By investing in the 2012 Mazda3 to improved functionality

By investing in the 2012 Mazda3 to improved functionalityCars play an important role, in addition to use as a means of transport, cars are a part of who we are. Without cars, we could not keep time, traveling long distances in a short time and we would not have a way of expressing our lifestyle. Consciously or unconsciously, most of us think of our cars as second homes, we take time to adjust our

Remembering Milton Friedman

Allen Sanderson reminisces about the great economist.

My New Job

As reported by the Harvard Crimson.

Ben and the Bound

There has been a lot of chatter lately about monetary policy under Ben Bernanke's leadership and how his Fed has dealt with the zero lower bound on interest rates.  One of the more thoughtful analyses of this topic I have seen is this paper by Larry Ball.

The President's Economic Rhetoric

As seen by Jim Capretta (with whom I had the pleasure to work when I was in DC some years ago).

Price Controls in Venezuela

From the NY Times, a great article for teaching Chapter 6 of my favorite textbook.

A Defense of Oil Speculation

From economist Jim Hamilton.

CBO looks at the president's budget

The CBO reports:

CBO estimates that the President’s budgetary proposals would boost overall output initially but reduce it in later years. For the 2013–2017 period, under most of the estimates CBO produced using alternative models and assumptions, the President’s proposals would increase real (inflation-adjusted) output (relative to that under current law) primarily because taxes would be lower than those under current law, and, therefore, people’s disposable income and their demand for goods and services would be greater. Over time, however, the proposals would reduce real output (relative to that under current law) because the deficits would exceed those projected under current law, and the effects of increasing government debt would more than offset the favorable effects of lower marginal tax rates on labor income. When the net impact of those two types of effects would shift from an increase in real output to a decrease would depend on various factors, including the impact of increased aggregate demand on output and the effect of deficits on investment. 

By CBO’s estimate, under the President’s proposals, the nation’s real output during the 2013–2017 period would be, on average, between 0.2 percent lower than the amount under current law and 1.4 percent higher than under current law. For the 2018–2022 period, CBO estimates that the President’s proposals would reduce real output, on average, by between 0.5 percent and 2.2 percent compared with what would occur under current law. 

Confirmation, 26 Years Later

A new paper on cyclical income risk reports the following:

we study the cyclical nature of idiosyncratic shocks, once observable factors are accounted for. Contrary to past research, we find that income shock variances are not countercyclical. However, uncertainty does have a significant countercyclical component, but it comes from the left-skewness increasing during recessions. That is, during recessions, the upper end of the income shock distribution collapses—large upward income movements become less likely—whereas the bottom end expands—large drops in incomes become more likely....Our findings are more in line with the way Mankiw (1986) modeled idiosyncratic shocks. Basically, he showed that one can resolve the equity premium puzzle if idiosyncratic shocks have countercyclical left-skewness—as found in the current paper.

FAVOURITE USED CAR FOR GIFTS

Those who have seen the movie "Fast and 'Furious, certainly know what their children are and what they like to drive. Boys are not known for their reckless driving. Consequently, parents believe that teen a car new only last engaged in cars. Therefore, they prefer to buy used cars for "reckless" in adolescence.

Boys for their first car to be special and better too. They think the worry, while

"Groupthink," and the FOMC

I have been on something of a blog vacation (and about time, you might say), though I can assure you there has been nothing relaxing about it. I was reading Laurence Ball's paper on "Ben Bernanke and the Zero Bound, I think that it raises some interesting questions, and I would like to relate this to current thinking (and current thinkers) on the FOMC.

Ball wants to have us think that the pre-2003 Ben Bernanke was a sensible person who argued that, in the context of the zero lower bound on the overnight nominal interest rate, a central bank is not powerless. According to Ball, pre-2003 Bernanke thought, first, that forward guidance (announcements about future monetary policy actions) and quantitative easing (large-scale asset purchases) at the zero bound are a good idea. Those policy options are indeed reflected in post-financial crisis monetary policy in the United States. Second, and more importantly, Ball argues that pre-2003 Bernanke advocated another set of zero-bound accommodative policies, which are:
(i) exchange rate depreciation
(ii) targets for long-term nominal interest rates
(iii) money-financed tax cuts
(iv) higher inflation targets

Ball is bothered by the fact that such policies have not been pursued by the current incarnation of the FOMC, as he appears to think that those policies would be appropriate at the current time. Ball has little to say - explicitly - about the science of monetary policy. He's thinking about a model of Ben Bernanke, not a macroeconomic model designed to evaluate and guide monetary policymakers.

Ball's premise is that pre-2003 Bernanke was right, and post-2003 Bernanke was wrong. What could have made Ben do such stupid things? Did he fall and hit his head? Not at all. The answer is "groupthink," and what Ball calls "personality." You have all probably heard about groupthink, which has entered the realm of pop psychology. The idea seems to be that a group may not be greater than the sum of its parts. Group members may interact in a way that produces bad results, if an urge to cooperate and forge consensus overwhelms good ideas. There's a long Wikipedia entry where you can read all about it. On the personality front, Ball characterizes Bernanke as "shy," and provides plenty of supporting evidence.

Actually, the general thrust of the paper can be summarized by: "Ben Bernanke is a wimp." I may be wrong, but I don't think he is. Economists are tough. We cannot survive as academics without being willing to defend our ideas. Bernanke flourished as an academic, and worked at Princeton, which of course is no slouch institution. He survived a period as department chair there, a position in which I'm sure he developed considerable skills in forging consensus. There is nothing wrong with consensus. Many healthy decision-making bodies thrive on it.

The key question, which I'm sure you are asking, is: What do we think of those zero bound accommodative policies - (i) through (iv) above - anyway? First, it's important to understand that a Central Bank is just that. It is a special kind of bank - a financial intermediary with some unique powers. In the United States, the unique powers of the Fed are its ability to issue currency (actually an implicit special power, but I don't want to elaborate on that here) and its ability to issue reserves which are used in intraday payments and settlement. Unless the Fed is exploiting those special powers, it really cannot influence anything.

What can the Fed do under current circumstances? It can change the interest rate on reserves (IROR). That's a decision that can only be made by the Board of Governors - not the FOMC. We're currently operating under a floor system (for a brief rundown read this post by Todd Keister) under which, roughly, the interest rate on reserves governs the behavior of the fed funds rate, with some slippage due to the idiosyncrasies of the US financial institutional setup. The Fed can also buy and sell assets - quantitative easing (QE). Finally, the Fed can resort to forward guidance - it can tell us about its intentions for future policy.

Everyone agrees, I think, that changing the IROR matters in the current context. Not everyone agrees that QE does what the Fed thinks it does. My view is, that with a large stock of excess reserves outstanding overnight, QE is irrelevant. Basically, that's a neutrality theorem. Under current circumstances, the Fed has no advantage over the private sector in turning long-maturity assets (Treasury bonds or mortgage-backed securities, for example) into overnight assets, so QE cannot matter. To my knowledge, no FOMC member agrees with me, and blog commenters tend to call me an idiot whenever I mention this. Watch.

Finally, what about forward guidance? When the Fed first "committed" to its forward guidance policy in August 2011, I stated that I thought this was bad commitment, and would create more confusion rather than less. That initial forward guidance policy has since been extended, and now reads like this:

...the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

But, the minutes of the March 13 meeting state:

It was noted that the Committee's forward guidance is conditional on economic developments, and members concurred that the date given in the statement would be subject to revision in response to significant changes in the economic outlook. While recent employment data had been encouraging, a number of members perceived a nonnegligible risk that improvements in employment could diminish as the year progressed, as had occurred in 2010 and 2011, and saw this risk as reinforcing the case for leaving the forward guidance unchanged at this meeting. In contrast, one member judged that maintaining the current degree of policy accommodation much beyond this year would likely be inappropriate; that member anticipated that a tightening of monetary policy would be necessary well before the end of 2014 in order to keep inflation close to the Committee's 2 percent objective.

So what are we to make of that? Does the forward guidance mean anything at all? I don't know about you, but I'm confused.

So, what of policies (i)-(iv) above? First, exchange rate depreciaton and higher inflation targets are not explicit policies. Exchange rate deprecation and higher inflation can be the result of policy actions by the Fed, but we can't just wish for these things and expect them to happen. Indeed, under current circumstances, the Fed simply cannot engineer a currency depreciation, or a a higher inflation rate, on its own. The IROR is not going lower. Ben Bernanke himself has stated that there are technical reasons why the IROR cannot go below 0.25%, and we're not going to get much from a quarter-point reduction anyway. Further, as I stated, asset purchases are irrelevant under current circumstances. Finally, there is enough noise in the forward guidance signal now to make that signal uninformative. Thus, exchange rate depreciaton and higher inflation are not happening, at least as the result of anything the Fed does currently.

What about targets for long-term nominal interest rates? Not happening. The Fed should not be setting a target for something it cannot control. What about money-financed tax policy? Not happening. That's the province of the Congress. Maybe you think Ben Bernanke can influence those crackpots, but you're wishing for a lot in that case.

So much for Ball's paper. But here's something interesting, which is related. Read this speech by Narayana Kocherlakota, President of the Minneapolis Fed. Speaking of turnarounds in thinking, I would not have predicted a few years ago that stuff like this would come out of Narayana's mouth.

What's Kocherlakota's view of policy under the current circumstances? He thinks that changes in the IROR matter, he thinks QE matters, and he thinks forward guidance matters. What's the model that helps him think about how to formulate policy? It seems to be some some kind of 1974-ish expectations-augmented Phillips curve. The inflation rate is determined by the output gap and the anticipated rate of inflation, and the anticipated rate of inflation in turn seems to be determined (in Kocherlakota's mind) by what the Fed says. What does the Fed care about? The output gap and the inflation rate. As is usual given this type of thinking, the idea is that we can get more output if we are willing to sacrifice by accepting a higher inflation rate.

What's wrong with that view of the world? (i) Where's the money? Inflation is always and everywhere a monetary phenomenon. Milton Friedman's quantity-theory view of the world was in several ways wrongheaded, but we can't escape the idea that the prices of goods and services are in fact the prices at which particular liabilities (public and private) are exchanged for those goods and services. The quantities of the particular liabilities in question have to be important for determining the prices. (ii) Phillips curve thinking got us into trouble before - in the 1970s - and it can do so again. (iii) If people on the FOMC think that QE and forward guidance work, those things should be in the model, so we can understand exactly how these things are supposed to work, and can evaluate the Fed's policy actions accordingly.

It's quite possible that Kocherlakota does not even believe in the model in the speech I linked to above, or in the model in this talk, for that matter. Here's a possible explanation for what is going on. Kocherlakota may think that if he stuck to what he actually knows about modern monetary economics - which is a lot - in framing arguments at FOMC meetings, that the other participants would not get it. After all, even some of the more sophisticated economists on the FOMC - John Williams and Charles Evans, for example - are Phillips curve guys. But maybe those people can be educated. I think it's worth a shot.

I think that Kocherlakota basically arrives at the correct conclusion about Fed policy here:

I would say that it would be appropriate to change the Fed’s current forward guidance to the public about the future course of interest rates. Currently, the FOMC statement reads that the Committee believes that conditions will warrant extraordinarily low interest rates through late 2014. My own belief is that we will need to initiate our somewhat lengthy exit strategy sometime in the next six to nine months or so, and that conditions will warrant raising rates sometime in 2013 or, possibly, late 2012.

It's the right conclusion, but it's actually inconsistent with what he's said in the rest of the speech. If he thinks that QE works, he should just want to do everything in reverse - sell the assets until excess reserves are down to zero, then start increasing the fed funds target, which will at that point in time be the policy rate. Some people on the FOMC might think this policy - reverse QE followed by increases in the target policy rate - would in fact be appropriate. What they need to understand is that QE doesn't work right now, and bad things can happen while they are learning by doing.

On Market Timing

Click on graphic to enlarge.

The Case for Federalism

Click here to read my column in Sunday's NY Times.

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My New Job

As of July 1, I will become the chairman of the Harvard economics department.  I will continue teaching ec 10 and revising my favorite textbooks, but I will have to cut back on my other teaching roles and various professional activities.  In particular, over the next three years, I will blog less and travel less to give talks at other venues.  I will be spending my time trying to make the world's best economics department even better.

Addendum: If you are curious, the current chairman is John Campbell.  Before John was Jim Stock.  Before Jim, Alberto Alesina.

But will he have time to finish his dissertation once he is elected?

Dan Marcin, a economics PhD student at the University of Michigan, is running for Congress.  Here is his website.  Notice that he is a proud member of the Pigou Club.

The Composition of Fiscal Austerity

My Harvard colleague Alberto Alesina and Francesco Giavazzi say it matters.  A lot.

Monitoring the So-called Recovery

Click on graphic to enlarge.

Really, Mr. Chait, Really?

Consider two passages.  First, a definition:

Social Darwinism is a belief, popular in the late Victorian era in England, America, and elsewhere, which states that the strongest or fittest should survive and flourish in society, while the weak and unfit should be allowed to die.

Second, a statement about public policy:

Public goods and Pigovian subsidies lead naturally to a tax system in which higher income individuals pay more in taxes. Surely, those with higher income and greater property benefit more from a governmental system that protects property rights. Moreover, the monetary value attached to other public goods (such as parks and playgrounds) and to positive-externality activities (such as basic research) very likely rises with income as well. Indeed, if the income elasticity of demand for these services exceeds one, as is plausible, a progressive tax system is perfectly consistent with the Just Deserts Theory.

What about transfer payments to the poor? These can be justified along similar lines. As long as people care about others to some degree, antipoverty programs are a type of public good. [Thurow 1971] That is, under this view, the government provides for the poor not simply because their marginal utility is high but because we have interdependent utility functions. Put differently, we would all like to alleviate poverty. But because we would prefer to have someone else pick up the tab, private charity can’t do the job. Government-run antipoverty programs solve the free-rider problem among the altruistic well-to-do.

Now here is the question: Is the person who wrote the second passage a Social Darwinist as defined in the first passage?

I think the answer is pretty clearly NO.  But nonetheless, Jonathan Chait calls me a Social Darwinist, citing as evidence the paper from which the second passage above is taken.  True, he quotes a different passage from that paper, but one would think a prominent journalist like Mr. Chait would read the entire paper and characterize the arguments fully before throwing around a pejorative like "Social Darwinist."

Inflation Risks

As seen by my Harvard colleague Martin Feldstein.

The Best 300 Professors

...according to The Princeton Review.   I cannot judge the reliability of the list, but it is still nice to be included.

Bertrand Competition

The NY Times reports an example from the pizza market.  My favorite line:

Mr. Kumar said he was contemplating checking with a lawyer to see if there might be a city law that somehow prohibits a business from selling pizza at outlandishly cheap prices.

How to teach PPP

Good pedagogical advice from Nick Rowe.  It works, however, only if you have some international students in your class.

Hal White

...has passed away.  He was truly a great econometrician.