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"?