In a speech by Janet Yellen on April 11, 2012, she talked about her preferred version of the Taylor rule to determine the Federal Funds rate.

The Taylor (1993) rule calls for the federal funds rate to begin rising in early 2013, whereas the Taylor (1999) rule has its liftoff in early 2015, a lot closer to the optimal control path. A sizable literature has examined the performance of simple rules like these by conducting stochastic simulations with a range of economic models. Many studies, including Taylor’s own analysis, suggest that the Taylor (1999) rule generates considerably less variability in real activity and only slightly more variability in inflation than his original rule. Given the differential responses to economic slack across these two rules, this finding is hardly surprising, but it is a key reason why I consider the Taylor (1999) rule to be a more suitable guide for Fed policy.

The Taylor rule (1999) actually had “liftoff” in early 2014 according to Tim Duy, when the rule (1999) went positive. Then she puts the rule into perspective of her broader view on the future of monetary policy.

“While the Taylor (1999) rule can serve as a useful policy benchmark, its prescriptions fail to take into account some considerations that I consider important in the current context. In particular, this rule does not fully take into account the implications of the zero lower bound on nominal interest rates and hence tends to understate the rationale for maintaining a highly accommodative stance of monetary policy under present circumstances.”

Where is she going with this idea of “maintaining a highly accommodative stance of monetary policy”?

Importantly, resource utilization rates have been so low since late 2008 that a variety of simple rules have been calling for a federal funds rate substantially below zero, which of course is not possible. Consequently, the actual setting of the target funds rate has been persistently tighter than such rules would have recommended. The FOMC’s unconventional policy actions–including our large-scale asset purchase programs–have surely helped fill this “policy gap” but, in my judgment, have not entirely compensated for the zero-bound constraint on conventional policy. In effect, there has been a significant shortfall in the overall amount of monetary policy stimulus since early 2009 relative to the prescriptions of the simple rules that I’ve described.

She mentions a “significant shortfall”. What is this shortfall? In the end, it is not what she thinks.

“Analysis by some of my Federal Reserve colleagues suggests that monetary policy can produce better economic outcomes if it commits to making up for at least some portion of the cumulative shortfall created by the zero lower bound–namely, by maintaining a highly accommodative monetary policy for longer than a simple rule would otherwise prescribe. This consideration is one important reason that the optimal control simulation generates a more accommodative path than the Taylor (1999) rule.

So in effect, she will keep the effective Fed rate at the ZLB beyond the moment when the Taylor rule (1999) goes positive. In her mind, this will compensate for the period when the effective Fed rate could not go negative. Thus presently, she is keeping the Fed rate at the ZLB in order to make up for the shortfalls in policy when the rate could not go negative.

There is a risk though. She is expecting a couple of years of slack in the economy now to give her room for this maneuver and for normalizing the effective Fed rate. That vision of plentiful slack is what is in the mind of Janet Yellen. I for one do not believe that such plentiful slack is available due to the effective demand limit.

Analogies

The Fed rate should move with the preferred policy rate rule when the rule catches up to the Fed rate.

Let’s say you are walking to the store with a friend, and suddenly the friend drops back to tie their shoe. So you wait for your friend to catch up. When your friend catches up to you, do you allow them to walk a little further ahead to make up for the time they were behind? No… you start walking together. You are supposed to walk together.

Is there an analogy that makes sense of Janet Yellen’s plan? Could it be “affirmative action”?

In affirmative action, you have people who have been disadvantaged for a period of time, so they fall behind everyone else. So you create a policy to give them extra advantages to catch up.

But the analogy of affirmative action assumes a comparison of someone who did fall behind and someone who did not. So who fell behind who? In reality, labor fell behind capital. So does Janet Yellen’s maneuver to hold the Fed rate at the ZLB give labor an extra advantage? No… Her maneuver keeps giving capital extra advantages. It is a backwards policy. She is helping the advantaged thinking that they will help the disadvantaged once the labor market tightens up. However, reports are showing that on balance firms do not plan on raising labor’s share.

The Shortfall is actually Labor’s, not Capital’s

Unless Janet Yellen’s plan can directly help labor gain a higher share of national income, she is simply creating more policy for cheaper capital, cheaper labor and sustained inequality. She is harming society by giving extra advantages to capitalists, who have garnered pretty much all the gains from the recovery…

In her mind, she is on the correct curve for monetary policy. Yet in reality she is putting monetary policy and society behind the curve.

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by David Zetland on Aguanomics

Time for a new boat
OM writes from California:

Have you thought or written about public purchase of water flows needed for the environment? We have a new water bond that includes a lot of funds for this sort of thing. It strikes me that it fits with the model of internalizing profits/externalizing costs. If there is not enough water in the river, that is because water users are not complying with permit term, flow requirements or other obligations. So why should the public pick up the cost of buying that water back? Does purchasing water needed for the environment with public funds tend to unjustly enrich those with unclean hands? Would resources be better spent on enforcement?

Here are my thoughts:
First, I would not pay to retire rights that were over-allocated, as the “right to use” (usufruct right) is not the same as the “right of ownership” in California.* I’d revoke overallocations by administrative fiat, as those allocations can not — and will not — be used.
Second, I’d redefine remaining allocations to exclude baseline environmental water flows. The Australians have done this in the Murray Darling Basin. The opposition to cut-outs will increase as their share of total flows rises, so it’s probably best to set them lower and get them in place.

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Lifted from an op ed e-mail from Stormy:

A piece in the Guardian is interesting, dealing with poverty (real poverty) and inequality.  I think that Angry Bear should really address what can be done about rising inequality.   Here are the last two paragraphs:

The prospect is one of a society such as the one we live in, only more so. Nobody, in the Beveridge sense of the term, is lacking the means of subsistence: nobody is “poor”. But it is a society that is also starting to look uncomfortably feudal, and many economists think it is overwhelmingly likely to be our future. I know, because they’ve told me. But this is a conversation we need to be having out in the open, because keeping quiet about it makes it more likely to happen.

This may sound grim, but I am not pessimistic. Rising inequality is not a law of nature – it’s not even a law of economics. It is a consequence of political and economic arrangements, and those arrangements can be changed. Inequality in the developed world fell for most of the 20th century; we can make it fall for most of the 21st century, too. But it won’t happen without sustained pressure on politicians from electorates. So let’s get on with it. Let’s start to make them hear what we’re saying: it’s about the inequality, stupid.

Instead of celebrating laissez-faire capitalism, we should start talking about how we would change things to lessen inequality.  Exactly what political or economic arrangements should be created?  Simply asking the rich to share is laughable. If you want to understand Ferguson, ask, “Where are the jobs?”

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Thomas Piketty’s Capital in the Twenty-First Century is the first book to make a data-driven examination of economic inequality. Based on hundreds of years worth of data, it attempts to determine the long-term trends in inequality and the social and political consequences that follow from them.

In this final post, I want to highlight the most important points of the book, including a few I have not yet discussed. Beyond that, I want to consider parts of the book that are perhaps a bit less persuasive.

First of all, the data has been almost unchallenged. The one person who claimed substantial flaws in it, Chris Giles of the Financial Times, is road kill.

Second, three major results emerge from the data bringing dearly-held economists’ views into question. A) There is no Kuznets Curve: Developed countries do not keep getting more equal; rather, the data show that they have become less equal since about 1980. B) There is no fixed share for capital and labor income, as assumed by the Cobb-Douglas production function: Capital’s share of national income has risen since 1975. C) Franco Modigliani’s view that most savings was for retirement, not inheritance, is wrong. Depending on the country, no more than 20% of private wealth is in the form of annuitized wealth that ends at death.

Third, the big theoretical payoff is that some economists’ happy stories about how everyone earns their marginal productivity are simply incorrect. These bedtime stories may make the rich feel like their high incomes and wealth are deserved. The fact of the matter, though, is that high incomes are not the result of merit but of bargaining power. The increase of capital mobility since the 1970s is one element in disciplining labor, while the reduction in the top income tax rate gave top corporate executives more incentive to push for large wage increases and exploit the large uncertainty regarding their individual contribution to corporate success.

Fourth and most obviously, r>g* is no historical necessity, but it has held true virtually everywhere for all of human history. As long as it is true, there is a tendency for inequality to worsen.

Moving on to aspects of the book I have not previously covered, one discussion that stood out was Piketty’s discussion of the weakness of measures of gross domestic product (p. 92). In particular, he notes that there are no good quality measures for adjusting GDP:

For example, if a private health insurance system costs more than a public system but does not yield truly superior quality (as a comparison of the United States and Europe suggests), then GDP will be artificially overvalued in countries that rely mainly on private insurance.

Parenthetically, it seems to me that any high-cost low-quality system would overstate GDP, whether it’s private or public. But the point to remember is that we are talking big bucks here: if the United States were spending merely what the #2 country (Netherlands, in terms of percent of GDP) does, we would be spending almost $1 trillion less, so presumably this means U.S. GDP is overstated by $1 trillion. That’s still a lot of money!

As I discussed before, Piketty advocates a global annual tax on wealth as the solution to the problem of inequality. However, he relegates an alternative global tax, on financial transactions, to a single paragraph plus a single footnote. He claims that an FTT would “dry up” “high frequency transactions,” and for that reason would not raise much revenue. Of course, this would depend on which transactions are taxed (James Tobin had originally proposed taxing foreign exchange transactions) and what the tax rate is. A balance can be struck between “throwing sand in the wheels,” as Tobin described it, and raising revenue. Contra Piketty, I don’t think it is something that can be rejected out of hand, and I plan to discuss an FTT more fully in the future.

So what’s wrong with the book? Honestly, not much. I mentioned before that I wasn’t fully persuaded by Piketty’s evidence that bigger fortunes necessarily earn higher rates of return. However, this is not a big issue, especially as the claim does seem fairly plausible.

At times, however, Piketty’s political arguments seem almost ad hoc. He attributes (p. 509) the rise of Reaganism and Thatcherism in part to a feeling people had that other countries were catching up to them. He presents no evidence for this claim, which does not strike me as particularly plausible. Similarly, he lectures the leaders of large EU countries (p. 523) for their failure to align taxation among the Member States, rejecting their leaders’ point that EU institutions (unanimity is required for changes affecting direct taxation) and other Member States (read: Ireland) can block fiscal coordination indefinitely. But it’s true! It’s right there in the Treaty! So he’s a little too glib about politics for my tastes; but then, I’m a political scientist, so perhaps I’m not the most neutral of sources.

Bottom line: You’ve already bought the book, so take it off the coffee table and read it! It may take you a few weeks, or a few months, but you’ll be glad you did.

* r>g means that the rate of return on investment, r, is greater than an economy’s growth rate, g.

Cross-posted from Middle Class Political Economist.

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I posted a graph where I overlaid the Effective Demand rule over the Taylor rule variations done by Tim Duy.

You can see differences between the rules since the crisis. Why the difference? And does the difference matter?

Basic Taylor rule

Target Fed rate = natural real rate + inflation + 0.5*(inflation – inflation target) + 0.5*(output – output target)

When inflation or output is below target, the target Fed rate will be lower. The problem we have seen with the Taylor rule is the trouble that the CBO has had with estimating potential output. The CBO has had to continually adjust downward potential output. There are disagreements to what potential output really is.

Rudebusch Variation of Taylor rule

On the other hand, the Glenn Rudebusch rule which is a variation of the Taylor rule measures unemployment to a Natural rate of unemployment.

Rudebusch target Fed rate = natural real rate + inflation target + 1.3*(inflation – inflation target of 2%) – 1.9*(unemployment rate – natural unemployment rate target)

Let’s test data through this equation. (I use the Short-term NAIRU data from FRED for natural unemployment rate target. CPI less food & energy for inflation. 2% natural real rate after crisis.) I now overlay my new run of the Rudebusch rule on the above graph (yellow line).

The yellow line and the green line (Tim Duy’s Rudebusch run) follow each other pretty well since 2002.

Effective Demand Rule

You will notice that the target rate of the Effective Demand rule rose faster than the Rudebusch rule after the crisis. Why? Well, it is because the Effective Demand rule measures the utilization of labor AND capital (TFUR in equation below), not just labor like the Rudebusch rule. After the crisis capacity utilization rose much faster than unemployment fell. So while the Rudebusch rule lagged behind with unemployment, the ED rule rose by following both capacity utilization and unemployment.

Is it better to include capacity utilization in a rule for the Fed rate?

The rapid rise in capacity utilization was increasing production and using up economic slack. If you just include unemployment in a policy rate rule, you would not see that effect.

Capital and labor are both directly related in the productive capacity of the economy to produce what is demanded. Some say that capital is being used more due to new technologies and replacing labor. If so, we must have a measure of capacity utilization along with unemployment in a policy rule.

Capacity utilization has been moving steadily on its trend line since the beginning of 2011, and so has unemployment. They are both heading toward a natural limit together. We may see utilization of capacity drop while utilization of labor rises, which is a sign that they are reaching their composite natural limit to meet effective demand.

It may also be reasonable to say that keeping nominal rates low makes the cost of capital cheaper and thus that much more desirable than hiring labor. In such a case, a higher Fed nominal rate would have reduced labor’s advantage disadvantage against capital.

So, I would say… definitely yes. A rule for a target Fed rate should include capacity utilization or another measure of capital utilization.

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This will be short and sweet, consider it a Health Care Open Thread.

‘Repeal and Replace’ is a pipe dream. Because all the good parts of ACA including guaranteed issue, coverage of pre-existing conditions and inclusions of young people on their parents’ policy actually cost money. At least up front. Which has to come from somewhere. And that ‘where’ tends to come from the pockets of Republican leaning constituencies including medical equipment manufacturers, insurance companies, and medical providers generally. For example a huge part of projected ACA savings comes from reduction of payments for Medicare Advantage, originally billed as a way to leverage the ‘efficiency’ of private (and profit making) economic entities to public ones. Which efficiency calculation has proved problematic even before you calculate the ‘profit’ thingee. With the result that Medicare reimburses Medicare Advantage providing insurance companies with a 14% surcharge over traditional Medicare. Or I should say “reimbursed”, because most of the much ballyhooed “cuts” to Medicare trumpeted by Republicans have come from elimination of the surcharge. Itself rather problematic given that there seems to be no evidence of actual “efficiencies” in MA.

Republicans have no answer for this dilemna. Just about every specific item they oppose about ACA serves as an offset to the increased costs of guaranteed issue and coverage of pre-exisitng conditions. Including their so-called ‘death panels’ which after all are simply cost-benefit analyses of current provision of medical care. Or the same thing that private corporations spend millions on hiring consultants to address. Because when it comes right down to it ‘efficiency’ in the private corporative sense boils down to cost controls.

As a result Republicans are flailing. Their ‘solutions’ such as they are, including cross state border insurance sales and tort reform do little to nothing to having negative consequences on the actual provision of medical care to end-users (aka ‘patients’) but instead reduce burdens on insurance company and provider bottom lines. The same for repeal of the medical device tax and employer mandates and individual mandates. All increase cost while providing bubkis on the ‘available’ and ‘affordable’ fronts.

Those of us who followed health care reform on a daily basis back in 2009 saw that it was at times the rawest form of legislative sausage making. In order to enjoy the nice juiciness of the Bratwurst of Affordable Health Care you had to stomach the knowledge of the nasty bits that actually saved money on the price of the resulting Sausage Dog. And Republicans have no recipe to provide that same Red Hot that doesn’t decrease the quality or increase the sawdust component.

Hoisted by their own Weinar, err Petard.

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On Tue, Sep 9, 2014 at 1:47 PM, Dan <cdansplace2@aol.com> emailed:

Rortybomb, New Piece on Where the ACA Should Go Next Rorty touts the 2009 House Bill which calls for a Public Option and described here To improve ‘Obamacare,’ reconsider the original House bill

Maggie Mahar replies:

Originally I favored a public option, but in fact, at the time, no one really spelled out who would run the public option–or how it would be run.

One of the best things about the ACA is that lets both HHS and CMS make end-runs around Congress. I would never want a public option that was run by Congress.

Here is the comment I just posted in reply to the post “Where the ACA Should Go Next”

I would need to know far more about the public option—and how it would be different from Medicare– before voting for it.

Medicare is extraordinarily wasteful– 1/3 of Medicare dollars are squandered on unnecessary treatments that provide no benefit to the patient. Why? Because Congress is Medicare’s board of directors, and lobbyists representing various specialist’ groups, hospitals, device-makers and drug-makers control Congress.

Meanwhile, Medicare does not cover much needed care, ie. vision checks are just one example. This is why the vast majority of Medicare beneficiaries must buy separate private insurance (MediGap or Medicare Advantage) to supplement what medicare doesn’t cover.

Finally, I favor narrow networks. They keep costs down. The doctors and hospitals that are not included in the networks are those that refuse to negotiate  prices.  By excluding them we remind doctors and hospitals that we can no longer afford letting providers charge whatever they wish. No other developed nation allows doctors and hospitals to simply set prices.

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The San Francisco Fed has a paper, Assessing Expectations of Monetary Policy, where they make a case that the market expects monetary policy to be more accommodative than the Fed is projecting. How could that be when the Fed has been so aggressively accommodative until now? Shouldn’t they tighten already?

In my view, the market does not see the economy being able to expand as needed over the next two years. They see economic opportunities dwindling. They see profit rates stalling and becoming more competitive. They see wages subdued. They see demand subdued. They see weaknesses in Europe and China. They see stock markets unable to continue hitting records. They see fatigue settling into stock traders.

In short, the market sees an economy that grows slowly over the next two years… so slowly, that the Fed will have to maintain its accommodative policy. The economy is hitting the effective demand limit, and businesses are seeing the effects.

The current growth in the US economy is projected to continue for years. One hears that the economy is finally taking off. However, now is a good time to use low nominal rates to increase production and gain market share in a more competitive atmosphere. The accelerated growth we see now could generally be a temporary attempt by firms to hedge against a tighter Fed policy next year. It could be like runners surging with a sprint toward the finish line, but of course they do not intend to continue sprinting beyond the finish line. And in this analogy, the finish line is projected tightening of Fed policy which will have tightening effects globally.

So the SF Fed paper is showing us that firms are not optimistic about the economy over the next two years. Yet firms are accelerating operations now to position themselves in an uncertain market.

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by Joseph Joyce

The IMF and Sovereign Debt

The continuing inability of the Eurozone economies to break out of their current impasse means that any optimistic projections of declining debt to GDP ratios are unlikely to be achieved. As long as European governments continue to raise funds in the financial markets on favorable terms, the current situation remains sustainable.  But the IMF is thinking ahead to the day when there is a change in the financial climate, and is proposing a change in the rules governing its ability to lend to governments that may need its assistance if they are to continue repaying their debt.

The Fund’s rethinking has been prompted by its concerns over its lending to Greece. The IMF, as part of a “troika” with the European Commission and the European Central Bank, participated in a loan arrangement in May 2010. The IMF’s contribution consisted of a $40 billion Stand-By Arrangement. The Fund had a problem, however: this amount far exceeded the normal amount of credit that the IMF normally provided to its members. Exceptions were allowed, but there were criteria to govern when “exceptional access” was permitted. One of these was a high probability that a government’s public debt was sustainable in the medium term. It was difficult to claim that was true for Greece in 2010, so an alternative criterion was established: exceptional access could also be provided if there was a “high risk of international systemic spillover effects.” This was used as grounds to justify the lending arrangement to Greece.

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Any one knowledgeable?…leave a comment on winners and losers.

Deal book today describes rather ho hum changes in capital requirements for banks with a positive spin:

FED’S DIET PLAN FOR BANKS The Federal Reserve said on Monday that it planned to increase the pressure on large financial firms to slim down, DealBook’s Peter Eavis writes. In testimony he will give before the Senate Banking Committee on Tuesday, Daniel K. Tarullo, the Fed governor who oversees regulatory policies, signaled the central bank’s plan to propose special capital requirements for the largest banks that will be even higher than those demanded under international banking regulations.

Mr. Eavis writes: “When regulators increase capital requirements, it forces banks to borrow less money to finance their lending and trading. The theory is that banks that rely less on borrowing are more stablebecause they are getting more of their financing from shareholder funds, which do not have to be repaid at short notice when turbulence hits. But as a bank has more equity funding, it in theory becomes harder for it to earn a return on its shares that satisfies investors. The bank might therefore decide that, to reduce its equity funding, it needs to shrink its assets. And if the largest banks fall considerably in size, they would pose less of a threat to the wider economy if they collapsed.”

Web of Debt describes the set of new rules as unprecedented and negative.

In an inscrutable move that has alarmed state treasurers, the Federal Reserve, along with the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, just changed the liquidity requirements for the nation’s largest banks. Municipal bonds, long considered safe liquid investments, have been eliminated from the list of high-quality liquid collateral. assets (HQLA).

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