Must- and Should-Reads:
…She’s also a hedgehog. Meaning, of course, that she applies her One Big Idea to everything and anything, and tends to exaggerate its power and the evidence in favor of it. That’s OK. Most promoters of big good ideas are hedgehogs…. I think that as a society we’ve gotten good at recognizing hedgehogs and mentally correcting for the hedgehogginess…. Dweck makes it clear many times that natural ability does, in fact, matter. She states that among people of similar natural ability, having a growth mindset makes a big difference. What she is saying is that the marginal effect of the growth mindset on performance is large for most people, even though natural ability matters a lot in the average…
…instead of taxing wealth or income, the government should encourage people to save by taxing only their spending… Rubio… Lee… Cardin…. Too bad they’re all wrong…. The theoretical arguments in favor of consumption taxes are typically based on the injustice of penalizing thrift by the poor. But those are just fables: Saving is overwhelmingly a pastime of the rich…. [It] might sound great in theory, but one that would be revenue and distributionally neutral would create tremendous smuggling opportunities and thus be impossible to enforce…
For most of its 80-year existence, the U.S. Export-Import Bank was a government program decidedly out of the spotlight. But over the past several years the bank has been front and center in debates about the role of the federal government in the U.S. economy. Proponents of the bank argue that the credit it provides is an important service that the free market won’t supply on its own. Opponents argue that the bank just acts as a subsidy for economic activity that would happen anyway in the free market. But in thinking about the program, it might be worthwhile to step back and think about broader macroeconomic conditions given the bank’s potential expiration at the end of June.
The bank, as you can guess from its name, is focused on financing U.S. business activity in international markets. According to the agency’s website, the bank’s mission is to help businesses “turn export opportunities into sales” and “get what they need to sell abroad and be competitive in international markets.” In other words, the bank is all about increasing U.S. exports.
But for anyone who’s taken an economics course on international trade knows, the level of exports really isn’t driven by credit financing. As Veronique de Rugy at George Mason University’s Mercatus Center points out, the bank only supports about 2 percent of all U.S. exports. Rather, much larger macroeconomic factors such as exchange rates and national savings play a decidedly bigger role. So what does determine the trade balance between two countries?
The first country, say China, consumes less than it produces, which means the country has net savings overall. The second country, say the United States, would like to consume more than it produces and in particular wants to buy goods or services from the first country. The result is that the United States ends up borrowing money from China to buy these goods. That’s one reason why China is running a trade surplus while United States is running a trade deficit. After a while, the United States will have to pay back China so it’ll reduce consumption, save more, and the roles will be reversed.
Of course, this process can be interrupted if the exchange rate is altered in some way. Say one of the countries has a currency, such as the U.S. dollar, that a lot of people want to hold to facilitate financial transactions. China, meanwhile, generally sets the exchange rate for its currency to make its exports more competitive in the international market. That means the United States will end up receiving a lot of savings from the rest of the world, including from China, allowing it to consume more than it otherwise would be able to purchase. And the currency will be stronger than it would have been otherwise. The result: a trade deficit with imports exceeding exports.
Whether or not exporters get financing from the U.S. Export-Import Bank, its existence would probably only have a marginal effect on net exports.
…And you realize that they don’t change overnight. Are you better off promoting the set of policies that presume that rule of law and contract enforcement will take care of themselves, or are you better off recommending a strategy that optimizes against the background of a weak rule of law?… I say… you do much better when you do the second. The best example is China. Its growth experience is full of these second-best strategies, which take into account that they have, in many areas, weak institutions and a weak judicial system, and therefore they couldn’t move directly to the kinds of property rights we have in Europe and the United States. And yet they’ve managed to provide incentives and generate export-orientation in ways that are very different from how we would have said they ought to have done it… The same can be said of Vietnam, say, or farther afield, a country like Mauritius.
…“further improvement in the labor market” (even though the unemployment rate is now back to spring 2008 levels), and convincing evidence that inflation (which has been running below target) is heading back to 2%. Waiting for both may require a lot of—well—patience…. The so-called hawks, who have been calling for rate hikes since 2009, have constantly warned of high inflation lurking just down the road. It must be a long road. The Fed’s favorite measure of core inflation (which omits food and energy prices) has been stuck in a narrow range between 1.3% and 1.7% since mid-2012. Headline inflation, which includes food and energy prices, is roughly zero. If the rationale for interest-rate hikes is heading off inflation, this performance practically cries out for patience…. A tight labor market could push up wages faster. Hawks look at today’s unemployment rate, which is 5.5% and falling, and see a labor market that is already tight and getting tighter. Ms. Yellen and the FOMC majority disagree. They patiently await “further improvement in the labor market”….
The impatience crowd once worried loudly and frequently about a different set of problems. Specifically, that near-zero interest rates and/or quantitative easing were allegedly causing financial-market “distortions” and “bubbles.”… The federal-funds rate has been near zero for over six years now, and the Fed’s balance sheet is roughly five times as large as when Lehman Brothers failed. Yet none of the hypothesized financial hazards have surfaced. So you don’t hear the scare stories much anymore. Here, too, the evidence suggests that patience is the right policy. To be sure, the Federal Reserve will not maintain near-zero interest rates and a $4.5 trillion balance sheet forever. Monetary policy will eventually begin to normalize. But not in June, and maybe not in September. Timing, they say, is everything. This is a time for patience.
…Previous work in economic history has emphasized the rapid decline in transportation costs and the fall in tariffs. However, a number of other trade costs mattered over this period, and not all of them followed the same path as real transportation costs…. When two nations adopted the gold standard, trade was higher by 15 percent, on average, relative to non-adopters. Monetary unions, political alliances, language, and trade treaties also affected the direction of trade…. Our data for the U.S., U.K., and France and their major trading partners between 1870 and 1913 show that trade costs fell at a rate of about 0.3 percent per year, which is significantly slower than the decline in average maritime freight rates of 2 percent per year. Our explanation for this is, first, that our all-encompassing trade-cost measure captures many other frictions….
Globalization in the 19th century had a very important ‘extensive margin.’ While the existing literature on pre-1914 globalization has emphasized a ‘great specialization,’ this characterization fails to take into account that a significant fraction of the growth of trade was due to the export of new goods and the opening up of new markets. Significant amounts of the observed trade flows were also in fact already intra-industry. This observation leads us to believe that then, as now, firm-level heterogeneity and trade costs mattered…. As fixed costs fell and presumably as new firms found it profitable to enter export markets, many industries experienced relatively slow productivity growth as low-productivity entrants were now able to survive…. Overall productivity growth between 1870 and 1910 was much slower than we would expect in the midst of such an unprecedented trade boom, and it was much lower than productivity growth in the new-goods sectors….
Observe that, from the middle of the 19th century, many countries dramatically extended the franchise, thereby increasing the level of ostensible democracy. A similar trend coincided with the more-recent wave of globalization, as the number and share of democracies in the world rose dramatically from the 1960s…. We use an instrumental-variables strategy inspired by Jeffrey Frankel and David Romer to see whether, in the first wave of globalization in particular, exposure to trade flows might have had a causal impact on democracy. There is little evidence that it did…
Rethinking Macro Policy III: Progress or Confusion?
It could have turned out very differently.
It could have been that the money-center universal banks did understand their derivatives books. It could have been that, after the financial crisis, trust in financial intermediaries would rebuild itself quickly. It could have been that the North Atlantic’s central banks would have been able to nail market expectations to a rapid return to normalcy, thus providing cash holders with powerful incentives to spend. It could even have been the case that fiscal expansion would have proven ineffective. It was Karl Smith who pointed out to me that in the guts of even the IS-LM model, fiscal policy expands I+G by reducing the perceived average riskiness of and thus getting households to hold more. In the model it is guaranteed that a sovereign that issues more debt thereby necessarily reduces the perceived riskiness of average debt. In the world not.
But we all go to the blackboard with the economy we have, rather then the economy we used to think we had.
If you had asked me back in 2005 whether the world could possibly turn out to be as “Old Keynesian” as it has turned out to be over the past decade, I would have said: No.
Now there are two possible ways we can respond, given how the world has surprised us over the past decade:
We can turn our excellent brains to constructing increasingly implausible rationalizations for why what we thought in 2005 was right after all.
Or we can mark our beliefs to market.
I strongly recommend the second.
That is all I am going to say about fiscal policy in the short run–with the note that these days the “short run” is not the two or three years I used to teach my undergraduates, but rather a period of time that is uncertainly and terrifyingly long.
So let’s move, in our imagination at least, into the medium run in the North Atlantic: into a world in which short-term safe nominal interest rates rarely if ever hit the zero nominal bound, and the full employment and price stability stabilization-policy mission could be left to central banks and monetary policy.
First question: Can, in a political-economy sense, central banks be trusted with this mission? Are they not captured, to too great an extent, by the commercial-banking sector that, myopically, favors higher nominal interest rates to directly improve bank cash flows and indirectly dampen inflation and so redistribute wealth to nominal creditors–like banks? No, they cannot be trusted. Yes, they are so captured. This is a problem.
Second question: What is the proper size of the twenty-first century public sector? We all know the stringent requirements for market optimality: rivalry, excludibility, information symmetry, a distribution of wealth that accords with utility and desert, competition, neutralization of price stickiness, financial regulation to offset positive-feedback, along with other largely-fruitless attempts to deal with other behavioral-economics failures of human calculation: envy, spite, myopia, salience, and so forth.
As we move into the twenty-first century, the commodities we want to produce are becoming less “Smithian”. More education–and I do not think anyone in the U.S. is happy with the decisions twenty-year olds are currently making about how much education they should get and how to finance the debt incurred. Deciding to fund education via long-term loan-finance and to leave societal cost-benefit investment calculations in the hands of adolescents: not a good idea.
Pensions: The privatization of pensions via 401k(s) has been, I think, a disaster. The rise in finance from 15% to 40% of profits has come from somewhere, and one big somewhere has been the ability of Wall Street to tempt investors to churn their 401(k)s–the 0.01% exploiting the 5% that are the investing class. Health-care spending as a share of total income will cross 25% if not 33%. In the U.S., we are making one last effort to preserve a private insurance market for those rich enough for insurance companies to value their willingness to pay and young enough for insurance companies to be willing to bear the risks. But information asymmetries are large and mounting as expenses riss. Enough said.
The twenty-first century will see information goods a much larger part of the total pie than the twentieth. And if we know one thing, it makes no microeconomic sense at all for services like those provided by Google to be funded and incentivized by how much money can be raised not off of the value of the services provided, but off of the fumes rising from Google’s ability to sell the eyeballs of the users to advertisers as an intermediate good. Infrastructure? R&D?
Now we know that as bad as market failures can be, government failures can be worse. We badly need new effective institutional forms. But the decreasing salience of “Smithian” commodities in the twenty-first century means that rational governance would expect the private-market sphere to shrink relative to the public.
This is very elementary micro and behavioral economics. We need to think about what its implications for public finance are.
Third, the proper size of the government debt. Back in the Clinton administration–back when the U.S. government’s debt really did look like it was an an unsustainable course–we noted that the correlation between shocks to U.S. interest rates and the value of the dollar appeared to be shifting from positive to zero, and we were scared that the U.S. was alarmingly close to its debt capacity and needed major, radical policy changes to reduce the deficit. Whether we were starting at shadows then, or whether we were right then and the world has changed since, or whether the current world is in an unstable configuration and we will return to normal within a decade is unclear to me.
But right now financial markets are telling us very strange things about the debt capacity of reserve currency-issuing sovereigns.
Since 2005, the interest rate on U.S. ten-year Treasury bonds has fallen from roughly the growth rate of nominal GDP–5%/year–to 300 basis points below the growth rate of nominal GDP. Because the duration of the debt is short, the average interest rate on Treasury securities has gone from 100 basis points below the economy’s trend growth rate to nearly 400 basis points below. And maybe you can convince yourself that the market expects the ten-year rate over the next generation to average 50 basis points higher than it is now. Maybe.
Taking a longer run view, Richard Kogan of the CBPP has been cleaning the data from OMB. Over the past 200 years, for the U.S., the government’s borrowing rate has averaged 100 basis points lower than the economy’s growth rate. Over the past 100 years, 170 basis points lower. Over the past 50 years, 30 basis points lower. Over the past twenty years Treasury’s borrowing rate has been on average greater than g by 20 basis points. And over the past ten years, 70 basis points lower.
Now nobody sees the United States or the North Atlantic economies as dynamically inefficient from a Golden Rule growth-theory standpoint as far as our investments in private physical, knowledge, and organizational capital are concerned. r > g by a very comfortable margin. Investments in wealth in the form of private capital are, comfortably, a cash-flow source for savers.
But there is this outsized risk premium, outsized equity and low-quality debt premium, outsized wedge. And that means that while investments in wealth in the form of private capital are a dynamically-efficient cash-flow source for savers, investments by taxpayers in the form of paying down debt are a cash-flow sink. Over the past 100 years, in the United States, at the margin, each extra stock 10% of annual GDP’s worth of debt has provided a flow of 0.1% of GDP of services in taxpayers in increased primary expenditures or reduced taxpayers.
What is the elementary macroeconomics of dynamic inefficiency? If a class of investment–in this case, investment by taxpayers in the form of wealth held by the government via amortizing the debt–is dynamically inefficient, do less of it. Do less of it until you get to the Golden Rule, and do even less if you are impatient. How do taxpayers move away from dynamic inefficiency toward the Golden Rule? By not amortizing the debt, but rather by borrowing more.
Now we resist this logic. I resist this logic. I tend to say that we have a huge underlying market failure here that we see in the form of the equity return premium–a failure of financial markets to mobilize society’s risk-bearing capacity, and that pushes down the value of risky investments and pushes up the value of assets perceived as safe, in this case the debt of sovereigns possessing exorbitant privilege.
But how do we fix this risk-bearing capacity mobilization market failure? And isn’t the point of the market economy to make things that are valuable? And isn’t the debt of reserve-currency issuing sovereigns an extraordinarily valuable thing that is very cheap to make? So shouldn’t we be making more of it?
Looking out the yield curve, such government debt looks to be incredibly valuable for the next half-century, at least.
And this gets us to the last question: isn’t high government debt–even for a reserve currency-issuing sovereign–risky?
What if there is a sudden downward shock to the willingness of investors to hold this debt? What if the next generation born and coming to the market is much more impatient than the current one? Governments might then have to roll over their debt on terms that require high debt-amortization taxes. If the debt is high enough, those taxes could push economies up the Laffer curve. Could that render the debt unsustainable, or the decision to tolerate a high government debt unwise?
Two considerations make me think that this is a relatively small danger. First, when I look back in history I cannot see any such strong fundamental news-free negative preference shock to the willingness to hold the government debt of the North Atlantic’s major powers s. The North Atlantic fiscal crises we see both after and before the advent of parliamentary goverment–of the Weimar Republic, Louis XIV Bourbon, Charles II Stuart, Felipe IV Habsburg, and so forth–appear driven by fundamental news: a government that loses its power to tax or its willingness to repay its debt. Second, as Rinehart and Rogoff point out at great length, 20th and 19th Century North Atlantic governments have proven able to tax their financial sectors via financial repression with great ease. And the amount of real wealth for debt amortization that can be raised by financial repression scales roughly with the value of outstanding government debt.
It is large-scale borrowing in harder currencies–or writing unhedged puts on your currency–that is the source of real trouble.
Rethinking Macro Policy III: Progress or Confusion?
Can, in a political-economy sense, central banks be trusted with the full-employment-and-price-stability stabilization-policy mission? Are they not captured, to too great an extent, by the commercial-banking sector that, myopically, favors higher nominal interest rates to directly improve bank cash flows and indirectly dampen inflation and so redistribute wealth to nominal creditors–like banks?
No, they cannot be trusted. Yes, they are captured to too great an extent by the commercial-banking sector. Yes, the commercial banking sector is very myopic in its conventional wisdom.
Rethinking Macro Policy III: Progress or Confusion?
Take the mechanics of demand stabilization and management off the table. Move, in our imagination at least, into a world in which short-term safe nominal interest rates rarely if ever hit the zero nominal bound. In that world, as a result, the full employment and price stability stabilization-policy mission could be left to central banks and monetary policy. Furthermore, confine our thinking to the North Atlantic, possibly plus Japan.
It seems to me then that there are four big remaining questions:
Can, in a political-economy sense, central banks be trusted with this mission? Are they not captured, to too great an extent, by the commercial-banking sector that, myopically, favors higher nominal interest rates to directly improve bank cash flows and indirectly dampen inflation and so redistribute wealth to nominal creditors–like banks?
What is the proper size of the twenty-first century public sector?
What is the proper size of the public debt for (a) countries that do possess exorbitant privilege because they do issue reserve currencies, and (b) countries that do not?
What are the real risks associated with the public debt in the context of historically-low present and anticipated future interest rates?