Monthly Archives: July 2013

Nothing is ever Democratized

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So says Nick Pinkston.

Did inkjet printers democratize printing? Does Amazon have a bunch of HPs printing off their books? No way – they have very specialized machines doing this, and the same is true for everything in engineering. Remember that old saying: “Good, Fast, Cheap – pick two” – this applies to all engineering problems. You optimize for “good” and “fast”, and this comes at the expense of “cheap” – which means it’s not democratized (few people can own it).

…
you may democratize prototype-grade 3D printers, but then others will be make huge, fast printers that are able to beat your per-unit cost by an order of magnitude – but at high capital cost.

Pointer from Tyler Cowen.

His skepticism about 3D printing sounds right to me. But the claim that nothing is ever democratized sounds too strong. Computers became democratized. Internet access became democratized. In some sense, wealth has become democratized.

What I mean by democratized is that lots of people were able to use them to be productive. Not everyone, of course. And if people look at their well-being primarily in comparison to others around them, then a democratized increase in well-being is mathematically impossible.

Which Book (or e-book) Do You Think I Should Write?

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1. A concise guide to housing finance policy issues. Would include chapters on past housing finance debacles, the role of special interests, why taxpayers end up bearing risk, comparisons with other countries, …

2. Secession Scenarios. This would describe scenarios in which a number of American communities of 10 million or fewer become self-governing. It will discuss technological enablers, political and economic preconditions, and ramifications.

3. Quackroeconomics. Sort of an anti-textbook. There are many criticisms of macroeconomics. This book will focus on the ones that matter.

4. ______?

The Fed, Interest Rates, and Inflation

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Scott Sumner points to David Glasner, who writes,

So, if the ability of the central bank to use its power over the nominal rate to control the real rate of interest is as limited as the conventional interpretation of the Fisher equation suggests, here’s my question: When critics of monetary stimulus accuse the Fed of rigging interest rates, using the Fed’s power to keep interest rates “artificially low,” taking bread out of the mouths of widows, orphans and millionaires, what exactly are they talking about?

I am not the person to whom this question is addressed. Anyway, read his whole post. Another excerpt:

Either the equilibrium real interest rate has been falling since 2009, or the equilibrium real interest rate fell before 2009, but nominal rates adjusted slowly to the reduced real rate.

In a number of posts, I have been saying that the closer you look at mainstream macroeconomics, the more incoherent it becomes. The issue of nominal and real interest rates is a case in point. Suppose you believe the following:

1. The Fed controls the short-term nominal interest rate, or at least a short-term nominal rate.
2. The long-term real interest rate is fixed by market conditions.
3. When the Fed lowers its interest rate, expected inflation goes up.

If you believe those three things, then when the Fed lowers the short-term rate,

(4) the long-term nominal rate has to go up.

Essentially everyone believes (1) and (3). But hardly anyone believes (4)*, so clearly (2) is what economists are least attached to. At least implicitly, macroeconomists believe that when the Fed lowers the short-term nominal interest rate, the long-term real rate goes down as well.

(*I tend to think of Scott Sumner as having coherent views, with which I disagree. Accordingly, I think of him as believing (4). What taking this view means, though, is that relative to other macroeconomists, one needs higher expected inflation to do most of the work in driving up aggregate demand. Expecting more inflation, people attempt to unload their money holdings onto goods. Since you don’t get a drop in real interest rates, it seems to me that the only reason for stock prices to go up is if you think that investors like it when people unload money and go into goods.)

My own idiosyncratic view is that I prefer to hold onto (2) and let go of (3). I would explain the drop in long-term real interest rates since 2009 by appealing to a drop in demand for investment relative to the supply of (savings minus government deficits). I assume this is worldwide, not just limited to the U.S. I would not credit the Fed with any of it. I am not sure that I would label it as an “equilibrium” phenomenon, because I think that bond buyers were not entirely rational. I know that for a while I had a really big exposure to TIPS, but as they went up in value (because real rates were declining), I thought to myself, “Hmm. Capital gains on a ‘risk-free’ asset. How nice. But if they can go up, can they not also go down?” So when the recent bond market sell-off hit, I had much less exposure (not that what I switched into worked out any better).

I view QE as the Fed swapping short-term debt (interest-bearing reserves) for long-term debt. The Fed gets to ride the yield curve in exchange for taking on huge market risk in its portfolio. This might reduce long-term real rates a bit, although I have always leaned toward skepticism on that score.

I lean to the view that inflation is a fiscal phenomenon. I have never heard of a country that cranked up the printing presses while running a balanced budget. I have never heard of a country running hyperinflation that was not fiscally profligate. There might be instances of countries running deficits of 100 percent of GDP or more who were able to return to balance without undertaking a formal default or going through a period of high inflation, but I cannot think of any.

Taking the view that inflation is a fiscal phenomenon does not help with short-term inflation predictions. For example, in the U.S. these days, we don’t know exactly when or how the fiscal imbalance will be resolved.

They will tear up my libertarian union card for saying this, but I do not believe that the Fed’s buying and selling of securities are a big distortionary factor in the financial markets. I think that the Fed could get us above the 0-2 percent inflation rate if it really wanted to, and maybe it should try, in case the AS-AD model turns out to be correct. But if you believe PSST, it could turn out that higher inflation would produce no increase in employment, and it might even make it worse.

A Question Comes Back to Haunt Me

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Simon Wren-Lewis asks,

Do budget deficits cause inflation? Let me be a little more specific: does raising the level of debt and keeping it there when the economy is at full employment raise the price level? The conventional answer is: not if the central bank controls inflation. Sometimes economists say the same thing in a different way: not if the debt is not monetised.

Pointer from Nick Rowe.

I was asked this question in 1975 on an Honors Exam given by William Poole (Swarthmore used outside examiners. Poole was then at Brown, I believe.) I said that if the government tried to use deficit spending to boost an economy that was already at full employment, this would cause ever-increasing inflation. “Wrong. I didn’t go to the University of Chicago for nothing,” Poole harrumphed. “If the central bank doesn’t increase the rate of money growth, inflation will not go up.”

A few years later, Sargent and Wallace wrote a paper that said that, in effect, that I was right, at least in a rational-expectations world. The reason is that when the government runs such deficits, it creates the expectation that they will be monetized, and because people anticipate that, prices start to rise.

In terms of the way Wren-Lewis asks the question, it seems to me that a textbook answer would be that it depends on the central bank’s reaction function. If it uses a Sumnerian NGDP target, then you get 100 percent crowding out of private investment, presumably because the long-term real interest rate goes up. With other reaction functions, you get some monetization of the debt. If the reaction function is to fix the money supply, then it is plausible that velocity goes up a bit, which gives you more inflation.

Truth be told, I think the sort of monetarist analysis in the preceding paragraph or that Rowe is reaching for is bunk. I am more inclined to think of money in financial terms, as just one of many forms of government debt. My thinking is that small changes in central bank policies get overwhelmed by other factors in financial markets and in the economy. To cause a shift in the inflation regime, the central bank has to be really determined.

Suppose we ask an opposite sort of question. What happens if the government is balancing its budget and the central bank wants to go on an inflation binge? On the one hand, it is certainly true that the central bank can find assets to buy (old government debt, private debt, foreign currency), so it ought to be able to cause inflation. On the other hand, has this ever happened? In practice, is high inflation always a fiscal phenomenon?

AD-AS, Debunked in One Chart

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In the WSJ blog. It shows the behavior of the Fed’s preferred inflation measure, the year-over-year percent change in core consumer prices in the GDP deflator, over the past several years. Early in 2007, it was 2.6 percent. It is now at its low point, of 1.1 percent. In between, there was a local trough of 1.2 percent late in 2009 and a local peak of 2.0 percent, about a year and a half ago.

If in 2006 you had given this data to practicing macroeconomic forecasters and asked for a prediction about the behavior of unemployment, what would have been the response? My guess is that the majority would have predicted no rise in unemployment at all. The remaining forecasters would have predicted (or inferred, based on an estimated Phillips Curve) a small increase in unemployment in 2009, followed by another small increase in 2012 and 2013. No one would have predicted or inferred an enormous increase in unemployment late 2008 and early 2009, followed by a gradual decrease and then a more pronounced decrease this year.

Let me re-state my concern with measuring aggregate demand as nominal GDP. If inflation remains absolutely constant, then any fluctuation in nominal GDP is arithmetically a fluctuation in real GDP. At that point, “explaining” changes in real GDP by changes in nominal GDP becomes completely circular.

Fiscal Policy and Employment

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So, we had this big fiscal stimulus in 2009, with lousy employment performance. Now, we have so-called austerity, and in addition to the 195,000 jobs added last month, the BLS reports,

The change in total nonfarm payroll employment for April was revised from +149,000 to +199,000, and the change for May was revised from +175,000 to +195,000. With these revisions, employment gains in April and May combined were 70,000 higher than previously reported.

Do Keynesians belong in the always-wrong club?

A Surprising Finding

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from Janet Currie, Mark Stabile, and Lauren E. Jones:

We examine the effects of a policy change in the province of Quebec, Canada which greatly expanded insurance coverage for prescription medications. We show that the change was associated with a sharp increase in the use of Ritalin, a medication commonly prescribed for ADHD, relative to the rest of Canada. We ask whether this increase in medication use was associated with improvements in emotional functioning and short- and long-run academic outcomes among children with ADHD. We find evidence of increases in emotional problems among girls, and reductions in educational attainment among boys. Our results are silent on the effects on optimal use of medication for ADHD, but suggest that expanding medication use can have negative consequences given the average way these drugs are used in the community.

Executive Nullification, Once Again

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The latest news in this slow 4th-of-July week is that the Obama Administration has announced that it will not enforce the law mandating that employers provide health insurance coverage. This is not the first time the Administration has nullified a law in this way.

I could make a case that Congress should insist that the President enforce the law, or else face impeachment. The fact that this suggestion seems absurd says something about the state of the health care law. However, it says even more about the state of our Republic.

UPDATE: Charles Murray has a similar take.

The Bipartisan Mortgage Reform Proposal

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Bipartisan because both parties are captive to special interests. Bloomberg, among others, covered the story, shallowly.

A bill to be offered by Senators Bob Corker and Mark Warner reflects a prevailing view among lawmakers that the two government-sponsored enterprises should cease to exist while a federal role in backing mortgage lending should remain. Corker, a Tennessee Republican, and Warner, a Virginia Democrat, held a news conference to introduce the measure yesterday.

Mortgage-backed securities have not proven that they can survive without a government guarantee. Without mortgage-backed securities, the mortgage banking industry probably would do very poorly. Hence the head of their trade association is quoted as praising the bill.

The big winners in the bill would be Wall Street, which has always wanted a government-guaranteed mortgage securities industry minus Freddie and Fannie. If you think that Wall Street firms did such a great job in helping the mortgage market over the past ten years that they deserve to be rewarded, then this is the bill you want to get behind.

Peter Wallison also sees this as the same-old, same-old.

It would be easy to love a bill that gets rid of these two institutions [Freddie and Fannie]—unless it fosters the same loose lending that led to the housing debacle. By keeping the government in charge, this bill does just that.