Monday, May 23, 2016

Variable Interest on Reserves and Volatility of Short Term Interest Rates

JP Koning commented on my last post suggesting that floating interest rates on reserves would lead to "incredible" volatility in short term interest rates.

First, I must admit that the institutional framework I described is consistent with the Fed doing interest rate smoothing as much as it desires.   I don't favor such a policy, but it would be possible.

If, instead, we consider a k percent rule for reserves (including k=0,) then a floating interest rate on reserves would tend to increase the volatility of short term interest rates relative to what would occur with a fixed interest rate on reserves, including keeping it at zero.

In my view, the added variability of short interest rates would be desirable to the degree it reflects changes in the supply or demand for credit.  This is equivalent to variation in the short run Wicksellian natural interest rate.   In that situation, a fixed interest rate on reserves, much less a policy of adjusting the quantity of reserves to smooth short run interest rates, is disequilibrating.   It is keeping the market rate from tracking the natural interest rate and creating undesirable short run fluctuations in aggregate nominal expenditures.

However, to the degree that shifts in the demand to hold money (or reserves) is creating short run fluctuations in interest rates, interest rate smoothing is exactly what should occur.  The quantity of reserves would be adjusted to the demand to hold them without creating short run distortions in interest rates or, more importantly, in expenditures on output.    If changes in the quantity of reserves are not permitted due to a quantity rule, then keeping the interest rate on reserves fixed would at the very least dampen the undesirable changes in other interest rates and in spending on output.  That would be the least bad option.

Since if favor allowing the monetary authority (or central bank) to make changes in the quantity of reserves more or less continually, I see no particular value in a market process that would lessen the harm given a fixed quantity of reserves.   (I favor index futures convertibility as a constraint.)

Anyway, my view on what would happen with a fixed quantity of reserves is that borrowing and expenditure plans would be slightly postponed or perhaps hastened based upon changes in short term interest rates.   Suppose that there is an increase in the demand for bank credit and banks demand more reserves.   This raises the interest rate banks must pay for reserves.   If the interest rate the central bank pays on reserves balances is fixed, even at zero, this will result in some banks reducing the amount of reserves they desire to hold.

If there are no reserve requirements, this effect is given its maximum possible effect.   It is this short run liquidity effect that is emphasized in money and banking theory--at least since Keynes.

If the interest rate on reserves rises in this situation, then the liquidity effect disappears.   The interest rate must rise until the quantity of bank credit demanded is back to its initial level, or else new deposits are attracted, for example by selling negotiable certificates of deposit.   Short run credit markets must clear.

Considering the effects on the demand for output, if some want to borrow from banks to purchase more output then others must be deterred from borrowing from banks so that they purchase less output.  Or else, others might be induced to lend more to banks, thus saving and spending less on output.  This added saving would reduce the demand for output, offsetting the increased demand for output by borrowers.

Certainly, it is possible that this would all occur by responding to changes in short term interest rates.   However, we can easily imagine spikes in interest rates being avoided by rationing.  Borrower would be told that funds are not immediately available and that because money is tight, you must wait a few days before making the planned purchase.  Low interest rates might well result in lots of calls to potential borrowers stating that funds are available now.

But, what if the problem is that the banks have no additional credit demand but simply decide that holding more reserves is a better policy.   Those traders in the money market office have made one mistake due to "too clever" manipulations too many.   What should happen is that the monetary authority create additional reserves.   But if it fails to do so, then efforts to obtain more reserves by selling securities or else temporarily restraining lending will tend to raise interest rates.   If the interest rate on reserves is fixed, then this raises the opportunity cost of holding reserves.   Some bank or other releases reserves.  While this increase in interest rates is disequilibrating, if the interest rate on reserves increases as well, then there will be no release in reserves!  There is no tendency for higher interest rates to result in a lower demand for reserves.  Only as expenditure on output (or really, lower output or lower prices) result in lower demand for reserves, will there be a return to monetary equilibirium.   The liquidity effect is gone and we are back to a pre-Keynesian world where nominal income must adjust so that the demand to hold money (or reserves) matches the given quantity.

But, of course, the quantity is not given and the monetary authority should expand the quantity of reserves in this situation so that there is no impact on short term interest rates or expenditures on output.

So, what is the effect on volatility of interest rates?   I think that they will fluctuate however much the monetary authority wants them to fluctuate.   Hopefully, they will fluctuate with changes in the short run natural interest rate only.   But nothing in the regime prevents the a central bank from changing the quantity of money to intentionally create monetary disequilibirum to smooth interest rates.  

Saturday, May 21, 2016

Interest on Reserves

George Selgin testified before a Congressional Committee about the Fed's policy of paying interest on reserves.



I agree with much of what he said.

Implementing interest on reserves in 2008 explicitly aimed at restricting aggregate demand and inflation was foolish.  It helped lead to disaster.

Further, paying banks to hold onto money rather than lend it is not wise during a financial crisis.

I also agree that a policy of paying interest on required reserves with no interest on excess reserves is better right now than the status quo.

On the other hand, I think reserve requirements are a bad policy and so that makes any distinction between required reserves and excess reserves irrelevant except as a compromise.

Further, I would like to see the demand for reserves by banks be independent of interest rates.  The best way to do that is to both pay interest on reserves and make that interest rate vary with market interest rates.

One policy would be for the Fed to pay less on reserves than market determined T-bill yields.   When T-bill yields change, the Fed would need to promptly adjust the interest rate it pays on reserves.   It makes reserves into a type of money market account.

Given the liquidity and safety of T-bills, they are a close substitute to reserves for banks.   If the T-bill rate rises, that would tend to increase the opportunity cost of holding reserves if the rate paid on reserves was fixed, even at zero.   This would lower the demand to hold reserves.   If the interest rate paid on reserves rises in proportion, there would be no impact on the demand for reserves.

More relevant to today, if the T-bill rate should fall, this would reduce the opportunity cost of holding reserves and raise the demand for them if the interest rate on reserves were fixed, including at zero.   If the interest rate on reserves instead fell as well, then there would be no tendency for lower interest rates to raise the demand for reserves.

In my view, given the current very low interest rates on T-bills, the appropriate interest rate on all reserves is negative.   If this creates too much of a burden on required reserves, then reserve requirements should be reduced, preferably to zero.

An alternative policy is to treat reserves like a mutual fund claim on the Fed's asset portfolio, while charging banks a management fee.   The yield banks would earn on reserves would change with the yield on the Fed's asset portfolio--presumably with the yields on assets that banks can hold directly.   This would make the banks' demand for reserves independent of interest rates as well.

Such a policy would expose the banks to credit risk on the Fed's balance sheet.   While I don't think it is desirable for the Fed to expose banks to risk by purchasing risky assets, I consider the alternative of the Fed providing interest bearing zero risk assets to the banks while itself holding risky assets to be even worse.

With such a policy, I think a "bills only" policy for the Fed's asset portfolio would be feasible.  (At least ignoring currency for a moment.)   This would make the mutual fund type reserves pretty much equivalent to the money market account reserves.   The yield banks earn on reserves would be slightly less than the interest rate that can be earned on the T-bills the Fed would hold in its asset portfolio.

I favor keeping the interest rate the Fed pays on reserves below T-bill rates (or having the Fed charge banks an ample "management fee.")   Part of the reason is to harness the stabilization process that Selgin himself discovered.   The difference between the interest rates banks can obtain on earning assets and the interest rate they receive from the Fed is the opportunity cost of holding reserves.   Banks must weigh that against the transactions costs of adjusting their reserve position by trading securities.   This determines the reserve balance that it is most profitable for banks to hold.   However, it also depends on the variance of gross clearings by banks which in turn depends on aggregate nominal expenditure.   If nominal expenditure grows at a slow steady rate, this should keep the demand for bank reserves also growing at a slow steady rate.   Normally, then, the Fed could maintain monetary equilibrium by keeping the quantity of bank reserves growing at a slow, steady rate.

As I understood Selgin's first version of the argument, he claimed that a fixed quantity of bank reserves would result in fixed equilibrium level of nominal expenditure on output.   The version I describe above has a slightly different emphasis but is based on the same reasoning.    

However, if the Fed is providing an asset with a fixed interest rate and no risk, then shifts in market interest rates or even the risk of bank assets will cause fluctuations in the demand for reserves interfering with the process described above.   Of course, it would simply require that the Fed manipulate the quantity of reserves.   More risk or lower market interest rates, the Fed would need to create more reserves for the banking system.   Less risk or higher market interest rates, the Fed would need to create fewer reserves.  In my view, it is better to avoid the need to make these sorts of adjustments in the quantity of reserves, and so that is the rationale for the mutual fund type reserves.

I have always had less confidence than Selgin in the process he discovered.  I think there is an important element of truth in the argument, but I don't favor either a fixed quantity of reserves or a constant growth path for reserves.   And so, I also favor index futures convertibility--more or less like Scott Sumner's proposals.   (Oddly enough, I also favor more central bank discretion than either of them!)

Finally, I reject any notion that the Fed or any other central bank should create "costless" reserves, paying interest on the reserves equal to "the" interest rate.   I have no idea why anyone would think that having the central bank manage all credit allocation would be desirable or wise.

Tuesday, April 12, 2016

Luddites and All That

Scott Sumner responded to the attack on free trade by asking if there will now be an attack on technological advance.   Well, Scott, where have you been?   The attack on "automation" and "robots" has occurred in parallel with the attack on free trade.

I think it is for the exact same reason.   In 2008, there was a deep recession and a very significant increase in unemployment.   The recovery that started in 2009 was very gradual and has only recently resulted in a return to full employment.  Long periods of time with weak labor markets result in the growth of bad economic ideas.   We are now suffering from the consequences of competition of low wage foreign workers, or maybe it is some more reasonable version of "unfair trade practices."   Or it is the long awaited time when labor will be replaced by machines destroying all of our jobs.

A student at Friday's meeting of The Citadel Libertarian Society stated with complete confidence that robots will lead to mass unemployment in the next thirty or forty years.   He explicitly stated that there is only so much that can be produced.

I think the first thing to keep in mind about the introduction of robots, other sorts of automation, or more simply, of labor saving technology is that the total production of goods and services not only can increase, but almost certainly will increase.

When someone states that "soon" robots (or other machinery) will have taken 90% of the "jobs," the baseline assumption should be that the remaining 10% of "jobs" remaining to humans will be enough so that every human who wants a job will have one, and that total output will be approximately 10 times more than was being imagined.  

Of course, "numbers of jobs done by machines" versus "number of jobs available for humans" is probably not the best way to think about growing real income and output due to improvement in technology.    It is fundamentally based upon the fallacy of thinking of the number of jobs as being fixed and each job as providing a flow of income like manna from heaven.   If more of the jobs are done by machines, then there are fewer jobs left for humans.    It is the same fallacy applied when thinking about those low wage Chinese workers taking "our" jobs through imports or the immigrants from central Mexico taking "our" jobs.

If, instead, jobs are recognized as productive activity, then people working provide added output which is what generates their income.   Robots (or other machinery,) or Chinese in export industries, or Mexican immigrants do not stop other people from working to produce output too.

It might seem that the amount that can be produced is limited by demand.   Sure we could produce more shoes, but who would want to buy them?   There only a limited number of jobs needed to produce shoes.   While in truth there are billions of people in this world who would like to have more shoes, there is no doubt that the amount of shoes that can be sold for an amount covering the cost of production of them is limited at any particular time.

But the "cost of production" is an opportunity cost.   The reason "costs" do and should limit the production of shoes (and anything else) is that labor and other resources must be pulled from the production of other valuable goods and services.   The whole problem of costly production is due to a need to use labor and other resources to produce other goods and services.

Further, from a "macro" perspective, an increase in the output generates a matching increase in real income, which allows for an increase in the demand for shoes.   If we consider an increase in shoe output alone, the added income for the entire economy is relatively small and the impact of that on shoe demand is also likely to be small.    But when considering growing output throughout the economy and growing real incomes, the demands for all sorts of goods increases.   For the most part, it is the increase in the "supplies" of other goods and services that results in more demand for shoes.   And the increase in the supply of shoes mostly generates an increase in demand for other goods and services.   

Now, this process most certainly will make shifts of labor from producing some goods rather than other goods necessary if resources are to be allocated to produce what people want to buy most.   This is why technological progress is a source of unemployment.   Creative destruction does destroy some firms and some jobs and even whole industries and vocations.   But it generates expansions in sales and demand for other firms and jobs.  Sometimes new industries and vocations are created.

I think the most likely course over the next thirty or forty years will be much the same.   Higher real incomes but with a need to change jobs sometimes.   Further, those who do need to change jobs may take a temporary loss in real income.   But what they will be able to buy with their new job will gradually be more and better, surpassing where they were before.   And if not for them, their children or grandchildren.    

It is not impossible that the demand for human labor in general will fall off due to technological change.  However, it is easy to be confused.   For example, suppose using robots becomes cheaper than using human workers in some industry.  Simple supply and demand suggests that the reduced demand for human labor results in lower wages.   However, the increased supply of the products due to the fact they are now cheaper to produce implies that these lower wages now have added purchasing power.   If, as is conventional, this is all supposed to be done in real terms, this just shows that the impact of substituting machinery for labor has ambiguous effects on real wages--the goods and services that can be purchased with labor.

An alternative perspective is that real output and real income rises, but improvement in labor saving technology results in a reduction in the share of real income going to labor and an increase in the share of real income that goes to other sorts of resources.  Call that investment income for now.   Since real income has increased and investors get a larger share, then that is an unambiguous improvement for them.   But labor has a smaller share of the bigger pie.   That is ambiguous and could either result in higher or lower real labor incomes.

Further, the very same improved automation--best understood as cheaper robots (or other machinery) increases the demand for complementary labor.   That tends to raise the share of income going to labor and reduce the share going to investment income.   

 Finally, even if the net effect of innovation is to provide equipment that substitutes rather than complements labor, that is only a problem if the demand for human labor falls and the supply of human labor doesn't fall as much or more.   Suppose growing productivity and higher real incomes causes people to work fewer hours per day, days per week, weeks per year, or years during their life.     While the technological progress might allow machinery to be substituted for labor, if the reduction in labor supply is greater than the reduction in labor demand, the result would be an increase in real wages.

Consider a scenario where the demand for labor falls off more rapidly than the supply, and the result is that despite growing total output, the share of that output going to those working falls off so rapidly that real wages fall.   The only way to make a decent living, then, would be to save, accumulate assets, and earn investment income.   In other words, it would be necessary to own robots--perhaps a fraction of one or else several.   (Shares of stock in a robotic operation or bonds funding a robot operation is more realistic.)   If we imagine someone born into such a world with nothing but their own mind and hands, they might have difficulty earning enough to survive, much less save enough to "retire" on investment income.

Aside from there not being many productive tasks for humans in this scenario, it would seem that the robots would also need to be quite expensive compared to their output.   Otherwise, it would be relatively easy to purchase a share of a robot and have a good income.   Also, there would need to be plenty of demand for the output of the robots.   The robot owners would need to have a large demand for some kind of output rather than be nearly satiated for material goods and services.  If not, these robots would have a low opportunity cost for endeavors like producing consumer goods or even building additional robots for the poor still working for a living.

The most plausible "nightmare" scenario is where automation substitutes for human labor but scarce natural resources limit the expansion of aggregate output and income.   Suppose the world depends on depleting fossil fuels.   Those owning claims to these land resources would earn a growing share of income.   Claims to "capital" like the robots wouldn't generate much income nor would human labor.

Nick Rowe pointed out that the development of mechanization in the twentieth century didn't result in draft horses remaining fully employed along with the new fangled tractors.   The employment of horses in production fell off.   His point was that human labor could also become obsolete.

I think that he was correct.  However, it seems to me that the reason horses became unemployed is that the human labor needed to direct them was too expensive--the opportunity cost was too high.   However, another factor and more relevant to a possible world where human labor becomes obsolete would be that the opportunity cost of using the agricultural land with horse powered equipment was too high.

It is not the fabulously wealthy "post scarcity" world that generates the problem.  It is rather a world of scarcity where human labor is not very scarce.   If such a future develops, perhaps a quasi-Georgian approach of sharing out the rents from this natural resource would be the least bad option.

Further, in the happier future, where nuclear fusion or solar power or whatever creates plenty of energy, and nothing else of true significance creates a binding constraint, and if it really was true that there was so little use for human labor that investment income is necessary to thrive, then I would think that bringing children into such a world without providing them with a trust fund would be irresponsible.   Providing your child with a "good education" so that they will get a "good job" would no longer be responsible or reasonable.    As for those irresponsible or unlucky (which would include arriving into this world with insufficient net worth,) perhaps providing tax funded trust funds for their children would be the least bad option.   In our imaginary world of plenty, that should be a small expense.

I don't think that trying to switch to a system of sharing consumption is likely to be desirable, even in such a world.  Nor do I see much point in trying to  make consumption or incomes equal.   Further, replacing markets to allocate resources with central planning would not be necessary and probably not desirable.   Even if information processing technology makes managing an entire world economy manageable or even more efficient than competition, I am not sure that putting human survival in the hands of a single artificial intelligence would be wise.   Having multiple ones compete is probably better.

But most importantly, it would be foolish to make major economic reforms now based upon what might happen in  the distant future.   Human labor remains the most valuable resource, and there are billions of people who are desperately poor.   For many years, the most likely scenario is that technological improvement will raise real wages and bring the majority of people out of poverty and into a decent standard of living.

For generations, people in market economies have put up with the uncertainties of creative destruction with the result that those of us in the developed world are very well off materially by historical and world standards.   Sometimes, some people must start over, and when they do, they are still much better off materially than most people in the developing world or anyone from a century ago.   Continuing with the market system not only will improve the material well being of our descendants, but also will benefit those in the rest of the word who are in desperate need.






Tuesday, March 29, 2016

Are Trade Deficits Dangerous?

An attack on trade deficits.

http://www.huffingtonpost.com/jared-bernstein/trade-deficits-are-not-scorecards_b_9559192.ht

Well, at least in certain circumstances.

There are several inconsistencies--or really a "bait and switch" rhetoric.

It starts with the claim that countries with trade surpluses are stealing away labor demand from countries with trade deficits.

This is not true and it is based on simplistic Keynesian thinking.   What the trade surplus countries are doing is providing additional saving which allows for additional investment--spending on capital goods.   There is no particular reason to suppose that increased demand for capital goods--machines, equipment, and buildings, is any less labor intensive than the production of import competing or export goods.

It may in fact be that growing trade has reduced the demand for some types of labor    It is even possible that it could reduce the demand for labor in general.   But that has nothing to do with trade deficits.    That is, even if the U.S. ran a trade surplus, the same effect could occur.   For example, suppose the U.S. imports furniture and t-shirts and exports wheat and corn.   It runs a trade surplus with the difference used by U.S. investors to build foreign factories (so they can better produce the furniture and T-shirts.)    Farmers in Kansas and South Dakota earn higher incomes.   Factory workers in small towns in North and South Carolina earn less.   They have to find new work--maybe moving to Kansas and providing services to the farmers.   Retired farmer Jones who rents some of his land to Farmer Smith enjoys some of the greater prosperity.   It is certainly possible that the effect is an increase in share of income going to the owners of farm land (most of whom are farmers) and less going to labor.    And if those ex-factory workers stick around in their hometowns in Appalachia, it is very likely that the effect will be lower incomes for them.

However, it is also possible for the opposite to occur.   For example, the U.S. could sell lumber to Japan and import cars.   Suppose the U.S. runs a trade deficit because Japanese investors are buying newly-constructed buildings in the U.S.   It is certainly possible that the construction of buildings and production of lumber is more labor intensive than the production of cars.

More importantly, a trade deficit and associated net capital inflow makes it less likely that trade would result in a reduction in the share of income going to labor.   The added capital investment, by providing additional supplies of a complementary factor, should raise labor demand.

The argument that trade between developing and modern economies results in a reduction in labor demand involves economizing on capital goods.   According to the argument, the modern economy has lots of capital--plenty of sophisticated machinery--that is absent from the developing economy.   By shifting production of goods that require less capital to the developing economy and production that requires more capital to the modern economy, the result is an increase in total production and an increase in the value of capital in the modern economy.   While the demand for labor in the modern economy could either increase or decrease, the labor share decreases--"labor" gets a smaller share of a bigger pie.   The bigger share of a bigger pie going to capital is clearly an improvement.  A smaller share of a larger pie going to labor could go either way.   If the well being of workers is your concern, what happens is of key importance.   (For a Marxist, the distribution of income between capital and labor is all that matters, so even if a smaller share of a bigger pie is more--who cares, there is more exploitation.)

Trade, in this way, provides a substitute for shifting capital from the modern economy to the developing economy.   If capital is actually moving the opposite direction, as happens with a trade deficit, that will tend to offset this process.

So, if the concern is that trade with Mexico or China is adversely impacting the demand for labor relative to capital, then a trade deficit and net capital inflow should be celebrated!    On the other hand, one would expect that if differential capital to labor ratios are really very important in the development process, the advanced economies not only should be exporting relatively capital intensive products to the developing world, they should also be running trade surpluses and their savings should be shifted to profitable capital investment in developing countries.

I don't want to entirely dismiss these processes regarding the optimal allocation of capital and how it impacts labor and capital, but I do think it all comes from a long tradition of focusing on a growing capital stock as the key source of economic growth.   In my view, the key source of economic growth is instead improvement in technology.   The ability of developing countries to change their production processes to reflect improved technology allows them to produce more output and earn more income.   The capital they have becomes substantially more productive.

After asserting that countries with trade surpluses compel other countries to consume more, the author takes that back--recognizing what is correct.   Countries with trade surpluses invest less than they save and countries with trade deficits invest more than they save.   The problem here, I think, is a mixture between old Keynesian thinking that investment is fixed and new Keynesian models that have no investment.

In the "workhorse" new Keynesian model, there is no investment at all.   Interest rates play a key role, however, and can only relate to consumer loans.   A saver/lender consumes less than income and a dissaver/borrower consumes more than income.   Of course, with their representative agent models, no one ends up saving or lending at all.  Everyone just consumes what they earn.    Still, it appears that the go to assumption about trade deficits is that they represent dissaving--consuming more than income.   Well, they can, but they don't have to.

Anyway, after making this false statement about trade deficits requiring dissaving, it is immediately reversed, noting as an aside that yes, a net capital inflow can be used for capital investment.   And then we get a list of bad investments that have occurred.   What evidence is there that it was the net capital inflow that funded the "bad investments?"  Of course, in hindsight, bad investments are a waste!   The market system punishes investors who make bad investments with losses.

Then we get a version of the "global savings glut" story.   The notion is that interest rates have been low worldwide because there is a "global savings glut."   The countries with trade surpluses--which are saving more than they invest--are exacerbating this problem.   It is really back to crude Keynesianism.   The paradox of thrift purportedly shows that saving is bad  and results in poverty.   Well, it isn't that bad, because here we have the recognition that added saving results in lower interest rates and more investment.

But the investment due to the lower interest rates are supposedly these wasteful and bad investments--bubbles.   But in reality, bubbles are alternatives to low interest rates.   It is rational to take more risk when safe interest rates are lower.   If you can earn a higher yield, it is sensible to take part of the benefit in terms of greater safety.   Turn that around and the result is lower yields makes taking higher risks reasonable.

But that doesn't make bubbles rational.   To motivate more sound investment, lower interest rates are necessary.  If there is a bubble, the demand for investment is irrationally high, allowing for more investment at higher interest rates.   With no bubbles, interest rates must be lower to generate the appropriate amount of sensible investment.

Further, the interest rates that most businesses have to pay to fund capital investment are not "crazy low."   The only interest rates that are "crazy low" are short term U.S. government guaranteed instruments.

The U.S. has had massive budget deficits, which is a reduction in U.S. saving.   That we run trade deficits and obtain a net capital inflow means that these deficits have a smaller negative impact on U.S. capital investment than otherwise.   If the U.S. started to run modest budget surpluses and so gradually pays off the U.S. national debt, would the U.S. still have a trade deficit?  Perhaps.  If so, let us hear complaints about other countries saving too much then.

Finally, all that said, it is bad for foreign countries to manipulate their economies to accumulate large official foreign exchange reserves.   But it is mostly bad for their people.

When "foreign exchange" was gold bullion, then when any one country accumulated more, other countries would have less.   Aside from devaluation, equilibrium required a deflation of prices and incomes.   Usually, such deflation was very painful with reduced output and employment.   If unexpected, there was a transfer from borrowers to lenders as well--a transfer that did not reflect the agreed sharing of risk of particular production processes.

In the twentieth century, there were efforts to have countries work together to avoid this sort of problem.   However, the end of the gold standard has solved these problems.   These traditional concerns about "trade surplus" countries just don't apply.    It is an artifact of a bad monetary order.

And that brings us to today.    In the late 20th century, the Fed doubled-down on its traditional fixation on interest rate targeting--focusing on short and safe rates.  It adopted inflation targeting.   The interest rate target results in problems when short and safe interest rates are very low.   But that is a self-inflicted wound.  Further, inflation targeting has generated slow recoveries ever since it was adopted.  These slow recoveries appear to create problems with short and safe interest rates, but the real problem has been the populist backlash due to years of weak labor markets.   Just now, the foreigners are taking all the jobs, or maybe it is the robots.    Sure.....that's the problem.   It happens with every recession and with a weak recovery, it just lasts longer.



Friday, February 19, 2016

The South Carolina Primary

I still plan to vote for Rand Paul.   The Republican leadership claims that they told the South Carolina Election Commission that Paul suspended his campaign, which means that my vote for him will be counted.  I saw an email from the Election Commission saying that he "resigned" from the election, which means that he will be on the ballot but the votes won't count.   I guess I will see tomorrow.  (P.S.  Just voted.  No signs saying that anyone withdrew.)

Why stick with Paul?  I sure don't see eye-to-eye with him on every issue.   But there are no other good options.

Cruz claims that he should inherit the "Liberty vote."   I actually heard him speak in person, I spoke a few words with him face to face, and Kathy and I have a picture with him.  He was at The Citadel a few years ago at an event for the Free Enterprise Foundation.   I don't remember too much, but his remarks sounded good to me.

Also, the attack ads on Cruz saying that he is "anti-defense" make me want to vote for him.   Is willing to cut excessive defense spending?  Good.    Has some concern for the 4th amendment?  Good.

But it is not enough.  (Also, it sure suppresses my willingness to vote for the candidates of the campaigns that generate the attacks--Rubio, Bush and Kasich.)

In my view, Cruz seems to be too much of a hawk, but he has said a few things that sound at least slightly realist in his foreign policy views.

My problem with Cruz is that he panders too much to the Christian Coalition/Moral Majority or whatever we call that faction these days.   He is running to be President of Evangelical Christians.

It is a bit humorous that he began his campaign at Liberty University.  It didn't do Cruz much good.  I received a robo-call from President and son of the founder, Jerry Falwell, supporting Donald Trump.   My wife is from Lynchburg, Virgina and I once waited on Falwell's uncle Gene (twin of Liberty University founder Jerry) at my father-in-law's feed and seed store.   But I visit Peakland Baptist when I am up there, not Thomas Road Baptist Church.

When can we expect there to be a Donald  Trump Chair of Free Enterprise (or more accurately, of crony capitalism) at Liberty University?

None of the other candidates are much better on the social issues.   They all are fully committed to a futile effort for government to promote traditional moral values by using law enforcement to punish sin.   But Cruz wears this on his sleeve.   Cruz leads with these social issues.   It makes him impossible for me to stomach.   He won't let me forget that I believe in personal liberty and he doesn't.

I don't like Cruz's position on immigration.   I appreciate his earlier support for legalization of  status (guest worker program) without citizenship (voting and welfare "rights.")   But he says that his support for that was just a legislative ploy and that he really doesn't favor providing for some kind of legal status for illegal immigrants.   So, either he is a liar or else he supports having an permanent illegal workforce here.

I am not too concerned with Republican political strategy.   But I think this is one of the problems that most Republican elected officials have with Cruz.   They don't think motivating Christian conservatives even more to vote Republican is a good strategy.   It will chase away other, more moderate voters.  (Which on these issues, they are clearly right about me.)   They also don't like Cruz because of his history of claiming that he is the only "true" conservative and the others are all sell outs.   It hurts their feelings.  I sometimes think that this is a case where the truth hurts, but it sure won't help Cruz "unite the party" and win in November.

Also, the fact that Cruz stood by while Trump acted the fool for months was awful.  It seemed as if as long as Trump insulted Bush, Cruz had no problem.   That Cruz has finally begun to stand up to Trump's nonsense, particularly his effort use his corporate lawyers to threaten suits to violate the first amendment, is great.   Finally.

What about Rubio?

When I see the attack ads claiming he is soft of immigration, that makes me want to vote for him.   I don't favor a pathway to citizenship--welfare "rights" and voting rights.   I do favor legalization of workers (guest worker status.)   I can understand a compromise, and if the path to citizenship is long and hard enough, it might be worth it to get legalization.  

The problem with Rubio is that he is a neo-con's neo-con.   No evidence of foreign policy realism.   Instead policeman of the world and nation-building.   I think it is delusional.    A futile effort to remake all of the world in America's image by military force.     I have no interest in having my students be killed, or worse, come back maimed, due to grandiose visions of what is possible in Iraq, Syria, Libya or Iran.  I have even less interest in that happening to my son.  In my opinion, one tour in Afghanistan was enough.

I am not at all pleased that Rubio has remained silent about Trump and has joined in with Trump to claim that Cruz is a liar and using dirty tricks.   An alliance of convenience, no doubt.

I can understand why Rubio is irritated with Cruz when Cruz makes out that there is a big difference between them--Rubio is the sell out, while Cruz is the principled conservative.  Of course, there isn't really that much difference.

Bush?  Kasich?

I appreciate Bush finally challenging Trump a bit.   Watching ad after ad bashing Rubio (for well over a month now,) when there is not much difference between Bush and Rubio was a bit sickening.  What a waste.   Aside from Trump, Bush has the most Republican voters who will never support him and the highest unfavorability rating from the general public,   Maybe it is immigration (and Bush's record on immigration is no problem for me) or common core.  But I think it is the Bush name.

But Bush keeps it up.   If Trump wins the Republican nomination, or worse, it will be the fault of Bush and his ego.

I did look at Kasich.   I remember him from when he was in Congress years ago.  I had a positive impression.   I don't like his campaign approach.   No problem with being positive, I guess.   But his emphasis of his "establishment" approach to foreign policy is only marginally better than Rubio's full-frontal neo-conservatism.    And his attacks on Cruz as being anti-defense because of a hint of applying fiscal conservatism to defense (something Kasich used to do,) turns me off.

Trump.  You must be kidding.

There is no doubt, I will put a good bit of effort fighting Trump if he is the Republican nominee regardless of who opposes him.

OK.  He is not the least bit neoconservative on foreign policy.  Good.

But what is he?   Invade and take their oil?    Kill their families?   Torture works?   It is like the return of Genghis  Khan.   Normal for the pre-modern era.   And, of course, that was what was "special" about the Axis powers in World War II.   A return to the "ethics" of international relations from an earlier era.   The winners exploit the losers and are proud of it.   Open and uncompromising evil--Donald Trump.

So, Rand Paul it stays.

Sunday, February 14, 2016

Negative Interest Rate Naysayers

Maybe I will turn into a Marxist.

Just kidding.

Still, when I read Bill Gross attacking negative interest rates, it makes me wonder.

I am a free market economist, and as far as I am concerned, the interest rate is a price.   The correct interest rate is the one that equates quantity supplied and quantity demanded.   If the supply of apples is so great compared to the demand that market clearing requires that people be paid to haul them away, then that is the least bad option.  

With interest rates, however, the relevant coordination is saving and investment.   Saving is that part of income not spent on consumer goods and services.   And investment is spending on capital goods.   If the interest rate that results in saving and investment matching up is less than zero, then that is the "right" interest rate.

Now, I certainly would agree that if there are government policies that discourage investment, then repealing them is a good idea.   That should raise investment demand and so raise the interest rate that coordinates saving and investment.   But I don't see how using monetary policy to keep nominal interest rates high, even above zero, is ever helpful.

And make no mistake--the Fed's policy of paying interest to banks for holding reserves is a policy aimed at keeping nominal interest rates up.

Situations where some real interest rates need to be less than zero for some period of time seem entirely plausible to me.    Since I don't see persistent inflation as desirable, that means that some nominal interest rates should sometimes be less than zero.   Situations where all real interest rates should be persistently negative seem pretty implausible to me.  In fact, I think excessive focus on a steady state, or worse, for those of the "Austrian" bent, thinking about the evenly-rotating economy, misses the point as to why negative nominal interest rates are sometimes coordinating.

It is the short and safe ones that should sometimes be negative.   It is pretty unlikely that the long and risky ones (or the expected rate of return on the typical real capital investment) should be negative.

Why Marxist?

Because negative interest rates mean that the wealthy can earn no income from merely holding wealth--postponing consumption--when this occurs.    And I wonder if the complaints we hear from people like Bill Gross are not gripes about the need to make risky commitments to earn capital income.    The "capitalists" are promoting their "class" interest in creating an economy where they can earn a riskless real rate of return.

But really, (as usual) I blame the Fed.   And, of course, their new Keynesian enablers.   The Fed likes to manipulate interest rates, so new Keynesian macro is about manipulating interest rates.   They are seeking to keep inflation and unemployment low.   So new Keynesian macro is a kind of social engineering about manipulating interest rates to optimize an objective function of deviations of inflation from target and real output from potential.  

Bill Gross can say that negative interest rates will fail to create jobs.   Isn't that what the Fed says it is trying to do with low interest rates?  Create jobs?

What the Fed can do and should be trying to do is control total spending on output.  Nominal GDP is probably the least bad measure.   Keeping spending growing at a slow, steady rate is the least bad goal.

There is good reason to believe that a drop, or even a slowdown, of spending on output will result in the "destruction" of jobs.  Or, more exactly, a tremendous slowdown in new hires, which results in net decreases in total employment and a rapid run-up of the unemployment rate.

If that has happened, there is good reason to believe that a prompt reversal and recovery of spending will result in a rapid increase in new hires and a reduction in the unemployment rate.   There have now been three recessions that have occurred with the Fed's policy of inflation targeting, which means no reversal and catch-up.  The recoveries have been very slow and gradual.   (I believe it is the misnamed "jobless" recoveries can be blamed for both Sanders and Trump.)   Fed thinking was little different during the Great Depression.  Sure, they wanted the deflation to end, but then they wanted prices to stabilize at the new low level.   Having prices recover would be "inflation."   Stagnation for years.

Maintaining or returning to an appropriate path of spending on output should never be understood as trying to create jobs or even control inflation.    Market forces must be allowed to control employment as well as the variety of prices and wages in the economy and the levels and rates of changes of indices of consumer or other prices.

In traditional monetary orders, chiefly metallic standards, the market process that generated recoveries from recession involved negative real interest rates and reflation.   Spending on output falls off, prices fall, with deflation causing a lower price level.   As the price level falls below its long run equilibrium, it is expected to rise again.  That is, there is expected inflation-- a reflation of prices.   Even if nominal interest rates cannot fall much below zero, the expected reflation makes real interest rates negative.   Now, this might not be all interest rates.  Risky long term bonds might have positive real interest rates.   But short and safe real interest rates might well be very negative.  This is the market force that causes the economy to bounce back rapidly.

A central bank that seeks to provide paper currency or deposit accounts that are perfectly safe and "free" keeps nominal interest rates from falling as low as they would if the only alternative was gold or silver coin. Worse, if the central bank pays interest on deposits, they can create an arbitrary floor on nominal interest rates well above zero.

And, if the central bank is committed to preventing any reflation, which it can do, even under a gold standard by accumulating sufficient gold reserves--then it keeps real interest rates from turning negative as well.   Inflation targeting under the sort of regime we have today is a commitment to prevent reflation.

I am aware that there is a market process that adjusts to a permanent increase in the equilibrium relative price of gold.   The level of prices and wages are permanently lower.   With an outside money like gold, it can even result in a permanent increase in the interest rate that coordinates saving and investment by a permanent decrease in saving supply.   Wealth held in the form of gold is worth more, and so there is less reason for saving.  

At one time, that was the key to my understanding of the market forces that generated recovery from recession.  (I haven't favored the deflationary wringer as an actual policy for several decades now.)  It is not clear that this market process works when there is no gold or silver base money and there is inflation targeting.   In my view, there is no real outside money.  It is all inside money--some mixture of government and private debt.

Today, I definitely take the view that negative nominal interest rates are better than allowing deflation and then reflation to generate the appropriate changes in real interest rates.    Sure, keeping expected nominal GDP on target might allow for long run price stability with even the shortest and safest nominal interest rates never falling to less than zero.   But it is better that all nominal interest rates be free to adjust with supply and demand.    Having an interest rate targeting central bank keep interest rates above market clearing levels is a bad policy.   Making sure that those holding wealth can always earn a risk less rate of return is not a goal that justifies price fixing.

The "Jobs" Fallacy and Trumpanomics

According to Bryan Caplan, average people make the mistake of focusing on "jobs" as a primary good.  

Years ago, the Wall Street Journal reported on a poll where the responses of average people were contrasted with the answers of economists.   One of the questions was about the purpose of economic activity:  Is it to create good jobs or produce consumer goods and services.   While I think the correct answer (and the one most consistent with economics) is to promote human welfare, of the two options, producing consumer goods and services is the least bad.   And that is the one that economists chose.  In contrast, the general public went for creating good jobs.   

I sometimes lampoon that result by proposing the perfect economy.   Everyone can have the choice of a good job requiring manual labor--digging holes and filling them up.   Or else, they can have a great office job--moving paper from the left side of the desk to the right side and then back again.   Each job will pay $100,000 per year.   Once everyone has these good jobs, will we be in utopia?   Of course not, we will all promptly starve to death because no consumer goods and services are being produced. 

Now tell me, what is the point of having people do work?   Is it to keep them from being bored?  Is it to provide an excuse to hand out paper money to them?   Or is it to produce useful goods and services?

Anyway, consider the notion of "a job" to be nothing more than an entitlement to get some money.    That somehow there must be goods and services to buy if the money is to have value is ignored.   Or, perhaps "jobs" are entitlements for manna from heaven.

Now, assume that jobs are limited.   

If the Chinese use their sneaky, unfair trade practices to steal "American" jobs, then they have more of these jobs and Americans have less.   They are richer, and Americans are poorer.   Elect Trump, and he will use his clever bargaining techniques to win back these jobs for Americans.   The Americans, now having more of the limited quantity of jobs, will be richer and the Chinese, having fewer of the jobs, will be poorer.

With illegal immigration, the same principle holds.  Foreigners, chiefly small brown people from Mexico and Central America, come in and steal jobs from regular Americans.  These foreigners are better off and the Americans are worse off.   If the foreigners can be rounded up and deported, then they will no longer be taking American jobs.   Americans will get the jobs and so Americans will be better off.  The foreigners won't have he jobs, and so they will be worse off.

And now you should understand Trumpanomics.    Appeal to economic ignorance.

In reality, jobs are about producing goods and services.   There is not a limited number of jobs available.   When the Chinese produce goods and services, that does not prevent Americans from producing goods and services.   When people come to the U.S. from Mexico and Central America, they produce goods and services.   That doesn't prevent native-born Americans from producing goods and services.] too.

We can and should have as many jobs as there are people who want to work.

However, it is true that imports from China or immigration of people from Mexico or Central America might result in a redistribution of income among people in the U.S.--including native-born Americans.   For some Americans, the Chinese or immigrants will be customers for their products.   For others, businesses will need their services along with the labor of the immigrants, raising their incomes.   For some Americans, cheaper prices for imported goods or the products of immigrants will raise their real incomes.   And, sadly, for some Americans, the competition of foreign labor will result in lower incomes.   

For the economically ignorant, Trump is promising to take from foreigners and give to Americans.  In reality, what his rhetoric suggests is taking from some Americans and giving to other Americans.   Sure, it will also hurt the foreigners.   Mexicans and Central Americans will produce less and earn less in their home countries.   If China cannot sell to the U.S., what Chinese workers produce will be of less value and they will be poorer.   And, as a whole, so will Americans--even if we only count native-born Americans (and legal immigrants.)   But some native-born Americans might well get a bigger piece of a smaller pie.    But the more these sorts of policies are followed, the more likely they are to end up with about the same share of a smaller pie--that is less.  

And that is the story of countries like Argentina.   They were one of the highest income countries in the world.  And then they listened to the "strong leaders" who would help the average Argentine get his fair share instead of allowing them to be exploited by the British Imperialists.   And Argentina, step-by-step sunk into the third world.  And that is what Trump is offering to Americans.

Of course, Trump will still have his gold-plated bathroom fixtures.   There are some very rich people in Argentina even today.   But most of us will suffer.   Economic ignorance is never a good idea.