Saturday, October 3, 2015


It seems obvious now that removing third world dictators from power has been a disastrous policy for the U.S. during the post Cold War era.  It was understandable that after its victory in the Cold War the U.S. would try out new policies, particularly those that were considered distasteful but necessary during the long conflict with the USSR.

But in Afghanistan, Iraq, Egypt, Libya and Syria, conditions are worse than before U.S. interventions, and it is difficult to argue that placating the original regimes would have been less productive or more costly than what occurred.  It turns out that the longstanding U.S. policy of tolerating and occasionally propping up authoritarian regimes may have been the best approach.

The country in the news now is Syria.  I think most people would agree that Assad is better than ISIS or Al-Qaeda, and there might not be any other realistic alternatives.  So why not let Russia support Assad?  Syria is likely to be a quagmire, and so the U.S. might achieve two objectives at once - stabilize Syria and impose large costs on Russia.  Perhaps that is Obama's strategy, even though he has to say otherwise.

Saturday, September 26, 2015

Rand Paul on Interest Rates

Rand Paul had an opinion piece in the Wall Street Journal last week arguing that the Federal Reserve should get out of the way and let markets determine interest rates.  Paul says that Fed officials should "withdraw their artificial monetary injections and let interest rates rise to their natural level."

But how does Rand Paul know that the "natural level" of interest rates is higher than current rates?  And what does he suggest that the Fed do?  Since the Fed is a monopoly provider of money, it can't simply do nothing.  It could try to mimic what a free market in money would do, but how would they know if a free market would have a fixed money supply (perhaps based on gold) or competing fiat currencies?  A fixed money supply would tend to produce deflation at the rate of economic growth, possibly leading to low nominal interest rates, while competing fiat currencies might increase supply over time to create stable prices, or perhaps even slowly increasing prices.

I would love to know the answers to these questions, but knowing just isn't possible without dismantling government.  Even if we knew what a free market in money would do, there is no guarantee that moving in that direction would improve overall welfare because we don't know how the distortion of monetary monopoly interacts with other economic distortions.  This idea is known as the theory of the second best.

The best policy is to move gradually toward freer markets in all areas of the economy, stopping periodically to see if unexpected problems occur, and changing the speed of adjustment in different areas in response.  It seems to me that this is just what much of the world has been doing for the past 45 years.  The savings and loan crisis of the 1980s and the financial crash of 2008 were indications that financial deregulation might have come faster than was warranted given the level of other economic distortions still remaining.  We should expect reregulation in some areas from time to time, even with an overall drift toward deregulation.  We need gradual deregulation of everything, not a sudden privatization of money. 

Without privatization of money, we just don't know the natural level of interest rates.  We can only think about the relative risks of erring on the high or low side, and I think the Fed was correct last week in deciding that the risks of tightening are greater than the risks of staying loose.

Friday, August 21, 2015

Krugman and Kocherlakota

I'm afraid I must interrupt my summer again after reading Paul Krugman's column today while on a flight to Columbus.  Krugman cites my fellow University of Chicago Ph.D. Narayana Kocherlatota in his argument for massive new government spending.

Krugman and Kocherlakota are both very smart people, but Narayana is by far the more reasonable of the two.  In fact, Narayana is one of the most reasonable people I have ever met, while Krugman regularly jumps to conclusions supported by his own political preferences instead of evidence.

In a speech the day before yesterday to a conference in South Korea, Narayana argued the following:

1. The long-run neutral real interest rate has declined.
2. A low real interest rate can create financial instability.
3. A low real interest rate makes effective monetary policy difficult because of the zero lower bound.
4. Higher market values of government debt is likely to raise real interest rates.
5. A higher level of government debt has important costs.
6. Policy makers need to balance the costs against the benefits of additional government debt.

Narayana also emphasized (twice) that additional government debt can be funded with cuts in future transfer payments instead of higher taxes, a point that Krugman ignores.  My position would be that the best way to achieve the higher debt levels that Narayana discusses would be to cut taxes, incur new debt, and pay for it with future cuts in all kinds of government spending.  Narayana is neutral on these questions, as a monetary policy maker should be, but Krugman makes it sound as if Narayana is on board with Sanders-style socialism.  Nowhere does Krugman acknowledge that higher debt levels will have potential costs as well as benefits.

Krugman also implies that Narayana advocates higher debt because "when interest rates are very low even when the economy is strong, there's not much room to cut them when the economy is weak."  Narayana doesn't make this argument - the problem of the zero lower bound is a related, but somewhat different issue.  I argued against the "not much room" argument here, and John Cochrane discusses it here.

Finally, it mighty be silly, but I was bothered by this from the Krugman column: "When the housing bubble burst, all that AAA rated paper turned to sludge.  So investors scurried back into the haven provided by the debt of the United States."  "Scurried" and "sludge" are terms associated with rats, which is apparently how Krugman thinks of private sector investors.  Government, on the other hand, is a "haven."

Tuesday, June 2, 2015


Summer is here, and I will take my usual break from blogging.  I will leave you with a few quick observations on trends I think are interesting.

1. College students are a lot more interested in social norms and the cultural environment more than they are in economics or war.  The Occupy Wall Street movement fizzled, and the anti-war movement never really got off the ground before the wars ended.  My theory is that the leaders of the current generation of college students want to make money and rule the world, so they guide student energy into non-threatening movements like gay rights and micro-aggressions against members of minority groups.

2. It has been seven years since the last recession started, and the average time of a business cycle since World War II has been 5.6 years.

3. A historical cycle of crime is emerging from current and historical data:  When crime rates are low, people start feeling sorry for criminals and restrain the police.  Crime then goes up, and at some point people stop feeling sorry and crack down.  Then the crime rate goes back down.

4. If there is a war between the U.S. and China and it goes anything like the war between the U.S. and Japan, China might someday regret having built a lot of airstrips off of its coast.

5. Clinton/Castro vs. Walker/Fiorina?  Republicans need a woman to offset Hillary, and Democrats need an ethnic first to fire up liberals without actually being liberal.  Besides, having a candidate with the same name as a recent U.S. enemy worked in '08 and '12.

6. According to Google Ngram viewer, use of the word "millionaire" in books peaked in 1910, and is now used only half as frequently.  Use of "billionaire" has increased by a factor of 3.5 since 1980, but is still used less than one forth as frequently as "millionaire."  "Plutocrat" peaked in 1917.  "Capitalist" peaked in 1936, and again in 1979.  "Bourgeois" peaked in 1972, and is in steep decline.  "Poverty" hit a low point in 1954, peaked in 1971, and now appears to have peaked again.

Have a good summer!

Tuesday, May 26, 2015

Why Raise Rates?

The Federal Reserve keeps reminding us that it must eventually raise interest rates after six years of keeping short term rates near zero.

Why must it raise rates?  Low rates are usually thought to encourage economic growth, which is supposed to be a good thing.  There appear to be two reasons: "side effects" and "holding fire."

The side effects story is that keeping rates low is desirable, but doing so will eventually cause bad side effects, like inflation and asset price bubbles.

The holding fire story is that rate reductions are needed to fight recessions.  If rates are already at zero, then when the next recession comes the Fed will not be able to fight it by lowering rates.

Do these stories make sense?  The main side effect of low rates, inflation, is certainly not showing up in the consumer or producer price indices.  Asset prices are high, but it isn't obvious that they are at crazy, tulip-bulb levels.  Capitalization rates have come down to maintain historic spreads over treasury rates, but I can't see why they should continue to fall just because rates are low - if rates stay low, spreads will find their natural level, and asset prices will increase or decrease with expectations of future earnings, not the level of interest rates.  Why couldn't we maintain current rates and multiples forever?

One reason low rates might not be sustainable is if excess bank reserves are building up that will eventually cause inflation.  But excess reserves are at least in part due to the fact that the Federal Reserve is paying interest on reserves.  If banks reduce their reserves too quickly, the Fed could always raise that rate or raise reserve requirements to slow the process down and prevent inflation.

The holding fire story seems to suffer from similar logical fallacies.  If interest rates are an accelerator, then keeping them at zero provides maximum stimulus for the economy.  Why would it be a good thing to raise rates, discouraging growth, just so that we can lower them again in case of weakness?  Why not keep the accelerator down all of the time? 

Suppose we reasoned that hunger results from cutting back on eating, and is relieved by increasing our food consumption.   We might conclude that when we have been well-fed for a while, we should stop eating three meals per day, so that if we get hungry we will be able to add a meal.  So we might start skipping lunch, and sure enough, we would get hungry, and when we added lunch the hunger would go away.  The Food Fed might think it had done a great job of hunger-cycle management, but the entire exercise would have been unnecessary - we could have just stuck with three meals per day all along.

Of course, four meals per day might make us fat - a bad side effect.  But if we are maintaining a healthy weight on three meals, why not stick with the plan?  In other words, if inflation shows up we could raise rates, but why do so before there is even a hint of inflation?

Similarly, suppose a race car driver let up on the gas so that he could floor it at the end of the race.  That might make sense if he was tricking another driver into holding back so that he could pass him at the last minute, but if he is only racing the clock (as we are in managing an economy) then the best strategy is to floor the accelerator as much as possible - as long as there are no bad side effects, such as crashing the car, or inflating prices.

I admit that these are very simplistic arguments, but where is the economic theory showing that we need to raise rates in order to be able to lower them in bad times?  If Larry Summers is correct, the equilibrium real rate of interest is well below current levels, and raising rates will only make things worse.

Friday, May 8, 2015

La Guardia

Why do people hate La Guardia airport so much?  I was in New York City two weeks ago, and had to leave a conference and get on a plane in a hurry.  It was mid-afternoon and it took 20 minutes to get there from midtown.  That is amazing, and one of the great things about New York.

The airport doesn't have inspiring architecture or big glass domes enclosing wasted space like this:

La Guardia is mostly a plain Jane airport:

But it gets the job done.  That isn't enough for Vice President Joe Biden, who called it a "third world" airport.  Reporting this comment, the New York Times ridiculed LaGuardia and praised other airports:

In Hong Kong, travelers can play a round of golf while waiting for a connecting flight. In Seoul, South Korea, people can strap on skates and kill time on the ice at the Sky Rink. And in Paris, parents are provided with free strollers as they cruise newly upgraded terminals

In today's New York Times, a civil engineer and transportation planner called for closing La Guardia, so that travelers can enjoy the amenities of JFK and Newark instead of enduring the "grubbiness" of the "dilapidated" Queens airport.

When I fly I want to get into and out of the airport.  I don't want to spend an extra hour getting to the airport so that I can walk through a longer duty-free shop zone or stop at a spa on my way to the gate.  I would put up with a lot of grubbiness to shave another 30 minutes off of my travel time and lower my taxes at the same time.

So called "infrastructure investment" isn't always worthwhile.