Sunday, November 30, 2014

Five Thoughts on Monetary Policy

1. Monetary policy may operate on (a) the quantity of bank liabilities (money); (b) the quantity of bank assets (credit); (c) the price of one or more assets relative to money (an interest rate);  and/or (d) the price of money, normally relative to some other money (an exchange rate). Which of these should be considered the most immediate target of central bank policy, both practically and conceptually, has been debated for over 200 years. All four positions are well-represented in both academic literature and central bank policymaking. For the US over the past 50 years, you could say that the center of gravity -- both in policy and in the economics profession -- has shifted from the quantity of credit to the quantity of money, and then from the quantity of money to the price of credit. [*] I don't know of any good historical account of these recent shifts, but they come through dramatically if you compare contemporary articles on monetary policy, ones from 20 years ago, and ones from 50 years ago.

Lance Taylor has a good discussion of the parallel debates in the 19th century on pages 68-84 of Maynard's Revenge, and a somewhat more technical version in chapter 3 of Reconstructing Macroeconomics. Below, I reproduce his table classifying various early monetary theorists in the four categories above, and on the orthogonal dimension of whether the money/credit system is supposed to be active or passive with respect to the economy. Obviously, confidence about the usefulness of monetary policy implies a position on the lower half of the table.

From Lance Taylor, Reconstructing Macroeconomics

It would be foolish to debate which of these positions is the correct one -- though the monetarist view that the quantity of money plays an important causal role is clearly inapplicable to modern economies. It also seems possible that we may be seeing a shift away from the focus on the price of credit, and specifically the single policy interest rate -- a position that is presented in many recent textbooks as the only possible one, even though it has been dominant only since the 1990s. In general what we should be doing is recognizing the diversity of positions and exploring the historical contexts in which one or another comes to dominate.

2. Regardless of which margin it operates on, monetary policy in its modern sense typically targets a level of aggregate output. This means changing how tightly liquidity constraints bind current expenditure. In other words, how easy is it for a unit that wants to increase its spending to acquire money, either by selling additional current output, selling an asset, or issuing a new liability? So regardless of the immediate target of monetary policy, the intermediate target is liquidity. (So what's the point? The point is liquidity. The point is liquidity. The point is liquidity.) This may seem obvious, but keeping this idea in mind helps, I think, to cut through a lot of confusion. Expansionary policy makes it easier for someone to finance increased spending relative to income. Contractionary policy makes it harder.

3. Orthodox macroeconomics confuses the issue by assuming a world of infinite liquidity, where anyone can spend as much they like in any given period, subject to an intertemporal budget constraint that their spending over the infinite future must equal their income over that same infinite future. This condition -- or equivalently the transversality or no-Ponzi condition -- is coherent as a property of mathematical model. But  it is meaningless as applied to observable economic behavior. The only way my spending over my whole lifetime can be limited, is if my spending in some particular period is limited. Conversely, if I can spend as much as I want over any finite horizon, then logically I can spend as much as I want over an infinite horizon too. The orthodox solution is literally to just add an assumption saying "No you can't," without any explanation for where this limitation comes from. In reality, any financial constraint that rules out any trajectory of lifetime spending in excess of lifetime income will rule out some trajectories in which lifetime spending is less than lifetime income as well.

More concretely, orthodox theory approaches monetary policy through the lens of a consumption loan, in which the interest rate represents not the terms on which increased expenditure today can be financed, but the terms on which expenditure today trades off against expenditure in the future. In reality, consumption loans -- while they do exist -- are a very small fraction of total debt. The vast majority of private loans are taken to finance assets, which are expected to be income-positive. The models you find in graduate textbooks, in which the interest rate reflects a choice between consumption now and consumption later, have zero connection with real-world interest rates. The vast majority of loans are incurred to acquire an asset whose return will exceed the cost of the loan. So the expectation is that spending in the future will be higher, not lower, as a result of borrowing today. And of course nobody in the policy world believes in consumption loans or the interest rate as an intertemporal price or the intertemporal budget constraint or any of that. (Just compare Bernanke's article on "The Credit Channel of Monetary Policy Transmission" with Woodford's Interest and Prices, the most widely used New Keynesian graduate textbook. These are both "mainstream" economists, but there is zero conceptual overlap.) If you are not already stuck in the flybottle of academic economics there is no reason to worry about this stuff. Interest is not the price of consumption today vs. consumption tomorrow, it's the price of money or of liquidity.

4. The fundamental tradeoff in the financial system is between flexibility and stability. The capacity of the financial system to delink expenditure from income is the whole point of it but also why it contributes to instability. Think of it this way: The same flexibility that allows an entrepreneur to ignore market signals to introduce a new product or process, allow someone to borrow money for a project that will never pay off. In general, it's not clear until after the fact which is which. Monetary reforms respond to this tension by simultaneously aiming at making the system more rigid and at making it more flexible. This fundamental conflict is often obscured by the focus on specific mechanisms and by fact that same person often wants both. Go back to Hume, who opposed the use of bank-credit for payments and thought a perfect circulation was one in which the quantity of money was just equal to the amount of gold. But who also praised early banks for allowing merchants to "coin their whole wealth."

You could also think of liquidity as providing a bridge for expenditure over dips in income. This is helpful when the fall is short-term -- the existence of liquidity avoids unnecessary fluctuations in spending (and in aggregate income). But it is a problem when the fall is lasting -- eventually, expenditure will have to confirm, and putting the adjustment off makes it larger and more disruptive when it comes. This logic is familiar in the business press, applied in particular, in a moralizing way, to public debt. But the problem is more general and doesn't admit of a general solution. A more flexible credit system smooths over short-term fluctuations but allows more dangerous long-term imbalances to develop. A more rigid system prevents the development of any large imbalances but means you feel every little bump right up your spine.

(EDIT: On Twitter, Steve Randy Waldman points out that the above paragraph sits uncomfortably with my rejection of the idea of consumption loans. I should probably rewrite it.)

5. Politically, the fundamental fact about monetary policy is that it is central planning that cannot speak its name. The term "natural interest rate" was introduced by Wicksell, introduced to the English-speaking world by Hayek, and reintroduced by Friedman to refer specifically to the interest rate set by the central bank. It becomes necessary to assert that the interest rate is natural only once it is visibly a political question. And this isn't only about the rhetoric of economics: Practical monetary policy continues to be constrained by the need for the outcome of policy choices to be disguised in this way.

Mike Konczal has a good discussion of how this need to maintain the appearance of "natural"market outcomes has hamstringed policy since 2008.
Starting in December 2012, the Federal Reserve started buying $45 billion a month of long-term Treasuries. Part of the reason was to push down the interest rates on those Treasuries and boost the economy. But what if the Fed ... had picked a price for long-term securities, and then figured out how much it would have to buy to get there? Then it would have said, “we aim to set the 10-year Treasury rate at 1.5 percent for the rest of the year” instead of “we will buy $45 billion a month of long-term Treasuries.” This is what the Fed does with short-term interest rates... 
What difference would this have made? The first is that it would be far easier to understand what the Federal Reserve was trying to do over time. ... The second is that it might have been easier. ... the markets are unlikely to go against the Fed ... the third is that if low interest rates are the new normal, through secular stagnation or otherwise, these tools will need to be formalized. ... 
The normal economic argument against this is that all the action can be done with the short-rate. ... the real argument is political. ... the Federal Reserve would be accused of planning the economy by setting long-term interest rates. So it essentially has to sneak around this argument by adjusting quantities. ... As Greta R. Krippner notes in her excellent Capitalizing on Crisis, in 1982 Frank Morris of the Boston Fed argued against ending their disaster tour with monetarism by saying, "I think it would be a big mistake to acknowledge that we were willing to peg interest rates again. The presence of an [M1] target has sheltered the central bank from a direct sense of responsibility for interest rates." 
I agree with Mike: The failure of the Fed to announce a price target for long bonds is a clear sign of the political limits to monetary policy. (Keynes, incidentally, came to support fiscal policy only after observing the same constraints on the Bank of England in the 1920s.) There is a profound ideological resistance to acknowledging that monetary policy is a form of planning. For a vivid example of this ideology in the wild, just go to the FRED website and look up the Federal Funds rate. Deciding on the level of the Fed Funds rate is the primary responsibility of the Federal Reserve, it's the job of Janet Yellen and the rest of the FOMC. But according to the official documentation, this rate is "essentially determined by the market" and merely "influenced by the Federal Reserve." There is a profound resistance, inscribed right in the data, to the idea that interest rates are consciously chosen consciously rather than somehow determined naturally in the market.

[*] This is a better description of the evolution of monetary theory than the evolution of monetary policy. It might be more accurate to say that policy went directly from targeting the quantity of credit to the price of credit, with the transitional period of attention to monetary aggregates just window dressing.

Are US Households Done Deleveraging?

This Tuesday, I'll be  at Joseph Stiglitz's event at Columbia University on finance and inequality, presenting my work with Arjun Jayadev on household debt. You can find the latest version of our paper here.

In preparation, I've been updating the numbers and the results are interesting. As folks at the Fed have noted, the post-2007 period of household deleveraging seems to have reached its end. Here's what the household debt picture looks like, in the accounting framework that Arjun and I prefer.

The units are percent of adjusted household income. (We can ignore the adjustments here.) The heavy black line shows the year-over-year change in household debt-income ratios. The bars then disaggregate that change into new borrowing by households -- the primary deficit -- and the respective contributions of interest payments, inflation, income growth, and defaults. A negative bar indicates a factor that reduces leverage; in most years, this includes both (real) income and inflation, since by raising the denominator they reduce the debt-income ratio. A positive bar indicates a factor that increases leverage; this includes interest payments (which are always positive), and the primary deficit in years in which households are on net receiving funds from credit markets.

Here's what we are seeing:

In 2006 and 2007, debt-income ratios rose by about 3 percent each year; this is well below the six-point annual increases earlier in the 2000s, but still substantial. In 2008, the first year of the recession, the household debt-income ratio rises by another 3 points, despite the fact that households are now paying down debt, with repayments exceeding new borrowing by nearly 8 percent of household income. This is an astonishing rate of net repayment, the greatest since at least 1931. But despite this desperate effort to deleveraging, household debt-income ratios actually rose in 2008, thanks to the sharp fall in income and to near-zero inflation -- in most years, the rise in prices automatically erodes the debt-income ratio. The combination of negative net borrowing and a rising debt burden is eerily reminiscent of the early Depression -- it's a clear sign of how, absent Big Government, the US at the start of the last recession was on track for a reprise of the Depression.

Interest payments make a stable positive contribution to the debt-incoem ratio throughout this period. Debt-service payments do fall somewhat, from around 7 percent of household income in 2006 to around 5 percent in 2013. But compared with other variables important to debt dynamics, debt-service payments are quite stable in the short-term. (Over longer periods, changes in effective interest rates are a ] bigger deal.) It's worth noting in particular that the dramatic reduction in the federal funds rate in 2007-2008 had a negligible effect on the average interest rate paid by households.

In 2009-2012, the household debt-income ratio does fall, by around 5 points per year. But note that household surpluses (i.e. negative deficits) are no larger in these years than in 2008; the difference is that we see resumed positive growth of inflation and, a bit later, real incomes, raising the denominator of the debt-income ratio. This is what failed to happen in the 1930s. Equally important, there is a sharp rise in the share of debt written off by default, exceeding 3 percent in each year, compared with a writeoff rate below one percent in all pre-recession years. Note that the checked bar and the white bar are of similar magnitudes: In other words, repayment and default contributed about equally to the reduction of household debt. If deleveraging was an important requirement for renewed economic growth then it's a good thing that it's still possible to discharge our debts through bankruptcy. Otherwise, there would have been essentially no reduction in debt-income ratios between 2007 and 2012. [*]

This much is in the paper. But in 2013 the story changes a bit. The household debt-income ratio rises again, for the first time since 2008. And the household balance movers into deficit, for the first time since 2007 -- for the first time in six years, households are receiving more funds from the credit markets than they are paying back to them. These events are linked. While the central point of our paper is that changes in leverage cannot be reduced to changes in borrowing, for the US households in 2013, it is in fact increased borrowing that drove the rise in debt-income ratios. Inflation and income growth were basically constant between 2012 and 2013. The 5-point acceleration in the growth of the household debt-income ratio is explained by a 4.5 point rise in new borrowing by households (plus a 1.5 point fall in defaults, offset by a 1-point acceleration in real income growth).

So what do we make of this? Well, first, boringly perhaps but importantly, it's important to acknowledge that sometimes the familiar story is the correct story. If households owe more today than a year ago, it's because they borrowed more over the past year. It's profoundly misleading to suppose this is always the case. But in this case it is the case. Secondly, I think this vindicates the conclusion of our paper, that sustained deleveraging is impossible in the absence of substantially higher inflation, higher defaults, or lower interest rates. These are not likely to be seen without deliberate, imaginative policy to increase inflation, directly reduce the interest rates facing households, and/or write off much more of household debt than will happen through the existing bankruptcy process. Otherwise, in today's low-inflation environment, as soon as the acute crisis period ends leverage is likely to resume its rise. Which seems to be what we are seeing.

[*] More precisely: By our calculations, defaults reduced the aggregate household debt-income ratio by 20 points over 2008-2012, out of a total reduction of 21.5 points.

Friday, November 21, 2014

Still Disgorging

From Bloomberg last month:
Companies in the Standard & Poor’s 500 Index really love their shareholders. Maybe too much. They’re poised to spend $914 billion on share buybacks and dividends this year, or about 95 percent of earnings, data compiled by Bloomberg and S&P Dow Jones Indices show. Money returned to stock owners exceeded profits in the first quarter and may again in the third. The proportion of cash flow used for repurchases has almost doubled over the last decade while it’s slipped for capital investments...
This is a familiar theme to readers of this blog.

Here are my own updated numbers. The figure shows dividends and total payouts for the S&P 500 and the nonfinancial corporate sector as a whole, for rolling five-year periods ending in the year shown. Payouts are given as a share of aftertax profits.

Shareholder payouts as a fraction of aftertax profits, 5-year moving averages

Unlike the past versions of this graph I've put up here, which came from the Flow of Funds, this is taken directly from the corporate financial statements compiled in Compustat. Among other things, this means that we can see share buybacks directly, rather than only net share retirement. But the picture is qualitatively similar to what you see in the aggregate data -- after being quite stable at around 50% of after tax profits through the 1970s, payouts doubled to about 100% of aftertax profits during the 1980s, and have remained near that level over the past 25 years.

I haven't broken out the S&P 500 before. (This is based on the current index membership -- it didn't seem worth the trouble to find historical indexes. So for the early years we are talking about a relatively small number of firms.) As you can see, the picture is basically similar. The rise in S&P payouts comes a bit later. And unlike the broader population of firms, there is no rise in dividends relative to profits in the 1980s and 1990s -- the entire increase in payouts comes from buybacks. The other difference -- not immediately evident from the chart -- is that profits, not surprisingly, are more stable in the S&P 500 than in the smaller firms outside the index. You can't tell from the figure, but the big spike in the black lines comes from a collapse in profits in the non-S&P firms, not an increase in payouts. The corporate sector excluding the S&P 500 reported substantial aggregate losses in 2001-2002, meaning a much lower denominator for the ratio in the early 2000s.

Incidentally, this figure was produced in R, which I am finally switching to after years of using SAS and (hangs head in shame) Excel. If you are starting a graduate program in economics -- and I know some readers of this blog are -- I strongly, strongly advise you to learn R and get in the habit of producing all your work in LaTeX with embedded R code, using sweave or knitr. Kieran Healey explains why. You should never cut and paste a graphic from one application to another, or copy statistical results by hand into a table. I think this is the single piece of advice I most wish I'd gotten when I started graduate school.

Tuesday, November 18, 2014

An Interview with Me

The other day I sat down with Dave Parsons for his podcast The Nostalgia Trap. You can find the resulting interview here. It's partly about politics, partly about economics, partly about me and my various adventures on the US left.

You should check out some of Dave's other interviews as well -- he gets some very interesting people to sit down with him and has conversations with them that are more expansive and wide-ranging than your usual interview.

Monday, November 17, 2014

"As If a Man Were Author of Himself"

A couple of years ago, I saw a performance of Coriolanus on the Boston Common. It was that rare experience of seeing a great Shakespeare play with no prior knowledge. I had only the vaguest idea of what the play was about, and didn’t know a single line from it. This is, to say the least, not the way we usually encounter Shakespeare.

You don't appreciate this play until you see it performed. It is fast-paced, genuinely exciting, and often funny -- qualities that do not come out on page. Some forgotten Shakespeare plays are forgotten for a reason. But this one, you have to wonder why it isn't up there in the canon with Macbeth and Othello and Lear. Maybe because it lacks show-stopping monologues (something you miss less on the stage.) More likely because the central character is such a cipher.

So who is Coriolanus? He turns out to be, essentially, John Galt — or Mitt Romney, or Leung Chun-Ying. Which means that this is a play that speaks to our current condition. The connection was obvious when I saw the play, less than a year after the end of Occupy (which this staging clearly referenced) and a few months before the 2012 elections. I meant to write something about it then. But I got distracted with other things, and after Mitt Romney left the big stage it seemed less relevant. But as Paul Krugman reminds us,  Coriolanuses still walk among us. So I’ll belatedly set down my thoughts now.

* * *

The play opens with a riot, by the plebians of Rome against the patricians. The rioters are surprisingly articulate. Far more so than urban rioters in similar contemporary stories (like the plain people of Gotham in the Dark Knight Rises.)
FIRST CITIZEN. We are accounted poor citizens, the patricians good. What authority surfeits on would relieve us; if they would yield us but the superfluity… the leanness that afflicts us, the object of our misery, is as an inventory of their abundance; our suffering is gain to them. Let us revenge this with our pikes … the gods know I speak this in hunger for bread, not in thirst for revenge.
Note that their demand — repeated a couple times over the play — is to have wheat from the storehouses sold at a fair price. This demand that "engrossers" be required to disgorge their stores was, I beleive, a common demand in urban riots — indeed, traditional English law required it. The patricians in Coriolanus often speak as though giving in to the rioters would imply a complete social breakdown -- but when Shakespeare has the plebians themselves speak, this is what they call for, not  aimless destruction.

To mollify the mob, the patrician Menenius explains to them that if they are the arms and legs of Rome, the nobility is the stomach. This metaphor might read differently then (like a fire that gives light vs. heat, a line that is always quoted backwards today) but it's hard not see it as a sly acknowledgement that the mob is right.
MENENIUS. There was a time when all the body's members
Rebell'd against the belly; thus accus'd it:--
That only like a gulf it did remain
In the midst o' the body, idle and unactive,
Still cupboarding the viand, never bearing'
Like labour with the rest … it tauntingly replied
... I am the storehouse and the shop
Of the whole body...
The strongest nerves and small inferior veins
From me receive that natural competency
Whereby they live …
Menenius is a bit of a clown, a kind of Polonius figure. It’s Coriolanus himself who gets the best songs from the conservative hymnal — that the common people are under the control of their appetites, they are capricious, that they can't govern themselves, they are liable to turn on each other without an authority over them.
CORIOLANUS: ... your affections are
A sick man's appetite, who desires most that
Which would increase his evil. He that depends
Upon your favours swims with fins of lead,
And hews down oaks with rushes. Hang ye! Trust ye!
With every minute you do change a mind
And call him noble that was now your hate,
Him vile that was your garland. What's the matter,
That in these several places of the city
You cry against the noble senate, who,
Under the gods, keep you in awe, which else
Would feed on one another?
This is a central theme of conservative and reactionary politics -- that ordinary people, left to ourselves, would be unable to solve our coordination problems, would fall into a war of all against all. This is always the story we're told about urban riots, it's the story that the purpose of Occupy was, in a sense,  to challenge. We heard  Coriolanus's voice most clearly after Hurricane Katrina, when the reality of violence by the authorities and of mutual aid in New Orleans were transformed in the popular imagination (with help of some vile propaganda) into fantasies of anarchic violence by the people trapped in the city. Rebecca Solnit's A Paradise Built in Hell is a good corrective to this myth.

To be fair, some of the common people in the play seem to accept this account of themselves:
FIRST CITIZEN. ...  once we stood up about the corn, he himself stuck not to call us the many-headed multitude. 
THIRD CITIZEN. We have been called so of many; not that our heads are some brown, some black, some auburn, some bald, but that our wits are so diversely coloured; and truly I think if all our wits were to issue out of one skull, they would fly east, west, north, south; and their consent of one direct way should be at once to all the points o' the compass.
But then that is how ideology works -- to foreclose the possibility of alternative forms of coordination.

Meanwhile the patricians are discussing the situation. Coriolanus asks Menenius  what it is, exactly, that the common people want.
MENENIUS. For corn at their own rates; whereof they say
The city is well stor'd. 
They say! They'll sit by th' fire and presume to know
What's done i' the Capitol; who's like to rise,
Who thrives and who declines; side factions, and give out
Conjectural marriages; making parties strong,
And feebling such as stand not in their liking
Below their cobbled shoes. They say there's grain enough!
Would the nobility lay aside their ruth
And let me use my sword, I'd make a quarry
With thousands of these quarter'd slaves, as high
As I could pick my lance. …
They said they were an-hungry; sigh'd forth proverbs,--
That hunger broke stone walls, that dogs must eat,
That meat was made for mouths, that the gods sent not
Corn for the rich men only:--with these shreds
They vented their complainings…
Even in Coriolanus' hostile summary, the mob sounds kind of reasonable, no? Note that he doesn’t deny that the city’s storehouses have enough grain to feed the populace. (And it soon becomes clear they do.) Rather, he is outraged by the idea that ordinary people have any opinion on these questions at all. The violence of his response is remarkable — he’d like to slaughter thousands of Roman citizens — especially considering he is the notional hero of the play. But then indiscriminate violence is often the response when the social hierarchy is seriously threatened -- consider the 20-30,000 Parisians killed in the ten days following the fall of the Paris Commune.

The concilatory faction among the nobility wins out, and tribunes are appointed to represent the plebians in government. In the production I saw, the tribunes really stole the show. Even if the text itself presents the tribunes mostly as half clowns, half villains, you have to love a play with a couple of communist agitators as central characters. Their costumes brought this out in the Boston Commons production, but it's right there in the text.

Before the social conflict can continue, however, it’s cut short by war on Rome’s borders. Coriolanus is given command of some of the Roman troops fighting against the Volscian invaders. Not surprisingly, he regards his rank and file soldiers about as favorably as he does ordinary Roman citizens.
You shames of Rome! … You souls of geese
That bear the shapes of men, how have you run
From slaves that apes would beat! Pluto and hell!
… by the fires of heaven, I'll leave the foe
And make my wars on you
Nonetheless, the Volscians are defeated; and after his wartime success, Coriolanus is a natural choice for consul. His fellow patricians urge him to accept the office. The catch is that Roman law requires the populace to approve new consuls. It's just a formality, but one that — with the recent unrest — can't be safely dispensed with.  Coriolanus wants the job but refuses to ask for it. His pride is expressed in a refusal to do anything that would seem to be asking for acknowledgement or reward.  This comes out specifically in the question of whether he will display his battle wounds to the public, apparently a relaible way of winning their admiration. He expresses unwillingness:
CORIOLANUS: I have some wounds upon me, and they smart
To hear themselves remember'd.
The funny thing is, no one has mentioned his wounds until now! Throughout the play, Coriolanus is a master of this sort of humblebragging.

Don’t worry, the other patricians tell Coriolanus, just show up and talk about your victories, and the people will approve you. They are weak-willed and easily swayed. But Coriolanus refuses. He hates more than anything else having to ask the masses for approval. Even if they'd give it, no problem, it infuriates him that they even get a say over their natural superiors like him. On behalf of the patrician class, Menenius begs him to suck up his pride and pretend, just for a moment, to want the people’s approval.
CORIOLANUS. Are these your herd?
Must these have voices, that can yield them now,
And straight disclaim their tongues?
What are your offices?
You being their mouths, why rule you not their teeth?
Have you not set them on? 
MENENIUS. Be calm, be calm. 
CORIOLANUS. It is a purpos'd thing, and grows by plot,
To curb the will of the nobility: Suffer't, and live with such as cannot rule,
Nor ever will be rul'd. …
In soothing them we nourish 'gainst our senate
The cockle of rebellion, insolence, sedition,
Which we ourselves have plough'd for, sow'd, and scatter'd,
By mingling them with us, the honour'd number
Of course, he isn't wrong. Granting even symbolic authority to the plebs calls into question the inevitbility of the authority of their superiors. The greatest strength of the rule of a small elite is that no other possibility is even thinkable. So any symbol that renders it thinkable, is threatening.

Recall the judgement of Charles LeClerc, the general sent to reconquer Haiti for Napoleon: "We must exterminate all the blacks in the mountains, women as well as men... wipe out half the population of the lowlands, and not leave in the entire colony a single black who has ever warn an epaulette." If it is possible for blacks to be officers, LeClerc reasoned, it is impossible for blacks to be slaves. There were similar reactions in the Confederacy to proposals to use blacks as soldiers.

Coriolanus thinks like LeClerc. And anyway, he personally is unwilling to acknowledge any dependence, even symbolic, on his  inferiors. He will be consul only thanks to his own natural superiority, not thanks to any kind of public approval.

Menenius begs him to reconsider:
MENENIUS. You'll mar all: I'll leave you.
Pray you speak to 'em, I pray you,
In wholesome manner. 
CORIOLANUS. Bid them wash their faces
And keep their teeth clean.
So, here comes a brace:
[Re-enter two citizens.]
You know the cause, sirs, of my standing here. 
FIRST CITIZEN. We do, sir; tell us what hath brought you to't. 
CORIOLANUS. Mine own desert. 
SECOND CITIZEN. Your own desert? 
CORIOLANUS. Ay, not mine own desire. 
FIRST CITIZEN. How! not your own desire!
CORIOLANUS. No, sir, 'twas never my desire yet to trouble the poor with begging. 
CORIOLANUS. Better it is to die, better to starve,
Than crave the hire which first we do deserve.
 Why in this wolvish toge should I stand here,
To beg of Hob and Dick that do appear,
Their needless vouches?
When I saw the play in the fall of 2012, the parallel with the “you didn’t build it” pseudo-controversy was glaring. (It's interesting also that Coriolanus refers to common people as “trades.”) The idea that the occupants of high positions might owe any of their success to those beneath them, is anathema. As Coriolianus warns his fellow patricians, hierarchy and democracy are an unstable mix:
You are plebeians,
If they be senators: and they are no less
When .. they choose their magistrates
How shall this multitude digest
The senate's courtesy? Let deeds express
What's like to be their words:--'We did request it;
We are the greater poll, and in true fear
They gave us our demands:'-- Thus we debase
The nature of our seats, and make the rabble
Call our cares fears; which will in time
Break ope the locks o' the senate and bring in
The crows to peck the eagles. 
The tribunes, though they often come across as clownish, clearly understand what’s at stake as well as Corolianus does. Here's one of the tribunes:
BRUTUS: So it must fall out
To him or our authorities. For an end,
We must suggest the people in what hatred
He still hath held them; that to's power he would
Have made them mules, silenc'd their pleaders, and
Dispropertied their freedoms; holding them,
In human action and capacity,
Of no more soul nor fitness for the world
Than camels in their war; who have their provand
Only for bearing burdens, and sore blows
For sinking under them.
In general, the tribunes' line against Coriolanus is that he is proud, that he is using his (unquestionably genuine) accomplishments and virtues to set himself up above the people. This kind of jealousy and suspicion of successful war leaders seems to be a central theme of human egalitarianism, going back to the paleolithic.

It's striking what tribune Brutus says to Coriolanus when he confronts him directly:
BRUTUS. You speak o' the people
As if you were a god, to punish, not
A man of their infirmity.
Here is the central theme of the play: the idea of “superior” people that they are somehow outside of society, outside the common condition of humanity, versus the reality that they are as dependent, as infirm, as the rest of us.

Coriolanus also hates his opposite number, the Volscian general Aufidius. (I have no idea who if anyone this represents historically.) But there’s a difference in the  quality of hatred for an equal as against a social inferior. Here, Coriolanus asks a Roman diplomat about Aufidius.
CORIOLANUS. Spoke he of me?

LARTIUS. He did, my lord.


LARTIUS. How often he had met you, sword to sword;
That of all things upon the earth he hated
Your person most; that he would pawn his fortunes
To hopeless restitution, so he might
Be call'd your vanquisher.

CORIOLANUS. At Antium lives he?

LARTIUS. At Antium.

CORIOLANUS. I wish I had a cause to seek him there,
To oppose his hatred fully.
Behold! these are the tribunes of the people;
The tongues o' the common mouth. I do despise them,
For they do prank them in authority,
Against all noble sufferance.
The one hatred involves a kind of admiration and attraction ("I wish I had cause to seek him there"); the other only contempt. Even opposing elites are closer to each other than to the people they rule.

The combination of his visible contempt and the tribunes' urging the people not to acclaim him unless he shows some respect, result in Coriolanus being denied the consulship, and then accused of treason and exiled from the city.  As he puts it, "the beast with many heads butts me away." It's interesting how often the play uses this kind of language for the common people; it brings to mind Linebaugh's Many-Headed Hydra. Linebaugh himself suggests that Shakespeare wrote the play in response to the Midlands revolt of 1607, a mass uprising against enclosures that, apparently, was the first appearance of "Levellers" in England. What's interesting about the play as a whole is that it faces forward to this kind of class politics, rather than backward, like the history plays, to the older world of dynastic, feudal politics. It might be the only Shakespeare play that George Scialabba would approve. (It was also the only Shakespeare play that interested Brecht.)

After leaving Rome, Coriolanus seeks out his old enemy Aufidius and pledges his service to him and the Volscians if they will make a new war on Rome. Like Rand's D'Anconia, he imagines he'll leave Rome as he found it. (So maybe the tribunes' accusations of treason were on the mark?) Aufidius, an aristocrat himself, is buying what Coriolanus is selling:
AUFIDIUS. ... the nobility of Rome are his;
The senators and patricians love him too:
The tribunes are no soldiers; and their people
Will be as rash in the repeal as hasty
To expel him thence. I think he'll be to Rome
As is the osprey to the fish, who takes it
By sovereignty of nature.
With Coriolanus and Aufidius sharing command, the Volscian army reverses its defeats and advances to the gates of Rome. The tribunes want to raise a new army (this is only mentioned in passing, but I thought it was an interesting detail). Meanwhile, the patricians send emissaries out, who know Coriolanus and perhaps can convince him to spare the city.  But Coriolanus turns them all away, even Menenius who, he says, was like a father to him:
CORIOLANUS. This last old man,
Whom with crack'd heart I have sent to Rome,
Lov'd me above the measure of a father;
Nay, godded me indeed. Their latest refuge
Was to send him...
As these lines suggest, the specific challenge Coriolanus faces here is denying the social ties that connect him to Rome -- denying that he owes anything to anyone, that he is in any way dependent, enmeshed in a web of social obligations. Or as he puts it:
... I'll never
Be such a gosling to obey instinct; but stand,
As if a man were author of himself,
And knew no other kin.
Coriolanus imagines himself as, precisely, a self-made man. But as Professor T. says, nobody is: The thing that libertarians always forget or ignore is the biological dependence everyone experiences, not least as children. It's only possible to imagine yourself as an autonomous monad, author to yourself, if family life is rigidly walled off from civil society and, in general, if women are kept out of sight.

You think I'm reading that into the play? No no, Coriolanus says it himself:
Not of a woman's tenderness to be,
Requires nor child nor woman's face to see.
And that's his downfall. Once Menenius returns in defeat, the Romans have one more trump to play. They send Coriolanus' mother, wife and son to plead with him. (It's a funny, proto-feminist touch that Menenius himself scoffs at this last attempt. If he, Coriolanus' mentor, failed, how could these women and children have a chance?) Coriolanus tries to convince himself to ignore even these most primal ties:
the honour'd mould
Wherein this trunk was framed, and in her hand
The grandchild to her blood. But, out, affection!
All bond and privilege of nature, break!
Let it be virtuous to be obstinate.
But he can't do it. The bond and privilege of nature wins out, and he refuses to continue with the attack. Alas for all our would-be Coriolanuses, everyone has a mother. Or as the defrocked priest warns Captain Bednar in the climactic scene of The Man with the Golden Arm, "we are all members of one another." (I only discovered writing this post that it's a bible quote, from Romans.)

And that's it. Coriolanus returns in disgrace to the Volscian capital, where his former allies murder him, and then -- guiltily and a bit incongruously -- offer him a stately funeral, declaring that his is
...the most noble corpse that ever herald
Did follow to his urn.
(I read somewhere that the reason so many Shakespeare plays end with these funeral marches is that, since theaters of the time did not have curtains, some device was needed to get the "dead" actors off the stage.)

So what are we supposed to think about this person? The play is a bit ambiguous. Structurally, Coriolanus is the hero. But he hardly comes across as admirable. On the other hand, he is the object of various "most noble Roman" orations, right up to Aufidius' closing lines. So maybe he is intended as a tragic hero? You might think so ... except for one remarkable scene in the middle of the play (cut unfortunately from the movie version), where Shakespeare tips his hand.

Here, Coriolanus has just won a major battle against the Volscians, and captured one of their cities, which is being sacked by the Roman troops. Cominius, the overall Roman commander, offers Coriolanus his share of the loot:
COMINIUS: ... Of all the horses,
Whereof we have ta'en good and good store, of all
The treasure in this field achieved and city,
We render you the tenth, to be ta'en forth,
Before the common distribution, at
Your only choice. 
CORIOLANUS: I thank you, general;
But cannot make my heart consent to take
A bribe to pay my sword: I do refuse it;
And stand upon my common part with those
That have beheld the doing.
That's our boy, no loot for him. He's too good for all that. But it turns out, he does have one favor to ask from the commander:
CORIOLANUS: The gods begin to mock me. I, that now
Refused most princely gifts, am bound to beg
Of my lord general.

COMINIUS: Take't; 'tis yours. What is't?

CORIOLANUS: I sometime lay here in Corioli
At a poor man's house; he used me kindly:
He cried to me; I saw him prisoner;
But then Aufidius was with in my view,
And wrath o'erwhelm'd my pity: I request you
To give my poor host freedom.

COMINIUS: O, well begg'd!
Were he the butcher of my son, he should
Be free as is the wind. Deliver him, Titus.

LARTIUS: Marcius, his name?

CORIOLANUS: By Jupiter! forgot.
I am weary; yea, my memory is tired.
Have we no wine here?

COMINIUS: Go we to our tent:
The blood upon your visage dries; 'tis time
It should be look'd to: come.

And, scene! Nothing more is heard of the old man.

It's an amazing scene. I couldn't believe it when I saw it. This is black humor worthy of Joseph Heller. Here's the noble Roman, making a noble request after his great victory: He doesn't want gold or women, only mercy for an old man who treated him kindly when he was in need. Oh how noble! Except ... he can't remember the fellow's name. Oh well. He was just a nobody anyway. Let's go have some wine.

It's tempting to call the play surprisingly modern. But the truth is, even in the 21st century it's hard to find such an unflinching portrait of an overdog. Here is someone whose only idea of morality is an image of himself. He's not interested in the effects of his actions on other people; the common people only matter to him as a backdrop for the stage on which he plays the hero. It must have been a type that Shakespeare knew well.

UPDATE: In comments, MisterMR supplies the historical context, from Livy.

Saturday, November 1, 2014

Michael Woodford on the Interdependence of Monetary and Fiscal Policy

(I started writing this post a couple weeks ago and gave up after it got unreasonably long. I don’t feel like finishing it, but rather than let it go to waste I’m putting it up as is. So be warned, it goes on for a long while and then just stops.)

I sat down and read the Michael Woodford article on monetary and fiscal policy I mentioned in the earlier post. It’s very interesting, both directly for what it says substantively, and indirectly for what it says about the modern consensus in economics.

(For those who don’t know, Michael Woodford is a central figure in mainstream New Keynsian macro. His book Interest and Prices is probably the most widely used New Keynesian macro text in top graduate programs.)

The argument of this article is that the question of what monetary policy rule is the best route to price stabilization, cannot be separated from what fiscal rule is followed by the budget authorities. Similarly, any target for the public debt cannot be reduced to a budget rule, but depends on the policy followed by the monetary authorities — though Woodford is not so interested in this side of the question.

This is not a new idea for readers of this blog. But it’s interesting to hear Woodford’s description of the orthodox view.
It is now widely accepted that the choice of monetary policy to achieve a target path of inflation can …, and ought, to be separated from .. the chice of fiscal policy.
Woodford rejects this view — he insists that fiscal policy matters for price stability, and monetary policy matters for the debt-GDP ratio. Most economists think that monetary policy is irrelevant for the debt-GDP ratio, he says,
because seignorage revenues are such a small fraction of total government revenues. … [This] neglects a more important channel … the effects of monetary policy upon the real value of outstanding government debt, through its effects on the price level and upon the real debt service required, … insofar as monetary policy can affect real as well as nominal rates.
There are two deeper issues in the background here, that help explain why orthodox economics ignores the importance of monetary policy for the debt ratio and fiscal policy for price stability. First is the idea, which we can trace from Wicksell through Hayek to Milton Friedman and on to today’s New Keynesians, that the “natural” interest rate in the sense of the interest rate consistent with price stability, must be the same as the “natural” interest rate in the sense of the Walrasian intertemporal rate that would exist in a frictionless, perfect-information economy that somehow corresponded to the economy that actually exists. Few economists are bold enough or naive enough to state this assumption explicitly, but it is fundamental to the project of reconciling orthodox monetary policy with a vision in which money is neutral in the long run. If you want the same interest rate to be “natural” in both senses, it’s a problem if the price-stability natural rate depends on something like fiscal policy, which is not reducible to tastes, technologies and endowments.

Second is the notion of the “long run” itself. For economists, this refers to a situation in which the endogenous variables have fully adjusted to the exogenous variables. This requires a clean (or anyway order-of-magnitude) separation between “fast” endogenous and “slow” exogenous variables; it also requires a sufficiently long time between disturbances.

Woodford, in the passage above, refers to the effects of changes in inflation and interest rates on the burden of the outstanding government debt. This is an important departure from orthodoxy, since in a true “long run” situation, debt would have fully adjusted to the prevailing interest and inflation rates. Woodford, in tune with the practical concerns of central bankers, rejects the ubiquitous methodological condition of modern macroeconomics, that we should only consider fully adjusted long run positions. His whole discussion of public debt, in this paper and elsewhere, rejects the usual working assumption that the existing levels of inflation and interest rates have prevailed since time immemorial. He explicitly analyzes changes in interest and inflation in the context of a historically given debt stock.

Woodford's attitude toward the “natural” rate is more complicated. He certainly doesn’t take it for granted that the price-stability and Walrasian “natural” rates are the same. But a big part of his project — in Interest and Prices in particular — is precisely to develop a model in which they do turn out to coincide.

Let’s continue with the paper. Most economists believe that:

“Fiscal policy is thought to be unimportant for inflation… [because] inflation is a purely monetary phenomenon,” or else because “insofar as consumers have rational expectations, fiscal policy should have no effect on aggregate demand.”

Woodford rejects both of these claims. Even if people are individually rational, the system as a whole can be “non-Ricardian.” By this he means that changes in government spending will not be offset one for one by changes in private spending. “This happens essentially through the effects of fiscal disturbances upon private sector budget constraints and hence on aggregate demand.” For this reason, “A central bank charged with maintaining price stability cannot be indifferent as to how fiscal policy is set.”

Traditionally, the orthodox view of inflation is that it is the result of the money supply growing at a different rate than real economic activity, the latter being independent of the money supply. This does allow for fiscal effects on the price level, but only insofar as public borrowing is monetized. In the familiar “fiscal dominance” scenario, the primary surplus or deficit is fixed by the budget authorities and if the implied issue of public debt is different from the desired holdings of the private sector, the central bank must finance the difference with seignorage. The resulting change in the money supply produces corresponding inflation.

As Woodford says, this is not a useful way of thinking about these issues in real economies, at least in developed countries like the United States. In reality, even when the central bank is subordinate to the budget authorities, as in wartime, this does not take the form of direct monetization of deficits. Rather, “fiscal dominance manifests itself through pressure on the central bank to use monetary policy to maintain the market value of government debt. A classic example is … U.S. monetary policy between 1942 and 1951. … Supporting the price of long-term [government] bonds seems to have been the central element of Fed policy through the late 1940s.” This policy did not affect the price level directly through the money supply, but rather because the target interest rate was too low during the war (although the resulting inflation did not show up until after 1945, due to price controls during the war itself), and too high during in 1948-1950, when the federal government was running large surpluses. In either case, Woodford emphasizes, the causality runs from interest rates, to the price level, to the money supply; the quantity of money plays no independent role.

The basic story Woodford wants to tell is the fiscal theory of the price level. If the stock of outstanding government bonds is greater than the public wants to hold at the prevailing interest rate, then the price of bonds should fall. Normally, this would mean an increase in rates. But if interest rates are pegged — or in other words, if the price of bonds relative to money is fixed — then the price of the whole complex of government liabilities falls. Which is another way of saying the price level rises. Another way of looking at this is that, if output is initially at potential and the volume of government debt rises  with no fall in its nominal price, this must
make households feel wealthier … and thus leads them to demand goods and services in excess of those the economy can supply. … Equilibrium is restored when prices rise to the point that the real value of nominal assets no longer exceeds the present value of expected future primary surpluses.
Of course, this begs the question of why government debt is voluntarily held at a positive price even when there is no reason to expect future primary surpluses. More broadly, it doesn’t explain why anyone wants to hold non-interest bearing government liabilities at all. Woodford could take a chartalist line, talk about tax obligations, but he doesn’t. But even then he'd haven’t of he wouldn't have explained why people hold large stocks of government debt, which by definition is in excess of tax burden.  The natural answer is that government liabilities are a source of liquidity for the private sector. But if he says that, the rest of his argument is in trouble. First, if demand for government debt is about liquidity, then private actors should consider the terms on which other private actors will accept government liabilities. Second, if liquidity is valuable, then real outcomes will be different in a liquidity-abundant world than in a liquidity-scarce one. This is the fundamental problem with the idea that money is neutral. If money were truly neutral, in the sense that the exact same transactions happen in a world with money that would happen in a hypothetical moneyless world, then there would be no reason for money to be used at all.

Despite these serious logical problems, Woodford uses the orthodox apparatus to make some interesting points. For example, he argues that the reason the mid-century policy of fixing a nominal interest rate did not lead to price instability, was because of adjustments in the federal budget position. It is, he says, a puzzle how
a regime that … fixed nominal interest rates was consistent with relatively stable prices for so long. … According to the familiar Wicksellian view summarized by Friedman, an attempt to peg nominal interest rates should lead to either an inflationary or a deflationary spiral. … It is striking that people were willing to hold long-term Treasury securities at 2.5% during the temporary high inflation (25% annual rate) of 1946-1947; evidently there was little fear … [of] an explosive Wicksellian ‘cumulative process.’
Woodford is right that the consistency of fixed nominal interest rates with price stability even after the removal of wartime price controls is a problem for the simple Wicksell-monetarist view. Whether his preferred solution — an expectation of continued federal budget surpluses — is right, is a different question.

Turning to the other side, the dependence of the budget position on prevailing interest rates, Woodford gives an excellent critique of the prevailing notion of a government intertemporal budget constraint (ITBC), in which government spending must be adjusted so that the present value of future surpluses just equals today’s debt. It is widely believed, he says, that government must satisfy such a constraint, “just as in the case of households and firms. It would then follow that fiscal policy must necessarily be Ricardian,” that is, have no effect on the spending choices of rational, non-liquidity-constrained private actors. “It is true,” he continues, “that general equilibrium models always assume that households and firms optimize subject to a set of budget constraints that imply an intertemporal budget constraint, though they may be even more stringent (as it may not even be possible to borrow against all … future income.”

Note the careful phrasing: I’ve noticed this in Woodford’s other writing too, that he adopts rational expectations as a method without ever endorsing it as a positive claim about the world. Of course we shouldn’t talk about intertemporal budget constraints at all, it’s a meaningless concept for private as well as public borrowers, for reasons Woodford himself makes clear.

This is a nice part of the paper, Woodford’s treatment of the “transversality condition.” This, or the equivalent “no-Ponzi” condition, says that the debt of a government — or any other economic unit — must go to zero as time goes to infinity. The reason mainstream models require this condition is that they assume that in any given period, it is possible for anyone to borrow without limit at the prevailing interest rate. This invites the question: why not then consume an infinite amount forever with borrowed funds? The transversality condition says: You just can’t. It is still the case that at any moment, there is no limit on borrowing; but somehow or other, over infinite time net borrowing must come out to zero. This amounts to deal with the fact that one’s assumptions imply absurd conclusions by introducing another assumption, that absurd outcomes can’t happen. Woodford sees clearly that this does not offer a meaningful limit on fiscal policy:
What kind of constraint upon fiscal policy does this [theory] require? A mere commitment to “satisfy the transversality condition” is plainly unsuitable; this would place no constraints upon observable behavior over any finite time period, so that it is hard to see how the public should be convinced of the truth of such a commitment, in the absence of a commitment to some more specific constraint that happens to imply satisfaction of the transversality condition.
What Woodford doesn’t see, or at least doesn’t acknowledge, is that the transversality condition is equally meaningless as applied to private actors. Which means that you need some positive theory about what range of balance sheet positions are available in any given period — in other words a theory of liquidity. And, that the intertemporal budget constraint is meaningless, has no place in any positive economics.

But in any case, even if we accept the intertemporal budget constraint for private units, it is not applicable to sovereign governments since, (1) they are large relative to the economy and (2) they are not maximizing consumption. All that is needed is that someone ends up voluntarily holding the government’s debt. Even if the government is optimizing something, it is not doing so with respect to fixed prices — or fixed output, though Woodford never considers the possibility of unemployed real resources, a rather major limitation of all his work I’ve read.

Woodford notes, reasonably enough, that if the government issues more liabilities than the public wants to hold at the prevailing prices, then the price of government liabilities will fall; “but this is a condition for market equilibrium given the government’s policy, and not a precondition for the government to issue” new liabilities. In this respect, he suggests that the government is in the same position as a company that issues stock, or, more precisely, a company that repurchases shares rather than issuing dividends. (The formal argument that dividends and repurchases are interchangeable, for which Woodford cites Cochrane, is relevant for my “disgorge the cash” work.)
The advantage of this analogy [between the government a share-repurchasing corporation] is that it is clear in the stock case that the equation is an equilibrium condition that determines the share price, … and not a constraint on corporate policies. There is no requirement, enforced in financial markets, that the company generate earnings that validate whatever market valuation of its stock may happen to exist.
The government is different from the company only because prices happen to be “quoted in units of its liabilities.”

As a positive argument this is not useful, for two related reasons. First, it is still essentially a monetarist account of inflation, except with total government liabilities replacing “money.” And second, he deliberately leaves out any discussion of real effects of inflation. This means that he doesn’t give any explanation for price stability is important. More broadly, he doesn’t have any account of the inflation process that links up to real-world discussions. The article purports to be about a central bank following a Taylor rule, but the word “unemployment” does not occur in it. Nor does the word “liquidity”, inviting the question of why anyone holds money in the first place. As I mentioned earlier, this is a larger problem with the whole idea that money is neutral. In this case, Woodford suggests that one can fully explain inflation in a framework in which inflation is costless, and then introduce costs (to motivate policy) without the positive analysis being affected. Interest and Prices does not have this problem — it is carefully constructed precisely to ensure that conventional monetary policy is both welfare-optimizing, and produces an outcome identical to a Walrasian world without monetary frictions. But this isn’t general — the book’s central model is custom-designed to produce just that result.

The question raised by the article is: If both price stability and debt sustainability are functions of both the government budget and monetary policy, why do we have such a strong consensus in favor of stabilizing output solely via the interest rate, and adjusting the government budget position solely in view of the government debt? Woodford admits that in principle, price stability can be achieved in a “bond price-support regime” in which the government budget responds to shifts in private expenditure and the central bank is responsible only for interest payments on government debt. Formally, Woodford acknowledges, this type of regime should work just as well as the conventional “independent” central bank setup. The problem is that in practice
the nature of the legislative process in a democracy makes it unlikely that government budgets can subjected to the same degree of discipline as monetary policy actions. A nontrivial degree of random variation in the equilibrium price level would be inevitable under the price-support regime, both as a result of random disturbances to fiscal policy that could not be prevented, and as a result of inability to adjust fiscal policy with sufficient precision to offset the consequences of other real disturbances. 
There it is. The only argument for central bank independence is an argument against democracy. Woodford continues:
Controlling inflation through an interest-rate rule such as the Taylor rule represents a more practical alternative, both because it is more politically realistic to imagine monetary policy being subordinated wholly to this task, and because it is technically more feasible to “fine-tune” monetary policy actions as necessary to maintain consistency with stable prices.
The claim that interest rates can be adjusted more quickly than budgets is worth taking seriously. Though of course, one way of taking it seriously would be to contemplate arrangements under which taxes and spending could be adjusted more quickly. But look at the other point: The selling point of orthodoxy, says the pope of modern macroeconomics, is that policy can “subordinated wholly” to “controlling inflation.” Look at Europe today, and tell me they aren’t reaping what they sowed.