Archive for March 2018


Odds and ends

I have a short piece over at CapX, where I make the case for NGDP targeting.  (You can think of it as complementing my recent longer piece on the subject.)  Here’s how I conclude:

Economists are beginning to understand that NGDP is the variable we should actually be concerned about. Instead of worrying about what might happen to inflation under NGDP targeting, we should consider what happens to NGDP if we insist on targeting inflation.

I leave for Japan tomorrow, so I won’t do much blogging in April.  And most of what I do write will be over at Econlog.  Here are a few interesting pieces I recently came across, starting with an analysis of the new GOP budget:

It fully funds Planned Parenthood. It increases outlays for Pell Grants and Head Start, and boosts funding for the Department of Labor and the Department of Education not only above the requests Trump had made, but above the levels in Obama’s last budget. It fails to deregulate the private health insurance market or to reform federal permitting rules on construction projects. Not a single agency was eliminated, though Trump’s original budget proposal had called for 18 to be scrapped. It makes no changes to entitlement programs, and oh, here’s something interesting, it actually forbids construction of a border wall in the Santa Ana National Wildlife Refuge in the Rio Grande Valley — the very place Trump supposedly wanted to begin construction.

This article suggests that refugees are good for America:

This year’s refugee quota, 45,000, is the lowest in three decades, and is not expected to be met. Mr Trump also excluded a lot of wretched people from it, by temporarily placing additional restrictions on anyone from a secret list of 11 countries, which is said to include South Sudan, as well as Syria and Iraq. A low-cost nativist signal to his supporters, these are the biggest changes Mr Trump has made to America’s immigration regime. They are also counter-productive, as well as cruel, a typical case of nativists mistaking American strengths for weakness.

The argument against refugees, which Republican governors in Texas and Michigan were making even before Mr Trump’s election, is that they are a financial burden and security threat. Both charges are unfounded. For though it is true that refugees represent a bigger upfront cost than other migrants—America spends between $10,000 and $20,000 resettling each one—they repay that in spades. A decade after their arrival, the average income of a refugee family is close to the American average. Mr Makender has paid over $100,000 in taxes. Americans can also relax about their odds of being killed by a refugee. None of the 3m-odd fugitives America has taken since 1980 has been involved in a fatal terrorist attack. That reflects the rigour of America’s vetting, refugees’ hunger for advancement—and America’s ability to feed it.

This article on teenagers in Russia (called “Puteens”) makes me more optimistic:

The internet unites the human race

This heightened sense of the world beyond their borders seems to make the Puteens more receptive towards it. The dynamic of constant confrontation with the West holds less appeal for them. Russia’s youngest adult cohort is more likely to have positive views of America and the European Union, and less likely to believe that Russia has enemies. (Their peers in the West also view Russia more favourably than older generations do.) They trust information from friends and relatives, and increasingly eschew the aggressive state-controlled news on television. Over 70% of 18- to 24-year-olds get their news online, compared with just 9% of those over 55; more than 90% of over-40s still rely on television. “They try to convince us that Americans all hate us; that Americans think Russia is a place full of evil people, bears on the streets and vodka,” says Lera Zinchenko, an aspiring actress from the Moscow suburbs. “I don’t think they hate us. I follow a few people on Instagram who travel all over the world, and there’s one girl who was in America and said people were super nice to her.”

This article suggests that China is becoming more like the West:

Start with administrative litigation, which usually involves private citizens suing government officials. Last year courts agreed to hear 330,000 such cases, more than double the total in 2013—the first full year of Mr Xi’s rule (see chart). Many of these involve disputes over land and housing, the most frequent sources of conflict between ordinary people and the state. Other common cases relate to pension benefits, compensation for workplace injuries and traffic tickets. Benjamin Liebman of Columbia Law School says that suing the government over such matters is becoming routine in China.

There have also been notable improvements in the arena of commercial law. Last year Chinese courts began hearings in 152,000 intellectual-property disputes, up nearly tenfold over the past decade. The explosive growth in IP cases has been fuelled by the growing litigiousness of domestic companies, which have more to protect as they become more innovative. But foreign companies are also benefiting. In August a court ordered three Chinese firms to pay 10m yuan ($1.5m) in damages to New Balance, an American footwear company. It was one of the largest trademark-related awards ever made by a Chinese court.

And don’t be overly depressed by the rise of right-wing authoritarianism.  At the global level, things are still getting much better.  This article discusses the dramatic rise in fish farming in Bangladesh, as well as fast rising chicken production in Nigeria.  The bottom line is that the great mass of humanity is seeing a dramatic increase in living standards:

However much farmers struggle with the consequences of their success, it is a far nicer problem than the one they used to grapple with. Walking down a market street, Mr Haque dips his hand into a sack of maize and a sack of rice. The grains will be bought by farmers, who will grind them into pellets for fish and cattle. “Twenty-five years ago, people were starving for want of this,” he says, marvelling. “Now we feed it to animals.”

If you are depressed about the world, that’s a reflection of you, not the world.

What does it mean to control interest rates?

Let’s start with an easier question.  In what sense does OPEC control oil prices?

Imagine that OPEC produces 40% of the world’s oil. The cartel also has substantial excess capacity. Now let’s think about its control of global oil prices.

Because both the demand for oil and the supply of non-OPEC oil are relatively inelastic in the short run, OPEC has the ability to double global oil prices, or cut them in half, almost overnight. That’s a lot of control. So let’s assume that OPEC targets global oil prices at $100/barrel, and adjusts output to make the price stick.

There is one problem with this policy; oil supply and demand become far more elastic in the long run. So now let’s assume that the $100 oil price causes a fracking revolution, and non-OPEC supply rises sharply. To keep the price at $100/barrel, OPEC must reduce output to 35% of global production, then to 30%, then to 25%, etc., etc. They can do this for a while, but it’s painful.

OPEC also worries about the long run viability of the oil market, so eventually it decides that it’s no longer wise to keep the price at $100, even though in a technical sense it could continue doing so up until the point where its output fell to zero. OPEC decides that it is in their long run interest to face reality, and allow the fracking boom to reduce oil prices. There are two ways of making this happen

1. OPEC could stop controlling oil prices. They could instruct their members to produce a total of 40 million barrels per day, and let the market set the price.

2. They could keep controlling the price, but gradually reduce the price as needed to keep output at close to 40 million barrels per day (as fracking output rises). Thus they might reduce the price to $95 for a couple months, and then later to $90, and after another 3 months down to $85, etc. Prices would fall in a sort of step function, eventually hitting $45 after a few years. At each step of the way, price would be set at a level expected to keep OPEC output pretty stable, but once at that new price, output would be tweaked each day as needed to keep the price stable. Then after a few more months, another $5 price cut.

So in case #1 OPEC is not controlling global oil prices and in case #2 OPEC is controlling oil prices. But the two cases are actually pretty similar, and as you make the price adjustments smaller, the two cases get even more similar. Thus you could imagine the price being adjusted by $1 at a time, not $5, and the adjustments occurring much more frequently.

At what point do you move from a scenario where OPEC is controlling the global oil price to one where the market is controlling the global oil price?

Now let’s go back and think about the fracking boom, described earlier. Suppose OPEC actually responded to the fracking boom with the step function approach to lowering prices, described in case #2. So for periods of several months at a time, the price would be fixed by OPEC, then a sudden drop of $5/barrel. How would you think about this multi-year price decline, from $100 to $45? Does it make more sense to talk about the fracking boom causing a huge plunge in oil prices? Or should we say that OPEC caused a huge plunge in oil prices?

1.  On the one hand, you could argue that OPEC controlled oil prices all through this period, and hence they caused the decline. They made the periodic adjustments in the official price, and all the time they had the ability to set world prices in a different position.

2. On the other hand, the fracking boom was the big disruptive force in the global marketplace. As fracked oil output soared, it caused global prices to fall. OPEC could have offset that, at least for a while, but they chose not to, keeping OPEC output close to 40 million barrels per day. OPEC did not take concrete steps to prop up oil prices.

Because terms like ‘cause’ are not well defined, there is no right answer. But in this case I think I’d prefer to say that the fracking boom caused the oil price plunge. And I don’t think it’s just me; many economic pundits would view that as a plausible way of describing what caused the big plunge in oil prices.

It turns out that this example is uncannily similar to the plunge in interest rates from July 2007 to May 2008. Before going over that example, recall an important aspect of the previous example. I said that while in the short run OPEC could have continued holding oil prices up at $100 for an even longer period, they also had long term objectives to think about, which made them conclude that it was wise to allow some price decline, so that their long term hold on the oil market would not be completely lost.

Now think about the Fed during 2007-08. Real estate is declining sharply, and there are many fewer mortgages being issued. The lower demand for credit puts downward pressure on interest rates. For the Fed to prevent interest rates from falling, they’d have to continually reduce the monetary base. That sort of tight money would keep rates from falling below 5.25% (via the liquidity effect).

But the Fed realizes that if it did what it took to prevent rates from falling, then this policy would disrupt its long run goals for the economy. Big time! So instead of reducing the monetary base it decides to allow interest rates to fall, while holding the base fairly stable. There are two ways it could do that:

1.  It could hold the base roughly stable at $855 billion (plus or minus 1%), and completely stop targeting interest rates. Let the market set interest rates.

2.  It could instruct the New York Fed to reduce rates by ¼% or ½% every few months, as needed to keep the base fairly stable. On days when the official fed funds target was not being adjusted, the New York Fed would hold rates stable with small adjustments in the base, up and down.

You could also envision intermediate cases, like the official fed funds rate target being adjusted in 5 basis point steps, instead of 25 basis point steps. The smaller the adjustments, the more it would look like the market was setting the rate at a level that resulted in a stable monetary base.

I would argue that case #1 and case #2 are actually pretty similar. But in case one it looks like the market is setting interest rates, and in case two it looks like the Fed is controlling interest rates.

Now let’s return to the weak credit markets, caused by the housing depression. Does it make more sense to talk about weak credit markets depressing interest rates? Or should we say the Fed caused interest rates to fall during 2007-08? And if the latter, exactly how did the Fed cause interest rates to fall? After all, they did not increase the monetary base, which is their usual way of causing interest rates to fall. (This is pre-IOR).

Opinions will differ, but I think it’s more useful to talk about weak credit markets causing a decline in interest rates, and the Fed just sort of getting out in front of the parade by adjusting its official target as the “natural rate of interest” fell during 2007-08. But since the Fed always has the technical ability to move the actual interest rate away from the natural rate, at least for a period of time, others will prefer to say that the Fed caused interest rates to decline. I would not strongly object to that claim. Still, it is interesting that while other pundits would agree with me on the fracking boom example, they’d probably disagree here, insisting it was the Fed that cut rates.

What I would strongly object to is the claim that the Fed caused interest rates to fall during 2007-08 with an easy money policy. I defy anyone to come up with a coherent definition of easy money, which would imply that money was easy during 2007-08 (when nominal rates fell), and also easy during the second half of 2008 (when real rates soared), and was also tight during the Argentine hyperinflation of the 1980s (when the base soared).

I recently gave a talk at Kenyon College, and this post (along with another at Econlog) was motivated by a discussion with Will Luther.  He directed me to an earlier post of his:

I was pleased to see David Henderson call out Bill Poole for claiming the Fed sets the federal funds rate. It doesn’t, of course. Welcome to the Wicksell Club, David! We don’t have ties or t-shirts. But our common cause is worthwhile.

Many of my economist friends get annoyed when I insist they refer to setting the federal funds rate target (as opposed to setting the federal funds rate). They know that the Fed is not literally setting the federal funds rate; that the rate is determined by suppliers and demanders in the overnight market; and that the Fed, as Bernanke has made clear, has a limited influence on even short term rates. But, they maintain, it is a convenient shorthand of little consequence.

I disagree. Perhaps I have spent too much time in a liberal arts environment, but I believe the language we use matters. In this case, the dominant Fed-sets-rate language makes it easy to assume that the federal funds rate is low because the Fed’s target is low. It makes it difficult to even consider the possibility that the Fed’s target is low because the market-clearing federal funds rate is low. Moreover, it suggests the Fed is in a direct and dominant position when, in fact, the Fed plays an indirect role and, at least by my assessment, is subservient to routine market forces. It also seems to perpetuate the all-too-common error of associating low rates with expansionary monetary policy and high rates with contractionary monetary policy. (Scott Sumner is right: Interest rates are not a reliable indicator of monetary policy.)

The Mercatus Center is a good resource for papers that discuss this issue. Check out Jeffrey Hummel’s paper.  A somewhat related paper by Thomas Raffinot is also useful.

Japan bleg

I will be visiting Japan next month (Tokyo/Kyoto and some rural areas) and would appreciate any suggestions (more along the lines of things to see, rather than places to eat.)  I was told the Bank of Japan has an excellent museum of woodblock prints, but was not able to find any information online.

When I was young, Britain was my favorite country.  Now it’s Japan, mostly due to Japanese art.  This will be my first trip to Japan.

Also, any suggestions for dealing with a foot problem (plantar fasciitis?) would be welcome.  I always do a lot of walking when I travel, and my left foot has been killing me for the past month.

Looking forward to my first “real” vacation in many years.


The government is beginning to see the light

Before getting into the main topic of the post, I’d like to point out that Mercatus has recently published a new primer on NGDP targeting, as well as futures targeting, written by Ethan Roberts and myself. I recommend it to people who want a short introduction to the concept:

The first section will clearly define monetary policy, describe the two main methods that central banks have traditionally used to carry out policy, and analyze the weaknesses of these methods. Later sections will articulate what NGDP is and how a policy of NGDP targeting works. Subsequent sections will list the most common criticisms of NGDP targeting and explain why these criticisms are misguided, and they will present arguments in support of the policy. Finally, the primer will provide specific recommendations for how to move from the current system to a system based on NGDP futures targeting.

I have a relatively low opinion of government, so I was very pleasantly surprised to see an outstanding report on monetary policy by the Joint Economic Committee.  You really need to read the entire thing, or at least the entire chapter entitled “Macroeconomic Outlook” from page 51 to 94, but here are a few excerpts:

The Report and Federal Reserve officials find low inflation rates “puzzling,” especially given the low unemployment rates. The “Phillips Curve” theory of price inflation posits that low unemployment rates drive up wages, which leads firms to raise prices to offset rising costs. The Committee Majority explores alternative explanations for below-target inflation. Notably, monetary policy may not have been as “accommodative” as commonly perceived.

The report then began describing policy in 2008, which was aimed at rescuing banks, not the broader economy:

Federal Reserve Bank of Richmond senior economist Robert Hetzel succinctly described the unusual credit policy:

Policies to stimulate aggregate demand by augmenting financial intermediation provided an extraordinary experiment with credit policy as opposed to monetary policy.

The Fed bought financial instruments from particular credit markets segments to direct liquidity toward them, which had the effect of injecting reserves into the banking system. This action alone would incidentally ease monetary conditions, but the Fed then sold Treasury securities from its portfolio to withdraw those reserves from the banking system (called “sterilization”), thereby restricting nominal spending growth.

I also get cited a few times:

Furthermore, despite the low level of the Fed’s fed funds rate target, monetary policy arguably remained relatively tight, as monetary economist Scott Sumner notes in the context of a 2003 Ben Bernanke speech:

Bernanke (2003) was also skeptical of the claim that low interest rates represent easy money:

[Bernanke:] As emphasized by [Milton] Friedman… nominal interest rates are not good indicators of the stance of monetary policy…The real short-term interest rate… 55 is also imperfect…Ultimately, it appears, one can check to see if an economy has a stable monetary background only by looking at macroeconomic indicators such as nominal GDP growth and inflation.

Ironically, by this criterion, monetary policy during the 2008-13 was the tightest since Herbert Hoover was President.

Then it discusses why various QE programs had little impact:

The Fed was clear from the outset that it would undo its LSAPs eventually (i.e., remove from circulation the money it created in the future). The temporary nature of the policy discouraged banks from issuing more long-term loans. Alternatively, as economist Tim Duy pointed out during the inception of the Fed’s first LSAP program:

Pay close attention to Bernanke’s insistence that the Fed’s liquidity programs are intended to be unwound. If policymakers truly intend a policy of quantitative easing to boost inflation expectations, these are exactly the wrong words to say. Any successful policy of quantitative easing would depend upon a credible commitment to a permanent increase in the money supply. Bernanke is making the opposite commitment—a commitment to contract the money supply in the future.

Sumner (2010), Beckworth (2017), and Krugman (2018) observe similar issues. Furthermore as Sumner (2010), Feldstein (2013), Beckworth (2017), Selgin (2017), and Ireland (2018) note, payment of IOER at rates competitive with market rates led banks to hoard the reserve, which contributed at least partially to the collapse of the money multiplier (Figure 2-3).

And it wasn’t just right of center economists that objected to IOR:

Regarding IOER, former Federal Reserve Vice Chairman Alan Blinder advised in 2012:

I’ve been urging on the Fed for more than two years: Lower the interest rate paid on excess reserves. The basic idea is simple. If the Fed reduces the reward for holding excess reserves, banks will hold less of them—which means they will have to find something else to do with the money, such as lending it out or putting it in the capital markets.

He later observed in 2013:

If the Fed charged banks rather than paid them, wouldn’t bankers shun excess reserves? Yes, and that’s precisely the point. Excess reserves sitting idle in banks’ accounts at the Fed do nothing to boost the economy. We want banks to use the money.

I suggested negative IOR way back in early 2009.

They also point out that the Fed has ignored the intent of the Congressional authorization of IOR:

The law specifies that IOER be paid at “rates not to exceed the general level of short-term interest rates.” However, from 2009- 2017, the IOER rate exceeded the effective fed funds rate 100 percent of the time, the yield on the 3-month Treasury bills 97.2 percent of the time, and the yield on 3-month nonfinancial commercial paper 82.1 percent of the time (Figure 2-5). The Fed is including its own discount rate (the primary credit rate) in the general level of short-term interest rates to demonstrate compliance with the law.

In connection to IOER, Representative Jeb Hensarling, Chairman of the House Financial Services Committee, stated:

[It] is critical that the Fed stays in their lane. Interest on reserves – especially excess reserves – is not only fueling a much more improvisational monetary policy, but it has fueled a distortionary balance sheet that has clearly allowed the Fed into credit allocation policy where it does not have business.

Credit policies are the purview of Congress, not the Fed. When Congress granted the Fed the power to pay interest on reserves, it was never contemplated or articulated that IOER might be used to supplant FOMC. If the Fed continues to do so, I fear its independence could be eroded.

The following is also an important point—making sure than monetary policy continues to be about money:

Noting that the large quantity of reserves produced by the Fed contributed to the fed funds rate trading at or below the IOER rate, John Taylor of Stanford University’s Hoover Institution said:

[W]e would be better off with a corridor or band with a lower interest rate on deposits [IOER] at the bottom of the band, a higher interest rate on borrowing from the Fed [the discount rate] at the top of the band, and most important, a market determined interest rate above the floor and below the ceiling… We want to create a connect, not a disconnect, between the interest rate that the Fed sets and the amount of reserves or the amount of money that’s in the system. Because the Fed is responsible for the reserves and money, that connection is important. Without that connection, 63 you raise the chances of the Fed being a multipurpose institution.

Most importantly, the government is beginning to recognize that it was tight money that caused the Great Recession:

The preceding observations and alternative views merit consideration. In particular, Hetzel (2009) states:

Restrictive monetary policy rather than the deleveraging in financial markets that had begun in August 2007 offers a more direct explanation of the intensification of the recession that began in the summer of 2008.

When people like Hetzel, Beckworth and I made that claim back in 2008-09, we were laughed at.  Who’s laughing now?

China is cleaning up fast

Here’s the NYT:

On March 4, 2014, the Chinese premier, Li Keqiang, told almost 3,000 delegates at the National People’s Congress and many more watching live on state television, “We will resolutely declare war against pollution as we declared war against poverty.” . . .

Four years after that declaration, the data is in: China is winning, at record pace. In particular, cities have cut concentrations of fine particulates in the air by 32 percent on average, in just those four years.

Back in 2013, I was very skeptical of claims that pollution was dramatically shortening life expectancy in China.  Despite the following, I’m still skeptical.

To investigate the effects on people’s lives in China, I used two of my studies (more here and here) to convert the fine particulate concentrations into their effect on life spans. . . . Applying this method to the available data from 204 prefectures, residents nationally could expect to live 2.4 years longer on average if the declines in air pollution persisted.

The roughly 20 million residents in Beijing would live an estimated 3.3 years longer, while those in Shijiazhuang would add 5.3 years, and those in Baoding 4.5 years. . . .

The U.S. Clean Air Act is widely regarded as having produced large reductions in air pollution. In the four years after its 1970 enactment, American air pollution declined by 20 percent on average. But it took about a dozen years and the 1981-1982 recession for the United States to achieve the 32 percent reduction China has achieved in just four years.

. . . Bringing all of China into compliance with its own standards would increase average life expectancies by an additional 1.7 years (as measured in the areas where data is available). Complying with the stricter World Health Organization standards instead would yield 4.1 years.

I’m still not buying these claims.  Beijingers currently live to be 82.  Will this reduction in pollution push their life expectancy up to 85.3?  I doubt it.  Would meeting the WHO standards boost life expectancy up an additional 4.1 years to 89.4?  Very unlikely.

To be sure, life expectancy has been rising in Beijing, and will keep rising–perhaps to 85 or 86.  But that was equally true when pollution was getting worse.  The effects of pollution have been exaggerated in the press, as Andrew Gelman so ably pointed out back in 2013.

Having said all that, this news is certainly very good, and means that Chinese RGDP growth was overstated during the boom period of 1980-2012, and is currently being understated.