A Question from a Commenter

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On this post.

Even if no arbitrage opportunity exists, why would anyone buy a TIPS in your scenario when they get a 1% higher real rate of return on the nominal treasury?

Suppose that actual inflation is 1 percent and the real five-year risk-free rate of interest wants to be 2 percent. Then five-year TIPS should yield 2 percent and five-year nominal Treasuries should yield 3 percent.

Next, the Fed wants to raise expected inflation to 2 percent. So it buys five-year TIPS to lower that interest rate and sells five-year nominal Treasuries to raise that interest rate. The commenter’s point is that the public will want to do the reverse. Some possibilities:

1. The Fed’s actions do not change market spreads at all.

2. The Fed’s actions change market spreads because the Fed becomes really large in these markets.

3. The Fed does some of its buying of five-year TIPS with newly-created money, leading to more actual inflation.

Each of these is possible, but I want to emphasize that we could see (1).

I Do Not Understand SPOE

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It stands for Single Point of Entry, and I wrote about it here. Peter Wallison and Paul Kupiec say that it won’t work.

Our analysis of the largest banks shows that most of these institutions could fail without causing their parent BHCs to be in default of danger of default. For the parent BHCs to be in danger of default, they would have to experience massive losses simultaneously in many or all of their bank and nonbank subsidiaries.

…For BHCs that will clearly become insolvent if their bank subsidiary fails, the SPOE can be invoked, but the mechanism it uses to prevent financial market disruptions is an extension of the government safety net…It will protect all large bank 39 creditors from losses by transferring bank losses to the parent BHC’s creditors and potentially to unaffiliated institutions that will be assessed to repay the OLF. Here, the SPOE strategy—because it promises to bail out failing large banks— reinforces the TBTF problem at the largestbanking institutions.

Think of two cases:

1. A bank subsidiary is in bad shape, but the overall holding company has positive value.
2. The holding company is insolvent.

I thought, perhaps naively, that the SPOE approach is not worth anything in case (2), but that it was supposed to apply to case (1).

However, Wallison and Kupiec say that the FDIC lacks the legal authority to implement SPOE in case (1). Their argument is that the FDIC was given a mandate to come up with a way to liquidate a failed bank, and SPOE is a way to recapitalize a failed bank, using the net worth of the holding company.

I think that the larger problem is the one I raised in my earlier post. I think that you tend to jump straight from an apparently solvent bank inside a solvent holding company to case (2) without stopping at case (1).

Perhaps I will gain more understanding of SPOE by watching the video of this event.

David Beckworth on Productivity Measurement

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He writes,

Has productivity growth in consumption really been flat since the early 1970s? No meaningful gains at all? This does not pass the smell test, yet this is one of the best TFP measures. This suggest there are big measurement problems in consumption production. And I suspect they can be traced to the service sector. I suspect if these measurement problems were fixed there would be less support for secular stagnation (and maybe for the Great Stagnation view too).

Actually, he wrote that some time ago, and he then quoted himself.

Put it this way. We do not have reliable measures of real GDP. Tell me how to measure output in health care, education, financial services, etc.

We do not have reliable measures of labor input. Tell me how to measure human capital. Tell me how to distinguish labor used in production from labor used to build organizational capital.

Labor productivity is the ratio of these two unmeasurables. Labor productivity growth is the percent change in those two unmeasurables. Economist John Fernald runs statistical algorithms on the moving average of this percent change in order to arrive at “breaks” in productivity trends. He makes the point (like Beckworth, I attended this conference) that measurement error ought to behave smoothly, so that the broken trends that he fits to the data should be indicating real change. But at that same conference, Steve Oliner showed that a measure of productivity in the computer industry shows a decline because the government statisticians were using an approach to tracking prices that may have been accurate in 2001 but greatly under-estimated price declines (and hence under-estimated productivity) by the end of that decade. Steve argued for humility in any claim to measure or forecast productivity trends, and I think that is an important take-away from the conference.

Hurricane Katrina and World War II

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Tatyana Deryugina, Laura Kawano, and Steven Levitt write,

Four years later, Hurricane Katrina victims are less likely to be unemployed.

…If moving costs (either financial or psychological) are high, then people will rationally forego higher earnings available elsewhere unless the expected benefit of moving is large enough to outweigh the fixed cost. The forced relocation caused by
the hurricane required displaced residents to pay the moving costs, leading to higher wages (although potentially lower utility levels).

Pointer from Tyler Cowen.

The PSST interpretation would be that forced relocation helps the economy more quickly find patterns of sustainable specialization and trade. That is my interpretation of the role that the second world war played in getting the United States out of the Great Depression. Millions of men were uprooted, and many of them chose to relocate to locations with better opportunities. When my late father attended a reunion of Soldan High School in St. Louis, he was stunned by the distance that many of his former classmates had traveled, both geographically and economically, from their home town. He reflected that this never would have happened without the war.

Standard macro would predict (and did predict) a major recession following the war. So might PSST, given the challenge of transition from wartime to peacetime. However, the fact that many returning servicemen actually thought about where they wanted to live after the war helped make the transition work. The paper on Hurricane Katrina suggests a similar effect.

College Incompletion Data

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From Tamar Lewin.

At most public universities, only 19 percent of full-time students earn a bachelor’s degree in four years, the report found. Even at state flagship universities — selective, research-intensive institutions — only 36 percent of full-time students complete their bachelor’s degree on time.

One could counter that many of these eventually do graduate, and that is ok, although the article points out that this makes college more expensive–and that does not even include opportunity cost.

One could also argue that colleges are doing a favor by admitting lots of students who will not graduate on time. They are “taking a risk” on marginal students, and all that.

Still, my position is that the reason that few come out of the funnel on time is that too many unqualified students are being crammed into the funnel in the first place. Talk to anyone who has taught at something other than a prestigious private institution, and chances are the professor will be surprised that the graduation rate is as high as it is. Most of those professors are bending over backward to grade generously, and even so….

UPDATE: Possibly related, Ben Wildavasky says that tuition at public universities is too low.

Central Planning, Capital Regulations, and the Risk Premium

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Per Kurowski writes,

current credit-risk-weighted capital (equity) requirements for banks, allow banks to hold government debt and loans to the AAAristocracy against much less equity than when financing “risky” small businesses and entrepreneurs, and so that is de facto what you get.

Risk-based capital regulations may or may not help regulators manage bank risk. (I argued here that the results were quite the opposite.) But they certainly affect the allocation of capital.

Many economists say that there is a huge demand for risk-free assets, as if this were a puzzle. Why is the “free market” so risk averse? Well, the government tells banks that they can earn a higher return on equity holding what the government defines as risk-free assets. AAA mortgage securities, Greek sovereign debt, whatever.

Kurowski’s post reminds me that financial regulation serves to allocate capital, and capital allocation by government can be thought of as central planning. There is a major socialist calculation problem involved. Moreover, there is a tarbaby problem. As the capital regulations produce perverse outcomes, policy makers look for policies to correct the outcomes, and these policies lead to other perverse outcomes, etc.

Pregnancy and Planning

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1. My review of Isabel Sawhill.

Although Sawhill refers to these pregnancies as unplanned and to the children as unwanted, I would note that the mothers’ “revealed preference” is to have children. Not only do they become pregnant, they choose not to terminate their pregnancies or seek to place their children for adoption.

2. David Frum writes,

This is the fascinating irony of the pro-life movement. The cause originated as a profoundly socially conservative movement. Yet as it grew, it became less sectarian. Women came to the fore as leaders. It found a new language of concern and compassion, rather than condemnation and control. Most radically and decisively, the movement made its peace with unwed parenthood as the inescapable real-world alternative to abortion.

What I gather that Frum is saying that conservatives used to stigmatize unwed motherhood, and instead now they stigmatize abortion.

Will stigmatizing unwed motherhood make a comeback, led by liberals? I think that this is unlikely. I think they will continue to hold to a “no-stigma” approach toward women’s choices. Frum implies that the no-stigma equilibrium is for women to have more abortions. I am skeptical about this. My point in (1) is that the assumption that these are unwanted children is questionable.

Michael Mandel and Megan McArdle on Regulation

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He writes,

even the most regulation-minded can see how the accumulation of well-intentioned rules can have a pervasive and negative effect on innovation. One useful analogy is that of a small child idly tossing pebbles in a stream. One or two or even ten pebbles won’t make an obvious difference in the flow of the stream. Yet, accumulating gradually over the years, thousands of pebbles can make an effective dam. Or to put it into technology terms, asking a software developer to add one more feature or requirement to a program may seem like a small and innocuous request. Yet enough such ‘minor’ requests turns a simple task into a bloated, ungainly, and bug-ridden piece of code that may be virtually unusable.

She writes,

Framing the problem as “bad regulations” misses the real problem with the system: even good regulations are now so expensive, in complexity points, that they are probably not worth passing.

Great minds and all that.

My solution, of course, is principles-based regulation. Instead of hard-and-fast rules promulgated by agencies, which as they multiply become more complex and incoherent, we would have a few clear principles articulated by Congress. Common-law precedent would fill in the specifics, and the evolution of this common law would not necessarily be toward greater complexity and incoherence.

I do not expect to convince doubters of the superiority of principles-based regulation a priori. All I ask is that we try it with some field of regulation. Incidentally, the FTC has in fact done some experimenting along these lines, particularly in the area of truth in advertising, reportedly with some success.

Incidentally, Mandel is with me on the need to do something about the FDA. He writes,

The problem is that the FDA interprets the “safety and efficacy” standard as meaning at least as safe and clinically efficacious as anything on the market currently. That immediately rules out an innovation that is safe, much cheaper, but not as efficacious as best medical practice. So if the FDA had been in charge of the phone or computer markets at the time, early mobile phones and personal computers would have not been approved for sale because they provided inferior quality to existing products.

The Greater FOOL Theory

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Peter Wood writes,

The passivity of this cohort when faced with a hard core challenge by those intent on replacing liberal education with illiberal social control is, in that sense, a troubling mystery. One way to resolve it is to conclude that the “libertarian moment” in higher education is mostly an illusion. Is it possible that the small “l” libertarians are themselves not really libertarian at all? Could they be simply the crowd that follows where the progressives lead?

Read the whole essay to get the context.

One of my still-gestating essays concerns what I call FOOL, the Fear of Others’ Liberty. My theory is that the desire for government, or more generally for “illiberal social control,” comes from the tendency of people to fear what others will do with their liberty. You are willing to see liberty stifled, especially when you think it will be others’ liberty that will be stifled much more than your own. I am inclined to think that FOOL explains a lot.

Technological Obsolescence of Labor

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Timothy Taylor writes,

when I run into people who are concerned that technology is about to decimate U.S. jobs, I sometimes bring up the 1964 report. The usual response is to dismiss the 1964 experience very quickly, on the grounds that the current combination of information and communications technology, along with advanced in robotics, represent a totally different situation than in 1964. It’s of course true that modern technologies differ from those of a half-century ago, but that isn’t the issue. The issue is how an economy and a workforce makes a transition when new technologies arrive. It is a fact that technological shocks have been happening for decades, and that the U.S. economy has been adapting to them. The adaptations have not involved a steadily rising upward trend of unemployment over the decades, but they have involved the dislocations of industries falling and rising in different locations, and a continual pressure for workers to have higher skill levels.

Suppose we make some simple assumptions:

1. Leisure is a normal good.
2. Skills are heterogeneous and adapt slowly to changes in technology.

The prediction I would make is that we would see a lot more leisure. For those whose skill adaptation is adequate, that leisure will take the form of earlier retirement, later entry into the work force, or shorter hours. For those whose skill adaptation is inadequate, that leisure will show up as unemployment or reluctant withdrawal from the labor force.

I think that if you look only at males in isolation, you will see this in the data. That is, men are working much less than they used to. For some men, this leisure is very welcome, but for others it is not. In that sense, I think that we should look at the fears of the early 1960s not as quaint errors but instead as fairly well borne out.

For women, the story since the 1960s is different. In the economy as a whole, the share of labor devoted to preparing food, washing clothes, and cleaning house has gone down. Also, a higher share of the remaining work in these areas is coming from the market, via restaurants and cleaning services, rather than from unpaid female labor. The upshot is that, from the 1960s to about 2000, we saw a continuation of the trend for women to increase their share of market work and reduce their non-market labor. So, while men were increasing their leisure, women were increasing their market work. Combining men and women, you would not see a decline in market work.

It seems that around 2000, the trend for more market work by women reached its peak, making the trend toward technological unemployment more visible. From now on, what was happening to men before will be what happens to the total labor force. That is, leisure will go up, and some of it will be less than voluntary.

I might suggest also that the distribution of leisure is becoming increasingly distorted by the welfare state. Some people have too much leisure, in part because implicit tax rates for low-skilled workers are high, and in part because we over-subsidize leisure among healthy seniors. Some people have less leisure than they might otherwise enjoy, in part because they are working to support those with too much leisure.