Category Archives: Economics

The Fed’s new ‘regime-based’ concept

From a new paper by St. Louis Fed President James Bullard:

The Federal Reserve Bank of St. Louis is changing its characterization of the U.S. macroeconomic and monetary policy outlook. An older narrative that the Bank has been using since the financial crisis ended has now likely outlived its usefulness, and so it is being replaced by a new narrative. The hallmark of the new narrative is to think of medium- and longer-term macroeconomic outcomes in terms of regimes. The concept of a single, long-run steady state to which the economy is converging is abandoned, and is replaced by a set of possible regimes that the economy may visit. Regimes are generally viewed as persistent, and optimal monetary policy is viewed as regime dependent. Switches between regimes are viewed as not forecastable.

It is a good time to consider a regime-based conception of medium- and longer-term macroeconomic outcomes. Key macroeconomic variables including real output growth, the unemployment rate, and inflation appear to be at or near values that are likely to persist over the forecast horizon. Any further cyclical adjustment going forward is likely to be relatively minor. We therefore think of the current values for real output growth, the unemployment rate, and inflation as being close to the mean outcome of the “current regime.”

Of course, the situation can and will change in the future, but exactly how is difficult to predict. Therefore, the best that we can do today is to forecast that the current regime will persist and set policy appropriately for this regime. If there is a switch to a new regime in the future, then that will likely affect all variables—including the policy rate—but such a switch is not forecastable.

Seems reasonable.

Why interest rates matter

Some context: I find that almost no one understands what interest rates are and what the Federal Reserve did last week when it “left rates unchanged.” But interest rates are important. Below is my brief, basic explanation of what interest rates are, what the Federal Reserve is doing when they set interest rates, and why timing interest rate hikes is a delicate task.

Interest is a price.

This isn’t a figure of speech. Interest is the literal price of borrowing money. It’s what we pay, in terms of future money, for the privilege of using someone else’s money in the present.

All prices, in turn, are informative. In fact, this is their essence: prices are a mechanism for communicating information about the world—specifically about how supply and demand conditions change. Friedrich Hayek explains:

We must look at the price system as such a mechanism for communicating information if we want to understand its real function … In abbreviated form, by a kind of symbol, only the most essential information is passed on and passed on only to those concerned. It is more than metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more than is reflected in the price movement.

This information isn’t just incidental. It doesn’t just help “those concerned” find opportunities that otherwise would have simply gone unrealized. It’s vital to the successful functioning of business everywhere. It facilitates rational economic calculation and makes sustained profit possible.

Interest is a price, prices are information, and information is essential to the rational economic order. Clearly, the implications here are many. One in particular is of unique importance this year, as the Federal Reserve begins to tinker with interest rates after more than 80 months of near-zero rates following the financial crisis.

Now, I’ve been skeptical of talk that the Fed was ever serious about raising interest rates this year. I predicted in December 2014 that we’d see no rate hike in 2015, and I was almost correct (missed it by a month). But whether I was right or wrong doesn’t change how interest rate hikes (and cuts) affect economic activity. Whether the Fed does or does not raise rates doesn’t dampen the unprecedented risk the Fed takes by artificially manipulating interest rates in pursuit of even the noblest of goals.

We’ll start with premise #1: That the Fed manipulates interest in order to effect change in the economy. This is undisputed. Monetary policy actions (like manipulating interest rates) is the central bank’s tool to combat recession, and the only sphere over which it maintains an almost absolute controlling power. By lowering interest rates following the 2008 recession, the Fed sought to boost the availability of credit (that is, make borrowing money easier by lowering the price of borrowing money) in an otherwise recessionary environment which would likely have seen rates skyrocket. This would put downward pressure on things like business creation and investment, home and car ownership, etc.

Premise #2 is related: Interest rate manipulation has real effects on economic activity. If this weren’t the case, why would the Fed fix rates? By lowering interest rates, the Fed did stimulate lending and business activity that otherwise would not have happened. It staved off further liquidation by purchasing bad assets from banks, and infused confidence into markets that likely propped up things like household spending and borrowing, employment, and investment.

Conclusion: Mistiming an interest rate hike could have seriously traumatic implications for global economic health. If the Fed raises rates too soon (that is, before the “natural” rate has risen equivalently), it risks destabilizing an unrealized equilibrium and undoing what steps entrepreneurs have taken thus far to re-establish their economic footing. If it raises rates too late, it risks inflating a speculative bubble–the type that burst in 2008, after a quick rate hike followed by several years of low rates.

Now, whether it’s possible for the Fed to accurately time an interest rate hike is, itself, a worthwhile question…

“Single-payer” cognitive dissonance

A telling chart from The AP (via The Atlantic). Many Americans who support single-payer healthcare like the idea of single-payer healthcare, but not the associated trade-offs.


I will grant, though, that four of the five points above aren’t really fair because most supporters of single-payer healthcare, I think, have in mind a single-payer system that 1) won’t require users to switch doctors, 2) won’t increase taxes, 3) won’t cause longer wait times, and 4) won’t delay new drug/treatment availability. But the third point–“People needed to give up other overage like employer coverage”–shows that almost almost one-third of single-payer supporters really don’t know what they’re advocating. If single-payer doesn’t mean people need to give up other coverage, then what does it mean?

Dehomogenizing deflation

From Selgin, Lastrapes, and White:

The postwar eradication of deflation would count among the Fed’s achievements were deflation always a bad thing. But is it? Many economists appear to assume so. But a contrasting view, supported by a number of recent studies, holds that deflation may be either harmful or benign depending on its underlying cause. Harmful deflation—the sort that goes hand-in-hand with depression—results from a contraction in overall spending or aggregate demand for goods in a world of sticky prices. As people try to rebuild their money balances they spend less of their income on goods. Slack demand gives rise to unsold inventories, discouraging production as it depresses equilibrium prices. Benign deflation, by contrast, is driven by improvements in aggregate supply—that is, by general reductions in unit production costs—which allow more goods to be produced from any given quantity of factors and which are therefore much more likely to be quickly and fully reflected in corresponding adjustments to actual (and not just equilibrium) prices.

Historically, benign deflation has been the far more common type.

In other words, not all falls in the price level are bad. When prices fall because of improvements in productive technologies, for example, that’s good. That’s the point of growth. That is growth.

Falling LFPR isn’t a huge deal

LFPR is low. That’s all over the news these days. Mostly just conservative pundits trying to downplay the economic recovery.

Now, there are good reasons to downplay the recovery. Zero percent interest rates for 80+ months with no end in sight—that’s a much better reason.

But that aside, the low (and even falling) LFPR alone just isn’t evidence of poor recovery. LFPR, as I’ve explained before, is sensitive to demographic shifts that don’t necessarily correlate with any economic trends in particular. Theoretically, a low LFPR is a long-term economic goal—more wealth means fewer people (especially 18-24 and 55+ year olds) need to work in order to maintain a certain quality of life. Stay in school longer, retire earlier, go fishing, chill-out, etc.

For example, the percentage of 16-24 year olds as part of the workforce has fallen since 1990, as college becomes attainable for more people. That’s good. The LFPR also fell dramatically over the past several hundred years, as capital accumulation made it possible for people to actually quit working when they get old, or to put off work until adulthood. Again, that’s good.

Also, LFPR fell almost every year from 1956 to 1964, during which time GDP grew by more than 50 percent. That’s really good.

So don’t worry too much about LFPR—at least not in the way pundits want you to worry. Vox has a good, well-balanced perspective.

In general, one index or metric never tells the whole story. Look for trends and patterns. Ignore the hiccups. Be generally optimistic.

On Pope Francis, think deeper

Pro-market Christians in America could learn much from Pope Francis about holy living and compassionate thinking if only they’d think more deeply about his message. Instead, they’re too quick to extract superficial, tangential inferences about what his teaching means for the cause of free market capitalism. Indeed, advancing free markets is no end in itself — it is, or ought to be, a corollary cause for those believe, with sound and defendable reasons, that markets are a just way to bring economic progress to all peoples. Citing Pope Francis’ (alleged) anti-capitalism alone to argue against his teaching reveals a total misunderstanding of why beliefs about economic life are worth holding and, possibly, of the very nature of God.

Neither should one evaluate Pope Francis according to whether he’s pro-America. If a Christian disagrees with the Pope, it ought to have something to do with the Pope’s theology. Patriotism, as an ideal, simply doesn’t rise high enough to serve as any defense against anyone who claims to speak for or about God, no matter what one may think of such a teacher’s true place or motive. If my God is wrong because you’re country is great, it’s country, not God, who you serve.

So don’t interpret Pope Francis’ exhortations against greed and inequality as falling somewhere to the left-of-center on the political spectrum. When the Pope criticizes the market, he’s not doing so as an advocate of further state regulation. He’s doing so as an advocate of holy living. In this sense, we ought to take his teaching on restraint, discretion, and sacrifice personally — applicable to our own lives in some way that perhaps only we can know — and not as part of some larger, implicit ideology or political campaign. Ironically, if we all did this, I’m convinced we’d hear much less about the “evils of capitalism,” even in the context of an economically competitive, “free market” society.

All of this hits on a larger, more insidious issue plaguing American churches today. Sadly, how many have chosen to interpret the Pope — as speaking anti- this or pro- that, instead of do this or do that — is how so many Christians interpret sincere exhortations from truly good teachers. Sound, Biblical teaching on issues like sexuality, family, and citizenship are too quickly seen as denouncements of this or that way of thinking about such issues rather than as (sometimes hard) lessons on how we, personally, can walk with God. The extent to which we think about the Pope’s, or any good teacher’s, lessons on life in such terms is the extent to which we fail to glean what’s truly valuable in good teaching. To be wise has never been so much about understanding what’s true and good, but about willing and living accordingly.

Hayek on competition and discovery

From F.A. Hayek’s Competition as a Discovery Procedure:

I should like to begin with the observation that market theory often prevents access to a true understanding of competition by proceeding from the assumption of a “given” quantity of scarce goods. Which goods are scarce, however, or which things are goods, or how scarce or valuable they are, is precisely one of the conditions that competition should discover: in each case it is the preliminary outcomes of the market process that inform individuals where it is worthwhile to search.

Are Americans generally wealthier than Brits?

From Fraser Nelson at The Spectator:

That fits our general idea of America: a country where the richest do best while the poorest are left to hang. The figures just don’t support this. As the below chart shows, middle-earning Americans are better-off than Brits. Even lower-income Americans, those at the bottom 20 per cent, are better-off than their British counterparts. The only group actually worse-off are the bottom 5 per cent.

I recommend the rest of the piece. It’s important to remember, though, that GDP isn’t everything. This Time response piece hits on that point:

It is also a little simplistic to equate poverty with GDP, which measures business and government spending as well as individual consumer behavior. Poverty is better reflected by rates of joblessness, education level and life expectancy. The UK’s unemployment rate is 6.6%, roughlycomparable to New York (36th among the states). The UK has a 91% high school equivalent graduation rate, which would put it in the top 5 among states. And the UK’s life expectancy at birth is over 80; that would rank it among the top 10 states.

Imagination, boldness, and modeling human choice

Israel Kirzner on entrepreneurial discovery:

For neoclassical theory the only way human choice can be rendered analytically tractable, is for it to be modeled as if it were not made in open-ended fashion, as if there was no scope for qualities such as imagination and boldness. Even though standard neoclassical theory certainly deals extensively with decision-making under (Knightian) risk, this is entirely consistent with absence of scope for the qualities of imagination and boldness, because such decision-making is seen as being made in the context of known probability function. In the neoclassical world, decision-makers know what they are ignorant about. One is never surprised. For Austrians, however, to abstract from these qualities of imagination, boldness, and surprise is to denature human choice entirely.

Larry White on lowering long-term risk

I’m taking Larry White’s Monetary Theory and Policy class this fall at George Mason University. Here’s a selection from his book, The Theory of Monetary Institutions on one interesting utilitarian argument for adhering to a gold standard.

A more reliable unit of account lowers the risk of long-term nominal contracts, as we have just noted with respect to bonds. Lower risk on long-term bonds encourages more long-horizon investment. When savers are more willing (do not demand so large a purchasing-power risk premium) to buy long-term bonds, a firm with a long-payback project, like a railroad company, can more cheaply sell bonds long enough to match the duration of its expected payoff stream from the real assets being financed. Such duration-matching eliminates the significant refinancing risk involved in relying on short-term debt, which is the risk that interest rates will be higher when the firm goes to roll over its debt. High-payoff long-horizon investment projects are therefore not shelved simply because of inflation risk, which undoubtedly aids economic growth, though the size of the effect would be hard to estimate.

A gold standard, then, has the effect of boosting confidence in money’s purchasing power in the long-term, thereby increasing general confidence in long-term investment and long-term bonds. Just a paragraph before, White explains that some railroad companies in the nineteenth century found willing buyers for 50- and 100-year bonds! Today, corporate bonds of 25 or more years are uncommon.

I recommend the book. Great so far.

OCA as normative theory

From a 1998 paper by Charles A.E. Goodhart (a great read, by the way):

One possible rationale is that the [Mengerian-form] theory was never meant to be a positive, explanatory theory, but instead a normative theory, of what should be. As one referee commented: ‘‘OCA theory is a normative, not a positive theory.’’ A weak form of this would be to recognize that, in practice, monetary institutions are inherently and au fond associated with considerations of political sovereignty, but that the subsidiary function of [Mengerian-form] OCA theory is to assess the balance of purely economic benefits and costs that this may generate. The problem with this is that the historical record of the association of money creation with the establishment and maintenance of a stable sovereign power is so overwhelming (apart from the case of tiny, and by the same token politically weak, states) that the balance of purely economic benefits and costs entailed by OCA must presumably be of second order importance.

Misusing “perfect competition”

From Peter Boettke’s 1997 paper Where did Economics Go Wrong? Modern Economics as a Flight from Reality:

Previously, the model of a perfectly competitive market was primarily used in thought experiments designed to be contrasted with real-world market institutions. Such counterfactual thought experiments illuminated the positive function of those institutions. In a world of complete information, for example, neither firms nor profits would logically exist. Therefore, the contrast of this imaginary world against the real world of firms and profits showed that such institutions may have some functional significance in coping with imperfect and incomplete information.

This counterfactual use of the theory of perfect competition was reversed by the formalist revolution in economics. The departures of reality from the model of perfect competition were now thought to highlight interventions in the market ecnomoy that would be necessary to approximate equilibrium. Competitive equilibrium and the maximizing behavior that would ideally produce it represented the hard core of the research program f economists from 1950 on. As this happened, economics as a discipline was transformed.

Brief musings on the market

  1. The DJIA lost 3.57 percent today. Last Friday it lost 3.12 percent. This is nowhere near even the 20th worst day in the DJIA’s history—a 6.98 percent loss on September 29, 2008. But the past two trading days do represent the DJIA’s 19th and 20th worst daily point losses ever.
  2. Most economists think Greenspan’s Fed left interest rates too low for too long when rates hovered between one and two percent for 32 months between December 2001 and May 2004. But that’s nothing compared to today, which marks roughly 80 months of near-zero rates.
  3. Even if the U.S. stock market recovers somewhat in the next few weeks, problems in China have proven to be very fundamental and very serious. I take this as another good reason to believe my 8-month old prediction—that the Fed will not raise rates in 2015. China is in full-on stimulus mode, and sharp divergence between central banks’ policies makes conducting monetary policy in the U.S. difficult. If the Fed continues to flirt with the idea of a rate hike, it will be while China, Japan, and the Eurozone still meddle with stimulus. At the very least, this risks boosting the dollar’s value even further and weakening U.S. exports in the process. Larry Summers made this point in the Financial Times today. I explained it last fall.

Discouraging recidivism

From Stuart Butler, writing at

Imagine if prisons faced a readmissions penalty. Let’s say that if an unusually high number of released inmates from a particular prison were convicted and sent back to prison within three years then the prison’s budget would be cut and the bonuses and salary increases of senior prison staff trimmed back. Just as with hospitals, the first reaction would be to complain at the “unfairness” of being held liable for a released inmate’s return to crime. But after that the prison management would start to do a much better job than today in preparing inmates for re-entry into the community. Petty restrictions and surcharges on phone calls to family members would quickly go – the erosion of family ties increases the likelihood of a return to crime. Limits on GED textbooks would certainly vanish.

Prisons would get serious not only about training inmates but also about working with potential employers to help line up jobs. Instead of dumping released prisoners on the street, prison managers, like today’s hospital managers, would become more interested in arranging stable housing for their ex-customers.

An educational outlook

I try to read First Trust’s Monday Morning Outlook every week. Today’s was especially good. Here’s a highlight:

The good reason for slow economic growth is that government statisticians are having a hard time measuring true output. Productivity and GDP growth are not as slow as the official numbers say. For example, when people download free apps to improve their communication and travel, that isn’t measured in GDP, yet our standard of living is clearly higher.

One thing we are confident about is that quantitative easing (QE) hasn’t made a dime’s worth of difference. Although it stuffed the banking system chock full of idle excess reserves, new figures from the government show weaker economic growth in 2012-13, while the Fed was engaged in expansive QE3, and then slightly faster growth in 2014, when the Fed was tapering and then ending QE.

When we put all this together, the picture is reasonably clear. The economy has been in recovery for six years and the unemployment rate has finally fallen to a level even the Fed thinks is close to full employment. Unemployment claims have been below 300,000 for twenty-one straight weeks, and at less than 0.2% of total jobs are at historical lows.

So, even though growth remains slow, it’s hard to argue rates should stay at zero. While some investors fear rate hikes, we see them as ratifying the strides the economy has made in the past several years. Surely, this is no economic boom like 1980s or 1990s. But even a modestly growing economy should have short-term rates higher than zero.