Economist Channel

David Henderson and I wade in to perilous waters in the July 31 Wall Street Journal. We try to stake out a different and more productive conversation than the usual shouting match between alarmists and deniers.

Climate change is often misunderstood as a package deal: If global warming is “real,” both sides of the debate seem to assume, the climate lobby’s policy agenda follows inexorably.

It does not. Climate policy advocates need to do a much better job of quantitatively analyzing economic costs and the actual, rather than symbolic, benefits of their policies. Skeptics would also do well to focus more attention on economic and policy analysis.

As usual, I have to wait 30 days to post the whole thing.

As economists, we both have a healthy skepticism of large computer based forecasting models. The famous 1972 club of Rome forecast that we would run out of resources, and the grand failure of large scale Keynesian models in the late 1970s are two humbling examples. The "climate" models also feature a lot of questionable economics. A crucial question -- how much carbon will the world's economies add on their own, without Paris-accord policies? That's economics, very questionable economics, and not meteorology.

That said, however, the point of the oped is to try to shift the debate away from climate science and mixed climate-economic computer models. Stop arguing about climate, and let us instead investigate costs and benefits of policies. That strikes us as a much more fruitful place for discussion. If you are wary of the climate policy agenda, the costs and benefits of those policies are more fertile ground for discussion than the science of carbon emissions and atmospheric warming. If you only argue about the climate, then you implicitly admit that if the models are right about climate, the whole policy agenda follows. Do not admit that point. They may be right about climate and wrong about policy.


In California, it is seriously suggested that the way to get more water is to build a high speed train, which will save carbon, which will cool the earth, which will... actually, it goes the other way, but never mind. To address an argument like that, you should not get dragged in to whether human-released carbon warms the planet. A simple dollars per ton and tons per inch of water would do.

If it is not clear enough, nothing in this piece takes a stand on climate science, either affirming or denying current climate forecasts. I will be interested to see how quickly we are painted as unscientific climate-deniers. Shifting a politicized debate is hard. That is, if anyone pays any attention.

A few other choice bits:

Global warming is not the only risk our society faces. Even if science tells us that climate change is real and man-made, it does not tell us, as President Obama asserted, that climate change is the greatest threat to humanity. Really? Greater than nuclear explosions, a world war, global pandemics, crop failures and civil chaos?

No. Healthy societies do not fall apart over slow, widely predicted, relatively small economic adjustments of the sort painted by climate analysis. Societies do fall apart from war, disease or chaos. Climate policy must compete with other long-term threats for always-scarce resources.

As something of a conservative libertarian, I do worry about the end of western civilization and our society falling apart. And I worry about the natural environment as part of that. Still, slow warming in the next two centuries, and a sea level rise (much smaller than the one that happened a mere 10,000 years ago), while a worry, is not obviously the top worry.

Global warming is not even the obvious top environmental threat. Dirty water, dirty air and insect-borne diseases are a far greater problem today for most people world-wide. Habitat loss and human predation are a far greater problem for most animals. Elephants won’t make it to see a warmer climate. Ask them how they would prefer to spend $1 trillion—subsidizing high-speed trains or a human-free park the size of Montana

I'm also something of an environmentalist, with a soft spot for people living in terrible conditions and for the awful permanence of species extinction. Starting with wooly mammoths.

The Intergovernmental Panel on Climate Change’s “scientific” recommendations, for example, include “reduced gender inequality & marginalization in other forms,” “provisioning of adequate housing,” “cash transfers” and “awareness raising & integrating into education.” Even if some of these are worthy goals, they are not scientifically valid, cost-benefit-tested policies to cool the planet.

When I read the IPCC report, starting on p. 26, I had to check that I was not unintentionally reading The Onion. We cut for space. A longer list (from that p. 26) of the IPCC's policy ideas

Reduced gender inequality & marginalization in other forms…. Improved access to & control of local resources; Manipulation of disturbance regimes; Community-based natural resource management…. Provisioning of adequate housing,… Micro finance; Disaster contingency funds; Cash transfers; Public-private partnerships…Patent pools & technology transfer…: Awareness raising & integrating into education; Gender equity in education; Extension services; Sharing indigenous, traditional & local knowledge; Participatory action research & social learning; Knowledge-sharing & learning platforms… behavioural shifts, or institutional & managerial changes that produce substantial shifts in outcomes. (under”practical” subheading) Individual & collective assumptions, beliefs, values & worldviews influencing climate-change responses.

Again, you do not have to get deep into cloud modeling and ice melt feedback loops to wonder if all of this list necessarily follows. And, for the record, I have no qualm with lots of this list. Gender equality and equity in education? Improved access to resources? Who can object? But this is supposed to be about effective policies to cool the planet, not a grab bag of things that would be nice. (I do have qualms with a lot of the list, of course. It's a rather Orwellian and statist vision. "Public-private partnerships" characterizes much of contemporary Russia.)

I like our last paragraph.

Climate policy advocates’ apocalyptic vision demands serious analysis, and mushy thinking undermines their case. If carbon emissions pose the greatest threat to humanity, it follows that the costs of nuclear power—waste disposal and the occasional meltdown—might be bearable. It follows that the costs of genetically modified foods and modern pesticides, which can feed us with less land and lower carbon emissions, might be bearable. It follows that if the future of civilization is really at stake, adaptation or geo-engineering should not be unmentionable. And it follows that symbolic, ineffective, political grab-bag policies should be intolerable. 

For the record, I favor a uniform carbon tax in place of all the other direct energy regulations and subsidies. (A neighbor just showed me his electric car, purchased in addition to a regular car, for one reason only: you can ride it solo  in the HOV lane, a right worth thousands in California.) The rate on such a tax can be raised or lowered as politics and science see fit. If we're going to do something, and if the health of the economy is a prime consideration, then we must do something economically efficient. (David disagrees, but he can explain his views in his own blog.) As I favor a uniform VAT in place of the idiotically complex income and corporate tax system. I recognize the essential failure of our political system to enact simple transparent reforms, but that's a question for another day.

I do think there is hope however. A while ago I went to a meeting organized by the Niskanen Center bringing together free-market and libertarian types with some large environmental organizations. The environmentalists were concerned about climate change, understand that feel-good policies (like the subsidy for my neighbor's car) aren't going to slow down climate change, and will suck resources away from policies that could. The free marketers were largely a bit skeptical about just how much of a threat climate change is, but appalled at the inefficiency of IPCC style regulations. There is a deal to be had -- we'll do something efficient and effective (say, a carbon tax) in return for eliminating the junk.  We can agree to disagree about the level of that tax. My sense is that environmental groups are not ready to say this in public, for fear of angering allies who want to use the environmental label for a grab bag of policies (see IPCC list!), and the libertarians and free market types don't trust the "get rid of" rather than "in addition to" everything else part of the bargain. But there is a bargain to be made, and strong political leadership could bring it about.

(By the way, we didn't choose the figure caption. We know that Rotterdam is not prone to floods. Much of it is below sea level, and Miami is 9 feet above sea level.)

Update: Ian Martin and Bob Pindyk have a classy AER paper on the subject of "insurance" and multiple potential catastrophes. They go beyond our point -- if you buy overpriced insurance for each catastrophe you exhaust GDP quickly -- and consider the general equilibrium interactions. Catastrophes affect marginal utility a lot, so when you insure against one you change the state-contingent valuations of another. Evaluating policies in isolation is doubly bad.

Dan Thornton has an interesting essay, ``The Limits of Monetary Policy: Why Interest Rates Don’t Matter.’’

Just why do we think that the Fed raising and lowering interest rates has a strong effect on output (or inflation)? Just why does the Fed control short-term interest rates rather than the money supply, or something else?

Dan's essay is a nice quick tour through the history of this question. No, there is not as much logic and evidence behind this hallowed belief as you might think, and yes, people did not always take the power of interest rates for granted as they seem to do now. Dan's historical tour is worth keeping in mind.

This question is especially relevant right now. We are unlikely to see big changes in interest rates going forward. And central banks are busy thinking of different things to control -- the size of the balance sheet; treasury, MBS, corporate bond, and even stock purchases; use of regulatory tools to control lending. So we may be on the cusp of a fairly major change in thinking about what central banks do -- what their primary tool is -- and how that tool affects the economy. (And, I hope, whether it is wise for central banks to use new tools that come along. Their mandate is not to be the great macroeconomic-financial planner after all.)

As Dan points out,

it is a well-known and well-established fact that interest rates are not very important for investment, or for spending decisions generally.

Quoting Bernanke and Gertler

… empirical studies of supposedly “interest-sensitive” components of aggregate spending [fixed investment, housing, inventories, and consumer durables] have in fact had great difficulty in identifying a quantitatively important effect of the neoclassical cost- of-capital variable [interest rates].

“So why do policymakers believe that monetary policy works through the interest rate channel and that monetary policy is powerful?” Well, there was one important event that brought economists and policymakers to this conclusion. Specifically, the Fed under Chairman Paul Volcker brought an end to the Great Inflation of the 1970s and early 1980s.

Prior to this event, Keynesian economists … believed that monetary policy was totally ineffective. “Why?” Keynesians believed that the only thing monetary policy could affect was interest rates. Since interest rates were not important for spending, the effect of monetary policy actions on interest would have essentially no effect on spending and, consequently, no important effect on output. Keynesians believed that monetary policy was essentially useless.

There was a smaller group of economists called monetarists who believed that monetary policy could have a large effect on output. But they believed this effect was due to the effect of monetary actions on the supply of money, not interest rates. Both Keynesians and monetarists believed that the effect through the interest rate channel would be tiny.

Bernanke and Blinder find that monetary policy works through the bank credit channel of monetary policy—not through interest rates. However, … because banks have financed most of their lending by borrowing funds from the public since the mid-1960s, it is unlikely that the bank credit channel is important. …It is now well-recognized that the bank credit channel of monetary policy is very weak.

When he became chairman of the Fed, Paul Volcker made ending inflation the goal of policy. … He announced that he wanted to pursue a new approach to implementing monetary policy that “involves leaning more heavily on the [monetary] aggregates in the period immediately ahead.” …it seems to have worked. Inflation declined from its April 1980 peak of 14.5% to about 2.4% in July 1983….The policy change was also followed by back-to-back recessions…. the fact that the change in policy was followed by a marked reduction in both inflation and output led economists and policymakers to dramatically change their view about the power of monetary policy to effect output and inflation.

…economists debated whether the success of the Volcker’s monetary policy was due to a marked reduction in the supply of money or to higher interest rates. But the growth rate of M1 monetary aggregate changed little over the period. Moreover, the growth rate of M2 actually increased. In contrast, the federal funds rate, which was 11.6% the day the FOMC changed policy, increased to a peak of 17.6% on October 22, 1979. The funds rate then cycled, hitting cyclical peaks above 20% in late 1980 and mid-1981. Given the behavior of the M1 and M2 monetary aggregates and the behavior of the federal funds rate during the period, a consensus formed around the idea that the success of Volcker’s policy was attributable to high interest rates not to slow money growth. 

Like the Phoenix, the idea that monetary policy worked through the interest rate channel rose from the ashes. … the FOMC adopted the federal funds rate as its policy instrument in the late 1980s, circa 1988. … Policymakers pay essentially no attention to monetary aggregates…

The problem is that nothing else changed. There have been no new studies showing that spending is much more sensitive to changes in interest rates than previously thought. … Bernanke and Gertler’s statement that monetary policy does not work through the interest channel is as true today as it was 20 year ago. What has changed is economists’ belief that monetary policy works through the interest rate channel. … economists’ and policymakers’ belief that monetary policy has strong effects on output through the interest rate channel is more akin to religion than to science. It is built on a belief that it seems to have worked once. 

This belief is reinforced by fact that few economists believe that policy could work through any of the other possible channels of policy: the exchange rate channel, the wealth effect channel, the money supply channel, or the credit channel. Monetary policy seems to work, but it cannot work through any of these other channels. Conclusion: it must work through the interest rate channel.

We ran into the situation, as you may remember, when the money supply, nonborrowed reserves, and various other non-interest-rate measures on which the Committee had focused had in turn fallen by the wayside. We were left with interest rates because we had no alternative. … – Alan Greenspan, FOMC Transcript, July 1-2, 1997, pp. 80-81. 

Where does this leave us? In the short run, the fact remains. We have no alternative. If I were to wake up as Fed chair tomorrow, I'd move the interest rate levers just about the same way as anyone else does. In the short run, I think these reflections should add to our humility -- we really don't understand the mechanism as well as most analysis suggests, and a new idea will come sooner or later.

In the longer run, those new ideas seem to be breaking out. Central banks, increasingly gargantuan financial regulators, are using a wide range of tools to influence the economy via asset prices. In my own view this is a bad idea. But like most bad ideas it is slipping in sideways largely un noticed.

The July 13 Wall Street Journal editorial updates yesterday's ray of hope.

One remaining debate is over Ted Cruz’s “freedom option.” The Texas Senator’s amendment says that any insurer that offers at least one ObamaCare-compliant plan could also sell other types of coverage off the exchanges. The expectation is that a more competitive and dynamic insurance market will emerge outside of ObamaCare. Released from federal mandates and price controls, insurers could offer many more innovative products designed for individuals, rather than standardized coverage planned in Washington.

Mr. Cruz acknowledges that insurance markets could “segment,” meaning that younger and healthier people would gravitate to the Cruz option, where premiums are likely to be much cheaper. Older people with more health expenses would remain on ObamaCare, which bars insurers from charging higher premiums based on health risks and bans exclusions for pre-existing conditions.

The logic of the Cruz proposal is that there is a rough consensus among Republicans that government should guarantee access to coverage for people with pre-existing conditions. In that case, government should pay for this guarantee, in the form of a de facto high-risk insurance pool, rather than hiding the cost in cross-subsidies imposed on private citizens.

The virtue of this approach is transparency and honesty. In a bifurcated market, premiums would be much higher for ObamaCare plans. But they’d be offset for consumers by much higher federal subsidies that rise with premiums...

So, the solution envisioned yesterday could actually emerge. The exchanges become what they already are -- places to get subsidies. Where you go to sign up for medicare, income-based premium subsidies, and so on. [The "rough consensus" really is not all that much about preexisting conditions. It is about subsidies based on income and age.] The rest of the market can be free.

It's not perfect. If we "bifurcate," just why should insurance companies have to offer an exchange policy? You can smell a cross subsidy from off exchange to on-exchange already, together with restrictions on competition to enforce that cross subsidy.

Will the off exchange policies offer guaranteed renewability, portability from state to state, and portability into and out of employment? Not yet, I think, but that's where they need to go.

The WSJ emphasizes preexisting conditions, but let's make a distinction between people with preexisting conditions right now, the day after Obamacare destroyed the individual market, and people who get conditions next year that become preexisting the year after that.

If the point of exchanges is to be high risk pools forever, for anyone who in the future develops a preexisting condition as the WSJ seems to envision, then Sen. Cruz free market idea will be very weak. It will offer people one year worth of cheap insurance, and then the minute anyone gets actually sick they transition to subsidized insurance.

The combination of free market and exchange has to be designed to keep people out of the exchanges. The previous limits on signing up for people who, starting a year from now, do not have continuous coverage, go a step in that direction. You want people to buy health insurance not so much for this year's expenses, but for the right to be covered next year if they develop a preexisting condition, and then to stay with their individual policies.

Yes, people who have preexisting conditions now cannot jump in to the market, because the market doesn't exist. But that does not mean that subsidized exchanges should forever be an absorbing state for anyone who gets sick or old. Which is all of us.

Still, the outlines of subsidies for those who need them, and freedom for the rest of us, seems to be on the table.

Update: 

Or maybe not. Mike Cannon writes there will be price controls on the "free" market alternative, linking them to exchange policies. Together with a requirement to offer exchange policies, this looks just like a small broadening of exchange policies, cross subsidies intact.  Since the exchange policies are specific to counties, I can't see how this is portable across even county lines, let alone state lines, guaranteed renewable,  and so forth.

Kristina Peterson, covering the senate health bill in in the July 11 Wall Street Journal reports a ray of hope for our legislative and policy process:

“If we’re going to subsidize Americans who can’t afford health insurance, do it directly. Don’t do it through the premiums of others,” said Sen. Jeff Flake (R., Ariz.) 

Few wiser words were spoken.

Our government wants to subsidize some people's health insurance -- poor, sick, old, disabled, veterans, children, people with specific diseases, and so on. And, in many cases, rightly so.  But our politics are allergic to "tax and spend." So, we hide it -- we force some people to buy overpriced insurance to subsidize others.

It is financially completely equivalent to taxing and spending. To those who don't want "taxing and spending," you are fooling yourself by allowing cross subsidies instead.

Except it's far more damaging to the economy than the disincentives of broad-based taxation.

Cross-subsidies cannot stand competition.

If competition and free entry are allowed, insurers offer policies tailored to the wealthy, healthy, young, able-bodied, etc., and peel them off from the cross-subsidy scheme. The equivalent tax and spend can simply say, here is a voucher, go buy health care and insurance from an innovative, competitive, dynamic, cost conscious markets.

A health care and insurance market that subsidizes certain groups cannot be competitive. Then costs spiral, then health care and insurance are even more "unaffordable," then the need for subsidies is greater, the overpriced insurance rises to ridiculous costs, and people need to be herded ever more reluctantly into the system.

Peterson's reporting neatly captures this lovely revelation.

The biggest sticking point in recent days has centered on a provision supported by GOP Sens. Ted Cruz of Texas and  Mike Lee of Utah that would allow insurers that sell plans complying with ACA regulations to also sell health policies that don’t.

Well, that sounds sensible, no? Why ban competition and innovation in health insurance? Whatever happened to selling insurance across state lines anyway? Well,

Health analysts say that would likely lower premiums for younger, healthier people, who would buy more limited policies, while causing premiums to rise for people with pre-existing conditions, who would buy the more comprehensive plans that comply with the ACA.

And

“His proposal would lead to unaffordable rates for people with pre-existing conditions,” Ms. Collins said Monday of Mr. Cruz’s proposal.

Cross subsidies cannot stand competition.

Senator Flake has it right. We are at a crossroads. America can choose to acknowledge the extent of subsidies we wish to have in our health care system, and forthrightly tax people to provide subsidies, transparently, on budget, where we can see what we're doing, and allow a vibrant competitive health care and insurance market to emerge -- or we can continue the cross-subsidy / anti-competition spiral to its inevitable denouement.

The Cruz/Lee/Collins/Flake debate hopefully makes that choice  abundantly clear. That this little bit of freedom -- you're allowed to sell off-exchange policies again -- cannot be tolerated ought to make the choice so clear, so stark, so simple that perhaps they will all see that "muddle through" is at an end.

Michael E. C. Moss puts it well in a related blog post,

the obvious compromise, the only good solution, is to do both: free-market pricing of healthcare and insurance in order to drive down prices, coupled with government subsidies for the needy to enable them to buy care and insurance at market prices. 

Farzon Nahvi, writing in the New York Times, reiterates the tired argument that health care can't be left to the free market, because people in comas can't negotiate.

As an emergency medicine physician in a busy urban hospital, I have patients brought to me unconscious several times a day...

Well, if the Times can recirculate tired stories, I can recirculate responses. Responding to an eerily similar essay way back in 2012, I argued in "After the ACA"  (starting p. 189)

Yes, a guy in the ambulance on his way to the hospital with a heart attack is not in a good position to negotiate. But what fraction of health-care and its expense is caused by people with sudden, unexpected, debilitating conditions requiring immediate treatment? How many patients are literally passed out? Answer: next to none.

What does this story mean about treatment for, say, an obese person with diabetes and multiple complications, needing decades of treatment? For a cancer patient, facing years of choices over multiple experimental treatments? For a family, choosing long-term care options for a grandmother with dementia?

Most of the expense and problem in our healthcare system involves treatment of chronic conditions or (what turns out to be) end-of-life care, and involve many difficult decisions involving course of treatment, extent of treatment, method of delivery, and so on. These people can shop. Our healthcare system actually does a pretty decent job with heart attacks.

And even then . . . have they no families? If I’m on the way to the hospital, I call my wife. She is a heck of a negotiator.

Moreover, healthcare is not a spot market, which people think about once, at fifty-five, when they get a heart attack. It is a long-term relationship. When your car breaks down at the side of the road, you’re in a poor position to negotiate with the tow-truck driver. That is why you join AAA. If you, by virtue of being human, might someday need treatment for a heart attack, might you not purchase health insurance, or at least shop ahead of time for a long-term relationship to your doctor, who will help to arrange hospital care?

And what choices really need to be made here? Why are we even talking about “negotiation?” Look at any functional, competitive business. As a matter of fact, roadside car repair and gas stations on interstates are remarkably honest, even though most of their customers meet them once. In a competitive, transparent market, a hospital that routinely overcharged cash customers with heart attacks would be creamed by Yelp.com reviews, to say nothing of lawsuits from angry patients. Life is not a one-shot game. Competition leads to clear posted prices, and businesses anxious to give a reputation for honest and ef cient service.

So this is not even a realistic situation.

To be sure, some conditions really are unexpected and incapacitating. Not everyone has a family. There will be people who are so obtuse they would not get around to thinking about these things even if we were a society that let people die in the gutter, which we are not, and maybe some hospital somewhere would pad someone’s bill a bit. (As if they do not now!)

But now we are back to the straw man fallacy. Once again, the idea that ACA is a thoughtful, minimally designed intervention to solve the remaining problem of poor negotiating ability by people with sudden unexpected and debilitating health crises is ludicrous. As is the argument that we should accept the entire ACA because of this issue.

More generally, (p. 185)

There is a more general point here... Critics adduce a hypothetical situation in which one person might be ill served by a straw-man completely unregulated market, with no charity or other care (which we have had for over eight hundred years, long before any government involvement at all), which nobody is advocating. They conclude that the hypothetical justifies the thousands of pages of the ACA, tens of thousands of pages of subsidiary regulation, and the mass of additional federal, state, and local regulation applying to every single person in the country.

How is it that we accept this deeply illogical argument, or that anyone making it expects it to be taken seriously? Will not one person fall through the cracks or be ill-served by the highly regulated system? If I find one Canadian grandma denied a hip replacement or one elderly person who cannot get a doctor to take her as a Medicare patient, why do I not get to conclude that all regulation is hopeless and that only an absolutely free market can function? Both straw men are ludicrous, but somehow smart people make the first one, in print, and everyone nods wisely.

(Sorry for recycling, but good prose is hard!)

This is also great example of selected sampling and the dangers of making policy by anecdote. I'm sure Dr. Nahvi is a wonderful and caring emergency room physician. But despite the vividness of his experience, that does not make him a great expert on policy. In a completely heartless free market, most of the people he describes showing up on his doorstep would have bought catastrophic coverage. They are employed, normal people who buy cellphones, life insurance, car insurance and home insurance. (That's his point -- poor people are treated for free in emergency rooms. His point is entirely the cost of treatment, for that extremely narrow group, people with assets who somehow don't have insurance.)  As a doctor, he does not see that economic counterfactual, or how cheap unregulated catastrophic coverage would be.  And emergency room physicians dealing with comatose patients are not exactly an unbiased sample of the health care system. Even if such patients need to have government support, just why does a routine dermatologist visit need to be subject to the tender mercies of the Federal Government?

And leave it to the times to deliberately confuse health care with health insurance, and to get in a gratuitous swipe at Paul Ryan,

When it comes to health care coverage, House Speaker Paul Ryan says, “We’re going to have a free market, and you buy what you want to buy,” and if people don’t want it, “then they won’t buy it.” In this model of health care, the patient is consumer, and he must decide whether the goods and services he wants to protect his life are worth the cost.

The health care debate has, apparently, become like the old joke about jokes in prison. One inmate says "31" and everyone laughs. Another says "22", and they laugh again. The new guy says "11!" and is greeted with silence. "What's wrong? he asks." "You didn't tell it right" they answer.

Well, "22" says the Times. "35" say I. We're going to make a lot of progress this way. At least people like me acknowledge and respond to their view. The bubble, apparently, is a one-way street.

Bryan Caplan has a nice post at ecconlib. The last part is an ode to the value of simple economic theory, much disparaged in public debate.

Bryan's central point: Economic theory lets you vastly broaden the range of experience that you can bring to one question -- the effect of minimum wages in Seattle, for example. Economic theory also forces logical consistency that would not otherwise be obvious. You can't argue that the labor demand curve is vertical today, for the minimum wage, and horizontal tomorrow, for immigrants. There is one labor demand curve, and it is what it is. Economics lets one experience illuminate the other, and done right forces politically uncomfortable consistency on those views. You can't argue that sticky too-high wages cause unemployment in recessions and in Greece, and not argue that sticky too-high wages from minimum wages laws do not cause unemployment in Seattle.

This kind of integrated thinking is far too rare in evaluating economic policies. But that's the fault of economists, not of economics.

Bryan:

In case you stay up at night worrying about the next financial crisis, the good folks at the Financial Stability Board have produced a nice soothing little video (original link in case the embed doesn't work, and so you can see that no, I'm not making this up),


The short summary:

Safer, Simpler, Fairer 

3 July 2017 

A decade on since the start of the global financial crisis, G20 countries have rebuilt the financial system so that it serves society, not the other way round. 

By fixing the fault lines that caused the crisis, the financial system is now safer, simpler and fairer than before.   

View and share our videos that explain the G20's work to reform the financial system.

As cheery propaganda, it's not quite up to the Chinese "belt and road" video standard, but pretty good. It needs more puppies and singing children. As unintentional humor, it scores highly. I mean, wasn't "safer" enough, questionable as it is? Did they really have to stretch for simpler and fairer? I don't think Dodd and Frank themselves buy that one.  As a good link to have around for the next financial crisis, better still. As an insight into the wisdom of the Financial Stability Board... well, sometimes I find things that leave even me sputtering to find a pithy summary. You'll have to enjoy it on your own, and try to come up with something good in the comments.

Update: Look at the "capital" bucket. What capital ratio is in the video? What capital ratio is in real life?

One of the frustrations -- or perhaps challenges -- of studying monetary economics and monetary policy is howFed talk and writing on economic mechanisms, causal channels, and effects of policies is far ahead of our actual, scientific knowledge. And writers outside the Fed go leaps and bounds beyond the Fed in advocating strong policies based on the latest stories.

A good example is Sebastian Mallaby, author of "The Man Who Knew: The Life & Times of Alan Greenspan," who wrote last week in the Wall Street Journal Review, that the Fed should surprise us more.

His basic idea: the Fed should monitor asset prices; diagnose when a boom turns in to a bubble; and then actively suppress higher stock prices. And, in addition to interest rates, asset sales, "macro-prudential" regulation (telling banks to stop lending), the Fed should deliberately surprise markets more, adding volatility, in place of central banks' and governments' centuries-old quest (often illusory) to smooth asset prices.

By being less transparent—and reserving the option of deliberately ambushing investors with a shock move—the Fed could discourage them from taking too much risk. 

The painfully learned lesson from the late 1990s and mid-2000s is that excess financial serenity leads to excess risk-taking, which in turn increases the chances of a blowup.

But the equally hard lesson of 2008 hasn’t yet been absorbed: that they [the Fed] should embrace modest, short-term market instability to head off truly disruptive crashes over the horizon. Instead, the calmer markets remain, the prouder the central bankers feel.
Mr. Greenspan and his colleagues faced the danger that the interest rate that would stabilize consumer prices would also destabilize asset prices. The Fed could have escaped this dilemma by acting less predictably. Instead, it telegraphed its intentions and avoided surprises.

Rather breathtaking, no? The last paragraph adds more -- when the Fed wants to lower interest rates to stoke the economy, that causes "bubbles," and the Fed should offset the bubble with deliberate volatility. Hit the gas and the brake at the same time. Greenspan wasn't obscure enough.


What's wrong with "bubbles" anyway? There is one sensible comment,

..when risks seem modest, Wall Street borrows to make bets that look great based on the Sharpe ratio.

Financial crises are always and everywhere about debt. But if Wall Street debt is the problem, just what is the entire Dodd-Frank apparatus to monitor Wall Street debt all about? Really, if Wall Street defaults are the problem, is deliberately inducing volatility to your and my portfolio the answer? Would not a little more capital be a better idea?

Academics do not know exactly how the financial system works. What I as an academic do know, a little more than the average person, is the limits of knowledge - just how much is not known, what the holes are in stories bandied about, and which stories have no basis yet in theory, experience, or evidence. An academic knows that many stories about how the world works are wrong, and we know that many other stories might be possible but have not been written down coherently and evaluated against experience. Knowing what you don't know is knowledge.

It is amazing in that context how much people advocate strong public policy actions -- actions that cost a lot of money, and threaten to put a lot of people in jail -- on stories that are either demonstrably false, or as in this case have no scientific foundation beyond cocktail party speculation, and many glaring logical holes.

For example, it is commonly bandied about, as in this article, that low interest rates induce investors to "reach for yield,'' and create "bubbles'' in asset markets. This is stated as a known, scientific, fact. I know, though it may be true, that this is not yet a known fact. Known facts have to start with a mechanism. Just what is the mechanism? Borrowing at 1% and lending at 3% is exactly the same as borrowing at 5% and lending at 7%. What connection is there between the level of short-term interest rates and the risk premium reflected in the differences between prospective rates of return on different assets?

Well, there are stories about it. Many theory papers have done so in the wake of such speculation. It takes a lot of friction carpentry -- only leveraged intermediaries hold assets, and a lot of nominal illusion or accounting constraints, so that 7-5 is not equal to 3-1. Yes, past booms have involved credit in some way. But most of the time low interest rates correlate with busts, not booms. There are empirical papers,  that seem to show some effects, with all the caveats about empirical work in economics. But none of this elevates it to a known and verified fact, ready for exploitation by policy makers. [I foresee also a swarm of comments opining that yes, low interest rates cause asset booms, thereby missing the point that we shouldn't make policy on such opinion, but rather on well understood causal channels.]

Good policy waits for some sort of scientific evidence. We don't want the government jumping on every food fashion that comes out of the organic farmer's markets of Palo Alto either.

And if the idea that the Fed has the technocratic competence to understand the difference between "boom" and "bubble," the political mandate to determine the correct level of stock prices -- something that affects many voter's pocketbooks! -- and is ready to exactly offset its manipulation of  short term rate by deliberately injecting just enough volatility to hold down prices... Well, I titled the post "technocratic illusions" for a reason.

I am often asked to opine about whether automation will destroy all the jobs. Yes, we talk about tractors, which brought farm employment from something like 70% of the country at the beginning of the 20th century to about 3% today. And cars, which put the horse drivers out of business. And trains, which put the canal boats out of business.

A more recent case occurred to me. This is what offices looked like in the 1950s and 1960s:

This is a "typing pool." There used to be basketball-court sized rooms that looked like this, all over the place, staffed almost exclusively by  women.

Then along came the copier -- many of these women are copying documents by typing them over again with a few sheets of carbon paper -- the fax machine, the word processor, the PC. And that's just typing. Accounting involved similar roomfuls of women with adding machines. Filing disappeared. Roomfuls of women used to operate telephone switchboards, now all automated.

This memory lives on in the architecture of universities. All the old buildings have empty hutches for secretaries.

If you are prognosticating in about 1970, and someone asks, "what will happen now that women want to join the workforce, but office automation is going to destroy all their jobs?" It would be a pretty gloomy forecast.

What actually happened: Female labor force increased from 20 million to 75 million. The female participation rate increased from below 35% to 60%. Women's wages relative to men rose -- they moved in to higher productivity activities than typing the same memo over a hundred times. Businesses expanded. And no, 55 million men are not out on the streets begging for spare change.

Civilian Labor Force Level: Women

Civilian Labor Force Participation Rate: Women

I'm simplifying of course. And surely some people with specific skills -- shorthand, typing without making mistakes, and so on -- who could not retrain didn't do as well as others. But the magnitude of the phenomenon is pretty impressive.

Update. So did women just take all the men's jobs? As MC points out, the male labor force participation rate did decline, from 87.5 to 70.0. That's a big, worrisome decline. But it's 15 percentage points, while the women's increase was 25 percentage points.

But even if women are moving in and men are moving out of employment, that does make the case that you don't just look at who has what jobs now threatened by automation! The typing pool got better jobs.

Please (please!) keep in mind the point here. No, this is not a post about all the ills of the labor market, and "middle class" America, and all the rest. Yes, there are plenty. The narrow point is, will automation mean that all the jobs vanish. In this case, even combined with a large expansion of the people wanting to work, it did not.


Also the male labor force expanded from 45 million to 82 million. So the idea that there is a fixed number of jobs and if women take them men lose them is not true.