…That’s 954 posts, almost a million words, and about a hundred posts in the past twelve months. The blog continues to serve as an enormously important part of my own intellectual life, permitting me to spend a few hours several times a week on topics of continuing interest to me, without needing to find the time within my administrative life to try to move a more orderly book manuscript forward. And truthfully, I don’t feel that it is faut de mieux or second-best. I like the notion that it’s a kind of ‘open source philosophy’….
Highlights of the past year include….
- Extensive discussion of critical realism….
- Some extended thinking about causal mechanisms
- A burst of posts about agent-based models….
- Several posts on Margaret Archer’s theory of morphogenesis
- Posts on rising global inequalities
- Posts on the recent history of China
- Posts on the continuing effects of racial inequality in the US
One thing I have always found intriguing about writing the blog is the amount of data the medium provides…. A blogger has an inherently closer relationship to his or her audience than a traditional academic…. With more than a million page views a year on the blog, this data is pretty granular. Here are the top five posts of all time since 2007, based on the number of page views:
- What is a social structure? (65,962)
- Lukes on power (33,131)
- Sociology as a social science discipline (29,446)
- Why a war on poor people? 16,352)
- Social mobility? (15,614)
The ‘war on poor people’… the great majority of those 16,000 views came within a few weeks of its publication…. linked in a column by Paul Krugman… the academic equivalent of a viral cat video on YouTube….
I suppose many scholars would look at blog entries as ‘working notes’ and published articles as ‘archival’ and final, more authoritative and therefore more suitable for citation and further discussion. But I’m not sure that’s the right way of thinking…
Category: Equitablog
Cato Institute Conference: The Future of U.S. Economic Growth: Panel II
Panel 2: The Future of Innovation: Stagnation, Singularity, or Something in Between?:
- Erik Brynjolfsson, Massachusetts Institute of Technology
- Robert Gordon, Northwestern University
- Stephen Oliner, American Enterprise Institute
A Question: For us economists, intensive economic growth is the rate in percent per year at which the real cost of obtaining the currently-produced bundle of marketed goods and services decline. what I am hearing from Erik is that, in his view, that is missing much if not most of the action: that what we really ought to be doing is measuring the rate at which the real cost of staying on the same utility surface is declining. And that these two are very different right now.
The fearfully sharp Robert Barro says somewhere that, with competitively-produced and sold commodities, the consumer surplus generated was as a rule of thumb roughly equal to the total cost, and that order of magnitude seems about right to me. But there seems every reason to think that when the real value produced is in the process of attracting an audience–a product to be sold to advertisers–that rule of thumb is wrong, and that consumer surplus generated is orders of magnitude larger than market cost. If true, that suggests massive misallocation. Metric gigatons of not just low-hanging but dropped fruit.
If only we could think up better societal division-of-labor coordinating mechanisms than either pounding information goods into the Smithian market that works so well for rival-and-excludible commodities but not so well elsewhere, or making your nut by selling as product the eyeballs and attention of those who are your real customers.
Entrepreneurship, down-side risks, and social insurance
When Americans talk about entrepreneurs, or at least the reasons for becoming one, the possibility of great success is most often the first topic of discussion. The great wealth that company founders such as Bill Gates or Mark Zuckerberg amassed certainly make the idea of starting a business more attractive to potential entrepreneurs. But according to a new National Bureau of Economic Research working paper, we should be paying more attention to the down-side risks when it comes to fostering entrepreneurship.
The new paper, by economists John Hombert and David Thesmar of HEC Paris, David Sraer of the University of California-Berkeley, and Antoinette Schoar of the Massachusetts Institute of Technology, looks at a reform in the French unemployment insurance system enacted in 2002. The reform allowed unemployed workers who start a new business to keep the right to their unemployment benefits for up to three years. They could use the accrued benefits to make up the difference between their business’s revenue and the level of benefits they would have otherwise received.
The four researchers find that the policy change acted as a sort of entrepreneurship insurance. Workers who before would have been hesitant to start a business may be more likely to do so now that they had some protection against downside risk. The new paper documents that the rate at which firms were created increased by 25 percent after the 2002 reform.
Were these new entrepreneurs people who would be good at starting a business but were just more risk averse? Or instead were they just people throwing their hats in the ring? Hombert, Schoar, Sraer, and Thesmar find that the new entrepreneurs were quite similar to the old ones and, in fact, slightly more ambitious in their goals. They also find that the newly created firms were just as likely to increase employment — and just as likely to fail — as the older cohorts of new firms.
So the evidence points toward these new entrepreneurs being capable businesspeople who just needed a safety net before starting a business. What’s more, these new firms had a positive impact on the overall economy. The level of total employment in the French economy was unchanged by the reform, but the four economists find that the new firms had higher wages and were more productive than the firms they replaced. The reform helped boost the productivity of the French economy.
Of course, these results are about the French economy. Extrapolating results across economies is always a risky endeavor. As the authors point out, the rate of business creation is much lower in France than the in the United States. So a similar reform in this country might have a smaller impact. But the underlying principle is important to consider. Many U.S. policymakers and economists are worried about the decline in entrepreneurship and business creation. They might want to consider investigating whether alleviating the down-side risks to starting a company can help solve that problem.
Afternoon Must-Read: Mark Thoma on Salim Furth’s ‘What’s Causing the Increase in Long-Term Unemployment?’
:
Economist’s View: ‘What’s Causing the Increase in Long-Term Unemployment?’: “Salim Furth, who ‘is senior policy analyst…
…in macroeconomics at the Heritage Foundation’s Center for Data Analysis’:
What’s Causing the Increase in Long-Term Unemployment?: Some economic indicators, including the short-term unemployment rate, have recovered to levels associated with ‘normal times.’ But long-term unemployment remains high…. Many economists, myself included, expected that the expiration of long-term unemployment benefits at the end of 2013 would sharply lower the long-term unemployment rate. Instead, the rate has continued its slow, steady decline…. Economists have not yet found convincing explanations…. The problem is worth studying.
They will have to find another social insurance program to blame… instead of, say, lack of demand (a policy failure) combined with the stigma attached to the long-term unemployed.”
Things to Read on the Afternoon of December 3, 2014
Must- and Shall-Reads:
- :
The 2015 Economic Outlook and the Implications for Monetary Policy - :
The Economic Consequences of the Peace, Chapter 3 | Library of Economics and Liberty - :
Why the Next Recession Will Be Different - :
Six Ways Health Reform Helps the Middle Class
-
:
2014 Headed Toward Hottest Year On Record–Here’s Why That’s Remarkable | ThinkProgress:
“It is not remarkable that we keep setting new records for global temperatures–2005 and then 2010 and likely 2014. Humans are, after all, emitting record amounts of heat-trapping carbon pollution into the air, and carbon dioxide levels in the air are at levels not seen for millions of years… ‘Fourteen of the fifteen warmest years on record have all occurred in the 21st century…. There is no standstill in global warming.’… What is remarkable… is that we’re headed toward record high global temps ‘in the absence of a full El Niño’…. It’s usually the combination of the long-term manmade warming trend and the regional El Niño warming pattern that leads to new global temperature records. But not this year.”
-
:
What’s the Matter with Economics?:
“Mainstream biologists are not blamed for creationism, and mainstream doctors are not held responsible for homeopathy…. John Cochrane, also of the University of Chicago… saying in 2009 that Keynesian economics is ‘not part of what anybody has taught graduate students since the 1960s. [Keynesian ideas] are fairy tales that have been proved false.’ The first statement is demonstrably false; the second is absurd…. Madrick’s second bad idea, Say’s Law… really is bad…. Madrick also tabs ‘low inflation is all that matters’ as a bad idea, which it is. But again, who believes it?… Perhaps you can imagine my surprise when I read that ‘economists in general are Friedman’s handmaidens.’… Eugene Fama…. As Madrick correctly states, the… strong form of the EMH… proved pernicious…. Madrick’s wonderful chapter on efficient markets should be required reading for everyone in the financial world…” -
:
In Parched Bond Markets, Sparks Are Dangerous:
“According to the governor of the Bank of England, it now takes seven times as long for investors to liquidate bond portfolios as in 2008. The reason? Eight years ago investment banks and brokers held such large inventories of bonds and other assets that they were happy to act as market makers…. The ‘exits’ for trades, to use banking jargon, are crowded. And that means that while the markets might seem placid today, particularly given the easing announced by the Japanese and European central banks, this calm could come to a halt if investors try to sell en masse. ‘Fundamentally, liquidity has become more scarce,’ Mr Carney says…. The big question is what will happen when the US Federal Reserve starts raising rates. If investors rush to sell US government bonds, that will create one seriously crowded exit…. Is there a solution? Behind the scenes, there is plenty of brainstorming. For now regulators seem opposed to the step bankers most want: a relaxation of reforms such as the international Basel III regulations or America’s Dodd-Frank act…. Ever since the days of Walter Bagehot, the 19th century British economist, central banks have accepted that one of their roles is to lend freely to solvent institutions in a crisis. But they have generally shied away from acting as market makers or from rescuing non-banks. ‘Backstopping market liquidity directly risks structurally distorting economic incentives,’ the BIS paper notes. But the 2008 crisis and its aftermath have forced central banks to break many taboos. If a bond crisis erupts, this one may crumble too, forcing central banks to jump in. As Mr Carney observed in Singapore: ‘Bagehot will need to be updated for the 21st century.’ Watch this policy space, and that sevenfold statistic.”
-
:
Two Relatively Painless Ways to Boost Growth:
“The first… greatly boost the numbers of permanent work visas (citizenship would be a plus) for high-skilled immigrants…. The second idea stems from the landmark decision by a California state court in June 2014, Vergara v. State of California, which held that the teacher unions’ tenure system violated the equal protection clause of the state’s constitution…. Students who are penalized by an educational system stacked against them virtually from the time they enter school until they graduate (or drop out, as all too many will), represent a huge waste of human capital…”
-
: Am I unreasonable?: “To prevail, it’s not enough for the King challengers to show that it’s possible to read the ACA to eliminate tax credits from states that refused to set up their own exchanges. They must also demonstrate that the ACA does so unambiguously—and that the IRS’s contrary interpretation is therefore unreasonable. Under Chevron, if the ACA could be read in a couple of different ways, the courts owe deference to the IRS’s authoritative decision about how best to read it.”
-
:
A critique of Powell, Woods, and Murphy on the 1920–1921 depression: “A series of recent reviews of the depression of 1920–1921 by Austrian School and libertarian economists have argued that the downturn demonstrates the poverty of Keynesian policy recommendations. However, these writers misrepresent important characteristics of the 1920–1921 downturn, understating the actions of the Federal Reserve and overestimating the relevance of the Harding administration’s fiscal policy. They also engage a caricatured version of Keynesian theory and policy, which ignores Keynes’s views on the efficacy of nominal wage reductions and the preconditions for monetary and fiscal intervention. This paper argues that the government’s response to the 1920–1921 depression was consistent with Keynesian recommendations. It offers suggestions for when Austrian School and Keynesian economics share common ground and argues that the two schools come into conflict primarily in downturns where nominal interest rates are low and demand is depressed. Neither of these conditions held true in the 1920–1921 depression.”
-
:
Structural Destruction:
“Researchers at the Federal Reserve recently produced a fascinating article in which they argued that severe recessions such as that in 2008-9 leave permanent economic scars…. A significant drop in trend RGDP for all four economic areas: Canada, which had neither a property market crash nor a banking crisis, shows the smallest fall…. Both the UK and the Euro area appear to have suffered a worse fall in trend RGDP directly attributable to the crisis than the USA did…. Canada–which did not do QE but maintained fiscal spending… has recovered better than the other three…. But Canada’s headache is nothing like as bad as that suffered by the other three. The US, UK and Euro area have not only failed to recover previous trend growth, they have actually slowed down again since the crisis. The US’s recovery slowed from 2011 onwards despite continual QE. It is hard to establish any cause for this other than misguided fiscal policy: the shenanigans over the fiscal cliff and the ridiculous sequester have taken their toll. It’s an entirely self-inflicted wound and now, thankfully, over…. Really shocking… is… the Euro area…. Like the UK, the Euro area suffered a second demand shock. But the response was very different. I criticise the UK government for inappropriate fiscal tightening, but at least it offset it with monetary easing…. I am frankly astounded at the tolerance of the young people, in particular, whose futures are being systematically wrecked. They will bear the scars for life. Why they are not rioting in the streets is a mystery…. Eventually, I suppose, the Euro area will recover, because economies always do. But by then an entire generation of Europeans will have been sacrificed to appease the gods of ordoliberalism and hard money…. The ‘Great Recession’ is no longer an adequate name for the time we are living through. As Brad DeLong said, it should now be known as the Greater Depression.”
-
:
A Phillips Curve with Anchored Expectations and Short-Term Unemployment: “We specify a simple Phillips curve based on the assumptions that inflation expectations are fully anchored at the Federal Reserve’s target, and that labor-market slack is captured by the level of short-term unemployment. This equation explains inflation behavior since 2000, including the failure of high total unemployment since 2008 to reduce inflation greatly. The fit of our equation is especially good when we measure core inflation with the Cleveland Fed’s series on weighted median inflation. We also propose a more general Phillips curve in which core inflation depends on short-term unemployment and on expected inflation as measured by the Survey of Professional Forecasters. This specification fits U.S. inflation since 1985, including both the anchored-expectations period of the 2000s and the preceding period when expectations were determined by past levels of inflation.”
Should Be Aware of:
- :
The Need to Address Noncognitive Skills in the Education Policy Agenda | Economic Policy Institute - :
An Urban Agenda for Economic Growth | Cato Institute - :
The Lee-Rubio Family-Friendly Tax Is a Disappointment | Brookings Institution
-
:
Dear Ed [Balls] and George [Osborne]:
“The two of you make an excellent case for delegating more control over fiscal policy to technocrats…. I don’t know how such delegation… could be made politically acceptable. Especially when our economics profession is licking its wounds after largely failing to realise that the financial system was going to explode. But some way has to be found so that your successors can have a better conversation… about the average size of the state, the strength of the automatic stabilisers, whether discretionary fiscal policy is needed on top of that… and, if so, on menus of latent measures…. Such a conversation would involve you setting out explicit and different positions on how much risk sharing the state should be doing across regions, income groups and generations, which spring out of your different political philosophies. I hope at least that Ed’s proposal that the OBR should be tasked with vetting your manifestos will prove hard to resist, and that this might be a first step along the way to the utopia I and other economists are seeking.”
-
: Angela Merkel on Vladimir Putin: “As the dog approached and sniffed her, Merkel froze, visibly frightened. She’d been bitten once, in 1995, and her fear of dogs couldn’t have escaped Putin, who sat back and enjoyed the moment, legs spread wide. ‘I’m sure it will behave itself,’ he said. Merkel had the presence of mind to reply, in Russian, ‘It doesn’t eat journalists, after all.’ The German press corps was furious on her behalf—‘ready to hit Putin,’ according to a reporter who was present. Later, Merkel interpreted Putin’s behavior. ‘I understand why he has to do this—to prove he’s a man,’ she told a group of reporters. ‘He’s afraid of his own weakness. Russia has nothing, no successful politics or economy. All they have is this.’”
Afternoon Must-Read: Joe Romm: 2014 Headed Toward Hottest Year On Record–Here’s Why That’s Remarkable
2014 Headed Toward Hottest Year On Record–Here’s Why That’s Remarkable | ThinkProgress:
“It is not remarkable that we keep setting new records for global temperatures…
…2005 and then 2010 and likely 2014. Humans are, after all, emitting record amounts of heat-trapping carbon pollution into the air, and carbon dioxide levels in the air are at levels not seen for millions of years… ‘Fourteen of the fifteen warmest years on record have all occurred in the 21st century…. There is no standstill in global warming.’… What is remarkable… is that we’re headed toward record high global temps ‘in the absence of a full El Niño’…. It’s usually the combination of the long-term manmade warming trend and the regional El Niño warming pattern that leads to new global temperature records. But not this year.
Is the Fed “Pretending”?: Daily Focus
Ted Rivelle is clearly saying things that make sense to him. But I don’t think what he says makes sense to the world, and it certainly does not make sense to me:
Fed’s game of pretend must end soon:
“Artificially low rates mean that improperly qualified borrowers…
…obtain loans and then bid resources away from those who might employ them more productively. Along the way leverage accumulates, increasing financial risk and market volatility…. The Fed’s reluctance to pull the plug on zero interest rates is understandable. Since low rates have enabled activities that would not survive a rate rise, a renormalisation will be painful…. So why do it? Because ‘kicking the can’ means the inevitable deleveraging will be more painful. Sustainable growth comes from improvements to work process and product. Merely adding leverage to a business does not improve its efficiency; higher home prices do not increase the wages of those in the home…. The game of pretend ultimately has to end. For investors, the question that matters is when and how. When the end game comes, leverage will be forced out of the system and asset prices will fall. If the Fed is willing to recognise that ultimately its policies cannot dictate economic realities, rate rises should begin soon, presumably in 2015…
In short, interest rates are “artificially” low when the market rate of interest is less than the natural rate of interest, at which the quality of planned savings supplied at full employment balances investment plus government demand for finance. If interest rates are low but if planned savings at full employment exceed investment, then interest rates are not “artificially low”: they are naturally low. If they are “artificially” anything, they are artificially high.
That Ted Reville has not grasped this distinction between interest rates that are merely low and interest rates that are “artificially” low is revealed by claims like:
improperly qualified borrowers [are now] obtain[ing] loans and then bid[ding] resources away from those who might employ them more productively…
We know when real productive resources are being bid for by the feckless bubble masters in a way in the way that snatches them out of the hands of those who might employ the more productively. We know because the snatching is done by bidding up the prices of the real resources. It is done by higher prices convincing those who might employ them truly productively that their project is no longer profitable.
What real investment projects now are being canceled because of unexpectedly and surprisingly high costs of real resources?
None.
The most we get is claims that:
Fake Growth, Fake Money, Fake Jobs, Fake Stability, Fake Inflation Numbers:
“From the notion that there is ‘core’ and ‘non-core’ inflation…
…to ignoring house prices and using ‘rental equivalence’; to ‘hedonic adjustments’ according to which, if your computer is ‘better’ than last year’s, then you should subtract an amount from the actual price every year to reflect that improvement, even though it is subjective and not really quantifiable; to a handful of other nonsensical adjustments, inflation is understated.
Inflation is also distorted by the increasing gap between the spending basket of the well-off and that of the middle class (check out London, Manhattan, Aspen and East Hampton real estate prices, as well as high-end art prices, to see what the leading edge of hyperinflation could look like).
Said differently, inflation is the degradation of the value of money. Money has no meaning beyond the value of the real things for which it can be exchanged. The inventions and tools of modern finance have made things look really complicated, but stripping inflation to its essence is critical to understanding what is real and what is false. The inflation that has infected asset prices is not to be ignored just because the middle-class spending bucket is not rising in price at the same rates as high-end real estate, stocks, bonds, art and other things…
The argument that economic growth is being hobbled because high-end art, Kensington townhouses, Manhattan apartments, Aspen condos, and East Hampton beach houses are being “bid… away from those who might employ them more productively” by “improperly qualified borrowers” is rich. Yes, the knock-on effects of what I am going to have to start calling the Greatest Crash of 2008-9 was to greatly reduce the natural rate of interest and so greatly increase the wealth of those today who own cash flows in the future relative to the wealth of those today with flows of cash to reply as new savings. Yes, the Federal Reserve did not mask this huge shift in wealth by keeping market interest rates constant and so driving an even extra-larger positive deflationary wedge between natural and market interest rates. Yes, the effect is that Paul Singer–and, I guess, Ted Rivelle–have lost relative wealth and status with respect to their peers who were not raving inflation-predictors. Yes, the magnitude and persistence of the fall in the natural rate of interest since 2008 is distressing and terrifying. But none of this means that the Federal Reserve by keeping interest rates artificially low is allowing unworthy unqualified borrowers to snatch control of resources out of the hands of those who could use them more productively.
In fact, if the Federal Reserve were to raise interest rates, we would find that resources would be used even less productively–the pool of unemployed resources that are not being used at all would increase.
And yet the feeling that there is something wrong with having interest rates so low–even though Knut Wicksell would tell us that it is natural for them to be so–is widespread. Ben Bernanke says that there is a:
risk… that rates will remain low…. [For] in an environment of persistently low returns, incentives may grow for some investors to engage in an unsafe ‘reach for yield’…. [The alternative risk that] rates will rise sharply…. The two risks may very well be mutually reinforcing…
And Larry Summers will say that if the problem is the collapse of the credit channel–the inability of a market in which participants have impaired balance sheets to properly mobilize the risk-bearing capacity of society in order to finance enterprise–the first-best answer cannot be pushing down the long-run rate of interest and so providing extraordinary incentives to invest in long-duration projects. That would produce an economy with (a) too-few risky short- and medium-term enterprises, (b) a too-high duration capital stock, and (c) too-much near-rational Ponzi finance. Much better to either (a) fix the balance-sheet problems and restore the risk-bearing capacity mobilizing power of the credit channel, or (b) failing that using the government as a financial intermediary to mobilize the taxpayers’ risk-bearing capacity when private finance cannot mobilize investors’.
The question, of course, is how important are these defects? And if–for reasons of policy failures of the government to get its fiscal act together or of banking and housing finance regulators to do their proper work to restore the credit channel–the first best is unavailable, with how much easy monetary policy should the central bank compensate?
It seems to be very clear that prudential regulation rather than interest-rate manipulation is overwhelmingly the proper tool to deal with Ponzi finance, irrational or near-rational, and with systemic risk created by too much “reaching for yield”. And often lost in this discussion is the fact that some “reaching for yield” is the point of easier monetary policy. As Hiroshi Nakaso puts it in The Potential Impact of Large-Scale Monetary Accommodation, the point of the policy is:
to achieve the price stability target of 2 percent at the earliest possible time… to dispel a view that… prices would not rise… to raise inflation expectations… to exert downward pressure across the entire yield curve through massive purchases of government bonds…. I would like to address a frequently cited remark that unconventional monetary stimulus could destabilize financial markets and the economy at large by encouraging ‘search for yield’ activities…. A rise in asset prices and a decline in volatility are intended effects…
So far I have seen no signs anywhere that “reach for yield” is creating any systemic risk. If other people do see such signs, could they please point them out as soon as possible? And the shortfall of aggregate demand from potential output creates an Okun Gap. A capital stock that is too-long in duration and too-light on short- and medium-term risky projects is a Harberger triangle. It takes a heap of Harberger triangles to fill an Okun Gap.
Evening Must-Read: Alan S. Blinder: What’s the Matter with Economics?
What’s the Matter with Economics?:
“Mainstream biologists are not blamed for creationism…
…and mainstream doctors are not held responsible for homeopathy…. John Cochrane, also of the University of Chicago… saying in 2009 that Keynesian economics is ‘not part of what anybody has taught graduate students since the 1960s. [Keynesian ideas] are fairy tales that have been proved false.’ The first statement is demonstrably false; the second is absurd…. Madrick’s second bad idea, Say’s Law… really is bad…. Madrick also tabs ‘low inflation is all that matters’ as a bad idea, which it is. But again, who believes it?… Perhaps you can imagine my surprise when I read that ‘economists in general are Friedman’s handmaidens.’… Eugene Fama…. As Madrick correctly states, the… strong form of the EMH… proved pernicious…. Madrick’s wonderful chapter on efficient markets should be required reading for everyone in the financial world…
(Not) The Honest Broker for the Week of November 28, 2014
Afternoon Must-Read: Gillian Tett: In Parched Bond Markets, Sparks Are Dangerous
In Parched Bond Markets, Sparks Are Dangerous:
“According to the governor of the Bank of England…
…it now takes seven times as long for investors to liquidate bond portfolios as in 2008. The reason? Eight years ago investment banks and brokers held such large inventories of bonds and other assets that they were happy to act as market makers…. The ‘exits’ for trades, to use banking jargon, are crowded. And that means that while the markets might seem placid today, particularly given the easing announced by the Japanese and European central banks, this calm could come to a halt if investors try to sell en masse. ‘Fundamentally, liquidity has become more scarce,’ Mr Carney says….
The big question is what will happen when the US Federal Reserve starts raising rates. If investors rush to sell US government bonds, that will create one seriously crowded exit…. Is there a solution? Behind the scenes, there is plenty of brainstorming. For now regulators seem opposed to the step bankers most want: a relaxation of reforms such as the international Basel III regulations or America’s Dodd-Frank act….
Ever since the days of Walter Bagehot, the 19th century British economist, central banks have accepted that one of their roles is to lend freely to solvent institutions in a crisis. But they have generally shied away from acting as market makers or from rescuing non-banks. ‘Backstopping market liquidity directly risks structurally distorting economic incentives,’ the BIS paper notes. But the 2008 crisis and its aftermath have forced central banks to break many taboos. If a bond crisis erupts, this one may crumble too, forcing central banks to jump in. As Mr Carney observed in Singapore: ‘Bagehot will need to be updated for the 21st century.’ Watch this policy space, and that sevenfold statistic.
Central banks “have generally shied away from acting as market makers or from rescuing non-banks”? If you are holding duration risk or entrepreneurial risk during the financial crisis, You are a bank. That is what banks do: they undertake liquidity, entrepreneurial, and duration transformations. You can call yourself a rubber duck if you want to and an attempt to engage in regulatory arbitrage. But you are a bank. And in the event of a financial crisis your life or death is the central bank’s business. For central banks to pretend that there are “non-banks” that perform liquidity, entrepreneurial, and duration transformations is for them to adopt the ostrich nature.
And “shied away from acting as market makers”? Bagehot’s Rule: in a financial crisis, lend freely at a penalty rate on collateral that would be good in normal times. If that isn’t being a market maker, then I am Marie of Roumania. It is being a market maker in exceptional times when nobody else is willing to be–when everyone else thinks that the likelihood that current traders know something is more of a risk to market makers than the close and intimate connection with order flow they get by being market makers is a gain. But it is being a market maker.
And “the big question is what will happen when the US Federal Reserve starts raising rates. If investors rush to sell US government bonds, that will create one seriously crowded exit…” Only if the Federal Reserve wishes it so. The Federal Reserve can pick any point on the yield curve it wishes, and absolutely nail that point. Whether it can nail other points depends on the credibility and implementation of its communications strategy. But it can nail one point. And if it is seriously worried about the risk that the long Treasury bond will collapse in value when it starts raising short-term safe interest rates, it can direct the New York Fed’s trading desk to target not the Federal Funds rate but the Ten-Year Treasury bond rate. And it can always back that up with interest on reserves.
Very few people in high finance seem to understand how powerful a central bank that prints an ultimate reserve asset for the world economy–that possesses exorbitant privilege–is. Only if it lets itself get backed into a corner in which it has pledged itself to defend against depreciation a currency value that the market does not believe in can it get into serious trouble, and the only reason the Federal Reserve would do that is if it feared as a shepherd that its major sheep had been very naughty and had done too much currency transformation as well.