Rethinking Science

Dear Scientists.  I am not one of you.  Or rather, [and this is part of the problem], you will, mistakenly, not think of me as such.  But I have some advice about how you need to go about rethinking what you do.  That you should is self-evident.  Take a look out any window and you will see that your failures are piling up.  No flying cars.  Teleporting.  Free power.  Or perpetual motion.  And many things deteriorate and break down.  Sometimes, I see mud.   Not surprisingly, there is discontent everywhere.  People are dying, even in this year of 2016.  A few weeks ago, my kids were in bed with a cold.  No-one predicted this, and there was no solution in sight.  All this, yet your disciplines carry on.  I say ‘disciplines’ advisedly, since from my perch I can see you scurrying about in your sub-specialisms, without my sense of the big picture.  Sometimes I browse the internet for Science things and I see pages full of equations.  I conclude from this that you are out of touch with reality, and your failings to improve it.  I have my own theory of the universe, gleaned from introspection, and many years living in it.  Soon you can purchase the book length version, or attend one of my lectures.  If any of you are open-minded enough to invite me to talk to you, I will happily appear in your seminar programs.  Of course my suggestions will not look like a conventional academic paper, because, my friends, that you would hope for this is exactly the problem!  If you are not so open-minded, and I strongly suspect you are not, that will again prove that you have a problem.  Perhaps if you spent less time deriving equations and more time studying the history of scientific thought and the sociology of science, we would not be in this predicament, and this earth would now be a land of milk and honey, so to speak.  The other day, I took my large motorbike to be fixed, and I met a man who wielded spanners and chains and oil and, lo, problem solved, and I thought ‘If only we could make a scientist see this!’  There is a painting called ‘The Scream’ [obviously an art history reference will be lost on you, but persevere, it will be good for you] and this is a good metaphor for what you will be faced with if you do not heed this advice to start holding some conferences soon to Rethink Science.

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Guest post at FT Alphaville on India’s demonetization

Link here.  H/t David Keohane for getting me going on this, and putting me right on facts about how many have bank accounts in India.

Me in Times Online on Autumn Statement

Here.  Sorry, behind paywall.

 

Kill two economic policy birds with one stone: more generous, funded transfer payments

Many are fretting, in the face of Brexit and Trump and Le Pen and AFD and Five-Star that economies are doing too little to combat inequality.

At the same time, with global real rates set to be low for the foreseeable future, economies are going to live closer to the zero bound in future, and in the shadow of business and financial cycles that we now realise can be larger than we thought before 2008.

So how about raising effective tax rates and spending them on more generous transfer payments through the social security/insurance system?

This helps inequality, [redistributing from those earning enough to pay taxes to those who are not] and it amplifies the automatic stabilisers, helping out monetary policy at the zero bound in the event of a recession.  The amplification of the stabilisers means that when a recession hits, tax revenues fall by more, the greater the effective tax rate to start with;  and transfer payments rise by more, the greater the replacement ratio used to start with.

Steady-state inequality is eased in two ways.

First, even at its resting point, capitalist economies will separate people from jobs and from the labour force, sometimes permanently. Higher taxes and transfers benefit those thus dumped on the scrapheap.

Second, recessions tend to hit those at the bottom disproportionately.  The automatic stabiliser amplification gives those who lose their incomes more when they do, but the recession itself will tend to be smoothed somewhat, so the income loss for those at the bottom will be less to begin with.  Averaging over many decades, this tendency to provide more income to the jobless, and reduce joblessness in recessions, will help inequality.

 

Helicopter money and QE. Avoiding the fuzzy reversibility problem.

One view of QE – encoded in, for example, Eggertson and Woodford’s 2003 paper, and similar – is as follows.

It comprises two steps, one effective, one redundant.  Step one is the creation of money to buy on the open market a short-dated government bond.  Step two is the trade of that short dated government bond for a long one.  If interest rates are at zero, but expected to be positive later on, step one may have an effect, but only if it induces, via some appropriate communication, lower interest rates out into the future.  If rates are zero and expected to be so forever, step 1 is redundant.

Step 2 is debt management, and exploits what central banks sometimes refer to as the ‘portfolio balance channel’.  Mark Carney called it that today at Treasury Committee.  And he also alluded to the fact that the ‘monetary channel’ as he termed it was not why QE worked.  We might presume he was thinking along the lines I’m sketching here.

The fuzzy distinction between helicopter money [HM] and QE comes about due to using Step 1.  But central banks can, and did sometimes, skip step 1 and simply swap short for long dated gilts.  The Fed did this explicitly in one round of QE, calling it ‘Operation Twist’ after a similarly named episode in the 1960s.

If central banks had always skipped the redundant Step 1 [you can always lower future rates using forward guidance], there would never have been any doubt that this was QE rather than helicopter money.  Indeed, it would have been better not to use the term QE at all, but stick to ‘debt management’.  I don’t recall anyone ever screaming at debt managers that they were doing helicopter money.

Doing it this way would also get round what one person who commented privately on my blog pointed out is a bit inconvenient for central banks.  Central banks are already talking [see Jackson Hole, for example, or also words by Mark Carney and Ben Broadbent] about the fact that the balance sheet size might not shrink back to what it was before the crisis.  This might not look good next to the promise that QE would be reversed, and the religious fervour with which they have said HM should be avoided.

If the portfolio balance channel had simply been exploited with debt management, there would have been no such fuzziness to worry about in contemplating a larger central bank balance sheet after the crisis.

However, you ought to be saying ‘not so fast!’  Suppose we consolidated debt management inside the central bank [it was in the UK until 1997].  And then allowed the central bank to do the issuing of the short debt which was used to get the funds to buy the long debt.  In the standard monetary version of the New Keynesian model, this is satisfyingly distinct from helicopter money.  Short term debt is not money.  But in the real world, things might not be so clear-cut.

But if there was a chance that the real world was like the model world, you might ask – why if the Bank of England, for example, thought that Step 1 [create reserves to buy short debt] was redundant, [what Mark Carney today implied] did they do it at all?  In his defence, he was inheriting a precedent set by the MPC under Mervyn King.  In early communications about QE, he and his MPC took a different view of the monetary channel.  Although subsequently the emphasis was slowly dropped.  And implementing ‘debt management’ in an orderly way, and on a sufficient scale, might have been impossible without this being done by the Debt Management Office.

[PS voice recognition software gets better the more you use it.  RSI sufferers take heart:  Even if you can’t do real work, you can still play.]

Helicopter money: are they doing it anyway, and, if so, so what?

One way to implement helicopter money is to have the government finance a tax cut or a government spending increase, with a conventional bond issue, and have the central bank buy the bonds with newly created electronic money.

During the post-2008 recession, tax revenues fell, government spending [in the UK, at least on transfer payments] and bond issuance rose, and central banks bought government bonds with electronic money.  A lot of them.

This policy was called ‘quantitative easing’, not ‘helicopter money’ because it was the first leg of a two-leg policy, where the second leg would involve reversing the bond purchase down the road after the economy had recovered.  But half way through, the two policies are indistinct.  ‘They’ might be doing helicopter money anyway, even though it’s called ‘quantitative easing’.

Are they doing helicopter money anyway?  And if they were, what would we infer from whether we should?

There seem to be several varieties of the argument.

One is they are doing helicopter money anyway, so they should jolly well come clean about it and stop hoodwinking the people.   And if they did, the policy would be more successful in boosting the economy.  QE involved a smaller stimulatory bang for the buck, the buck being a risky intermingling of monetary and fiscal institutions.

Another variation on the argument, that I heard recently, was that they might be doing it anyway, and that shows that if they did do it explicitly, we would not expect any magical extra stimulus to follow.  So best leave central bank policies as they are.

Yet another is:  since when we do QE, we will look like we are doing helicopter money anyway,  we shouldn’t do QE at all’.  This argument was circulating inside central banks at high velocity as it became clear that central banks were going to run out of interest rate cuts and something else would have to be done.   Evidently, it was set aside as central banks went ahead with QE regardless.

Central banks’ retort is:  a helicopter money plan is clearly delineated from a QE plan by the fact that it involves only one leg, not two, of the QE policy, ie a transaction that is never reversed.

But this delineation is only as good as the ability central banks have to tie their hands in the future to reverse the bond purchases, thus finally revealing with certainty that the policy was QE and not HM.  Since that might involve tying the hands of different people who succeed the current decision makers as Governors and voting members, such certainty is not possible.  Knowing this, QE is unavoidably somewhat HM-like.

But by the same token, a bond purchase that was determinedly announced as HM would be unavoidably QE-like: subject to a possible reversal down the road when a more conservative central banker takes over.

Where do I come out on all this?

I think that there is some possibility of influencing the guess that people have about whether QE is reversed at down the road.

Committees don’t turn over completely each period, so quicker reversals can be executed more reliably than slower ones.

New members are likely to find the reputation for promise keeping of some value to themselves – perhaps to distinguish a new round of QE from HM, or vice versa! – so they won’t feel entirely unbound.

And the separation between the policy could be encouraged – if not entirely guaranteed – by the finance ministry, or a third party body that scrutinises the central bank [in the UK, the Treasury Committee, say].  And I say ‘not entirely guaranteed’ for the obvious reason that we can’t expect the fiscal authority to discipline itself to limit monetary financing, precisely the reason why there is often legislation that attempts to rule it out.

Since there’s hope that the two can be delineated, QE should be the first resort at the zero bound, [well, after plain bond financed fiscal policy, that is] and HM the last.

[Inspired by slide-show I saw recently that I can’t attribute as it was given under Chatham House rules].

Central banks’ desire not to use QE as the marginal tool of adjustment, their exit and entry plans.

The plan for unwinding central bank QE, at least as stated by the Bank of England and the Fed, is that asset sales won’t start until the recovery has got to the point where sales won’t have to be reversed.

That means waiting until the recovery warrants interest rates being raised sufficiently far above the floor that any need to loosen again can be achieved by lowering rates, rather than restarting QE.

The reason for this was that central banks did not want QE to be the marginal tool of monetary policy.  Partly because of worries that stop-start-reverse sales would disrupt bond markets, and partly because of the extra uncertainty in using QE relative to the more tried and tested interest rate tool.  [Though one might contest this relative statement since there is much debate about the effectiveness of very low interest rates near their floor, and we have accumulated experience with using QE].

The curious thing about this exit plan, in retrospect, is that it suggests an apparent inconsistency in the way that asset purchases were used on the way in.  If central banks had really wanted to avoid QE being the marginal tool of stimulus, they ought to have bought so many assets that it was possible to keep interest rates sufficiently far above the floor that the interest rate tool could subsequently be used to fine tune, as news about the economy evolved.  [You might ask:  isn’t this just what the BoE did, keeping rates at 0.5%?  No, is the answer:  that floor was chosen as the point at which the monetary policy committee then judged that further cuts would be contractionary rather than stimulative, because of their effects on bank balance sheets, a point revised down subsequently.]

Past policy can be justified by noting that there were also serious concerns about the credibility of central bank policy with bloated balance sheets, so they had to weigh balance sheet size against avoiding using QE as the marginal tool [though I don’t recall this argument being made back then].  But in future, now we know that QE does not make the world fall apart or lead to hyperinflation, if the ‘marginal tool avoidance’ argument survives at all, it can be applied symmetrically.