Category: Equitablog

Is There a Valid “Stop the Misallocation of Capital” Argument for Raising Interest Rates Right Now?

Posted on by Brad DeLong

Kristi Culpepper: @munilass: “Best explanation of difference between people who believe Fed…

…should raise rates vs people who think Fed should hold tight…. People who think Fed should raise rates think Fed is only making things worse by encouraging misallocation of capital. People who think Fed should hold tight are obsessed with inflation measures, pressures from global economy. So Fed is caught between narratives of two groups that are essentially always going to be talking past each other.

That was the keen-eyed observer Kristi Culpepper tweeting a few days ago. It struck me as incisive and insightful both about those who do and about those who do not want the Federal Reserve to raise interest rates.

I think she is correct about what those who want the Federal Reserve to raise interest rates are thinking: they are thinking that the prices that are interest rates are somehow wrong, and are leading people who are responding them to do things that are stupid for society as a whole.

But how stupid?

The argument is that the incentives to create long duration assets generated by extremely low interest-rate’s are too high. Therefore we as a society are creating too many long duration assets. But are we? The standard long duration asset is a building. And residential construction is still deeply depressed, well below anything we might think of as its normal equilibrium level. From the standpoint of residential construction, low interest rates are only partially compensating for other market failures that are currently leading us to build too few houses, not too many.

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When I make this argument to those who want the Federal Reserve to raise interest rates, they move on. They point to non-residential construction–which is indeed healthy. but they cannot point to anyother long-duration investments in physical objects or organizations. And, indeed, in a world where the chief complaint about business is its short-termism, a configuration of market prices that puts a thumb in the scale in favor of projects of long-duration would seem to be a thing we need, not a thing to avoid.

And so they move on further: The argument becomes a claim that the Federal Reserve has made debt too valuable, and So the Federal Reserve is inducing overleverage. But too cheap relative to what? Issuing debt is richly valued. But the proceeds are not being used to build long-duration physical or organizational assets in excessive amounts. The proceeds are being used to buyback equities, but equities are also richly valued. So where is the incentive to overleverage? I do not see it.

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And so we come to the last argument: Commercial banks are being squeezed between the zero floor on deposits and the low rates they earn in their traditional relatively-safe loan habitats. Commercial banks should be focused on running their banking branch-and-ATM networks efficiently, and efficiently lending on a large scale to loan customers where they understand the risks. But, now, because low safe interest rates and the zero lower bound on what they can pay deposits, commercial banks have to become judges of risk–a task that they are not well qualified to do, which pits them against people who can and do adversely-select and moral-hazard this.

This is, I think, correct: Low interest-rate are bad for the commercial banking sector. But they are very good for labor and for capital. And, as long as they do not induce undue inflationary pressures, for the economy as a whole.

So are we supposed to sacrifice the health of the economy as a whole simply to make life easier for the commercial banking sector?

Now do not get me wrong. I wish that interest rates were higher. I think it expansionary fiscal policy to push up interest rates is clearly the first best policy.

But we are not going to get that–at least not until 2017 at the earliest.

And the scary thing is that the Federal Reserve does indeed seem to contain a great many people whose answer to that question is: Yes: we do want to sacrifice the health of the rest of the economy in order to make life easier for the commercial banking sector. Therefore we are going to raise interest rates now:

  • even though inflationary pressures are not yet visible on the horizon,
  • even though the Federal Reserve has ample ability to raise interest rates in order to catch up should inflationary pressures appear, and
  • even though the Federal Reserve has no ability to reverse course and offset the damage done should raising interest rates to be a mistake.

Carter Glass and Louis Brandeis are rolling in their graves…

Must-Read: Daniel Kahneman: Thinking, Fast and Slow

Posted on by Brad DeLong

Must-Read: Daniel Kahneman (2012): Thinking, Fast and Slow: “As interpreted by the important Chicago school of economics…

faith in human rationality is closely linked to an ideology in which it is unnecessary and even immoral to protect people against their choices. Rational people should be free, and they should be responsible for taking care of themselves The assumption that agents are rational provides the intellectual foundation for the libertarian approach to public policy: do not interfere with the individual’s right to choose, unless the choices harm others.… I once heard Gary Becker [argue] that we should consider the possibility of explaining the so-called obesity epidemic by people’s belief that a cure for diabetes will soon become available…

Much is therefore at stake in the debate between the Chicago school and the behavioral economists, who reject the extreme form of the rational-agent model. Freedom is not a contested value; all the participants in the debate are in favor of it. But life is more complex for behavioral economists than for true believers in human rationality. No behavioral economist favors a state that will force its citizens to eat a balanced diet and to watch only television programs that are good for the soul. For behavioral economists, however, freedom has a cost, which is borne by individuals who make bad choices, and by a society that feels obligated to help them.

The decision of whether or not to protect individuals against their mistakes therefore presents a dilemma for behavioral economists. The economists of the Chicago school do not face that problem, because rational agents do not make mistakes. For adherents of this school, freedom is free of charge.

Noted for the Morning of October 8, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Might Like to Be Aware of:

How delayed foreclosures can actually lead to higher wages

Posted on by Nick Bunker
Veer.com

The foreclosure crisis in the aftermath of the bursting of the U.S. housing bubble was incredibly damaging to millions of families. Due to the sheer number of mortgages in default, and the varied policy responses to slow down the rate of foreclosures, the average amount of time it took for a mortgage to go from initializing the foreclosure process to its completion rose from 9 months before the Great Recession of 2007-2009 to 15 months during and after the recession. While these borrowers faced the threat of losing their homes, they got a temporary reprieve from imminent eviction. A new paper argues that this delay in foreclosures had a significant effect on the labor market, which has implications for how we think about helping workers when they are unemployed.

The working paper, by economists Kyle Herkenhoff of the University of Minnesota and Lee Ohanian of the University of California-Los Angeles, attempts to better understand the relationship between the housing and labor markets. While others have looked at this topic, most of the prior work modeling the foreclosure process assumed that missing a payment on a mortgage immediately led to eviction. Clearly this doesn’t happen in reality. Herkenhoff and Ohanian model how a longer foreclosure process affects the behavior of workers, particularly those who are unemployed.

The two economists are working with a so-called search-and-matching model of the labor market, which focuses on the process of how workers and employers actually end up getting matched together in the form of a job. Using these models, the economists set up a relationship that determines how much unemployed workers search for a job. Herkenhoff and Ohanian analyze how much a workers’ job searching changes if foreclosure on their home were delayed.

Herkenhoff and Ohanian find that the searching declines when workers are in less dire need of a job to pay for their mortgage or pay for lodging elsewhere. The foreclosure delay acts like an implicit extension of credit from the mortgage holder to the borrower. This reduction in these workers’ search efforts also ends up having a significant impact on employment—the rate of employment for those with mortgages ends up being 0.75 percentage points lower in an economy where it takes 15 months to get to foreclosure, compared to one where it takes nine months.

This delay in finding a job affects the quality of the jobs that these unemployed workers end up with. As the unemployed workers are less desperate to take a job, they can take more time to find one that’s a better match for them. The end result is a higher average wage for the unemployed workers when there is a foreclosure delay. And that increase offsets the decline in employment so that total wages actually increases. Specifically, the total amount of wages in the economy goes up by 0.3 percent.

As the authors point out, these results are very similar to those found when studying the effect of extended unemployment insurance on the quality of jobs eventually taken by unemployed workers. In that case, credit gets extended to the unemployed worker (in the form of unemployment benefits) and the search intensity decreases, but average match quality and wages go up. Earlier research by Herkenhoff shows the general case of constrained credit has a significant impact on wages and job matching.

While the results from this paper shouldn’t be viewed as a specific endorsement of housing policy in regards to the labor market, it’s clear that extensions of credit to unemployed workers—be they implicit or explicit, or from private or public institutions—can help these workers come out of unemployment better off than if they were left to fend for themselves.

Must-Read; Weijia Li: Party-State Relationships in One-Party Regimes

Posted on by Brad DeLong

Must-Read: Weijia Li: Party-State Relationships in One-Party Regimes: “Although China and Soviet Union are both Communist regimes…

…they… feature very different party-state relationships. In contemporary China, the party secretary exerts political leadership, but fiscal and economic power is delegated to the governor. In the Soviet Union, the party secretary retained substantial and comprehensive economic power. I argue that the difference can be attributed to the discrepancy between market economy and planned economy. Using a simple growth model, I derive economic consequences of fiscal delegation that are consistent with empirical regularities. The delegation of fiscal power drastically reduces central authority’s concern about local officials’ loyalty… solves a major dilemma between loyalty and competence in autocracy… promotes political stability and meritocracy in China…

Must-Read: David Autor: The Limits of the Digital Revolution: Why Our Washing Machines Won’t Go to the Moon

Posted on by Brad DeLong

Must-Read: David Autor: The Limits of the Digital Revolution: Why Our Washing Machines Won’t Go to the Moon: “Much of what can be readily automated as repetitive information and tasks has been done…

…and the frontiers are elsewhere… into higher-level abstract reasoning and tasks that require some mixture of creativity, and intuition, and expertise, and also moving downward into jobs that require physical dexterity and some cognitive flexibility. It’s not that we’ve reached the limits of… computerisation… it’s just that that particular strand that has been so important has not completely played out but is not the frontier…. A lot of the computerisation has been most evident in the so-called ‘middle-skill activities’ and that process is to a substantial extent complete, but that means that it will move into other activities. Whether that’s worse or better depends very much on who you are…. It corresponds to rising productivity…. It has distributional consequences…. If you’re doing a job and all of a sudden a machine can do it cheaper, that’s almost never going to be a good thing for you. If you’re doing a job and a machine makes you more productive at doing that work, that’s almost always a good thing for you…

Must-Read: Harold Pollack: If you want mental health services to prevent violence, Medicaid expansion is critical

Posted on by Brad DeLong

Must-Read: Harold Pollack: If you want mental health services to prevent violence, Medicaid expansion is critical: “Oregon’s mass homicide sparked the usual debate about whether guns or mental health is the best focus in preventing atrocities…

…Given this stark frame, the centrality of gun policy is hard to deny. Compared with other wealthy democracies, America has surprisingly similar rates of car theft, aggravated assault, and other forms of nonlethal violence. Our gun homicide rate is about three times the average…. Gun policy measures such as improved background checks included in the nearly-passed, bipartisan, post-Newtown Manchin-Toomey bill would certainly be helpful. Many conservatives place greater emphasis on the mental health system. In some ways, this rhetoric is misplaced. The fraction of American violence attributable to severe mental illness is… on the order of five percent. We must also avoid reinforcing cruel stereotypes….

Still, it’s always wise to consider how our mental health systems could treat people more effectively, and more-reliably keep weapons away from dangerous individuals… expand the power of police and mental health professionals to temporarily confiscate guns from individuals whose behavior raises real concerns, but who do not meet the stringent criteria required to justify involuntary commitment…. Texas Senator John Cornyn has proposed… [to] expand states’ provision of mental health information to the National Instant Criminal Background Check System…. The potential impact of such data-sharing remains unclear…. Cornyn’s proposal does not address the most glaring issue in American mental health policy: the Affordable Care Act’s Medicaid expansion… the public health cornerstone of ACA…. Medicaid expansion provides financial stability to the whole network of safety-net medical, psychiatric, and addiction care…. In 2013, the National Alliance on Mental Illness (NAMI) released a report endorsing Medicaid expansion…. Addressing the connection between mental illness and violence, NAMI concluded:

In the aftermath of Newtown, many politicians and policy makers have promised to take steps to fix America’s broken mental health system. Expanding Medicaid in all states would represent a significant step towards keeping those promises.

Senator Cornyn is an implacable opponent of Medicaid expansion. Indeed he rallied at the Texas state capitol to oppose it…. Addiction and psychiatric disorders within the population of Texans deliberately left uninsured… 140,000… with addiction disorders… 54,000 live with severe mental illness… indigent criminal offenders and those seeking care at addiction treatment centers and stressed safety-net facilities that have lost billions of dollars because Texas has declined Medicaid. Leaving aside the human consequences for the uninsured, this is very poor violence prevention policy. If any other politician suggests that mental health rather than gun policy is central to reducing mass homicides, ask where they stand on Medicaid expansion. Their answer will be clarifying.

Must-Read: Ryan Avent: Ben Bernanke’s Big Blunder

Posted on by Brad DeLong

Must-Read: I find myself thinking about six things:

  1. The failure of the Bernanke Fed to focus on the unwinding housing bubble and learn about the outstanding sources of systemic risk in 2006 and 2007.
  2. The decision by the Bernanke Fed in September 2008 that it was time to demonstrate that it did not guarantee the debt of money-center shadow banks, step aside, and allow the uncontrolled bankruptcy of Lehman Brothers.
  3. In fact, the earlier decision by the Bernanke Fed to stand by rather than to handle the situation when, in the summer of 2008, Lehman Brothers crossed the line from solvent to insolvent and thus the Federal Reserve arguably lost the legal power to handle a Lehman-centered crisis.
  4. The failure of the Bernanke Fed to commit to a policy of catching-up to 2%/year inflation should prices fall below its inflation target.
  5. The failure of the Bernanke Fed to choose a more appropriate, higher inflation target than 2%/year.
  6. The failure of the Bernanke Fed to admit that the 2%/year inflation target had proved to be a mistake, and shift to a more sensible nominal GDP target.

These are six major failures of technocratic rationality in monetary policy. Is there anything to offset them, other than “we stopped another Great Depression from happening”?

Ryan Avent: Ben Bernanke’s Big Blunder: “Two weeks ago, The Economist repeated its endorsement of a change in the Fed’s monetary policy target…

…from an inflation rate to a growth rate for nominal GDP (NGDP): or total spending and income in an economy in dollar terms. In November of 2011, during Mr Bernanke’s chairmanship of the Fed, the monetary-policy committee considered a change to an NGDP target, but opted to stay with the old, inflation-focused framework. Mr Bernanke writes:

For nominal GDP targeting to work, it had to be credible. That is, people would have to be convinced that the Fed, after spending most of the 1980s and 1990s trying to quash inflation, had suddenly decided it was willing to tolerate higher inflation, possibly for many years.
And so in January of 2012 the Fed reiterated its inflation-targeting stance and officially designated a 2% rate of inflation, as measured by the price index for personal consumption expenditures, as the target.

We all know what happened next. Since then, the Fed has spectacularly undershot its inflation target…. Markets suspect rates might not rise to 0.5% until well into 2016, and most Fed members think rates will never get any higher than 3.5%. Treasury prices suggest that inflation will be closer to 1% than 2% over the next five years. There is good reason to believe that Mr Bernanke’s Fed made a big mistake, in other words. An NGDP target would have worked out better… helped the Fed choose policy more appropriately at a tricky time in the recovery. In 2011 high oil prices drove headline inflation above 2%… the central bank sensibly shrugged aside calls to raise rates in response to rising prices. Yet it also took no additional action to boost the economy. The recovery subsequently lost pace, inflation fell, and by the end of 2012 the Fed was forced to restart QE. Had the Fed instead focused its attention on NGDP, it would have been forced to react to an economy that was well below an appropriate level of output and which was growing too slowly…. Instead it took the costly choice to dither.

Just as importantly, a switch to an NGDP target would have sent a strong signal about Fed priorities…. Mr Bernanke notes that the Fed spent the 1980s and 1990s trying to quash inflation. It did not arrive at that policy strategy passively…. Paul Volcker… [did not say] that the Fed couldn’t possibly rein in double-digit inflation because it lacked credibility as an inflation-fighter after a decade of neglecting the problem. Instead, he used the tools available to him to demonstrate the Fed’s credibility. Mr Bernanke’s Fed could have, and should have, taken similarly bold action….

Instead, it made itself a prisoner of its own complacency. As a result, inflation and interest rates will spend most of the 2010s at dangerously low levels, leaving the American economy disconcertingly vulnerable to new economic shocks. The book, by the way, is titled The Courage to Act

What does and does not boost economic growth?

Posted on by Nick Bunker
Hands of the magician with magic wand and top hat, Veer.com

At a time of stagnant U.S. economic growth, magic seems to be not only an attractive option to boost growth, but perhaps the only feasible one. In a series of essays recently published by the Cato Institute, economists and analysts offered a number of ideas to boost growth that they’d implement if they had a magic wand. Commenting on the wide number of proposals in the collection, Washington Post columnist Robert Samuelson says the essays as a whole offer no singular consensus among economists about what policies to implement to boost economic growth. And that’s true—mainly because there’s no consensus about what actually increases growth in the long run. But what economists have done is knock down ideas that won’t boost economic growth, and point out broad areas that might boost it.

First, we have to be clear about what we mean when we talk about economic growth. If we just want to pump up economic growth in the short run, there are a number of ways to do that. But what we should be concerned about is the pace of long-run economic growth. And while economists still really aren’t sure about its source, they have a good idea about what won’t produce a higher growth rate.

Going back to the origins of the Solow growth model, many economists once believed that increasing savings could permanently boost the pace of economic growth, measured as the increase in gross domestic product per person. But under Solow’s framework, adding more capital and labor will only temporarily boost growth, and the pace of growth in the long run will eventually go back to where it was before. What needs to be increased, then, is productivity.

In contrast to the full employment assumptions in the Solow model, making sure labor and capital are utilized to their full potential is still critically important, —especially in the current United States with the aging of the Baby Boomers and the slowdown in female employment since 2000. So policies like the one proposed by Equitable Growth’s Heather Boushey that help workers balance work and family responsibilities are important to boost overall economic growth. But it’s definitely not the end of the story.

Taking a look at another famous growth model can help shape our thinking about what might boost productivity and long-run growth. Twenty-five years ago, economist Paul Romer, now of New York University, published a paper that developed an “endogenous” growth model. In Solow’s model, productivity increases are assumed. In Romer’s model, increases and growth come from individuals in the economy adding to the stock of human knowledge.

Romer’s innovation was to emphasize the knoweldge and ideas that help the economy and incorporate them into his growth model as “nonrival goods.” A good is nonrival if my use of it doesn’t restrict your ability to use it. Ideas are a great example of nonrival goods, as you and I can both use the idea of, say, nonrival good at the same time. As University of Toronto economist Joshua Gans put it in a blog post about the Romer model, “to understand growth surely we need to understand what incentives there are to create and also detract from the pool of knowledge that can help future idea creators.”

In other words, focusing on how ideas are created and then how those ideas are propagated through the economy are key for long-run growth. Spurring innovation can’t and won’t be the only solution to faltering growth. But it’ll certainly play a part.

So yes, economists and policymakers don’t know the exact policies to implement right away to boost economic growth. But there is an understanding of the general areas to focus on or not focus on. There’s a ways to go, but we know the general path to walk on.

Must-See: American Public Square: Dinner at the Square: A Dose of Reality: A Medicaid Status Report

Posted on by Brad DeLong

Must-See: Alas! I seem to be missing the Kathleen Sibelius panel on Medicaid expansion this evening at UMKC:

American Public Square: Dinner at the Square: A Dose of Reality: A Medicaid Status Report

But I do have a question that I would like to ask panelist Michael F. Cannon of the Cato Institute. I would greatly appreciate it if somebody else would ask the question–and get an answer:

Mr. Cannon: You said that:

  • RomneyCare had begun a process of adverse-selection meltdown in Massachusetts that was “well underway”,
  • people would not sign up for ObamaCare in large numbers,
  • people who signed up for ObamaCare would not pay their premiums,
  • ObamaCare would in fact reduce private insurance coverage by making it riskless for healthy people to drop insurance,
  • a federal exchange was a profoundly different legal object than a state exchange, even though ObamaCare commanded Secretary Sibelius to establish “such exchange” when a state that did not establish one,
  • states that did not expand Medicare Medicaid would have healthier state budgets than those who did, and
  • I could go on for quite a while…

I have counted more than a dozen predictions you have made ever since, back in 2005, Mitt Romney set us on our current health-policy path. All of yours have gone wrong. None of yours have gone right.

How has the fact that you have been so wrong about so much over the past decade changed your thinking about how health insurance markets work, and about health policy?

What has this episode taught you about your milieu–about think-tanks controlled by billionaires with strong ideological commitments, and surrounded by flatterers who assure them they are right about everything? And what has this episode taught you about yourself and your peers who draw their paychecks from such think-tanks?