Did an experiment “deepen and prolong” the Great Recession?

(Long and fairly geeky)

That’s the claim emblazoned on the cover of US academic George Selgin’s 2018 book Floored.   It is a big claim by a smart author, who has written many years (often quite sceptically, to say the least) about aspects of central banking.  And, for once, I won’t bury my conclusion: I wasn’t convinced.

The “experiment” Selgin is writing about is the decision, implemented at the start of October 2008, to pay (effectively a full market) interest rate on excess reserves (over and above the regulatory minimum the Fed persists in requiring) held by banks in their accounts at the Federal Reserve.    The Fed was late to the business of paying interest on these deposit balances (other countries, including New Zealand, had done so earlier).  It required Congressional authorisation –  itself a somewhat unusual feature –  and even having obtained that approval the new regime wasn’t supposed to be implemented until 2011.   And when the legislation was passed the focus had been on required reserve balances (not paying interest on those just represented a federal tax).   But with Fed liquidity operations during the 2008 financial crisis adding lots of excess reserves, the new interest on reserves policy was rushed into effect from 1 October 2008, with the aim of supporting demand for those reserves, and stopping market interest rates falling further than the Fed wanted.

That might seem a bit odd.  But remember that although the Federal Reserve was pretty responsive to liquidity stresses and frozen financial markets, they were slow to grasp the severity of the economic downturn.  This is from an earlier post

For example, the FOMC met two days after the Lehmans failure [in mid-Sept].  Had the Fed thought the Lehmans failure would prove “catastrophic”, or even just aggravating the severity of the recession, a cut to the Fed funds rate would surely have been in order.  There wasn’t one.  And the published records of the meeting show no sign of any heightened concern or anxiety about the financial system or spillover effects to the economy. 

It wasn’t until mid-December 2008 that the Fed funds target range was lowered to 0 to 0.25 per cent (with excess reserves now being remunerated at 0.25 per cent).

Congress had actually specified that any interest paid on reserves was to be at a rate that did not “exceed the general level of short-term interest rates”.   And yet, as various charts in the book demonstrate, the rate paid on excess reserves was to consistently exceed other short-term rates (including LIBOR, GC repo rates, and Treasury bill rates).   Notwithstanding the Congressional mandate, this wasn’t an accidental outcome, but a matter of deliberate design, since the Fed’s explicit aim –  outlined in various policy documents Selgin cites –  was to make excess reserves “attractive relative to alternative short-term assets”.    For that to happen, the interest rate had to be attractive.

Selgin’s argument is that this choice was at the root of much evil.    Specifically, by making excess reserves attractive –  so that banks didn’t want to get rid of them –  the historical link between excess reserves and broader monetary aggregate measures was broken.   Had banks been encouraged/incentivised to use, and (individually) try to get rid of, excess reserves, access to credit would have freed up much more quickly, demand would have expanded, and the economic downturn would have been (a) less deep, and (b) less prolonged.   As far as I can tell, the main channel seems to be a demand one, but he also argues that the productivity growth slowdown would also have been less severe.

Here’s why I’m not convinced.

First, take the counterfactual in which interest had not been introduced on excess reserves.  By 8 October 2008, the Fed funds target rate was still 1.5 per cent.  Without any remuneration on excess reserves, short-term market rates –  at least those that didn’t involve pricing any bank credit risk – would have been heading towards zero pretty quickly.    But by 16 December, the Fed funds target (now a range) was reduced to 0 to 0.25 per cent.   With no interest on reserves, the increasing volume of excess reserves would have reduced more market rates to zero.  But that is a difference of (a) two months and then (b) 25 basis points.    25 basis points rarely makes that much difference.

The argument is that credit conditions would have eased up more quickly.  Well, maybe, but in late 2008 and early 2009, not only was there extreme uncertainty about the creditworthiness of many marginal borrowers, but there was a great deal of reluctance among borrowers to take on new credit (who knew when demand and activity would recover?).  For entirely understandable reasons, most people were in batten-down-the-hatches mode.

I’m quite prepared to concede that lower interest rates could/would have made some difference – by then not so much in altering the depth of the trough, but in supporting the recovery that got underway from about mid-2009.  But (a) the near-zero effective lower bound on nominal interest rates prevented short-term falling to anything like the extent (to say -5 or -6 per cent) that analysts estimated (using Taylor rule frameworks) might, in the abstract have been desirable, and (b) the Fed didn’t want to lower interest rates further.  How do we know that?  Because they made no effort to utilise all the leeway they did have (various other central banks later cut their policy rates as low as -0.75 per cent), or to take emergency steps to ease the effective lower bound.   (In fact, had they been able to take their policy target rate materially negative, introducing interest on effective reserves would have been a prerequisite –  if you could earn zero on funds in the Fed accounts, while all around you rates were negative, the option of just leaving your money at the Fed would have been exceedingly attractive.)

And, of course, it wasn’t just the Fed that didn’t want (or believe it necessary for) short-term interest rates to be lower.    Bond yields for a long time were pricing a pretty quick rebound in short-term interest rates, and it wasn’t until 2012 –  well after the trough of the recession –  that US 10 year Treasury yields got down to around 1.5 per cent.   The Fed and markets were mostly, and repeatedly, focused on the first tightening (which didn’t actually take place until 2015).   That was a mistake, of course, but presumably involved the best expert judgement of the FOMC about where short-term rates neeeded to be.  If they’d read the economy correctly, official short-term rates would have been set lower, regardless of the interest on reserves policies.

The other main reason I’m sceptical is that all of this is a US-specific story, and yet the US experience of the recession and recovery wasn’t unusually bad, even though the US was itself the epicentre of the crisis.    If Selgin’s story was correct, the combination of being the crisis epicentre and adopting the IOR policy in the middle of it all, should have left the US economic performance looking pretty poor relative to, say, (a) other big countries (G7) with their own currencies, and (b) non-crisis advanced countries.  That should be so whether we focus on either real GDP per capita or real GDP per hour worked.

There are three other G7 floating exchange rate countries.  Two –  Japan and Canada –  didn’t have a homegrown financial crisis at all, while the UK was caught up in the US crisis.  Of those countries, all three had slower higher productivity growth than the US over the decade after 2007, and the US also had higher growth in real GDP per capita (although the differences with Japan and Canada are small).    Comparing the US with the smaller floaters who didn’t have a crisis (Australia, Norway, Israel, New Zealand) the US looks to have been pretty much in the middle of the pack.  Precise comparisons depend on which periods and which variables you focus on, but the US experience really doesn’t stand out in the way the Selgin hypothesis appears to require.  Of course, one never knows the (economic) counterfactual, but much as he criticises the IOR policy, Selgin doesn’t (that I noticed) set out one either.

In his book Selgin cites another short piece he wrote last year specifically about New Zealand’s experience with interest on reserves.  He claims our experience supports his case.   I’m also not convinced about that.

Some history.  When the OCR system was introduced in 1999, we designed it as (what is known as) a channel system.  The OCR itself was set half-way between the interest rate paid of deposits (25 basis points below OCR) and the rate at which banks could borrow (collateralised) from the Reserve Bank (25 points above OCR).  Actual settlement cash balances were tiny (of the order of $20 million in total).   Banks were required to keep their accounts in credit at the end of each day, but otherwise they had no real demand for positive balances. $1 each was, in principle, sufficient.    Banks lent and borrowed among themselves to manage the impact of net customer flows between them.

That system worked only because of a strange bifurcation we had (consciously and deliberately) introduced a few years earlier.  Until the late 1990s, interbank settlements were done only once at day (leaving lots of intraday credit exposures which could have led to havoc etc if ever there was a bank failure).  Like most other countries, we replaced that with a real-time gross settlement (RTGS) system, under which large wholesale transactions (mostly fx, but also fixed interest securities) were settled individually during the course of the day.  In a system with perhaps $30-40 billion of daily transactions, $20 million of total reserves wasn’t going to be enough.

To meet these liquidity needs, we set up a system of collateralised intra-day credit (“autorepo”), in which we lent banks billions of dollars during the day and took their securities as (in economic terms) collateral. At the end of the day, all those intraday transactions were unwound, and the system ended each day still with only $20 million or so of aggregate sewttlement balances.  By the mid 2000s, however, there was impetus for change from several sources.  Maintaining the separate software (the “autorepo module” in Austraclear) seemed cumbersome, probably expensive, and unnecessary.  And the stock of government bonds was steadily diminishing (lots of fiscal surpluses, and high offshore demand for NZ government bonds) and the Bank’s appetite for lending on paper issued by banks themselves (mostly bank bills) –  which had never been high – was diminishing.

And so we adopted a radically simpler system.  Instead of lots of lots of intraday repos, and the $20m balances at the end of the day, we just combined the two.  The Reserve Bank injected additional liquidity (billions of dollars of it) and bought various financial assets with the proceeds.  Bank wanted –  or needed – substantial balances to cope with the ups and downs of intra-day settlement flows.    They held more settlement cash balances and fewer securities, and we issued more settlement cash balances and held more securities.  This chart from Selgin’s New Zealand paper illustrates the magnitude of the change.


Since the change was not intended to have any macroeconomic consequences, unsurprisingly there was a considerable change in the ratio of (say) broad money to settlement cash balances.  But for big picture purposes, that change itself was inconsequential.

However, one consequence –  the one that is the focus of Selgin’s note –  was that we no longer had a channel system. If we were paying an interest rate on $8 billion of settlement cash balances, that was going to be the operative Reserve Bank rate (hardly anyone borrowed from us again through the standing facility, except to test that it still worked) and the OCR was redefined as the deposit rate.  We’d moved –  consciously and deliberately –  to a floor system.   Selgin makes quite a lot of the idea that a mere a 25 basis point change had materially altered demand for reserves (hence the parallel he seeks to draw with the US), but in fact what really created the new demand was the Reserve Bank’s decision to end autorepo (and special intraday credit).   Banks could simply not have settled their payments –  sometimes well over $1 billion each  –  without holding a lot more settlement balances.

The simple system was initially introduced didn’t last long, in part because the early stages of the financial crises (abroad) broke upon us relatively soon.   Initially, we’d been willing to pay the OCR rate on any balances banks had in their accounts at the end of each day.   But for a variety of reasons, many people at the Bank were not happy about the consequences of this, including the fact that if a bank wanted to hold more settlement cash balances and couldn’t find any other bank keen to lend to them, we had to respond by increasing settlement cash balances, or see market interest rates potentially move out of line with our target.    I took the view that if there was a higher demand for settlement cash balances –  and macro conditions were where we wanted them – we should simply supply them.  The taxpayer typically profited from us doing so.

From memory I was the lone dissenter on the relevant committee when it was decided to introduce “tiering”. Under these arrangements, we would tell each bank how much they were allowed to hold at a full OCR interest rate, and anything else in their accounts at the end of each day would earn a rate a lot lower.  There were earnest bureaucratic efforts to devise formulae to determine how much banks should be allowed to hold, and through my remaining years in the Bank these were updated very so often.  I could never quite reconcile myself to this sort of (perhaps largely harmless) “central planning” or rationing.

Selgin –  who has written a lot in the course of his career about free banking, and the (not free) pre-Federal Reserve regime –  seems to think that tiering (which made excess reserves quite unattractive to banks) made a material difference, including to our economic performance.  Tiering was actually introduced as part of a package and (at least in my observation) the other component – lending secured on bank bills –  was at least as important, if not more so.  Selgin argues that, in consequence, credit spreads in New Zealand never blew out to the extent in the US and Europe, while somewhat grudgingly conceding what looks to me quite an important difference:

though the difference also reflected the fact that New Zealand’s banks were not so encumbered with toxic assets as some U.S. and European banks.

As in, not at all exposed to the sort of assets creating problems then in the Northerm Hemisphere.

It is certainly true that –  as compared to the US system –  tiering did lead to some new overnight interbank lending. Selgin puts a lot of store on this (and on the death of the overnight market in Fed funds in US), but I think it is a mistaken emphasis.   First, had our banks had anything like the degree of concern about each other that US banks did, there’d have been no interbank lending during the crisis.  And second, and more important, banks have plenty of other interactions in which to monitor the creditworthiness of each other.  Overnight loans have always seemed pretty minor relative to those other exposures (eg collateralisation on net positions in derivatives markets etc).

Selgin’s bottom line about New Zealand is this

The RBNZ’s success in keeping credit flowing may have in turn contributed, if only to a modest extent, to New Zealand’s Great Recession being  both one of the first to end and one of the shallowest.

And yet, with barely any domestic financial crisis ourselves and –  on Selgin’s telling –  with superior monetary management, here is the chart of per capita GDP.

crisis costs 2019

Yes, our recession was a little shallower than that of the United States –  you’d surely expect that when we didn’t have big banks toppling over, or new ones being bailed out almost every week.  A year or so later, we actually had a relapse, and across the whole decade there was rarely more than 1 per cent difference between the total cumulative growth rate.   And this is the chart on which New Zealand looks relatively good.

Here, by contrast, from the OECD data, is real GDP per hour worked for the two countries.

us nz prod

Our underperformance isn’t necessarily much worse than it was pre-crisis, but (a) the US did have the crisis and Selgin asserts it was very costly, and (b) we have the monetary management system that he regards as superior to that in the US.  There just doesn’t seem to be anything in the data to support a story that interest on reserves really made any material difference to macro outcomes.

The bigger issue always was the over-optimism about the outlook that meant that Fed wasn’t as aggressive as it could have been (actually neither was the Reserve Bank).  That remains a concern now when the authorities in neither country have done anything to “fix” the near-zero lower bound constraint.  And, by definition, the next serious downturn is getting closer every day.

For those (geeks) interested in such things, it is an interesting and stimulating book.   And he raises some points which I found more persuasive about the reluctance of the Fed to more actively reduce the size of its balance sheet, even years after the crisis.  That has the effect of leaving the central bank nearer the centre of the credit allocation process than it really should be. In turn, that risks inviting Congressional (or industry) pressure in the next downturn for the central bank to do more of that credit allocation: if there is a role for government in such matters, it is surely one for fiscal policy and Congress itself, not for the central bank.

Those readers with institutional subscriptions can read my, considerably shorter, review of Floored on the Central Banking journal website.

Wages and productivity

There has been a longrunning US debate/puzzle around the relationship (or apparent lack of it) between productivity growth and growth in wages/compensation. It was revisited earlier this week in a (very long) post on the excellent Slate Star Codex blog.  The author introduces his post with this chart, pretty familiar to anyone aware of this issue.

wages US

I’ve always found the issue interesting, but been content to do little more than read the occasional summary article.  Arguments often seem to turn on rather arcane measurement issues and I just don’t know the very detailed US data that well.

But as I read through the long post, I noticed something that probably hadn’t struck me previously.  The productivity measures used in this chart (and others like it) are those for the non-farm business sector.   That is the series that gets the most focus in the US, which makes some sense in that it is (a) regularly published by US official agencies, and (b) if you are interested in the performance of the business sector (and not wanting to be thrown around by climatic effects) it is probably natural to focus on.

By contrast, I tend to focus on measures of GDP per hour worked.   That is mostly because (a) it is what is available on a fairly consistent basis for a wide range of countries, and (b) because it is what is readily able to be calculated quarterly for New Zealand, using published data.  And my interests tend to be the economy as a whole.

In the US context it can make quite a lot of difference which series one focuses on.   In this chart, I’ve shown the two series, starting from 1970 (which is when the OECD real GDP per hour worked data starts from).

US productivity.png

It shouldn’t be much of a surprise that whole economy productivity growth is slower than that for the non-farm business sector: incentives (lack of them) and opportunities (types of activities governments do) both tend to work that way.

And then, of course, I noticed that charts like the first one tend to use real variables, which opens up all manner of issues about the “correct” deflator, including issues as to whether the CPI was well-measured in years gone by (there were some fairly significant biases).    But quite recently, I’d compared nominal wage growth in New Zealand to growth in nominal GDP per hour worked, which abstracted from deflator issues (even if it might raise other questions), so I thought I’d do the same for the United States.

I took the compensation per hour series for the US non-farm business sector (official US series) and nominal GDP per hour worked (from the OECD), indexed them all to 1970, and divided one series by the other.  This is the the result.

us compensation

On this measure, US wage growth has lagged a bit behind the growth in the overall economy “ability to pay”.  But it is a hugely smaller gap than is suggested by something like the (widely-used) first chart in this post.

Is nominal GDP per hour worked a reasonable benchmark?  I reckon it is.  Growth in nominal GDP per hour worked captures both real productivity effects and changes in the terms of trade (which have been adverse for the US over this fifty year period).    As ever, there isn’t likely to be some mechanical relationship between labour earnings and GDP per hour worked.  Market pressures shift over time, and so does (for example) the relative importance of capital in generating what growth there is.   Labour shares of the total economy’s output always have, and probably always will, fluctuate over time.   But it seems at least as good a benchmark against which to analyse developments as most others on offer.

Since most of my readers are from New Zealand, two final charts as a reminder of how things are here.

First, a chart comparing real GDP per hour worked with the measured sector labour productivity data.   We don’t have such long runs of data, so this is just since 1996.

NZ productivity measured and total

Unsurprisingly, whole economy productivity growth lags that in the measured sector (that excludes much of goverment activity).

And here is a chart I’ve shown previously showing how wages (the analytical unadjusted LCI series) have grown relative to nominal GDP per hour worked.

wages and GDP

Whatever the story in the US, wage rates in New Zealand have been increasing faster than nominal GDP per hour worked (loosely, “the ability of the economy to pay”).

That might seem quite good for New Zealand employees.  But it is worth bearing in mind that since 1995, we’ve had about 28 per cent growth in labour productivity (real GDP per hour worked) and the US has had about 44 per cent growth in economywide labour productivity.  The windfall of a higher terms of trade has helped us, but if your economy isn’t generating much real productivity growth it isn’t a good outlook for anyone much (workers or owners) in the longer term.



The Fed and Lehmans

On the day of the US mid-term elections it seems appropriate to have a US topic.

I read a lot of books each year.  Many of them provide a fresh angle on some or other issue I’m interested in, but few lead me directly to change my mind.  Professor Laurence Ball’s The Fed and Lehman Brothers is one of the exceptions.   I wasn’t pre-disposed to expect much from Ball (a professor of economics at Johns Hopkins university): my impressions of him were formed by his visit to New Zealand 20 years ago when, as Reserve Bank professorial fellow at Victoria University, he somewhat embarrassed his hosts by suggesting that the conduct of key elements of fiscal policy should be handed over to independent technocrats.  Interesting idea I suppose, but given that the point of spending public money on the fellowship had been to buttress public support for an independent Reserve Bank, it didn’t really help, especially in an election year with Winston Peters in the ascendant.

But the new book looked intriguing. As it turned out, it was much more than that, and I’d go as far as to call it a “must-read” for any serious student of the 2008/09 financial crisis.

It is a very careful and detailed study focused largely on one question: could the US authorities have lawfully prevented the failure of Lehmans that fateful weekend in September 2008 if they had wanted to?   Key decisionmakers have claimed, at the time and subsequently, that there were no lawful options open to the Fed (Bernanke, for example, is quite explicit in his claim that the authorities could only have intervened in breach of the law).  Ball shows, pretty conclusively, that such claims are simply wrong.  The decision not to provide liquidity support to the Lehmans group was just that, a choice.  And he goes on to illustrate that although in law any decision to have provided liquidity support (or not) rested solely with the Board of Governors of the Federal Reserve, in fact the key player was the US Secretary to the Treasury, Hank Paulson, with the Fed apparently deferring to his preferences.

Under the Federal Reserve Act as it stood in 2008, the Fed could lend to non-banks (as Lehmans then was, and as Bear Stearns had been) only in “unusual and exigent circumstances”.  Most commentators will agree that in September 2008 –  a year into an unfolding financial crisis, shortly after the US government had intervened to support the mortgage agencies –  that particular strand of the legal test could readily have been passed, in respect of a major investment bank closely intertwined with the rest of the wholesale financial system in the US and abroad (Lehmans had major operations in London).  The other strand of the legal test was that any loans had to be “secured to the satisfaction of the Reserve Bank” making the loan.  There apparently wasn’t much (or any) case law on this provision, but it was generally accepted within the Fed that the Federal Reserve shouldn’t be lending if they weren’t pretty sure of getting their money back.

But what wasn’t in the statute was a requirement that the borrower itself still be solvent (positive net equity).   A financial institution’s directors would presumably have quite severe limits on their ability (or willingness to risk doing so) to trade while insolvent, but from the point of view of the Federal Reserve, considering providing lender of last resort liquidity support, the relevant issue wasn’t the solvency of the institution, but the adequacy of the specific collateral the Fed would receive to cover any loan.  Nonetheless, senior policymakers have since claimed that Lehmans was insolvent and that, in any case, there was insufficient good collateral to support a loan of the size that might have been required.    Ball challenges both claims.

He does so using an array of published material, including regulatory filings, bankruptcy examiners’ reports, and the report (and supporting documents) of the Financial Crisis Inquiry Commission.

On the solvency front, one issue Ball has to grapple with is that when Lehmans was placed in bankruptcy there proved to be a considerable shortfall in net assets: not just shareholders (who lost everything) but creditors lost significant sums (and some court cases are still unresolved).   But that is a quite different issue from whether there was positive net value in the business at the point where the decision not to provide liquidity support was being made.  Economists have long recognised the concept of “bankruptcy costs”, and Ball makes a pretty compelling case that the bankruptcy process itself resulted in significant transfers of value to other parties that would be unlikely to have occurred in a more orderly process (the three areas he singles out relate to the termination of derivatives contracts, the fire sale of subsidiaries, and the disruption of various investment projects (mainly in real estate) that Lehmans was party to.  But on a going concern basis Ball concludes his detailed analysis this way

…the best available evidence suggests that Lehman was on the border between solvency and insolvency based on realistic mark-to-market accounting, and it was probably solvent based on its assets’ fundamental values.

As noted earlier, the critical (legal) criterion wasn’t about institutional solvency, but about the specific collateral the Fed could have obtained.

You might have assumed –  in a hazy way I think I did –  that by the end Lehmans wouldn’t have had much decent collateral left.  Perhaps you assumed that if the Fed had lent, it would all have been “secured” on dodgy commercial real estate loans.  But, as Ball demonstrates, that view is quite wrong.    Lehmans had been funding a large proportion of its balance sheet (as was the norm then for investment banks) through repos using fairly high-quality securities (ones that Fed was happy to accept), and the run on Lehmans primarily took the form of counterparties not being willing to roll over this repo finance (itself an interesting phenomenon, given that repo contracts should have left any counterparty with a clean ownership of the collateral security in the event of bankruptcy). But to the extent the repos didn’t roll over –  and it was clear they wouldn’t have on the Monday morning without Fed support – Lehman would still have been left with the (good quality) securities.  It also had long-term funding on its balance sheet, which couldn’t go anywhere in the short-term.  Ball demonstrates that Lehman had sufficient volumes of good quality acceptable collateral that it could have secured a large enough Fed loan to have replaced all its short-term funding if necessary.   The numbers would have been large, but as Ball points out no larger than the amounts injected into AIG a few days later (for a risky equity stake), or lent to Morgan Stanley a short time later.

There is an important distinction to be made here.  The issue Ball is dealing with is not whether the US authorities should have taken over, and recapitalised, Lehmans.  His argument –  nested in the liquidity provisions of the Federal Reserve Act –  is that liquidity support could (lawfully) have been provided, and that had it been provided it would have opened the way to a less costly, less disruptive, resolution over the following months.  Perhaps it would have been possible to inject more private equity to the holding company and enable it to continue as a going concern.  But if not, the prospects for a takeover of the business would have been greater –  for example, a key obstacle to Barclays taking over Lehmans was the need for a shareholder vote which would have taken at least a month –  or it would have been possible to have sold subsidiaries –  including the valuable asset management subsidiary –  in a more orderly and competitive process.  At worst, a more orderly wind-down would have been facilitated.

One of the other things Ball documents is the work that had gone on inside the Fed over several months, right up to the fateful weekend, on possible liquidity support mechanisms for Lehmans.  It seems pretty clear that there was never a presumption inside the Fed that if a private buyer was not be found that Lehmans would simply be left to the tender mercies of the bankruptcy administrator.  (In fact, as he notes even when Lehmans was forced to file for bankruptcy, the Fed provided substantial liquidity support to keep the New York broker-dealer subsidiary open for several days until Barclays committed to purchase it.)

So why didn’t the Fed prove willing to provide liquidity support for the whole group?  Ball argues, pretty conclusively, that the key player here was Secretary to the Treasury, Hank Paulson.  In law, the Secretary to the Treasury (or anyone else in the Administration) had no role in such decisions.   And it is not as if, in the specifics of the time and system, Paulson had any greater political legitimacy than, say, Bernanke.  Both were appointed by (outgoing) President Bush, and both had been confirmed by the Senate.   Presumptively, Paulson was likely to be out of office in January 2009 no matter who won the election, while Bernanke had more of his term to run.  But, of course, the politics around Wall St “bailouts” had been turning increasingly nasty since the Bear Stearns intervention (where the Treasury had got involved, implicitly underwriting the Fed’s credit risk) and Paulson –  a strong personality –  was quite open that he didn’t want to be remembered by history as Mr Bailout.  Perhaps the distinction between well-collateralised liquidity support and (actual or implicit) equity support got bypassed in the heat of the moment.

But the other relevant aspect, given the political aversion to more “bailouts”, seems to have been a sense within the Fed that the pressures on Lehmans had been so well-foreshadowed, over months, that its failure wouldn’t prove that disruptive.  Key players now claim that that wasn’t their view –  Bernanke is on record claiming that he always knew it would be a “catastrophe” –   but Ball demonstrates that such claims are simply inconsistent with what the Fed was saying or doing at the time.  For example, the FOMC met two days after the Lehmans failure.  Had the Fed thought the Lehmans failure would prove “catastrophic”, or even just aggravating the severity of the recession, a cut to the Fed funds rate would surely have been in order.  There wasn’t one.  And the published records of the meeting show no sign of any heightened concern or anxiety about the financial system or spillover effects to the economy.  If that was the prevailing view at the top levels of the Fed, it makes more sense as to why central bankers would defer to political pressure not to have provided (liquidity) support for Lehmans.

Central bankers don’t emerge with much credit from Ball’s book.  Anyone can make mistakes in the heat of the moment –  even a large institution with a deep bench like the Federal Reserve –  but what is perhaps more troubling is the suggestion (which seems pretty convincing to me) that key players (Bernanke, Geithner and Paulson) had been spinning the situation in their memoirs, rather than confronting the specifics of the data and the law.  Perhaps I become a bit more sympathetic than I was to (former BOE Governor) Mervyn King’s choice to avoid memoirs, and a defence of his involvement, in his own post-crisis book.  Thank goodness then for the efforts of a careful, apparently dispassionate, academic like Ball.

Of course, to agree with Ball’s conclusion that the Fed could have provided liquidity support to Lehmans if it had wished to do so is not to immediately jump to the conclusion that they should have done so.   Although it isn’t the focus of his book, it is pretty clear that Ball thinks such support should have been given.

A counter-argument could have a number of strands:

  • first, Lehmans had been under pressure for months to raise additional outside equity, and had failed to do so.  Had they done so, even at deeply discounted prices, it is unlikely that the wholesale run would have developed as it did (and even had it done so, the politics of liquidity support might have been different),
  • second, had Lehmans been a bank supervised by the Fed it would probably not have been allowed to stay open even as long as it did without new capital.  In bankruptcy courts, the relevant test might be whether there are still positive net assets, but bank supervisors who are doing their job should have been intervening pretty strongly –  including using directive powers –  before any question arose as to whether net assets were still (perhaps barely) positive, and
  • third, there is still the unanswered question (which may never be satisfactorily resolved) as to just how much the Lehmans failure exacerbated the recession.  Counterfactual history is hard.   The consensus view at present is that the adverse effects were large, but if much of the disruption would have happened anyway –  even if Lehmans had been left limping for a couple of months on liquidity life-support –  the case for intervention is weaker than many would allow (and, for example, AIG’s plight was largely unrelated to the Lehmans failure).  After all, there is a salutary place for market discipline, including around the urgency of injecting new capital when dark clouds loom.

I was one of those who tended to welcome the decision not to “bail out” Lehmans (better still not to have intervened around Bear Stearns months earlier) but I probably haven’t distinguished clearly enough between liquidity and solvency support.   The latter option –  which wasn’t something the Fed could have done anyway –  isn’t the focus of this book, but Ball does make a pretty persuasive case around liquidity support, including based just on facts that were available at the time (on the aftermath, no one could be certain).

I could still mount a counter-argument based on the first couple of bullet points above.  Providing liquidity support in such circumstances would have sent a signal to boards and managers of other institutions that any urgency to raise new capital, at deep discounted prices, was less than it might have seemed.  On the information availabe at the time, that would have been unfortunate.   Then again, within days that whole argument was tossed out the window as the authorities rushed to respond to a deepening crisis.

But perhaps what finally gets me over the line in thinking the Fed made a mistake, in not lending and in deferring to Paulson (in a politicised time six weeks out from an election), is an assessment of the probabilities.  Perhaps the Lehmans failure really wasn’t that big a deal.  Perhaps the Fed at the time was justified in its view that a failure could be managed without too much spillover downside.  But operating in a world of heightened uncertainty, no one could really know.  There had to be a chance that simply allowing Lehmans to go into bankruptcy –  the largest bankruptcy in US history, all done in rush –  would prove very very disruptive and economically costly.  But if providing strongly-collateralised liquidity support, quite possibly at a high interest rate and with ample haircuts, could have alleviated that risk –  even if it was only a 10 per cent risk – it is hard not to conclude (even without the benefit of hindsight) that the central bank should have acted.  After all, lender of last resort provisions are put in statutes for a purpose –  and not just a decorative one.



Debt default by the US government

There was a great deal of debt defaulted on during the Great Depression.   Businesses failed, farms went bust, and some mortgage borrowers defaulted too.    But a huge number of governments also defaulted on their obligations, not just in places like Greece or Argentina which had form in that regard, but including many of the governments of the richest countries in the world.  You could read about the New Zealand episode here.   Most countries in Europe (including the UK and France) defaulted on their (substantial) war debts to the United States –  in fact, only Finland paid in full.  But even the United States government defaulted.

There is an interesting and accessible new book out about that experience, American Default.   It is written by UCLA Chilean academic Sebastian Edwards (who has been used as an adviser and author here, including this paper at a Treasury/Reserve Bank conference a few years ago), who got onto the subject after acting as an adviser to law firms involved with sovereign defaults by Argentina after 2001.

Going into the Great Depression most countries were, directly or indirectly, on the Gold Standard (indirect in New Zealand’s case, where the banks managed the exchange rate to maintain parity with sterling which was fixed to gold).  But the US situation was a bit different than most.   After the experiences with inflation (and fiat money) during the Civil War, in the subsequent decades –  right up to the early 1930s –  US government bonds were issued with a provision (the “gold clause”) that entitled the borrower, at his/her own option, to be repaid in gold.  Many corporate bond contracts had similar provisions.  They were intended as a protection for the lender against unexpected inflation (arising when the fixed parity between dollars and gold was broken, or abandoned), and at least in the early decades must have allowed US borrowers to borrow more cheaply, and/or for longer-terms than they would have otherwise been able too.  In that respect, they were similar to the way in which many countries with a track record of high or variable inflation found it difficult to borrow in their local currency, and borrowed in foreign currencies instead.

By 1933, many countries (notably the UK) had already broken the link to gold.  But the US (and France and several other smaller European economies) hadn’t.  Breaking the link was part of what enabled those countries to begin recovering from the Depression (both by devaluing against gold-based currencies, and by allowing interest rates to be cut further).   By 1933, there was plenty of gold in the US, but no recovery –  indeed, Roosevelt took office in the midst of a banking panic.  As in many other countries, the price level had fallen significantly, such that the real value/burden of any debt contract outstanding was materially greater than had been expected only a few years earlier.

That said, the US government itself was not particularly heavily indebted.  Economic historian Peter Temin’s book on the Great Depression includes a table suggesting that gross debt of all level of US government in 1929 had only been about 35 per cent of GDP.  (By contrast, in New Zealand, Australia, and the UK general government public debt in 1929 had been in excess of 170 per cent of GDP.)   Corporate bonds outstanding seem to have been of a similar size.   Of course, in all cases these debt ratios rose as economies moved towards the depths of the Depression, as both real GDP and the level of prices fell.

It seems that Roosevelt didn’t have a clear strategy in mind when he took office (and the tie to gold hadn’t been a campaign issue).  The actual approach unfolded gradually over the year or two after he took office.  What did the US government do?

The first major step –  extraordinary in a free society –  was to simply outlaw private sector holdings of gold.   All but trivial amounts of gold had to be delivered to the government, with less than a month’s notice, for which holders were paid at the then still-current official price of gold (US$20.67 an ounce).   Private holdings of gold were forbidden for decades.  A few weeks later Congress passed a declaration explicitly prohibiting gold clauses in future securities issues, and abrograting (voiding) existing provisions.   The government then began buying up gold (in the international market) steadily raising the US dollar price of gold until in January 1934, with Congressional authorisation, the official price was reset at $35 an ounce (where it remained until 1971).  US citizens couldn’t get hold of gold, but the US remained willing to buy at the price from overseas sellers.

In effect, the US was off the Gold Standard and had devalued its exchange rate. Gold purchases were increasing the domestic monetary base. In combination, such measures should, and did, support a lift in US economic activity and in prices (commodity prices in particular, in USD terms, rose quite quickly and substantially as one might expect).

And, in the process, the US government managed a huge windfall gain for itself.  As another recent treatment of this episode (by Richard Timberlake, not referenced by Edwards) records, the book profits on the revalued gold was roughly equal to total Federal government revenues in 1934.  Compel citizens to sell you an asset at one price and then re-set the price, more in line with economic realities, and in the process transfer a great deal of wealth from citizens to the government.   It isn’t the sort of approach one would normally expect in a country with the rule of law.

But, of course, the interesting thing about the United States is the way the constitution sometimes intrudes in the freedom of governments to do just as they want.  Had a New Zealand, Australian, or British government adopted measures like those in the US, there would have been nothing much anyone could have done about it, once the parliamentary battle was lost.  But in the US many of these sorts of issues are only finally resolved at the Supreme Court, testing the validity of congressional or executive actions against the provisions and protections of the Constitution.

And that is what happened in this case, although only in respect of the abrogation of the gold clauses.  There were several cases taken, each with slightly different factual bases, covering both private and government obligations.    The claim wasn’t to be paid in physical gold –  private holdings of which were now illegal –  but to be paid the dollar value of the gold equivalent when the bond had been issued.  In dollar terms, that would be 69 per cent (35/20.67) more than otherwise.  There were substantial sums at stake.

As Edwards illustrates, the Supreme Court hearings were closely followed by markets and the press (and at the time the court was perceived to be roughly evenly divided between what might loosely be described as “conservatives” and those of a more moderate or “progressive” disposition).   Media coverage suggested that the government’s lawyers had not had the best of the hearings themselves.   The Court’s ruling was eagerly awaited, and with some trepidation by the government.  Contingency planning had been undertaken, and in Roosevelt’s papers is the draft text of an address he intended to deliver had the Court ruled comprehensively against the government, and papers outlining the actions he intended to initiate in response.    An adverse outcome wasn’t going to be acceptable.  Roosevelt seems to have regarded the abrogation of the gold clauses as an essential element in his overall strategy to lift economic activity and prices; indeed one of the key arguments made to the Supreme Court was around a justification of national emergency.

As it happens, the government won in practice.   The abrogation of the gold clauses, at least as applied to Federal government debt, was ruled unconstitutional (by an 8 to 1 margin).   But by a 5 to 4 margin, the Court ruled that the abrogation had not produced any damages to bond holders, and so those bondholders were prevented from taking further action (in something called the Court of Claims) against the government.  In other words, there were to be no practical consequences for having passed an unconstitutional law (I’m not entirely clear –  it isn’t discussed in the book – why having ruled it unconstitutional the Court didn’t overturn that provision, but clearly they didn’t).

Had the gold clauses in private and government bonds been allowed to stand, issuers would have been required to pay 69 per cent more (dollars) than otherwise (but, in effect, the same amount of gold).  In his book, Edwards seems to accept that this would have been a highly damaging, undesirable, and unacceptable outcome.  I’m less convinced.

For a start, they were the terms on which contracts had been entered into (at numerous different dates), and the cases before the Supreme Court all involved substantial and sophisticated issuers including the US government itself (although I understand that some residential mortgages at the time may also have contained the clause).  And it is not as if changes in gold parities and prices had never happened before (indeed, in other countries they had been frequent during World War One and the subsequent decade). No one, in contracting –  or purchasing – these bonds could credibly claim to have put no weight at all on the possibility of the US ever changing the gold price of dollars.  In fact, the US was still issuing bonds containing the gold clause into 1933, 18 months after the UK (for example) had gone off gold.

It is probably fair to suggest that no one really anticipated a deflationary event as severe and sustained as the Great Depression, but there is at least an arguable case that bankruptcy courts and limited liability exist to handle cases where things turn out unsustainably far from expectation.  But that is a case-by-case procedure, not a blanket transfer of wealth from lenders to borrowers.  In the US government case –  see the numbers earlier –  federal debt was not large and even Roosevelt acknowledged that losing the case would not have bankrupted the government.   Quite possibly the situation would have been different for some corporates.  But it is also worth remembering the whole point of the Roosevelt strategy (not so different in its end aims from those in many other countries), which was to markedly raise the economywide price level and reverse the sharp falls that had happened during the Depression.  To the extent that strategy was successful, the abrogration of the gold clauses would clearly leave lenders materially worse off than they would have been otherwise.  For borrowers in the tradables sector (admittedly probably a minority), the depreciation in the exchange rate itself markedly (and immediately) improved their capacity to service the debt, so it is even less obvious what the case was for the arbitrary use of government power to provide debt relief.

One of the government’s other arguments was that since the price level in the mid 1930s was materially lower than it had been a decade earlier, anyone who held the bonds throughout would be getting an unexpected windfall gain simply being paid out in dollars (since the purchasing power of those dollars was greater than it had been), let alone being paid out at the new higher gold price.  But even to the extent that argument was valid, it doesn’t take any account of secondary market trading in the affected securities.  A person who purchased a new issue bond in (say) 1926 might indeed be getting a windfall gain –  and windfall gains and losses happen all the time in economic life –  but a secondary market purchaser who’d purchased that bond in late 1932 would have lost out badly (and might well have put a high value on the gold clause as protection against just such an eventuality).

(To illustrate the windfall point, in the late 1980s and early 1990s New Zealand governments were determined to get inflation sustainably down. There wasn’t a great deal of confidence that would happen.  As late as November 1990, the 10 year bond yield averaged 12.96 per cent.  Actual CPI inflation in the subsequent 10 years averaged 1.8 per cent.  Similar windfall losses happened when inflation unexpectedly rose, and stayed up, in the 1970s.)

The sorts of revaluation effects the Roosevelt administration successfully tried to overturn happen not infrequently in systems where borrowers –  especially those not in the tradables sectors, without an export revenue hedge – have taken on considerable foreign currency debt, only for a substantial devaluation or depreciation in the exchange rate to occur.  It happened, for example, in New Zealand in 1984: much of the government’s debt was in foreign currency terms, and a 20 per cent devaluation immediately increased the servicing burden by 25 per cent.  Granted that New Zealand wasn’t in the depths of a depression in 1984 , but no one thought it would fair, reasonable (or even possible) to default on that additional servicing burden.

But in the early 1930s, both New Zealand and Australia were in the depths of really rather severe economic depressions –  perhaps not quite as bad as in the US, but certainly much worse than in, say, the UK.   Both countries had really large volumes of central, local (and state, in Australia) government debt issued abroad –  debt burdens far heavier than those facing the US government when Roosevelt took office.  The distinction between New Zealand or Australian pounds and pounds sterling wasn’t that clear in those days, but as the exchange rate diverged during the Depression, initially with government acquiescence and then at government direction (our own formal devaluation happened in early 1933) debts payable in London were suddenly costing the borrowers far far more than they had envisaged (in New Zealand pound terms).  And the price levels in New Zealand, Australia, and London were all quite a bit lower than initially envisaged.   New Zealand and Australian governments would have welcomed some debt relief on their overseas debts, but it never came: the powerful counterargument was “well, if we are going to successfully boost global price levels such relief won’t end up being necessary”.  And it wasn’t.

The big difference perhaps between the New Zealand and Australian cases and the US one in the 1930s is that the US debt was almost entirely held by domestic investors and was issued wholly under US domestic law.  The US didn’t need to tap international markets on a continuing basis, unlike both New Zealand and Australia.  And so New Zealand and Australia imposed defaults in respect of government  debt issued to domestic holders, but not to foreign ones, and the bulk of the (public) debt was foreign.  But rereading the account of the New Zealand (and Australian) experience in the 1930s, what is striking is the extent to which lenders were willing voluntarily to write down the value of their claims, voluntarily converting to less valuable (government) securities, apparently from some sense of “fairness” or the “national interest”.   One can wonder what sort of response Roosevelt would have achieved had he tried moral suasion rather than legislative coercion.   Perhaps it wouldn’t have worked for private sector issuers –  and for example, the New Zealand government used various legislative interventions in the 1930s to relieve farm debt –  but some case-by-case approach still seems preferable than the rather arbitrary use of legislative instruments to relieve all corporate borrowers from obligations they voluntarily entered into.  Especially, when the economy and the price level were just about to recover, improving (markedly) future servicing capacity.

Of course, had the US recovery subsequently been strikingly more robust and successful than those of other countries, there might be a stronger prima facie case for this (distinctive) debt relief component of Roosevelt’s strategy.  But it wasn’t.  As is well-recognised, it wasn’t until around 1940 that real GDP per capita in the US got back to 1929 levels (years behind, say, New Zealand, Australia, and the UK in that regard).  And the recovery in the price level also lagged.

Here is a chart of the price levels, indexed to 100 in 1929.

price levels

Prior to World War One, price level movements tended to be quite slow and gradual.  There was little sign anywhere of entrenched expectations of future trend changs (up or down).  After World War Two, inflation became an entrenched feature of the system.  In this period, things were in transition.   There were windfall gains and losses, falling heavily on different groups at different times.   But if deflation was the story of the Depression specifically, across all four countries the dominant theme of the period is a lift in the price level.  Even by 1939, in New Zealand and Australia and the UK price levels were more or less back to pre-Depression levels (it took a few years longer in the US).     There seems little obvious case for a borrower, not initially over-indebted, to use legislative powers to abrogate contracts freely entered into to remove significant value from lenders, at a time when the entire of macro policy was to drive up the price level.

A fair, and interesting, point Edwards makes (and which I also make in the treatment of the New Zealand default) is that there were few obvious adverse consequences from this US default.  There is little sign that borrowers became more reluctant to lend, or charged higher risk premia.  If so, that suggests that perhaps people in aggregate really did see it as a step not unjustifed in the extraordinary circumstances.

It is an interesting book about a now little-known episode in US history.  Edwards combines history, economics, and legal analysis, but presents in a way designed to appeal to the intelligent lay reader, not just to the geeky economic historian.  Debt default episodes –  here, there, and everywhere –  should be better understood.  We surely haven’t seen the last of sovereign defaults perhaps –  the way fiscal policy is going – even in the United States.

Greenspan and pressure on independent central bankers

I’ve been reading a succession of long biographies of influential Americans.  The US election result prompted me to read biographies of the four presidents from Eisenhower to Nixon – one president with no prior experience in elected office, and three very flawed individuals –  and in the middle of all that I read (to review) Sebastian Mallaby’s big new biography of Alan Greenspan, The Man Who Knew.  There is some overlap:  Greenspan played a role in Nixon’s 1968 election campaign  – in domestic policy, and in doing polling analysis (his economic consultancy/forecasting firm had just acquired its first computer) –  and Greenspan was nominated to his first official government job, Chairman of the Council of Economic Advisers, in the last days of the Nixon administration.

I’d strongly recommend the Greenspan book.  It is well-written, deeply-researched (the author notes that one of his research assistants read the full transcripts of every FOMC meeting in the 19 year Greenspan term), and as interesting for the pre-Fed period as for Greenspan’s lengthy term as Chairman.  For some there might be a little too much on his succession of girlfriends over 40 years –  of one, we learn what she was wearing when Greenspan first encountered her in the Oval Office –  or the tennis holidays, but it is a biography of the man and his times, not the story of monetary policy.  Even in New Zealand bookshops, the price of the 750 page hardback isn’t extortionately expensive.

I’m not going to attempt a full review here.  Instead, I wanted to highlight Mallaby’s account of one interesting little episode from the early 1970s, when Greenspan was still prospering from his success as an economic adviser to major corporations (“the man who knew”).

As I noted, Greenspan had been quite involved in the 1968 Nixon campaign –  Nixon built a fairly formidable team of policy advisers, and carried many of them into the White House with him.    Greenspan had turned down the offer of a fulltime government position after the election, reckoning that the only positions that interested him were ones he was not yet senior enough to be offered (eg Secretary to the Treasury).  But he stayed involved, serving on the commission that (sucessfully) recommended the abolition of military consciption and on a presidential commission on financial reform.

By 1970, the chairman of the Federal Reserve was Arthur Burns, one of Greenspan’s former professors with whom Greenspan had stayed close.  Burns had also been quite involved in both Nixon presidential campaigns, and (somewhat against his own wishes, so his diary records) had been brought into the White House at the start of Nixon’s term as Counsellor, with Cabinet rank.

One of Nixon’s perennial concerns (he was a politician after all) was his re-election prospects.  As it happened he needn’t have worried –  his 1972 margin of victory was one of the largest ever – but he did, obsessively.  And in mid 1971 he was very concerned about what the state of the economy might be by the election time in 1972.   He had been convinced that Fed misreading of the state of the economy had contributed to his narrow defeat by Kennedy in 1960.

On 23 July 1971, Mallaby records,

Nixon invited three advisers to join him on the presidential yacht, Sequoia, for a Friday-night cruise on the Potomac.  The men kicked about ideas on how to deal with the wayward Fed chairman. Burns was behaving like a professional Eeeyore, talking down the economy with one gloomy comment after another…..Building on a suggestion from John Connally, the Treasury secretary, Nixon and his henchmaen settled on a plan.  They would make Burns shut up by planting a negative story in the press about him.

Burns had been urging the president to take a stand against inflationary wage increases. the Nixon men resolved to tell the press that Burns had simultaneously been lobbying behind the scenes for a personal pay raise [in fact, he had argued for an increase in the Chairman’s salary, but starting from the commencement of his successor’s term].  Coupling this charge of hypocrisy with crude intimidation, they would also inform reporters that Nixon was contemplating a reorganization of the Federal Reserve to curb the chairman’s authority.

Four days later the story appeared in the press, and the President’s press secretary “gave the story legs by refusing to deny it”.

With Burns now on the defensive, Nixon’s men moved in for the kill.  They would get a message to Burns demanding a positive speech on the economy. If the Fed chairman wanted to avoid all-out war he would have to cry uncle.

Charles Colson, a member of the Sequoia trio who would later serve jail time for organising Nixon’s dirty tricks, tracked down Greenspan.  He phoned him in New York and asked him to get Burns to change his tune on the economy.

Years later Greenspan insisted he refused to do Colson’s bidding.  But Colson’s handwritten notes from the conversation suggest otherwise.  After taking Colson’s phone call, Greenspan spoke at length to Burns.  Then he reported back to the White House.

Burns were seriously put out –  “very disturbed” was Greenspan’s description.  Mallaby continues for a couple of pages, with accounts of conversations between Nixon, his chief of staff Haldeman, and Connally about keeping up the pressure on Burns, including Greenspan’s role.

And then

Within twenty-four hours, the Fed chairman caved and Nixon appeared at a press conference to disavow the shameful attacks on his good character.  “Arthur Burns has taken a very unfair shot,” the President said, explaining how Burns had in fact turned down  a pay increase when the White House budget office had recommended one. A transscript of Nixon’s remarks was forwarded to Burns, who was soon on the phone to express his gratitude.

“It warmed my heart,” an elated Burns told Nixon’s speechwriter, William Safire.  “I haven’t been so deeply moved in years. I may not have shown it, but I was pretty upset.  This just proves what a decent and warm man the president is.  We have to work more closely together now.”

Burns’s diary for the years 1969 to 1974 has been published –  and is a good read for junkies.  Unfortunately, it is a little patchy and doesn’t cover July 1971.

Mallaby asserts that this episode, in which Greenspan appears to have played a not unimportant role, was a key turning point in the whole of monetary policy in the 1970s (Burns remained chair until 1977) when inflation became an increasingly serious problem, not just in the US, but around much of the advanced world.

In fact, distasteful as the episode is , reflecting no credit on anyone involved, Mallaby probably exaggerates when he writes that

The central bank had not been so clearly under the thumb of the White House since the Fed-Treasury accord of 1951. Politics had triumphed, and Greenspan had been a party its victory.

It is worth remembering the timing.  All this happened just a few weeks before the US suspended gold convertibility and the Adminstration imposed wage and price controls and temporary import levies.  They weren’t normal times, and nor  –  as the fixed exchange rate era broke down –  was it an era in which one might expect the usual distance between the White House and the Fed.

As importantly though, White House pressure on the Fed wasn’t new.  Burns’s diary on 21 March records his request for a meeting with Nixon “to have a candid talk about the war of nerves the White House gang had set in motion”.

And nor was the tension within Burns, between his anti-inflation instincts and his apparent desire for access to, and influence with, the President new.  In the same entry he records:

I informed the President as follows: (1) that his friendship was one of the three that has counted most in my life and that I wanted to keep it if I possibly could; (2) that I took the present post to repay the debt of an immigrant boy to a nation that had given him the opportunity to develop and use his brains constructively; (3) that there was never the slightest conflict between my doing what was right for the economy and my doing what served the political interests of RN; (4) that if a conflict ever arose between those objectives I would not lose a minute in informing RB and seeking a solution together; (5) that the sniping in the press that the White House staff was engaged in had not the slightest influence on Fed policy, since I will be moved only by evidence that what the Fed is doing is not serving the nation’s best interests

and so on.  He notes “RN seemed pleased by my reassurances to him, indicated that he never had  any doubts, that he would put an end promptly to the sniping about the Fed that has been going on at the White House…”

Perhaps more useful still, is Allan Meltzer’s comprehensive history of the Federal Reserve.  Meltzer was a monetarist and in the 1970s had not been particularly supportive of the rather ad hoc way in which the Fed ran monetary policy and allowed inflation to build up.   But in his careful discussion, and analysis of the documentary record, Meltzer absolves the Fed of the charge that in the run-up to the 1972 presidential election it was shaping policy according to political imperatives.  As he notes, the FOMC votes were rarely close (typically unanimous), and the FOMC itself was manned by plenty of independent-minded people who had been appointed by Presidents Kenndy and Johnson (one of the most independent had been appointed first by another Democrat president, Truman).

As he notes

Burns was able to get a majority vote of the FOMC because he could appeal to beliefs that considerable resources were idle, that inflation would be held back by price controls, and that their principal mandate was to contribute to full employment.  This was compatible with service to the president’s reelection campaign.

It is an alien world in many respects –  quite different models of how to think about inflation, the primary role of the central bank etc –  and none of the key figures emerges that well –  Nixon, Burns, Greenspan, Colson, Connally, Haldeman.  Some of that is clearer with hindsight, others should have been clear at the time.  But it wasn’t a case of the President’s placeman successfully orienting policy simply to re-election.

One of the themes of Mallaby’s book is how Greenspan, who started out very close to Ayn Rand, quickly gravitated towards the centre of affairs –  at times willing to compromise perhaps rather too much to retain that place. Mallaby praises Greenspan’s deft political management skills.  I couldn’t help feeling slightly uncomfortable.  One example was the account of the way Greenspan hosted annual 4 July parties at the Fed, at his own expense, for the movers and shakers of Washington and their families –  effectively buying influence and regard.  I came away from the book with a strong sense that 19 years was just too long for any one unelected official to hold such an influential office –  and as the book illustrates there is no evidence that Greenspan was uniquely well able to read the economy, or judge the best policy response –  but perhaps that is a topic for another post another day.

An economist for President?

My two young US citizens have been badgering me about the US election, and when I tell them I’m just glad I don’t have to choose this year, one says “but what if someone had a gun at your head and forced you to choose between Trump and Clinton?”.  Watching Trump’s convention address last week confirmed many of the reasons why I would not support him, and watching Clinton’s address yesterday had much the same effect for her.  Last week’s New Yorker had an interesting profile of the Libertarian Party candidate Gary Johnson, but the more I read about him the less appealing he also seems to be.   I’m still glad I don’t have to choose –  and, what’s more, get to live in a country that has had women as head of state for 128 years of its 176 year modern history.

About the same time I was reading the Johnson profile, I stumbled on “Kotlikoff for President“: prominent economist Laurence Kotlikoff (a professor at Boston University) is running for President, urging voters to give him –  and his running mate, another prominent economist, Ed Leamer (at UCLA) –  a write-in vote in this year’s presidential election.  Kotlikoff is perhaps best known for his push to ensure that governments are fully transparent about the nature of the intergenerational fiscal obligations they take on.

A quick skim through Kotlikoff’s campaign website confirms that there are many issues I disagree with him on – not limited to his banking reforms proposals, contained in his 2010 book. Jimmy Stewart is Dead: Ending the World’s Ongoing Financial Plague with Limited Purpose Banking which he presented, and I had a chance to discuss with him, when he visited New Zealand two or three years ago.  It wasn’t so much that I thought his proposal was wrong, as that I thought he was much too optimistic as to what difference it would make –  my typical reaction to monetary reform proposals.

But what really interested me in working through his economics material was his discussion on immigration and population issues, in particular the bolded passage.


Immigration has been a major topic in the Republican Presidential debates. But the discussion has been remarkably disconnected from the facts. Notwithstanding the suggestion that illegal immigrants are overrunning our borders, there are and have been more illegal immigrants leaving our country than entering it. Indeed, over the last decade, roughly 1 million more illegal immigrants have left our country than have entered it. This is tribute, in large part, to our immense, decades-long effort to secure our borders. We still need to work extremely hard on border enforcement to eliminate illegal entry to our country. But we shouldn’t presume nothing has been accomplished.

The real issue with immigration is legal immigration. We are adding 1 million legal immigrants to the population each year. The great majority are unskilled. This isn’t hurting investment bankers or the software engineers at Google. This is hurting low-skilled U.S. workers. It’s the last thing we need if we are trying to restore our middle class.

Population Explosion

Legal immigration is also fueling a veritable population explosion. Unless we reduce legal immigration, our population will rise by one-third – over 100 million people – in just 45 years. That’s the current population of the Philippines. Most of these additional people will locate in the nation’s major cities. Driving in our major cities at peak hours is already a major challenge. With one-third more people, driving in our major cities may be like driving in Manila – an experience I don’t recommend.

Kotlikoff’s academic speciality is public finance, and Leamer specialises in trade and econometrics, but it was unusual to see  any such prominent academic economists speak up on the issue, expressing unease about the US immigration policy.  And recall that legal US immigration –  the bit Kotlikoff and Leamer focus on –  is one third the size, in per capita terms, of New Zealand’s non-citizen immigration programme.  The US grants around one million green cards a year –  every year roughly one new person for every three hundred already there. We aim to grant 45000 to 50000 residence approvals a year –   every year roughly one new person for every hundred already here.  In a single year, that difference might not sound like much.  Over even 20 years, it is enormous: over 20 years the US will have let in one person for every 15 already there, and we’ll have given the right to live here to one person for every five already here.

I’ve been reluctant to focus on the implications of immigration for wages.  My focus has been on the more macro perspectives: the potential impact on real interest rates, the real exchange rate, and tradables sector growth and investment prospects, in a country that has a modest savings rate and is constrained by its remoteness from the rest of the world.  I’ve also been a little uneasy about the wages story in aggregate in the short-term, since I read the evidence as suggesting that in aggregate immigration tends to boost demand more than it does supply in the short-term.  If anything, surprise immigration surges tend to lower the unemployment rate not raise it, at least in the short-term.

But the repeated (fallacious) insistence of business groups that large scale immigration eases skill shortages for the economy as a whole –  a proposition I dealt with here – eventually forced me to realise that at least in those occupational groupings where there is substantial immigration, that immigration simply must be holding down wages for New Zealanders in those sectors below what they would otherwise be.    The effect might be quite small at an economywide level, but if your sector can persuade the central planners in MBIE (and their Minister) to allow relatively easy recruitment of immigrant labour it simply must dampen the wage rate you as employer would otherwise have to pay.   If the available supply of labour diminishes, the typical response will be for the price to rise.

One could readily think of a number of occupational groupings that stood out when I looked last year at either residence approvals’ occupations or those getting Essential Skills work visas (and that is before starting on the sorts of role the people on working holiday visas tend to cluster in), such as

  • chefs
  • retail managers
  • dairy workers
  • aged care worker or nurse
  • restaurant or café managers
  • cook
  • truck driver

For each of these occupations, the alternative to a ready availability of immigrant labour must have involved, at least in part, higher wages.  Each firm would tend to pay higher wages to attract good people from other employers, and the industry as a whole will end up paying higher wages which will, over time, attract more locals into the industry.  Sympathetic as I am to aged care workers, it has always seemed that the heavy reliance –  as a deliberate matter of policy – on immigrant labour probably explains rather more about the pay differentials they complain about in pay-equity suits, rather than any sort of structural gender-based discrimination.

I understand why government politicians will want to deny these sorts of adverse wages effects. It is more puzzling why Opposition ones do  – especially Opposition parties with their roots in the trade union movement.  And even more so why most economists are at pains to try to deny any adverse effects on anyone.    Unless there are big productivity spillovers from the sheer presence of super-talented foreigners –  and in the New Zealand, most immigrants just aren’t super-talented (any more than most locals are), and no one has been able to find evidence of such spillover benefits at all – if there are any medium-term economic benefits from immigration at all they result from dampening the price of labour relative to the price of capital.  If labour is cheaper more projects are viable than would otherwise be the case.

In case anyone thinks this is just crazy stuff, there is a huge  formal literature on how immigration worked, and affected economic outcomes, in the first great modern age of immigration – the 50 to 70 years prior to World War One.   I’ve touched this in a previous post, referencing a piece by leading Irish economic historian (and professor at Oxford), Kevin O’Rourke.    Overnight, I stumbled on a new accessible essay by O’Rourke written prompted by the recent 100th anniversary of the Irish rising of 1916.  Here is what he has to say about the implication of emigration for wages.

Ireland was hardly the only country to experience mass emigration in the nineteenth century. If its emigration rates were particularly high, this was not due to a uniquely repressive environment (of either Irish or British origin). Irish wages were much lower than American wages, Ireland’s marital fertility rate was high, and there was a large stock of previous migrants to facilitate the transition to a new life in a New World. High emigration is precisely what would be predicted under such circumstances; the Irish were not unusually prone to emigrate, other things being equal.

And as was the case elsewhere, high emigration had a profound impact on the Irish economy, lowering the supply of workers competing for jobs, and raising wages. The wages of unskilled Irish building labourers rose from around 60 per cent of what their British counterparts were earning in the 1830s, to more than 90 per cent in the decade before World War I. Something similar happened in economies as superficially dissimilar as Italy and Norway, and in all three countries emigration was largely or entirely responsible for this wage convergence.

Irish wage convergence was emphatically not due to a superior Irish growth performance

This is just a standard non-contentious result in the modern literature about this historical period –  for anyone interested check out the writings of Hatton, Williamson and O’Rourke himself, for example. Emigration from Europe to the New World (including New Zealand) lowered wages here and raised them in the source countries. It greatly helped the process of income convergence –  although in New Zealand’s case, it took significant public subsidies to make even the high wages on offer here attractive to “enough” people.

There are occasional attempts to explain why the 19th and early 20th century experience might not be applicable today, but I’ve not found any of them even remotely persuasive. Instead,  most modern academic enthusiasts for high immigration to Western countries are either altogether unaware of the historical literature, or simply choose to ignore it.    That is particularly unfortunate –  one could think of worse descriptions –  in the New Zealand case, where since the 1970s we have had huge net emigration of New Zealanders and since the end of the 1980s huge policy-facilitated and promoted immigration of non-New Zealanders.  If it had just been the outflow of New Zealanders, the 19th and early 20th century experience might have led us to expect a substantial measure of income convergence between New Zealand and Australia (as outflows from Invercargill or Taihape helped keep factor returns in those places somewhat in touch with those in the rest of the country).  But if such a process had been incipiently at work, the policy programme to bring in so many non New Zealanders to a country no longer sufficiently attractive to its own would have worked to directly stymie the prospects of such convergence.   And yet in none of the MBIE or Treasury work on immigration I’ve seen has the historical convergence literature been applied to the New Zealand experience.  That seems like quite an omission.

It seems like a good year for Kotlikoff and Leamer to get some coverage for the issues they are promoting. I hope their sensible comments on the immigration policy issues do get some more attention.   And that as we approach our election next year –  with one of the largest controlled non-citizen immigration programmes anywhere in the world (and one of the worse long-term productivity performance –  we can have some thoughtful engagement with the costs and benefits of immigration, including the distributional ones, informed by the historical experience, as well as by the models of modern academic immigration enthusiasts.



How have big cities done in the US?

I’ve written several times about the apparent economic underperformance of Auckland –  apparent, that is, in the official annual regional GDP per capita data that Statistics New Zealand publishes.

We only have the data for the period since 2000, and no doubt more recent periods in particular will be subject to revisions. And there is noise in the data from year to year.  But whereas in 2000 average GDP per capita is estimated to have been 24 per cent above that in the rest of New Zealand, by the year to March 2015, that margin had shrunk to only 12 per cent.

ngdp akld ronz

That shouldn’t have been happening if the advocates of our “economic strategy” had been correct: between the agglomeration gains from cities, a rapidly rising population increasingly concentrating the population in our one moderately-large city, and all the claimed spillover effects from a skills-based immigration programme, everything should have been set for Auckland to have continued to outstrip the rest of New Zealand.  But it just hasn’t happened –  if anything, rather the reverse.   As I noted the other day, Census data suggest that until the mid 1990s more New Zealanders were moving to Auckland than were leaving.  But even that flow has reversed (albeit on a small scale) over the years since then –  the years that coincide with Auckland’s relative per capita economic decline.

There aren’t comparable official data in Australia (regional GDP data are all at a state level), but in the US the BEA publishes real per capita GDP estimates for each of the metropolitan statistical areas (MSAs).    The data are available from 2001 to 2014.

Here is a chart showing the median real GDP per capita for six areas people often think of when they think of the economic success of US cities (Boston, Houston, New York, San Francisco, San Jose, and Washington DC ) relative to GDP per capita for the US as a whole.

real gdp pc us cities

There is some variability, but over these 13 years as a whole average per capita incomes in these cities –  already much higher relative to the rest of the country than is the case in Auckland –  have increased a little further.  The change over the full period isn’t large –  but nor would one expect it to have been.  But the change is in the direction one would have expected.

Those six cities aren’t all of the biggest MSAs in  the United States.  The others in the top twelve (each with populations above 4.5 million)  are centred on Chicago, Dallas, Miami, Los Angeles, Atlanta, Philadelphia.  If we take the whole group of 12 cities, the median city had average GDP per capita 24 per cent higher than that in the United States as a whole in 2001.  In 2014, that margin has increased to 29.7 per cent.

Of course, in a country with a lot of big cities there is quite a diversity of experiences (different shocks, changing opportunities etc).  In five of these twelve MSAs, average GDP per capita had actually fallen relative to the US as a whole over this thirteen year period.  Most of the falls were pretty small, and might be not much more than normal year to year variance.   But Atlanta did stand out.


The fall, relative to the rest of the United States, has been even larger than the relative decline of Auckland.

I don’t know much about the Atlanta economy.  There has been very rapid population growth –  from just over 4 million people in 2001, to around 5.7 million now.   And they have managed that growth while having median house prices of around US$180000, and a price to income ratio near 3.  That is major achievement in its own right.  But it is also one that makes me a little skeptical of claims that fixing Auckland’s dysfunctional housing and land supply market would materially boost per capita income prospects in Auckland (a claim the Productivity Commission has signed up to).

Auckland’s economic underperformance is real, and should be troubling.  It isn’t a “quality problem“, but reflects a serious failure of the economic strategy pursued by both this government and its predecessor.  Fixing the land supply market should be a policy priority in its own right, but it looks like a quite different issue to fixing the issues around Auckland’s overall economic underperformance.  That looks more like the fruit of an immigration policy that funnels huge numbers of people into Auckland, which doesn’t seem to be a natural location for generating lots of  highly-remunerative economic opportunities.  When our largest city has so badly underperformed over fifteen years, despite all the hopes and aspirations, it is time for politicians and official agencies to start facing up to the uncomfortable data.


Technology, Bill Gross, and prime-age employment

Bill Gross, the renowned US bond manager, puts out a monthly Investment Outlook opinion piece, a public outlet for some of his ideas and concerns.  I used to read them quite regularly, and although I don’t do so these days, somewhere I saw a reference to the latest issue, and so dug it out.

His focus this month is on the advance of technology and the possible threat to the future employment opportunities of people in advanced countries.  Among his possible solutions is a Universal Basic Income –  as he notes (and despite the recent flurry of interest on the left in New Zealand) it has also had significant support on the right, especially in the US.

The centerpiece of his discussion is this chart

Chart I: Advance of the Robots, Retreat of Labor

Bill Gross March 2016 Chart
Source: U.S. Bureau of Labor Statistics

As he describes it:

As visual proof of this structural change, look at Chart I showing U.S. employment/population ratios over the past several decades. See a trend there? 78% of the eligible workforce between 25 and 54 years old is now working as opposed to 82% at the peak in 2000. That seems small but it’s really huge. We’re talking 6 million fewer jobs. Do you think it’s because Millenials just like to live with their parents and play video games all day? I think not. Technology and robotization are changing the world for the better but those trends are not creating many quality jobs. Our new age economy – especially that of developed nations with aging demographics – is gradually putting more and more people out of work.

It is certainly a rather bleak picture, for the United States.  But it isn’t remotely representative of the experience across the advanced world.

The OECD only has detailed annual labour market data to 2014.    In the US, as Gross illustrates, the employment to population rate in 2014 for the 25 to 54 age group was 3.0 percentage points lower than it had been in 1990.   A handful of countries had done even worse – Estonia, Finland, Greece and Sweden (three of them countries with little or no macro policy flexibility, now inside the euro).  But the median OECD country (for which there was data right through the period) had employment to population rates 2.6 percentage points higher in 2014 –  when most Western economies weren’t exactly buoyant –  than in 1990.  New Zealand did better than the median, being 5.8 percentage points higher than in 1990.

employment to popn change

In fact, in eight of the 34 OECD countries, employment to population ratios for 25 to 54 year olds in 2014 were at the highest levels they had been in the last 25 years.  On the other hand, 14 countries had employment to population ratios for this age group that were more than 3 percentage points below the 25 year peak.  Perhaps unsurprisingly, 12 of them were euro-area countries, plus the United States and Sweden.

But employment to population ratios are quite substantially affected by the economic cycle.  Participation rates  –  those employed and those actively seeking work – are less severely affected.

participation rate 2104 less post 1990 peak

The participation rates for these prime-age people in 2014 were higher than they had been in 25 years for fully a third of the OECD countries (11 of 34, including New Zealand).  And another 13 countries had participation rates in 2014 within 1 percentage point of the peak (participation rates are somewhat cyclical, and in few countries was 2014 a year of intense cyclical pressure on labour resources).  The US was among a very small handful of countries where the participation rate was still well below the previous peak.

And here is how the US experience compares (and contrasts over the last 15 or more years) with that of the median OECD country, in a chart going back to 1980.

e to popn since 1980

Looking at the participation rate, the contrast is even more striking and appears to have begun earlier.

partic rate since 1980

Quite what is going on in the United States is an interesting question, but it looks to have been quite idiosyncratic.

Perhaps the answer lies in technological developments.  In much of the economy, the US represented the technological frontier for several decades.  But as an explanation it doesn’t really ring true when the US experience is contrasted with that of a bunch of similarly high-productivity (GDP per hour worked) northern European countries.

And perhaps there is a future to worry about in which there won’t be jobs for many of those who want them.  But it does seem to have been a recurrent worry, going back at least as far as the Industrial Revolution, and –  so far at least –  the concern hasn’t come to anything very much for the economy as a whole.  Productivity gains enable society to have more for the same, or fewer, inputs: labour once used to, say, connect telephone calls now does other stuff.  In general, therefore, productivity gains are something to celebrate, and if anything the concern in the last decade or so has been how weak underlying productivity growth appears to have been.

Of course, at least when the public sector is concerned, genuine productivity gains resulting from the application of technology don’t always free up any labour anyway.   My local community newspaper reports this week that the Wellington City Council libraries are introducing a new RFID self-service book-issuing system, which will “be quick and make using the library simpler”.  What’s not to like about that?  Cost savings should  flow from that, I thought, which should be welcomed by the ratepayers.  But no.  Instead:

The council’s community facilities leader, councilor Sarah Free, said the upgrade would offer users the best of modern technology.  … “I’m pleased to say there will be no staff reductions as a result of this upgrade”.

Perhaps there really is a revealed need for additional staff who will “focus on helping people find specialized resources or use library services”.  It feels a bit like gold-plating to me –  a council always keen to spend money, and rarely to save it – but in a sense in just illustrates the way in which the nature of jobs changes as technology advances without –  as yet –  any sign that it leaves large chunks of the population, who want to work, unable to find work.



Is the Fed risking a policy reversal?

The Wall Street Journal ran an article yesterday by Jon Hilsenrath about this week’s (widely-expected) increase in the Federal funds rate target.  So extraordinary have the times been that many Americans will have gone almost a quarter of their working life and never experienced an increase in official interest rates.

Hilsenrath is generally regarded as a well-briefed journalist, and writes intelligently about the Federal Reserve and related issues.  This article seems to have two separate points to it.  The first is the suggestion that Federal Reserve officials themselves are worried that “they’ll end up right back at zero”.  And the second is a report of a new WSJ poll of economists about the outlook for the Fed funds target rate over the next five years.

Taking the poll first, 58 per cent of the surveyed economists reportedly expect that the Fed funds target rate will be back at zero in the next five years, and 16 per cent think the target will have been taken negative.

58 per cent seemed, if anything, a surprisingly low percentage, and not telling us very much.  After all, most policy rate cycles seem to have been only around five to seven years.  In the US, the Fed started raising rates in February 1994 and was back where it started by September 2001.  And then it started raising rates in June 2004 and was back where it started by October 2008.

In Australia, the RBA started raising rates in August 1994 and was back to the same level by September 2001.  It started again in November 2003, and was back where it started by December 2008, and the rate cycle that started in October 2009 was unwound by December 2012.

And what about New Zealand (abstracting from the very quickly reversed small cycles)?

Start                                      End

March 1994                         November 1998

November 1999                November 2001

January 2004                      December 2008

In New Zealand we never quite got to a cycle even as long as five years.    So if I was ever asked, and without looking at a single piece of data, I’d say there was always a pretty good chance that policy rate tightening cycles would be fully unwound within five years.

Some will argue that the current US position is different, in that it is starting from such a low rate.  Perhaps, but the Fed funds target was 1 per cent before the previous cycle got underway.  Neutral rates seem to have been declining around the world, and there is little sign that the US is an exception to that.  And on the other hand, as the WSJ article notes, the US recovery has now been underway for six years, so it is a long way into the recovery (weak as it has been) for the tightening cycle to be starting.

So if Fed officials had only this sort of five year horizon in mind in worrying about the possibility of reversal, it probably shouldn’t be newsworthy.  Shocks will inevitably happen, and there is a good chance that even if a tightening is warranted now, it won’t be needed in several years’ time.

But it would be more newsworthy if some significant chunk of the FOMC were worried that the US might experience the sort of policy reversal all too many advanced countries have had in the last few years.  The WSJ article lists a number of policy reversals in the period since the 2008/09 recession , including that of the ECB and those of smaller countries such as Sweden and Israel.  Mercifully, and perhaps reflecting the extent to which New Zealand has dropped under the radar in recent years, they don’t highlight New Zealand –  the only advanced country to have had two quick policy reversals since 2008/09.  I wrote about the various policy reversals a few months ago (here and here).

All too many central banks have misjudged the extent of the inflationary pressures in their economies, tightening before the evidence was in that inflation was really increasing.  Acting pre-emptively probably made sense in the early post-recession period –  forecast-based policy has, after all, been the mantra.  But it has become harder to justify as the years went by, and inflation continued to remain surprisingly weak (at any given interest rate) in most countries.  In New Zealand, forecast-based policies have probably ended up increasing the variability of interest rates.

Perhaps the US is different, and they really will be able to sustain not just a single Fed funds rate increase but a succession of them (of the sort apparently envisaged by many FOMC members in the dot chart).  But it isn’t clear to me why the US should be different.  It has been a pretty anaemic recovery, and if the unemployment rate has fallen a long way, the employment rate is still very subdued.  And the real exchange rate has risen a lot.  It isn’t that high by historical standards, but a 15 per cent increase in the real exchange rate over the last 18 months or so makes a difference even in a country where exports are only 14 per cent of GDP (tradables are a much larger share).

In this climate, I’d have thought that the inflation numbers themselves should be a key guide.  But even there, there is little obvious reason to think higher interest rates are warranted.  The Fed chooses to target inflation as measured by the deflator for personal consumption expenditure (PCE) –  as distinct from the CPI.  Headline annual PCE inflation is 0.2 per cent (those weak petrol prices, which affect US inflation more than NZ inflation, because taxes are a much lower share of petrol prices).  PCE inflation excluding food and energy has been 1.3 per cent over the last year –  an inflation rate unchanged now for many months.  And the trimmed mean PCE inflation rate has also been steady, at 1.7 per cent.  The Fed’s chosen target is 2 per cent inflation.  Perhaps one could argue that inflation is not too far from the target, especially if one chose to emphasis the trimmed mean measure, but it is not getting any closer.  Given the state of knowledge, and the precedents from other countries, it seems quite likely to be premature to act now.


Which raises the question of why are they (apparently) moving now?  Perhaps the majority of the FOMC is just falling into the same trap other central banks (including the Reserve Bank) have done, expecting a resurgence of inflation (even though there is little or no sign of it yet).  Perhaps it is the low unemployment rate?    But is it not plausible that the NAIRU could be moving lower again?  Former senior Fed official Vince Reinhart has an interesting commentary out, in which he suggests that part of the motivation for a move now might be a desire by Janet Yellen to establish credibility as someone sufficiently tough and willing to move, that she can afford to make the case later for moving only very gradually.  Perhaps there is something to that story, but I hope not.  My impression is that central bankers usually play things fairly straight, reacting to the data as they read it (whether reading it correctly or otherwise) because any other approach is a dangerous game. Of course, American politics is different, and there is a lot of suspicion of the Fed on the right.  But in an anaemic recovery, when so many other central bankers have tightened and then had to reverse themselves, and in a global economy where the threats seem to be growing rather than dissipating, and where (for example) commodity prices are moving ever lower, adopting a strategy that might jeopardise the US recovery out of some desire to “establish credentials” would seem particularly inappropriate.   Within the terms of their own articulation of their mandate, there is little sign that the Fed has had monetary policy too loose in the last seven years –  Scott Sumner and others make a reasonable argument that they were too slow to ease at the start –  and no sign that monetary policy is too loose now.  None of us might adequately understand why interest rates are as low as they are, but that isn’t a basis for a central bank to try to end that on the basis of not much more than a mental model that “in a sensible well-functioning economy, interest rates really should be higher than they are now”.

And all that is before the growing signs of renewed financial fragility and risk.  I found this chart that I saw in a newsletter yesterday somewhat sobering.


Some thoughts on Bernanke’s book

Ben Bernanke must have been busy.

Passing through Denver airport last Tuesday, the day after the book had been released,  I found a large pile of autographed copies of Bernanke’s new book The Courage to Act.    That was one bookshop in one city (not even one of the twenty largest in the US), and it had me wondering just how many days the former head of US central banking system had had to devote to autographs.  I guess even eminent  authors have to earn their –  no doubt rather large –  advances.

The stock of books on the post-2007 financial and economic crises continues to grow.  And it is still early days.  We can expect many more in coming decades –  akin perhaps to the continuing flow of works on the Great Depression, and the unresolved controversies that still  surround that episode.

Many of the key US participants have now published their accounts:  Hank Paulson, Secretary to the Treasury (to January 2009), Tim Geithner (New York Fed, and then Secretary to the Treasury), Sheila Bair (head of the FDIC).   And now Bernanke has joined them.  Each has a story to tell, and a case to make –  typically, a reputation to burnish or defend.

Bernanke’s book written for a mainstream intelligent lay audience. Plenty of copies are likely to be unwrapped on Christmas morning

For anyone who closely followed the crises, and their aftermath, there isn’t much new in Bernanke’s book.  It is a good refresher as the specific dates and events begin to blur in the memory.  And although no one will buy the book for story of his upbringing story, I found his account of a Jewish boy growing up in protestant South Carolina in the 1950s and 60s interesting.

It isn’t a great book by any means.  The writing often feels a bit pedestrian, and although he enlisted a former reporter to work with him on the book, that former reporter was on a year’s leave from the Public Affairs Division of the Federal Reserve.   Enhancing the sense of being written a little too close to the events and people he describes, Bernanke records that after leaving the Fed on Friday 31 January 2014 he started work in the book, from his new perch at Brookings, the following Monday.  I guess market demand (and the scale of publishers’ advances) was at its peak immediately after he left the Fed.  I hope he thinks about another substantive and more reflective contribution, perhaps aimed at a narrower audience, in 10 or 15 years’ time.

Bernanke does acknowledge the odd mistake, but they are “easy” ones, around the timing of particular interest rate adjustments.  Mostly this is a defence of his record, without actually engaging with any more-substantive critiques or alternative views.  In some ways, I found that a little surprising, especially in view of the dismal economic performance of most of the advanced world since the crises.  Arguments that seemed compelling in 2008 or 2009 – when a fairly fast snap-back in economic activity, employment  and inflation pressures were expected  – must surely look at least a little different now?

Here are some of the specific aspects of the book that struck me:

Bernanke doesn’t seem to have met a bailout he didn’t like.  Even in hindsight he does not think Bear Stearns should have been allowed to fail and close. He wanted to bail-out Lehmans (constrained only by lack of legal authority for either the Fed or the US Treasury) despite the enormous losses that Lehmans incurred.  He thought that holders of sovereign debt in Europe should not have been exposed to the possibility of loss, and appears not to consider that (eg) wholesale creditors of Irish banks should have been exposed to losses.  Somewhat to my surprise, he is not critical at all of the far-reaching guarantees offered to Irish bank creditors in October 2008, which triggered the range of guarantees around the world.  And he acknowledges that he favoured putting in place comprehensive guarantees for US banks (rather than the targeted, on new issues, wholesale guarantee approach that was eventually adoped [and which was also adopted for wholesale issues in New Zealand]).

In his defence, Bernanke might argue that the US did not in 2008 have good mechanisms for dealing with failing banks.  But in an interview with PBS the other night, I heard him acknowledge that “too big to fail” issues have still not been fully addressed in the US.    And in the book there is nothing sustained on the nature of the moral hazard to which such bailouts –  and the prospects of them being repeated in future –  is likely to give rise to.  Having come through the largest financial crisis in US history that is disappointing.

It is easy for people who spend their entire working lives in the public sector to assume too readily the benevolence and competence of government agencies and interventions.  Most of Bernanke’s career was spent in academe, but he has a fairly heroic view of public officials and their contributions.  There is no sense at all, anywhere in the book, of any concept of “government failure”, or of any sense that well-intentioned official interventions can sometimes (often?) have unintended adverse consequences.  Not unrelatedly, without directly addressing the issue, there is a strong sense that the crises were caused by the private sector, with courageous government officials intervening to save the private sector from itself.  It is a common view, but one might have hoped that someone with Bernanke’s academic stature might have been better able to make the case, including by dealing with stronger arguments of the sceptics.  His is a technocrat’s world. The one group he is consistently critical of is the US Congress and although one might sympathise to some extent, Bernanke shows little sign of appreciating the importance (or reality) of genuine differences of ideology or worldview.  Like many bureaucrats, he has lofty distaste for political theatre and the messy world of dealmaking –  but then, like them, he never had to face an election.

There is a paragraph towards the end of the book when Bernanke recounts a farewell dinner held in early 2013 when Tim Geithner ended his term as Secretary to the Treasury.    The attendees were former Treasury secretaries and former heads of the Fed.  Bernanke reflects:

Government policymaking at the highest levels involves long hours and near-constant stress, but it is exciting to feel part of history, to be doing things that matter.  At the same time, we all knew the frustrations of struggling with extraordinarily complex problems under unrelenting public and political scrutiny.  Rapidly changing communications technologies….seemed not only to have intensified the scrutiny but also to have favoured the strident and uninformed over the calm and reasonable, the personal attack over the thoughtful analysis.  In a world of spin and counterspin, we all knew what it was to become a symbol of a moment in economic history –  to serve as an unwilling avatar of Americans’ hopes and fears, to become a media-constructed caricature that no one who knew us would ever recognise.  But that’s the baggage that comes with consequential policy7 jobs, as we all knew too well.  The deepest frustration we shared, it soon became clear, was not with the baggage but with government dysfunction itself.

Technocrats as sacrificial heroes, saving the world from politicians and private markets…..

And yet, curiously, Bernanke seems untroubled by the continued growth in the size of government (whether spending/GDP, or the regulatory state). Ultimately those are choices made by the same Congresses that he views with such disdain.

I could go on at length, but there were several other areas of the book that left me disappointed:

  • There was no sustained engagement with the question of why, eg, real GDP per capita is still so far below the pre-crisis trend level (or, for all the contrasts he attempts to draw between himself and the Depression-era policymakers, why in many countries the record eight years on from 2007 is worse than that eight years on from 1929)
  • Bernanke is confident that (successive rounds of ) QE was the right policy, but actually offers little substantive basis for believing that QE made very much sustained difference at all.  Would US bond yields really have been much higher in the last few years absent QE?
  • Somewhat relatedly,  Bernanke does not discuss at all issues around removing or alleviating the zero lower bound on nominal interest rates.  In one sense that isn’t too surprising  – he started writing the book just a few days out of office, and ZLB issues can quickly get quite technical –   but for someone of the academic stature of Bernanke not even to have addressed the issue is a bit disappointing.    Perhaps he thinks nothing can be done, or should be done, but with year after year of policy interest rates near zero, it is not as if the ZLB proved to be a short-lived (or Japanese) curiosity that no one now needs to worry about.
  • Bernanke had a US-specific job, but I thought his treatment of the rest of the world was disappointingly weak.  Of course, US readers often aren’t that interested in the rest of the world, but I thought he was far too easy or glib about what could or should have been done in Europe (the poor old German taxpayer, facing not-low debt levels and a falling population, should apparently have spent a lot more).  And I spluttered when I got to the references suggesting that the IMF, under Strauss-Kahn and Lagarde, had shown no signs of favouring Europe.    And, as a hobbyhorse of mine, there wasn’t much sign that Bernanke has ever thought seriously about what marked out the countries that experienced crises from those that did not (there is, for example, only very brief reference to Canada), and whether the incidence of financial crisis can explain much about how respective economies have performed since 2007).
  • And there was nothing at all on the still extraordinarily large role the government plays in the housing finance market in the United States –  something that goes well beyond anything seen in most OECD countries, and which at least some observers suggest might have contributed to the severity of the US crisis..

I had been meaning for some time to write something about the contrasts between the legal constraints on central banks and government ministers in the United States on the one hand, and New Zealand on the other.  This was prompted by reading a fascinating book, To the Edge: Legality, Legitimacy, and the Responses to the 2008 Financial Crisis, by Philip Wallich, and contrasting it with our law, and my experiences in our Treasury during the 2008/09 crisis.  The powers of the Reserve Bank of New Zealand and New Zealand’s Minister of Finance in dealing with financial crises are extraordinary broad by comparison with those of the US authorities (either in 2008/09 or now).  No question could have arisen as to the Reserve Bank’s ability to lend to any institution it chose, or as to the ability of the Minister of Finance to guarantee any liability or institution he chose.  The US situation was very different, as Bernanke recounts.   There is a real tension here.  The New Zealand powers are frighteningly broad in the wrong hands –  as I read the Public Finance Act, the Minister of Finance could at a stroke bankrupt New Zealand, with no requirement for Cabinet or parliamentary approval –  but they are also very flexible.  I’m not at all sure what the right balance is, but would have been interested in Bernanke’s view on such issues in the light of his experience.  My guess is that he would favour more flexibility than the US had then or now, but how are citizens to be protected from official caprice and well-intentioned misjudgement?  Congress might be quite as bad as Bernanke suggests, but it is they who have an electoral mandate that the best central banker will never have.

Finally –  and perhaps mercifully –  there was nothing in the book of the numerous visitors who must have tramped through Bernanke’s offices over the years.  I wonder what he made of repeated meetings with visiting New Zealand delegations (that I used to read the file notes of) or those of the myriad visitors from other countries.  As a reserved academic, I suspect it wasn’t a highpoint of the job, but….at least they weren’t members of the US Congress.

I suspect Bernanke would have felt more at home in a system of government –  akin to ours, or that of Canada or the UK –  in which the legislature was kept more firmly in its place by the political executive, and there is perhaps less robust media scrutiny.    He ended the book

It is hard to avoid the conclusion that today we need more cooperation and less confrontation in Washington.  If government is to play its vital role in creating a successful economy, we must restore comity, compromise, and openness to evidence.  Without that the American economy will fall tragically short of its extraordinary potential.

For all its problems, of course, the US remains strikingly more successful economically than most of the countries  –  even the advanced democracies – where MPs make rather fewer problems for senior officials.