Must-Read: Narayana Kocherlakota: Three Antidotes to the Brexit Crisis

Posted on by Brad DeLong

Must-Read: Correct, IMHO, from the very sharp Narayana Kocherlakota. Now perhaps his successor Neel Kashkari and the other Reserve Bank presidents not named Charlie Evans might give him some back up?

The one thing I do not like is Narayana’s “Granted, there is a risk that such steps will spook markets by signaling that the Fed is concerned about the state of the U.S. financial system.” That sentence seems to me to misread market psychology completely. As I see it–and as the people in markets I talk to say–right now markets are fairly completely spooked by their belief that the Federal Reserve is unconcerned, and takes that lack of concern as a sign of Federal Reserve detachment from reality. Narayana’s following sentences seems to me to be highly likely to be the right take: “I’d say the markets are already pretty spooked” and “By demonstrating that it is paying attention to these obvious signals, the Fed can help to bolster confidence in its economic management”.

Let me stress that, at least from where I sit, that confidence in Federal Reserve economic management is, right now, lacking.

The people I talk to in financial markets tend to say that they believe markets took Stan Fischer on January 5 to be something of a wake-up call with respect to Fed groupthink:

Liesman: When I looked at where the market is priced, the market is priced below where the Fed median forecast is. Quite a bit. Two rate hikes really, if you count them in quarter points. Does that concern you that the market needs to catch up with where the Fed is or is it a matter of you think the Fed needs to recalibrate to where the market is?

Fischer: Well, we watch what the market thinks, but we can’t be led by what the market thinks. We’ve got to make our own analysis. We make our own analysis and our analysis says that the market is underestimating where we are going to be. You know, you can’t rule out that there is some probability they are right because there’s uncertainty. But we think that they are too low.

For eight straight years now the Federal Reserve has been more optimistic than the markets. And for eight straight years now the markets have been closer to being correct. And yet the Federal Reserve still believes that it “can’t be led by what the market thinks” and has “got to make our own analysis”? Why?

Narayana Kocherlakota: Three Antidotes to the Brexit Crisis: “The Fed should ensure that banks have enough loss-absorbing equity capital…

…not allow them to return equity to shareholders…. The measure should apply to all banks, so markets won’t read it as a signal about individual institutions’ relative strength. Second, there’s a risk that investors’ flight to safe assets could develop into a broader credit freeze. To mitigate this, the Fed should lower its short-term interest-rate target…. Finally, the Fed should consider reviving the Term Auction Facility, which allows banks to borrow funds from the central bank with less of the stigma…. Granted, there is a risk that such steps will spook markets by signaling that the Fed is concerned about the state of the U.S. financial system. That said, as an outsider who gets much of his information from Twitter, I’d say the markets are already pretty spooked. By demonstrating that it is paying attention to these obvious signals, the Fed can help to bolster confidence in its economic management. One important lesson of the last financial crisis is that the guarantors of stability must be proactive if they want to be effective. It’s time for the Fed to put that lesson into practice.

The misplaced debate about job loss and a $15 minimum wage

Posted on by David Evans

Overview

The leading criticism of the “Fight for $15” campaign to raise the federal minimum wage to $15 an hour is the presumed loss of jobs. Employers, the argument goes, would eliminate some workers or reduce their hours in the short-term, and in the longer run, further automate their operations in order to ensure that they will need fewer low-wage workers in the future. For many leading minimum wage advocates, even a gradually phased-in $12 wage floor would take us into “uncharted waters” that would be “a risk not worth taking.”

On the other side is the long historical concern with making work “pay,” even if that means some job loss. In this view, the most important consideration is the overall employment impact on low-wage workers, after accounting for the additional job creation that will come with higher consumer spending from higher wages, which will almost certainly at least offset any direct initial job losses. And even more importantly, what really matters in this view are the likely huge overall net benefits of a large increase for minimum-wage workers and their families.

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The misplaced debate about job loss

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If we are serious about job opportunities for low-wage workers then there are many effective ways to compensate those who lose their jobs, ranging from expansionary economic policy to increased public infrastructure spending, more generous unemployment benefits and above all, public-sector job creation. A related issue is whether it makes moral, economic and fiscal sense to maintain a low federal minimum wage and then ask taxpayers to subsidize the employers of low-wage workers by propping up the incomes of poor working families only via means-tested programs such as the Earned Income Tax Credit and supplemental nutrition assistance.

The debate has been, effectively, a stalemate, with the federal minimum wage set at extremely low levels ($7.25 since 2008) by both historical and international standards. Part of the explanation for our persistent failure to establish a minimally decent wage floor at the federal level has been the way the discourse has been framed—even by many of the strongest advocates for substantially higher minimum wage.

In recent years, the best evidence shows that moderate increases from very low wage floors have no discernible effects on employment, which has helped make the case for substantial increases in the minimum wage. But the very strength of this new evidence— research designs that effectively identify employment effects at the level of individual establishments—has contributed to the adoption of a narrow standard for setting the “right” legal wage floor—defined as the wage that previous research demonstrates will pose little or no risk of future job loss, anywhere. For all sides, the central question has become: Whose estimate of the wage threshold at which there is no job losses whatsoever is the most credible?

Some economists, for example, point to existing evidence that the effects on employment when the minimum wage is increased within the $6-to-$10 range are minimal. Yet other researchers continue to argue, with credible statistical support, that sizable increases within this $6-to-$10 range do cause at least some job loss in some establishments in some regions, even if limited to high-turnover teenagers.

But there certainly is no evidence that can be relied upon to identify the no-job-loss threshold for a legal wage floor that would apply to the entire United States—the wage below which it is known that there is little or no risk of job loss anywhere, and above which there is known to be a risk of job loss that is high enough to be not worth taking. The only truly reliable way to do this would be to regularly increase the federal minimum wage while carefully monitoring the employment effects, much as the United Kingdom’s Low Pay Commission has done for the minimum wage that was instituted there in 1999.

There are different stakeholders in this debate. On the one side, there are the academic economists who care deeply about empirical confirmation of price-quantity tradeoffs and restaurant owners who care equally as much about their profit margins. On the other side, there are workers and their advocates who desire the establishment of a minimum living wage. Given the many parties with a big stake in the outcome, relying on evidence-based criteria about job loss for setting the wage floor all but guarantees unresolvable controversy.

The methodological double bind in setting the minimum wage

Then there is the methodological problem—a classic case of “Catch 22.” Because the identification of the wage at which there is expected to be zero job loss must be evidence-based, there is no way to establish the higher nationwide wage floors necessary for empirical tests. There are other places that have enacted higher minimum wages—think Santa Monica, Seattle, New York state, France, Australia or the United Kingdom—but they would face the same problem if they relied exclusively on zero job loss as the criterion for the proper wage floor. In practice, high minimum wage locations have relied on other criteria when making the political choice to set the legal wage, namely a wage that more closely approximates a minimum living wage than what the unregulated market generates.

In practical terms, local and state government’s past reliance on statistical tests for other jurisdictions not only means that we must assume that they are directly applicable (why would evidence from Seattle, New York state or the United Kingdom be a reliable guide to the effects at the level of the entire U.S. labor market?), but also requires that places imposing a no-job-loss standard must always lag far behind the leaders, and effectively condemns them to setting the wage floor well below the actual wage that will start generating job loss. In short, the no-job-loss criterion cannot stand on its own as a coherent and meaningful standard for setting the legal wage floor, and by relying on old statistical results from other places, ensures a wage that is too low on it own terms.

Ignoring the net benefits of raising the minimum wage

When the criterion for raising the minimum wage is concerned only with the cost side of an increase, the costs of some predicted job losses are all that matters. If the wage floor is set above the no-job-loss level, what kind of jobs will be lost? Who will be the job losers? What alternatives were available to them? These are the kinds of questions that must be asked to determine the costs of minimum wage related job losses. But there are obviously benefits to raising the legal wage floor. Shouldn’t they be counted and compared to the costs?

Those benefits are evident directly for the workers receiving wage increases as a result of a rise in the minimum wage, either because they are earning between the old minimum wage and the new one (say, between $7.25 and $15) or because they earn a bit above the new minimum wage—because employers increase wages to maintain wage differentials among workers by skill or seniority. The benefits also are evident for taxpayers–with a much higher minimum wage there would be less need to rely on means-tested redistribution to increase the after-tax and benefit incomes of working families.

Forgetting the ethical and efficiency arguments for raising the minimum wage

Relaying on the no-job-losses criterion for setting an appropriate federal wage floor entirely ignores the main traditional justification for the minimum wage: The moral, social, economic, and political benefits of a much higher standard of living from work for tens of millions of workers. On both human rights and economic efficiency grounds, workers should be able to sustain at least themselves and ideally their families. And on the same grounds, it is preferable to do so from their own work rather than from either tax-based public spending or private charity.

It is hard to put this argument for a living wage better than Adam Smith did several centuries ago:

A man must always live by his work, and his wages must at least be sufficient to maintain him. They must even upon most occasions be somewhat more; otherwise it would be impossible for him to bring up a family…. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable.

A public policy straightjacket

Determining a suitable federal minimum wage based solely on a zero job loss rule is a public policy straightjacket that would effectively rule out any significant raise of the wage floor above that which already exists. Yet from a historical perspective, strict adherence to such policymaking criteria would have also made it impossible to ban child labor (job losses!), as well as many critical environmental and occupational health and safety regulations. It would also foreclose any consideration of policies like paid family leave, which exists in every other affluent country.

Conclusion

Breaking out of this public policy straightjacket requires policymakers to rethink their criteria for raising the minimum wage. It also means that economists must shake off their fear of challenging the prevailing orthodoxy—a no-immediate-harm-to-anyone way of thinking—and see the longer-term benefits to millions of workers. It is estimated that the move to a $15 minimum wage by both California and New York state will directly raise the pay for over one-third of all workers.

If we really care about maximizing employment opportunities then we should not hold a decent minimum wage hostage to the no-job-loss standard. Rather, we should put a much higher priority on full-employment fiscal and monetary macroeconomic policy, minor variations of which would have massively greater employment effects than even the highest statutory wage floors that have been proposed.

But it is also well within our capabilities to counter any job loss that can be linked to the adoption of what the prominent University of Chicago economist J. B. Clark in 1913 called “emergency relief” such as extended unemployment benefits, education and training subsidies, and public jobs programs. A minimum living wage combined with other policies common throughout the affluent world, such as meaningful child-cash allowances, would put the United States back among other rich nations that promote work incentives while all but eliminating both in-work poverty and child poverty. It would put the country into waters that most other affluent nations have charted and are already navigating.

—David Howell is a professor of economics and public policy at The New School in New York City. This note reflects and builds on the material that appears in the working paper published by the Washington Center for Equitable Growth, “What’s the Right Minimum Wage? Reframing the Debate from ‘No Job Loss’ to a ‘Minimum Living Wage,’” co-authored with Kea Fiedler and Stephanie Luce.

Photo Uncredited, Associated Press

The importance of childhood education and the birth lottery for U.S. innovation

Posted on by Bridget Ansel
A new paper looks at the role of education in the innovation gap.

The U.S. economy could use more innovation these days. Despite the proliferation of apps and concerns about a robot takeover of the labor market, U.S. productivity growth just isn’t very strong these days. The exact reasons for weak productivity growth aren’t fully understood by economists, but a jump in innovation would seem likely to help increase it.

Getting such a boost, of course, is easier said than done. Most policies that seek to increase innovation in the United States are focused on getting as much out of current innovators as possible. But because the first seeds of new innovation sprout in many different ways perhaps policymakers should instead be focused on creating more innovators. New research shows that the key to increasing the ranks of innovators may reside in the childhoods of potential innovators.

The new research is from a working paper by Alex Bell of Harvard University, Raj Chetty of Stanford University, Xavier Jaravel of Harvard, Neviana Petkova of the U.S. Department of the Treasury, and John Van Reenen of the Massachusetts Institute of Technology. The paper takes a look at the background of innovators, as measured by individuals who filed for a patent between 1996 and 2014. (An assumption here being that patents are good indicator of innovation.) The authors have access to administrative data collected by the federal government on these patent holders that lets the economists take a look at the patent holders’ family backgrounds.

Unsurprisingly, children from low-income backgrounds are much less likely to end up getting a patent than children from high-income backgrounds. Patent holders also are more likely to be white and male. What explains these two gaps? The economists seek to answer this question by looking at the standardized test scores for all individuals who passed through the New York City public school system from 1989 and 2009. The test scores cover from the 3rd grade to the 8th grade. By linking this data with the data on patent holders, the economists can see how much of this innovator gap is related to a test score gap.

The co-authors find that only 30 percent of the difference in patenting rates between low- and high-income children can be explained by the gap in math test scores in the 3rd grade. The amount of the gap for women and children of color explained by test scores is even smaller, at 3 percent and roughly 10 percent, respectively. So education, as measured by standardized test scores, clearly plays a role in patenting later in life, at least when it comes to explaining the income gap. But a significant portion of the income gap can’t be explained by educational differences.

So that leaves the advantages of growing up in rich households. Those advantages include wealthy family and community connections, better educational opportunities, and exposure to people working in innovative fields.

Current U.S. innovation policy is focused on getting more out of the innovators we already have, such as tax credits for research and development, which increases innovation on the intensive margin. But policymakers also should be focused on increasing innovation on the extensive margin: raising more children to become innovators. This would mean less focus on tax policies that reward innovation in the short term and more on policies that can help expand the pool of next-generation innovators to include more women, people of color, and those from low-income backgrounds. The upshot might be not only more economic growth but also more equitable growth.

Must-Read: John Holbo: Podcasts I Just Listened to

Posted on by Brad DeLong

Must-Read: John Holbo: Podcasts I just listened to: “I just listened to a Federalist podcast interview with Randy Barnett…

…Not my cup of tea, usually, but I have an interest in Barnett’s stuff. The guy really has a bug in his ear about John Roberts. A couple months back he was blaming Roberts for Trump and I was like–fine, fine, you lost your Obamacare case. You are a bit bitter, venting steam. But he’s still banging on about how Roberts is the betrayer-in-chief of the Constitution, hence to blame for Trump. This is polemically unfair, in ways I could spell out, but won’t. (If you really want to ask, that’s what comments are for.)

But I’ve got to wonder whether this sort of thing isn’t really pissing off Roberts. It would piss me off, if I were Roberts. Barnett isn’t just some guy. He’s like the brain and soul of the Federalist Society, these days. A bit of on-again, off-again grousing about Roberts’ ‘bad’ decisions is one thing. But Roberts is shaping up to be this consistent, vile Judas in the conservative imaginary. Roberts is going to be Chief for a while, I expect. Dale Carnegie would suggest that the way to work the refs effectively is not this. If Roberts actually turns into some flaming Living Constitutionalist slave-to-the-democratic-mob in 20 years, maybe you can give Barnett half credit.

Corey Robin: “It might piss Roberts off to hear this kind of talk now from Barnett…

…But it might also make him think twice and wonder whether, in his drive to be the conservative Court’s steward and statesman, he’s not in fact betraying the values and vision he came on the Court to pursue.

John Holbo: “I think the chance that Roberts doesn’t realize that Barnett is really uncharitably caricaturing Roberts’ position is slight…

…I don’t really think Roberts is going to move left, but I fully expect him to stick by his guns, and to realize that his guns are actually firing at the Federalist Society now.

Must-Reads: July 5, 2016

Posted on by Brad DeLong

Should Reads:

Must-Read: John Authers: Yield on 10-Yr U.S. Treasury…

Posted on by Brad DeLong

Must-Read: That the Brexit vote would deliver a substantial leftward IS shock to the global economy was not very foreseeable. But that something could deliver such a shock was very foreseeable indeed.

S P 500© FRED St Louis Fed 30 Year Treasury Constant Maturity Rate FRED St Louis Fed 30 Year Treasury Constant Maturity Rate FRED St Louis Fed

Do not be reassured by the recovery of the stock market: P = D/(r-g). That the stock market has not gone up as a result of Brexit indicates that the lower interest rates expected in the long run (r) have been offset by the lower growth rate of profit due to additional expected economic weakness (g).

By now Yellen and Bernanke before her have had three full Reserve Bank president-appointment cycles–2006, 2011, and 2016–to get the non-Governor members of the FOMC on the page. It is no longer credible to claim that technocratic imperatives of ideal monetary policy have to bow to the requirements of maintaining committee consensus to promote banking-sector confidence with the Fed.

If financial markets were going to scream any louder that a régime shift to a less deflationary monetary policy régime is called for, how would they do that?

John Authers : On Twitter:

U.S. democracy stuck in an “inequality trap”

Posted on by Ed Paisley

Economic inequality in the United States appears to be trapped in a vicious cycle, as shown by several new working papers published today by the Washington Center for Equitable Growth alongside other recent research. Non-white, lower-income Americans are far less likely to vote than wealthier white citizens, and much of this participation gap is due to discriminatory practices at the ballot box. As a result, the political interests of lower-income minorities are not well-represented, and these interests are vastly different than those of their voting counterparts. This in turn means that policy decisions are made that exacerbate economic inequality and the inequalities that limit citizens’ voices in the first place.

To figure out how to break this cycle, social scientists need to understand what is happening at various points along the political continuum. So, let’s first examine new and existing research on the vote.

Voting inequalities are entrenched in existing inequalities

The disgraceful history of voter disenfranchisement is no secret. For more than a century, African Americans (and other marginalized groups) were restricted or even disqualified from voting. Today these practices are formally outlawed, yet we still see patterns in voter turnout that indicate that voting discrimination is alive and well. When looking across race and ethnicity, for example, data demonstrates that non-voters are predominantly African American, Hispanic, Asian, and other ethnic minorities. Non-voters also tend to be younger, less educated, and less affluent than their voting counterparts.

These trends are, in part, related to deep-seated institutional marginalization through practices including ballot access restriction—long lines, voter identification laws, and changes to polling sites—and voting dilution. But individual behaviors may play an important a role in generating voter turnout disparities, too. Recent research shows that attitudes toward civic engagement may be developed long before a citizen reaches voting age.

According to a new working paper by Sarah Bruch from the University of Iowa and Joe Soss from the University of Minnesota, enduring negative peer-to-peer relationships and authoritative interactions between 7th through 12th grades lowers the odds of civic engagement and electoral participation later in life, and also reduces future trust in government. Non-white students are disproportionately more likely than others to endure these negative interactions, suggesting that school environments may not only add to existing social inequalities but also contribute to inequalities in civic engagement and democratic participation.

Without a vote, the voice of diversity goes unheard

The absence of equal political participation translates into unequal policy voice. If wealthier white citizens had similar policy preferences to their lower-income, minority counterparts, then the participation gap would not necessarily be so troubling. Yet evidence suggests that voters’ policy preferences in the United States continue to vary sharply by race and income in ways that imply that a functional democracy needs to give equal voice to these various groups in order to be truly representative.

Just how different are these preferences? A recent report from Demos unpacks how net support for policy changes based on a variety of demographic characteristics. Using 2012 election data from the American National Election Study, Demos finds large discrepancies between the public opinions of white voters and non-white non-voters and between rich voters and poor non-voters. White voters supported more spending on the poor by a margin of 5 percentage points, for example, while non-white non-voters and poor non-voters supported these same measures by a margin of 50 percentage points. On the question about whether the government should reduce inequality, there were diametric oppositions between the two groups, respectively.

Perhaps unsurprisingly, the policy preferences of non-white, lower-income non-voters—economic policies that address on poverty and inequality—are already seldom the focus of congressional attention. Analyzing mentions of terms such as economic growth, inflation, poverty, inequality, deficit, and unemployment in the Congressional Record between 1995 and 2012, researchers Peter Enns at Cornell University, Nathan Kelly and Jana Morgan at the University of Tennessee, and Christopher Witko at the University of South Carolina find in their new working paper that Congress prioritizes the interests of the upper-class largely because they dole out political resources in the form of the all-important political campaign contributions necessary for re-election.

The four political scientists note that economic inequality increased during the period of their study while over the same time period congressional “nonresponse” to inequality or redistribution also increased. In fact, the term inequality was mentioned only 80 times in a year at its highest point compared to 30,000 mentions of “deficit,” an issue the authors note is of much greater concern to the wealthy than to the working-class.

Without a voice represented through the vote, the likelihood that issues of economic inequality are elevated in this skewed congressional climate is slim.

When the voice goes unheard, the policies that could change that go unheard, too

With Congress evidently uninterested in issues of economic inequality, it should come as no shock that the actual policies that have a tangible impact on minority and low-income voters struggle to pass. Take the minimum wage. William Franko of Auburn University and his co-authors Kelly and Witko find that changes in election rules at the state level, particularly those that limit the voice of already-marginalized voters, are associated with economic inequality. Specifically, the researchers observe that high levels of class-biases in voting make states less likely to pass minimum wage increases, and as these class-skews in voter turnout grow, states become less prone to pursuing other policies that could reduce inequality.

The same pattern is apparent when it comes to the issue of taxes. Christopher Faricy of Syracuse University finds in his new working paper that increases in public conservatism—ideologies that often don’t represent the voice of minorities—correlates with a reduction in tax progressivity. In other words, there are lower levels of social spending and lower taxes on the rich.

Without policies such as the minimum wage or progressive taxation put into practice, the tools we have to combat the economic inequalities that disproportionately burden minorities and other vulnerable groups are limited.

How do we break the inequality trap?

These recent findings suggest that inequalities seem to beget inequality writ large. As University of Oregon economist and Equitable Growth grantee John Voorheis, along with Princeton University’s Nolan McCarty and Georgetown University’s Boris Shor, show in their paper, increasing income inequality in the United States is associated with even more political polarization and gridlock, which, in turn, makes addressing inequality through public policy more challenging, too. As Faricy puts it, we’re witnessing an “inequality trap.”

So, how do we break the cycle and escape the trap? That’s a complicated question with an even more complex answer.

Expanding the franchise might be a good step. Through measures such as automatic registration, weekend voting, voting by post, reduced I.D. requirements, increased language accessibility at polling sites, and same-day registration, we can reduce the barriers to accessing the polls. Early interventions programs in schools may also play a role in changing the culture around disparate civic participation. But an equally important step, as Nick Carnes of Duke University points out in his new working paper, is reducing political gatekeeper biases and recruiting more working-class and minority candidates to be on the ballot in the first place.

In conjunction, all these efforts may work to ensure more people can voice their vote and vote their voice for the people and policies that help promote equity.

Photo by Jeff Chiu, Associated Press

Must-Read: Jamie Chisholm: Treasury Yields Hit Record Lows

Posted on by Brad DeLong

Must-Read: May I please have a theory from the Federal Reserve–I am not asking for much: just a theory–as to why they continue to be confident that their models are a better guide to likely futures than financial markets, and as to why they continue to regard the lower tail of outcomes as something that can be handled if and when it happens rather than something they need to be desperately clawing away from as fast as they can?

Jamie Chisholm: Treasury Yields Hit Record Lows: “The 10-year Treasury yield is down 7 basis points to 1.39 per cent…

…earlier touching 1.377 per cent, its most meagre offering on record. The 30-year Treasury yield also hit an all-time low of 2.14 per cent. Equivalent maturity German Bunds and UK gilts are down 3bp to minus 0.17 per cent and off 4bp to 0.80 per cent, respectively — also flirting with record lows. The Bank of England has already said it is likely to loosen policy further in coming months, and governor Mark Carney on Tuesday said banks could stop building up rainy-day funds in an attempt to support lending. Shares in real estate companies, life insurers and housebuilders are leading declines in London, following the Standard Life news. Miners are under pressure too, as the ‘risk off’ mood batters commodities, with base metals lower and Brent crude down 3.6 per cent to $48.31 a barrel.

Must-Read: Kieran Healy: The Moral Economy of Technology

Posted on by Brad DeLong

Must-Read: When I think of the standard uses of “moral economy”, I think not of “fairness” and “justice” but rather of tradition and hierarchy. I think of the Odyssey, in which the fact that Laertes looks like a badly-treated garden slave rather than like a prince is a violation of the moral-economic order:

Indeed your face and figure have nothing of the slave about them, and proclaim you of noble birth. I should have said that you were one of those who should wash well, eat well, and lie soft at night…

The market can and very often does produce pressure for outcomes that violate “moral economy” understood as tradition and hierarchy, but they may or may not violate “moral economy” understood as reasonable and humane notions of justice and fairness. Indeed, Prometheus the fire-bringer’s and the disruptions he causes have an alternative and stronger claim to “moral economy”:

Kieran Healy: The Moral Economy of Technology: “‘moral economy’ refers to some kind of informal but forceful collective control over the market…

…justice over efficiency, fairness over freedom, and community expectations over individual opportunity…. Technologies are counting and classifying your actions constantly in an effort to make you a better person. Their promoters and investors constantly moralize about their products, too…. This kind of moral economy is not about justice or fairness. Instead it evangelizes social progress through technological disruption. This vision has deep historical roots that are uncomfortably entwined with the origins of the social sciences…. The Saint-Simonian vision became what Hayek called ‘the religion of the engineers’, full of faith in the power of rational expertise. That religion is very much still with us….

Consider two basic experiences of our new world of smart devices and internet-enabled things. The first is the nice one… the lives of people who live in Apple advertisements… a computer or device knows what you want it to do, or has anticipated a need that you have and acted on it in a pleasing way. It is a feeling of magic and delight, or at least a sense of ease and convenience…. The second basic experience is the bad one. I associate it with a parade of malfunctioning, misconceived or badly-designed software and smart devices…. Most recently I’ve experienced it with allegedly smart devices that pretend they can talk with and understand you, but which are really just verbal command lines operating on the narrowest of gauges. If you stray from the expected path at all, the illusion of both interactivity and smartness is destroyed….

Social theorists consistently underestimate the value of technology’s delightful aspects… want to say your Fitbit or Apple Watch is exercising a subtle form of control over you by encouraging you not just to meet your step count for the day but also encouraging you to value the act of meeting your step count for the day, and most perniciously by arranging things so that you experience your valuation of the act of meeting your step count for the day as a satisfying personal choice, rather than an instrument of neoliberal governmentality. Conversely, though, the same theorists also consistently overestimate how often software and hardware actually works properly…. They reverse left and right, so that cheerful hype becomes a harsh critique of the all-consuming power of technology. But… they do not reverse up and down. The technology is still assumed to work, even though it probably doesn’t, most of the time. It matters which technologies are going to work, and which ones are just going to be billion dollar cargo-cults…

Must-Read: Anat R. Admati, Peter M. DeMarzo, Martin F. Hellwig, and Paul Pfleiderer (2013): Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Socially Expensive

Posted on by Brad DeLong

Must-Read: Very good. Mind you, I am not sure that it is right–while the risk premium ought to be linear in units of fundamental operating risk, and while requiring banks to maintain larger capital reserves ought to be irrelevant (save for the small financial-repression taxes involved) to costs of financing for Modigliani-Miller reasons, it is not clear to me that that is how things actually work in reality:

Anat R. Admati, Peter M. DeMarzo, Martin F. Hellwig, and Paul Pfleiderer (2013): Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why Bank Equity is Not Socially Expensive: “We examine the pervasive view that ‘equity is expensive’…

…which leads to claims that high capital requirements are costly for society and would affect credit markets adversely. We find that arguments made to support this view are fallacious, irrelevant to the policy debate by confusing private and social costs, or very weak. For example, the return on equity contains a risk premium that must go down if banks have more equity. It is thus incorrect to assume that the required return on equity remains fixed as capital requirements increase. It is also incorrect to translate higher taxes paid by banks to a social cost. Policies that subsidize debt and indirectly penalize equity through taxes and implicit guarantees are distortive. And while debt’s informational insensitivity may provide valuable liquidity, increased capital (and reduced leverage) can enhance this benefit. Finally, suggestions that high leverage serves a necessary disciplining role are based on inadequate theory lacking empirical support.

We conclude that bank equity is not socially expensive, and that high leverage at the levels allowed, for example, by the Basel III agreement is not necessary for banks to perform all their socially valuable functions and likely makes banking inefficient. Better capitalized banks suffer fewer distortions in lending decisions and would perform better. The fact that banks choose high leverage does not imply that this is socially optimal. Except for government subsidies and viewed from an ex ante perspective, high leverage may not even be privately optimal for banks.

Setting equity requirements significantly higher than the levels currently proposed would entail large social benefits and minimal, if any, social costs. Approaches based on equity dominate alternatives, including contingent capital. To achieve better capitalization quickly and efficiently and prevent disruption to lending, regulators must actively control equity payouts and issuance. If remaining challenges are addressed, capital regulation can be a powerful tool for enhancing the role of banks in the economy.