Raquel Fernandez the Cynic

Here's an interview with Raquel Fernandez. This concludes with:

Economists essentially have a sophisticated lack of understanding of economics, especially macroeconomics. I know it sounds ridiculous. But the reason why I tell people they should study economics is not so they’ll know something at the end—because I don’t think we know much—but because we’re good at thinking. Economics teaches you to think things through. What you see a lot of times in economics is disdain for other's lack of thinking. You have to think about the ramifications of policies in the short run, the medium run, and the long run. Economists think they’re good at doing that, but they’re good at doing that in the sense that they can write down a model that will help them think about it—not in terms of empirically knowing what the answers are. And we have gotten so enamored of thinking things through that the fact that we don’t know anything needs to bother us more. So, yes, it’s true that the average guy on the street doesn’t understand economics, and it’s also true that we don’t understand economics. We just have a more sophisticated lack of understanding than the guy on the street

Fernandez knows something, about which she is quite certain. As economists, we really don't know anything at all. Apparently we are good at thinking, but it's just fooling around - nothing more serious than video games.

Fernandez is frustrated:

The methodology of economics is so strong that we have had a large impact on many fields, from political science to sociology and even neuroscience. It’s been a very successful paradigm in that what economics does very well is think rigorously. But sometimes that’s not been very fruitful in the sense that there are certain questions that you can’t ask because you don’t know how to model them.

Ah, those pesky models, getting in the way of fruitful science.

Fernandez thinks we're not scientists:

... as “scientists” we often don’t have much to say. I don’t think we are scientists. I think we’re more like doctors in the sense that we do research, but in the end there’s a patient, and you have to say, given one’s knowledge, what’s the best way to treat the patient?

Well, when I think about my doctor, what she does looks to me like applied science. She wants to do some tests on me. I ask her some questions about it. She cites scientific evidence from published research. When I talk to Jim Bullard I get the same vibes. He's doing applied science. He knows what's in the journals. He talks to his staff and other economists, and uses frontier knowledge to argue for good policy choices. That frontier knowledge is based on theory, i.e. models, and empirical evidence. Science, basically.

Fernandez thinks we don't love Paul Krugman enough:

But the people who go and give advice usually end up with a very bad rap in economics. I am amazed at how much hatred—and I will say hatred—Paul Krugman evokes from some fellow economists. But one of the reasons for this is that he says things for which there is not “scientific” support and which go against what these people believe is "good" economics.

She's confused here. Krugman does not get a bad rap because he chooses to give advice. He gets a bad rap because some people, me included, think he is giving bad advice. We don't hate the man, we just disagree with him. And yes, this has a lot to do with science (no scare quotes).

Sargent and Sims

There is a nice profile of the new Nobelists in today's NY Times.  Here is an excerpt for my army of ec 10 teaching fellows (and for teachers of introductory economics everywhere):

Economics, rather than politics, became his life’s work partly because of an inspiring teaching assistant named Jerry Kenley. Fifty years later, sitting in his office at N.Y.U., Mr. Sargent remembers his old T.A.  

“Jerry liked to say, ‘Economics is organized common sense.’ I still think that’s about right,” Mr. Sargent says. Those early classes touched on everything from farm subsidies to taxation. “Wow, it really got me going,” he says.

My View of the Ec 10 Walkout

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

Discount Window Lending, Secrecy, and Stigma

This story is months old, but received some attention in the last week. In March, the Fed released the details of its lending during the financial crisis, under court order. Whether it took Bloomberg 9 months to process the information, or the timing just seemed right, Bloomberg had a story this week (I think; there is no date on the post) on the details. Further, Eliot Spitzer (how could we forget him?) and Jon Stewart picked up on it.

It has of course been well-known for a long time that the Fed lent to financial institutions, particularly large ones, in a massive and unprecedented fashion during the financial crisis. This is the first instance I know of the release of information about the details of the Fed's lending operations - who received the loans, how much, and at what interest rates. Typically we know the total quantities of discount window lending through the Fed's primary and secondary facilities, which appears in the Fed's reported balance sheet numbers, but little else.

It would be useful at this point to review the Fed's key lending programs to financial institutions that were active during the crisis. In the chart, I show the Fed's lending through the Term Auction Facility (TAF), the Term Asset-Backed Loans Facility (TALF), primary credit (regular discount window lending), and the specific AIG lending program (which gets its own line on the Fed's balance sheet).

As you can see in the chart, total lending by the Fed gets up to at most $600 billion - nowhere close to the $7 trillion that got gasps from Jon Stewart's studio audience, but nevertheless some serious pocket change, considering that the size of the Fed's balance sheet pre-crisis was about $900 billion. The interesting thing here is that, early in the crisis, lending to AIG and through the primary credit facility totaled less than $200 billion at most, with the majority of the lending conducted through the TAF. Thus, most of the discount window lending during the crisis occurred by way of auctions rather than through conventional lending. Note that some of the media stories focused on the fact that some of the loans went out at 0.01%, when the discount rate (the rate on the primary facility) was 0.5% at its lowest. These 0.01% loans had to occur through TAF.

The Bloomberg story makes a calculation that the Fed gave away $13 billion to various financial institutions, but if most of the funds were auctioned off, this can't be right. But how could a financial institution win an auction at 0.01% when the funds could be held as overnight reserves and earn 0.25%? The usual answer for this is "stigma," which actually seemed to be a concern of the Fed during the crisis. The Fed wanted to inject more liquidity into the financial system, and sometimes seemed to think that financial institutions were unwilling to take this as loans from the Fed. Why? There is empirical evidence and theory (in this paper by Huberto Ennis and John Weinberg) that banks are reluctant to borrow from the Fed because this might signal that they are in trouble.

But why would banks face stigma if the Fed keeps the details of its lending programs secret? Apparently there are ways to figure these things out, at least for large institutions. For example, a large quantity of lending in the Richmond Fed district is likely going to Bank of America. So if financial market participants can figure these things out anyway, why should the Fed keep its lending a secret? Why indeed?

Central bank lending is typically rationalized by appealing to the lender-of-last-resort role of a central bank. The conventional view is that there is some temporary market failure that makes the assets of some financial intermediaries temporarily illiquid, or there is an inherent vulnerability of illiquid banks to panics. Thus, it might seem useful for the central bank to lend to financial intermediaries during a crisis. The central bank takes the "illiquid" assets as collateral on its loans, potentially giving the collateral a haircut commensurate with its "true" market value. Central banks are supposedly wary of lending to banks which are actually insolvent rather than just illiquid. It is certainly not economically efficient to prolong the life of a bank that will fail anyway.

But run your mouse over the chart in this Bloomberg post. The three largest borrowers from the Fed during the crisis were Citigroup, the Bank of America, and the Royal Bank of Scotland. It seems widely recognized that the first two were essentially insolvent during the financial crisis, if not now, and the last one essentially failed during the crisis. Lending to these banks certainly does not appear to have been simple liquidity-easing.

I think one could make a case that the details of all of the Fed's activities, including its lending, should be made public, at the time these activities take place. Surely, there is stigma in borrowing from the Fed only if the Fed lends to banks that are essentially insolvent. If the Fed sticks to its appropriate lender-of-last-resort role, then it is only correcting short-term liquidity problems. Indeed, if the Fed is doing its job, then a Fed loan should be a certificate of viability.

In any case, we need more serious research on central bank lending, when it is appropriate and when it is not, what is appropriate collateral for a central bank loan, what are appropriate collateral haircuts, what is the role of central bank lending relative to conventional and unconventional open market operations, etc.

Death to Pennies

A theme I have written on before. Hat tip to Alex Tabarrok.

Is my ideology that obvious?

A perspective on the Ec 10 walkout from Connel Fullenkamp, a former student who now teaches at Duke:

I really don’t think that Professor Mankiw was trying to brainwash his students with any conservative ideology or agenda. I make this statement based on my own experiences.... I was a teaching assistant for Mankiw’s first-year Ph.D. course in macroeconomics for two years, which means that I sat in on his entire course twice.

If there’s any strong ideological undercurrent in Mankiw’s teaching, I would say that it’s Nerdism: the belief that people should listen to, and learn from, nerds.  Because believe me—and I say this with genuine respect and affection—Mankiw is a nerd’s nerd.

The Draghi Deal

If I understand the news coming out of Europe correctly, the new head of the European Central Bank is offering a simple deal: If fiscal policy becomes hawkish, monetary policy will be dovish.  In other words, as government spending is cut to put European governments on a sounder financial footing, monetary policy will do its best to ensure that any adverse impact on aggregate demand is kept to a minimum. 

That seems a sensible compromise, given all the competing risks.  Indeed a similar deal might well make sense for the United States.

My more liberal friends argue, based on Keynesian principles, that we need dovish fiscal policy as well.  They often argue for short-run fiscal expansion coupled with long-run fiscal contraction. The problem is that fiscal policymakers cannot bind their future selves. It is hard to make commitments to future fiscal contraction credible, especially as short-run actions expand the budget deficit.

My more conservative friends argue, based on monetarist principles, that a dovish monetary policy risks future inflation.  In my view, however, there are bigger risks than inflation just now.  They include prolonged high unemployment and meager growth.

So I see Draghi as a fiscal hawk and monetary dove (at least under present circumstances).  I wonder, which U.S. central bankers are in the same camp?