What the left hand buyeth, the right hand issueth

Roger Farmer has a great post showing how the maturity composition of outstanding US debt lengthened as the Fed embarked on its program of buying long dated securities.    As Summers reportedly put it, while the Fed was engaged in quantitative easing, the Treasury was doing ‘quantitative contraction’.  And surely the two arms of government should be better coordinated than that.

A few points.

The first thing to note is that what we saw doesn’t necessarily imply that the US Treasury was shifting its behaviour in order to scupper what the Fed was doing.  Its mandate to get value for money when selling debt could well imply a maturity composition of issuance that means the proportion of long-term debt brought to market rises as the term premium falls (the relative price of long-term bonds to short-term bonds rises).  So it’s conceivable that that issuance pattern amounts to running on autopilot.  In order for us to substantiate that the Treasury obstructed the Fed actively, we’d have to detect a shift in the historical relationship between the term premium and the composition of issuance.

In the UK, the Debt Management Office, an agency of the UK Treasury, and separate from the Bank of England since 1997, undertook not to change the pattern of issuance away from what would have been the case in the absence of QE.  One might have hoped for this strict form of cooperation in the States too, if you were a QE supporter.  But doing that would involve a shift in behaviour, forgoing ‘value for money’ considerations in debt sales that would lead to maturities being sold into parts of the curve where demand was strongest.  The DMO/BoE might have expected QE to reduce the term premium (especially once purchases were shifted away from the essentially neutral maturity composition of early rounds) and this would normally prompt the issuer to take advantage.  It will be interesting to see whether the DMO can be judged to have kept to this promise.  With such an extended program of purchases, I don’t see how such a promise could be evaluated.  How would the DMO or any similar agency know what it would do such a long time ahead?

Regardless, it’s also conceivable that Fed plans were not thwarted in their attempt to achieve a certain amount of stimulus through quantitative easing.  If the Fed understood the unchanging or even changing maturity reaction function of the Treasury, their purchases from the open market could be calibrated accordingly.  So long as we suppose that there are no costs associated with tilting the Fed balance sheet to compensate for the extra Treasury twisting, the Fed could do whatever was necessary to achieve its goals.

Note that some like Vissing-Jorgensen and Krishnamurthy question whether lowering the term premium through QE is a good thing at all.  They document that private yields were not materially lowered by QE.  And describe how purchases of long-term debt imposed costs by depriving the markets of a safe store of value with duration.  For these authors, even if the Treasury had been trying to frustrate the Fed, they would surely be saying ‘two thumbs way up’, since the policy would have relieved society of a costly shortage.

Some might balk at calls for coordination between the two arms of government for fear that it corrodes the independence of the central bank in its conduct of monetary policy.  These calls are not entirely vacuous, since histories of the Fed in the 1960s and 1970s seem to conclude that the Fed regularly subordinated itself.  But here what is being asked for – regardless of its rights and wrongs – is for the Treasury to subordinate itself to the Fed.  The reverse of what is usually feared.  If that were achieved (presuming it hasn’t been already) it does not follow that the Fed would have to reciprocate in some other way.

‘Monetarists’ of sorts may scoff at all this debate, arguing that this is all of second-order importance.  What matters, they might say, is how much the balance sheet expanded in line with the corresponding creation of central bank reserves.   For them, the composition is just a detail.   Of course, concerning oneself solely with total issuance and total purchases leads to a related question about co-ordination, even subterfuge, and one that certain political factions have pushed, namely, whether the Treasury’s total issuance rose because of QE, or vice versa.   However, I personally lean towards the view espoused by Woodford and others in several papers, which is that the monetary expansion part of QE is essentially redundant, no different in effect from forward guidance, and that the only independent stimulus is to be got by the twisting of maturities, or the risk transfer from private to public.  Under this view, the effects seen of quantitative easing could have been got by the Treasury issuing very short-term debt in order to take back longer term debt.

What this debate and the ambiguities in resolving it make clear is that some institutional refinement is in order.  Appropriate coordination needs to be hard-wired into the debt management function and into monetary policy, not currently in place in either the US or the UK.  My involvement in QE on the inside at the Bank of England convinced me that all parties were determined to do the right thing.  But that British kind of solution to this new (or is it old) problem is probably not the best one, because it allows composition or quantity conspiracy-theorising to live on.

Advertisements

The FT and the undergraduate economics curriculum

Another post in quick succession, brought on by realising that my Bristol train is too jiggly to do algebra or write code, which I am supposed to be doing right now.

This responds to a thoughtful and thought-provoking FT leader on how economics should be taught in the light of the financial crisis, tweeted (and I am guessing written) by Giles Wilkes yesterday. And follows another post I wrote a while ago about the putative course on panics and bubbles, that Manchester university wisely chose not to incorporate into its curriculum, offering instead my own sketch.

A few reactions.

First, the leader diagnoses the state of the profession, in failing to apprehend the impending crisis, from the content of undergraduate courses. I think that’s connecting dots a long way apart. Influential people in the profession comprise the very top, mostly US academics, and policymakers. Many of these now have PhDs. Many that came into economics PhD courses did so from other undergraduate disciplines. [And probably did better as a result, because of those disciplines higher maths content.] Others long since left their undergraduate courses, whatever they were, behind, with long practical on the job training in central banking, finance, and just getting stuff done. If there is a problem with undergraduate teaching, it’s that it struggles to reflect the depth of thinking at the academic frontier and the rich interplay between that frontier and the practical wisdom of policymakers. (Exactly what Wendy Carlin’s great new textbook attempts to redress). But one cannot put the crisis down to the content of undergraduate courses in some dim and distant past.

Second, the leader draws a contrast between the increasing mathematical elegance emphasised in economics, and the ugly, chaotic, timeless-ness reality of the real world. I don’t agree that this is a good contrast. For me, ugly reality demands more, harder maths, not less. The little interaction I’ve had with bio-informatics, evolutionary theory, engineering and physics would suggest to me that other disciplines reveal the same lesson too. Which leads me to an addendum : students on these other courses would snigger at the complaints economics students make about the maths they are put through, which are typically at a much lower level of difficulty than that demanded by these sciences.

Third, the leader mentions Rajan’s premonition of the crisis at Jackson Hole. Rajan, in my view, is as hard-core as they come with regard to the mathematical, microfounded rigour demanded of economics. Just take a look at his published papers, or the courses he taught. He was not the heterodox, informal sociological thinker dismissed by a maths-bound consensus. If one wanted to caricature the consensus he was battling, it was against i) policymaking based on ill-thought-through platitudes that markets are always good and self-correcting and ii) a segment of academia influential with central banks that had chosen to ignore mathematically tricky finance and, freed from that onerous task, chose to burrow ever deeper into the details of finance-absent optimal monetary policy questions.  [I have to admit I was in that camp].

Fourth, the leader encourages us to think that we should get more heterodox thought into undergraduate courses. A note of caution from me: most, but not all, of what I have encountered is not much better than pub talk, and, being so informally worked out does not yet amount to anything that could be judged a coherent alternative to the so-called ‘mainstream’. (Which I put in quotes to re-emphasise I point I made in my last blog on this, that the mainstream is itself incredibly diverse).

Fifth, a thought about the difficulties facing undergraduate economics course designers. One of which is that it caters for those who intend to take the subject further, for those who want to use it as a ticket into some other walk of life (and probably also for those who chose it by default or mistake but can’t change track). For those who intend to take the subject forwards to MSc and PhD level, then further, deepening their knowledge as a practitioner, commentator, or researcher, there is a lot to learn, and a lot of it is a hard slog best begun early. Material on the sociology and history of economic thought, on the wilder flowerings of dissident corners of the subject, political economy, can be and probably is devoured in the bath by most people bitten by the economics bug, and they won’t need more than the occasional ‘have a read of this’ from their tutors to do it. For those who use the econ course as a ticket to some other walk of life. I wonder how they would be served by a more informal and heterodox curriculum. Once you have covered the economics of regulation and competition; the debates about the causes of business cycles and how to avert them; the economics of banking and finance; empirical economic methods, is there any time for anything else? Many of the customers for economics undergraduate degrees are also highly quantitative: financial and business analysts; actuaries; management consultants. I suspect that a more informal and heterodox course would lose students who were headed in this direction. For others who are interested in political economy, to take them into a life in the media, or politics. Well, study political economy!

Sixth, points on incentives.

Note that by far the dominant factor in the academic labour market is publications. This is what determines promotion and/or job offer prospects, because this is what determines the departments’ rank in the Research Excellence Framework, which in turn is what determines important marginal funding for universities.  Continuous innovation and  change in the curriculum is hard to achieve when it is in most academics’ interests to labour most arduously at their own research. (Which is why efforts like those of Wendy Carlin, which are an externality to me and my peers, are so helpful).

Another incentives point: Although I have not been in the business long, it seems also to me that course content at the most introductory levels is dictated by hard-to-dislodge equilibria in the major textbook market. Core course content is decided by what the famous academics who chose to write a low-level textbook decided should be in those courses.   When looking to which course they will take, students know that what they perceive to be good courses elsewhere follow these textbooks, and expect their own university to follow suit. Jumping away from these norms is a business risk for departments worried about nurturing their brand.

A competing constraint is how universities recruit and retain their teaching staff. The economics undergraduate curriculum is being debated as though it were part of a national schools curriculum.  But it isn’t. Part of the attraction of teaching at this level is that you get the chance to choose what to teach and how to teach it, particularly in the later years of the undergraduate degree where it seems the market pressure from the leading textbooks is weakest.   There’s no mechanism for stamping uniformity on national course content, and even if there was, doing it would persuade many doing the teaching to do something else with their time instead.  If anyone forces me to teach heterodox macro, I will be off, for sure!

When we give [our taxes to the central bank] how much do we receive?

This post repeats a gripe I had after Bank of England Governor Mark Carney spoke at the ‘inclusive capitalism’ conference, ranging over matters of economic and moral philosophy on which I contended he was not hired to talk.  On 9 September, Andrew Haldane, the Bank’s Chief Economist, gave a speech on the economics of volunteering, entitled, ‘in giving, how much do we receive‘.   As always with his work, it was a great and thought-provoking read.

Speaking off topic isn’t all bad.  Perhaps doing stuff on volunteering or the ethics of capitalism can do something to differentiate the central bankers from the bankers,  to diffuse the impression that all people who work in finance are money-focused nutcases.

But.  There are some downsides.

Reason 1.  If there is a finite time for the national consciousness to devote to the economics of volunteering, perhaps that should go to the lead thinker who specialises in that area.

Reason 2.  Comparative advantage again.  Even if, let’s say, Andrew was the lead thinker in volunteering, since there is a finite amount of Andrew Haldane work effort, that should be spent on what he is best at, namely, talking central banking.  One speech on volunteering is one less on monetary or financial policy strategy.

Reason 3.  There’s an offsetting risk to the ‘cuddly BoE’ benefit of talking about things like this.  Which is that people wonder:  ‘hang on, didn’t we pay this lot to try to think about how to fix the financial system?  What are they doing spending their time freelancing on third sector economics?’  Extreme analogy:  the David Cameron Cornwall wetsuit picture, or the George Bush golfing videos.

Reason 4.  This is a delicate time for monetary and financial policy strategy and communication thereof.  Shouldn’t the BoE’s top employees be solely focused on refining the messages, about the first interest rate rise, about QE exit and debt management, about the FLS, about Help 2 Buy, about macro-pru?  Isn’t the modern science of messaging about careful repetition and refinement?  If so, isn’t talking off topic going to confuse and distract?

 

Even devolving balanced-budget tax and spend powers is tricky

Phew.  Or, wait?  What economic form is devolution going to take?  I blogged before that there was an argument that devolving borrowing powers out to component states would weaken the speed and force with which discretionary fiscal policy could be used to stabilise the macroeconomy, an especially important tool when we are at the zero bound to nominal interest rates.  A natural question arises:  well, what about devolving balanced budget tax and spend powers, then?  Isn’t that ok?  If the Federal government needs to do discretionary borrowing and taxing later on top of these local taxes, won’t that  work?  This would allow great differences in the size of the state in Scotland versus England, for example.  Scotland could set much higher taxes, and spend more on education and health.

I’m not sure this can work either:  even balanced budget tax and spend powers would have to be proscribed.  To take an extreme example.  Imagine Scotland sets taxes right up to its Laffer limit, the point at which any further increase in taxes levied there would raise no more money, and would just shrink the tax base.  (I’m not accusing the Scots of wanting to do this.  It’s just an example).  In that case, although the Federal government could in principle borrow and spend to stimulate the economy at the zero lower bound, it would find that its borrowing costs were higher on account of the Laffer-maximising balanced budget policy in Scotland, since markets would know that there was no scope for paying the debt back out of that part of the UK’s tax base.  And, when it came to pay the debt back, that would wind up being paid out of taxes raised in the rest of the UK, which (just for argument’s sake) I’m assuming has a smaller state, with a tax base ripe for raising funds.  This would not be fair, since it places the burden of fighting recessions on a part of the Union only.  And it would limit the fiscal room that parts of the union with the smaller welfare states would have to do the recession fighting, leading to a choppier business cycle, and a greater chance of hitting and becoming trapped at the zero bound for all.

Devolving balanced budget tax and spend powers also limits risk sharing.  Following through the extreme example above, a boom in a Scotland which spends the increase in taxes and stays at the Laffer limit prevents redistributed flows away from Scotland to pay for a recession in England.  I see this as a terrible cost of fiscal localism.  But some local nationalists seem to celebrate it.

 

Salmond’s QE grab

I read on Faisal Islam’s twitter feed that Alex Salmond had suggested on Sky to Adam Boulton that the SNP should get its rightful share of the gilts bought under the QE program by the Bank of England.  This prompted an exchange between finance gurus Frances Coppola, Dan Davies and Eric Lonnergan.

A QE grab would be nice for a newly independent Scotland.  Take a share of the gilts, and when they mature, the Treasury pays them out of RoUK taxes!  Lovely-jubbly, as one TV character used to say.   I’m sure the RoUK government would not accept that.  As things stand, when the gilts mature, the Treasury pays out money to the Bank (in fact it does so all the time on account of the gilts’ coupons).  But, remembering that the Bank is part of the public sector, this is really just one part of the public sector paying itself.  Salmond’s proposal, taken on its own, would lead to the UK government paying out not to itself, but to another government.

How could this be dealt with fairly?  One way would simply be to unwind QE before Scotland sets up its own currency.  Another would be to financially engineer a clean split of the BoE’s balance sheet.  When it sets up its own currency, Scotland takes away 1/10th of the debt stock, but the Scottish Central Bank takes 1/10th of the gilts on the BoE’s balance sheet.  The gilt contracts would have to be rewritten so that when maturing, the SCB gets a payment from the Scottish Treasury.  (Nothing would be rewritten presumably, but new liabilities would be set up to make this happen).

It’s easy to get blinded by thinking about reserves and cash and confusing things like that, when trying to fathom the fairest division of the ‘spoils’.  The only really significant thing about QE is debt management.  Exactly the same effect could have been achieved when embarking on QE by the DMO issuing lots of very short-term Treasuries and swapping them for longer term gilts in the market, tilting the private sector portfolio away from longer term gilts.  (In fact, this could still be done, by the consolidated public sector ‘swapping’ the reserves that were created for short-term debt.)  Then, Alex Salmond would simply be saying:  ‘can we inherit 1/10 of the share of the new, slightly shorter term portfolio of government debt liabilities please?’  Oh, well, I guess he would not be shouting about that!  It’s the artifice of the Bank holding the gilts, and them being a result of electronic reserve creation that fuels the sense that there could be a fair profit to make.

[The Bank itself might not agree with this, at least if their early communication about the importance of expanding the money supply, or their educational material about pumping or injecting money into the economy are to be taken at face value.  But this part of QE is hot air in my view.]

Salmond’s financial sophistry is akin to the SNP’s consistent message that, in exchange for taking their share of the debt, they should get a ‘share of Sterling’, as though it were an asset, and not a club with a set of rules the SNP want to free themselves from.

That said, to be fair, the UK Government has engaged in its own naughtiness over QE, appropriating the coupon payments from QE to make its own public finances look healthier than they really are.  The presumption is that those flows will be reversed, so that the Bank of England can ultimately reverse QE itself and restore its balance sheet to (something like) its former state.  But the fact that the funds were taken in the first place for no reason than massaging the accounts did not bode well for that.  The latest protracted undershoot of the inflation target, while very unwelcome and worrying in itself, has the fortunate side-effect that it works against suspicions that dangerous mixing of monetary and fiscal matters could be the harbinger of debt monetisation and inflation stealth.

Project Fear, or Project Stop Them Having Their Cake and Eating It?

The effort to get supermarkets to explain that they will probably raise prices in an independent Scotland, and to get Banks to make plain their plans to redomicile into the Rest of the UK, has been dubbed, seemingly successfully, ‘Project Fear’.  The same idea has been used to describe the effort to describe the economic realities of independence.

But I see it differently.

It would be pretty strange if the banks stayed silent in the run up to the referendum, refusing to comment on Better Together speculation that they would redomicile, fuelling the Yes campaign’s scorn of their forecasts, and then to redomicile anyway after a Yes vote.  If that’s what had played out, the Yes would have been won on false pretenses.

Likewise, wouldn’t it have been almost dishonest if the supermarkets had kept their own post independence pricing strategies to themselves, until it was too late and votes were cast?

In fact, if you think about it, these organisations’ silence about their intentions for so much of the campaign, leaving it so late, is odd.  I would call that silence Project Have Your Cake and Eat It.  Here the cake is ‘appearing cool, exploiting a bit of Scottish localism to boost the brand, feigning neutrality about the whole thing, especially when it seemed like there was no chance of a Yes win’.  And this cake was being had, and eaten, in the sense that all the while there were clear strategic plans in the event of independence, based on the bottom line only, with not a thought for the welfare of the Scots, or English, or anyone, in fact, unsurprisingly, simply for the benefit of their shareholders.

Hence, if the Government and HMT were involved in ‘Project Fear’, I’d think it was better named ‘Project Stopping Them Having Their Cake And Eating It’.

 

Devolved borrowing would create the same mess as giving Indy Scotland a currency union

This hurried post, that I would have liked to think about much more carefully, is prompted by the all-party promise for more devolved powers for Scotland, in the event of a ‘No’ vote, and also the provocative paper put out by the National Institute for Economic and Social Research by Angus Armstrong and Monique Ebell.

I don’t think that we should be offering Scotland devolved powers to borrow independently, incurring deficits and running up debt.  Doing so risks creating the same eurozone style mess that would result if the Rest of UK offered a newly independent Scotland a currency union without fiscal union.

First, such a system would create what is known as the ‘tragedy of the commons’.  The name refers to the situation where individual farmers have an incentive to overgraze common grass land with their cattle, collectively ruining the land.  It’s not in the interests of any one farmer to behave better, because doing so won’t encourage the others, and they will simply get less grass themselves.  Fiscally, overgrazing means overborrowing, taking advantage of the protection of the Federal authorities and the central bank that they sponsor.   This might not be a big deal, because of the much greater size of England relative to others (as Armstrong and Ebell point out), but it would still be unfair on the English.  And, who knows, perhaps it would be an existential problem.  The eurozone was hobbled by three tiny states (Greece, Ireland and Portugal), and the contagion it fed to larger ones.  Whatever problems are caused in this way could be eliminated by establishing credible central institutions that promise not to bail out one of the individual countries in the event that they get into difficulty.  But trying to set up such institutions from scratch is not easy.

Second, the crisis has taught us that the old way of doing macroeconomic stabilisation – having fiscal policy on autopilot, letting monetary policy do the work – isn’t adequate.  As Simon Wren Lewis and others have argued, nimble, discretionary fiscal policy IS needed, and urgently so, in the event that the economy encounters the zero lower bound to interest rates, where conventional monetary policy tools can do no more.  Devolving the power to borrow will weaken the fiscal room and coordination power retained by the centre to enact a powerful fiscal stimulus.  We won’t be able to rely on the individual fiscal units to borrow and spend separately, because it may not be in all their interests.  Witness the sorry tale unfolding in the eurozone, with those governments that don’t need a fiscal stimulus for their own economies (eg Germany) naturally reluctant to implement one for the benefit of the euro area as a whole.  Unconventional ‘monetary policy’ tools used by central banks don’t offer a way out of this problem because they involve the central bank taking large fiscal risks that have to be underwritten by the central government.  (This is why German ECB board member Weidman is against the ECB’s planned purchases of private securities).  Such underwriting requires that adequate fiscal ‘room’ to bail out the central bank if needs be is maintained.  And for me that rules out devolved borrowing.

Third, devolving the power to borrow inhibits risk-sharing, as Adam Posen argued powerfully in his article imploring the Scots to vote ‘No’.  ‘Risk-sharing’ sounds like a technical detail, a piece of financial arcana.  But it’s not.  It goes to the heart of what the public sector is for:  rule for dishing out resources to the unfortunate, funded by the fortunate.  Huge, slow to materialise risks like longevity uncertainty combined with defined benefit pensions;  quick to materialise risks like natural disasters or financial crises, or conflicts:  devolved borrowing weakens mechanisms to channel funds from the lucky to the unlucky people in the UK, and at a time when there seems to be a lot of risk about.

UK political parties have (rightly) ruled out offering a currency union to an independent Scotland, calculating (I think correctly) that the Scots would not accept, or be able to follow through on the fiscal promises required to make that viable.  For the same reasons, I hope that the devolution promises made today don’t entail much in the way of powers to borrow (we can’t tell yet).  Because if they do, they would risk creating the same mess that the curency union they won’t offer would entail.  Whatever the heartbreak, separation would be better than setting up an ineffectual fiscal federation.