Posts tagged money
Posts tagged money
Jose Pagliery interviewed me for a CNNMoney article on Bitcoin. Here are the 2 passages with quotes from me:
Even economists who embrace the power of central banks, like University of Michigan professor Miles Kimball, recognize the currency’s potential.
"Bitcoin really shows governments are behind the curve," Kimball said. "It demonstrates there’s a demand for an electronic equivalent of cash."
"Governments absolutely demand a monopoly on money and credit. They’re not going to give it up easily," Paul warned. "They will come down hard."
Kimball hopes politicians will take a less combative approach, choosing instead to compete.
"I suppose they could just try to crush Bitcoin, but that’s the wrong way to do it," Kimball said. "Governments should be creating their own version of Bitcoin. They should be ashamed they haven’t."
Our interview is also reflected in the mention of how Bitcoin dominance would take away central banks’ "ability to help slow and speed up economic activity," and in the discussion M-PESA. Jose did not fully reflect my claim that Bitcoin is an attempt at digital gold; even once things settled down, a dominant Bitcoin would give us monetary policy as bad as the gold standard did, which was pretty bad.
I found this New York Fed blog post interesting because of the analogy between the currency crisis in 1696, created by bimetallism, and the crisis we have had in recent years because of the zero lower bound.
Full text below, mirrored with his permission:
Paul Krugman wrote a post over the weekend in response to the speech that Larry Summers gave at the IMF about the possible stagnation of the U.S. economy due to the zero lower bound (ZLB). The post gives a good summary of Summers’ speech and issues facing the economy due to the ZLB. A key argument in the post is that the economy has been fighting against a liquidity trap decades through successive economic bubbles.
So with all that household borrowing, you might have expected the period 1985-2007 to be one of strong inflationary pressure, high interest rates, or both. In fact, you see neither – this was the era of the Great Moderation, a time of low inflation and generally low interest rates. Without all that increase in household debt, interest rates would presumably have to have been considerably lower – maybe negative. In other words, you can argue that our economy has been trying to get into the liquidity trap for a number of years, and that it only avoided the trap for a while thanks to successive bubbles.
An argument that bubbles have been good for the economy is a counter intuitive claim that is likely to be met with heavy resistance, but that reaction is precisely why (according to Krugman’s logic) the economy is having trouble escaping the fallout of the housing bubble. Less serious bubbles in the past have been met with painful, yet short, recessions because the economy was able to essentially shrug off its past mistakes and move on to new productive investments. However, the housing bubble was a widespread phenomenon that has personally impacted a massive proportion of the population. Huge negative effects hit individual consumers much harder than previous bubbles, which has caused a fear of economic instability within the population that is unrivaled since the Great Depression.
People are now afraid of bubbles and are actively trying to prevent future bubbles from disrupting the economy. The response and fear of the public has lead to overwhelming support for financial reform like Dodd-Frank. The movement for financial reform might actually be impairing economic growth, as Krugman states:
He goes on to say that the officially respectable policy agenda involves “doing less with monetary policy than was done before and doing less with fiscal policy than was done before,” even though the economy remains deeply depressed. And he says, a bit fuzzily but bravely all the same, that even improved financial regulation is not necessarily a good thing – that it may discourage irresponsible lending and borrowing at a time when more spending of any kind is good for the economy.
It is a particularly terrifying idea that financial reform is harming the economy because it is discouraging irresponsible lending, which would help to create another bubble that leads us to a temporary recovery. It is plausible that the economy could stagnate, a la Japan, due to handcuffed monetary policy and regulation acting to prevent a bubble-fueled recovery. This one blog post by Krugman is perhaps the best argument yet for Miles Kimball’s idea of e-money (read Miles on e-money here).
The Summers speech/Krugman post has lead me to closely examine my beliefs on monetary policy and has convinced me that e-money offers the best alternative to the current policy regime. E-money can provide large social benefits by avoiding an arbitrary boundary on perhaps the one policy mechanism that economists understand very well. If Summers and Krugman are correct about the possibility of stagnation, support for e-money (or other similar policy alternatives) is almost a moral imperative for economists. It is the duty of economists to use the influence they hold to improve the economy and the lives of the people in it. I am now convinced that e-money is perhaps the best example of socially beneficial policy changes that can occur because of the influence of the economics profession.
Here is a link to my 38th column on Quartz, coauthored with Noah Smith, “The shakeup at the Minneapolis Fed is a battle for the soul of macroeconomics—again.” Our editor insisted on a declarative title that seriously overstates our degree of certainty on the nature of the specific events that went down at the Minneapolis Fed. I toned it down a little in my title above.
Here is the full text of my 35th Quartz column, “Get Real: Robert Shiller’s Nobel should help the world accept (and improve) imperfect financial markets,” now brought home to supplysideliberal.com. It was first published on October 16, 2013. Links to all my other columns can be found here.
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© October 16, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2015. All rights reserved.
With the world still suffering from the 2008 financial crisis, it is good to see Nobel prizes going to three economists who have set the bar for analyzing how stock prices and other asset prices move in the real world: Eugene Fama, Robert Shiller, and Lars Hansen. Eugene Fama is best known for setting the benchmark for how financial markets would work in a world of perfect efficiency. Robert Shiller pointed out that financial markets look much less efficient at the macroeconomic scale of financial market booms and busts than they do at the microeconomic level of prices for individual stocks. And Lars Hansen developed the statistical techniques that have served as the touchstone for arbitrating between competing views of financial markets.
In many respects the “popular science” account of the work of Fama, Hansen and Shiller, given by the official Nobel prize website, is excellent. But its understated tone does not fully convey the drama of Fama and Shiller painting two diametrically opposed pictures of financial markets. (Nor the beauty and the clarity of Hansen’s way of thinking about the statistical issues in refereeing between these opposing views—but that would be too much to expect in a popular science treatment.) Fama’s picture of financial markets is Panglossian: all is for the best in the best of all possible worlds. In Shiller’s picture, financial markets are much more chaotic. As Berkeley economics professor and well-known blogger Brad DeLong puts it:
Financial markets are supposed to tell the real economy the value of providing for the future—of taking resources today and using them nor just for consumption or current enjoyment but in building up technologies, factories, buildings, and companies that will produce value for the future. And Shiller has, more than anyone else, argued economists into admitting that financial markets are not very good at this job.
Shiller’s view of financial markets that are swept up in successive excesses of optimism and pessimism allowed him to sound a warning of both the crash of the dot-com bubble in 2000 and the collapse of the house price bubble that interacted with high levels of leverage by big banks to bring down the world economy—to depths it still hasn’t recovered from.
Even when they don’t fully believe that all is for the best in the best of all possible worlds, the imaginations of most economists are captivated by the image of perfect markets, of which Eugene Fama’s Efficient Markets Theory provides an excellent example. The bad part about economists being riveted by the image of perfect markets is that they sometimes mistake this image for reality. The good part is that this image provides a wonderful picture of how things could be—a vision of a world in which (in addition to the routine work of facilitating transactions) financial markets gracefully do the work of:
One way to see how far the world is from fully efficient financial markets is that perfect markets would function so frictionlessly that the financial sector itself would earn income that was only a tiny fraction of GDP, where in the real world, “finance and insurance” earn something like 8% of GDP (see 1 and 2,) with many hedge fund managers joining Warren Buffett on Forbes’ list of billionaires.
One reason the financial sector accounts for such a big chunk of GDP may be that information acquisition and processing is much harder in the real world than in pristine economic models. After all, there is a strong tradition in economics for treating information processing (as distinct from information acquisition) as if it came for free. That is, look inside the fantasy world of almost all economic models, and you will see that everyone inside has an infinite IQ, at least for thinking about economic and financial decisions!
In the real world, being able to think carefully about financial markets is a rare and precious skill. But it is worse than that. Those smart enough to work at high levels in the financial sector are also smart enough to see the angles for taking advantage of regular investors and taxpayers, should they be so inclined. Indeed, two of the most important forces driving events in financial markets are the quest for plausible, but faulty stories about how the financial markets work that can fool legislators and regulators on the one hand and stories that can fool regular investors. A great deal of money made by those in the financial sector rides onconvincing people that actively managed mutual funds do better that plain vanilla index funds—something that is demonstrably false on average, at least. And a surprisingly large amount of money is made by nudging regular investors to buy high-fee plain vanilla index funds as opposed to low-fee plain vanilla index funds. (There is a reason why for my retirement savings account I had to drill down to the third or fourth webpage for each mutual fund before I could see what fees it charges.) Even those relatively sophisticated investors who can qualify to put their money into hedge funds have been fooled by the hedge funds into paying not only management fees that typically run about 2% per year, but also “performance fees” averaging about 20% of the upside when the hedge fund does well, with the investor taking the full hit when the hedge fund does badly. So one crucial requisite for financial markets to do what they should be doing is for regular investors to know enough to notice when financial operators are taking them for a ride (which as it stands, is most of the time, at least to the tune of the bulk of fees paid) and when they are getting a decent deal.
For getting funds from those who want to save to those who need to borrow, the biggest wrench in the works of the financial system right now is that the government is soaking up most of the saving. The obvious part of this is budget deficits, which at least have the positive effect of providing stimulus for the economy in the short run. The less obvious part is that the US Federal Reserve is paying 0.25% to banks with accounts at the Fed and 0% on green pieces of paper when, after risk adjustment, many borrowers (who would start a business, build a factory, buy equipment, do R&D, pay for an education, or buy a house, car or washing machine) can only afford negative interest rates. (See “America’s huge mistake on monetary policy: How negative interest rates could have stopped the Great Recession in its tracks.”)
Yet, the departure from financial utopia that I find the most heart wrenching is the failure of real-world financial markets to share risks in the way they do in our theories. If financial markets worked as they should:
Some of these things don’t happen because people don’t understand financial markets well enough. But some don’t happen because the financial markets have not developed enough to offer certain kinds of insurance. All three winners this year richly deserve to be Nobel laureates. I tweeted the day before the announcement in favor of Robert Shiller because he, more than anyone else, has been trying to make financial markets live up to this vision of risk sharing. It not just that this is a big theme in the books he has written. Shiller has also patented new types of financial assets to enhance risk sharing and helped create the Case-Shiller home-price index as a foundation on which home-price insurance contracts could be based. Shiller’s vision of risk sharing is far from being a reality, but one day, maybe it will be. If that day comes, the world will look back on Robert Shiller as much more than a Nobel-Prize-winning economist. As Brad DeLong says of Shiller: “Pay attention to him.”
In a loose sense, I have thought of the Tea Party as populists. But in reading H. W. Brands’ history American Colossus: The Triumph of Capitalism, 1865-1900, I learned that in 19th Century U.S. history it was the members of the People’s Party who were called “Populists.” The 19th Century Populists saw low interest rates as good for the interests of common people, who were more likely to be debtors, and high interest rates as good for the big banks, who represented creditors. As a result, they were what we would now call monetary policy doves.
Ignatius Donnelly was a very interesting character. Before being nominated for vice president in 1900 on the People’s Party ticket, he had invented many controversial historical theories, particularly about Atlantis, Catastrophism, and Sir Francis Bacon as the author of what we know as the works of Shakespeare. The title of his Catastrophist work Ragnarok: The Age of Fire and Gravel (in which he argues that the Biblical Flood, and consequent destruction of Atlantis, was the result of the near collision of the Earth with a comet) reminds me of the title of my science fiction story "Ragnarok" that I posted back in September.
Ignatius’s monetary theory was more on target than his history. H. W. Brands (p. 442-443) quotes from Ignatius’s dystopian novel Caesar’s Column, where Ignatius took a dig at the deflationary policies of the Benjamin Harrison administration:
Take a child a few years old; let a blacksmith weld around his waist an iron band. At first it causes him little inconvenience. He plays. As he grows older it becomes tighter; it causes him pain; he scarcely knows what ails him. He still grows. All his internal organs are cramped and displaced. He grows still larger; he has the head, shoulders and limbs of a man and the waist of a child. He is a monstrosity. He dies. This is a picture of the world of to-day, bound in the silly superstition of some prehistoric nation. But this is not all. Every decrease in the quantity, actual or relative, of gold and silver increases the purchasing power of the dollars made out of them; and the dollar becomes the equivalent for a larger amount of the labor of man and his production. This makes the rich man richer and the poor man poorer. The iron band is displacing the organs of life. As the dollar rises in value, man sinks. Hence the decrease in wages; the increase in the power of wealth; the luxury of the few; the misery of the many.
Danny Vinik and I talked for about 75 minutes on Tuesday evening. He did a very nice article based on our interview. One thing I talked a lot about in the interview is that of all the possible ways to handle the demand-side problem, repealing the zero lower bound is the one that leaves us best able to subsequently pursue supply-side growth. Fiscal stimulus leaves us with an overhang of government debt that then has to be worked off by painfully higher taxes or lower spending. Going easy on banks and financial firms to prop up demand (as Larry Summers at least halfway recommends in his recent speech at the International Monetary Fund) risks another financial crisis. Higher inflation to steer away from the zero lower bound (as Paul Krugman favors) messes up the price system, misdirects both household decision-making and government policy, and makes the behavior of the economy less predictable. (On Paul Krugman, also see this column.)
Let me push a little further the case that electronic money can clear the decks on the demand side so that we can focus on the supply side with this example. Suppose you firmly believed that the demand side played no role in the real economy—that the behavior of the economy could be described well by a real business cycle model, regardless of what the Fed and other central banks do, and regardless of the zero lower bound. From that point of view, in which monetary policy only matters for inflation, electronic money would still be valuable as a way of persuading others that it was OK to have zero inflation rather than 2% inflation.
There are many famous names in journalism featured in this Twitter discussion. In order of appearance, they include Josh Barro, James Pethokoukis, Matt O’Brien, Tony Fratto, Matthew C. Klein, Caroline Baum, and Ramesh Ponnuru. I make only a cameo appearance.
Here is a link to Dylan Matthew’s extremely skillful writeup of his interview with me last Thursday (November 14, 2013) on eliminating the zero lower bound on nominal interest rates by making electronic money the unit of account and legal tender. Dylan’s piece provides the most accessible explanation of the nuts and bolts of my proposal for how to get the negative interest rates I have argued we desperately need in our monetary policy toolkit.
My answer to the question in Wonkblog’s title is
This post complements my recent column “Larry Summers just confirmed that he is still a heavyweight on economic policy,” which could have been called “Larry Summers and the zero lower bound.” In brief, Larry Summers gave a powerful speech at an IMF conference, emphasizing the costs of the zero lower bound—which might include the kind of “secular stagnation” (Larry’s words) that Japan has suffered in the last two decades. I then argue that we should simply eliminate the zero lower bound.
But I did not explain in “Larry Summers just confirmed that he is still a heavyweight on economic policy,” why we shouldn’t just steer away from the zero lower bound by engineering higher inflation (assuming we can). This Pieria post on the costs and benefits of inflation in the absence of the zero lower bound makes that case. (Also see the Powerpoint file for my November 1, 2013 presentation at the Federal Reserve Board, and my Twitter discussion with Daniel Altman on the costs and benefits of inflation in the absence of the zero lower bound.)
In ”Larry Summers just confirmed that he is still a heavyweight on economic policy,” I address the politics of eliminating the zero lower bound by saying
Politics will stay the same until a critical mass of people do what it takes to make them different. Summers proved at the IMF conference that he is still an economic policy heavyweight—someone who could contribute a lot toward reaching that critical mass in the war against the zero lower bound, if he is willing to join the fight.
I don’t know Larry’s views on repealing the zero lower bound in the way that I advocate, but Larry Summers’ IMF talk has led to discussion in other quarters about eliminating the zero lower bound. Matthew Yglesias renewed his advocacy of abolishing paper currency in "The Biggest Problem in Economic Policy Today" a few hours after my column appeared. Brad DeLong picked up on my column here, and Paul Krugman picked up on Brad DeLong’s post in his “Secular Stagnation, Coalmines, Bubbles, and Larry Summers.” (And others are picking up on Paul’s post.) In his post, Paul said the most positive thing I have seen him say so far about negative nominal interest rates as a real-world policy:
If the market wants a strongly negative real interest rate, we’ll have persistent problems until we find a way to deliver such a rate.
One way to get there would be to reconstruct our whole monetary system – say, eliminate paper money and pay negative interest rates on deposits.
Finally, Dylan Matthews of Wonkblog interviewed me last Thursday about repealing the zero lower bound to add negative interest rates to the policy toolkit. That interview might appear even as early as today.
If you want to mirror the content of this post on another site, that is possible for a limited time if you read the legal notice at this link and include both a link to the original Pieria exclusive and the following copyright notice:
© October 28, 2013: Miles Kimball, as first published on Pieria. Used by permission according to a temporary nonexclusive license expiring June 30, 2015. All rights reserved.
Historically, there have been many different monetary systems. Tom Sargent surprised me with the range of monetary systems that have existed in the United States since 1776 when he presented his paper “Fiscal Discriminations in Three Wars” at the University of Michigan this Fall. Nevertheless, we have become used to our current monetary system, and have gained useful experience with it, so any proposal to change it should be carefully justified.My efforts in that regard are laid out in “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.” By “our current monetary system” I mean the monetary system of most advanced economies and most emerging economies in 2013. The proposed new monetary system I call an “electronic money system” because the electronic dollar, euro, yen, pound, or the like would be the unit of account.
The brief appeals for eliminating the zero lower bound at the bottom of “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.” plus my column “America’s Big Monetary Policy Mistake: How Negative Interest Rates Could Have Stopped the Great Recession in Its Tracks” are my attempts to show how the polemics for repealing the zero lower bound could be approached in the political arena. The links collected under the heading “Operational Details for Eliminating the Zero Lower Bound” in “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.” address the nuts and bolts of eliminating the zero lower bound.
For an overview of the operational details, I recommend starting with my Pieria post “Going Off the Paper Standard.” What is missing in my justification for changing our monetary system is a point by point tally of the costs and benefits of repealing the zero lower bound. Hence this post: costs first, then benefits. My title reflects an important complementarity that exists between repealing and lowering the long-run inflation target.