EconTalk

Posner on the Financial Crisis

Mon, 16 Nov 2009 06:30:00 -0500

Richard Posner, federal judge and prolific author, discusses the financial crisis with EconTalk host Russ Roberts. Posner (despite the title of his recent book on the crisis, A Failure of Capitalism) places most of the blame for the crisis on the Federal Reserve, inattentive regulators and the subsidization of risk. He also criticizes economists for complacency in the face of impending disaster. A recent convert of sorts to Keynesianism, Posner confesses some disillusion with the implementation of the stimulus plan and the expanding role of the Federal government.

Play

Time: 1:03:20

How do I listen to a podcast?

Download

Size: 29.0 MB

Right-click or Option-click, and select "Save Link/Target As MP3.

Readings and Links related to this podcast

Podcast Readings HIDE READINGS
About this week's guest: Richard Posner's Home page The Becker-Posner Blog A Failure of Capitalism: The Crisis of '08 and the Descent into Depression, by Richard Posner at Amazon.com. A Failure of Capitalism. Posner's blog at the Atlantic. About ideas and people mentioned in this podcast: Articles: "How I Became a Keynesian: Second Thoughts in the Middle of a Crisis," by Richard Posner. The New Republic, September 23, 2009. "Monetary Policy and the Legacy of Milton Friedman," by Anna Schwartz. Cato Journal, vol 2, Spring/Summer 2008. "Externalities," by Bryan Caplan. Concise Encyclopedia of Economics. "Government Debt and Deficits," by John J. Seater. Concise Encyclopedia of Economics. John Maynard Keynes. Biography. Concise Encyclopedia of Economics. Milton Friedman. Biography. Concise Encyclopedia of Economics. Gary Becker. Biography. Concise Encyclopedia of Economics. Podcasts and Blogs: "Keynesian Economics," by Russ Roberts. Cafe Hayek. John Taylor on Monetary Policy. EconTalk podcast. Sumner on Monetary Policy. EconTalk podcast. Milton Friedman on money. EconTalk podcast. Podcasts on the Financial Crisis of 2008. EconTalk podcasts. Higgs on the Great Depression. EconTalk podcast. Rauchway on the Great Depression and the New Deal. EconTalk podcast. Nye on the Great Depression, Political Economy, and the Evolution of the State. EconTalk podcast.

Podcast Readings

About this week's guest:

Richard Posner's Home page
The Becker-Posner Blog
A Failure of Capitalism: The Crisis of '08 and the Descent into Depression, by Richard Posner at Amazon.com.
A Failure of Capitalism. Posner's blog at the Atlantic.

About ideas and people mentioned in this podcast:

Articles:

"How I Became a Keynesian: Second Thoughts in the Middle of a Crisis," by Richard Posner. The New Republic, September 23, 2009.
"Monetary Policy and the Legacy of Milton Friedman," by Anna Schwartz. Cato Journal, vol 2, Spring/Summer 2008.
"Externalities," by Bryan Caplan. Concise Encyclopedia of Economics.
"Government Debt and Deficits," by John J. Seater. Concise Encyclopedia of Economics.
John Maynard Keynes. Biography. Concise Encyclopedia of Economics.
Milton Friedman. Biography. Concise Encyclopedia of Economics.
Gary Becker. Biography. Concise Encyclopedia of Economics.

Podcasts and Blogs:

"Keynesian Economics," by Russ Roberts. Cafe Hayek.
John Taylor on Monetary Policy. EconTalk podcast.
Sumner on Monetary Policy. EconTalk podcast.
Milton Friedman on money. EconTalk podcast.
Podcasts on the Financial Crisis of 2008. EconTalk podcasts.
Higgs on the Great Depression. EconTalk podcast.
Rauchway on the Great Depression and the New Deal. EconTalk podcast.
Nye on the Great Depression, Political Economy, and the Evolution of the State. EconTalk podcast.

Highlights

Time	Podcast Highlights HIDE HIGHLIGHTS
0:36	Intro. [Recording date: November 2, 2009.] Indict capitalism for the crisis; book came out in May; forecast the worsening of things at the time. What is the source of the problem. Wouldn't say capitalism indicted in the book. Failure of the governmental institutionalism of capitalism: Federal Reserve and the regulatory system controlling financial business. Need that. Argue in book: Banking is an inherently risky business; have to have regulatory controls and a Central Bank that controls the money supply, interest rates, and so on. All part of the capitalist system, not just markets. Property rights, Central Bank. Totalitarian and socialist systems have worse problems but they don't have this particular problem of a banking system that can go awry. Real problem, one problem: unsound monetary policy by the Federal Reserve system in the early 2000s. Cheap credit, too much money. Interest rates fell very dramatically. Fed fooled by the fact that there wasn't much inflation as measured by the Consumer Price Index (CPI). But there was inflation--particularly in houses, other real estate, and the stock market. Asset price inflation, particularly in housing, creates a great danger for the economy because houses are bought with debt--80% mortgage, sometimes 100% mortgage. When you have a housing boom, the banking system becomes very heavily involved in housing, financing the boom. If the boom turns out to be an inflationary phenomenon, a bubble that just bursts, you can bankrupt the whole banking industry. That's essentially what happened. What reinforced the problem was that the regulation of the banking system, which is very fragmented in the United States, was just not up to the task of identifying these risks. The Federal Reserve, the Securities and Exchange Commission (SEC), and so on, just didn't realize that there was a risk of a housing bubble that might burst; and didn't realize that over the last several decades there has grown up a large banking industry, referred to as a shadow banking industry, of companies that do what is functionally banking but they are not regulated as banks--broker/dealers like Merrill Lynch, Lehman Brothers--they've all disappeared in one way or the other, become absorbed in other things--borrowing their capital and lending it. Didn't have Federal Deposit insurance. Were regulated by the SEC, which was very lax and doesn't understand banking. Great regulatory gap, which interacted with the low interest rates which were pushing the banks into more and more housing financing. Unsound monetary policy; lax regulation, regulatory inattention; and finally a very complacent economics profession which was lulling everybody to sleep by saying there's never going to be another depression, and if there's a recession the Federal Reserve can cure it painlessly, just lower interest rates which stimulates economic activity. Turned out last fall that that didn't work.
6:41	Focus on the regulatory inattention. In book, forceful argument against people who claim that investors who were irrational or myopic, yet seem willing to put that picture on regulators. Starting about 2002, increasing in 2003 and 2004, increasing voices talking about the nature of housing prices being unsustainable. Why was it regulators' who are blamed as inattentive--why not the people who financed those investments? Seems like it was excessive risk-taking by capitalists, who are being portrayed as rational. How do you square that? Their risk-taking wasn't excessive ex ante: if you are a financier in 2003-2006 even, you see that there is tremendous demand for loans for houses; very profitable because interest rates are so low and you can borrow very cheaply in order to meet this huge demand. Now you know that of course there's a risk that there could be a big dive in housing prices and you're broke. Being told by the Federal Reserve and economists that there's no housing bubble; housing prices are rising because of fundamental factors of supply and demand and will continue to rise as long as it's a good investment. As businessmen, they knew they could be wrong. Taking a lot of measures like securitization to minimize risk. Can't be in business without taking the risk of bankruptcy. The problem is what's a risk of bankruptcy for an individual bank or individual broker/dealer can through this chain reaction effect that we saw last fall can bring down the whole economy. Responsibility of the regulators is to say to these banks: you're taking risks which are rational in terms of your goals, but you are creating a risk that you don't really care about because it's not a risk to your shareholders but to the whole economy. That's what you have regulation for. If businessmen thought it was their job not to take risks that would endanger the global economy, then you wouldn't need regulation. But businessmen just worry about their own company. Like pollution: We don't expect businessmen to worry about pollution because the pollution affects other people, not their business or consumers--maybe people a thousand miles away, acid rain. Business is profit maximization, not environmental protection. Same with banks. Their business isn't systemic risk, global economy, depressions. They'll take risks as long as they are being paid more than the expected cost of the risk.
11:25	Puzzle: there is an externality; but in the case of pollution, all the costs are borne by the people downwind. Business can avoid those costs. In the case of financial institutions, many of them were wiped out or should have been. Moral hazard problem: If you thought you might be bailed out, you not only had an incentive to ignore the externality, you had an incentive to increase it. Sure, but no different from pollution. If you are paid to pollute, you are going to pollute more. Suppose you have pollution that actually does affect your own workers; but government says it will pay their medical costs. Question is: rational and profitable to make risky investments, always a question of the tradeoff. Regulatory failure: if you tell banks they can do whatever they want and will get bailed out, it's perfectly rational for them to take more risks. Whatever environment the government creates, the businessmen will adapt to that environment. Doesn't mean they won't make mistakes. Responsibility for creating the environment is the government's responsibility, which they failed to discharge. Lumping together two types of regulatory failure. One kind is not regulating them enough; the other is encouraging them. Big difference, both in historical valuation and prevention in the future. Don't see the difference. Can have stupid regulation because it's terribly lax or stupid regulation because it actually subsidizes foolish activities. Community Reinvestment Act (CRA), Fannie Mae, Freddie Mac--don't think they contributed critically. No question that the CRA, 1977, strengthened during the Clinton administration, Fannie Mae, Freddie Mac borrowed at low rates because they were assumed to have informal backing by the government--encouraged subprime mortgages. Regulatory encouragement of stupid behavior. The other is the failure to control the externalities that private behavior can create. Both regulatory failures. Going forward: set of prescriptions based on those failure? If correct that the basic problems were unsound monetary policy, regulatory inattention, and complacency on the part of the economics profession, all relatively self-correcting. John Taylor, Taylor Rule, simple rule for what the Federal Reserve should set interest rates, Federal funds rate. Supposed to look at a few factors. Taylor observed that in the early 2000 period, the Fed was greatly deviating from that rule. Taylor wanted it to be rising; Fed held it at 1% for three years. Fed should pay more attention to the Taylor Rule. Don't need a new institution; they just need a reminder that they need to worry about bubbles, have to be smarter. Obviously they are now alert to this problem. In the case of regulatory laxity: for commercial banks, Wachovia and City Group, the Fed, the FDIC, and the Comptroller of the Currency have all the powers they need; all they have to do is be more alert; ask, "What is this thing called a mortgage backed security?" Off balance sheet liabilities, credit default swaps: be more alert. Maybe we can't trust them to be more alert. Paul Volker has suggested that banks should not be allowed to engage in risky conduct, shouldn't be allowed to have divisions that engage in proprietary trading. That would be a structural reform; complicated; worth considering. Off-balance liabilities: create special investment vehicles in which to park these risky assets and don't show them on their balance sheets; the derivatives that they trade, credit default swaps, are off-balance sheet contingent liabilities--hard for the examiners to find out what the real financial situation of the bank is. Maybe all those liabilities should be put onto the balance sheet. Lots of little things that can be done. Focus argument: If the commercial banking industry is insulated from this high risk type of financial activity, then if the high risk people go bust again at least you have a safe commercial banking industry as a kind of backbone of global finance.
20:47	Won't be much of a backbone if they are not doing anything risky. Crucial question: What kind of shadow banking system do we want? Used to be called investment banks. Already doing the same stuff. If we don't get rid of too big to fail, very different to be confident that those banks will be prudent. Does the bailout of those banks reinforce the risk-taking? If you have an implied promise to save these companies because of either their size or their critical interconnections if in a position to cause a chain reaction, then you have to worry about that. What's happened is that as a result of the events of last fall, the big 5 investment banks all vanished. Lehman Brothers went broke; Bear Sterns and Merrill Lynch were acquired by banks; Goldman and Morgan Stanley converted to bank holding companies. J.P. Morgan Chase is a real bank [i.e., not an investment bank). The other four all regulated now by the Federal Reserve; so the Fed now has the shadow or investment banks under its wing. Once you are under the Fed's regulatory control, their examiners have complete power over you. Hedge funds and insurance company funds aren't under the Fed and yet have vast resources and take a lot of risk. Apart from that, in the years to come, there will be new kinds of institutions: what to do? They will fall automatically under the regulatory control of the SEC, which historically had no interest; but now, after the huge failure last fall, good new director, trying to create a culture and procedures and expertise to control the systemic risk that a large investment bank could impose. Not sure we can do much more beyond that.
24:54	Underlying or proximate causes of the crisis: Leverage was a huge part of it. When housing loans were requiring 20% down, there was not much of a problem. What role did the erosion of that play? Why did it erode? Not going to blame irrational exuberance. Why did lenders get so careless about requiring skin in the game? If house prices are rising, there is no reason to be as cautious in lending. If you are confident they will rise at a rate of 5% a year. If you lend someone a 100% mortgage, in four years he'll have a 20% equity. When prices are rising, you have low default rates; if someone gets into trouble, he doesn't abandon the house and have it foreclosed on. House prices had been rising for a long time; and kept rising. Bernanke and distinguished economists said it was permanent: rising population; restrictions by local zoning authorities limiting amount of land available for building new houses--indefinite price increase. There were people warning against it, but consensus view was that it was a very healthy market. Consumers want to get in on it--two houses--bankers catered to it. Greenspan, icon of fiscal rectitude, in early 2000 saying that he thought people should be getting adjustable rate mortgages--but that's risky. Especially when the rates are artificially low. Government failure. Next question would be: in many of these markets, the bottom third of housing in some cities was rising at double-digit rates starting in the mid- to late-1990s, well before Greenspan was holding interest rates artificially low. Those who argue for the cause being irrational exuberance, animal spirits, saying people just decided prices were going up. In the book, you reject that mania of crowds kind of argument. Why was that appreciation going on, given that the fundamentals turned out not to be true? Believe in bubbles; but don't think buying in a bubble is irrational. Ex post it was stupid; but inside, don't know when it's going to end. But what gets it started? The low interest rates. The big expense in buying a house is the mortgage, so if interest rates go down, a house is much more affordable. Supply can't increase fast enough. At some point it becomes self-sustaining because the prices kept rising even after mortgage rates rose. You see prices going up, so you say to yourself that other people are saying that prices are going to continue to rise and you don't want to miss out. Universal. As soon as the stock market started rising in April, read the newspapers; experts saying it's time to get on the bandwagon. Rational exuberance--didn't coin the term. Still need an explanation for why it gets started. Bubble started expanding in the 1990s, not the early 2000s. But the rate of increase was greater in the 2000s. Not so sure. Depends on the market. In some cities, very little appreciation and very little collapse. In other cities, enormous appreciation in the early 1990s. Story is yet to be told what role government played. Doesn't matter. Even if interest rates in the early 2000s didn't have much effect the Fed, if it had spotted the bubble, could have burst it by raising interest rates. It didn't. That's the great failure.
32:34	That's not the way the book is being received. Being received as a recanting of Chicago free market economics. It is to a certain extent. Complacency of the profession: the belief that Greenspan, the great free market guy, Ayn Rand fan, that he had squared the circle; that he had by low interest rate policy managed to stimulate the economy but avoid inflation. That's a tremendous error, due in part to overconfidence in conservative economic policy--not even good economics. Even Chicago economists know there is such a thing as an externality. Can't just say that these bankers are intelligent and clearly are not going to take excessive risks. Of course if there is enough money in it they will take risks that are excessive from the overall economy's standpoint. Golden parachutes. To say that what makes perfectly good sense for the bankers makes perfectly good sense for the economy as a whole is a tremendous mistake. A bit unfair to Milton Friedman who is gone and can no longer defend himself to say that it is Chicago-economic trusting in Greenspan's discretionary ability to fine tune the economy. About half of Friedman's career was a monument to the dangers of Fed discretion. He has always argued--book with Anna Schwartz--that the Great Depression would have been just a recession if it hadn't been for monetary policy by the Fed. Theory. Bernanke and Greenspan: all you have to do to avoid economic trouble is when the economy slows down, make sure you don't reduce the money supply--which is what the Fed did in 1930. What happened last fall, September, when the financial collapse occurred, monetary policy proved to be totally ineffectual. Fed had begun reducing interest rates in 2008 realizing there was a problem; right after September 15 they pushed it way down, and pushed it down to zero with no effect. Why do you say with no effect? The banks now have $1 trillion in cash. When you force down the Federal funds rate, you get unlimited cash reserves for banks. What you don't get is lending. That's the great Friedman mistake. Disagree. True that there's not much lending; agree that they are holding excess reserves; but part of the reason is they are being paid. Scott Sumner podcast. Banks were paid to hold those reserves; Fed mitigated the impact of that. Not mysterious. The fix the Fed has gotten itself in: if the federal funds rate is zero, no bank will lend to any other bank because that's the secured interbank lending rate. We don't care about that. We do care about that because banks need to borrow reserves in order to make loans. The fear was that the interbank lending would completely close. By paying interest on the reserves the government encouraged the banks to hold onto reserves so they could do some lending. The problem would be that if you couldn't make any money lending, you wouldn't lend--you'd just buy Treasury bills. But you don't just lend to each other--banks lend to businesses. Critical question is would they lend to new businesses; they are worried about the future, so certainly anxiety and can accept the fact that banks were being more cautious, and they should be--but two things are important. First, the federal funds rate didn't go to zero, but to ¼ percent. Second, Milton Friedman's legacy: Friedman never advocated the federal funds rate. But he advocated things like deflation: the Fed should reduce the money supply every year by a fixed percentage. Ingenious but academic moon-gazing. The notion was that because you don't earn interest by holding cash, you hold a suboptimal amount of cash. Disfavor holding cash relative to other safe securities because you don't get any interest on cash. But if you have deflation, then the cash comes to be worth more in time. Utterly unworkable. Why? If it were expected it wouldn't be a big deal. Chaos. Another Friedman idea: instead of having the Federal Reserve you would have a fixed rate at which the money supply would expand. Not an entirely bad idea. If we'd had that we mightn't have had this recession. But if you have that and the economy does get into trouble, and you don't have a central bank, then you can be in really serious trouble--no flexibility to deal with an emergency. Crucial question is whether most emergencies are caused by that flexibility or by other causes. Crazy to say you are going to eliminate the Central Bank. Like planes without pilots--if you really trust your machinery.
43:31	Recent article on Keynes; read the General Theory, probably the best summary of Keynes ever written. A lot of debate as to what Keynes really meant. Keynes has come to mean a certain set of things which are convoluted enough. Still troubled by it. Idea of government stimulus as a way to get out of the mess in the short run. Are you in favor, and on what grounds? In favor of the principle, beginning to wonder about the execution. Simplest way to think about it is that suppose you have a situation where people are afraid, banks are afraid, and there is a tremendous amount of hoarding. The amount of currency in the economy has increased a great deal. The sale of safes has boomed; people are keeping a lot of cash in their houses; the banks are hoarding. The amount of cash held by non-financial businesses has increased substantially. Also a lot of personal savings--more in personal bank accounts. The money is not being used to buy things in the economy. The government can borrow it and put it to work. That's the theory--substitute public demand for a terribly impaired and fearful private demand. People will be happy to lend to the government because the government isn't going to default. Perfectly good theory. Problem is, number one, the tendency is to institute these programs too late. This $787 billion stimulus should have been enacted last fall; instead it didn't get enacted until February 20, 2009; and now it turns out that because of governmental red tape it moves very slowly; and many of the expenditures are stupid and don't do anything. Want to use the money to put people to work. Don't want to use it to give them tax breaks because they may decide to hoard that stuff. Cash for clunkers program--give people money to buy a car. Some would have bought a car anyway. A lot will buy a car earlier--just moved consumption up by a month. Program was in August; in September a tremendous drop in purchases. Even if more purchases, you are purchasing from dealers' inventories. Don't get any production or hiring until they put in orders to replace those inventories. If they have swollen inventories, it may take a very long time before any rehiring of auto workers. If most of the stimulus is going to be spent next year in 2010 when the economy is recovering, then you have serious inflation problem. Principle makes sense. Some stimulus efforts in the 1930s. Germany and Japan recovered quickly from the Great Depression because they poured money into military expansion, which can be quite an effective stimulus. Puts a lot of people to work; drafting people reduces unemployment. Timing is critical, design of the program is critical. Don't think we've done a good job.
49:37	Theory behind it. Taping this early November 2009; stimulus plan passed in February. A grand total of $120 billion of the $787 billion has been spent so far; two thirds of the $120 billion has been spent by the Department of Education, Labor, Health and Human Services. Not shovel ready projects. The Department of Transportation has spent all of $4 billion. Isn't surprising that a lot of construction workers are not finding their way back into the workforce. Theory and the Keynes article, you correctly pointed out, Taylor analyzed: in March or February of 2008 when George Bush was still President, he signed a set of tax rebates--$168 billion. Everyone concluded they were too little, way too small; market-oriented economists said they were rebates rather than changing incentives. Much of that was saved. Saved for rational expectations reasons--people anticipated future taxes--or for Keynesian reasons, animal spirits, hoarding. If we spend $120 billion, or $200 billion if the stimulus had been rolled out more quickly, the people who receive it are going to have the same incentive to be cautious about the future. They Keynesian multiplier isn't going to kick in any more via government spending any more than it would via the central bank pouring money into the economy. The distinction is between transfer payments and investment. If the government just borrows money and gives it to people, whether it is in the form of a tax rebate or tax credit or unemployment benefits or health benefits, then people may save a great deal of it, especially if they think it is a one-time thing. Genuine contribution by Milton Friedman: there is a great deal of evidence that people tend to save what is called transitory income--windfalls, non-recurrent incomes. If their permanent income increases--e.g., job promotion--then they adjust their standard of living and spend more. If it's just a windfall, win $100 in a casino, you are likely to save it rather than adjust your standard of living. The part that is saved doesn't do the economy any good. There is still a problem of what's spent, because what's spent is retail, which doesn't lead to any more employment. You bought it from the store's inventory. Maybe they'll replace it, but until then there won't be any more employment. The other problem is that the consumption expenditures people make when they receive these windfalls has no relation to the problems of the economy. The problems are centered in particular industries, like construction--very high level of unemployment in construction and manufacturing. About half of the lost jobs since December 2007. Varies across states. The idea was to get people to work. Roosevelt in 1933 created the Works Progress Administration (WPA) and the Land Conservation Corps. Within months they had hired millions of people--to do some painting and cleaning the sidewalks, not necessarily productive but put people to work. What we do now is bleak and not as effective. Increase in output in the third quarter is due in part to the $120 billion. What role did Roosevelt or the war play in the recovery? Open question. We don't have a consensus.
56:20	Expansion of discretion in the economy by central government--obviously in the banks, and in areas not covered before: Special Master for executive compensation, role of the government in the auto industry, continued role of government in distorting the housing industry. What are your thoughts on where we are heading for the balance between government and centralized/decentralized decision-making? Does the Constitution have anything to say about it? No--things have changed so much since the 18th century, and really the Supreme Court has written a pretty blank check to the government. You never know. Supreme Court in the 1930s. Very unhealthy shift in the line between government and business. In particular, actually acquiring government control of General Motors (GM) by the government taking a majority stock interest very unsound. Similarly taken over Fannie Mae and Freddie Mac and AIG--these are really government companies. Essentially control City Group--owns about a third of the stock; throws its weight around with all the large banks. Compensation stuff. Also enormous increase in government expenditures--health care industry. These deficits will lead either to very high taxes, or to inflation or devaluation to try to wipe out the national debt. Worrisome about the current administration--and not a party thing because we saw the deficits surge during the Bush administration--the political system is extremely hospitable to expansions in government and extremely reluctant to finance them, so enormous borrowing. Not clear it's sustainable. Talk about the administration being serious about the deficit, but there don't seem to be any concrete plans for doing anything. If the national debt is entirely internal that's one thing, but 45% of the public part of the national debt is owned by foreigners. We're dependent on foreigners to finance our federal government and we're paying enormous interest costs every year to foreign governments and foreign investors; drain on American wealth. On track to continue growing unless we default; with inflation we would reduce the burden but weaken our standing with regard to the dollar as a reserve currency, which is a very profitable for our country. Might discipline future governments from borrowing so extensively. Powerful interest groups like the elderly who just want their benefits now and have tremendous political power. Co-blogger Gary Becker might suggest that the elderly care about their children, which might mitigate some of it, maybe.

Posted by Russell Roberts at http://www.econtalk.org/archives/2009/11/posner_on_the_f.html.

Sumner on Monetary Policy

Mon, 09 Nov 2009 06:30:00 -0500

Scott Sumner of Bentley University and the blog The Money Illusion talks with host Russ Roberts about monetary policy and the state of the economy. Sumner argues that tight money in late 2008 precipitated the recession. He argues that the standard measures of monetary policy--growth in reserves or the Federal Funds rate--are misleading. Sumner suggests focusing instead on nominal GDP. He argues that the failure of the Fed to counter the drop in nominal GDP in late 2008 intensified the recession and points to the growth in unemployment. Along the way he discusses the Taylor Rule and other monetary prescriptions.

Play

Time: 1:09:02

How do I listen to a podcast?

Download

Size: 31.7 MB

Right-click or Option-click, and select "Save Link/Target As MP3.

Readings and Links related to this podcast

Podcast Readings HIDE READINGS
About this week's guest: Scott Sumner's Home page The Money Illusion. Scott Sumner's blog. My views on money/macro, by Scott Sumner. The Money Illusion. About ideas and people mentioned in this podcast: Books: The Purchasing Power of Money, by Irving Fisher. Discussions of MV = PT. On Econlib. The Theory of Interest, by Irving Fisher. Interest rates and intertemporal exchange. On Econlib. Articles: "Monetary Supply", by Anna J. Schwartz. Concise Encyclopedia of Economics. "Monetary Policy", by James Tobin. Concise Encyclopedia of Economics. "Inflation", by Lawrence H. White. Concise Encyclopedia of Economics. "Interest Rates", by Burton G. Malkiel. Concise Encyclopedia of Economics. "The Influence of the Rate of Interest on Prices", by Knut Wicksell. On Econlib. "Monetarism", by Bennett T. McCallum. Concise Encyclopedia of Economics. "Keynesian Economics", by Alan S. Blinder. Concise Encyclopedia of Economics. "National Income Accounts", by Mack Ott. Concise Encyclopedia of Economics. "Consumer Price Indexes", by Michael J. Boskin. Concise Encyclopedia of Economics. "Gold Standard", by Michael D. Bordo. Concise Encyclopedia of Economics. Podcasts and Blogs: Macroeconomic Disconnects and More Scott Sumner, by Arnold Kling. EconLog discussions of Sumner's thought. John Taylor on Monetary Policy. EconTalk podcast. Meltzer on Inflation. EconTalk podcast. Milton Friedman on Monetary Policy. EconTalk podcast. Boettke on the Austrian Perspective on Business Cycles and Monetary Policy Pete Boettke. EconTalk podcast. More EconTalk podcasts on Money and Monetary Policy

Podcast Readings

About this week's guest:

Scott Sumner's Home page
The Money Illusion. Scott Sumner's blog.
My views on money/macro, by Scott Sumner. The Money Illusion.

About ideas and people mentioned in this podcast:

Books:

The Purchasing Power of Money, by Irving Fisher. Discussions of MV = PT. On Econlib.
The Theory of Interest, by Irving Fisher. Interest rates and intertemporal exchange. On Econlib.

Articles:

"Monetary Supply", by Anna J. Schwartz. Concise Encyclopedia of Economics.
"Monetary Policy", by James Tobin. Concise Encyclopedia of Economics.
"Inflation", by Lawrence H. White. Concise Encyclopedia of Economics.
"Interest Rates", by Burton G. Malkiel. Concise Encyclopedia of Economics.
"The Influence of the Rate of Interest on Prices", by Knut Wicksell. On Econlib.
"Monetarism", by Bennett T. McCallum. Concise Encyclopedia of Economics.
"Keynesian Economics", by Alan S. Blinder. Concise Encyclopedia of Economics.
"National Income Accounts", by Mack Ott. Concise Encyclopedia of Economics.
"Consumer Price Indexes", by Michael J. Boskin. Concise Encyclopedia of Economics.
"Gold Standard", by Michael D. Bordo. Concise Encyclopedia of Economics.

Podcasts and Blogs:

Macroeconomic Disconnects and More Scott Sumner, by Arnold Kling. EconLog discussions of Sumner's thought.
John Taylor on Monetary Policy. EconTalk podcast.
Meltzer on Inflation. EconTalk podcast.
Milton Friedman on Monetary Policy. EconTalk podcast.
Boettke on the Austrian Perspective on Business Cycles and Monetary Policy Pete Boettke. EconTalk podcast.
More EconTalk podcasts on Money and Monetary Policy

Highlights

Time	Podcast Highlights HIDE HIGHLIGHTS
0:36	Intro. [Recording date: October 30, 2009.] Critical of monetary policy for the mess we are in. Different perspective. What went wrong and when? Divide up the crisis into two parts. Initial part when subprime mortgages became a big issue in late 2007 played out as most people think. Economy slowed down a little bit up until about August 2008; no damage to the broader economy. Where people went wrong is in underestimating the impact of monetary policy made after August 2008: highly contractionary in the only definition that makes any sense. A couple of ways of looking at monetary policy. A lot of people are surprised by hearing that monetary policy was contractionary: didn't the Fed cut interest rates to low levels? Very misleading indicator of monetary policy. In the 1930s, the Fed also cut interest rates to low levels, but today most economists think monetary policy was highly contractionary in the Great Depression. Some people point to real interest rates; but those actually rose sharply in the last half of 2008. Others point to the monetary base--the money actually printed by the Fed--and that did almost double late in the year; but really two reasons why that's not a good indicator. One: when interest rates get to really low levels, people tend to hoard cash. During the Great Depression, the monetary base rose sharply in the early 1930s, yet monetarists like Friedman and Schwartz still regard monetary policy as being highly contractionary. In addition the Fed started paying interest on bank reserves in October 2008, and that explains much of the increase in excess reserves. The traditional indicators are not very reliable. When we look at those, even though on the surface they look expansionary--the low interest rate and the huge increase in bank reserves that the Fed injected into the system: is the argument that velocity--the rate at which people are spending the money--is what dropped, out of either anxiety, uncertainty about the future, caution, the low interest rates. Is that the fundamental mechanism by which these seemingly expansionary moves were relatively ineffective? Yes, velocity did drop; reasons complex. As economy slowed, the Wicksellian real or natural interest rate fell to a very low level. That would be the interest rate that would provide equilibrium in the economy. As interest rates fall, people tend to hoard money more--the demand for money rises. Also, there is financial uncertainty. Money is a safe liquid asset. There was a huge increase in uncertainty about where assets were headed. What people overlook is that monetary policy is really about adjusting the stance of policy to reflect changes in the economy. The reason why Friedman and Schwartz argue that monetary policy was contractionary in the early 1930s despite the big increase in the monetary base and the decrease in interest rates is that the Fed adopted a contractionary stance relative to what was needed. So their actions didn't prevent the broader money supply from falling, or prices or nominal GDP from falling sharply. Monetary policy should not be focusing so much on interest rates or money supply but rather setting a policy stance that's expected to produce on-target growth in aggregate demand. What happened is the Fed adopted a contractionary policy relative to what was needed to keep aggregate demand growing at its normal rate, which is about 5% a year over recent decades. Defining that as the total dollar value of spending in the economy, or nominal GDP. Instead of growing at a normal rate of 5%, it actually fell at a rate of about 2% a year after about 2008. Monetary policy was too contractionary relative to what was needed to offset the falling velocity.
6:07	Talk about terminology. Most people come to macroeconomics, realizing it or not, as Keynesians. In our cultural blood. Aggregate demand--Keynesian idea, need to keep spending up. Contrast that Keynesian story with the story of Irving Fisher, early 1900s. Fisher, and later Milton Friedman, use a simple framework for thinking about money--an accounting identity, that MV=PT. That is, the amount of money, times the rate at which it's turning over equals aggregate activity--PT, sometimes PY, where T or Y equals transactions and P is the price level applied to those goods and services. MV=PT, MV=PY. Have to be equal. If we see PY falling, either because there is deflation, with P going down, or Y going down, that is real economic activity, we want to offset that with M going up, to make sure economic activity stays the same or continues to grow. How does that relate to the Keynesian idea? Or is it the same idea? In a way it is the same idea, but the two schools approach a lot of the surrounding ideas differently. If there is a drop in MV or a drop in nominal spending, PY, that's essentially a drop in aggregate demand in the Keynesian language. Where they differ isn't so much in their views about the proximate cause of a recession. Both the Keynesians and monetarists believe that not enough nominal spending is the proximate cause of a recession. Where they differ is what's causing that to occur. The monetarists put more weight on failures of monetary policy; the Keynesians put more weight on consumer pessimism, sitting on their wallets, animal spirits and have doubts about whether monetary policy can actually fix that problem. Third perspective, Austrian perspective. Problem: in both stories, a similar element of animal spirits. In Keynesian [Russ accidentally says "monetarist" here] story, it's that people get nervous, sit on their money, don't spend it; government has to step in and spend more. In the monetarist story, it's people get nervous, velocity goes down, they don't spend as much, and government has to step in and boost M. So in the monetarist story, boost M; in the Keynesian story, boost Y or some measure of real spending. A little misleading. Keynesian story is actually about trying to get nominal spending up. The question about whether that increase in nominal spending results in more real output or more inflation is, according to the Keynesian model, a function of where we are on what's called the aggregate supply curve. If at full employment, get inflation, if there is excess capacity, unemployment, mostly get real output growth. Both talking about driving nominal spending higher. Keynes would admit that if you are at full employment and you do that you are probably going to get inflation. The monetarists are more pessimistic about likelihood of increasing real output; think inflation is relatively more likely outcome. In the 1960s and 1970s, monetarists gained ground because it seemed like the Keynesian policies just resulted in inflation. But those are differences in how they interpret the parameters. Fisher, Friedman, and the Keynesians all have demand-side models of recessions; different from real business cycle or classical models.
11:42	Current situation or historical interludes like the Great Depression. What caused the post-August 2008 contraction? Complex: depends on how you look at it from a policy point of view. Can either look at it as velocity going down being the cause, or as the Fed failing to react to that as they should have with a more aggressive monetary policy. For the previous 25 years, the Fed had been offsetting changes in velocity with changes in the money supply in order to keep nominal GDP growing at 5% a year on average. That's the Great Moderation, which suddenly ended in late 2008; Fed allowed nominal GDP to fall sharply below the trend line; we're about 8% below where we should be if they had continued that policy. Because of that decline, real output fell as well--hard for the economy to adjust in the short run to a nominal shock. Play Keynesian for a minute: A Keynesian would respond that's all well and good. You're saying the Fed was insufficiently aggressive in responding to this contraction even though they doubled the nominal base and even though they pushed interest rates down to a quarter of a percent--they had nothing left. Keynesian would say: we have to turn to government spending to get the economy going again. Response: Most economists don't pay much attention to what the Fed is doing. Yes, they increased the monetary base, but they instituted a policy of paying interest on reserves explicitly to prevent inflation from getting out of control. James Hamilton, Bob Hall have talked about the policy. They bribed banks to hold onto the money instead of moving it out into the economy. In one sense, you can say that's understandable--if you double the money supply, you will get hyperinflation. But how can you say monetary policy is ineffective if they were instituting a policy to prevent it from being too effective. Why did they do that? Their explanation is slightly different but comes to the same thing. Said they wanted to keep control on interest rates. Recall that when they did this, interest rate targets were still at 2%. When they flooded the banking system with reserves, this would have normally driven the Federal funds rate down to zero immediately in the free market. But they wanted to keep their target rate at 2%. So they had to pay banks to hold onto the reserves, not lend them out, to prevent the excess reserves sloshing around from driving interest rates immediately to zero. What should they have done? Should have let interest rates fall to zero immediately. It was obvious at that time that we were going into a very severe downturn; Fed was very slow to react to that fact. They were backward looking in their policy. We had just gone through a high inflation blip--remember the high oil prices--pushing the headline rate of inflation up to 5%. But by September and October the economy was deteriorating and oil prices were plunging; all the forward looking indicators suggested that inflation and real growth were going to come in way below the Fed's targets. Like driving a car down a road steering by looking through a rear view mirror. Instead should be looking forward.
17:19	Is it possible that they were too focused on interest rates and worried if they pushed them down to zero, not only is there an inflation worry but we'll have lost our last piece of ammunition in our fight? Strange fear, but possible. Strange: we're not going to do what we need to do in an emergency because we won't have the ammunition to do it some time later. To play the Keynesian--qualitative easing--of course we have to turn to government spending because monetary policy is impotent. Tried increasing reserves; when you finally pushed interest down further, you had nothing left. One more example for inflation hawks. Joan Robinson, a real strong Keynesian, argued back in 1938 that the German hyperinflation couldn't have been caused by easy money because interest rates weren't low. Today: that's an absurd argument. But we are making the same argument. Look at other examples; set an explicit target; constrain Fed by rules. Hayek also thought it should be nominal GDP. Quantitative easing: Talk about what tools the Fed has available--fancy term for creating more money even when interest rates are low. Focus on interest rates is a red herring. Three tools and three steps. First would be to stop paying interest on reserves, and if necessary have an interest penalty on excess reserves so that banks don't hoard the reserves. If that's not enough to increase aggregate demand, can do quantitative easing, putting more cash out into the economy by buying government bonds--bonds that are on the balance sheets of banks or even held by the public. Fallacy of composition: what's true for the individual is not true for the group. If you put a lot of cash out into people's pockets, typically they don't want to hold all their assets in the form of non-interest-bearing cash, so they'll try to get rid of it. As individuals they can do that, but as a society we can't; so the attempt of everyone to get rid of all these excess cash balances will drive up aggregate demand. That's the fundamental principle of that underlies basically all of monetary economics. When we say aggregate demand--and also dollar value of GDP--when that grows 5% it could be a 5% increase in prices with an unchanged real standard of living; or it could be a 5% increase in our real standard of living and prices are constant. Confusing because there is something else going on along the way, for example, in the middle of a recession or doing fine or over-expanded and will get more inflation. Would be a misinterpretation to think that by the Fed injecting money into the economy it will get the economy to grow. It's not going to be real growth necessarily; could just be inflation. Trick to understanding macro is to juggle two balls in the air at one time. One is the long-run classical model, that our real growth is determined by real factors like population growth, technology, productivity, free markets. The other is that in the short run, the fluctuation in nominal GDP that wouldn't make any difference in the long run will affect real GDP in the short run. Nominal shocks like changes in the money supply can have a short-run impact on real output until wages and prices have fully adjusted. That shock could come from a Fed mistake or an unexplained change in behavior by consumers/investors. Can't control real growth in the long run, so let's have growth in nominal GDP that would keep inflation low. Using 5% in blog, which would be about 2% inflation and 3% real growth. Perhaps it should be lower; but need some kind of stable long run policy. What about the business cycle--the short run? To minimize that, should have nominal GDP grow at a relatively stable rate. If there is a sharp change in nominal GDP growth, in the long run it will only affect inflation. But in the short run it can create a business cycle--either too much output, an overheated economy, or a recession if too little nominal spending. Hard to say whether money affects real growth or not. In the long run it doesn't. Nominal growth that's expected--already priced into wages and prices--doesn't have any real effect. It's the unexpected shocks that matter.
25:21	Unexpected. If everybody knew that prices were going to grow at 2% a year, everybody would factor that into interest rates. Value of the money changing hands a year from now goes up. Inflation would be irrelevant; deflation would also be irrelevant. People have this bizarre fear of deflation; unusual in our lifetime. If everybody understood that prices fell 2 or 3% a year, they would factor that into wage expectations, their borrowing and interest rates. Where you get real effects is when outcomes don't mirror very closely your expectations. If I lend you $1000 and expect to get $1100 back, and prices are stable; if suddenly prices went up in a way that wasn't anticipated at the time of the loan, those swings in reality versus expectations discourage economic activity. If they are anticipated, those nominal changes are relatively unimportant. In a normal post-war recession quite often inflation slows to a level less than expected. In 1982, bad recession even though inflation 4%, but it was much lower than the expected 10% that we had been having. Caused a lot of unemployment. This time around, went from mild inflation to mild deflation; hurts employment if wages are slow to adjust. But this recession we had a problem we didn't have in the 1982 recession--went into it with a fragile banking system devastated by the subprime crisis. With an unexpected deflation, also, it is hard for people to repay loans. Also had the debt crisis get much worse because people had borrowed money anticipating the inflation we had, but instead prices started falling in 2008. One additional point: better to look at this process from the perspective of nominal GDP rather than the perspective of inflation. Inflation figures are very inaccurate; also, nominal GDP can be thought of as the nominal dollar income that the public has to repay their debts. It's the total command over resources. So, by the middle of this year people's nominal income, including corporations and the public was about 8% below what it would have been to follow the usual trend. People had about 8% less dollars to repay their loans with than they had anticipated. What was originally half a trillion or trillion dollar mortgage crisis spread to many other kinds of debts, including industrial loans, better quality loans. Most not due to original bad lending practices but secondary effect of falling nominal GDP. This is what the Austrians call a secondary deflation. The first crisis described the start in late 2007; Austrian term is malinvestment--too many houses, too big houses. Secondary deflation made the problem much worse; same as in Great Depression. If you are just looking at news it kind of looks like it was one big problem. Can see this in terms of the U.S. housing market--just a few states. No decline in most other states at all. When nominal GDP starts falling, it affects the whole economy. Housing prices started falling in states like Texas which had avoided the whole initial problem.
33:08	Clarifying question: Made the observation that it's difficult to measure prices as a whole--consumer price index (CPI), etc. Attempt to create a basket of goods is very challenging. Example from blog: consumer price index in the middle of this year, core inflation still up about 1%. Looked at components: housing almost 40% of the core inflation. The government claimed housing prices were up 2% between mid-2008 and mid-2009. That's because of the peculiar way they measure. Implicit rent: government tries to figure out what your house would rend for. They don't look at the market or housing prices, which have been falling. But people sign long-term rent contracts; they will be locked into a long-term schedule. Why does nominal GDP avoid that problem? It also has P times Y. It puts more weight on new construction. Nominal amount of new houses constructed fell sharply; which caused construction workers to lose their jobs. Distinction between GDP deflator and the CPI? Yes, but the GDP deflator is also flawed; but it's better. Nominal GDP is measuring the size of the nominal shock that will eventually cause the price deflator to be 10% lower. In the short run what will happen is that prices will fall less than 10%, but output will also fall. Nominal GDP will fall 10% because prices and output will each fall 5%. Would still cause that a negative nominal shock. In the long run, you'll just end up with 10% lower prices. Consumer price index, which includes a lot of sticky prices such as rents or prices in catalogs, it's not going to pick up what's going on real time in the economy when there is a sudden nominal shock. What picks this up best is many asset prices--stock prices, commodity prices fall much more quickly than the CPI. Not in favor of targeting asset prices, but it's understandable why people are pointing to them. Their prices appear to be more flexible.
37:33	Suggesting that the Central Bank should be keeping an eye on nominal GDP as the best current measure of whether the economy is shrinking or growing and therefore whether monetary policy needs to respond. How does that differ from the Taylor rule? He wants to maintain a stance taking into account both the growth of the economy and inflation. Correct? Inflation and how the economy is doing relative to its full employment level. Taylor Rule is similar; but the big difference is John Taylor prefers a backward-looking approach. Take historical data, looking at past inflation and past real GDP growth data. Sumner suggesting that the policy should be forward-looking: always set policy such that nominal GDP is expected to grow at the target rate, say, over the next 12 months. Taylor also wants to use the Federal Funds rate as the primary level. Sumner skeptical. Could instead create a nominal GDP futures market, in a sense make money redeemable into these futures contracts. In essence, the Fed would stabilize the price of a nominal GDP futures contract, much like they used to stabilize the price of gold under a gold standard. Nominal price was fixed; Central Bank would either buy or sell gold at that price to maintain it. Problem with the gold standard was that sometimes when the price of gold was stable, other prices would change, so it didn't always produce an optimal result. But it did avoid huge amounts of inflation. Let's create an asset better than gold and have money convertible into them--these nominal GDP futures. How would that literally work? Contract that pays off depending on what nominal GDP turns out to be a year from now. So if speculators thought we'd have 7% nominal GDP growth, but the Fed's target is 5%, they would take a long position, buying these contracts from the Fed. That would be a signal to the Fed to do an equal decrease in the money supply in order to lower expectations of nominal GDP growth. Why would I buy that, though, knowing that the Fed is working against me? Sounds like: let's have a race, and I'll bet that you are going to win. You are going to bet that you are going to lose. But it's easy for you to run slower. Hard for you to run faster; but you are in control. Why would I bet you that you are going to run slowly? Assuming the Fed is serious in trying to hit its target, so the Fed takes a passive position. Not quite right to say the money supply is under control of the Fed; it's really under control of the speculators. Goal is to set up a system that works automatically. Fed automatically does the opposite. Can make that policy work. With any policy, even a gold standard, there is always the risk that the government will try to profit from it. In the Great Depression, the Fed almost doubled the price of gold and made a lot of money on their gold stocks. Have to assume that the Central Bank will adhere to the rule.
43:29	Different political economy question. Milton Friedman, in 2006, made a comment on this program. In the 1970s in grad school, taught that the Fed was worried about the growth of some monetary aggregate--M1, M2. So in those years, Friedman was often advocating an automatic growth rule in M2, say 3% a year, roughly equal to the rate of productivity, so we would have a stable price level. Somewhere in the 1980s and 1990s, Central Bankers stopped talking about aggregates like M1 and M2, and started talking about interest rates: set interest rates to set prices and stabilize inflation. Same goal, different target. Standard argument as to why they switched was that we couldn't measure M1 and M2 as accurately. Hard to measure inflation, so instead of having inflation target we'll have a Federal Funds Rate target because that's easier to measure. Asked Milton Friedman why the change; he chuckled and twinkle in his eye, and said that's what they say, but they are really just trying to keep a stable money supply. Milton sent an Excel spreadsheet. The reason they talk about interest rates is it makes them look more impressive; they are steering the ship. This was at a time when Alan Greenspan, Chairman of the Fed, was considered a genius, maestro. What of claim by Friedman that you still want to look at monetary aggregates? Money supply is better than interest rates as a stance of policy. Back to hyperinflation example: money supply correlates better with inflation than interest rates. But still going beyond M2 to the aggregates themselves, inflation or nominal GDP, and especially expectations of them, are really the best target. Why stop at an intermediate target? It's true that an open market operation affects the monetary base and that affects M2 through the multiplier, and then depending on velocity that affects nominal GDP. But not really trying to control M2--trying to control inflation or nominal GDP. In one of Friedman's last books, Money Mischief, he actually sort of endorsed a proposal by Robert Hetzel to have the Fed do exactly that--target inflation expectations. Target the gap between an indexed bond and a conventional bond. Gap between those two interest rates is roughly what the market thinks inflation will be over the period of the bond. Friedman said good things about that proposal. Not unsympathetic to the ideas. When he wrote that book we didn't even have an indexed bond market in the United States. Different question: John Taylor's been critical of the Fed during the 2002-2004 period for deviating from the Taylor Rule, lowering the Federal Funds rate much below what the Taylor Rule would have suggested. Monetary policy too expansionary in that period. Agree? Perspective on that period? Don't think interest rates are a good indicator of monetary policy, so low interest rates are not a sign of easy money. Low interest rates in Japan or in the United States in the 1930s not a sign of easy money. Friedman said low interest rates are usually an indication that money has been tight and that you have had deflation in an economy, or very low inflation. Understand Taylor's argument; but look at nominal GDP. Mixed view: In early part of that period, growth was pretty slow and low interest rates appropriate. Recession in 2001. Later part, expansionary policy, nominal GDP growing a bit too fast. However, the mistake we made doing too much expansion, inflation, was very small compared to the mistakes we made in the 1960s and 1970s; didn't have huge housing bubbles in those decades. Don't think the Fed's easy money alone can explain the recent situation and the size of the subprime fiasco. Other mistakes were made, either in private sector or by regulators that go beyond monetary policy.
51:37	Back to political economy issue: Think of a whole range of stances we'd like to see the Fed take. Some would be very discretionary--they have a lot of choice, a lot of freedom to steer the economy, micromanage it. Or more restrained, more hemmed in: have them take a stance to try to keep nominal GDP on some kind of target growth rate. Friedman pushed for a target of a monetary aggregate, non-discretionary; Taylor, non-discretionary restraint on Federal Funds rates. All attempts to encourage less discretion on the Central Bank. Given the political reality, is it feasible that any of these are likely to be successful? Might we be better off with a different kind of Central Bank or different kind of monetary system--private money, a gold standard, something that might be easier to enforce? Futures contract scheme you were talking about--complicated--harder to enforce the constraints on the Fed. Central Bankers are human beings who want to have a reputation for skill. Political reality. Is this the best way to go? Hard to say. Problem with getting the government out of money is that it's not really clear what the monetary system would look like. Gold standard combined with free banking; even some free banking experts skeptical. Gold standard doesn't necessarily promote economic stability. Could have periods of inflation and depression if there is an increase in demand for gold. May not be linked to gold; but then what would you link the dollar to? Don't know what that system would look like. With all its flaws, could argue that the discretionary system we've had in the past 25 years hasn't really done any worse than the past systems in terms of the business cycle. Reality of the modern world: governments like to have a lot of control; move forward incrementally. One incremental improvement: set an explicit target. That's been done in other countries, but not yet in the United States. Another: target the level instead of the growth rate. Spell out where they want something like the price level to be and commit to try to return to that trajectory if they deviated from it. A little more optimistic. Look back at the last 100 years of Fed history; can see some really gross errors that were made; can also see the Fed learning from the mistakes. Never quite repeated the same mistake of the Great Depression, letting M2 fall 30%. After the 1960s and '70s rethought strategy toward inflation; strategy improved. Now this crisis has revealed a third problem: don't know how to handle sudden changes in expectations and velocity; too backward-looking in their policy. Can perhaps learn from that as well. Before this crisis we had the 25 most stable years in American history in terms of the business cycle. Followed by a really bad recession which both Taylor and you have put at the feet of the Fed, though with different explanations. Too much hubris. Six years ago we were confident we had mastered this business cycle thing.
57:50	What seems to be true: if you look back at the last century, the Fed does seem to have gotten better at moderating inflation, which was its job. It's also now looked on as the killer of business cycles, which is difficult to do. We could give them a B+ because we haven't had hyperinflation, deflation, and price level has been fairly stable. However: when Alan Meltzer was on this program, he was confident that the reserves the Fed has on their books and the banks have been hoarding are going to go flying out the door; inflation will reignite; pressure to raise interest rates and political pressure for them not to. What are your thoughts? "Good economists don't make forecasts. They infer market forecasts." Right now, the futures markets, CPI, bond market all forecasting very low inflation. Why? Because the Fed has an operating procedure that allows them to break out of inflation. Though they don't watch expectations enough, there are inflation hawks at the Fed. Every cycle we've had since 1982, we've gone to lower and lower trend rates of inflation. Think that this one is the same; we're now coming out of this recession at an even lower trend rate of inflation. But we haven't doubled the monetary base at any of those times. They'll either keep paying interest on that or they'll pull those reserves out of the banking system. One point on the free market view: realistic view; country is not going to let nominal GDP bounce around according to the gold market. Problem you have is when the Fed makes mistakes and creates deflation, it looks like a failure of the free market. Conventional view is the free market is not working. Want to keep nominal GDP growing at a steady rate partly for libertarian reasons--the free market will look much better to the average person, won't be looking for bad policies like bailing out banks that are really just treating the symptoms of bad monetary policy.
1:01:37	Given those past mistakes, what could the Fed be doing now? We've seen a mix of both monetary and fiscal policy. The Fed's made a massive increase in reserves; they've lowered interest rates. That's had some impact? At the same time the Federal Government has pledged to spend an enormous amount of money. What would get us out of the mess now? Tempting to look at the low interest rates like the Fed is doing a lot, but the countries that are successful, like Australia, which hasn't had a recession since 1991, actually have much higher interest rates because higher rates are a sign of prosperity. Lower interest rates are a sign of failure. Need to set an explicit target, for, say, nominal GDP and promise to do whatever is necessary to get expected growth up to that target. Or it could be an inflation target. Would have to increase reserves and lower the rates they are paying on those reserves to encourage that money to get out into the economy. Also possible that just setting a target would so increase expectations that the same amount of money out there would help, changing velocity. Doubling of the monetary base and low interest rates are symptoms of deflation. Need a broader strategy. Might be higher interest rates, or lower interest rates. Could charge a negative penalty on excess reserves. Paradox: crystal ball, would much rather interest rates be 4% than 0%--recovering rather than in the Japanese situation. Both the fiscal stimulus and the monetary policy haven't worked very well. Both suffer from people being anxious about the future. Governments and economists are not very good at changing people's expectations. We don't have a good model of giving people confidence. Monetary policy can be very powerful, even too powerful as in Zimbabwe. Fed hasn't tried to shift people's expectations. Instead the Fed has basically predicted failure. Wasn't the doubling of the base their way of saying to the world they were going to be aggressive in trying to increase the rate of growth of prices? Lars Svensson: the Fed should always target its forecast. Starting last October 2008, the Fed started forecasting inflation and real growth at levels far below what everybody believed the Fed wanted. So the Fed started forecasting failure. Could say there was nothing more they could do. But interest rates at that time were 2% and they were paying banks to keep banks from letting interest rates fall below 2%. So they could have done much more. Even when rates hit zero, they can an almost infinite amount of quantitative easing or the printing of money. The Fed wasn't taking any action to move expectations up to its target.

Posted by Russell Roberts at http://www.econtalk.org/archives/2009/11/sumner_on_monet.html.

Heller on Gridlock and the Tragedy of the Anticommons

Mon, 02 Nov 2009 06:30:00 -0500

Michael Heller of Columbia Law School and author of The Gridlock Economy talks to EconTalk host Russ Roberts about the book and the idea that fragmented ownership is a barrier to innovation. Heller makes an analogy between the tragedy of the commons and what he calls the tragedy of the anticommons--the problem of bundling together numerous individual claims to a resource. Examples discussed include drug innovation when the innovator wants to use technologies of multiple patent holders, new music or visual media where the creator wants to use multiple copyrighted works, and allocation of spectrum rights and its role in wireless innovation.

Play

Time: 58:44

How do I listen to a podcast?

Download

Size: 26.9 MB

Right-click or Option-click, and select "Save Link/Target As MP3.

Readings and Links related to this podcast

Podcast Readings HIDE READINGS
About this week's guest: Michael Heller's Home page The Gridlock Economy: How Too Much Ownership Wrecks Markets, Stops Innovation, and Costs Lives, by Michael Heller at Amazon.com. About ideas and people mentioned in this podcast: Books: Patent Failure: How Judges, Bureaucrats, and Lawyers Put Innovators at Risk, by James Bessen and Michael Meurer at Amazon.com. Articles: "Tragedy of the Commons," by Garrett Hardin. Concise Encyclopedia of Economics. "Property Rights," by Armen Alchian. Concise Encyclopedia of Economics. "Intellectual Property," by Stan Liebowitz. Concise Encyclopedia of Economics. "Symmetric Tragedies: Commons and Anticommons," by James Buchanan and Yong Yoon. Journal of Law and Economics, Vol. 43, No. 1. 2000. JSTOR. Podcasts and Blogs: Boldrin on Intellectual Property. EconTalk podcast. Hazlett on Telecommunications . EconTalk podcast. Helprin on Copyright. EconTalk podcast. Epstein on Property Rights, Zoning and Kelo. EconTalk podcast.

Podcast Readings

About this week's guest:

Michael Heller's Home page
The Gridlock Economy: How Too Much Ownership Wrecks Markets, Stops Innovation, and Costs Lives, by Michael Heller at Amazon.com.

About ideas and people mentioned in this podcast:

Books:

Patent Failure: How Judges, Bureaucrats, and Lawyers Put Innovators at Risk, by James Bessen and Michael Meurer at Amazon.com.

Articles:

"Tragedy of the Commons," by Garrett Hardin. Concise Encyclopedia of Economics.
"Property Rights," by Armen Alchian. Concise Encyclopedia of Economics.
"Intellectual Property," by Stan Liebowitz. Concise Encyclopedia of Economics.
"Symmetric Tragedies: Commons and Anticommons," by James Buchanan and Yong Yoon. Journal of Law and Economics, Vol. 43, No. 1. 2000. JSTOR.

Podcasts and Blogs:

Boldrin on Intellectual Property. EconTalk podcast.
Hazlett on Telecommunications . EconTalk podcast.
Helprin on Copyright. EconTalk podcast.
Epstein on Property Rights, Zoning and Kelo. EconTalk podcast.

Highlights

Time	Podcast Highlights HIDE HIGHLIGHTS
0:36	Intro. [Recording date: October 29, 2009.] Quote from book: Private ownership usually creates wealth, but too much ownership has the opposite effect. It creates gridlock. Gridlock is a free-market paradox, when too many people own too many pieces of one thing, cooperation breaks down, wealth disappears, and everybody loses. Explain. Gridlock--too many owners--riff on familiar concept of tragedy of the commons. In a tragedy of the commons, too few owners, resulting in overuse of the resource. Too few owners in the ocean and people over-fish it; too few owners of the air, and people pollute it. Solution to tragedy of the commons is to privatize--single decision-maker who invests in the lake so there are more fish tomorrow. But privatization can overshoot. Instead of too few owners and a tragedy of the commons, we can have too many owners, and a tragedy of the anticommons. Instead of a resource being wasted in the economic sense through overuse, the resource can be equally wasted through underuse in an anti-commons. Too many owners creates potential of their blocking each other. Let's start with the commons: intuition and parallels and contradictions. Taping just a few weeks after Elinor Ostrom won the Nobel Prize; work talked about in book. What are some of the ways that societies deal with common property to avoid the tragedy? Privatization not the only one. Historically, when people thought about the commons they often thought about what is now called more precisely "open access"--that absolutely anyone can use a resource. Hard to have conservation outcomes in an open-access regime. What privatization does is align individual incentives with the resource. Historically two other solutions noted for the tragedy of the commons. One: state control. Command and control, regulation: state tells you how much you can do. Privatization often seen as a solution to over-regulation in a commons. Ostrom, basis for Nobel Prize: noticing the conditions under which commons property can succeed outside of state control on the one hand and privatization on the other. Circumstances that groups can manage resources effectively even though they are commons to the insiders and private to the outsiders. Ostrom noticed aspects like repeat play--having relationships that go across the resource and other resources; having a small number of people; sharing the same church. She's identified the circumstances in which commons resources can perform economically at a very high level.
4:54	In those situations, norms or informal rules emerge through the cooperation of those players; and they are enforced not by the state but by repeat play or connections between people that would create affection or some sort of altruistic play between them. Altruistic on the one hand, but also wealth-maximizing on the other. Don't need to look to the leviathan or complete atomization--intermediate solution. Altruism: if I personally benefit and impose costs on the rest of the group, if I care about the rest of the group that tendency will be mitigated somewhat. What Ostrom showed was this whole range of possibilities between altruism and wealth-maximization between what has long been thought to be the entire spectrum of ownership. In the middle are some interesting institutions. Anticommons idea and what gridlock book suggests is that there is an entire half of property relations and a lot of economic problems on the other side of private property. Commons-to-private is only half the spectrum; the other half spans from private to anti-commons ownership. So, in the anti-commons--how would that work? The commons is familiar. "Overuse" has been a word in English for 400 years. The problem of underuse--of resources being destroyed by being wasted by not being deployed is almost completely invisible. "Underuse" only became a word in English--in Scrabble--three or four years ago. One-way ratchet. Many examples where the real economic problem is that there are multiple owners competing with each other, resource left economically idle. What is the most underused natural resource in America? Airwaves. Artifact of the way we define property rights in broadcast spectrum. We have thousands of owners with non-transferable limited use; virtually impossible to assemble national high-speed wireless network. Because so many fragmented owners, United States has fallen out of the top ten, almost out of the top twenty. Missing wireless and entertainment services that are available in the rest of the world. Tom Hazlett: tragedy of the telecommons, cost the U.S. economy trillions of dollars.
9:38	Hard to take advantage of the potential of the system because of what we would call transactions costs--hard to negotiate with so many owners. One way to understand a tragedy of the anticommons, like a tragedy of the commons, is that these are both different versions of transactions costs failures. In the anticommons, in theory you could purchase all those rights and have control. In open-access story, harder to do. Everyone could agree not to fish. Perfectly symmetrical. Buchanan and Yoon paper: mathematical symmetry. Wireless life pleasant: what would a visitor from overseas notice that is missing? Possibility for a lot more remote medical work, easy and powerful video conferencing; real time multimedia; downloads watching TV in real time on cell phone; shopping beaming advertising and coupons to phone. Nextel network. Hard to know you are missing something if you only look within the United States. Podcast with Hazlett. What is the policy solution that would unlock those resources and get rid of the gridlock? First step is to notice that there is an economic loss from the misspecification of property rights. How we define property rights is more powerful than people realize. We don't know to be upset with the allocation of spectrum licenses because we don't know what we are missing. FCC policy. What can they do? Challenge is how to assemble resources in a low-transactions cost way. Wider array of uses and easier transferability. Make telecom licenses look more like ordinary property. Not so much fragmentation and number of owners as it is the nontransferability and restrictions on use.
14:23	Use of patents: medicine and music. Hidden example of gridlock. A lot of cutting edge treatments, gene therapy, require intervention across a whole range of genes, and each of those genes is separately patented. Diagnostic tool for cancer. Imagine walking into an auditorium and it's filled with all the owners of all the relevant patents. Unless you can get agreement from everyone in the room, the tool or therapy doesn't work. Each of those is usually some small biotech startup and each is usually very committed to the value of their individual patent and each demand the corresponding price. Hold-up problem; complementary input--need all the sections of train track to get from here to there, and if you miss any one of them you get nothing. Separate ownership is sub-optimal. In the drug context, as drug development has moved from a single patent, single molecule, innovation is increasingly breaking down. In the last year, 40,000 gene patents granted; steady increase in drug R&D investment. Number of drugs that treat disease has been going steadily down. Drug discovery gap, due to many problems such as FDA approval; but an important part is patent gridlock. Drugs that could and should exist that aren't being created. Patent system is suppose to spur innovation; paradoxically, too many patents can mean fewer life-saving innovations. Golden rice: tension between over and under patenting. If you want to have some high tech innovation in the world of plants, it use to be the case that you hybridized traits you wanted. Produced the green revolution. Inputs used to all be in the public domain, just like drug discovery. More and more those inputs are being separately patented. Freedom to create new plant products is more and more hedged in by the patents that you confront. Scientists Potrykus and Beyer: child blindness stems from Vitamin A deficiency around the world. Simple way to solve that would be to have the Vitamin A produced by the ordinary rice that is eaten. Figured out a way to do this, but in the process of engineering that new golden rice, they discovered that it infringed on roughly 70 U.S. patents. Rice is ready to go and could save millions of lives, but couldn't bring it to market because to do so they would have to negotiate dozens of separate patents. Already had this valuable product in hand; were able to shame the patent owners to create a humanitarian license. But for similar examples are ones we don't even hear about. Anger that these property rights were preventing him from getting the product to market, but realized that these patents had created the techniques that allowed him ultimately to create his product. Tension there. Fundamental policy question. Some examples in book result of accidents; some result of policy decisions made in the past or private decisions where it's hard to anticipate problems would come down the road. Is it a mistake to allow people to patent a particular gene? Is suggestion that we should have less? zero? What about products that are very expensive to bring to market because of the cost of assembling property rights? Want to extend the debate to include the possibility of hidden cost. Patents are a good thing. If it weren't for patents, there wouldn't be the biotech revolution. Massive inflow of money into biotech research arises because it's possible to get production. What gridlock discussion suggests is that against that general backdrop of patents being a good thing, we need to think about what are the potential costs. Privatization isn't the endpoint--it's an optimum between overuse and underuse, between commons and anticommons. What we are aiming for is not the most amount of property rights, but the best design for property rights. A lot of implications for that insight for patent law. Past week conference on the gridlock economy, podcast online. Particularly salient for semiconductors and telecomm, banking, internet shopping--require assembly of thousands of patents. Several thousand patents involved in a cell phone; no way to do online banking without dealing with ten thousand patents. Impossible to discover the patents you need, and impossible to know whether the claims cover your product or not. Cannot design high tech product that isn't infringing on hundreds of patents. Products that are most successful are subject to hold up by patent owners who can claim willful infringement even if you didn't even know their patent was involved.
25:00	Anticipating that legal cost, a lot of people are uninterested in innovation. Tragedy of anticommons. With a tragedy of the commons, very visible--you can see the pollution in the air or that you are not catching the same number of fish in the ocean. Tragedy of the anticommons tends to be invisible. It's the drugs that aren't invented, cellphones that don't come to market. Invisible tragedy. Michele Boldrin podcast: getting rid of patents. Legal scholars and economists on how to treat intellectual property relative to past treatment. Where are we going? We should be paying more attention to the gridlock features of patents. Mike Meurer , Jim Bessen: Patent Failure. Tried to measure overall effect of patents on economic growth. Leaving aside pharmaceuticals and chemicals, where patents seem to be wealth-producing, the net is that patents are wealth-destroying. Googles of the world would rather live in a world where property is not protected through patents but through other means. Encouraging if true: patent environment is a sort of commons; if all players think we are degrading it then we will probably move toward a different environment down the road. Talk to staffers on the Hill: how do we get patent reform? Bill aimed at patent gridlock; Congress won't go forward without bipartisan agreement, where bipartisan is not Democrat and Republican but pharmaceuticals and Information Technology (IT). True of any common solution--existing set of owners, have to find a way to compensate them if you need their support for a transition. Patent law written in 1952 to support a style of innovation, not the way America innovates any more. Compromise reached fifty years ago. Patent law is not tuned to the new style of innovation.
30:52	Music and documentaries: mashup or bundling of the nature of innovation. In the world of patent, one-patent, one-product. In the world of artistic expression--music or film or TV--today much less trying to put together separate pieces. Eyes on the Prize, documentary on Dr. Martin Luther King put together 20 years ago, Henry Hampton. Hampton pulled video clips from 80 archives; had 300 photos; about 120 fonts; won an Emmy, but disappeared. Couldn't be burned on a DVD, couldn't be shown on TV, because he didn't control all those small pieces of copyrights he needed. Most important film account of the American civil rights movement couldn't be seen. No central registry of copyright owners; even if you can identify them, have to bargain with each of them; can't assemble all the licenses. Clearing rights in the copyright world: half-Sherlock Holmes, half-Monty Hall. Many products don't come to market because even a second can become very costly. Nature of rap music has changed because of this gridlock; if you are a fan of old hip hop, Chuck D, Public Enemy, used to rap over a collage of sound. Rappers today don't do that--instead use single sample because licensing 300 is impossible. Whole style of expression is illegal. Also true for film and television. Would think there would be an exemption for fair use; but publishers and music companies are uneasy about testing that limit. In Russ's last book, wanted to use a quote of about 3 words from a movie; publisher, Princeton U. Press, insisted on permission; negotiation with multiple sources. Copyright in American law is never an absolute right. Want to give authors some protection in order to promote the writing of books. Don't want to give too much or in cases where it will reduce speech. Exemptions where permission isn't required--fair use, built into copyright laws going back to the 1700s. Previously unnoticed virtue of the fair use exemption is that it becomes a place where you can solve gridlock. Wider that exception is, the easier to assemble a collage of small snippets. University presses often on the wrong side of this debate, in favor of strong copyright and limited fair use. Usually professors want the widest dissemination of their work; often willing to give it away for free. Payment to faculty is more in prestige and recognition. Fair use policies are not decided by faculty, but by universities' general counsel office; worried about potential costs of being sued. Reasonable use--what people are actually doing. Trying to brush you back from the plate, like baseball; changes the strike zone. Only way to get right to use that 35 words is to assert it. The person who wrote those 35 words wouldn't mind seeing those words in the book. K-Pax, Kevin Spacey movie--not hurting their sales. Got the rights, easy once right person to talk to was found; relatively cheap. Eye on the Prize--also got the rights. Part of the reason in both cases that that happened is that it had a little of the flavor of the golden rice story--can cajole people when the cause is noble and desirable. Want to design a property rights system that creates a lot of wealth. Gridlock book written at non-technical level, lots of photos--each had to be licensed. Deed to a square inch of land in Alaska from Quaker Oats cereal in boxes in the late 1950s. What if you needed to assemble that land for some purpose? Picture took weeks to track down; worked out a quitclaim agreement. University press books look so boring because most people don't have the patience and curiosity to do all these negotiations.
42:25	One of the costs of this isn't just the back and forth of negotiation--long time listeners, right to use the opening music for EconTalk was given. First choice was the opening bars of If I Had a Million Dollars, by Bare Naked Ladies; had a lot of trouble trying to get the publisher to agree; wanted a very high price. Would like to think that the men of Bare Naked Ladies would be proud to give us the rights. But they don't control those rights. World Copyright Summit. Piracy a big concern. Biggest concern is not piracy any more but gridlock. So difficult to assemble the rights people need that people end up either not using them or being pirates. Piracy is an artifact of breaking through gridlock. Fragmented rights. No central registry: wouldn't that help? There is no central clearing house. Would that be an enterprise worth pushing? Costs and who bears them? We have a registry for land; can pretty much figure out who controls land. Cars--we have the DMV. For copyright, have an enormous number of works and an enormous number of rights in them, which fragments quickly over time as the original creator dies. In music context--lyrics, performer, all different kinds of rights which fragment. Google Books trying to address this problem of fragmented ownership by scanning all the world's books, central pile, jump start a registry of books. Right now they have digitized many works that are in the public domain. Lots of digitized versions of books written before 1923. There are books that are in copyright and in print: publishers control them, can negotiate. But there are roughly 20 million books that are under copyright but not in print. Can't go to publisher and buy them. Bulk of knowledge from 20th century: unless you live near a library no way to access them or search it easily. Google is scanning those books and trying to make them available at the word level--can search by word; if you want to download it, you pay a fee, which goes to the central registry. How can Google do that if they don't own the rights to the books? Suit between authors' guild and Google, which claims what they are doing is fair use. Since they are out of print, the owners aren't making money off them anyway. Can discover it, quote it. Hasn't been settled. Negotiated settlement attracted opposition over the last few months; other countries have objected, anti-trust; settlement pending. Trying to solve a basic gridlock problem. Class action mechanism, aggregates a series of claims no one of which is worth pursuing individually but collectively generates a lot of value.
52:11	Two issues: Example of air space. How did that evolve--flying over your house: could you stop an airplane for trespassing? Intuition: When you own a piece of land you own up to the heavens and down the center of the earth, a column of ownership. Makes sense for 50 feet up, but how about 1000 feet up? Not an issue till the invention of airplanes in the 20th century; no one had ever thought about it before. Overfly from NYC to DC means flying over the property of thousands of people, each one of whom would potentially have a claim against you. Lawyers and policy makers struggled how to make it possible. Part of solution was to say that you own up to the heavens, but as a matter of law, the heavens is 1000 feet up. Solved the gridlock problem and made it possible to fly by a timely redefinition. Airports: hard to build an airport. Public policy solution sometimes invokes eminent domain. A lot of private solutions also work--don't make a public announcement, buy land privately. Public solution feasible for Martin Luther King documentary--could pass a law saying this documentary that showed on TV with all of its citations and visuals, the documentary maker is entitled to them all; same way as with for an airport or shopping mall. Is that likely? Has it been abused? Public choice problems. People hate having their homes taken by eminent domain. You can always solve the problem by eliminating private ownership. Last-best solution in every case. Kelo. In intellectual property rights, in drug area, there already exists a "march in" right--the government already has the right to march in and take patents. If ever exercised, would crush the incentive of drug firms to spend a billion dollars to create a new drug and get it through the FDA approval process. First and most important step is to note that there is a problem. Then think about tools for making it easier for entrepreneurs in the market to assemble rights. Radio play; patent pools: you can pop a DVD disk into a DVD player is the several hundred patents required to make that work have been pooled together and you play one licensing fee to the pool together. What kinds of market institutions might be able to facilitate?

Posted by Russell Roberts at http://www.econtalk.org/archives/2009/11/heller_on_gridl.html.

Calomiris on the Financial Crisis

Mon, 26 Oct 2009 06:30:00 -0500

Charles Calomiris of Columbia Business School talks with EconTalk host Russ Roberts about the financial crisis. Calomiris argues that it is important to put the crisis in historical perspective in the context of other bank crises. He argues that bank crises differ widely across time and place--some times and some places are placid, others are prone to regular crises. Calomiris argues that frequent episodes of failure are tied to government guarantees such as various forms of deposit insurance or similar incentives for risk-taking. Looking at the current crisis, Calomiris indicts "too big to fail," the government's reliance on ratings agencies as a measure of risk, and poor corporate governance as the key causes.

Play

Time: 1:28:27

How do I listen to a podcast?

Download

Size: 40.5 MB

Right-click or Option-click, and select "Save Link/Target As MP3.

Readings and Links related to this podcast

Podcast Readings HIDE READINGS
About this week's guest: Charles Calomiris's Home page About ideas and people mentioned in this podcast: Books: Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, by Charles Mackay. Manias, panics, and bubbles prior to the mid-1800s. On Econlib. Lombard Street: A Description of the Money Market, by Walter Bagehot. Banking and the role of lender of last resort. On Econlib. Articles: "Time to buy or just buying time? The market reaction to bank rescue packages", by Michael R King. BIS Working Paper, No. 288, September, 2009. "Regulating Bankers' Pay", by Lucian A. Bebchuk and Holger Spamann. October 2009. Georgetown Law Journal, forthcoming. Harvard Law and Economics Discussion Paper No. 641. "The Credit Rating Industry", by Richard Cantor and Frank Packer. Federal Reserve Bank of New York Quarterly Review. 19, Summer-Fall 1994, p. 1-26. "Banking Crises Yesterday and Today", by Charles Calomiris. PEW Task Force Reports. Sep. 29, 2009. "The Subprime Turmoil: What's Old, What's New, and What's Next", by Charles Calomiris. Kansas City Federal Reserve Board, Oct. 2, 2008. "Bank Runs", by George G. Kaufman. Concise Encyclopedia of Economics. "Federal Reserve System", by Richard H. Timberlake. Historical overview. Concise Encyclopedia of Economics. "Savings and Loan Crisis", by Bert Ely. Concise Encyclopedia of Economics. History, including discussion of Regulation Q. "Financial Regulation", by Bert Ely. Concise Encyclopedia of Economics. "Deposit Insurance", by George G. Kaufman. Concise Encyclopedia of Economics. Podcasts and Blogs: Gary Stern on Too Big to Fail. EconTalk podcast. Alan Blinder on Bob Brinker's Moneytalk April 25, 2009. Honey's Bob Brinker Beehive Buzz blog. Blinder describes CDARS. John Taylor on Monetary Policy. EconTalk podcast. Discussion of the Taylor Rule. Kling on Credit Default Swaps, Counterparty Risk, and the Political Economy of Financial Regulation. EconTalk podcast. Business Cycles, Recessions, and the Great Depression. Related EconTalk podcasts. Financial Crisis of 2008. Related EconTalk podcasts.

Podcast Readings

About this week's guest:

Charles Calomiris's Home page

About ideas and people mentioned in this podcast:

Books:

Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, by Charles Mackay. Manias, panics, and bubbles prior to the mid-1800s. On Econlib.
Lombard Street: A Description of the Money Market, by Walter Bagehot. Banking and the role of lender of last resort. On Econlib.

Articles:

"Time to buy or just buying time? The market reaction to bank rescue packages", by Michael R King. BIS Working Paper, No. 288, September, 2009.
"Regulating Bankers' Pay", by Lucian A. Bebchuk and Holger Spamann. October 2009. Georgetown Law Journal, forthcoming. Harvard Law and Economics Discussion Paper No. 641.
"The Credit Rating Industry", by Richard Cantor and Frank Packer. Federal Reserve Bank of New York Quarterly Review. 19, Summer-Fall 1994, p. 1-26.
"Banking Crises Yesterday and Today", by Charles Calomiris. PEW Task Force Reports. Sep. 29, 2009.
"The Subprime Turmoil: What's Old, What's New, and What's Next", by Charles Calomiris. Kansas City Federal Reserve Board, Oct. 2, 2008.
"Bank Runs", by George G. Kaufman. Concise Encyclopedia of Economics.
"Federal Reserve System", by Richard H. Timberlake. Historical overview. Concise Encyclopedia of Economics.
"Savings and Loan Crisis", by Bert Ely. Concise Encyclopedia of Economics. History, including discussion of Regulation Q.
"Financial Regulation", by Bert Ely. Concise Encyclopedia of Economics.
"Deposit Insurance", by George G. Kaufman. Concise Encyclopedia of Economics.

Podcasts and Blogs:

Gary Stern on Too Big to Fail. EconTalk podcast.
Alan Blinder on Bob Brinker's Moneytalk April 25, 2009. Honey's Bob Brinker Beehive Buzz blog. Blinder describes CDARS.
John Taylor on Monetary Policy. EconTalk podcast. Discussion of the Taylor Rule.
Kling on Credit Default Swaps, Counterparty Risk, and the Political Economy of Financial Regulation. EconTalk podcast.
Business Cycles, Recessions, and the Great Depression. Related EconTalk podcasts.
Financial Crisis of 2008. Related EconTalk podcasts.

Highlights

Time	Podcast Highlights HIDE HIGHLIGHTS
0:36	Intro. [Recording date: October 21, 2009.] Financial crisis: put it in historical perspective. One event and about 20 different explanations. All have some truth; what weight do you attach to each? By putting this crisis on the historical regression line of other crises, you get a lot more useful perspective on what was really important. What do they have in common that we should be focusing on this time? First, banking crises are different from other crises historically. While all financial crises--banking, stock market, real estate, sovereign debt--all have a cyclical timing story that has to do with monetary looseness that gets cycles going, what's different about banking crises is that that isn't enough to get them to happen. Right that monetary policy explains the timing; but missing that banking crises pretty much uniformly have to have something wrong with the microeconomic incentives in the banking system. Not going to get a crisis of this magnitude just coming from a normal business cycle reaction of the banking system. Something deeply wrong with microeconomic incentives. In particular, incentives produced by government policy? Yes. If you are telling people with poor credit history that they can get credit with almost no money down and without verifying their documents, and you are making that a government policy through a variety of channels--FHA lending, pressures placed on Fannie Mae and Freddie Mac, and a variety of other means such as state programs. Also, the mortgage tax deduction, but that's not a large effect because the people getting subprime mortgages are not paying a lot of income tax. Big deal was FHA and affordable housing push since 1994 that the government had on Fannie and Freddie. Also other changes. There was a government legislation in 2006 with the SEC proposing rules in early 2007 to make it harder for ratings agencies to be tough on mortgage-backed securities that were subprime. All sorts of Congressional actions pushing subprime lending to happen more and faster. Credit card securitization has been going on for a long time. Some say this is all about securitization, and the so-called "originate and distribute" model having flaws in it. But if that were true, why didn't credit card securitization also fail? In contrast, all the lessons learned for 30 years in the credit card securitization business and which are continuing to be applied, were completely put aside in the mortgage securitization business. That's because of the incentives established by government programs that made it possible for people to put those incentives aside--in large part. Other aspects of the microeconomic incentives.
5:48	Current crisis; history, reverse myopia, viewing it as unique, perfect storm. In fact, extraordinarily large number of these banking crises in the United States and elsewhere in the world going back to the 19th century. A lot of people conclude from the frequency of those crises that the banking system is inherently at the mercy of human psychology. Minsky explanation, "Madness of Crowds" story: humans are frail; all of a sudden we get nervous and there is a run on the bank. Or, all of a sudden we just get greedy and want to have a higher rate of return. What's wrong with this story? Economic historians today do not subscribe to it. Basic facts are wrong with it: If it were true that banking crises were pervasive historically and tended to accompany business cycles generally, then we wouldn't see huge variation across time and place in the likelihood of having a banking crises. What we do see actually is banking crises were much more pervasive in some places and some times than in other places and other times. Example: From 1874-1913, period of our first big globalization of markets, free entry into banking throughout most of the world, fixed exchange rates, big capital flows--similar in many ways to the current globalized economy. Where are the big banking crises? There aren't too many if you mean by bank crisis waves of bank failures with lots of losses. Can list them on one hand: Argentina in 1890; Australia in 1893 were really the only two big ones. Each had negative net worth of failed banks of 10% of GDP. A couple of others: Norway in 1900; Italy in 1893. All share features having to do with distortions of government policy that were risk-inviting. Most important: only four of them. Looking at 1978 to the present, the number of banking crises defined by the same criterion of large amount of loss relative to GDP--there are about 140 of them. Twenty of those are significantly bigger than the two previous big ones--Argentina and Australia. About 20 of them have cost more than 20%. Looking at an era when something is very different. Couldn't it be that people got greedier? Historian familiar with human nature--unlikely that human nature has changed in the greed dimension. So what did change? Government policies that invite risk--government protections and bailout policies, which were present in Argentina and Italy, and different kinds of policies that were promoting development of real estate important in Australia. Common argument: If Fannie Mae and Freddie Mac had something to do with the current crisis, how do you explain the real estate bubble elsewhere? As if no other government thought it was a good idea in the last 15 years to over-promote home ownership. But it's not unique to the United States. Very widespread phenomenon. Norway in 1900 actually had a Fannie Mae prior to its financial crisis. Governments sometimes do things that aren't wise in terms of promoting risk in real estate and in protecting banks in ways that removes market discipline and often leads to excessive risk taking because the banks are doing it at someone else's expense.
11:27	Play skeptic for a minute. Two points: One, 1978 as starting point for recent wave of bank crises. But FDIC started around 1934; 1938 was start of Fannie Mae, when it was a truly Federal program. Why are the recent years so much worse? Second, a lot of people believe that when the Fed was created in 1913, it was created as a lender of last resort that had to be created because the banking sector was so prone to this kind of problem. Second one: We do have evidence that the Fed reduced the propensity in the United States for financial panics. Want to distinguish between banking panics and the crisis phenomenon of large amounts of bank failures. Not the same, though they sometimes overlap. The Fed, through its stabilizing seasonal fluctuations in the market for borrowing, particularly having to do with the cotton market in the United States, had an important effect on making things more stable at a seasonable frequency; it was that seasonal instability that made liquidity problems that gave rise to panics--but only in the United States, which had a peculiar structure of unit banking. The Fed reduced the frequency of panics; but we didn't have a history of bank failures as in recent times. Panics versus large waves of failures. The richness of the historical record is pretty great; consensus has developed. What is unit banking? Banks were constrained by regulation to only operate in one location. At its peak, over 20,000 banks operating in the United States, and with only a few exceptions, with virtually no branches. Couldn't cross state lines. Highly undiversified banks, so shocks to agricultural markets could cause many problems. Also, because so many players, they couldn't really coordinate their behavior in response to the shocks. Canada, to the north, has a branch banking system from the 1860s on--during periods of U.S. banking panics 1873, 1884, 1890, 1893, 1896, 1907--experienced none of those panics. Canada had a different microeconomic structure. Canada didn't have a Central Bank until 1935. Central Banking was helpful in the United States, but only because of the fragility of the U.S. banking structure. Whole different topic. Broader history of causing over-speculation which leads to very large losses in banks was avoided in the United States with exception of agricultural losses in the 1920s or complete destruction of the world economy in the 1930s. Bank losses--story is a story of distorted microeconomic incentives.
17:31	Back to first question: Incredible number--140 banking crises since 1978. For story to be correct, would need to see an increase in encouragement of risk-taking, particularly moral hazard--encouraging risk-taking without worries about the downside risk. How come it started in the United States in 1979 with the Savings and Loan (S&L) crisis? Why didn't we get this earlier? Simple answer: First, deposit insurance wasn't always so generous. Franklin Roosevelt opposed deposit insurance; irony is that people think of deposit insurance as one of his great legacies. Why was he opposed? During the late 1910s and 1920s, every state deposit insurance program that had been created--all eight of them--failed disastrously and much worse than any other systems. At the time everyone understood this. Why did it get created? Created as a temporary measure for small deposits only; pressed by Henry Steagall of Alabama who came from a state where small banks were politically influential and saw this as a way to prevent competition by preventing consolidation. Why would it prevent consolidation? When you protect deposits, it would remove competition along the dimension of risk. Large banks, like those Canadian branching banks, could compete with small banks by saying "Look how stable we are." If small banks want to compete, they want to have Uncle Sam behind them. Big deal in Alabama, less important in New York. Over time that coverage increased. In 1980, increased to $100,000; by statute. Gary Stern podcast. In practice, 99.7% of all deposits ended up being insured regardless of the limit in the 1980s. Alan Blinder didn't help matters by inventing something called CDARS. Great if you are rich. How deposit insurance works: Suppose you are a family of four. First, you are covered in the old days before this crisis to $100,000--can open an account singly for each of the four; then any pair can open a joint account; then any three can open another account; and then all four. Can have 13 accounts at same bank covered up to $1.3 million--each account up to $100,000. Then can go to every other bank and get same. Hard work. CDARS created a swap concept so banks could set up syndicates. Say you have $50 million and go to one bank; ask to swap it out to other banks. With the current $250,000 deposit insurance limit, your bank has to find 200 banks that are willing to participate in your deposit. Each bank gets, nominally, $250,000 deposits of yours, but from your perspective you have $50 million at one bank. The banker wants you to stay just with him. So the bank says, don't worry. Now we've created CDARS that allows people to effectively have all of their money insured. So deposit insurance went from being a temporary measure only for very small deposits pushed by an Alabama advocate of small rural banks, known to be as special interest legislation, to be increasingly protective of more and more banks. Can see why bankers like to not have to compete on the dimension of risk. Also, monetary policy and fiscal policy became much more volatile, particularly after the 1960s as inflation went up. Powerful generator. The 1960s were extremely low risk in terms of volatility of the stock market or price level. In the 1970s, cranked it up, had risks to bet on; coverage went up dramatically. Combination of expanding coverage and expanding risk that allows you to see what happens with the S&L crisis in the late 1970s. Even Friedman and Schwartz, thought to be politically conservative, thought deposit insurance was generally okay; in 1963 wrote this system seems to work well. Were looking at a placid period. Used to have "postal savings" in the United States--alternative system if people were worried about putting money in the bank. Invest in U.S. Treasury Securities instead--no risk at all. Don't need deposit insurance to protect against risk. Deposit insurance has been the single most important contributor to risk in the financial system. Hopeless probably to get rid of it; spread throughout the world. Which is why we have had so many banking crises.
26:45	If you look cross-sectionally at times when deposit insurance is reduced, you actually see less risk. Mexico: 100% de jure deposit insurance in the 1990s. Had their big crisis; and deposit insurance went down. Didn't go down de jure, but there were so many losses that people started saying they weren't sure the government could cover that many losses. Banks with weak assets started seeing people withdraw their money; first discipline in a long time. Also in England, which had historical banking panics with costly resolution problems: 1819, 1825, 1836, 1847, 1857--reflected that the government was pressuring the Bank of England. In the London bills market, put options--if things started to go bad for you and you are holding a bill of exchange that you worried might have some losses--a form of lending--you could just "put" it to the Bank of England at the discount rate and let it be the Bank of England's problem collecting on the bill. Why did this happen? Parliament required as a quid pro quo that in exchange for certain privileges that it gave the Bank of England that the Bank of England give this kind of put option. Sounds a lot like Fannie and Freddie--get this privilege but had to give something back. Gave back huge systemic risk. Every time a crisis happened, relax restrictions on abilities to lend. Bank of England would say "Please don't relax the restrictions! We don't want to lend!" and Parliament would say "You know what you have to do." Finally after the 1857 crisis, the Bank of England, with the support of the press and Parliamentary hearings that backed them up, said "Enough." Public statement--implicit put option no longer exists. One more banking crisis--Overend Gurney crisis--largest bill broker in England, bailed out by the Bank of England in 1857, but in 1866 when they came looking for money again the Bank of England said No and didn't bail them out. That was the last banking crisis until WWI--different kind of crisis. This is the mainstream interpretation going back over 100 years--can read about it in dusty old books. Protection of banks--we rely now entirely on regulation and supervision. Used to be supervised by depositors, but they no longer have skin in the game. We now have to depend on regulators. Bankers have lobbied against reforms that have been proposed. Combination of subsidizing risks in the housing market and not tracking risks in prudential regulation in an environment where there is no depository discipline any more because of deposit insurance--and furthermore even beyond the explicit protection--and implicit protection of "too big to fail" starting in 1984 with Continental Illinois. Now have a system where we rely entirely on prudential regulators to stop risk, while the government out of its other pocket is subsidizing huge risks, particularly in housing. No surprise that when we finally get another government-caused problem in the form of very loose monetary policy from 2002-2005, negative real Fed Funds rate, departures from the Taylor rule--combine these government mistakes and end up with a huge banking crisis that looks a lot like what other banking crises look like in other places and other times.
34:07	Skeptical view: All that's true, but the worst excesses of the crisis occurred in 2004-2006, when subprime securitization exploded--a little over $1.5 trillion--mostly generated by Wall Street firms, not Fannie and Freddie; mostly bought and held by Wall Street firms using models of risk that were overly optimistic. Greedy and myopic. Nothing to do with the government. In 2004, Fannie and Freddie decided to get into subprime mortgages in a big way, particularly in low-docs and no-docs (documents) mortgages. Sent emails in February; read the emails because testified before Congress. Risk managers thought it was crazy--know from the late 1980s that if you tell people you are not going to check on them you attract low credit risks. Most vocal was fired. Fannie and Freddie the big players. If Fannie and Freddie decided they were going to make markets in those securities, the securities are going to take off; and they tripled in 2004. How do you quantify that? Data in paper. Ed Pinto: when you look at outstanding paper, Freddie and Fannie hold $1.6 trillion of the non-FHA--who are also doing this--$3 trillion loss exposure to subprime lending. Start with the fact that prime and subprime mortgages are not just labeling issues but performance issues. Different buckets for mortgages. If the bucket has performance that looks identical to subprime then it's essentially subprime. On their face they are subprime--Fannie and Freddie had their own naming conventions; but if you don't believe they are subprime on their face, then observe that they are subprime in performance--ten times worse than prime loans. Ex ante or on delinquency basis--both subprime. Pinto on firm ground saying that Fannie and Freddie understated. People who financed them didn't need to look because they were counting on the bailout. First: Fannie and Freddie did play a huge role. No just the no-docs. Half of subprimes are related to no-docs. Other half relating to the modeling assumption that you would never have housing prices go down. Very fast process--2004-first quarter of 2007. Also weird: starting in the middle of 2006, as Joseph Ackerman said in a speech in December 2008 at the European Central Bank, that the gig was up.
40:17	In the middle of 2006, it's clear that it was an unreasonable assumption to believe that housing prices would never go down. Also unreasonable to believe that no-docs wouldn't attract bad credit risks. We already knew that. How did we forget? People are greedy? Even if you wanted to pretend you didn't know till then, the ratings agencies were telling you that housing prices have stalled, modeling assumptions too optimistic, and the 2004-2005 cohorts starting to see excessive delinquencies. Joseph Ackerman: Deutsche Bank--makes sure it has no exposure--Goldman Sachs does the same. JP Morgan Chase never got into it. Deutsche Bank gets covered sort of by buying credit default swaps. Big story aside from 2004 beginning: Fannie and Freddie continue to buy at peak levels for the second half of 2006 and the first quarter of 2007. So do UBS, Citibank, and Merrill Lynch. Shocking. The problem wasn't originate-distribute. Bear Stearns and Lehman Brothers were also involved, but they were small players. If the other five larger institutions had stopped doing this in 2006, we wouldn't be having this conversation. Side note: In 2007, 23% of all of Freddie and Fannie's home purchase loans--as opposed to refinancing--was for low-downpayment mortgages. Shocking. What were they thinking? We know what Freddie and Fannie were thinking--heavily involved in the Washington politics; accounting scandal in 2003; Alan Greenspan had turned against them in 2000; started having a few people starting to be vocal opponents. Congress was always defending them; starting to come apart at the seams.
45:52	Still have to try to understand Merrill and Citi and UBS? If you had asked specialists in corporate governance before the crisis: Which of the banks do you think is best at creating value for its stockholders? Probably Citibank and UBS would have come toward the bottom. Also from an ethical standpoint. Cultures not good cultures. Stockholders are the ones who really got hurt--if they didn't get out in time. A lot of them made a lot of money. For a long time these banks generated high rates of return. Especially for their own senior managers. Key question: Why were these managers willing to do these investments when they should have known better? Salient that not everybody that's doing it. Can understand about Freddie and Fannie, but not such a clean story for Citi and UBS. We've designed these institutions by regulation to be relatively immune to corporate governance--not a large number of stockholders with a large enough share. Citi, have one person. Need concentrated ownership. A few banks with bad corporate governance could take very large risks. Expand: Regulations were put in place to restrain concentrated ownership. Argument: make sure the institutional investors--who would be involved in other transactions--public companies, wouldn't have too high ownership. Lawyers think ownership creates conflict. Economists think ownership creates the right kind of conflict. Stewardship. Lawyers run the legal process; 1940 Act. As a result, ownership stakes are de-concentrated. Sanjay Bagat (sp?) paper--corporations work better with concentrated ownership, particularly with ownership by sophisticated institutional investors. If somebody has 10-20% ownership of a firm they want to make sure the managers are doing things well. With two or three people--get together for dinner and can jointly decide to throw out a bad manager. Myth of fragmented ownership hasn't penetrated lawyers. Poland restructuring in 1990s: Jeff Sachs and others convinced the Poles that they needed to establish concentrated ownership in the newly privatized firms. The new mutual funds that were created were assigned big chunks of interest. Opposite of United States. Design flaw. Hedge funds and private equity funds are not covered by the 1940 Act in other areas; in the banking area they are barred from becoming controlling investors because of concern about the overlap of commerce and banking. We've set up large holding banks in the United States to be the most undisciplined places for corporate governance in the world. Doesn't always go wrong, but went wrong hugely for Citibank. Bebchuk and Spamann paper: incentives for management within bank holding companies.
54:42	Ratings agencies: a lot of people think they are a major part of the problem. Reflecting another problem, related to last question. Not just why these banks originated these things but why they bought them. Also want to try to understand why insurance companies, pension funds, and mutual funds bought huge amounts of this stuff in 2006 going into 2007. Why were the ratings agencies willing to pretend that these things were still triple AAAA long after they should have known better? And they did know better in the middle of 2006. Standard argument--they were being paid by the people issuing the securities; conflict of interest. Wrong. It was not a secret that they had a conflict of interest. Sponsors are selling. Ratings agencies are working for the buy side whether the buy side is paying them or not. Two issues about the buy side: one, the buy side are the ones for whom the ratings are used for regulatory purposes. If you are a pension fund, mutual fund, or insurance company, or a bank and you buy these securities, the ratings matter because you are regulated by the amount you buy. They let you leverage them differently; they might have prohibitions on how much of a certain class you can buy; you get to do more things as a buy side investor if you have more favorable ratings. Cantor and Packer paper: Securitizations, which are all bought by corporate institutions, not individuals--all of the grade inflation starting in the 1980s was located in securitization-related markets, not in corporate debt markets. The institutional investors wanted grade inflation because grade inflation loosened the regulations that bound it. That's where "too big to fail has to come in." Story told by someone at one ratings agency: Sponsors go out and ask ratings agency if it will give them a favorable rating; then go out and ask another agency; and they go with the agency that gives the best story. Agency shopping. Why would that work? It only works if the buy side wants it to work. Let's say Moody's is the best--most demanding, most trustworthy--of the three. When Moody's is dropped by the sponsor, the buyer knows Moody's would have rated it higher, so he says he's not going to pay so much for it. If the buy side behaved that way, ratings couldn't have gotten inflated. Agent asked by buyer why a rating was so off: "We didn't rate that because it was so horrible. Why did you buy it?" Answer was: "We have to put our money to work." What does that mean? If you are out there running a fund, mutual fund, whatever. Hedge funds have better incentives about risk. Other institutional investors say they have to put their money to work. They are making their fees for managing risky investments. Nobody is giving them a hard time. They are the ones who drove ratings shopping and the race to the bottom. Why? If you are making your 1% on assets managed, you want assets managed to be large. Not consistent. Consistent: have to be able to think of more than one idea. If we hadn't had the monetary policy blunder of 2002-2005 we wouldn't be here talking today. If we hadn't had Fannie and Freddie pushing to get affordable housing to happen with virtually no money down, we wouldn't be here today. And if we had had good prudential regulation for measuring risk credibly we wouldn't be here today. Didn't have that third thing because we were relying on the banks to tell them what the risk was--a joke--or to have the ratings agencies tell them what the risk was--a double joke. The ratings agencies are working for the buy side--the institutional investors and the banks. The ratings agencies' incentives were that as soon as regulation was outsourced to them they would become grade inflators because they got paid for it. People who paid them were the buy side.
1:03:32	Then question has to be: why were these three banks--we already understand Fannie Mae and Freddie Mac--but what about Citi, UBS, and Merrill Lynch--willing to buy so much of their own bad stuff? Agency problems: why people are willing to invest other people's money badly. They earn fees on other people's investing. Two problems: why would I keep giving such companies my money? Because ratings agencies were a coordination device for plausible deniability. Everybody investing can say they did the same thing as everyone else. Where are you going to put your money instead if everybody's under the same compensation rules? Problem with that, for two reasons: One, that would conflict with the Lehman Brothers, Bear Stearns, Goldman Sachs, JP Morgan Chase division--doing well before the bubble started to pop. Pressure on other banks to do as well. Some resisted it, and they are profiting now. Missing the point: those institutions were run by people who were operating in good corporate governance environments maximizing shareholder value, including their own CEO shareholder value but not just their own. There is another regulation: mutual funds. Mutual funds are not allowed to have fee structures like hedge funds. Not allowed to have profit sharing on the up-side only. If you are running a mutual fund, if you want to take 20% of the profits and 0% of the losses and a flat fee of 2%--standard fee for hedge funds--that's not legal. No money manager is going to write that contract. Can't afford to take the downside. Optimal contract probably doesn't look very different from the hedge fund contract. Pensions also not allowed. They are allowed to have fees that are proportional to assets managed. Want to keep assets managed growing. But as an investor you know they have that incentive. Who do you go to instead? Some incentive for someone to establish a better-run mutual fund. Poor people--ordinary middle class folks--can't use CDARS and neither can we go to hedge funds because we don't have enough. So we have to play the game with the mutual funds, which are all coordinated by the same bad regulation. Don't want to put everything on regulation. JP Morgan Chase was regulated the same way--why didn't they do badly? We have to explain these things. Most of story so far, though, is bad government monetary policy, bad government subsidization of risk in the mortgage market, bad government prudential regulatory policies that outsourced stupidly to ratings agencies with bad incentives which in turn outsourced to the banks themselves to tell them what the risks were, and bad policies that limit the concentration of ownership within banks and bad policies that limit the incentives of institutional investors to not have skin in the game. Then we are surprised that the private markets aren't working perfectly.
1:08:52	Discussion from before started taping: a lot of critics of markets have suggested that the above story is wrong; it's all about deregulation and we let banks get into too many things, all the Graham Leach Bliley Act. Institutionally wrong. To Obama administration's credit, though they said these things before the election, have stopped saying them. Deregulation did three things since 1980. First, removing Regulation Q, which was a limit on interest banks could pay on savings deposits. Didn't make sense to begin with and everybody glad we got rid of it. Number 2: eliminating restrictions on branching--at state level, regional level, and finally in 1994 nationwide branching. This clearly stabilized banks and made banks more efficient. Number 3: removal of restrictions on underwriting of corporate securities, which had been phased out starting in 1987 with experimentation that was done; testified--never made sense--that somehow banks got too risky when they underwrite corporate securities. No real risk associated with underwriting, a very short term period when you are making a market. All we are talking about, having to do with Glass Steagall, is allowing banks to get into the underwriting business, without limit, which had been phased out 1987-1989. This has nothing to do with subprimes. We wish they would have done more with underwriting corporate securities and less with subprime debt. If none of the deregulation just described had been done, banks could still have done everything that they did. Stand-alone investment banks were very much a part of this problem. They weren't even covered any of this. Merrill Lynch, Bear Stearns, and Lehman Brothers weren't even affected by any of these regulations. Two other reasons it's nonsensical: When the investment banks like Merrill Lynch got into trouble, the fact that we had relaxed the Glass Steagall barrier meant that Bank of America could buy Merrill Lynch, which stabilized the system; and JP Morgan Chase could buy Bear Stearns. Also meant that in September 2008 when things started heating up for Goldman Sachs and Morgan Stanley, that they could become bank holding companies, which gave them immediate access to depository funding and a more regular relationship with the Federal Reserve, which also stabilized the system. So actually, the deregulation stabilized the system. Zero effect on the risks at the heart of this.

Posted by Russell Roberts at http://www.econtalk.org/archives/2009/10/calomiris_on_th.html.

Munger on Shortages, Prices, and Competition

Mon, 19 Oct 2009 06:30:00 -0500

Mike Munger of Duke University talks with EconTalk host Russ Roberts about the limits of prices and markets, especially in the area of health. They talk about vaccines, organ transplants, the ethics of triage and what role price should play in allocating. The discussion concludes with a discussion of how markets respond to price controls, particularly minimum wages.

Play

Time: 1:08:00

How do I listen to a podcast?

Download

Size: 31.2 MB

Right-click or Option-click, and select "Save Link/Target As MP3.

Readings and Links related to this podcast

Podcast Readings HIDE READINGS
About this week's guest: Mike Munger's Home page Kids Prefer Cheese. Mike Munger's blog. About ideas and people mentioned in this podcast: Articles: Armen Alchian. Biography. Concise Encyclopedia of Economics. Mentions Rose Bowl ticket example. "Why Health Care Will Never be Equal," by N. Gregory Mankiw., New York Times, September 19, 2009. "Price Controls", by Hugh Rockoff. Concise Encyclopedia of Economics. "Rent Seeking", by David R. Henderson. Concise Encyclopedia of Economics. "Rent-Seek and You Will Find", by Mike Munger. On Econlib. "Minimum Wage Effects on Training on the Job", by Masanori Hashimoto. JSTOR. The American Economic Review, Vol. 72, No. 5 (Dec., 1982), pp. 1070-1087. "Minimum Wages and On-the-Job Training", by Daron Acemoglu and Jorn-Steffen Pischke. Nov. 2001. Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 384. "Rent Control", by Walter Block. Concise Encyclopedia of Economics. "Tragedy of the Commons", by Garrett Hardin. Concise Encyclopedia of Economics. "Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Reply", by David Card and Alan B. Krueger. PDF file discussing their work in their 1994 results: "Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania." AER. September 1994, 84(4), pp. 772-93. "What is Seen and What is Not Seen," by Frederic Bastiat at the Library of Economics and Liberty. Podcasts and Blogs: Munger on Price Gouging. EconTalk podcast. Giving Away Money: An Economist's Guide to Political Life. EconTalk podcast with Mike Munger on rent-seeking. Willingham on Education, School, and Neuroscience. EconTalk podcast. Discussion of per-cup tax on coffee.

Podcast Readings

About this week's guest:

Mike Munger's Home page
Kids Prefer Cheese. Mike Munger's blog.

About ideas and people mentioned in this podcast:

Articles:

Armen Alchian. Biography. Concise Encyclopedia of Economics. Mentions Rose Bowl ticket example.
"Why Health Care Will Never be Equal," by N. Gregory Mankiw., New York Times, September 19, 2009.
"Price Controls", by Hugh Rockoff. Concise Encyclopedia of Economics.
"Rent Seeking", by David R. Henderson. Concise Encyclopedia of Economics.
"Rent-Seek and You Will Find", by Mike Munger. On Econlib.
"Minimum Wage Effects on Training on the Job", by Masanori Hashimoto. JSTOR. The American Economic Review, Vol. 72, No. 5 (Dec., 1982), pp. 1070-1087.
"Minimum Wages and On-the-Job Training", by Daron Acemoglu and Jorn-Steffen Pischke. Nov. 2001. Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 384.
"Rent Control", by Walter Block. Concise Encyclopedia of Economics.
"Tragedy of the Commons", by Garrett Hardin. Concise Encyclopedia of Economics.
"Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania: Reply", by David Card and Alan B. Krueger. PDF file discussing their work in their 1994 results: "Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania." AER. September 1994, 84(4), pp. 772-93.
"What is Seen and What is Not Seen," by Frederic Bastiat at the Library of Economics and Liberty.

Podcasts and Blogs:

Munger on Price Gouging. EconTalk podcast.
Giving Away Money: An Economist's Guide to Political Life. EconTalk podcast with Mike Munger on rent-seeking.
Willingham on Education, School, and Neuroscience. EconTalk podcast. Discussion of per-cup tax on coffee.

Highlights

Time	Podcast Highlights HIDE HIGHLIGHTS
0:36	Intro. [Recording date: October 14, 2009.] Housekeeping: Last week, asked what would happen to the size of coffee if a per-cup tax was put on coffee, Willingham podcast; hints have been added. Archive of all podcasts available on EconTalk. On Twitter at EconTalker.
1:42	Price signals. Email from listener, Caleb: use of prices in allocating scarce stuff, particularly in area of vaccines. If you have a potentially life-saving vaccine, do we really want to let the market set the price? Often isn't enough vaccine to go around. Are we limited by the physical rules of the world around us or can we make up an alternative world? If we can make up an alternative world, where people always do what "we" think is the right thing and were altruistic, we might not want to have price. Might want to have people working for the public good, with full information and with all the right incentives and resources to do their job. A lot of medical people think we live in that world. Maybe economists live in their own world. Suppose we don't have enough and we are worried about how to allocate stuff and how to choose a system where there is more stuff to allocate. If you look just at how do we allocate stuff we have, seems that price isn't fair. The rich are going to get more; violates moral intuition. Do rich really get more? True that market can price some out of the goods, but that's not always true. Even if it were true, wealthy people would have some advantage. What people ignore is the importance of the responsiveness of the amount of stuff we have to the mechanism we choose for allocating it. We can allocate by price; people could queue up--first in line get it; could use lottery; could use authority--scientists have studied this and they think person A needs it more than person B. Could use personal preference, favoritism--probably bad idea but a lot of the schemes we actually choose end up increasing the amount of favoritism that somebody who's going to hire someone--in context of the minimum wage--or local official in face of a shortage; or set up a rent-seeking contest, making whether you get it depend on the amount of time and effort you put into making the application. Ditch-digging contest--if you want the scarce thing, you have to dig as big a ditch as possible. Part of the reason people don't like price is that it's impersonal. Price does two things--it allocates, some choose not to buy it, like luxury cars, the nth pair of shoes, or a vaccine. What non-economists focus on is that price also redistributes between buyer and seller within any transaction. My loss as a buyer looks like your gain as a seller; so it looks like a 0-sum game--though it's not. If the transaction is going to take place, that if is very important. If it does not take place the buyer will be worse off. Can change the buyer into a non-buyer, particularly if the shortage is unnecessary--meaning if we used a different scheme there would be more of this stuff. Vaccines: notorious shortages in the United States--when people want to have a vaccine, it always comes in late, there's not enough. It's true that it's not very expensive, cheap once you actually get it. But long line you have to wait for. Like buying sausage in Poland or the Soviet Union--had to check and see if your local butcher actually had meat that day; most days they don't. On a good day, the butcher has meat; people run down, stand in line, and the first few in line can buy meat, at the state-sponsored price which is ridiculously low. The reason there may not be much in the front window is that he's selling it out the back; don't know that we have a black market in vaccines in the United States; confident that we would if H1N1--the swine flu--became much more virulent. People from the former Soviet Union coming to the United States would often carry large amounts of cash. Why? Response: What if there is a TV? Usually no TVs in Soviet stores, but if there were, you wanted to be sure had a lot of cash on hand that day.
10:21	In the case of vaccines: isn't the problem just a physical problem? The reason there's a shortage is that it takes a while to produce it. Might be true. But the fact is that in the last two years three large manufacturers have left the business--can't make profits or guarantee the employment of their workers. Physical problem--maybe government should buy these companies as well as General Motors (GM)--but that misses the point. If for some reason it's not profitable for the private sector to produce this, there must be some reason we are not compensating or giving signals to the private sector about the value of these vaccines that is not getting through. Most people feel it's really valuable right now, really want one. Two vaccines now--regular flu and H1N1 vaccine--possible confusion or conflation. Walgreen's has given twice as many flu vaccines as it did last year, just for the ordinary flu--which season doesn't start till December. Flu can kill you if you are old, young, or frail. Worries people. Total of 600 deaths from swine flu so far; we have 36,000 deaths every year from flu in the United States. Many other vaccines crucial and important. We've taken the profit out, basically said that if you come up with a better vaccine you can't profit from it an inordinate amount; government is the major purchaser of these vaccines, which is another non-market aspect. Won't let price be what the market can bear; thus frequent shortages. Too important to let the market do it; put the Motor Vehicle Department in charge of it will all of their efficiency and politeness. Why should government be better at doing it? Heart of the matter--we have a sense that it's wrong to use the profit motive at all as a way of organizing production that's involved in serving really desperate needs. Emotional aspect discussed in other podcast. Story: talking with doctor about swine flu; she remarked that she'd be getting her shot soon--probably better that doctors get vaccinated sooner because they come in contact with people who have it. But with regard to profit motive, she said: I wouldn't trust a vaccine that was made by somebody trying to make a quick profit or take advantage of people. Captures a lot of the emotional and philosophical view about desperate situations. Of course, she charges for her services; if you go to her with your child and said you don't think you want to pay her today because you wouldn't trust her--with child really sick--she'd be horrified to be told she was distrusted. Would she be an even better doctor at no price. Fundamental truth to her observation: we'd like to rely on love and affection and decency as a way to get stuff done, but that's not working for the swine flu. She needs to cover the average cost--medical school--but she might be happy to help people free at the margin. But shortages occur at the margin; vaccines are physical things. Big asymmetry of information. Went to drug store, got flu vaccine; someone unknown, put a needle--don't know where it's been--into a bottle and injected arm. Crazy! Great--only $5 instead of having to make appointment with a doctor and pay $100; displacing some of the monopoly and entry barriers, because now there are all sorts of things that physicians' assistants can do.
18:31	At a point in time there is only a limited physical amount of vaccine available, not enough to go around at the price being charged. Do we want our society to decide who lives and dies based on how much someone is willing to pay? Greg Mankiw example, NY Times column. Suppose there is a Dorian Gray pill--every day you take it, you don't age; and a year's supply costs $150,000 dollars. Would we want to allow that pill to be bought and sold by the marketplace? The premise is that there aren't enough of these pills to go around; and in paper, Mankiw supposes that you can't much change the amount. If you could subsidize it and make it so that there was enough to go around, that would be different. What would be the alternatives? Could do it by authority? Who are the people who are smartest, who would contribute most to society? Maybe the prettiest. Not Matt Holliday, missed fly ball in the outfield; true Cardinal Fan. Could have a lottery. Or could have price. If we used price, objections because it would create a two-tiered society. Might take a vote and outlaw the pill. About to do that in health care. Liver transplant costs about $1.2 million before you go through all of it. We obviously can't do that for everybody. Some wealthy people who have gilt-edged health plans probably can get a liver transplant. What if 70-year old? Germany or England impossible legally to get a liver transplant. Laws can only control what's legal. Vaccines: are we going to let people make their own choices knowing that they can make bad choices? Disagree: not good example. Characterized Mankiw's example in a certain way. Kind of example that makes for a good high school biology or ethics discussion in religious schools: four people on a boat, only enough water to save one: who gets it? Should give it to the youngest--he would live the longest and hence benefit most. Or to most valuable person, most beautiful, smartest, best carpentry skills, best artist, best parent--arguable. Learn from those conversations. Whoever could pay the most for it, and then compensate, giving money elsewhere. But it's the wrong question: if you are in a rowboat, and you only have enough water for one, people do brutal things or honorable things--and it's a moral dilemma. But the way people pose the moral dilemma is a false way of posing it. Does it correspond to anything in economic life, in a market system? For example, when cars were first invented, only rich people had cars. Could have said early on that it isn't right that rich people are scooting along in these vehicles while poor people are on horses or on foot; we can't allow a two-tiered system. Took 60 years, two generations--everybody has a car. Not everybody can have a Lexus. Eleven-year old wants a Ferrari. To say it's not fair if rich people get the Farraris and poor people don't--that is true--but poor people get Hondas, really nice, get you from A to B just as successfully. Incentive for person making the Dorian Gray pill to sell it to lots of people at a lower price.
28:06	Two different things Mankiw's example might illustrate. First, suppose there is not enough of the stuff. Then we have to decide if we are going to ration it by price, need, or something else. Second, suppose the amount of the stuff responds sharply to the way that we allocate it. Then: are we going to let price or command cause the increased supply? Top-down or bottom up. People trust command more than price. Go to the pill: unrealistic, artificial to say there is not enough and we can't make any more. Liver transplant example: is that not a perfect counter-example to claim that it doesn't correspond to anything in real life. An economist is someone who believes as a matter of moral good that the infant mortality rate should be positive--some children when born should died because it is too expensive in terms of the opportunity costs to keep them all alive. We'd have to give up education for other children, etc.--just not worth it. Health care is always rationed; the idea that it should be free is insane. Suppose you will live another 20 years and you will die for sure now without some operation--how do we decide how to allocate that. We can afford it; but we wouldn't like to. We could afford to give everyone a liver transplant who wants one, but what would we have to give up? That's what "afford" means. Could afford to give kid a Ferrari--just a skinflint--sell house, could afford it. Choose not to afford it. We choose not to give liver transplants to everybody. Liver transplant is more important--people say the reason we can't let market decide for liver transplants is they are more important. Other way around. Want market, economies of scale that come with liver transplants. Why are liver transplants so expensive? We don't let people pay for livers. We bury so many good livers--some would be donated in exchange for funeral donations and college education for kid. Also expensive because of complexity of operation involved. It's not that we don't allow any liver transplants. We just subsidize some kinds, but not others. If a 90-year old person is rich, he can go somewhere else and buy one. Artificial shortage. Other argument: could look for non-top down ways. Acquisition of the liver; and to whom does it go. Letting the market handle more of the compensation from whom the liver is harvested--allowing them to sign a contract saying the compensation after unlikely event of death would go to heirs. 100% likely; but at a time when a good donor, so between the ages of 25 and 55 for non-drinker. Under that situation there is a moral hazard problem--both the heirs and sometimes the doctor are over-eager to advance the time of death. Monte Python skit along those lines. It's happened in poor societies and bad systems of justice--can get people murdered for their body parts. Black market now in these organs because we have not gotten our act together. Doctors want to get access to those organs--discretionary authority, power in the hands of individuals. Livers now are so precious; more likely to pull the plug. If there were more of a market in it we wouldn't be so likely to pull the plug.
37:31	Other kinds of price restriction--minimum wage. Discussed in a previous podcast in other countries that use more command and control. Classic Alchian and Allen example: out of print textbook--article in Concise Encyclopedia of Economics on Econlib: Why would the people who run the Rose Bowl not try to make as much money as possible? 100,000 seats, more than that many people want to go. Why not raise the price of seats? Many answers to this problem. Rock concerts. Suggestion: might want to have excess demand for those tickets: People who are selling the tickets don't get the difference in price, but if you keep the price low they themselves get the benefit of being able to allocate them. Like political power of old kings to give away treasure. Tom Hazlett. FCC decided to give away portions of spectrum based on an application. Rent-seeking may dissipate some of that value in a way you don't recover through money. Chinese officials: terrible problems with price ceilings. Rice is really expensive, so let's put a ceiling on it; then everybody can afford it. Problem is: that creates a shortage. Can give out coupons. The local official gives out too many coupons--inflation in coupons--and can give them out with discretion or give them out through a black market. Who do people blame? The lazy farmers--not producing enough rice. People fundamentally misunderstand the minimum wage. It's a floor, but it creates a difference between the market price and the price that people are allowed to transact, so a lot of transactions don't take place. Get paid more if you have a job than you would without the minimum wage. But what if you don't have a job? Creates a reserve army of unemployed. Whole bunch of people looking for this job. Employer looks around and decides who to hire based on other criteria. Standard way to teach about a price floor like this--say the wage for a particular low-skilled person. In the absence of the minimum wage, say you make $5/hour; but it's $7.25 with minimum wage, so there are not many of those jobs. Orson Scott Card: That's good because those are crummy jobs, jobs that people can't make a living on. A bunch of people are hurt, say the economics-trained supporters, but some people are making $7.25, so they are better off. Utilitarian: add up the gains to the people who get to keep the jobs, take away those who lost the $5, and now it's an empirical question: What's the elasticity of the demand for low-skilled labor? How responsive to price? What if it's not very many fewer? What if thousands get a raise and only one person loses a job? Plus social safety net available. Blind application of supply and demand. Barzel, how competition takes place. On a different margin. Price is one way people compete. When wage is artificially high, more people want to work--excess supply. Normally that pushes wages down; but that's illegal; assume no black market, though plenty of that. Created a reserve army of people who would like to work at $7.25. Not just waiting outside. The beneficiary who is employed at $7.25 is in a position to be exploited by his employer and often exploits himself: how hard you work, how many breaks you get, split shift, pay for own uniform, do you get training on the job--mentoring, get better at what you are doing. All of that will be reduced. Plus some of these businesses that were close to failing will fail. It's not just that your employer will take advantage of you, but you realize that if you lose your job it will be a lot harder. Pushes down non-monetary compensation.
50:20	Like hydraulics: if there is this surplus, it gets pushed to some other margin. Regulating airline prices in the 1960s--couldn't lower your price, so they started competing on the kinds of meals they offered, sandwiches, then steaks; lunch was large sirloin steak between two tiny slices of bread, called a sandwich. Also competed by offering more flights for connecting cities, meaning more seats available. Stewardesses more attractive, seats more attractive. But that mix was not the mix the consumer wanted. The guy employed at minimum wage would prefer being treated better at lower wage. Not true for every single worker; some employers will be just as pleasant, won't fire anybody, won't substitute machines for people; but maybe not true now when times are hard-pressed. Ironic: employer who responds to the incentives is an exploiter, barks at workers, no benefits, no health care, no ride to work if living nearby; will fire at the drop of a hat. Then people say that's what happens with greedy employers--yet it's the law. Flip side: you're going to tell me that in the absence of the minimum wage that people making $5 an hour are going to get health care benefits and friendly employers? At the margin, it has to be true. Workers will exploit themselves in the presence of the minimum wage. Two economists talking in their fantasy world about competition. Is that naive? Faith-based economist? If you close off one margin, we do see people to compete on other margins. Munger worked minimum wage job for two summers; wouldn't have been able to find a job had it been higher--a "living" wage of $10-$14/hour. Couldn't have worked way through college. Raising the minimum wage means some people who are economically marginal are able to find a foothold, develop work skills, and maybe move to something else. Some don't, but big increase between $7.25 and $5. Most would understand the effects if it were $50/hour.
57:41	If you artificially price stuff, you will see quantity responses. Interesting: non-quantity responses, hidden aspects. Rent-control apartments: landlord slow to fix the toilet, doesn't paint, you fix things yourself, chooses people on discriminatory ways even if it's against the law. What would non-economists think? It happens at the margin, not sure of margins. Willing to bet that most listeners have never thought about competition on margins other than wage before. Just raising the question: this is a possible cost of minimum wage, prices on rice or apartments--let's try to take that into account.
59:31	[Note recording date is October 14, 2009.] Last week, Elinor Ostrom and Oliver Williamson awarded Nobel Prize in Economics. Ostrom: empirical work studying tragedy of the commons and how groups of people have responded to that challenge through non-monetary cultural norms, voluntary agreements. Standard way economists look at the tragedy of the commons is: It's going to be ruined. Species will go extinct, grass will be eaten to a nub, so we need government. Garrett Hardin's conclusion: only government can solve this. Ostrom asked: Is it true? A type of work disdained by most economists--she does case studies. Munger: That's why I'm in a political science department. Russ: And so is she. She saw what different people did in different situations. Maybe this matters. Card and Krueger: minimum wage increases employment; skeptical, also skeptical of empirical work in other direction. Hard to tease out such small effects. Recent jump in teenage unemployment is suggestive. Would be useful to look at the non-quantitative measures. Can't run a regression. Useful to see how those have changed. Useful to see how competition actually works, as opposed to saying supply and demand cross, therefore we're done. Talk to employers, workers; natural experiment. Some of what Card and Krueger would like to exploit: sent out a survey, tried to control for other factors. On a more sociological style, case-study basis. What might you uncover? City of Santa Fe raised their "living wage" to something dramatic, from something like $7/hour to $14/hour. Interviewed people: what would you do with the money? No one asked if they thought they might lose their jobs over this. Would be interesting to go back to those folks and ask how their lives have changed. What happens in a poor neighborhood when housing prices go up? You get gentrification. Why wouldn't that happen when the minimum wage goes up--you get job gentrification? People who before wouldn't have applied now apply and crowd out all the residents of this neighborhood who used to live in this low wage neighborhood. Not true that things stay static. Illustrates essence of economics: And then what? Attributed to Thomas Sowell? Can't hold everything else constant. Understanding economics improves your imagination. Improving your imagination improves your economics. Can see the hidden stuff you'd miss otherwise. The Seen and the Unseen.

Posted by Russell Roberts at http://www.econtalk.org/archives/2009/10/munger_on_short.html.

Willingham on Education, School, and Neuroscience

Mon, 12 Oct 2009 06:30:00 -0500

Daniel Willingham of the University of Virginia and author of the book Why Don't Students Like School? talks with EconTalk host Russ Roberts about how the brain works and the implications for teaching, learning, and educational policy. Topics discussed include why we remember some things but not others (and what we can do about it), the central role of memory in problem solving and abstract reasoning, the current state of math education in America, and what makes a good teacher.

Play

Time: 1:03:00

How do I listen to a podcast?

Download

Size: 28.9 MB

Right-click or Option-click, and select "Save Link/Target As MP3.

Readings and Links related to this podcast

Podcast Readings HIDE READINGS
About this week's guest: Daniel Willingham's Home page About ideas and people mentioned in this podcast: Books: Why Don't Students Like School?: A Cognitive Scientist Answers Questions About How the Mind Works and What It Means for the Classroom, by Daniel Willigham at Amazon.com. "On Education," by Benjamin Rogge. Part VIII of Can Capitalism Survive? On Econlib. Articles: "Education", by Linda Gorman. Concise Encyclopedia of Economics. Podcasts and Blogs: Dan Pink on How Half Your Brain Can Save Your Job. EconTalk podcast. Making Schools Better: A Conversation with Eric Hanushek. EconTalk podcast. Duggan on Strategic Intuition. EconTalk podcast. Coyle on the Soulful Science. EconTalk podcast. Empirical work and role of math in economics.

Podcast Readings

About this week's guest:

Daniel Willingham's Home page

About ideas and people mentioned in this podcast:

Books:

Why Don't Students Like School?: A Cognitive Scientist Answers Questions About How the Mind Works and What It Means for the Classroom, by Daniel Willigham at Amazon.com.
"On Education," by Benjamin Rogge. Part VIII of Can Capitalism Survive? On Econlib.

Articles:

"Education", by Linda Gorman. Concise Encyclopedia of Economics.

Podcasts and Blogs:

Dan Pink on How Half Your Brain Can Save Your Job. EconTalk podcast.
Making Schools Better: A Conversation with Eric Hanushek. EconTalk podcast.
Duggan on Strategic Intuition. EconTalk podcast.
Coyle on the Soulful Science. EconTalk podcast. Empirical work and role of math in economics.

Highlights

Time	Podcast Highlights HIDE HIGHLIGHTS
0:36	Intro. [Recording date: October 6, 2009.] Understanding how our brains process information. Claim: thinking is hard, brain tries not to do it. What do you mean? We think of ourselves as the pinnacle of creation exactly because we are so good at abstract thought. Compared to other animals, there is no doubt. When you compare the mental processes involved with abstract reasoning, high level thought, dealing with novel problems, to other mental processes the mind and brain handle, they are not all that effective. Compare vision--unbelievably reliable. Walk into a room and in less than one second, appreciation of the objects in the room and almost never wrong. Thinking processes--very slow, unreliable, effortful. Vision takes no effort; after an hour of hard work thinking about a difficult problem people will say they are tired out. Most of the time we will avoid thinking if we can; refuge we move to is memory. In our everyday lives, constantly encountering problems that if we wanted to we could think about them in novel ways. Go to grocery store; confronted with three dozen varieties or more of bread. Could compare them all on price, visual appeal, nutritional content. But most of the time you just buy what you've bought before. Most of the time we just move to memory; but memory isn't as reliable as vision. We think our memory is not that good, but it is actually pretty reliable, and certainly more reliable than high-level thinking is. What gets into our memory? We think everything's in there if we could just tap into it. What gets into short- and long-term memory? Common myth that memory works like a video camera. Can never prove that that's not true. Most cognitive psychologists think that memory is fairly selective. Surprising thing is the selection process. Used to think things got into memory if you tried--that's what studying is. As an adult, rarely study but things constantly get into your memory--current events, what friends are up to, movie plots. Some sticks, some doesn't. Wanting to remember something does nothing--know that from looking up the same word four times. Where your keys are. Principle seems to be the extent to which you think about things deeply and carefully; and connecting things to things you already know about. Implications for students and also for teachers. Ask student years later what they remember and the things they remember are the things that were important to them, not to you as a teacher. Ask students after class what they got out of it; often not what you put in.
7:43	Work on this. Students remember jokes, stunts, the projector falling off the podium. After a year, you remember about 50% of what you learned a year earlier. Takes sustained work to affix something in memory. Remember what we think about--sounds like a throwaway, but a little more complicated. Can't store everything. Memory system lays its bets in a very intelligent way: whatever you are thinking about now is something you are likely going to need to think about later. The longer you think about something, the more likely you are to hold onto it. Also the features you were thinking about at the time--thinking about the meaning of something versus the sound of something versus what something looks like. Barking dog--black and brown dog versus characteristic of the dog's bark versus meaning--likelihood dog will bite you. If you are thinking about what the dog looks like, that's the part you are likely to remember. Implies that you have some control about what you remember. If you are not trying to remember anything about the dog and it just scares you, if someone later asks you what color it was you are less likely to remember. If you have a reason to remember the breed of the dog, conscious effort, make connection with other Dalmations you've seen or think of the movie. Encourages you to control your thoughts at that time. In a laboratory you tell people that they will see a series of words come up; for each word, think about how much you like the word, pleasant or unpleasant word and rate on scale of 1 to 7. For the other half, you do the same and also tell them that later there will be a memory test for these words. The people who know there is a memory test coming later don't do any better than those who didn't know. Tell people you will pay them by the more words they remember, still no difference. Wanting to remember something makes no difference. It's the rating process.
12:38	Next level: Role that memory plays in abstract reasoning. Mnemonics: people like the idea that you go to a cocktail party and to remember someone's name you attach it to something. Ty Cobb's batting average is 367--stuck with that one, in the hard drive. Deeper point: abstract reasoning, which we amateurs think of as thinking really hard. Tell students that to do well in class, have to spend time thinking. Imagine them puzzling over economics problems; but most people don't know how to do that. A lot of what we think of as abstract reasoning is really synthesizing things that are in memory and applying them from previous examples, looking for analogies. Psychologists have been working on reasoning a lot and the extent to which memory of the particular topic you are trying to reason about is important to memory. One extreme view: memory is completely intertwined with reasoning and if you don't know something about it, reasoning about the topic is utterly hopeless. Other extreme view: reasoning is a skill, a muscle, and once you are good at reasoning any problem that comes down the pike you can handle it. Looks like the former is probably more true than the latter, but certainly not the whole story. Knowledge is really important for reasoning; many times we are drawing analogies to previous problems we've encountered, but analogies often don't occur to us. Example: Give people a medical problem to solve that doesn't require any background knowledge about medicine--trying to save a patient's life and patient has tumor, can use special rays. Then give them a problem that is conceptually identical but it's in a different cover story--a military story. Even immediately after either solving the medical problem or being told the solution, they still see the analogy. Depressing. A lot of times in economics like incentives matter; prices adjust, shouldn't hold constant--do whole set of examples and go to apply it to something else and sometimes the students don't see that it's the same underlying example just with different surface structure. Change things a little bit and students don't understand that it's the same. With enough experience, you do get around that problem, else you'd never learn. Expertise does develop and can see that deep structure. Knowledge important: school context, scientific reasoning or historical analysis examples. In history, trying to teach how historians think; sourcing is important, who wrote it, what was their reason, who was their audience. Easy enough for students to memorize that, but quite another matter to actually do it. Student may ask the source of a document--letter written home by an American soldier to his brother, written in 1917, brother in Arkansas. Fine, but what do you do with that? Have to know something about WWI. Is Arkansas relevant? Background knowledge necessary to deploy thinking skills. Tradeoff and connection between facts and reasoning. Modern American education--retrieval of facts, not a lot of abstract reasoning. Need to know year United States entered the war, who was the President. Rewards good note takers. But to get to the next level you've got to know that stuff. Facts are easy to denigrate as an educational goal, but they are crucial. Yet if they are the only goal, it's a waste of time. Sweet spot between memorization, stock of factual knowledge, and taking it to the next level. Facts are necessary but not sufficient. Facts are easy to test, seem objective; set standards that are largely fact-based. Students' proficiency with factual knowledge probably correlated with deeper knowledge. The tests probably are measuring something important but lead to terrible consequences in the classroom because of the way they are structured. In economics education, the multiple choice exam: The marginal rate of substitution is a. the ratio of the prices, b. the ratio of marginal utilities, etc. All that really does is get people to know the definition; but that's not what economics is. Shouldn't be the finish line, but the starting line.
23:04	Example in book: farmer's got a field of a certain width and length, rectangular field, wants to seed it with a certain crop, knows how much seed he needs per square foot and cost of seed; has to figure out expenditure. Basic word problem in high school algebra. Then ask about painting the side of a barn and the students don't recognize it as the same problem. Economics example, will answer in comments to this podcast after responses: If you put a tax on coffee by the cup, which Seattle was thinking of doing--$.10 tax on every cup of coffee in Seattle; let's say $.50 per cup to make it more dramatic. What happens to the size of the cup of coffee if that tax passed? Bigger, smaller, stay the same? Students have trouble getting started; a few can see it, most don't; let them get started; show why wrong answers don't work, let them see how you approach the problem yourself; then show them the right answer. Try to show them how that response to a change in prices and intervention in markets has parallels to other examples. One view: they have to work at it, try it themselves; another is that if you show them enough variants they will start to get it. Pedagogical approach of students watching Russ work problems that are not simple versus them struggling, unable to do it, till maybe some of them get it. Middle approach. If you really have got the students engaged and ask them to do the problem themselves--from the point of view of memory is that they are going to remember the incorrect solution. Discovery learning: unguided discovery, have at it and see if you can solve this problem. Proposed in the 1960s, but it has problems: lots of students don't get the solution, get frustrated. Worry that they will remember the wrong answer. It can work really well--situation specific. Think about kids learning computer software. With no instruction they fiddle with it and learn. That's because there is immediate feedback in the environment telling them whether they have been successful. Discovery learning probably fine for computer software. Frog dissection, not so much. Fiddling with a frog to figure out how it works, probably not going to learn that much. Economics probably more like frog. Guide students. Study groups in graduate school; bad paths shot down immediately by the brighter and more intuitive students; iterate your way towards the right solution but in real time. Ideally a good study group was a group honest enough to say when things were wrong. Grad school students highly motivated with a great deal of background knowledge. Different than trying to do that with a fourth grade class. Romance about that kind of learning at the lower grades.
30:25	Dan Pink podcast--proponent of drawing on the right side of the brain. Claim: left side once was road to success, good at math, engineering, analytical stuff, would make a good living; harder to do now and right-brain creativity, empathy will be increasingly important. Haven't read his book. Neuroscientific, approximation; somewhat out of fashion. When you think about being creative--creativity requires a lot of expertise. Difficult to be creative if you haven't done a lot of the linear thinking. Big emphasis, high schools trying to teach creativity. Can you teach creativity? Can try to create a habit of mind to be somewhat irreverent and try to think problem through in own way. Hunch is that a lot of this is cultural. Americans don't need a lot of instruction to think of ourselves as individuals; value in every individual's opinion; don't take everything as received wisdom. Compare to some east Asian cultures, probably east India as well; anecdote. Some very prepared to be creative thinkers, frequently will discuss that they were not encouraged to be creative in school or at home or anywhere else. Encouraged to respect authority. Not great empirical data, but makes some sense, intuitive. Could look at innovation. Highly likely that sociologists have thought about this. "Thinking outside the box"--critical of that phrase in the book. Applying problem-solving strategies where you would normally use memory. Lots of times when you are drawing on memory. Driving home. Could think outside the box--is this route the fastest, the greenest in terms of fuel economy--but unlikely to do that. Didn't mean to be critical of it; but you can't think outside the box all the time. Big issue in curriculum design in K-12 education. Creativity is a wonderful thing. Alfred North Whitehead: Civilization advances by maximizing the amount of stuff we don't have to think about. Driving home, thinking about what we'll do tonight, thinking about the financial crisis--productive not to think outside the box. Shave-time problems: when you first start shaving you have to think about it, but later not. Practice conserves mental energy. Balance--could be automatically doing something in a really dumb way. Want reliable guide to know when to reconsider. That's what friends are for. That's what markets are for--sometimes markets tell us, special and you try a new kind of bread; or friend suggests a better route home. Social interactions.
38:54	Example of thinking outside the box down to a smaller level: Math education. Trend toward understanding the process. Can always look up facts on the internet; have a calculator; better to know the process, can always figure it out on your own if you need to. National Math Panel report written at request of President Bush--need to have three types of knowledge. Need to know math facts, have memorized the multiplication table and simple addition and subtraction; need to memorize procedures, long division; conceptual knowledge--need to know why these things work. We are doing okay on the first two in America; but terrible on conceptual knowledge. International comparisons--the younger kids are the better they [Americans] do. At that age, factual knowledge and procedures take you pretty far on those tests. The United States starts to get bad relative to international is high school. Conceptual knowledge means why the procedure works. Why when you are dividing fractions the thing to do is to invert and multiply? Remarkable statistic: high percentage of sixth graders don't really understand what an equals sign is, what it means. Lots of them think it means put the answer here. Don't understand that it signifies equality. Algebra will be very confusing. If you don't understand division conceptually, you will have trouble with factoring later. Pitched as too much emphasis on facts. We need to maintain the factual knowledge. Inverting of fractions--akin to driving while talking on cell phone, eating at the same time--something a human can do and not have an accident most of the time. Tradeoff between getting kids to invert and knowing why you invert. Difficult tradeoff. Can't let it be a tradeoff; have to make target that they have both. Math hierarchical; really true at the conceptual level. Procedural approach is recipe for getting kids to hate math. Flip side: right answer is not really important, it's understanding the fundamentals. Those arguments not really embraced by very many teachers. Three million teachers in this country, big diversity of opinion; many pick and choose among the theory and don't go for ideas way out on a limb. Useful to do back-of-the-envelope calculations--how many mortgages in the United States? how big might the ultimate cost of the crisis be and what does that translate per capita? Don't want to do a precise calculation.
46:52	Related question: use of statistical analysis to bolster a viewpoint. Empirical work in education of the efficacy of empirical work. Difficult to measure correctly; axes being ground by people pushing an agenda. In neuroscience? Not writing for the academy--writing for teachers; relative newcomer. Status of empirical research in education--very bad reputation in colleges, particularly in colleges of arts and sciences. A lot of good empirical research gets done, but whether it's heard is the problem. Difficulty in getting that research heard is a function of the way education schools are staffed. Decision for school of education programs to put all kinds of scholars into the same school--historians, psychology, critical theory, etc. can be made relevant to education. Idea is to lead to interdisciplinary flowering of thought; but instead everyone has different definitions of what it means to know something, what should be considered persuasive evidence. Equally true in the college of arts and sciences, but psychology professors don't talk to English professors too much and no one expects them to; working on different problems, each have important issues. In an Ed-School, expected to talk; result is cacophony; no one's voice is being heard. As parents and teachers we want to know what works, which is hard to discover. Does this work: Take the great teachers, don't take the great subjects. Great teacher can make anything an intellectual journey. What makes a great teacher? Difficult problem. One step back: what makes a successful teacher depends on definition of what you think the goal of school is. Americans don't agree on this. Bill Ayers, terrorist with whom Barack Obama was palling around: he is more recently a professor of education at the University of Illinois, Chicago; interested in social justice education. At the forefront, it's on getting people to think for themselves with an emphasis on this not being a just world; goal of students and teachers is to make the world a more just place. Insidious and unproductive because we all disagree about how to make a just world. Ayers can't believe anyone would see things differently: we may disagree about methods but surely we'd agree that that's the goal of education. Contrast that with Partnership for 21st Century Skills, outfit in southwest trying to serve as a catalyst between business interests, government, and schools--now have 13 states that have signed on to their goals; serious commitment, rewrite standards, re-do education of teachers and assessment. Their idea is that the goal of education is to be able to get a job. No one is talking about what the goals of education ought to be, not a conversation that is being had in any state. Education is at the state, not federal, level. We have an intuitive sense of what a good teacher is, but defining it independent of the goals is impossible. Almost anybody would say that a teacher students enjoy learning from and from whom they actually learn something--can start there. Use that as a starting definition.
56:05	Different dichotomy: a lot of people who want their kids to like school; a lot of popular teachers are entertaining but not terribly informative. "She's a great teacher because her class is so much fun." Easy to make a class fun if there is no content. "He really knows his stuff but he can't communicate it." Maybe he doesn't know his stuff; maybe he just looks like a genius because he's so complicated and convoluted, versus parsimonious thought. High school and grade school: popular teachers are often not the best--can be, but not always. Teacher/student relationship counts for a lot. Best learning takes place when we respect those teachers. Good data, especially for early grades; older, more resourceful, easier and more strategies to get past the fact that they don't like the teacher. If a first grader is fearful or doesn't like a teacher, deal-breaker. Teacher needs to be well organized. Best data from college students--talk to undergraduates, boils down to those two dimensions: did they seem like a nice person and did they come to class well-organized. Passion; like to think it counts for a lot; maybe just comforting. Don't know. Enthusiasm in the classroom: if the professor seems bored, why on earth would you be interested? Teaching principles of economics, 390 students in class, didn't use microphone, thought if microphone use would lose students or if used, would have to be really pumped up.
1:00:41	If you could change one or two things what would they be? Wouldn't be based on insights from neuroscience. Would get policy-makers to rethink the jobs of all of the adults in the system--not just teachers but the people writing the standards for each state, administrators, professors of education--from the point of view of cognitive science. We are posing cognitive problems that are impossible to solve. Nobody could do what is expected of a teacher; most can't, so they do something else.

Posted by Russell Roberts at http://www.econtalk.org/archives/2009/10/willingham_on_e.html.