Monetary Policy Isn’t the Channel through which You Want to Conduct Housing Policy

suburb housing

Robert Shiller has a column out (July 13) in The New York Times arguing against our longstanding national policy of incentivizing homeownership through direct and indirect subsidies. I’m very much of the persuasion that the benefits of homeownership that advocates have proclaimed, such as “planning, discipline, permanency and community spirit”, are outweighed by the costs of policies we’ve enacted to encourage it. So I agree with roughly 90% of what he has to say, especially with regards to getting rid of the mortgage interest deduction.

Unfortunately, continuing the troubling trend of reaching for policy ends with monetary policy other than full employment and moderate inflation, Shiller includes the Federal Reserve’s programs of quantitative easing (QE) among a list of programs and arrangements he is critical of.

These three rounds of QE that the Fed has implemented since the onset of the financial crisis operate under the theory that purchasing long-term bonds and mortgage-backed securities reduces long-term interest rates and spurs business investment. That’s a correct theory, and evidence of it being correct, while sadly underwhelming in the context of 7.6% unemployment and 1.2% inflation (core PCE), can be seen in interest rates on a myriad of long-term bonds. Moreover, as the Fed has begun formally discussing the conclusion of QE3 at recent FOMC meetings, market reactions have shown that investors are very susceptible to these bond buying programs.

10 year UST june 19

More generally speaking, and perhaps more intuitively from a consumer point of view, accommodative monetary policy boosts spending on durable goods that are dependent on consumer credit—cars and houses, etc. Reducing interest rates means that these items become more affordable, purchases of these goods increase, as does employment along their supply chains.

Along that line, ending the accommodative monetary policy at the Fed, QE, for the sake of stopping people from buying houses is insane. Again, unemployment is high and inflation is low. Effectively ending what meager recovery we’re having for the sake of traditionally non-monetary policy related objectives is an extremely bad proposal. It’s certainly the case that tighter money will diminish our collective ability to buy houses and stop another housing bubble from forming. That’s because tight money has the curious effect of reducing aggregate demand, reducing consumer spending, reducing investment, and increasing unemployment. Namely, it causes recessions.

While the risks and consequences of eventual knock on effects stemming from QE seem much more subdued than what many people such as Shiller have been saying, they are a possibility. But raising economy wide borrowing costs, eroding expectations of future growth, and pumping up the value of the dollar and consequently hurting our national export position so that people buy fewer houses is not something central bankers should be considering at a time of 7.6% unemployment and 1.2% inflation. And it’s not something that smart, Yale economists should be promoting.

Yet they are doing just that. It’s nuts.

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Getting What You Pay For, or Why Policy Makers Should be Making More Money

worth every pennyIn catching up with a long neglected RSS reader, which I’ll blame on the holiday season, this post from December by Scott Sumner on how much of a premium is justifiable in order to secure competent and efficacious central bankers caught my attention for a couple reasons. First, I agree with it. Second, it tangentially relates to topics that surface quite often: pay and term limits for elected representatives.


I don’t care how much is costs, even if we have to pay FOMC members a billion dollars a year, we will save much more money in the long run if we can get “strong” central bankers (pun intended) who have the vision to see what needs to be done, and who understand that effective policies require explicit target paths for macro aggregates.

And Matt O’Brien, who Sumner directs to:

That’s another way of asking how long it will take the economy to return to trend. Here’s where things get really depressing. According to Fed Vice Chair Janet Yellen, we won’t get back to full employment until after 2018. If we assume the output gap will steadily shrink until then, that leaves us with roughly another $4 trillion in lost income. Maybe more. If [Sveriges Riksbank Deputy Governor Lars Svensson] really could double our recovery speed, he’d be worth $2 trillion to us. Even if that’s being wildly optimistic, something on the order of hundreds of billions of dollars probably isn’t. Tell me that wouldn’t be worth paying Svensson a billion dollars a year. Maybe more.

OK, so this isn’t an original argument by any means, but here it is: people respond to incentives.

As is the case with central bankers, although arguably less so, Representatives and Senators serving in Congress have really important jobs and their pay only reflects that to a certain extent.

Washington D.C. is commonly referred to as a revolving door, in that many public employees comprising the upper echelons of our governmental infrastructure frequently take up jobs in fields intrinsically linked to their roles in government. Congressmen become lobbyists, SEC heads and staffers become bankers, those working in defense become private contractors, etc. In many cases the flow is circular as people transfer back and forth from the private to public sector over the course of their career—you know, like a revolving door! While it’s reassuring that these people develop an unquestionable level of expertise in their fields, it’s troublesome considering the adversarial stance these jobs require them to take against their former friends, colleagues, and employers. Congress should be passing legislation most in line with the public’s wants and needs, the SEC should be prosecuting ill-behaving financial intermediaries, and the Pentagon should be awarding contracts based on merit only.

Paying our public employees more, while not being a door jam, would slow its revolutions. Many find this argument revolting. It’s understandable. Bureaucrats and politicians are unpopular! Yet it makes sense. There’s the benefit which runs parallel to Mr. Sumner’s line of reasoning; high pay attracts the best and most capable. That’s certainly important. Legislating and rule making isn’t easy and requires talented people. Furthermore, the pay of a job can be safely assumed to be positively correlated with its prestige. We would be attracting the best people with the added benefit of incentivizing their staying for an extended period.

In the case of Congress, though, there are second order benefits that in my opinion outweigh the first. A higher base pay is more likely to leave members less inclined to be lured away during or after their careers as policy makers to work for the very sectors and industries under their purview, for whose benefit or detriment they still wield disproportionate influence following their service. A legislator who’s spent his or her career crafting banking regulation as a member of banking and finance committees knows their way around the letter of the law, not to mention has personal relationships with the other members who do as well. They’re hugely valuable to those who are under the effects of this member’s legislation. Why isn’t the case that we pay this person such a sum that to take a job as a banking lobbyist upon retirement would require a vendetta or heart full of malice? Strip from them any semblance of economic necessity to work for them. Bid the price of our policy makers’ wages up to a level at which the costs outweigh the benefits for firms and trade groups to make the hire.

Examples abound, just recently we saw Evan Bayh and Chris Dodd immediately take jobs as big time lobbyists after their terms expired—Dodd as head of the Motion Picture Association of America and Bayh as a consultant for the clients of the law firm McGuireWoods. Jim DeMint, even more recently, left the Senate in the middle of his term to head up the Heritage Foundation, a movement conservative advocacy organization, where he’ll be making over $1million/year. The optics of career switches such as these foment distrust among the public, regardless of whether any harm is actually being done in the conduct of their business with each other. Unfortunately, the distrust itself begets damage because our institutions of governance are weakened through eroding support. By aligning our politicians’ self-interest with the outcomes we demand, we can reach a healthier and more stable equilibrium.

Now, this is contingent upon your definition of what it would mean to be a better functioning Congress. Democrats and Republicans aren’t going to suddenly start agreeing with each other and usher in a centrist fantasy era. That’s not in the cards. However, if better functioning means a Congress that is less cozy with industry groups, less beholden to their largesse and employment opportunities, then we’re on the right track.

Which brings me to term limits. Term limits are prescribed as a means to limit corruption. This analysis entails a misunderstanding of what drives corruption, as people perceive it. Many think that simply being in D.C., living that “Beltway life”, naturally corrupts our representatives. That could be true, although that isn’t really a falsifiable hypothesis so who can say for sure! It follows, then, that the solution is to get them in and out; they’re voted in, go to D.C., do their job, and leave, allowing voters to put fresh blood in. Career politicians are evil.

I disagree. Again, politicking and legislating is hard. Weirdly enough, freshman members of congress go through an extensive training course upon their election, before their term starts. There’s a lot to know. Is the country better served by having a perennial team of amateurs running the show? A better question, I suppose, is whether they would even be running the show. Term limits wouldn’t apply to those in the background, such as staffers, who would have more experience and clout in a legislature constantly cycling through those who are supposed to be in charge. The same applies for lobbyists, who suddenly take on an air that says “let me show you the ropes around here, kid.”

Furthermore, a term limited member of congress has to do something after being a congressman. Most can’t just call it a life and retire. This puts them in a situation in which they are more dependent on others for, again, largesse and jobs following their service. Together, high pay and tenure provide a positive incentive to do a good job.

The political science literature agrees, term limits don’t accomplish much in the way of more effective governing.

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What Hath Austerity Wrought?

The politics of austerity is evolving and will continue to do so if the euro zone’s second biggest economy, France, elects a new government. Further evidence is on display in the Netherlands, where Mark Rutte recently tendered his resignation as support for his government’s newly proposed austerity budget collapsed.

Below is a chart from Business Insider showing the growth of real gross domestic product from 2003. Concentrating on the United Kingdom, I’ve added a line showing the clear shift away from stimulative fiscal policy to austere fiscal policy. Another thing this line clearly demarcates is the exact time of the 2010 parliamentary elections and the formation of a new Conservative government, headed by David Cameron, that swept into office on a campaign of reigning in government expenditures.

Note the cutoff in positive growth, the flattening of the line. Not surprising, really. You don’t magically increase aggregate demand in an environment in which private actors are overwhelmingly deleveraging by cutting the only type of spending your economy has going for it–government spending.

Now compare this recession to the Great Depression.

To put it plainly, the UK isn’t doing well. And neither are any other countries that have adopted policies of austerity in the aftermath of 2008, save perhaps Germany for dissimilar reasons.

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All Quiet on the Monetary Front

From the FOMC’s latest statement:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects moderate economic growth over coming quarters and consequently anticipates that the unemployment rate will decline gradually toward levels that the Committee judges to be consistent with its dual mandate. Strains in global financial markets have eased, though they continue to pose significant downside risks to the economic outlook. The recent increase in oil and gasoline prices will push up inflation temporarily, but the Committee anticipates that subsequently inflation will run at or below the rate that it judges most consistent with its dual mandate.

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee expects to maintain a highly accommodative stance for monetary policy. In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

The Committee also decided to continue its program to extend the average maturity of its holdings of securities as announced in September. […]

Arguments regarding credibility and how difficult it is to earn in the world of central banking are often brandished about. Central bankers often imply that it’s the most dear and precious thing, and that it should not be squandered at any cost. The Federal Reserve has a lot of said credibility insofar as they are really good at fighting inflation. But that’s where the problem presents itself: that inflation fighting credibility comes at the cost of unemployment fighting credibility (it doesn’t have to, and there are examples of this, but that’s been the popular policy stance in the U.S. and Europe).

Many observers expected a more hawkish stance from the Fed following the positive news of the past few months; that qualifies as bad central banking to me and displays a lack of the appropriate kind of credibility. If they’re going to make explicit remarks such as keeping rates near zero through 2014, which I think they should continue to do, they shouldn’t find it acceptable that people second-guess them. Especially now, when expectations are the primary policy tool! I would find it mighty troubling that an unambiguous and neutral statement–by the Fed’s standards–was interpreted to be good news simply because the bad decisions that were expected didn’t materialize.

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*Most* Signs Point to Continuing Recovery

The economy added a healthy 227,000 net jobs in February, marking the third consecutive month of job growth exceeding 200,000.  The unemployment rate remained unchanged at 8.3%, as the number of newly employed was essentially canceled out by those rejoining the labor force. Perhaps just as important, revisions to previous months’ numbers were significant: an additional 78,000 net jobs were added in December and January than was previously measured. All good news.

So will that continue? Some think we’re in for a few months of less than impressive growth in GDP, which would presumably result in a similar story for labor. Others aren’t convinced of that. Real gross domestic product involves a fair amount of inherent haziness, especially regarding productivity gains and losses. It’s just as likely that a shift in composition and geography of labor in some sectors could contribute to these future reductions in RGDP growth without sacrificing a commensurate number of jobs. For example, rising wages in outsource-destination countries, as well as further decline of the dollar, could lead to a repatriation of some jobs. Hence reduced GDP and more jobs.

A larger concern of mine, however, is one that many commentators share. Barring unforeseen oil induced shocks (ahem, dropping bombs on Iran…ahem), the biggest threat to a sustained recovery is an overzealous Federal Reserve. With core inflation hovering around the Fed’s now explicit target of 2%, it’s to be expected that inflation hawks on the FOMC will start getting louder. Moreover, we should expect certain prices to rise faster than some; an unabated recovery will naturally precipitate higher rent and gasoline prices. This shouldn’t be seen as distressing, although it certainly will. It will be the natural result of i) increased demand for oil as business activity increases and more people drive to work, and ii) pent-up demand for apartments and houses, which was subdued as a result of stagnate new household formation during the recession. There has at least been talk of QE3, or “Sterilized” bond purchases–which is a really informative and helpful thing to call it. If the Fed really wanted to put us over the top, this is the course of action they’d take, especially now. Expectations of QE3 are nearly nonexistent considering the recent improvements in the labor market and economy writ large. That’s why such a move would be unequivocal: the Fed stands behind this recovery.

While I don’t think that’s likely, it’s my hope that they’ll remain at least neutral, rather than tighten policy at a tragic time. There should be enough non-maniacs voting at FOMC meetings at any given time to prevent that.

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Depression and Total War, in Color

The Library of Congress recently released a huge collection of color photographs, taken by the Farm Security Administration (FSA) and later the Office of War Information (OWI), from the late 1930s and 1940s. Stunning stuff.

It’s all quite àpropos of current circumstances. Mobilization, also know as large and sweeping direct government spending in some circles, finally brought us back to full employment.

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New Name, New Look, Same Old

I’ve got a real problem when it comes to sticking with a publishing platform. I’ve decided to migrate back to WordPress (and might I add that things are looking really spiffy around here, nowadays). About all my posts from the old site have been moved over, although I had trouble with the importing tool so I had to do it manually and thus the dates are not reflective of when they were originally published. Hope that doesn’t throw people.

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Meaningful Long-term Budget Forecasts and Beating the Health Care Horse

When someone is talking about debt and deficits, they’re implicitly talking about future spending on health care. That’s the determining factor in forecasted long-run problems. Not trivialities like discretionary spending, not social security. Health care. But Mark Thoma asks whether or not those forecasts are logically sound. The math isn’t wrong, and it makes intuitive sense; extrapolating from where things stand now, health care spending will become an increasingly large part of the budget. But more fundamentally?

We can’t forecast very well beyond a 3 to 6 month horizon, yet we are relying upon projections for decades in the future as the basis for cutting social programs now. The CBO, for example, uses a 70 year projection for revenues and outlays, and that is the basis of a lot of the worry over the long-term budget picture. But, did we have any idea at all 70 years ago — in 1942 — what health care costs would be today?

The point is well taken. Hell, I’ll be very disappointed if I’m not half-machine by 2070. Essentially, a lot of things can happen to steer us off this path. We could suddenly stop consuming health care at the level we do now, meaning lower demand and prices. Technological progress could turn medicine into something vaguely resembling robiticized manufacturing—done by robots on the cheap.

So, what to make of all the talk of projections of this sort? This might sound slightly cynical, but… I think everyone sort of already understands this uncertainty on some level. Most of these fiscal doomsayers aren’t considering these forecasts as much more than political ammunition for propagating normative prescriptions.

Thoma goes on to quote Jeff Sachs, who rails against conservative tendencies in calling for an end to the welfare state based off this notion of imminent bankruptcy. Why bring pain to millions now because something might or might not happen seventy years from now?

One of the unshakable myths of the punditariat is that the federal government is going bankrupt because of entitlements spending, especially spending on Medicare and Medicaid. Each day we hear the drumbeat saying that either we cut entitlements now or we are finished as a nation.

I want to defend the obverse side of that coin. Why should we progressives wish to change health care as an institution? Maybe we’re in no danger of being run dry because of health care! Well, while we might not know how health care costs will manifest themselves seventy years from now, we do know, contra Thoma’s remark on our predictive capabilities, what it will cost ten to twenty years from now. I say that because regardless of what changes lay in front of us, minus the discovery of the fountain of youth, the health care sector is large and has inertia and won’t be radically and quickly changing course. Steering the Titanic, and all that. To wit, we know health care is going to stay expensive and get more expensive in the short- to medium-term. We should try to make that not so. The facts also show that our aggregate outcomes, in terms of better health, aren’t commensurate with our level of spending. That’s simply a waste of resources that could otherwise be directed to more socially beneficial undertakings. Secondly, and more importantly, the old standby: there is an immense amount of suffering and inequity that takes place in heath care markets—namely, insurance markets. Per the progressive view on the state and the role it should play in society, we can ameliorate this suffering and inequity.

Should the CBO and varying other parties even bother with these types of forecasts? Are they useful? In any prophetic way, not really. We don’t know how anything is going to play-out that far down the road. However, it’s useful in highlighting that we do suffer from a health care problem, even if its exigency is overstated. So, as they say, “When in Rome, use all estimates of future health care spending to your advantage.”

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How Does the Affordable Care Act Work?

Because of socialism and death panels.

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The United States of America Isn’t a Business

Atrios, stating the simple truth that being good at something doesn’t axiomatically make you good at something else, points to a Paul Krugman post regarding the ubiquitous sentiment that smart businessmen make good economic policymakers.

Leaving aside all the questions about what Mitt Romney did or didn’t do at Bain — and about his self-aggrandizing double standard — there’s an even broader question: why does anyone believe that success in business qualified someone to make economic policy?

For the fact is that running a business is nothing at all like making macro policy. The key point about macroeconomics is the pervasiveness of feedback loops due to the fact that workers are also consumers. No business sells a large fraction of its output to its own workers; even very small countries sell around two-thirds of their output to themselves, because that much is non-tradable services.

This makes a huge difference. A businessman can slash his workforce in half, produce about the same as before, and be considered a big success; an economy that does the same plunges into depression, and ends up not being able to sell its goods.

The answer to that question is probably rooted in the fact that [number far exceeding 90%] of people have never been privileged to a class on even rudimentary macroeconomics. (Also an explanation for why Ron Paul has so many followers when, literally, he has 19th century views on how the world operates).

I’m not saying that is necessarily a fault of their own. Contrarily, this chronic notion speaks to the continuing failures of American elites to be honest and forthright with the electorate.

That is, unless they actually believe this nonsense. That can’t be the case, though, right? 


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