Macro-prudential = Micro Management

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So says John Cochrane.

This is not traditional regulation—stable, predictable rules that financial institutions live by to reduce the chance and severity of financial crises. It is active, discretionary micromanagement of the whole financial system. A firm’s managers may follow all the rules but still be told how to conduct their business, whenever the Fed thinks the firm’s customers are contributing to booms or busts the Fed disapproves of.

Echoing what I wrote.

Politicians want to make credit allocation decisions. Whatever its nominal purpose, bank regulation is used to enable politicians to undertake credit allocation.

A Question

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From the comments on this post.

if it were made clear that in the event of a crisis the shareholders would be wiped out and the bondholders would take whatever loss was required, then why should anyone care what financial structure an institution chooses?

This approach could have been taken in 2008. Several economists argued that Citigroup could have been handed over to the bondholders. Why wasn’t this done? Here are some possible adverse consequences:

1. Depositors will hear “Citigroup is bankrupt” and rush to pull deposits out, even though they are safe.

2. Holders of bonds at other banks will sell those bonds in order to buy safer assets.

Of course, these concerns can always be raised about bank debt. If the government will never allow bank debtholders to take a loss, then in effect we have 100 percent government guarantees to bank debtholders. Russ Roberts has argued vociferously that this is in fact the regime we have been under, and the consequence is that banks have the incentive to maximize their debt financing.

It appears that the government cannot credibly commit to letting bank creditors bear some of the losses from an insolvency. If that is the case, then it would seem that taxpayers have an interest in forcing banks to have a capital structure with less debt and more equity.

Want Job, Won’t Look For One

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Troy Davig and José Mustre-del-Río explore this category in the labor market surveys.

The crisis saw a sharp rise in the number of people who, in response to surveys, indicated they wanted a job but were not actively seeking one. As long as these individuals are not actively seeking work, they are not considered part of the labor force and are not counted as unemployed in official government statistics such as the unemployment rate. The group continued to swell through the first few years of the economic recovery and, by early 2013, numbered some 6.7 million—nearly 2 million more than before the crisis. Residing on the periphery of the labor market, this group may be viewed as a “shadow labor supply.”

Pointer from James Pethokoukis. I am not sure what this trend means. It’s one of those things I put on the blog in case I want to come back to it later.

One possibility is that the market sent a bunch of workers memos saying, “You are now ZMP.” The ones who are still looking for jobs did not understand the memo. The folks being labeled here as “shadow labor supply” get it.

Banks and Political Power

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Simon Wren-Lewis and I may disagree on many things, but not on this.

Most economists are instinctively against state subsidies, unless there are obvious externalities which they are countering. With banks the subsidy is not just an unwarranted transfer of resources, but it is also distorting the incentives for bankers to take risk, as we found out in 2007/8. Bankers make money when the risk pays off, and get bailed out by governments when it does not.

Read the whole thing. Pointer from Mark Thoma

Textbooks and the Cloud

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Frances Woolley writes,

When a new textbook costs $150 or $200, the maximum fine for downloading copyright material is $5,000, and the probability of being caught and convicted is fairly low (especially for those who know how to take appropriate precautions), it is surprising that anyone actually buys textbooks.

This suggests that textbooks may not end up as e-books. Instead, a textbook might be a web service delivered from “the cloud.” To me, this makes more sense educationally as well as economically. The e-textbook should not just be apdf file. It should be interactive.

Macroeconomic Methodology

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Here is the draft introduction and conclusion to my chapter on economics as history rather than physics.

Economists love to dress up as physicists. We like to put theories into the form of equations. However, there are important differences between physics and economics, and these differences are particularly pronounced in the case of macreconomics…

1. Politicians and journalists want answers to questions such as, “How many jobs will (or did) a certain stimulus proposal create?” However, it is not possible to give reliable answers to such questions. Economists who purport to do so are misrepresenting the state of knowledge that actually exists.

2. Economists would like to know which theories are ruled out by the data and which theories are supported by the data. However, our ability to make statements along these lines is quite limited.

3. I believe that the study of macroeconomic events is going to have to be comparable to the study of revolutions, wars, or other historical events. There will be many plausible causal factors per event.

4. It will not necessarily be the case that the best explanations for macroeconomic events will be a single “model” that uses the same causal factors for every event. Instead, each important macroeconomic event may have important idiosyncratic elements involved.

5. Many very different explanations for an event will be consistent with the data.

6. Neither the use nor non-use of equations will ensure clarity or logical consistency. Confusion may be embedded in verbal descriptions of macroeconomic theories. Confusion also may be embedded in equations.

7. Neither verbal descriptions nor equations express verifiable relationships. Macroeconomic hypotheses will contain assumptions that will be highly contestable.

Marriage and Child-Bearing Trends

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On this post, Kay Hymowitz left a comment.

Women today marry on average at 27; in 1950 it was closer to 20. Eighty percent of women marry at some point. Though that’s down from 90% in the mid century,it’s still the large majority. The big story is that though the age of marriage has gone up markedly, the age of first birth has not. I co-authored a report on the “crossover” between marriage and birth ages; you can find it here: http://nationalmarriageproject.org/wp-content/uploads/2013/03/KnotYet-FinalForWeb.pdf

In his book, Nick Schulz writes,

in 1960 almost 70 percent of adults ages 20 to 29 were married, while in the late 200s about one quarter were hitched.

He quotes James Heckman as saying that parenting matters for early childhood motivation to learn, which in turn affects longer-term outcomes. Thus, he is not on the same side as Bryan Caplan and Judith Rich Harris, who see nature mattering much more than nurture.

Nick tells an anecdote about asking manufacturing executives what was missing in the skill set of the labor pool.

“To be honest,” said one executive, rather sheepishly, “we have a hard time finding people who can simply pass a drug test.

Nick ends up advocating for building support for marriage and disdain for unwedded pregnancy.

when the baleful effects of certain cultural norms, actions, and behaviors become overwhelmingly evident for all to see, societies are able to shape their cultures in a healthier direction…the recognition of the harms of smoking. Something similar seems to be happening with recognition of the harms of obesity.

I wish Nick had gone into more depth about why women are having children before marriage. I have the sense that without knowing what their thought processes are, it is hard to know what to recommend.

Loosening the Monetary Dial

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Hasan Comert’s Central Banks and Financial Markets is strong reinforcement for my tendency to be skeptical of the effectiveness of monetary policy. What Comert says is that the evolution of the financial system has tended to decouple monetary aggregates from bank reserves and long-term interest rates from the Fed Funds rate. For example, consider sweep accounts. On p. 33, Comert writes,

Depository institutions developed computer programs to analyze customers’ checkable accounts, which are subject to reserve ratios, and automatically sweep them into savings deposits which were not subject to required reserve ratios.

On p. 47, Comert presents a striking chart showing that the ratio of required reserves to total deposits at depository institutions has declined from about 3.25 percent in 1959 to about 0.25 percent in 2007. At this point, it is perhaps a misnomer to call these “required” reserves. Instead, today there is essentially no connection between the level of reserves that the Fed supplies and the size of the financial sector.

Another way to see the decline in the influence in monetary policy is to track the correlation between the Fed Funds rate and mortgage rates. On p. 145, Comert writes,

the correlation between a one-year mortgage rate and the Fed rate was about 0.700 in the 1990s. It delined to about 0.250 in the period from 2002q1 and 2007q3. On the other hand, whereas the correlations between the 30-year fixed mortgage rate and the Fed rate was about 0.500 in the first period, it is 0.172 for the levels and 0.063 but insignificant for the differences in the second period.

I do not say that the Fed’s monetary dials are completely disconnected. I think that if they were really determined to cause rampant inflation, they could do so. But I do not think that their dials allow for fine tuning. I am not sure that if they were really determined to get an inflation rate of 4 percent, as opposed to 1 percent or 10 percent, that they could do that.

Barry Weingast on Violence

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This was a very interesting Russ Roberts podcast, which I missed last week while I was at the beach.

the median poor country has violence– Russ: Poor defined as? Guest: The bottom half of the distribution of countries. Russ: The median within that half. Guest: The median within that half experiences violence every 7 years. Russ: A regime change. Not just some fighting outside the palace. That’s shocking. Guest: Right.

When a regime changes through violence, the rules of property can change along with them. It is hard to invest for the long term under such circumstances. Also, people come to see control over government as the main route to obtaining or securing wealth. Finally, Weingast argues that in order to prevent coups, governments have to make economic concessions to groups that otherwise might become violent. Governments have to use regulation and subsidies to keep the peace.

I should note that in the United States, a similar process takes place but without the threat of violence. The housing lobby can threaten to throw a legislator out of office, and so the housing lobby gets what it wants. I am not convinced that the U.S. has less rent-seeking than less developed countries. Maybe it’s true, but I would like to see data. However, I am convinced that stability of regime is a good thing.

Pattern-Seeking

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Temple Grandin and Richard Panek write,

Michael Shermer, a psychologist, historian of science, and professional skeptic – he founded Skeptic magazine — called this property of the human mind patternicity. He defined patternicity as “the tendency to find meaningful patterns in both meaningful and meaningless data.”

What all these examples tell me is that in society, the three kinds of minds — visual, verbal, pattern thinkers — naturally complement one another. When I recall collaborations in which I’ve successfully participated, I can see how different kinds of thinkers worked together to create a product that was greater than the sum of its parts.

I don’t know why it is written in the first person. I suppose that means that the thoughts belong to Grandin?

Anyway, finding meaningful patterns in both meaningful and meaningless data, which Grandin says describes people on the autistic spectrum, might also describe macroeconomists.