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Source: Real Clear Politics

The electoral college is back in the news, with Democrats suddenly discovering it's a terrible idea.

I wrote at length in defense of the college in a previous post. I wrote just before the 2012 election so I can credibly claim that my view is not a sudden discovery motivated by partisan feeling.

I don't want to repeat the whole post, though I'm still proud of it and hope I can send some traffic there.

Short version: The electoral college forces candidates to attract geographically dispersed support. Moving a swing state from 45% to 55% is much more important than moving a solid blue or solid red state from 75% to 85%.

This is vital. Our country is already polarized, and that polarization is reflected in geography.  See the map. A set of rules that encourages further polarization would be a disaster. American democracy failed miserably once. 700,000 people died and government of the people, by the people, and for the people nearly did perish from the earth. Things like this don't happen again only when people think they can, and vice versa.

In a pure popular vote contest, after candidates and parties adapt their positions and coalitions of support, we are likely to see whole swaths of the country with 70, 80, 90% or more majorities of one or the other party -- and even greater demonization of the other side. Fill in the gaps what happens next.

The deep point: When you set up rules for anything, there is a tension between measurement and incentives. Once people show up at the polls on election day, there is a strong case that "each vote should count the same." But if you do that, the incentives, and hence the outcomes will be much worse.


In the end, we care more about a good outcome -- good policy, and politics that keep the country from flying apart. So, swallow hard, measure imperfectly but set up better (slightly less bad) incentives.

This is a point worth repeating. It's the kind of thing that economists really do have to offer to students of politics and the world at large.  Good incentives for politicians, parties, and agendas  matter more than good measurement.

In that view, the important thing about the college is that we add up to the Presidency by winner-take-all over large geographic chunks. Whether we have actual electors is a separate issue. That means the movement by some states to apportion their electors according to the relative votes is a step in exactly the wrong direction, and induces more polarization.

I have learned some deep lessons from this election and especially its aftermath. Like most policy-wonk types I supposed that people care about policies, and about results, and vote accordingly. And are amenable to sensible discussion about policy, and sensible negotiation. If you're reading this blog, you probably fall in the same bubble. Most political analysis I've seen in economics runs the same way - we line voters up by policy preferences and then analyze voting systems.

What has become very clear to me since the election is a fact probably blindingly obvious to real students of politics -- that's not at all how it works. Most people vote by cultural affinity, brand, values, and a sense of personal identity.  To the extent policy matters at all, it's part of the buzzwords, propaganda and tag lines thrown back and forth.  These things are related to where you live and who you interact with on a regular basis, which is why geographic polarization is such a problem -- and why measures like the electoral college, which push our democracy to have more even representation of tribal and partisan alignments and identities are so important.

I live in a little Democratic bubble here in Palo Alto. Since the election, it is just remarkable how universally in public conversation, people assume that it would be impossible for anyone in earshot to sympathize with Republicans, let alone (heavens) actually be one or to have supported Mr. Trump. Going to book events with my wife, for example, the prelude to talking about the latest young adult fiction is moaning and groaning about how terrible this all is. Waiters at restaurants commiserate. These are good, caring people, achingly anxious never to offend anyone -- but it is simply beyond possibility that the person they're talking to, obviously a somewhat normal rational moral and caring person, not wearing a white sheet, could not feel the same way. I have traveled to a few Republican bubbles too, where people speak with similar certitude that there are no dissenting opinions around.

I got a good taste of this yesterday. I was listening yesterday to NPR, as Evan Osnos on the New Yorker Radio hour interviewed Anna Galland, executive director of moveon.org. (There's no transcript here, so forgive small errors of my transcription)

Evan started with the common Democratic complaint that Republicans, naming Mitch McConnell "famously said basically that they would do everything they could to .. try to interfere and to obstruct his [Obama's] presidency. Now we find that on the left there is a similar move to obstruct [Trump's] presidency obstruct Obama." Given the 8 years of complaint that Republican's obstruction was nefarious, reflected racism, or otherwise improper,  this was a good question. "What happened to ... some basis for cooperation?"

Ms. Galland's response was fascinating:

"Donald Trump lost the national popular vote.. He has no mandate. He's going to be trying to do the most extreme things in recent memory... It's not just a policy problem.. how are  we going to make it through the next 4 years with our constitutional democracy intact... and civil liberties?"  

"The order of the day here is to first stand up and project a clear moral opposition to what he's proposing to do to our country.. make sure people hear and see from people they relate to that I'm standing up." 

Mr. Osnos pressed:  "What's the argument against cooperating on shared objectives like a big infrastructure even if you object on values?" Ms. Galland replied that she felt there a moral case against cooperating with Trump on "basically anything."

"you can't play footsie with a white supremacist" 

For those of you who still think policy matters, the entire interview contained just one statement about actual policies -- just what the "most extreme things" Trump is going to do are,  and that she felt she would have to support in order to go along with an infrastructure bill:

"trying to deport millions of Americans or block an entire world's religion from entering the United States." 

Even on infrastructure -- a bill that has to get through a Congress, pass innumerable laws (Davis-Bacon, minority set-asides, etc.)

"there is no way that an infrastructure bill or any other initiative from Trump is going to advance progressive values... maybe well get three jobs out of it or a few roads repaired.. [we need instead]  a progressive infrastructure bill for the people not for billionaires"

Whatever that means. Describing moveon's many petitions, and why sign them, she said that petitions let people

 "connect with communities that share your common values.. moral commitments"

Now, our task today is to listen and think, not to take potshots at the low-hanging fruit. Gross falsehoods, "fake news," rampant hypocrisy? You bet. No, Mr. Trump is not a "white supremacist." (Where are the Facebook false-news raters now?) Since when does popular vote equal "mandate?" (A view I would be curious to see if she would have agreed with had Mrs. Clinton won with similar numbers. "Well, Mrs. Clinton swept the electoral college but didn't win the popular vote. So I really don't think she has the mandate to enact moveon's agenda over Republican's objections. We'll just have to let it wait four years?" Somehow I doubt it !) No, even if he deports millions of undocumented immigrants (something I oppose as strenuously as Ms. Galland), they are not in fact "Americans."  The chance that the Trump Administration will block any muslim from entering the United States is zero. How is this different from birtherism, calling President Obama a socialist or worse, and Republican rejectionism? Of course it isn't. Where was Ms. Galland when the Obama Administration was busy undermining constitutional democracy and civil liberties?

Sure, but leave that alone. It's not the point. And such argument is pointless.  Listen instead. This isn't about actual policy. It's about "values" and "morality." Somehow a highway bill, full of pork, signed by President Obama will advance "progressive values" and the exact same highway bill signed by President Trump will not.

This is not a set of views that rational argument can sway. When morality, values, and identity are at stake you will make no headway with that.

Ms. Galland has obviously never been in a room with a Republican whose opinion she cared a whit about, as you and I care about the good opinion of people we talk to. This is what happens when people live in self-confirming bubbles.

Well, power to her. Her job is to mobilize a base, demonize an opposition, spread around whatever propaganda including outright lies (sorry, that "white supremacist thing" qualifies), monger fears, and cast her tribe as the moral savior of the nation.

But we need a democracy in which a presidential candidate does not find Mrs. Galland's mindset a path to power. We need communities in which people understand that good people of many different values and identities live together (I wish I could call that "diverse" except the word has come to mean its opposite) and are forced by the rules of common decency to listen to each other.

The electoral college does that -- or at least is one small force keeping the trends in the other direction from getting stronger.

(By the way, the New Yorker ratio hour radio makes me listen to an ad proudly announcing that it is supported by Morgan Stanley and New York Life. Lenin was right about capitalists selling you the rope.)

As you can see, we have changed the title of the blog. It is now simply "economics, psychology, policy". The main function of the blog will continue to be to disseminate information in the areas of behavioural economics, economic psychology, and broad cognate areas. It will also be used to disseminate information about the activities in both the Dublin and Stirling research groups. The twitter account is also changing name to simply econpsypol and will also serve the above functions. I hope to post more and I welcome suggestions for interesting things we can do.

How would you like to work at Hoover for a year, focusing on research with no teaching or other responsibilities, and soaking up the intellectual climate of Hoover and Stanford? If you are an economist roughly 3-10 years post PhD, doing research with some policy relevance that would benefit from a year here, this could be for you.

More information and application form here.

A draft of a new paper is up on my webpage, "Michelson-Morley, Occam and Fisher: The Radical Implications of Stable Inflation at Near-Zero Interest Rates." This combines some talks I had given with the first title, and a much improved version of "does raising interest rates raise or lower inflation?"

Abstract:

The long period of quiet inflation at near-zero interest rates, with large quantitative easing, suggests that core monetary doctrines are wrong. It suggests that inflation can be stable and determinate under a nominal interest rate peg, and that arbitrary amounts of interest-paying reserves are not inflationary. Of the known alternatives, only the new-Keynesian model merged with the fiscal theory of the price level is consistent with this simple interpretation of the facts.

I explore two implications of this conclusion. First, what happens if central banks raise interest rates? Inflation stability suggests that higher nominal interest rates will result in higher long-run inflation. But can higher interest rates temporarily reduce inflation? Yes, but only by a novel mechanism that depends crucially on fiscal policy. Second, what are the implications for the stance of monetary policy and the urgency to “normalize?” Inflation stability implies that low-interest rate monetary policy is, perhaps unintentionally, benign, producing a stable Friedman-optimal quantity of money, that a large interest-paying balance sheet can be maintained indefinitely. However, with long run stability it might not be wise for central bankers to exploit a temporary negative inflation effect.

The fiscal anchoring required by this interpretation of the data responds to discount rates, however, and may not be as strong as it appears.

Big novelties in this draft -- at least things I have learned recently:

1) There is now a mechanism that produces a temporary decline in inflation from a rise in interest rates. It comes out of the fiscal theory of the price level and long term debt. If the Fed unexpectedly raises interest rates, that lowers nominal bond prices. If the real present value of surpluses does not change (if monetary policy does not change fiscal policy), then a lower nominal value of the debt and unchanged real value of the debt require a drop in the price level. It works, but it has nothing to do with your grandfather's ISLM, "aggregate demand,'' Phillips curve, money, sticky prices, and so on.

2) In this case and more generally, a temporary decline in inflation when interest rates rise unexpectedly does not rescue traditional policy advice!

It's only temporary! So you do not get long-lasting disinflation or stabilization out of raising rates. Raising rates gives you a temporary disinflation, then inflation gets worse. This is a mechanism perhaps for the 1970s, when each rate rise fell apart in more stagflation -- Chris Sims calls it "stepping on a rake" -- not the 1980s. For that sort of disinflation you need fiscal policy too.

And since only unexpected rate changes have the negative inflation effect, it can't be the basis of systematic, expected policy, like the Taylor rule in old-Keynesian models.

3) If unexpectedly raising interest rates lowers inflation temporarily, and then they go up, and vice versa, that doesn't mean it's a good idea for the Fed to exploit this mechanism for fine-tuning the path of inflation. the Fed is likely better off just raising interest rates and waiting.

In sum, there is a big difference between a temporary negative sign and a long run positive sign, long run stability, and the traditional view which is a temporary and permanent negatives sign and long-run instability.

4) All of this stability needs fiscal backing or "anchoring." Why do people want government debt so much with awful prospective deficits? The only reasonable answer is that we live in a time of very low interest rates. The present value of surpluses is high because the discount rates are low, not because prospective surpluses are large, but because discount rates are low. Discount rates could change quickly.

There will be a few more drafts of this paper and slides and talks. Unless one of you finds a big mistake and clears up my thinking on it.

The fact: interest rates hit zero, and nothing happened. No deflation spiral. No sunspot volatility. It seems that inflation is stable when interest rates are pegged.

Source: Wall Street Journal

"President-elect Donald Trump owns a helicopter in Scotland.

To be more precise, he has a revocable trust that owns 99% of a Delaware limited liability company that owns 99% of another Delaware LLC that owns a Scottish limited company that owns another Scottish company that owns the 26-year-old Sikorsky S-76B helicopter, emblazoned with a red “TRUMP” on the side of its fuselage."

So write Jean Eaglesham, Mark Maremont, and Lisa Schwartz in the Wall Street Journal

"WTF?" wonders the incredulous reader. Why does Mr. Trump structure his finances with such mind-boggling complexity, to say nothing of astronomic legal costs? The article is pretty thin on explaining the logic of all this.

You can see the Journal writers struggling for a narrative. Is this about Mr. Trump's "conflict of interest" issues? Is this something nefarious about Mr. Trump, efforts to hide something? (You can be sure earnest investigative reporters at the Times will be beating both drums for the next four years. And just as sure that nobody will pay much attention unless they can tempt Mr. Trump into saying something stupid about it all.)

Let me suggest a productive narrative. Mrs. Clinton's email saga laid bare for all of us to see the financial arrangements of prominent public figures -- "charitable foundations" to funnel money around, all "legal." In my view, rightly felt disgust at that look into our political system had a lot to do with the election. Mr. Trump's financial arrangements lay bare for all of us to see the financial arrangements of the super-wealthy in this country, also massively complex, perfectly "legal," and smelling equally of last week's fish. The right response is equal disgust at the obscene tax code and crony capitalist system that produces this mess.  Mitt Romney's taxes were 550 pages long, and he only had investments, not operating companies! Fellow peasants, get out your pitchforks!


What are all these shell companies about? I would love to hear from some of the attorneys who set these things up. But we get some hint from the article

LLCs registered in Delaware are widely used for real estate because of their tax advantages.

Delaware LLCs don't have to publish any financial information or even disclose the identity of the owner. In addition, the most a member of an LLC can lose if the company fails is normally the amount he or she has invested in that company

I actually know something about this because, like Mr. Trump I own an aircraft. Mine doesn't even have an engine, but the law is the same. When you register an aircraft, the state sales tax authorities come looking for you and want their share. If you register the aircraft in a Delaware LLC, they have a much tougher time finding you. Google "Delaware Aircraft Registration" and many ads from very nice companies will pop up explaining it all. If your airplane is worth less than $100,000, it's not worth the bother. (Disclosure: I paid the sales tax. Chump that I am.) If its worth millions, it is very much worth the bother. Google the FAA aircraft registry (public, online) and you will see lots of Delaware owners. Hint, there aren't a lot of airports in Delaware.

I suspect this is about a lot more than sales taxes. There has been another drumbeat that Mr. Trump should sell or transfer his businesses to his children. This is ridiculous to anyone who pays taxes. If you actually sell a business you pay a huge capital gains tax, and if you transfer it you pay a huge gift tax. The affairs of real estate moguls are exquisitely structured to avoid estate and gift taxes, through vehicles and trusts that need to operate over long spans of time. It helps a lot to have very complicated structures where nobody knows what anything is worth.

(The second big advantage, mentioned in the above ads, is protection from liability. If the plane crashes into a puppy farm, they won't be able to go after Mr. Trump's other assets.)

The journal article also tries on the narrative that we don't know how much Mr. Trump is really worth, I think keeping up the spin from the campaign that maybe he was lying about his billions. But that too deserves a better narrative. We don't know how much he's worth. Neither does Mr. Trump, pretty obviously. Why did he set up his businesses so it is impossible for even him to know how much he's worth? Well, stated that way, one conjectures it's a pretty good idea for the IRS to be unable to figure out how much you're worth too!

Every time a sensible person pipes up that we should repeat 1986, lower marginal rates of the federal income tax, broaden the base, and simplify the tax code, our friends on the left (including a lot of prominent economists, who should know better than to echo propaganda) scream "tax cuts for the rich!" Reading this story, I can imagine just how much Mr. Trump's lawyers and accountants chuckle when they hear that. Personal income taxes? Who even bothers with those!

What has happened to America that, if you have the money to buy a plane, it is perfectly normal to route that purchase through a network of Delaware LLCs? What has happened to America that any citizen living on an investment portfolio should file 550 pages of personal tax returns? What has happened to America that if you ask for estate planning, even just on the web, it is perfectly normal that any citizen should set up a living trust, a trust A and trust B to get spousal exemptions, a descendants' trust to preserve the generation-skipping limit, and if you have any real money a grantor retained annuity trust and so on? What has happened to America that every wealthy person, and especially sports personalities, politicians and moguls, sets up a "charity" so they can write off private jet travel, the salaries of their entourage, and "employ" their relatives? Workers of America (and by this I mean rather unfashionably people who, like, actually work, and therefore pay taxes) unite, you have nothing to lose but your piles of papers and what should be your seething sense of injustice!

Really, and I appeal to my friends on the left here: Seeing this insanity, don't you want to throw it all out and have a simple VAT or consumption tax -- and nothing else? Both Mr. Trump and Mrs. Clinton would pay a lot more taxes! (The Hall-Rabushka proposal is one good implementation.)
Drain the swamp, please, Mr. Trump. The tax code is a good place to start. When all the lawyers and accountants who set these things up for you are driving for Uber,  you will know you have done a good job.

(Previous Trump Tax post here.)

Source: Wall Street Journal

On November 7 I wrote "Don't believe the economic pessimists," an oped about growth in the Wall Street Journal. Now that 30 days have passed, I can post the whole thing here. pdf here (my webpage).

Don't Believe the Economic Pessimists

No matter who wins Tuesday’s presidential election, now ought to be the time that policy makers in Washington come together to tackle America’s greatest economic problem: sclerotic growth. The recession ended more than seven years ago. Unemployment has returned to normal levels. Yet gross domestic product is rising at half its postwar average rate. Achieving better growth is possible, but it will require deep structural reforms.

The policy worthies have said for eight years: stimulus today, structural reform tomorrow. Now it’s tomorrow, but novel excuses for stimulus keep coming. “Secular stagnation” or “hysteresis” account for slow growth. Prosperity demands more borrowing and spending—even on bridges to nowhere—or deliberate inflation or negative interest rates. Others advocate surrender. More growth is impossible. Accept and manage mediocrity.

But for those willing to recognize the simple lessons of history, slow growth is not hard to diagnose or to cure. The U.S. economy suffers from complex, arbitrary and politicized regulation. The ridiculous tax system and badly structured social programs discourage work and investment. Even internet giants are now running to Washington for regulatory favors.

If you think robust growth is impossible, consider a serious growth-oriented policy program—one that could even satisfy many of the left’s desires.


• Taxes. The ideal tax system raises revenue for the government while distorting economic decisions as little as possible. A pure tax on consumption, with no corporate, income, estate, or other taxes is pretty close to that ideal.

The U.S. tax system is the opposite: By exempting lots of income, the government raises relatively little money. Yet an extra dollar is heavily taxed, greatly lowering incentives and encouraging people to find or create exemptions. This massive complexity and obscurity undermine faith in the system.

Progressives, ponder this: With a sales tax of only 25%, the government would likely have gotten a lot more money from Donald Trump—who has employed complex but legal tax-avoidance schemes—than it did by purporting to tax income at high rates.

• Regulation. U.S. regulation is arbitrary, slow, discretionary and politicized. Speak out on the wrong side of the party in power and some federal agency will be after you.

Imagine a deep rule-of-law regulatory reform, along the lines proposed by House Speaker Paul Ryan’s “Better Way” plan. Congress must review and approve major regulations. People and businesses have a right to see evidence and appeal. Regulators face a shot clock—no more years and years of delays on decisions. Agencies must conduct serious, transparent and retrospective cost-benefit analysis.

Imagine a similar deep reform of state and local restrictions including zoning laws and occupational-licensing regulations.

• Social programs. When many people earn an extra dollar, they lose more than a dollar of benefits. If we fixed these disincentives, more Americans would work—and fewer would need benefits.

• Health. Replace ObamaCare with a simple health-insurance voucher. Deregulate insurance and entry into health care dramatically.

• Finance. Replace strangling regulation of financial companies with a simple rule: If you issue enough equity that stockholders bear the risks, you can do what you want. Rep. Jeb Hensarling has proposed such legislation. Hearty competition is the best consumer protection.

• Labor. The best worker protection is a worker’s ability to swiftly change jobs. This is more likely if employers do not face a mountain of red tape, complex rules and legal liability.

• Immigration and trade. The politically incorrect truth: Allowing Americans to buy from the best supplier and permitting people who want to work and start businesses to immigrate is good for the economy. Trying to impoverish China will not revive America.

• Education. Let lower-income Americans get a decent education from charter schools and vouchers.

• Energy. Trade all the crony subsidies and credits and regulations for a simple uniform revenue-neutral carbon tax. The country will have more growth and less carbon.

It would take an entrenched obtuseness to claim such a program cannot substantially improve economic output and incomes. If you claim such good policy cannot help, then it follows that bad policies do not hurt. Nativism, trade barriers, overregulation, legal capture, high taxes, controlled markets and people excluded from work won’t hurt our slow but positive growth. Don’t give populists cover to try it again.

If you object that such good policy is politically infeasible, then you at least grant that robust growth is economically possible. And small steps help. Current bipartisan proposals to reform taxes, Social Security, immigration, the regulatory state and trade agreements would go a long way to reviving growth. Have a bit more faith in democracy.

On the other hand, the major party presidential candidates’ signature plans—child-care tax credits, college subsidies, higher taxes on people who don’t hire good enough lawyers; threatening a trade war and deporting millions of unauthorized immigrants—cannot revive substantial growth.

So why is there so little talk of serious growth-oriented policy? Regulated and protected industries and unions, and the politicians who extract support from them in return for favors, will lose enormously. The global policy elite, steeped in Keynesian demand management for the economy as a whole, and microregulation of individual businesses, are intellectually unprepared for the hard project of “structural reform”—fixing the entire economy by cleaning up the thousands of little messes. Even economists fight to protect outdated skills.

Mr. Cochrane is a senior fellow of the Hoover Institution and an adjunct scholar of the Cato Institute.

Where will the next crisis come from?  Every crisis starts with a pile of debt that can't be paid back, and shady accounting to hide that debt. When one big one goes under, everybody starts to question the shady deals they've invested in, the extend-and-pretend game ends, heretofore simple rolling over of short term debt suddenly ends, and the run starts. Governments bail out. Really big crises happen when governments run out of bailout power or will and you have a sovereign debt crisis or inflation. Governments bail out by borrowing, but if people won't lend the government money to bail out, either default or inflation must follow.  Reinhart and Rogoff describe a frequent "quiet period" between financial crisis and sovereign crisis. So far we have just had quiet.

So, where around the world is there a lot of debt that might not be paid back and really shady accounting? Well, duh, China, right?

So if I have to dream up a nightmare scenario it goes something like this: A pile of debt in China is found wanting. China's government takes desperate steps -- huge bailouts, sell its pile of treasuries, force people to buy worthless assets, print up lots of money, but prop up its value by stopping people from taking currency abroad, and so forth.


The next step is some sort of "contagion" to the rest of the world. Foreign businesses turn out to have invested more in China than we think (shady accounting again). Or supply chains are disrupted, we discover we're pretty darn dependent on trade and so on.

Meanwhile, the usual "information-insensitive" securities become "information-sensitive" in Gary Gorton's nice language. Italian banks are ready to go, and a hint Italy might leave the euro to bail them out might enough to get the Italy run going. Seeing China blow up might be just the hint people need to think about that. That event would be enough to put Italian and European  sovereigns at risk, or force the ECB to real monetization in the trillions.

Can it spread to the US? We're usually the quality to which people fly. But Illinois and California's pensions don't look a lot better than Chinese banks really. Student loans loom. The Federal government has guaranteed a lot of debts! And the long-run cash flow forecasts for the US government aren't great. The prospects of a strong economy help demand for our debt, but a China-Europe crisis could well send us back to a recession. And in a global sovereign crisis, China and Europe will be cashing in their treasuries.  Can we really borrow another $5 trillion  for bailout and stimulus while foreigners are dumping $4-5 trillion or so of our treasuries?

This is absolutely not a forecast. The definition of a crisis is that it is unpredictable. It needs a lot of things to go wrong, a lot of firebreaks to fail. (Equity is one essential firebreak against asset failure turning in to liability failures.) After the event, it becomes obvious, and we hail a few lucky guessers (ignoring those guessers' may other wrong calls).

At best it is a scenario, a chain of events that could happen, with very small probability.   The next crisis -- there will be one, someday, until that charmed day that the world adopts equity-financed banking and governments run fiscal surpluses -- may come from somewhere else totally.  But the art of risk management is to think through improbable chains of events.

Why bring it up now? Well, in today's Wall Street Journal Lingling Wei reports that "China's banks are hiding more than $2 Trillion in loans," In the lead editorial rightly making fun of currency manipulation, the WSJ notes that China has already dumped $1 Trillion dollars of its reserves (likely US Treasuries) and facing $100 billion per quarter capital outflows. China is imposing strong limits on its citizens ability to move capital out of the country (translation: sell Chinese currency, bonds, bank accounts and get same in dollars abroad). At the start of the new year, individual Chinese will be allowed to take out their yearly allotment. I would guess they do it soon.

All these are signs of propping a currency up, not pushing it down; declining demand for currency and bonds that will be needed if China wants to do a massive bailout of bad debts. (Allow bankruptcies? Well, we in "capitalist" America don't do it, so I doubt China will do it either.)

These are signs that a run on China is already starting. Not all runs explode. Many fizzle out. But maybe this first link in the chain is closer to blowing up than we think. How are those firebreaks doing?

The Fed has a huge "balance sheet" -- It owns about $3 trillion of government bonds and mortgage backed securities, which it finances by issuing about $1 trillion of cash and $2 trillion of reserves -- interest-bearing accounts that banks have at the Fed. Is this a problem? Should the Fed trim the balance sheet going forward?

On Tuesday Dec 6, I participated on a panel at Hoover's Washington offices to discuss the book "Central Bank Governance And Oversight Reform" with very distinguished colleagues, Michael Bordo, Charles Plosser, John Taylor, and Kevin Warsh. We're not afraid to disagree with each other on panels -- there's no "Hoover view" one has to hew to, so I learned a lot and I think we came to some agreement on this issue in particular.


Me: The balance sheet is not a problem. The Fed is just one gargantuan money market fund, invested in Treasuries, with a credit guarantee from the Treasury. Interest bearing reserves are perfect substitutes to bonds. The Fed is just making change, taking $20 bills (Treasuries) and giving out $5 and $10 in return. The Fed can easily run monetary policy by just paying more or less interest on reserves.

Plosser: The balance sheet is a big problem. Yes, John's right that interest bearing reserves won't cause inflation so long as banks just sit on them. But will banks just sit on them? Right now, banks don't see enough profitable lending opportunities to care. But if they do, will the Fed really pay enough interest to keep hugely inflationary amounts of reserves from feeding the money supply? What will Congress say when the Fed is paying 3%, 4%, or more to banks to bribe the banks not to lend money to American business and consumers?

Worse, focus on what the Fed is buying not what it is issuing. If the Fed were just buying short-term treasuries John might have a point. But it's buying long term bonds, intervening in the bond market; mortgage backed securities, funneling money to houses. This is credit allocation. The ECB is buying corporate bonds and the BOJ is buying stocks. Congress already raided some of the Fed's assets. So there may not be a big economic problem but there is a huge political economy problem.

(This isn't a quote, and I'm going from memory as we don't have a record of the panel. I hope I'm not mis-characterizing Plosser's view too much. If I am, well, take it as what I learned from the discussion and my own much better sympathy for a countervailing view.)

Taylor: The Fed should not just wind down the huge balance sheet, but it should go back to a very small amount of reserves that do not pay interest. Then it should go back to controlling interest rates by open market operations, and a binding money multiplier. (Taylor, being a lot more polite than the rest of us, did not go into detail on this, but I think he's worried about the Fed being able to control interest rates under interest on reserves (IOR), and whether changing interest rates under IOR with a slack multiplier will make any difference. Again, if this isn't Taylor's view, at least it is a view that I appreciate more after the discussion.)

Well, how to we reconcile this?

I think Plosser is right about the asset side of the balance sheet, and he seems to think I'm mostly right about the liability side. How to square that circle?

I think we would all be happier if the Fed did not keep maturity and credit risk on its balance sheet. Instead, if the Fed really wants to intervene quickly in asset markets and buy anything but short term treasuries (a big if, but there seemed to be consensus that at least in a crisis such purchases might have to be made) then the Fed should swap them to the Treasury within, say, 6 months, so any long-term credit allocation and risk is in the Treasury where it belongs.

(This is, I think, illegal right now. The Fed cannot deal directly with the Treasury, one of many bright little ways our ancestors set up the system to prevent inflationary finance. But that can be fixed.)

And, granted that large amounts of interest-bearing reserves are a good thing -- lots of non-inflationary oil in the economic car -- the Fed doesn't have to be the one to provide them. I brought up again my proposal that the Treasury should issue fixed-value floating-rate small-denomination electronically-transferable debt -- i.e. reserves -- to everyone, not just banks. You should be able to go to treasury.gov and sign up for the treasury's money market fund. All the Fed is doing by buying short-term treasuries and issuing reserves is creating this new class of government debt out of other kinds of government debt. Why not have the Treasury issue it directly? Then the Fed could in fact wind down its balance sheet to near nothing, without losing any of the liquidity and financial stability benefits of interest on reserves.

Plosser seems to go along. Taylor not yet, but sitting on a panel it was hard for any of us to think how this would work in a world of very small non interest bearing bank reserves. (I think it would -- Treasury floaters would not be much different from short term treasury debt from a bank's perspective.)

So we learn from each other on the panel, as well as the sharp questions from the audience. Thanks to everyone who came (and to our second panel on the Blueprint for America), it was a very productive day.

Update
Discussion now available online, embed below, link here. Now we can see how my memory matches up with the facts.

The paper below co-authored by many of the leading figures in the application of randomised trials in public policy is well worth reading.

From Proof of Concept to Scalable Policies: Challenges and Solutions, with an Application 

Abhijit Banerjee, Rukmini Banerji, James Berry, Esther Duflo, Harini Kannan, Shobhini Mukerji, Marc Shotland, and Michael Walton

Abstract
The promise of randomized controlled trials (RCTs) is that evidence gathered through the evaluation of a specific program helps us—possibly after several rounds of fine-tuning and multiple replications in different contexts—to inform policy. However, critics have pointed out that a potential constraint in this agenda is that results from small, NGO-run “proof-of-concept” studies may not apply to policies that can be implemented by governments on a large scale. After discussing the potential issues, this paper describes the journey from the original concept to the design and evaluation of scalable policy. We do so by evaluating a series of strategies that aim to integrate the NGO Pratham’s “Teaching at the Right Level” methodology into elementary schools in India. The methodology consists of re-organizing instruction based on children’s actual learning levels, rather than on a prescribed syllabus, and has previously been shown to be very effective when properly implemented. We present RCT evidence on the designs that failed to produce impacts within the regular schooling system but helped shape subsequent versions of the program. As a result of this process, two versions of the programs were developed that successfully raised children’s learning levels using scalable models in government schools.

A common criticism of randomised controlled trials in Economics is that the causal effects they examine are too local in nature. They apply to a particular site, at a particular time, and are specific to aspects of the treatment and how it was implemented etc., Furthermore, results that apply in trials may have different effects when scaled to a population e.g. an effective education intervention scaled to the entire population may affect the labour market in various ways that can't be understood from the trial data. Furthermore, political effects such as public backlash or political corruption may apply differently to well-designed and intensely monitored trials than to large national scaled programmes. The paper goes in detail to many such problems with RCTs and should be read for this reason alone by anyone working on or interested in applying this approach.

So, given these problems, how can we go from the results of such trials to examine policy systems as a whole?. The authors provide an example of a large-scale education study in India where various different approaches were taken, working with the government, to scale an education intervention to 33 million children. They describe how different interventions were developed based on evidence on child learning and then rolled out in different provinces, with many attempts to control for context dependence. They describe the role of RCT data in the context of scale-up and the various challenges that result from an administrative perspective when attempting to scale up interventions that have been shown to be successful at trial stage. The authors draw a number of general lessons about the importance of iteration, close working relationships with administrative bodies, good process evaluation, and a range of other factors that must be in place to allow for successful scale up.

When Paul Krugman, Larry Summers,  Sarah Palin, and the Wall Street Journal all agree on something -- that presidential deal-making and strong-arming over plant location is a terrible idea -- it's worth paying attention to.

I think Tyler Cowen did the best job of describing what's wrong with the deal, interviewed on NPR. (Transcript, Highlights and audio link).

(This is an impressive radio interview. I long to be able to express something that quickly clearly and coherently on radio. Tyler must have really prepared hard for it.)

INSKEEP: Don Evans says this is a way for the president-elect to send a strong message to workers and to corporations about what his priorities are. What's wrong with that?

TYLER COWEN: We're supposed to live under a republic of the rule of law. Not the rule of man. This deal is completely non-transparent. And the notion that every major American company has to negotiate person-to-person with the president over Twitter is going to make all business decisions politicized.


INSKEEP: What do you mean it's nontransparent, first of all?

COWEN: We don't know exactly what the company is getting. There's plenty of talk that the reason Carrier went along with the deal was because they were afraid their parent company would lose a lot of defense contracts. So this now creates the specter of a president always being willing to punish or reward companies depending on whether or not they give him a good press release.

INSKEEP: Why don't you explain to me the thing about the parent company, which is United Technologies?

COWEN: Yes, they do a lot of defense contracting. It's at least 10 percent of their revenue. Carrier, from the state of Indiana, was already offered the tax break before the election. They turned it down. Now, all of a sudden, Trump is President. Bernie Sanders is telling Trump to threaten the defense contract of the parent company, and now, all of a sudden, the company takes the deal. And Trump is known for being somewhat vindictive. This, to me, is scary. It indicates an environment where business decisions are now about how much you please the president.

INSKEEP: Now, you just said an interesting thing. Bernie Sanders, a socialist of the Democratic Party, did, a few days before the deal was announced, say that Trump ought to use the leverage of the defense contracts to get United Technologies to change its behavior. We don't know on a factual basis that's actually what happened, but - but you're noting that this is kind of a leftist thing to do.

COWEN: That's correct. Trump and Bernie Sanders, for all of their populist talk, their are actual recipes in both cases lead to crony capitalism.

INSKEEP: What's crony capitalism?

COWEN: Crony capitalism is a system where businesses who are in bed with the government and who give the president positive press releases are rewarded and where companies who oppose or speak out against the president are, in some way, punished.

INSKEEP: David Wessel of the Brookings Institution said on our air the other day that this act reminded him of something that is done from time to time in France - under the socialist government in France. And I'm also thinking of Venezuela, where the late President Hugo Chavez would go on TV and denounce companies and demand that companies do specific things. And of course, the economy there has ended up being a complete mess. Is that - is that a fair comparison at all?

COWEN: Well, we're not close to that point yet, but we're taking baby steps in that direction. And the way you avoid getting to that point is by having people speak out when they see the baby steps.

INSKEEP: If the president-elect gets results, at least some of the jobs - at least for now - are staying in Indiana. Does it really matter how he does it?

COWEN: Well, keep in mind the broader numbers. Since the year 2000, Indiana has lost 150,000 manufacturing jobs. And this, at best, assuming all goes well, saves a thousand of those. So to actually make a dent in the problem, jawboning isn't the way to do it. It's changing economic incentives and making it more cost-effective to hire people in the United States. And none of this really does that.

(If it's not obvious one could add, 1) Every million dollars of tax break Carrier gets to stay in Indiana is a million dollars someone else has to pay instead -- likely a smaller company that hires more people. 2) If the US could, in fact, take jobs back from Mexico, then each such job taken back is one more Mexican who wants to migrate to the US. 3) Capital and current accounts add up. If carrier invests $1 M in Mexico, then US exports must increase by $1M. And vice versa. 4) If it's profitable to build air conditioners in Mexico, then someone else will do it and that Carrier plant is toast anyway.)

Brooks and Shields

Who will defend President-Elect Trump? Surprisingly, Mark Shields, in a very interesting Shields and  Brooks segment on the PBS newshour.

First David Brooks did a great job of slamming the deal, as Cowen did

 The job of government is to be a level playing field where companies compete and make money honestly. And by rewarding one company over another, by getting involved in these sort of petty deals, the first thing you’re doing is encouraging rent-seeking, for companies to make money off government, rather than the honest way. 

And the second thing, it’s — and especially in this administration, it’s an invitation to corruption. If you’re cutting deals with company after company, doing this kind of deal, that kind of deal, inevitably, there is going to be a quid pro quo. There is going to be under-the-table lobbying. 

And it’s just a terrible precedent for our economy and for the administration. 

 But that's easy. Shields, the "left" commenter, had the harder job, defending Trump's action:

I think it is bad public policy. I think it’s a political masterstroke. I think Donald Trump raised this issue during the campaign. When it first appeared, when Carrier showed the gross insensitivity, where it was on YouTube, where they went in and told the 1,000 workers that their jobs were leaving, that the company was leaving, and it was just — it was abjectly insensitive to the workers. And Donald Trump picked that up. It was part of his prairie populism of the time, unlike his Cabinet appointments to Treasury and Commerce.

And I think Donald Trump, this is a masterstroke that he said he would do something, he did it, and it’s been a long time since the president of the United States has made that kind of an announcement.

Is it a coherent national macro-policy? No. But as a micro-act, it’s a very positive act politically. And I think it reflects better upon him and his commitment to these people and their well-being and their survival than an awful lot that’s happened in the past.

I'm almost -- but not quite -- convinced. Shields' narrow window of hope is that this was a one-off, rather brilliant symbolic political act, and that now the Trump administration will focus on serious policy, which mostly means bringing rule of law back to regulation and eliminating interference of this sort.

Yes, presidential politics is not ivory tower economics, and occasionally Presidents have to do something abjectly wrong to garner support for a greater purpose. It's a delicate and dangerous act though -- if this is where we're going, early in an administration is the best time to do some hard things, set in motion policies that actually work, set a high bar against demands for cronyist payouts, and trust that four years of good policy will pay off.

The best hope in this direction is for the President to score some points, and for a loud chorus of serious policy people, from left and right, to denounce any more moves in this direction. This is exactly what has happened.  Really, it gives one great hope that just about every commentator left and right says this is not the way to go.

Shields and Brooks are also nicely consistent. Shields:

I give Barack Obama great credit for the rescue of the United States automobile industry. It saved hundreds of thousands of jobs. 

Unlike, say, Paul Krugman, who has been madly tweeting (correctly) that Carrier is bad policy -- but the same thing done by Democratic administrations such as the auto bailout are of course fantastic ideas.

Peggy Noonan

I was most disappointed in Peggy Noonan, usually excellent, in the Wall Street Journal, and approving of the deal for all the wrong reasons: to her it wasn't just a little political pandering thank you, but the path forward

This is called economic nationalism but whatever its name it suggests a Republicanism in new accord with the needs of the moment...

She went on to tell the story of a related Kennedy escapade. Excerpts:

It was 1961 and the new president, John F. Kennedy, had been trying to signal to big business that they could trust him.. His impulses were those of a moderate of his era: show budgetary constraint, keep costs and prices down, prevent inflation.....

That September Kennedy asked the industry to forgo a price increase. He asked the steelworkers union for wage demands... Early in 1962 his labor secretary, Arthur Goldberg, put together a deal. In the spring the union and the steel companies accepted it. Everyone understood the industry would not raise prices.

A few days later Roger Blough, chairman of the board of mighty U.S. Steel, asked to see the president. He handed him a four-page mimeographed statement announcing his company would raise steel prices $6 a ton. ...
Soon Bethlehem Steel raised its prices. Other companies followed.

Now Kennedy was enraged. Accepting Blough’s decision would undo all his wage-price guideposts. It would also constitute a blow to the prestige of the presidency. And labor would never trust him again.

So he went to war. At a news conference the next day he called the steel companies’ actions “a wholly unjustifiable and irresponsible defiance of the public interest” by “a tiny handful of steel executives whose pursuit of private power and profit exceeds their sense of public responsibility.” He implied they were unpatriotic in a time of national peril. ...

Kennedy ordered the Defense Department to shift its steel purchases from U.S. Steel to companies that hadn’t raised prices. The Justice Department under Attorney General Robert Kennedy launched an antitrust investigation, summoned a federal grand jury, and sent FBI agents to the homes and offices of steel executives. There were rumors of threats of IRS investigations of expense accounts and hotel bills. (my emphasis)

Bethlehem Steel was the first to back down. A week after informing the president of the price increase, Roger Blough returned to the White House to surrender...

I emphasized the paragraph of actions that Kennedy took. Each measure is blatantly illegal and an abuse of power. If you think abuse of the regulatory state and prosecutorial power for political purposes are new dangers, let this remind you just how far back it goes.

Curiously, Peggy seems to get that.

It was a big win for Kennedy but it was a bloody affair, and on some level he knew it. His relations with business never quite recovered. The administration’s brutality left a stain. Robert Kennedy’s ruthlessness inspired the anti-nepotism law that is said, these days, to bedevil the Trump family. A nascent, national conservative movement was embittered and emboldened: Barry Goldwater said JFK was trying to “socialize the business of the country,” and decided soon after to run against him.

... presidents shouldn’t abuse their power—and he did. They especially can’t do it to shore up their own political position, and he did that, too. 

So how does she justify it?

But it’s also true he thought he was right on the policy and that the policy would benefit the American people.

And the American people could tell. His approval ratings, high then, stayed high. People appreciate energy in the executive when they suspect it’s being harnessed for the national good. The key is to wield it wisely and with restraint. But yes, a little muscle judiciously applied can be a unifying thing.

No, Peggy.  Crucially, he was wrong on the policy. No, we do not fight inflation by jawboning companies and unions not to raise prices. That does not "benefit the American people." This isn't fancy economics. Leaders from Emperor  Diocletian to Nicolás Maduro have tried to quell inflation by muscling businesses -- sending police to terrorize businessmen in their homes -- not to raise prices, and it always ends with more muscle and more inflation -- as Kennedy's did.

He may have "thought" he was right. His Keynesian advisers had also forgotten lessons of two thousand years of history and thought jawboning an excellent idea. But this is precisely why we have a rule of law -- so that leaders who "think" they are right about the proper level of steel prices cannot wreck the economy.

Just as Trump's action is abjectly wrong on policy. For just as many thousands of years, leaders have been cutting Carrier-like deals, to just as contrary effect. It is our duty to say that, to undercut the political popularity that presidents can gain by counterproductive policies, especially when the means trample the rule of law.

"a Republicanism in new accord with the needs of the moment" is a Republicanism that works. And the point of "work" is not just to win the next election, or give people things that feel good but impoverish them. The need of the moment is leadership, to channel people's well deserved anger into a productive direction.

I hope Peggy will someday write a piece titled, "the worst sentence I ever wrote," in honor of

"A little muscle judiciously applied can be a unifying thing," 

especially when the "unification" comes by feeding people falsehoods like Carrier deals save jobs, or jawboning lowers inflation.  Just how does this not describe Castro? Or Chavez? Or...well, fill in the blanks.