Category: Equitablog

Commercial bankers, you see, are not rentiers. Rather, they are intermediaries. And they are intermediaries who find an economy in which interest rates are likely to kiss the zero lower bound a very difficult environment in which to operate.

Thus if I were a commercial banker working for or advising the Federal Reserve, I would think like this:

The interest rate on relatively safe loans is going to bounce around with the state of the business cycle, as the Federal Reserve leans one way or another and as speculators expect the Federal Reserve to keep leaning or to normalize. But there is a fixed point of reference: The average around which the interest rate on relatively safe loans will bounce around will be equal to the rate of real profit, minus the yield discount for relative safety, plus the expected inflation rate.

Commercial banks need a wedge of about 300 basis points between their cost of funds and the returns on the loans they make. They need this wedge in order to operate their networks of ATMs, keep open their branches, and pay for their administrative processes. Commercial banks cannot pay negative interest on deposits. And commercial banks really do not want to sock their depositors with unexpected fees: that is a way for a bank to become a much smaller bank relatively quickly.

That means that:

• either there has to be a wedge of at least 300 basis points between the nominal interest rate on the loan banks make and zero
• or the commercial banking business model does not work.

If the average interest rate is below zero, then banks banks have to reach for yield. They must thus get into the business of making risky loans–loans that they are not equipped to judge well, and are made into situations rife with adverse selection and moral hazard.

Thus Commercial banks have a hard time making their business model work when the Federal Reserve target and the market expected inflation rate is, say, 2% per year. They would have a much easier time making their business model work when the Federal Reserve target and the market expected inflation rate were 4% per year.

Now combine this insight with the mechanics of maintaining an inflation target: When the actual inflation rate is less than 4% per year, the Federal Reserve should–slightly paradoxically–lower interest rates in order to boost spending and so get the inflation rate back up. And conclude that the commercial bankers and their allies in the Federal Reserve–the 36 Class “A” banker directors of the regional Federal Reserve Banks, the 36 Class “B” non-banker directors of the regional Federal Reserve Banks who are chosen by member banks to “represent” labor, agriculture, consumers, etc., but who do so mostly in the breach, and the regional Federal Reserve Bank Presidents who come out of the banking sector–ought to be among the strongest advocates of not raising interest rates now, and the strongest advocates of raising the 2% per year inflation target to 4% per year.

They are not.

Why not? Perhaps it is just that they do not believe in the Fisher Effect–do not believe that the average level of nominal interest rates would be 200 basis points higher under a 4% per year inflation target than under a 2% per year target.

Any other candidate explanations?

Must- and Should-Reads:

• Must-Read: David Roberts: Jon Chait Wrote an Optimistic Take on Climate Change. Is it justified?
• Must-Read: Jared Bernstein: The Press Calls Him on It!
• Must-Read: Harriet Torry and Jon Hilsenrath: Lesson for Fed: Higher Interest Rates Haven’t Been Sticking
• Austan Goolsbee: “I mean, who looks at the economy and says: ‘You know what went wrong in the 2000s? We didn’t cut high income people’s taxes enough'”
• Dave Weigel: “Christie says the official low unemployment # is bunk: ‘There’s someone in the Perkins building who just throws darts at a dartboard.'”
• Bill Black: Now the DOJ Admits They Got it Wrong
• Diane Coyle (1997): The Weightless World: Strategies for Managing the Digital Economy

Might Like to Be Aware of:

• J-F. Dubeau: Why Inkshares Matters to Readers and Writers of Fantasy and Science Fiction
• Joe Romm: Here’s Why 2016 Could Be Even Warmer Than 2015* Andrew Kaczynski: Ted Cruz, Who Repeatedly Vouched For John Roberts [in 2005], Slams Him At Length
• Bryan Lowry: Brownback’s Office Attacks ‘Ever-Litigating’ [Kansas] School Districts
• Andrew Flowers: The Science Of Grading Teachers Gets High Marks
• Alice Domurat Dreger: Opioids: An “n of 1” Reflection

As I said, my reading of the Great Depression era–FDR’s New Deal, Neville Chamberlain’s announcement that it was the policy of HMG to reverse the deflation that had occurred since 1929, Takahashi Korekiyo’s policies in Japan before his very untimely murder by militarist-fascist captains and majors–had convinced me that expectational effects were a thing. Thus I anticipated that Abenomics was likely to be a substantial huge success. 1979-1984 had taught us the limits of the expectations channel: that at the worker- and the manager-level expectations of inflation and deflation were likely to be adaptive and backward-looking. But Roosevelt, Chamberlain, and Takahashi in the 1930s gave me confidence in the expectations channel as far as money demand and investment were concerned. Thus I believed that the announcement effect of Abenomics stood a very good chance of working very well indeed.

I expected it to (1) reverse Japan’s deflation, (2) raise asset prices substantially, (3) bring price inflation and inflation expectations into line with its targets, and (4) spur a strong recovery. Why? Because I believed expectations relevant for financial markets were forward-looking, and reasonable forecasts that could be affected by credible policy announcements. (1) and (2) have happened. (3) and (4) have not.

Slides from Adam Posen’s Discussion of Hausman and Wieland’s Abenomics update:

Does Abenomics Support or Discredit Standard [New-Keynesian] Macro?

• The forward-looking expectations/crediblity centered view of monetary policy comes off poorly

  • Ball and others had warned us that you really need real growth and wage rises to get inflation up
  • Combo of exchange rate movement and the BOJ program should have been “credible” by any standard
  • May be a little unfair, in that the combination of labor market changes and global forces can account for a rather large share of the ‘shortfall’ in inflation (i.e., core targeting was more successful)
  • Hidden surprise is that unlike 1990s/early 2000s, clean banks and balance sheets, still no effect
  • Remains the issue of response to shocks (which I agree is the proper definition of anchoring)

• Fiscal policy comes closer to being as expected, at least in the short-run

  • Multipliers on fiscal policy not unexpectedly large, but persistence of shock was as surprise
  • The authors’ showing the uniformity of consumption impact across ages/credit status may just illustrate the (sole) relative importance of liquidity constraints which are largely absent in Japan today
  • Much more troubling with respect to fiscal theories of price level, debt-sustainability, and distinctions of permanent/temporary tax impacts

• Three surprises/challenges for me with respect to overall policy assessment

  • Hidden surprise is that unlike 1990s/early 2000s, clean banks and balance sheets, still limited effect
  • Should we stop talking about credbility?–if forward-looking matters, shouldn’t there be Ricardian effects of fiscal policy and/or a stock market response to VAT hike?
  • If labor flexibility and shareholder rights-enhancing reforms don’t work when tried, does this mean that structural reform is overrated?

What Are the Puzzles Abenomics Presents to Macro?

• Remember, the message of Japan 1990-2003 is that policy worked as expected [by simple IS-LM]

  • Has something changed?
  • Japan is more open and more market-oriented now than in 2003 which goes other way

• Underscores the misleading emphasis on (simple? or just flexible?) forward-looking expectations–even amongst well-informed businesses and investors

• Challenges us to further examine the global forces (still tbd) behind inflation levels and consumption/savings trends–especially since not simple RBC looking either

• Highlights the puzzles in trade balance and exchange rate pass-through:

  • How can depreciation have large effects on exports volumes but not imports?
  • How can depreciation affect a huge chunk of the economy and not (first-round) affect general inflation?

• Why is low inflation so inertial not just sticky?

• Are we having to take more literally falling in and out of two states of the world–between recession-land and boom-world?

Those are Adam Posen’s take-aways from the Abenomics experience so far. Are they right?

I will have to think about this for quite a while…

Must-Read: I guess I must be more optimistic than David Roberts–I still think the odds are favorable that we will learn how to manage our climate before we have had 100,000,000 unnecessary and avoidable premature deaths from global warming:

David Roberts: Jon Chait Wrote an Optimistic Take on Climate Change. Is it justified?: “my favorite part is Chait’s straight talk…

…about the Republican Party:

The entire world is, in essence, tiptoeing gingerly around the unhinged second-largest political party in the world’s second-largest greenhouse-gas emitter, in hopes of saving the world behind its back.

Well put! And he calls climate denialism “a regional quirk in the most powerful country on Earth,” which captures both the absurdity and danger of it….

Chait’s optimisms decline in plausibility as the piece goes along. Technological innovation: 8…. US policy progress: 7…. International political progress: 6…. China political progress: 5. Chait is right to mock Republicans for saying that US action won’t make any difference because China won’t reciprocate–and then ignoring or dismissing it when China reciprocates. In fact, China is dumping enormous resources into clean energy and placing increasingly stringent limits on coal…. Developing country progress: 4….

The gaping hole in Chait’s piece? He has written the grassroots climate movement(s) out of existence. All he says about environmentalists is that they ‘sank into despair’ after the cap-and-trade bill failed…. It’s not just ‘environmentalists’ now–the climate justice movement is far broader than that and includes many other constituencies. And they did not sink into despair when the cap-and-trade bill (which they hated) died, they organized. Chait may not like the fact that the movement rallied around Keystone XL, but rally it did. And it’s beyond absurd that Chait mentions the closing of hundreds of coal plants in the US without mentioning the grassroots Beyond Coal movement…. Chait has always had a beef with the left activists in general and climate activists specifically… a bit personal… distorted his otherwise typically lucid political analysis…. It’s a little crazy to write about humanity getting serious about saving itself without even mentioning the growing grassroots movement that has dedicated itself to doing just that….

Overall optimism verdict: 7…. The status quo trajectory still leads to disaster. But… for the first time in my lifetime, it looks like it might be real fight.

Must-Read: Jared Bernstein: The Press Calls Him on It!: “The media, often pilloried for just reporting what the candidates tell them…

…performed notably well in this case, digging deeply into the numbers, referencing historical failures of these sorts of policies, and generally getting it factually correct. That’s worth applauding…. Granted, it wasn’t hard… Jeb’s economics’ team claims that supply-side magic dynamics offsets 65 percent of the tax cuts, an unbelievably large proportion…. But I still think we should give credit where it’s due…. Josh Barro… Catherine Rampell… John Cassidy… Bruce Bartlett…. The first partial analysis of the plan by experts (other than the economists associated with the campaign) was just released by the Citizens for Tax Justice. They report that 53 percent of the income tax cuts from the plan would go to the top 1 percent…. I don’t want to make too much of this spate of revealing analysis, but dare I dream? Could we actually be heading back to Factville!?…

Must-Read: Harriet Torry and Jon Hilsenrath: Lesson for Fed: Higher Interest Rates Haven’t Been Sticking: “In the seven years since the world’s central banks responded to the financial crisis…

…by slashing interest rates, more than a dozen banks in the advanced world have tried to raise them again. All have been forced to retreat… the eurozone, Sweden, Israel, Canada, South Korea, Australia, Chile and beyond…. [The] two central banks that haven’t raised rates since the crisis—the Fed and the Bank of England—have enjoyed stronger recoveries than others…. “Tightening too early can have very large costs, as it has had in the Swedish case,” said Lars Svensson, who quit as Riksbank deputy governor in 2013 in protest at the bank’s policy decisions…. Central banks can’t push rates higher in the long run than their economies can fundamentally bear, said Mr. Svensson. In the postcrisis environment, central banks have had trouble setting rates low enough to energize their economies, he said….

Fed officials now say they plan to move gradually. But their expectations for rates could still be too high. Officials in June estimated the Fed would raise the short-term federal-funds rate from near zero now to 1.625% by the end of 2016 and to 2.875% by the end of 2017. Investors have a different view… under 1% at the end of 2016 and under 1.5% at the end of 2017…

Live from DuPont Circle: Last Thursday two of the smartest participants at last Friday’s Brookings Panel on Economic Activity conference–Martin Feldstein and Glenn Hubbard–claimed marvelous things from the enactment of JEB!’s proposed tax cuts and his regulatory reform program.

They claimed it would boost economic growth over the next ten years by 0.5%/year (for the tax cuts) plus an additional 0.3%/year (for the regulatory reforms).

That would leave the U.S. economy in ten years producing $840 billion more in annual GDP than in their baseline. That would mean that over the next ten years faster growth would produce an average of $210 billion a year of additional revenue to offset more than half of the $340 billion a year “static” revenue lost from the tax cuts, making the net cost to the Treasury not $340 billion/year but $130 billion/year. And that would mean that in the tenth year–fiscal 2027–the $400 billion “static” cost of the tax cuts in that year would be outweighed by a $420 billion faster-growth revenue gain.

The problem is that if I were doing the numbers I would reverse the sign.

• I would say that, on net, deregulatory programs have been very costly to the U.S. economy in unpredictable ways–witness the subprime boom and the financial crisis.

• I would say that the incentive effects would tend to push up growth by only 0.1%/year, and that would be more than offset by a drag on the economy that would vary depending on how the tax cuts were financed.

  • If they were financed by issuing debt, I would ballpark the drag at -0.2%/year.
  • If they were financed by cutting public investment, I would ballpark the drag at -0.4%/year.
  • If they were financed by cutting government programs, there might be a small boost to growth–0.1%/year–but any societal welfare benefit-cost calculation would conclude that the growth gain was not worth the cost.

And there is substantial evidence that I am right:

• You cannot find a boost to potential output growth flowing from either the Reagan or the Bush tax cuts.

• You cannot find a drag on growth from the Obama tax increases.

• You can find an effect of the Clinton tax increases–but it is that, thereafter, growth was faster, because the reduction in the deficit powered an investment-led recovery.

Over the past thirty years, the agencies that do the government’s accounting have tried to reduce their vulnerability to the imposition of a rosy scenario by their political masters by claiming as a matter of principle that they do not calculate positive growth impacts of policies. This is clearly the wrong thing to do–policies do affect growth rates. But is overestimating growth effects in a way that pleases one’s political masters a less-wrong thing?

[Name Redacted] suggested at the conference that the right thing to do is probably to apply a substantial haircut to the growth-boost claims of political appointees.

The problem is that when I look at the example of “dynamic scoring” that was on the table at Brookings today–the 0.8%/year growth boost that I really think should be a -0.1%/year growth drag–the haircut I come up with, for Republican policy proposals at least, is 112.5%.

Yet the near-consensus of the meeting was that dynamic scoring–done properly–was a thing that estimating agencies like JCT and CBO (and Treasury OTA) should do.

If there were to be a day less favorable to such a consensus conclusion, I do not know what that day would have looked like…

Fall 2015 BPEA 11:45 AM Fr: With respect to Looney and Yannelis…

If I recall correctly, back in the 1950s, the then-president of the University of California, Clark Kerr, took a look at the situation and foresaw that come 2000 ten times as many students would be qualified to benefit from a University of California undergraduate education as in his day–50,000 a year rather than 5,000 or so. In his vision, UC had to expand tenfold, and of course tuition would still be free. Then in the 1970s we started to retrench–both in numbers of slots, and in public subsidy per slot. The number of slots did not grow as fast as projected, and tuition at public universities rose from next to nothing to what are now very healthy amounts. This was a very defensible decision from a standard public finance perspective: college attendees are richer than average and the college wage premium appeared very low in the 1970s.

Now it seems reasonably clear that this decision to shift from grant- to loan-financing of attendance at public universities has probably not been a net plus for non-college workers, has kept a substantial number who really ought to be going to college from doing so–handing over long-term human capital-investment decisions to adolescents not being that good idea–and has landed us with a large for-profit university-driven student loan problem.

Andrei Shleifer taught me two decades ago with the example of privatized prisons that there are some places where we really do not want hard market profit-and-loss incentives operating without sociological checks. In addition to prisons, pensions, health insurance, research and development, and other information goods come to mind. And now I would add higher education.

Adam Looney and Constantine Yannelis: A Crisis in Student Loans? How Changes in the Characteristics of Borrowers and in the Institutions they Attended Contributed to Rising Loan Defaults: “This paper examines the rise in student loan delinquency and default…

…drawing on a unique set of administrative data on federal student borrowing, matched to earnings records from de-identified tax records. Most of the increase in default is associated with the rise in the number of borrowers at for-profit schools and, to a lesser extent, 2-year institutions and certain other non-selective institutions, whose students historically composed only a small share of borrowers. These non-traditional borrowers were drawn from lower income families, attended institutions with relatively weak educational outcomes, and experienced poor labor market outcomes after leaving school. In contrast, default rates among borrowers attending most 4-year public and non-profit private institutions and graduate borrowers—borrowers who represent the vast majority of the federal loan portfolio—have remained low, despite the severe recession and their relatively high loan balances. Their higher earnings, low rates of unemployment, and greater family resources appear to have enabled them to avoid adverse loan outcomes even during times of hardship. Decomposition analysis indicates that changes in characteristics of borrowers and the institutions they attended are associated with much of the doubling in default rates between 2000 and 2011. Changes in the type of schools attended, debt burdens, and labor market outcomes of non-traditional borrowers at for-profit and 2-year colleges explain the largest share.

Must- and Should-Reads:

• dew: “Americans’… fall into three groups of roughly equal size: Those who have a moderate to strong preference for auto-centric suburban living, those who have a moderate to strong preference for… walkable urbanis[m]… and those who have weak or no preferences..”
• Must-Read: Lawrence Summers: Why the Fed Must Stand Still on Rates
• Must-Read: Dani Rodrik: Economists vs. Economics
• Must-Read: Josh Bivens and Lawrence Mishel: The Divergence Between Productivity and a Typical Worker’s Pay: Why It Matters and Why It’s Real
• Nicholas Bagley: Oh Boy. Here We Go Again
• Bruce Bartlett: Jeb’s Tax Plan Makes George W. Bush’s Policies Look Good
• Izabella Kaminska: So Where Did That Chinese Dollar Liquidity End Up?
• Bruce Bartlett: Jeb’s Tax Plan Makes George W. Bush’s Policies Look Good
• Must-Read: Larry Summers: “If there’s one thing that characterizes our politics now,
• Must-Read: Rob Kunzig: Labor Economics Are Having a Moment–and so Is Larry Mishel
• Must-Read: Andy Menke et al.: Prevalence of and Trends in Diabetes Among Adults in the United States, 1988-2012

Might Like to Be Aware of:

• Nate Silver: Stop Comparing Donald Trump And Bernie Sanders