Thursday, January 2, 2014

John Cochrane: one of my favorite economists

John Cochrane is one of many excellent economists that are flying under most people's radar. The Richmond Fed has helped correct that problem by recently publishing an extensive interview with him. In it, he debunks persuasively and clearly a lot of popular misconceptions, and speaks in plain language about what we should be doing to make the economy stronger. Here is my sampling of his key points, but I encourage you to read the whole thing.

On Dodd-Frank regulatory reform:

The core idea is to stop runs by guaranteeing debts. But when we guarantee debts, we give banks and other institutions an incentive to take risks. In response, we unleash an army of regulators to stop them from taking risks. The deeper problem is the idea that we just need more regulation — as if regulation is something you pour into a glass like water — not smarter and better designed regulation. Dodd-Frank is ...  a long and vague law that spawns a mountain of vague rules, which give regulators huge discretion to tell banks what to do. It’s a recipe for cronyism and for banks to game the system to limit competition. ... a better approach would be to purge the system of run-prone financial contracts — that is, fixed-value promises that are payable on demand and cause bankruptcy if not honored, like bank deposits and overnight debt.

On "too big to fail:"

... "too big to fail" is not about whether the institution survives. It's about whether its bondholders and creditors lose money.
You have to set up the system ahead of time so that you either can’t or won’t need to conduct bailouts. ... the only way to precommit to not conducting bailouts is to remove the legal authority to bail out. ... if we purge the system of run-prone financial contracts, essentially requiring anything risky to be financed by equity, long-term debt, or contracts that allow suspension of payment without forcing the issuer to bankruptcy, then we won’t have runs, which means we won’t have crises.

On whether recessions that follow financial crises are necessarily more severe, as argued by Reinhart and Rogoff:

Reinhart and Rogoff only showed that recessions following financial crises have been, on average, longer and more severe — not even "always," let alone "necessarily." An alternative explanation for the correlation is that governments tend to do particularly bad things in the wake of financial crises. They tend to bail out borrowers at the expense of lenders, overregulate finance, pass high marginal tax rate wealth transfers, alter property rights, and introduce other distortions.

On whether the finance industry has gotten too big:

The role of economics shouldn't be to pronounce whether something is too big or too small. Our role should be to look at an industry and see if it's working right. Where are the distortions, where are the subsidies, where are the market failures, where are the things that push it to function well or not?

On Quantitative Easing:

QE has essentially no effect. Interest rates are zero, so short-term bonds are a perfect substitute for reserves. [This is substantially similar to what I have argued, namely that QE does not involve "printing money," it only involves the "transmogrification" of note and bonds into T-bill equivalents.]
... neither the theory nor the evidence make me think QE is effective. But the good news is that we therefore can't worry too much about its reversal. It’s neither going to cause hyperinflation, nor need it cause much trouble when the Fed "tapers."

On the barriers to economic recovery:

Long-term growth is like a garden. You have to weed a garden; you don't just pile on fertilizer — stimulus — when it's full of weeds. So let's count up the weeds. A vast federal bureaucracy is going to be running health care and has cartelized the market. Dodd-Frank is another vast federal bureaucracy, directing the financial brains in the country to compliance or lobbying. The alphabet soup of regulatory agencies is out there gumming up the works. Then there are social programs. The marginal tax rates that low-income people face, along with other disincentives to move or work, mean that many of them are never going to work again. If a Martian economist parachuted down, would he not be struck by the vast number of disincentives and wedges the government places between willing employer and employee? Would he or she really say "the one big wedge between you hiring someone to make something and sell it is the zero bound on nominal Treasury rates"?

11 comments:

Benjamin said...

I like the John Cochranes of the world---but why is it they never mention the federally operated VA, or the USDA, or ethanol, or the $1 trillion in income taxes consumed by just three agencies: Defense, VA and Homeland Security? Or the home mortgage interest tax deduction...
As for QE3, since it started we are up 25 percent on equities, 10-15 percent on property, the private sector has been adding almost 200k jobs a month, and near-record auto sales.
Maybe QE3 ain't working---or maybe it should have tried earlier and bigger.

Hans said...
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Hans said...

Ben Jamin, do not forget to mention the 1tr we spend for the welfare parasites in America..

Also, are you aware that we are sending out men and women into combat without the proper and necessary equipment.?

"The core idea is to stop runs by guaranteeing debts. But when we guarantee debts, we give banks and other institutions an incentive to take risks. In response, we unleash an army of regulators to stop them from taking risks. The deeper problem is the idea that we just need more regulation — as if regulation is something you pour into a glass like water — not smarter and better designed regulation."

Mr Grannis, this is not an issue that would require an economic degree from a leading college, but rather some common sense or as it has been described - garage logic..

In fact, the quote given above would apply to perhaps the majority of bills and thrills coming from CONgress...

We have allowed unabated growth in the governmental unit sector and now this is what we shall reap..

There are many individuals whom will be pleased to see 3% GNP growth; as if it is some form of a economic miracle for America!

Mediocrity, has come a long way in such a short time..

Our Founding Fathers would hold us in complete and utter contempt..

Benjamin said...

Hans--
My point is that there is excessive federal spending in the sacred cows of both parties. John Cochrane would have more credibility if he acknowledged that. But it is always Obamacare and never the much-more socialized VA that garners Cochrane's attention.
Or the $6 trillion in outlays and incurred liabilities from Iraqistan.
Sadly the GOP will never balance the budget.

Hans said...

"Sadly the GOP will never balance the budget."

God helf us if this is true, Ben Jamin..

I am afraid that the impact of CommieCare will have a much greater disastrous effect than spending at the VA.

BTW, I love your word Iraqistan.

Ed Livermore Jr. said...

Scott, will you provide an example of a "run prone" contract?

bt-commenter said...
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bt-commenter said...
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bt-commenter said...

Let's not forget the last time the budget was balanced, by that Communist Bill Clinton. With those tax increases that the entire GOP would not for and said at the time would strangle the economy.

And the big tax cut the W Bush enacted that was going to pay for itself through all that growth it was going to unleash. Which handily erased that surplus. Easing the surplus WAS the point of the Bush tax cuts. Can't go on about how bad the government is unless and needing to drown unless it's all 'Broke'.

And how Obama-Commy-Romney-Care was originally proposed by the Heritage Foundation, and trumpeted by most republicans as a wonderful, market-based system that solves the free-rider problem through an individual mandate. It was a conservative model of health reform, until that darn house negro went and did it.

Scott Grannis said...

Re: the Bush tax cuts. Bush cut tax rates in mid-2003, but tax revenues never declined from the $1.8 trillion rate which prevailed prior to the cuts. Five years later, tax revenues had surged almost 40% to $2.5 trillion, thanks largely to the spurt of growth which followed the tax cuts. The budget surplus reached under Clinton was reversed under Bush primarily because of the 2001 recession, which in turn was a by-product of very tight monetary policy.

So: there is no basis for saying that the Bush tax cuts erased the Clinton surplus. The surplus was erased by the recession which had its roots during the Clinton years.

Steve Alderson said...
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