Friday, December 15, 2017

Hazlett on Spectrum

The public and media discussion of "net neutrality" seems to have degenerated to "we want stuff for free." In the end, it does cost something to deliver internet, and the bandwith is limited.

The (artfully named) "net neutrality" regulation was really a return to utility rate regulation, in which the regulators say who gets what, and how much they can charge. Just what a rosy success that was not, seems to have been forgotten.

In this context, it seems especially worth reporting on an event from last week. Tom Hazlett, former Chief Economist of the FCC, came to Hoover  to discuss his new book "Political Spectrum,"  which covers the history of the US government regulation of radio (TV, and cell phone) waves, largely through the same FCC that was in charge of "net neutrality." (I haven't read the book, this is a summary of the seminar discussion.)

Contrary to conventional wisdom, the market for spectrum worked well until 1927, in just the way economists might expect. Property rights to spectrum emerged, evolved, and worked well.

Radio was, at first, considered only for point to point communication. It stayed that way until 1920, when the first broadcast occurred.  Within 2 years there were 500 broadcasters.

Contrary to the common allegation of “etheric bedlam” the market was actually orderly through 1926.  Under the 1912 radio statute, the Department of Commerce enforced first-come first-serve rules, basically homesteader rights to spectrum in a geographic area. Those emergent property rights were registered with Department of Commerce, and easily bought and sold.

Regulation emerged in much the way a public choice economist might predict. The regulators wanted much more discretion — they wanted to control who got to broadcast and what was said. The existing large commercial stations wanted to limit entry and competition. The National Association of Broadcasters quickly became a lobbying group and advocated “public interest, convenience, and necessity” to regulate. Herbert Hoover, (sadly) the commerce secretary at the time stopped enforcing enforcing first-come first-serve rights in 1926. Now there was chaos, the “breakdown in the law.” According to Hazlett, this was a strategic breakdown to get regulation going. That regulation was formalized in the 1927 radio act. The first sentence of the act preempted private  rights to spectrum.

Now, rather than property rights, spectrum was allocated by a “mother may I” system.  In 1932 FCC,  took over authority of wires to.

Regulation was quickly captured to stop competition and innovation.

Thursday, December 14, 2017

Exceptionalism

Law and the Regulatory State is a little essay, my contribution to American Exceptionalism in a new Era, a volume of such essays by Hoover Fellows. It takes up where Rule of Law in the Regulatory State left off.

A few snippets:
To be a conservative—or, as in my case, an empirical, Pax-Americana, rule-of-law, constitutionalist, conservative libertarian—is pretty much by definition to believe that America is “exceptional”—and that it is perpetually in danger of losing that precious characteristic.  
So why is America exceptional, in the good sense? Here, I think, economics provides a crucial answer. The ideas that American exceptionalism propounds have led to the most dramatic improvement in widely shared well-being in human history.... Without this economic success, I doubt that anyone would call America exceptional. 
Despite the promises of monarchs, autocrats, dictators, commissars, central planners, socialists, industrial policy makers, progressive nudgers, and assorted dirigistes, it is liberty and rule of law that has led to this enormous progress. 
I locate the core source of America’s exceptional nature in our legal system—the nexus of constitutional government, artfully created with checks and balances, and of the rule of law that guides our affairs. And this is also where I locate the greatest danger at the moment. 
The erosion of rule of law is all around us. I see it most clearly in the explosion of the administrative, regulatory state.
This is the main theme:
the rules are so vague and complex that nobody knows what they really mean..  the “rules” really just mean discretion for the regulators to do what they want—often to coerce the behavior they want out of companies by the threat of an arbitrary adverse decision.
The basic rights that citizens are supposed to have in the face of the law are also vanishing in the regulatory state.
Retroactive decisions are common,..
I fear even more the political impact. ... The drive toward criminalizing regulatory witch hunts and going after the executives means one thing: those executives had better make sure their organizations stay in line.
The key attribute that makes America exceptional—and prosperous—is that candidates and their supporters can afford to lose elections. Grumble, sit back, regroup, and try again next time. They won’t lose their jobs or their businesses. They won’t suddenly encounter trouble getting permits and approvals. They won’t have alphabet soup agencies at their doors with investigations and fines... We are losing that attribute.
In many countries, people can’t afford to lose elections. Those in power do not give it up easily. Those out of power are reduced to violence. American exceptionalism does not mean that all the bad things that happen elsewhere in the world cannot happen here.
Always be optimistic though:
The third article in exceptionalist faith, however, is optimism: that despite the ever-gathering clouds, America will once again face the challenge and reform. There is a reason that lovers of liberty tend to be Chicago Cubs fans.
The other essays are great. Niall Ferguson basically thinks exceptionalism is over.

Wednesday, December 13, 2017

Asset Pricing Competition


John Campbell's text, "Financial Decisions and Markets" is out from Princeton University Press. With some mild chagrin, I must say it's a splendid book. (Chagrin, of course, because it's an obvious major competitor to my own effort in Asset Pricing.)

It is spare, concise, and clearly written. How can I say that of a 450 page book, with wide text and tiny margins? Well, it's the concise version of the Encyclopedia Britannica, breathtakingly comprehensive and up to date in its coverage of important research topics.

The first part is a whirlwind tour of asset pricing theory. Here, John adopts the traditional organization -- expected utility, static portfolio choice, static CAPM and APT as equilibrium relations where supply meets demand, and finally we meet the discount factor and consumption-based pricing. I chose to go the other way around, and start with the basic asset pricing equation \(p_t u'(c_t) = E_t [\beta u'(c_{t+1}) x_{t+1} ]\), following Bob Lucas' insight that asset pricing is the same as in an endowment economy, and filling out the CAPM and APT and so forth as special cases. I never even got to portfolio theory -- it's in a draft chapter for the long-delayed next version. I still think that's the right organization, but most people don't want to teach it that way. John's more conventional organization, combined with clarity and concision, may be more what you want.

Even here, John's empirical taste and contributions rings through Any textbook is in many ways a summary of its authors' research journey, and John's journey has gone far and wide. You see a preview of the style on the 6th page of chapter 2 (p. 28) where you meet approximations for log returns, and the growth-optimal portfolio on the next page. On calculating minimum-variance portfolios, on p. 37, you get  graph of time-varying return correlations from Campbell Lettau Milkier and Xu (2001), a provocative fact usually ignored. After efficiently presenting the classic CAPM, we get (p. 51) an insightful application to Harvard's endowment, highlighting the difficulties of using these oft-repeated portfolio and pricing theories in practice.

Friday, December 8, 2017

The hard road of free markets

The fundamental reason so many markets are not free, and so dysfunctional, is that the voters of our democracy don't really want freedom. Freedom will come when we want it, when we insist on it, when the average voter sees a free market solution rather than endless controls as the answer to real world problems. The sad paradox of free markets is that free markets do not need people to understand them to work. But democracy does require voters to understand how things work.

In that vein today's internet browsing (both HT marginal revolution) brings good news and bad news.

Good news - one more piece of evidence that people from left and right are finally beginning to see the huge damage of zoning and construction restrictions, including inequality, income segregation, and perpetuation of economic status. That "progressives" now see this too is a most heartening development.

Thursday, November 30, 2017

Bitcoin and Bubbles

Source: Wall Street Journal

So, what's up with Bitcoin? Is it a "bubble?'' A mania of irrational crowds?

It strikes me as a fairly pure instance of a regularly occurring phenomenon in financial markets, one that encompasses some "excess valuations" in stock markets, gold and commodities, and money itself.

Let's put the pieces together. The first equation of asset pricing is that price = expected present value of dividends. Bitcoin has no cash dividends, and never will. So right off the bat we have a problem -- and a case that suggests how other assets might have value above and beyond their cash dividends.

Well, if the price is greater than zero, either people see some "dividend," some value in holding the asset, beyond its cash payments; equivalently they are willing to hold the asset despite a lower expected return going forward, or they think the price will keep going up forever, so that price appreciation alone provides a competitive return. The first two are called "convenience yield," the latter is a "rational bubble."

"Rational bubbles" are intriguing, but I think fundamentally flawed. If a price goes up forever, eventually the value of bitcoin must exceed all of US wealth, then all of world wealth, then all of interplanetary wealth, then all of the atoms in the universe. The "greater fool" or Ponzi scheme theory must break down at some point, or rely on an irrational belief in the next fool. The rational bubbles theory also does not account for the association of price surges with high volatility and high trading volume.

So, let's think about "convenience yield." Why might someone be willing to hold bitcoins even though their price is above "fundamental value" -- equivalently even though their expected return over a decently long horizon is lower than that of stocks and bonds? Even though we know pretty much for sure that within our lifetimes bitcoin will become worthless? (If you're not sure on that, more later)

Wednesday, November 29, 2017

Eight Heresies of Monetary Policy


Eight Heresies of Monetary Policy

This is a talk I gave for Hoover, which blog readers might enjoy. Yes, it puts together many pieces said before. This post has graphs and uses mathjax for equations, so if it isn't showing come back to the original. Also here is a pdf version which may be more readable.

Background

As background, the first graph reminds you of the current situation and recent history of monetary policy.

The federal funds rate is the interest rate that the Federal Reserve controls. The funds rate rises in economic expansions, and goes down in recessions. You can see this pattern in the last two recessions. Since about 2012, though, when following history you might have expected the funds rate to rise again, it has stayed essentially at zero. Very recently it has started to rise, but very slowly, nothing like 2005.

The black line is reserves. These are accounts that banks have at the Fed. Crucially, these bank accounts now pay interest. Starting in 2008, reserves grew dramatically from about $20 billion to $2,500 billion. The three cliffs are the three quantitative easing' episodes. Here, the Fed bought bonds and mortgage backed securities, giving banks reserves in exchange.

Inflation initially followed the same pattern as in the last recession. It fell in the recession, and bounced back again in 2012.Inflation has been slowly decreasing since. 10 year government bonds have been quietly trending down, with a bit of an extra dip during the recession.

The next graph plots US unemployment and GDP growth.

You can see we had a deeper recession, but then unemployment recovered about as it always does, or if anything a little faster. You can see the big drop in GDP during the recession. Subsequent growth has been overall too low, in my view, but it has been very steady. If anything, both growth and inflation are steadier in the era of zero interest rates than they were when the Fed was actively moving interest rates around.

These central facts motivate my heresies: Inflation, long term interest rates, growth and unemployment seem to be behaving in utterly normal ways. Yet the monetary environment of near-zero short term rates and huge QE is nothing but normal. How do we make sense of these facts?

Heresy 1: Interest rates
  • Conventional Wisdom: Years of near zero interest rates and massive quantitative easing imply loose monetary policy, "extraordinary accommodation,'' and "stimulus.''
  • Heresy 1: Interest rates are roughly neutral. If anything, the Fed has been (unwittingly) holding rates up since 2008.

Wednesday, November 15, 2017

Journal graphics in a bygone era


To illustrate MV = PY. (It was MV=PT then.)  In  Irving Fisher, "The Equation of Exchange 1896-1910," The American Economic Review Vol. 1, No. 2 (June, 1911), pp. 296-305, via JSTOR.

Tuesday, November 14, 2017

Mind the Gap

Mind the Gap is an extraordinary blog post on land use regulations. (HT the dependably excellent Marginal Revolution.) It is great for its detail, but most of all for its fresh voice. Sure, send one of my free-market economist friends in to examine the pathologies of any city, and we start almost reflexively on land use regulations. But the author is clearly from a different background -- the sort of person who "was in Hamtramck, Michigan a couple of years ago to participate in a seminar about reactivating neighborhoods." Lessons discovered the hard way, from different backgrounds, are often the freshest.

The big point of the blog post is how land use regulations force a steppingstone pattern of urban decay. It's hopelessly expensive to convert any building "up" the economic foodchain of uses, so bit by bit buildings get used for less and less productive uses, that don't attract the attention of regulators, until they become vacant lots, or until a large commercial developer can come in, demand tax subsidies, and rebuild the whole neighborhood.

The post starts with the story of a family that
bought an old fire station a few years ago with the intention of turning it in to a Portuguese bakery and brew pub.
Alas,
Mandatory parking requirements, sidewalks, curb cuts, fire lanes, on site stormwater management, handicapped accessibility, draught tolerant native plantings… It’s a very long list that totaled $340,000 worth of work. They only paid $245,000 for the entire property. And that’s before they even started bringing the building itself up to code for their intended use. Guess what? They decided not to open the bakery or brewery. Big surprise.

(The post is full of great photographs like this one.) So instead,

Monday, November 13, 2017

Two on energy subsidies

The WSJ has two good and related opeds on energy and transport subsidies recently, Randall O'Toole on Last Stop on the Light-Rail Gravy Train and Lee Ohanian and  Ted Temzelides write on energy and transport subsidies

O'Toole:
Last month, Nashville Mayor Megan Berry announced a $5.2 billion proposal that involves building 26 miles of light rail and digging an expensive tunnel under the city’s downtown. Voters will be asked in May to approve a half-cent sales tax increase plus additions to hotel, car rental and business excise taxes to pay for the project.
Just in time for self-driving Ubers to arrive.

I love trains. But we have to admit practicalities. One transportation economist summed all there is to know about transit with "Bus Good. Train Bad." (With a few exceptions, such as Manhattan.)  And light rail, worse. Trains are expensive, and once built, immobile. If people want to go somewhere else, tough. Rolling stock lasts around 50 years, meaning they bake in technical obsolescence. Trains carry far fewer people per lane-mile than busses. And a fleet of self-driving Ubers linked by computer will be able to use bus lanes.

Actually, even buses are more and more questionable. As I wait for the interminable lights on El Camino to cross to Stanford (on bicycle), I have taken to counting passengers on the well-subsidized bus line. The modal number is zero.

As Randy has pointed out elsewhere, the main beneficiaries of light rail are suburban largely white commuters with a nostalgia thing for trains. The main people paying for it are inner city minorities who don't get bus service anymore.
To pay for new light-rail lines that opened in 2012 and 2016, Los Angeles cut bus service. The city lost nearly four bus riders for every additional rail rider.
Congestion got you down? Real time tolling, adjusted minute by minute, will either cure traffic congestion forever, or will bail out indebted local governments with massive revenues, or both. Or, let people live somewhere near where they work!

Lee and Ted consider the transition from horse to auto and truck,
‘In 50 years, every street in London will be buried under 9 feet of manure.” With this 1894 prediction, the London Times warned that the era’s primary source of transportation energy—the horse—would soon create an environmental crisis. ...
The enormous demand for a cleaner and more efficient source of energy led to remarkable innovations in the internal combustion engine. By 1920 horses in cities had been almost entirely replaced by affordable autos and trucks...
And to be honest, horse manure replaced by auto exhaust -- but as bad as auto exhaust is, it's a lot better than horse manure.
Suppose governments in the 1890s, desperate to replace the horse, had jumped on the first available alternative, the steam engine. Heavy subsidies would have produced more steam engines and more research on steam technology. This would only have waylaid the development of the far superior internal combustion engine. 

Source: Obtainium works
(Actually, the government did subsidize railroads a good deal, and perhaps by doing so did stall the development of the truck.)

More than horse manure, I love the image of an alternate reality steampunk America...At left a cool  steampunk RV. (Image source)

Which brings us back, I'm afraid to the main force behind rail subsidies, which Randall has pointed out before: Nostalgia. Nostalgia for what seems like a simpler age. I understand that too. I love trains. But that doesn't make them practical, especially at billions of dollars per mile.

If we're doing nostalgia, how about doing it full time -- high speed stagecoach lines? Bring back the horse! It's all renewable!'

Thursday, November 9, 2017

The real questions the Fed should ask itself

The real questions the Fed should ask itself.  This is a cleaned up and edited version of a previous blog post, commenting among other things on Janet Yellen's Jackson Hole speech in favor of most of Dodd Frank, that appeared in the Chicago Booth Review. When you think of the Fed, think more of the giant regulator than about where interest rates go.

Thursday, November 2, 2017

Yellen Retrospective

The newspapers report today that President Trump has decided to nominate Jerome Powell to replace Janet Yellen as Fed Chair.

The Federal Reserve's mandate is to "promote maximum employment, stable prices, and moderate long- term interest rates." Ms. Yellen can look back with pride on these outcomes during her term:




All three variables are doing better than they have in half a century. Many people complain about many things at the Fed, including me, but relative to the stated mandate, she has every right to put these charts on the wall of her new office.

One could complain that Ms. Yellen didn't face any particular challenges. As presidents are tested in wartime, so Fed chairs are tested by events. Ms. Yellen didn't face a recession or financial crisis. In this quiet late summer of the business cycle, her job was largely to do nothing, and resist calls from people who wanted her to take big steps. The Fed's major tool is the federal funds rate, has barely moved.



True, but she did not screw up either. So much of monetary history consists of unforced errors, that not making one is an accomplishment. The late summer of business cycles has historically been a time when central bankers over or under react.  And there has been no lack of loud voices calling for drastic action one way or another. In particular, the siren song of "macro prudential policy" that the Federal Reserve should manipulate stock and housing prices has been strong. Her predecessor, Ben Bernanke, will be much more written about for the Fed's management of the 2008 crisis and recession, as well for its failure to see it coming in 2007.  Not screwing up doesn't earn you as big a place in history, but perhaps it should.

No matter how one feels about monetary policy, and the more important (in my view) question of Fed financial regulation, President Trump is breaking with tradition by not reappointing her. The tradition that if the Fed chair has done a reasonable job, he or she is reappointed is a good one for maintaining the independence of the Fed. Let us hope that it is not gone for good.

Good luck to Ms. Yellen in her next endeavor. And to Mr. Powell in this one.

Wednesday, November 1, 2017

Tax Graph


The tax discussion is moving to personal income taxes, and the world is waiting to hear the actual Republican proposal, due tomorrow (Thursday).

With apologies to blog readers who know all this in their sleep, I thought I might explain just why (some) economists keep chanting "broaden the base, lower marginal rates," or why I keep saying that taxes don't matter, tax rates matter to economic growth.  This is grumpy economist, Saturday morning cartoon edition. Perhaps a colorful graph will help as you try to explain taxes to relatives this Thanksgiving.

Start with the blue line. Suppose you work 40 hours a week, and make $100,000. Suppose the government wants half of it. One way to get that is with a flat tax -- for every dollar you earn, send 50 cents to the government.  The government gets $50,000.

Now consider the red line. This line can represent a progressive tax: Exempt the first $50,000 of income, so people who make less have to pay a smaller share of their income in taxes, and charge a 100% tax rate on the rest. Equivalently, this line represents $50,000 of tax shelters and deductions -- employer-provided health care, charitable contributions to a foundation that employs your relatives and flies you around on private jets, a deduction for home mortgage interest, credits for the solar cells on your roof, and so on.

At first glance, this tax system raises the same amount of money. (That's "static scoring.")

You can see the hole in the argument. If we tax the marginal dollar after $50,000 at 100%, you won't bother working the second 20 hours, and the government will get no revenue. More deeply, slowly, and insidiously, in my view, people choose easy college majors that lead to $50,000 jobs, not harder ones that lead to $100,000 jobs, or they don't start businesses.

Friday, October 27, 2017

Economists and taxes

My last post on taxes continued the question, who bears the burden of the corporate tax? Will a reduction in corporate taxes benefit stockholders or workers? It was a fun technical discussion.

But the whole time I want to scream: That is the wrong question! And the public economists job should be to scream from the rafters, that is the wrong question!  By just accepting the question, we are doomed to bad answers.

The public, and politicians, analyze taxes entirely through the lens of who gains and who loses. Income redistribution, yes, but also redistribution from renters to homeowners, married to unmarried, young to old, city dwellers to farmers, Texans to Californians, and so on. The political and popular discussion is about taxES, and who pays what.

Economists serve best when they offer thoughts outside the standard left-right partisan divide. Our first function should be always to remind people that marginal tax rates matter to the economy not taxes. 

Our second insight is always to analyze things comprehensively. The Federal income tax is not what counts, the entire wedge between work and consumption matters. Whether the corporate tax is progressive or not does not matter, whether the overall tax code is progressive (plus the overall spending code, and forced cross-subsidy code!) matters.   Don't tax wine over beer to redistribute; tax goods evenly and achieve progressivity through a progressive income (or better, consumption) tax, or spend money on programs to help people whose distress is correlated (imperfectly) with beer drinking.

Economists may feel their moral sentiments about redistribution are really important. But we have little professional reason to argue our feelings are better than anyone else's. What we can argue is, if you'r going to do more or less redistribution, do it efficiently and comprehensively.

In this context, the current tax reform proposal, and its instant dismissal from self-identified Democratic economists, echoing political rhetoric, is a deep disappointment.

The economists' tax reform starts with a detailed breakdown by income. (I'm caving to political reality that our nation is obsessed with income, not more meaningful measures of economic advantage and disadvantage.) Then, we create a tax reform in which each group pays the same amount (ideally, bears the same burden), but trades lower marginal rates for fewer deductions, exemptions, and for the reduction or elimination of taxes that either highly distort economic activity or lead to lots of inefficient avoidance  (corporate, rates of return, estate).

In short, we aim for a revenue-neutral, redistribution-neutral, reform. We recognize that eventually tax rates must be high enough to cover spending. There isn't a big need to argue over Laffer effects. Even if scored as statically revenue neutral, when the economy booms, revenue flows in, and we have paid off the debt we can start lowering rates. We recognize that if the structure if the tax reform is fixed, we can later continue to argue over the right amount of redistribution.

1986 came close. It wasn't perfect. But at least the rhetoric was this, and politicians explained this goal to the public. You will pay the same taxes, but at lower rates for fewer deductions, and the economy will grow. And lo, it did.

For thirty-one years, we have waited to finish the job. As the tax code grew more complex, with higher statutory rates and more deductions, we waited to redo the job. Reform proposal came and went, with at least a nod to this amount of economic sense.

But no more. Now tax policy is all redistribution all the time. Democratic politicians have decided that their mantra is "tax cuts for the rich." Well, a slogan is a slogan. More sadly, self-identified democratic economists echo this mantra, and little other. Anytime you're arguing one side's talking point or another, you're doing little to illuminate a discussion.

Each provision is examined in isolation for its redistributive impact. It's profoundly hypocritical of course.  Tax deductions are indeed a "tax cut for the rich" since people in the 40% marginal bracket who itemize get a lot more than Joe and Jane down in the lower brackets. But you hear either silence, or pretzel logic defense, such as the New York Times defense of the profoundly regressive deduction for state and local taxes.

I was disappointed at both the rhetoric and the small progress of the administration's proposal's to date. Yes, cutting the corporate rate is a good idea. But they don't even try to argue for marginal rate reductions or incentives. The buzzword is to give "tax cuts to help the middle class," which the left can then argue is a "lie" or not. Once you fall for redistributionist rhetoric, once you say that tax policy is all about giving the right people more and the wrong people less money, I think the hope for a tax reform that actually gets the economy going is dim.

The holy trinity was off the table from the start -- home mortgage interest deduction, charitable deduction, and employer-provided health deduction. The fourth horseman of the apocalypse, the deduction for state  and local taxes, is in danger. (Sorry for mixing metaphors!) This is like a wayward husband saying, "sure, I'll clean up my act. However, the drinking, gambling, and smoking are off the table." The corporate tax reduction does not seem to be coming with a serious cleanup of the thousands of deductions and extenders, each catnip to the lobbyists who keep them in place.

The political challenge for a reform is to say to each group, "you're going to give up your deduction, yes even interest on future home mortgages. But, your rates will go down so much that you will end up paying no more overall, and as the economy grows you will pay less. I want your help holding the fort against those who will demand their deductions and subsidies." That's a deal that pretty much held together in 1986. But if we go into the negotiation saying "oh, and by the way the big three are getting theirs unscathed," and "therefore really big rate reductions are off the table," then the hope of putting that coalition together is gone. It's  a free for all, call your congressperson and make sure you keep yours.

The bottom line: I support the current tax proposal, as incomplete and flawed as it is. It is a step in the right direction. We get the corporate tax rates down to those common in that low-tax free-market nirvana, Europe. It is not, however, 1986 on its own.

I do not support the rhetoric. "Tax cuts" do not work absent spending cuts. Cuts in distorting marginal tax rates matter. The people in charge must surely understand this, so the choice to market it as "tax cuts for the middle class" represents, I think, an unwise rhetorical choice.  The American people are smart enough to understand this, and playing redistribution, bidding for support with handouts, is not a winning game.

Moreover, the sense I have from talking to people, less enshrined in economic theory, is that massive tax complexity and uncertainty are larger drags on growth than a stable simple but high tax rate would be. I see "simplification" in the rhetoric, but no substantial simplification in the body of the proposal. It leaves most of the "finish 1986" job undone, and unless magic happens on entitlement reform, this tax bill will be undone soon as the deficit widens. If it is all we get, and if it is passed as Obamacare was passed, with no votes from the other party, it will not give the sense of permanence necessary to induce a lot of investment and growth.

It needs to be a first step, not this generation's tax reform for the next 31 years. I understand the politics. Republican leadership needs to do something. If Democrats will unite in "resistance" to a bill celebrating mom and apple pie, they need to do something on their own. If they do something, and look like winners, they can get support to do more. But it must be that first step. And even so, I would have hoped for some more courage in the first step. Enshrining the triplet of deductions without  a fight, not even mentioning marginal rates, makes it ever harder to remove them in a second step.

And I wish I were hearing a lot of this, and not just echoing the political line "tax cuts for the rich," from top economists more critical of the proposals.



Corporate tax burden again

This post continues the question, who bears the burden of the corporate tax? The next post will have broader thoughts on the tax plan and economists' reaction to it.

I'm responding in many ways to Larry Summers, who weighed in on the corporate taxes issue in a Washington Post oped. He eloquently and concisely makes most of the arguments floating around now against the corporate tax cut, so I don't have to wade through the venom in Krugman posts to find nuggets of economic sense that one discuss on objective grounds.

This is a long post, so let me summarize the conclusions

1) Even if stockholders do bear the burden of the corporate tax, that is entirely the stockholders who are there when the tax is announced. Current stockholders bear little or no burden.

2) The novel "monopoly" argument is seriously deficient.

3) Even if stockholders bear the burden of the corporate tax, the corporate tax is an insanely inefficient way to make a more progressive tax code.

So who does bear the burden of the corporate tax? 

I think every economist in this debate admits, if some reluctantly, that "corporations" pay no taxes. As an accounting matter, every cent corporations pay comes from higher prices, lower wages, or lower payments to shareholders. The only question is which one.  And indirect general equilibrium effects are central.  The question is not just, how do corporations respond immediately, but how do wages, prices, and capital in the whole economy adjust. "Make corporations pay their fair share" is just nonsense.

Tuesday, October 24, 2017

Hall graphs

Bob Hall gave a lovely talk on wages, and how a reduction in the cost of capital from tax or regulatory reform might raise capital, and by doing so raise labor productivity and hence wages.  The graphs speak for themselves.




Saturday, October 21, 2017

Greg's algebra

How much do workers gain from a capital tax cut? This question has reverberated in oped pages and blogosphere, with the usual vitriol at anyone who might even speculate that a dollar in tax cuts could raise wages by more than a dollar. (I vaguely recall more blogosphere discussion which I now can't find, I welcome links from commenters. Greg was too polite to link to it.)

Greg Mankiw posted a really lovely little example of how this is, in fact, a rather natural result.

However, Greg posted it as a little puzzle, and the average reader may not have taken pen and paper out to solve the puzzle. (I will admit I had to take out pen and paper too.) So, here is the answer to Greg's puzzle, with a little of the background fleshed out.

The production technology is \[Y=F(K,L)=f(k)L;k\equiv K/L\] where the second equality defines \(f(k)\). For example \(K^{\alpha}L^{1-\alpha}=(K/L)^{\alpha}L\) is of this form. Firms maximize \[ \max\ (1-\tau)\left[ F(K,L)-wL \right] -rK \] \[ \max\ (1-\tau)\left[ f\left( \frac{K}{L}\right) L-wL \right] -rK \]

Friday, October 20, 2017

Taylor for Fed

I might as well share with blog readers my favorite for the Fed: John Taylor.

A preface is in order though.

Monetary policy is not, right now, the flaming hot mess that characterizes so much of the Federal Government. And all the candidates are good.

The Fed's official mandate is low interest rates, low inflation, and maximum employment -- as large as monetary policy can make it. Interest, inflation, and unemployment are each lower than they have been in living memory. The stock market is high yet surprisingly quiet (low volatility).

One may question whether this is because or despite the Fed. (My view, largely despite.) One may quibble about low growth and labor force participation. One may worry about over-regulation, though Congress mandated most of it. But by the standards of the Fed's mandate, we must admit that the outcomes we see are fine. In any other branch of the Federal government, performance like this relative to mandates, together with a tradition of reappointment, would argue for Ms. Yellen's swift reappointment.

Ms. Yellen's critics, such as the Wall Street Journal editorial page, are forced to argue that she might fall short faced with future challenges. She might keep interest rates too low for too long, and let inflation pick up. (Inflation is still nowhere in sight.) She might raise interest rates too fast if the economy does start to grow more, in fear of inflation, and choke off supply side growth. (Yes, the two criticisms are inconsistent.) She might not handle the next crisis well.

Indeed. And taking the measure of people and trying to figure out how they will deal with future challenges is just what this process is supposed to be about. One can also complain that the process of monetary policy has too much discretion, too many speeches, and needs a more stable rules based approach. I have complained that the Fed is massively over-regulating finance, and this will cause a less competitive and efficient financial system in the future.

But recognize that all this is hypothetical, and there is little to complain right now about in the outcomes we tasked the Fed to achieve.

Still, let us suppose Mr. Trump decides he wants a new person at the Fed. Why John?

John is, quite simply, the top monetary economist of his generation. He understands the theory, he understands the empirical work, he deeply knows the history. He took the baton from Milton Friedman.

How does inflation work anyway?

Monetary policy, central banking and inflation are hard. It's well to remember that. Today's blog post adds up a few things that seem like they're obvious but are not.

Inflation is hard. 

Central bankers are puzzled at persistently low inflation.  From WSJ,
Ms. Yellen said, as the “biggest surprise in the U.S. economy this year has been inflation.” 
“My best guess is that these soft readings will not persist, and with the ongoing strengthening of labor markets, I expect inflation to move higher next year,” Ms. Yellen said, adding that “most of my colleagues on the [interest-rate-setting Federal Open Market Committee] agree.”
Of course, they've been expecting that for several years now.  And she seems fully aware that they may be wrong once again:
She cautioned, however, that U.S. central bankers recognize recent low inflation could reflect something more persistent. “The fact that a number of other advanced economies are also experiencing persistently low inflation understandably adds to the sense among many analysts that something more structural may be going on,”  
"Something more structural" is a pretty vague statement, for the head of an agency in charge of inflation, that has hundreds of economists looking at this question for years now! That's not criticism. Inflation is hard.

Why is it so hard? The standard story goes, as there is less "slack" in product or labor markets, there is pressure for prices and wages to go up. So it stands to perfect reason that with unemployment low and after years of tepid but steady growth, with quantitative measures of "slack" low, that inflation should rise, as Ms. Yellen's first quote opines.

That paragraph contains a classic economic fallacy, that of composition; the confusion of relative prices and the level of prices and wages overall. If labor markets get "tight," companies finding it hard to find workers, then yes, one expects wages to rise. But one expects wages to rise relative to prices. You only tempt workers to move to your company by offering them wages that allow them to buy more. Similarly, if there is strong demand for a company's products, its prices will rise. But those prices rise relative to other prices and to wages. Offering a company higher prices when its wages, costs, and competitor's prices are all rising does nothing to get it to produce more.

So, in fact, standard economics makes no prediction at all about the relationship between inflation -- the level of prices and wages overall; or (better) the value of money -- and the tightness or slackness of product and labor markets! The fabled Phillips curve started as a purely empirical observation, with no theory.

Thursday, October 19, 2017

Tyler: Equity financed banking is possible!

Tyler Cowen wrote an extended blog post on bank leverage, regulation and economic growth on Marginal Revolution. Tyler thinks the "liquidity transformation" of banks is essential, and that we will not be able to avoid a highly levered banking system, despite the regulatory bloat this requires, and the occasional financial crisis. As blog readers may know, I disagree.

A few choice quotes from Tyler, though I encourage you to read his entire argument:
I think of the liquidity transformation of banks in terms of...Transforming otherwise somewhat illiquid activities into liquid deposits. That boosts risk-taking capacities, boosts aggregate investment, and makes depositors more liquid in real terms.  
Requiring significantly less bank leverage, at any status quo margin, probably will bring a recession. 
...many economies are stuck with the levels of leverage they have, for better or worse. 
I fear ... that we will have to rely on the LOLR function more and more often. 
I don’t find the idea of 40% capital requirements, combined with an absolute minimum of regulation, absurd on the face of it. But I don’t see how we can get there, even for the future generations.
Depressing words for a libertarian, usually optimistic about markets.

This is a good context to briefly summarize why "narrow", or (my preferred) equity-financed banking is in fact reasonable, and could happen relatively quickly.

Tyler's main concern is that people need a lot of "liquidity" -- think money-like bank accounts -- and that unless banks can issue a lot of deposits, backed by mortgages and similar assets, bad things will happen -- people won't have the "liquidity" they need, and businesses can't get the investment they need.

Here are a few capsule counter arguments.  In particular, they are reasons why the economy of, say 1935 or even 1965 might have required highly levered banks, but we do not.

1) We're awash in government debt.

Thursday, October 5, 2017

Cowen on Fed Chair

Tyler Cowen has a good thought on the Fed chair question. The next chair has to be a good politician, in all the positive senses of that word, more than a good technocrat:
The Fed has functioned as a technocracy for a long time, but might the future bring a Fed that is irrevocably split between competing factions? ...the future could bring a Fed divided over how much it should assert its political independence, how much it should assume responsibility for possible asset bubbles, how it should respond to an international financial crisis, or how much it should align with an “America First” mindset. .... 
The backdrop is this: Ben Bernanke’s Fed, with its bailouts during the financial crisis, ate up a lot of the Fed’s political capital, though arguably for the worthwhile cause of saving the financial system. As a result, the Fed no longer has its pre-crisis credibility. As long as the American economy is on the path of a slow and steady recovery, with relatively high asset prices, that’s bearable. 
But the next time major economic volatility comes around, Fed decisions will be scrutinized and politicized like never before. This will happen in the mainstream media, on social media, and perhaps by our very own president in his tweets or offhand remarks. The key factor for any Fed leader will be the ability to maintain and project a coherent, unified voice at the Fed, so that the Fed remains an island of relative sanity in the polarized nation. This will be a problem of crisis management, but unlike Bernanke’s crisis management it will be fought first and foremost in the trenches of public opinion.
(The open vice chair positions are good ones for technocrats, who need to be able to translate the abstruse language of the staff.)

My related thought: We focus a lot on interest rate policy, but most of what the Fed does these days is financial regulation and supervision, and those decisions are likely much more important going forward.  The challenging question there is "macro-prudential." Is it the Fed's job to worry about "asset bubbles," and to micromanage "credit booms" and their eventual busts? Or is it better for the Fed to limit its authority, to preserve independence, credibility, and insulation from political demands for action and political criticism of its actions, by pronouncing there are economic events beyond its scope?

Moreover, if the Fed is to limit the scope of its financial dirigisme, it had better do so beforehand not afterwards. If everyone expects the Fed to set prices and bail out hither and yon, and then the Fed gets religion (perhaps under relentless political pressure), the crisis will be so much worse. Bernanke also benefitted from acting far beyond expectations of what he would or could do. The next chair will be in the opposite situation, have to set limits of crisis reaction, and disappoint expectations. It's much better to do that ahead of time -- and much harder for an institution like the Fed to scale back people's expectations, and to renounce and pre-commit against attractive-sounding powers.

Update: 

Narayana Kocherlakota predicts Jerome Powell. In line with some of the above thoughts, Narayana's view basically is that monetary policy is doing fine. Low unemployment, low inflation, low interest rates, low macro and financial volatility. Mission accomplished. Moreover, if there is a hawk vs. dove question, President Trump looks likely to be on the dove side of it. (Sadly, I doubt that rules and precommitment vs. discretion is ringing in the appointment decision.) However, supervision and regulation is the key issue going forward, and Narayana views Powell as Yellen monetary policy plus a regulatory/supervisory reform.

(I learned to use both words from Ms. Yellen's Jackson hole speech. Regulation is rules, supervision is sending Fed people to look over banks' shoulders. It's a good distinction.)