Month: January 2020

Labor economists refer to \”prime-age\” men and women, by which they mean those in the 25-54 age group who are in the prime age group for working.  But there is half-century trend that prime-age males are becoming less likely to be in the labor force. Nicholas Eberstadt discusses the subject in \”Education and Men without Work\” in the Winter 2020 issue of National Affairs. 

The steadiness of this pattern over a half-century suggests that it\’s not about trade with China in the last couple of decades, or about specific recessions. Something deeper and steadier is going on. This decline in men in the workforce is concentrated in groups with lower skills, but Eberstadt points out that not all men with lower education levels are experiencing the decline. Instead, there are sharp differences in labor force participation among low-skilled men across geography, foreign- vs. native-born, and married vs. unmarried. He writes:

Modern America has witnessed increasing dispersion in state-level prime-age male labor-force participation rates since at least 1980. Moreover, major, enduring, and sometimes even widening gaps in prime-age male labor-force participation rates are evident for geographically adjoining states (compare, for example, Maine to New Hampshire, or West Virginia to Virginia or Maryland). … [A] gap of roughly 25 percentage points separated the labor-force participation rates of foreign-born and native-born prime-age male high-school dropouts in 2015. Elsewhere I have shown that the gap in labor-force participation rates between married and never-married prime-age male high-school dropouts was on the order of 20 percentage points as of 2015. … 

To my taste, Eberstadt underemphasizes the poor labor market prospects of low-skilled US workers; for example, his article does not include the word \”wages.\” But he is focused instead on a different theme, which is that the long-term reduction in male participation in the labor force is also wrapped up changes in \”family structure, government-benefit dependence, and mass incarceration and felonization.\” Of course, these factors are often intertwined and mutually reinforcing. Here\’s a flavor of his argument on each theme:

On the connection from marriage to workforce participation:

Even after controlling for age, ethnicity, and education, married men are decidedly more likely to be in the workforce than men who have never married. This \”marriage effect\” is so powerful that married prime-age male high-school dropouts generate labor-force participation rates in the same league as their never-married, college-graduate peers. … Lest it go unsaid: The collapse of work for men in modern America is much more closely associated with family structure than race.

Many of the men who are out of the workforce are supported in substantial part either by government payments that come directly to them or that come to family members. Eberstadt notes further:

Available information, however, points to a number of troubling features about the world of prime-age male disability and non-work. Apart from the small fraction (around 13% in 2015) of prime-age male non-workers who are adult students, the remainder report spending many of their waking hours watching and playing on screens — over 2,000 hours per year on average. Almost half of these non-working men report taking pain medication on any given day (which should raise a red flag for those worried about the opioid crisis). And when we stratify by educational attainment, we find that around three-quarters of prime-age non-working men without a high-school diploma are reporting disability benefits, while over four-fifths report access to government health-program support. These facts taken together would perhaps be unexceptionable if we did not already know, thanks to journalist Sam Quinones and others, that the Medicaid and Medicare programs have been widely abused for opioid consumption.

On the issue of mass incarceration:

America incarcerates a larger share of its population than virtually any other country on earth. But the vast dimensions of mass felonization are little known to the public, mainly because, scandalously, the U.S. government simply does not collect data on this demographic characteristic of the national population. One signal study attempting to reconstruct the stock and flow of the U.S. felon population, however, estimated that, as of 2010, nearly 20 million adults in America had been convicted of at least one felony. A little bit of arithmetic would suggest that the current U.S. felon and ex-felon population is now on the order of 24 million — meaning that well over 20 million felons and ex-felons today are not behind bars. Since sentenced criminals are disproportionately male, this means that over one in eight adult men in the civilian non-institutional population (the pool from which labor-force statistics are drawn) has a felony in his background — and the ratio for prime-age men today is most likely even higher than this. … The \”felonization effect\” in reducing post-war prime-age male labor-force participation rates has not yet been calculated, but it is clearly significant in quantitative terms.

For a more in-depth dive into these issues, including lower wages for low-skill workers, as well as links to marriage, government benefits, and incarceration, a useful starting point is a three-paper symposium in the Spring 2019 issue of the Journal of Economic Perspectives (where I labor in the fields as Managing Editor):

• \”The Declining Labor Market Prospects of Less-Educated Men,\” by  Ariel J. Binder and John Bound 
• \”When Labor\’s Lost: Health, Family Life, Incarceration, and Education in a Time of Declining Economic Opportunity for Low-Skilled Men,\” by Courtney C. Coile and Mark G. Duggan
• \”The Tenuous Attachments of Working-Class Men,\” by Kathryn Edin, Timothy Nelson, Andrew Cherlin, and Robert Francis

When the Federal Reserve conducts monetary policy, it announces a target for the \”federal funds\” interest rate. The implication is that if this specific rate rises or falls, it will affect other interest rates throughout the US economy; for example, like federal funds interest rate moves closely together with other key benchmark interest rates, like  the interest rate for overnight borrowing on AA-rated commercial paper. However, the identity of the parties borrowing and lending in the \”federal funds\” market has changed dramatically since the Great Recession. John P. McGowan and Ed Nosal describe the shifts in \”How Did the Fed Funds Market Change When Excess Reserves Were Abundant?\” (Economic Policy Review, Federal Reserve Bank of New York, forthcoming).

As part of federal financial regulation, banks and certain other financial entities (to which we will return in a moment!) are required to hold a minimum amount of reserves at the Federal Reserve. Back before 2007, banks usually tried to minimize these reserves, because the Fed didn\’t pay them any interest for the funds in these reserve accounts. But sometimes it would happen, at the end of a business day, that a bank would realize that its deposits and withdrawals has created a situation where it didn\’t meet the minimum level of reserves. For a fundamentally healthy bank, this wasn\’t a problem. The bank with a slight deficiency of reserves would borrow from another bank that had ended the day with a slight excess of reserves.  The \”federal funds\” interest rate was the rate paid for this lending, which was typically for a very short-term loan, like overnight. As McGowan and Nosal write:

Prior to the 2007 financial crisis, trading in the fed funds market was dominated by banks.1 Banks managed the balances—or reserves—of their Federal Reserve accounts by buying these balances from, or selling them to, each other. These exchanges between holders of reserve balances at the Fed are known as fed funds transactions.

But during the Great Recession and its aftermath, the Fed used large-scale asset purchases, sometimes known as \”quantitative easing,\” to conduct monetary policy. The Fed purchased several trillion dollars in US Treasury bonds and in mortgage-backed securities from banks. The Fed paid for these financial securities by putting money in the the reserve account that banks had with the Fed. In theory, banks could lend out these reserves. But the flood of quantitative easing money came so fast, and arrived in economic times that were so uncertain, that banks didn\’t in fact lend out most of the money. In addition, the Fed announced in October 2008 that it would start paying interest on banks reserves–which made the banks feel financially healthier.

As a result of this pattern of events, banks no longer tried to hold the minimum legally required level of reserves at the Fed. Instead, banks as a group were holding reserves several trillion dollars in excess of the legal requirement. As a result, banks no longer had any reason to borrow money in the federal funds market, and given that the Fed was now paying them interest on reserves, they didn\’t have any reason to lend money in that market, either.

Bottom line: When the Fed talked about conducting monetary policy to raise or lower the federal funds interest rate back in 2007 and earlier, it was talking about an interest rate in a market where banks were borrowers and lenders. But for the last decade or so, banks have little interest in borrowing and lending in the federal funds market. So when the Fed talks about raising or lowering the federal funds interest rate, what entities are  actually doing the borrowing and lending in that market?

The main lenders in the federal funds market, as McGowan and Nosal explain, are the Federal Home Loan Banks. These banks have accounts at the Federal Reserve, but do not receive interest payments from the Fed on funds held in these accounts.

The Federal Home Loan Bank system was created by Congress in 1932 to facilitate financing in the U.S. housing market. The FHLBs accomplish this mission by lending to banks that lend in the U.S. housing market. Loans from the FHLBs are called advances. To receive an advance, banks must become members of the lending FHLB, and the advances are typically secured by U.S.-based real estate collateral. The FHLBs fund the advances by issuing securities. FHLBs maintain liquid assets, or buffers, to ensure timely repayment of their security liabilities when due. FHLB liquidity buffer assets typically consist of fed funds sold, Treasury bill securities, and Treasury reverse repo investments. FHLB liquidity buffers also serve as a reserve of liquidity that can be drawn upon to grant member advances on a timely basis.

Because FHLBs are not deposit-taking institutions, they are not subject to reserve requirements and thus are ineligible to earn IOER [interest on excess reserves] from the Fed. Since they are not eligible for IOER, FHLBs are challenged in their efforts to obtain interest income on their liquidity pools. FHLBs have a strong motivation to sell fed funds, since whatever rate they obtain on fed funds transactions is greater than the zero compensation they would receive on any end-of-day balances held in their accounts at the Fed.

The main borrowers in the federal funds market are foreign banking organizations. The incentive to borrow works like this. Say that you are running a bank, and you have some way to borrow money at less than the interest rate that the Fed is paying for reserves. You could then borrow that money at the lower interest rate, deposit it at the Fed and get a higher interest rate, and earn money off the difference. This sort of deal doesn\’t work well for domestic US banks, because when those banks borrow money and have additional funds, domestic US banks also need to pay extra into the Federal Deposit Insurance Corporation, which provides insurance to bank depositors against the risk that a bank will go broke. However, foreign banking organizations don\’t have depositors, and don\’t need to pay insurance premiums to the FDIC. Thus, they are willing to borrow from the Federal Home Loan Banks at an interest rate below what the Fed is paying on reserves, deposit these funds in their reserve account at the Fed, and earn a profit from the gap between the two. As McGowan and Nosal explain:

[M]ost fed funds borrowing transactions are motivated by “IOER arbitrage”—borrowing overnight at a rate below the IOER rate, leaving the funds at the Federal Reserve overnight to earn the IOER rate, and earning a positive spread on the transaction. Foreign banking organizations (FBOs) currently have a large presence in the fed funds market because of their borrowing advantage over domestic banking institutions. Since FBOs do not offer retail deposits, they are exempt from paying Federal Deposit Insurance Corporation (FDIC) insurance assessments, which all domestic banks must
pay. The FDIC methodology for calculating these assessments changed in the post-crisis period. They are now based on the size of a bank’s balance sheet and not on the bank’s deposit liabilities, as they were pre-crisis. Borrowing costs are reduced if assessments are lower; in the case of FBOs they are zero.

In the old days before 2007, the Federal Reserve conducted monetary policy by influencing the market for banks that were lending or borrowing their own reserves. Now, the primary tool for conducting monetary policy is the interest rate that the Federal Reserve pays for excess reserves. That interest rate will shape the desire of Federal Home Loan Banks to lend funds and the desire of foreign banking organizations to borrow them–and thus affect the federal funds interest rate.

Back in 1848, John Stuart Mill made a classic argument that money was insignificant to the essential nature of an economy, because it was only a facilitator for what really matters–the actual transactions. Mill wrote (Principles of Political Economy, Book III, Ch. VII):

There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, than money; except in the character of a contrivance for sparing time and labour. It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order.

In a globalized economy, one might similarly argue that the exchange rate market is an insignificant thing. What really matters, one might claim, is the real flows of imports and exports, or the patterns of international financial investments. However, the exchange rate market involves trades totaling  $6.6 trillion per day. This is vastly more than needed to finance exports and imports, or to finance foreign direct investment and portfolio investment. Instead, the foreign exchange market is clearly being driven by financial transactions: specifically, those who are hedging against shifts in exchange rates, those who are trying to make a profit by trading in exchange rate markets, or both. It cannot be viewed as, in Mill\’s language, an intrinsically insignificant thing.

The go-to source for information about exchange rate markets is the Triennial Survey conducted by the Bank for International Settlements (an international organization run by the central banks and monetary authorities of 60 different countries).  The BIS Quarterly Review for December 2019 offers a five-paper symposium with details on the size and operation of exchange rate markets. Here, I\’ll mention some of the highlights from the overview paper by  Philip Wooldridge, \”FX and OTC derivatives markets through the lens of the Triennial Survey.\”  The five papers that follow in the issue are:

• \”Sizing up global foreign exchange markets,\” by Andreas Schrimpf and Vladyslav Sushko
• FX trade execution: complex and highly fragmented, by Andreas Schrimpf and Vladyslav Sushko
• \”Offshore markets drive trading of emerging market currencies,\” by Nikhil Patel and Dora Xia
• \”The evolution of OTC interest rate derivatives markets,\” by Torsten Ehlers and Bryan Hardy
• \”OTC derivatives: euro exposures rise and central clearing advances,\” by Sirio Aramonte and Wenqian Huang

A basic question in the issue is how to account for the fact that the size of exchange rate markets expanded by roughly 30% from $5.1 trillion per day in the April 2016 survey to $6.6 trillion per day in the April 2019 survey. Again, this rise cannot be explained by a rise in exports and imports, or by a rise in international foreign direct investment and portfolio investment, which aren\’t nearly large enough to be explain a foreign exchange market of this size.

One shift is that exchange rate trading is happening with shorter-term financial instruments. As a result, they need to be traded more often during a calendar year. Wooldridge writes:

The trading of short-term instruments grew faster than that of long-term instruments. This mechanically increased reported turnover because such contracts need to be replaced more often. Schrimpf and Sushko (2019a) emphasise that the trading of FX swaps, which is concentrated in maturities of less than a week, rose from $2.4 trillion in April 2016 to $3.2 trillion in April 2019 and accounted for most of the overall increase in FX trading.

Another shift is that exchange market trades involving currencies of emerging market countries is on the rise:

While globally trading continued to be dominated by the major currencies, in particular the US dollar and the euro, in FX markets the trading of emerging market currencies grew faster than that of major currencies. As discussed by Patel and Xia (2019), the share of emerging market currencies in global FX turnover rose to 23% in April 2019 from 19% in 2016 and 15% in 2013.

In my reading, the biggest underlying changes relate to what Wooldridge calls \”electronification,\” which is the pattern that more exchange rate transactions are happening through electronic or automated trading. The cost of exchange rate transactions has fallen, but the cost of the information technology infrastructure for carrying out those transactions has risen. 

\”In FX markets, London, New York, Singapore and Hong Kong SAR increased their collective share of global trading to 75% in April 2019, up from 71% in 2016 and 65% in 2010. Trading in OTC interest rate derivatives markets was also increasingly concentrated in a few financial centres, especially London. Schrimpf and Sushko (2019a) attribute this geographical concentration to network externalities. For example, it is more cost-effective to centralise counterparty and credit relationships, or technical and legal infrastructures, in a handful of hubs than to spread them across many countries. The faster pace of trading also increased the advantages of locating traders\’ IT systems physically close to those of the platforms on which they trade.\”

When economists refer to \”concentraion,\” they are referring to what share of sales in a given industry go to the top few firms. Thus, it may seem obvious that more concentration will mean less competition, and higher profits. This can happen! But it\’s not the only possibility–and other possibilities may be in certain industries more relevant for the current US economy.

Here are a couple of nice readable overviews of the issues, both with references to a number of the key academic papers:

• Jeff Cockrell. \”Does America have an antitrust problem?\” in the Chicago Booth Review (Winter 2019/2020)
• Tim Sablik and Nicholas Trachter, \”Are Markets Becoming Less Competitive?\” in an Economic Brief from the Federal Reserve Bank of Richmond (June 2019, EB 19-06)

Consider a few examples to illustrate the issues here:

Imagine a town somewhere that has three not-too-fancy but locally owned restaurants competing with each other: maybe a pasta place, a burger place, and a doughnut place. Then, national restaurant chains arrive in this town: maybe an Olive Garden, a Dunkin\’ Donuts, a Cheesecake Factory, a Red Robin, an Arby\’s, and a Subway. From a standpoint of competition in the local market, it seems clear that competition has increased.  There used to be three restaurants, while now there are six. But from a national point of view, if this pattern happens in many towns, the big chain firms are expanding their market share and the restaurant industry will have greater concentration.

Sablik and Trachter offer some evidence that this kind of example–more local-level competition but less national-level competition–is pervasive. This figure shows that average industry concentration measured at the national level has been rising in recent decades, while measured at the local level it has been simultaneously falling.

The underlying lesson here is one of the classic problems in antitrust policy. If you say that \”competition\” is rising or falling, you have to define with some precision which market you are discussing.

Another possibility is the rise of \”superstar\” firms. The idea here is that certain firms in a range of industries have made large-scale investments in technology, along with the organizational capabilities to use that technology productively. As a results, these \”superstar\” firms are gaining market share, and thus leading to higher measures of industry concentration, while also earning higher profits. This pattern could explain a variety of other observed economic phenomena: for example, markups over cost of production would rise, because more firms would be producing with a technology that combined high fixed costs with low marginal costs; the labor share of income could decline, because leading firms are producing with a greater investment in technology and lower spending on labor; and the diffusion of productivity within a given industry would rise, as the \”superstar\” firms in an industry pull away from the rest.

However, notice that in this case rising concentration of industry is rising because of greater competition, not despite it. For a recent example of research on this \”superstar\” firms theme, see \”The Fall of the Labor Share and the Rise of Superstar Firms,\” by David Autor, David Dorn, Lawrence F. Katz, Christina Patterson, and John Van Reenen (this is the October 2019 version of a paper forthcoming in the Quarterly Journal of Economics).

With examples like these in mind, Cockrell offers an overall judgement from Chad Syverson: “Concentration isn’t a good barometer of the extent of competition in the market,” says Chicago Booth’s Chad Syverson. “It’s not just a noisy barometer; we don’t even know what direction the needle is pointing. There are cases where, clearly, things happen in a market to make it more competitive, and concentration goes up.”

As an example, imagine rules that made made your personal data more portable.  A step like this would probably encourage more competition in certain industries, because if your data moved with you, it would be easier to switch between phone companies, or banks, or health insurance providers. However, if it is easier to switch and competition goes up, a possible result is that the already-big providers grow even bigger, and concentration rises as well.

In short, when thinking about the extent of competition in a market, and how certain antitrust or regulatory policies might affect competition. it\’s reasonable to look at measures of industry concentration and how such measures  might shift. But before one has a knee-jerk negative reaction to measures of higher industry concentration, one needs to be quite specific about how concentration is being measured: how a specific industry is defined, and whether the focus is local, regional, or national. One also needs to be aware that higher competition can lead to higher concentration for an extended  period of time. 

One of the frustrations of describing Milton Friedman\’s work to a noneconomist is that you usually have about four sentences to provide the overview, and maybe can speak a second paragraph if your listener is especially forbearing. It\’s not enough. But the Fraser Institute has now published The Essential Milton Friedman, by Steven E. Landsburg (2019). It\’s a free e-book, 73 pages long, that offers an intro-level, highly readable nonspecialist overview of many of Friedman\’s most prominent ideas, by an author who knows this subject in much greater depth but is just hitting the high spots  The website also includes some short videos and links to other resources. Taken as a whole, the materials seem to me aimed at teachers who want to bring these ideas to their students, as well as those who would just like to learn more themselves.

The topics any economist would expect are covered here: monetary policy, the permanent income hypothesis, the foundations of inflation and unemployment, and also Friedman\’s arguments in Newsweek columns and best-selling books for the abolition of the military draft, private K-12 schools (with government support for their finance), floating exchange rates, a reduction in occupational licensing, and in support of free markets. Here, I\’ll mention some other aspects of Friedman that caught my eye: his role in shaping how economists argue and communicate.

For a number of years, Friedman taught a \”price theory\” course to the first-year PhD students at the University of Chicago. Here\’s the story as told by Landsberg:

In the 1950s, Friedman’s counterpart at MIT was the enormously influential future Nobelist Paul Samuelson, who also taught microeconomics. Here are a few sample questions pulled almost at random from Samuelson’s final exams and problem sets:

• Write a 45-minute essay explaining what Hicks does in Books I and II of Value and Capital, relating the parts to each other.

• In 45 minutes, state the fundamental problems of bilateral monopoly, duopoly and/or game theory. What solutions have been advanced? Appraise them.

• In 45 minutes, discuss the principal theories relative to capital and interest. Appraise.

At around the same time, Friedman at Chicago was posing exam questions like these:

• Will a specific tax of, say, $1 per cup of coffee raise the price of coffee by more or less than an equivalent tax equal to a specified percentage of the price?

• True or false: Technological improvements in the production of rayon, nylon, and other synthetic fabrics have tended to raise the price of meat.

• If soybean farmers receive a subsidy of a fixed number of dollars per acre, will the yield per acre rise or fall?

• It’s been alleged that the Kodak company’s highly profitable film business allows it to undercut its competitors’ prices in the market for cameras. Under what circumstances would it make sense for Kodak to behave in this way?

Again, these questions were asked of first-year PhD students in economics, but the first set of questions were from MIT and the second set were at Chicago. The MIT questions were explicitly about describing strengths and weaknesses of existing theories. Friedman\’s Chicago questions were instead asking students to do economic reasoning in real time. For example, an answer to the question about how improvements in synthetic fabrics affect the price of meat would require a student to spell out in step-by-step detail the different ways in which how one might affect the other. Perhaps synthetic fabrics are a substitute for leather, and leather is produced jointly with meat? In addition, perhaps synthetic fabrics are cheaper and thus allow people to spend less on certain items of clothing, which might lead them to spend more on products including other kinds of clothing? Either \”true\” or \”false\” can be correct here! The challenge is to spell out a model connecting technological improvements in of one good to price change in another good, and to spell out each of the assumptions that would lead your answer.

This notion of economic discourse as a commitment to spelling out the underlying models,  assumptions, and empirical methods is now taken for granted–but it wasn\’t always the case.

One vivid example of Friedman\’s approach in action involved the decision to abolish the military draft and to move to an all-volunteer force. Landsberg tells the story:

In 1966, he [Friedman} participated in a now legendary conference at the University of Chicago, organized by the anthropologist Sol Tax. By all accounts, the shining star of that conference was Friedman’s former student (and my own former colleague) Walter Oi, who estimated the full cost of conscription in brilliant detail. Before Oi’s presentation, a poll of the 74 attendees found two-thirds in favour of the draft; afterwards, a follow-up poll found two-thirds opposed.

Three years later, President Richard Nixon appointed Friedman to a special commission to make recommendations regarding the future of the draft. The 15 members were deliberately chosen to represent a diversity of views: Friedman was one of five who vocally opposed the draft; another five vocally supported it; and the remaining five were declared agnostics. After extensive debates and meetings, Oi and Friedman won over every one of the draft’s supporters and agnostics, and the commission delivered a unanimous report to the president recommending that the draft be abolished.

I remember once hearing Friedman say that when he would speak at colleges and universities in the 1960s, there was often intense opposition to his free-market ideas–until he explained his opposition to the draft, when the audience was then abruptly and strongly on his side.

Friedman put forward his positions with a smile on his face and without using ad hominem attacks, but his rhetoric often had an edge.. Here\’s a story about the arguments concerning the draft.

The same sharp tongue was in evidence during Congressional testimony about the military draft. Friedman was called to testify along with General William Westmoreland, the top commander of US forces in the Vietnam War. Westmoreland, an opponent of the volunteer army, said that he preferred not to command an army of mercenaries. Friedman immediately responded by asking Westmoreland whether he preferred to command an army of slaves. He went on to observe that if volunteer soldiers are mercenaries, then so is everyone else who is paid to do a job, including Westmoreland, Friedman, and every physician, lawyer and butcher in the country.

Here\’s a story about his debates with student radicals of the 1960s and 1970s:

When he debated with leaders of the radical Students for a Democratic Society, Friedman always stressed that he and they sought the same things—individual freedom, pluralism, and prosperity for the masses. “Th e only difference between us,” he said with a smile, “is that I know how to achieve those things and you don’t.”

I should add that the Fraser Institute has published two previous introductions to great economic thinkers: The Essential Adam Smith, by James Otteson (2018), and The Essential Hayek, by Donald J. Boudreax (2014). These books (both under 100 pages of not-too-dense text) also provide a real overview of the person and the ideas from a highly informed author, but in the style of a reader-friendly introductory overview.

Ben S. Bernanke delivered his Presidential Address to the American Economic Association last weekend on the topic, \”The New Tools of Monetary Policy\” (January 4, 2020, here\’s a weblink to watch the lecture, and here\’s a written-out version of the paper on which the lecture was based). To set the stage, he started the talk with a figure similar to this one showing the \”federal funds\” interest rate–the key interest rate on which Fed policy focuses.

The shaded areas in the figure refer to recessions. As you\’ll see, in each recession since 1980 the Fed took actions to reduce the federal funds interest rate by about 5-6 percentage points as a way of stimulating the economy. Although the federal funds interest rate has risen a bit in the last few years, it now sits in the range of 2-2.25%. For some years now, there have been arguments that substantial rises in the global supply of financial capital (sometimes called the \”savings glut\”) has permanently reduce interest rates to these lower levels. Whatever one\’s views on these underlying arguments, it seems unlikely that  the federal funds seem likely to rise much or at all in the near future, and certainly not to climb back up to the range of 5-6% or more. Thus, when (not if) the next recession arrives, the Fed will be unable to reduce the federal funds interest rate by 5-6 percentage points. So what can it do?

Bernanke makes a case that the Fed will be able to compensate with a combination of two nontraditional monetary policies: quantitative easing and forward guidance. \”Quantitative easing\” is also commonly called \”large-scale asset purchases.\” For example, the Fed purchased US government bonds and also mortgage-backed securities from banks. From 2009-2014, Bernanke reports: \”Total net asset purchases by that point were about $3.8 trillion, approximately 22 percent of 2014 GDP.\” Banks hold reserves at the Fed, and so the Fed paid for these purchases by crediting the banks with a correspondingly higher level of reserves–which the banks could then lend out if they wished. 

\”Forward guidance\” refers to an announcement that the central bank intends to continue a certain policy into the future. For example, consider the situation circa 2010, when the federal funds interest rate had already fallen to near-zero and large-scale asset purchases were underway. Financial markets are always looking to the future, and so a natural concern would be whether these policies were likely to be reversed. When a central bank promises that certain policies will be sustained for a certain amount of time, or until certain economic objectives are achieved, it should dramatically reduce any concerns over a near-term policy reversal.

Bernanke argues that in a US context, the combination of large-scale asset purchases and forward guidance can have an economic effect similar to cutting the federal funds rate by about 3 percentage points. Thus, when (not if) the next recession hits, a combination of these tools and cutting the federal funds rate back to a near-zero rate should provide a sufficient stimulus–but just barely.

However, estimating the effect of policies like quantitative easing and forward guidance is an inexact science. As Bernanke writes: \”[T]he uncertainty surrounding the reported estimates is high. Reasonable people can disagree about the precise effects of asset purchases on financial conditions, the credibility of forward guidance, or the effects of changes in financial conditions on growth and inflation.\”

Kenneth Kuttner reviewed the US evidence in the Fall 2018 issue of the Journal of Economic Perspectives, and argued that the Fed\’s previous round of quantitative easing had a similar effect to reducing interest rates by 1.5% (\”Outside the Box: Unconventional Monetary Policy in the Great Recession and Beyond,\” 32:4, 121-46). But when the Federal Reserve started using such policies starting in 2008, no one could be sure how they would work or how long they would last.  If such policies were implemented again, one can make a case that their effects would be greater (because the policies would be better-coordinated and understood) or smaller (because they would no longer have the shock value of being new and different).

What if the Fed were to find that quantitative easing and forward guidance were not enough to boost the US economy in a recession? There are basically three other sets of options that Bernanke mentions.

First, central banks in other countries have experimented with other types of monetary policy tools.
For example, central banks in other countries didn\’t just purchase government debt and government-backed debt (like US mortgage backed securities), but also in some cases bought corporate debt, commercial paper, corporate stocks, and shares in real estate investment trusts. But Bernanke notes:
\”Other than GSE-backed mortgages, the Fed does not have the authority to buy private assets, except under limited emergency conditions, and—in light of the political risks and philosophical objections by some FOMC participants—seems unlikely to request the authority.\”

The Bank of England and the European Central Bank have in some cases offered direct loans to the private sector, rather than working though banks. Bernanke reports that the Fed considered this option, but decided that in the context of the US economy, borrowers had reasonable access to credit through bank loans and corporate bond markets, and so the Fed did not go down this road. But he adds: \” Still, one can imagine circumstances—for example, if constraints on bank lending are interfering with the transmission of monetary policy—in which this option might resurface in the United States.\”

A number of other countries have pushed their policy interest rate into negative territory. Bernanke comments: \”Federal Reserve officials believe that they have the authority to impose negative short-term rates (by charging a fee on bank reserves) but have shown little appetite for negative rates

Tyler Cowen has conducted one of his thought-provoking and entertaining interviews in \”Abhijit Banerjee on Theory, Practice, and India\” (Medium.com, December 30, 2019, both podcast and transcript available). Among his other accomplishments, Banerjee was of course most recently a co-winner of the Nobel prize in economics last fall. The interview is worth consuming in full. As it says in the overview:

Abhijit joined Tyler to discuss his unique approach to economics, including thoughts on premature deindustrialization, the intrinsic weakness of any charter city, where the best classical Indian music is being made today, why he prefers making Indian sweets to French sweets, the influence of English intellectual life in India, the history behind Bengali leftism, the best Indian regional cuisine, why experimental economics is underrated, the reforms he’d make to traditional graduate economics training, how his mother’s passion inspires his research, how many consumer loyalty programs he’s joined, and more. 

A century ago, John F. Carter wrote an essay about “These Wild Young People’ by One of Them,” in the Atlantic Monthly (September 1920,  pp. 301-304, an excerpt is here, although as far as I know the entire essay isn\’t freely available online). It offers a useful reminder that complaints from young adults about the terrible world they are inheriting, so much worse than any previous generation ever inherited, are nothing new. Enjoy the 100 year-old version of the classic young-to-old intergenerational rant:

For some months past the pages of our more conservative magazines have been crowded with pessimistic descriptions of the younger generation, as seen by their elders and, no doubt, their betters. Hardly a week goes by that I do not read some indignant treatise depicting our extravagance, the corruption of our manners, the futility of our existence, poured out in stiff, scared, shocked sentences before a sympathetic and horrified audience of fathers, mothers, and maiden aunts – but particularly maiden aunts. …

I would like to say a few things about my generation.

In the first place, I would like to observe that the older generation had certainly pretty well ruined this world before passing it on to us. They give us this Thing, knocked to pieces, leaky, red-hot, threatening to blow up; and then they are surprised that we don\’t
accept it with the same attitude of pretty, decorous enthusiasm with which they received it, \’way back in the eighteen-nineties, nicely painted, smoothly running, practically fool-proof. \’So simple that a child can run it!\’ But the child could n\’t steer it. He hit every
possible telegraph-pole, some of them twice, and ended with a head-on collision for which we shall have to pay the fines and damages. Now, with loving pride, they turn over their wreck to us; and, since we are not properly overwhelmed with loving gratitude, shake their heads and sigh, \’Dear! dear! We were so much better-mannered than these wild young people. But then we had the advantages of a good, strict,
old-fashioned bringing-up!\’ How intensely human these oldsters are, after all, and how fallible I How they always blame us for not following precisely in their eminently correct footsteps! 

Then again there is the matter of outlook.. When these sentimental old world-wreckers were young, the world was such a different place … Life for them was bright and pleasant. Like all normal youngsters, they had their little tin-pot ideals, their sweet little visions, their naive enthusiasms, their nice little sets of beliefs. Christianity had
emerged from the blow dealt by Darwin, emerged rather in the shape of social
dogma. Man was a noble and perfectible creature. Women were angels (whom they smugly sweated in their industries and prostituted in their slums). Right was downing might. The nobility and the divine mission of the race were factors that led our fathers to work wholeheartedly for a millennium, which they caught a glimpse of just around the
turn of the century. Why, there were Hague Tribunals! International peace was at last assured, and according to current reports, never officially denied, the American delegates held\’ out for the use of poison gas in warfare~ just as the men of that generation were later to ruin Wilson\’s great ideal of a league of nations, on the ground that such a
scheme was an invasion of American rights. But still, everything, masked by
ingrained hypocrisy and prudishness, seemed simple, beautiful, inevitable.

Now my generation is disillusionized, and, I think, to a certain extent, brutalized, by the cataclysm which their complacent folly engendered. The acceleration of life for us has been so great that into the last few years have been crowded the experiences and the
ideas of a normal lifetime. We have in our unregenerate youth learned the practicality and the cynicism that is safe only in unregenerate old age. We have been forced to become realists overnight, instead of idealists, as was our birthright. We have seen man at his lowest, woman at her lightest, in the terrible moral chaos of Europe. We
have been forced to question, and in many cases to discard, the religion of our fathers. We have seen hideous peculation, greed, anger, hatred, malice, and all uncharitableness, unmasked and rampant and unashamed. We have been forced to live in an atmosphere of
\’to-morrow we die,\’ and so, naturally, we drank and were merry. We have seen the rottenness and shortcomings of all governments, even .the best and most stable. We have seen entire social systems overthrown, and our own called in question. In short, we have seen the inherent beastliness of the human race revealed in an infernal apocalypse.

It is the older generation who forced us to see all this … We are faced with staggering problems and are forced to solve them, while the previous incumbents are permitted a graceful and untroubled death. … A keen interest in political and social problems, and a determination to face the facts of life, ugly or beautiful, characterizes us, as it certainly did not characterize our fathers. We won\’t shut our eyes to the truths we have learned. We have faced so many unpleasant things already, – and faced them pretty well,-that it is natural that we should keep it up.

Now I think that this is the aspect of our generation that annoys the uncritical and deceives the unsuspecting oldsters who are now met in judgment upon us: our devastating and brutal frankness. And this is the quality in which we really differ from our predecessors. We are frank with each other, frank, or pretty nearly so, with our elders, frank in the way we feel toward life and this badly damaged world. It may be a disquieting and misleading ha.bit, but is it a bad one? We find some few things in
the ·world that we like, and a whole lot that we don\’t, and we are not afraid to
say so or to give our reasons. In earlier generations this was not the case. The young men yearned to be glittering generalities, the young women to act like shy, sweet, innocent fawns–toward one another. And now, when grown up, they have come to ·believe that they actually were figures of pristine excellence, knightly chivalry, adorable modesty,
and impeccable propriety. But I really doubt if they were so. …

The oldsters stand dramatically with fingers and toes and noses pressed against the bursting dykes. Let them! They won\’t do any good. They can shackle us down, and still expect us to repair their blunders, if they wish. But we shall not trouble ourselves very much about them any more. Why should we? What have they done? They have made us
work as they never had .to work in all their padded lives – but we\’ll have our cakes and ale for a\’ that. 

For now we know our way about. We \’re not babes in the wood, hunting for great, big, red strawberries, and confidently expecting the Robin Red-Breasts to cover us up with pretty leaves if we don\’t find them. We\’re men and women, long before our time,
in the flower of our full-blooded youth. We\’ have brought back into civil life some of the recklessness and ability that we were taught by war. We are also quite fatalistic in our outlook on the tepid perils of tame living. All may yet crash to the ground for aught that
we can do about it. Terrible mistakes will be made, but we shall at least make them intelligently and insist, if we are to receive the strictures of the future, on doing pretty much as we choose now. 

Insert a few references to some modern -isms–say, environmentalism, capitalism, militarism. racism, and sexism–and this essay from 1920 could be republished today. This doesn\’t make it wrong, of  course. The essay is a fair representation of one set of incomplete truths that each generation tells itself. At least some of the young, at least in a certain mood, are shocked, shocked, when they reach adulthood and discover that previous generations have let them down and the world still has problems. At least some of the middle-aged and old, at least in a certain mood, don\’t actually disagree with this insight that problems continue to exist, but they have a hard time viewing this discovery of the young as a profound or thoughtful insight. And so the generations go.

George Bernard Shaw (1856-1950) had this phrase carved into the mantelpiece of his living room: \”They say. What do they say? Let them say.\”