Archive for March 2023


Alternative Approaches to Monetary Policy

That’s the title of my new book, which can be found for free at this link:

Alternative Approaches to Monetary Policy

A few comments:

1. This is just a rough draft, although it has gone through the editorial process, so I hope there are relatively few typos. I will revise the book after receiving feedback, and the revised book will eventually come out as a “first edition.” That version will also be available online for free, or in paper for a modest price.

2. You can think of this book as addressing the question of how to identify monetary policy. In my view, a big failure of the profession has been the widespread assumption that the Fed adopted an easy money policy in 2008 and a tight money policy in 2022. Both claims are false, indeed exactly the opposite is true. That’s bad!! And that’s what motivates me to keep harping on this issue.

3. These false beliefs about monetary policy have important consequences; they contribute to bad policy decisions.

I’ll have lots more to say about the book in the future. I hope the final version is much better than the current version.

The following graphs from page 101 illustrate some of my views on the relationship between the stance of monetary policy, exchange rates (E), interest rates, and the monetary base.

Two views

There seems to be an increasingly widely held view that the US is about to slide into recession. One piece of evidence is the inversion of the yield curve.

And yet, the level of fed funds futures is still pretty high in early 2024, around 3% to 4%. That’s much higher than during 2019, which was a boom year. Indeed, that suggests a soft landing. So what’s going on? I’m not sure, but here’s one hypothesis worth considering:

Let’s suppose that I’m correct in my claim that the US economy is wildly overheated. In that case, we might observe a recession in growth rate terms and yet a relatively strong economy in terms of levels.

I recall a recent set of posts by George Selgin that showed how the US economy was pretty strong in the years after 1945, despite a big drop in measured GDP from the overheated levels of WWII. Obviously we aren’t as overheated as during that war (when unemployment fell to barely above 1%), but our labor market is more overheated than during any period I can recall. I continue to run into service firms that cannot meet demand because they simply cannot find the workers.

I realize that this is an optimistic scenario and there are plenty of reasons to be pessimistic. Here are two examples:

Reducing inflation is often painful.

Biden’s economic policies are pretty inefficient.

Nonetheless, the level of interest rate futures for 2024 still leaves me a glimmer of hope that we might get a softish landing—not so much in terms of RGDP growth (which will likely be poor), but in terms of the labor market.

(I don’t like to forecast either asset prices or the business cycle. But consider “labor market better than RGDP” to be my conditional forecast for 2023-24. BTW, that also describes 2022.)

PS. People keep asking me about AI. I do believe that at some point it will boost growth. But recall that it took about 40 years to go from the early IBM computers in the 1950s to the tech productivity spurt of 1995-2004. And even that lasted only a decade. I’ll believe it when I see trend RGDP moving back above 2%.

The principle of parsimony

In November, a SARS outbreak occurs in an area around a wild animal market in a giant city in southern China. The city is more that 1000 kilometers from the bat caves where SARS viruses are believe to originate. It is believed that the virus went from bats to mammals sold in the market, who then infected human workers and shoppers.

Of course I’m describing the 2002 SARS-1 outbreak.

And also the 2019 SARS-2 outbreak. And yet for some bizarre reason, most people view these two events as being completely unrelated. An alternative “lab leak” hypothesis has gained majority support, despite precisely zero pieces of evidence in favor of that hypothesis. Consider:

1. The first cases all cluster around the Wuhan animal market, not the Wuhan lab which is a 40 minute drive away, and across one of the world’s largest rivers. If lab workers brought the virus into the vast Wuhan metropolitan area and created a “super spreader” event, what are the odds that it would have occurred in that specific place? Wuhan is a crowded city (I’ve been there), with hundreds of similar places where the public congregates in large numbers. What’s the most parsimonious explanation for the location of the outbreak?

2. There are newly released environmental samples of the virus in the specific part of the animal market where the most suspect animals were sold. Keep in mind that the market is huge, the size of two football fields. Some of those Covid samples contain genetic material from raccoon dogs but not humans. What’s the most parsimonious explanation?

3. Two variants of Covid (A and B) crossed over to humans near the animal market in November or December 2019. Do people really believe that lab workers brought both of those variants to the market? Isn’t the most parsimonious explanation that the virus mutated in the animals (say raccoon dogs), and then spilled over a couple times to humans in the market?

4. Lab leakers wonder why no animal hosts have been found. But we now know that the Chinese are attempting to cover up evidence pointing to the animal market hypothesis. This is a pretty clearly established fact (even if the lab turns out to be the source of the pandemic.) This should be a major scandal! But the Chinese government is getting off scot-free due to the media’s obsession with an alternative narrative that is supported by no evidence.

(I suspect the Chinese government doesn’t know where the pandemic originated, and to play it safe is denying both the lab and the animal market.)

5. Lab leakers continue to propagate false evidence. There are claims that the virus “looks engineered”. False. There are claims that the Wuhan lab took a database offline in September 2019. (This is not true.) But if it were true, what were they covering up? The virus crossed over into humans in November 2019. There have been false claims of Chinese reports of an “emergency” at the lab in November 2019. But then what about the September 2019 timeline? Lab leakers just keep throwing mud at the wall, hoping something will stick. But there’s still zero evidence for a lab leak. None.

I understand there’s still no “proof” that it was the animal market. But come on people, what’s the most plausible explanation here? Ever heard of the principle of parsimony?

For those of you who rely on Fox News for your information, check out this video if you want to expose yourself to some actual evidence.

Fiscal policy to control inflation?

In 1968, President Johnson tried to use tax increases to control inflation. The policy was a miserable failure. This policy experiment helped to launch the supply side movement. Economists like Art Laffer and Robert Mundell argued that a combination of tax cuts and monetary austerity was the best way to achieve a combination of growth and low inflation.

Now we have some progressives arguing the exact opposite, claiming that the best way to control inflation is with higher taxes and less emphasis on contractionary monetary policy. I’d prefer that we don’t use fiscal policy in either direction.

Here’s Simon Balezon and Milan Singh (at the Matt Yglesias Substack), with one of the more thoughtful pieces advocating a role for fiscal policy in fighting inflation:

The collapse of Silicon Valley Bank is in part a story of mismanagement and poor regulatory supervision, but it’s also in an important sense a consequence of the decision by the Federal Reserve and other major central banks to fight inflation by raising interest rates. Which in turn should put on the table the long-ignored question of why exactly interest rate hikes have become the world’s preferred anti-inflationary measure.

A big part of the answer is simply that raising interest rates is a thing that central banks have the legal authority to do, and there’s widespread belief that it makes sense to delegate macroeconomic stabilization to central bankers. But if you step back from that aspect of institutional design, there’s a strong argument that taxes are a superior inflation-fighting tool, one that would slow inflation in a more direct and more predictable manner. If the main problem with fiscal policy as an anti-inflationary measure is that the main inflation-fighting institution isn’t allowed to use it, then maybe optimal policy would involve adding a fiscal dimension to the Fed’s authorities.

After all there is something deeply perverse about raising interest rates to slow the economy only to flip around and do bailouts to prevent interest rates from slowing the economy too much.

I have several problems with this analysis. Let’s start with interest rates, which are a bad way to think about monetary policy. Tight money leads to slower NGDP growth, which leads to lower interest rates. So it’s a mistake to assume that an anti-inflation policy is a high interest rate policy.

Yes, a tight money policy will temporarily cause the market rate to rise about the natural rate of interest, but 90% of interest rate variation is movements in the natural rate, and the Fed reduces the natural interest rate when it adopts a tight money policy.

So then why did interest rates rise in 2022? Because the Fed had an expansionary monetary policy, leading to really fast NGDP growth. (I explain this in more detail at Econlog.)

If you want to reduce the sort of wild interest rate volatility that is occasionally associated with banking distress, then adopt NGDPLT. That won’t completely eliminate interest rate volatility, but it will greatly reduce volatility.

One counterargument is that NGDPLT has (at best) only a 10% chance of being adopted in the foreseeable future. OK, but what are the odds of this Balezon and Singh proposal:

You could imagine a set of institutional arrangements where the Fed (or any nation’s central bank) is authorized to raise or lower the VAT at its regular meetings to control aggregate demand.

Yes, I can “imagine” that. But I’d say there’s less than a 10% chance of the US adopting a VAT in the next few decades, and less than a 10% chance that Congress would give the Fed control of VAT rates if this hugely unpopular tax regime were adopted.

Of course, just because something is a difficult sell doesn’t mean it’s not worth thinking about. But as we saw in 1968, fiscal doesn’t work if monetary policy is off course. And if monetary policy is doing its job, you won’t see all the negative side effects cited by Balezon and Singh.

Let’s focus on getting a sound monetary regime (NGDPLT). If that happens and we find there are still issues to be addressed, then we can start contemplating a role for fiscal policy. Right now I fear that side effects due to bad monetary policy are wrongly seen as being the inevitable side effects of any monetary policy regime. That’s not true.

How many world killers?

How many people wish to destroy all human life? I’d guess the answer is at least six digits, maybe seven. In other words, hundreds of thousands, if not millions.

(If 0.1% of humans wish to kill humanity, that’s 8 million people. If it’s 0.01%, then 800,000 people.)

In the past few years, I can recall several stories of airline pilots committing suicide and taking an entire commercial airliner with them. Depressed people seem to occasionally have an urge to spread their own suffering onto the rest of humanity.

Are airline pilots typical human beings? No, they are screened in an attempt to filter out people with mental problems. If I sit on the subway and scan people’s faces, the average person seems less mentally stable than the average pilot I observe when exiting a plane.

Obviously this is all guesswork, and I don’t think it matters very much whether the number of potential world killers is 800,000 or 8 million. It only takes one.

The real question is whether ordinary people will ever gain the power to destroy the world.

I must confess that I don’t understand the alignment debate. I have no opinion on whether AIs will be capable of pursuing their own goals, which might be unaligned with the best interest of society. My fear is not unaligned AIs, it’s AIs that are aligned with depressed people.

Perhaps there’s no reason for me to have this concern. But if I’m wrong, it’s not because no one would want to destroy the world, it’s because technology with never give individuals the power to destroy the world, and governments have no interest in destroying the world. That’s why I’d be wrong to have this concern.

In any case, I don’t understand why I keep seeing one article after another on what AIs might or might not decide to do, and very little on what they would be capable of doing if used by one of those hundreds of thousands of people that wish to destroy all human life.

If you have trouble imagining what I am talking about, consider a scientist that becomes convinced that humans are destroying the animal kingdom, and then becomes severely depressed. The Unibomber had very weak technology at his disposal. But in the future? Engineer a highly contagious and deadly virus with (like HIV) a long incubation period. Perhaps it’s already happened in a virus research lab.

Lots of people hope that future AIs will be aligned with humans. I fear that future AIs will be aligned with humans. It’s not AI that I distrust, it’s humans.

PS. When you pass a certain age, you become aware that they are many questions that you’ll never see answered. At age 67, I won’t live long enough to see how the world addresses global warming. I probably won’t live along enough to see if they ever complete the high speed rail project in California. I probably won’t live long enough to see which worldwide trend follows the current wave of nationalist authoritarianism. I won’t live to see humans go to Mars. I won’t live to see if fusion energy pans out. I won’t live long enough to see if we can solve the business cycle with NGDPLT.

If you think of long sports careers like LeBron James, the stars entering the NBA today will be the last generation I’ll follow to the end. I’ll never again see a Packer as talented as Rodgers or a Buck as talented as Giannis.

When I was younger, there was a sense of time being limitless. I felt that eventually I would see answers to these sorts of questions. Now I realize that I’ll never find out the endgame for AI. I don’t even have strong views as to what’s likely to happen, other than that the future will be far different and far stranger than we can imagine.