Month: October 2022

As the Federal Reserve raises US interest rates in an effort to quell inflation, are there any lessons to be learned from similar previous episodes. The most recent Global Financial Stability Report from the IMF offers some discussion.

Here’s a figure showing the patterns of past monetary tightening back to 1960. The figure is a little busy, here’s what you’re looking at. The shaded areas are when recessions occurred, with the horizontal black lines near the bottom of the figure showing the total decline during each given recession. The yellow line is the rate of inflation. The red line shows the federal funds interest rate, which is the policy rate targeted by the Fed: this is shown as a solid red line during periods when the Fed is raising interest rates, but as a dashed red line at other times. The blue line shows the yields on 10-year US Treasury bonds which can be viewed as one way of measuring market interest rates.

What might we learn from these patterns? In some cases, the monetary tightening and higher interest rates was followed by no recession at all (1965, 1984, and 1994) or by rather small recessions (1970 and 2001). What are the chances that we sidestep a substantial recession this time? The IMF offers a mixed view. On one side:

In terms of inflation levels, the current period resembles more closely the 1970s and
early 1980s, when recessions following tightening cycles were characterized by high inflation and low growth (so-called stagflation). In those episodes, a substantial rise in the policy rate was necessary to tame inflation, followed by significant economic downturns.

On the other side;

While the current inflationary environment may be reminiscent of the 1970s or early 1980s, the nature of the COVID-19 shock is unprecedented. Moreover, the policy framework today is also very different. The Federal Reserve benefits from inflation-fighting
credibility built over the past several decades, helping long-term inflation expectations remain much better anchored. That said, financial vulnerabilities have emerged in some sectors in the wake of the COVID pandemic, and financial market volatility has notably risen after having remained relatively compressed over the preceding protracted period of low rates. The financial and regulatory architecture, however, has evolved considerably since the global financial crisis, and policymakers today have at their disposal a number of risk management tools that could be used to deal with the potential adverse systemic fallout from a disorderly tightening in financial conditions.

Finally, I’d just add that in past cycles of monetary tightening, the federal funds interest rate (red line) was consistently raised to a point where it was at or above the inflation rate (yellow line). In other words, the real interest rate (nominal interest rate minus inflation rate) was positive. However, in the current situation, the federal funds interest rate remains well below the inflation rate (red line below yellow line on the far right of the figure). The real federal funds interest rate has been negative most of the time since 2008. In addition, market interest rates as proxied by the 10-year Treasury bond yields has historically been (mostly) at or above the inflation rate, but even after recent increases, it remains well below the current inflation rate.

Thus, the policy question for the present is whether making the policy interest rate less negative, in a situation with negative market interest rates, will be enough to bring down inflation. A key element to this question is whether the inflation rate is being partly driven by temporary factors–price increases linked to the Russia-Ukraine war, as well as ongoing supply chain problems and other disruptions from the pandemic.

It seems to me that the Fed is (in effect) hoping that some of the existing inflation will fade on its own, and that its step-by-step increases in interest rates will be sufficient to knock out any remaining inflation. In this scenario, the current procession of monetary tightening might be followed by lower inflation with no recession or only a modest recession. On the other side, it’s possible for inflation to begin from one-time causes, but then develop its own ongoing momentum. If the existing inflation doesn’t fade on its own, then the Fed seems committed to an ongoing succession of higher and higher interest rates, and a significant recession sometime next year becomes more likely.

From the standpoint of producing carbon-free energy, using ethanol to supplement gasoline might seem like a no-brainer. Ethanol comes from crops like corn, which collect carbon from the atmosphere as they grow. When the ethanol is burned, it does releases carbon into the atmosphere–but then carbon can again be collected in the next corn crop. But of course, nothing is that simple. Corn needs to be grown, typically using machinery and fertilizer, and then processed into ethanol, all of which require energy inputs. If growing additional corn for ethanol requires cultivation of additional land, plowing and preparing that land will release substantial amounts of carbon dioxide. Moreover, the use of corn for ethanol drives up demand for corn and keeps the price of corn higher than it would otherwise be, which is a political selling point for US farmers, but can put stress on the diets of the poor–especially in developing economies.

These issues have bubbled up again with the disruption of agricultural markets due to Russia’s invasion of Ukraine, combined with the ongoing global supply chain disruptions, but the topic isn’t new. Back in 2011, I amused myself for a few months at this blog by posting examples about of international organizations that had come out against subsidizing biofuels like ethanol. For example, in a June 2011 post, ”Everyone Hates Biofuels,” I pointed out a report in which 10 international agencies made an unambiguous proposal that high-income countries drop their subsidies for biofuels. I followed up with ”The Committee on World Food Security Hates Biofuels” in August 2011 and ”More on Hating Biofuels: The National Research Council” in October 2011. For a couple of additional whacks at the pinata, see “Biofuels and Hunger in Low-Income Countries” in January 2013 and “Against Biofuel Subsidies” in June 2015.

For an update, Dan Charles focuses on the environmental issues in a readable essay “How green are biofuels? Scientists are at loggerheads” (Knowable Magazine, October 6, 2022). Here’s a figure showing the rise in US ethanol production, which was launched to higher level starting in 2005 with a mixture of government requirements and subsidies.

Charles emphasizes some useful points about where the argument over biofuels currently stands. One key issue dividing supporters and opponents is the extent to which corn grown for ethanol affects land use. On one side, there is a detailed and comprehensive model of land use called the Global Trade Analysis Project at Purdue University, or GTAP-BIO, which broadly suggests that the rise of ethanol hasn’t cause much additional land to come under cultivation but instead has been enabled by higher crop productivity on existing land.

On the other side, the crops for ethanol have to come from somewhere. Charles writes:

 Ethanol factories now consume about 130 million metric tons of corn every year. It’s about a third of the country’s total corn harvest, and growing that corn requires more than 100,000 square kilometers of land. In addition, more than 4 million metric tons of soybean oil is turned into diesel fuel annually, and that number is growing fast.

Charles notes that the amount of US farmland under cultivation had been gradually declining from the 1980s up until the passage of the Renewable Fuel Standard in 2007. At this point, the decline in cropland stopped–because of the rise in corn and soybean production for biofuels. “Without the ethanol boom, the pre-2007 trend in land use would have continued. More land — 5 million acres — would have remained in grass between 2008 and 2016, rather than being converted to grow crops.” Thus, it can simultaneously be true that crops for ethanol have not dramatically expanded land under cultivation, and also that without crops for ethanol, there would be substantially less land under cultivation.

If we work from the political assumption that US corn and soybean farmers are a potent and focused special interest, and that their Congressional representatives will be able to block the withdrawal of ethanol requirements and subsidies for the indefinite future, what are the possible next steps here? There seem to be two answers on which supporters and opponents of ethanol can more-or-less agree.

One approach “is figuring out ways to measure those environmental benefits and pay landowners for them, just as they get paid for growing corn. To some extent, the US Department of Agriculture does this already, with programs that pay farmers to preserve areas of grassland or forest. Such initiatives are set to expand; the Inflation Reduction Act, which Congress passed in August, gives them an extra $18 billion in funding.”

The other approach is technological. For some years now, there has been discussion of “cellulosic biomass,” which involves getting ethanol from prairie grasses. This transmutation is possible in a laboratory, at high cost, but it seems far from being a commercial proposition. But if the process was commercially viable: “The grass could be harvested, leaving the roots to grow undisturbed, building up carbon-rich organic matter in the soil and avoiding most of the environmental damage that results from converting land into cornfields.”

Ultimately, the idea of using corn and soybeans as a primary energy source doesn’t seem like sensible policy, whether the goals are environmental or to ensure affordable global food supplies. Charles writes:

[T]he world’s croplands, which have claimed vast ecosystems, cover less than half an acre per person on the planet. Producing enough biofuel to power one typical passenger car, meanwhile, requires more than 1.2 acres. (Photovoltaic solar arrays produce many times more usable energy per acre of land than biofuels, and can also be located in dry areas that can’t grow food.)

As time goes by, I find it increasingly hard to explain to the non-econ world just what happened back in September 2008, when during a period of perhaps 2-3 weeks there seemed to me a meaningful chance (and by “meaningful,” I mean large enough to keep me awake at night) that the US banking and financial sector would melt down in a way that would have led not just to the substantial recession that did occur, but to something much worse. But in one of those odd quirks of history, the Federal Reserve at that time was being chaired by a former academic economist named Ben Bernanke who was actually a recognized expert in the subject of banking and financial collapses, based on research that he and others like Douglas Diamond and Philip Dybvig had done back in the 1980s and 1990s. The Great Recession from 2007-2009 was very bad, and it could have been so much worse.

The Royal Swedish Academy of Sciences has now awarded what is formally known as the “Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2022” to Bernanke, Diamond, and Dybvig “for research on banks and financial crises.” As usual, the prize committee has published two explanatory pieces for those who want to know what the fuss is all about. There’s a shorter “popular science background” article called “The laureates explained the central role of banks in financial crises,” and a longer and more technical (that is, about 70 pages) “scientific background article titled “Financial Intermediation and the Economy.” Earlier narratives tended to describe the “Great” character of the Depression as a list of poor decisions and things that went wrong. Bernanke made a strong case that the length and depth of the Great Depression was intimately tied to one main cause: the crisis fo the banking system at the time. The prize committee writes:

Prior to Bernanke’s study, the general perception was that the banking crisis was a consequence of a declining economy, rather than a cause of it. Instead, Bernanke established that bank collapses were decisive for the recession developing into deep and prolonged depression. Once a bank goes bankrupt, the relationship between the bank and its borrowers is cut; this relationship contains knowledge capital that is necessary for the bank to manage its lending efficiently. The bank knows its borrowers, it has detailed information about what borrowers have used the money for and what requirements are needed to ensure the loan will be repaid. Building up such knowledge capital takes
a long while, and it cannot simply be transferred to other lenders when a bank fails. Repairing a failed banking system can therefore take many years, during which time the economy functions very poorly. Bernanke demonstrated that the economy did not start to recover until the state finally implemented powerful measures to prevent additional bank panics.

At about the same time in the early 1980s, Diamond and Dybvig were developing a theoretical model of banking and the financial sector that addressed these issues. They began with the basic idea of a bank as a “financial intermediary”–that is, some economic agents (people and firms) have savings they would prefer not to spend in the present, while others would like to borrow and spend now, and then repay later. Banks serve as the intermediaries between these groups.

But an immediate challenge arises here. What is a substantial number of savers been decide to withdraw their money from these theoretical banks, perhaps because the savers don’t trust that their savings are safe at the bank? The theoretical bank will not have the money for everyone: after all, that money has already been loaned out to people who borrowed to purchase homes and cars, and to businesses who borrowed to make investments. Thus, there is a possibility of a “bank run,” where people rush to the theoretical bank and try to withdraw their funds right now–and in doing so, they make it impossible for the bank to continue functioning.

The bank run is of course a staple of stories and accounts of the time before the 1930s: two of the best-known examples from movies are from Jimmy Stewart in It’s a Wonderful Life and when the little boy Michael tries to withdraw his tuppence from the bank run by Dick van Dyke in Mary Poppins. However, if the government provides deposit insurance, then there is no reason for bank runs. From this perspective, it isn’t a coincidence that when federal bank deposit insurance was enacted in 1933, he role of the fragile banking system in propagating the Depression faded away, and the worst of the Great Depression ended.

But a follow-up tradeoff emerges here. If there is bank deposit insurance, then savers no longer need to worry about whether the bank is making sensible decisions about lending, or whether the bankers are chasing higher risks and perhaps higher payoffs. Thus, Diamond in particular emphasized that deposit insurance needs to be paired with government oversight of banks to make sure that they are not taking undue risks. This pairing of deposit insurance and financial oversight of banks functioned to keep the US banking and financial system stable for a number of decades.

But there were warning signs that not all the problems has been addressed. Perhaps most notably, during the savings and loan crisis of the later 1980s, a number of S&Ls found themselves in a bad financial situation: they had made long-term loans for home mortgages over the previous decades at relatively low interest rates, but the high rates of inflation in the 1970s had pushed up interest rates. Under law, the S&Ls were limited in the interest rates they could pay, so savers instead wanted to move their funds to money market accounts, which didn’t have the same restrictions. This was a modern kind of bank run: funds being withdrawn from one part of the financial sector and moved to another. A number of the S&Ls were faced with bankruptcy as their deposits diminished, and some of the managers chose the strategy of making risky loans at high interest rates to try to regain solvency. Some politicians pressured the financial regulators of their local financial institutions not to crack down. Ultimately, federal government ended up needing to pay off more than $150 billion to protect depositors who had kept funds in these institutions. For more background, readers could start with the three-paper symposium in the Fall 1989 issue of Journal of Economic Perspectives.

With the Great Recession of 2007-9, a somewhat similar problem arose again. A substantial and growing part of the US financial sector had moved outside banks, into what is often called the “shadow banking” sector. If you wanted a loan for a house, you could get it through a non-bank institution, and behind the scenes, mortgage loans were repackaged and sold to investors like pension funds or insurance companies. Businesses found other ways to borrow as well, by using bond markets as well as their own versions of loans that were repackaged and resold. These shadow banking financial institutions were not under the rules of federal deposit insurance or the prudential scrutiny of federal bank regulators. Risky loans were made. And when the shadow banking institutions went sideways, the actual banking system was threatened as well. It was extraordinarily important to have a knowledge base, and people in charge who understood that knowledge base, to recognize that the dire problems of financial institutions in 2007 and 2008 should not just be viewed as an outcome of mortgage sector problems, but that these issues could become a cause of additional and deeper problems.

These underlying problems persist today. Every new innovation in the broader financial sector–the shadow-banking sector–raises the issue of possible financial runs from one sector to another, along with questions of how government might create (or not!) some combination of safety guarantees and a regulatory apparatus. The Nobel prize committee wrote:

Banks and bank-like institutions have existed for thousands of years. Today they are active in every country around the world. Banks obviously perform important functions, but they have also been at the epicenter of some of history’s most devastating economic crises such as the Great Depression. Nevertheless, it was not until the work of this year’s laureates, Ben S. Bernanke, Douglas W. Diamond, and Philip H. Dybvig, that we had a comprehensive theory of why banks exist in the form we observe, what role they play in the economy, why they are fragile, and an empirical account of how devastating
and long-lasting the consequences of massive bank failures can be. …

The research from the 1980s for which this year’s Prize in Economic Sciences is awarded obviously does not provide us with final policy recommendations. Deposit insurance does not always work as intended. It can lead to perverse incentives for banks and their owners to gamble to take the profit if things go well and let taxpayers pay the bill if not. Runs on new financial intermediaries, engaging in profitable maturity transformation like banks, but operating outside of bank regulation, were arguably key for the financial crisis 2007–2009 leading to the Great Recession. When central banks act as lenders of last resort, this can lead to large and unintended wealth redistribution and have negative moral hazard
effects on banks who may increase reckless lending, potentially leading to future crises.

How to regulate the financial market so that it can perform its important function of channeling savings to productive investments, without from time to time causing financial crises, is a question that is actively debated to this day. The same is true about what policies are most effective in preventing a threatening crisis from developing. However, based on the foundational work of the laureates and all research that has followed, society is now better equipped to handle financial crises.

Richard V. Reeves points out a disconcerting finding: in studies of interventions that seek to boost the life prospects of the disadvantaged, when positive effects are found, the benefits tend to accrue to women, not men. He discusses the findings in “Why Men Are Hard to Help,” appearing in the most recent issue of National Affairs. The essay is adapted from his recent book:  Of Boys and Men: Why the Modern Male Is Struggling, Why It Matters, and What to Do about It. Some examples:

Thanks to a group of anonymous benefactors, students educated in the city’s K-12 school system receive paid tuition at almost any college in the state. Other cities have similar initiatives, but the Kalamazoo Promise is unusually generous. It’s also one of the few programs of its kind to have been robustly evaluated — in this case by Timothy Bartik, Brad Hershbein, and Marta Lachowska of the Upjohn Institute. They found that the Kalamazoo Promise made a major difference in the lives of its beneficiaries — more so than other, similar programs made in theirs. But the average impact disguises a stark gender divide. According to the evaluation team, women in the program “experience very large gains,” including an increase of 45% in college-completion rates, while “men seem to experience zero benefit.” The cost-benefit analysis showed an overall gain of $69,000 per female participant — a return on investment of at least 12% — compared to an overall loss of $21,000 for each male participant. In short, for men, the program was both costly and ineffective.

One of the other studies that jumped off my desk in considering this evidence was an evaluation of a mentoring and support program called “Stay the Course” at Tarrant County College, a two-year community college in Fort Worth, Texas. Community colleges are a cornerstone of the American education system, serving around 7.7 million students — largely from middle- and lower-class families. But there is a completion crisis in the sector: Only about half the students who enroll end up with a qualification (or transfer to a four-year college) within three years of enrolling. Many of these schools produce more dropouts than diplomas. The good news is that there are programs, like Stay the Course, that can boost the chances of a student succeeding. The bad news is that, as the Fort Worth pilot shows, they might not work for men, who are most at risk of dropping out in the first place. Among women, the Fort Worth initiative tripled associate-degree completion. This is a huge finding: That kind of effect is rare in any social-policy intervention. But as with free college in Kalamazoo, the program had no impact on college completion rates for men.

But Stay the Course and the Kalamazoo Promise are just two among dozens of initiatives in education that seem not to benefit boys or men. An evaluation of three preschool programs — Abecedarian, Perry, and the early Training Project — for example, showed “substantial” long-term benefits for girls but “no significant long-term benefits for boys.” Project READS, a North Carolina summer reading program, boosted literacy scores “significantly” for third-grade girls — giving them the equivalent of a six-week acceleration in learning — but there was a “negative and insignificant reading score effect” for boys. …

Students who attended their first-choice high school in Charlotte, North Carolina, after taking part in a school-choice lottery earned higher GPAs, took more Advanced Placement classes, and were more likely to go on to enroll in college than their peers — but the overall gains were “driven entirely by girls.” A new mentoring program for high-school seniors in New Hampshire almost doubled the number of girls enrolling in a four-year college, but it had “no average effect” for boys. Urban boarding schools in Baltimore and Washington, D.C., boosted academic performance among low-income black students, but only female ones. College scholarship programs in Arkansas and Georgia increased the number of women earning a degree but had “muted” effects on white men and “mixed and noisy” results for black and Hispanic men.

And so on, and so on, for studies of the effects of wage subsidies, worker training, and other areas. Reeves notes that a number of studies of such programs point out the gap between outcomes for boys and girls, or men and women, and then note (as academic research papers love to do) that it deserves further study. But those further studies–much less proposals for policies that would have improved outcomes for men–don’t seem to happen.

Thus, Reeves, like the rest of us, ends up falling back on explanations that have a plausible ring, but aren’t exactly the result of gold standard cause-and-effect social science research. He writes: “The problem is not that men have fewer opportunities; it’s that they are not seizing them. The challenge seems to be a general decline in agency, ambition, and motivation.” I

Reeves also notes: “[W]here there is a difference by gender, it is essentially always in favor of girls and women. The only real exception to this rule is in some vocational programs or institutions, which do seem to benefit men more than women — one among many reasons we need more of them.” Perhaps such programs speak more clearly to those with lower agency, ambition, and motivation?

If women had dramatically lower rates of college attendance, it would be viewed as a national problem. Indeed, it was viewed that way. As Reeves notes:

In 1972, Congress passed Title IX — a landmark statute to promote gender equality in higher education. Quite rightly, too: At the time, there was a 13 percentage-point gap in the proportion of bachelor’s degrees going to men compared to women. Just a decade later, the gap had closed. By 2019, the gender gap in bachelor’s degrees was 15 points — wider than it had been in 1972, but in the opposite direction. Today, women far outperform men in the American education system. … In the United States, for example, the 2020 drop in college enrollment was seven times greater for male students than for female students. At the same time, male students struggled more than female students with online learning.

Societies with a substantial proportion of disgruntled and flailing young men will suffer from an array of other related problems.

The US Energy Information Administration gives this answer for August 2022:

I was buying gas recently, and because I was also picking up snacks, I went into the gas station to pay the cashier rather than swiping my credit card at the pump. I said something low-key conversational about “price of gas sure is up” and he visibly winced. So I added something like: “Of course, the gas station makes, what, about 5 cents when you sell a gallon of gas?” He visibly relaxed and even gave me a rueful smile. It made me suspect that the customer service people behind the counter, everywhere, have probably been taking a lot of face-to-face direct heat for higher prices.