Rewriting the Taylor Rule

r = p + 0.5y + 0.5(p – 2) + 2 is the original Taylor rule, where r = the Federal funds rate, p = the inflation rate, and y = the output gap. Jared Bernstein writes in a comment about the Taylor rule and monetary policy:

I used this version: 2+p+(0.5(p-2)+y where p is year-over-year percent change in the PCE inflation index and y is the output gap: 2*(nairu-unemp) where 2 is the Okun coefficient and the nairu is from CBO.

John Taylor had a couple of issues with what Jared wrote. I did too but my take is a little different than John’s. Let’s start with this:

He then goes on to give this definition the Taylor Rule: The federal funds rate should equal ... 2 + p + 0.5(p – 2) + y ... where p is year-over-year percent change in the PCE inflation index and y is the output gap: 2*(nairu-unemp) where 2 is the Okun coefficient and the nairu is from CBO ... But this is not the policy rule I recommended in a 1993 paper using a formula which has come to be called the Taylor Rule.

Actually, Jared omitted a closing parenthesis so it is not clear if he meant the original Taylor rule or what John Taylor thinks Jared used. To be fair, the original 1993 formula should be simplified to: 1 + 1.5(p) + 0.5(y). Let’s make the algebra as simple as possible. John does admit:

I realize that there are differences of opinion about what is the best rule to guide policy and that some at the Fed (including Janet Yellen) now prefer a rule with a higher coefficient.

But then he adds something where I would differ:

There are other important cross-checks on such calculations. Bernstein’s estimate of the output gap uses an Okun’s law coefficient of 2, but if you use 1.5 (the empirical estimate over the past 50 years) rather than 2, the gap is smaller, which also moves the rate up toward positive territory. Similarly, the average of the San Francisco Fed’s most recent survey of output gaps is smaller than what Bernstein uses.

The original Okun’s law coefficient was actually 3, which would imply a 6.6% gap. I realize there have been other estimates such as an estimate where the coefficient was closer to 2.5 (implying a 5.5% gap). And if one uses the CBO’s measure of the output gap, which is mentioned in the SF Fed’s survey, it indicates an output gap equal to 5.8%. Even if the coefficient for the output gap is 0.5 – as in Taylor’s 1993 paper – an output gap of 5.8% and an inflation rate of 1% implies negative interest rates. But I guess John Taylor’s latest excuse for criticizing any expansionary stance from the FED is his belief that we are not that far from full employment. Go figure!

A Zimmerman-Martin Thought Experiment

So suppose it was George Zimmerman, not Trayvon Martin, who was shot to death in Sanford, Florida.  Imagine a simple reversal: Martin was visiting the apartment complex, walking along, and realized he was being followed by an older, larger man.  The man got out of his car and started chasing him.  There was a struggle, Martin feared for his life, so he pulled out the gun and shot Zimmerman.  After a couple of days of uncertainty, Martin was arrested and charged with second-degree murder.

And suppose that all the ambiguities of the incident remained the same.  There were no direct eyewitnesses.  A final scream for help could have come from either of them.  Martin claimed that he was underneath Zimmerman, his head bashed against concrete, but this is only a claim.  All we know is that a visiting black teenager shot to death a white community patrol volunteer, and that his defense is that he was “standing his ground”.

How do you think the jury would have decided it?

Carbon Money: A Data Point from Down Under

One of the long running disputes about policies to reduce the risk of catastrophic climate change is what to do about carbon revenues.  Whether you have a carbon tax or auction permits, businesses that get hit by them will pass along their costs to consumers.  That’s a feature, not a bug, since the point is to change the behavior of the entire society, and prices are a better way to do this than a plethora of regulatory directives and a mammoth enforcement machine.

Meanwhile, the taxes or permit fees generate a flow of revenue to the government.  What should you do with it?

Many environmental groups say that it should be spent on environmental programs and energy conservation.  Everyone loves these programs, they say, and they will be so happy about their expansion that they won’t mind the extra cost of paying for them.

Then there are doubters (me among them) who think that this is not a politically viable strategy.  No, outside environmentalist circles most people are not in love with environmental programs and will worry more about their own financial well-being.  Moreover, carbon revenues, like all sales taxes, are regressive: lower income groups will pay a higher percentage of their income, which is a lousy way to fund government programs.  The approach we advocate is giving the money back—having the government rebate carbon revenues on a per capita basis to the public.  This would shield most people from financial losses and turn a regressive system into a progressive one.

This has mostly been a shouting match, since there is little evidence about political sustainability one way or the other.  Nevertheless, we have just had a data point from Australia.  In the wake of an internal Labor Party coup, in which former PM Kevin Rudd ousted Julia Gillard to reclaim his old post, that country’s carbon tax was revoked and replaced with a watered-down cap-and-trade system, expected to slash carbon prices by about 75%.  That’s a pretty good predictor of how much the effectiveness of the program will go down.  (In the current range of carbon prices the elasticity of demand, whatever it is, is probably stable.)  Under the Australian system, carbon revenues were used to fund environmental programs, so these will be slashed as well.  The account of the backsliding published in this morning’s New York Times makes it clear that the motivation was strictly political: a general election looms in September, and public opposition to the tax was crippling the Labor Party’s campaign.

Out of the corner of my ear I hear some greens saying, “But the public was brainwashed!  Right wing interests in Australia spent gobs of money running ads denouncing the carbon tax and making all sorts of false claims!  It isn’t a fair test!”  No, it’s terribly unfair, but in what country do you think business interests will roll over and not fight tooth and nail against aggressive carbon policy?  Have you followed the politics of the European Trading System recently?  And do you think that the Koch brothers will just haul out the white flags the moment the US congress passes a meaningful climate bill (if that moment ever comes)?  The point of having a political strategy is to overcome opposition, not embrace martyrdom.

To be fair, this is only half a data point.  It shows the vulnerability of programs to raise prices and increase environmental spending, at least in the current economic environment, but it doesn’t tell us whether the rebate approach would have worked better.  Maybe they’re both doomed.  Maybe we’re all doomed, and climate catastrophe is unstoppable.  But half a data point is better than none, and I’d like to see more tough-minded thinking from greens about how they want to reconcile the price impacts of carbon policy with political realism.

ephemera

Testimony before Congress of Defense Secretary Georg Wilhelm Friedrich "Chuck" Hegel.

Q: Mr. Secretary, can you tell us how you think the sequester will affect your department?

A: Well, the Owl of Minerva flys only at dusk, if you catch my drift, so I won't be able to say much about that until later.

Q: Mr. Secretary, you've been called an  Idealist. Are you?

A: Absolutely, absolutely.

Q: (Senator Sanders): To follow up, Mr. Secretary: you seem to be standing on your head - Would you mind if I turned you right-side up?

A: Sorry?

Q: Never mind. Could you tell us what your broad strategy for US defense policy will be?

 A: Well, I thought I'd just let Spirit Actualize itself  and go from there.

Q: How much will that cost?

A: I hate to bring the old Owl up again, but I'll get back to you.

Q: Thank you, Mr. Secretary.

A. Thank you. It's been Real, It's been Rational.

The Political Economy of Central Bank Activism

Yet another call for limiting central bank intervention in order to keep up the pressure for “structural reform” in the Eurozone has me thinking about the larger context.

Item 1: This morning I am reading a piece by two Dutch economists arguing for restrictions on the ECB’s promise to support sovereign debt markets (OMT) on the grounds that significant costs in financing fiscal deficits are needed to push reluctant governments to make necessary structural reforms.

Item 2: There have been never-ending demands for the Fed to relent on QE.  The justifications keep changing but the demands remain the same.

I agree with Noah Smith’s hypothesis that the true motivation, or at least one of them, is to not let a crisis go to waste, and to use economic pain as leverage to achieve other goals—a smaller state, less regulation, etc.  This is a strategy that dare not speak its name.  Proponents don’t say “let’s hold governments and populations hostage through austerity in order to force them to pursue a neoliberal agenda”; that would not go over well.  But this is not to accuse them of deceit.  In their own minds they probably see neoliberal reforms as self-evidently beneficial to the point that there is no need to spell them out or argue for them: everyone they know understands that this has to be the solution.  (It’s communicated through adjectives, like the “bloated” civil service, the “unaffordable” welfare state, “rigid” labor markets, and so on.)

But let’s take a moment to think about the mechanism.  Exactly what sort of pressure is envisioned that would override democratic preferences and force governments to cut the safety net, promote greater inequality and take other unpopular acts?  The answer is the bond market.  Governments that defend redistribution and restrictions on the market are expected to be punished by higher interest rates on their debt.  This empowers the creditors, wealthy individuals and institutions, to impose their presumed preferences on democratic majorities.  The great sin of aggressive bond market intervention by central banks to support sovereign debt is that it blunts this instrument, supplying publicly created liquidity when private wealth is skeptical.

From an analytical point of view, there are several questions to ask.  (1) To what extent do the risk perceptions of private wealth-holders accurately reflect the true long run prospects of national economies and their governments?  (2) Do more generous or more regulatory governments face higher interest rates on sovereign debt in general?  (3) What basis is there for the assumption that the economic costs of welfare programs, regulations and other government policies are systematically undervalued in the political process, such that they have to be defended by bond markets?

My guess is that most opponents of central bank activism don’t ask these questions explicitly; they simply assume the answers—that bond markets are rational and make the right calls, that they punish governments that fail to respect the logic of free markets, and that the enemy of “reform” is electoral populism.  You could say that, intellectually, they have simply taken sides.

Burkhardt Shrugged

Montreal Gazette: 

Edward Burkhardt, chief executive officer of Rail World Inc., which owns the MMA, defended the use of a one-person crew during his visit to Lac-Mégantic Wednesday, saying, "We actually think one-man crews are safer than two-man crews because there’s less distraction." .

 One-man crews safer than two-man crews? Dagny Taggart would smile.

"Dagny Taggart Would Smile."

A better way to run a railroad? Altas shrugged:

"The train derailed early Saturday morning, causing explosions and a fire that officials say killed at least 13 people, forced the evacuation of 2,000 residents and destroyed about 30 buildings. In addition, about 50 people remain unaccounted for." -- Globe and Mail

Edward Burkhardt, CEO of Rail World Incorporated, was hailed 15 years ago as an Ayn Randian "achiever" in "A Better Way to Run a Railroad," originally published in the May 1998 issue of the Atlas Society's Navigator magazine:

Inevitably, the success of Wisconsin Central attracted the animosity of those who resent achievement. The vultures were ready to pounce whenever misfortune struck. And they did pounce in the aftermath of a train derailment caused by a broken switch in the small community of Weyauwega, Wisconsin, in March 1996. Thirty-five cars derailed, almost half of them containing liquefied petroleum gas. One car exploded, but the heroic efforts of the train’s conductor minimized the extent of the fire. No one was injured... 

... Over 97 percent of the affected residents and businesses settled with the railroad within months. All but one of the remaining cases were settled out of court.  

But the Wisconsin newspapers climbed all over the railroad, sensationalizing its safety record and operating practices. The politically reflexive Federal Railway Administration picked up the cue, sending a small army of inspectors to the property to examine all aspects of the railroad’s operation. Fines were levied against the railroad, primarily for nit-picking violations of regulations whose impact on safety was questionable. For example, Wisconsin Central had been experimenting with a one-man crew on certain trains, a common practice in New Zealand and Europe. As part of the resulting “agreement” with the FRA, that experiment had to be suspended. Recently, the Wisconsin legislature passed a law prohibiting one-man train crews in the state.

  UPDATE: From the Globe and Mail:

This is not Mr. Burkhardt’s first experience of the disaster of derailment. 

While he was at the helm of Wisconsin Central, a train jumped the tracks at 5:50 a.m. on March 4, 1996, in Weyauwega, Wis., releasing hazardous material that caught fire and consumed rail cars loaded with liquefied petroleum gas and propane. The derailment, according to a U.S. National Transportation Safety Board report, consumed a mill and forced the evacuation of thousands. 

"There were no injuries directly attributable to the derailment, but three persons suffered minor injuries during the evacuation," the NTSB said, blaming the derailment on improper maintenance "because Wisconsin Central management did not ensure that the two employees responsible for inspecting the track structure were properly trained."

Will There Be A Major Chinese Crash?

Maybe. 

We have seen substantial volatility in the past in Chinese financial markets.  In particular the stock markets suffered sharp declines in both 2007 and 2011, with the former large enough to possibly even be called a "crash."  However, neither of these or earlier hiccups and declines slowed the real economy noticeably.  As it is, Chinese real growth has been slowing, which certainly reduces expectations of future income flows from Chinese financial assets.  The stock market has been declining since April, with that decline now more than 20%, the usual cutoff for a bear market.  The question is whether this decline is a period of distress following a peak in a larger scale adjustment that will be followed eventually by a much larger panic and crash that could then feed back on the real economy, slowing it much more dramatically with serious implications for the world economy.

Something that makes the current situation more disturbing is that we are finally seeing this decline  emanating significantly from the financial sector, particularly banking, which has long been known to be riven with corruption and bad loans, with overvalued properties in danger of sharply declining adding to the problems they face.  The peak came in April with a sudden spike of overnight interest rates up to  25%, following a massive surge of broad-based debt.  We know that the Chinese system is different from others and has many powers.  So, they may be able to overcome all this.  But the situation seems much more  dangerous  than previously, with this being beyond the control of the Chinese government authorities.

The depths of  the problems of the financial and particularly banking sector in China is summarized in an amazing sentence from near the end of an article on July 1 in the Financial Times by Robert Chancellor, in a column titled, "China crunch shows financial fragility."  Referring  to how  possible  investors in Chinese bank  stocks might view possible further purchases:

"They may note the  numerous indicators of financial fragility, including excessive credit growth; moral hazard arising from the belief that the state has underwritten all financial risk; related-party lending between state-controlled banks and state-owned enterprises; loan-loss forbearance; de facto financial liberalisation (accompanying the growth of the shadow banking system); extreme asset-liability mismatches created by WMPs [wealth management products] and interbank lending; elevated bank leverage hidden by off-balance sheet exposures; contagion risk posed by undercapitalised credit guarantee networks; and a financial system plaguedby Ponzi finance practices and contaminated with corruption and fraud."

The late Hyman P. Minsky could not have  put it better.

Social Security Stupidity from MoneyWatch

Suppose you wanted to take a couple of months off relying on those funds you accumulated in our savings account? Can you bank tell you that your can’t pay your current bills using the funds in your savings account? Jonelle Marte must think this is right:

“Long-term deficit? We can hardly afford our bills today. … In 2010, the Social Security Administration began collecting less revenue in taxes than it needs to cover benefit payments, forcing the agency to tap its $2.7 trillion trust fund sooner than some had expected. It was the first time since 1983 that expenditures had exceeded noninterest income

With this beginning, you might wonder whether it is worth your time to read the rest of the post. Save your time and don’t bother. I hope Jonelle has saved up funds in a bank that is reasonable as this post was so incredibly dumb – one has to wonder how long she’ll keep her current job. Or am I overestimating the standards at MoneyWatch?

Glenn Greenwald Shout Out to Dean Baker

"So the last point I want to make is that one of the things I set out to do and I think that Mr. Snowden set out to do and that I know the people at The Guardian set out to do was not simply to publish some stories about the NSA. It was to really shake up the foundations of the corrupted and rotted roots of America’s political and media culture. And the reason I say that is that there is an economist Dean Baker, who yesterday on Twitter wrote that he thinks the stories that we’re doing are shining as much light on the corruption of American journalism as they are on the corruption of the National Security Agency. 

"I think that is true for several different reasons. Number one is if you look at the 'debate' over—the charming, very endearing debate over whether or not I should be arrested, prosecuted and then imprisoned under Espionage Act statutes for doing journalism—What you find is that debate is being led by other people who are TV actors who play the role of journalists on TV. They’re ones who are actually leading the debate and the reason they are doing that is they purport to be adversaries of political power or watchdogs of political power but what they really are servants to political power. They’re appendages to political power."

Increases in Certain Price Over the Past Ten Years

Paul Krugman provided us certain information on the price of bread and milk as a reaction to a rant from Erick Erickson:

The rest of America is nervous about where their next meal and paycheck are coming from, how they are going to afford to bail their kids out of crumbling schools, and the price of a gallon of milk and loaf of bread that keep going up though Ben Bernanke tells them there is no inflation.

I’m a little surprised that this rant failed to mention the price of gasoline so permit me to provide a similar chart for that. Paul’s graphs (plus ours) show that these prices are volatile but haven’t had much of an upward trend over the past 5 years. But I guess one could say they have risen a bit over the past 10 years. Mik prices as of May 2013 were 28% higher than they were as of May 2003, while bread prices rose by 40% over the same period. And gasoline prices have risen by 135% over this 10-year period. But let’s break this into the period from May 2003 to May 2008 (a period where Federal Reserve policy wasn’t that expansionary) versus the period from May 2008 to May 2013 (where the Federal Reserve has increased the monetary base substantially). Milk prices rose by 40% over the earlier period and have moderated since. Bread prices rose by 37% over the earlier period with the increase over the past 5 years being just over 2%. Gasoline prices are even more fun given how Republicans tried to argue that Obama has doubled gasoline prices as they focus on the change since December 2008 ignoring the fact that this followed a major dip from its height in May 2008. If we use our 5-year period (May to May), gasoline prices soared by 144% during the earlier period and have basically moderated since. Correct me if I’m wrong but I don’t recall Mr. Erickson complaining about hyperinflation when George W. Bush was President.

The Minions of Marginal Revolution

Pour yourself a cup of coffee (or tea if you're like me), pull up a chair and have a look at the comments to a question posed by Tyler Cowen, "Who is the most influential public intellectual of the last twenty-five years?"  Hint: "intellectual" is interpreted rather broadly.

"Ned" Snowden: Hedge-Levellers, Frame-Breakers and Whistleblowers

In a comment a couple of weeks ago at Juan Cole's Informed Comment blog, Warren Lunsford called Edward Snowden a "Luddite":

In this Snowden disclosures it appears we are finding standard Marketing Science applied to National Security and Federal Criminal Investigations of Enemies of our County. I would think Snowden is a Luddite. Just as a group of early 19th century English workmen destroyed laborsaving machinery as a protest, we find Snowden attempting the same activity against the application of Modern Technology for National Security.

Lunsford was right but for the wrong reasons. There is indeed an important parallel between Snowden's actions and the frame-breaking of the Luddites (as well as the hedge-levelling of the commoners resisting enclosure). But Lunsford got his chronology backward.

The enclosures of the commons and the mechanization of industry were usurpations that disrupted long-established regimes of property and legality. The real innovation here was the criminalization of protest against actions that previously would themselves have been regarded as violations of acknowledged rights.

The law doth punish man or woman
That steals the goose from off the common,
But lets the greater felon loose
That steals the common from the goose.

Nicholas Blomley (2007) wrote about "the consequential and often contradictory role of material objects in producing enclosure" emphasizing "the important work that hedges did, physically, symbolically and legally, in the dispossession of the commoner." I would argue, as did Marx, of course, that machinery performs a similar function of physical, symbolic and legal dispossession of labor power from the worker as does information technology dispossess citizens of their privacy.

This is not to say that machines or IT, any more than hedges, are culpable for the dispossession. That would be to reduce them to their physical aspect alone. Rather it is the interaction of this physical aspect with its symbolic and legal interpretations that resulted and results in dispossession.

The Infernal Errors of Dan Brown

Just finished reading Dan Brown's Inferno while in Italy.  I know I should not bother correcting stuff, but for this book he declares at the beginning, "All artwork, literature, science, and historical references in this novel are real."  So, he is inviting closer scrutiny than in earlier books, where he definitely stretched and invented and distorted lots of books, but avoided such claims.  Here are some errors of fact in this book (which is a fun read anyway, although formulaic).

p. 95: "To this day, modern banks use the accounting method invented by the Medici - the dual-entry system of credits and debits."  Wrong.  It was first used in Pisa where I sit at this moment a good two centuries prior to the Medicis getting into banking. BTW, the oldest continuously existing bank in the world is also here in Tuscany, the now-troubled Monte dei Peschi di Siena, where its HQ still is since it was founded in 1472, which is the period of the Medicis.  [Correction:  Double entry accounting was not invented in Pisa, but in Florence.  However, it was initially done by merchants in the late 1200s prior to the Medici, although they may have been the first to use it in banking.  Brown is not as far off on this matter as I initially suggested.]

p. 96:  "You can't get into the [Boboli] gardens from here.  The entrance is way over by the Pitti Palace.  You'd have to drive through Porta Romana and go around."  False.  From where they were standing just outside of the Porta Romana, southern entrance to Old Florence, there is an entry to the gardens just to their right, a few meters away, not requiring going through the Porta Romana.

p. 103 (and related pages):  A graph of world population is shown starting 2 million years ago, which, with this scale highly magnifies recent growth while not really showing that the growth rate of world population has been decelerating since the mid-1970s.  It is repeatedly declared, including by a character with an IQ of 208, and never questioned, that it is a "mathematical certainty" that exponential population growth is simply continuing at a constant rate with no mention of the slowdown.  It is mentioned that world population might reach 9 billion by 2050.  The latest estimates are that this level might be reached later and might be the maximum world population will ever reach.  Population growth is almost certainly going to go negative before the century is over due to the spread of falling birth rates across more and more countries, which is happening.

p. 106: "If we head northeast, we'll reach the palace."  From where the characters were at that point (having entered Boboli Gardens by jumping over a wall near the southern entrance), the palace is northwest, not northeast.  The error of the location of the palace is repeated throughout the coming pages.  It is on the northwest end of the gardens, not the northeast.

p. 136: an even more ridiculous figure with rates of growth of various variables stuck on top of each other so that they all appear to converge at a point at the right end of the figure.  Some of these are extremely misleading.   Thus, one is the rate of growth of the demand for fresh water.  Yes, that is growing, but the rate of growth of the supply of clean fresh water has been growing more rapidly as a rising percentage world population  obtains clean water.  I will note that some of the variables do reflect real problems, such as species extinction and overexploited fisheries.

pp. 141-142:  He has the Vasari corridor starting at the northeast end of the Boboli Gardens and going east across the Arno River.  It is at the northwest corner (near the palace) and goes basically north and a bit west across the Arno.

pp. 144-145: "A quick Internet search led him to  information about a prominent nineteenth-century mathematician and demographer named Thomas Robert Malthus, who predicted a global collapse dut to overpopulation."  I do not think anybody has ever described Malthus as a mathematician, although arguably he was a demographer.  In any case, besides being a minister, he was the first Professor of Political Economy in Britain, and he did not predict "global collapse."  He did predict ongoing poverty and stagnation due to overpopulation, but not this more dramatic outcome.  That would come with some of his followers, particularly in the 1970s, when this book would have been more timely.

There are numerous repetitions later of the inevitably of  global collapse due to overpopulation, accompanied by such statements as "The mathematics is indisuputable" (p. 214).  Nowhere does Brown ever let any character remotely bring up the numerous well known issues questioning this that are mentioned above.

p. 294: "In the 1940s, Nazi scientists had dabbled in a technology they'd dubbed eugenics..."  The term was invented decades before the Nazis and was highly respected and supported by many progressives in the US and elsewhere.  It was the Nazi embrace of this already dubbed and established eugenics that made it become a disrespected movement.

p. 324: "Architectrually speaking, the word basilica defined any eastern, Byzantine-style church erected in Europe or the West."  The first buildings to which the term was applied were built in Rome during the Roman Empire period, prior to the Byzantine period.  The term moved east initially, and more generally is a church term tied to having a saint buried or strongly associated with the building
[Addition: The first basilica was built in 184 BCE in Rome by Cato the Elder.  They were originally public building located in the forum of a major  Roman city.  Their crucial architectural  detail was the presence of colonnades in the interior to create separate spaces, not a dome, although some do have domes.]

Border Security as Militarized Keynesianism – Outsourced

I think we have found a proposal to increase government purchases that Republicans like:

Leahy said a proposal drafted by Sens. Bob Corker (R-Tenn.) and John Hoeven (R-N.D.) “reads like a Christmas wish list for Halliburton.” The amendment requires implementation and activation of $4.5 billion in technology and equipment to achieve full surveillance of the U.S.-Mexico border. “I am sure there are federal contracting firms high-fiving at the prospect of all of the spending demanded by some of our friends on the other side in this amendment,” Leahy said on the Senate floor. Leahy criticized the GOP-sponsored language for waiving standard federal contracting rules. “That is a potential we must watch out for — for waste and fraud,” he said.

Normally – this kind of largesse for military contractors should be roundly condemned by those who care about fiscal responsibility and/or efficient allocation of resources. But we are far below full employment and this seems to be the only form of stimulus we can expect from the modern Republican Party.