Saturday, March 28, 2009

Another, simpler type of useful tariff

I wrote earlier of a type of product where tariffs actually make sense - basically, a heavily branded product where there's actually not much of a difference in quality, but a big difference in price.

Another type would be a good with significant negative externalities, like rainforest-derived products. For example, if you have paper, which is produced fairly responsibly in the US and extremely irresponsibly in Brazil, putting a tariff on Brazilian paper increases the price of paper to Americans and reduces the welfare Americans as a whole receive from paper. However, the destruction of the rainforest represents a significant negative externality to the world, and Americans as well.

Rational economic theory states that goods with negative externalities should be subject to Pigouvian taxes. Tariffs on the product functionally then can serve as a partially-Pigouvian tax. On a strictly economic basis (excluding moral or socially responsible issues), you can't have the US put on full Pigouvian taxes, because it sacrifices US welfare for the benefit of everyone else (tragedy of the commons). But you can partially tax it - the welfare we'd lose in paper would be made up for by making it easier to find pharmaceuticals or other things that the rainforest helps us do.

In that sense, this represents another type of good tariff. Not quite as interesting as the other kind, but no less valid, I think.

Friday, March 27, 2009

My Senior Thesis

Trying to post my senior thesis here as storage. Anyone know how to do that?

Electricity Grid Efficiency

So much more efficient, both environmentally and cost-wise. Brilliant. Here's hoping the rest of the country follows suit.

Full credit to John for sending this in.

Shakespeare knew how financial crises worked

Full credit to this one for Nate Oman - BRILLIANT.

To read it in its original format:

Over the weekend, I re-read A Merchant of Venice, and I was struck by the fact that Shakespeare manages to include in the play virtually every element of the current financial crisis. Scene one begins with a discussion of risk assessment, and Antonio's belief that he has managed to tame the vagaries of commercial fate through diversification. Asked by Salarino if he "Is sad to think upon his merchandise" (I.i.40), Antonio responds:
Believe me, no. I thank my fortune for it
My ventures are not in one bottom trusted,
Nor to one place; nor is my whole estate
Upon the fortune of this present year.
Therefore my merchandise makes me not sad. (I.i.41-45)
Having ignored the problem of fat tails and black swans, Antonio decides to engage in a bit of dodgy finance. He borrows in the wholesale market from Shylock under terms that appear favorable, but have a huge downside in the unlikely event of his default. Antonio, of course, is unconcerned. From his point of view he is getting cheap money by taking on what seems like an extremely remote risk. He then takes these borrowed funds and uses them to make what can only be described as a no doc, subprime loan. Bassiano wants money for a speculative venture -- the wooing "In Belmont [of] a lady richly left" (I.i.161) -- and Antonio agrees, in effect renting out his credit rating:
Try what my credit in Venice can do;
That shall be racked even to the uttermost
To furnish thee to Belmont to fair Portia.
Go presently inquire, and so will I,
Where money is; and I no question make
To have it of my trust or for my sake. (I.i.180-185)
Shylock, for his part, does not approve of the loose monetary policy in Venice, which he rightly blames on wild lending practices, such as Antonio's loans:
How like a fawning publican he looks.
I hate him for he is a Christian;
But more, for what is low simplicity,
He lends out money gratis and brings down
The rate of usance here with us in Venice. (I.iii.38-42)

Faced with such low returns on normal loans, Shylock is forced into the shadowy world of loan-to-own, in this case targeting, as he tells Antonio, " equal pound/ Of your fair flesh, to be cut off and taken/ In what part of your body pleaseth me" (I.iii.147-149). As he later reveals, Shylock is engaged in a bit of arbitrage in the commodity markets and wants Antonio's flesh "To bait fish withal" (III.i.49).

When all Antonio's "argossies" reportedly wreck at the same time -- a wildly improbable event predicted by none of Antonio's complex statistical models and, as we have seen, completely discounted by him -- his over-leveraged balance sheet sends him spinning into bankruptcy and ruin. For his part, after Lorenzo makes off Madoff-like with Shylock's daughter and his savings -- "A diamond gone cost me two thousand ducats in Frankfurt!" (III.i.77-78) -- he is left to lament (albeit in prose):

Why thou loss upon loss! The thief gone
with so much, and so much to find the thief, and no
satisfaction, no revenge, nor no ill luck stirring but
what lights o' my shoulders, no sighs but o' my breath-
ing, no tears but 'o my shedding. (III.i.85-89)
Of course, once his ill-fated bet on Bassiano and the power of risk management starts to unwind, Antonio's surrogates begin lobbying the government to change the rules so as to avoid unwanted contracts. To his credit, the Duke resists these entreaties, because, as Antonio acknowledges:
The duke cannot deny the course of law;
For the commodity that strangers have
With us in Venice, if it be denied,
Will much impeach the justice of the state,
Since that the trade and profit of the city
Consisteth of all nations. . . . (III.iii.26-31)
His laudable concern for the commercial reputation of Venice, however, does not prevent the Duke from using the bully pulpit in an attempt to brow-beat Shylock into renegotiating his contract with Antonio:
Shylock, the world thinks, and I think so too,
That thou but leadest this fashion of they malice
To the last hour of act; and then 'tis thought
Thou'lt show thy mercy and remorse more strange
That is they strange apparent cruelty'
And where thou now exacts the penalty,
Which is a pound of this poor merchant's flesh,
Thou wilt not only loose the forfeiture,
But touched with human gentleness and love,
Forgive a moiety of the principal,
Glancing an eye of pity on his losses,
That have of late so huddled on his back,
Enow to press a royal merchant down
And pluck commiseration of his state
From brassy bosoms and rough hearts of flint,
From stubborn Turks and Tartars never trained
To offices of tender courtesy.
We all expect a gentle answer, Jew. (IV.i.16-34)
The Duke's speech, of course, falls into the standard rhetorical tropes from the perennial battle between Main Street and Wall Street, finance and the "real economy." Shylock is asked to forgive the principal out of "human gentleness and love" and Antonio's unfortunate losses "huddled on his back," nevermind, of course, that it was Antonio who got himself into the problem with the first place through irrational exuberance and shoddy lending practices. Of course, beneath the velvet appeal to mercy and solidarity there is the steel fist of an unstated threat. Shylock is "Jew," the member of a hated minority and the memory of young men following him through the streets taunting him over the loss of his daughter just a few scenes before must be fresh in his memory. The duke is willing to stand behind the "justice of the state," but for how long in the face of an increasingly belligerent public that his sided decisively with Antonio?

Of course, the story is resolved when deus ex machina Portia arrives with clever legal arguments that allow Antonio to escape his obligations while giving the city a fig leaf behind which it can hide its ultimately thin commitment to contractual sanctity. (Of course, realist that I am, in the end I think that that it is Portia's rhetoric -- "The quality of mercy is not strained..." (IV.i.182) -- rather than her legal analysis that does the real work.) The ending, however, requires the forced conversion of Shylock and what amounts to public control of his capital through a series of strong-arm negotiations rather than outright legislation.

Needless to say, finance and capitalism will never be the same in Venice again. With Antonio and his friends in control, I shudder for the prospects of efficient capital allocation in the future. I think that we can expect more loans to well-connected folks like Bassanio with questionable business models.

Thursday, March 26, 2009

Cochrane on the Credit Crisis

As a reminder, there are 2 major portions of this crisis. There's a credit crunch, in which banks don't know the true value of their assets and want to ensure they have the money to service their deposits and other liabilities, so they don't lend, and nobody can get money when they need it, even on a short term, highly reliable basis. The other portion is the recession, in which output is falling, reducing employment, consumption and leaving much of our capacity idle. These two issues are highly interrelated and worsen each other, but they're also separate. Specifically, it'll be almost impossible to fix the recession until the credit crunch is fixed, and the longer we let the recession go, the worse it makes the credit crisis because more and more people don't pay back loans due to loss of employment. So the credit crunch is very important to fix quickly.

As I mentioned, these are interrelated.

I'll start and say that Cochrane makes a VERY elementary mistake in his treatment of fiscal stimuli, one that Krugman and DeLong both tear him apart for.

However, he does have some good points on monetary stimulus, and, most relevant to here, he has interesting points on the liquidity crisis.

To make a very complex train of thought simple, he advocates that the US provide a monetary stimulus (increasing the money supply) while also easing the credit crunch by buying high quality corporate debt.

While corporations with junk ratings individually have quite high likelihoods of default during credit crises (default rates have historically been between 1 and 10%, and it's likely this will be higher than that range), as a whole, corporate America is probably likely to be able to pay off their debt. Needless to say, in this environment, interest rates are quite high. Purchasing this debt a) increases the money supply, avoiding recessionary deflation, b) provides LIQUIDITY quickly in the exact spot where banks won't do it but is still important to America, and c) buys a LOT more time to sort out the toxic assets on bank balance sheets.

Functionally, instead of trying to get banks to lend more, the government just does it for banks. In a few years, when everything has settled down, the government can dispose of the corporate bonds it has acquired, likely at a profit. This increases government revenue (we're running massive deficits) while minimizing inflation risks associated with quantitative easing, which is where the US buys back its own debt for cash to increase the money supply. The relative advantage is that in a few years, when the public is sick of holding money and government debt because it can finally stomach risk again, the government doesn't have to drastically increase interest rates to get money out of the system - it has high-yielding corporate debt to sell that can be attractive in markets without absurd risk aversion.


DeLong and Krugman tear apart Cochrane's fiscal stimulus mistake:

Lucas agrees with Cochrane on the liquidity crisis part:

A parable of culpability

Imagine a family. Nancy is the mother, Sam is the father and Joe is the young child.

Joe (the young child) sets up a yard sale. An older child he doesn't recognize (named Neville) approaches, wanting to buy something. Joe, as many young children are, is not comfortable interacting with people he doesn't know.

Joe asks Nancy (his mother), who wishes to teach Joe the lesson that it hurts everybody for him to refuse to interact with people he doesn't know. She tells Joe to sell Neville what he wants at his yard sale, regardless of whether the young Joe is comfortable making the sale.

Neville promptly buys Joe's 1 dollar bill for the price of two shiny quarters and runs away. Joe is very excited, at first. It takes him until that evening to realize he's been had. Nancy yells at him, saying it was irresponsible to make that sale to Neville. She punishes Joe and sends him to his room.

Later that day, Nancy goes to the supermarket with Joe and her husband, Sam, and sees an older child bemoaning his fate. Joe recognizes Neville, but Nancy is trying to teach the young Joe a lesson and doesn't listen. Instead, she starts speaking to Neville.

Neville says he had a dollar, had spent it on 2 ice creams, and was now having a bad day and wanted more ice cream. Thinking it would teach Joe a lesson about responsibility, the mother makes Joe give the two quarters to Neville, who promptly goes and uses it to buy more ice cream. He takes the last of the ice cream. Sam now realizes that in order to have ice cream himself, he will need to ask his wife for taxi fare to go to a different ice cream store because he had brought enough money for ice cream but not for both ice cream and taxi fare.

Ridiculous, no? Nancy, the mother, exhibits behavior that makes no sense? Joe, the young child, is repeatedly punished for being naive, while Neville gets rewarded for bad behavior? Sam just kinda got screwed?

Structurally, the young Joe is the set of US investment banks. Nancy, his mother, is Congress. Neville, the dishonest child, is the set of subprime homebuyers while Sam is the rest of the US homeowning population.

Cheers to Neville Chamberlain, Joe the Plumber, Uncle Sam and Nancy Pelosi for the names. I understand Neville Chamberlain has nothing to do with it... he's just easy to make fun of

Interesting links, mostly from Mankiw

Stock returns are lower and volatility is higher when Congress is in session. As a proxy for American economic growth, that's not a good thing with an unbalanced legislature:

Some funny and interesting proposals for getting monetary policy past the issue of a zero bound:

On the trivial pursuits of Congress:

Jeffrey Sachs explains why the public-private program proposed by Geithner creates substantial moral hazard and pays banks a greater-than-fair value for their assets.

On problems with the charity tax (that you can't functionally tax charitable giving and expect the level of charitable giving to remain the same), from Feldstein:

On why it may not be such a good thing for AIG employee retention to force return of the AIG bonuses - A letter from an AIG EVP to the CEO:

On the "disparity in income growth"

I've been reading some Philip Arthur Fisher, who is generally considered as the father of modern growth investing and as one of the first to link the notion of competitive advantage with sustainable growth.

Although his books were written in the 1950's , he had a few interesting quotes that made me think a little bit about our present situation with regards to the Bush tax cuts and the spread of incomes.

The first:
"[The Middle Ages] was a period when most of the Western world lived in an environment of unnecessary want and human suffering. This was largely because the considerable mental ability of the period was devoted to fruitless results. Consider what might have been accomplished if half as much thought had been given to fighting hunger, disease, and greed as was devoted to debating such points as the number of angels that could balance on the head of a pin."

The second:
"Modern war always causes governments to spend far more than they can possibly collect from their taxpayers while the war is being waged. This causes a vast increase in the amount of money, so that each individual unit of money, such as a dollar, becomes worth less than it was before... This, of course, is the classic form of inflation...Expressed in constant dollars - that is, in real value - American stocks [and therefore American industry as a whole] in both World War II and the Korean period undoubtedly did fare less well than if the same period had been one of peace... there was too great a diversion of effort from the more profitable peace-time lines to... defense work."

The third:
"Now we come to a very different type of price influence. This is a change that is purely psychological. nothing has changed in the outside or economic world at all. The great majority of the financial community merely look upon the same circumstances from a different viewpoint than before. As a result of this changed way of appraising the same set of basic facts, they make a changed appraisal of the price... they will pay for the same shares."

And one from a paper by Parker and Vissing-Jorgensen, published by NBER:
"The consumption of high-consumption households is more exposed to fluctuations in aggregate consumption and income than that of low-consumption households in the Consumer Expenditure (CEX) Survey. The exposure to aggregate consumption growth of households in the top 10 percent of the consumption distribution in the CEX is about five times that of households in the bottom 80 percent. Given real aggregate per capita consumption growth about 3 percentage points less than its historical mean during the past year, these figures predict that the ratio of consumption of the top 10 percent to the bottom 80 percent has fallen by about 15 percentage points (relative to trend). Using income data from Piketty and Saez (2003), we show that the income(especially the wage income) of rich households is more exposed to aggregate fluctuations, so their higher income exposure is a likely contributor to their higher consumption exposure."

in other words...

any assertion that the middle class has suffered over the last decade while the rich have done considerably better neglects the notion that we WERE IN A FINANCIAL BUBBLE. Generally, large fluctuations in the economy help the rich more than the poor, and a financial bubble happens to disproportionately help rich people because of the nature of the kind of people who a) can afford to buy mortgage-related investments and, significantly, b) do business that relates to mortgage-related investments.

Thus, all that perceived gain by the top 1% of households may have just been fictitious (see the third Fisher quote). What is much MORE likely is that everybody declined just a little bit in real terms because we were in the middle of two wars (see Fisher quotes 1 and 2).

Thus, the Democratic crusade to bring the middle class up at the expense of the rich because the rich have "benefited so much from the last decade and the poor have not" misses the crucial point that much of that benefit seemed real and was not, and the rich are being hurt much more by this downturn than the poor, media coverage notwithstanding.

EDIT: On the "rich are being hurt much more by this downturn than the poor" quote - Obviously, the rich are in a much better position than the poor, and even small changes in the assets of the poor makes a big difference in quality of life, whereas moderate changes in the assets of the rich are less important to their welfare. My quote was pointing out that in terms of assets lost, the rich have lost, proportionate to what they have, much more than the poor, indicating that any "gains" the rich have made the last ten years were far more illusory than real.

My point with this post is to point out how disingenuous it is to claim that the rich have done exceedingly well in the last ten years while the middle class and poor have gotten screwed. In reality, it's very likely that everyone's real welfare has declined slightly, whether rich or poor.

Monday, March 23, 2009

Steve Forbes thinks Obama is incompetent

I don't agree on Bernanke - he's made his share of mistakes but I think he's right now. The rest of what he says? Makes a lot of sense. And what he misses is that an incompetent, un-reelectable Obama means that the Republicans win in 2012... who exactly are we going to be subjected to? The party's completely divided - if we get a fiscal conservative, moderate intellectual Republican, then that's fine. If we get a wackjob (Sarah Palin...), we're in trouble.

Chinese Monopoly in Key Resources

China has developed a monopoly in rare earth metals, a family of 17 metals that are key in the development of wind turbines, lithium batteries, semiconductors, and basically every piece of technical everything.

The US used to have mines, but they were closed due to price wars. Vietnam and Thailand have some undeveloped mines... but a lot of the international sources are owned by China.

China's already restricting supply - they have enough to supply the world with as much as it needs for a long, long time, but they instead provide only 10% of world demand outside of China in a move to try and get other countries to move their R+D and manufacturing to China.

Yet another move China has made right under our nose, with no response from us.

Via (in the comments section), there are three major companies in Australia who own most of the rare earth metal resources in Australia. The article posted above indicates China moving in on a bunch of the Australian assets already, so this is valuable color. Thanks, Sparty.

Science Research and Immigration

67% of everyone in the United States who entered Science and Engineering between 1995 and 2006 were immigrants. Almost 25% of all international patent applications from the US name foreign nationals as inventors.

US immigration policies prevent an absurd percentage of skilled foreigner workers from becoming citizens, so thees people return home with their skills. Their talent then benefits India, China and Canada instead of the US.

The US needs to keep growing to survive its debt load. The way for us to grow is innovative science and technology. Is there anything above that makes any sense?

One of the most important things I ever learned about

One of the most underappreciated concepts of mathematics, in my view, this quite easily applies to a number of things, from quantitative finance and the economic bailout to psychology and behavior to amorality and the substitution of science for religion by many educated people. This is easily one of the five most important things I've learned about as an undergraduate, in any of the multiple majors I considered.

The link has about 8 different explanations of how this works. I posted an extremely simplistic summary one.

Gödel showed that within [any] rigidly logical system... propositions can be formulated that are undecidable or undemonstrable within the axioms of the system. That is, within the system, there exist certain clear-cut statements that can neither be proved or disproved. Hence one cannot, using the usual methods, be certain that the axioms of arithmetic will not lead to contradictions ... It appears to foredoom hope of mathematical certitude through use of the obvious methods. Perhaps doomed also, as a result, is the ideal of science - to devise a set of axioms from which all phenomena of the external world can be deduced.

Sunday, March 22, 2009

Cool Quotes

Some thoughts...

...on the US obesity epidemic and health quick-fixes:
"This is my body, and I can do whatever I want to it. I can push it; Study it; Tweak it; Listen to it. Everybody wants to know what I am on. What am I on? I am on my bike busting my ass six hours a day; What are YOU on?" - Lance Armstrong

...on redistribution:
"You cannot legislate the poor into freedom by legislating the wealthy out of freedom. What one person receives without working for, another person must work for without receiving. The government cannot give to anybody anything that the government does not first take from somebody else. When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that, my dear friend, is about the end of any nation. You cannot multiply wealth by dividing it." - Dr. Adrian Rogers

...on a healthy skepticism:
"Anyone who has the power to make you believe absurdities has the power to make you commit injustices.
" - Voltaire

...on foreign policy:
"There is no such thing as an ex-KGB agent" - Vladimir Putin

...on the media:
"A witty saying proves nothing." - Voltaire

...on bailouts:
"Be not made a beggar by banqueting upon borrowing" - Ecclesiasticus 18:33

...on accepting the status quo:
"Every generation needs a new revolution" - Thomas Jefferson

...on blind atheism:
"A faith is a necessity to a man. Woe to him who believes in nothing. " - Victor Hugo

...on blind faith:
"Religion is the opiate of the masses." - Karl Marx

...on how to identify someone who is behaving well:
"There is no greatness where there is not simplicity, goodness and truth" - Leo Tolstoy

...on why populism is idiotic. and on blind atheism, part 2:
"Just because it doesn’t make sense to you doesn’t mean it doesn’t make sense." - Dr. Adrian Rogers

...on Black Swans:
"All the forces in the world are not so powerful as an idea whose time has come. " - Victor Hugo

...on short-term thinking:
"You know how to interpret the appearance of the sky, but you cannot interpret the signs of the times" -Matthew 16:3

...on blind optimism:
"Everything will turn out right, the world is built on that." -Mikhail Bulgakov

...on effort:
"Whatever your 100% looks like, give it." - Lance Armstrong

...on effort, part 2:
"I can accept failure, everyone fails at something. But I can't accept not trying. " - Michael Jordan

...on personal responsibility vs. blaming circumstance:
"Everything can be taken away from man but one thing: the last of the human freedoms - to choose one's attitude in any given set of circumstances, to choose one's own way" - Viktor Frankl

...on immigration:
""You were right," said the Master impressed by the neatness of Korovyov's work, "when you said: no documents, no person. So that means I don't exist since I don't have any documents."" - Mikhail Bulgakov

Credit to 13-D's Kiril Sokoloff for 6 of these.

Immigration Issues that go largely ignored

I'm going to lay out some facts that come together in a conclusion. See how many you need to read (in order) to guess the conclusion!

1)From what I understand, your average immigrant is significantly younger than your average American.

2) The United States has largely been in debt for the vast majority of its history.

3) Social Security, which actually currently runs a surplus, is going to start running unimaginably crushing deficits in the next decade without some serious reform and some serious luck

4) A major reason the United States has survived being in debt for over 200 years of its history is because it keeps growing in line with the long term growth of its debt, keeping the debt level as a percentage of GDP down.

5) England successfully reduced its debt level from bankrupt to solid-to-strong over the course of a century. Much of this was through fiscal discipline, but a major portion was growth, as well.

6) When people retire, they stop being productive.

7) The baby boom generation is hitting retirement age.

8) In the 1920s, the United States was the low-cost goods and resources producer to the rest of the world.

9) The Great Depression hit the US so hard because worldwide demand for its goods plummeted. The US largely shifted to the high-education, high-intellectual capital, branded, concept jobs that dominate it today.

8) China has a lot more people than us and is much more nimble because of the authoritarian nature of their government, so a lot of the high-tech, high-education ideas that have driven our growth since the 40s are going to them, and they have more of the natural-resource, commodity, manual labor, factory, etc. jobs because labor supply is still so high.

The United States, in order to have any chance of surviving as a world empire, needs to be able to outgrow its debt. Growth is going to become significantly harder with an aging population and a China that can, all of a sudden, start taking away a lot of the jobs that we have had an advantage in for so long. In order to deal with that, we need young people and we need to a) defend our dominance in the high-education jobs department, and b) replace our losses there with manufacturing and production in other areas.

Immigration provides a lot of that - immigrants are younger, and often productive in very different ways to people who grew up in America. Educated immigrants are especially valuable to the US. Restricting immigration is one of the fastest ways to turn us into Western Europe, but bigger, which isn't good, because the Western European model isn't so scalable, especially given our much, much larger military expenditures.

I've railed a lot against liberals recently, which I think is fair, given that liberals control both the White House and Congress, and the White House and Congress have had some TERRIBLE policy recently (stem cell research excluded - I love Obama's stem cell research policy). However, here, I get to rail against conservatives. The conservative notion that you can protect American jobs by restricting immigration, and that immigration being illegal is somehow indicative of immigration being destructive, is downright stupid.

Restricting immigration is just as protectionist as tariffs, which are also absolutely idiotic in 99.9999% of cases.

The reason immigration is monitored is to regulate the kind of people who can enter - people who can be productive and exist in our society without hurting other people. That should imply a qualification, not a quota... analogously, restricting who can get a driver's license may reduce the number of accidents on the road, but that doesn't mean it makes people as a whole better off.

Implementing Responsible Universal Health Insurance

As mentioned in my "is healthcare scalable" post, one of the only ways to provide everyone with healthcare in the United States in a feasible manner is to make a serious push towards preventative medicine.

Therefore, if the government implements a universal healthcare plan (which I think can be great in theory, with severe execution issues), one of the most important things is to ensure that people actually are forced to take responsibility for their own health. In my mind, that includes a number of policies:

1) Pigouvian taxes on unhealthful activities. This will significantly cut costs and provide funding at the same time. I'm thinking big trans-fat taxes, big smoking taxes, big alcohol taxes, taxes on sodas, etc. Similarly, pigouvian subsidies on good things - healthy weight loss products should be tax-free, gym memberships should be partially tax deductible, etc. The subsidies pay for themselves, and the taxes reduce incidence.

2) Healthcare premiums that actually reflect initial health status. Obese people should pay more for health insurance, smokers should pay more for health insurance, etc. Without this feature, you functionally have healthy people subsidizing the unhealthy behaviors of their peers.

These things should be remeasured every year at a checkup. If you miss your checkup by more than some number of months, your premium automatically starts going up on the assumption your condition has deteriorated until you go have a checkup. The months flexibility means that if people gain a little, they still have the opportunity to go back down - it's not totally heartless and left to chance, because you schedule your own checkup. But you can't be irresponsible forever and avoid the consequences.

3)This can be used to further other policies by creating a 1 (or if you're tolerant of stupidity, 2) strike policy. If you're caught using illegal drugs once/twice, you lose the right to government health insurance, or you have a MASSIVE premium hike for the rest of your life. If you're using ecstasy, cocaine, oxycontin, heroin, marijuana (which IS, by the way, SIGNIFICANTLY more harmful to your health than cigarettes and alcohol, contrary to popular belief), etc, it isn't fair for the rest of us to have to subsidize fixing you for your irresponsible and illegal behavior.

Same goes for driving under the influence, soliciting a prostitute, etc.

4) This relates to 2. Preventative healthcare steps should factor in significantly. If you don't get annual checkups, your premium should go up. If you're of the appropriate age (and gender, where appropriate) and don't get mammograms or pap smears or colonoscopies, your premium should go up. The cost of catching colon cancer or breast cancer is so much less if you catch it early, and is better for everyone involved. Laziness or lack of perception of risk is the major reason for these things not happening. When it hits your healthcare premiums, maybe that improves compliance.

Friday, March 20, 2009

The ridiculousness of the executive compensation debate

and that 165million is spread over a lot of people, too

(thanks to John for sending this in)

Tuesday, March 17, 2009

hyperinflation in the US

Yes, we CAN avoid hyperinflation, despite flooding the US economy with liquidity.

what we can't do is avoid hyperinflation and keep interest rates down. Low interest rates stimulate the economy.

Mihov believes we'll raise interest rates and shut down lending facilities. That would be the rational choice. Unfortunately, we just passed the EAWA; a Canadian was turned back at the border for trying to buy American goods to bring to Canadian stores because a border policeman thought he was "stealing American jobs"... and the border policeman has not been disciplined; we have a "Buy American" proposal for steel in the stimulus; and a number of cities and states are looking at imposing price controls on things from rent to oil to milk.

So assuming the US government will act rationally in an economic sense by suppressing growth at the end of a recession/depression may be pushing it.

Links and quotes on Price Controls, Protectionism, US Growth and the Budget

Krugman, Nobel Prizewinner in Economics, wouldn't accept Mankiw's bet that US growth would fall well below Obama's expectations

More problems with the protectionist Employ American Workers Act:

Mankiw on the Budget

Price Controls

(Side note: It would be hubris for an economist to say he understands more about how politics works than a politician. The economist may have ideas for ways to improve politics, and certainly may have knowledge on certain issues, but in terms of actually "getting stuff done" politically, an economist would be stupid to ignore the experience of a politician.

Of course, in this article, the reverse happens. Two economists say that rent control doesn't help provide cheap housing, and this state assemblyman thinks he knows more economics?)

A particular quote I loved, from a former socialist who rejects rent controls...

"In many cases rent control appears to be the most efficient technique presently known to destroy a city -- except for bombing," said Swedish economist Assar Lindbeck, a former socialist who has been researching rent control since the 1960s.

"In New York City, the Bronx basically fell to pieces because of rent control. You even had the extreme of landlords burning down their houses."

The South Bronx lost 40 percent of its housing stock in the 1960s and '70s, largely due to arson. Many buildings were suspected to have been torched by the landlords themselves, who found that their buildings were literally worthless: There was no way to make a profit due to rent controls, and nobody would buy a building that could not make a profit. Burning the building allowed them to collect insurance money and pay off debts.

"The reason people ask for [rent control] is that those with contracts gain in the short term ... It's a way that politicians can buy votes," Lindbeck said. "But the policy really hurts people entering the market -- young people and immigrants."

Mark-to-market vs cost accounting

I'll quote Buffett here: "It's better to be approximately right than precisely wrong."

Mark-to-market accounting makes VERY large assumptions about market efficiency that just aren't true. At times, large groups of people act irrationally in the exact same way, and for a time, things can get priced far below or above their intrinsic worth.

The problem is that when you mandate mark-to-market accounting (basically, something is listed as valued at what the market will currently pay for it, instead of what you paid for it originally, or what an educated guess is of what you're likely to recover for it in the end), that creates a positive feedback loop that amplifies the effect - so even if original mispricedness was irrational, it can wreck lending.

I understand the problems with letting banks model out what they think their securities will be worth and valuing them that way - there's an incentive to inflate the number. However, the swings of market panic are often much worse than a consistent inflation of value - if something is always 30% inflated, movements in the price of that security are amplified by only 30% in dollar magnitude (and 0% in percentage). Unfortunately, mark-to-market significantly increases swings in market value, and that's a problem when market value determines actionable ability.

To pose the question a different way... do you really think no mortgages will ever be paid off? Because a lot of assets are almost priced that way.

Friday, March 13, 2009

Possible Black Swan Disasters, and a little good news

I try to keep a general list of "black swan"-type events in my head, because aggregating exceedingly unlikely but highly impactful events generally means that one of them will actually happen. My criteria for events are those that are "game-changing". Things like the mortgage crisis and Hurricane Katrina were significant, but in the long run, (presumably) recover. I'm talking sudden, generally unexpected BIG things that reshape the face of an industry/field, the country or the face of the world for decades or even centuries. 

On a world scale, the extinction of the dinosaurs was a black swan. Alexander the Great and Julius Caesar were black swans. Jesus and Mohammed were black swans. The wheel, written language, the printing press, electricity, the light bulb, the combustion engine, refrigeration, the semiconductor and the internet were black swans. X-rays, penicillin and sanitation were black swans. Horace Mann's public school was a black swan (for the United States). The reinvention of republican democracy in the US was a black swan. World War 1 was a black swan. These type of events often shape history, and given that we're currently on top, that is likely only bad news for us.

Black swans in individual fields happen, also - the world of ornithology (I'm told) was rocked by the discovery of black swans in Australia, which is where the term got its name. Whether or not you think cellphones really did completely change the face of the world, they certainly changed the face of telecommunications. Et cetera. 

These kind of events are often not prepared for to the level they should be, because people perceive their likelihood as zero while decision-making, even if they acknowledge it separately. I group them in terms of "what preparation the world should be doing", which is why all of the events are negative.

My current list reads:
Warfare of Mass Destruction
       Avian Flu
       resistant TB
       resistant Malaria
       resistant Plague
       Hemorrhagic fever
Derivative-related economic meltdown from lack of diversity in bets
US government debt default
Yosemite mega-volcano eruption
Asteroid/meteor/comet strike
Global warming-related melting of Siberian permafrost

Depressing, I know, but policies and budgets need to be aware of these so that preparations can be made.

In any case, there are always black swans that DON'T happen because of excellent prevention. Nuclear war was narrowly averted (arguably) during the Cuban Missile Crisis. The Y2K bug was anticipated and avoided. Again, et cetera.

Which is why it's always nice to see the world make a little progress at avoiding disaster.

The way nuclear bomb manufacture relates to nuclear power plants is a little interesting. Nuclear power plant fuel (for all but a few specialty Thorium and Plutonium nuclear plants) is a combination of isotopes of Uranium - U-235 and U-238. U-238 is the overwhelming majority (>99%) of the world's uranium, and is not fissionable (does not react). One cannot extract the U-235 chemically, only mechanically, by taking advantage of the minute difference in atomic weight. Therefore, extraction is extremely expensive and difficult. Uranium that has added U-235 (extracted from another block of mostly U-238) is called "enriched" uranium. To be used in a nuclear reactor, the uranium must be ~2.5-3.5% U-235. To be used in a nuclear weapon, 85% U-235 is required for a good weapon, 20% is required for a moderately usable weapon, and if you have enough of the actual material, you can go a little under 20%. In any case, reactor fuel is not even close pure enough to be used for a fission bomb, and other use in a bomb is not the traditional "nuclear" bomb, and doesn't cause nearly the same level of harm.

HOWEVER, if you put reactor fuel through a nuclear reactor, one of the waste byproducts is Plutonium. Plutonium is relatively easy to extract, much cheaper than U-235 and, most dangerously, fissions very well for nuclear bomb purposes. The Hiroshima bomb was a U-235 bomb, and I believe that every other bomb ever exploded (Nagasaki, all the test weapons, etc) are Plutonium weapons.

Thus, nuclear reactors are extremely dangerous in the wrong hands. Give Iran a nuclear power reactor, and it has access to Plutonium. It'd need to extract it, which isn't quite as easy as I've made it sound, but it's MUCH easier than extracting plutonium from no waste at all.

However, nuclear energy is a viable way to partially address some concerns around global warming, which can hit an unstoppable spiral once it hits a critical point (we don't really know what that level is, but we've got good reason to believe it exists) 

Thus, the ability to create a reactor that DOESN'T spit out usable plutonium would be an incredible way to cheapen energy, reduce carbon emissions and still secure nuclear warfare. 

So to finally get to my point, Israeli scientists have figured out a way to "spike" reactor Uranium with Americium that gets embedded in the Plutonium waste. Extracting it requires an additional method of processing, which is another step we can try and secure. This is very good news for black swan delayance/avoidance.

Wednesday, March 11, 2009

Stock Market and the Economy

one more Nate Silver-related post.

In defense of Barro's research, stock market crashes are usually a leading indicator of a recession or depression. Stocks are priced on expectations of future earnings, so stocks SHOULD drop before the economy actually starts going south.

Stocks fluctuate much more than the magnitude of the recession/depression because equity is at the bottom of the corporate capital structure (A company worth 100, 60 in debt and 40 in equity, if it loses 20% of its value, the debt isn't affected, really, but the equity loses 50% of its value. Similarly, if it gains 20% in value, debt isn't affected but the equity gains 50%. The company's overall value represents the economy, the equity value represents the stock market).

If the economy bottoms at a 5% GDP drop, which is a recession, you would expect a substantially larger stock market drop prior to the recession.

You have a situation were X causes Y, and you can't observe X but you can observe Y. The strength of the causality varies time to time and is difficult to estimate, which is why it was worth Barro's time. If you can estimate the strength of that causality, you can look at what we've seen in the stock market, plug it into Y and reverse engineer to get a sense of X.

I haven't read Barro's paper. Silver is a much better statistician than I am, and if he has objections to the econometric method Barro used and thinks that the prediction is therefore not very useful, that's a fair point. But calling it irrelevant and simplistic ignores the economic intuition underlying Barro's paper.

Again, Silver is a phenomenal statistician, but he's excluded the economic intuition behind Barro's work.

EDIT: I'll point out that I do agree with his very last point - stock market prices have a very large propensity to be irrational for sustained periods of time. Stock markets are an imperfect proxy predictor, not a measuring tool, for economic performance. However, if you pay attention to things like standard deviations and all that, which Barro must have if he predicts a 20% chance of a depression instead of just saying "I don't predict a depression", you can get a rough control for that if you think psychology is in the normal range this time compared to other times of similar stock market crashes.

Jungle Primaries as a Better Way to Elect?

Washington state just announced a "jungle primary" system, and California is considering a similar one.

Instead of having a democratic primary and a republican primary, a jungle primary mixes all of the parties together and pits the top two finishers against one another in the final election.

You may need to be able to vote for TWO candidates, to avoid two moderates canceling each other out and leaving an extreme liberal and extreme conservative. But even if it's just one primary vote per person, you're more likely to have moderate politicians. Given the crap we see coming from both extremes of the ideological spectrum, more moderates would be better.

Nate Silver and the stock market

Nate Silver is a talented statistician, but one of his recent posts makes politics into economics.

Because he is staunchly pro-Democrat, Silver's article attempts to debunk the notion that various Obama moves (stimulus, budget, etc) have caused the massive stock market drops that occur as Obama announces them. His logic is that markets are pretty good at pricing in information beforehand, so the stimulus and budget and such were priced in before Obama announced them. Thus, the stimulus and budget didn't cause the stock market drop, coincidence did.

What Silver is missing is that the market is sometimes very good at pricing in QUALITY EXPECTATIONS information beforehand. If everybody knew the stimulus package was going to pass, but the stimulus package turns out to be in some way worse than expected (which most economists DID think), then the moment of the stimulus' announcement DOES constitute new data. If the market expected Republicans to remove more bad components, or if the market expected Obama to be more budget-conscious, and then the actual package was worse, then the short-term economic outlook DOES change significantly from one second before the stimulus gets announced to the moment the stimulus gets announced.

In fact, you don't even need the stimulus to be bad for it to cause stock market drops. The stimulus was undoubtedly a democratic spending package rather than a short-term-stimulus-optimizing collection of programs. If the market was expecting a mix more heavily weighted to the latter and got the former, simple math means that expected stimulus from the stimulus package falls the moment the details are released. Stock market therefore drops.

Size and date of things like the stimulus and the budget are only roughly correlated with quality of these plans, but all of them are critical in setting economic expectations.

Tuesday, March 10, 2009

Is there a kind of protectionism that ISN'T bad?

I am overwhelmingly against protectionism, like almost every economist. This even extends to labor, where I'm against immigration restrictions on people who can work productively here (more on this in a future post).

However, I've been thinking, and there's one kind of good that protectionism may not be so bad on. With goods where there's no difference in utility provided by the good between the American and the foreign version, and there's no difference in cost of the good (or the foreign one is more expensive), but because of heavy branding, the foreign one still sells better, then protectionism is a way of forcing perfect information, and can be a good thing (BEFORE you factor in retributive tariffs, which will always be a problem and probably mean that this is stuck in the realm of theory).

An example would be something like perfume.

1) It is highly unlikely that there are any major "quality" differences in perfumes across countries, because the quality is entirely observable in the scent, and the base is alcohol, which is universal. There shouldn't be any hidden quality variables (like health effects or how long the scent lasts) with various different perfumes that aren't the same for American and foreign varieties.

2) It is also highly unlikely that there are major cost differences in perfumes. Though I'm no perfume expert, I'd imagine perfume production costs are largely commodity raw materials and capital costs, with fairly low labor costs. Any slightly higher labor costs in the US are probably offset by the fact that we have some of the lowest capital costs in the world due to our financial-system-until-2006 and our advanced science and scientists. Commodities are commodities and cost the same roughly year round.

3) Branding is HUGE in perfume - A bottle of the original Chanel scent can cost almost $1000, while cheaper varieties made in America can cost 1/10 that. Even if Chanel's scent is distinctive, you probably can come up with a close substitute without violating patent laws. People who buy Chanel are either doing so for the "cache" and bragging rights or because they don't know such close substitutes exist.

Therefore, by tariffing Chanel perfume, you reduce consumption of Chanel (by a little bit), raise money for the government, and may actually increase the overall utility of the people who are forced to switch from Chanel to lower-quality perfume, even if they don't know it. You provide them with $800 of extra disposable income without really affecting the quality of perfume they have. Some portion of that $800 will get spent on American goods, so America ends up being better off for that tariff.

This is a highly unusual circumstance (I'd imagine it's mostly consumer goods, mostly upscale, mostly with low labor component of production), and ignores retributive tariffs, which is a game theory issue and probably still means tariffs are a bad idea. However, if you could guarantee no retributive tariffs, these criteria constitute (probably) the one type of tariff that makes people better off. I am no perfume expert, but it seems like the type of good that meets the criteria.

Sunday, March 8, 2009

Fractional Reserve Banking... not anymore...

On a very related note to the inflation post earlier, the M1 multiplier has dropped below one. This basically means that for every dollar you put in a bank, the bank holds onto more than one dollar (possible because the bank presumably has its own money, and also has received money from the Federal Government in stabilization funds). The number is currently $1.21.

Before this crisis began, GS lent about about 95% of the money it received in deposits, and even the more conservative consumer banks lent out 80-90%.

This is generally accepted as a very bad thing - it means credit is not available for people who need it, which means the economy can't easily restart.

It also means that when banks start lending again, inflation shoots up. The decline in the M1 multiplier is the causal effect of increasing the money supply so much (see prior post) and the increase in credit defaults.

Still, it does mean the financial crisis is in full bore. The post I wrote earlier with no commentary (the letter to Krugman) seems more attractive.

A VERY scary inflation graph

Basically, if we went back to 2006, before the credit crisis began, and the only thing we did was enact the stimulatory things the Bush and Obama governments have been doing, the price of everything would approximately DOUBLE. In my opinion, this would quite quickly eat at any benefits.

Of course, this is extremely simplistic. We need to expand the monetary base (which is what would cause the prices to rise) substantially if we want to survive the crisis, and it's something we can contract later, and any US inherent productivity capacity growth (distinct from GDP in that GDP measures what we do produce and capacity measures what we can produce) would decrease that over time.

However, it does make a decent case for this: EXPECT INFLATION IN THE FUTURE.

It creates a sick paradox, too. I harp on redistribution a lot, but that's cuz it's important.

The problem is that if prices for everything (on average) double, poor people can't afford what they're buying. However, money in the hands of rich people mitigates the level of inflation you see because of higher investment. In other words, money in the hands of rich people lets you 'grow out' of your inflation, but poor people get hammered in the interim. Everyone's better in the long run, but you need to make sure poor people survive to see the long run. Money moved to poor people prolongs the pain for everyone, but in the interim, poor people do better.

Really, really pray that this green energy investment actually pays off, and big time. If the cost of green energy drops significantly, you may see a significant reduction in our trade deficit, and if you're really successful, the cost of energy may drop. That's a way to help mitigate inflation.

Why I criticize both Democrats and Republicans

My brother kindly asked me to put bullet points at the top of my articles. So I'll try and see how it works out:
- This person, as well as I, support many of the programs Obama has been doing.
- Doing all of it at once, however, ignores that we need to make tradeoffs, because this budget is the highest it's been in half a century or more (maybe much more).
-Redistributing wealth from the top down to pay for all of this, under the eye of the painfully bureaucratic government, is probably a bad idea.
-Sidenote on redistribution: Mankiw ran statistics - currently, the bottom 40% of the US population pays the lowest in taxes it ever has, despite being the best off it ever has been. This is thanks to the Bush tax cuts. Bottom quintile pays about 4% of income and second lowest pays 9 point something %. The wealthy pay around the average of what they have paid in the last few decades. The Bush tax cuts dropped it from its Clinton-era highs, but it's still well above it's Reagan lows. Currently stands at 31 point something % for the top 1% of population.
Article reprinted below, because it pretty well typifies how I feel about US politics.

You wouldn’t know it some days, but there are moderates in this country — moderate conservatives, moderate liberals, just plain moderates. We sympathize with a lot of the things that President Obama is trying to do. We like his investments in education and energy innovation. We support health care reform that expands coverage while reducing costs.

But the Obama budget is more than just the sum of its parts. There is, entailed in it, a promiscuous unwillingness to set priorities and accept trade-offs. There is evidence of a party swept up in its own revolutionary fervor — caught up in the self-flattering belief that history has called upon it to solve all problems at once.

So programs are piled on top of each other and we wind up with a gargantuan $3.6 trillion budget. We end up with deficits that, when considered realistically, are $1 trillion a year and stretch as far as the eye can see. We end up with an agenda that is unexceptional in its parts but that, when taken as a whole, represents a social-engineering experiment that is entirely new.

The U.S. has never been a society riven by class resentment. Yet the Obama budget is predicated on a class divide. The president issued a read-my-lips pledge that no new burdens will fall on 95 percent of the American people. All the costs will be borne by the rich and all benefits redistributed downward.

The U.S. has always been a decentralized nation, skeptical of top-down planning. Yet, the current administration concentrates enormous power in Washington, while plan after plan emanates from a small group of understaffed experts.

The U.S. has always had vibrant neighborhood associations. But in its very first budget, the Obama administration raises the cost of charitable giving. It punishes civic activism and expands state intervention.

The U.S. has traditionally had a relatively limited central government. But federal spending as a share of G.D.P. is zooming from its modern norm of 20 percent to an unacknowledged level somewhere far beyond.

Those of us who consider ourselves moderates — moderate-conservative, in my case — are forced to confront the reality that Barack Obama is not who we thought he was. His words are responsible; his character is inspiring. But his actions betray a transformational liberalism that should put every centrist on notice. As Clive Crook, an Obama admirer, wrote in The Financial Times, the Obama budget “contains no trace of compromise. It makes no gesture, however small, however costless to its larger agenda, of a bipartisan approach to the great questions it addresses. It is a liberal’s dream of a new New Deal.”

Moderates now find themselves betwixt and between. On the left, there is a president who appears to be, as Crook says, “a conviction politician, a bold progressive liberal.” On the right, there are the Rush Limbaugh brigades. The only thing more scary than Obama’s experiment is the thought that it might fail and the political power will swing over to a Republican Party that is currently unfit to wield it.

Those of us in the moderate tradition — the Hamiltonian tradition that believes in limited but energetic government — thus find ourselves facing a void. We moderates are going to have to assert ourselves. We’re going to have to take a centrist tendency that has been politically feckless and intellectually vapid and turn it into an influential force.

The first task will be to block the excesses of unchecked liberalism. In the past weeks, Democrats have legislated provisions to dilute welfare reform, restrict the inflow of skilled immigrants and gut a voucher program designed for poor students. It will be up to moderates to raise the alarms against these ideological outrages.

But beyond that, moderates will have to sketch out an alternative vision. This is a vision of a nation in which we’re all in it together — in which burdens are shared broadly, rather than simply inflicted upon a small minority. This is a vision of a nation that does not try to build prosperity on a foundation of debt. This is a vision that puts competitiveness and growth first, not redistribution first.

Moderates are going to have to try to tamp down the polarizing warfare that is sure to flow from Obama’s über-partisan budget. They will have to face fiscal realities honestly and not base revenue projections on rosy scenarios of a shallow recession and robust growth next year.

They will have to take the economic crisis seriously and not use it as a cue to focus on every other problem under the sun. They’re going to have to offer an agenda that inspires confidence by its steadiness rather than shaking confidence with its hyperactivity.

If they can do that, maybe they can lure this White House back to its best self — and someday offer respite from the endless war of the extremes.

Macroeconomics Articles

The Obama mortgage plan targets lowering interest payments to stem foreclosures, instead of instead of principal. A Yale Econ Professor and a BU Law Professor think this is a bad idea (from Mankiw):

An argument about the correct projected growth rate, starting from today. Basically, Mankiw vs DeLong, Krugman and the CEA/Romer/Summers/Obama. This blog strips down a bunch of the probability that Mankiw, DeLong and Krugman have on their blogs... unfortunately, Obama and his advisers aren't exactly blogging. It seems that Mankiw's technically correct (not a huge surprise - Krugman's never done macro and the CEA has to be political as well as economic which strips their analysis. Mankiw and DeLong are both pretty talented macro guys, but Mankiw noticed an outlier that DeLong didn't (Reagan's tax policies and the state of the world meant very fast growth after the 80s recessions, which sadly, Obama's stimulus and the international crisis doesn't help with)

I recommend reading the source blogs as well.

Friday, March 6, 2009

Thinking about Welfare's Inefficiencies

There's a widespread popular belief that welfare provides for people better than a lot of minimum wage working. I don't deny the distorting effects that social cushioning can provide to a low-paid worker on the margin, but these distorting effects are probably much less than most people think:

In Oregon, food stamps from welfare equal $21 per week to eat on.

However, everyone hears stories like this:

This is allegedly a checkout person at a retail store who gets furious at the myriads of foodstamp recipients he sees buying "Delmonaco steaks and lobsters."

Talk to most people, and the amount of the food stamps is usually what they talk about. Liberals will typically talk for a long time about how inadequate welfare checks are for the people who need to survive on them, while conservatives will usually talk about how individuals on welfare receive more than many blue collar workers, and they shouldn't need so much help from the government and should get a job themselves.

What if (and I'm hoping someone with access to data can send it to me) the problem isn't the amount, but enforcement of the qualification threshold? Conservatives are almost certainly wrong in universally stating that people on welfare could do better for themselves if they tried; certainly, there are many cases of people who ARE trying and still aren't making it. However, liberals may not be fair in implying that every worker on welfare is suffering and needs welfare to survive. It is quite plausible that some of the recipients of welfare don't actually need it, and therefore use it to "cheat the system". This explains some of the anecdotal lavish purchases on welfare without making incorrect blanket statements about welfare recipients.

Therefore, perhaps qualifications for welfare are a better focus for people concerned about social spending. Better qualifications creates a more efficient system, with better efficacy per dollar spent. Individuals who need the help could receive more money, or at least it would cost less to give them the same amount. In a world with substantial opportunity costs of government spending in individual areas, that's an important goal.

On a side note, we can create a structural, instead of emotional or anecdotal, system of thinking about welfare, to make decisions and opinions about it more rational. If one gives both liberals and conservatives the benefit of the doubt and assume the most sophisticated version of their arguments, the liberal vs conservative argument for/against welfare is one of type I vs type II error. Both liberals and conservatives who are non-naive are forced to acknowledge that there are 4 kinds of people:

1) people who need welfare who qualify for welfare
2) people who need welfare who don't qualify for welfare
3) people who don't need welfare who qualify for welfare
4) people who don't need welfare who don't qualify for welfare

The relative sizes of these groups is up for debate, as is the severity of Type I errors (a large number of people in group 2) vs Type II errors (a large number of people in group 3). While intuition states that a large group 3 is less severe than a large group 2, this ignores the notion of opportunity cost; you may be better off with a large group 2 and using all the money you save to help people who fall in that group in different ways.

It seems to me that liberals misclassify members of group 3 as group 1, and therefore overemphasize group 2. Therefore, they try and minimize group 2 first, and then given the constraints imposed by minimizing 2, do their best to minimize group 3. Conservatives misclassify members of group 2 as group 4, and therefore overemphasize group 3. They try and minimize group 3 first, and then given the constraints imposed by minimizing 3, do their best to minimize 2.

It may be more sensible in a world with opportunity costs to try and minimize them jointly. Presented in the manner I just did, that seems to be a common sense middle ground. However, nobody on either side seems to be advocating for that; instead, we hear anecdotes and evidence about how we need to push further in one direction or the other.

Another decent case for mandating philosophy, economics and statistics for all college students; at least then, educated people will have some background in structural thinking and data analysis. Anecdote-based and evidence-based arguments are very important and certainly better than nothing, but they are more prominent in policymaking than they deserve to be relative to structural thinking. The dogmatic treatment of welfare by liberals and conservatives serves as a decent example of that.

Increasing Gvt Revenue without Increasing Taxes

Don't say this very often, but props to Alabama for progressive thinking. Alabama lengthened hours of liquor sales and will start allowing sales of liquor on Sundays. This will be more convenient for consumers while increasing overall sales (and therefore overall tax revenues).

I'm not alcohol's biggest fan and think it should be subject to Pigouvian taxes, the same way I think of tobacco, trans-fats, gasoline, guns, incandescent lights and water bottles. However, legally limiting the hours of alcohol sales seems to be an inefficient way of preventing drinking. Taxes can cause the same level of inconvenience but also raise state revenue while allowing people to actually consume if they want to.

Here's hoping other states follow suit.

Wednesday, March 4, 2009

Electing Better Politicians, part 2

I figured I should separate this post cuz it's a different idea.

Problem: Politicians prioritize getting re-elected over making substantial change.


Instead of paying politicians a salary, politicians should post some predetermined percentage of their own net worth at the beginning of their term (perhaps a progressive scale, like income taxation, on net worth percentage as the politician gets richer).

They would receive this money back, scaled by a multiplier. That acts as their salary.

There are many ideas for how you could do the multiplier, but I favor an accountability approach:
25% national approval rating of their branch of government
25% approval rating of their own personal performance
50% factors that the candidate chooses themselves during their campaign and announces to the public. These would have to be selected and publicly announced before receiving the party nomination, so gerrymandering doesn't strip the system of effectiveness. Once chosen, these cannot change.

There would need to be some nontrivial percentage of politicians who lose money or don't make any money over their term, in order to make the system effective at redirecting politicians towards the true goals of their term.

50% based on composite approval ratings accounts for the fact that priorities change as terms go along. Nobody thought national security would be so central to Bush's term.

The other 50% forces politicians to be explicit about what they will try to do. I hope everyone was as appalled as I was to see McCain and Obama spew the same rehearsed crap in every debate (typified and unintentionally parodied by Palin's abominable, buzzword-centered performance in the debate with Biden and in the infamous Couric interview). If Obama or McCain had 10%, 20%, 50%, some amount of net worth riding on their job performance as they define it, then we'll learn alot about what they ACTUALLY prioritize.

50% seems high... but why SHOULDN'T public service force people to put their money where their mouth is? You are taking on a position where your agenda affects literally millions of people. Why shouldn't people be held accountable or risk personal ruin? The other job that intuitively strikes one as just-as-important is medicine, and a doctor risks personal ruin every time he walks into an operating room, because he can lose his license if he fails to do a good job. Politicians should be held to the same standard.

Tuesday, March 3, 2009

Electing Better Politicians

Someone sent me a link to Lena Chen's blog, claiming that she had a photo I'd actually find interesting for this blog. I never thought in a million years Lena Chen's blogging and mine would have anything in common.

For those who don't link to other sites, according to a USA Today poll:
Responses to "Do you favor or oppose the federal government temporarily taking over major US banks in danger of failing in an attempt to stabilize them?": 54% favor, 44% oppose, 3% no opinion.

Responses to "Do you favor or oppose the federal government temporarily nationalizing major US banks in danger of failing in an attempt to stabilize them?": 37% favor, 57% oppose, 6% no opinion.

This image raises the notion that perhaps improving our educational system will improve the functioning of Congress. In my opinion, the rise of the media age has increased the extent to which our Congresspeople pander to the whims of public opinion. They are, in a sense, prioritizing getting re-elected over making a substantial difference.

This supports two ideas:
1) a more educated populace would mean politicians pandering to a more educated public. It would pay more dividends than just a more productive public.

2) Being a senator or representative should be an unpaid, part-time job. Otherwise, there's too much incentive for congresspeople to prioritize re-election (they lose their job if they don't win!)

I understand that there's still the power kick, and that's not going to go away easily. My next post will be an alternate system that may hold politicians more accountable.

Monday, March 2, 2009

Perils of big government and restricting executive compensation

Fannie and Freddie were partially privatized because government intervention in their activities was inefficient and harming the mortgage and housing market in the US in the 70s.

They collapsed largely because of federal legislation requiring them to issue more subprime mortgages at bad prices. Bipartisan Congressional intervention in ~05 was at the root of much of this crisis.

Now the government is saying that they'll never be private again, and will remain tools of the Federal Government. I understand why this makes political sense for the individuals who want to stay in power, but can someone explain to me why this makes economic sense?

Another part that stood out:

"On Monday, Freddie Mac’s chief executive, David M. Moffett, unexpectedly resigned less than six months after he was recruited by regulators, having chafed at low pay and the burdens of second-guessing by government officials, according to people with knowledge of the situation.

Fannie Mae has also experienced a wave of defections as people leave for better-paying and less scrutinized jobs."

I've said on this blog before that government restrictions on executive pay increase turnover and decrease competent management. This is a picture perfect example.

Minimum wage, social security and tax cartels

Three interesting components of this article:

1) A textbook explanation for why minimum wage increases unemployment and distorts labor-capital allocation decisions. Decent argument to be made that, net, the harm to individuals currently at the minimum wage caused by lowering the minimum wage is less than the gain to individuals currently unemployed who can take minimum wage jobs.

2) A good explanation of one way to partially mitigage Social Security issues. Wages tend to grow faster than prices; that's the definition of growth. Social Security payments in the U.S. are indexed to wage growth, meaning that Social Security payments actually increase in purchasing power over time. I understand why this is nice-sounding (people who have retired still get to benefit from further economic growth), but when you can't afford Social Security to begin with, indexing to prices lengthens the amount of time for which the program can remain solvent without lowering seniors' standard of living.

3) A warning of potential tax cartels. When countries raise taxes in isolation, productive people leave for lower tax areas (think Rolling Stones in Britain moving to France because of Britain's 90% marginal tax rate on high incomes). However, if countries coordinate the rise of taxes, productive people have nowhere to move. This is easier said than done, because there are a number of small countries (mostly former British colonies) that refuse to comply with Europe's attempts to do this. Without punishment, incentives to deviate from this scheme are high, so the OECD is blacklisting countries that don't raise taxes in concert with everywhere else.

This would be a tremendously bad thing for the world. Countries can harmonize tax rates but most can't force productive people to keep being as productive as they were. In the past, if England had a ridiculously high tax rate and the productive people moved to France or America, at least the world benefited from their productivity. Net loss to England (but less than just subtracting the productivity of those individuals, because world productivity went up), and net gain to everybody else. Under tax cartels, a productive individual who DOESN'T do his job for fun (as the Rolling Stones plausibly did) will cut back his hours instead of moving. The country he lives in benefits in the very-short term as short term tax revenues increase. Long-term, productivity reductions mean tax revenue suffers as well (see the Hinc and Linc post from February). Everybody else in the world suffers immediately.

Computerizing Medical Records in Stimulus, Mea Culpa

According to this article, the lack of computerized health records represents market failure. In short, the health records have such a high positive externality:benefit to doctors ratio that most individual small practices (75% of all practices have less than 10 people) have to treat it as an unreimbursed cost, not an investment.

In that case, it's textbook for government intervention.

That DOESN'T mean it should have been in the stimulus package - it probably should have been outside legislation. Hard to know the opportunity cost because it's hard to know the savings. Presumably, most of the savings come from at the end - moving from 80% computerized to 100% computerized records, because that's when sharing records becomes most feasible.

It's not ridiculous to think that they may be high. In that case, mea culpa. Perhaps this component of the stimulus is fine.

Doesn't mean lots of the rest of it aren't bad. See my post.

Medical Price Caps: A Bad Idea

This should serve as evidence why it'd be a very bad idea to forcibly reduce medical expenses through capping prices of health services or cutting doctor pay (which are very similar in end effect).

Instead of making some major statistical argument, I'm posting this article. I'm highlighting quotes from doctors I think are most pertinent to the notion that supply of talented doctors is stretched to a limit and fairly inelastic in the short and medium term, and why you can't cap medical expenses through insurance, regulation or anything else:

• It saddens me that my lifelong enjoyment and enthusiasm for medicine has all but died. I have watched reimbursement shrink, while overhead has more than doubled. I've been forced to take on more patients. I work 12- to 14-hour days and come in on weekends. It's still the most amazing job in the world, but I am exhausted all the time.
--Vance Harris, MD, family physician, Redding, California

• In many ways, doctors are held to an unrealistic standard. We are never, ever allowed to make a mistake. I don't know anybody who can live that way.
--James Dillard, MD

• Not a day goes by when I don't think about the potential for being sued. It makes me give patients a lot of unnecessary tests that are potentially harmful, just so I don't miss an injury or problem that comes back to haunt me in the form of a lawsuit.
--ER physician, Colorado Springs, Colorado

• Everyone thinks all doctors know one another. But when we refer you to specialists, we often have no idea who those people are. Generally, we only know that they accept your insurance plan.
--Pediatrician, Hartsdale, New York

• Plan for a time when the bulk of your medical care will come from less committed doctors willing to work for much lower wages. Plan for a very impersonal and rushed visit during which the true nature of your problems will probably never be addressed and issues just under the surface will never be uncovered.
--Vance Harris, MD

[Of every $100 in medical practice revenue,]
$41 Amount that goes into the doctor's paycheck

Over the course of a year, that adds up to $155,000, the annual salary of the average family physician. That number rose just 3.3% between 2002 and 2006, while expenses increased nearly 25% over the same period.

The whole article:


41 Secrets Your Doctor Would Never Share

Reader's Digest offered two dozen doctors a chance to tell it like it really is, and general practitioners, surgeons, shrinks, pediatricians, and other specialists took the challenge. Some wanted to be anonymous; some didn't care. But all of them revealed funny, frightening, and downright shocking things that can help you be a better, smarter patient.

We're Impatient

• I am utterly tired of being your mother. Every time I see you, I have to say the obligatory "You need to lose some weight." But you swear you "don't eat anything" or "the weight just doesn't come off," and the subject is dropped. Then you come in here complaining about your knees hurting, your back is killing you, your feet ache, and you can't breathe when you walk up half a flight of stairs. So I'm supposed to hold your hand and talk you into backing away from that box of Twinkies. Boy, do I get tired of repeating the stuff most patients just don't listen to.
--Cardiologist, Brooklyn, New York

• I was told in school to put a patient in a gown when he isn't listening or cooperating. It casts him in a position of subservience.
--Chiropractor, Atlanta

• Thank you for bringing in a sample of your (stool, urine, etc.) from home. I'll put it in my personal collection of things that really gross me out.
--Douglas Farrago, MD, editor, Placebo Journal

• One of the things that bug me is people who leave their cell phones on. I'm running on a very tight schedule, and I want to spend as much time with patients as I possibly can. Use that time to get the information and the process you need. Please don't answer the cell.
--James Dillard, MD, pain specialist, New York City

• I wish patients would take more responsibility for their own health and stop relying on me to bail them out of their own problems.
--ER physician, Colorado Springs, Colorado

• So let me get this straight: You want a referral to three specialists, an MRI, the medication you saw on TV, and an extra hour for this visit. Gotcha. Do you want fries with that?
--Douglas Farrago, MD

• I used to have my secretary page me after I had spent five minutes in the room with a difficult or overly chatty patient. Then I'd run out, saying, "Oh, I have an emergency."
--Oncologist, Santa Cruz, California

• Many patients assume that female physicians are nurses or therapists. I can't tell you how often I've introduced myself as Dr. M. and then been called a nurse, therapist, or aide and asked to fetch coffee or perform other similar tasks. I have great respect for our nurses and other ancillary personnel and the work they do, but this doesn't seem to happen to my male colleagues.
--Physical medicine and rehabilitation doctor, Royal Oak, Michigan

• The most unsettling thing for a physician is when the patient doesn't trust you or believe you.
--Obstetrician-gynecologist, New York City

• It really bugs me when people come to the ER for fairly trivial things that could be dealt with at home.
--ER physician, Colorado Springs, Colorado

• Your doctor generally knows more than a website. I have patients with whom I spend enormous amounts of time, explaining things and coming up with a treatment strategy. Then I get e-mails a few days later, saying they were looking at this website that says something completely different and wacky, and they want to do that. To which I want to say (but I don't), "So why don't you get the website to take over your care?"
--James Dillard, MD

• I know that Reader's Digest recommends bringing in a complete list of all your symptoms, but every time you do, it only reinforces my desire to quit this profession.
--Douglas Farrago, MD [Note: I don't know what this guy's problem is. Most doctors I've talked to (my parents included) really prefer lists]

Pills, Pills, Pills

• Sometimes it's easier for a doctor to write a prescription for a medicine than to explain why the patient doesn't need it.
--Cardiologist, Bangor, Maine

• Those so-called free medication samples of the newest and most expensive drugs may not be the best or safest.
--Internist, Philadelphia

• Taking psychiatric drugs affects your insurability. If you take Prozac, it may be harder and more expensive for you to get life insurance, health insurance, or long-term-care insurance.
--Daniel Amen, MD, psychiatrist, Newport Beach, California

• Ninety-four percent of doctors take gifts from drug companies, even though research has shown that these gifts bias our clinical decision making.
--Internist, Rochester, Minnesota

Bills, Bills, Bills

• Doctors respond to market forces. If the reimbursement system is fee-for-service, that results in more services. If you build a new CT scan, someone will use it, even though having a procedure you don't need is never a good thing.
--Family physician, Washington, D.C.

• I really do know why you're bringing your husband and three kids, all of whom are also sick, with you today. No, they are not getting free care.
--Douglas Farrago, MD

• Doctors get paid each time they visit their patients in the hospital, so if you're there for seven days rather than five, they can bill for seven visits. The hospital often gets paid only for the diagnosis code, whether you're in there for two days or ten.
--Evan S. Levine, MD

• Twenty years ago, when I started my practice, my ear, nose, and throat procedures financially supported my facial plastic surgery practice. Today, my cosmetic practice is the only thing that allows me to continue to do ear, nose, and throat procedures, which barely cover my overhead.
--Ear, nose, throat, and facial plastic surgeon, Dallas/Fort Worth

Free Advice

• Avoid Friday afternoon surgery. The day after surgery is when most problems happen. If the next day is Saturday, you're flying by yourself without a safety net, because the units are understaffed and ERs are overwhelmed because doctors' offices are closed.
--Heart surgeon, New York City

• In many hospitals, the length of the white coat is related to the length of training. Medical students wear the shortest coats.
--Pediatrician, Baltimore

• Often the biggest names, the department chairmen, are not the best clinicians, because they spend most of their time being administrators. They no longer primarily focus on taking care of patients.
--Heart surgeon, New York City

The Darker Side

• It saddens me that my lifelong enjoyment and enthusiasm for medicine has all but died. I have watched reimbursement shrink, while overhead has more than doubled. I've been forced to take on more patients. I work 12- to 14-hour days and come in on weekends. It's still the most amazing job in the world, but I am exhausted all the time.
--Vance Harris, MD, family physician, Redding, California

• In many ways, doctors are held to an unrealistic standard. We are never, ever allowed to make a mistake. I don't know anybody who can live that way.
--James Dillard, MD

• Not a day goes by when I don't think about the potential for being sued. It makes me give patients a lot of unnecessary tests that are potentially harmful, just so I don't miss an injury or problem that comes back to haunt me in the form of a lawsuit.
--ER physician, Colorado Springs, Colorado

• Doctors often make patients wait while they listen to sales pitches from drug reps.
--Cardiologist, Bangor, Maine

• It's pretty common for doctors to talk about their patients and make judgments, particularly about their appearance.
--Family physician, Washington, D.C.

• Everyone thinks all doctors know one another. But when we refer you to specialists, we often have no idea who those people are. Generally, we only know that they accept your insurance plan.
--Pediatrician, Hartsdale, New York

• In most branches of medicine, we deal more commonly with old people. So we become much more enthusiastic when a young person comes along. We have more in common with and are more attracted to him or her. Doctors have a limited amount of time, so the younger and more attractive you are, the more likely you are to get more of our time.
--Family physician, Washington, D.C.

• Plan for a time when the bulk of your medical care will come from less committed doctors willing to work for much lower wages. Plan for a very impersonal and rushed visit during which the true nature of your problems will probably never be addressed and issues just under the surface will never be uncovered.
--Vance Harris, MD

• At least a third of what doctors decide is fairly arbitrary.
--Heart surgeon, New York City

• Doctors are only interested in whether they are inconvenienced -- most don't care if you have to wait for them.
--Family physician, Washington, D.C.

The Sensitive Side

• When a parent asks me what the cause of her child's fever could be, I just say it's probably a virus. If I told the truth and ran through the long list of all the other possible causes, including cancer, you'd never stop crying. It's just too overwhelming.
--Pediatrician, Hartsdale, New York

• Most of us haven't been to see our own physicians in five years.
--Physical medicine specialist, Royal Oak, Michigan

• When a doctor tells you to lose 15 to 20 pounds, what he really means is you need to lose 50.
--Tamara Merritt, DO, family physician, Brewster, Washington

• If a sick patient comes to me with a really sad story and asks for a discount, I take care of him or her for no charge.
--Surgeon, Dallas/Fort Worth

• Though we don't cry in front of you, we sometimes do cry about your situation at home.
--Pediatrician, Chicago

Shocking Stats

60% of doctors don't follow hand-washing guidelines.
Source: CDC Morbidity and Mortality Weekly Report

96% of doctors agree they should report impaired or incompetent colleagues or those who make serious mistakes, but ...

46% of them admit to having turned a blind eye at least once.
Source: Annals of Internal Medicine

94% of doctors have accepted some kind of freebie from a drug company.
Source: New England Journal of Medicine

44% of doctors admit they're overweight.
Source: Nutrition & Food Science; Minnesota Medicine

58% would give adolescents contraceptives without parental consent.
Source: New England Journal of Medicine

Anatomy of a Doctor's Bill

Just how much of the $100 your doctor charges for taking 30 minutes to investigate your stomach pain goes into his pocket? After paying the bills, he gets less than half. The breakdown, according to Robert Lowes, senior editor at Medical Economics:

$3.50 for malpractice insurance

$3.50 for equipment, repairs, and maintenance

$6 for supplies, including gowns, tongue depressors, and copy paper

$7 for rent and utilities

$11 for office expenses, such as telephones, accounting fees, advertising, medical journals, licenses, and taxes

$28 for secretary, office manager, and medical assistant salaries and benefits

$41 Amount that goes into the doctor's paycheck

Over the course of a year, that adds up to $155,000, the annual salary of the average family physician. That number rose just 3.3% between 2002 and 2006, while expenses increased nearly 25% over the same period.

Alternative monetary policy

I don't have commentary on this article; it's very complicated and I'm still trying to work out some of the second- and third-order effects of the policies proposed. But it's an interesting read in terms of keeping informed of some of the debate.

The comments are quite informative, as well, so I've pasted some below.

Dear Mr. Krugman,

Since last October I have been worried that nominal GDP growth would fall far short of the level consistent with full employment. Last fall I forcefully presented this argument to a number of economists (and was fortunate that Greg Mankiw and Robert Barro were willing to spend more than an hour listening to my views.) I suggested that despite the near-zero interest rates, an unconventional monetary policy could still be highly effective.

Because you are currently the most influential progressive voice on economic issues, and because you are an expert on liquidity traps, and because you have been skeptical about the effectiveness of monetary policy in the current environment, I decided to write you in the hope that you will reconsider your views on monetary policy. Not reconsider your model of “expectations traps,” but rather consider whether things have gotten so bad that the risks of a highly unconventional monetary policy are now outweighed by the risks of not adopting such a policy.

Before getting into specifics, I should add that although I have a reputation as a “right wing economist,” I believe my that proposal is very much in the interests of those who favor the broader policy goals of President Obama. The American public is not as patient as the Japanese public. If we stagger through 4 years of Japanese-style deflation (or even zero inflation), it is very unlikely that Obama will be re-elected. And the American electorate today is also very different from the electorate in 1935 (when FDR was concerned with Huey Long), middle class voters with falling 401k balances would not turn to someone to the left of Obama.

I think that we all agree that faster nominal GDP growth would be desirable. You have argued that the stimulus plan is too small, both private forecasters and the various financial markets now seem pessimistic, and even the Fed expects nominal GDP growth to fall well short of their target for the next several years (and they’ve been notably too optimistic throughout this crisis.) So the only question now is: Can monetary policy be effective in an environment with zero interest rates and a damaged financial system? For several different reasons, I believe it can.

1. Historical examples: As you know FDR was able to turn deflation into substantial inflation almost immediately after taking office, through his policy of leaving the gold standard and sharply devaluing the dollar. I would be the first to admit that the specific policy of devaluation is inappropriate in the current environment, as the rest of the world also faces a severe demand shortfall. But this example shows that rapid inflation can be achieved through unconventional monetary policies in an environment with near zero interest rates and a severely damaged banking system.

2. Easy Reforms: Eventually I will get to quantitative easing, but there are some even easier steps that could make the problem much more manageable, without incurring the risks of highly unconventional policies. One easy step would be to stop paying interest on reserves. These interest payments increase the demand for reserves, and are thus deflationary (as were the reserve requirement increases of 1936-37.) Of course this would make T-bill yields immediately fall to zero, and banks would still probably hoard substantial amounts of reserves. But then why not go one step further and charge an interest penalty on excess reserves? That would end the current problem of banks treating reserves and T-bills as near perfect substitutes. Yes, it wouldn’t solve that problem with respect to cash held by the public, but so far most of the hoarding of base money has been done by banks. (This is probably because, unlike during the early 1930s, deposits are now FDIC insured.) I don’t know if the interest penalty idea would work, but the Fed should certainly consider it.

3. Quantitative Easing: This is actually not my ideal solution, as I’ve published many papers advocating Nominal GDP (or CPI) futures targeting. But I also think it is a mistake to adopt an untried scheme in the midst of a crisis. Quantitative easing (although somewhat risky in budgetary terms) seems less uncertain, as it is merely an extreme version of the open market operations that are normally used to control the base. I understand the expectations trap argument at a theoretical level, but in another post I argued that this problem may not limit the Fed’s options as much as one might imagine. The post is here, but the basic idea is that the two famous liquidity traps (the U.S. in the 1930s and Japan more recently) don’t fit the current situation. The Fed is not constrained by a gold price peg (as in the 1930s) and the Fed does seem to have a sincere desire for roughly 2-3% inflation (unlike the BOJ, which raised rates in both 2000 and 2006, despite continual declines in their GDP deflator.)

I think you have acknowledged that there is some level of quantitative easing that would boost demand. If I am not mistaken you are concerned that if such a policy boosted inflation expectations sharply, the Fed would have to quickly sell off these assets, suffering massive capital losses. I understand that argument, but for two reasons I don’t think quantitative easing would be as difficult as many imagine. First, as James Hamilton pointed out, we could begin with Treasury inflation-indexed bonds which might not depreciate if the Fed succeeded in inflating the U.S. price level. I wouldn’t even rule out having the Fed consider buying some riskier U.S. assets (or foreign government bonds), which might actually appreciate if the Fed action succeeded in boosting aggregate demand.

4. Set an explicit NGDP (or CPI) target and engage in “level” targeting: The other reason why I am not so concerned about the possible losses from quantitative easing is that I think that such a policy (especially if combined with my earlier proposal to reduce excess reserves) would not require as much monetary base expansion as one might envision. It is very misleading to look at the huge increase in excess reserves that has occurred in an environment without a credible anti-deflationary policy (and with interest being paid on bank reserves) and extrapolate to what would be required to actually boost AD. Indeed a credible policy along the lines I propose might actually require the Fed to immediately reduce the now bloated base. One key to making the policy credible (as many have already argued) is to set an explicit nominal target, and commit to make up for any shortfall this year with even faster nominal growth in the future (and vice versa.) I know that your expectations trap argument raises questions about credibility. But explicit targets tend to be more credible because it is embarrassing for policymakers to go back on their word–they don’t like to lose credibility (for good reasons.) And Bernanke, et al, already have reputations very different from the members of the BOJ.

I would also point to hints from the financial markets that a bold move might be highly welcome. The strong stock market response to the only slightly more expansionary than expected rate cut in December 2008 (by which time it was already clear to you that we were in a liquidity trap) suggests to me that markets might respond very positively to an announcement similar to the array of steps proposed here. (Multifaceted policy initiatives are more likely to be welcomed by markets, as we don’t know exactly which specific step works best.) I understand that some might argue that the stock market was grasping for straws last December, but as my post here on the earlier December 2007 contractionary policy surprise shows, stock and bond markets often show a very sophisticated understanding of the impact of monetary policy.

5. What do we have to lose?: We can get rid of interest on bank reserves (and consider a penalty rate), set an explicit nominal target, and engage in quite substantial quantitative easing using indexed bonds (and perhaps a few foreign government bonds) without incurring much risk at all. And even if we have to eventually move more heavily into assets more exposed to U.S. inflation risk (long term T-bonds) I don’t see how those risks are any worse that what we are now doing at the Fed. Isn’t a risky policy that has a good chance to boost AD superior to a risky policy that has little chance of achieving that goal?

6. Confusing causality: Lots of people tell me that we need to fix the banking system first. But isn’t that reversing causality? Yes, the original sub-prime crisis was caused by bad decisions by banks (among other factors), but isn’t the current deterioration in higher quality mortgages, commercial loans, industrial loans, etc, mostly due to the precipitous drop in nominal GDP that began late last summer? Even if we end up with some capital losses from unconventional monetary policy, isn’t it also possible that monetary stimulus could vastly reduce the cost of bailing out the banks? And also consider the impact of faster nominal GDP growth on the budget deficit. So yes, there are some potential capital losses from unconventional monetary policy, but given what we are now going through those losses don’t seem quite so scary anymore. FDR showed that boldness can be surprisingly effective–I read somewhere that his housing bailout programs in 1933 ended up costing much less than expected because of his effective steps to boost nominal GDP growth.

Of course there is some risk of overshooting toward high inflation, but I believe those risks are minimal. The Fed can closely monitor yield spreads for signs of a change in inflation expectations. Admittedly (as Bernanke and Woodford pointed out in a 1997 paper on the circularity problem in targeting market expectations) such monitoring does not provide useful information about the proper stance of monetary policy when it is 100% credible–but we are currently far from that situation.

To conclude, I ask you to reconsider your position on monetary policy. If you did change your view, some people might accuse you of inconsistency. But remember what your hero once said:

“When the facts change, I change my mind — what
do you do, sir?”

The Obama administration is obviously struggling in coming up with an effective solution to the banking crisis. The stimulus package seems inadequate, either because (as you believe) it is too small, or (as I believe) the multiplier may be less than we think. The economic data seems to be consistently worse than expected. The facts have changed.

Scott Sumner

  1. Aaron Jackson
    1. March 2009 at 08:31

    Excellent argument… my thoughts exactly! If you can get Krugman to change his mind with this note, then I think you should be considered for next year’s Nobel prize. After all, if he does change his mind and is influential in enacting the policy changes you describe above, I think you are right in suggesting that it would greatly speed up the adjustment process, and markets would finally get some good news (which would help right expectations and consumer confidence). Averting further economic malaise on a global scale is definitely Nobel-worthy!

  2. Sprizouse
    1. March 2009 at 12:07

    In response to #2… the treasury still issues debt (mostly) to its own citizens. Long run, interest-paying debt payments to our own citizenry is a good thing and better in the long-term than in the short by issuing non-interest paying bonds.

    The larger concern is, of course, the amount of treasuries being bought by foreign countries. Lowering or completely cutting rates on treasuries might push foreigners away but again, because more than 60% of government treasuries are still bought and retained by US citizens, it would probably hurt us more.

  3. Podunk
    1. March 2009 at 12:28

    I’m not an economist, so I’ve been trying to catch up a bit reading you, DeLong, Cowen, Krugman, et al. In my layman’s mind, it seems you’re saying that targeting a nominal GDP growth rate rather than the real inflation rate would be automatically counter-cyclical. In boom years when the real GDP was growing at a greater than 3% rate, it would put the breaks on automatically, whereas when real GDP growth was slow or negative, it would basically shift to higher inflation. Both work out about the same for banks and other borrowers, who are making decisions with the implicit assumption that a dollar borrowed now will only cost .x dollars to pay back later. When nominal deflation happens, the dollars now cost 1.x to pay back, and insolvency ensues.

    With the debt load of the American public and government what it is, a bit of extra inflation during a deflationary downturn might not be such a bad thing. I’m not certain the same could be said of Japan in the 90’s, where I believe the savings rate was much higher. In that case, the inflation would devalue the savings and might have been politically impossible.

    Is this understanding anywhere close to the mark? Is the suggestion instead that real GDP would be prevented from contracting with business cycles? Am I completely off the mark here?

  4. Mercure
    1. March 2009 at 13:21

    Why are you assuming that Krugman is against unconventional monetary policy? Do you have any quote?
    I am a regular reader of Krugman and I think that is opinion is that unconventional monetary policy have to be tried. But he thinks that there is a very low probability that it will be effective so we need a fiscal stimulus in the same time. We can’t wait for the results of this unproven experiment before using the fiscal policy.

    Are you asking him too support ONLY a monetary policy solution to the crisis?
    Here’s a quote:
    “Nonetheless, I guess the Fed had to try the “Bernanke twist.” And it did”

  5. Qingdao
    1. March 2009 at 13:22

    Shouldn’t this letter be addressed to that other Princeton econ professor, Dr. Bernanke?

  6. Bill Woolsey
    1. March 2009 at 14:05

    Perhaps we could get together some kind of petition
    advocating the end interest on reserve balances at the Fed and
    considering penality rates on excess reserves.

    Everyday I hear politicians and the press claim that banks are lending enough money. Do they realize that the Fed is paying banks not to make loans?

  7. Jim Pinney
    1. March 2009 at 14:38

    Exactly right. Get a good solid inflation going. Bernanke knows he should do this - with a price level target not an inflation rate target. Greg Mankiw has advised that as well.

    I think the administration is well advised to be very worried about bank nationalization or reorganization. The issue is not the stock holders but rather the debt holders. Bust them with a haircut and all hell might just break out - making Lehman look like a Sunday school picnic. I don’t understand why people who advise nationalization treat this threat so lightly. It would be just terrible. I read one saying that “there is some threat of a Lehman”. Indeed - some threat of the end of the world. To ignore that is just nutty. Again, an inflation would make this unnecessary, or much cheaper - because a lot of those bum loans would turn much better with larger amounts of cash running all over the place.

    Do something REALLY DRAMATIC. Decisively change expectations. Mr. Rich Guy and Mr. Banker - all that cash you are currently sitting on will soon be worth a lot less (in real terms) than it is now. Get out then and spend it. Buy assets - or buy a car or take a vacation. But don’t sit on it.

    And the Fed could do this - with explicit support from the Treasury. A joint announcement - that the administration supports an explicitly higher price level target - and aggressive action to get there. Stop paying interest on reserves. Do the interest penalty on reserves. Those excess reserves would charge out of the Fed zoom zoom zoom. That is what we need. And we need it soon. Do it !

  8. ssumner
    1. March 2009 at 14:58

    Thanks, you guys have both been a big help to me. I appreciate the support. You’ll find my next post a change of pace, although I plan to return to money topics because I think this issue is paramount right now.

  9. ssumner
    1. March 2009 at 15:02

    Bill, I forgot to respond to your petition idea. A few weeks ago I was thinking of asking James Hamilton ( if he’d be willing to start such a petition, as he has somewhat similar views to me on the need for a more expansionary monetary policy. And he is much better known. We just need to keep trying to popularize this idea, and eventually we will generate interest in a petition.

  10. Jim Pinney
    1. March 2009 at 15:10

    the ft is on board

  11. Jon
    1. March 2009 at 16:17

    “Perhaps we could get together some kind of petition
    advocating the end interest on reserve balances at the Fed and
    considering penality rates on excess reserves.”

    The daily effective rate is running between 0.18-.24 and the reserves are paying 0.25, making the spread free-money. But reserves are at least 10x higher than necessary to support a doubling in bank credit–given that the reserve ratio is close to zero in the US, I doubt this has much to do with anything. The January loan officer survey supported the same: lending is flat because demand for new credit is flaccid.

  12. Chris Wood
    1. March 2009 at 16:24

    A few responses, I just want to say I am biased to Krugman, but like a good discussion:

    2. The real reason that is not going to happen is the treasury uses the reserve amounts as a off book funding source. If you stopped paying interest, the banks would just buy bonds instead with the same amount they over fund the reserve with. Thus, crowding out private sector even more. Not to mention the public image problem with an even bigger deficit.

    3. Based off of “he basic idea is that the two famous liquidity traps (the U.S. in the 1930s and Japan more recently) don’t fit the current situation”.

    Yes, the real problem both of these problems were fixed by external exports of some kind. Depression by exporting bombs to blow people up, and Japan by exporting goods to countries not having the problem.

    The real risk is quantitative easing might and I stress might help short term, the real problem is it is very risky. Right now the US is a safe haven right now, and its bonds are being funded. If you spook the foreign capital with inflation worries, they will just go elsewhere. Then the US is Zimbabwe, removing 9 zeros from its currency every 6 months. That is a very big risk for a relatively small gain.

    4. “But explicit targets tend to be more credible because it is embarrassing for policymakers to go back on their word–they don’t like to lose credibility (for good reasons.) And Bernanke, et al, already have reputations very different from the members of the BOJ.”

    Bernie Madoff had a reputation too.

    5. What do we have to loose? Zimbabwe anyone??

    6. Right now, we are going through losses, but they are slow monthly losses. These the government can do something about. Adding more risk, might make things break faster. Those are like atomic bombs going off down the street. All you can do is duck and cover.


    Personally, I think nationalization is the only real fix. It would reduce the cost of the bailouts, and provide equity in the long run. People would get to keep their jobs, excluding the management that should not be there anyways. Salary caps and bonuses removed will eliminate any unnecessary fat. Sell the parts when we are in a boom again. “If you screw up, sometimes you have to pay the piper.”

  13. Peter
    1. March 2009 at 16:25

    I think Paul would agree with almost everything that you said about monetary policy. I am only an undergrad economics major so my views are pretty naive, but I think his argument is that conventional monetary policy is useless in a liquidity trap which is why both unconventional monetary policy and fiscal policy should be applied. In a blog post he links to a 1998 paper where he suggested that Japan should employ price level targeting in order to bring down real interest rates when the nominal interest rate is already zero. If I remember correctly, he is fond of telling the story of Princeton economists (himself included i guess) who recognized that the US could easily become another Japan, so they decided to study and develop proposals for a situation just like the one we’re in today. This may be why he has said he was relieved that Bernanke is Fed chairman.

  14. KJR
    1. March 2009 at 16:44


    Another great post. It is both refreshing and enlightening to read about your policy views (especially as someone who shares your skepticism in regards to the effectiveness of the fiscal policy being employed through the current stimulus package). As an aside, maybe you should forward this letter to some of the folks in our nation’s capital as well. Keep up the great work.

  15. Jon
    1. March 2009 at 17:01


    I agree with your goal (monetary expansion) but not with your diagnosis. In particular, take a look at the decline in high-powered money shown here:

    This reflects adjustments to Fed total credit to account for Treasury deposits at the Fed and the swap-lines. The economy is rolling from a 30% decline in money not a failure of monetary policy at the ‘zero bound’.

  16. smokedgoldeye
    1. March 2009 at 17:44

    Why is “fiat money forever” your premise?

    In 1967, Alan Greenspan wrote:
    “An almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions. They seem to sense–perhaps more clearly and subtly than many consistent defenders of laissez-faire–that gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other. . . . This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.”

    Forget QE and the risks of horrific hyperinflation. Let’s have a petition to get the government completely out of the money supply business. Sea shells or gold. I’m easy. As long as the government can’t ever quantitatively ease it.

  17. ssumner
    1. March 2009 at 17:48

    Sprizouse, I know this seems odd, but the goal is not to reduce long rates, but to raise them. Any policy that is truly expansionary will raise long rates through the “income and expected inflation effects.” See my rational expectations post.

    Podunk, Yes, it is intended to be countercyclical, and yet still hold down long term inflation.

    Mercure, I don’t have the same impression, but perhaps I need to look more closely at his recent posts. The ones I read seemed to suggest that nothing more could be done with monetary policy, that not only was the view that more money could help now discredited, but that Friedman and Schwartz’s view that more money could have helped prevent the Depression was also discredited. I admit that I don’t read all his posts, so I will check out whether I have misinterpreted his views.

    Qingdao, There is only a small chance that Krugman reads my blog, but no chance that Bernanke does. One step at a time. If some more important economists can be sold on this idea, they will have the influence to talk to Bernanke. In addition, I think it is very possible that Bernanke partly agrees with me, but there is also the FOMC. BTW: I once visited Qingdao.

    Jim, Yes I recall when Mankiw advocated price level targeting on his blog. (It was a month after I met with him for an hour and suggested that we needed price level or NGDP targeting. Although in fairness, I think he was already leaning that way.) The FT piece is interesting. The UK could also devalue, but I don’t think it is a plausible policy for us. On banking, you probably know more than me.

    Jon and Chris, What about a negative rate on reserves, if we are in a liquidity trap. Would that work?

    Second Jon question, I agree the fall in the monetary base is puzzling and worrisome, but wasn’t the economy in trouble even before the base started falling a couple weeks ago? I wish I knew what the Fed was thinking, right now I just don’t know what to make of their policy. Are they trying hard to be more expnasionary? Or not?

  18. Ken
    1. March 2009 at 18:41

    Hey Scott,

    How well do you think you understand the balance sheets, risks, and operations of the large US financial institutions, e.g. C and BAC?

    Is it possible that macro-economists are confused because they don’t have sufficient understanding of the financial institutions through which monetary policy is supposed to travel?


  19. Jake
    1. March 2009 at 18:46

    Typo note: “Lot’s of people tell” should read “Lots of people tell…”

  20. Jon
    1. March 2009 at 18:59

    “Jon and Chris, What about a negative rate on reserves, if we are in a liquidity trap. Would that work?”

    Most of the excess reserves are coming from the TAF and PDCF. I think its plausible that the banks would return their excess funds to the Fed in that scenario.

    If we’re in a liquidity trap now, its surely a different sort. Evidence of cash hoarding–except by the Treasury–is very weak. If you look back at the TAF auctions, most auctions in the last four months were under-subscribed and all were correspondingly sold at the minimum rate. This minimum tended to be set below the interest-rate on excess reserves. (compare: and AFAIK, this was a big contributor to the Fed Funds rate consistently running below the target. So the increase in bank-reserves is not in itself proof of a liquidity trap.

    “I agree the fall in the monetary base is puzzling and worrisome, but wasn’t the economy in trouble even before the base started falling a couple weeks ago? I wish I knew what the Fed was thinking, right now I just don’t know what to make of their policy. Are they trying hard to be more expnasionary? Or not?”

    Falling a couple weeks ago? I’m confused. The big sterilizations started in late September. This was preceded by a gradual drop in the monetary base less reserves from 2007 on. But yes, I don’t understand their thinking. There is so much sterilization going on once you factor in the Treasury that the policy is not particularly expansionary.

    My guess: many of the Feds actions are tailored to saving the European banking system, but that’s a complex supposition.

  21. travis
    1. March 2009 at 19:00

    From the graph of the monetary base, it looks like reserves are decreasing (Federal Reserve Credit) and circulating credit is increasing. That is exactly what we want. Reserves are being put to work in the real economy.

  22. Scott Wimer
    1. March 2009 at 19:31

    I guess it’s really naive to wonder why we need to use the taxpayer as ablative shielding to defend the debtors of the various mis-managed banks and financials.

    The bondholders charge interest to offset the risk of default.

    Apparently they also charge me. And my kids. And my kids’ kids.

  23. Chris Wood
    1. March 2009 at 19:43

    Jon and Chris, What about a negative rate on reserves, if we are in a liquidity trap. Would that work?


    Federal reserve legislation requires 3% I do believe of a banks money to be with the Feds. Since we give them interest on those funds, that is really essentially a negative rate from the governments side. Other countries like Canada, that have had no problem with their banking system do not have such a requirement.

  24. Jon
    1. March 2009 at 20:27

    “Federal reserve legislation requires 3% I do believe of a banks money to be with the Feds.”

    This is incorrect. First the Fed sets the reserve ratio, not legislation, its part of the Federal Register not the USC. Second, the reserve requirement is applied to checkable accounts and other forms of transaction accounts. Nonpersonal time deposits have no reserve requirement. The effective reserve requirement is consequently <1%>

    One reason the ECB started to offer interest on reserves was to compensate for the higher reserve-ratio in the EU.