Cochrane on Fed policy and humility

Lars Christensen has an excellent post discussing John Cochrane recent op ed in the WSJ.  I’ll borrow one of the passages also quoted by Lars:

First lesson: Humility. Fine-tuning a poorly understood system goes quickly awry. The science of “bubble” management is, so far, imaginary.

Consider the idea that low interest rates spark asset-price “bubbles.” Standard economics denies this connection; the level of interest rates and risk premiums are separate phenomena. Historically, risk premiums have been high in recessions, when interest rates have been low.

…Second lesson: Follow rules. Monetary policy works a lot better when it is transparent, predictable and keeps to well-established traditions and limitations, than if the Fed shoots from the hip following the passions of the day. The economy does not react mechanically to policy but feeds on expectations and moral hazards. The Fed sneezed that bond buying might not last forever and markets swooned. As it comes to examine every market and targets every single asset price, the Fed can induce wild instability as markets guess the next anti-bubble decree.

Third lesson: Limited power is the price of political independence. Once the Fed manipulates prices and credit flows throughout the financial system, it will be whipsawed by interest groups and their representatives.

Great stuff. Unfortunately the Fed is going in the other direction, and it will get worse under Summers.



13 Responses to “Cochrane on Fed policy and humility”

  1. Gravatar of Edward Edward
    1. September 2013 at 09:12

    John Cochrane drives me insane,
    I had a spat with him on his most recent post,

  2. Gravatar of Saturos Saturos
    1. September 2013 at 09:36

    So Lars Svensson has a blog. WHY HASNT SCOTT LINKED TO IT YET???
    These slides seem relevant, for instance (found on his blog):

  3. Gravatar of Saturos Saturos
    1. September 2013 at 09:58

    Cochrane does have a great recent post (actually three weeks old) on carbon taxes:

  4. Gravatar of ssumner ssumner
    1. September 2013 at 10:35

    Edward, Good comments at Cochrane.

    Saturos, Do you have a link for Svensson’s blog? I didn’t know he had one.

    I agree with much of what Cochrane says, but on balance I’m still more pro-carbon tax than he is. I think he underrates the extent to which global warming is a “known known” whereas some other catastrophic risks are more speculative.

    Still, I could support his final suggestion.

  5. Gravatar of Saturos Saturos
    1. September 2013 at 21:32

    Scott, just subscribe to He’s put the blog on the front page of his academic site,

  6. Gravatar of Saturos Saturos
    1. September 2013 at 21:35

    Any thoughts on this Scott?

  7. Gravatar of Steve Steve
    1. September 2013 at 23:10

    Saturos, ssumner,

    I would argue that a carbon tax will actually be *more* distortionary than the current patchwork of regulations.

    I know that seems crazy — that’s not how it works in the ivory tower laboratory — but a carbon tax is so heavily regressive, and also so punitive to competitiveness of globally exposed industries, that the government would inevitably create so many loopholes the result would be ugly.

    Consider Boxer-Sanders, and the proposed $600 billion EPA slush fund to be used to reimburse businesses and individuals who are unduly harmed — with the reimbursement determined at the discretion of the EPA with no congressional oversight!!!

    Yes, the current patchwork of regulations is horrible. But the mere threat of more regulation (including potential carbon taxes) serves as an overhang to discourage bad behavior, while overly onerous regulations tend to be rewritten (eventually) when the costs prove to be high.

    Unfortunately, there are so many uncertainties in the “carbon problem” that there is zero chance of getting more clarity than a patchwork of regulatory hacks, and a carbon tax wouldn’t change that. Uncertainties include:
    1) Technological progress — batteries, efficiency, solar, nuclear, biofuel, sequestration, etc.
    2) Will other countries play “follow the leader” if the US moves? That’s the ex-post justification for a domestic solution to a global problem, but it’s rarely evaluated critically.
    3) Climate science uncertainties — still at least an order of magnitude spread between the low case and the high case. Orders of magnitude generally matter in economics…

  8. Gravatar of Steve Steve
    1. September 2013 at 23:28

    Elaborating on point 2, there’s an enormous moral incongruity to a carbon tax. The supposed rationale is that CO2 imposes an external cost. The problem is that virtually all of that cost falls on citizens outside the United States, but carbon tax advocates don’t at all seem interested in reimbursing the alleged victims. Rather, carbon tax advocates prefer to reimburse a third party, the wealthy urbanite who works in a domestic service industry.

    Put another way, if technology, innovation and capital stock accumulation are the answers to CO2, America is and will continue to be a leader.

    But if CO2 imposes a crippling cost on global humanity, and Americans try to justify keeping a carbon tax bounty within its own borders, I doubt the rest of the world will share a liberal sense of moral smugness for taking “carbon tax leadership.”

  9. Gravatar of Saturos Saturos
    2. September 2013 at 07:42

    Steve, your first post doesn’t explain why the patchwork regulations are any better. I’d prefer other parts of the tax code being used to compensate for any inevitable regressivity. And I think the argument is that if it comes to the point where much of the developing world will need to be compensated, we’re screwed anyway – revenues from a carbon tax should be allocated to further R&D to abate the problem (costs we can bear disproportionately); which is more pressing than compensating the wealth of those nations for bearing the burden.

  10. Gravatar of ssumner ssumner
    2. September 2013 at 07:52

    Saturos, Yes, I’m doing a post on that.

    Steve, I don’t see why carbon taxes would be “crippling.”

  11. Gravatar of Steve Steve
    2. September 2013 at 09:03

    Saturos, ssumner,

    The problem is that a carbon tax *IS* a patchwork of regulations. It’s basically an opt-out system rather than an opt-in system. Boxer-Sanders proposes that 40% of society get exempted from the tax, but only if they can persuade an unelected and unaccountable group of bureaucrats at the EPA in Washington DC that they deserve an exemption. I believe Australia encountered the same problems with a carbon tax, but I’m not an expert on Australia.

    If the goal is to force consumers to be more efficient, then the CAFE, LEED and EnergyStar programs seem to work. Add on restrictions on coal power, and fund national research labs. An opt-in patchwork forces national debate on these sorts of programs.

    The problem with an opt-out patchwork (a carbon tax with rebates) is that it operates in the shadows and rewards the well connected who are more easily able to garner exemptions. This happens precisely because of the (false) claim that a carbon tax is an elegant, fair, and all-encompassing solution to the problem. It’s the NSA, Obamacare, and IRS all rolled into one.

    Think about it on a case by case basis. Suppose you are a small business trying to develop a new (3d?) manufacturing tech. Are you globally exposed? No, you don’t even have any customers yet. Rebate denied without comment.

    Suppose you are a blue collar worker at an ammonia plant. You commute by car, because there’s no alternative. Mixed use zoning doesn’t happen at fertilizer factories. But your “choice” to commute by car is undesirable. Rebate denied.

    Suppose you own the ammonia plant. You probably have a lobbyist. Rebate approved.

    Suppose you represent the Harvard endowment. You want half a billion a year for your “carbon sinks”, i.e., timber land in Idaho. Call up your Kennedy School buddy at the EPA. Done deal. Half a billion annual rebate, no questions asked.

  12. Gravatar of Steve Steve
    2. September 2013 at 11:41

    “if it comes to the point where much of the developing world will need to be compensated, we’re screwed anyway”

    Send the Army Corps of Engineers to Bangladesh. Spend $50 billion on flood control infrastructure. It gives the army something useful to do, and it actually helps the supposed victims of CO2. No one is screwed anyway, except for the Beltway crowd who were expecting a carbon tax honey pot.

  13. Gravatar of Scott Sumner Scott Sumner
    3. September 2013 at 09:59

    Steve, I oppose a carbon tax with opt outs.

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