Slok on Greek Wages

Source: Torsten Slok

Torsten Slok, prodigious producer of graphs, sends this one along.

A section of macroeconomics holds that nominal wages are sticky, pretty much forever. Hence, countries like Greece need their own currencies so they can depreciate them. Somehow this didn't produce great prosperity the first, oh, 147 times Greece tried it, but anyway, it's common to bemoan how terrible it is for Greece to be part of the euro because wages can't fall and it can't depreciate.

Or not, as the graph shows.


Now, obviously, it took 5 years, and those haven't been pleasant 5 years. A devaluationist might counter that an exchange rate could have fallen 25% overnight. But this graph hides the composition. I would guess that not all Greek wages went down by the same 25% -- that some are going down more than others, and that like all prices the dispersion is more interesting than the average. That process -- moving out of inefficient businesses (and government, where wages have also fallen) and into better ones -- is always painful and would not happen under a quick depreciation.

So, before critics go all nuts, I'm not making a case that wages are as flexible as exchange rates -- clearly not. But the common view that nominal wages may never fall, and eternally sticky wages account for years or decades of stagnation, just isn't true per the graph.

A slight complaint -- the graph title is "competitiveness," not "relative wages." There is a lot more than wages in "competitiveness," like, say, productivity. You can be "competitive" with very high wages if you have a dynamic, efficient, high-productivity economy. And "competitive" is a terrible word anyway -- it has a very mercantilist ring, which is not how trade works.

Immigration and wages

Following up on my last immigration post, a thought occurred to me.

The most common objection is the claim that letting immigrants in will hurt American wages. Before, I've addressed this on its merits: If labor doesn't move, capital will. Your doctor's lower wages are your lower health costs. Immigrants come for wide open jobs, and to start new businesses. And so on.

What occurs to me this morning is the inconsistency that conservatives make this argument.

Suppose it were true. Would that mean the government should keep out migrants to keep American wages up?

Well, do you believe that the Federal government should mandate a large minimum wage, to raise American’s wages? Do you believe that the Federal Government should ban imports and subsidize exports, to raise American’s wages? Do you believe that the Federal Government should give more power to unions, to raise American’s wages? Do you believe that the Federal Government should pass even more stringent rules in its own contracts to pay higher wages? Do you believe that the government should pass more licensing restrictions, to lessen competition and raise American's wages? Should Illinois restrict people Indianans working in Illinois, to keep up Illinoisans' wages?

These are all the same sorts of steps. At least people who believe all these wrong things believe them together. It makes no sense whatsoever to oppose, correctly, all of these counterproductive economic interventions, but to support exactly the same intervention aimed at immigrants.

As usual in the immigration debate, incoherence is a sign that the real arguments are not the ones people are talking about.  On both sides. 

The optimal number of immigrants

Hoover's Peregrine asked me to write an essay with the title, "What is the optimal number of immigrants to the U.S?"  (Original version and prettier formatting here. Also a related podcast here.)

My answer:

Two billion, two million, fifty-two thousand and thirty-five (2,002,052,035). Seriously.

The United States is made up of three and a half million square miles, with 84 people per square mile. The United Kingdom has 650 people per square mile. If we let in two billion people, we’ll have no more population density than the UK.

Why the UK? Well, it seems really pretty country and none too crowded on “Masterpiece Theater.” The Netherlands is also attractive with 1,250 people per square mile, so maybe four billion. Okay, maybe more of the US is uninhabitable desert or tundra, so maybe only one billion. However you cut it, the US still looks severely underpopulated relative to many other pleasant advanced countries.

As you can see by my playful calculation, the title of this essay asks the wrong question.

What is the optimal number of imported tomatoes? Soviet central planners tried to figure things out this way. Americans shouldn’t. We should decide on the optimal terms on which tomatoes can be imported, and then let the market decide the number. Similarly, we should debate what the optimal terms for immigration are – How will we let people immigrate? What kind of people? – so that the vast majority of such immigrants are a net benefit to the US. Then, let as many come as want to. On the right terms, the number will self-regulate.

Econ 101: Figure out the price, set the rules of the game; don’t decide the quantity, or determine the outcome. When a society sets target quantities, or sets quotas, as the U.S. does now with immigration, the result is generally a calamitous waste. With an immigrant quota, an entrepreneur who could come to the U.S. and start a billion dollar business faces the same restriction as everyone else. The potential Albert Einstein or Sergey Brin has no way to signal just how much his contribution to our society would be.

Why fear immigrants? You might fear they will overuse social services. Morally, just why your taxes should support an unfortunate who happened to be born in Maine and not one who happened to be born in Guadalajara is an interesting question, but leave that aside for now. It’s easy enough to structure a deal that protects the finances of the welfare state. Immigrants would pay a bond at the border, say $5,000. If they run out of money, are convicted of a crime, don’t have health insurance, or whatever, the bond pays for their ticket home. Alternatively, the government could establish an asset and income test: immigrants must show $10,000 in assets and either a job within 6 months or visible business or asset income.

In any case, welfare is a red herring. Immigrants might go to France for a welfare state. The vast majority of immigrants to the US come to work, and pay taxes. Overuse of social services is simply not a problem. But if you worry about it, it’s easy to structure the deal.

You might fear that immigrants compete for jobs, and drive down American wages. Again, this is not demonstrably a serious problem. If labor does not move in, capital – factories and farms -- moves out and wages go down anyway. Immigrants come to work in wide-open industries with lots of jobs, not those where there are few jobs and many workers. Thus, restrictions on immigration do little, in the long run of an open economy such as the US, to “protect” wages. To the extent wage-boosting immigration restrictions can work, the higher wages translate into higher prices to American consumers. The country as a whole – especially low-income consumers who tend to shop at Wal-Mart and benefit the most from low-priced goods – is not better off.

And finally, if it did work, restricting labor benefits some American workers by hurting Mexican workers. Is it really America’s place in the world to take opportunities from poor Mexicans to subsidize our workers’ standard of living? We are a strange country that rigorously prohibits employment discrimination “because of birthplace, ancestry, culture, linguistic characteristics common to a specific ethnic group, or accent….” [EEOC] and then requires such discrimination because of, well, birthplace.

But if that’s a worry, fine. The government could license protected occupations such that only US citizens can hold the protected occupational licenses. Too intrusive? Well, that’s what we’re trying to do by keeping people out, and good policy is not produced by putting nice appearances on nasty policies.

More seriously, one can worry that our society quickly absorbs educated people: engineers, programmers, venture capitalists, MBAs, and professors, but does not quickly absorb people with less education. If the low-skill, low-assimilation objection has merit, let in anyone with specific skills and credentials. Let’s talk about the terms, not the numbers.

Maybe you worry about social values. One can easily demand that immigrants speak English, and have a vague understanding of American institutions, history, and law, though we don’t require this of our citizens. Fine. Let’s talk about the deal, not the numbers.

Maybe you worry, how will we build homes and find jobs for all these people? “We” don’t. They will. Markets, not the government, already provides homes and jobs for citizens. And anyway, aren’t we supposed to be worried about our stagnant economy? Everyone wants more housing construction in the US, yet there are only so many people who need only so many houses. Imagine the construction boom from millions of additional immigrants each year. Our ancestors did not need the American Indian Federal Government to provide them jobs or build them houses. Neither do new immigrants.

The first order issue facing the US is the ridiculous number of talented people who are forced to leave after visiting, often getting engineering diplomas from US colleges, and our mistreatment of de-facto immigrants who are here. Anyone who gets a degree here should be able to stay. Instead, we kick them out. Another 11 million people are here, working hard, paying taxes, owning property, but scurrying around in semi-legal status. This is a national embarrassment. We criticize other nations for “apartheid” when they deny legal status to people who have been living there for decades, or even generations. Yet one in twenty people living within US borders suffers the same fate.

If you’ve been here x years, have a job, stayed out of trouble, then you should get to stay. If we let everyone else who wants to migrate on these same terms, then we don’t have to worry about the unfairness of letting illegals “jump the line.” Get the terms right, and there will be no lines and no unfairness.

Let’s talk about the deal, not the numbers. For every objection to open immigration, it’s easy enough to find terms of the deal to resolve the matter. The right terms will allow the optimal amount of immigration to settle itself, so that no apparatchik in Washington has to come up with a number. Once we get the terms right, every person who can benefit our society will come, and America will truly be a great nation of great immigrants again.

*****

If I were to write it again, I might add doctors and nurses. While revising "after the ACA," an essay on health issues,  I realized how immigration and health economics are linked. We keep doctors and nurses out. And we bemoan how expensive health care has become. Well, immigration restrictions are designed to keep American wages up, and there they are, working as promised. But keeping doctor wages up means keeping your health costs up. The principle applies everywhere.

I also have been looking for a more forceful analogy for  the plight of 11 million "illegal alien" (right) or "undocumented workers" (left) (I would like to find a neutral, unpoliticized word). Here we have 11 million people, living among us, often for decades or their whole lives, working here, owning houses and cars, starting businesses, paying taxes, taking part in our society... and yet with few legal rights. They can't really sue if swindled, they certainly can't vote on how the society they live in works, they can't get driver's licenses, they live in constant fear.

Watching some of the civil rights anniversaries, perhaps the plight of African-Americans in the 50s south is a resonant example. They had similarly few legal rights and in particular the right to vote. We are outraged. Why are we not outraged at the same plight of 11 million immigrants? OK, they are "illegal." But Jim Crow had the full force of law too.  Does "they should respect the law" apply to segregation laws? The fugitive slave act was a law too. Not all laws are good. And "they should get in line and follow the law" is empty -- it is simply impossible for the average migrant from Mexico, China, or India to come legally to the US.

It's not a perfect analogy. There is not a KKK or systematic violence against immigrants.  Historical analogies too quickly trivialize the past, like calling people Nazis.  But I do think that eventually we will see our current treatment of immigrants as an almost similar moral outrage, and good analogies to things we rightly deplore are worth pursuing. I need better ones.

Summers on Stagnation

Larry Summers has published a very interesting speech, U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound. I heard a version of the same thoughts last October, at the joint Brookings-Hoover conference "The U.S. Financial System—Five Years After the Crisis."

I was struck then, as I am now, at how much consensus there is among macroeconomists. Yes, you heard it here. And Larry expresses it elegantly, as you might expect. While the press talks about recovery, macroeconomists look at output growth and employment and it still looks pretty dismal.

Source: Larry Summers

GDP fell in the recession, but has not recovered relative to trend. What was a recession is turning into everyone's nightmare, perpetually slow growth.

Usually, GDP rises back to "potential" or "trend." This time, the "potential" is falling to meet the lackluster results. Potential decline, Larry points out, already closed 5% of the gap, leaving only 5% left. This is starting to look like lack-of-growth theory, not business cycle dynamics.

The unemployment rate is declining, but the employment-population ratio has not budged, even looking at prime-age men to offset some of the demographic effects.

Source: Larry Summers

You have heard these very points on this blog and John Taylor's blog. Ed Lazear's slide deck starts the same way. Bob Hall's macro annual paper starts the same way. Charlie Plosser's speech starts the same way.  I repeat here, with Summers' pictures, to emphasize the extroardinary consensus.

It's also extraordinary because the Washington policy machine has gotten bored with growth or lack of growth and moved on to squabble about other things.

Now, to analysis. Larry makes a very interesting case that fundamental forces in the economy push us to low real interest rates. The ones I found most interesting,

First, reductions in demand for debt-financed investment. ...probably to a greater extent, it is a reflection of the changing character of productive economic activity... Ponder the fact that it used to require tens of millions of dollars to start a significant new venture, and significant new ventures today are seeded with hundreds of thousands of dollars. All of this means reduced demand for investment, with consequences for equilibrium levels of interest rates.

and

[Fourth] is a substantial shift in the relative price of capital goods [falling about 20% since 1980].. Something similar, but less dramatic, is present in the data on consumer durables. To take just one example, during a period in which median wages have been stagnant over the last 30 years, median wages in terms of automobiles have almost doubled..

In sum, one aspect of the new "stuff cheap, people [with skills] expensive" economy is a reduction in the real rate of interest. It took a lot of money to build railroads. It doesn't take a lot of money to build apps.

Source: Larry Summers

Summers points to an interesting calculation of the "natural" rate of interest by Laubach and Williams, which I will have to look up. So far, the "negative natural rate" at the basis of all the new-Keyensian analysis I have read has been a deus-ex-machina, not independently measured. Interesting.

Here, as must be the case, inevitably, we part company. It's a quantitative problem. The natural rate is per Laubach and Williams, about -0.5%. But we still have 2% inflation, so the actual real interest rate is -1.5%, well below -0.5%. With 2% inflation, we need something like a 4-5% negative "natural rate" to cause a serious zero bound problem.  While Summers' discussion points to low interest rates, it is awfully hard to get any sensible economic model that has a sharply negative long run real rate

Moreover, to Summers, the one and only problem worth mentioning in the US economy is that the "natural rate" is negative while nominal rates cannot fall below zero. Can't we think of one single solitary additional distortion in the American economy?

What to do? Summers sees the problem as eternal lack of "demand" and recommends more of it. I think this more of a microeconomic/lack of growth theory problem needing the removal of distortions.

We still agree a bit -- Summers starts with "There is surely scope in today’s United States for regulatory and tax reforms that would promote private investment." That's distortion removal.

And I am interested that his calls for stimulus do not rely on the idea that consumers ignore the fact that government debt must be repaid. "Although it should be clear from what I am saying that I do not regard a prompt reduction in the federal budget deficit as a high order priority for the nation, I would be the first to agree with Michael Peterson and his colleagues at the Peter G. Peterson Foundation that  credible long-term commitments would be a contributor to confidence." Apparently the confidence fairy reads Ricardo, as do fully-Ricardian new-Keynesian models.

It's hard to object to "policies that are successful in promoting exports, whether through trade agreements, relaxation of export controls, promotion of U.S. exports, or resistance to the mercantilist practices of other nations when they are pursued, offer the prospect of increasing demand," though that can quickly be misread as invitation to our own mercantilist efforts.

But this is all small potatoes, compared to 5% loss of potential, 5% loss of GDP, and a creepingly slow escalator, no? So, really the core of Larry's prescription is

as I’ve emphasized in the past, public investments have a potentially substantial role to play...ask if anyone is proud of Kennedy Airport, and then to ask how it is possible that a moment when the long-term interest rate in a currency we print is below 3 percent and the construction unemployment rate approaches double digits is not the right moment to increase public investment in general—and perhaps to repair Kennedy Airport in particular

It's hard to argue with fixing potholes, especially in Chicago. And there is no argument against investment that earns a positive rate of return. The question, though, is not whether those are good investments but whether making such investments can raise GDP 5%, potential GDP by 5%, and raise the desultory growth rate.  Even at a multiplier of one, there are not $750 billion of positive net present value roads and bridges to build -- and we haven't started with the opposition of anti-sprawl and environmental lobbies who don't want roads and bridges built in the first place. The Keystone pipeline, and LNG export terminals are infrastructure too. (I should be careful however. There surely are $750 billion a year of alternative-energy boondoggles to build!)

Here, of course, Summers thinks multipliers -- even multipliers for tax financed (notice the Ricardian comment) and wasted (that's in the models, the usefulness of the infrastructure has nothing to do with the multiplier) is in the range of 4 to 5.

To me, this is just magical thinking -- that the key to long run prosperity is government spending, even if wasted.

But these are old arguments, and I did not write to rehash old controversies. From my point of view, the speech is an eloquent statement of the problem, and the gulf between Summers and people who think like I do is much narrower than the gulf between macroeconomists and the policy establishment which is not even thinking about slow growth anymore. From my point of view, the focus on and evident emptiness of the "demand" solution -- its reliance on magic -- just emphasizes where the real hard problems are.

A last note of praise. Notice Summers said nothing about the minimum wage, the earnings of the top 1/10 of a percent, and other fixations of the current partisan squabble.

Revolving Door

Source: Lucca, Seru and Trebbi

David Lucca, Amit Seru and Francesco Trebbi have an interesting working paper, "The Revolving Door and Worker Flows in Banking Regulation." (NBER working paper here, ungated ssrn link here.

They construct

"a unique dataset of career paths of more than 35,000 former and current regulators across all regulators of commercial banks and thrifts -- the Federal Reserve Banks (Fed), the Federal Depository Insurance Corporation (FDIC), the Office of Comptroller and Currency (OCC), the Office of Thrift Supervision (OTS), and state banking regulators -- that have posted their curricula vitae (CVs) on a major professional networking website." 

I found Figure 4, above, pretty interesting. 10% of people in this sample move from regulator to industry or back again each year. And this flow has doubled since the financial crisis and regulatory expansion.


Much of the paper is about business cycle effects, and doesn't really get in to the political economy which we're all chomping at the bit to understand. Section 4 does talk about the "quid pro quo" vs. "regulatory schooling" channels, and they find that

The evidence on higher gross inflows and outflows during periods of more intense regulatory activity are consistent with the regulatory school view. According to this view, workers may move into the regulatory sector to get schooled in the new complexity and then move from regulation to the private sector to earn the returns from regulatory schooling at times of higher enforcement activity when their regulatory human capital may be more valuable. The evidence is inconsistent with the quid-pro-quo channel 

which they explain

according to which future employment opportunities in the private sector may affect the strictness of actions of regulatory personnel.

but they are full of caution about the results.

Most of all I want to cheer a deeply empirical approach to what usually are anecdotal analyses. This is a good first step, not the conclusive end of a literature.

The conclusion is interesting too. A sign of a good economist is he or she always has two hands.

Critics of the regulatory revolving door have proposed restricting the ability of regulatory personnel to transition to the private sector, which under federal law (see 12 U.S.C. § 1820(k)) is subject to a 30 one-year “cool-off” period for any compensation -- as an employee, officer, director, or consultant -- with a previously supervised institution. There have also been discussions to further tighten the hiring of industry insiders by regulatory agencies. Such arguments, while no doubt important, ignore other important positive aspects of the revolving door, such as its potential to enhance the ability of regulatory agencies to hire better quality workers. Our results suggest that the regulatory sector faces a retention challenge, as measured by the lower employment spells of regulatory personnel in more recent years and for workers with higher education. While more work is needed to quantify the regulatory distortions induced by the revolving door, our findings do suggest that tightening the revolving door without altering other aspects of worker incentives may further create challenges for regulatory agencies to seek and retain talent.

Shakman Decree

A piece of local news in Chicago is worthy of wider attention. As reported on the front page of the Chicago Tribune June 16, A federal judge lifted the 42 year-old "Shakman decree" covering city hiring.

Back in the day, city employees from garbage collectors on up were hired and promoted for political work. Literally, garbage collectors had to bring in campaign cash or get fired.  Mike Shakman and a group of other lawyers sued the city in 1969, and doggedly stayed after the city in scandal after scandal since.

Why do you care? An enduring puzzle to me, as a macroeconomist, and hence not particularly expert on political questions, is how do governments ever become clean and competent, or stay that way? We economists tend to throw up our hands, say "public choice" or "rent-seeking" and then assume regulators will always be captured and governments always corrupt. But that's empirically not true. Some governments and government institutions are remarkably honest and efficient, at least by libertarian economists' cynical expectations. How do they do it? What's the machinery? How do you fight corruption? This is one concrete example worth studying of just such machinery.


Quoting Shakman,

it is realistic to expect and recognize that the city has put in place the systems and the people and the commitment to clean up its act. 

And the judge

U.S. Magistrate Judge Sidney Schenkier declared the city in “substantial compliance” with a set of rules, procedures and internal policing requirements to keep politics out of hiring.
The judge noted that Chicago has put in place procedures governing hiring, firing, promotions, discipline, overtime and the like that are designed to remove the influence of politics from those decisions. It also has set up an internal policing process, under the auspices of the Department of Human Resources and the inspector general's office.

So it is possible to set up bureaucracy to police bureaucracy -- if the people at the top (Emanuel) find it in their best interests to do so.

It's not a magic bullet, and requires perserverance:

“None of us think there will never be another example of patronage hiring in the city or public employment influenced by patronage,” Shakman said. “That's unrealistic to expect,...

U.S. Magistrate Judge Sidney Schenkier ..cautioned that “substantial compliance does not mean the city has achieved a state of perfection.”

Killing off patronage is “not a revolutionary process, but an evolutionary one — it happens over time,” said Schenkier, the seventh judge to preside over the case.

Part of the machinery is dedicated lawyers like Shakman, who bring about such important change, at not inconsiderable cost. Fighting the machine for 42 years is not good career advice for a Chicago lawyer. Another part of the machinery is our local newspapers, who have pretty much supported the process all along. A sadder part of the machinery is Federal law. Local corruption is most often fought by Federal lawsuits and Federal prosecutions.  That leaves open the question, how do we fight Federal corruption?

Disclosure: Mike is a friend, neighbor, and fellow glider pilot, so I'm also personally glad to see his efforts recognized here and by a University of Chicago Distinguished Alumnus Award.

FERC Follies

The Monday lead editorial in the Wall Street Journal on a FERC (Federal Energy Regulatory Commission) story is revealing on the increasingly politicized nature of the American Regulatory State. Pulling the FERC story out of the editorial's larger point,

For 10 years Mr. Van Scotter has run a paper mill in the northern Maine town of Lincoln, population 3,000. [FERC Director] Mr. Bay accuses Lincoln Paper and Tissue of having manipulated in 2007-08 a federal program meant to promote energy conservation.... Lincoln Paper may be liable for a $5 million civil penalty and $379,016.03 in disgorgement, plus interest.

... Yet Lincoln Paper broke no known law.... 

Lincoln Paper chose to participate in "demand response" on the New England electric grid, where large power users were paid for the electricity they didn't use...Lincoln Paper had an aging steam-powered generator on site that supplied a minority of the mill's energy needs and took the remainder from the regular grid. Mr. Bay claims that Mr. Van Scotter intentionally ran this generator less than he normally would when the baseline was being created. Then he ramped the generator back up to make it seem as if he was drawing less energy off the meter and thus stealing the demand payments. ...

But...FERC never defined "baseline" and made no rules about the right way to set one or how equipment should be operated during the measurement period.

So how can Mr. Van Scotter be accused?

As Mr. Bay recently told the Senate in a letter, "the absence of a violation of market rules is not a defense to market manipulation..

The journal calls this "Orwellian."  Catch-22 might be better. Under a FERC program, you can get federal money for cutting energy below a baseline. How do we compute the baseline? We won't tell you. But we can come after you later if we don't like what you did.

I found the last tidbit the most revealing.

...Lincoln Paper is entitled to no discovery during FERC investigations or even to know the identity of its accusers. Seven of the nine deposed witnesses remain anonymous under Mr. Bay's rules. He wants to play prosecutor, jury and executioner.

In the regulatory state, rights that we have had since about the Magna Carta dissolve.

With "baseline" undefined, surely lots of companies made, er, interesting computations to get Federal dollars. How did Mr. Van Scotter attract attention? Who did he not pay off, or do a favor for? Did he give to the wrong political action committees? Did he say something impolite about the FERC? The secrecy with which the FERC operates is an open invitation to this sort of abuse. (See, IRS.)

Keeping this kind of trouble at bay is how companies less "unsophisticated in the ways of Washington" now operate -- see big banks, health insurers, energy companies.  Long and vague laws, authorizing longer and vaguer regulation, with few of the rights of the accused that legal proceedings involve, let politically-appointed regulators treat companies with capricious discretion.  Threatening this kind of trouble is how Washington gains political support. Smart companies play along.

Fortunately, in this case, there is a legal remedy, though slow and expensive. Smart journalism still serves its disinfecting role, as the existence of the editorial attests. And eventually, one hopes, an outraged electorate will rise to demand change once it understands what "regulation" has become.

Are we saving too much for retirement?

Another graphic novel in the Booth Capital Ideas magazine. This is just page one, click on the link to see all four pages. It's an interesting conversation between an economist (Matt), who thinks about intertemporal choice, and a psychologist (Dan), who thinks about how you imagine your future self. It really works best as a four page spread so you can follow all the arrows as they jump around.

Geithner Review

I found quite interesting Matt Stoller's review of Treasury Secretary Tim Geithner's book at vice.com.  Matt read between the lines of the personal part of the book, and the glimpse it offers into the lives and career paths of well-connected people in our Eastern finance-government-academia establishment. There still is such a thing.

I haven't read the book, as I find Geithner's all-bailout, all-the-time view of finance rather simplistic. And I don't endorse all the review's contrary economic ideas either. The review is also bit personal, a tone I don't endorse. Cronyism is a disease of a government and polity which elects it, not supposed moral failings of specific individuals. We will not build a better government by hoping that good-looking well-mannered Dartmouth grads will voluntarily turn down opportunities for power, priviledege and wealth that land in their laps through family and school connections.

The review points to a very nice multi-authored article, "The Value of Connections In Turbulent Times" by Daron Acemoglu, Simon Johnson, Amir Kermani, James Kwak, and Todd Mitton, using stock price reactions to measure the value of insider connections.

The announcement of Tim Geithner as President-elect Obama’s nominee for Treasury Secretary in November 2008 produced a cumulative abnormal return for …nancial …firms with which he had a personal connection. This return was around 15 percent from day 0 through day 10, relative to other comparable …financial fi…rms. ... Roughly in line with market expectations, the Obama administration hired people from Geithner-connected fi…rms into top level fi…nancial policy positions.... We argue that this value of connections refl‡ects the perceived impact of relying on the advice of a small network of …financial sector executives during a time of acute crisis and heightened policy discretion.

This tale has a strong lesson for how "resolution authority" will work out. Better keep your private cell phone contact list up to date.

This reinforces a larger point, which my colleagues Luigi Zingales and Raghu Rajan have been making for a while (here and here), among many other voices. The antagonist to free markets in our time is not state control or bureaucratic socialism. It is crony-capitalism, a system that relies on large private companies, but under detailed government control,  government favors dispensed in return for political support and buckets of money, arbitrary prosecutions and regulatory "crucifixion" (to borrow a term from an infamous EPA staffer) awaiting those who speak out or don't play along.

One last point on Tim Geithner's career. We lost a wonderful opportunity. If the Treasury Secretary can't fill out Turbo-Tax correctly, surely it is time to simplify our tax code. Alas, the crony state demands an absurd tax system, so that brief moment vanished.

The Economist on Narrow Banks

The Economists Free Exchange blog covers narrow banks, and parts of my "run free" paper in a post somewhat mean-spiritedly -- or perhaps unintentionally self-descriptively --  titled "Narrow Minded." I always appreciate publicity, but a few parts seem wrong enough to address.

After nicely covering the history of the idea, the Economist writes,

such a plan raises huge practical questions. The first is implementation: how to get from today’s system of highly indebted banks to one in which they are financed chiefly by equity. 

That's not hard. We're slowly raising capital requirements, and all we have to do is to keep raising them. My Pigouvian tax on debt would help a lot -- I think banks screaming how hard it is to issue equity or how terrible not to pay dividends for a while would suddenly find it much easier if paying 5 cents for each dollar of debt issued. Announcing that institutions above 50% equity and with less than 20% short-term debt are exempt from Basel and Dodd-Frank asset regulation might cause a rush for the exits.

Politically, there would be formidable opposition from vested interests. 

And this is, somehow, an argument against the plan rather than for it? There is formidable opposition from vested interests against abolishing agricultural subsidies, trade protection, occupational licensing, and taxicab monopolies. Dear Economist, when did feeding the cronies become an argument for keeping bad policy in place, not a main indicator of needed change?

Economically, the transition would require banks to dispose of a vast stock of loans, or raise an equivalent amount of long-term debt and equity.

The first is simply untrue, and the second is deeply misleading. For every dollar of long term debt or equity that must be raised, one dollar of short term debt is paid back. No extra funds from investors are required, and no selling of assets is required. It's just a Modigliani-Miller / Yogi Berra reslicing of the same pizza.

A second concern is whether a split between narrow banks and wider lending-and-investment firms would actually eliminate runs. If other institutions replace banks in making loans, they could end up creating fragilities of their own. Mutual funds, for example, are financed by shareholders, not creditors; but if such shares are seen as stable and safe, investors will treat them as deposits—and try to withdraw their investment if that safety is threatened.

This is just simply wrong, and in the "Economist should know better" camp. You cannot "withdraw your investment" from a floating-value  fund.  The fund makes no fixed-value promises. It cannot fail. It cannot suffer a run. Look up the definition of run, dear Economist! A floating-value fund, and especially an exchange-traded fund with no one-day NAV promise,  is the paradigmatic example of a run-proof institution.

Yes, investors can all try to dump stocks, either held directly or held through funds, and stock prices can go down. There is no failure, no bankruptcy, and no crisis in this. We want a system that allows booms and busts without crises, not the promise that wise regulators will step in to stabilize stock prices!

After this happened even once, people would simply flock to the narrow banks, and there would be no source of lending.” To prevent this, the authors argue, governments would have to intervene to save the “not-so-narrow intermediaries”.

Now we're deep into the silly season. The intermediaries do not need any saving. They have not made any promises. A floating value fund cannot go bankrupt! Yes, stock prices can fall, and your fire sale is my buying opportunity. Do we really want Governments and their central banks buying stocks to prop up their values? Do we really want governments allocating credit? Have we so lost sight of what a "crisis" is, and is not?

Third, such a system would still need plenty of regulation.

The fact that we need some regulation -- that I don't produce a libertarian-anarchist nirvana solution in which absolutely zero regulation is required -- is somehow a defense of the current monstrous setup? I think we need cops at stoplights. Is this a defense of Dodd-Frank? Come now, it takes about 1/10th the regulation, because we can throw out all regulation of the safety of bank asssets, all the risk weights, all the stress tests, all the "resolution," and so on. The perfect is truly the enemy of the good at the Economist.

But given the growing cost and inefficiency of today’s regulatory regime, the concept of narrow banking surely deserves more serious consideration.

I'll take the grudging endorsement and return a grudging gratitude for the mention of the idea!

Hall on Supply vs. Demand

I'm reading Bob Hall's Macro Annual paper (ungated here). The burning question is, how much of our low GDP relative to the pre-2007 trend and forecasts corresponds to "supply" (really "equilibrium") which monetary and fiscal "stimulus" can't help, and how much is "demand" that they might. (I live in a more model-based and equilibrium tradition, so I don't want to fully endorse these words and the concepts behind them, but they'll have to do for now.) Bob's paper is a really nice quantitative exercise aimed at answering the question, rather than just bloviating as us bloggers tend to do.


Bob starts with

The years since 2007 have been a macroeconomic disaster for the United States of a magnitude unprecedented since the Great Depression. 

He measures our shortfall at 13.3 percent of GDP. Now we add up where it comes from and how much "demand" might help.

From the conclusion

There is no reason to expect that the cumulative shortfall in productivity growth of 3.4 percentage points of output could be reversed by a sudden increase in product demand. That shortfall seems to be the result of a period of reduced innovation, possibly the result of the crisis. ..Whether the return to a normal economy will result in a catchup in productivity growth in the longer term [JC: do inventions proceed on a time trend, and we can quickly implment them] is an unsettled question of growth economics.

...the capital stock is ... responsible for the largest part of the output shortfall, 5.0 percentage points. It can't respond immediately to a boost to product demand, but a boost would probably trigger an accelerator response that would close some part of the shortfall. In the longer run, the strong mean reversion in the historical capital/output ratio should work to close the entire gap. 

... Unemployment dropped slowly to 1.3 percentage points above normal in 2013, contributing 0.9 percentage points to the shortfall in output in that year. The return to normal has been slower than in previous post-recession episodes because the crisis shifted the composition of jobseekers toward those with low job- finding rates and low exit rates from unemployment. An increase in product demand would accelerate the remaining move back to normal....

Labor-force participation fell substantially after the crisis, contributing 2.5 percentage points to the shortfall in output. The decline showed no sign of reverting as of 2013. Part is demographic and will stabilize, and part are effects low job-fi nding rates, which should return to normal slowly. But an important part may be related to the large growth in bene ficiaries of disability and food-stamp programs. Bulges in their enrollments appear to be highly persistent. Both programs place high taxes on earnings and so discourage labor-force participation among benefi ciaries. The bulge in program dependence is a state variable arguably resulting from the crisis that may impede output and employment growth for some years into the future.

I add that up as 3.4+5.0+2.5 = 10.9% / 13% not particularly amenable to "stimulus," and instead reflecting "supply."  Capital stock "mean reversion" means investment which doesn't happen on its own, and I'm dubious of "accelerators." Take your own conclusions.

The paper is good for a detailed search theoretic view of labor markets.

My only big complaint: The title: "Quantifying the lasting harm to the U.S. economy from the financial crisis." I would insist on adding "and policy responses to that crisis." We have had swift recoveries from previous crises.

Gladstonian Republicans

Before politicians were telegenic.
Source: Wall Street Journal

I enjoyed very much last weekend's WSJ Oped, "In Search of Gladstonian Republicans" by By John Micklethwait and Adrian Wooldrige. Some highlights and then comments.

"Imagine that the world's superpower reduces the size of government by a quarter over the next 30 years, even as its population grows by 50%. Imagine further that the superpower performs this miracle while dramatically increasing both the quality of public services and the nation's diplomatic clout. And imagine that the Republican Party leads this great revolution while uniting its manifold factions behind one of its favorite words: liberty.

Impossible? That is exactly what Britain, then the world's superpower and pioneer of the new economy, did in the 19th century. Gross revenue from taxation fell from just under £80 million in 1816 to well under £60 million in 1846, even as the population surged and the government helped build schools, hospitals, sewers and the world's first police force. The Victorians paid for these useful new services by getting rid of what they called "Old Corruption" (and we would call cronyism) and by exploiting the new technology of the day, like the railway. For these liberal reformers were the allies of the new commercial classes who were creating the industries that were transforming the world ...

Gladstonian liberalism provides a remarkable template....

First, rip out cronyism. Between 1815 and 1870 British Liberals replaced a government based on patronage, sweeping aside the special privileges for the East India Company, West Indian sugar makers and British landowners. Today the American right's dirty secret is its love of big government, especially tax breaks for business (including sugar). The U.S. tax code has $1.6 trillion of exemptions, most of which go to the well-off....

Having helped dismantle Britain's protectionist Corn Laws in the 1840s, he [Gladstone] would be astonished that America still doles out $30 billion a year in agriculture subsidies and employs 100,000 people in the Agriculture Department....

Gladstone would concentrate money on the poor, targeting the welfare state for the rich. More money goes to the top 5% in mortgage-interest deduction than to the bottom 50% in social housing. ...

Third, simplify government, particularly the numbers. In the early 19th century, British government accounts were incomprehensible, deliberately so. The aristocrats who ran the country wanted to conceal the fact that most government spending went to support their relations in the form of sinecures, church livings, pensions and ceremonial jobs. Gladstone insisted on standing before Parliament and explaining the budget in detail: If he couldn't explain it to a gathering of his peers, then he knew that it was worthless. America's current budget is so full of perks for vested interests that only lobbyists and their lawyers can understand it. ...

I think this advice also addresses a sensible middle in the current inequality squabble.

The big "inequality" problem in the US is the situation of the bottom 20% or so, stuck in many ways, outside education, decent jobs, and suffering a lot of social dysfunction. Taxing Larry Ellison and sending them checks is not going to address their problems and everyone knows it.

In the top 1%, aside from Gallic fears of dynastic ambitions among these nouveau-riche, it's hard for serious people to see the problem if formerly middle-class entrepreneurs conjure up wonders that make us all better off and make fortunes doing so.

But there is common ground in 1% riches gained by government favoritism and crony connections. The one halfway sensible argument I have heard for large income or wealth taxation is as rough-and-ready remedy for crony profits.

But people who wangle government contracts and crony protection also know how to wangle exemptions to high tax rates. And higher statutory tax rates just focus their efforts, and focus politician's efforts on extracting political and financial support for offering exemptions. The cure ends up perpetuating the disease.

Even if it could work, I think that approach also gives up too soon. It accepts a horribly inefficient crony-capitalist state, and then tries second set of distortions to offset the first.

How much better to focus on cutting out the cronyism in the first place. Here free market economics, libertarian politcs, and left-wing outrage can meet productively.

How does it happen? I was interested by  "the allies of the new commercial classes who were creating the industries that were transforming the world."  Sudden new technology can create a class with interest in breaking down the crony system.  Uber finally is breaking government imposed taxi monopolies, by suddenly creating a group of happy customers who will bring political pressure to bear, in a way that potential customers of slow-growing new businesses did not.

Alas, half of our tech moguls seem happy to endorse government-centered liberalism, and the other half seem to already be heading to government rent-seeking, as in merger antitrust regulation and big patent wars.  Health care and banking are now firmly in the camp of gaming the government for profit rather than innovation. So while the technological underpinnings are similar, the business coalition for liberty may be harder to find.

The left will have to come the realization that the regulatory state breeds cronies, and does not cure them.  When you need to ask armies of bureaucrats for permission to run a business, the quid pro quo of protection and subsidy for political support is inevitable, and getting favors from the government is the only way to make money.

I loved "incomprehensible, deliberately so." That's our tax and regulatory code. If us peasants knew what was going on we'd be in the streets.

PS, I don't know much of anything about 19th century British history, so if you think Gladstone really wasn't such a good guy, oh well. The ideas in the article are good in any case.

Sugar Mountain

Last Saturday I got to go to the biannual meeting of the Macro-Finance Society. This is a great new effort spearheaded by outstanding young macro-finance researchers.

(The society is limited to people with PhDs after 1990, occasioning the title of this post, a reference to a song about a bar limited to people under 21, a reference you will not get unless your PhD was granted well before 1990.)

I can't blog all the great papers and discussions, so I'll pick one of particular interest, Itamar Drechsler, Alexi Savov, and Philipp Schnabl's "Model of Monetary Policy and Risk Premia"

This paper addresses a very important issue. The policy and commentary community keeps saying that the Federal Reserve has a big effect on risk premiums by its control of short-term rates. Low interest rates are said to spark a "reach for yield," and encourage investors, and too big to fail banks especially, to take on unwise risks. This story has become a central argument for hawkishness at the moment. The causal channel is just stated as fact. But one should not accept an argument just because one likes the policy result.

Nice story. Except there is about zero economic logic to it. The level of nominal interest rates and the risk premium are two totally different phenomena. Borrowing at 5% and making a risky investment at 8%, or borrowing at 1% and making a risky investment at 4% is exactly the same risk-reward tradeoff.



In equations, consider the basic first order condition for investment, \[ 0 = E \left[ \left( \frac{C_{t+1}}{C_t} \right)^{-\gamma} (R_{t+1}-R^f_t) \right] \] \[ 1 = E \left[ \beta \left( \frac{C_{t+1}}{C_t} \right)^{-\gamma} \right] R_t^f \] Risk aversion \(\gamma\) controls the risk premium in the first equation, and impatience \(\beta\) controls the risk free rate in the second equation. The level of risk free rates has nothing to do with the risk premium.

Yes, higher risk aversion or consumption volatility would increase precautionary saving and lower interest rates in the second equation, holding \(\beta\) fixed. But that is the "wrong" sign -- lower interest rates are associated with higher, not lower, risk premiums.

Worse, that "wrong" sign is what we see in the data. Risk premiums are high in the early part of recessions, when interest rates are low. Risk premiums are low in booms, when interest rates are high. OK, I'm a bit defensive because "by force of habit" with John Campbell was all about producing that correlation. But that is the pattern in the data. I made a graph above of the Federal Funds rate (blue) and the spread between BAA bonds and treasuries (green, right scale). You can see the risk premium higher just when rates fall at the early stage of every recession, and premiums low at the peaks of the booms, when rates are at their peaks.

So, if one has this belief about Fed policy, there must be some other effect driving a big negative correlation between risk premiums and rates, yet the Fed can cause premiums to go up or down a bit more by raising or lowering rates.

Every time I ask people -- policy types, central bankers, Fed staff, financial journalists -- about this widely held belief, I get basically psychological and institutional rather than economic answers.   Fund managers, insurance companies, pension funds, endowments, have fixed nominal rate of return targets. People have nominal illusions and don't think 8% with 1% short rates is a lot better than 10% with 9% short rates. Maybe. But basing monetary policy on the notion that all investors are total morons seems dicey. For one thing, the minute the Fed starts to exploit rules of thumb, smart investors change the rules of thumb. Segmented markets and institutional constraints are written in sand, not stone, and persist only as long as they are not too costly.

OK, enter  Drechsler, Savov, and Schnabl. They have a real, economic model of the phenomenon. That's great. We may disagree, but the only way to understand this issue is to write down a model, not to tell stories.

The model is long and hard, and I won't pretend I have it all right. I think I digest it down to one basic point. Banks had (past tense) to hold non-interest-bearing reserves against deposits. This is a source of nominal illusion. If banks have to hold some non-interest bearing cash for every investment they make, then the effective cost of funds is higher when the nominal rate is higher.  We are, in effect, mismeasuring \(R^f\) in my equation.

This makes a lot of sense. Except... Before 2007 non-interest-bearing reserves were really tiny, $50 billion dollars out of $9 trillion of bank credit. Quantitatively, the induced nominal illusion is small. Also, while it's fun to write models in which all funds must channel through intermediaries, there are lots of ways that money goes directly from savers to borrowers, like mortgage-backed securities, without paying the reserve tax. Banks aren't allowed to hold equities, so this channel can't work at all for the idea that low rates fuel stock "bubbles."

And now, reserves will pay interest.

At the conference, Alexi disagreed with this interpretation. He showed the following graph:

Fed funds are typically higher than T bills, and the spread is higher when interest rates are higher. They interpret this quantity (p.3) as the "external finance spread." Fed funds represent a potential use of funds, and the shadow value of lending.  Alexi cited another mechanism too: "sticky" deposits generate a relationsip (at least temporary) between interest rate levels and real bank funding costs.   So by whatever mechanism, they say,  you can see that cost of funds vary with the level of interest rates.  In response to my sort of graph, yes, lots of other things push risk premiums around generating the negative correlation, but allowing the causal effect.

Read the paper for more. I have come to praise it not to criticize it. Real, solid, quantiative economic models are just what we need to have a serious discussion. This is a really important and unsolved question, which I will close by restating:

Does monetary policy, by controlling the level of short term rates, substantially affect risk premiums? If so, how?

Of course, maybe the answer is "it doesn't."

Taylor rules

Last week I attended a conference at Hoover, "Frameworks for Central Banking in the Next Century." It was very interesting for its mix of academics, Fed people, and media. The Wall Street Journal had an interesting article Monday morning, "BOE's Carney may need to play a fourth card" on BOE governor Mark Carney's struggles with rules. I am left with more questions than answers, which is good.

Rules 

What do we really  mean by "rules?" The clearest version would be mechanical, the Federal Funds rate shall be \[ i_t = 2\% + 1.5 \times (\pi_t - 2\%) + 0.5 \times (y_t-y^*_t ) \] say, with \(i\) = interest rate, \(\pi\) = inflation \(y - y^*\) = output gap. The numbers come in,  the Fed mechanically borrows and lends at that rate. This is something like an idealized gold standard.

That is not what anybody has in mind, obviously.  So what do we really mean by "rules?"


One of the biggest problems is what goes in to the output gap part. If the Fed is going to respond to economic conditions, how do we measure those conditions? Unemployment? The Fed got in a bit of a mess first saying 6.5%, then rethinking whether maybe employment vs. unemployment matters, and then worrying about long-term unemployed. Once you get to "labor market conditions," the line between rule, judgment, and discretion gets muddy.  Output gap? Then relative to whose "potential?" Just how much of current slow growth is "supply" vs. "demand" possibly fixable by monetary policy is at the center of the current policy debate.  It's easy to say "we're really following a rule, we just think the output gap is bigger than you think." Athanasios Orphanides famously pointed out that contemporary views of the output gap in the 1970s justified a lot of loose policy that to later eyes looked like violations of a rule. I don't mean to say it's impossible, or that many people haven't thought long and hard about it, just to point that this is a tough question.

Moreover, I think even the ardent rules supporters have in mind some flexibility to deal with temporary exigencies. The rule is sort of a long-run commitment, not something mechanical. After all, much of the point is to "anchor long run expectations." But  my diet also seems to have a daily temporary exigency, and once again rule vs. discretion gets muddy.

David Papell's presentation and Monika Piazzesi's comments were very thought-provoking in this regard. David set out to measure the extent of rules-based vs. discretionary policy.  This is deep. Fundamentally, if we can't measure something, it becomes a much muddier concept. I don't think David succeeded, but he did the obvious first step and leaves me with a much clearer view of the problem.

David estimated rules with OLS regressions, roughly \[i_t = r^* + \phi_{\pi} (\pi_t - \pi^*) + \phi_y (y - y^*) + \varepsilon_t\] He sensibly measured the amount of rule-following vs. discretion by the volatility of the error term, and correlated that volatility with economic performance to try to measure the contribution of rules-based policy to economic stability.

But the Fed can surely answer, "We're following a rule, but you're using the wrong measure of u. Our measure of u becomes your error term."  The Fed can also answer "that's a ridiculously simplified textbook rule. We follow a rule, but it includes a lot of other right hand variables like financial stability, long-term unemployment, housing bubbles and 10 different measures of output gaps. Variation in those omitted right-hand variables is showing up in your error term, not deviations from a rule."

Those replies would also answer the economic performance correlation. The Fed could go on and say "in times of high economic instability, the other components of our rule move around a lot, so there is more omitted-variable volatility. Economic volatility causes estimated Taylor Rule residuals, not the other way around."

More deeply, Mike Woodford's book recommends that the Fed respond directly to shocks to other parts of the economy, or shocks to the "natural rate," and then add Taylor rule responses, \[i_t = r_t^* + \phi_{\pi} (\pi_t - \pi^*) + \phi_y (y_t - y^*) \] (There is now a t subscript on \(r^*\)). So optimal rule-based policy has this character of apparent "discretionary" residuals from regressions.

So really where is the line between rule, a guideline (Captain Barbossa),  a general indication of intent, "forward guidance," communication, principled discretion and willy-nilly discretion? Where is the line between law, commitment, promise, pie-crust promise (Mary Poppins, made to be broken), and the golden-retriever approach to life? Is the issue about rules vs. discretion, or is it just about simple and transparent rules vs. complex and obscure rules; about communication rather than commitment?

At a deep level, we social scientists think of the Fed like every other actor as always following "rules," some function from environment to action that describes behavior. Optimization always results in such a rule.  Genuine randomness (the quantum mechanics of behavior?) is't really part of the framework; unpredictable behavior is the result of simplified models and agent's better information, not genuine randomness. (There is an exception for mixed strategies of course, but I don't think that's relevant here.)  So is there anything but rules based policy? This question has long bugged me in interpreting impulse-response functions. The Fed never says "and we added 25 basis points for the fun of it." They always describe all actions as reactions to the environment -- a rule.

Framed that way, I think one answer is before us. If we go back to Kydland and Prescott rules vs. discretion, or Odysseus, the key to a "rule" is precommitment.  You're following a rule (and a rule is beneficial) when you commit to an action ex-ante that you would prefer not to take ex-post, and that commitment has benefits to your overall objective.

"Forward guidance" or "communication" say "here is what we think we will feel like doing in the future." (But we retain the right to change our mind.) A rule says "here is what we will do in the future," maybe describing a state-contingent set of actions, "even if we will not feel like it at the time." ("And here is a set of costs we impose on ourselves so that we will choose to follow through" helps a lot to make it credible.)

It's pretty clear that the Fed has been doing the former, not the latter. The WSJ article on the BOE makes a similar point. Three rules in a year is not a lot of commitment.

This difference is where my scepticism of stimulative promises came from. If the Fed promised to keep rates low in the future, in order to stimulate today, that promise can only have effect if people imagine the Fed chair going to Congress when inflation has hit 5% and saying "no, I promised to keep rates low in order to boost the economy in the recession, and now I have to do that though we all know it's time to raise rates." Nobody believes the Fed chair will do such a thing.  The "guidance" is a "forecast of how the Fed will feel," not a commitment, not a promise with a self-imposed cost, some way of binding itself to the mast.

The intricate legal structure surrounding the Fed, and many of its traditions,  do constitute a lot of "rules," by the way. The Fed might dearly like to drop money from helicopters, buy Treasury debt directly, or lend directly to under-"stimulated" businesses. Legal restrictions against such actions are regretted ex-post, and admired as producing overall better outcomes. At best, forward guidance amounts to a set of promises that the Fed will feel it somewhat costly to renege on.

Now, I think we are ready to start thinking about measurement. I don't think that can be a purely empirical exercise. We need to write down some sort of objective, and find promised behavior ex ante that is regretted ex post, but nonetheless beneficial overall. I'm not sure how to do it, but at least the concept has some potentially measurable content.

Models

My second thought prompted by the conference overall, and made concrete by thinking about David's paper is: What is the model of the economy in which the rule is supposed to work?

In David's regression, we can ask the question: Embed the rule in a model. Suppose that the Fed follows the rule perfectly, and we generate artificial time series from the model, and run the regression. Does the regression reveal the Taylor rule that the Fed is following?

In the new-Keynesian model, the answer is no.  Bob King pointed out  long ago that we can write the Taylor rule in such models as \[i_t = i_t^* + \phi_{\pi} (\pi_t - \pi_t^*) + \phi_y (y_t - y^*_t ) \] where we now interpret the * variables as equilibrium values, and the non-starred values as deviations from equilibrium. When the Fed follows such a rule, in that model, we observe \( i_t = i_t^* \) , \( \pi_t = \pi^*_t \) and \( y_t = y_t^* \). There is no variation in the right hand variables on which to estimate the Taylor rule. The Taylor rule is not identified when placed in a new Keynesian model. In a new-Keynesian model, the "Taylor rule" becomes the "Taylor Principle," a set of off-equilibrium threats not seen in equilibrium. The Fed introduces instabilty to gain determinacy, rather than introduce stability as it does in old-Keynesian models. (This is a not so subtle plug for "Determinacy and Identification With Taylor Rules")

More generally, the point of monetary policy is to stabilize output and inflation, so simple regressions of interest rates on output and inflation no more measure the policy rule, than simple regressions of inflation and output on interest rates measure the effect of monetary policy. This is a point James Tobin made about 50 years ago (post hoc ergo propter hoc). Chris Sims got a Nobel Prize for VARs to address the problem.

Most simply, monetary policy shocks affect output and inflation, so the right hand variable is correlated with the error term.  The new-Keynesian model is an extreme case of this behavior, in which the right hand variable and error terms are perfectly correlated.

These questions were not really on anyone's mind. They are hard questions, they are old questions, and they don't have easy answers.

The larger question is, what model of the economy do policy people use to think about how monetary policy affects the economy?  The clear answer at this conference is, some unwritten mixture of old Keynesianism and old Monetarism. Old Keynesianism: higher rates reduce "demand" which reduce output which through a Philips curve reduces inflation. Old Monetarism: higher interest rates reduce some quantity of money which works its way through to prices. Neither can be written down or spoken aloud without provoking chuckles. But we had a whole conference on "rules" without an explicit mention of "transmission mechanism" (i.e. "model"), and surely the verbal reasoning conformed more to those 40 year old stories than anything written since.

That wide gulf is worth pondering from both sides.

(There were a lot of really interesting papers and discussions. I especially recommend Marvin Goodfriend's paper, which I'll try to blog at some point in the future.)