Joshua Foer on Memory

After reading Joshua Foer’s book Moonwalking with Einstein: The Art and Science of Remembering Everything, I think it is too bad that ancient memory techniques are not routinely taught in our schools. 

Wikipedia currently has this to say about Joshua:

Foer sold his first book, Moonwalking with Einstein, to Penguin for publication in March 2011.[2] He received a $1.2 million advance for the book.[1] Film rights were optioned by Columbia Pictures shortly after publication.[3]

In 2006, Foer won the U.S.A. Memory Championship, and set a new USA record in the “speed cards” event by memorizing a deck of 52 cards in 1 minute and 40 seconds.[4]Moonwalking with Einstein describes Foer’s journey as a participatory journalist to becoming a national champion mnemonist, under the tutelage of British Grand Master of Memory, Ed Cooke.

Here are a few passages that give you some flavor for the book, though the book is more light-hearted than these three passages fullly reveal. Let me mention that the book Ad Herrenium that Joshua mentions is available both as a nicely bound Loeb Classical Library book on Amazon, and free online here. Joshua:

I have to warn you, Ed said, as he delicately seated himself cross-legged, “you are shortly going to go from having an awed respect for people with a good memory to saying, ‘Oh, it’s all a stupid trick.’” He paused and cocked his head, as if to see if that would in fact be my response. “And you would be wrong. It’s an unfortunate phase you’re just going to have to pass through….

Much as our taste for sugar and fat may have served us well in a world of scarce nutrition, but is now maladaptive in a world of ubiquitous fast food joints, our memories aren’t perfectly adapted for our contemporary information age. The tasks we often rely on our memories for today simply weren’t relevant in the environment in which human beings evolved. Our ancestors didn’t need to recall phone numbers, or word-for-word instructions from their bosses, or the Advanced Placement U.S. history curriculum, or (because they lived in relatively small, stable groups) the names of dozens of strangers at a cocktail party.

What our early human and hominid ancestors did need to remember was where to find food and resources, and the route home, and which plants were edible and which were poisonous. This are the sorts of vital memory skills that they depended on every day, and it was–at least in part–in order to meet those demands that human memory evolved as it did.

The principle underlying all memory techniques is that our brains don’t remember all types of information equally well. As exceptional as we are at remembering visual imagery… we’re terrible at remembering other kinds of information, like lists of words or numbers….

Virtually all the nitty-gritty details we have about classical memory training–indeed, nearly all the memory tricks in the mental athlete’s arsenal–were first described in a short, anonymously authored Latin rhetoric textbook called the Rhetorica ad Herrenium, written sometime between 86 and 82 B.C….

The techniques introduced in the Ad Herrenium were widely practiced in the ancient world. In fact, in his own writings on the art of memory, Cicero says that the techniques are so well known that he felt he didn’t need to waste ink describing them in detail (hence our reliance on the Ad Herrenium). Once upon a time, every literate person was versed in the techniques Ed was about to teach me. Memory training was considered a centerpiece of classical education in the language arts, on par with grammar, logic, and rhetoric. Students were taught not just what to remember, but how to remember it. (pp. 90–95)

"Well done,” Ed said, with slow and deliberate applause. “Now I think you’re going to find that the process of recalling these memories is incredibly intuitive. See, normally memories are stored more or less at random, in semantic networks, or webs of association. But you have now stored a large number of memories in a very controlled context. Because of the way spatial cognition works, all you have to do is to retrace your steps through your memory palace, and hopefully at each point the images you laid down will pop back into your mind as you pass by them. All you’ll have to do is translate those images back into the things you were trying learn in the first place. (p. 104)

… But after having learned how to memorize poetry and numbers, cards and biographies, I’m convinced that remembering more is only the most obvious benefit of the many months I spent training my memory. What I had really trained my brain to do, as much as to memorize, was to be more mindful, and to pay attention to the world around me. Remembering an only happen if you decide to take notice….

So why bother investing in one’s memory in an age of externalized memories? The best answer I can give is the one I received unwittingly from EP, whose memory had been so completely lost that he could not place himself in time or space, or relative to other people. That is: How we perceive the world and how we act in it are products of how and what we remember. We’re all just a bundle of habits shaped by our memories. And to the extent that we control our lives, we do so by gradually altering those habits, which is to say the networks of our memories. No lasting joke, invention, insight, or work of art was ever produced by an external memory. Not yet, at least. Our ability to find humor in the world, to make connections between previously unconnected notions, to create new ideas, to share in a common culture: All these essentially human acts depend on memory.  (pp. 268-269)

Quartz #20—>Why Austerity Budgets Won't Save Your Economy

Link to the Column on Quartz

Here is the full text of my 20th Quartz column, Here is a link to my 20th column on Quartz: “Why Austerity Budgets Won’t Save Your Economy.” now brought home to supplysideliberal.com. It was first published on April 1, 2013. Links to all my other columns can be found here.

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 Quartz column and the following copyright notice:

© April 1, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

“Austerity” in the title means “Naked Austerity,” in line with the hashtag #nakedausterity that I introduced on Twitter:

Definition for #nakedausterity : Tax increases and/or government spending cuts unaccompanied by other measures to maintain aggregate demand.

The point of the hashtag is this:

When you are worried about debt, #nakedausterity is not the answer.

Don’t miss the discussion of the costs of national debt toward the end of the column.

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Austerity is in vogue. For some time now, countries in Europe have been raising taxes and cutting government spending because they are worried about their national debt. They have hit on the word austerity to describe these tax increases and government spending cuts. The US is now following suit.

But the trouble with austerity is that it is contractionary—that is, austerity tends to slow down the economy. In bad economic times, people can’t get jobs because businesses aren’t hiring, and businesses are not hiring because people aren’t spending. So in bad economic times, it adds insult to injury when the government does less spending, less hiring, and taxes more money out of the pockets of those who would otherwise spend.

The contractionary effect of austerity creates a dilemma, not only because a slower economy is painful for the people involved—that is, just about everyone—but also because tax revenue falls when the economy slows down, making it harder to rein in government debt. This dilemma has fueled a big debate.  There are four basic positions:

1. Arguing that austerity can actually stimulate the economy, as long as it is implemented gradually. That is the position John Cogan and John Taylor take in their Wall Street Journal op-ed, “How the House Budget Would Boost the Economy,” which I questioned in my column, “The Stanford economists are so wrong: A tighter budget won’t be accompanied by tighter monetary policy.”

2. Arguing that debt is so terrible that austerity is necessary even if it tanks the economy. This is seldom argued in so many words, but is the implicit position of many government officials, both in Europe and the US.

3. Arguing that the economy is in such terrible shape that we have to be willing to increase spending (and perhaps cut taxes) even if it increases the debt. This is the position taken by economist and New York Times columnist Paul Krugman. Indeed, Krugman is so intent on arguing that the government should spend more, despite the effect on the debt, that in many individual columns he appears to be denying that debt is a serious problem.  A case in point is his reply, “Another Attack of the 90% Zombie,” to my column emphasizing the dangers of Italy’s national debt, “What Paul Krugman got wrong about Italy’s economy.”  (In addition to this column, I responded on my blog.)

4. Arguing that there are ways to stimulate the economy without running up the national debt.  This is what I also argue in my column on Krugman. For the US, the most important point is that using monetary policy to stimulate the economy does not add to the national debt and that even when interest rates are near zero, the full effectiveness of monetary policy can be restored if we are willing to make a legal distinction between paper currency and electronic money in bank accounts—treating electronic money as the real thing, and putting paper currency in a subordinate role. (See my columns, “How paper currency is holding the US recovery back” and “What the heck is happening to the US economy? How to get the recovery back on track.”) As things are now, Ben Bernanke is all too familiar with the limitation on monetary policy that comes from treating paper currency as equivalent to electronic money in bank accounts. He said in his Sept. 13, 2012 press conference:

If the fiscal cliff isn’t addressed, as I’ve said, I don’t think our tools are strong enough to offset the effects of a major fiscal shock, so we’d have to think about what to do in that contingency.

Without the limitations on monetary policy that come from our current paper currency policy, the Fed could lower interest rates enough (even into negative territory for a few quarters if necessary) to offset the effects of even major tax increases and government spending cuts.

The price of debt

Since I see a way to stimulate the economy without adding to the national debt—and even in the face of measures to rein in the national debt—I face no temptation to downplay the costs of high levels of national debt. What are those costs? The most obvious cost of high levels of national debt is that at some point, lenders start worrying about whether a country can ever pay back its debts and raise the interest rates they charge. (This all works through the bond market, giving rise to James Carville’s famous quip: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”) One can disagree with their judgment, but lenders are showing no signs of doubting the ability of the US government to pay its debts. But there can be costs to debt even if no one ever doubts that the US government can pay it back.

To understand the other costs of debt, think of an individual going into debt. There are many appropriate reasons to take on debt, despite the burden of paying off the debt:

• To deal with an emergency—such as unexpected medical expenses—when it was impossible to be prepared by saving in advance.
• To invest in an education or tools needed for a better job.
• To buy an affordable house or car that will provide benefits for many years.

There is one more logically coherent reason to take on debt—logically coherent but seldom seen in the real world:

• To be able to say with contentment and satisfaction in one’s impoverished old age, “What fun I had when I was young!”

In theory, this could happen if when young, one had a unique opportunity for a wonderful experience—an opportunity that is very rare, worth sacrificing for later on. Another way it could happen is if one simply cared more in general about what happened in one’s youth than about what happened in one’s old age.

Tax increases and government spending cuts are painful. Running up the national debt concentrates and intensifies that pain in the future. Since our budget deficits are not giving us a uniquely wonderful experience now, to justify running up debt, that debt should be either (i) necessary to avoid great pain now, or (ii) necessary to make the future better in a big enough way to make up for the extra debt burden. The idea that running up debt is the only way to stimulate an economic recovery when interest rates are near zero is exactly what I question in my previous column about Italy’s economy. If reforming the way we handle paper currency made it clear that running up the debt is not necessary to stimulate the economy, what else could justify increasing our national debt? In that case, only true investments in the future would justify more debt: things like roads, bridges, and scientific knowledge that would still be there in the future yielding benefits—benefits for which our children and we ourselves in the future will be glad to shoulder the burden of debt.

Quartz #18—>Show Me the Money!

Link to the Column on Quartz

Here is the full text of my 18th Quartz column, “The Stanford economists are so wrong: A tighter budget won’t be accompanied by tighter monetary policy.”I honestly couldn’t think of a good working title of my own before my editor Mitra Kalita gave it the title it has on Quartz. But it finally came to me what I wanted my version of the title to be: the main theme is short-run monetary policy dominance, so my title is “Show Me the Money!”

The heart of this column is a discussion of the paper I wrote with Susanto Basu and John Fernald:“Are Technology Improvements Contractionary?”  It was first published on March 19, 2013. Links to all my other columns can be found here.

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 Quartz column and the following copyright notice:

© March 19, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

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Until the election last year, Stanford economics professor John Taylor was one of Mitt Romney’s chief campaign economists. This morning, he joins his Stanford colleague John Cogan in a Wall Street Journal opinion piece, “How the House Budget Would Boost the Economy.” Cogan and Taylor write:

According to our research, the spending restraint and balanced-budget parts of the House Budget Committee plan would boost the economy immediately.

Leaving aside the long-run merits of the House Budget, let’s evaluate Cogan and Taylor’s argument about what its short-run effects would be. The key to any hope that cutting spending would stimulate the economy is that the spending cuts are all in the future—hopefully after the economy has already fully recovered:

The House budget plan keeps total federal outlays at their current level for two years. Thereafter, spending would rise each year, but more slowly than if present policies continue.

If government spending doesn’t change for the next two years, why might the budget being put forward by the US House of Representatives boost the economy now?  Put plainly, their argument is that companies sitting on big piles of cash will invest more and individuals who have money to spend because they have funds in stocks, bonds and bank accounts will spend more now because of reduced concerns about higher future business and personal taxes.

The thing that Cogan and Taylor leave obscure in their argument is that the short-run effect of the House Budget would depend critically on the Federal Reserve’s reaction to it. Let me illustrate the importance of what the Fed does by pointing to the short-run effects of technology shocks. All economists agree that, in the long run, technological progress raises GDP—more than anything else. Yet, in our paper “Are Technology Improvements Contractionary?” which appeared in the scholarly journal American Economic Review, Susanto Basu, John Fernald and I showed that, historically, technology improvements have led to short-run reductions in investment and employment that were enough to prevent any short-run boost to GDP, despite improved productivity. (Independently, using very different methods, many other economists, starting with Jordi Gali, had found the negative short-run effect of technology improvements on how much people work.)

How can something that stimulates the economy in the long run lead people to work and invest less? It is all about the monetary policy reaction. Historically, in the wake of technology improvements, the Fed has cut interest rates somewhat, but has failed to do enough to keep the price level on track and accommodate in the short run the higher level of GDP that eventually follows from a technological improvement in the long run.

So what monetary policy do Cogan and Taylor envision to go along with the House Budget’s proposed cuts in future government spending? Arguing that the results of the House Budget would be even better than predicted by the model they are relying on, Cogan and Taylor write:

Nor does the model account for beneficial changes in monetary policy that could accompany enactment of the budget plan. Lower deficits and national debt would reduce pressure on the Federal Reserve to continue buying long-term Treasury bonds.

To translate, Cogan and Taylor are envisioning tighter monetary policy to go along with the House Budget. But, to the extent that their arguments about the stimulative effects of cutting future government spending have any merit, it would be in conjunction with continued—and likely accelerated–Fed purchases of long-term government bonds and mortgage bonds. As I discussed in an earlier column and at much greater length on my blog, John Taylor is so strongly opposed to even what the Fed is currently doing to support the economy that he is willing to resort to specious arguments to argue for Fed tightening. There is no hope that the House Budget will stimulate the economy as Cogan and Taylor claim unless John Taylor gives up his misguided wish for tighter monetary policy.

Quartz #16—>Monetary Policy and Financial Stability

Link to the Column on Quartz

Here is the full text of my 16th Quartz column, “Queasy Money: We should stop expecting monetary policy alone to save the US economy” now brought home to supplysideliberal.com and given my preferred title. It was first published on February 22, 2013. Links to all my other columns can be found here.

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 Quartz column and the following copyright notice:

© February 22, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

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Minutes of the US Federal Reserve’s monetary policy committee meeting on Jan. 29  and 30 and other recent statements by Fed officials reveal a vigorous debate within the central bank about the effects of monetary policy stimulus on financial markets. Most strikingly, the minutes indicate that Kansas City Federal Reserve Bank president Esther George “…dissented from the committee’s policy decision, expressing concern that loose credit increased the risks of future economic and financial imbalances….” In the same vein, Cleveland Fed president Sandra Pianalto expressed in a Feb. 15 speech her worry that “… financial stability could be harmed if financial institutions take on excessive credit risk by “reaching for yield” —that is, buying riskier assets, or taking on too much leverage—in order to boost their profitability in this low-interest rate environment.”

These worries are not without some foundation. For example, in a Feb. 20 Wall Street Journal article “Fed Split Over How Long to Keep Cash Spigot Open,” reporters Jon Hilsenrath and Victoria McGrane show graphs of dramatic flows of money into junk bonds, junk loans, and real estate investment trusts. Nevertheless, Boston Fed president Eric Rosengren is quoted as saying:

…that it wasn’t the central bank’s job to halt every episode of financial excess. Individual financial institutions regularly fail without bringing down the economy, and financial bubbles don’t always wreck financial systems. When the tech bubble burst in 2000, for example, the U.S. experienced a relatively brief and shallow recession. It didn’t lead to the same cascade of market collapses and a deep downturn as in 2008.

And they report Dallas Fed president Richard Fisher saying that although he is alert to possible dangers, “These robust markets are part of the Fed’s policy intent.”

In an extended question and answer session at the University of Michigan on Jan. 14, Federal Reserve Board Chairman Ben Bernanke revealed his philosophy about dealing with financial stability:  “… we will, obviously, be working very hard in financial stability. We’ll be using our regulatory and supervisory powers. We’ll try to strengthen the financial system. And if necessary, we will adjust monetary policy as well but I don’t think that’s the first line of defense.” Although Bernanke does not want fears about financial stability to constrain monetary policy too much, he is more concerned about the effects of quantitative easing (buying long-term Treasury bonds and mortgage-backed securities) and forward guidance (making announcements about future short-term interest rates) than he would be if the Fed could just push the current short-term interest rate below the near-zero level it is at now:

… we have to pay very close attention to the costs and the risks and the efficacy of these non-standard policies as well as the potential economic benefits. And to the extent that there are costs or risks associated with non-standard policies which do not appear or at least not to the same degree for standard policies then you would, you know, economics tells you when something is more costly, you do a little bit less of it.

I find wisdom in the words of Rosengren, Fisher and Bernanke. In my view:

1. It is almost impossible for monetary policy to stimulate the economy except by (a) raising asset prices, (b) causing loans to be made to borrowers who were previously seen as too risky, or (c ) stealing aggregate demand from other countries by causing changes in the exchange rate.
2. Quantitative easing is likely to have unprecedented effects on financial markets—effects that will look unfamiliar to those used to what the standard monetary policy tool of cutting short-term interest rates does.
3. It is not risk-taking we should be worried about, but efforts to impose risks on others—including taxpayers—without fully paying for that privilege.

1. Monetary Policy Works Through Raising Asset Prices, Loosening Borrowing Constraints, or Affecting the Exchange Rate.  It doesn’t make sense for firms to produce things no one wants to buy. Aggregate demand is the willingness to buy goods and services that determines how much is produced in the short run. Aggregate demand is the sum of the willingness of households (meaning families and individuals) to spend and build houses, of firms to buy equipment, build factories, office buildings, and stores, and spend on research and development, of government purchases, and of net exports: how much more foreigners buy from us than we buy from them (an area where the US is now in the hole).

To analyze household spending, it is a useful simplification to think of households as divided into two groups: (i) those who either don’t need to borrow or can borrow all they want at reasonable rates, and (ii) those who are borrowing as much as they can already and can’t borrow more. Economic theory suggests that those who don’t need to borrow or can borrow all they want at reasonable rates will look at the value of their wealth—including the asset value of their future paychecks—and spend a small fraction of that full wealth every year. The size of that fraction depends primarily on long-run factors, and is mostly beyond the Fed’s control. So, by and large, the only way the Fed can get those who don’t need to borrow to spend more is by increasing the value of their full wealth. If the full wealth goes up because they expect fatter paychecks in the future, no one gets worried, but otherwise that increase in wealth has to come from an increase in highly visible asset prices.

Those who are already borrowing as much as they can, will only be able to spend more if they can get their hands on more money in the here and now. Tax policy matters here, but the most recent change—the expiration of the Obama payroll tax cut—goes in the wrong way, reducing what people living from paycheck to paycheck have to spend. My proposal of a $2,000 Federal Line of Credit to every taxpayer would be a way to stimulate the spending of this group without adding much to the national debt. But this is beyond the Federal Reserve’s authority under current law. The way monetary policy now affects the spending of those who face limits on their borrowing is by lowering the cost of funds to banks so much that banks start to think about lending to people they were unwilling to lend to before.

A similar division by ability to borrow helps in understanding business investment as well. For firms who have trouble borrowing, additional investment spending will depend on borrowers-previously-deemed-too-risky getting loans. For firms that don’t need to borrow or can borrow all they want at reasonable rates, the key determinant of business investment is how valuable a firm thinks a new factory, office building, store, piece of equipment, or patent will be. But, by and large, the same factors that affect how valuable a new investment will be affect how valuable existing factories, office buildings, stores, equipment, and patents are. So the prices of the stocks and bonds that would allow one to buy a firm outright—with all of its factories, office buildings, stores, equipment and patents—will have to increase if the Fed is to encourage investment. The same logic holds for houses: it is hard to make it more valuable to build a new house without also making existing houses more valuable and pushing up their prices.

Aside from government purchases—which are the job of the president and the warring Democrats and Republicans in Congress rather than the Fed—that leaves net exports. There the problem is that while any one country can increase its aggregate demand by increasing its net exports, this doesn’t work when all countries try to increase net exports at the same time. The reason that monetary expansion isn’t  a zero-sum game across countries is because monetary policy can increase aggregate demand by raising asset prices and encouraging lenders to lend to borrowers they didn’t want to lend to before. The big danger is that those making the decisions within the Federal Reserve will mistake the normal workings of monetary policy—acting through asset prices and risky lending—for financial shenanigans that need to be stamped out by premature monetary tightening.

2. Nonstandard Monetary Policy. That said, nonstandard monetary policy in the form of purchases of long-term Treasury bonds and mortgage-backed securities and “forward guidance” on future short-term interest rates take the economy into uncharted territory. But uncharted territory brings not only the possibility of new monsters but also the near certainty of previously unseen creatures that might look like monsters, but are harmless.

3. Facing the Real Financial Dangers Squarely. So what distinguishes the real monsters from the paper dragons? Eric Rosengren had the key when he pointed to the contrast between the collapse of the internet stock bubble in 2000 and the financial crisis in 2008, that stemmed from the collapse of the housing bubble.  The difference was that, by and large, people invested in the internet stock price boom with their own money, and took the hit themselves when the bubble collapsed; people invested in the house price boom—both directly and indirectly—with borrowed money, and so imposed their losses on those they borrowed from and on taxpayers through bailouts. “High capital requirements” is the name of the policy of forcing big banks to put enough of their own money at risk to be able to absorb financial losses without imposing those losses on others. Capital requirements for banks are akin to down payment requirements for individuals buying houses. The financial crisis we are still suffering from arose from too little of both. Needless to say, banks hate capital requirements, since the secret for all too great a share of financial profits is taking the upside while foisting the downside on others (often taxpayers) who don’t know they are taking the downside, and aren’t being compensated for taking that risk.

Beyond pushing for high capital requirements—especially during booms, when financial shenanigans are most likely—the Fed can do a lot to foster financial stability by continuing to make a list of possible macroeconomic risks to use in subjecting financial firms to “stress tests” as it has done in 2009, 2011, 2012 and 2013. But it can do more with this list of possible macroeconomic risks by requiring financial firms to explicitly insure themselves against these risks and imposing very tough capital requirements on those who purport to provide such insurance. Indeed, for deep pockets, the ideal provider of such insurance would be a sovereign wealth fund, as I proposed in “Why the US Needs Its Own Sovereign Wealth Fund.” The problem is not having taxpayers bear these risks, it is having taxpayers bear these risks without being compensated for doing so. The bedrock principle should be to bring as many macroeconomic risks as possible out of the shadows into the light of day, so that prices can be put on those risks. If risks are out in the open, then those who face them will face them knowingly, and won’t be able to shirk the responsibility they have undertaken when those risks materialize.       

Fostering financial stability by enforcing high capital requirements during booms and working toward the naming and pricing of macroeconomic risks is its own reward. But it also has the extraordinary benefit of freeing up monetary policy to pursue its main mission of protecting the economy from inflation and high unemployment. The more potential evils we face, the more tools we need. Rather than attempting to use the familiar tool of monetary policy for a task to which it is ill-suited, let us fashion new tools to enhance financial stability.

Quartz #15—>How to Stabilize the Financial System and Make Money for US Taxpayers

Link to the Column on Quartz

Here is the full text of my 15th Quartz column, “How to stabilize the financial system and make money for US taxpayers” now brought home to supplysideliberal.com. It was first published on February 8, 2013. Links to all my other columns can be found here.

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 Quartz column and the following copyright notice:

© February 8, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

Note: a version of this column is also slated to be published in FS Focus, the financial services magazine of the ICAEW, an organization of accountants in the UK. In that version, the passage from “In brief, …” to the end of its paragraph was replaced with this passage, which I think you will find interesting as well:

At its inception, a US sovereign wealth fund would be established by issuing $1 trillion worth of low-interest safe Treasury bonds and investing those funds in high-expected-return risky assets. That takes those risky assets off the hands of private investors and puts safe assets in the hands of those private investors instead. Having fewer risky assets on their balance sheets overall would make those private investors readier to back private firms in taking on the additional risks involved in buying equipment, building factories, or starting up new businesses. And having more safe assets in the hands of private investors would provide good collateral for the financial arrangements those projects would need. Thus, the establishment of the sovereign wealth fund encourages investment and stimulates the economy. The Fed has plenty of tools for keeping the economy from being stimulated too much. So the mere existence of the sovereign wealth fund gives the Fed a wider range of stimulus levels to choose from. Moreover, any given level of stimulus would requires a less aggressive course of quantitative easing (QE) on the part of the Fed than it would otherwise need to pursue.

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Geopolitically, the world still lives in the shadow of Sept. 11, 2001. Economically, the world still lives in the shadow of Sept. 15, 2008, the day Lehman Brothers collapsed and ushered in a deep financial crisis. The fundamental problem: big banks and other financial firms that pretended to take on huge risks without, in fact, being able to shoulder those risks. Under the guise of taking such risks, these financial firms reaped the reward during the good times. But when the risks came home to roost, only US taxpayers—the US government acting on their behalf—had the wherewithal to absorb those risks.

In the future, shouldn’t US taxpayers get some of the reward from taking on the macroeconomic risks that are too big and too pervasive for banks and financial firms to shoulder? Such risk-bearing is richly rewarded. Indeed, as George Mason University professor Tyler Cowen points out in his American Interest article, “The Inequality that Matters,” a shockingly high fraction of the wealth of the super-rich comes from finance. But more importantly, having US taxpayers rewarded for actually taking on macroeconomic risk—risk that US taxpayers end up bearing in large measure anyway—would crowd out the charade of big banks and financial firms pretending to take on that risk. And it is that pretense that brought the world to the dreadful, long-lasting economic quagmire it is in now.

In my Quartz column a little over a month ago I explained “Why the US needs its own sovereign wealth fund” primarily as a way to give the Federal Reserve more running room in monetary policy. In brief, the mere existence of a US sovereign wealth fund, one that issued through the Treasury $1 trillion worth of low-interest safe bonds and invested it in high-expected-return risky assets, would give the Federal Reserve a lot more room to maneuver.  Moreover, it would allow the Fed to pursue a less aggressive course of quantitative easing (QE) than it would otherwise need to pursue. The US fund would draw political controversy to itself, and away from the Fed, thereby preserving the independence of monetary policy that we need in order to avoid inflation in the long run.

But a US sovereign wealth fund can do more if given the independence it needs to focus on (1) making money for the US taxpayer and (2) financial stability, rather than extraneous political objectives. These two goals are consistent, since the same contrarian strategy serves both. Buying assets cheap, relative to their fundamentals, and selling assets that are expensive, relative to their fundamentals, both pushes asset prices toward their fundamentals and, by buying low and selling high, makes profits that we can use to help pay off the national debt. It takes almost inhuman fortitude to withstand the winds of investment fashion. But given appropriate compensation policies, a $1 trillion US sovereign wealth fund would be able to hire the next generation’s Warren Buffett to take care of US taxpayers’ money. They deserve no less.

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Update: I discovered in a forgotten email a pdf of a version of this in print (on page 8) and a link to a version on the Economia website. I find those mostly interesting for the visuals:

Quartz #13—>John Taylor is Wrong: The Fed is Not Causing Another Recession

Link to the Column on Quartz

Here is the full text of my 13th Quartz column, “John Taylor is Wrong: The Fed is not causing another recession,” now brought home to supplysideliberal.com. It was first published on January 29, 2013. Links to all my other columns can be found here.

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 Quartz column and the following copyright notice:

© January 29, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

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In his Wall Street Journal editorial headlined “Fed Policy is a Drag on the Economy“ this morning, Stanford economist John Taylor makes the remarkable claim that the US Federal Reserve’s efforts to keep interest rates down by asset purchases now—and promises of asset purchases in the future—is like rent control. If this were true, then the Fed’s actions to lower interest rates could be contractionary and could cause another recession. But it is just wrong.

The Fed’s actions to lower interest rates are more like  encouraging the construction of more apartments—by granting building permits more readily—in an effort to keep rents down. That makes all the difference. The Fed’s actions are stimulative because the Fed is acting within the framework of supply and demand bringing markets to equilibrium. While the Fed is intervening in asset markets, contrary to Taylor’s claim, it is not doing anything to take away the role of interest rates to equate supply and demand. So when the Fed brings interest rates down, people will build more houses and factories, and buy more machines and consumer durables than they otherwise would.

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This column is the two-paragraph précis of my post “Contra John Taylor.”

Twitter provided some reviews of these two pieces that I liked. Here are a few:

• Noah Smith: Miles Kimball bellows, turns green, shreds his clothes, and hurls John Taylor into low Earth orbit
• Daniel Altman:With @TimHarford smacking down Rachman and @mileskimballsmacking down Taylor, I think the Internets are won for today.
• Tomas Hirst: An excellent post from @mileskimball explaining why #QE scaremongers are wrong
• Jonathan Prober: Thought your elaboration upon your agreement with Taylor on scope of Fed intertwined with your discussion of SWF was top notch
• Matthew Yglesias

Paul Krugman cited “Contra John Taylor.” in his column “Calvinist Monetary Economics,” writing

Actually, as Miles Kimball points out, [John Taylor is] committing a basic microeconomic fallacy — a fallacy you usually identify with Econ 101 freshmen early in the semester…

Why the Nominal GDP Target Should Go Up about 1% after a 1% Improvement in Technology →

Don’t miss the discussion further down of sticky prices vs. sticky wages.  

Quartz #12—>Yes, There is an Alternative to Austerity vs. Spending: Reinvigorate America's Nonprofits

Link to the Column on Quartz

Here is the full text of my 12th Quartz column, “Yes, there is an alternative to austerity vs. spending: Reinvigorate America’s nonprofits,” now brought home to supplysideliberal.com. It was first published on January 15, 2013. Links to all my other columns can be found here.

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 Quartz column and the following copyright notice:

© January 15, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

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Despite serving only one term from 1989-1993, US President George H. W. Bush (just released from the hospital yesterday after a bout of fever and other complications) has cast a long shadow over subsequent events. His decision to leave Saddam Hussein in place after the First Iraq War led to his son’s immensely controversial Second Iraq War. And the negative reaction to his decision to compromise with Democrats in raising taxes in 1990 despite his pledge “Read my lips, no new taxes” has set the terms of the tax policy debate ever since. Tax reformer Grover Norquist codified the principle of “no new taxes” into the Taxpayer Protection Pledge, which goes as follows:

I, ____ pledge to the taxpayers of the state of ____, and to the American people that I will:

ONE, oppose any and all efforts to increase the marginal income tax rates for individuals and/or businesses; and

TWO, oppose any net reduction or elimination of deductions and credits, unless matched dollar for dollar by further reducing tax rates.

Republican Speaker of the House John Boehner made a nod toward this pledge two weeks ago, pushing for the temporary resolution of the fiscal cliff, when he reminded his rank and file that, technically, taxes had already gone up, due to the expiration of the younger Bush’s tax cuts at year end. The implication was that members of Congress would really be voting for a tax cut, not a tax increase, and so would not be breaking their pledge. There is no doubt that this matter of interpretation will feature prominently in the GOP primaries in 2014.

The ongoing crisis in long-run US taxing and spending policy is born from the collision of an almost unstoppable force on the spending side with Grover Norquist’s almost immovable object on the taxing side. Former Treasury Secretary Larry Summers ably describes the almost unstoppable force on the spending side in his Washington Post editorial “The Reality of Trying to Shrink Government.” The bottom line is that the explosion of government spending is primarily the result of (1) an aging population, (2) having to pay interest on ballooning government debt, and (3) the increasing cost of medicine that keeps discovering ways to do more with the expensive skilled labor of doctors and other medical professionals. To put it bluntly, the only way to keep government spending constant in the future, let alone reduce it, would be to dramatically reduce benefit levels for Social Security, Medicare and Medicaid, or to gut all the other functions of government, from national defense to the judicial system to scientific research.

It is easy to be misunderstood when mentioning Hitler, but here I want to invoke a comparison solely in his role as an inept commander-in-chief of the German armed forces and in no other capacity. In his book, The Storm of War: A New History of the Second World War, Andrew Roberts argues that Hitler’s no-retreat, “stand-or-die” orders were strategically disastrous for the German forces. German generals had a brilliant record at turning tactical retreats into great German victories. But Hitler’s stand-or-die orders took away the advantage of maneuver and left German troops to be mowed down by the Russians under Stalin. My point is that the “stand-or-die” approach is likely to do no better against the spending juggernaut than it did against Stalin.

In our long-run fiscal situation, the alternatives (of which we may need more than one) are to convince the American people to swallow straight benefit cuts, to directly raise tax rates, to grow the economy to get more revenue through:

1. Increased immigration, done in a way that focuses on economic growth, as I discussed in a previous Quartz piece entitled “Obama could really help the US economy by pushing for more legal immigration”

2. A more efficient tax system that encourages capital formation, as discussed in my “Twitter Round Table on Consumption Taxation”

3. A big push for increased scientific research to accelerate technological progress

But then what? I propose that many of the jobs the government has set for itself actually be done outside the government, by the non-profit sector.

In my recent blog post “No Tax Increase Without Recompense” (there’s a cliff notes version here), I propose a “public contribution system” that goes far beyond the current tax deduction for charitable contributions. In this program:

A public contribution is a donation to a nonprofit organization meeting high quality standards that engages in activities that (a) could be legitimate, high-priority activities of Federal or State governments and (b) can to an important extent substitute for spending these governments would otherwise be likely to do.

My proposal is to raise marginal tax rates above about $75,000 per person—or $150,000 per couple—by 10% (a dime on every extra dollar), but offer a 100% tax credit for public contributions up to the entire amount of the tax surcharge.

In addition to helping the government budget by taking over tasks the government is now doing and by reducing revenue lost to the current charitable deduction, I believe the non-profit sector (with the usual level of regulation) can do many things better than the government, and this program would be much less painful for people than paying the same amount in taxes. It is easy to find fulfillment in philanthropy. There is satisfaction in knowing one has made a difference in the world, in a way of one’s own choosing. And giving can serve as a good opportunity for teaching children to care. No doubt, some would view these contributions to charitable causes as almost as onerous as the taxes to which they would be an alternative. But I don’t think that would be the typical reaction.

Many people talk as if taxes are hateful only because the government is taking our money. But taxes are also hateful because the government is arrogating to itself the choice of what should be done with the money it takes from us. The government is jealous of its power. But let us insist that any resolution of our long-run fiscal crisis reduces, rather than adds to, government power. We do need to take care of those who are poor, sick and elderly. A program of public contributions shrinks government, while getting the job done. And it would be a fitting honor for George H. W. Bush, who said movingly in his inaugural address:

I have spoken of a thousand points of light, of all the community organizations that are spread like stars throughout the Nation, doing good… . The old ideas are new again because they are not old, they are timeless: duty, sacrifice, commitment, and a patriotism that finds its expression in taking part and pitching in.

Thomas Herndon, Michael Ash, Robert Pollin and Mike Konczal: Researchers Finally Had a Chance to Replicate Reinhart-Rogoff, and There Are Serious Problems. →

I thought it important to put this up right away, since I have referenced the correlations in the Carmen Reinhart, Vincent Reinhart and Ken Rogoff paper “Debt Overhangs, Past and Present.” It is likely that the later paper I relied on has some of the same problems as the earlier paper that Mike Konczal discusses based on Thomas Herndon, Michael Ash, and Robert Pollin’s paper “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” In particular, I would like to know how the figures from “Debt Overhangs, Past and Present,” that I copied over in my post “Noah Smith Joins My Debate with Paul Krugman: Debt, National Lines of Credit, and Politics” are affected by the emendations of Thomas Herndon, Michael Ash, and Robert Pollin. I would be grateful for any help in figuring this out. 

Luigi Zingales: Pro-Market vs. Pro-Business

From Chrystia Freeland’s book Plutocrats, pp. 261-262:

Luigi Zingales, a professor at the University of Chicago’s Booth School of Business, frames [a central issue for government policy] as the choice between being promarket and being pro business. Super-elites are often the product of a strong market economy, but, ironically, as their influence grows, they can become its opponents. 

Here is how Zingales, an ardently patriotic immigrant to America and a passionate defender of the market economy, describes the dynamic: “True capitalism lacks a strong lobby. That assertion might appear strange in light of the billions of dollars firms spend lobbying Congress in America, but that is exactly the point. Most lobbying seeks to tilt the playing field in one direction or another, not to level it. Most lobbying is pro-business, in the sense that it promotes the interests of existing businesses, not pro-market in the sense of fostering truly free and open competition. Open competition forces established firms to prove their competence again and again; strong successful market players therefore often use their muscle to restrict such competition, and to strengthen their positions. As a result, serious tensions emerge between a pro-market agenda and a pro-business one.”

Quartz #11—>Why the US Needs Its Own Sovereign Wealth Fund

Link to the Column on Quartz

Here is the full text of my 11th Quartz column, “Why the US needs its own sovereign wealth fund,” now brought home to supplysideliberal.com. It was first published on January 3, 2013. Links to all my other columns can be found here.

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 Quartz column and the following copyright notice:

© January 3, 2013: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

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The fate of the US economy, like that of Japan, the euro zone, and the rest of the world will rest on an important fact: unless private investors or another government counteract central bank asset purchases 100%, central banks can drive asset prices up and interest rates down by buying any asset that has an interest rate above zero. The Fed has committed to continue buying $45 billion of longer-term Treasurys every month and $40 billion a month of mortgage-backed securities until the economy recovers.

But what if longer-term Treasuries and mortgage-backed securities are the wrong assets for the Fed to buy? Most of those rates are already below 3%, so it’s not that easy to push the rates down further. What is worse, when long-term assets already have low interest rates, pushing down those interest rates pushes the prices of those assets up dramatically. So the Fed ends up paying a lot for those assets, and when it later has to turn around and sell them—as it ultimately will need to, to raise interest rates and avoid inflation, it will lose money. Avoiding buying high and selling low is tough when the Fed has to move interest rates to do the job it needs to do. At least economic recovery reduces mortgage defaults and so helps raise the prices of mortgage-backed securities through that channel. But the effects of interest rates on long-term assets cut against the Fed’s bottom line in a way that is never an issue when the Fed buys and sells 3-month Treasury bills in garden-variety monetary policy.

From a technical point of view, once 3-month Treasury bill rates (and overnight federal funds rates) are near zero, the ideal types of assets for “quantitative easing” to work with are assets that (a) have interest rates far above zero and (b) are buoyed up in price when the economy does well. That means the ideal assets for quantitative easing are stock index funds or junk bond funds!

Yet, is the Federal Reserve even the right institution to be making investment decisions like this? University of Chicago finance professor John Cochrane writes in his Wall Street Journal editorial “The Federal Reserve: From Central Bank to Central Planner.”

In his speech Friday in Jackson Hole, Wyo., Mr. Bernanke made it clear that “we should not rule out the further use of such [nontraditional] policies if economic conditions warrant.”

But the Fed has crossed a bright line. Open-market operations do not have direct fiscal consequences, or directly allocate credit. That was the price of the Fed’s independence, allowing it to do one thing—conduct monetary policy—without short-term political pressure. But an agency that allocates credit to specific markets and institutions, or buys assets that expose taxpayers to risks, cannot stay independent of elected, and accountable, officials.

This is not a criticism of personalities. It is the inevitable result of investing vast discretionary power in a single institution, expecting it to guide the economy, determine the price level, regulate banks and direct the financial system.

As Cochrane points out, isn’t it a bit much to expect the Fed to both choose the right amount of stimulus for the economy and decide which financial investments are the most likely to turn a profit for a government that faces remarkably low borrowing costs?

Why not create a separate government agency to run a US sovereign wealth fund? Then the Fed can stick to what it does best—keeping the economy on track—while the sovereign wealth fund takes the political heat, gives the Fed running room, and concentrates on making a profit that can reduce our national debt.

Sovereign wealth funds are already standard for governments that have paid off their national debt and gone into the black. And some countries have both debt and sovereign wealth funds on their balance sheet. In order of holdings, the Monitor Group’s Sovereign Wealth Fund Assets Under Management Table shows that Norway, China, United Arab Emirates, Singapore, and Kuwait have the top sovereign wealth funds. Markets today are so hungry for assets as safe as US Treasurys, and so frightened of risk (pdf), that a US sovereign wealth fund would be paid handsomely to provide safe assets and shoulder some of the risk. But those financial returns are a bonus over and above the primary aim: fostering full economic recovery.

As an adjunct to monetary policy, the details of what a US Sovereign Wealth Fund buys don’t matter. As long as the fund focuses on assets with high rates of return, the effect on the economy will be stimulative, and the Fed can use its normal tools to keep the economy from getting too much stimulus. So there can be a division of labor: the US Sovereign Wealth Fund can focus on making as high a return as possible for the US taxpayer, and hire accordingly, as other sovereign wealth funds do, while the Federal Reserve focuses on getting the amount of stimulus right, which is where its expertise lies. The US Sovereign Wealth Fund needs the same level of independence as the Fed, and a single mandate to earn high returns, given the level of risk it is taking on. Above some minimum, the US Treasury can be given the authority to determine the amount the US Sovereign Wealth Fund is allowed to borrow so that no one institution would have too much power or too much responsibility.

Since it would horn in on their turf, big investment banks on Wall Street are likely to offer a chorus of complaints about a US Sovereign Wealth Fund. But after many years of playing a “heads I win, tails you lose” game with the US Government and the US taxpayers, the big investment banks have no moral standing to object to the US government and the US taxpayers finally getting some of the return that should go along with the risks that they have always had to bear.

We Don't Talk Enough About the Story Outside the Model

Tomas Hirst interviewed me for his newly upgraded aggregator website Pieria. The site includes me as one of its “experts.” Here is the link to the interview on Pieria. It appeared yesterday. I highly recommend taking a peek at the new Pieria: here is the homepage.

The full text of the interview is below. Q is Tomas, A is Miles. This interview is closely related to Noah Smith’s post “What is Economic Equilibrium.”

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Q: Has the financial crisis prompted a renewed interest in debating and challenging the economic orthodoxy of the “Great Moderation”?

A: The blogosphere was there before the crisis and was helping that conversation to grow, but the crisis certainly brought more people in. Indeed Scott Sumner said on his blog that he was motivated to start blogging because of the crisis. I think people are thinking about a wider range of things.

There are always fashions in economic research, but perhaps not surprisingly there’s more time being devoted to looking at what was going on. People have been working on models where having collateral matters, for example, which show that when the value of houses goes down it’s harder to borrow and lend.

Q: Have the events of the past few years changed the way that you think about policy responses to a crisis?

A: The Great Depression and the Japanese “Lost Decade” certainly made me think about issues surrounding the zero lower bound a lot. It’s true that I wasn’t thinking about the idea of electronic money and negative nominal rates at the time, although I had seen a piece by Greg Mankiw in which he toys with the idea of getting rid of the zero lower bound.

So I was thinking about quantitative easing but then I shifted to thinking about new ideas. It’s too bad that people are simply taking the zero lower bound as a given. I think it will be a hugely important discussion to get people to realise that it’s not some law of nature, it’s an artefact of our paper currency policy.

Q: Some people might consider moving to a world in which we had negative nominal interest rates rather uncharted territory compared with more traditional stimulatory policies such as increasing government spending. Do you think there is a role for more conventional policy moves to pull economies out of a slump?

A: As Reinhart. Reinhart and Rogoff have said, national debt above 90% of GDP has a negative impact. Obviously that’s just a stylised fact just like the fact that you tend to have a long-lasting slump after a financial crisis but I think it’s fairly proven that there are problems with having the national debt at too high a level.

Although you could say that stimulating the economy by massive fiscal stimulus is better understood, some of what we understand is that that has downsides in terms of national debt. Being well understood doesn’t always mean that it’s a better policy.

I would say in that context the conservative policy would be national lines of credit. It is something that is in the range where we understand what it would do, although there is some debate over just how much stimulus it would provide. My guess is that it would have a similar impact on demand as handing people that amount of money.

Policies such as bringing forward already planned government spending would also be a quite conservative option. You could, for example, accelerate the restocking of certain types of military equipment that you know you are going to have to buy later anyway.

As soon as you’re doing types of government spending that you wouldn’t be doing otherwise then that’s a fairly long-term addition to the national debt with probably pretty serious negative consequences.

Q: Are you worried about possible unintended consequences of negative nominal interest rates and electronic money?

A: It depends really on how much you believe in monetary neutrality and monetary superneutrality.

If you believe in approximate monetary neutrality then we’ve already seen negative rates before. It is just low real interest rates. It’s only untried if you think that nominal illusion is important.

I have no doubt that it could be confusing to people at first but the main thing we know is that it would mark a return to the type of effective monetary policy that gave us the “Great Moderation”. If you take away the zero lower bound then monetary policy can keep the economy on target and you get the separation between fiscal policy and keeping the economy at its natural level of output.

That is very helpful in terms of the political economy as it’s a wholly different debate to how much you want to redistribute and how you value different kinds of government spending. It becomes very difficult when you try to mix those things up with trying to keep output at its natural level.

Q: What do you make of the argument that there is a case for raising interest rates in a downturn in order to raise inflation expectations and improve confidence in the economy, as some have suggested?

A: I think that’s a huge mistake. It’s a theoretical error that comes from the fact that people are so used to defining and modelling equilibria that they don’t realise that each of these models has to have a story outside the model for how you got to equilibrium.

As far as I know that’s true without exception. Yet we don’t talk enough about the story outside the model. The reason for this is that it can’t be formalised in the same way.

When people don’t think about how you get to an equilibrium they come to conclusions that are just wrong.

In the real world raising rates would be very contractionary. You can have a model in which there are multiple equilibria but I’m pretty sure that raising rates is not the way to move from the equilibrium we’re in to a better one. I can’t imagine the expectations of people in the real world being such that they would see the Federal Reserve or the Bank of Japan raising rates and think that the economy is suddenly going to do great.

Even if it’s theoretically possible, it would only be one of the possibilities. In terms of way that people like John Taylor have been arguing this point, it seems as though he believes rates should go up and is looking for any reasons that could support this conclusion even if they don’t all come from the same theory.

Q: Does any of your current work touch on this subject?

A: Bob Barsky, Rudi Bachmann and I have a paper in progress that’s related to this. Here’s the model that I’ve worked with a lot, which Bob Barsky also got excited about, and then we recruited Rudi:

Let’s simplify it by leaving aside Q-theory and having no adjustment cost for investment. Now I have a delay condition for investment that says “I want to accelerate investment if the net rental rate is greater than the interest rate”.

So I have a graph of output on the horizontal axis and on the vertical axis I’ve got the net rental rate and the real interest rate. I have a net rental rate curve, which we call a KE curve because I think Sargent called it that. There’s no mystery that the rental rate goes up with output. When the economy is booming you’re going to be more eager to rent some capital by leasing office space or rent some

machines.

The other curve is a monetary policy rule. When I think in continuous time, the number one thing I need for the stability of monetary policy is for it to be steeperthan the net rental rate. However, you’ve got a problem when you get down to the zero lower bound as it’s tough to keep interest rates steeper than rental rates. So you can easily get multiple equilibria.

If you have zero gross investment, that would be a low level of output. Suppose that level of output gives you a net rental rate below zero. That would be an example of a stable equilibrium with zero gross investment. If you did nothing eventually the capital stock would deplete to the point where the net rental rate would come above zero and the economy would restart, but that could be an awfully long slump.

The other thing that can happen is that you have some fiscal stimulus that could get you past the unstable equilibrium in the middle and you could jump up to the good equilibrium again. The very existence of the good equilibrium depends upon monetary policy so you might need a combination of monetary and fiscal policy.

Yet you can get out of it just through monetary policy. If you don’t have a zero lower bound then you can keep cutting the interest rate until it does get past the net rental rate. Moreover, you wouldn’t have fallen into the bad equilibrium in the first place if you had electronic money and no zero lower bound.

What I think is happening in people’s thinking is that they have observed that you have higher interest rates during a boom. That, however, is about the net rental rate and not about the monetary policy. In fact, when you have these two upwards-sloping curves it is precisely by cutting interest rates that you achieve higher interest rates as the economy recovers.

It’s theoretically possible that the economy could miraculously jump to the good equilibrium with no impulse whatsoever and that could coincide with a rise in the interest rate. But in terms of causality it’s still the miraculous restoration of confidence that caused the jump, not the higher interest rate.

Quartz #10—>Read His Lips: Why Ben Bernanke Had to Set Firm Targets for the Economy

Link to the Column on Quartz

Here is the full text of my 10th Quartz column, “Read his lips: Why Ben Bernanke had to set firm targets for the economy,” now brought home to supplysideliberal.com. It was first published on December 13, 2012. Links to all my other columns can be found here.

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 Quartz column and the following copyright notice:

© December 13, 2012: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

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The Fed has announced for the first time what levels of unemployment and inflation would lead it to keep short-term interest rates close to zero:

In particular, the Committee decided to keep the target range for the federal funds rate at 0 to ¼ percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-½ percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

There are several remarkable aspects to this sentence. First, the Fed is saying more clearly than ever before that 2% is its long-run inflation target. Second, it is saying it thinks the unemployment rate can be brought down at least as far as 6.5% without causing too much inflation, though it will keep a close watch on where inflation seems to be headed to make sure. Third, the Fed is saying it is willing to tolerate inflation temporarily above 2% if that is what it takes to bring the unemployment rate down that low.

I applaud this move by the Fed. Although the Fed said, “The Committee views these thresholds as consistent with its earlier date-based guidance,” I am not so sure. It is not that easy to know how long it will take for the economy to recover. Specifying the actual economic indicators that the Fed is looking at, and how it is reading them, is much better. Saying specific dates had the danger of suggesting the Fed would keep interest rates low for too long if the economy recovered more quickly than expected. This danger was significant because an important line of thought has suggested that the Fed should promise to overheat the economy in the future to stimulate the economy now. The specific guidepost for unemployment and inflation that the Fed has laid down in yesterday’s statement make it clear that the Fed is not promising to overheat the economy in the future to stimulate the economy now. But those guideposts also make it clear that the Fed intends to continue to do what else it feels it can to return the economy to the lowest level of unemployment consistent with steady inflation.

There are things that the Fed could do to get the economy more quickly to robust health. Most obviously, there is no reason that the Fed should limit its purchases of additional long-term treasury bonds and mortgage bonds to the $85 billion per month rate it has announced. But to take the chains off of monetary policy, the best thing for the Fed to do would be to urge Congress to give it the authority to subordinate paper money to electronic money to eliminate the “zero lower bound” that paper money puts on short-term interest rates, as I discuss in “How paper currency is holding the US Recovery Back” and “Could the UK be the first country to adopt electronic money?”

Quartz #8—>Judging the Nations: Wealth and Happiness Are Not Enough

Link to the Column on Quartz

Here is the full text of my 8th Quartz column, “Obama the Libertarian? Americans say they’d be happy if the government got out of their way,“ now brought home to supplysideliberal.com. The title of this post is the original working title of the column. Below the text of the column itself, I have an important outtake from my original draft.  This column was first published on December 4, 2012. Links to all my other columns can be found here.

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 Quartz column and the following copyright notice:

© December 4, 2012: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

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Four years from now—or 40—how should we evaluate Barack Obama’s presidency? This is not an easy question. For example, when things go badly (or well), a tricky aspect of this question is “To what extent is the president responsible for what happened?” Ruchir Sharma argues that in their judgment of the last four years, voters put the primary blame for our economic troubles on inevitable after-effects of the financial crisis that hit in 2008. Another tricky aspect of judging a presidency is deciding how to sum things up when a policy initiated by the president helps one group while hurting another. But the first question to ask four years from now, in 2016, will be “Are you better off than you were four years ago?”

It’s often assumed that in answering this question people are referring to their financial situation. But what if they took happiness into account as well? As Allison Steed points out in her Nov. 29 article in the Telegraph, “Here’s How Much You Need to Be ‘Happy’ in Different Countries,”  financial aspirations can differ a lot across countries. And money is clearly not the only thing that matters for happiness. A Pew Research Center Report on happiness around the world shows that while happiness goes up with per capita GDP, at similar middle-income levels, the Latin American countries do better than expected while Eastern European countries do worse than expected.

In two previous Quartz columns, I discussed evidence that happiness is not enough: people want to be rich, successful, happy and much more. In previous research my co-authors and I found that in both hypothetical situations and the real-world choices young doctors make about which residency to choose, happiness was very important, but so was money and prestige.  This would be paradoxical if each of the people we surveyed defined “happiness” as “whatever it is I want,” but in fact, people used the word “happiness” to mean “feeling happy.”

That people want more than money makes GDP an inadequate measure of well-being. That they want more than happiness makes happiness an inadequate measure of well-being. So it won’t work to simply replace GDP with Gross National Happiness as Richard Layard advocates in his book, Happiness. And looking at National Life Satisfaction has a similar problem.

So let’s get serious about what it means for an individual or a nation to be better off. Constructing a solid measure of national well-being requires answering the two questions “What do people want and how much do they want it?” So my coauthors Daniel Benjamin, Ori Heffetz, Nichole Szembrot and I set out to answer exactly those questions in our National Bureau of Economic Research Working Paper “Beyond Happiness and Life Satisfaction: Toward Well-Being Indices Based on Stated Preference.” We gave about 4,600 US adults hard choices to make in computer-generated scenarios where they had to identify both what people wanted for themselves and what they wanted for the nation as a whole. We didn’t want to prejudge, so we started with a list of 136 aspects of life that people might care about, drawing from a wide-ranging scientific and philosophical literature, as well as spirited discussions among the four of us.

The answers we found to “What do people want and how much do they want it?” were at once surprising and the height of common sense. I want to focus on the answers people gave for what they wanted for the nation as a whole, since that is primarily what a president should be judged on. One important finding is that, even across divisions of party, religion, age and sex, people by and large put the same things at the top of the list of what they want for the nation.  And the things they want for the nation as a whole are similar to the things they want for themselves.

Let me give my take on the top 25 things we found people want for the nation as a whole. Freedom comes first: freedom from injustice, corruption, emotional abuse and abuse of power; freedom of speech and political participation, freedom to pursue one’s dreams and the freedom of having choices. Besides freedom, people want for the nation goodness, truth, loyalty, respect and justice.

Only after freedom and goodness, do the “bread-and-butter” aspects of people lives start to come in. These bread-and-butter aspects are reflected in 11 of the top 25 aspects of life, including people’s health and freedom from pain, financial security, someone to turn to in time of need, emotional stability, a sense of security and peace, and activities to enjoy. Beyond freedom, goodness, and the practical, bread-and-butter aspects of people’s lives I just listed, people want meaning—the sense that one is making a difference in the world–for themselves and for others.

Freedom, goodness, truth, loyalty, respect, justice, bread-and-butter concerns, meaning: people’s hopes for our nation, and for themselves, extend to a lot more than money and happiness. I believe the breadth of what people want for the nation has implications for the policies our country should pursue, and how we should judge President Obama four years from now. In drawing out those implications, I will leave aside the bread-and-butter concerns, and concerns about “justice,” since I think our leaders understand those better than the other concerns.

One of the best ways to increase the freedom in the world is to allow more people to come to the United States to experience and tell of the freedom we have here, as I advocated in my Quartz column “Obama Could Really Help the US Economy by Pushing for More Legal Immigration.” But there is a lot to be done to preserve and bolster freedom in the US. Taxes represent a loss of freedom that should be mitigated in the kinds of ways I suggest in my post “No Tax Increase Without Recompense.” The conflict between employees’ freedom at work and employers’ freedom to lay down work requirements need to be fairly adjudicated, as discussed in my post “Jobs.” And every government regulation, in addition to whatever other costs and benefits it has, causes a loss of freedom from telling somebody what they must do.

When we do constrain freedom by regulation, it should be in service of something important, such as truth: people’s freedom from being lied to, deceived or betrayed. It is worth remembering that the standard results about the virtues of the free market all depend on deception being effectively neutralized–so there is no fundamental conflict between economic growth and laws that block corporate deception and throw scam artists in jail.  Enforcing the basic principle of telling the truth, like enforcing property rights, is an area where government is on the side of the angels.

Meaning, goodness, loyalty and respect are the trickiest for public policy to foster. As a social scientist who does research supported by government grants, I would like to think that there is some sense of meaning for all of us in humanity’s efforts at scientific research, such as medical research and the kind of research to slow global warming advocated by Noah Smith in his Atlantic column “The End of Global Warming: How to Save the Earth in 2 Easy Steps.” But I think a big part of what government needs to do to foster meaning, goodness, loyalty and respect is to stay out of the way. In this regard, I am worried about recent discussion of limiting the charitable deduction. My proposal for a system of “public contributions” is a way to reform and refocus the purpose of the charitable deduction instead, in order to reduce the government deficit, and reduce the footprint of the government, without depriving people of help they need.

From doing this research, I am left with the overwhelming impression that—even in the realm of intangibles—what people hope for and wish for is not one thing, but many things. Our desires are boundless. And that is how it should be. As Robert Browning wrote, ”Ah, but a man’s reach should exceed his grasp, Or what’s a heaven for?”

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In early drafts, I related what I say in the Quartz column to Jonathan Haidt’s six moral tastes in his book The Righteous Mind: Why Good People Are Divided by Politics and Religion. Here is a New York Times book review by William Saletan, and here is a good passage from Jonathan Haidt summarizing his theory, chosen by Bill Vallicella, in Bill’s post “Jonathan Haidt on Why Working Class People Vote Conservative.”

There is a key chunk of text making the link to Jonathan Haidt’s theory that was appropriately cut for being too wonkish, but that I think you might find valuable

1. for making that connection and 
2. for more carefully stating the key findings about people’s preferences in hypothetical policy choices from my paper with Daniel Benjamin, Ori Heffetz and Nichole Szembrot. 

Here it is: 

The most important boon people want for the nation as a whole is freedom. In the words we used for the choices we gave them, the #1, #2, #10, #13, #18 and #23 things people want for the nation are

• freedom from injustice, corruption, and abuse of power in your nation
• people having many options and possibilities in their lives and the freedom to choose among them;
• freedom of speech and people’s ability to take part in the political process and community life;
• the amount of freedom in society;
• people’s ability to dream and pursue their dreams; and
• people’s freedom from emotional abuse or harassment.

The next most important boons people want for the nation are goodness, truth, loyalty, respect and justice. On our list, the #3, #6, #8, #17, #19 and #21 most highly-valued aspects of the good society are

• people being good, moral people and living according to their personal values;
• people’s freedom from being lied to, deceived or betrayed
• the morality, ethics, and goodness of other people in your nation;and
• people having people around them who think well of them and treat them with respect
• the quality of people’s family relationships
• your nation being a just society.

The exact picture of “goodness” and “justice” might differ from one person to the next, but it is clear that they represent more than just money and happiness.  University of Virginia psychologist Jonathan Haidt,  in his brilliant book The Righteous Mind: Why Good People Are Divided by Politics and Religion argues that morality comes in six flavors (“The righteous mind is like a tongue with six tastes.”):

1. liberty vs. oppression,
2. fairness vs, cheating,
3. sanctity vs. degradation,
4. loyalty vs. betrayal,
5. authority vs subversion, and 
6. care vs. harm.

The first five of Haidt’s flavors of morality are well represented above.  The fourth flavor of morality, care vs. harm, is the one many authors focus on, to the exclusion of the others. It is the bread and butter aspects of people’s lives. In our findings, care vs. harm is reflected in 11 of the top 25 (numbers 4, 7, 9, 11, 12, 13, 16, 18, 22, 24, 25), including “the overall well-being of people and their families” in your nation, people’s health, financial security, and freedom from pain; “people having people they can turn to in time of need” and a “sense of security about life and the future in general” and balance, as reflected in the items “people’s mental health and emotional stability,” “how much people enjoy their lives” and “how peaceful, calm and harmonious people’s lives are.”

In addition to all of these, people want meaning, as reflected by #5 and #14 on our list: “people’s sense that they are making a difference, actively contributing to the well-being of other people, and making the world a better place, and “people’s sense that their lives are meaningful and have value.”  In addition to his discussion of key dimensions of morality, in The Righteous Mind: Why Good People Are Divided by Politics and Religion, Jonathan Haidt emphasizes the importance of meaning—in particular, the importance of feeling one is a part of a larger whole. One of his central metaphors is “We are 90 percent chimp and 10 percent bee.” That is, Haidt believes that perhaps 90% of the time we are out for ourselves, however gently, but perhaps 10% of the time we are out for a higher cause (like the general good of everyone in our group) to the deepest level of our beings. A sense of “meaning” often comes from making that connection to something greater than ourselves.  

You can see my other posts on happiness in the happiness sub-blog linked at my sidebar, and here:

http://blog.supplysideliberal.com/tagged/happiness

The Rise and Fall of Venice

Medieval Venice

From Chrystia Freeland’s book Plutocrats, pp. 278-279:

Venice owed its might and money to the super-elites of that age, and to an economic and political system that nurtured them. At the heart of the Venetian economy was the commenda, a joint-stock company that lasted for a single trading mission. The brilliance of the commenda was that it opened the economy to new entrants…. The commenda was a powerful engine of both economic growth and social mobility–historians studying government documents from AD 960, 971 and 982 found that new names accounted for respectively 69 percent, 81 percent, and 65 percent of all the elite citizens cited.

Venice’s elite were the chief beneficiaries of the rise of La Serenissima. But like all open economies, there was turbulent. We think of social mobility as an entirely good thing, but if you are already on top, mobility can also mean competition from outside entrepreneurs. Even though this cycle of creative destruction had created the Venetian upper class, in 1315, when their city was at the height of its economic powers, they acted to lock in their privilege. Venice had prospered under a relatively open political system in which a wide swath of the people had a voice in the selection of the republic’s ruler, the doge, and successful outsiders could join the ruling class. But in 1315, the establishment, which had been gradually tightening its control over the government, put a formal stop to social mobility with the publication of the Libro D'Oro, or Book of Gold, which was an official registry of Venetian nobility. If you weren’t in it, you couldn’t join the ruling oligarchy. 

This political shift from a nascent representative democracy to an oligarchy marked such a striking change that the Venetians gave it a name: La Serrata, or the closure. And it wasn’t long before the political Serrata became an economic one, too. Under the control of the oligarchs, the Venetian state gradually cut off the commercial opportunities for new entrants. The commenda, the legal innovation that had made Venice (and other Italian city-states) rich, was banned.

Quartz #2—>Does Ben Bernanke Want to Replace GDP with a Happiness Index?

Link to the Column on Quartz

Here is the full text of my 2d Quartz column, now brought home to supplysideliberal.com. This column was first published on October 8. Links to all my other columns can be found here.

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 Quartz column and the following copyright notice:

© October 8, 2012: Miles Kimball, as first published on Quartz. Used by permission according to a temporary nonexclusive license expiring June 30, 2014. All rights reserved.

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As chairman of the Federal Reserve, it is Ben Bernanke’s job to devour data like the latest report on how more Americans have found jobs.  But he wants even more data. In a prerecorded talk for a conference this past summer, Bernanke said, ”…we should seek better and more-direct measurements of economic well-being, the ultimate objective of our policy decisions.”  He’s not talking about more accurate versions of regular economic indicators, though.

Rather, Bernanke suggests that survey measures of happiness and life satisfaction should take their place alongside GDP as measures of how a nation is doing. In doing so, he joined current British Prime Minister David Cameron, who said ”it’s time we focused not just on GDP but on GWB—general wellbeing” and former French Prime Minister Nicolas Sarkozy, who said he would ”fight to make all international organisations change their statistical systems by following the recommendations” of the Stiglitz report. He refers to Nobel Prize winning economist Joseph Stiglitz’s committee’s work proclaiming “the time is ripe for our measurement system to shift emphasis from measuring economic production to measuring people’s well-being.” The emphasis is in the original.

In Sarkozy’s case, historian Brian Domitrovic opines that Sarkozy was just trying to divert attention from poor GDP statistics, saying “France has excellent reason to suppress GDP statistics. Since 1982, among developed nations, France has been a clear laggard in GDP growth.” He went on: “The oldest and most pathetic trick in the book when you lose a contest is to try to move the goal posts. GDP statistics of the past quarter century have shamed France but flattered the US, Britain and East Asia. Mr. Sarkozy’s gambit to paper over this real difference will be lucky to find any takers.” Domitrovic is pointing out the very real danger of the manipulation and politicization of national statistics when the right way to measure something like “well-being” is unclear.

How can we avoid the dangers of manipulation and politicization of new indicators of national well-being? Here is a simple answer: if we are going to use survey measures of well-being such as happiness and life satisfaction alongside well-seasoned measures such as GDP as ways to assess how well a nation is doing, we need to proceed in a careful, scientific way that can stand the test of time. For example, in my research with Dan Benjamin, Ori Heffetz and Alex Rees-Jones in the August American Economic Review, people say they are willing to sacrifice happiness for money if the price is right. Without understanding how much people want money and how much they want happiness, no one should pretend to know whether GDP or happiness is a better measure of a nation’s performance.

But it isn’t just happiness vs. money. Should we be measuring anxiety or measuring stress? How much weight should we put on being satisfied with life as opposed to happiness? Without good answers to these questions, it will all degenerate into political posturing and dueling statistics. But if we do it right, the ultimate prize will be a new way to judge whether the government is doing its job. And to me there is no question what the government’s job is. It is to smooth the way so people can get what they want and lead the kind of lives they want to lead—without deciding for them what they should want.

Franklin Roosevelt on the Second Industrial Revolution

Website for Golden Spike National Monument

In her book Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else, Chrystia Freeland quotes this wonderful passage about the Second Industrial Revolution from Franklin Delano Roosevelt’s speech to the Commonwealth Club of San Francisco, not long before he was elected President of the United States for the first time: 

It was in the middle of the nineteenth century that a new force was released and a new dream created. The force was what is called the industrial revolution, the advance of steam and machinery and the rise of the forerunners of the modern industrial plant. The dream was the dream of an economic machine, able to raise the standard of living for everyone; to bring luxury within the reach of the humblest; to annihilate distance by steam power and later by electricity, and to release everyone from the drudgery of the heaviest manual toil. It was to be expected that this would necessarily affect Government. Heretofore, Government had merely been called upon to produce conditions within which people could live happily, labor peacefully, and rest secure. Now it was called upon to aid in the consummation of this new dream. There was, however, a shadow over the dream. To be made real, it required use of the talents of men of tremendous will and tremendous ambition, since by no other force could the problems of financing and engineering and new developments be brought to a consummation.

So manifest were the advantages of the machine age, however, that the United States fearlessly, cheerfully, and, I think, rightly, accepted the bitter with the sweet. It was thought that no price was too high to pay for the advantages which we could draw from a finished industrial system. This history of the last half century is accordingly in large measure a history of a group of financial Titans, whose methods were not scrutinized with too much care, and who were honored in proportion as they produced the results, irrespective of the means they used. The financiers who pushed the railroads to the Pacific were always ruthless, often wasteful, and frequently corrupt; but they did build railroads, and we have them today. It has been estimated that the American investor paid for the American railway system more than three times over in the process; but despite this fact the net advantage was to the United States.

Noah Smith Joins My Debate with Paul Krugman: Debt, National Lines of Credit, and Politics

Paul Krugman’s graph of the debt/GDP ratio against interest rates

Update: You can see what I have to say in the wake of Thomas Herndon, Michael Ash and Robert Pollin’s critique of Carmen Reinhart and Ken Rogoff's work on national debt and growth in my column “An economists mea culpa: I relied on Reinhart and Rogoff.” (You can see my same-day reaction here.) Also, on the substance, see Owen Zidar’s nice graph in his post “Debt to GDP & Future Economic Growth.” I sent a query to Carmen Reinhart and Ken Rogoff about whether any adjustments are needed to the two figures from the paper with Vincent Reinhart that I display below, but have not yet received a reply to that query. I think that covers most of the issues that recent revelations raise.

Note that I have revised “What Paul Krugman got wrong about Italy’s economy.” This post is now the go-to source for what I originally said there, relying on “Debt Overhangs, Past and Present” (which has Vincent Reinhart as a coauthor along with Carmen Reinhart and Ken Rogoff). My original passage is in an indented block a little above the colorful pictures your eye will be drawn to below.

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In a world where people wrote frankly, Noah Smith has written the response to my Quartz column “What Paul Krugman got wrong about Italy’s economy” that Paul Krugman should have written: 

• Noah Smith: “Fancy Stimulus Tools: Policy vs. Politics,”

instead of what Paul actually wrote in response to my column:

• Paul Krugman: “Another Attack of the 90% Zombie.”

(The brief summary of my column is that electronic money could help the UK and the Federal Lines of Credit could help both Italy and the UK stimulate their economies without the problems that might arise from adding substantially to their debt by a simple increase in government spending, as indicated by my original title: “How Italy and the UK Can Stimulate Their Economies Without Further Damaging Their Credit Ratings.”)

Noah follows an earlier Paul Krugman column “Debt, Spreads and Mysterious Omissions,” in using the graph above to distinguish between Italian debt and US or UK or Japanese debt by pointing out that individual euro-zone countries are not able to borrow in their own currency in the same way the US, the UK or Japan can. Paul used this distinction to minimize the danger to the US of high debt levels; here is the first sentence of “Debt, Spreads and Mysterious Omissions”: 

Binyamin Applebaum reports on a new paper by Greenlaw et al alleging that bad things will happen to America, because debt over 80 percent of GDP leads to high interest rates, and is skeptical – but not skeptical enough. 

Paul explains that an important argument that the US may be OK revolves around the suggestion that Japan can get away with the debt levels at the rightmost extreme of the graph above because: 

…what really matters is borrowing in your own currency – in which case the US and the UK are, in terms of borrowing costs, like Japan rather than Greece. That’s certainly what the De Grauwe (pdf) analysis suggests.

Even the quickest look at the data suggests that there’s something to this argument; for example, taking data from the paper itself, and dividing the countries into euro and non-euro, we get a scatterplot like this:

There is no hint in Paul’s earlier piece, “Debt, Spreads and Mysterious Omissions” of a claim that we should not worry about high debt levels for euro-zone countries, and even less reason to worry about US debt. A reader could be forgiven for coming away from “Debt, Spreads and Mysterious Omissions” thinking Paul thought that maybe high debt levels might be worrisome for countries that cannot borrow in their own national currency (such as Greece and Italy), but not for countries that can borrow in their own currency.  

Noah joins Paul in taking me to task for relying too much on Carmen Reinhart, Vincent Reinhart and Ken Rogoff’s paper  “Debt Overhangs, Past and Present”:

Krugman has a good point: The “90%” thing is not well established; it is obviously just Reinhart and Rogoff eyeballing some sparse uncontrolled cross-country data and throwing out an off-the-cuff figure that got big play precisely because it was simple and (to deficit scolds) appealing. The 90% number alone is not a justification for worrying about debt.

But unlike Paul, Noah notes that all I need to argue for the main point of my column is that less debt is better than more debt:

But I feel that this argument over debt levels is mostly a distraction. The important thing, which is being overlooked, is that Miles has come up with a really interesting policy tool to increase the amount of stimulus per unit of debt incurred. That tool is Federal Lines of Credit, or FLOCs - basically, the idea that government should lend people money directly.

Paul is so used to–and intent on–arguing that getting out of recessions is so important that it is worth incurring additional debt to do so, that he seems to miss my point that it is possible to stimulate economies to escape recessions while incurring much less debt than a straight increase in government spending would incur.

I am actually on record agreeing with Paul (and Noah) that the Great Recession was so serious that it was worth a massive increase in debt to escape it if that were the only available way to stimulate the economy. In “What Should the Historical Pattern of Slow Recoveries after Financial Crises Mean for Our Judgment of Barack Obama’s Economic Stewardship”:

So the fact that Barack did not push for a bigger stimulus package really is an indictment of his economic leadership. According to the reported statement by Larry Summers, it was a political judgement that a bigger stimulus was not politically feasible. I am not at all convinced that a bigger stimulus was politically impossible. It would not have been easy, I’ll grant that, but I was amazed that Barack managed to get Obamacare through. If, instead, Barack had used his political capital and the control the Democrats had over both branches of Congress during his first two years for a bigger stimulus, couldn’t he have done more? …

Notice that in all of this, I am treating a larger stimulus of a conventional kind as the best among well-discussed policy options when Barack took office in 2009. So I am backing up Paul Krugman’s criticisms of Barack’s policies at the time. However, given what we know now we could do even better, as I discuss in my post “About Paul Krugman: Having the Right Diagnosis Does Not Mean He Has the Right Cure.”

 A similar judgment might well hold for Italy, as Paul argued in “Austerity, Italian Style” (the piece that kicked off this current debate with Paul), except: 

1. We all agree that Italy’s debt problem is worse than the debt problem for the US. 
2. Much more importantly, a policy option (National Lines of Credit) is now on the table (at least for discussion in the op/ed pages) that could stimulate the Italian economy with much less addition to debt than a straight increase in spending–a policy option that was not on the table for the US in 2009.

Astute readers will have noticed that in “What Should the Historical Pattern of Slow Recoveries after Financial Crises Mean for Our Judgment of Barack Obama’s Economic Stewardship” I relied on a stylized fact from Carmen Reinhart and Ken Rogoff’s book This Time is Different: Eight Centuries of Financial Folly. If I am led astray, it is because of my enormous respect for Ken Rogoff’s judgment, but in this case, I would be very surprised if Paul had not at some point in his New York Times columns relied on the Reinhart and Rogoff stylized fact that recessions have tended to last a long time after financial crises in more or less the same way I did. (Though I know Ken Rogoff, I don’t think I have ever been fortunate enough to meet either Carmen or Vincent Reinhart yet.) But of course, the meaning of the Reinhart and Rogoff stylized fact that across many countries recessions have historically lasted a long time after financial crises is just as much up for grabs as the meaning of the Reinhart, Reinhart and Rogoff stylized fact that across many countries GDP growth has been low during periods when debt to GDP ratios have been high.

For the record, despite, Paul’s title “Another Attack of the 90% Zombie,” I do not think I unduly emphasized the 90% figure itself. Here is what I actually wrote: 

And national debt beyond a certain point can be very costly in terms of economic growth, as renowned economists Carmen Reinhart, Vincent Reinhart, and Kenneth Rogoff convincingly show in their National Bureau of Economic Research Working Paper “Debt Overhangs, Past and Present.”

Where do the United Kingdom and Italy stand in relation to the 90% debt to GDP ratio Reinhart, Reinhart and Rogoff identify as a threshold for trouble? (It is important to realize that their 90% threshold is in terms of gross government debt. That is, it does not net out holdings by other government agencies. )

In context in relation to Italy, this means “Surely, in practice, some level of the existing debt to GDP ratio for Italy should make us worry about adding to Italy’s national debt. Can we get some idea of whether we should worry about Italian debt or not?”

Let’s look at Reinhart, Reinhart and Rogoff’s stylized fact about debt to GDP ratios and realized economic growth in a little more detail to see if there is enough suggestive evidence that we should be concerned about adding to Italy’s national debt. Here is Diagram 1 from “Debt Overhangs, Past and Present”:  

In this sample of 26 high-debt episodes, there has never been a case when a country had both a debt/GDP ratio higher than 90% and high real interest rates beat its own national GDP growth rate average during that period of time. Figure 4 gives more detail for specific episodes:

Niklas Blanchard writes this about “Debt Overhangs, Past and Present” in his post in this debate with Krugman (see this full account of my discussion with Niklas):

There is a lot not to like about the Reinhart, Reinhart, and Rogoff study, and Krugman nails much of it; it doesn’t deal with causation. I’m actually kind of confused as to why Miles mentions the study (although he may enlighten me in the comments). However; more importantly, it doesn’t specify 90% debt: GDP as a regime change to a new steady state, or as a transitory experience resulting from something like a recession, or a war. In normal times, the regime change itself is the cause of the turbulence, not the subsequent destination (like going over a waterfall). There is ample evidence that suggests that countries with high transitory debt loads are able to deal with them without incident — provided they return to robust nominal growth. Japan deals with it’s sky-high debt load through financial repression and ultra-tight monetary policy. The cost of this type of action is that the government steals wealth from households.

In retrospect, I should have avoided the word “threshold,” with its suggestion of a sudden change. I never intended to suggest there was a sudden regime shift. Of course, the 90% debt/GDP ratio is a somewhat arbitrary level that Carmen, Vincent and Ken use to cut their data. But, looking at the whole set of 26 historical episodes above that debt/GDP ratio, there seems ample grounds to be worried about the effects additional national debt might have on Italy’s situation–and I don’t think it is amiss to be worried about the effects additional national debt might have on the situation in the UK or the US. There is no evidence from a randomized controlled trial available for the effects of national debt. So I don’t know how to judge whether we should be worried about the effects of national debt for countries in various situations other than from theory–which I will leave for other posts and columns–or by trying to glean what insights we can from case studies (which is what attempts to find natural experiments would be in terms of sample size), from exercises like the one Carmen, Vincent and Ken conducted in “Debt Overhangs, Past and Present,” or from correlations such as those shown in Paul’s graph above, which suggests that we should be more worried about high debt/GDP ratios for countries that cannot borrow in their own national currency.

Unlike Paul, Noah grapples with my National Lines of Credit proposal–or “Federal Lines of Credit” for the US. (You can see my posts on Federal Lines of Credit collected in my Short-Run Fiscal Policy sub-blog: http://blog.supplysideliberal.com/tagged/shortrunfiscal.) Noah writes:

However, I do have some skepticism about FLOCs. First of all, there is the idea that much of the “deleveraging” we see in “balance sheet recessions” may be due to behavioral effects, not to rational responses to a debt-deflation situation. People may just switch between “borrow mode” and “save mode”. In that case, offering them the chance to take on extra debt is not going to do much. Second, and more importantly, I worry that FLOCs might draw money away from infrastructure spending and other government investment, which I think is an even more potent method of stimulus; govt. investment, like FLOC money, is guaranteed to be spent at least once, but unlike FLOCs it can increase public good provision, which is a supply-side benefit.

In answer to Noah’s first bit of skepticism, the main point of National Lines of Credit is to encourage more spending by that fraction of the population that will spend as a result of being able to borrow more, without adding to the national debt by sending checks to people like those in “save mode” who won’t spend any more. If people don’t draw on their lines of credit from the government, it doesn’t add to the national debt. And even if people draw on their lines of credit from the government to pay off more onerous debt, this is likely to both (a) make them better credit risks–that is, more likely to have the means to pay the government back and so not add to the national debt and (b) make them feel more secure, and so possibly get them to switch at least a little bit from “save mode” to “spend mode.”

On infrastructure spending, I should say more clearly than I have in the past that spending more on fixing roads and bridges would likely be an excellent idea for the US on its own terms, because of the supply-side benefits. But if it crowded out a Federal Lines of Credit program, one has to consider that Federal Lines of Credit can get more than a dollar’s worth of first-round addition to aggregate demand (which is then multiplied by whatever Keynesian multiplier is out there) per dollar budgeted for loan losses, while spending on infrastructure gives exactly one dollar worth of first-round addition to aggregate demand (which is then multiplied by whatever Keynesian multiplier is out there) per dollar budgeted for that spending. The spending on roads and bridges has to have enough of a positive effect on later productivity and tax revenue to outweigh its less potent stimulus per dollar budgeted. The other big problem with additional infrastructure spending is that, alas, it cannot be turned on and off quickly. The legal, administrative and regulatory process for spending on roads and bridges is just too slow to be of much help in short recessions, or if one wants to hasten a recovery that has already built up a good head of steam. So our current situation is one of the few in which spending on roads and bridges would be a fast enough mode of stimulus. Most of the time, roads and bridges should be seen primarily as a valuable supply-side measure when infrastructure is in the state of disrepair seen in the US.  

I said that Noah, unlike Paul, grapples with my National Lines of Credit proposal. Indeed, Paul shows no evidence of having read the second half of my article. One theory is that he really didn’t read the second half. Most favorably, Paul could be saving discussion of Federal Lines of Credit (and electronic money, which I also discuss in “What Paul Krugman got wrong about Italy’s economy”) for other posts. The most intriguing theory (that is not as positive as the idea that Krugman posts on FLOC’s and electronic money are coming, and one that I would not give all that high a probability to) is that Paul likes my proposals enough that he wanted to point people to those proposals, and too much to criticize them, but thinks they are too controversial to implicitly endorse by discussing them without criticizing them. If so, I am grateful to Paul for that backhanded support. Noah has a theory (that does does not preclude this theory that Paul is intentionally flagging my proposals while keeping some distance): 

That said, I think the FLOC idea is an interesting one. Why have most stimulus advocates ignored it? My guess is that this is about politics. In an ideal world, pure technocrats (like Miles) would advise politicians in an honest, forthright fashion as to what was best for the country, and the politicians would take the technocrats’ advice. In the real world, it rarely works that way. For every technocrat who just wants to increase efficiency, there’s a hundred hacks and politicos who are only thinking about distributional issues - grabbing a bigger slice of the pie. These hacks are very willing to use oversimplified narratives and dubious sound bytes to embed their ideas in the public mind. And that kind of thing really seems to be effective.

This means that politics’ response to policy is highly nonlinear - give the enemy an inch, and they take a mile. It also means the response is highly path-dependent; precedent matters.

So Krugman et al. may be ignoring FLOCs and other stimulus engineering tricks because of political concerns. If they concede for a moment that debt is scary, it will just shift the Overton Window toward Republican types who are deeply opposed to any sort of stimulus, and would oppose Miles’ FLOCs just as lustily as they opposed the ARRA.

In other words, finding optimal, first-best technocratic solutions might be far less important than simply embedding “AUSTERITY = BAD!!!” in the public consciousness.

My own politics are more centrist (to the extent they fit within the US political debate at all. (See my post “What is a Partisan Nonpartisan Blog?” as well as the mini-bio at my sidebar and Noah’s early review of my blog, “Miles Kimball, the Supply-Side Liberal.”) From that point of view, I have argued in “Preventing Recession-Fighting from Becoming a Political Football” (my response to the Mike Konczal post criticizing Federal Lines of Credit that Noah mentions) that Federal Lines of Credit have substantial political virtues in providing a way out of the current political deadlock between the Republican and Democratic parties over economic policy.

Many thanks to Noah for clarifying this debate with Paul, as well as to Niklas Blanchard, whose two bits I discussed in my post a few days ago, and to Paul himself for engaging with me in debate, at least at one level.

Update: With Noah’s permission, let me share an email exchange about the post above:

Miles: Did you like my response? 

Noah: I did! It was quite thorough.

I think the criticisms of FLOCs are still basically three:

Criticism 1 (mine): There is a limited amount of political will for increased spending. And because of the supply-side benefits of infrastructure, that finite will is better spent on infrastructure even than on the most cost-effective pure stimulus.

Criticism 2 (Mike Konczal’s): FLOCs have different distributionary consequences than other stimulus approaches, since FLOC borrowers will be responsible for repaying the stimulus borrowing, not taxpayers.

Criticism 3 (Mike Konczal’s): It will be very difficult to handle the inevitable FLOC defaults. Whether they are forgiven or collected aggressively, it will make some people very angry.

Criticism 4 (everyone else’s): FLOCs may get good “bang for the buck”, but they won’t get much bang in total, because people are in “deleveraging” (or “balance sheet rebuilding”) mode.

I think that these are not inconsiderable obstacles to the FLOC idea…

Miles: I don’t understand 4. Here is what I think it means. FLOC’s can be scaled up to get more impact, but they will have decreasing returns since people have consumption that is concave in amount of credit provision. Even though the costs are also concave in the headline amount of credit provision, this means that a FLOC program can only be so big. So ideally we want other things as well–infrastructure and electronic money.  Sounds good.  

On 1, I would be glad if the debate were between FLOC’s and infrastructure spending.  

On 2 and 3, Mike only gets one of these at a time at full force: making the amount of credit provision proportional to last-years adjusted gross income dramatically reduces the repayment problem (and the size of the program can be adjusted to compensate for the lower MPC), but this makes it distributionally less favorable.  

Noah: No, I think you may be misunderstanding 3. No matter how much FLOC lending is done, x% of people will default on their FLOC loans. What the government then does to that x% - cancels their debt, sues them, or refers them to collections agencies - is going to be a political bone of contention. It’s an image problem (evil govt. suckering people into borrowing money they can’t afford to pay back), not an efficiency problem.

Miles: I agree. That is why FLOC’s need to be paired with National Rainy Day Accounts that most likely make it unnecessary to ever use FLOC’s again after the first time.

I added the link about National Rainy Day Accounts just now. As a conceptually similar idea to FLOC’s and National Rainy Day Accounts for individuals, see what I have to say about helping the states spend more now (to stimulate the economy) and less later in “Leading States in the Fiscal Two Step.”

Anat Admati, Martin Hellwig and John Cochrane on Bank Capital Requirements

The Banker’s New Clothes, by Anat Admati and Martin Hellwig

In the March 1, 2013 Wall Street Journal, John Cochrane had an eye=-opening review of The Banker’s New Clothes, summarizing the argument of authors Anat Admati and Martin Hellwig:

Running on Empty: Banks should raise more capital, carry less debt–and never need a bailout again.

It motivated me to buy the book and download it to my Kindle.

In Admati and Martin’s argument, as distilled by John, the first thing to understand is that capital requirements do not by themselves reduce the amount of funds available for lending; they are on the liability side, not the asset side: 

“Capital” is not “reserves,” and requiring more capital does not reduce funds available for lending. Capital is a source of money, not a use of money.

Moreover,

Capital is not an inherently more expensive source of funds than debt. Banks have to promise stockholders high returns only because bank stock is risky. If banks issued much more stock, the authors patiently explain, banks’ stock would be much less risky and their cost of capital lower. “Stocks” with bond-like risk need pay only bond-like returns. Investors who desire higher risk and returns can do their own leveraging—without government guarantees, thank you very much—to buy such stocks.

And yet, banks choose very high debt/equity ratios than other firms. What is going on? 

Nothing inherent in banking requires banks to borrow money rather than issue equity. Banks could also raise capital by retaining earnings and forgoing dividends,…

Why do banks and protective regulators howl so loudly at these simple suggestions? As Ms. Admati and Mr. Hellwig detail in their chapter “Sweet Subsidies,” it’s because bank debt is highly subsidized, and leverage increases the value of the subsidies to management and shareholders.

Equity is expensive to banks only because it dilutes the subsidies they get from the government. That’s exactly why increasing bank equity would be cheap for taxpayers and the economy, to say nothing of removing the costs of occasional crises.

Would high capital requirements inevitably gum up the works of banking? No:  

… it was not always thus. In the 19th century, banks funded themselves with 40% to 50% capital. 

How high should capital requirements be? Here is John Cochrane’s answer, which I second: 

How much capital should banks issue? Enough so that it doesn’t matter! Enough so that we never, ever hear again the cry that “banks need to be recapitalized” (at taxpayer expense)!

To be specific, I would say 50%. After all, equal amounts of equity and debt would not be an unusual debt/equity ratio for a non-banking firm that didn’t face a massive implicit subsidy from the likelihood of a bailout. Indeed, even the debt/equity ratios seen for non-banking firms are likely to tilt toward a higher debt/equity ratio than would be socially optimal as a result of the favorable tax treatment of debt relative to equity. (See Simon Johnson’s Congressional testimony on that point here.) And equal amounts of equity and debt did not constitute an unusual debt/equity ratio for banks in the era when the implicit bailout subsidy was not yet in place.

Gita Gopinath Helps France Beat the Euro Straitjacket →

It was a very interesting seminar when Gita came to Michigan to present the paper described in this excellent Bloomberg article.