less like Sweden and more like Sicily. He has too many promises that he cannot keep. He must betray those supporters whom he wooed with a conspiracy theory dressed up as an economic policy, backed with crude invective worthy of an American Berlusconi.

From the beginning I’ve thought that Berlusconi was the best comparison for Trump.  Fortunately, presidents don’t have as much power as people assume, so Trump won’t change America as much as the Economist fears.  (Berlusconi was of course a failed leader, but also one who didn’t change Italy all that much.) But that doesn’t mean criticism of Trump is overwrought or unhinged. He really is as bad as his more fervent critics imagine, it’s just that in our system he’ll usually get tied up in red tape.  The biggest risk is in foreign policy.

PS.  It’s interesting that Trump picked a fesso to be his VP, not another furbo like Chris Christie.  Perhaps someone better versed in psychology can explain why.

PPS.  I’m definitely the sort of person that Berlusconi and Trump would view as a dickhead.

PPPS.  Early in 2016 I predicted that the right would kiss up to Trump as soon as he gained power, citing the same phenomenon in the French press during Napoleon’s return to power (a rough translation of the French, from 1815):

Now if we want to follow him in his victorious march to Paris, we only need consult the Monitor. To guide our readers in this historic research, we will give a curious extract. We will find the graduated march of Napoleon to Paris, with the modification that the approach produced in the opinions of the newspaper.
– The cannibal went out of his lair.
– The Corsican ogre just landed the Gulf of Juan.
– The tiger arrived at Gap.
– The monster slept in Grenoble.
– The tyrant has gone through Lyon.
– The usurper was seen at sixty leagues from the capital.
– Bonaparte is advancing with great strides, but it will never enter Paris.
– Napoleon will be under our ramparts tomorrow.
– The Emperor arrived at Fontainebleau.
– His Imperial and Royal Majesty yesterday made its entry into the Tuileries surrounded by his loyal subjects!

A few weeks later the National Review devoted an entire issue bashing Trump, with one conservative intellectual after another telling us that he was a despicable politician who was completely unsuitable for higher office.  And now we know they were right.  But the National Review is not gloating about the fact that Trump really is Putin’s puppet.  If a Democratic President were forcing one CEO after another to kowtow to him, and then telling them where to put their factories, conservatives would be freaking about about the end of capitalism, about the caudillo form of government coming to America.  Instead they are mocking Democrats who hold the same principled view that NR held a year ago:

And here’s the National Review today, kissing up to Trump:

As Trump would say “Sad!”

When I was young, I knew a small businessman that used to deal with quite a lot of currency.  He marked the corner of each note that passed through his hands with a pen.  I think he was interested in seeing how often the notes came back to him.

I thought of this when doing a recent post over at Econlog, on monetary offset. (BTW, the post is recommended.)  Suppose someone wanted to figure out if he were having any influence on the broader economic discussion.  One technique would be to “mark” each important concept with a different name. Thus you could relabel “monetary dominance” as “monetary offset”.  Or “the identification problem” could be relabeled “never reason from a price change.”  If these new names caught on, then it would suggest that you might have somehow influenced the conversation.  Even better, the relabeler might have independently rediscovered the concepts, something that occurs quite often in the history of economics.

Why might a new name catch on?  Perhaps the importance of monetary dominance was forgotten, and the idea was revived under a new name.  Or perhaps the full implications of the identification problem were often overlooked, and the new term applied it to unfamiliar situations.  In any case, a successful relabelling would be an indication of some sort of flaw in the economic profession, a blind spot.

PS.  Here’s Bloomberg:

Such a move, which would put the U.S. president and its central bank at odds, is called a monetary offset.

Here’s Trump:

I recall a story suggesting that when Bush left office he told Obama something to the effect, “Whatever you do, don’t piss off the CIA.”

Can someone confirm?

PS.  Matt Yglesias gets it exactly right.

PPS.  Before getting comments, perhaps I should point out that I don’t “believe” the recent allegations.