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September 9, 2010

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The WSJ "Symposium" on Monetary Policy

Posted: 09 Sep 2010 12:42 AM PDT

The WSJ asked several people, mostly on the right, about whether the Fed has the power to do more. John Taylor's answer was predictable, the problem is that they aren't following the Taylor rule and the sooner they get back to it, the better, so I'll move on to the next participant, Richard Fisher of the Dallas Fed.

Fisher is predictably hawkish, adopts the GOP line on business uncertainty causing problems, and concludes:

The minutes of the last Federal Open Market Committee (FOMC) meeting noted that "a number of participants reported that business contacts again indicated that uncertainty about future taxes, regulations, and health-care costs made them reluctant to expand their workforces." ... Can the Fed do more to propel job creation? Barring an unforeseen shock, I would be reluctant to expand the Fed's balance sheet... Of course, if the fiscal and regulatory authorities are able to dispel the angst that FOMC participants are reporting, further accommodation may not be needed. If businesses are more certain about future policy, they'll release the liquidity they're now hoarding.

The claim that business uncertainty is holding up the recovery will appear again below, so I'll hold off with the evidence against it.

Next is Frederic Mishkin. I wasn't sure how he'd answer. He's fearful that debt monetization will lead to lack of fiscal discipline, that losses on asset purchases might lead to a loss of Fed independence, and that all roads lead to inflation:

The ... Fed's recent announcement that it will reinvest payments from agency debt and mortgage-backed securities into long-term Treasurys has opened the door to large-scale asset purchases. Should the Fed pull the trigger?
Purchasing long-term Treasurys might suggest that the Fed is accommodating the fiscal authorities by monetizing the debt—thereby weakening the government's incentives to come to grips with our long-term fiscal problems. In addition, major holdings of long-term securities expose the Fed's balance sheet to potentially large losses if interest rates rise.
Such losses would result in severe criticism of the Fed and a weakening of its independence. Both the weakening of its independence and the perception that the Fed is willing to monetize the debt could lead to increased expectations for inflation sometime in the future. That would make it much harder for the Fed to contain inflation and promote a healthy economy.
Expanding the Fed's balance sheet through large-scale asset purchases can be necessary in extraordinary circumstances, such as during the depths of the recent financial crisis. But in relatively normal times, the costs of using this tool are sufficiently high that it should not be used lightly.

Relatively normal times? Now? Ah, he means relatively normal on Wall Street, not Main Street. Anyway, next up, Ronald McKinnon. He wants to "spring the near zero interest rate liquidity trap" by, essentially, increasing interest rates. That's a bad policy, so let's move on.

I didn't expect Vincent Reinhart to be the most reasonable of the bunch, though perhaps given the bunch that was selected it might have been a good bet. I could sign on to something along these lines:

The Fed should promise to purchase government and mortgage-related securities between its regularly scheduled meetings as long as activity is forecast to be subpar and inflation is low or headed down. Purchases of, say, $100 billion every six-to-eight weeks would add up to a number worthy of shock and awe for those with a somber economic outlook.
But those foreseeing a quick return to above-trend growth or expecting a slower trend would similarly be reassured that the Fed would not keep its foot on the accelerator for too long. Most importantly, by linking to economic conditions, the Fed would not be providing an open-ended promise to monetize the federal debt.

Last up is Allan Meltzer, and he follows Taylor in calling for the Taylor rule, and he, like Fisher, adopts the "government policy is creating business uncertainty" line:

When Congress established the Fed in 1913, it gave it a dual mandate: high employment and price stability. In its nearly 100-year history, the Fed has achieved both objectives only rarely: 1923-1928, a few years in the mid-1950s and early 1960s, and from 1985 to 2004, when the Fed followed the Taylor rule that incorporates Congress's mandate. Those 20 years when the Fed followed the rule were the longest sustained period of stable growth and low inflation in Federal Reserve history.
In "A History of the Federal Reserve," I concluded that the principal mistakes the Fed has made have resulted from giving excessive attention to current events... By focusing on the short-term, the Fed neglects the longer-term consequences of its actions. ... A rule would change that. ... At times like the present, a rule helps the Fed to recognize that current problems are mainly the result of mistaken government policies that create massive uncertainty.
The Fed added more than a trillion dollars of excess reserves to respond to the financial crisis. ... Adding a few hundred billion to the trillion dollars already available would ... do little for the economy that banks could not do now.
There is very little that the Fed can do to change the near-term, but it can have important influence on the future. The Fed has sacrificed much of its independence during this crisis by helping the Treasury carry out fiscal policy. Adopting and following a rule, like the Taylor rule, is an effective way to regain independence.

The second to the last paragraph misstates the case that people are making for Quantitative Easing. First, as Ben Bernanke, Joe Gagnon, and others have pointed out, research indicates that the Fed could move long-term rates down a bit with QE. If the Fed does this, it then creates an incentive for more business investment and the purchase of more consumer durables. Yes, banks have plenty of funds to lend, and this would give them more, but the problem is lack of demand, and lower interest rates are intended to boost demand back up a bit. It's the demand side effects that matter, not the increased supply of funds. Now, I happen to think that those effects wouldn't be as strong as we need by themselves, fiscal policy needs to join the effort, but the Fed has a role to play.

As for the business uncertainty claim, here's Paul Krugman:

So I just read the latest speech from Richard Fisher of the Dallas Fed; it's one of the most depressing things I've read lately, and given what I read that's saying a lot.

Much of the speech is taken up with arguing that it's not the Fed's job to help the struggling economy, because the big problem there is business uncertainty about future regulation. Urk. Like others, I've tried to point out that there is no evidence for this claim: business investment is no lower than you'd expect given the state of the economy, while surveys say that weak sales, not fear of regulation, are holding back business expansion. Oh, and just to make it perfect, Fisher cites Mort Zuckerman to bolster his case.

Back in April, I said I had given up on policy makers, they weren't going to do anything more for the economy, at least nothing beyond "token help" that they could use to political advantage. Every once in awhile I get my hopes up that monetary or fiscal policy authorities might take action after all, but I shouldn't. Lucy always takes the football away.

"The 'Ever-Expanding' Government Sector, Illustrated"

Posted: 09 Sep 2010 12:33 AM PDT

Menzi Chinn:

The "Ever-Expanding" Government Sector, Illustrated: Just some numbers to bring reality into the general discussion:

Figure 1: Employment in government (blue), in thousands, seasonally adjusted (blue), and excluding temporary Census workers (red). Source: BLS, August employment situation release.

Small Towns and Attitudes Toward Regulation

Posted: 09 Sep 2010 12:15 AM PDT

As many of you know I grew up in a small town, it was just a bit under 4,000 people at that time, the same town that my mom was born in. I recently went back there for a high school class reunion (35th). While I was there, something struck me that I've been meaning to write about.

In the town I grew up in, pretty much everyone knows who the best doctor is, the best dentist, the best painter, the best carpenter, and so on. There were sometimes disagreements about exactly who was best, e.g. who had the best restaurant, but we all knew who to choose if you needed something done, something to eat, your house cleaned, lawn mowed, legal work, child care, whatever. The people who didn't weren't very good at these kinds of jobs didn't survive for very long. I can think of three lawyers off the top of my head, and if I needed one, I'd know who to choose, or certainly who to ask (growing up, my next door neighbor was the county clerk, and she could be very helpful in navigating anything related to the courthouse -- she saved me once when I was in court for going 95 mph and the judge thought a night in jail would be a good lesson -- thanks to her I escaped jail, but I did get the message -- losing my license for a month helped with that).

I thought about this again yesterday as I was trying to change dentists. I've lost confidence in the one I have, but have no idea who to choose. I asked a few people, and they had recommendations, people mostly say the like who they have, but it was nothing like the kind of comprehensive knowledge I had where I grew up. Same for choosing a painter, a car mechanic, or most anything else. I never really know if I can trust them when the initial choice is made.

In an environment like I grew up in, there is little need for many types of regulation, it is largely redundant. If I still lived there and needed a room added onto my house, I have a friend I grew up with who does that type of work and I would trust him to do it right. Period. And if it wasn't right, he would make it good. These are people you see frequently around town, or hear about from others, people you grew up with from kindergarten through high school (even college since many of us ended up at Chico). Sure, the doctors and dentists and the like came from outside, but my grandmother was a nurse, one of my mom's good friend worked for a dentist in town, people played golf with the doctors, dentists, etc. at the local 9-hole course, socialized with them at the Tennis Club -- you knew what you needed to know. If someone got sick at your restaurant, it was over for the owner. Word would spread quickly and everyone would know. If you had a good story and a good reputation -- being good in grade school and being known as honorable has its rewards -- you might survive. The town, person by person, would make it's call. That call wasn't always correct, small town rumors, cliquishness and the like are known menaces, but for the most part the town took care of itself. So while it wasn't always perfect -- there are parts of the town I don't miss at all -- it managed well enough.

What I'm wondering is whether this can, at least in part, explain differences in attitudes toward regulation between more conservative rural areas and larger cities that are generally much more liberal. In a larger city, you are much more vulnerable to predatory type behavior, unfair treatment, much more likely to be dealing with strangers you have never seen before and will never see again. That uncertainty, and the experience of being taken advantage of if you aren't continuously on guard, and sometimes even if you are -- maybe a contractor did a lousy job and refuses to fix the flaws or refund money -- might lead you to declare "there ought to be a law!," or that "someone needs to stop this!" You would be much more inclined to think that regulation was needed.

That's not to say that things are perfect in small towns, they're not of course, or that exploitation of the weaker by the stronger isn't present. It is. Farm labor comes to mind. And there is still a role for safety and other types of regulation. But there does seem to be a much stronger sense that people can take care of themselves without the need for a bunch of rules and regulations, and without the need for police looking over your shoulder to make sure that you comply.

And that's just the town. If you add in all the farmers who live in the vicinity -- the reason for the town to exist at all -- farmers who are their own bosses and think they ought to be able to do as they please with the land that has often been handed down for generations, it's easy to see how a "leave us alone to take care of ourselves" attitude comes about.

Just a thought.

links for 2010-09-08

Posted: 08 Sep 2010 11:02 PM PDT

"The Dramatic Jump in the Actual Unemployment Rate [is] Largely a Cyclical Phenomenon"

Posted: 08 Sep 2010 04:08 PM PDT

Minnesota Fed president Narayana Kocherlakota says once again that there's little that monetary policy can do for the unemployment problem because it's largely structural (here's Brad DeLong's reaction, see here too). However, researchers at the Cleveland Fed say their estimates tell a different story:

The dramatic jump in the actual unemployment rate we have observed since the beginning of the recession is being interpreted in our flows-based analysis as largely a cyclical phenomenon, with little movement in the long-term rate. The long-run trend does appear to have increased from its prerecession level, but by only a small margin.

The natural rate of unemployment is not 9.6 percent, the current unemployment rate. It's not even close to that (the Cleveland Fed says it's "roughly 5.6 percent to 5.7 percent"). But even if it was as high as 7.5 percent (to be clear, this is a hypothetical), are we just going to give up on the other 2.1 percent? I think that the cyclical component is a lot larger than 2.1 percent, and that even if there is a sizable structural problem there are still things we can do to help the structural transition along, including using low long-term interest rates to encourage the investment that helps that structural change happen faster. But even if you think the natural rate has increased quite a bit, and there's nothing the Fed can do for the structurally unemployed, it hasn't gone up as high as 9.6% and there's no reason to give up on those who can be helped.

And they do need help. As the Cleveland Fed notes in the link given above, even though the problem is largely cyclical in their view, it's looking like a long recovery is ahead:

Since we have not seen a big rise in the long-term unemployment rate, we might expect to converge to this "natural" rate soon. Unfortunately, this is not likely to be the case, and there are several reasons to suspect that the adjustment might take a long time. The first is the sheer extent of the gap between the current and long-term unemployment rates, regardless of the specific long-term rate one believes holds (figure 6). ... When the U.S. economy experienced a similar-size gap after the 1981–1982 recession, it took several years for the observed unemployment rate to drop to levels closer to the trend.
And it might be even harder for the labor market to adjust this time around. The rate of adjustment depends on how fast workers are reallocated between unemployment and the available jobs. The slower rates of worker reallocation we have found may act to slow the closing of the unemployment gap.
There are other reasons to believe that unemployment rates may stay well above the long-term rate for an extended period of time. Because of the length of the recession, there is a considerable number of potential workers who are not formally in the labor force. We have seen one of the sharpest drops in the labor force participation rate in the postwar data, as many unemployed workers simply stopped looking for a job. If some of these discouraged workers decide to search for a job as aggregate economic activity picks up, unemployment might decline at an even slower rate because the pool of unemployed workers is being replenished with workers re-entering the labor force.
Another concern raised by our findings is the negative impact of long-term unemployment on the human capital of the workforce. Longer unemployment spells are a problem because unemployed workers who are unemployed for too long can lose industry- and job-specific skills. Losing skills can reduce their odds of finding a job during the recovery as well as lower their productivity when they finally do find one.
Ultimately, an increase in the demand for labor will determine how fast the unemployment stock will be depleted. ...

Continuing the last point, we are simply not doing enough to create the labor demand that is needed. And, unfortunately, the claim that the problem is almost all structural and therefore there's little we can do is one of the things standing in the way of giving labor markets the help that they need.

Food Stamp Participation Climbs 10%

Posted: 08 Sep 2010 12:00 PM PDT

Given all the worries Boehner and others have expressed about the bad incentives that social insurance creates, is this one of the programs that would be on the chopping block in his proposal to roll government spending back to 2008 (pre-ARRA) levels?

"John Boehner's Stale 'Two-Step Job Creation Plan"

Posted: 08 Sep 2010 10:18 AM PDT

On Boehner's economic "plan," pgl sets the tone:

CNNMoney Fails Introductory Macro. by pgl: OK – I just ripped off the title of Peter Dorman's ripping of Peter Orszag's NYTimes oped but how else can you describe the CNN/Money piece entitled Boehner unveils his own plan to aid economy?. Boehner and other GOP leaders propose to cut government spending which would deepen the recession. How can any reporter say this is an aid to the economy? Could at least one reporter have the intelligence and integrity to entitle such a piece Boehner unveils his own plan to screw economy? If you any decent reporting on such GOP gibberish – let us know.

And Ezra Klein has backup:

John Boehner's stale 'two-step job creation plan', by Ezra Klein: Minority Leader John Boehner is proposing what his members are calling a "two-step job creation plan." The two steps? Pass a budget that costs only as much as the 2008 budget, and extend the Bush tax cuts for everyone, including the wealthiest Americans.
So on the one hand, a measure that will make a small dent in the deficit. On the other hand, a measure that will lead to a huge increase in the deficit. There's no theory of the economy in which this really makes sense: If the market is worried about the government's finances, this makes them worse, not better. ...
It's also worth noting that these policies are both stale: The Bush tax cuts are ... tax policy from 10 years ago, designed to deal with a very different set of circumstances. ... Our economic situation has changed dramatically in the past few years. Don't Republicans have any fresh thinking on what to do about it?

I thought Ezra's wonk book made the salient point:

...many Republicans, at the same time that they are claiming that a $50 billion investment in America's infrastructure is a budget-buster, are pushing to extend the Bush tax cuts for the wealthiest two percent of Americans. ...

And the cost of those tax cuts is much, much higher than the cost of the infrastructure proposal. On the other side -- i.e. the benefits -- given our infrastructure needs, which are nearly universally acknowledged to be large, the benefits from infrastructure spending would be similarly large. As Paul Krugman argues, the benefits from infrastructure spending are likely to exceed the benefits from extending the tax cuts:

So suppose we're going to put $50 billion of resources that would otherwise be idle to work. Is it better to use them to produce public goods like improved roads, or private goods like more consumer durables? That's not at all obvious — and anyone who tells you that basic economics settles the question, that is says that devoting more resources to production of private goods is better, doesn't understand Econ 101.

And there's a pretty good argument to be made that we are, in fact, starved for public goods in this country, so that it would actually be a good idea to shift some resources to public goods production even if we were at full employment; in that case, we should definitely give priority to public goods when trying to put unemployed resources to work.

Would we be better or worse off today if the Bush tax cuts at the upper end of the income distribution had been used instead for a decade long program to rebuild infrastructure? My answer won't be hard to guess.

"The Odd Logic of Tort Reform"

Posted: 08 Sep 2010 09:14 AM PDT

Aaron Carroll summarizes recent research on tort reform as a means of controlling health care costs:

Health Affairs covers malpractice, by Aaron Carroll: ...The September issue of Health Affairs focuses on medical malpractice in the United States, and there are a number of pieces in there worth reading. I'm going to discuss just a few. ...
Low Costs Of Defensive Medicine, Small Savings From Tort Reform, by J. William Thomas, Erika C. Ziller, and Deborah A. Thayer. While many seem to believe that capping damages and awards is the panacea to the high cost of health care in the US,... the authors ... found that a 10% reduction in premiums would lead to behavior changes that would result in a savings of about 0.1% of health care costs. That doesn't mean it's not worth doing; it does mean that those who think simple tort reform is the real answer to lowering health care costs may be misguided.
National Costs Of The Medical Liability System, by Michelle M. Mello, Amitabh Chandra, Atul A. Gawande, and David M. Studdert. This is the all-star team, and they ... found that the annual medical liability system costs are about $55.6 billion in 2008 dollars, or about 2.4% of all US health care spending. You'll note a theme when I say that this isn't chump change, but it's not nearly the amount portrayed during the health care reform debate when some argued tort reform would solve the health care cost issue. ...
Physicians' Fears Of Malpractice Lawsuits Are Not Assuaged By Tort Reforms, by Emily R. Carrier, James D. Reschovsky, Michelle M. Mello, Ralph C. Mayrell, and David Katz ... found ... tort reform doesn't appear to change physicians' malpractice concerns much, and therefore may not decrease defensive medicine or health care costs much.
There are others, and I hope to get to them soon. Since I have often argued (from this post on) that malpractice reform is not the answer to the cost problem, I grant you that most of these conformed with my world view. ...

And, in response to some push back:

The odd logic of tort reform, by Aaron Carroll: Well, I seem to have touched a nerve. I'm getting a lot of email telling me I'm off the mark when it comes to tort reform. Some of this email is coming from physicians who claim to usually agree with me. You're sure I'm wrong here. You're sure that tort reform (by which you mean setting caps on damages) really would reduce health care costs and make physicians practice differently.

Unfortunately, most of you are coming at me with anecdotes. So I'm going to ... use data.

Let's start with Texas. In 2003, Texas capped non-economic damages on malpractice lawsuits at $250,000. It's pretty much what they Republicans wanted to do with health care reform as well (see their plan). In an op-ed in the Washington Post, Governor Perry and Speaker Gingrich said:

Texas, for example, has adopted approaches to controlling health-care costs while improving choice, advancing quality of care and expanding coverage. Consider the successful 2003 tort reform.

Well, that's a fact we can check. Did tort reform have any of these effects? Here's a handy chart from Public Citizen using data from the Dartmouth Atlas of Health Care (Selected Medicare Reimbursement Measures):


That dotted line is when tort reform when into effect. Not only were costs for Medicare enrollees not controlled, they went up faster than the national average. In fact, Texas reimbursement rates in 2007 were the second highest in the country. What exactly did Governor Perry and Speaker Gingrich mean by "successful"?

Maybe they were talking about health insurance premiums? Were they controlled after reform? Again, a handy chart using data from the Agency for Healthcare Research and Quality, Medical Expenditure Panel Survey:


Health insurance premiums again did not see a dramatic decrease after tort reform.

Oddly enough, Governor Perry and Speaker Gingrich also claimed that Texas-style reforms "increased coverage". To check that you need only go to the US census:


Do you see the increase in coverage? I ask, because I can't. This claim is actually laughable, because Texas as a state has the highest level of uninsurance in the US. Sometimes the Washington Post baffles me. Is there any fact-checking at all?

Some people believe – just know – that reducing malpractice awards will lead to fewer lawsuits which will lead to a reduction in premiums which will lead to a reduction in defensive medicine which will lead to a reduction in health care costs. It's a matter of faith. It has to be, because there's just not that much evidence it will happen.

Update: There's more, this time on California rater than Texas.

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