Thursday, December 18, 2014

Real or risk-neutral wolf?

Today's Torsten Slok chart. In yesterday's chart, we saw that the market forward curve keeps forecasting a recovery that never comes. Here, we see the same pattern, over much longer time period, in the survey of professional forecasters. They're always forecasting that interest rates will rise.

I think there are deep lessons from this chart. And not the simple "economists are always wrong," or even "economic forecasts are biased." The chart offers a nice warning about how we interpret surveys.

Expectations matter a lot to modern macroeconomics. But you can't directly see expectations. So many researchers have turned to surveys to measure what people say they "expect." And they find all sorts of weird things. People "expect" stock returns to be implausibly high in booms, and low in busts. Professional forecasters "expect" interest rates always to go up.

The trouble here, I think, is that we have forgotten what "expect" means to the average person.

Wednesday, December 17, 2014


Torsten Slok at Deutsche Bank sends the graph, along with some musings on the eternal question: When (if?) interest rates rise, will it look like 1994, or like 2004? Will rates rise quickly, leading to a bath in long-term bonds? Or will rates rise slowly and predictability?

The graph shows you actual short term rates (red) and forward curves. As this lovely graph points out, the forward curve has been predicting rises in rates for years now. And it's been wrong over and over again. Economists all over have been forecasting a robust recovery too, and that hasn't happened either.

(To non-finance people: The forward rate is the rate you can lock in today to borrow in the future. So the forward curve ought to reflect where the market expects interest rates to go. If people expect rates to rise more than the forward curve, they rush to lock in now, which drives up the forward curve. Also, the forward curve is a cutoff between making and losing on long-term bonds. If interest rates rise following the forward curve, then long bonds and short bonds give the same return. If rates rise slower, long-term bondholders make more money. If rates rise faster, long bonds make less than short or even lose money. So, should you buy long term bonds? Compare your interest rate forecast to the last dashed line and decide.)

The chart .. makes you humble when it comes to the timing of the first rate hike.
But once the Fed starts hiking, they will likely raise rates faster than the market currently is anticipating. Think about it: The Fed has basically decided that they will only start hiking rates once there are signs of inflation.. If the economy is overheating, then raising the fed funds rate to 0.5% is not going to slow the economy down....To cool the economy down, the fed funds rate needs to be above the neutral fed funds rate, which we estimate to be get inflation under control, the Fed will likely have to raise rates well above the neutral level, potentially above 5%...
So his scenario is, interest rates low and more good times for long term bonds until (if) inflation substantially exceeds 2%, then a big rout, as small rises will not do much quickly to dampen inflation. More like 1994.

An interesting view into the brains of bond traders:

Monday, December 15, 2014

Who is afraid of a little deflation? Op-Ed

This was a Wall Street Journal Op-Ed from a month ago. Now I can post the whole thing in case you missed it then.

Who is Afraid of a Little Deflation?

With European inflation declining to 0.3%, and U.S. inflation slowing, a specter now haunts the Western world. Deflation, the Economist recently proclaimed, is a “pernicious threat” and “the world’s biggest economic problem.” Christine Lagarde , managing director of the International Monetary Fund, called deflation an “ogre” that could “prove disastrous for the recovery.”

True, a sudden, large and sharp collapse in prices, such as occurred in the early 1920s and 1930s, would be a problem: Debtors might fail, some prices and wages might not adjust quickly enough. But these deflations resulted directly from financial panics, when central banks couldn’t or didn’t accommodate a sudden demand for money.

The worry today is a slow slide toward falling prices, maybe 1% to 2% annually, with perpetually near-zero short-term interest rates. This scenario would unfold alongside positive, if sluggish, growth, ample money and low credit spreads, with financial panic long passed. And slight deflation has advantages. Milton Friedman long ago recognized slight deflation as the “optimal” monetary policy, since people and businesses can hold lots of cash without worrying about it losing value. So why do people think deflation, by itself, is a big problem?

1) Sticky wages. A common story is that employers are loath to cut wages, so deflation can make labor artificially expensive. With product prices falling and wages too high, employers will cut back or close down.


Government Debt Management at the Zero Lower Bound is a very nice and interesting paper by Robin Greenwood, Sam Hanson, Josh Rudolph, and Larry Summers.

Figure 1. Comparing Quantitative Easing and Treasury Maturity Extension, 2007–2014 ...the cumulative change in 10-year equivalents (scaled as a percentage of GDP) associated with the respective balance sheet policies undertaken by the Federal Reserve and the Treasury. Positive values increase the interest rate risk placed in public hands (Treasury policies), while negative values decrease it (typically Fed QE, but also Treasury maturity shortening in 2008–2009).

First point, what the Fed taketh away, the Treasury giveth. (Hence the title of this post). The Fed bought lots of long-term debt, with the idea that this would raise the price, lower the interest rate on the long-term debt, and thus stimulate the economy.

At the same time, however, the Treasury was selling lots of long-term debt. Interest rates are very low, and debts are high, so it's a great time to lock in low-rate financing. Homeowners and businesses are doing the same thing.

Thursday, December 11, 2014

Level, Slope and Curve for Stocks

"The Level, Slope and Curve Factor Model for Stocks" is an interesting and important empirical finance paper by Charles Clarke at the  University of Connecticut.

Charles uses the Fama-French (2008) variables to forecast stock returns, i. e.,  size, book to market, momentum, net issues, accruals, investment, and profitability. \[ Ret_{i,t+1} = \beta_0 + \beta_1 Size_{i,t} + \beta_2 BtM_{i,t} + \beta_3 Mom_{i,t} + \beta_4 zeroNS_{i,t} + \beta_5 NS_{i,t} + \beta_6 negACC_{i,t} + \] \[ + \beta_7 posACC_{i,t} + \beta_8 dAtA_{i,t} + \beta_9 posROE_{i,t} + \beta_{10} negROE_{i,t} + e_{i,t+1} \] He forms 25 portfolios based on the predicted average return from this regression, from high to low expected returns.  Then, he finds the principal components of these 25 portfolio returns.

Source: Charles Clarke

And the result is... hold your breath... Level, Slope and Curvature! The picture on the left plots the weights and loadings of the first three factors. The x axis are the 25 portfolios, ranked from the one with low average returns to 25 with high average return. The graph represents the weights -- how you combine each portfolio to form each factor in turn -- and also the loadings -- how much each portfolio return moves when the corresponding factor moves by one.

No surprise, the 3 factors explain almost all the variance of the 25 portfolios returns, and the three factors provide a factor pricing model with very low alphas; the APT works.

Now, why am I so excited about this paper?

Monday, December 8, 2014

Policy penance

The last few posts haven't worked out so well, that's for sure. After a too-grumpy reaction to Alan Blinder's review,  I wanted to say something nice and find common ground with the "what's wrong with macro" articles and even Krugman's posts. In doing so I was much too quick and superficial in characterizing what's going on at high levels of our policy institutions. The only result was that  I managed to annoy all my friends and colleagues at the Fed, IMF, and so on.

As penance, I'll try a blog post that more accurately characterizes the interaction of research and policy, "Keynesian" and modern economics, and so on, as I see it.

If we look one step below the political level, for example at the FOMC minutes and what research staff are up to at institutions like Fed and IMF, you see a very sophisticated interaction between the ideas of modern economic research and policy. The FOMC minutes and speeches by board members (all easy to find on the Fed's website) are a great source. The FOMC seems, to an outsider,  like the world's highest-level debating club on modern macroeconomics.

On many of the dividing lines between traditional Keynesian and modern economics, the policy discussion is decidedly modern.

Friday, December 5, 2014

Uber stars vs. taxi regulators is a great story about Uber, taxi scams, captured regulation, and so on.  Have fun.

How The “Sin City Shuffle” Works There are two main routes to get from the Vegas airport to the Strip. One of them is illegal. To figure out which one you’re on, apply this test: Look outside. If you can’t find outside, you’re in a tunnel—which means you’re being ripped off.

The I-215 tunnel adds about $10 to your fare, but one in three cabbies “longhauled” undercover cops through it anyway. The country hasn’t seen this kind of brazenness since Bankerty Robberson opened a Skimask Hut outside Wells Fargo in 1979.

What can possibly be done about such a confounding crime? I had plenty of time to research this on a recent trip to Vegas, while my own cabbie, Mickey, drove me to the Bellagio by way of Montpelier, Vermont.

Uber’s absurd answer to longhauling is straight from your childhood: When a driver behaves badly, he only gets one star. Within hours, Uber adjusts your fare. Their systems can do this automatically because they have everything they need to calculate an “ideal” fare—start point, end point, traffic conditions, and past fares. If the driver keeps scamming others, he automatically gets fired.

But Nevada officials found fault in Uber’s stars. In fact, they kicked the company out of town for not protecting tourists.
Read the rest here

Thursday, December 4, 2014

What's wrong with macro?

Reflecting on my overly grumpy last post, as well as many recent Krugman columns, I think there is really a fundamental consensus here.

There is, in fact, a sharp divide between macroeconomics used in the top levels of policy circles, and that used in academia.

Wednesday, December 3, 2014


Alan Blinder has what looked like an interesting-looking essay in the New York Review of Books, "What's the matter with economics?" Alan has usually been thoughtful, the WSJ house liberal columnist, so I approached it hoping for well-reasoned argument I might disagree with, but be interested by and learn something from. And it started well, pointing out the many things on which economists all agree and policy does not.

Alas, then we get to macro. Something about stimulus sends people off the deep end.  One little quote pretty much summarizes the tone and (lack of) usefulness of the whole thing:
The great Milton Friedman of the University of Chicago, a favorite target of Madrick, may have been right or wrong; but he was certainly far to the right. Much the same can be said of several other economists cited by Madrick as representing the mainstream. For example, he quotes John Cochrane, also of the University of Chicago, as saying in 2009 that Keynesian economics is “not part of what anybody has taught graduate students since the 1960s. [Keynesian ideas] are fairy tales that have been proved false.” The first statement is demonstrably false; the second is absurd. People can and do argue over the macroeconomic views associated with the so-called Chicago School, but it’s clear that the views of that school are far from the mainstream.
"Demonstrably false" and "absurd" are pretty strong.

Am I wrong that graduate programs do not teach any Keynesian economics? I went to look at the Princeton University Economics Department graduate course offerings. Following up on the ones titled "macro," I found

Tuesday, December 2, 2014

McCloskey on Piketty and Friends

Deirdre McCloskey has written an  excellent essay reviewing Thomas Piketty’s Capital in the Twenty-First Century.

As an economic historian and historian of economic ideas, McCloskey can place the arguments into the framework of centuries-old ideas (and fallacies) as few others can. She has read philosophy and "social ethics." She can even knowledgeably review the literary references.

Her central point: "trade-based betterment," (she wisely avoids "capitalism" to emphasize that  the focus on "capital" is about a hundred years out of date) has raised living standards by factors of 30 or more -- much more if you think about health, freedom, lifespan, tavel, etc. unavailable at any price in 1800;  it has led to much greater equality in many things that count, such as consumption, health and so on; and stands to do so again if we do not kill the goose that laid these golden eggs.  From late in the review,
Redistribution, although assuaging bourgeois guilt, has not been the chief sustenance of the poor....If all profits in the American economy were forthwith handed over to the workers, the workers ... would be 20 percent or so better off, right now....
But such
one-time redistributions are two orders of magnitude smaller in helping the poor than the 2,900 percent Enrichment from greater productivity since 1800. Historically speaking 25 percent is to be compared with a rise in real wages 1800 to the present by a factor of 10 or 30, which is to say 900 or 2,900 percent. 
As a too-long post on a far-too-long review of a enormously-too-long book, I'll pass on some particularly good bits with comment.

On the long history of fashionable worrying:

Monday, December 1, 2014

Sequester and vortex redux.

I posted this last week, but I was unaware at the time of the Paul Krugman's "Keynes is slowly winning" post; Tyler Cowen's 15-point response, documenting not only Keynesian failures but more importantly how the policy world is in fact moving decidedly away from Keynesian ideas, right or wrong (that was Krugman's point); and Krugman's retort, predictably snarky and disconnected from anything Cowen said, changing the subject from Keynesian ideas are winning to the standard what a bunch of morons they're not Keynesians though I keep telling them to be. (I like Krugman's chart though. I see a glass half full -- look at all those nominal wage cuts, even in Spain! And look how many people got raises.)

In that context, I added two "Facts in front of our noses." Keynsesians, and Krugman especially, said the sequester would cause a new recession and even air traffic control snafus. Instead, the sequester, though sharply reducing government spending, along with the end of 99 week unemployment insurance, coincided with increased growth and a big surprise decline in unemployment. And ATC is no more or less chaotic than ever. Keynesians, and Krugman especially, kept warning of a "deflation vortex." We and Europe still don't have any deflation, and even Japan never had a "vortex."  These are not personal prognostications, but widely shared and robust predictions of a Keynesian worldview. Two strikes. Batter up. 

The original: (This is a re-post if you saw it the first time around, but easier to copy and paste than link.) 
Multiplier? What multiplier? 

Saturday, November 29, 2014

Frameworks for Central Banking in the Next Century

The special issue of the JEDC containing papers from the conference "Frameworks for Central Banking in the Next Century" is available until Jan 18 online for free. My "monetary policy with interest on reserves" is here.  Alas, Elsevier doesn't allow me to post a pdf and only allows free access until Jan 18, so if you want pdfs grab them now. 

The lineup is pretty impressive. Of those I have read, I highly recommend Sargent, Prescott, Ohanian, Ferguson and Plosser to blog readers. In particular, if you thought Friedman was always and everywhere MV=PY and 4%, read Sargent.

The lineup:

Wednesday, November 26, 2014

Target the spread?

To send you off with some more Thanksgiving good cheer, here is another out of the box Neo-Fisherian idea.

Perhaps the Fed (or the Treasury) should target the spread between real and nominal interest rates.

Above, I plotted the real (TIPS) and nominal 5 year rates. By the usual relationship \[ i_t = r_t + E_t \left[ \pi_{t+1} \right] \] we typically interpret the difference between real (r) and nominal (i) rate as the expected inflation rate.

Now, the usual Neo-Fisherian idea says, peg the nominal rate (i), eventually the real rate (r) will settle down, and inflation will follow the nominal rate. It's contentious, among other reasons, because we're not quite sure how long it takes the real rate to settle down, and there is some fear that real rate movements induce a temporarily opposite move in inflation.

So why not target the spread? The Fed or Treasury could easily say that the yield difference between TIPS and Treasuries shall be 2%. (I prefer 0, but the level of the target is not the point.)  Bring us your Treasuries, say, and we will give you back 1.02 equivalent TIPS. Give us your TIPS, and we will give you back 0.98 Treasuries. (I'm simplifying, but you get the idea.) They could equivalently simply intervene in each market until market prices go where they want. Or offer nominal-for-indexed swaps at a fixed rate.

Now, I think, the Neo-Fisherian logic is even tighter. If the government targets the difference \( i_t - r_t  \), in a firmly committed way, \( E_t \left[ \pi_{t+1} \right] \) is going to have to adjust.  I plotted 5 years, because I'm attracted to the idea of nailing down 5 year inflation expectations, but the general idea works across the maturity spectrum.

Sequester, growth, and the deflation that did not bark.

Multiplier? What multiplier? 
Wall Street Journal, November 26 2014:
The economy expanded at its fastest pace in more than a decade during the spring and summer,... Gross domestic product...grew at a seasonally adjusted annual rate of 3.9% in the third quarter... combined growth rate in the second and third quarters at 4.25%, affirming the best six-month pace since the second half of 2003." 
The upward revision to overall growth, driven by [sic] stronger consumer and business spending and a smaller drag from inventory investment, surprised economists... 
Paul Krugman, February 22 2013, "Sequester of Fools"
The sequester, by contrast, will probably cost “only” around 700,000 jobs.
New York Times, Februrary 21 2013, "Why Taxes Have to Go Up"
Democrats and Republicans remain at odds on how to avoid a round of budget cuts so deep and arbitrary that to allow them now could push the economy back into recession. The cuts, known as a sequester, will kick in March 1 [my emphasis]

Sunday, November 23, 2014

Behavioral Political Economy

I was interested to read "Behavioral Political Economy: A Survey" by Jan Schnellenbach and Christian Schubert. (HT marginal revolution's irresistible links.)

Context: I have long been puzzled at the high correlation between behavioral economics and interventionism.

People do dumb things, in somewhat predictable ways. It follows that super-rational aliens or divine guidance could make better choices for people than they often make for themselves. But how does it follow that the bureaucracy of the United States Federal Government can coerce better choices for people than they can make for themselves?

For if psychology teaches us anything, it is that people in groups do even dumber things than people do as individuals -- groupthink, social pressure, politics, and so on -- and that people do even dumber things when they are insulated from competition than when their decisions are subject to ruthless competition.

So on logical grounds, I would have thought that behavioral economists would be libertarians. Where are the behavioral Stigler, Buchanan, Tullock, etc.?  The case for free markets never was that markets are perfect. It has always been that  government meddling is  worse. And behavioral economics -- the application of psychology to economics -- seems like a great tool for understanding why governments do so badly. It might also inform us how they might work better; why some branches of government and some governments work better than others.

This nice paper got my attention, since the paper says that's starting to happen.
...Assuming cognitive biases to be present in the market, but not in politics, behavioral economists often call for government to intervene in a “benevolent” way. Recently, however, political economists have started to apply behavioral economics insights to the study of political processes, thereby re-establishing a unified methodology. This paper surveys the current state of the emerging field of “Behavioral Political Economy”
I came away horribly disappointed. Not with the paper, but with the state of the literature that the authors ably summarize.

Saturday, November 22, 2014

Writing compactly

A correspondent sends a suggested edit of a part of my writing tips for PhD students

With markup

Keep it short

Keep the paper as short as possible. Be concise. Every word must count. As you edit the paper ask yourself constantly, “can I make the same my point in less space?” and “Do Must I really have to say this?” Final papers should be no more than  under 40 pages, drafts should be shorter. (Do as I say, not as I do!) Shorter is better.

Keep it short

Be concise. Every word must count. As you edit, ask yourself, “can I make my point in less space?” and “must say this?” Final papers should be under 40 pages, drafts shorter.  Shorter is better.

Well, I did say "do as I say, don't do as I do!" 

Friday, November 21, 2014

Segregated Cash Accounts

An important little item from the just released minutes of the October Federal Open Market Committee meeting will be interesting to people who follow monetary policy and financial reform issues.
Finally, the manager reported on potential arrangements that would allow depository institutions to pledge funds held in a segregated account at the Federal Reserve as collateral in borrowing transactions with private creditors and would provide an additional supplementary tool during policy normalization; the manager noted possible next steps that the staff could potentially undertake to investigate the issues related to such arrangements.
A slide presentation by the New York Fed's Jamie McAndrews explains it.

The simple version, as I understand it, seems like great news. Basically, a company can deposit money at a bank, and the bank turns around and invests that money in interest-paying reserves at the Fed. Unlike regular deposits, which you lose if the bank goes under, (these deposits are much bigger than the insured limit) the depositor has a collateral claim to the reserves at the Fed.

This is then exactly 100% reserve, bankruptcy-remote, "narrow banking" deposits.  I argued for these in "toward a run-free financial system" as a substitute for all the run-prone shadow-banking that fell apart in the financial crisis. (No, this isn't going to siphon money away from bank lending, as the Fed buys Treasuries to issue reserves. The volume of bank lending stays the same.)

Dusty corners of the market

Thursday and Friday I attended the NBER Asset Pricing conference. As usual it was full of interesting papers and sharp discussion. Program here.

A bloggable insight: Itamar Drechsler, and Qingyi F. Drechsler "The Shorting Premium and Asset Pricing Anomalies." They carefully found the cost to short-sell stocks.

Here's their Table 5. F0 are all the easy to short stocks. F3 are the hardest to short stocks. They construct long-short anomaly portfolios in each group. "F 0 Mom" for example is the average monthly return of past winners minus that of past losers, among the easy to short stocks. Now compare the F0 row to the F3 row. The anomaly returns only work in the hard-to-short portfolios.

The second panel shows  Fama-French alphas, which are better measured. The sample is alas small. But the result is cool.

The implication is that a lot of anomalies exist only in hard to trade stocks. There is a lot more in the paper, of course.

Table 5: Anomaly Returns Conditional on Shorting Fees

We divide the short-fee deciles from Table 2 into four buckets. Deciles 1-8, the low-fee stocks, are placed into the F0 bucket. Deciles 9 and 10, the intermediate- and high-fee stocks, are divided into three equal-sized buckets, F1 to F3, based on shorting fee, with F3 containing the highest fee stocks. We then sort the stocks within each bucket into portfolios based on the anomaly characteristic and let the bucket's long-short anomaly return be given by the di erence between the returns of the extreme portfolios. Due to the larger number of stocks in the F0 bucket, we sort it into deciles based on the anomaly characteristic, while F1 to F3 are sorted into terciles. Panel A reports the monthly anomaly long-short returns for each anomaly and bucket. Panel B reports the corresponding FF4 alphas. Panel C reports the FF4 + CME alphas. The sample period is January 2004 to December 2013.

(From Table 4 caption) The anomalies are: value-growth (B=M), momentum (mom), idiosyncratic volatility (ivol), composite equity issuance (cei), nancial distress (distress), max return (maxret), net share issuance (nsi), and gross pro tability (gprof). The sample is January 2004 to December 2013.

Thursday, November 20, 2014

Inequality at WSJ

"What the Inequality Warriors Really Want" a Wall Street Journal oped on inequality. It's a much edited version of my evolving "Why and How we Care About Inequality" essay. Any writers will appreciate the pain that cutting so much caused.

As usual I can't post the whole thing for 30 days, but you might find the WSJ short version interesting, especially if you couldn't slog through the whole thing. Their comments might be fun too.

Monday, November 17, 2014


The Syndics of the Drapers' Guild by Rembrandt, 1662.

I enjoyed Sheilagh Ogilvie's The Economics of Guilds in the latest Journal of Economic Perspectives. Bottom line:
..the behavior of guilds can best be understood as being aimed at securing rents for guild members; guilds then transferred a share of these rents to political elites in return for granting and enforcing the legal privileges that enabled guilds to engage in rent extraction. 
The paper nicely works through all the standard pro-guild and pro-regulation arguments. If you just replace "Guild" with "regulatory agency" it sounds pretty fresh.

Did guilds provide contract enforcement, security in weak states, property right protections not otherwise available? No.