A Gentleman’s Bet on the Fed

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I would bet that five years from now the size of the Fed balance sheet will be at least 85 percent of what it is now. I would make the same bet for ten years from now, but it is easier to hold me accountable in five years. Unlike Bryan Caplan, I prefer non-money bets.

My view is that “monetary policy” is just a ruse. If you want to understand government’s role in financial markets, focus on credit allocation. From that perspective, I do not think that the Fed will want to reallocate credit away from government debt and mortgage securities any time soon. . .or, in fact, any time.

Ideology and Keynesian Economics

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Scott Sumner posts on the controversy, which was recently re-ignited by what I thought was a reasonable post by Russ Roberts. My thoughts.

1. There is a correlation between belief in Keynesian economics and preference for a larger government. Economists who advocate for higher government spending to fight recessions also tend to argue at other times either to increase or not reduce every non-military component of government spending.

2. Nonetheless, those economists who believe in Keynesian economics and generally support higher government spending usually will insist that they are not ideological. In their view, they are merely scientists, who are free from confirmation bias.

3. Any online discussion that employs the term “Keynesian economics,” “macroeconomic facts,” or “Paul Krugman” will, with probability one, be un-constructive and uncharitable.

I am becoming increasingly convinced that the Internet is making us stupid politically. On the Internet, there is an impulse to react immediately to political comments, which means engaging your emotions rather than any self-critical reasoning. There is an impulse to be uncharitable to those with whom you disagree. Some of my responses:

1. I try to schedule blog posts at least a day in advance. My goal is to react less to the “threat” posed by political disagreement.

2. I look for opportunities to challenge the views of other libertarians, although not as often as Tyler does.

3. Recently, I made a determination to avoid commenting on political issues on Facebook. In fact, I would love an app that filters out all political posts on Facebook. I prefer even the pointless cute animal posts. But I mostly just like pictures and personal status updates of friends’ weddings, travel, anniversaries, etc. At some point I may have to sort through and unfriend the folks who only post on politics.

Axel Leijonhufvud on the Financial Sector and Recalculation

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Leijonhufvud offers a view of the role of finance in macroeconomics, particularly in producing deep recessions.

But financial systems can become fragile. When this is the case, one default can trigger an avalanche of defaults. Most avalanches are small and self-limiting. But in extreme cases they can take down very large portions of the web of contracts. A major collapse of the web will be associated with a breakdown in the economic organization of a country and widespread unemployment of labor and other resources. But it is more serious than that. A default avalanche leaves a myriad of broken promises in its wake. Social relations are disrupted by distrust and recriminations all around. . .

A financial crash reveals a large, collective miscalculation of economic values. The incidence of the losses resulting from such miscalculations has to be worked out before the economy can begin to function normally again. Because the process of a crash is unstable, it cannot be left for the markets and bankruptcy courts to work out the eventual incidence. If we had done so this time, it would simply have led us into another Great Depression.

What I believe he is arguing is that choices have to be made concerning who gets paid and who does not. You cannot expect justice to be fair–you just want it to be swift.

I like the “web of contracts” description of the role of the financial sector. It is an idea worth coming back to. It ties in both with Leijonhufvud’s classic work on the “corridors” interpretation of Keynes (see my discussion, but also explore other sources) as well as with PSST and recalculation.

Educated to be Irresponsible

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The Washington Post writes,

Heavy drinking is one of the most significant predictors of sexual assault in college, according to the poll of 1,053 current and recent college students. Analysis of the results found that women who say they sometimes or often drink more than they should are twice as likely to be victims of completed, attempted or suspected sexual assaults as those who rarely or never drink. Several male victims also pointed to alcohol’s role in their assaults.

Long-time readers will know that I am angry about how colleges treat drinking. When my daughters were in college, I sent only two communications to school officials. Both of these were suggestions for taking a more pro-active approach to drinking. One suggestion was to tell admissions officers to try to admit more students with a lower propensity to drink, in order to change the culture at a small college. The other suggestion was to encourage arrest and prosecution of a repeat-offender drunken vandal.

The students are not treated as adults, in that they are not held accountable for the crimes that they commit when drunk, including vandalism and assault. On the other hand, they are not treated as children, in that the schools enforce no rules against drinking.

Sometimes I think that the main point of college is not to teach critical thinking. It is to teach that there is no such thing as individual responsibility or accountability. “Alcohol” is responsible for bad behavior. The person drinking the alcohol is not responsible. The administrator condoning the drinking is not responsible.

In a larger sense, students are taught mindless sociology, in which group identity is everything, and individual responsibility is nothing. Individual effort plays no role in affluence–it is all a matter of “privilege.” Individual shortcomings play no role in poverty–it is all a matter of oppression.

In fact, there is a lot of truth to sociological views of power and group status. However, to treat this as the only truth about human relationships is to go to far.

What is odd is that I do not know anyone who deep-down believes in the pure sociological story. That is, I do not know any parent who tells their children, “Everything is determined by your group identity. You are not responsible or accountable for anything you do in life.”

If the higher education industry were more entrepreneur-friendly, I would start a college for students who want a low-cost, high-quality education and not a party school. Right now, most colleges act as if this is not a large target market. My hypothesis is that such colleges are missing an opportunity.

Axel Leijonhufvud vs. Calomiris and Haber

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Leijonhufvud writes,

The financial structure inherited from the 1930s divided the system into a number of distinct industries: commercial banks, savings and loan associations (S&Ls), credit unions, and others. It also divided it spatially. Banks located in one state could not branch across the line into another. This structure of the financial sector gave it great resilience. On another occasion I used the metaphor of a ship with numerous watertight compartments. If one compartment is breached and flooded, it will not sink the entire vessel.

This is directly the opposite of what Calomiris and Haber argue. They say that American cultural hostility to large banks produced an overly fragmented system, and that this fragmentation is the root cause of the peculiar instability of American finance.

Leijonhufvud elaborates,

At the time, the abolishment of all the regulations that prevented the different segments of the industry from entering into one another’s traditional markets was seen as having two obvious advantages. On the one hand, it would increase competition and, on the other, it would offer financial firms new opportunities to diversify risk. Economists in general failed to understand the sound rationale of Glass-Steagall. The crisis has given us much to be modest about.

In other words, economists championed open competition without thinking about how this would turn idiosyncratic risk into systemic risk.

The thing is, I was following these regulatory issues at the time, and I do not think that economists were as influential as we would like to believe. I think that the driving factors were computer technology, inflation, and massive lobbying. With high inflation, the regulatory ceilings on deposit interest rates that were a vital part of the regulatory structure became untenable. Moreover, with computer technology, it became easy for Wall Street to “disintermediate” banks using money market funds and securitization. These forces produced an inevitable turf battle between commercial banks and investment banks, which took years to resolve, as everybody lawyered up on the lobbying front. There were multiple possible political/regulatory outcomes, but hanging on to Glass-Steagall was not one of them.

Another Leijonhufvud quote:

Deregulation. . .allowed the great investment banks to incorporate and one by one they all did so. . .Incorporation meant limited liability for the investment bank and no direct liability for its executives. The incentives for executives in the industry changed accordingly. . .Now they are seen as jet-setting high rollers. Economists in general failed to predict this change in bankers’ risk attitudes. We have much to be modest about.

I cannot disagree with that.

However, I would instead put most of the emphasis on the regulations that directly affected housing finance. The pressure to lend with little or no money down and the designation of highly-rated mortgage securities as low risk for bank capital purposes are the main villains in the story as I tell it.

Concern with the term “public goods”

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Frances Woolley writes,

in the US, as elsewhere, most public expenditure goes towards redistributive transfers, health and education. Table 2 shows
total government expenditures for 18 OECD countries. Most government expenditures go towards health (7 to 19 percent of government spending), education (7 to 15 percent), and ‘social protection’ programs that more directly redistribute income (19 to 45 percent).
The goods most often cited as public goods are unimportant in terms of overall government expenditure for OECD countries: defense accounts for 1 to 6 percent of spending; public order between 2 and 5 percent of spending.

Pointer from Bryan Caplan.

It is an interesting and wide-ranging essay, difficult to excerpt. Here is another:

substantial insights into the economics of non-rival goods can be gained from the analysis of clubs (for providing local goods that are non-rival but excludable), the theory of natural monopoly (for goods such as Microsoft office where there are substantial initial development costs but the additional cost of an extra Word user is (close to) zero), or the economics of information (for the development of new technologies or drugs, where the manufacture of the new drug may cost a dollar or two per user, making it close to non-rival but the drug development may cost millions). While it is interesting and useful to have a theory for the special sub-set of non-rival goods that happen to be non-excludable also, there too few such goods to justify the place such goods hold in the public economics curriculum

One point she is making is that we should not encourage students to think that the theory of public goods explains or describes the actual role of government.

Axel Leijonhufvud vs. Genghis Khan

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Leijonhufvud writes,

For the past 60 or 70 years, macroeconomics was dominated first by “Keynesian” theory—or, I should say, by what was widely thought to be Keynesian theory—then by Monetarism and most recently by Dynamic Stochastic General Equilibrium (DSGE) theory—an evolutionary sequence of theories that ended up in a fool’s paradise conducive to much mathematical elaboration, and thus very congenial to modern economists. Intertemporal equilibrium models incorporating no financial markets did not offer much help in understanding the events of recent years.

In other words, Stan Fischer and Olivier Blanchard were no better than their Dark Age counterparts from Minnesota.

Public Availability of Freddie, Fannie Loan Performance Data

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Todd W. Schneider has a write-up and some analysis.

I decided to dig in with some geographic analysis, an attempt to identify the loan-level characteristics most predictive of default rates, and more. As part of my efforts, I wrote code to transform the raw data into a more useful PostgreSQL database format, and some R scripts for analysis. The code for processing and analyzing the data is all available on GitHub.

I recommend reading the entire post.

Thoughts on Hatred and Persecution

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In a post called Fearful Symmetry, the pseudonymous Scott Alexander draws parallels between the mentality of the Social Justice Warrior and his or her opponent.

The social justice narrative describes a political-economic elite dominated by white males persecuting anybody who doesn’t fit into their culture, like blacks, women, and gays. The anti-social-justice narrative describes an intellectual-cultural elite dominated by social justice activists persecuting anybody who doesn’t fit into their culture, like men, theists, and conservatives.

My thoughts:

1. He is describing two distinct forms of persecution. Persecuting people for being black, woman (or man), or gay is hating them for who they are, for something that they cannot change. Persecuting people for being a conservative or theist is hating them for what they believe, and by implication you will stop hating them if they change their beliefs.

2. Historically, Jews have experienced both forms of hatred. As I understand it, the Inquisition sought to change their beliefs. The Holocaust was existential hatred.

3. It is not clear to me which form of hatred is “better.” Both forms can lead to violence and extreme forms of inhumanity.

4. Probably both forms can be traced to the xenophobia that is in human nature. Coincidentally, I have just received a review copy of Nature, Human Nature, & Human Difference: Race in Early Modern Philosophy, by Justin E. D. Smith. Perhaps this book will shed more light on these topics.

5. Just because you can find one example of somebody on the other side who explicitly argues for persecuting your group does not mean that your group is necessarily persecuted. Before you become paranoid, make sure that everyone really is out to get you.

6. It seems easy to go from “I am a member of a persecuted group” to “I therefore have a license to persecute.” I think that it would be helpful if we could refrain from making that move. If you took away the “license to persecute” aspect, then I think that people would find grievance politics and persecution narratives less attractive.