The Federal Reserve System's Dysfunctional Governance in 1934

“Currie described the situation in a 1934 memo to Eccles: “Decentralized control is almost a contradiction in terms. The more decentralization the less possibility there is of control.” The problem was that “[e]ven though the Federal Reserve Act provided for a very limited degree of centralized control, the system itself by virtue of necessity was forced to develop a more centralized control of open market operations.” The ad hoc institutional development consisted of “fourteen bodies composed of 128 men who either initiate policy or share in varying degrees in the responsibility for policy.” (The fourteen were the twelve Federal Reserve Banks, the Federal Reserve Board, and the once powerful Federal Advisory Council, a group of bankers that advised the Federal Reserve Board.) These various bodies, and their governors and boards, made governance and public accountability a virtual impossibility. Currie glumly concluded that “[s]uch a system of checks and balances is calculated to encourage irresponsibility, conflict, friction, and political maneuvering” such that “anybody who secures a predominating influence must concentrate on handling men rather than thinking about policies.“”
— Peter Conti-Brown, The Power and Independence of the Federal Reserve

Scott Sumner on Negative Interest Rate Policy

Link to Scott Sumner’s post “Miles Kimball on Negative Interest Rates” on his blog “The Money Illusion”

I am grateful to Scott Sumner for permission to mirror his post “Miles Kimball on Negative Interest Rates” as a guest post here. This will gives you an idea of what Scott thinks of one of my main emphases. Here is Scott:

David Beckworth did a very interesting podcast with Miles Kimball. You probably know that Miles is an economics professor at Michigan and blogs under the name “Supply Side Liberal” (a label not far from my own views.)

Here are some good points that Miles emphasized:

1. If the Fed had been able to do negative interest back in 2008, the average interest rate over the past 8 years would probably have been higher than what actually occurred. Lower in 2008-09, but then higher ever since, as the economy would have recovered more quickly. He did not mention the eurozone, but it’s a good example of a central bank that raised rates at the wrong time (in 2011) and as a result will end up with much lower rates than the US, on average, for the decade of the “teens”. Frustrated eurozone savers should blame German hawks.

2. He suggested that if the Fed had been able to do negative interest rates back in 2008-09, the financial crisis would have been milder, because part of the financial crisis was caused by the severe recession, which would itself have been much less severe if rates had been cut to negative 4% in 2008.

3. Central banks should not engage in interest rate smoothing. He did not mention this, but one of the worst examples occurred in 2008, when it took 8 months to cut rates from 2% (April 2008) to 0.25% (December 2008.) The Fed needs to be much more aggressive in moving rates when the business cycle is impacted by a dramatic a shock.

Although I suggested negative IOR early in 2009, I was behind the curve on Miles’s broader proposal (coauthor Ruchir Agarwal), which calls for negative interest on all of the monetary base, not just bank deposits at the Fed. To do this, Miles recommends a flexible exchange rate between currency and electronic reserves, with the reserves serving as the medium of account. Currency would gradually depreciate when rates are negative. Initially I was very skeptical because of the confusion caused by currency no longer being the medium of account. I still slightly prefer my own approach, but I now am more positively inclined to Miles’s proposal and view it as better than current Fed policy.

Miles argued that the depreciation of cash against reserves would probably be mild, just a few percentage points. Then when the recession ended and interest rates rose back above zero, cash could gradually appreciate until brought into par with bank reserves. He suggested that the gap would be small enough that many retailers would accept cash at par value. As an analogy, retailers often accept credit cards at par, even though they lose a few percent on the credit card fees.

If cash was still accepted at par, would that mean that it did not earn negative interest, and hence you would not have evaded the zero bound? No, because Miles proposes that the official exchange rate apply to cash transactions at banks. This would prevent anyone from hoarding large quantities of cash as an end run around the negative interest rates on bank deposits. So that’s a pretty ingenious idea, which I had not considered. Still, I think my 2009 reply to Mankiw on negative IOR holds up pretty well, even if I did not go far enough (in retrospect.)

Why is negative interest still not my preferred solution? Because I don’t think the zero bound is quite the problem that Miles assumes it is, which may reflect differing perspectives on macro. Listening to the podcast my sense was that he looked at macro from a more conventional perspective than I do. At the risk of slightly misstating his argument, he sees the key problem during recessions as the failure of interest rates to get low enough to generate the sort of investment needed to equilibrate the jobs market. That’s a bit too Keynesian for me (although he regards his views as somewhat monetarist.)

In my view interest rates are an epiphenomenon. The key problem is not a shortfall of investment, it’s a shortfall of NGDP growth relative to nominal hourly wage growth. I call that my “musical chairs model” although the term ‘model’ may create confusion, as it’s not really a “model” in the sense used by most economists. In my view, the key macro problem is the lack of one market, specifically the lack of a NGDP futures market that is so heavily subsidized that it provides minute by minute forecasts of future expected NGDP. If the Fed would create this sort of futures/prediction market (which it could easily do), then the price of NGDP futures would replace interest rates as the key macro indicator and instrument of monetary policy. Recessions occur when the Fed lets NGDP futures prices fall (or shadow NGDP futures if we lack this market). Since there is no zero bound on NGDP futures prices, we don’t need negative interest rates. However, in place of negative rates the central bank may need to buy an awful lot of assets. You could say there is a zero lower bound on eligible assets not yet bought by the central bank. Which is why we need to set an NGDPLT path high enough so that the central bank doesn’t end up owning the entire economy.

To conclude, although Miles’s negative interest proposal is not my first preference, put me down as someone who regards it as better than current policy.

PS. I was struck by how many areas we have similar views. For instance he thought blogging was really important because what mattered in the long run was not so much the number of publications you have, but whether you’ve been able to influence the younger generation economists (grad students and junior faculty).

PSS. I will gradually catch-up on the podcasts, and then do another post on the 2nd half of the Brookings conference on negative IOR.

Us and Them

This is my latest sermon, to be given today at the Community Unitarian Universalists in Brighton.  Here is the abstract:

Abstract: Group identity is the source of many of the best and the worst things that people do. In the form of patriotism, school spirit, esprit de corps, or brotherhood or sisterhood, it can encourage crucial sacrifices and help provide meaning to people’s lives. But the dark side of group identity is the felt division of the world into “us” and “them”–with “them” viewed as not fully human. A key challenge for liberal religion is to help create a strong group identity that can embrace all of humanity.  

I have been a strong supporter of more open immigration. So I have been concerned by the strength of anti-immigration sentiment revealed by Donald Trump’s success as a political candidate on an anti-immigration platform, and the Brexit vote in the United Kingdom to leave the European Union, also driven in important measure by anti-immigration sentiment.   

Economists argue over whether immigration is good for the people in the receiving country or not, for the most part coming down on the side of immigration raising the wages of the large majority of people in the receiving country, with the important exceptions of slightly earlier immigrants and those without a high school diploma. (Immigrants also are likely to raise rents and property values, which is good for those who own property and not so good for those who don’t.) But the most important benefit of immigration often goes unmentioned–the benefit to the immigrants themselves–many of whom come from nations that–relative to the United States–are in bad shape either economically or politically. To me, it is a breach of economic ethics to do a cost-benefit analysis that puts a zero weight on any category of human beings affected by a policy as anything more than a mathematical exercise; and to discuss immigration without mentioning the benefit of immigration to the immigrants themselves is to make the same error in a less formal way. 

Although I am skeptical of it, an argument can be made that for some policy-making purposes, it would be appropriate to give a higher weight to the effects of a policy to current citizens than to the effects of that policy on an equal number of potential future citizens, but as can be seen in an exercise I have had my students do, when coming from a desperately poor nation, the benefits of immigration to an immigrant are so much greater than the costs to those in the receiving country that even if the well-being of immigrants is counted as worth only one-hundredth as much as the well-being of citizens, immigration often looks like a good deal.

So the key issue in immigration policy is whose well-being counts: who is in the charmed circle of people whose lives we are concerned about and who is not. On this question of whose well-being counts, Aristotle encouraged Alexander the Great to view all Greeks as friends and all non-Greeks with only as much concern as if they were beasts (1,2). In the same vein, I don’t think it is just an anthropologists’ legend that the word many hunter-gatherers have for their own tribe can be reasonably translated as “the People,” with the implication of a less-than-fully-human status for those in other tribes. 

In many ways, we demonstrate that we do care about people in other nations. We provide both private and public foreign aid, with a fair bit of it altruistically designated for the world’s poorest of the poor. I think concern for the world’s poorest of the poor would be even greater than it is if there were a program for schoolchildren in the United States and other rich nations to chat over Skype–perhaps in broken English–with sister classrooms of schoolchildren in very poor areas of the world. I would be willing to bet a great deal that such a program would not go on for very long before someone got the bright idea that one of the best ways to help their friends abroad would be to help them immigrate to the the United States or other rich nation. And of course, if doable, that idea would be a sound one. The poorest of the poor, if brought to our shores, would soon be at a much higher standard of living than in the land they came from. The basic reason is simple. Leaving aside ruling cliques able to take over natural resource wealth, countries and regions become rich by being relatively well run. The same human being, in a relatively well-run country, does much better than in a poorly-run country.   

According to the Gospels, Jesus had an answer for whose well-being counts both in the way he recognized women, lepers, children, Samaritans and tax-collectors day after day as full human beings, but also in his great charge:

Therefore go and make disciples of all nations, baptizing them in the name of the Father and of the Son and of the Holy Spirit, (Matthew 28:19)

In my blog post “‘Keep the Riffraff Out!’” which tries to ferret out that sentiment in many nooks and crannies of our public policy, I pursued an analogy between nations and religions, writing this:

Mormonism is a proselyting religion. Close to 35 years ago, I was one of many Mormon missionaries trying to persuade people in Tokyo to become Mormons. And most of you will one time or another see Mormon missionaries at your door, wherever you are in the world. 

One of the positive features of a proselyting religion that is not always fully appreciated is that newcomers are fully welcome, as long as they make even a minimal attempt to fit in. And if they so choose, it is not hard for them to become full members of the community.

Sometimes, members of the Mormon Church question the virtue of bringing someone into the community who has enough needs that they are likely to require more help from the community than the amount they are able to help others. But the young women and men serving for a year and a half or two as full-time missionaries and higher Mormon Church authorities quickly overrule such sentiments.

I don’t believe in the supernatural anymore, so I don’t believe in Mormonism. But I do believe in America. 

I wish America were a proselyting nation, eager to bring newcomers into the fold. I believe it would be a better world if more of the world’s 7 billion people were Americans. There are many people who would be willing converts to being Americans, but we keep them out.  

Today I want to pursue the analogy between nations and religions in a little more detail. I think there are three basic models, that I will call the Unitarian-Universalist model, the Mormon model and the Zoroastrian/Orthodox Jewish model. 

When my wife Gail and I, as well as some of our friends, fled from Mormonism sixteen years ago, we were not only welcomed by what is now the First Unitarian Universalist Congregation of Ann Arbor with open arms, but welcomed just as we were. I am sure former Mormons must have seemed weird to some of the members of the congregation, but they took all of that in stride, partly because they were conscious of their own idiosyncrasies.  

When converts join the Mormon Church, they are expected to follow a substantial set of rules of conduct and behavior. Right away, they are expected to contribute not only financially but in assigned roles in the congregation. And even patterns of insider jargon and oddities such as a positive attitude towards Jell-O are soon inculcated. So it isn’t long before newcomers have patterns of action and speech that feel comfortable to the long-timers in a congregation.  

Zoroastrianism has relatively few converts, and Orthodox Judaism makes it hard for people to convert if they weren’t Jewish at some level to begin with. One reason they are not proselyting religions is that historically, they were minority religions in lands where trying to convert others would have been seen as an affront to the dominant religion. But even now–though attitudes toward converts may be shifting–there are many Zoroastrian priests and Orthodox Rabbis who are very reluctant to accept someone as a convert who shows up on their doorstep wanting to convert. 

The analogy is to three types of immigration policies:

  1. Welcoming people as they are, with all of the multicultural complexity that entails, 
  2. Welcoming people on the condition that they quickly take on the patterns of the dominant culture, 
  3. Discouraging people from coming in. 

There are sincere believers in each type of policy. Personally, I find it hard to decide between the Unitarian-Universalist model of accepting people as they are and the Mormon model of trying to change people to better fit the cultural norms of the nation they are joining–if only to help guarantee people’s willingness to accept newcomers, and to help generate extra esprit de corps that may help people be more altruistic toward one another. 

So far I have been talking about citizens and foreigners or members and non-members of a religion. But these are both special cases of a powerful psychological lens: “us” versus “them.” For many of the few people who would ever pay any attention to anything I said, the main us-them distinction is between those who are relatively well-educated–say those who have at least some college education or maybe a bachelor’s degree (or who act as if they do) and those who don’t have so much education (or act as if they don’t). Or for others, the main us-them distinction may be quite directly between the “us” of those who accept foreigners and other marginalized groups and the “them” who don’t. 

It is hard not to want to exclude those who want to exclude and hard not to be intolerant of those who are intolerant, but Edwin Markham’s poem “Outwitted” shows the way to be intolerant of intolerance and to exclude exclusion without being intolerant of people who are intolerant or trying to exclude people who are exclusionist. Edwin wrote:

“He drew a circle that shut me out-

Heretic, rebel, a thing to flout.

But love and I had the wit to win:

We drew a circle and took him In!

For those of us who can empathize with foreigners who want to join us in our fair land, one of the great tasks of empathy that we face is to understand the feelings of those who want to “keep the riffraff out” without thinking of them as riffraff. Full human beings–who should be treated as full human beings–can and do often want to treat other human beings as less than full human beings. This is not a rare quirk of human nature, but a common one. So we had better learn to deal with it.

My point of entry into attempted empathy with anti-immigrant sentiment is to think of the difference between a big city and a small town. Big cities are complex and attract people who like complexity. Adding, say, 5% to the population of that big city by the entry of additional immigrants adds a bit to the complexity, but doesn’t change the fundamental character of the big city. By contrast, in a small town of, say, 1000 people, where everyone knows almost everyone else, adding three families of immigrants could seem as if it totally changed the character of the town. Things just aren’t the way they used to be once those immigrants arrive, and there was a certain comfortable charm to the way things used to be. So the effect of immigrants on their surroundings isn’t just a matter of population percentages, but also a matter of how demographically complex the community was to begin with. Of course, in addition to the first few immigrants seeming like a big deal, the point at which “outsiders” become numerous enough to gain serious political influence–when it didn’t seem as if they had it before–is also a potential moment for distress. 

In a Twitter debate I had about immigration policy after the Brexit vote, Morgan Warstler and Nick Rowe both argue that some of the opposition to immigration comes from people’s desire to, in effect, belong to a club that they like. A hint of evidence for this view can be found in the claim I have seen that those who are “socially-connected” by attending church or belonging to a literal club have been less likely to vote for Donald Trump. One theory for this would be that if one’s main social group is something smaller than the entire geographical community one lives in, immigrants moving into one’s geographical community are less disruptive of one’s social relationships than if one’s main social group is one’s entire geographical community. If this is true, a church one actually attends, by providing a social group somewhat buffered from demographic shocks, may tend to make make one more accepting of immigrants coming into one’s geographic community. By contrast, a church one doesn’t attend may act as a quasi-ethnic identity that makes one less tolerant of outsiders.  

As I read the current news, it is painful for me to see refugees from war-torn lands shunned as if they were nuclear waste that can’t find a home even in Yucca mountain. And I hate to see people so eager to exclude immigrants that they will accept other serious costs to do so. To me, one of the most important principles is that human beings are human beings, and that everyone’s well-being counts. 

I would love to find the secret to instilling in people a kind of patriotism not only for their own nation, but also for humanity. It may be only my parochial pride talking, but I think we are a remarkable and wonderful species. Without treating other animals or plants or sophonts badly, we should feel good about belonging to the ranks of homo sapiens.

On the other hand, when we see people behaving badly, it is worth remembering that they, like us, are still apes–so, perfect behavior is not to be expected. Let us give each other a break and forgive often, even as we strive to encourage the best in ourselves and others, while standing firmly against the worst impulses of human nature in others and ourselves.

Selfishness and the Fall of Rome

Link to Adrian Goldsworthy’s How Rome Fell: The Death of a Superpower

pp. 418, 419: 

It is only human nature to lose sight of the wider issues and focus on immediate concerns and personal aims. In the Late Roman Empire this was so often all about personal survival and advancement–the latter bringing wealth and influence, which helped to increase security in some ways, but also rendered the individual more prominent and thus a greater target to others. Some officials enjoyed highly successful careers through engineering the destruction of colleagues. Performing a job well was only ever a secondary concern. Even emperors were more likely to reward loyalty over talent. Officials and commanders needed only to avoid making a spectacular mess of their job–and even then enough influence could conceal the facts or pass the blame onto someone else. None of this was entirely new, but it became endemic. When ‘everyone’ acted in the same way there was no real encouragement to honesty or even competence. The game was about personal success and this often had little connection to the wider needs of the empire. 

It was not a phenomenon unique to the Late Roman Empire, nor are its implications only of significance to the United States or indeed any other country. All human institutions, from countries to businesses, risk creating a similarly short-sighted and selfish culture. It is easier to avoid in the early stages of expansion and growth. Then the sense of purpose is likely to be clearer, and the difficulties or competition involved have a more direct and obvious impact. Success produces growth and, in time, creates institutions so large that they are cushioned from mistakes and inefficiency. The united Roman Empire never faced a competitor capable of destroying it. These days, countries and government departments do not easily collapse–and Western states do not face enemies likely to overthrow them by military force. In the business world the very largest corporations almost never face competitors that are truly their equal. Competition within the commercial market at any level is obviously rarely carried out on entirely equal terms. 

In most cases it takes a long time for serious problems or errors to be exposed. It is usually even harder to judge accurately the real competence of individuals and, in particular, their contribution to the overall purpose. Those in charge of overseeing a country’s economy generally reap the praise or criticism for decisions made by their predecessors in office. 

Henry George: Protective Tariffs are as Much Applications of Force as are Blockading Squadrons

“Trade does not require force. Free trade consists simply in letting people buy and sell as they want to buy and sell. It is protection that requires force, for it consists in preventing people from doing what they want to do. Protective tariffs are as much applications of force as are blockading squadrons, and their object is the same–to prevent trade. The difference between the two is that blockading squadrons are a means whereby nations seek to prevent their enemies from trading; protective tariffs are a means whereby nations attempt to prevent their own people from trading. What protection teaches us, is to do to ourselves in time of peace what enemies seek to do to us in time of war.”
— Henry George in Protection or Free Trade (1886). 

In Praise of the 9th Amendment

“The enumeration in the Constitution, of certain rights, shall not be construed to deny or disparage others retained by the people.”

Link to the Wikipedia article on the 9th Amendment to the Constitution of the United States

It is not now, but the 9th Amendment to the Constitution should be one of the greatest defenses of liberty that we have. Here is a very brief description of an interpretation that I find attractive: 

A libertarian originalist, Randy Barnett has argued that the Ninth Amendment requires what he calls a presumption of liberty. Barnett also argues that the Ninth Amendment prevents the government from invalidating a ruling by either a jury or lower court through strict interpretation of the Bill of Rights. According to Barnett, “The purpose of the Ninth Amendment was to ensure that all individual natural rights had the same stature and force after some of them were enumerated as they had before.”[13]

Randy Barnett’s key argument is that the many voters in the thirteen states who ratified the US Constitution would have understood the 9th amendment to mean that there was a personal sphere of liberty that encompassed a great deal. For example, based on the original public meaning of the 9th amendment, it wouldn’t take “penumbras” and “emanations” to see a guarantee of privacy rights in the US Constitution.  

Randy Barnett also argues that the Privileges or Immunities Clause of the 14th Amendment– “The Citizens of each State shall be entitled to all Privileges and Immunities of Citizens in the several States”–which the Supreme Court gutted in the Slaughterhouse Cases, was meant among other things to extend this presumption of liberty to actions of the states. The Supreme Court has partially restored the meaning of the Privileges or Immunities Clause by its interpretation of the Due Process Clause of the 14th amendment, but without as broad a scope of liberty. In particular, many aspects of economic liberty are no longer recognized as protected by the US Constitution. 

John Koskinen: It Takes Patience and Persistence to Change Government Policy

“Academics frequently say the culture is hard to change because the bureaucrat is opposed to major change: I think that’s exactly wrong. You can’t make changes in a large bureaucracy by simply shouting and exhorting. It takes time. Talk to someone in the private sector about marketing and they’ll talk to you about the number of impressions it takes before somebody hears their message. Government is the same way.”
— John A. Koskinen, as quoted in the July 3, 1997 Wall Street Journal article “A Business Executive Sees What Works in Government,” by Albert R. Hunt

John Stuart Mill’s Roadmap for Freedom

The entire argument of John Stuart Mill’s On Liberty is summarized in the 12th paragraph of the “Introductory” chapter:

But there is a sphere of action in which society, as distinguished from the individual, has, if any, only an indirect interest; comprehending all that portion of a person’s life and conduct which affects only himself, or if it also affects others, only with their free, voluntary, and undeceived consent and participation. When I say only himself, I mean directly, and in the first instance: for whatever affects himself, may affect others through himself; and the objection which may be grounded on this contingency, will receive consideration in the sequel. This, then, is the appropriate region of human liberty. It comprises, first, the inward domain of consciousness; demanding liberty of conscience, in the most comprehensive sense; liberty of thought and feeling; absolute freedom of opinion and sentiment on all subjects, practical or speculative, scientific, moral, or theological. The liberty of expressing and publishing opinions may seem to fall under a different principle, since it belongs to that part of the conduct of an individual which concerns other people; but, being almost of as much importance as the liberty of thought itself, and resting in great part on the same reasons, is practically inseparable from it. Secondly, the principle requires liberty of tastes and pursuits; of framing the plan of our life to suit our own character; of doing as we like, subject to such consequences as may follow: without impediment from our fellow-creatures, so long as what we do does not harm them, even though they should think our conduct foolish, perverse, or wrong. Thirdly, from this liberty of each individual, follows the liberty, within the same limits, of combination among individuals; freedom to unite, for any purpose not involving harm to others: the persons combining being supposed to be of full age, and not forced or deceived.

The first key concept here is of a personal sphere that an individual cares about more than other people do–or where other people care mainly if they have freely chosen to interact with that individual. In the middle of the description of that concept is an important phrase: “free, voluntary and undeceived consent.” It is not enough to establish valid consent that it be free and voluntary. It must also be undeceived. 

The delineation of this personal sphere is the hard part. John Stuart Mill identifies what goes on inside one’s own brain as the most obviously personal sphere. It then requires a deep set of arguments to argue that freedom of thought requires freedom of speech–that we can’t really be who we freely, voluntarily and undeceivedly choose to be even in our own minds unless there is freedom of speech. For one thing, it is easier to think something if one dares to express it to others. For another without other people having freedom of speech, one will have relatively few choices of things to think.

Moving beyond speech to action, the delineation of a personal sphere ultimately requires reference to the physicality of human beings and ownership of objects. There are various ways to delineate this personal sphere. But as long as the principles are followed of giving each person a roughly equal personal sphere, without too much overlap, it will probably be all right. There may even be some ownable things that are “frills” and therefore can be distributed unequally as incentives without compromising people’s lives. 

Finally, the idea that people can choose to pool their personal spheres for certain purposes to get together as a group and do their thing is very important. This is one of the most contested areas of the concept of liberty. For example, in current US law, getting together as a group for consensual sexual activity is a liberty that is now quite well protected, but getting together as a group for consensual economic activity is much less well protected–in part because many consensual economic activities that provide surplus to both parts still have a strong adversarial dimension because of disagreements over the relevant wage or price that divides the surplus. Debates about the scope of group liberty rage, with some arguing that sexual freedom should be curtailed, and others arguing that economic freedom should be expanded, while others argue for the status quo of freedom for consensual sexual activities and restraints for consensual economic activities. 

Here, it is worth noticing that every argument for how two parties conducting consensual economic activity might affect others has a counterpart argument for how two parties conducting consensual sexual activity might affect others and vice versa. 

The moral is that liberty is wonderful, but not simple. It takes deep thought to understand liberty. 

To dig deeper into the principles of liberty, see links to other John Stuart Mill posts collected here.