Wednesday, March 4, 2015

Mankiw on dynamic scoring

Greg Mankiw has a nice op-ed on dynamic scoring

The issue: When the congressional budget office "scores" legislation, figuring out how much it will raise or lower tax revenue and spending, it has been using "static" scoring. For example, it assumes that a tax cut has no effect on GDP, even if the whole point of the tax cut is to raise GDP.

This is obviously inaccurate. But, as Greg points out, there is a lot of uncertainty in dynamic scoring.

Saturday, February 28, 2015

Doctrines Overturned

(This post is based on a few talks I've given lately. There's not much terribly new. But the effort to revisit, clarify and repackage may be useful even if you're a devoted blog reader, as it is to me.)

The Future of Monetary Policy / Classic Doctrines Overturned

Everyone is hanging on will-she or won't-she raise rates by 25 basis points.

I think this focus misses the more interesting questions for current monetary policy. The last 10 years or so are a remarkable experience, a Michelson-Morleymoment, which overturn long-held monetary policy doctrines. The plan to raise rates via interest on reserves in a large balance sheet completely changes the basic mechanism by which monetary policy is said to affect the economy.

Wednesday, February 25, 2015

On RRP Pro and Con

Thanks to a comment on the last post, I found The Fed working paper explaining Fed's thinking about overnight reverse repurchases, Overnight RRP Operations as a Monetary Policy Tool: Some Design Considerations by Josh Frost, Lorie Logan, Antoine Martin, Patrick McCabe, Fabio Natalucci, and Julie Remache.

(I should have found it on my own, as it's the top paper on the Fed's working paper list.) Cecchetti and Shoenholtz also comment here

My main question was just what "financial stability" concerns the Fed has with RRP, and this paper explains.

Run Free Video

This is a talk I gave at the joint Mercatus/Cato "After Dodd-Frank" conference last spring.  It's based on Toward a Run-Free Financial System.

Friday, February 20, 2015

Liftoff Levers

I read the minutes of the January FOMC meeting. (I was preparing for an interview with WSJ's Mary Kissel) There is a lot more interesting here, and a lot more important, than just when will the Fed raise rates.

Mainstream media missed the interesting debate on "liftoff tools." Maybe the minute the Fed starts talking about "ON RRP" (overnight reverse repurchase agreements) people go to sleep.


Here's the issue.  Can the Fed raise rates? In the old days there were $50 billion of reserves that did not pay interest. The Fed raised rates, so the story goes, by reducing the supply of reserves. Banks needed reserves in proportion to deposits, so they offered higher rates to borrow reserves.

Now, there are about $3 trillion of reserves, far more than banks need, and reserves pay interest. They are investments, equivalent to short-term Treasuries. If the Fed reduce their quantity by anything less than about $2,950 trillion, banks won't start paying or demanding higher interest.  And the Fed is not planning to reduce the supply of reserves at all. It's going to leave them outstanding and pay higher interest on reserves.

But why should that rise transfer to other rates? Suppose you decide that the minimum wage is too low, so you pay your gardener $50 per hour. Your gardener is happy. But that won't raise wages at McDonalds and Walmart to $50. This is what the Fed is worried about -- that it might end up paying interest to banks, but other interest rates don't follow.

Thursday, February 19, 2015

Pennacchi on Narrow Banking

I stumbled across this nice article, "Narrow Banking" by George Pennacchi. The first part has a informative capsule history of U.S. banking.

George defines a spectrum of "narrow" banks. For example he includes prime money market funds -- borrow money, promise fixed value instant withdrawal, buy Greek bank commercial paper. But that is "narrower" than traditional lending, as the assets are short term and usually marketable.

Some interesting tidbits:
Prior to the twentieth century, British and American commercial banks lent almost exclusively for short maturities. Primarily, loans financed working capital and provided trade credit for borrowers who were expected to obtain cash for repayment in the near future
... the typical structure of these early banks contrasts with the modern view of banks, according to which the received wisdom is that “[t]he principal function of a bank is that of maturity transformation---coming from the fact that lenders prefer deposits to be of a shorter maturity than borrowers, who typically require loans for longer periods” (Noeth & Sengupta 2011, p.8)....maturity transformation was often considered a violation of prudent banking.

Thursday, February 12, 2015

Regulation and competition

From taxis to banks, regulation is quickly captured to stifle competition. Only it's usually polite not to say it out loud. Today's WSJ has a lovely little piece, Regulation is Good for Goldman confirming the former and violating the latter pattern.
the Goldman Sachs CEO explained how higher regulatory costs are crushing the competition.
“More intense regulatory and technology requirements have raised the barriers to entry higher than at any other time in modern history,” said Mr. Blankfein. “This is an expensive business to be in, if you don’t have the market share in scale...
he said his bank is “prepared to have this relationship with our regulators”—and the regulators are prepared to have a deep relationship with Goldman—“for a long time.”
.. it is unusual to see a financial CEO like Mr. Blankfein state the effect so candidly. Goldman can afford to hire battalions of lawyers and lobbyists to commune with regulators... As ever, powerful government mainly helps the powerful.
I have met several people who started financial companies in the pre-Dodd-Frank era. They all say there is no way they could start their businesses now. Working out of the garage, you can't afford a multi-million dollar compliance department.

Run-Free Funds Expand

Louise Bowman at Euromoney reports
Fidelity Investments has announced plans to convert up to $125 billion-worth of prime US money market funds (MMFs) into government-only funds –
Meaning, funds that invest only in government securities.
...a move that is a direct consequence of the new SEC regulations covering this business that were announced in July.
...From October next year, MMFs must hold at least 99.5% of total portfolio assets in cash or government securities and repos collateralized by such instruments to be exempt from new regulations imposing fees and gates on such funds in times of stress. The rules are designed to slow deposit runs and reduce systemic risk
In case you missed it, in the financial crisis the Reserve Fund, which held a lot of Lehman debt, suffered a run, and too big to fail quickly expanded to money market funds.

What are they invested in now?

Tuesday, February 10, 2015

WIlliamson on Fisher, Phillips and Fjords

Steve Williamson has an excellent blog post "Pining for the Fjords" Point 1, the Phillips curve is dead, UK version. (And, too many are cheering, "Long live the Phillips curve!"). Point 2, Steve seems to have signed on to the new-Fisher view that a zero rate fixed for a long time, with apparently credible fiscal policy, will drag inflation slowly down, not up.

Point 1: The Phillips curve in the UK.

Source: Steve Williamson
 ...from peak unemployment during the recession, the unemployment rate drops about 2 1/2 points, while the inflation rate drops about 3 points... Presumably utilization has been rising in the U.K., but inflation is dropping like a rock.
See his post for early and late samples, core inflation, etc.
The Phillips curve is not resting, sleeping, or pining for the fjords. It is dead, deceased, passed away. It has bought the farm. Rest in peace.
 Or, borrowing another picture from Steve,

Steve continues
The Bank Rate has been set at 0.5% since March 2009. Here's the latest inflation projection from the Bank: (Inflation returns to 2% now that unemployment has decreased.) So, like Simon, the Bank seems not to have learned that the parrot is dead. In spite of a long period in which inflation is falling while the economy is recovering, they're projecting that inflation will come back to the 2% target.
The best part, which you might miss at the bottom of his post
...20 years of zero-lower-bound experience in Japan and recent experience around the world tell us that sticking at the zero lower bound does not eventually produce more inflation - it just produces low inflation.

Friday, February 6, 2015

Beware of Greeks Bearing Bonds

Once again, the news is full of opinions that Greece might be forced to leave the Euro. Once again, it makes little sense to me. U.S. corporations, municipalities, and even states default, and do not have to leave the dollar zone as a result.

Most recently, the story goes, if Greek banks can't use their Greek government bonds as collateral with the ECB, the Greek government will have to leave the euro so it can print Drachmas to bail out the banks. There are of course many ways in which this makes little sense -- if the bank has promised Euros, then a Drachma bailout does not stop a default. The government would have to pass a law "converting" euro deposits to Drachmas. But consider the story anyway.

Another common story right now: If Greece were to default, it would have a hard time borrowing to fund primary deficits. By leaving, it can print up Drachmas to pay bills.

OK, here's the obvious solution: Greece can print up small-denomination zero-coupon bearer bonds, essentially IOUs. They say "The Greek government will pay the bearer 1 euro on Jan 1 2016." Greece can roll them over annually, like other debt. Mostly, they would exist as electronic book entries in bank accounts, but Greece can print up physical notes too.

Thursday, February 5, 2015

Bachmann, Berg and Sims on inflation as stimulus

RĂ¼diger Bachmann, Tim Berg, and Eric Sims have an interesting article, "Inflation Expectations and Readiness to Spend: Cross-Sectional Evidence" in the American Economic Journal: Economic Policy.

Many macroeconomists have advocated deliberate, expected inflation to "stimulate" the economy while interest rates are stuck at the lower bound. The idea is that higher expected inflation amounts to a lower real interest rate. This lower rate encourages people to spend today rather than to save, which, the story goes, will raise today's level of output and employment.

As usual in macroeconomics, measuring this effect is hard. There are few zero-bound observations, fewer still with substantial variation in expected inflation.  And as always in macro it's hard to tell causation from correlation, supply from demand, because from despite of any small inflation-output correlation we see.

This paper is an interesting part of the movement that uses microeconomic observations to illuminate such macroeconomic questions, and also a very interesting use of survey data. Bachman, Berg, and Sims look at survey data from the University of Michigan. This survey asks about spending plans and inflation expectations. Thus, looking across people at a given moment in time, Bachman, Berg, and Sims ask whether people who think there is going to be a lot more inflation are also people who are planning to spend a lot more. (Whether more "spending" causes more GDP is separate question.)

The answer is... No. Not at all. There is just no correlation between people's expectations of inflation and their plans to spend money.

In a sense that's not too surprising. The intertemporal substitution relation -- expected consumption growth = elasticity times expected real interest rate -- has been very unreliable in macro and micro data for decades. That hasn't stopped it from being the center of much macroeconomics and the article of faith in policy prescriptions for stimulus. But fresh reminders of its instability are welcome.

At first blush, this just seems great. Finally, micro data are illuminating macro questions.

Thursday, January 29, 2015

Uber and Occupational Licenses

I enjoy moments of agreement, and common sense in publications where it's usually absent. Eduardo Porter writing in the New York Times on the lessons of Uber vs. Taxis for occupational licensing is a nice such moment.
[Uber's] exponential growth confirms what every New Yorker and cab riders in many other cities have long suspected: Taxi service is woefully inefficient. It also raises a question of broader relevance: Why stop here?

Just as limited taxi medallions [and ban on surge pricing, and the mandated shift change  -JC] can lead to a chronic undersupply of cabs at 4 p.m., the state licensing regulations for many occupations are creating bottlenecks across the economy, raising the prices of many goods and services and putting good jobs out of reach of too many Americans.

... like taxi medallions, state licenses required to practice all sorts of jobs often serve merely to cordon off occupations for the benefit of licensed workers and their lobbying groups, protecting them from legitimate competition.

...“Lower-income people suffer from licensing,” Professor Krueger told me. “It raises the costs of many services and prevents low-income people from getting into some professions.
This is an all too often overlooked effect of so much government-induced cartelization. The costs of higher prices are paid by middle and lower income people. And many job opportunities are denied to lower income people.

Wednesday, January 28, 2015

Unemployment insurance and unemployment

"The Impact of Unemployment Benefit Extensions on Employment: The 2014 Employment Miracle" by Marcus Hagedorn, Iourii Manovskii and Kurt Mitman is making waves. NBER working paper here. Kurt Mitman's webpage has an ungated version of the paper, and a summary of some of the controversy. It's part of a pair, with "Unemployment Benefits and Unemployment in the Great
Recession: The Role of Macro Effects" also including Fatih Karahan.

A critical review by Mike Konczal at the Roosevelt Institute blog, and a more positive review by Patrick Brennan at National Review Online are both interesting. Both are thoughtful reviews that get at facts and methods. Maybe the tone of the economics blogoshpere is improving too. Bob Hall's comments and response on the earlier paper are also worth reading. This is a bit deja-vu from the observation that North Carolina experienced a large drop in unemployment when it cut benefits. My post here, WSJ coverage, and I think there are some papers which google isn't finding fast enough at the moment.

The basic issue: I think it's widely accepted, if sometimes grudgingly, that unemployment insurance increases unemployment. If you pay for anything, you get more of it. People with unemployment insurance can hold out for better jobs, put off moving or other painful adjustments, and so on. The earlier paper points out that there are important general equilibrium effects as well. We should talk about how UI affects labor markets, not just job search.

Quick disclaimer. Let's not jump to "good" and "bad."  Searching too hard and taking awful jobs in the middle of a depression might not be optimal. Pareto-optimal risk sharing with moral hazard looks a lot like unemployment insurance.  Perhaps that disclaimer can settle down the tone of the debate.

But the question remains. How much?  How much does unemployment insurance increase unemployment? And the related macro question, just why did unemployment in the US suddenly drop coincident with sequester and the end of 99 week unemployment benefits?

Tuesday, January 27, 2015


The last two weeks have been full of monetary news with the Swiss Franc peg, and the ECB's announcement of Quantitative Easing (QE). A few thoughts.

As you have probably heard by now, the Swiss Central Bank removed the 1.20 cap vs. the euro, and the franc promptly shot up 20%.

To defend the peg, the Swiss central bank had bought close to a year's Swiss GDP of euros (short-term euro debt really) to issue similar amounts of Swiss Franc denominated debt.

This is a QE -- a big QE. Buy assets, print money (again, really interest-paying reserves). So to some extent the news items are related. And, it's pretty clear why the SNB abandoned the peg. If the ECB started essentially the opposite transaction -- buying debt and selling euros -- the SNB would soon be awash.

A few lessons:

Thursday, January 22, 2015

Autopsy -- the Op-Ed

This was an Op-Ed in the Wall Street Journal December 22 2014. WSJ asks me not to post them for a month, so here it is now. I was trying for something upbeat, and to counter a recent spate of opeds on how ISLM is a great success and winning the war of ideas.

An Autopsy for the Keynesians

Source: Wall Street Journal
This year the tide changed in the economy. Growth seems finally to be returning. The tide also changed in economic ideas. The brief resurgence of traditional Keynesian ideas is washing away from the world of economic policy.

No government is remotely likely to spend trillions of dollars or euros in the name of “stimulus,” financed by blowout borrowing. The euro is intact: Even the Greeks and Italians, after six years of advice that their problems can be solved with one more devaluation and inflation, are sticking with the euro and addressing—however slowly—structural “supply” problems instead.

U.K. Chancellor of the Exchequer George Osborne wrote in these pages Dec. 14 that Keynesians wanting more spending and more borrowing “were wrong in the recovery, and they are wrong now.” The land of John Maynard Keynes and Adam Smith is going with Smith.

Why? In part, because even in economics, you can’t be wrong too many times in a row.

Tuesday, January 13, 2015

Asset Pricing Mooc

The new and improved online version of my PhD class "Asset Pricing Part 1" will open for business January 18.

You can learn more about the class and sign up for it on the Coursera website here. (Part 2, which follows this spring is here. Part 1 and 2 will be completely separate Coursera classes, so take what you want.)

The videos and quizzes have been useful for people who are not "taking" the class, or as supplementary materials for people teaching regular classes. I taught my PhD class by asking the students to watch the videos before coming to class, which allowed a higher level discussion. Feel free to use these resources any way you wish!

While we're at it, I maintain a section of my research website with extra materials for people using the Asset Pricing book in classes, here, and my teaching materials from MBA and PhD classes are here

To whet your appetite, here is the syllabus from the two classes.

Part 1 syllabus:
  • Week 1: Stochastic Calculus Introduction and Review. dz, dt and all that. 
  • Week 2: Introduction and Overview. Challenging Facts and Basic Consumption-Based Model. 
  • Week 3:
    • Classic issues in Finance
    • Equilibrium, Contingent Claims, Risk-Neutral Probabilities.
  • Week 4: State-Space Representation, Risk Sharing, Aggregation, Existence of a Discount Factor.
  • Week 5: Mean-Variance Frontier, Beta Representations, Conditioning Information. 
  • Week 6: Factor Pricing Models -- CAPM, ICAPM and APT. 
  • Week 7: Econometrics of Asset Pricing and GMM.  
  • Final Exam
Part 2 syllabus: 
  • Week 1: Factor pricing models in action
    • The Fama and French model
    • Fund and performance evaluation.
  • Week 2: Time series predictability, volatilty and bubbles.
  • Week 3: Equity premium, macroeconomics and asset pricing.
  • Week 4: Option Pricing.
  • Week 5: Term structure models and facts.
  • Week 6: Portfolio Theory.
  • Final Exam

Thursday, January 8, 2015

Deflating Deflationary Fears

Source: Charles Plosser
From a nice paper by Charles Plosser with that catchy title.  Yes, it's 10 years old, but the lesson is appropriate in today's hysteria. That dreaded deflationary spiral is always just around the corner.

Wednesday, January 7, 2015

Piketty Facts

Most Piketty commentary (like the Deridre McCloskey review I blogged earlier) focuses on the theory, r>g, and so on. After all, that's easy and you don't have to read hundreds of pages.

"Challenging the Empirical Contribution of Thomas Piketty's Capital in the 21st Century" by Phillip W. Magness and Robert P. Murphy is one of the first deep reviews of the facts that I have seen. I haven't read it yet, but the abstract looks promising:
Thomas Piketty's Capital in the 21st Century has been widely debated on theoretical grounds, yet continues to attract acclaim for its historically-infused data analysis. In this study we conduct a closer scrutiny of Piketty's empirics than has appeared thus far, focusing upon his treatment of the United States. We find evidence of pervasive errors of historical fact, opaque methodological choices, and the cherry-picking of sources to construct favorable patterns from ambiguous data. Additional evidence suggests that Piketty used a highly distortive data assumption from the Soviet Union to accentuate one of his main historical claims about global “capitalism” in the 20th century. Taken together, these problems suggest that Piketty’s highly praised and historically-driven empirical work may actually be the book’s greatest weakness.
Comments on the paper welcome. If I get a chance to read it I'll post some.

Time use of the non-employed

Source: New York Times
The decline in labor force participation means that a larger and larger fraction of the population, including many prime-age men, are not working and not actively looking for work.

What do they do all day? The New York Times has a lovely article answering that question.

I took a screenshot at left to advertise the post, but go to the Times where the graph is interactive.

Next question, where does the money come from?

Understanding the lives of people in this predicament seems to me a useful step to understanding the big decline in participation.

Tuesday, January 6, 2015

Strange Bedfellows

Jeff Sachs has written a very interesting Project Syndicate piece on Keynesian economics. It's phrased as a critique of Paul Krugman, but his message applies much more broadly. Krugman was mostly articulating fairly standard views on stimulus, "austerity'' and so forth. (We need a better word than "Keynesian'' for what Jeff calls "crude aggregate-demand management.'' But I don't have one handy.)

This is a good example for people outside economics (and quite a few inside) who think all economists line up on an easy right-left divide. If you expected Sachs to support the standard Keynesian consensus because he's "liberal," or to use his words, in favor of "progressive economics," you would be wrong. He looks at the facts, the forecasts, and the Krugman's curious rewriting of history in a "victory lap," and comes to his own conclusions.

Needless to say, I'm happy to find someone else making many of the basic points in my
Autopsy for Keynesian Economics (ungated version). I'm even more happy that someone of a "progressive" political orientation comes to the same conclusions that I do from a more libertarian orientation.  I'll be curious to see if Sachs comes in for the same sort of venomous personal attacks -- with essentially no attempt to argue the content -- as my piece attracted from the politicized lefty economics blogosphere. Do they treat "friends" more nicely, or "traitors" more harshly? We'll see.

On infrastructure, Sachs writes
To be clear, I believe that we do need more government spending as a share of GDP – for education, infrastructure, low-carbon energy, research and development, and family benefits for low-income families. But we should pay for this through higher taxes on high incomes and high net worth, a carbon tax, and future tolls collected on new infrastructure. We need the liberal conscience, but without the chronic budget deficits.
Here too, we can almost agree. We can agree on the principle that infrastructure spending is important, and should be evaluated on the basis whether its benefits exceed its costs, not on the "stimulative" powers of its spending. Then we can go back to evaluating whether all of these particular investments have benefits greater than costs, and whether those particular taxes merit their distortions.