Don’t Blame the Euro

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John Cochrane writes,

It is a new proposition in monetary economics to me that adopting a common currency forces countries to move to common productivity, any more than adopting the meter forces countries to do so. Alabama and California share a currency and not productivity. Fresno and Palo Alto share a currency and not productivity. A common market in products with free movement of capital and labor might force out economic, legal, and regulatory inefficiency, but that would happen regardless of the units of measurement.

I had a brief chat with Cochrane a few weeks ago, and he lamented Milton Friedman’s monetarist influence. Macroeconomists under the influence of Friedman will tell you that a national currency with a flexible exchange rate is a great thing, because you can get more inflation when you need it. The conservative macroeconomists will tell you that the inflation comes naturally from depreciation in the currency markets. Liberal economists will tell you that the inflation comes from central bank manipulation of the money supply.

Cochrane is quite skeptical. His focus is on real factors, not monetary factors.

I agree. In terms of skepticism about monetarism, I take second place to no one. I believe that the euro has microeconomic benefits (transactions are more efficient), not macroeconomic costs.

The problem of overconfidence

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Chris Dillow writes,

overconfidence can be a form of strategic self-deception. A new paper by Peter Schwardmann and Joel van der Weele shows this. They got subjects to do intelligence tests and then selected some at random and told them that they could earn more money if they could convince other subjects that they had performed well on the tests. They found that the selected subjects were even more overconfident about their performance than non-selected ones.

Pointer from Mark Thoma.

We might ask when overconfidence will be selected for. Perhaps in sales. Perhaps in high-level executives. Almost certainly in politicians.

When will overconfidence be subject to checks and balances? My first thought is when firms face competition, profits, and losses.

Why pick on big banks?

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A reader writes,

I would describe the posture of big banks (and other well-heeled financial institutions) as “pleading for mercy,” more than “buying friends and influence.” Banks are giant piles of treasure and if in the olden times they would send hordes, spells and dragons, now they send the DOJ, regulators (state, fed and quasi-public, like FINRA) and the plaintiffs’ bar.

Big banks are subject to shakedowns by grandstanding government officials. But I think that in exchange for paying this “tax,” big banks get enough benefits from government that they are better off big.

I do not believe that there are economies of scale in banking at such high levels. We do not see banks get large organically. They get large through mergers. The result is to create institutions with very high levels of operational risk, because senior management cannot possibly keep track of what the various units are doing. But if one of the units messes up, the taxpayers are there to provide a bailout.

A commenter writes,

1) In reality, it was the medium size banks or investment banks that were the worst offenders. not the largest one. In the case of the largest ones, only Citi really was that borderline survived if you assume BofA was sort shotgun to take Meryll Lynch.
2) Haven’t most long time businesses consolidated a lot the last 30 years. Grocery stores or airlines. The economy has naturally moved this direction with most long time businesses.
3) Historically the US has been the developed world oddball with a heavy local banking presence.
4) In terms of the S&L crisis there was bailouts and lots of failure of small institutions. In fact the government probably wrote a bigger check on that crisis than the 2008 Housing Crisis despite being significantly smaller.

Regarding point (4), the bailout cost the taxpayers $150 billion. Even adjusting for inflation, the bill for the financial crisis was quite a bit higher. Also, most of the cost of the S&L crisis could have been avoided had the regulators not relied on “extend and pretend.” The S&L business model was destroyed by inflation in the 1970s, but most of the clean-up did not take place until a decade later, by which time the losses had multiplied.

Regarding point (3), this is very much a plus for the United States in my opinion. We have the best developed stock markets and venture capital market in the world in part because until the 1980s our banking system was unusually fragmented. There is a decent argument (made most strongly by Calomiris and Haber) that our banking system was too fragmented historically, but by now I believe that our banking system is too concentrated.

Regarding point (2), there are industries where firms grew to dominate because of superior execution and/or economies of scale. That is definitely not how the top banks in the U.S. became large. They got big through mergers. And through all sorts of regulatory barriers to competition.

Moreover, in other industries there has been new entry. The competition in groceries in recent decades has been very intense. Airline competition has been more uneven, but still there has been much more entry than in banking, even though the fixed cost of getting an airline operating would appear to be much higher than the fixed cost of opening a bank.

Regarding point (1), I do not claim that big banks are inherently riskier or more poorly run than smaller institutions. My main problems with big banks are:

1. Their CEOs have immediate access to key politicians.

2. Money managers who lend to banks have to multiply the probability that the bank is/becomes insolvent times the probability that it will not be bailed out. For small banks, the second probability is not high, because the FDIC tries to resolve these banks with mergers, and that leads to excess willingness to lend to those banks. But for small banks, the second probability is exactly zero, and that distorts behavior even more.

3. In a crisis, the big banks are certain to receive bailouts. The CEO of a big bank can expect huge rewards for success, or even for mediocrity, with no accountability at all for failure. How could the rest of us not feel angry about that situation?

Political speech to close minds

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Scott Alexander writes,

if everything you’ve tried so far has failed, maybe you should try something different. Right now, the neutral gatekeeper institutions have tried being biased against conservatives. They’ve tried showing anti-conservative bias. They’ve tried ramping up the conservativism-related bias level. They’ve tried taking articles, and biasing them against conservative positions. I appreciate their commitment to multiple diverse strategies, but I can’t help but wonder whether there’s a possibility they’ve missed.

The blatant anti-conservative bias in the media and on campus makes no sense if you think that their goal is to open the minds of those who agree with them or of those who disagree with them. However, it makes perfect sense if you think that their goal is to close the minds of those who agree with them.

My theory of political speech is that it has exactly that purpose: to close the minds of those with whom you agree. That theory is spelled out in The Three Languages of Politics.

The new edition will be out next week, and it is currently available for pre-order. Comments on Amazon refer to the first edition. The new edition has been revised and extended.

Provocative Sentences

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From a commenter,

The mistake libertarians tend to make is in thinking that the state is the enemy. Actually, the state may well be on the libertarian side – but the neighbors, not so much. The thing is, relatively libertarian political orders have become more wealthy and more successful than less libertarian ones – and states know that.
So, states tend to impose more relative liberty than their populations would like – not full-on liberty, but more than the populations would like.

Instead of “impose more relative liberty,” it would be better to say “impose fewer restrictions.”

I think that it is generally true that people with ideology X tend to assume that most people really want a more X-like polity, but the evil System will not give it to them, when in fact the reverse may well be the case. Progressives believe that if the will of the people were followed, then we would have Progressive policies. Conservatives believe that if the people had their way, then Conservative policies would be followed. And libertarians are often guilty of reading into public opinion more libertarian sentiment than is really out there.

This is related to the issues posed by Jacob Levy. See this forum.

Climate Science vs. Macroeconomics

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Climate change is much in the news. My view of climate science is that it shares a lot of the same problems as orthodox macroeconomics. Common features include:

1. Use of computer models in which there are a variety of parameter choices that can be used to fit historical data. There is no single model that is thought to represent truth. Instead, forecasts are made using a “consensus” of several models.

2. High causal density.

3. Some question about the use of aggregate data. Macro talks about “the” wage rate or “the” capital stock or “the” unemployment rate or “the” price level, but the divergencies and disparities are much more significant. Similarly, climate science talks about “the” average global temperature, when variations across seasons and locations is enormous.

Some differences include:

1. Macroeconomics clearly has some intrinsic political survival value. The Fed wants to be as powerful as it can be, so it sponsors a lot of research that deals with the importance of monetary policy. Politicians want excuses to run deficits, so Keynesian macro is attractive to them. Climate science has less intrinsic political value. Politicians do not really want to undertake the policies that would be needed to reduce carbon dioxide emissions.

2. Keynesian macroeconomics notoriously contradicts what one would predict using microeconomic models that otherwise work well. Climate science has more reliable “microfoundations” in greenhouse gas theory, although the fact that carbon dioxide is a relatively minor greenhouse gas (compared with water vapor, for example) is rarely mentioned in the press.

3. The proponents of Keynesian economics, while they might seem a bit dogmatic to someone like me, are not out to suppress those who disagree. The vast majority of them are charitable enough to acknowledge that there are reasonable doubts about the subject. Of all macroeconomists, I can think of only one who regularly hurls snarling, ad hominem insults at those who disagree. The others stick to arguing substance. Proponents of climate change theory routinely derogate skeptics.

I am a macroeconomics skeptic. I think that my background in the subject is deep enough that my reasons for skepticism are legitimate. See, for example, my memoirs of a would-be macroeconomist.

I am a climate science skeptic, but not based on a similarly deep background. I just look at the superficial similarities with macroeconomics and infer that skepticism is warranted. It is plausible to me that the climate “consensus” is way off. However, it could be off in either direction–maybe the temperature increase will be faster and sharper than the consensus forecast.

When it comes to the differences between macro and climate science, points (1) and (2) favor climate science. However, point (3) leans against climate science. Good ideas are persuasive. If you need to excommunicate unbelievers, you are dealing in religion, not science.

When to break up the big banks

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Stephen G. Cecchetti and Kermit L. Schoenholtz write,

From our perspective, by raising the odds of an effective resolution, FIBA (as a complement to Dodd-Frank) boosts the credibility of the U.S. regime. Over time, foreign regulators also may be reassured that the Chapter 14 mechanism is similar to the FDIC’s SPOE strategy, which they have welcomed. In both cases, the regime’s credibility depends on the presence of living wills and adequate loss-absorbing capital.

Pointer from Mark Thoma.

No, I don’t expect you to be able to follow what they are saying, even if you read the whole post. What it boils down to, and this is a mainstream view, is that with the right tools in place, the next time a big bank gets into trouble, the regulators will be able to “resolve” it without a bailout.

In effect, they are saying that we do not need to break up big banks now, and in fact that would be a bad idea. But when a crisis comes along, then, by golly, that will be a marvelous time to break up the big banks. The way I see it, “resolution” is nearly synonymous with breakup.

Again, this is a mainstream view. But to me, it could hardly be more absurd. In the middle of a crisis, the appeal of an untried approach for breaking up big banks is going to be nil. If you cannot break them up now, when there is no crisis, you will never break them up. Bailouts are an absolute given.

Emotions about winning and losing

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Tyler Cowen writes,

In venture capital, I suspect that hatred of losing may be a disadvantage. No matter how successful you may be, most of your individual investments will lose money and hatred of losing may make you too risk-averse. It might be better to have the ability to simply forget your losses and put them behind you.

I discovered in high school playing poker with friends that I hated losing, but I didn’t enjoy winning very much in that context. So I stopped playing poker. Decades later, I hated “angel investing,” perhaps for the same reason, and I stopped doing that.

Romance is probably another area in which you probably take a different approach if you love winning more than you hate losing, or vice-versa. Think of it as a game in which your self-esteem is at stake.

But I wonder if the relative strength of your feelings about winning or losing is generic or instead is specific to context. As Tyler points out, there are some activities where losses are relatively costly, and in that context I would say that it makes sense to be averse to losing.

My advice to people is to take chances that have high upside and low downside, while avoiding the reverse. It is relatively simple, obvious advice, and in some sense it is neutral with respect to winning and losing per se.

The Labor Share Story

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Noah Smith writes,

There are, by my count, now four main potential explanations for the mysterious slide in labor’s share. These are: 1) China, 2) robots, 3) monopolies and 4) landlords.

Pointer from Mark Thoma. Smith’s essay is a useful summary. However, note that he writes this:

Matt Rognlie found that national income accounts showed an increasing amount flowing to owners of land. More recently, economist Dietrich Vollrath examined a paper by Simcha Barkai about rising profits, and found that profits from owner-occupied housing also rose sharply.

The national income accounts include a category called “imputed income from owner-occupied housing.” The term “imputed” is a fancy way of saying “made up.”

It is possible that the made-up numbers on income from owner-occupied housing make as much sense as anything else in the national income accounts. In that case, there might really be something going on that has increased the share of income accruing to land and reducing the share accruing to labor. But keep in mind that land is not homogeneous, and neither is labor. And keep in mind that if the ratio of house prices to income falls back to what Robert Shiller thinks is the normal level, these land-owners all of a sudden are not going to feel so rich.

Arguments for Liberty

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That is the title of a new and recommended book. From my review:

Arguments would make an excellent book of supplemental readings for a course in political philosophy. Such a course could use another supplement, consisting of readings of philosophers arguing for non-libertarian ideas.

Later, I write,

After reading this book, I could not help pondering why it is that libertarianism does not hold sway among most philosophers or with the general public. My answer is that people rely on what I call small-community intuitionism.