John Taylor on the State of the Economy
Jul 19 2010

John Taylor of Stanford University talks with EconTalk host Russ Roberts about the state of the economy. Is the economy recovering? What policies have helped and hurt? Taylor gives his views on both monetary and fiscal policy including the stimulus package passed last year, and current Fed policy. The conversation closes with a discussion of the global economy, particularly Poland and its recent success in avoiding recession.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


Jul 19 2010 at 10:15am

I don’t think that there is much of a puzzle as to why the banks are holding the excess reserves, as oppose to lending them out. I am a Clemson Finance major / Econ minor interning at one of the top 5 bank’s Corporate Banking division. The banks are all scared to lend because of credit risk, and also, there isn’t much demand for the credit lines in the first place.

So, it would seem that their needs to be some analysis on the effects of monetary policy when there is 1) no demand for credit, and 2) no supply of credit.

Of course, all this makes me think of my Money and Banking class, and the liquidity trap. Russ, I think that would be an interesting topic for a podcast. Finally, thank you for producing Econ talk, it has been part of my inspiration to pursue a Finance PhD and find a place in academia.

Jul 19 2010 at 3:02pm

What makes Econtalk so great is the opportunity to hear “close up” top minds on economics such as John Taylor, as well as more off-beat minds and topics such as last week’s. This talk confirmed once more that we live at a peculiar moment in financial market history, a sort of “knife-edge.” On the one hand, slow growth and expectations for more slow growth suggest minimal inflationary pressure or need for an inflation premium in market interest rates. On the other, the prospect of massive growth in debt over the coming decade with no current prospect of a rational resolution of it suggests a real risk of hyperinflation.

In interesting topic would be to revisit why we had recession with inflation in the 1970s (“stagflation”) and why we there’s no threat of it now (presumably the commodity shocks in the 1970s play an important role).

Seems to me there was some lack of clarity in the conversation in distinguish between the Fed Funds target rate and the rate paid by the Fed on excess reserves. I think Taylor was saying the former was between 0 and 25 pb and the latter was 25 bp. The former is determine by open market operations the latter is simply set by the Fed. Right? Isn’t it the case that the Fed only started paying interest on reserves in 2008? Therefore, that the interest on reserves is a new tool that the Fed only created recently? Which means we now have a new source of confusion when discussing rates, Fed policy, and monetary economics.

Dustin Klang
Jul 19 2010 at 3:38pm

Dr. Roberts,

This program deviated from previous podcasts with respect to the volume of references to specific aspects of federal economics policy. Though you have humbly acknowledged your own biases on multiple occasions, these conversations show an admirable restraint and an obvious conscious attempt to dispassionately evaluate each topic. How often do you find that, in an effort to stay within the possible realm of human objectivity, self censorship is necessary? . Do you find it difficult to curtail speech that might be considered ‘political’?

Dr. Taylor,

You had mentioned a possibility, or a perceived possibility, of the U.S. not “paying it’s debt”. It seems, to this laymen, inconceivable that the U.S. would default on nominal debt obligations when the mostly digital printing press is readily available for use in ‘honoring’ said debt. Do you, sir, believe this fear to be substantiated? Is this fear more prominent in academia, private, or state spheres?

Jul 19 2010 at 4:04pm

At 6:35 John Taylor makes a understatement that is true and common but breathtakingly callous.

“extending unemployment insurance reduces the incentives to actually take a job which might not have been as attractive otherwise.”

In other words: reducing desperation is bad because desperate people will do work when it is a necessity that they would not accept if they were not desperate.

I am curious what the overall economic effects are of systemic misery. Goods and services have no intrinsic value, and so (at a human scale), necessary goods and services have no maximum worth and immediately unnecessary goods and services have no minimum worth. “Unfair” transactions occur because people can’t wait to bargain for an normally acceptable trade. What are the macro effects of this? Globally, this is more of an issue than within the US. But it seems to me, that we should want, always, to remove pain, fear, and desperation from the emergence of market forces.

Jul 19 2010 at 8:07pm

It seemed to me that Dr. Taylor didn’t want to answer questions about (1) the monetary impact of purchasing mortgage backed securities while bank reserves are increasing and (2)valuations associated with the purchases.

Obviously I don’t know for sure but it sure looks like a liquidity trap to me.

Hope to God that there was a reasonable valuation associated with the MBS purchases. I trust the Fed officials; I really do but I hate that the topic wasn’t discussed further.

Jul 19 2010 at 9:48pm

A macro-economist announcing a testable hypothesis? Be still my beating heart! “[E]xtending unemployment insurance reduces the incentives to actually take a job which might not have been as attractive otherwise.” Mr. John Taylor at approximately minute 6:00. If you’ve never been unemployed before, then you’ll have to take my word for this proposition: state unemployment agencies require that you certify weekly that you are (1) ready and able to work, (2) have not worked, (3) are looking for work and (4) have not turned down work in the last week.

It gets even better! The average weekly unemployment check in the United States is $300 per week, that’s $1,200 per month. Divide that by your average work month (160 hours) and you get an awesome $7.50 per hour (before taxes). So, drum roll please, Mr. John Taylor of the illustrious Stanford University posits that [enough to make a difference(?)] people, whom are long-term unemployed, are defrauding their state unemployment agency so that they can earn minimum wage and live just a hair above the federal poverty line. Those lazy dogs. We should send them back where they came from! [Insert heavy dose of sarcasm here].

Ah, yes, and I noticed all the weasel words Mr. Taylor used but I’m not letting him get away with this statement. Oh no! Whatever Mr. Taylor’s rationalization, my statement must be true: that people are actually turning down work to stay on unemployment. Otherwise, Mr. Taylor’s hypothesis is meaningless. He would be left to defend a statement that says the incentive is to not take a job but people aren’t really turning down work. Good luck.

Don Tillman
Jul 20 2010 at 2:37am

I haven’t finished listening to this episode yet, but something just hit me…

The Keynesian Multiplier is mentioned early on in the discussion. And let’s face it; the power of those two words is pretty remarkable. We’ve seen so many cases of government spending passed right through congress with the magic words “Keynesian Multiplier” tacked on, instantly enabling the assertion that Nobel prize winning economists agree that the action will not only pay for itself, but provide an extra percentage more, regardless of what the actual effects of the legeslation should be. It’s like saying “Open Sesame”.

So… is there any competition in this field of powerful economic catchphrases? Where’s the exact-opposite-of-Keynesian Multiplier? Is there a “Hayekian Multiplier”, a larger negative number that one can use to quantify the costs of government spending?

If not, I think now would be an excellent time to put one together.

Keith Beacham
Jul 20 2010 at 6:46am

@Don Tillman

Has it occurred to you that perhaps the real answers and explanations for our economic woes are unknowable?
That what Taylor, Roberts, Krugman and Delong are most adept at is speaking a language that was constructed in the land of economic make believe. Keynesian stimulus, Laffer curves, Hayekian emergent order may be at best contextual and at worst nonsense (elegant gibberish). I doubt that after abandoning Keynes you will find refuge with Hayek.

Jul 20 2010 at 11:01am

This idea of regime uncertainty is so tiring.

No one I know stops working because they might pop into the next highest tax bracket. Likewise many of these huge multinationals end up paying no taxes anyway. The idea that increases in tax rates will stymie growth is just not supported by reason or historic evidence. Of course we heard these same tales just before Bill Clinton lead us to unprecedented growth in spite of tax increases.

The uncertainty in our system results from its pollution by trillions of dollars of toxic assets created by the private sector and infesting their own accounts as well as anyone they might lend or trade with.

The consumer that creates the demand that creates the need for investment is either out of work or digging out of debt or saving because of the economic uncertainty …again mostly coming from the private sector.

We are in trouble as it is for a long time to come. I vote that we go completely free market so the job of destroying our country and its economy can be complete and this silly conversation can be over with for future generations to benefit from. Of course 70 years hence they’ll attempt to re-write the history of this great crash as was done of the last one.

Anyway the regime uncertainty bit is baloney and you provided no significant argument or evidence to back the claim. But I’m sure we’ll continue to hear it and it will continue to be taught in the class rooms.

Jul 20 2010 at 12:29pm

I largely agree with what muirgeo writes above about the tiresomeness of “regime uncertainty”, but most especially this:

“The uncertainty in our system results from its pollution by trillions of dollars of toxic assets created by the private sector and infesting their own accounts as well as anyone they might lend or trade with.

I simply wanted to add that Mr. Roberts did a great job exposing the “regime uncertainty” bit for the hypothetical it is when he asked Taylor (at about minute 12) if we actually empirically know the size of the effect Taylor proposes is caused by “regime uncertainty”.

Taylor tried to dodge the question by saying some stuff about “common sense”, but Mr. Roberts appropriately brought the question back to evidence. As a result, Taylor was forced to basically admit that he doesn’t have, or know of, any evidence quantifying and supporting the “regime uncertainty” effects he had just spent 5 minutes claiming were currently seriously hampering our economic “recovery” (I would note that, beyond his apparently evidence free assertion of “regime uncertainty” effects, Taylor’s belief in this current “recovery” is reason enough to wonder about the soundness of his economic worldview).

Once again, thanks to Mr. Roberts for providing such an excellent and valuable service for free!

Jul 20 2010 at 7:36pm

I don’t offhand see the essential difference between short term Treasuries and bank reserves.

Why isn’t paying interest on bank reserves just the same as selling government debt to the banks, as far as monetary policy goes.

Maybe answering my own question: it possibly would merely have amounted to swapping a mortage backed security for a government bond, a balance sheet upgrading for the banks

An amusing trick at the end would be to make bank reserves payable only in mortgage backed securities, after the panic blows over.

Russ Roberts
Jul 20 2010 at 8:05pm

Steve (and Christian),

You describe the following statement as callous:

“extending unemployment insurance reduces the incentives to actually take a job which might not have been as attractive otherwise.”

I don’ remember what else was said around the quote, but there’s no callousness there. It’s a hypothesis that I think is almost certainly true. You can reject the hypothesis. You can say that people don’t respond to incentives. You can accept it and say the effects are too small to be important. You can also reject any conclusion one draws from the hypothesis–for example, that it implies that the government should cut off unemployment benefits. But I don’t think it’s a callous statement.

Christian makes the point that unemployment benefits aren’t very generous. They aren’t. But that too has nothing to do with the point. Ungenerous benefits means that there is more of an incentive to look for work even though people receive them compared to if they were more generous.

Here is one summary of the economics literature from a paper by Card, Chetty, and Weber who are at UC-Berkeley:

One of the best-known empirical results in public finance and labor economics is the “spike” in the exit rate from unemployment around the expiration of jobless benefits (see e.g., Robert Moffett, 1985; Lawrence Katz and Bruce Meyer, 1990a; Katz and Meyer, 1990b). This sharp surge in the hazard rate is widely interpreted as evidence that recipients are waiting until their benefits run out to return to work. The spike in exit rates has become a leading example of the distortionary effects of unemployment insurance (UI) and social insurance programs more generally (see e.g., Martin Feldstein, 2005).

Some have recently questioned whether this relationship still holds as strongly as it once did. But suffice it to say that it isn’t a ridiculous or callous argument. It might simply be true and something to take into account when assessing policy.

Jul 20 2010 at 8:27pm

I really don’t understand Prof. Taylor’s phrase “the framework that worked.” Didn’t this framework lead us into the Great Recession? He says (about minute 39:00) that it worked for 20 years. Isn’t that an amazingly small sample?

Russ Roberts
Jul 20 2010 at 8:34pm


Regime uncertainty is about much more than tax rates. (Although there is a lot of evidence that people respond to tax rates–and of course it depends on the size of the rate and the amount of the change.) When people talk about regime uncertainty they mean the rules of the game generally. If you think you’re going to have to comply with new regulations and you don’t know what they’re going to be, would you invest in a new company? The financial bill that recently passed isn’t really legislation–it’s an idea of legislation still to be completed. The health care bill’s actual implementation isn’t clear either. There’s a chance that strong energy regulation is coming, too. I would expect that uncertainty to effect the willingness of businesses and investors to take risk. It’s not really a radical idea.

On the debate between more or less government, I suspect it won’t ever be settled. The world is just too complex to be as open and shut as you seem to wish.

Robert Kennedy
Jul 20 2010 at 9:16pm

I’m grateful that muirgeo listens to Econtalk and posts his thoughts. I suspect that many listeners, myself included, have confirmation bias that leads us to embrace many of the comments on these podcasts without the appropriate rigor of analysis. Personally, I didn’t challenge many of Mr. Taylor’s comments until I read some of the previous posts.

That said, I do have a different perspective this comment:

The uncertainty in our system results from its pollution by trillions of dollars of toxic assets created by the private sector and infesting their own accounts as well as anyone they might lend or trade with.

While I agree that the private sector was the primary culprit in creating most of the assets, I submit that various government policies enabled them to do so:

  • The 1936 regulation from the Comptroller of the Currency that required banks to only hold investment grade bonds as determined by private rating agencies. Without that regulation, investment firms would not have the motivation to game the ratings of their CDSs and later, banks would not have been forced to divest them when they were re-rated
  • The actions of the Federal Reserve in early 2000s to artificially keep interest rates low, thus increasing the temptations to create products based on the higher rates of residential mortgages
  • Other actions of the Federal Reserves during that same time frame that attempted to hold up asset values, thus lulling investors into ignoring the risk of asset value declines
  • The implied government guarantees of Fannie & Freddie and their near monopoly on the residential mortgage market that encouraged risky decisions by other market players
  • Deposit guarantees from FDIC and other agencies that encouraged risky investments by Citi and other federally guaranteed institutions
  • The various government policies that drove up the price and demand of residential housing, including the mortgage interest rate deductions, CRA policies, etc.

From my point of view, if those policies had not existed, these toxic assets would have never reached the critical mass that they did because the market players would have been unwilling to assume the associated risks. Yes, they would have would have been invented but once the actors understood the risks that they were taking, they would have never grown as they did.

My 2 cents.

Jul 20 2010 at 9:34pm

Russ Roberts wrote:

“The financial bill that recently passed isn’t really legislation–it’s an idea of legislation still to be completed. The health care bill’s actual implementation isn’t clear either. There’s a chance that strong energy regulation is coming, too. I would expect that uncertainty to effect the willingness of businesses and investors to take risk. It’s not really a radical idea.”

And yet when you asked for the evidence quantifying/capturing this idea, Taylor gave you nothing in answer but some talk about common sense and taxes. In fact, your response to muirgeo is just more of the same. If you have the evidence, please don’t be shy. Educate us.

I mean I wouldn’t be surprised if there is some very weak evidence linking stuff like uncertainty about new/future regulation(s) to less investment (though I can think of a couple of counterfactuals where you might expect flat or increased spending going into a possible change). But thinking that uncertainty regarding the financial bill, health care bill & energy bill combined could have anywhere near the depressive effect that uncertainty about all the quite possibly worthless paper throughout ( see, extend and pretend/mark to make believe) FIRE has and is having on our economy seems odd.

Do you really take issue with muirgeo’s description of why all that money is being held by the banks? (“The uncertainty in our system results from its pollution by trillions of dollars of toxic assets created by the private sector and infesting their own accounts as well as anyone they might lend or trade with.”) Because, at least early in this podcast, it seemed that you were on the verge of making just that obvious point to taylor. The point being that there are real fears on the part of banks that some, maybe many, of their counter-parties are, or will be, insolvent and thus, they hoard.

Or maybe I’ve misread what you’ve written above or misperceived you as being on the verge of making the above point to John Taylor or, most likely, I’m just not understanding something fundamental to the argument.

Thanks for engaging. Another valuable but free service.

Jul 21 2010 at 4:55am

Two things have been bothering me about the discussion of regime uncertainty on econtalk and in Russ’s and others discussion of the crisis. The first is statements like he just made in the comments, “If you think you’re going to have to comply with new regulations and you don’t know what they’re going to be, would you invest in a new company?” Every business makes every decision under uncertainty. Regime uncertainty is just one aspect of that uncertainty and it’s always existed, ask the cigarette companies. Thus, it annoys me to no end that it’s always taken separate from other uncertainty and spoken of in binary terms. Regime uncertainty can drive up the cost of doing business, but so can every other type of uncertainty.

This leads to the second annoying thing. No one in the regime uncertainty argument seems to ever try to actually find data that they purport measures regime uncertainty. Is it because across various volatility spreads and bond yields the U.S. looks better than other countries that didn’t have anything to cause “regime uncertainty”? For instance, as best I can tell, Poland’s real interest rates are higher than the U.S. (I’m not familiar with the National Bank of Poland’s website, so I’m not certain I’m interpreting it correctly). But it suggests that lenders consider the U.S. a much safer bet than the well-run according to Taylor Poland. Is it because regime uncertainty is a canard? Is it because the U.S. has low other uncertainty?

Finally, can we stop once and for all the binary “why would anybody invest in such an environment?” line. There is some probability that the government will take all my money or tax me at a really high rate in the future. I’m still earning money and investing in human capital. Russ are you still working and saving? Are you still encouraging your kids to get an education? Do you let them slack off more, because you believe the probability that future marginal tax rates will cut the return to high-skilled labor? I think it’s quite likely that increased uncertainty has some effects, but we know and acknowledge that regime uncertainty has not crippled individual decisions, why should it cripple business decisions?

Jul 21 2010 at 9:36am

Perhaps “regime uncertainty” is not the correct phrasing. It should be called “regime certainty.” Certainty that this regime is going to continue a legacy of “tax and spend.” As a result businesses will conserve their resources in order to weather the storm of taxation and costly regulation. You want proof? Look no further than the Cafe Hayek blog today, where Obama’s own Christine Romer concludes that after examining “all major postwar tax policy actions…tax increases are highly contractionary.”

Russ Roberts
Jul 21 2010 at 11:23am

Yes, there are many types of uncertainty. Uncertainty about the future is a constant. The amount of change in the rules of the game is not a constant. Some eras have relatively stable rules. Others have lots of change. When there is an increase in the amount of uncertainty about what the rules of game are going to be, I would expect that to change people’s behavior.

Yes, it is hard to measure. That doesn’t mean it’s not relevant. I am confident that there is more uncertainty about the regulatory environment in the US right now than there was ten or five years ago. How important is that? It’s hard to measure and know. But that doesn’t mean it doesn’t matter.

It is also easy to confuse uncertainty about regulation with more regulation. If the health and financial legislation that has passed recently was clear as to how it would be implemented, that could still discourage or encourage economic growth. The fact that we don’t know how it will be implemented is a separate issue that discourages risk-taking regardless of how the legislation actually turns out.

Finally,to answer Charlie’s question about my personal behavior–yes, I am still working and saving. But I’m not investing my money right now the way I did five years ago. I used to put most of it in the market. Right now I’m accumulating cash because I’m very unsure about the future. (And yes, I know that’s not risk-free either.)

BTW, Bob Higgs does have some quantitative evidence on the effects of regime uncertainty during the 1930’s. It’s not a “proof” but it’s suggestive.

Frank Howland
Jul 21 2010 at 3:26pm

I think Russ should have probed a bit more when John Taylor repeatedly compared extending unemployment benefits to the first time home buyers credit and cash for clunkers programs. Yes, there are incentive effects for all three programs, but just as surely unemployment benefits are different, and very probably are substantially more effective as stimulus measures. People who are unemployed are quite likely to spend a large fraction of their benefit checks, so consumer spending is much more likely to increase as a result of this program than it is as a result of the other two programs (which mostly just shift spending across time).

Furthermore, as Taylor acknowledges, the job market is extremely sluggish. Thus the negative effects of unemployment insurance on job finding are likely to be attenuated.

In addition, it *looks* callous when conservative economists and Republican politicians advocate tax cuts for the employed and for the rich and reject unemployment insurance for the unemployed (who are mostly not well off).

Another point that Russ might have pushed Taylor on is whether he advocates any unemployment insurance whatsoever; it would seem to follow that we ought to abolish such insurance altogether.

Finally, if one is skeptical of econometrics in general, one ought to be especially skeptical of econometric results in macro, even those produced by very smart people like John Taylor.

All this said, this program was quite interesting. (1) I think the labor market story is quite important–I worry that many people just don’t have the skills needed to get decent jobs (2) The questions of what is going on in housing finance, what the Fed is doing with all those mortgage backed securities, and monetary policy in general are definitely worth pursuing.

Jul 21 2010 at 4:23pm

The critics of the “regime uncertainty” argument are confusing reductions at the margin with going to zero. The current legislative environment is clearly having a negative impact on economic activity, it’s not causing everyone to close up shop and go home.

It’s important to remember that real economic growth accumulates slowly over time. 25 years at 3% is a doubling of standard of living over a generation. 3% a year, however, is easy to miss and easy to erase with bad policy.

And yes, (1.001)^720 is 2.05

Jul 22 2010 at 3:06am

“I am confident that there is more uncertainty about the regulatory environment in the US right now than there was ten or five years ago.”

The point is that this confidence comes with no evidence attached, and that bothers some people.

In 1998, big tobacco signed a settlement agreeing to pay out $206 billion for selling a legal product.

In 2000, a U.S. election came out “inconclusive” and went all the way to the supreme court. The U.S. was days away from having an election decided by congress.

In 2001, a 9/11 shaken country passes the patriot act in October. The act gives the government unprecedented power to search telephone and e-mail conversations, as well as increase the Treasury’s power to regulate financial transactions.

In 2001, Enron declared histories largest bankruptcy. Enron’s share price dropped from $90 to pennies, and the accounting scandals causing the bankruptcy also took down Arthur Anderson, the U.S.’s largest accounting firm.

In 2002, six months later Worldcomm displaced the record for largest bankruptcy in another accounting scandal.

At the same time Sarbanes-Oxley, in response to the fraud rewrites accounting rules with a sweeping regulatory change and a sharp increase in compliance costs.

In 2003, the Bush tax cuts invoke an entirely new uncertainty. The tax cut over 10 years has different parts sunsetting at different times. It becomes increasingly difficult to predict what future tax writes businesses will face, as well as dividends/capital gains, and estate taxes, which all dramatically effect how businesses structure investment decisions and capital holders invest.

I’m tired, so I’ll truncate the rest. I haven’t even mentioned two wars of unknown length and all of the political-economic consequences of an engagement in the middle east. Bankruptcy law was rewritten in 2005, as well as energy policy.

I get that your gut “feels” different now, but you’ve given no hint of evidence that any of the current changes are different than the myriad of changes that take place all the time in the regulatory environment. Each of these instances create the same “regime uncertainty” you see as a problem now. Neither one of us know if the uncertainty is greater or less now. So until you have evidence perhaps you should curtail statements like, “I am confident that there is more uncertainty about the regulatory environment in the US right now than there was ten or five years ago.” Because without evidence, you’re really just using your gut, you’re feeling and not thinking. And it’s quite likely your gut in this instance is confused by all the other uncertainty that is being ramped up in the last two years. And it’s quite possibly a bit blinded by hindsight bias, as well as an extreme distaste for the dominant ideology in government at present.

Jul 22 2010 at 10:42am

Professor Roberts,

I’m an avid listener to Econtalk and though I sometimes don’t agree with the points of view expressed, it is always thought provoking and rewarding.

But there is something that is a bit out of sync with the views expressed on your program compared to what I am observing. I have been in the financial services industry for a number of years and what I am seeing sometimes runs counter to what is on the program. This most recent program was mostly pessimistic but what I am personally seeing is at worse neutral and in some cases more optimistic. After 2+ years of heavy reductions, many companies, now stronger, are better positioned and improving. They may not be hiring yet but at least they are stronger.

I suspect that the gap I’m seeing between the program and elsewhere is that academic economists don’t have access to the confidential information that companies are using to make their decisions. This is no fault of your program; however, if this is the case, it should be something you are aware of.

Jul 22 2010 at 6:50pm


I found it distressing your mocking dismissal of the idea that workmen’s compensation can act as stimulus (only an idea know-nothing wack-jobs like Krugman and Pelosi would believe).

Even if you and your guest do not take the idea seriously, there are many WELL EDUCATED and WELL RESPECTED economists who DO. Many of them presumably spent a similarly significant portion of their life thinking about, discussing, and investigating economic ideas and claims.

None of this makes them correct, but I do think it demonstrates that they should at least be taken seriously and their arguments and claims evaluated as such. Do you honestly think that economists such as Krugman, Nouriel Roubini, and Greg Mankiw believe unemployment insurance is stimulative because they just haven’t really given it any thought?

Now just because they are nobel prize winning, highly educated, well respected, college textbook writing economists does not mean they are correct. Far from it. But to me, at least, it seems that they shouldn’t just be lumped together with Nancy Pelosi as economic know-nothings with an agenda to support.

This kind of activity seems all too common on this podcast at times (not to mention most libertarian comment areas). Hayek or Mises or Friedman could be 100% right about everything in economics, it still wouldn’t mean their opponents arguments should not be carefully considered and addressed as well.

I would like to say, despite the bias I enjoyed this podcast and found it very informative.

Jul 22 2010 at 11:29pm

I would think that the oil industry would be a great place to find data now on regime uncertainty. For oil companies, whether to drill or not is purely a capital allocation problem. I’m sure each company has its own formula, taking into account international markets, the probability of hitting oil, etc. They deal with tons of regime uncertainty, whether it’s Obama’s or Chavez’s. Somebody in those companies is plugging a number in somewhere when they decide whether to drill, and there are a measurable number of wells that aren’t being drilled because the regime uncertainty risks are causing the models to say “Don’t drill this well right now.” It’s probably hard for academics to get that data, but I think it is naive to think it doesn’t exist.
In this case, the result is probably to increase the short run profits of the oil companies, so consumers are taking the brunt of the effect through higher prices. If Congress believably said “We won’t tax oil a penny for the next 30 years.”, the oil companies would be racing to drill, they would end up with lower profits, and gas would be $1/gallon. The profits they have now are the excess profit demanded by being in such an uncertain market.
I realize that this doesn’t constitute an “example” in the sense of actually containing measured data, but I’d like to hear someone credibly explain how it could be playing out in any other way.

Russ Roberts
Jul 23 2010 at 2:10pm


Excellent point–there is always some regime uncertainty, or more accurately, there are changes in the rules of the game–some of them encourage risk-taking and most do not.

I think your list confuses (as many of us have done in this discussion) regime uncertainty and a bad regime. You can have really bad policies that are certain and that discourage risk-taking. It’s not just uncertainty about the rules of the game that matters but the rules themselves.

But your basic point is correct–there is always political meddling and uncertainty about future meddling. How do you quantify whether such uncertainty is rising or falling? (Again, separate from the actual policies.) Probably not possible.

You are right that the tobacco settlement introduced uncertainty about property rights. I think the unfinished (in that the rule-making is yet to be undertaken) makeover of the health care system and the financial system are of a different order of magnitude. But maybe not. You’re right–it’s very hard to know and prone to confirmation bias.

It also may be the case that much of what I perceive as anxiety about the future is due to the shattering of certainty about the future course of the value of one’s house and the growth in the S&P 500. When things change, people struggle to cope with a new paradigm or a shattered old one. Animal spirits do matter.

Don Venardos
Jul 23 2010 at 4:08pm

When discussing the disincentive of unemployment compensation it is remiss to not also discuss the job market. When unemployment is low then the negative effects of paying unemployment are much higher because it is far easier to find a job. However, when unemployment is high and there are more people trying to find work than work available there is must greater incentive to take whatever job you can get because you may not be able to find another one. Before economists sit down and have a theoretical discussion of the issue they really ought to spend some time with people that are currently unemployed. There are many variables in employment that are just not accounted for in the current economic models such as the cost to hirer an employee and the resultant reluctance of an employer to hire someone that is overqualified or has a much higher salary history because the expectation is that they will leave as soon as they can find a better job.

I read professor Taylor’s testimony to congress and given the high correlation between investment and real GDP growth and decline wouldn’t the best stimulus package be providing additional capital to venture capital firms? I haven’t heard anyone talk about that.

Jul 24 2010 at 2:24am

On one side, Taylor advocates a central bank mechanism(taylor rule) to
regulate money supply, So, he’s OK with monetary adjustments that affect
economy wide aggregates.

The tools at the Fed layer of the money system have tradiontally
been blunt instruments, Taylor seems to prefer this paradigm.

On the other side, Taylor’s distressed about the Fed buying anything other
than Govt paper b/c its too much like fiscal policy, which usually involves
like picking winner and loser sectors and industries, etc.

But, isn’t it a more *productice* use of “monetary medicine” to be
directed only at the sectors that need it ? Otherwise a lot will
be wasted on areas not needing it eg inflation.

As an analogy, crop dusters don’t fly at 40000 feet, That would
be wildy inefficient.and neither should any “helicopter drops” be done
at 40000 feet in this case.

Justin P
Jul 25 2010 at 3:03pm

Re: Regime Uncertainty

You want evidence of Regime Uncertainty, here it is:

The problem the critics have with it is more political than anything else. They like the current administration and the loved the administration that Higgs criticized in his seminal paper. Their partisanship keeps them from accepting the RU principle nothing more.
Proponents of RU can give any and all evidence they want and the critics will never accept it as proof.

Jul 26 2010 at 8:01pm


Christian wrote above: “It gets even better! The average weekly unemployment check in the United States is $300 per week, that’s $1,200 per month. Divide that by your average work month (160 hours) and you get an awesome $7.50 per hour (before taxes). So, drum roll please, Mr. John Taylor of the illustrious Stanford University posits that [enough to make a difference(?)] people, whom are long-term unemployed, are defrauding their state unemployment agency so that they can earn minimum wage and live just a hair above the federal poverty line.”

Actually, the choice is just a bit different. I might just get $7.50 for unemployment, which may not be much. But time at home might have some unforeseen advantages such as spending more time with kids (especially when they are out of school during the summer). Also, I may be able to do some additional work on the side that goes unrecorded(i.e., barter or cash payment). In other words, I could be collecting $7.50 AND be getting $6 / hr doing some yardwork. In that situation, it would take a job offering $13.50 or more to induce me to return to work — I would have an incentive to be more selective.

@ muriego

You mention that you don’t know anybody who would stop working because they were pushed into a higher tax bracket. In that case, there should be no effect at a 99% marginal rate at, say, $200K. I think we would all agree that would be absurd and then people would stop working after $200K. But what about 98% marginal rate? 97%? … go on down the line and start asking where does that line stop (i.e., it doesn’t affect marginal behavior)? It might be lower than you think.

Anecdote 1: A friend of mine runs a specialized contracting business and is trying to front-load as much business as possible this year because he knows that he will be facing higher taxes next year. He plans next year to take it a bit easier and not work as hard — not pursue jobs that might prove more of a hassle. This may mean laying off four or five members of his work crew. He volunteered this information to me irrespective any prompting on my part other than “how’s business going?”

Anecdote 2: Way back in the 1980s, I was working as a graduate student on a project with a number of professors. The professors received a stipend for their participation (probably in the range of about $8 – 10 K). One of the profs, who was very adamant about increasing the role of government and increasing the level of taxation on “the rich,” asked to defer his stipend payment one year (take it in January as compared to August) because he had been involved in other projects and knew his marginal tax rate on that stipend would be higher in the current year than in the forthcoming year b/c he would be kicked up into a higher tax bracket. Not anticipating anything in the forthcoming year, he could take the stipend then and not have to pay as much (which really “only” amounted to a couple hundred dollars difference). Granted, the person didn’t stop working, but it definitely shows a sensitivity to incentives.

Granted, these are just anecdotes, but they are powerful anecdotes illustrating that people are consciously responding to incentives … whereas you implied that people will not be affected by small changes in the tax rate.

Finally, it should be noted that high marginal tax rates for “the rich” (I like to call them “the productive”) in the 1950s led many companies to change their compensation schemes and offer their employees “salary” in non-monetary fashion such as company cars or health insurance. I would argue that high marginal rates in the past led to some of the health insurance problems we have today — creating an incentive for what seems to be a “third party” paying for health insurance and an incentive to overuse health care.

Frank Flynn
Aug 2 2010 at 8:24pm

Russ says (in an answer to a reply calling the comments about unemployment benefits callous):

“You can say that people don’t respond to incentives”

This gets to the heart of one of my problems with the way economists speak. That is the habit (style?) of dialog in which a single answer must be correct in a system that is too complex for any single answer to be true 100% of the time.

The original premise – that extending unemployment benefits discourages the unemployed from accepting work – is certainly true for some and not true for others. Is it true more than 50% of the time? I don’t think so based on my few acquaintances who have been unemployed recently.

Here’s a better example – at 11:33 – “We have direct evidence that higher taxes discourage anything that is taxed.” This will be provable in a big way next year. After the Estate tax (death tax) which is 0 this year, 2010 goes back up to where it was before the Bush tax cuts; we should see a noticeable decline in the death rate (yes?).

Look at the language here “direct evidence”, “discourage anything” – it leaves no room for doubt or discussion. But I doubt many folks will be choosing death this year for the tax break (I could be wrong, we’ll see).

Karl H
Aug 5 2010 at 12:17pm

Someone please explain to me the spike in employment when benefits expire? Don’t people come on and off benefits at different times depending upon when they lost their jobs? I’ll have to look up the references given above, but unless all of, say, the Midwest, got pink slips on the same week and stepped into new jobs during the same month, it would seem like that effect should be spread out over time. And given that benefits did run out for awhile, shouldn’t there be employment data showing a spike recently?

Also, if people are just staying out of the labor market due to them having benefits, shouldn’t this put postive pressure on wages? After all, there are all of these jobs waiting for someone to fill them, right? So to entice them back into the labor market, wages would have to increase to…Oh, just above the poverty level. Someone above mentioned that you could be making money on the side doing odd jobs, so you might have to offered a job making more than the poverty level, but I’d like to see the data that the underground economy is so strong that it can keep people employed constantly throughout the year and would therefore figure into their calculation about going back to work.

I guess whether or not unemployment benefits are a stimulus depends upon what you mean by the term. I would find it hard to believe that people are saving that money, mostly because they need to eat and have shelter. So is it ‘stimulating’ the economy?, probably not because they would have to spend money to eat – either using their savings or gov’t assistance, either way. On the other hand, you are sure that that money will get put back into the system with a certainty that you wouldn’t get by keeping low the tax rate of the highest wage earners since with regime uncertainty (!) they might just save that money.

The discussion of the productivity increase over the past couple of years: Wouldn’t the simple answer be that you are willing to work harder and/or longer just to keep your job since your chances of finding another one are so slim? Anecdote: a friend of mine worked at a company that went through round after round of layoffs. By the end he was doing the jobs of 2.5 people and working very long hours (as a salaried employee). His only incentive to do this: if he didn’t his manager let him know that they could easily find someone who would. So in his case productivity went up 250%! (Until it went to zero when he had got laid off and the jobs went over to India…

Aug 8 2010 at 1:43pm

Didn’t Garrett Jones in his podcast make the point that in previous recessions productivity was down, an observation which inspired the Real Business Cycle theory?

When playing Devil’s Advocate you should have brought up the claim that though things are bad post-stimulus they would have been even worse without it, or that the cutbacks on the part of state-governments formed an “anti-stimulus” that neutralized the federal government’s spending. Maybe you should have a stimulus proponent (Brad Delong?) on to argue that case.

Aug 9 2010 at 6:18pm


Russ said:

“You describe the following statement as callous:

‘extending unemployment insurance reduces the incentives to actually take a job which might not have been as attractive otherwise.’

… there’s no callousness there. It’s a hypothesis that I think is almost certainly true. You can reject the hypothesis… But I don’t think it’s a callous statement.”

A clearly untrue statement is not callous. Taylor’s statement is callous only if it is true. It unsympathetically ignores the underlying mechanisms effecting job “attractiveness” that arise from prolonged unemployment and it implies a fair and an exploitative exchange are fundamentally no different.

I just listened to another podcast I thought was quite good and reminded me of this issue.

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Podcast Episode Highlights
0:36Intro. [Recording date: July 8, 2010.] State of the economy. People worried about a double-dip recession; economy seems to be "losing steam," metaphor annoying as if it's some great engine that has to be stoked constantly. Where do you think we are headed? Slowdown from the beginning of what looked like a stronger recovery; last year when growth went down, first quarter this year. Recovery disappointing, could have been better. Lackluster, but I don't see a double-dip. Labor market: job market has been mediocre; unemployment only down because people have been discouraged. What do you think is happening there? Partly slowness of the recovery. When you are getting growth of 2 and a half to 3% that's not much faster than the potential of the economy in the growth of the labor force. You need to have more growth than that to get the unemployment down when it gets so high. Also factor we've seen in a lot of the recent recessions: lagging of job growth. In this case, I think some other factors. Debating the unemployment compensation, continuing its length, sometimes discourages. Also, since this has been a big recession compared to the last 25 years, people have used this opportunity to make some adjustments in their workforce. See that here at Stanford, in private firms. Hard to come back rapidly to some of those jobs. Labor market: What do you think of this argument about productivity in its behavior over the business cycle? Some have argued that part of the reason the recovery has been so sluggish is that productivity growth has been so spectacular--which is unusual--that it's harder to add jobs: firms are getting so much out of their existing work force that they don't have the demand for workers they usually have. Anything to that argument? No; old argument. I don't see that. High productivity is a benefit; get more out of work, people demand the product. Maybe short term now and then it can have some effects; longer term, any reasonable time period that's not a reason not to hire. Is it true that productivity has been growing? Always productivity spurts during a recovery: you are getting an increase in output without so much of an increase in employment. Going into a recession you get a little bit of the reverse; that hasn't happened so much in this downturn. I think that has to do with the fact that it's been an opportunity to make some adjustments. Competing services; excuses, can adjust the number of workers using these computers; extra increase in productivity.
5:28Unemployment insurance. Two great economists, Paul Krugman and Nancy Pelosi, have been quoted as saying that unemployment insurance is a great stimulus to economy, suggest a sort of free lunch. If there are unemployed people, you extend the term of unemployment insurance longer than in the past because that way they have more money to spend; the multiplier kicks in; so that way not only do you ameliorate their pain and suffering but you also enhance the growth of the economy. In all seriousness, that argument has been advanced by Paul Krugman, and Nancy Pelosi did latch onto it, which she called a win-win. Missing one big part of it: extending unemployment insurance reduces the incentives to actually take a job which might not have been as attractive otherwise. Neglected. You hear incentives downplayed during a recession, and think of more Keynesian kind of effects. Mistake. Even in bad times you have huge amounts of incentives that are affected by public policy. We saw that in Cash for Clunkers: huge incentive to buy early and then it plummeted later; first-time home-buyers. The Keynesian side of it: I just don't see that in the data. We've had a big stimulus package here; part of that is sending checks to people who are lower-income, part unemployment compensation. In my reading, hasn't done much good. Devil's advocate: when you go back to the Great Depression, standard case used to be that it was the showcase of Keynesian policy. New Deal came along; Roosevelt used deficit spending and he primed the pump, put the steam back in the engine, and the economy recovered. There's not a lot of evidence that's true. The economy did recover from its nadir, low point in 1932-1933; but it stalled in 1938. Some say that's because of monetary policy; but general consensus now amongst advocates of Keynesianism are that it was not tried by Roosevelt. He didn't spend enough, he raised taxes, he wasn't enough of a deficit spender. Fear similar story as we look back 25 years from now: We didn't really try the stimulus package, it wasn't big enough. For example, we're now in July 2010, so 17 months into the signing of the bill; there have been $415 billion spent so far--not the $787 you heard about, some say higher than that even. Of that $415, $163 billion were tax rebates, which for Keynesians are still stimulus, but you and I are skeptical of that. There was only $252 billion of direct spending so far; and only $14 billion was Department of Transportation spending, so 5%, which is not the way it's portrayed. Should that have had an effect? Any case that we didn't do enough? Didn't have much effect. But that's the reality; that's what we get from this program; can't wave magic wand and have everything spent in the first two months. You have environmental permits, reality if people don't want the project here but want it somewhere else. If you just look at the numbers, both the downturn and the upturn, is this private investment. A lot of inventory and private investment discouraged in the panic and then picking up realizing things weren't so bad. Even if it's a small amount, that small amount is having a relatively insignificant effect. Especially when you include these transfer payments--rebates or whatever you call them. You can look at the numbers and see they have not jump-started consumption as has been advertised. One of the problems with this whole discussion people are having on both sides is that in many respects it's a theoretical argument. We are using our theory, which is good, and we have all this data; the data seems to me it is not working, so doing more of it is bad. Plus, and I think many countries around the world are realizing this, there are some real negatives. There is the increased debt. There is the increased expectation of higher taxes. Drags. We have those in some of our models; coming to roost already.
11:33Step back from the current mess for a minute, talk about that empirical question. Do we have anything remotely reliable on what we call crowding out--expectations. To a lot of people it's just obviously true that if you give a lot of people money and they spend it, it stimulates. They ignore that some might not spend it, or that other spending might go down in the face of that spending. Crowding out phenomenon. Argument would be that when people are worried about the future taxes, they are going to be more prudent and spend less. Do we know anything about the magnitude of that? Incentives; those of us who are less interventionist tend to argue that those incentives are strong. Empirically is there much evidence that people take those effects into account? On the micro side, there is lots of evidence. National experiments we've had: the Cash for Clunkers, First-time Home Buyers--huge incentive effects. Not like it's not out there. Of a different nature than saying: If we spend $780 billion over the next three or four years, your taxes are going to be higher if you are in the 60% of the American populace that pays income taxes; and therefore you are going to respond to that spending program by cutting back. Do we have any evidence on that? We have direct evidence that higher taxes discourage anything that is taxed. The link you are looking for is what evidence do we have that links people's expectations of future deficits to that, and there it's necessarily weak. Have to go with what you know will affect behavior, and that is a tax increase. Common sense says that the higher taxes are going to come in the future. On the books right now, unless Congress makes some changes. Expectations are harder to measure.
13:50Private investment point: What happened to private investment over the last few years and what explains it? If you look at this recession and recovery, GDP growth declined a lot, a couple, three quarters; flattened out and increased a lot and stabilizes there. Huge dip, that's the recession. You can look at the different components of GDP--consumption, investment, etc.--and see to what extent some of those are more important. When you do that, by far the biggest is investment. Idea is that firms were quite frightened, not only in the United States but globally, so they cut back on their investment. Their sales dropped, so they also cut back on inventory investment. Rapid around the world. When they saw that there was a bottom, it wasn't the end of the world--as early as December 2008, January 2009; you can see that in measures of expectations, so investment turns around and inventory investment turns around. That cycle is really explained by the investment, natural dynamics of the economy. You superimpose onto that the various action to stimulus packages, Cash for Clunkers, and you see the little blips and ripples, but it's the main trajectory of the economy recovering, and now the recovery is slowing. Similar pattern in the Great Depression: enormous decrease in private investment, and then it stagnated in the face of what some call regime uncertainty--all the chaos of the rule changes and policy changes. Do we see any evidence of an uncertainty about the future on the part of private investment or has it pretty much recovered steadily? Private investment pause has occurred as you've gone from 5.6% to 2.7% for the first quarter. You see investment rising and then slowing down--part of my story, investment driven. Reasons for that not completely clear. I emphasize the same things you mention during the Great Depression, uncertainty about policy, debt increasing in ways we haven't seen before. Projected by the CBO to be 947% of GDP if we don't make a correction. Inconsistency, that can't stand. That's not a forecast--it's a warning flag. Either current policy has to change or some other kind of disaster that resolves the inconsistency. The disaster could be a hyperinflation; could be the United States doesn't pay its debt. The hope is you get the policy correction. But still not there yet. Nobody's articulating that strategy. Part of the resolution will be tax increases; negative for the economy. Plus regulatory reform on the financial side, which is very complex. Going to be left to the regulators to implement--regulators who were quite disappointing during the crisis itself. Health care. People still talking about environmental regulation. Worries about the general rule of law: intervention with the automobile companies; now you are having this strange kind of interventions with British Petroleum (BP), putting money aside for the government to allocate. Rule of law has been so important for the United States and our economic system that if you start to lose that it could have big effects which could be pretty bad.
18:40Monetary policy. What has the Fed been doing over the last six months, and what do you think they should be doing? They've got the interest rate down to the bare minimum; came down back in December of 2008, sitting there between 0 and one-quarter percent--that's the Federal Funds rate. Long rates have come down rather than up recently. Flight-to-safety concerns over what's going on in Europe. The other big thing about monetary policy is, especially in the last year and a half, has been the major purchases by the Fed of mortgage-backed securities. That's blown their balance sheet; in order to buy those securities they have to effectively print money--electronically they just credit the banks' balance sheets with deposits at the Fed, reserves. Their balance sheet has exploded; really has to come down if they are going to take control of monetary policy at some point. I don't think those purchases of mortgages have been very effective. Empirical work here at Hoover and at Stanford and find that it's been a very small impact on the mortgage and financial market. In the meantime it's changed the monetary policy--more like fiscal policy or credit allocation policy, not monetary policy classically defined where you are controlling money growth to keep the economy stable and inflation rates low. Raised the question of the independence of the Fed. Congress. Added to all the things done in the worst of the crisis--the bailouts of certain firms with Federal Reserve funds. Think the Fed should get back to the framework that worked before all this began, and as soon as possible. How would it do that? The balance sheet is about $2 trillion--don't they hold a massive amount of these mortgage-backed securities, some purchased from banks, and some--they are basically funding the mortgage market through Fannie and Freddie. Fannie and Freddie used to be quasi-public; put into conservatorship in September of 2008, and since then they continue to operate holding interest rates artificially low--not sure how artificial that is in this environment. Isn't the Fed simply acquiring all the mortgages that they are backing? It had been doing that; bought out a trillion and a quarter of the mortgage-backed securities. But they stopped in April of this year. Program is over. Purchases of those mortgages didn't move rates around when you control for other factors--risk factors and other things that move rates around. I think they could sell those mortgage-backed securities. If they do it in a gradual way, then other people will buy the securities. The banks have lots of reserves with which to buy longer-term securities. I think it's quite possible to do that without being disruptive at all. Politically it's hard for the Fed to do that because they'll be seen to be selling mortgages at a time when the economy is struggling. Because it will take reserves out of the system--contractionary? Not clear it's contractionary because there are all those excess reserves. There is a puzzle about why the banks are holding all those excess reserves. They seem to just take on whatever the Fed provides, but clearly they are holding them for some reason. Another concern I have with all these unorthodox policies the Fed undertook because unwinding them could lead to some problems. The mortgage side could be okay; but bank reserves, not safe to say it's contractionary.
24:13Numbers, private investment, Federal reserve policy: links up to those papers will be up on the web. Testimony before Congress. Sticking with the Fed: unattractive story. So much going on, a little bit bewildering; distressing in a democracy that the head of the Fed can act without so much public explanation. But a different argument: The Fed looked at the banks in 2008 and saw a disaster. They kept that quiet. They said some banks healthy, some aren't; we'll make everybody take some Troubled Asset Relief Program (TARP) money because we don't want to put the imprudent firms at risk because we could have a catastrophic set of bankruptcies. What they seem to have pursued since then is a set of subsidies to the banking system. The purchases of mortgage-backed securities--they were on the books at a certain level at those banks, probably not correct at the level they were marked to; Fed basically bought those and gave them a goodie. The Fed today continues to pay a quarter of a percent interest on reserves, an unprecedented policy which encourages them to keep their money at the Fed and just receive that nice flow, which is a subsidy from me to them. Either a nasty political payoff or a desperation move to hide the insolvency of this sector that could have catastrophic impacts. What do you think of that story? Part of the reason for this is to help the banks. If you have a very low interest rate that they can borrow at in the Federal Funds market that they can borrow at and then lend at higher rates, that helps the bank profitability. The interest on reserves, deposits held at the Fed is a quarter of a percent. Paying interest on reserves is what just started before the panic began. Was originally higher and just came down. Could be zero. The reason they are doing that is they want to be able to control the interest rate even if there is a lot of excess money in the economy. So now there is a lot of excess reserves, so much that's why they drive the interest rate down to zero. But in addition, the Fed can affect the interest rate by setting the interest it pays on the reserves that banks hold with it. Two different instruments. They don't want to reduce the money supply--they want to reduce those reserves and want to be able to raise the interest rate when they have to. So they are holding that there so that when and if they have to raise interest rates they'll be able to do it by raising interest on reserves. Could be zero now. But other than to help banks' balance sheets why would they want to encourage banks to hold those excess reserves? They pumped all these reserves in by buying the mortgage-backed securities, but those reserves didn't go into the economy. The classical mechanism by which the Fed would be expansionary--the Bernanke promise that we'll never make the same mistake we made in the Great Depression where the Fed contracted the money supply--haven't they effectively followed a non-expansionary monetary policy in the midst of a crisis? Or to put it another way, if they hadn't been paying interest on those reserves, wouldn't banks be encouraged to do something more productive with it? What am I missing here? What you are missing is 25 basis points. It's now very low rate, rather than 0 it's .25. How much difference would it make if it were zero? Russ: I don't know. Taylor: I agree if it's 2 or 3 or 4 it would make a big difference. Here's what you want to think about as a counterfactual. If the rate were zero, would the banks get rid of all those reserves? I don't think so. They're holding them for other reasons. Scared. Worried about their capital ratios, the loans that they could make. I'd like to see it at zero, but I don't think it would make the banks lend out all those reserves. Maybe we should just set it to zero and see, but I think it's too low a rate to make much of a difference. The Fed thinks about their Federal Funds rate not literally zero now, 0 to .25 is what they want it to be, so when the time comes that they want to raise it, most likely they are going to want to do that by raising the interest rate they pay on bank reserves. They are not going to change the money supply because there are so many reserves out there they can't do it. Instrument.
30:59Now I'm really confused. Let me think about my micro situation. Had the misfortune the other day of looking at my money market fund. My money market fund is paying a tenth of a percent. Rule of 72--you divide the interest rate into 72 and tells you how many periods it takes for your money to double. Doesn't really work in this case because it's such a low number. But applying it, foolishly, a mere 720 years from now my money will double. That doesn't really encourage me. It is tax free, in munis. As an individual, my investment opportunities are miserable right now. I look at the Standard and Poor's (S&P), the stock market, equities, I'm scared, don't know what they hold. There's Treasuries. Not much else. One view is there is not much because people are scared. But surely the fact that banks have this guaranteed quarter of a percent holds interest rates lower than they otherwise would be. Or do you disagree? Taylor: Higher than they otherwise would be--because otherwise you'd have zero. Russ: Well, actually, I don't know. Isn't it artificially being held down? Taylor: The market is being artificially held down by this massive amount of bank reserves. Interest rate in the market is determined by supply and demand for money in the market--bank reserves. Incredible excess of reserves, which drove the interest rate down to near zero. That happened in the fall of 2008: was 2%, went down to 1% as the Fed expanded the money supply--by that I mean bank reserves. Consistent with that, they also had dropped the interest they pay on reserves--it had been at 2%. Unprecedented, hadn't done that before. Lowered that as the market interest rate comes down. In a way, the interest on reserves now at 25 basis points is probably a little above the market. That's what your point is--if you could lower it, you'd get a slightly lower interest rate, and that might be good. Russ: Have to look at the quantity. We tend to look at the price. But that money's just sitting there. Maybe I've got the supply and demand wrong. If there were a 1% alternative that a bank could earn--it's risky, compared to a quarter of a percent sure thing. Stick with the quarter of a percent sure thing and the money sticks in there. True, the market rate might go down, but there would be investment; there would be activity instead of the money just sitting there. Taylor: So, instead of 75 basis point margin, get 100 basis point margin. Could be a factor. Just don't think it's large enough. Question of elasticity. Suggesting that that policy lever is important because if market rates start to go higher in the future, the Fed will then be able to ratchet that number up to ease the rate at which reserves flow back into the system to reduce inflation--is that what you are worried about? Traditionally monetary policy affects the short term interest rate by supply and demand--just a straight micro story. But now they have pushed so much money out there that the supply is overwhelmed and driven the interest rate essentially to zero. So, there's two ways they could raise the interest rate. One is pull back on the supply, and that's going to raise the interest rate. But most likely they are not going to do that. Think they should do that, but mostly they are not. Worried about selling off the mortgage-backed securities, which they need to do to get that money supply back down. So, instead: We'll just set the interest rate that we pay the banks, and that's going to affect the market interest rate. Fed's paying me 1%--that's going to affect me through arbitrage. Can just leave that gigantic amount of reserves out there. But that's to reduce the volume of those extra reserves from flooding the market in the future. That's the mop. Allan Meltzer podcast--Fed, Bernanke assures us that when times get better, all those extra reserves can be mopped up. Meltzer argues they won't have the political will to do that. But you are saying this is the mechanism by which they are going to do it. They can sell mortgage-backed reserves. Can raise the interest rate on reserves. Can also do this "mop-up"--what that means is they go out and borrow money separately. Hope they sell the mortgage-backed securities because mortgage-backed securities is not monetary policy, not the framework that worked well for 20 plus years. Anxious that they get it back as soon as possible to monetary policy as possible. Can't just wave your hand and say let's get back to where things were when they were normal. We've got that problem in a lot of sectors of the economy. AIG, auto industry, government stake with Fannie and Freddie. The government is enmeshed in many sectors of the economy. We have in the back of our mind: Well, when things get better we'll just go back to where we were. But the path is not so obvious. Also, if you wait too long to get back, you lose credibility that you'll ever get back. Example: During the rescue package in Europe for Greece, our Fed participated in that; made loans to the European Central Bank (ECB), using same techniques, balance sheet. Same unorthodox policy, not an exit strategy. If you leave these mortgage backed securities on your books, maybe the housing market gets weak again next year and you end up buying a lot more of these things. Then monetary policy becomes forever intertwined with fiscal policy; precedent has been formed. Lots of reasons we should do this more quickly. Never-never-land of unorthodox policy.
39:45If Ben Bernanke were sitting here, wouldn't he say that in the fall of 2008, he didn't have a choice? Quantitative easing--the acquisition of other assets--the Fed was impotent, pushing on a string unless it went out and bought other assets. What might it have done differently at that point? The ability to go in and help certain firms or sectors was the major problem. The panic. The Fed used its balance sheet to bail out the creditors of Bear Sterns. It pledged bridge loans in the case of Fannie and Freddie. Then it pulled back and said no balance sheet for Lehman Brothers. Then the next day it went back to balance sheet for AIG. Then back to no balance sheet, and we have the TARP. Back and forth spooked the market tremendously. After the panic, talk about the mortgage-backed securities--maybe you can see an effect here or there, but it's very small, and it put the Fed in this precarious situation of people questioning its independence and how does it reduce this without causing turmoil. The period where the Fed's actions were helpful was in the middle of the panic. Pre-panic bad, post panic bad. In the panic, when they helped the commercial paper market and some of the problems that the money market mutual funds were having, that demonstrated a great degree of coordination with other Central Banks and other parts of our government and was very helpful. But in the meantime you had this bad thing that probably led to the panic. Talking about the Money Market Fund, not that Reserve Primary in the wake of the Lehman bankruptcy broke the buck--meaning they weren't going to be able to honor their promises of redemption right away at par--which caused a lot of people to be very anxious generally. Fed guaranteed money market funds. In addition, created some facilities where banks could buy the asset-backed securities that were being disposed of. Commercial paper market was another money market the Fed helped support during that period. Have to look at each of these things separately to see if they work or not. Most important thing that stopped the panic was the clarification of what the TARP was going to be used for. The panic occurred from the time the TARP was rolled out--they were going to buy toxic assets, and nobody could figure out how that was actually going to work. Three weeks later they changed their mind and the panic really stopped right away. Not to say that they resolved it completely, but at least it was clarity. Written powerfully in your book Getting Off Track and in writing on this that the failure to follow the Taylor Rule, behavior policy that had worked so well in the past, that Greenspan in the 2005 period held rates too low too long and then pushed them up too fast. Don't even need to look at the Taylor Rule to see that: just so much different than the policy that was being followed in most of the 1980s and 1990s. Couple of podcasts on that.
44:20What is your best guess of whether we should be worried about inflation or deflation? Remarkable moment to be an economist, to be a grad student. We were taught money supply is what determines inflation. If the growth of the money supply is too fast, going to have an inflation. But we had this massive supply of reserves and don't have any inflation. Maybe we have some measured deflation; some signs inflation might be growing now. Where are we on that? A lot of economists use different measures of money. Milton Friedman would stress the broader aggregates: M1 or M2. The thing that has exploded so much is reserves at banks--very narrow money, monetary base. Currency plus reserves held by banks at the Fed. Relationship between narrow money and the broad money has changed, so we really haven't had a massive explosion of the broad money. Consistent with the monetary theories. However, also have this recession we are in; things have to be unusual to have a big inflation during a recession. It can happen, but also we're getting a slow recovery from a recession. Deviations from Phillips Curve, where inflation falls during recession, are deviations when the economy recovers quickly; but the economy is not recovering quickly. So that's another drag on inflation. Goes back to the inconsistency in the future. Large amount of narrow money will eventually get translated into broad money as banks start lending. The question is: how will that get resolved? Meltzer and others are skeptical. They are going to have to do that or we will have a big inflation. Investors in the money markets are discounting that as a possibility and looking at some other possibility because the markets don't show much of an increase in inflation coming down the line.
47:10International scene. You recently were in Poland. Talk about why you went and Poland's experience. Went there because it is so unusual. The only economy in the 27 countries in the European Union that did not have a recession during this Great Recession. I think the reason is they didn't over-react; kept their policy steady; didn't have a big stimulus package; monetary policy remained pretty steady. Like some other emerging-market countries--Brazil, India--they had made some reforms trying to keep their debt level low, trying to make sure you didn't borrow too much in foreign currencies, also good monetary policy in place. First time in Poland was 1989, just when they were moving from central planning to markets; the finance minister at the time. Very impressive, strong leader. In the years leading up to this crisis was Poland's central bank governor, and I think made some good decisions. Will put a link to chart on blog--first thought is data error, they miscounted GDP or something. Does it feel like it's a healthy economy? Is their unemployment rate low? Here we are in Palo Alto, CA, and it looks pretty healthy. Have to watch what you are doing. Short of a great depression, you can't really see it. Have to watch what you are doing. Biggest comparison was 1989--place was dirty, pollution terrible, hardly any shops, people looked glum. Now, vibrancy, shops, things to do, cleaner. Public service so much better. Germany vs. Poland, longer term thing. Maybe they just took you to the nice neighborhoods. Their policy environment relative to the rest of the EU--are they less interventionist? Yes, but hard to tell. Work to determine what is a stimulus and what isn't. The United States has been relatively transparent on what is and what isn't being spent. China, very hard to figure out what the money has been spent for or how much is being spent. Poland was being challenged by international groups and by opposition parties to do more--use stimulus. The G-20 was forcing everybody to take a stimulus. What they did was effectively describe the policies they were taking anyway as stimulus. Tax revenues may have been scheduled to change--that's our stimulus. Great research opportunities: natural experiments. What about what's going on in Greece? Raising their retirement age from under 50 to over 65, change the generosity of the pension plans. Taken necessary steps toward some fiscal responsibility. Hasn't passed into law yet. A lot of people are pointing to our longer run situation, especially with regard to entitlements--Medicare and Social Security particularly--that Greece is a bit of a wake-up call for us. Others say we don't have that same fragility. What lessons? First, this is another example that these crises are largely caused or prolonged by government actions. Large deficits--the private sector didn't do that. Governments need to get their acts together. Our debt-to-GDP ratios based on our current policies are expected to rise much more than Greece at this point. Have to have faith that somehow we are going to make the adjustment. Can't just say it's going to go away. Important lesson in many respects. We do have time to make the changes; we have to lay out the plan. Attractiveness of U.S. assets, particularly Treasuries? Standard explanation is a flight to safety. But we are doing a lot of things that don't seem to predict they are going to be safe. If the rest of the world got its act together and their assets looked more attractive, would their assets look safer than the U.S.? Doesn't seem to be on the horizon. No expectation of inflation, and no risk premium, despite what appears to be our profligate behavior. The United States is still viewed as a country that will get its act together. But someone's got to actually do it. In terms of interest rates, there's probably a view out there that we are going to have a slow period for a while. Possibility of lower growth. Tendency when you are thinking about the future sometimes for investors to think that the rosy scenario is just going to pan out. The "this time is different" view, Reinhart and Rogoff. Can be inconsistencies out there, psychology of pricing assets or how people think about the future.