Archive for the Category financial regulation


Greg Ip on monetary policy

Where does all the time go?

I just noticed that I’ve fallen behind on the set of podcasts by David Beckworth, so I will work through the ones I’ve missed, starting with the Greg Ip, one of our best economic journalists.  Here’s my favorite comment by Ip:

And it actually may be better to have lots of small financial disruptions than one big financial disruption.

In Greg’s recent book he discusses this idea in more detail.  In the interview, Greg uses analogies such as the danger of continually preventing small forest fires, and thus building up fuel for a catastrophic fire.

Over the past 50 years the government has prevented financial crises about every decade or so, by either bailing out depositors of large banks, or arranging assistance in the case of LTFC (1998).  And this had the effect of storing up fuel (moral hazard) for an even bigger crisis in 2008.  But I would go much further that Ip, who approves of FDIC.  It’s not politically possible to abolish FDIC, but perhaps we could create a two-tier system where insured deposits are backed by safe assets, so that taxpayers are not put at risk.  Deposits used for lending to businesses and homebuyers would not be insured, but would offer higher interest rates to depositors.  Let bank depositors choose how much risk they are willing to take.  Ip also is appropriately critical of the regulatory overreach of Dodd-Frank. BTW, banks would hate my FDIC reform proposal, but it could be combined with the complete repeal of Dodd-Frank.

There are also a few areas where I disagreed with Ip.  At one point he wondered why there was so much discussion of the need for monetary stimulus. After all, unemployment in the US and Japan is relatively low, and the unemployment rate in the eurozone is now declining at a decent clip.  This is a good argument, but I think he’s also missing something important.  Monetary policy must be judged as a regime, not in terms of day-to-day considerations of macroeconomic stability.

For better or worse, central banks now focus most of their effort on inflation targeting, with some attention also paid to keeping unemployment close to the natural rate. Recall that the natural rate hypothesis predicts that the public will eventually adjust their expectations to match any inflation rate, and unemployment will eventually move back to the natural rate.  When viewed from this perspective, I think what Greg’s really asking is what difference does it make if the Eurozone has 1% inflation, or 1.9% inflation, as long as it is reasonably steady and as long as unemployment seems to be adjusting back to the natural rate.

I see two problems with the ECB allowing 1% inflation to be the new normal:

1.  If this were to occur, the public would lose faith in the ECB’s inflation promises. This would make ECB policy less effective in the next crisis.  If central banks are going to set inflation targets, then those targets should mean something.  If they decide not to target inflation (as I’d prefer) then it’s essential that they set some other target, such as NGDPLT.

2.  If 1.0% inflation, rather than 1.9% inflation, becomes the new normal in the ECB, then nominal interest rates will move to a permanently lower track.  And since real interest rates seem to be entering a new normal which is well below the rates we saw in the 20th century, a lower trend rate of inflation would mean that the ECB will be stuck at the zero bound for a much greater percentage of the time.  Indeed financial markets are already quite pessimistic about the future course of eurozone rates, especially for safe assets like German and Swiss long-term bonds.

Notice that points 1 and 2 relate to each other; both make it more difficult for the ECB to achieve its goals in the future.  So there is real value in taking an announced inflation target seriously, and trying to hit it.  BTW, the US is doing much better than the eurozone and Japan on the inflation front, but just today Kocherlakota warned that even the US is likely to fall short of 2% inflation going forward.  (I’m a moderate on this question—I think they’ll probably fall a bit short, but perhaps not as much as Kocherlakota and some of my fellow MMs believe.  I see something around 1.8% as the new normal.)

At one point Ip asked David the question of what should the Fed actually do to implement an NGDPLT policy regime.  I hate these “concrete steppes” questions, but we need to face the fact that this is what everyone wants to know.  The reason why I hate these questions is because I know the sort of answer people are looking for:

Desired answer:  Some big bazooka of a monetary policy instrument that is so powerful that it can clearly move NGDP to the desired policy path.

My answer:  NGDPLT is the big bazooka, and once implemented you merely need to do tiny little OMOs, like we did back before 2008.

And I know that this answer won’t satisfy anyone.  They think money has been very easy, and if we’ve fallen short then we must need very, very, very easy policy.  We MMs think money has been tight, and that a NGDPLT target could be hit with the sort of moderate policy we had before 2008.  In other words, if 5% NGDPLT were adopted in 2007, or right now, the policy would look pretty much like what you saw in Australia after 2007, or what you see in Australia today.  Positive interest rates.

But yes, you do need a big “instrument” bazooka lurking in the background, just in case.  That makes the system credible, so that you don’t actually have to use it. For David the big bazooka is the Treasury, promising to do a coordinated fiscal/monetary expansion if the Fed runs out of ammo.  For me the big bazooka is a Fed promise to buy any and all financial assets, anywhere in the world, until market expectations of NGDP growth are equal to 5% (or whatever the target chosen.)

And the other point I always make is that the lower the NGDP target (i.e. the lower the trend inflation rate) the bigger the Fed balance sheet as a share of GDP.  If NGDP growth is so low that nominal rates fall to zero, then the Fed balance sheet can get very large.  If the NGDP target rate is set high enough where rates stay above zero, then the Fed balance sheet stays small.  I prefer a small Fed balance sheet.

Inflation or socialism?  It’s your choice.

Sad news from down under

[Update:  Check out the comment section, it looks like the US is ultimately to blame for this too.  Everywhere I travel I hear people complaining about our government’s arrogance.  People tell me “I used to look up to the US.”  I no longer hear anything positive about the US.  Meanwhile we have a welcome sign out for corrupt officials from all over the world who want to launder money here in real estate, and we couldn’t care less what the rest of the world thinks about it.  Do as we say, not as we do.  What a disgraceful government. Just one more issue the media will ignore, as they cover the clown show called “debates”.]

When I visited Australia and New Zealand back in 1991 they seemed like much freer countries than America.  Probably they still are.  But I was disappointed to see this:

Over the past seven years, the team at Victoria Link have been running New Zealand’s only prediction market, iPredict. It is one of only three “commercial” prediction markets operating globally. We’ve really enjoyed turning it from research into a practical tool which has become part of the New Zealand political narrative.

Prediction markets function based on the assumption that people will be more accurate when they back their opinion with money. There is a wide academic field studying this, and it could one day result in more accurate forecasting of a huge variety of events and even change how governments make decisions.

As prediction markets do not comfortably fit within any existing regulatory boxes, we have been working closely and positively with the Financial Markets Authority (FMA) to enable us to operate economically within the financial market regulations.

Regrettably the Ministry of Justice has not been so positive. We applied for an exemption from the Anti-Money Laundering and Countering Financing of Terrorism Act. We believed we would secure an exemption due to the limited possible investment into iPredict trades and the small nature of the Prediction market transactions.

Our application has been declined by the Minister, Simon Bridges, on the grounds that we are “a legitimate money laundering risk”. This is essentially because we have no customer due diligence checks. He considered the level of regulatory burden is proportionate to the risk. He formed these views without any discussions with us.

We are an academic not-for-profit organisation and our agreement with the FMA dictates we place caps on transactions. For example, over the past seven years, we have handled a total of 3,782 withdrawals, with an average trader net worth of $41. Our withdrawal process is lengthy and we are a low risk of money laundering.

Because the cost of compliance is too high, we are forced to wind up operations in NZ.

It seems that it’s not just the US government that is anti-science, other governments are too.

Over at the blog Offsetting Behavior they printed an email from Glenn Boyle, who helped set up iPredict:

When we were setting iPredict up between 2005 and 2008, all the holdups were technological and financial, not regulatory.  Liam Mason and others at the Securities Commission were generally helpful and tried to eliminate roadblocks rather than put them in our way, and there certainly didn’t seem to be any impediments thrown at us by ministers.

I recall the money laundering bogeyman coming up only once, and then only in jest.  I don’t remember the exact wording, but it was something along the lines of “you’ll probably get hit with money laundering charges if the Americans invade or we ever elect a communist government.”  Ouch…

This wasn’t taken seriously at the time though.  Looking back through all the various memos etc I prepared during the 3+ years iPredict was being set up, I can’t find any reference to money laundering regulation at all.  I guess we were naive!

Ironically, it was a conservative government that put iPredict out of business.  Can’t have people laundering $41, which is what, $28 in US money?

HT:  Stephen Kirchner

The Salem witchcraft trials redux

In the 1600s, Salem put people in trial for being witches.  Today we are much more enlightened; Salem puts people on trial for not being honest-to-God, actual witches.  Or something like that.  In the comment section of my previous post Niklas Blanchard (I wish he was still blogging) reminded me that my impoverished imagination is incapable of dreaming up any absurd analogy that is too far-fetched to be true:

Starting this week, fortune tellers in Warren, Mich., must be fingerprinted and pay an annual fee of $150 “” plus $10 for a police background check “” to practice their craft. The new rules are among America’s strictest on palmists, fortune readers and other psychics, part of a growing push to regulate a business that has never been taken, or overseen, very seriously. But officials in Warren, a town of 138,000 near Detroit, say it’s time to weed out tricksters. “We had no mechanism of enforcement to protect people against unsavory characters,” Warren city-council member Keith Sadowski says. “We want to be sure there is some recourse in case we do get somebody who is not legitimate.” . . .

Three years ago, Salem, Mass., famous for its 17th century witch trials “” and something of a magnet for spiritual artisans “” tightened its rules on background checks for psychics while easing its cap on the number of local fortune tellers allowed in town. . . .

Not all psychics fear tougher government oversight. “I think it’s wonderful,” Julia Mary Cox, a Michigan psychic plying her craft near Warren, says of the town’s new rules. “There are so many people practicing out there, doing it under false pretenses, giving honest people a bad name.” But she concedes she wishes Warren’s new rules could more clearly separate true fortune tellers from false seers. “They are not looking at any training,” she notes. “I have a college degree, I have a background in religion and philosophy and English, and I have experience doing this.”

So I’d like to amend my previous post.  Any insinuation that the government is inconsistent in applying its “principles” is hereby retracted.  The SEC is just following a long and venerable tradition in American regulation.

PS.  Add one more to my American freak show post.

PPS.  Mark, is Keith any relation?

Should soothsayers be regulated?

I have a new post at Econlog that is far more important that this throwaway effort.  I also recommend a recent post on China by David Beckworth, which I initially overlooked.  And excellent posts on the Fed by Tim Duy and Evan Soltas. But if you insist on continuing . . .

Scott Alexander is perturbed that 80% to 90% of doctors don’t know how to answer an extremely simple statistics question like this:

Ten out of every 1,000 women have breast cancer. Of these 10 women with breast cancer, 9 test positive. Of the 990 women without cancer, about 89 nevertheless test positive. A woman tests positive and wants to know whether she has breast cancer for sure, or at least what the chances are. What is the best answer?

(OK, technically 26% got it right, but it was multiple choice with 5 choices—you do the math.)  Nobody who’s taught in college should be surprised by this.  Unless you test students on material that they are told they’ll be tested on, and that they studied for the night before, most students basically can’t answer anything, even 8th grade level questions. Heck, I’d probably get some elementary stat questions wrong (although at least I can do the “story problems” like the one above) Alexander is concerned about the implications of this (here’s he’s referring to another question):

Good news! 42% of doctors can correctly answer a true-false question on p-values! That’s only 8% worse than a coin flip!

And this paragraph is your friendly reminder that six months after this study was published, the FDA decided it was unsafe for individuals to look at their own genome since they might misunderstand the risks involved. Instead, they must rely on their doctor. I am sure that statisticians and math professors making life-changing health or reproductive decisions feel perfectly confident being at the mercy of people whose statistics knowledge is worse than chance.

Obviously I agree.  But the FDA is model of rationality compared to the SEC.  At least with the FDA you can sort of understand the logic of the regulation.  If doctors actually knew what they theoretically should know, what they were taught in college, then they would have more expertise than the average person.  But not even that excuse is true for the regulation of stock pickers:

The Investment Advisers Act of 1940 is a United States federal law that was created to regulate the actions of those giving investment advice for compensation as means to protect the public.

The Act defines an “investment adviser” as anyone who, for compensation engages in the business of advising others about the value of securities or the advisability of investing in, purchasing, or selling securities.

So you go to your investment adviser for stock picking advice, not to some idiot like me. And that’s because your investment advisor is better able to pick the right stocks and mutual funds than I can.  Or at least that’s the theory.  In fact, they do worse than I’d do, in all but a few cases.  The rest of the post will exclude the tiny number of investment advisors that simply tell you to put everything into low cost index funds.

For the rest, the vast majority of regulated investment advisers, they either understand than indexed funds outperform managed accounts, and hence are dishonest, or they don’t understand and are incompetent.  So the SEC regulation virtually forces people like my mother to go to investment advisers who are either knaves or fools.

(On the other hand if doctors profit from needless cancer tests, then maybe medicine isn’t so different from the investment industry.  Maybe the doctors are just pretending not to understand statistics, as a cover.)

Progressives like to talk about the “science” of an issue (at least sometimes, not the science of gender differences, or GMO foods, or taxing capital income, or free trade, or that studies show that voucher schools are cheaper, but at least for global warming.) OK, the science of finance says that indexed funds outperform managed funds.  That stock pickers are no more helpful to investors than soothsayers. So if we force stock pickers to be regulated, why not do the same for palm readers, fortune tellers, soothsayers, tea leaf readers, and all the rest?  Alternatively, is the SEC going after unlicensed stock pickers any different from the leaders of Salem going after witches?  Aren’t both types of prosecution equally “anti-science”?


This is a follow up to my previous post.

Part 1:  Capitalism later

When I was young I believed the GOP was more supportive of small government than the Dems.  I’m not sure why I believed this; when I came of age Nixon was president, and he was arguably the most anti-libertarian president of my lifetime (with the important exception of ending the draft.)

Supporters of the GOP always used to say that the president (Nixon, Ford, Reagan) wanted smaller government, but the Congress wouldn’t go along.  When the GOP finally took Congress in 1994, the alleged roadblock was President Clinton.  Finally, in 2001 nirvana arrived for us libertarians; the GOP took all branches of government, and we got . . . one of the biggest new entitlement programs in history, a massive increase in the National Security State, and a much greater Federal involvement in education.  The fastest growth in Federal spending since LBJ was president (for several years.)

That should have ended any illusions about the GOP being the party of small government, except to the most hopelessly deluded.  But with the rise of the Tea Party movement we are again hearing this meme—the GOP wants to trim the size of government.  For instance, the GOP has spent the last two years bashing Obama for not reining in Fannie and Freddie.  And now that they have taken Congress, the Wall Street Journal says they are ready to act:

Earlier this year, leading House Republicans proposed to privatize mortgage giants Fannie Mae and Freddie Mac or place them in receivership starting in two years.

Now, as Republicans prepare to assume control of the House next week, they aren’t in as big a rush, cautioning that withdrawing government support in the housing market should be gradual. . . .

Republicans were backing a bill by Rep. Jeb Hensarling (R., Texas) to start cutting the government’s ties to the mortgage giants or begin winding them down in two years; if they were deemed financially viable, they would become fully private within five years.

“Of all the dumb regulation that caused our economic crisis, none was dumber than that which created the (Fannie and Freddie) monopolies,” Mr. Hensarling said in March. . . .

Many Republicans now concede that a speedy exit may not be practical, because Fannie Mae and Freddie Mac have such a dominant position in the nation’s housing market. Mr. Garrett said he has “not established a specific timeframe for winding them down.”

[Insert obligatory Claude Rains exclamation here.]

Some might argue that the GOP is simply facing reality, the economy is weak and a drop in the housing market might further depress aggregate demand.  But since when is the GOP worried about AD?  They have been insisting that the Fed is making a mistake in trying to boost AD with a more expansionary policy—that this would merely bail out the Obama administration’s failed big government policies.  No, the GOP is not motivated by a desire to boost AD.  And neither are they opposed to more intervention in the free market.

The mostly like explanation is that the GOP’s paymasters in real estate and banking quietly had a word with them after the election.  I’d guess it went something like this:

“We greatly appreciate the help from the Tea Party in getting you guys back into a position of power.  But now these neophytes need to step aside and let the big boys take over.”

So which is it?  Is the GOP lying when they say we don’t need more AD, and that Fed policy is too easy?

Or are they lying when they say we need smaller government, and that the housing fiasco was caused by people like Barney Frank, who promoted the GSEs?

Part 2:  Regulation later

And then there’s the Dems.  They used the subprime fiasco to rail against unregulated free market capitalism, the so-called “market fundamentalism” of people like . . . well people like me.  Of course the true market fundamentalists were always opposed to the housing/banking system, which was riddled with moral hazard.  Unfortunately there were plenty of so-called market fundamentalists who cheer-leaded the “deregulation” of banking the the US, Ireland, Iceland, etc, thereby discrediting the entire movement.

In any case, the Dems did get around to “re-regulating” the housing mortgage system in the US.  More than a kilo-page of re-regulation.  There’s just one thing, they forgot to ban un-insured subprime mortgages.  That’s right, the alleged cause of the entire mess, which is already banned in many countries the Dems seem to hold up as models, was given a free pass.  There is no requirement that buyers put at least 20% down.  Indeed there is no requirement that they put even 5% down.  Nor are there any plans to phase in such a ban over a 5 or 10 year time frame.

So if regulation isn’t really the motivation of the Dems, what is?  The same WSJ article provides one answer:

Democrats tend to favor a more active role for the government in housing to ensure that underserved communities have access to mortgages.

So there you are.  The GOP doesn’t favor small government and the Dems don’t favor regulation.  Instead the GOP favors a bloc of people who vote for the GOP and contribute money to their campaigns, and the Dems favor a bloc of people who vote for the Dems and contribute money to their campaigns.

I’m not so cynical (yet) that I would deny there are some idealists in politics.  My hunch is that some politicians (even some I don’t like such as Barney Frank) are driven partly by idealistic motives.  After all, Frank recently mentioned abolishing Fannie and Freddie.  But whatever idealism exists is not strong enough to overcome the special interest groups.

Fortunately, good governance is not a zero-sum game, so once and a while the two parties come together and strike a deal that is win-win (such as the 1978 deregulation bill, or the 1986 tax reform, or the 1996 welfare reform.)

The most one can hope for is that some creative politician will be able to cobble together another such compromise sometime in the next 10 years.   Of course it would be much easier to do if we were Switzerland, Denmark, or Singapore.  Heck, if we were even Canada or Australia.  But we are a nation of 310 million people with very diverse cultural values and perspectives on economics.

Happy New Year!