Tuesday, April 30, 2013

Stevenson-Wolfers on Reinhart-Rogoff

They write:
In the end, all the corrections advocated by the critics shift the average GDP growth for very-high-debt nations to 2.2 percent, from a negative 0.1 percent in Reinhart and Rogoff’s original work. The finding remains that economic growth is lower in very-high-debt countries (see chart). It has been disappointing to watch those on the left seize on the embarrassing Excel errors but ignore this bigger picture.

Click on graphic to enlarge. 

Sunday, April 28, 2013

Snapshots from the Performance


The President as Financial Planner

He and Michelle seem inattentive to their own finances:
The Obamas paid $45,046 in mortgage interest in 2012, which appears from the disclosure statement to be at a 5.625% interest rate with Northern Trust. That suggests an outstanding principal balance of about $800,000. 
On the other hand, the bulk of their investments are in Treasury notes. Based on the disclosures, I estimate they hold about $3 million in Treasury notes (also held by Northern Trust), yielding 0.71% if averaging a five-year maturity. 
By selling some of those Treasuries and paying off the mortgage, they would effectively be getting five more percentage points on the amount; they would also be about $40,000 better off each year before taxes, not to mention being less exposed to notes that could take a hit from possible rising rates. 
The Obamas would pay more in taxes but make much more after taxes -- especially since they aren’t getting the full deduction anyway, due to the AMT. That's more money going to the U.S. Treasury and more money for them; Northern Trust would be the loser.

Tuesday, April 23, 2013


Several people have asked me to comment on the coding error found in one of the Reinhart-Rogoff papers. I have avoided the topic, since I don't think I have a lot to add to the discussion.  But because so many people have asked, here are a few observations:

1. Everybody makes mistakes. I once made an analytic error in one of my published papers and, after it was pointed out to me, subsequently wrote a correction (published version).  Finding and correcting errors is a part of the research process.  Sure, errors are embarrassing, but there is nothing dishonorable about making them.

2.  Policy should not be based on the results of a single study.  And my experience is that it never is.

3. I believe that high levels of debt and deficits are a negative for the economy in the long run.  My views on this issue have not changed substantially since I wrote about it with Larry Ball almost twenty years ago.

4. I never thought there was a magic threshold for the debt-to-GDP ratio above which all hell breaks loose.  The world is more continuous than that.

5. The coding error in Reinhart and Rogoff has gotten a lot more media attention than it deserves.  Some people on the opposite side of the policy debate have taken advantage of this opportunity to pound the drum for their views.  But just because someone in Team A makes an inadvertent excel error does not mean that everything Team B believes is true.  To suggest otherwise would be a truly egregious mistake.

A Reading for the Pigou Club

Europe's Cap-and-Trade Scheme Failing Spectacularly

Wednesday, April 17, 2013

Help a Student!

A student I know (specifically, my older son) is trying to collect some survey data.  Click here if you are willing to participate.  The survey will take about 15 minutes.

Update: No more data is needed.  Thanks to the more than 1000 of you who participated.

A Message from Jason Alexander

Sunday, April 14, 2013

Rethinking Macro

The IMF is holding a conference "Rethinking Macro" on April 16-17.  You can watch a live webcast.  Click here for information.

Friday, April 12, 2013

Congratulations, Raj

My Harvard colleague Raj Chetty has won the John Bates Clark Medal.

Liquidity Traps and Low Real Rates

Not much time for blogging these days, but I thought I would contribute to this discussion by David Andolfatto, Tyler Cowen, Paul Krugman, and Brad DeLong.

Here are the facts: (i) The short-term nominal interest rate is essentially at the zero lower bound (ZLB); (ii) real bond yields (of all maturities) are very low relative to history. People have a hard time explaining those facts with Keynesian models. In a typical sticky price New Keynesian model, the problem that the ZLB can present for monetary policy is that the real rate of interest is too high, and there is no way to lower it. But if one thinks that history is a guide to what is right, then it looks like what is wrong is that the real rate is too low, not too high.

How do New Keynesians deal with this? If you read Ivan Werning's paper, for example, you'll see that he sidesteps the question. In Werning's model, the central bank wants to be at the ZLB because there is a negative shock to the natural rate of interest, and he analyzes how policy should deal with that problem. But what's a natural rate shock? I don't think we want to think of the financial crisis as a change in preferences, with everyone becoming contagiously more patient, any more than we would want to think of the Great Depression as a contagious attack of laziness.

If you press New Keynesians on this question, they will say that the natural rate shock - or preference shock - stands in for something that is going on in another type of model. One explanation I have heard appeals to incomplete markets frameworks. In such models, if exogenous debt limits for individuals fall, then the real interest rate will go down. In those models, the real rate is always below the "natural rate," which is the rate of time preference, and the gap between the natural rate and the actual real rate depends on how tight borrowing constraints are. There's something like this going on in Eggertsson and Krugman's paper.

But carry that one step further. Why would borrowing constraints be tighter in the world we're living in now? One explanation could be that collateral has become more scarce. The financial crisis essentially destroyed a large quantity of privately-produced collateral, which took the form of asset-backed securities. Government debt is a substitute for privately-produced collateral, and with a lot of sovereign debt in the world looking very dodgy, the world demand for the debt of the US government is very high. Assets that are used in financial exchange, and which serve the role of collateral in credit transactions carry a liquidity premium. The prices of those assets are higher than their "fundamental," where the fundamental price is what would be justified purely by the future payoffs on the assets and risk. The more scarce the assets are, the higher the liquidity premia, and the higher the prices. Higher asset prices is the same thing as low real interest rates. Simple.

Thus, the explanation is not a drop in "natural" rates of interest. It's the scarcity of safe assets for use as collateral and for exchange in financial markets.

I've been thinking about this a lot lately, and think I have come up with something interesting. I'm presenting some preliminary work on this on Monday at this conference. I'll tell you more later when I have the bugs worked out.

Thursday, April 11, 2013

Tuesday, April 9, 2013

Solow on Bernanke

In The New Republic, with thoughtful and thought-provoking commentary on the financial system.

Saturday, April 6, 2013

The President's Latest Bad Idea

Apparently, President Obama's budget is going to include some kind of penalty for people who have accumulated more than $3 million in retirement accounts.  The details are not yet known, but I think we know enough to say that this is a terrible idea.

A sizable body of work in public finance suggests that consumption taxes are preferable to income taxes.  Completely replacing our tax system with a better one is, however, hard.  Retirement accounts, such as IRAs and 401k plans, are one way our tax code has gradually evolved from an income tax toward a consumption tax.  The use of these accounts should be encouraged, not discouraged.

By the way, exceeding $3 million in such accounts is not very difficult for an individual who is financially successful and frugal.  Under current law, a self-employed person can put about $50,000 a year in a SEP-IRA.  If he does that every year for 40 years, and his savings earn a return of 5 percent per year, he will retire with about $6 million.

So, yes, President Obama's $3 million constraint would be a significant disincentive for saving.  It would move the tax code in the wrong direction.

Monday, April 1, 2013

Help Me Revise

My duties as chairman of the Harvard economics department have left me too little time to work on textbook revisions. As a result, I have decided to crowdsource the next edition. Anyone who wants to make a change in the book is free to do so. Like Wikipedia. If you want to learn more about how you can participate in the revision, click here.

Yes, this was an April 1 joke.