Category Archives: links to my essays

Macro-Prudential Tools

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Olivier Blanchard explains, (link fixed)

It’s very clear that the traditional monetary and fiscal tools are just not good enough to deal with the very specific problems in the financial system. This has led to the development of macro-prudential tools, which what may or may not become the third leg of macroeconomic policies.

[Macroprudential tools allow a central bank to restrain lending in specific sectors without raising interest rates for the whole economy, such as increasing the minimum down payment required to get a mortgage, which reduces the loan-to-value ratio.] In principle, they can address specific issues in the financial sector. If there is a problem somewhere you can target the tool at the problem and not use the policy interest rate, which basically is kind of an atomic bomb without any precision.

The big question here is: How reliable are these tools? How much can they be used? The answer — from some experiments before the crisis with loan-to-value ratios and during crisis with variations in cyclical bank capital ratios or loan-to-value ratios or capital controls, such as in Brazil — is this: They work but they don’t work great. People and institutions find ways around them. In the process of reducing the problem somewhere you tend to create distortions elsewhere.

Although Blanchard is appropriately cautious about these tools, I do not think that he is sufficiently cynical. I wrote,

Politicians want to make credit allocation decisions. Whatever its nominal purpose, bank regulation is used to enable politicians to undertake credit allocation.

Deschooling Society

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My latest essay.

within a decade or two, the idea that learning can be located in time and space will no longer seem natural. The essence of the revolution that I foresee will be our embrace of anywhere-anytime learning. It could be that schooling as an institution will adapt to this paradigm, but I would bet against it.

Meanwhile, a more moderate proposal (still radical by today’s standards) is to get rid of school districts. As Bruno Behrend points out, the case against school districts is a strong one. Still,

people can’t yet envision an education system without the bureaucracy, powerless boards, “group rights” (what a frightening, tribal, concept), and the millions of unnecessary jobs that school districts force upon us.

As I have said before, people are really afraid of letting go of coercion in education. They think that we need adults to be in a position to coerce children, school officials need to be in a position to coerce parents and teachers, local politicians need to be in a position to coerce school officials, state politicians need to be in a position to coerce local officials, and national politicians need to be in a position to coerce state politicians. And, of course, teachers’ unions need to have particularly strong power.

Secretary Sebelius: Insurance != Insurance (paging Ezra Klein)

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She is quoted saying,

At a White House briefing Tuesday, Health and Human Services Secretary Kathleen Sebelius said some of what passes for health insurance today is so skimpy it can’t be compared to the comprehensive coverage available under the law. “Some of these folks have very high catastrophic plans that don’t pay for anything unless you get hit by a bus,” she said. “They’re really mortgage protection, not health insurance.”

My differing views are here:

The health coverage most Americans have is what I call “insulation,” not insurance. Rather than insuring them against risk, most families’ health plans insulate them from paying for most health care bills, large and small.

I would like to know Ezra Klein’s take on this. Some possibilities:

1. He is alarmed that such an important person and the aides who prepared her talking points are clueless, and he will write a column along those lines.

2. He recognizes that she is clueless, but he thinks it is not an important story. If so, perhaps he will leave a comment here explaining why.

3. He recognizes that she is clueless and that this is an important story, but this is not the sort of thing he wants to call to the attention of Washington Post readers. (This is the least charitable possibility, so it does not really belong on this blog.)

4. He has received a background briefing that “clarifies” her remarks, and he will write a column along those lines.

5. He himself believes that catastrophic health insurance should not qualify as health insurance, and he will write a column along those lines.

Asymmetrical Surveillance

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Bruce Schneier writes,

welcome to a world where all of this, and everything else that you do or is done on a computer, is saved, correlated, studied, passed around from company to company without your knowledge or consent; and where the government accesses it at will without a warrant.

I was strongly influenced by David Brin’s The Transparent Society, which envisioned a world where surveillance is symmetric: you can be watched by corporations and government, but in turn you can watch them. The current state, as described by Schneier, is asymmetrical.

My own view is that we need a new set of checks and balances for the 21st century. I articulated this about ten years ago in The Constitution of Surveillance. Comments on that essay would be welcome. However, please compare my proposals to the status quo or to alternative proposals, not to nirvana.

Macro Without Theory

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Garett Jones writes about sticky-wage Keynesian economics.

there’s no failure of “effective demand” for final goods in a sticky-wage Keynesian world. The reason there’s so little output during a recession according to sticky-wage Keynesians is because high wages make output too expensive to produce.

I think that Keynesians have good reason to resist being boxed into a particular microfoundations model, or theory. I think they are better off just asserting that more spending leads to more output, and responding to the question of “why” with hand-waving. To me, Keynesian economics is nothing more and nothing less than the view that spending creates jobs and jobs create spending. The attempt to articulate microfoundations has never added value.

Incidentally, the Scott Sumner view is that nominal GDP creates jobs, which might appear to be close to the Keynesian view. However, Sumner argues that the central bank controls nominal GDP, which means that fiscal policy only affects the mix between private-sector and public-sector spending.

The Keynesian counter-argument is that the central bank is constrained in some way. Again, I think they are better off just asserting this rather than relying on some specific explanation, such as low nominal interest rates. First, there are powerful arguments that low nominal interest rates are not a constraint. Second, I do not think that Keynesians want to tie themselves down to a view that says that fiscal stimulus is completely unnecessary when interest rates are above zero.

For those of you not already familiar with my own views of macro, see the papers listed here.

Cyprus: Have a Nice Day

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The New York Times reports

In the early hours of Saturday morning, after 10 hours of talks, finance ministers from euro area countries, the International Monetary Fund and the European Central Bank agreed on terms that include a one-time tax of 9.9 percent on Cypriot bank deposits of more than 100,000 euros, and a tax of 6.75 percent on smaller deposits, European Union officials said.

Pointer from Tyler Cowen, who thought it worthy of a follow-up. A couple of further thoughts:

My understanding is that the depositors would receive bank equity in exchange for debt. No one believes that this will make them happy. (Perhaps the depositors should be asked to read Admati and Hellwig?) In fact, every economist I have read has pretty much the same reaction as mine to this policy.

While a surprise tax on bank deposits may seem like the best idea that the eurocrats could come up with under the circumstances, it might not bode well for the longer term. In terms of the two drunks model, this looks like both drunks falling down without making it home.

Consider: Suppose that you hold bank deposits in a bank in a fiscally troubled country, such as Italy, Portugal, Spain, or Japan. You are deciding whether to keep those deposits there. Until Friday, you had not considered that the government might confiscate a portion of your deposits. Now, how much assurance do you need that your deposits will not be suddenly taxed in order to keep you from running to your bank and shifting your funds elsewhere? Solve for the equilibrium, as Tyler would say.

Huemer Unbound

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Michael Huemer writes,

the question of political authority is not “Should we have government?” The question is: Should the government be subject to the same moral constraints as apply to private agents? The failure of theories of political authority means that we must apply to the state the same moral standards that we apply to private agents. If a private agent would not be justified in using coercion to achieve a particular goal, then the state is also not justified in using coercion to achieve that goal.

The state is an institution, not an individual. Individuals play roles within this institution, such as legislator, policeman, or citizen. These roles are defined partly by law and partly by custom. When one talks about applying moral standards to the state, what I think this means is that we are applying moral standards to its laws and customs. For that purpose, using the metaphor of the individual to characterize these laws and customs may be helpful but it is not obligatory.

Consider another institution–a business. Should we say that a business is like a family, and the owner should be subject to the same moral standards as apply to a parent? Some people might find that analogy attractive, but I do not.

I think that the term I am looking for here is “category error.” Saying that a business or “the state” belongs in the same category as an individual strikes me as such an error. Instead, I think that “the state” belongs in a category that is closer to “relationship” or “institutional arrangement.” Within that institutional arrangement, we give authority to firemen to break traffic laws in the line of duty. When they are off duty, they are subject to the same laws as the rest of us. There are many relationships and institutional arrangements in which we authorize people to do things to us that differ from what we would permit a random stranger to do.

The problem I have with government is with the scope and scale of monopoly control. I think that the laws and customs in the United States today give too much authority to government officials. I wish that everyone had much more freedom to choose laws and customs without being forced to accept the territorial monopolies that we call government. However, I would not lean on Huemer’s arguments to make that case. Instead, I focus on the knowledge-power discrepancy.

I wrote about Huemer’s book here, and we had a follow-up exchange here.

Institutions-Intensive Economy

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My latest essay:

Over the course of Coase’s lifetime, the locus of economic activity has been shifting, from the farm to the factory floor to the office and even to “the cloud.” With each step, the concept of property has become more difficult to define, the economic entities have become more difficult to locate in time and place, the proportion of wealth that is intangible has risen, and earnings have become increasingly contingent on social constructs rather than on individual attributes.

Some of the themes circle back to the book that Nick Schulz and I wrote.

John Cochrane on Banking, Expert Forecasting

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1. He liked Admati and Hellwig more than I did.

Ms. Admati and Mr. Hellwig do not offer a detailed regulatory plan. They don’t even advocate a precise number for bank capital, beyond a parenthetical suggestion that banks could get to 20% or 30% quickly by cutting dividend payments. (I would go further: Their ideas justify 50% or even 100%: When you swipe your ATM card, you could just sell $50 of bank stock.)

I think he is being careless. My own essay tries to consider why households would prefer to hold bank debt rather than bank equity. Keep in mind, however, that all of us agree that the relationship between government and banks is problematic, and that the problems are not solved by regulation.

2. He cites a nice essay by Alex Pollock listing statements by regulators prior to the housing crisis that showed their mindset before the crisis. They thought they had everything under control. In 2009, they changed their minds. Now, with Dodd-Frank, they tell us they have everything under control again. Note that Pollock could have included many more pre-crisis quotes, such as the “before” quote from Ben Bernanke.

Of course, Bernanke still believes that we live in mediocristan. On the outlook for long-term interest rates, the other day He said,

While these forecasts embody a wide range of underlying models and assumptions, the basic message is clear–long-term interest rates are expected to rise gradually over the next few years, rising (at least according to these forecasts) to around 3 percent at the end of 2014. The forecasts in chart 4 imply a total increase of between 200 and 300 basis points in long-term yields between now and 2017.

Of course, the forecasts in chart 4 are just forecasts, and reality might well turn out to be different. Chart 5 provides three complementary approaches to summarizing the uncertainty surrounding forecasts of long-term rates. The dark gray bars in the chart are based on the range of forecasts reported in the Blue Chip Financial Forecasts, the blue bars are based on the historical uncertainty regarding long-term interest rates as reflected in the Board staff’s FRB/US model of the U.S. economy, and the orange bars give a market-based measure of uncertainty derived from swaptions. These three different measures give a broadly similar picture about the upside and downside risks to the forecasts of long-term rates. Rates 100 basis points higher than the expected paths in chart 4 by 2014 are certainly plausible outcomes as judged by each of the three measures, and this uncertainty grows to as much as 175 basis points by 2017.

Pointer from Mark Thoma.

The Role of Banks

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1. I write,

Franco Modigliani and Merton Miller point out that the real assets in the economy (fruit trees, oil wells, office buildings, and so on) are all owned ultimately by households. That fact is not changed by the way that financial claims are rearranged into debt and equity. As Miller was fond of putting it, “No matter how many slices you cut, it’s still the same pizza.”

Read the whole thing. It seems as though I constantly come across folks making broad generalizations about what to do about banks that are not grounded in an understanding of what banks do. My essay is an attempt to address that problem. It was provoked by receiving a new book by Anat Admati and Martin Hellwig.

2. Evan Soltas writes,

I can estimate that the average hour worked in the financial industry generates nearly 30 times the average per-man-hour profit in the rest of the economy. That’s up from six times the average in 1964.

This could very well be a question of global comparative advantage, but I find that hard to believe on the basis of the employment figures. It seems substantially more likely, rather, that the financial sector’s profitability comes from the implicit and explicit subsidies of a market with high barriers to entry.

Pointer from Phil Izzo.

Keep in mind that the interesting fact is the increase in the relatively profitability of the financial sector. I think this creates quite a puzzle.

Have barriers to entry increased? Not in any obvious way. Much of the infamous deregulation that took place since the 1960s was designed to increase competition, which should have reduced profitability (Gary Gorton even argues that we need to reverse that, to increase profitability in finance in order to give banks an incentive to hang on to their franchises). We got rid of restrictions on interstate banking. The erosion and repeal of Glass-Steagall were hailed at the time as allowing commercial banks and investment banks to compete on one another’s turf.

Has the subsidy increased? That is a more difficult question. But I do not immediately see how it has.

If one thinks in terms of natural forces, for an industry’s profits to increase, one needs some of the following:

1. An increase in demand.

2. An increase in efficiency.

3. Enough barriers to entry to maintain profit margins.

I suspect that (2) is very important. Off hand, would not finance benefit more than other industries from information technology?

I would tell a story in which the main barrier to entry in finance is the value of reputation. In other industries, innovation creates opportunities for upstarts. In finance, it is more likely to create opportunities for those few incumbent firms that adopt technology quickly and intelligently, because upstarts cannot establish reputations rapidly enough. Thus, one might expect to see a big expansion of profits in the industry as a whole, concentrated in a relatively few firms.

Incidentally, this model may fit higher education going forward. If the Internet creates opportunities for tremendous increases in efficiency, then the “profits” may accrue to universities with strong reputations who adopt technology quickly and intelligently. I would prefer to see competition from upstarts, but first someone must find a way to overcome the reputation advantage of the incumbents.