Macro Musing Podcast

I did a podcast with David Beckworth, in his "macro musings" series, on the Fiscal Theory of the Price Level, blogging, and a few other things.



(you should see the link above, if not click here to return to the original).

You can also get the podcast at Sound Cloud, along with all the other ones he has done so far, or on itunes here.  For more information, see David's post on the podcast.

Blinder on Trade

Alan Blinder has an excellent op-ed in the WSJ on trade. It's hard to excerpt as every bit is good.

1. Most job losses are not due to international trade. Every month roughly five million new jobs are created in the U.S. and almost that many are destroyed, leaving a small net increment. International trade accounts for only a minor share of that staggering job churn. ...

2. Trade is more about efficiency—and hence wages—than about the number of jobs. You probably don’t sew your own clothes or grow your own food. Instead, you buy these things from others, using the wages you earn doing something you do better.  ...

3. Bilateral trade imbalances are inevitable and mostly uninteresting. Each month I run a trade deficit with Public Service Electric & Gas. They sell me gas and electricity; I sell them nothing....

4. Running an overall trade deficit does not make us “losers.”...

5. Trade agreements barely affect a nation’s trade balance. ..a nation’s overall trade balance is determined by its domestic decisions, not by trade deals... America’s chronic trade deficits stem from the dollar’s international role and from Americans’ decisions not to save much, not from trade deals. Trade deficits are not a major cause of either job losses or job gains. ...trade makes American workers more productive and, presumably, better paid.

One could say much more. Trade is not a "competition," for example. But,  having done this sort of thing, I'm sure lots of other good bits are on the cutting room floor.

Alan is more sympathetic to government "help" to trade losers, which I agree sounds nice if it were run by the benevolent and omniscient transfer payment planner, but I think works out poorly in practice when we look at the success or failure of actual trade adjustment programs. But that is a small nitpick.

Alan closes by wishing that Bernie Sanders and Donald Trump understood these simple facts a bit better. I think his list of politicians needing enlightenment could be a little longer. But he's courageous enough for speaking the kind of heretical truth that will come back to haunt him should he ever want a government job.

Obtaining a patient signature on the Treatment Plan Estimate . . . helping you create a more efficient workflow

I moderated my first online Dentrix user meeting last Friday and it was AWESOME! It’s called Freestyle Friday and it is open Q&A, which means YOU get to ask the questions during the live event and I get to help you solve it.

One of the most popular questions was about signing treatment plan estimates when you are paperless. This office was printing the estimate, having the patient sign it and then scanning it into the Document Center. I asked the participant why the office didn’t like this option and the answer was, “It is just so time-consuming.” Let’s look at some alternatives to being more efficient.

I gave this office two options to try and they can go back to their office and see which way works best for them. My preferred way is always not the best way for the office … which is why I love Dentrix so much as it gives a few different alternatives so you can choose.

Here are your options for obtaining an electronic signature on your treatment plan estimates. Take note that even if you are not paperless, you might find this workflow extremely helpful.

• The first option is to do a “virtual print” to the Dentrix Document Center and then have the patient sign inside of the Document Center. You can find step-by-step instructions on how to do this by reading my blog titled, “A Little Known Secret”. After you have pulled the treatment plan into the Document Center, you can make notes about the agreement and then have the patient sign electronically. If you click on Edit > Sign Document or click on the icon for Sign Document, then you can have the patient sign the document in the Document Center. This will lock up the document to prevent any editing or accidental deleting.
• The next option is to attach an electronic signature directly to the Treatment
  
  Plan case. Highlight a treatment case in the Treatment Plan module or Treatment Plan panel in the patient chart, then click on the Settings tab at the bottom of the panel. When you scroll all the way down, you can create or edit the consent forms you would like to use in your office. If you click on the Supporting Information tab just above that, you can attach a selected consent form to your case. When you do this, it will open a new window to prompt you to have the patient sign. After you have the patient sign using an electronic signature device, click on Save and Close. It will automatically save a copy of the consent form along with the signatures in the Document Center.

The main difference between these two options is that the first option will save an exact copy of the Treatment Plan estimate with which the patient leaves. The benefit of this is that you can re-print it for the patient later or review it over the phone and you have the exact copy he or she does. The second option does not save a visual picture of the treatment plan estimate, only the consent form and signatures. You choose what is best for your practice.

For more information on electronic signatures, CLICK HERE.

Lessons Learned I

I spent last week traveling and giving talks. I always learn a lot from this. One insight I got:  Real interest rates are really important in making sense of fiscal policy and inflation.

Harald Uhlig got me thinking again about fiscal policy and inflation, in his skeptical comments on the fiscal theory discussion, available here. At left, two of his graphs, asking pointedly one of the standard questions about the fiscal theory: Ok, then, what about Japan? (And Europe and the US, too, in similar situations. If you don't see the graphs or equations, come to the original.) This question came up several times and I had the benefit of several creative seminar participants views.

The fiscal theory says
 \[ \frac{B_{t-1}}{P_t} = E_t \sum_{j=0}^{\infty} \frac{1}{R_{t,t+j}} s_{t+j} \]
 where \(B\) is nominal debt, \(P\) is the price level, \(R_{t,t+j}\) is the discount rate or real return on government bonds between \( t\) and \(t+j\) and \(s\) are real primary (excluding interest payments) government surpluses. Nominal debt \(B_{t-1}\) is exploding. Surpluses \(s_{t+j}\) are nonexistent -- all our governments are running eternal deficits, and forecasts for long-term fiscal policy are equally dire, with aging populations, slow growth, and exploding social welfare promises. So, asks Harald, where is the huge inflation?

I've sputtered on this one before. Of course the equation holds in any model; it's an identity with \(R\) equal to the real return on government debt; fiscal theory is about the mechanism rather than the equation itself. Sure, markets seem to have faith that rather than a grand global sovereign default via inflation, bondholders seem to have faith that eventually governments will wake up and do the right thing about primary surpluses \(s\). And so forth. But that's not very convincing.

This all leaves out the remaining letter: \(R\). We live in a time of extraordinarily low real interest rates. Lower real rates raise the real value surpluses s. So in the fiscal theory, other things the same, lower real rates are a deflationary force.

The effect is quite powerful. For a simple back of the envelope approach, we can apply the Gordon growth formula to steady states. Surpluses \(s\) grow at the rate \(g\) of the overall economy. So, in steady state terms,
 \[ \frac{B_{t-1}}{P_t s_t} = E_t \sum_{j=0}^{\infty} \frac{(1+g)^j}{(1+r)^j} \approx \frac{1}{ r - g} \]
\[ \frac{P_t s_t}{B_{t-1}}  \approx  r - g \; \; (1) \]
(and exact in continuous time). The left hand side is the steady state ratio of surpluses to debt. The right hand side is the difference between the real interest rate and the long-run growth rate.

So, with (say) a 2% growth rate g, and a 4% long-run interest rate r, surpluses need to be 2% of the real value of debt. But suppose interest rates decline to 3%. This change cuts in half the needed long-run surpluses! Or, holding surpluses constant, if long-run interest rates fall to 3%, the price level falls by half.

You can see the punchline coming. Long term real interest rates are really low right now. If anything, we're flirting with \(r \lt g\), the magic point at which governments can borrow all they want and never repay the debt.

With this insight, Harald should have been asking of the fiscal theory, where is the huge deflation? And the answer is, well, we're sort of there. The puzzle of the moment is declining inflation and even slight deflation despite all our central bankers' best efforts.

Pursuing this idea, there is a larger novel story here about growth, interest rates, and inflation.

Obviously, there is an opposite prediction for what happens when real interest rates rise. Higher real rates, unless accompanied by higher surpluses, will drive inflation upwards.

In conventional terms, looking at flows rather than present values, suppose a government that is $20 Trillion in debt faces interest rates that rise from 2% to 5%. Well, then it has to increase surpluses by $600 billion per year; and if it cannot do so inflation will result.

A similar story makes sense for the cyclical falls in inflation. What happened to our equation in 2008?  Surpluses fell -- deficits exploded -- and future surpluses fell even more. Debt rose sharply. Why did we see deflation? Well, real interest rates on government debt fell to unprecedentedly low levels. This really isn't even economics, it's just accounting. The equation holds, ex-post, as an identity!

To think a bit more about real rates, growth, and inflation, remember the standard relation that the real interest rate equals the subjective discount rate (how much people prefer current to future consumption) plus a constant times the per capita growth rate
\[ r = \delta + \gamma (g-n) \]
The constant \(\gamma\) is usually thought to be a bit above one.

With \(\gamma=1\) (log utility), then we have \(r-g = \delta-n\). The magic land of unbounded government debt can occur because government surpluses can grow at the population growth rate, while interest rates are determined by the individual growth rate. But population growth is tapering off, and must eventually cease, and bondholders prefer their money now. With \(\gamma \gt 1 \) ,
\[ r-g = \delta - n + (\gamma-1)(g-n) \; \; (2)\]
The new term is the per capita growth rate, which is positive, further distancing us from the land of magic.

More to the point, though, we now have before us the central determinant of long run real interest rates. Real interest rates are higher when economic growth is higher. And \(r-g\) rises when economic growth \(g\) rises.

So, going back to my equation (1), we actually had a puzzle before us. Higher real interest rates would mean lower values of the debt, and would thus be inflationary if not accompanied by austerity to pay more to bondholders. But higher real interest rates must come with higher economic growth, and higher economic growth would raise surpluses, helping the situation out. Which force wins? Well, equation (2) answers that question: With \(\gamma \gt 1\), the usual case (a 1% rise in consumption growth comes with a more than 1% rise in real interest rates), higher growth g comes with higher still interest rates r, and thus remains an inflationary force, again holding surpluses constant.

All in all then, we have the hint of a fiscal theory Phillips curve: Inflation should be procyclical. In good times, interest rates rise and the real value of government debt falls, producing more inflation. In bad times, interest rates fall and the real value of government debt rises, producing less inflation.

Central banks have been absent in all this. The natural next question is, does this provide another reinforcing channel by which central banks might raise inflation if they raise interest rates? I don't think so, but one needs more equations to really answer the question.

What matters here are very long-term real interest rates, the kind that discount expectations of surpluses -- yes, we need some surpluses! -- 20 to 30 years from now to establish bondholder's willingness to hold debt today.

In no model I have played with can central banks affect real interest rates for that long. I think a quick look out the window convinces us that central banks cannot substantially raise interest rates in a slump, with supply of global savings so strong compared to demand for global investment. Long-term interest rates really must come from supply and demand, not monetary machination. Higher real interest rates require higher marginal products of capital, and thus higher economic growth, not louder promises, more speeches, or more energetic attempts to avoid the logic of a liquidity trap.

Chari and Kehoe on Bailouts

V. V. Chari and Pat Kehoe have a very nice article on bank reform, "A Proposal to Eliminate the Distortions Caused by Bailouts," backed up by a serious academic paper.

Their bottom line proposal is a limit on debt to equity ratios, rising with size. This is, I think, a close cousin to my view that a Pigouvian tax on debt could substitute for much of our regulation.

Banks pose a classic moral hazard problem. In a financial crisis, governments are tempted to bail out bank creditors. Knowing they will do so, bankers take too much risk and people lend to too risky banks. The riskier the bank, the stronger the governments' temptation to bail it out ex-post.

Chari and Pat write with a beautifully disciplined economic perspective: Don't argue about transfers, as rhetorically and politically effective as that might be, but identify the distortion and the resulting inefficiency. Who cares about bailouts? Well, taxpayers obviously. But economists shouldn't worry primarily about this as a transfer. The economic problem is the distortion that higher tax rates impose on the economy. Second, there is a subsidy distortion that bailed out firms and creditors expand at the expense of other, more profitable activities. Third there is a debt and size distortion. Since debt is bailed out but not equity, we get more debt, and the banks who can get bailouts become inefficiently large.
For sake of argument, I think, Chari and Pat take a benign view of orderly resolution and living wills. Their point is that even this is not enough. Though functioning resolution would solve the tax distortion and subsidy distortion, the debt-size externality remains.

The extent of regulator intervention depends on the aggregate losses due to threatened bankruptcies. Individual firms do not internalize the effect of their decisions on aggregate outcomes and, therefore, on the extent of such intervention. Just as with bailouts, individual firms have incentives to become too large relative to the sustainably efficient outcome 

Their alternative: A regulatory system that

limits the debt-equity ratio of financial firms and imposes a Pigouvian tax on the size of these firms.

The paper is not specific beyond this suggestion. It's intriguing for many reasons outside the paper.

First, they limit the ratio of debt to equity, not the ratio of debt to assets. Current bank regulation is centered on the ratio of debt to assets, but then we get in to the mess of measuring risk-weighted assets, many of them at book value.  Abandoning this whole mess is a great idea.

Thinking about some of the same issues, I came to the conclusion that a simple Pigouvian tax on debt would work better than current debt-to-asset regulations. If you borrow $1 (especially short) you pay an 5 cent tax per year.

There is an interesting question then whether this tax on debt or a regulatory debt-to-equity ratio limit will work better.

Chari and Pat don't say what the optimal debt/equity ratio should be, and how that should be enforced dynamically. If up against the limit, do they want banks to sell assets ("Fire sales" and "liquidity spirals" banks will complain), to issue equity ("agency costs", banks will complain) or what?  Chari and Pat also don't say whether they want regulators to target the ratio of debt to book value of equity or to market value of equity. I like market value, further avoiding accounting shenanigans. I suspect the regulatory community will choose book value, so inure themselves from responding to market signals.

I like announcing a price rather than a quantity -- a Pigouvian tax on debt rather than a debt-equity ratio -- as it avoids the whole argument, and the just this side vs. just that side of any cliff.   My tax could rise with size, to address their size externality as well.

But they don't analyze the idea of a tax on debt rather than their ratio, so perhaps both would work as well within their model. Their ratio of debt to equity is sufficient for their ends, but perhaps not necessary.

Chari and Pat take a benign view of debt, and the functioning of resolution authority: They

start from the perspective that because debt contracts are widespread, they must be privately valuable and, in all likelihood, also valuable to society in general.

They also posit that "orderly resolution" authority will in fact swiftly impose losses on creditors, and that by using "living wills" the offending banks can be quickly broken up.

I think they make these assumptions to focus on one issue. That's good for an academic paper. But in contemplating a larger regulatory scheme, I think we should question both assumptions.

In a modern economy, liquidity need not require fixed value, and I think we could get by with a lot less debt.  That leads me to much more capital overall. They implicitly head this way,  presuming that debt is vital, but then advocating debt equity ratio regulations that will presumably mean a lot more equity.

I suspect that resolution authorities, hearing screaming on the phone from large financial institution creditors of a troubled bank,  and with "systemic" and "contagion" in mind, will swiftly bail out creditors once again.  I think that a bank too complex to go through bankruptcy, even a reformed bankruptcy code, is hopeless for the poor Treasury secretary to carve up in a weekend. So another reason for more equity is to avoid this system that will not work, as well as to patch up its remaining limitations even if it works perfectly.

Chari and Pat also step outside the model, stating that the resolution authority

is worrisome because by giving extraordinary powers to regulators, it allows them to rewrite private contracts between borrowers and creditors...[this]... can do great harm to the well-being of their citizens. Societies prosper when citizens are confident that contracts they enter will be enforced

Their closing sentence is important

We emphasize that regulation is needed in our framework not because markets on their own lead to inefficient outcomes, but because well-meaning governments that lack commitment introduce distortions and externalities that need to be corrected.

Hygienists . . . you are one of the primary educators in the practice

We all know that research shows the systemic links between oral health and the rest of the body, especially the relationship between periodontal disease, cardiovascular disease, diabetes and respiratory disease. As oral health providers, it is our responsibility to educate our patients about the significance of periodontal disease and how it will affect the rest of their body.

One of the tools you have as a hygienist is the Dentrix perio chart module, but do you know everything that it will do to help you with visual aids for educating your patients? Let me show you a few of my favorite things you can do with your perio chart.

1. Use the Graphic Chart to show your patient what a 9mm pocket looks like or where there is a lot of bleeding. You can enlarge a specific quadrant or arch to show specific areas in more detail by clicking on the + in the corners and center of the graphic chart. You can also click on the Show Options button to include the data measurements.
   
2. If you want to show your patient any changes in their perio chart, you can compare up to four exams at a time. I would recommend only comparing two exams at a time because then it will show you a colored arrow if the pocket depth got better or worse (a green arrow means it got better and a red arrow means it got worse).
   
3. You can print both of these two visual aids for your patient to take home.

As the hygienist, you are one of the primary educators in the practice. Use the tools you have in your software to enhance the case acceptance for perio therapy and help your patients work toward a healthy lifestyle. These diagnostic techniques are extremely important to getting your claims paid, but far more important is educating your patients about the link between other oral health and systemic diseases.

A better living will

"US rejects 'living wills' of 5 banks," from FT. WSJ puts this event in the larger story of Dodd Frank unraveling. Juicy quotes:

WSJ: “living wills,” ... are supposed to show in detail how these banking titans, in the event of failure, could be placed into bankruptcy without wrecking the financial system.

FT:...the shortcomings varied by bank but included flawed computer models; inadequate estimates of liquidity needs; questionable assumptions about the capital required to be wound up; and unacceptable judgments on when to enter banktruptcy.

FT: David Hirschmann of the US Chamber of Commerce, the biggest business lobby, said the living wills process was “broken”. “When you can’t comply no matter how much money you put into legitimately trying to comply, maybe it’s time to ask: did we get the test wrong?” he said.

WSJ: Six years after the law was passed, and eight years since the financial crisis, regulators given broad authority to remake American finance, with thousands of regulatory officials on their payroll, cannot figure out a system to allow financial giants to fail, even in theory. What are we paying these people for?

It seems like a good moment to revisit an idea buried deep in "Toward a run-free financial system."  How could we structure banks to fail transparently?

Recall, here is how banks are structured now (extremely simplified). Banks hold assets like loans, mortgages and securities. Banks get money to fund these assets by selling a tiny amount of equity, i.e. stock, and by a huge amount of borrowing, including deposits, long-term bonds, and short-term debt.

The trouble with this system is, if the value of the assets falls by more than $10 in my example, the equity is wiped out, and the bank can't pay its debts. If short-term debt holders worry about this event, they all clamor to get paid first, so a run can happen. That's not really a problem either; bankruptcy is set up exactly to handle this situation. The creditors who lent money to the bank split up the assets. Yes, they don't get their full money back, but if you lend to a bank that's leveraged like this, that's the risk you take.

The trouble is the widespread feeling that big banks are too big, too complex, too illiquid, to utterly muddy, to carve up this way. If it takes years in court, and if all the value of the assets is drained away by lawyers, you have a real problem. Furthermore, we often want the profitable parts of the bank to remain in operation while the creditors squabble about assets. (Ben Bernanke's classic paper on banking in the great depression makes this point beautifully.) The ATM machines should not go dark, the offices where people know their customers and can keep things going should stay in operation.

Hence, big banks become too big -- or too something -- to fail. In that situation, the government is mighty tempted to bail out the creditors and keep the thing limping along. Given that temptation, a lot of large, politically well connected creditors also scream that there will be ``systemic dangers'' if they don't get their cash now, adding to the bailout pressure. A "living will" is supposed to stop this chain, by allowing  bank assets to very quickly get divvied up among creditors.

But the large banks are, apparently, so large and complex that nobody can figure out a living will. That's debateable, for example Kenneth Scott and John Taylor argue bankruptcy can work.  But let's go with the idea. Is there an alternative to Bernie Sanders' bust up the banks? Here's one.

Starting from the left, suppose the bank holds all the same assets it does today. But, it issues 100% equity to finance its assets. Now, a 100% equity financed bank cannot fail. If you don't have any debt, you can't fail to pay debts. Yes, the bank can lose money and slowly go out of business. But it cannot go bankrupt. As it loses money, the value of its equity declines, until shareholders get mad and liquidate the carcass. Nobody can run to get their money out ahead of the other person. End of bankruptcy, end of bank runs, end of financial crises.

(Technical note. Yes, that's a bit overstated. A bank can potentially invest in derivatives and other securities where it can lose more than all of the investment. The amount of monitoring needed to make sure this doesn't happen is trivial next to the Basel sort of thing required to make sure a bank never loses more than a few percent of its value.)

OK, gulp, you say. But don't people "need" to have bank accounts? Isn't "transformation" of debt into loans the crucial feature of the financial system? Don't equity holders "require" high risk, high-return stock? No, argues the "run-free financial system" essay. But let's not go there. Let's just restructure things so that the bank can hold exactly the same assets it has today, and its investors can hold exactly the same assets they hold today.

So, moving to the right in my little picture, suppose bank stock is held in a mutual fund, exchange traded fund, or a special-purpose "bank." Bank stock is the only asset these companies hold, and that stock is also traded on exchanges. These banks fund themselves by the same mix of debt, equity, deposits, and heck even overnight wholesale debt, commercial paper, and so forth.

Now, if the value of the bank stock falls, these holding companies fail, just as my original bank failed. But there is a huge difference. You can resolve the holding company in a morning and still make it to play golf in the afternoon.  The only asset is common stock, commonly traded! There are no derivatives positions to unwind, no strange positions in offshore investment trusts, or whatever.  The "living will" simply specifies how much common equity each debtholder gets in the event of bankruptcy. There is never any need to break up, liquidate, assess, or transfer bits and pieces of the big bank.

Furthermore, there is no more obscurity over the value of  the holding company assets. We see the value of bank assets, marked to market, on a millisecond basis.

The holding companies can provide all the retail deposit services banks now provide. In fact, they could contract out to the banks to provide those on a fee basis, so the customer might not even need to know.

In addition, any sane holding company would hold the stock of several banks, diversifying the risk, and thus reducing the chances of ever needing to be wound up. Come to think of it, any sane holding company would also diversify out of banking, but now we're back to my larger vision of equity-financed banking and sensible small changes in financial structure to achieve it.

In the meantime, there you have it. 100% equity financed banks can still give bank creditors exactly the same assets they hold today, and allow failures of those debts to be resolved in a morning.