Wednesday, April 16, 2014

Toward a run-free financial system

A new essay, expanding greatly on a previous WSJ oped and illustrated by a great comic. Here's the introduction, follow the link for the whole thing.

Toward a run-free financial system
John H. Cochrane
April 16 2014


The financial crisis was a systemic run. Hence, the central regulatory response should be to eliminate run-prone securities from the financial system. By contrast, current regulation guarantees run-prone bank liabilities and instead tries to regulate bank assets and their values. I survey how a much simpler, rule-based, liability regulation could eliminate runs and crises, while allowing inevitable booms and busts. I show how modern communications, computation, and financial technology overcomes traditional arguments against narrow banking. I survey just how hopeless our current regulatory structure has become.

I suggest that Pigouvian taxes provide a better structure to control debt issue than capital ratios; that banks should be 100% funded by equity, allowing downstream easy-to-fail intermediaries to tranche that equity to debt if needed. Fixed-value debt should be provided by or 100% backed by Treasury or Fed securities.  

Monday, April 7, 2014

Weekend Labor Markets

This weekend produced several interesting readings on the state of labor markets.

1. Glenn Hubbard,

In the Wall Street Journal on "The Unemployment Puzzle: Where Have All the Workers Gone?" Like economists of all stripes, the fact that the unemployment rate -- the fraction of people looking for jobs -- is down masks the deeper problem, that so many people are not working and not looking.

Glenn sets out well the basic question:

Tuesday, April 1, 2014

Krugman on reading

Paul Krugman has a fascinating blog post up. To be fair, I will quote it in its entirety, with my emphasis added in bold. 
I’ve written before about the myth of the stupid progressive economist.Many conservative economists have a fixed idea in their heads — it’s more than just a presumption, because it seems completely impervious to evidence — that progressive economists are dumb guys who don’t understand basic economics. And because of this fixed idea, conservatives appear literally unable to read what my side writes; they criticize the dumb things they’re sure we must have said, without checking to see if that’s what we actually said.

In the linked post I wrote about health reform issues, but you also see this in macro: five years and more into this discussion, freshwater economists still can’t wrap their brains around the notion that modern Keynesians (both New and eclectic) have actually done a lot of hard thinking over the past few decades. I’ve called this a failure of reading comprehension, but it’s actually an unwillingness to read at all, to so much as glance at what the actual argument might be.

And I mean that quite literally. Brad DeLong quotes from a John Cochrane paper (no link) which declares that those stupid Keynesians don’t understand why monetary policy is ineffective. It’s not because of the zero lower bound, it’s because bonds and monetary base are perfect substitutes:
In this analysis, monetary policy is impotent, but not for the usual reason that interest rates are nearly zero. The Fed can arbitrarily exchange Treasury debt for money, and increase the money supply as much as we like. But nobody cares if it does so, since the “flight to liquidity” is equally towards all forms of Government debt. If we want more fruit and less cheese, putting more apples and less oranges in the fruit basket won’t help. 
So, I think I can say without boasting that the modern revival of liquidity-trap economics began with my 1998 Brookings Paper (pdf). Here’s the first sentence of that paper:
THE LIQUIDITY TRAP – that awkward condition in which monetary policy loses its grip because the nominal interest rate is essentially zero, in which the quantity of money becomes irrelevant because money and bonds are essentially perfect substitutes – played a central role in the early years of macroeconomics as a discipline.
That was 16 years ago. Just saying.

It's pretty amazing to write a whole column about people who, and I quote "criticize the dumb things they’re sure we must have said, without checking to see if that’s what we actually said." and then so patently and blatantly not, well, check to see if that's what I actually said.

"no link?" Dear Professor, let me acquaint you with this thing called Google, with which you can check quotes if you are so inclined when Brad doesn't give you the link. (Update: Hilarious "let me google that for you" link from a correspondent.)

If you did, you would find no statement of mine, ever, that says anything like "those stupid Keynesians don’t understand why monetary policy is ineffective." This is slander, pure and simple. I have never used the word "stupid" to describe any economist.  Serious, scholarly, new-Keynesians like Mike Woodford are incredibly smart.

And to write this in the middle of a column complaining that I don't check to see what others have actually said??? Are there no mirrors at the New York Times?

As for my supposed lack of reading skills, I invite the learned professor, if he wishes to join the club of people who check facts, to browse my research webpage and or the page of my monetary economics class. He will find a lifetime of work reading and thinking hard about New, and Old Keynesian models, going back decades. I even got an A in my Keynesian classes at Berkeley in the 1980s.

Since he advocates reading, let me suggest my Determinacy and Identification with Taylor Rules, including the references, or the more recent New Keynesian Liquidity Trap. You can say it's all wrong, but you cannot say I have not read and thought hard about new-Keynesian economics, including all of Woodford's book. But to do that, you have to read past one 2009 blog post, which seems to be the beginning and end of Brad DeLong's reading, and Krugman's passing along of opinions without doing any reading.

Perhaps this is all petulance because I didn't cite Krugman for the idea that at zero rates bonds and money are perfect substitutes. (In, let us remember, a blog post designed to explain to a popular audience how neoclassical models work, with very few citations, not an academic article.) Anyway, Keynes and Friedman (optimum quantity of money) had those ideas long ago. Indeed it did "play a central role in the early years," which is why a citation is not required for every paper that talks about it afterward. And perhaps I should add a little Emily Post etiquette lesson: There is a fine art of fishing for citations. Slander and insults are usually not very effective.

It was April 1. It's so outrageous I did stop to check that it wasn't a parody! Apparently not.

PS: Comments off, for obvious reasons.

Monday, March 31, 2014

EconTalk MOOC Podcast

Russ Roberts
podcast interview with Russ Roberts on EconTalk about my experience teaching a MOOC and thoughts on the economics of MOOCs. (The interview was based a bit on my last post here.)

Russ is a very good interviewer, and the EconTalk series quite interesting.

Wednesday, March 26, 2014

The sign of monetary policy, part II

(This blog post uses mathjax to show equations. You should see pretty equations, not ugly LaTex code.)

The ECB is in the news today. They want some inflation, yet the overnight rate is already zero. They're talking about negative interest rates, which leads to a great lunchroom discussion about bags of euros wandering around Europe.  All very interesting.

Yet it brings to mind a heretical thought I explored in an earlier blog post: What if we have the sign wrong on the effect of monetary policy? Could it be that to get more inflation, our central banks should raise rates not lower them? (Leave aside whether you think more inflation is good, which I don't. But suppose you want it, how do you get it?)

It's not as crazy as it sounds.


I did two interviews that blog readers might enjoy.

This is an interview with Jeff Garten at Yale, covering financial crises and reform/regulation efforts rather broadly. Source here. It's part of a very interesting series of interviews on the "future of global finance" with lots of superstars. I give Niall Ferguson the prize for most creative  author photo.

This one is a podcast interview on the ACA and how free-market health care can work, with Don Watkins at the Ayn Rand institute's "debt dialogues" series. If you follow the link you get several formats.

Monday, March 24, 2014

Goodman Vs. Emanuel

On the fourth anniversary of the ACA, Saturday's Wall Street Journal had an excellent pair of pro and con OpEds from John Goodman "A costly failed experiment" and Ezekiel Emanuel "Progress, with caveats."

Stein on Financial Stability in Monetary Policy

Fed governor and Harvard Professor Jeremy Stein gave an important speech on March 21, Incorporating Financial Stability Considerations into a Monetary Policy Framework. I have a few minor criticims, specifically on standard errors, causal mechanism, and Lucas critique. But it's great for Jeremy to think out loud this way, and give me occasion to do the same. You should read the whole thing.

Stein's bottom line:
...all else being equal, monetary policy should be less accommodative--by which I mean that it should be willing to tolerate a larger forecast shortfall of the path of the unemployment rate from its full-employment level--when estimates of risk premiums in the bond market are abnormally low.
This view has put Stein a bit in the camps of the hawks, meaning simply those who for one reason or another think the time to raise rates is sooner rather than later.

Friday, March 21, 2014

A World Without Banks?

A graphic short story in this month's "capital ideas."  Click on the link or the image to read the whole thing (4 panels). If you can find the print magazine, the visual quality is much better. I think it does a great job of making economic ideas visual without too many talking heads and big balloons full of text. More of these to come in future "Capital Ideas." More work from this unusually talented graphic novelist here. (My side of this "debate" is a bit captured here.)

Thursday, March 20, 2014

Hello Discretion

Today, the much-anticipated first Fed policy statement of the Yellen era came out. FOMC statement, here.

Some interesting tidbits:
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. ... asset purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on the Committee's outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. 
In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. 
With the unemployment rate nearing 6-1/2 percent, the Committee has updated its forward guidance. 
In other words, the committee will do whatever it feels like doing, whenever it feels like doing it, based on whatever information it decides is relevant. The Committee updated its forward guidance by throwing it under a bus, or at least by clarifying that it is of the form "here is what we think now we will want to do in the future, but we can change our minds at any time."

The larger context is the debate between commitment or rules and discretion. Discretion wins.

You might expect me to be fulminating. I'm not. (Though I'm waiting for a rules vs. discretion blast from John Taylor! (Update: here it is.)  I regard this as simply stating reality.

University Debt

Bloomberg has a story on the University of Chicago's big debt expansion. Obviously, it's a topic around faculty lounges too.

A few thoughts. Why does a university simultaneously borrow $3.6  billion but have $6.7 billion Invested? If borrowing is such a big deal, why not just spend the endowment on new buildings?

Answer: universities can borrow at municipal rates, free of federal tax to the lender, if they are building something. Borrowing at tax-free rates makes financial sense, even you just stuff the marginal dollar into endowment. Of course the endowment is not invested in Treasuries -- universities don't do simple tax arbitrage. So the model is more that of a leveraged hedge fund -- borrow at low tax-free rates, up to the limit imposed by tax law, and invest in high risk, (hopefully) high-return projects like hedge funds, private equity, real estate etc. The fact that investment returns are also not taxed makes this a doubly advantageous strategy. Donors: if you give now, your gift grows tax-free, while if you earn the rate of return and then give the money to the university, you pay taxes on the intervening returns.

Monday, March 17, 2014

House of Debt

Atif Mian and Amir Sufi have started a blog related to their new book, "House of Debt." Amir and Atif are admirably data-oriented, which ought to make for good reading.

Today's post "Fed Meetings and Asset Prices" is a good example. They put together one-day returns on the June 19 "taper tantrum" when the Fed announced it might (heavens) start tapering bond purchases. There is, of course, a large literature studying announcement effects. Atif and Amir  put together an unusually wide spectrum of asset classes.

Monday, March 10, 2014

Goodman Plan

John Goodman has an excellent health-care piece at National Review Online. You don't have to subscribe to every element of his "plan" to appreciate many of his trenchant observations of coming Obamacare disasters. (Any "plan" that advertises it is crafted to meet perceived political constraints is bound to be less than perfect as a matter of economics.)

The slight weak point: he keeps community rating and guaranteed issue, but talks about how people need to sign up immediately or lose that benefit as they do in Medicare. I'm not sure just how he wants to do that or if that's realistic. But the big picture is right on: deregulated, individual, portable insurance.

Transferability between plans is a nice point:  "if an expensive-to-treat patient moves from Plan A to Plan B, the former has to compensate the latter for any above-average expected costs — just the way Medicare compensates private plans."

But read it for the mess we're in now. Lots of looming problems have not made headlines. Yet.

Asness and Liew on Efficiency

Source: Institutional Investor
Cliff Asness and John Liew -- Chicago PhD's and now founding principals of AQR -- have a nice piece in Institutional Investor on Fama, Shiller, Nobel Prizes and efficiency.

They do a good job on the joint hypothesis theorem -- maybe a more important part of Fama's 1970 paper than efficiency itself -- and value and momentum strategies.

They point out one big difficulty for the inefficiency view (p.5). If value stocks are just overlooked and growth stocks irrationally overpriced, why do value stocks all subsequently rise or fall together, and growth stocks go the other way? "Cheap stocks would get cheaper across the board at the same time. It didn't matter if the stock was an automaker or an insurance company. When value was losing it was losing everywhere."

A second very important theorem: the average investor must hold the market portfolio, so alpha is a zero sum game. If you're going to profit, it helps a lot to identify just who the morons are whose money you are taking and why they're willing to give it to you. Everyone thinks the other guy is "behavioral." Are you sure it's not you?

Saturday, March 8, 2014

Employment-Population Ratio: war of the graphs

The comments on my last post were particularly good, and pointed to some alternative graphs. And, I think, to the important conclusion, that there is no substitute really for sitting down and doing some economics.

Thursday, March 6, 2014

Friday, February 28, 2014

Budish, Cramton and Shim on High Frequency Trading

Today I taught a really nice paper to my MBA class, "The High-Frequency Trading Arms Race" by Eric Budish, Peter Cramton and John Shim. I've been fascinated by high frequency trading for a while (Some previous posts in the new "trading" label on the right.)

Eric, Peter and John look at the arbitrage between the Chicago S&P500 e-mini future and the New York S&P500 SPDR.  This is a nice case, because there are no fancy statistical strategies involved: high speed traders simply trade on short-run deviations between these two essentially identical securities. Some cool graphs capture the basic message.

First, we get to look at the quantum-mechanical limits of asset pricing. At a one hour frequency, the two securities are perfectly correlated.

But as we look at finer and finer time intervals, price changes become less and less correlated.  If the ES rises in Chicago, somebody has to send a buy message to New York. We write down Brownian motions for convenience, but when you actually look at very high frequency they break down.

It's not obvious this activity "adds liquidity." If you leave a SPY limit order standing, then the fast traders will pick you off when they see the ES rise before you do. The authors  call this "sniping."

Wednesday, February 26, 2014

Cost-Benefit Analysis for Financial Regulation

Is cost-benefit analysis a good idea for financial regulation? Ostensibly an essay addressing that question, this piece expanded to a rather critical survey of financial regulation, as I thought about what the costs and benefits of financial regulation are. It's based on a presentation I gave at the Sloan Conference on Benefit-Cost Analysis at the University of Chicago Law School last fall, with many interesting papers, most of them more optimistic.

HTML here, to make it easy to read. Pdf and permanent link here which is where updates and a final (I hope) published version will reside.


Regulations should only be enacted if their benefits exceed their costs. Who can object to that?

That’s not the question. The question is whether legal requirements for cost-benefit analysis, a new legal and regulatory process erected around such calculations, a “judicially enforced quantification” (Coates 2014) on top of the current regulatory procedure, would produce better policies. Would laws forcing regulatory agencies to produce cost/benefit analysis, of certain specified types, with specified codified methods, and allowing proponents and opponents of regulation – who often have strong private reasons to favor one outcome or other – to challenge regulations on the basis of cost/benefit analysis – and especially, to challenge the cost-benefit process – overall produce better policy results?

Monday, February 17, 2014

In Box

It is a delight of being an economist how many fascinating papers come through the in box. It is a deep frustration that I don't have the time to read them all.  Here are a few on my in-box today, courtesy of NBER, SSRN, and AEA email lists. Disclaimer: I've only read the abstracts so far. (If you can't get NBER working papers, Google usually finds ungated versions on authors' webpage or ssrn.)

1. The Demise of U.S. Economic Growth: Restatement, Rebuttal, and Reflections by Robert J. Gordon.

Thursday, February 13, 2014

A Brief History of the Efficient Markets Hypothesis

Back in 2008, Gene Fama made a nice video for the American Finance Association on the history of the efficient markets hypothesis. The video is finally out on the new AFA youtube channel here. You may have to drag the cursor back to see the introduction, on which I did a pretty good job if I do say so myself.