Monthly Archives: July 2014

The Era of Mood Affiliation

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Menzie Chinn, who may or may not endorse the content, offers a guest post by Alex Nikolsko-Rzhevskyy, David Papell and Ruxandra Prodan. They write,

How does this relate to the proposed legislation? Our evidence that, regardless of the policy rule or the loss function, economic performance in rules-based eras is always better than economic performance in discretionary eras supports the concept of a Directive Policy Rule chosen by the Fed. But our results go further. The original Taylor rule provides the strongest delineation between rules-based and discretionary eras, making it, at least according to our metric and class of policy rules, the best choice for the Reference Policy Rule.

In the current political climate, the proposed legislation will inevitably be interpreted in partisan terms because it was introduced in the House Financial Services Committee by two Republican Congressman. Not surprisingly, the first reporting on the legislation by Reuters was entirely political. This is both unfortunate and misleading. We divided our rules-based and discretionary eras with the original Taylor rule between Republican and Democratic Presidents. If we delete the Volcker disinflationary period, out of the 94 quarters with Republican Presidents, 54 were rules-based and 40 were discretionary while, among the 81 quarters with Democratic Presidents, 46 were rules-based and 35 were discretionary. Remarkably, monetary policy over the past 50 years has been rules-based 57 percent of the time and discretionary 43 percent of the time under both Democratic and Republican Presidents. Choosing the original Taylor rule as the Reference Policy Rule is neither a Democratic nor a Republican proposal. It is simply good policy.

I would take the empirical work with a grain of salt. Imagine that monetary policy has no effect whatsoever. Then the Fed may be more likely to appear to be following a Taylor rule when the economy performs well than when it performs poorly.

(Tyler Cowen comments tersely on the post, “not my view.” See Nick Rowe as well.)

But the larger point is that the authors correctly guess that the reaction to the legislation will be based on mood affiliation rather than substance. See my earlier post.

The other recent example suggesting that we are in an era of mood affiliation is the Ex-Im bank.

Two SNEP Goals Connected

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Jed Graham writes,

The $2.8 trillion Social Security Trust Fund is on track to be totally spent by 2030, the Congressional Budget Office said Tuesday. That’s one year earlier than projected in 2013 and a decade earlier than the CBO estimated as recently as 2011.

Graham points out that lower estimates for employment are contributing to the more adverse outlook for Social Security. I would say that this links two of the three main goals for SNEP, one of which is to increase employment and another of which is to work toward a sustainable Federal budget.

In fact, the third goal, to get the FCC and the FDA out of the way of progress, also links to the other two.

Break up California?

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Tim Draper’s proposal.

“It’s important because it will help us create a more responsive, more innovative and more local government, and that ultimately will end up being better for all of Californians,” said Roger Salazar, a spokesman for the campaign. “The idea … is to create six states with responsive local governments – states that are more representative and accountable to their constituents.”

…But the plan has raised bipartisan hackles across the state, and opponents say it stands little chance of gaining voter approval. If it does win the support of voters, it must still be passed by Congress, which opponents say is also unlikely.

This may be the best hope for those of us who want better, less-intrusive government. Governmental institutions need to be broken up into smaller parts, both in size and scope. Narrowing scope means having different units of government for education, transportation, trash collection, etc.

Boudreaux on McCloskey

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He writes,

Until the 17th century, those who earned their living through trade were the Rodney Dangerfields of their eras: they got no respect. Merchants and other people operating on the supply side of commercial activities and transactions were tolerated. But they were viewed and spoken of with contempt. Unlike warriors who dirtied their hands honorably (namely, with blood), traders dirtied their hands dishonorably (namely, with profit). Unlike the nobility who got their riches honorably (namely, by idly collecting land rents), merchants got their riches dishonorably (namely, by actively trading). Unlike the clergy who won their rewards honorably (namely, by pondering the eternal), the bourgeoisie won their rewards dishonorably (namely, by responding to what Hayek later called “the particular circumstances of time and place”).

In the same symposium, Joel Mokyr writes,

Corruption is the institutional dog that did not bark. It is perfectly reasonable to think of a hypothetical world in which predatory rent-seeking by a powerful elite could have expropriated the profits of innovative entrepreneurs in the Industrial Revolution, as was traditionally done in the medieval world. Instead, the British aristocrats who ruled the country in the 18th century let the entrepreneurs have their way and pocketed the capital gains on their real estate holdings and the interest on their railway bonds. Organizations such as the rent-seeking monopolies, set up in the age of mercantilism (think of the East India Company or the Bank of England), were either dismantled or turned into public institutions. Slowly but certainly rent-seeking institutions were weakened. By 1850 or so the country was as free of it as any nation had the right to hope for.

How then to think of the “ideas vs. institutions” debate? Oddly enough McCloskey and Acemoglu-Robinson both seem committed to a “one-or-the-other” mode. But it is not so. Institutions rest on beliefs. If we have rules against the sale of narcotics, it is because someone in power believes that such drugs are socially bad. When those beliefs change, the institutions (hopefully) adapt. Adaptiveness requires meta-institutions that can change the rules when beliefs and/or circumstances change. Britain’s great success between 1750 and 1914 rested on the existence of such meta-institutions. When needed, Parliament set up a committee that researched and investigated matters ad nauseam and then changed the rules. Slowly, and perhaps not always quite perfectly, British formal institutions adapted. But the same was true for private-order institutions: the rather sudden rise of country banks in the second half of the 18th century illustrates the high degree of adaptiveness of private-order British institutions

Data to Ponder

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It comes from William Emmons, but I cannot find the presentation, which is referenced here. I got as far as I did by following a pointer from Tyler Cowen.

Emmons shows median real income for households headed by college graduates roughly constant from 1991 to 2012, with median real income over that same period falling over 15 percent for households headed by those without college degrees.

Some remarks:

1. I would guess that the share of households headed by someone with a college degree has gone up, so that perhaps overall median household income has gone up. And mean incomes have probably gone up even more, because the mean includes high-salary individuals, successful investors, and entrepreneurs.

2. This looks like workers without college degrees becoming ZMP.

3. Other factors of production, namely capital and foreign workers, are putting downward pressure on American wages.

What Banks Do

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Samuel G. Hanson, Andrei Shleifer, Jeremy C. Stein, and Robert W. Vishny write,

the specialness of traditional banks comes from combining stable money creation on the liability side with assets that have relatively safe long-run cash flows but possibly volatile market values and limited liquidity. To make this business model work, banks limit their leverage, rely on deposit insurance, but also hold loans and securities that are relatively safe in the long run even if they are vulnerable to short-term price fluctuations.

…In a cross-section of types of financial intermediaries, intermediaries with stickier liabilities hold less liquid assets. Banks, in particular, appears as having extremely sticky liabilities as well as very illiquid assets…act as a bridge between households who want to put their money in a safe place they do not need to watch, and securities markets where even assets with relatively low fundamental risk can have volatile market prices.

My mantra is that the nonfinancial sector wants to hold riskless, short-term assets and to issue risky, long-term liabilities. The financial sector accommodates by doing the opposite. Government is tempted to back the financial sector with insurance and guarantees, and this in turn can cause the financial sector to become larger and riskier than it would be otherwise.

My Opinion of Labor Search Theory

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Nick Rowe writes,

“search” theory should really be called “search/matching” theory. Because without heterogeneity of workers and jobs the search problem would be trivially easy. “You want a job?” “Yes. You want a worker?” “Yes.” “Done!”. And “search/matching” theory should really be called “wait/matching” theory. Because even if both sides of the labour market have perfect information about the other side — about who’s looking for a job and who’s looking for a worker — there might not be any suitable matches on the market right now, and one or other side might choose to wait until a better match appears on the market.

The big problem with search theory is that it assumes that jobs are given. The PSST story is that in order to create a job, you need to discover some sustainable pattern of comparative advantage.

I do not put much stock in the story of unemployment workers wandering around, lost, unable to find the jobs that are sitting out there. I put my emphasis on a story of entrepreneurs trying to figure out what sorts of profitable business enterprises can be assembled using the resources available, including the stock of unemployed workers. Nowadays, it’s hard to put together profitable enterprises with low-skilled workers, because you have to cover payroll taxes and health care costs, provide enough take-home pay to make it worth their while to forego government benefits, and compete with other businesses that can hold down costs through automation and/or outsourcing.

Polling Economists on Monetary Policy Rules

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The IGM forum asks economists whether or not they agree with the following:

Legislation introduced in Congress would require the Federal Reserve to “submit to the appropriate congressional committees…a Directive Policy Rule”, which shall “describe the strategy or rule of the Federal Open Market Committee for the systematic quantitative adjustment of the Policy Instrument Target to respond to a change in the Intermediate Policy Inputs.” Should the Fed deviate from the rule, the Fed Chair would have to “testify before the appropriate congressional committees as to why the [rule]…is not in compliance.” Enacting this provision would improve monetary policy outcomes in the U.S.

All economists who answered the poll said that they disagreed (a few were “uncertain”), most of them strongly. My comments:

1. The responses are mostly based on liking Bernanke and Yellen while disliking Congress. For example, Robert Shimer writes,

Under current Fed leadership, the statement is likely to be false. Under future leadership, accountability might be justifiable.

Richard Thaler (co-author of Nudge) writes,

I can’t think of any agency in government that would work better with greater supervision from Congress

2. John Taylor testified in favor of the legislation. He was not among those responding to the poll.

3. Robert Hall, saying that he disagreed, referred to an article that he wrote in 1984 which concludes,

What is important about monetary strategy is to have one. Any policy on the frontier of unemployment and price variability that is not fiercely hawkish will give better performance than we had under the meandering policy that we had over the past 30 years.

Nominal GNP targeting is one policy on the frontier…But this paper has shown that differences among sensible policies are small compared to the difference between historical policy and any sensible policy.

4. I still am somewhat unclear what Tyler Cowen means by “mood affiliation,” but this poll seems to be driven by it.

Does Inflation Have a Zero Bound?

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Chris House writes,

If the 1 percent reduction in core inflation is sufficient for the Keynesian model to generate the huge recession we just went through then where was the huge recession in the late 1990s? Where was the enormous recession in 1986?

I think I made this point somewhere along the way, also.

When the Phillips Curve was trumpeted by Samuelson and Solow, the thinking was that causality ran from unemployment to (wage) inflation. In the 1970s, the idea was that causality ran from inflation to unemployment. This latter view is what is now impossible to defend. To the extent that New Keynesians accept the inflation-to-unemployment causality story (which they seemed to do), they are in trouble as I see it.

However, even for older Keynesians, who look at the causality as unemployment-to-inflation, recent experience is somewhat puzzling. I wrote this in 2010:

Looking ahead, the next 12 to 18 months should be interesting. The unemployment rate has been so far above 6 percent for so long that if the Fuhrer equation holds up, we should be seeing some pretty strong downward pressure on inflation. Instead, if inflation remains between 0 and 2 percent, this will look to me like another anomaly for the Phillips Curve.

But, you know, the beauty of 1970s undergraduate textbook macro is that you can use it to tell a story for anything. What we seem to be getting is a story that suggests a zero lower bound for inflation. You cannot cut nominal wages, so there.

Mark Thoma has more links, and his conclusion is worth quoting:

this is an empirical question that will be difficult to resolve empirically (because there are so many different ways to estimate a Phillips curve, and different specifications give different answers, e.g. which measure of prices to use, which measure of aggregate activity to use, what time period to use and how to handle structural and policy breaks during the period that is chosen, how should natural rates be extracted from the data, how to handle non-stationarities, if we measure aggregate activity with the unemployment rate, do we exclude the long-term unemployed as recent research suggests, how many lags should be included, etc., etc.?).

Also, read the follow-up. The phrase “an empirical question that will be difficult to resolve empirically” pretty much sums up macroeconomics, as far as I am concerned.

An Issue on Which to Demur

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Rich Karlgaard writes,

It’s actually the poor and lower middle classes whose wealth — such as it is –lies fallow in no-interest bank accounts (or wealth-eroding cash if they have no bank account at all). It’s not the rich, but middle-class retirees that try to eke out a living on low-yield interest rates.

He is arguing against Paul Krugman, who claimed that low interest rates hurt the rich, who otherwise enjoy clipping bond coupons.

I think it would be wise for economists to refrain from making claims about broad classes of people gaining or losing from low interest rates. Interest rates are an endogenous variable. At best, you can talk about who benefits from whatever exogenous event created low interest rates. Even then, general equilibrium analysis of that sort is rather difficult.

Maybe you want to talk about who benefits from the Fed’s policies. That is a proper question. In my view, the only clear beneficiaries are shareholders and managers of large banks.