Wednesday, January 16, 2013

Jon Stewart vs. Paul Krugman

Jon Stewart and Paul Krugman have been butting heads over the trillion-dollar coin idea. Stewart concludes that it is a "dumb f*****g idea," and Krugman thinks Stewart is "lazy" and "unprofessional." You can find the video here.

As someone who has called Krugman lazy in the past, I'm quite willing to offer you my opinion on this contoversy. Krugman is on shaky ground here. It's a bit much for Krugman to be criticizing Stewart for not getting all the subtleties of the idea behind #mintthecoin. In fact, many economists seem confused about it, and Krugman himself does not entirely get it (see this post). I think we can cut Stewart some slack - he's one of the more intelligent human beings on the tube, and he's trying to get a laugh. Obviously Krugman does not have much patience for people who don't take him seriously.

More to the point, #mintthecoin is interesting in that it draws attention to monetary economics and the relationship between monetary and fiscal policy. Other than that, Stewart has it nailed as a dumb f******g idea. The key problem is that this vehicle for circumventing the federal debt ceiling threatens central bank independence. Wherever the trillion-dollar coin is deposited, it constitutes a monetary policy action, and our institutions are set up so as to keep the Fed at arm's length from the Treasury. This would be like having President Obama show up for an FOMC meeting. Bad idea.

Tuesday, January 15, 2013

More on Floor Systems

The discussion of floor systems, between Steve Randy Waldman and Paul Krugman has expanded. In line with my last post, Waldman gets it, more or less, with a little confusion. Krugman is confused.

What adds to the confusion, in part, is Krugman's example:
...what happens if the US government issues a trillion-dollar coin to pay its bills?
I discussed that in this post. Krugman thinks it makes a difference whether the interest rate on reserves is close to zero, as it is now (at 0.25%), or say 5%. If there is a significant quantity of excess reserves, actually there is no difference.

Suppose, as in Krugman's example, the Treasury issues currency to pay its bills. Where the currency is deposited - at private financial institutions or the Fed - or even if the currency issued by the Treasury circulates, doesn't make a difference. What matters is the consolidated balance sheet of the Fed and the Treasury, and so there is no difference between what happens when the Treasury issues currency to finance its deficit, and what happens if the Treasury issues debt, of any maturity, and the Fed purchases the debt with reserves. It's neutral - a liquidity trap - whether the interest rate on reserves is 0%, 0.25%, or 5%. For example, if the Treasury issues currency, that will not ultimately affect the quantity of currency in circulation, with the extra outside money ultimately increasing the quantity of reserves one-for-one.

Where Waldman is confused, in part, is here:
Further, a floor system is very attractive to central bankers. It maximizes policy flexibility...
Actually, a floor system gives a central bank no more or less flexibility than does a channel system. For the Fed, the only difference is that they control the overnight policy rate in a different way.

Monday, January 14, 2013

Floor Systems

The quantity of reserves held by US financial institutions is now approaching $1.6 trillion, and the Fed has promised to increase that stock by $85 billion per month for the indefinite future. Thus, it seems safe to say that the Fed will be working within a monetary regime with a large quantity of excess reserves for a very long time.

In a financial system, like the one we have in the US currently, in which there is a positive stock of deposits with the central bank overnight, and the interest rate on those deposits essentially determines the overnight interest rate, the central bank works within a floor system. I have discussed that in several blog posts, including this one. To quote myself:
A floor system is different. Under such a system, the central bank sets an interest rate on reserves and a central bank lending rate, and plans to have a positive supply of reserves in the system overnight. As a result, the overnight rate must be equal to the IROR, by arbitrage. An open market operation in short-term government debt in a floor system will have no effect, at the margin, as the central bank is simply swapping one interest-bearing short-term asset for another. The instrument of monetary policy in a floor system is the IROR, which determines short-term nominal interest rates.

Currently, the Fed operates under a floor system. The supply of excess reserves is enormous, and the IROR determines short-term interest rates. There are some weird features of the system, such as the fact that the GSEs receive no interest on their reserve accounts, and there is some lack of arbitrage which results in a fed funds rate less than the IROR, but I think those weird features are irrelevant to how monetary policy works.

Under a floor system, we are effectively in a perpetual liquidity trap. Conventional open market operations in short-term government debt do not matter, whether the IROR is 5%, 0.25%, 10%, or zero. But, not to worry, the central bank can always change the IROR except, of course, when it hits the zero lower bound (neglecting the possibility of taxation of reserve balances, which is another issue altogether).

Steve Randy Waldman seems to agree with that. Paul Krugman does not. Here's what Krugman says:
Now, under current conditions that doesn’t matter; dead presidents don’t pay interest, but neither do T-bills, so short term debt and currency form an aggregate (a Hicksian composite commodity, for the serious nerds out there), whose composition doesn’t matter. But interest rates won’t always be zero, and at that point the size of the monetary base — dead presidents plus a sliver of bank reserves that can be converted into dead presidents at will — will matter again.
That's incorrect. The nature of the liquidity trap does not change if the interest rate on reserves (IROR) rises. With a positive stock of reserves in the system, there's a liquidity trap no matter what the IROR is. If the Fed swaps short maturity debt for reserves it's essentially irrelevant - the two assets are roughly identical. It's not a big deal though, as the Fed would conduct monetary policy in exactly the way it did in 2007. The policy rate is the IROR (not the fed funds rate), and moving the policy rate will have essentially the same effects as targeting a particular fed funds rate through open market operations.

Addendum: Where I don't agree with Waldman is on this:
Consistent with the “Great Moderation” trend, the so-called “natural rate” of interest may be negative for the indefinite future, unless we do something to alter the underlying causes of that condition.
I haven't seen a convincing explanation for why the "natural rate of interest" is currently low, or worse still, persistently low. See this post.

Friday, January 11, 2013


If you have not run across this, you have probably been hibernating for the last few weeks. Do a search on #mintthecoin, and fill yourself in on the issue at hand. Where political conflict meets crackpot monetary economics, there is plenty of room for nonsense, of course.

The closest historical parallel to this I could find (and you may know of others) was the issue of playing-card money in New France, beginning in the 17th century. I good account is in this Bank of Canada publication. Typical practice in the colony in New France was for the King of France to make gold shipments to the colony, which were then used for government expenditures in the colony - mainly paying the troops. In 1685, the shipment was delayed. The troops had to be paid, and an inventive French official in the colony thought up a scheme for getting this done. Playing cards in the colony were requisitioned, autographed, made out as IOUs in varying denominations, and used to make government payments. These notes were promises to pay gold in the future, and they circulated as media of exchange. The first playing card issue was in fact subsequently retired, though the colony would repeatedly resort to this expedient in the future, and the promises eventually became weaker.

It's not like this went unnoticed in France, though. The colonials got some resistance from the King of France:
He [His Majesty] strongly disapproved of the
expedient which he [de Meulles] has employed of circulating card notes, instead of money, that being extremely dangerous, nothing being easier to counterfeit than this sort of money.

You can see how this is like the #mintthecoin controversy. Faced with the intransigence (or tardiness) of another branch of government, new liabilities are invented that will allow the government to conduct its business, and not everyone is happy as a result.

Private financial intermediaries are also in the business of inventing new financial instruments, in order to sidestep regulations, or to take advantage of new technologies. An interesting historical example, which actually shares some of the features of the New France playing-card money episode, was the use of clearinghouse certificates in pre-Federal Reserve banking panics in the United States (see this paper by Gary Gorton). It's useful to think of the banking panic episodes that occurred in the period 1863-1913 as currency shortages, typically set off by the failure of some large financial institution(s). Depositors, in a panic over what bank might fail next, ran on banks to convert deposits into National Bank notes (circulating paper money backed by government debt) and gold. The suspension of convertibility by banks would then result in significant disruption of payments.

Later in the National Banking era (1863-1913), clearinghouses thought up a means to mitigate the panics. For example, in the 1907 panic, banks in the New York clearinghouse suspended convertibility of deposits into gold, but were authorized to issue clearinghouse certificates, which circulated as media of exchange and could be redeemed after the panic was over. This appears to violate the rules governing banks in the United States at the time, as National Banks could issue National Bank notes only under certain conditions (principally, the notes had to be backed - essentially in full - by federal government bonds), and state-chartered banks faced a punitive tax on note issues. Presumably a clearinghouse certificate was a liability of the clearinghouse and not of an individual bank so as to skirt banking regulations on note issue.

In contrast to the experience with clearinghouse certificates, private banking innovation can of course sometimes be detrimental to social welfare. Part of the narrative of the financial crisis involves the use of off-balance sheet vehicles - structured investment vehicles and special purpose vehicles, for example - by financial institutions. Certainly these activities were not benign, and it is an open question how such entities should be regulated.

What about #mintthecoin? Most of the elements in the #minthecoin story are contained in the above anecdotes. There is financial innovation. That innovation involves moving some activity off a balance sheet so it will not cause trouble. Engaging in this new activity could prevent a major disruption of payments, but could also cause some other trouble.

As has become more clear in the last few years, monetary and fiscal policy are closely intertwined. It's hard to tell where fiscal policy stops and monetary policy starts. When the Fed swaps short-maturity government debt for long-maturity government debt, or purchases mortgage-backed securities with reserves, are those monetary policy actions or fiscal policy actions? You tell me.

Broadly, here's what the Treasury and the Fed do in the United States. In order to finance its deficit, the Treasury issues interest-bearing debt in various maturities. The Fed then engages in what amounts to debt management. It can purchase the interest-bearing debt of the Treasury and issue other types of liabilities - outside money - which consists of reserves (essentially transactions accounts of financial institutions with the Fed) and circulating currency. What is ultimately important is the debt of the consolidated Treasury and Fed - its size and composition. Both size and composition are determined jointly by the actions of the Fed and the Treasury. Ultimately, the outstanding consolidated debt consists of interest-bearing securities, reserves (now interest-bearing as well), and currency (not interest-bearing).

Legislation puts some restrictions on how the Fed and the Treasury interact, and what kinds of liabilities they can issue. The Fed cannot lend directly to the Treasury - the Fed buys government debt on the secondhand market. The Treasury cannot issue Federal Reserve notes or bank reserves. The Fed cannot issue marketable interest-bearing securities.

There are loopholes, however. Under the Federal Reserve Act, the circulation of Federal Reserve notes falls under the Fed's purview. But where and how are Federal Reserve notes produced? By the Bureau of Engraving and Printing, which is a government agency. It's actually part of the Treasury Department. Similarly, coins, which constitute part of the stock of currency in circulation, are produced by the U.S Mint, also a government agency and part of the Treasury Department.

Reserve accounts at the Fed are essentially transactions accounts for financial institutions, used for interbank clearing and settlement. These reserve accounts have withdrawal privileges. For example, a bank with a reserve account can make withdrawals of Federal reserve notes and coins from its account, and can make deposits of notes and coins. Part of the business of regional Federal Reserve banks is to manage the stock of currency. Regional Feds take delivery of notes and coins from the printer and the mint, and in general maintain the stock of currency and manage its growth. Presumably there is some accounting transaction when the printer or the mint delivers new currency to the Fed, but that transaction is irrelevant, as ultimately any profit the Fed makes is returned as a transfer to the Treasury.

Until recently, like me you were probably under the illusion that the Treasury could not issue outside money. Not so, apparently. The Treasury is allowed to issue special coins, and to put them directly into circulation. This is what #mintthecoin is all about. Typically, the innovation is described as the issue of a $1 trillion coin by the Treasury, which is deposited with the Fed. The Treasury then spends out of its account with the Fed, and thus sidesteps the Federal debt ceiling, which applies only to the stock of interest-bearing Treasury debt.

What's that about? Many non-bank institutions hold reserve accounts with the Fed. These institutions include American Express, the GSEs (Fannie Mae and Freddie Mac), and the U.S. Treasury. The Treasury account with the Fed that is currently in use is the General Account. Since the financial crisis, the balance in this account has varied substantially, but averages about $60 billion. Presumably the Treasury general account carries with it the same privileges as any other reserve account, though I assume it does not bear interest (not that this would matter), as the GSEs do not get interest on their reserve balances. Thus, there appears to be nothing that prevents the Treasury from minting coins, depositing them in its reserve account, and spending out of the account.

As far as I know, no one has pointed out that the Treasury could also mint coins and deposit them in private depository institutions. Through the Treasury Tax Loan Program, which was more relevant before the financial crisis (when the management of the stock of reserves was more critical), the Treasury holds accounts at various financial institutions. Typically, these accounts were used for deposits of tax revenue, but there seems no good reason why the Treasury could not deposit coins in such accounts.

In terms of accounting and standard fiscal/monetary policy, there is nothing weird about #mintthecoin, as some other writers have stated. Whether the coins are deposited directly with the Fed, or with a private depository institution, ultimately they will end up at the Fed. If the Fed were to respond passively, the stock of outside money goes up by the amount of the Treasury coin issue. This is identical to what happens when the Treasury issues debt and the Fed buys it. The Fed need not be passive, however. One possibility is that the Fed sells an amount of government debt from its portfolio equal to the coin issue. Under current circumstances, given that the entire stock of debt held by the Fed is long-term, the net effect is identical to what would happen if the Treasury issued long-term debt instead of coins. And under current circumstances, if the Fed is passive, this is equivalent to what would happen if the Treasury issued short-term debt, as currently short-term debt and reserves are essentially identical assets.

Surely we can be more inventive than #mintthecoin, though. Here are two other suggestions. I'll leave it to you to determine the legality of these options, or who might get upset.

1) The off-balance-sheet option: Fannie Mae became a private institution, and Freddie Mac was established, as part of a Johnson administration move to take the mortgage market activities of Fannie Mae off the federal government's balance sheet. Suppose that Fannie Mae were to issue agency securities and use the proceeds to pay salaries at the Pentagon, or Pentagon employees were to temporarily become employees of Fannie Mae. Currently under government "conservatorship" Fannie Mae has to do what the federal government tells it to do, but its agency securities are not part of the government debt for accounting purposes.

2) The playing-card or clearinghouse certificate option: Federal government departments could issue their employees certificates promising payment in the future, in lieu of salary. I'm not sure what makes a government debt obligation fall under the debt-ceiling limit, but the idea would be to design the IOUs so that they don't meet those criteria. Like the playing cards and clearinghouse certificates mentioned above, there's nothing to stop people accepting these IOUs in exchange.

What should the President do? If I were him, I would try to stay out of trouble. The federal debt limit is idiotic, but we're stuck with it. The President is playing a repeated game with incomplete information. The key piece of private information concerns the payoffs for his opponent (and maybe for him as well). I'm not a game theorist, but I think the relevant theory tells you that anything can happen, so I think Barack is on his own on this one.

Sunday, January 6, 2013


I've been making some progress on a paper, but Paul Krugman is at it again, so I need to go into defense-of-macroeconomics mode.

We'll start where Krugman finishes:
And if the perception spreads, instead, that business-cycle macro is just ideological posturing, that influential economists choose their doctrines to suit their political prejudices, and that the field not only fails to progress but sometimes actually retrogresses, this will be bad for the profession as well as the world.
My neighbor Joe Schmoe told my other neighbors that I kick my cat. Joe and I were having dinner together the other night, and Joe told me: "You know, everyone's saying you kick your cat." To which I replied: "I don't kick my cat. Even though she is now transferring her hair to my clean towels, I have no desire to kick her."
Joe: "But it would be bad for you and the world if people perceive that you kick your cat."

What Krugman discusses in his blog post is a paper by Roger Gordon and Gordon Dahl, reporting the results of an opinion survey by the Booth School at the University of Chicago. Basically, a panel of academic economists from the top economics schools in the US was put together, and these people were asked their opinions on particular policy questions. Perhaps surprisingly, these people tend to agree.

But Krugman isn't buying it. The crux of his argument is that
...macroeconomics – and in particular the study of recessions and policy responses thereto – is special, and ... the Booth panel responses just don’t provide sufficient information on what is happening in that corner of the field.
Is macroeconomics special? Certainly not, in terms of how we do our work. One of the key aspects of post-1970 macroeconomic research has been the free flow of ideas among macroeconomics, labor economics, industrial organization, economic theory, and other fields. If macro seemed like a foreign language to non-macros in 1969, that is certainly not the case today. It's basically the same language, and the same toolkit.

Which brings us to the next issue. Krugman thinks that the Chicago Booth panel of experts doesn't include enough macroeconomists to give us a good read on how views differ. Well, these are successful economists who have, for the most part, been trained in mainstream PhD programs where macroeconomics is taught in the PhD core. They work in top departments where they can talk to macroeconomists. As I noted above, modern macro is amenable to communication - it's easy for people outside the field to drop into macro seminars and conferences and get ideas. Indeed, the average person on this panel knows at least as much about macroeconomics as Paul Krugman does. I don't see how the knowledge of the panel limits their ability to make judgements about "macro" issues.

Is the Booth panel asked about a lot of topics that do not involve macroeconomics? No. If you look through the list of topics, there are very few that you won't find addressed in the research of practicing economists who call themselves macroeconomists.

So, it seems hard to make a case that the survey evidence tells us any more or less about consensus in macroeconomics than it does about consensus in labor economics. Suppose, however, that we're skeptical about the whole survey exercise. Who cares about the armchair opinions of some group of economists, who may or may not have the relevant evidence and theory at their fingertips? Maybe Krugman has something else he can tell us to make his point?

The remainder of his piece focuses mainly on remarks by prominent macroeconomists taken out of context, represented by Krugman as doing " best to justify that belief quantitatively, with as little subjective interpretation as possible." Some people might politely call this "stretching the truth."

First up is Tom Sargent, who Krugman claims "denounced the president." If you read the Sargent interview which is the original source, you'll see that's not what Sargent did. Here's the quote:
In early 2009, President Obama’s economic
advisers seem to have understated the substantial professional uncertainty and disagreement about the wisdom of implementing a large fiscal stimulus. In early 2009, I recall President Obama as having said that while there was ample disagreement
among economists about the appropriate monetary policy and regulatory responses to the financial crisis, there was widespread agreement in favor of a big fiscal stimulus among the vast majority of informed economists. His advisers surely knew that was not an accurate description of the full range of professional opinion. President Obama should have been told that there are respectable reasons for doubting that fiscal stimulus packages promote prosperity, and that there are serious economic researchers who remain unconvinced.
You'll notice that the President hasn't been denounced here. At worst, Sargent is calling into question the judgment of Obama's economic advisors, who apparently were not giving him an accurate picture of the relevant economic science. Sargent's interview, interesting in many respects, is perhaps most famous for this:
Rolnick: You have devoted your professional life to helping construct and teach modern macroeconomics. After the financial crisis that started in 2007, modernmacro has been widely attacked
as deficient and wrongheaded.
Sargent: Oh. By whom?
Rolnick: For example, by Paul Krugman in the New York Times and Lord Robert Skidelsky in the Economist and elsewhere. You were a visiting professor at Princeton in the spring of 2009. Along with Alan Blinder, Nobuhiro Kiyotaki and Chris Sims, you must have discussed these criticisms with Krugman at the Princeton macro seminar.
Sargent: Yes, I was at Princeton then and attended the macro seminar every week.
Nobu, Chris, Alan and others also attended. There were interesting discussions
of many aspects of the financial crisis. But the sense was surely not that modern macro needed to be reconstructed. On the contrary, seminar participants were in the business of using the tools of modern macro, especially rational expectations theorizing, to shed light on the financial crisis.
Rolnick:What was Paul Krugman’s opinion about those Princeton macro seminar presentations that advocated modern macro?
Sargent: He did not attend the macro seminar at Princeton when I was there.
Rolnick: Oh.
If you thought that Paul Krugman was a person who likes to criticize what macroeconomists do without spending much time learning about what macroeconomists do, that's another shred of evidence for you.

The second guilty party is Ed Prescott, who is quoted as saying:
Stimulus is not part of the language of economics.
Actually, I like that. What Ed is saying is that "stimulus" is a word that is used for marketing purposes. He's saying: "Ask me a question I can answer." The relevant economic questions are: What happens when government spending on goods and services increases? Does it matter what the government spends on? Does the state of the economy matter for these effects? If so, how? Does it matter how the spending is financed? What if the government cuts taxes? What happens? Does it matter what taxes we cut or who receives the tax cuts? What about transfers? These are important questions, and I'm sure Ed agrees. So, whatever the charge against Ed is supposed to be, I say not guilty.

Last up is Bob Lucas, who gets the most severe blast.
Finally, Robert Lucas made a personal attack on Christina Romer for advocating stimulus, calling it “shlock economics” and questioning her intellectual honesty.
You can read what Lucas actually said here. Lucas was answering a question at an open forum about the usefulness of large macroeconometric models. Here's the complete exchange:
QUESTIONER: Ben Steel, Council on Foreign Relations. Bob, I edit a journal called International Finance and I get a lot of submissions from people who build big models -- big economic models -- and the shortest referee reports I get back condemn these submissions by saying this model is subject to the Lucas critique. In the last session, we had quite an animated discussion which spilled over into the lunch about models on fiscal multipliers, what they are.

On the one extreme, we have models by people like Mark Zandi at Moody's who say that the fiscal multiplier for the spending initiatives we're discussing are on the order of 1.5. On the other hand, we have people like Robert Barro at Harvard who say there's zero or negative. How would you go about applying the Lucas critique to these types of models to sort of educate us in how we should think about the validity of these models?

LUCAS: Do I need the Lucas critique for -- I'm with Barro is the short answer. (Laughter.) The Moody's model that Christina Romer -- here's what I think happened. It's her first day on the job and somebody says, you've got to come up with a solution to this -- in defense of this fiscal stimulus, which no one told her what it was going to be, and have it by Monday morning.

So she scrambled and came up with these multipliers and now they're kind of -- I don't know. So I don't think anyone really believes. These models have never been discussed or debated in a way that that say -- Ellen McGrattan was talking about the way economists use models this morning. These are kind of schlock economics.

Maybe there is some multiplier out there that we could measure well but that's not what that paper does. I think it's a very naked rationalization for policies that were already, you know, decided on for other reasons. I don't -- I'd like to talk about the Lucas critique but I don't -- I don't think we can -- (chuckles) -- deal with that issue.
Christina Romer's name comes up here alright, but Lucas's tone is more empathetic than anything. I don't see any disrespect. The schlock Lucas is referring to is not a reference to Romer in particular, but to the use of large macro models for policy analysis. There's consensus on that. Most of the macroeconomics profession thinks of old-fashioned large-scale macroeconomic models as useless for anything but forecasting. Students working on doctoral dissertations aren't busy modifying some sector of the FRB/US model or some such, as might have been the case in 1968.

The bottom line Krugman wants to push is that macroeconomics, among fields in economics, is unusually contentious, and that this contentiousness is driven by ideology. In other words, Republican economists and Democrat economists filter both theory and evidence to support preconceived beliefs about how the world works.

Since Krugman brought up Sargent's name, it's useful to read this New York Times article, written after Sargent got his Nobel prize. Here's a good quote:
He doesn’t wear his political opinions on his sleeve. “They really don’t matter in my research,” he said. But because others have applied labels to him, he decided it was worth setting the record straight. He’s a Democrat, he said, “a fiscally conservative, socially liberal Democrat,”
That would be an accurate description of my politics, actually. Sargent goes on:
“If you go to seminars with guys who are actually doing the work and are trying to figure things out, it’s not ideological,” he said. “Half the people in the room may be Democrats and half may be Republicans. It just doesn’t matter.”
Excellent. That describes my experience exactly.

Apparently Krugman thinks that the theoretical apparatus that came out of Lucas's and Prescott's work is somehow ideologically biased. How could that be? Take Lucas's Expectations and the Neutrality of Money paper, for example. The basic model he works from is Samuelson's overlapping generations model. Do you think Samuelson was a Republican? When Kydland and Prescott wrote Time to Build and Aggregate Fluctuations, they were basically tweaking a well-developed modeling framework that came from the work of Solow, Cass, Koopmans, Brock, and Mirman. It's highly likely that none of those people were/are Republicans.

As I've stated before, I don't think that macroeconomics, among fields in economics, is unusually contentious, or unusually ideologically driven, though I'm sure you can find examples of both if you look. I agree with Paul Krugman that much of the Republican party is a despicable bunch, and not worth voting for. But I don't like it when he attempts to sow dischord, by picking on well-respected septuagenarian (or almost septuagenarian, in Sargent's case) macroeconomists and mischaracterizing their public statements. That's pretty despicable.

By the way, have you heard Krugman kicks his cat?