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| Russ Roberts |
Russ is a very good interviewer, and the EconTalk series quite interesting.
Monday, March 31, 2014
EconTalk MOOC Podcast
Russ is a very good interviewer, and the EconTalk series quite interesting.
Wednesday, March 26, 2014
The sign of monetary policy, part II
(This blog post uses mathjax to show equations. You should see pretty equations, not ugly LaTex code.)
The ECB is in the news today. They want some inflation, yet the overnight rate is already zero. They're talking about negative interest rates, which leads to a great lunchroom discussion about bags of euros wandering around Europe. All very interesting.
Yet it brings to mind a heretical thought I explored in an earlier blog post: What if we have the sign wrong on the effect of monetary policy? Could it be that to get more inflation, our central banks should raise rates not lower them? (Leave aside whether you think more inflation is good, which I don't. But suppose you want it, how do you get it?)
It's not as crazy as it sounds.
We know in the long run that higher inflation must come with higher nominal interest rate. Nominal rate = real rate plus expected inflation. Tradition says though that you temporarily steer the wrong way. First lower the nominal rate, then inflation picks up, then deftly raise the nominal rate to match inflation. If you instead raise rates and then just sit there waiting for inflation to catch up all sorts of unstable things happen.
But maybe not. Here is a simple and complete model of the "wrong" sign.
At the end of each period \(t-1\) the government issues \( B_{t-1} \) face value of bonds. In the morning of period \(t\), the government redeems the bonds for newly printed cash. At the end of period \(t\), the government soaks up the cash by selling new bonds \(B_t\) and with lump sum taxes net of transfers \(S_t\). The real interest rate is \(r\) and the price level at time t is \(P_t\). The real value of government debt is then the present value of future primary surpluses,
\[ \frac{B_{t-1}}{P_t} = E_t \sum_{j=0}^{\infty} \frac{1}{(1+r)^j} S_{t+j}. \]
(You can derive this from just watching the flow of money,
\[ B_{t-1} = P_t S_t + Q_t B_{t}; \ Q_t = E_t \frac{1}{1+r} \frac{P_t}{P_{t+1}} \]
where \(Q_t\) is the nominal bond price. Divide by \(P_t\) and iterate forward.)
Now, taking expected and unexpected values of the bond valuation equation
\[ \frac{B_{t-1}}{P_{t-1}} E_{t-1}\frac{P_{t-1}}{P_t} = E_{t-1} \sum_{j=0}^{\infty} \frac{1}{(1+r)^j} S_{t+j} (1) \]
(1): By changing the nominal quantity of debt, with no change in fiscal policy \( {S_t}\), the government can freely pick expected inflation. This is like a share split. Doubling debt with no change in surpluses must raise the same revenue, so cut bond prices in half. It also means the same surplus is divided among twice as many bonds next period, so causing the inflation.
(2): Once debt \(B_{t-1}\) is predetermined, unexpected fiscal shocks translate one for one to unexpected inflation.
In practice, my little model government adopts an inflation target. This is an agreement between "Treasury" and "Fed," binding both. To the "Treasury," it's a commitment to equation (2): You won't give us any surplus surprises. You will raise as much surplus \( {S_t} \) as needed to validate the inflation target.
The "Fed" figures out what it thinks the real rate is, and announces a nominal rate, supplying as much debt as anyone wants at that rate -- but not touching fiscal policy \( {S_t} \). By fixing the nominal rate, and thus fixing expected (inverse) inflation, (1) describes the amount of debt \( B_{t-1} \) that will be sold at this auction. (Equation 1 sounds a little warning, however. That might take a lot of debt! To change the price level 5%, the government has to issue 5% more debt, or about a trillion dollars.)
In this model, to raise (expected) inflation, the Fed and Treasury agree to a higher inflation target, and then the Fed raises rates.
This isn't that deep. Again, we've known about \(i_t = r_t + E_t \pi_{t+1} \) for a long time. But this fills in the determinacy and dynamics question. Yes, if the government just fixes \(i_t\), once \(r_t\) sorts itself out, then inflation must follow.
Ok, I left out stickiness, short runs, and so forth. But this seems (to me) like a pretty compelling simple long-run model of interest rate and inflation targeting, and it at least spells out a mechanism by which raising nominal rates and waiting for the inflation to happen will not be completely destabilizing.
Here is some history. I plotted the change from a year ago of inflation, together with the 3 month treasury rate. You should mentally shift the inflation rate to the right a year, as interest rates are associated with future, not past inflation, but I couldn't get Fred to do that. Once you do, you see pretty much my story. Higher interest rates lead to higher inflation. And the history since 1982 has been slowly lower interest rates leading to slowly lower inflation. Of course you can say that higher interest rates anticipate higher inflation. But there's precious little evidence for the opposite story, that higher interest rates lower inflation and vice versa.
Well, except 1980-1982. There are some short term dynamics, but if you're worried about decades of no inflation like Japan, maybe you shouldn't be thinking about vigorous short run dynamics.
More deeply, we are, and will remain, in a brave new world, where the mechanism for short-run dynamics may have changed completely. We are living the Friedman Rule -- $2.5 trillion or so of excess reserves, and interest rate = 0 mean that money and bonds are the same thing.
Here's a conventional reserve demand picture. We're out at the right edge. The conventional mechanism would have the Fed unwind $2.45 trillion of open market operations, until the reserve demand curve wants a larger interest rate, as illustrated by "really?"
Everything I hear out of the Fed says they won't do that. We will stay satiated in liquidity, we will stay on the horizontal axis of the money demand curve, we won't go back to rationing reserves. Instead, they'll just raise the whole graph by paying more interest on reserves.
Living the Friedman optimal quantity of money is good. But who is to say any theory or experience based on the old mechanism will still apply to dynamics? 1980 was arguably a strong move on the left side of the graph, creating all sorts of monetary havoc. Raising the whole graph and leaving it there, with no rationing of liquidity whatsoever, is a completely different experiment.
As before, I view this just an intriguing possibility, not settled theory, and I'm using today's news to think out loud.
Some credit (without blame if you think this is all nuts): Lars Svensson motivated this thought at a conference a while ago, while I was expounding on the fiscal theory. Lars pointedely asked why I thought inflation targeting countries had done so well. Well, I think this is the answer: The inflation target binds the Treasury as much as it does the the central bank. Then together they slowly lower rates to lower inflation, the slowly part to tiptoe over shortrun dynamics.
The ECB is in the news today. They want some inflation, yet the overnight rate is already zero. They're talking about negative interest rates, which leads to a great lunchroom discussion about bags of euros wandering around Europe. All very interesting.
Yet it brings to mind a heretical thought I explored in an earlier blog post: What if we have the sign wrong on the effect of monetary policy? Could it be that to get more inflation, our central banks should raise rates not lower them? (Leave aside whether you think more inflation is good, which I don't. But suppose you want it, how do you get it?)
It's not as crazy as it sounds.
We know in the long run that higher inflation must come with higher nominal interest rate. Nominal rate = real rate plus expected inflation. Tradition says though that you temporarily steer the wrong way. First lower the nominal rate, then inflation picks up, then deftly raise the nominal rate to match inflation. If you instead raise rates and then just sit there waiting for inflation to catch up all sorts of unstable things happen.
But maybe not. Here is a simple and complete model of the "wrong" sign.
At the end of each period \(t-1\) the government issues \( B_{t-1} \) face value of bonds. In the morning of period \(t\), the government redeems the bonds for newly printed cash. At the end of period \(t\), the government soaks up the cash by selling new bonds \(B_t\) and with lump sum taxes net of transfers \(S_t\). The real interest rate is \(r\) and the price level at time t is \(P_t\). The real value of government debt is then the present value of future primary surpluses,
\[ \frac{B_{t-1}}{P_t} = E_t \sum_{j=0}^{\infty} \frac{1}{(1+r)^j} S_{t+j}. \]
(You can derive this from just watching the flow of money,
\[ B_{t-1} = P_t S_t + Q_t B_{t}; \ Q_t = E_t \frac{1}{1+r} \frac{P_t}{P_{t+1}} \]
where \(Q_t\) is the nominal bond price. Divide by \(P_t\) and iterate forward.)
Now, taking expected and unexpected values of the bond valuation equation
\[ \frac{B_{t-1}}{P_{t-1}} E_{t-1}\frac{P_{t-1}}{P_t} = E_{t-1} \sum_{j=0}^{\infty} \frac{1}{(1+r)^j} S_{t+j} (1) \]
\[ \frac{B_{t-1}}{P_{t-1}} [E_{t}-E_{t-1}] \frac{P_{t-1}}{P_t} = [E_t-E_{t-1}] \sum_{j=0}^{\infty} \frac{1}{(1+r)^j} S_{t+j} (2) \]
(1): By changing the nominal quantity of debt, with no change in fiscal policy \( {S_t}\), the government can freely pick expected inflation. This is like a share split. Doubling debt with no change in surpluses must raise the same revenue, so cut bond prices in half. It also means the same surplus is divided among twice as many bonds next period, so causing the inflation.
(2): Once debt \(B_{t-1}\) is predetermined, unexpected fiscal shocks translate one for one to unexpected inflation.
In practice, my little model government adopts an inflation target. This is an agreement between "Treasury" and "Fed," binding both. To the "Treasury," it's a commitment to equation (2): You won't give us any surplus surprises. You will raise as much surplus \( {S_t} \) as needed to validate the inflation target.
The "Fed" figures out what it thinks the real rate is, and announces a nominal rate, supplying as much debt as anyone wants at that rate -- but not touching fiscal policy \( {S_t} \). By fixing the nominal rate, and thus fixing expected (inverse) inflation, (1) describes the amount of debt \( B_{t-1} \) that will be sold at this auction. (Equation 1 sounds a little warning, however. That might take a lot of debt! To change the price level 5%, the government has to issue 5% more debt, or about a trillion dollars.)
In this model, to raise (expected) inflation, the Fed and Treasury agree to a higher inflation target, and then the Fed raises rates.
This isn't that deep. Again, we've known about \(i_t = r_t + E_t \pi_{t+1} \) for a long time. But this fills in the determinacy and dynamics question. Yes, if the government just fixes \(i_t\), once \(r_t\) sorts itself out, then inflation must follow.
Ok, I left out stickiness, short runs, and so forth. But this seems (to me) like a pretty compelling simple long-run model of interest rate and inflation targeting, and it at least spells out a mechanism by which raising nominal rates and waiting for the inflation to happen will not be completely destabilizing.
Here is some history. I plotted the change from a year ago of inflation, together with the 3 month treasury rate. You should mentally shift the inflation rate to the right a year, as interest rates are associated with future, not past inflation, but I couldn't get Fred to do that. Once you do, you see pretty much my story. Higher interest rates lead to higher inflation. And the history since 1982 has been slowly lower interest rates leading to slowly lower inflation. Of course you can say that higher interest rates anticipate higher inflation. But there's precious little evidence for the opposite story, that higher interest rates lower inflation and vice versa.
Well, except 1980-1982. There are some short term dynamics, but if you're worried about decades of no inflation like Japan, maybe you shouldn't be thinking about vigorous short run dynamics.
More deeply, we are, and will remain, in a brave new world, where the mechanism for short-run dynamics may have changed completely. We are living the Friedman Rule -- $2.5 trillion or so of excess reserves, and interest rate = 0 mean that money and bonds are the same thing.
Here's a conventional reserve demand picture. We're out at the right edge. The conventional mechanism would have the Fed unwind $2.45 trillion of open market operations, until the reserve demand curve wants a larger interest rate, as illustrated by "really?"
Everything I hear out of the Fed says they won't do that. We will stay satiated in liquidity, we will stay on the horizontal axis of the money demand curve, we won't go back to rationing reserves. Instead, they'll just raise the whole graph by paying more interest on reserves.
Living the Friedman optimal quantity of money is good. But who is to say any theory or experience based on the old mechanism will still apply to dynamics? 1980 was arguably a strong move on the left side of the graph, creating all sorts of monetary havoc. Raising the whole graph and leaving it there, with no rationing of liquidity whatsoever, is a completely different experiment.
As before, I view this just an intriguing possibility, not settled theory, and I'm using today's news to think out loud.
Some credit (without blame if you think this is all nuts): Lars Svensson motivated this thought at a conference a while ago, while I was expounding on the fiscal theory. Lars pointedely asked why I thought inflation targeting countries had done so well. Well, I think this is the answer: The inflation target binds the Treasury as much as it does the the central bank. Then together they slowly lower rates to lower inflation, the slowly part to tiptoe over shortrun dynamics.
Interviews
I did two interviews that blog readers might enjoy.
This is an interview with Jeff Garten at Yale, covering financial crises and reform/regulation efforts rather broadly. Source here. It's part of a very interesting series of interviews on the "future of global finance" with lots of superstars. I give Niall Ferguson the prize for most creative author photo.
This one is a podcast interview on the ACA and how free-market health care can work, with Don Watkins at the Ayn Rand institute's "debt dialogues" series. If you follow the link you get several formats.
This is an interview with Jeff Garten at Yale, covering financial crises and reform/regulation efforts rather broadly. Source here. It's part of a very interesting series of interviews on the "future of global finance" with lots of superstars. I give Niall Ferguson the prize for most creative author photo.
This one is a podcast interview on the ACA and how free-market health care can work, with Don Watkins at the Ayn Rand institute's "debt dialogues" series. If you follow the link you get several formats.
Monday, March 24, 2014
Goodman Vs. Emanuel
On the fourth anniversary of the ACA, Saturday's Wall Street Journal had an excellent pair of pro and con OpEds from John Goodman "A costly failed experiment" and Ezekiel Emanuel "Progress, with caveats."
Goodman starts with a zinger. The point was universal coverage. "Four years later, not even the White House pretends that this goal will be realized."
The best parts, to me: After noticing that families near 14% of the poverty level get about $8,000 in medicaid benefits, or about $11,000 worth of subsidies on exchanges,
But most important, recall that the idea was not simply to expand Medicaid and high-subsidy insurance. "Free health care for all" would have produced a lot of people signing up. That's not the measure of success.
A very interesting paragraph:
Even if it did, though, this point has nothing to do with the ACA, exchanges, and the rest! The government could easily have passed this magical program without touching health insurance. This is like saying we should fly to Hong Kong first class because the snacks on the plane are good.
He mentions the recent slowdown in costs. But he concedes there was a recession, and that took place before the ACA set in. No need to restart that fight. We'll see if the ACA really ends up being cheap.
But Emanuel concedes all is not right and needs some pretty radical fixing.
Goodman starts with a zinger. The point was universal coverage. "Four years later, not even the White House pretends that this goal will be realized."
The best parts, to me: After noticing that families near 14% of the poverty level get about $8,000 in medicaid benefits, or about $11,000 worth of subsidies on exchanges,
the employees of a hotel who earn pretty much the same wage ... will be forced to have an expensive family plan... the ObamaCare mandate amounts to about a $10,000 burden on these businesses and by extension their employees.This leads to a novel (to me) economic effect.
As businesses discover that almost everyone who earns less than the average wage gets a better deal ...in the exchange or from Medicaid, and that most people who earn more than the average wage get a better deal if insurance is provided at work, trends already evident will accelerate. Higher-income workers will tend to congregate in firms that provide insurance. Lower-income workers will tend to work for firms that don't. But efficient production requires that firm size and composition be determined by economic factors, not health-insurance subsidies.And John is prescient on just why exchange policies seem to be pretty awful:
Under ObamaCare, insurers are required to charge the same premium to everyone, regardless of health status, and they are required to accept anyone who applies. This means... they have strong incentives to attract the healthy (on whom they make a profit) and avoid the sick (on whom they incur losses).
The result has been a race to the bottom in access and quality of care. To keep premiums as low as possible, the insurers are offering very narrow networks, often leaving out the best doctors and the best hospitals.He has some nice alternatives, including
giving everyone the same universal tax credit for health insurance would be a good start. More easily accessible health savings accounts for people in high-deductible plans is another good idea.
Every provision in ObamaCare that encourages employers either not to hire people or to reduce their hours should go. Everything in the law that prevents employers from providing individually owned health insurance that travels from job to job should go. And everything that makes HealthCare.gov more complicated than eHealth (a 10-year-old private online exchange) should go.By contrast, I was interested that Emanuel, an architect of the law, was so weak in its defense.
Look at access to care. According to Gallup, the percentage of uninsured Americans declined from 18% in the middle of 2013 to 15.9% in the first quarter of 2014..Interesting that pro and con opeds start with essentially the same opening sentence! The glass is indeed 85% empty. Ezekiel passes on the canard that health insurance is "access to care."
But most important, recall that the idea was not simply to expand Medicaid and high-subsidy insurance. "Free health care for all" would have produced a lot of people signing up. That's not the measure of success.
A very interesting paragraph:
Look at quality. In 2010, as part of the Affordable Care Act, the federal government launched the Partnership for Patients, a push to reduce infections and other preventable errors and injuries that occur in hospitals through financial incentives. The results have been dramatic. In three years, avoidable central line infections have dropped 41%. Ventilator-induced pneumonias have dropped 55%. Unnecessary, elective C-sections have dropped more than 50%. Hospitals are also getting better at preventing falls, which have declined more than 11%. Overall, the Partnership for Patients has prevented roughly 15,000 deaths, averted hundreds of thousands of injuries, and saved more than $4 billion.This was news to me. And astonishing. After all these years of complaining that doctors are too careful because of out-of-control liability, it took a Federal program to get doctors to wash their hands and prevent falls?
Even if it did, though, this point has nothing to do with the ACA, exchanges, and the rest! The government could easily have passed this magical program without touching health insurance. This is like saying we should fly to Hong Kong first class because the snacks on the plane are good.
He mentions the recent slowdown in costs. But he concedes there was a recession, and that took place before the ACA set in. No need to restart that fight. We'll see if the ACA really ends up being cheap.
But Emanuel concedes all is not right and needs some pretty radical fixing.
Step one would be to operate the exchanges like a cutting-edge e-commerce website, not a traditional government program. ...The challenge is more than getting the sites to work faster and more reliably. The challenge is to get them to run like Zappos or REI, with a relentless focus on improving the insurance offerings, attracting customers, and facilitating an easy, informative shopping experience.I just love this paragraph. It's written in a strange new voice that takes over policy discussions -- the regulatory passive. "to operate..getting the sites to work... to get them to run...." Just who is going to do all this toing? News flash: the ACA is a "government program," and it's run by Health and Human Services? When did government programs ever not operate like, well, government programs? When did any government program relentlessly "focus on improving the insurance offerings, attracting customers, and facilitating an easy, informative shopping experience." Try the Post Office some day. But no,
..there must be constant improvement. And it can probably occur only with a 21st-century, private-sector management structure—one that empowers a CEO, probably with health-insurance experience, and a team of tech-savvy management specialists, to run the entire operation.
Ah, just bring in a czar to command the operation.
Step two would be to change the way doctors and hospitals are paid as quickly and efficiently as possible. In order to control costs and improve quality, there needs to be a transformation in the way care is delivered. There needs to be continuous monitoring of patients in order to intervene early to prevent acute exacerbations of chronic illnesses. And when patients do get sick, there needs to be a greater focus on treating them outside of the hospital so the care they receive is safer, more efficient and lower-cost.
That wonderful regulatory passive again. "to change... there needs to be a transformation... there needs to be monitoring...there needs to be a greater focus." Who prey tell is going to do all this stuff? Why are they going to do it? Who is going to pay for it?
Interestingly, the bottom line ends up not being so different from Goodman. Government programs act like government programs -- for example following arcane procurement rules -- because, by Federal Law they have to run like government programs. And those laws aren't silly, they were put in place because otherwise people steal.
There is a place filled with "CEOs with health-insurance experience and teams of tech-savvy specialists." There is a place where "big transformations in the way " services "are delivered" happens. There is a place that "private-sector efficiency "happens. It's called "the private sector." Really, Emanuel has without realizing it written a pretty effective piece for deregulation of the whole mess.
And, though his closing paragraph praises the law, consider the closing sentence
Now is not the time for autopilot. Lawmakers need to enhance the exchanges and more rapidly adopt alternatives to the fee-for-service payment system.This actually calls for legislative and regulatory changes no smaller than what Goodman calls for!
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