Conversable Economist

Living in Minnesota, one hears stories about the economic activity happening in the Bakken formation in western North Dakota and eastern Montana. Stories about people who are paid to drive to work from an hour or more away, because there\’s not enough housing nearby. Stories about school bus drivers who triple their salary by moving to that area and driving a shuttle to get workers to work sites. With national unemployment remaining stubbornly high, what are the actual job numbers for this area? Should many more of the unemployed be moving to North Dakota? In a short \”Beyond the Numbers\” briefing paper, Paul Ferree and Peter W. Smith of the Bureau of Labor Statistics review some of the numbers in \”Employment and wage changes in oil-producing counties in the Bakken Formation, 2007–2011.\” 

For those of you who are a little fuzzy on your North Dakota geography, here\’s a map of the counties around the Bakken formation and the job gains in those counties from 2007-2011.

The overall numbers look like this, according to Ferree and Smith: \”From 2007 to 2011, employment in these counties grew from 77,937 jobs to 105,891 jobs, an increase of 35.9 percent. Total wages paid in these counties more than doubled over the same period: in 2007, workers in these counties earned about $2.6 billion, and in 2011 they earned $5.4 billion. Their average annual pay increased from $33,040 to $50,553 for an increase of 53.1 percent. Over the same period, national employment decreased by 4.4 percent, while average annual pay increased by 8.1 percent from $44,458 in 2007 to $48,043 in 2011.\”

Here\’s a breakdown by industry of gains in jobs and wages. It\’s interesting to note that while jobs in mining almost tripled in this time, jobs in \”Professional and Technical Services\” and in \”Transportation and warehousing\” actually more than tripled. Also, the gain in wages for mining jobs was actually below the average wage gain for this area, while wages in the \”Real estate and rental and leasing\” area doubled in this time. 

On one level, maybe the most important level, the economic news from the Bakken area seems to me very positive. People have jobs! People are getting higher wages! Many of those jobs are for blue-collar skills that have not been well-rewarded in the U.S. economy in recent years. Sure, there are environmental issues worth discussing, but they can be managed. In addition, I\’m sure the jobs and wages in the Bakken area are also supporting jobs and wages in other areas for suppliers, transporters, and energy users. Expanded energy production offers a real opportunity for jobs and growth in the U.S. economy, at a time when such opportunities are not thick on the ground.

That said, it clearly lacks numerical perspective silly to say that America\’s unemployed should all be headed for Williston, North Dakota. The boom from 2007-2011 added less than 30,000 jobs in this area, while the U.S. economy has about 11.7 million unemployed people. In addition, although some of the job gains are for blue-collar workers, a number of the additional jobs are going to those with specific professional and technical skills–or those with detailed knowledge of the local real estate market.  Ultimately, I suspect that the direct economic effects of the oil shale boom in the Bakken area and elsewhere in North America may be smaller than the indirect effects of those increased domestic energy supplies on the rest of the economy. 

The last few years have been unkind to macroeconomics. Questions that were thought to be largely settled have been reopened. Questions that didn\’t seem relevant to high-income economies with developed financial sectors all of a sudden seem quite relevant. The IMF recently held a conference on \”Rethinking Macro Policy\”: the papers can be downloaded and presentations can be viewed here.
In a background paper, Olivier Blanchard, Giovanni Dell\’Ariccia, and Paolo Mauro pose 12 open questions about macro policy in \”Rethinking Macro Policy II:Getting Granular.\” Here, I\’ll list their 12 questions and say a few words about each.

The first five questions concern central banking.

1) Should Central Banks Explicitly Target Activity?

In the early 2000s, the rough consensus was that central banks should focus on price stability. They write: \”One of the arguments for the focus on inflation by central banks was the “divine coincidence”: the notion that, by keeping inflation stable, monetary policy would keep economic activity as close as possible (given frictions in the economy) to its potential. So, the argument went, even if policymakers cared about keeping output at potential, they could best achieve this by focusing on inflation and keeping it stable. Although no central bank believed that the divine coincidence held exactly, it looked like a sufficiently good approximation to justify a primary focus on inflation and to pursue inflation targeting.\”

There are now a number of proposals that central banks should focus not on price stability, but on either focus on increasing the supply of money and credit in a way that would target nominal GDP or real economic activity. It\’s not clear  how well this would work! But after the last few years, it\’s a reasonable question to ask.

2) Should Central Banks Target Financial Stability? 

In the early 2000s, the general sense was that central banks should treat financial bubbles with \”benign neglect.\” For example, the melt-down of the dot-com bubble in the late 1990s was unpleasant, and a short recession arrived in its aftermath. But a common argument at the time pointed out that having the Federal Reserve try to determine when the stock market (or some other financial market) is \”too high\” or \”too low\” has a lot of dangers, too. Better to let financial bubbles work themselves out, the argument went, and the central bank could focus on the real economy and mitigating recessions when needed.

 But now there are proposals that the central bank should look at some financial markets, at least. For example, there seems to be some evidence that sharp rises in bank credit can be forerunners of a financial bubble that can burst into a recession.

3) Should Central Banks Care about the Exchange Rate?

Large economies like the United States have for the last few decades just let financial capital flow back and forth across their borders, with the exchange rate of their currency be determined in global financial markets. But flows of international financial capital seem to have an increasing potential for causing severe financial dislocation. Remember the east Asian crisis back in 1998, the problems of Russia and Argentina a few years later, and now the more recent experiences of  Iceland, Ireland, Greece, Portugal, Spain, and who knows who\’s next? The practicalities of how to limit the disruptive capital flows while encouraging the productive capital flows are daunting. But they are now in the conversation of macroeconomic policy-makers.

4) How Should Central Banks Deal with the Zero Bound?

In those old pre-2007 days, most central bank policy centered on raising or lowering interest rates. But what happens when an economy is stumbling so badly that the targeted interest rate is cut essentially to zero? Blanchard, Dell\’Ariccia and Mauro write: \”The crisis has shown that economies can hit the zero lower bound on nominal interest rates and lose their ability to use their primary instrument—the policy rate—with higher probability than was earlier believed.\” The evidence on how all the various forms of quantitative easing work is still accumulating, but at present it\’s pretty mixed between what I would label as  \”useful if not enormous effects\” and \”not much sustained effect worth mentioning.\”

5) To Whom Should Central Banks Provide Liquidity? 

In the old days, which refers to anything before about 2007, central banks were sometimes called the \”bank for banks.\” They provided liquidity to banks. Other financial institutions and markets–money market funds, mutual funds, insurance companies, investment banks,  securitized lending–were outside what central banks were expected to do. But in the financial crisis that erupted in 2008 and 2009, central banks around the world made all sorts of short-term loans to all kinds of financial institutions. Having set this precedent,will such loans again be provided in the future? And under what conditions, on what terms?

Their next four questions are about fiscal policy.

6) What Are the Dangers of High Public Debt?

Back in the halcyon times before 2007, very high levels of public debt were an issue for countries that seemed economically shaky for many reasons: countries in Latin America like Argentina, or Russia in the late 1990s, or in southern Europe like Turkey or even Italy, or sometimes highly-indebted countries that needed World Bank or IMF bailout plans. But public debt levels were not a first-order problem for high-income economies. They write: \”At the start of the crisis, the median debt-to-GDP ratio in advanced economies was about 60 percent. This ratio was in line with the level considered prudent for advanced economies, as reflected, for example, in the European Union’s Stability and Growth Pact. … By the end of 2012, the median debt-to-GDP ratio in advanced economies was close to 100 percent and was still increasing. …The lessons are clear. Macroeconomic shocks and the budget deficits they induce can be sizable—larger than was considered possible before the crisis. And the ratio of official debt to GDP can hide significant contingent liabilities, unknown not only to investors but also sometimes to the government itself.\”

7) How to Deal with the Risk of Fiscal Dominance?

I don\’t actually know what \”fiscal dominance\” means. But the actual discussion here is about the ways in which monetary authorities can reduce the costs of debt: keeping interest rates and thus government borrowing costs low; buying and holding government debt directly; creating inflation to eat away at the real value of government debt. All of these policies have their risks, but with public debts in many countries heading to levels that would have been considered sky-high just a few years back, all possibilities are on the table.

8) At What Rate Should Public Debt Be Reduced? 

They write: \”[W]hile fiscal consolidation is needed, the speed at which it should take place will continue to be the subject of strong disagreement. Within this context, a few broad principles should still apply …  Given the distance to be covered before debt is down to prudent levels and the need to reassure investors and the public at large about the sustainability of public finances, fiscal consolidation should be embedded in a credible medium-term plan. The plan should include the early introduction of some reforms—such as increases in the retirement age—that have the advantage of tackling the major pressures from age-related expenditures while not reducing aggregate demand in the near term.\”

9) Can We Do Better Than Automatic Stabilizers?

Automatic fiscal stabilizers help ameliorate the swings of boom and bust. But should they be designed to be larger?  They write: \”Why not design better stabilizers? For instance, for countries in which existing automatic stabilizers were considered too weak, proposals for automatic changes in tax or expenditure policies are appealing. Examples include cyclical investment tax credits, or pre-legislated tax cuts that would become effective if, say, job creation fell below a certain threshold for a few consecutive quarters. Perhaps because the policy focus has been on consolidation rather than on active use of fiscal policy, there has been, as far as we know, little analytical exploration .. and essentially no operational uptake of such mechanisms.\”

The final three questions refer to \”macroprudential\” policies, which is one of those terms invented in the last few years. For an overview of the arguments for macroprudential policies, a good starting point is the article by Samuel G. Hanson,  Anil K. Kashyap, and Jeremy C. Stein, \”A Macroprudential Approach to Financial Regulation,\” in the Winter 2011 issue of my own Journal of Economic Perspectives. They write: \”Many observers have argued that the regulatory framework in place prior to the global financial crisis was deficient because it was largely \”microprudential\” in nature. A microprudential approach is one in which regulation is … aimed at preventing the costly failure of individual financial institutions. By contrast, a \”macroprudential\” approach … seeks to safeguard the financial system as a whole.\” Thus, the traditional microprudential approach looked at each financial institution individually, to see if it had sufficient capital and risk controls. A macroprudential approach would look at overall patterns of leverage and risk, and see whether regulatory changes might be needed across the sector. But again, fresh questions arise.

10) How to Combine Macroprudential Policy and Microprudential Regulation?

Do the normal bank regulators also look at macroprudential issues? If macroprudential policy is going to involve steps like changing how easy it is to get loans, should legislators and Congress become involved? How does the central bank fit it here?

11) What Macroprudential Tools Do We Have and How Do They Work?

They write: \”One can think of macroprudential tools as falling roughly into three categories: (1) tools
seeking to influence lenders’ behavior, such as cyclical capital requirements, leverage ratios, or dynamic provisioning; (2) tools focusing on borrowers’ behavior, such as ceilings on loan-to-value ratios (LTVs) or on debt-to-income ratios (DTIs); and (3) capital flow management tools.\” They also write: \”In practice, however, implementation is not so easy.\”

12) How to Combine Monetary and Macroprudential Policies?

Will monetary policy and macroprudential policy be at adds? What happens when the economy is staggering and financial risks are high? The central bank looks at the staggering economy and cuts interest rates. But the macroprudential policy makers look at the high financial risks and take steps to make it tougher to borrow or to build up leverage.

Many of these policy questions come down to an question that is only answerable with the passage of time. Was what happened in the lead-in to the Great Recession a rare event, or an event that is likely to occur again in one form or another? If it was a once-a-century event, then agonizing over how to adapt macroeconomic policy is not all that useful. We can make a few tweaks, and slowly retreat back to the conventional wisdom circa 2005. On the other side, if the global economy and financial sector are increasingly prone to these kinds of upheavals, then more fundamental changes in policy-making will be needed.

How much do high schoolers know about economics? The National Assessment of Educational Progress did its first economics test in 2006, and the U.S. Department of Education has now released the results of the 2012 follow-up test in \”Economics 2012: National Assessment of Educational Progress at Grade 12.\” NAEP tests are carried out for a nationally representative sample of high school students.

I\’ve never read the actual questions for an NAEP economics test. The report explains that the questions are categorized in three overlapping ways. There are three main content areas: the  market economy, the national economy, and the international economy.  The questions are also divided into three \”cognitive\” categories: knowing, applying and reasoning. And the questions are divided into three assessment contexts: individual and household questions on topics related to earning, spending, saving, borrowing, and investing; business questions related to entrepreneurs, workers, producers, and investors; and public policy questions on domestic and international issues.

The results are not especially encouraging. About one-fifth of 12th-graders are \”below basic,\” and the median score is \”basic\” rather than \”proficient.\” Here\’s the overall performance in 2006 and 2012.

The modest gains from 2006 to 2012 are mainly at the lower end of the test score distribution.

However, performance on the economics test follows a pattern that is common across subjects: those with more educated parents tend to perform considerably better. I won\’t enter here into the disputes over the extent to which these differences reflect family or social influences or differences in school performance. I\’ll just note that children from families where the parents have lower levels of education are especially in need of a basic understanding of how the economy works at a personal and social level. Also, whatever the cause, education level is clearly one of the ways that families with higher socioeconomic status pass that advantage on to their children.

For those who want more detail on high school classes in economics, here\’s a post from October 2012 on \”High School Classes in Economics and Personal Finance.\”

Since Japan\’s bubble economy burst in the early 1990s, large budget deficits are one policy that the government has used in an attempt to stimulate the moribund economy. Japan\’s budget deficits have been at least 5% of GDP since the late 1990s, and more like 9-10% of GDP in the last five years. The OECD discusses Japan\’s budget deficits, and the rest of its economic situation, in the just-published OECD Economic Surveys JAPAN.  The \”Overview\” for the study is available here; the entire report can be read for free via a clunky on-line browser here.

In terms of gross government debt, Japan is the world leader. This chart shows the five countries with largest ratios of gross debt/GDP. Japan has been the clear leader since about 2000, although Greece has been making a run at the top spot in the last few years.

However, most economists tend to focus on net government debt, which subtracts out debt that the government owes to itself. (For example, in the U.S. context, net debt doesn\’t count debt held by the Social Security trust fund.) Thus, net debt focuses on how much the government has borrowed in global capital markets. By this measure, Italy was the world debt leader through the 1990s and into the early 2000s, but since then, Japan and Greece have been battling it out for the lead.

Japan\’s enormous debt poses a challenge both to those who advocate larger budget deficits, and for those who do not.  For those who advocate larger budget deficits, the challenge is that Japan\’s enormous rise in debt over about two decades has clearly not been sufficient to restore Japan\’s economy to robust health. Of course, one can object that a number of other complementary policies are also needed, and the OECD report discusses monetary policy, deregulation, energy policy, education, labor market policies, and more. But if the truly extraordinary increase in Japan\’s government debt has not been sufficient to stimulate its economy, it suggests that these other policies are of considerable importance.

On the other side, for those who advocate smaller deficits, Japan\’s enormous rise in government debt over two decades, with net debt reaching 150% of GDP,  has clearly not led to a financial crisis either.

The OECD report straddles the fence here. It warns that Japan\’s debt is far too high, and calls this the country\’s \”paramount policy challenge.\” But it also argues that immediate attempts to bring down this debt could keep Japan\’s economy sluggish, and so argues that a \”flexible fiscal policy\” is needed.

Here is the OECD report, dancing: \”The public debt ratio has risen steadily for two decades, to over 200% of GDP. Strong and protracted consolidation is therefore necessary to restore fiscal sustainability, which is Japan\’s paramount policy challenge. … Stopping and reversing the rise in the debt-to-GDP ratio is crucial. Stabilising the public debt ratio by 2020 may require, depending on the evolution of GDP and interest rates, an improvement of the primary fiscal balance from a deficit of 9% of GDP in 2012 to a surplus as high as 4% by 2020. Controlling expenditures, particularly for social security in the face of rapid population ageing, is key. Substantial tax increases will be needed as well, although this will also have a negative impact on growth. Given the size and duration of fiscal consolidation, Japan faces the risk of a marked rise in interest rates, threatening a banking system that is highly exposed to Japanese government debt.\”

Contemplate that for a moment: the recommendation is for moving from a deficit of 9% of GDP in 2012 to a surplus of 4% of GDP by 2020–that is, a swing in the government budget balance position of 13% of GDP in just 8 years. 

The U.S. debt situation differs from that of Japan in two ways: 1) the U.S. debt/GDP ratio is far smaller; and 2) domestic savings in Japan are high enough that the country can finance its government borrowing from domestic sources. In contrast, the U.S. government has depended for years on inflows of foreign investment capital to finance its debts. Thus, Japan\’s government needs to be concerned that its domestic savers will start looking elsewhere for higher rates of return, while the U.S. government needs to be concerned as to whether international investors will continue to put their money in Treasury bonds.

I remember when I was a high school debater back in the 1970s, and the oil price shocks led to arguments over the prospects for solar, wind, geothermal, and other kinds of power.  Here we are more than three decades later, and carbon-based fuels continue to rule. The International Energy Administration surveys the global situation in \”Tracking Clean Energy Progress 2013.\” 

Here is the Energy Sector Carbon Intensity Index. As the IEA report explains: \”The IEA Energy Sector Carbon Intensity Index (ESCII) tracks how many tonnes of CO2 are emitted for each unit of energy supplied. It shows that the global aggregate impact of all changes in supply technologies since 1970 has been minimal. Responses to the oil shocks of the 1970s made the energy supply 6% cleaner from 1971 to 1990. Since 1990, however, the ESCII has remained essentially static, changing by less than 1% …\”

(For the record, I edited this figure from the version in report by cutting off the projections for the future,and stopping with the present.)

Just to be clear, the IEA is a cheerleader for clean energy. Not that there\’s anything wrong with that! The report advocates \”at least\” tripling R&D budgets for clean energy. I\’m typically supportive of most R&D efforts, but it\’s important to remember that the U.S. government has spent about $150 billion (in 2012 dollars) on energy R&D since the 1970s, without much effect on moving away from carbon-based energy. R&D spending doesn\’t guarantee effective commercialization. But the report also offers a useful reminder that cleaner energy is about a lot more than trying to force-feed solar and wind power companies. For example:

Greater efficiency in energy consumption. \”Industrial energy consumption could be reduced by around 20% in the medium to long term by using best available technologies (BAT).\” Nearly half of global energy consumption is for either heating or cooling, two activities where efficiency gains are often possible.  The IEA calculates that nearly half of its desired gains in reduction of carbon emissions by 2020 can be achieved by greater energy efficiency.

Deal with Coal. The report notes: \”Coal technologies continue to dominate growth in power generation. This is a major reason why the amount of CO2 emitted for each unit of energy supplied
has fallen by less than 1% since 1990… Coal-fired generation, which rose by an estimated 6% from 2010 to 2012, continues to grow faster than non-fossil energy sources on an absolute basis. Around half of coal-fired power plants built in 2011 use inefficient technologies. … Coal plants are
large point sources of CO2 emissions, so concerted efforts to improve their efficiency can
significantly reduce coal consumption and lower emissions.\” TThus, one step is to make burning coal, where that is going to happen, more efficient.  In addition, natural gas can play a substantial role to lower emissions of carbon and various pollutants by offering a practical alternative to coal-fired electricity generation.

Push Carbon Capture and Storage. Maria van der Hoeven writes in her Foreword: \”I am particularly worried about the lack of progress in developing policies to drive carbon
capture and storage (CCS) deployment.\” The report notes: \”While 13 large-scale carbon capture and storage (CCS) demonstration projects are in operation or under construction, progress is far too slow to achieve the widespread commercial deployment envisioned …\”
 
Smarter electrical grids. Smart grids can operate in a number of ways. They can allow charging higher prices at times of peak loads, to encourage shifting demand. They can be programmed so that heating or cooling can be automatically adjusted when demand is especially high. They are going to be a necessity if the electrical grid is to be based on a wider range of energy sources, some of which may vary with sun and wind.



Those who express concern over consequences of high energy use–from conventional pollutants to the risks of climate change to effects of price fluctuations and geopolitical issues–are sometimes a little too quick to offer a policy prescription that involves waving a magic wand of R&D spending over solar or wind or biofuels. I\’d be delighted if that magic wand actually produced a commercially viable and vast source of clean energy, and maybe it will. But in the meantime, sensible policy-makers need to focus on cobbling together a range of less glamorous but perhaps more practical alternatives.

If skill level is so important in the U.S. economy, then why are the share of low-skilled jobs in labor force rising? The answer lies with the phenomenon of job \”polarization,\” a decades-long pattern in which the share of of medium-skill jobs is falling, while the share of both high-skill and low-skill jobs is rising. Didem Tüzemen and Jonathan Willis examine some aspects of this phenomenon in \”The Vanishing Middle:Job Polarization and Workers’ Response to the Decline in Middle-Skill Jobs,\” published in the First Quarter 2013 issue of the Economic Review from the Federal Reserve Bank of Kansas City.

Tüzemen and Willis describe the underlying dynamics in this way. Workers in high-skill occupations \”are typically highly educated and can perform tasks requiring anallytical ability, problem solving, and creativity. They work at managerial,professional, and technical occupations, such as engineering, finance,management, and medicine.\” In contrast, workers in low-skill occupations, typically have no

Of course, the polarized labor market also means a more polarized income distribution. Intriguingly, they offer a chart of median wages that suggests that it isn\’t the pay of those at different skill levels that has diverged, but rather the number of people working at jobs at these skill levels.

The authors document a number of patterns about job polarization in the last three decades. For example:

\”Given the sharp decline in manufacturing employment in the past three decades, this sector might appear to have been the main driver of job polarization. However, empirical evidence reveals that job polarization has been primarily due to shifts in the skill-composition of jobs within sectors as opposed to the shifts in employment between sectors in the economy. All sectors have experienced declines in the within-sector share of workers in middle-skill jobs. …  This distinction is important for labor market policy as it suggests that the impact of job polarization has been widespread across the economy rather than concentrated in a single sector, such as manufacturing. …\”

\”Job polarization has affected male and female workers differently. In response to the decline in the employment share of middle-skill occupations, employment of women has skewed toward high-skill occupations, while employment of men has shifted proportionally toward low- and high-skill occupations. …\”

\”From 1983 to 2012, the employment share of workers age 55 and older in high-skill occupations increased. This shift was related to the aging of the labor force and the delay in retirement of workers in higest demand – those with higher levels of education. In contrast, among workers ages 16 to 24 the largest increase was in the employment share of workers in low-skill occupations. Compared to the 1980s, younger people have been staying in school longer and postponing their entry into the labor force. These developments have shifted the composition of workers in the labor force and suggest that the retirement of the baby boom workers over the next decade may reduce the supply of highly-skilled workers.\”

For a global perspective on military expenditures, my go-to source is the Stockholm International Peace Research Institute. In their recent \”Fact Sheet,\”  Sam Perlo-Freeman, Elisabeth Sköns, Carina Solmirano and Helén Wilandh review \”Trends in World Military Expenditure, 2012.\”

One theme of the report is that global military spending dropped by half of 1% or so in 2012. But at least to my eye, the recent leveling out of military spending in a time of considerable economic stress around the world catches my eye less than how global military spending sagged from the late 1980s to the late 1990s, and the rebounded over the following decade. Some of this recent rise , of course, is higher U.S. military spending in the aftermath of the terrorist attacks of September 11, 2001. But in a more global perspective, it\’s also a rise in Chinese and Russian military spending.

The U.S accounts for 39% of global military expenditures, by far the highest of any country. The list below of the top 15 countries for military spending includes about 80% of all global military spending. U.S. military spending is about as much as the next 10 countries on the list, combined. In addition, while countries around the world on average spent 2.5% of GDP on the military in 2012, the U.S. military spending in 2012 was 4.4% of GDP.

But look at some of the countries in the top 15 in military spending: China at #2, Russia at #3, Japan at #5, Saudi Arabia at #7, India at #8, Brazil at #11. The regional patterns of military spending do seem to be shifting, albeit slowly. In the last few years, military spending is down in North American and western Europe, but up in many other regions. Military spending in Asia overtook that of western and central Europe a few years ago, and the gap is widening.

As I have confessed before on this blog, I have no particular expertise in global military and geopolitical issues. When political candidates argue over whether the U.S. should strive for a capability to fight two wars at a time, one-and-a-half wars at a time, or one war at a time, and what level of spending is appropriate in each case, I am out of my depth. But I can read a trendline.
After the disintegration of the Soviet Union in the early 1990s, the U.S. Was by far the preeminent military power in the world, but as countries like China, India, and Brazil continue their rapid economic growth, this U.S. military advantage will surely diminish. Moreover, while the ability of the U.S. military to win a set battle remains largely unchallenged, the ability of the U.S. to achieve its broader geo-strategic goals through a strategy based heavily on military force is certainly in question.

I was struck some commentsw that Henry Kissinger, no shrinking violet when it came to the application of force, gave in an interview last fall. Kissinger said:

\”I have seen and been involved in four wars that we started with great enthusiasm, and which turned into a debate about the speed of withdrawal—with no other outcome. We must develop a policy where, if we engage ourselves, we prevail. This means a revision of our military strategy, which has so far been based on physically stopping aggression by overwhelming it. It got us into a position where the enemy could control the pace of operations, and the length of the war. We have to develop a peripheral strategy. When the British fought Napoleon, they did not go into the continent of Europe. The strategy in Spain drained France without putting Britain into a position where it was risking its cohesion and its capabilities. I think we need a strategic concept of that nature.\”

Something tells me that my own sense of appropriate U.S. geo-strategic goals would not necessarily align closely with those of Henry Kissinger. But the idea of \”peripheral strategy,\” in which potential conflicts are shaped and managed and defused by methods that do not require \”physically stopping aggression by overwhelming it,\” seems important to pursue. 

Not that long ago, it seemed as if there was an emerging consensus among economists and central bankers that the goal of monetary policy should be \”inflation targeting\”–that is, aiming at a low and steady inflation rate in range of about 2% per year. In the aftermath of the Great Recession, this consensus has, if not shattered, at least taken a severe hit. In an e-book  Lucrezia Reichlin and Richard Baldwin have just edited an e-book called \”Is inflation targeting dead? Central Banking After the Crisis,\” published by VoxEU, with 14 short and readable essays on the question. 

In their introduction, Reichlin and Baldwin point out that when it comes to talking about the Great Recession, \”inflation targeting is cast alternatively as perpetrator, innocent bystander, or saviour.
• Perpetrator: Inflation targeting made monetary policy too easy before the Crisis and
insufficiently so since. It helped build the Crisis in the 2000s and today hinders the
clean-up.
• Bystander: The regime was like a coastal schooner finding itself in the path of Hurricane
Sandy. Inflation targeting was developed during ‘the Great Moderation’. No
one ever claimed it was robust enough to deal with a five-year sequence of once-in-a-
lifetime crises.
• Saviour: Things would have been much worse without inflation targeting’s anchoring
of expectations.\”

They argue that while inflation targeting in a narrow sense was clearly abandoned in 2008, a broader notion of inflation targeting  has an important role to play going forward, because it offers a clear framework for limiting the temptation of politicians to print money. They write:

\”Inflation targeting is alive and well. It is needed now more than ever. Inflation expectations will need to be kept anchored while the advanced economies work the debt-laden economic malaise. The debt creates temptations for governments to bail out debtors with unexpected inflation. Inflation targets and central-bank independence are the conventional ways of keeping politicians away from the printing presses. Central banks’ balance-sheet expansion and even permanent money creation are all options that can be used and considered but if there is any chance they will succeed, the credibility
of the commitment to a medium-run inflation target should not be lost. The questions remain on the effectiveness of such policies and, given their quasi-fiscal nature, on how to deal with the challenge they represent to central bank independence.\”

The eminent Michael Woodford contributes an essay called: \”Inflation targeting: Fix it, don’t scrap it.\” He writes:

\”It is important, first of all, to recognise that proponents of inflation targeting do not actually have in mind a commitment by the central bank to base policy decisions purely on their consequences for inflation, and to act so as to keep the inflation rate as close as possible to the target rate at all times. Mervyn King (1997) memorably referred to this as the ‘inflation nutter’ position, and distinguished the ‘flexible’ inflation targeting that he advocated from it …  And the theoretical case for inflation targeting has never rested on an assertion that a single-minded focus on inflation stabilisation would achieve the best outcome … Quantitative investigations of optimal monetary policy in a variety of structural models and under varying assumptions about parameters and shocks have instead found as a much more robust conclusion that optimal monetary policies involve a low long-run average rate of inflation, and fluctuations in the inflation rate that are not too persistent …

And indeed, there are important advantages for real stabilisation objectives of maintaining confidence that the medium-run inflation outlook is not changed much when shocks occur. For example, …if changes in the rate of inflation were expected to be highly persistent, it would be much more difficult for monetary policy to have an effect on real variables as opposed to simply affecting inflation. …

I thus believe that it would be possible to avoid the problems with inflation targeting as currently practised, that have been the focus of recent criticism of inflation targeting as such, while retaining the essential features of an inflation targeting regime: not only a public commitment to a fixed numerical target for the medium-run rate of inflation, and a commitment to regularly explain how policy decisions are consistent with that commitment, but the use of a forecast-targeting procedure as the basis both for monetary-policy deliberations and for communication with the public about the bank’s decisions and their justification. And I believe that it would be desirable to retain these
features of inflation targeting as it has developed over the past two decades.\”

I can\’t do justice to the volume in a blog post, but one theme that comes up in several of the papers is that some of the arguments for  inflation-targeting seem to assume that it has slowed down and limited the responses of central banks, and that an alternative monetary framework like targeting nominal GDP would have justified an even more aggressive monetary policy with more powerful results. Several of the authors are skeptical of this claim. Adam Posen makes the point that if the nontraditional tools of monetary policy (like quantitative easing and a \”forward guidance\” policy of announcing that interest rates will remain low for several years) are not effective, then it doesn\’t matter what framework you claim to be using. Posen writes:

\”Talk about alternatives to inflation targeting is, to me, a result of frustration – the lack of recovery despite massive monetary-policy shifts. But to my mind, the frustration is misdirected. Sifting a central bank’s target from inflation to nominal GDP in no way changes the effectiveness of policy instruments. Either quantitative easing works through the channel of promoting confidence, promoting asset prices, promoting aggregate demand and reallocation of the riskier assets, like all monetary policy, or it does not. If it does not do that, then it does not do that for nominal GDP any more than it does for inflation. The fact is we could have pursued more aggressive monetary policy, achieved better goals and been totally consistent with the current inflation target. There is no need to incur all the risks, dangers, and confusion of switching regimes – especially not to a regime like nominal-GDP targeting, which lacks inflation targeting’s robustness.\”

To me, one of the biggest surprises about the policies of the Federal Reserve since 2008 or so is how little effect they have had in stimulating nominal GDP growth–whether inflationary or real.

The ZIP code turns 50 this year, and the U.S. Postal Service Office of Inspector General has published a research paper (RARC-WP-13-006) to tell \”The Untold Story of the ZIP Code.\”

The ZIP code greatly helped the automation and efficiency of mail delivery: before the code, a typical piece of mail needed to sorted and handled by 8-10 pairs of hands. But  in addition, the ZIP code is an open source product for organizing data by geography. The report notes:

\”The ZIP Code was established as an open use product publicly accessible from the outset. In fact, the Postal Service only filed a trademark for the “ZIP Code” name in 1973 The openness of the ZIP Code as a platform for economic activity is part of the reason for its immense success far beyond its initial conception. Unlike most commodities, the ZIP Code is not rivalrous; use by one party does not exclude its use by any other. The Post Office took no steps to make the ZIP Code exclusive but rather provided it as a public good for use by any party, free of charge. … \”

\”Other organizations and businesses soon realized the ZIP Code possessed an elegant simplicity for efficiently organizing data by geography. The U.S. Census Bureau, for example, uses the ZIP Code to organize its statistics. Other industries, like real estate and target marketing companies, redefined the way they do business by basing their informational structure on the ZIP Code. The ZIP Code is solicited or used in a variety of transactions, such as buying gas with a credit card at an automated pump. Today, a ZIP Code and physical mailing address are widely recognized attributes of an individual’s identity.\”

The study estimates an economic value on the ZIP code of about $10  billion per year. The summary chart looks like this:

 How might the ZIP code be extended in the future? The report offers two main suggestions. One is that ZIP codes could be linked with geocodes. \”Geocoding is the process of associating precise geographic latitude and longitude coordinates with physical addresses, including street addresses and ZIP Code boundaries.\” This is already done in the UK. Adding geocodes would help the Post Office to plan faster and more efficient delivery patterns–and would also help private sector firms that do lots of shipping and deliveries. In addition, detailed geocoding of zip codes could include local features of terrain, or be used to track weather or disease. The other main change would be to link ZIP codes with demographic data. The report envisions that people could opt into a system where they provide data to the post office, which would allow better targeting of advertising. But in addition, one suspects that if geocodes and demographic information were linked with ZIP codes, clever innovators would find ways to use that data in ways that are beyond our current imagination.

Finally, the report suggests in comments here and there that the development of ZIP codes might also assist economic development around the world. The report notes: \”Current estimates show as many as 4 billion people worldwide are unaddressed and approximately sixty Universal Postal Union countries have no postal code system. …  There is strong evidence that implementing addressing systems in impoverished neighborhoods can actually increase the overall quality of life by allowing basic infrastructure, such as electricity, water, communication, and government services to be delivered to the area. This was seen in the slums of Calcutta, for example, where spray-painting unique addressing numbers on houses yielded significant positive effects on overall quality of life in the city’s neighborhoods. This effort has allowed the local government to organize the delivery of water and electrical utilities to the slums and residents now have the legal identities required to apply for bank accounts and jobs.\”

Mr. Zip, who was introduced as a symbol of the postal service at the same time as the ZIP code, has also turned 50.

Back in 2008 and 2009, I believe that there was a genuine risk of an international economic meltdown that could have been far worse than the grievous recess that actually occurred. (For some graphs that vividly illustrate the financial crisis, see here and here.) The nontraditional policies of the Federal Reserve and other central banks around that time–not just the reduction in the federal funds interest rate to near-zero, but also setting up a wide array of short-term lending facilities and the \”quantitative easing\” policy of buying financial assets–may well have limited the economic crisis from getting much worse. But that said, the recession ended back in June 2009, and I have my doubts that central banks should be continuing to maintain rock-bottom interest rates and continuing to buy financial assets for years into the future.  The question \”Do Central Bank Policies Since the Crisis Carry Risks to Financial Stability?\” is investigated in the Chapter 3 of the April 2013 issue of the Global Financial Stability Report, published by the IMF. Here\’s their summary:

\”[T]he interest rate and unconventional policies conducted by the central banks of four major regions (the euro area, Japan, the United Kingdom, and the United States) appear indeed to have lessened vulnerabilities in the domestic banking sector and contributed to financial stability in the short term. Th e prolonged period of low interest rates and central bank asset purchases has improved some indicators of bank soundness. Central bank intervention mitigated dysfunction in targeted markets, and large-scale purchases of government bonds have in general not harmed market liquidity. Policymakers should be alert to the possibility, however, that financial stability risks may be shifting to other parts of the financial system, such as shadow banks, pension funds, and insurance companies. … Despite their positive short-term effects for banks, these central bank policies are associated with financial risks that are likely to increase the longer the policies are maintained. The current environment shows signs of delaying balance sheet repair in banks and could raise credit risk over the medium term. … Central banks also face challenges in eventually exiting markets in which they have intervened heavily, including the interbank market; policy missteps during an exit could affect participants’ expectations and market functioning, possibly leading to sharp price changes.\”

One example of these potential stresses involves the money market mutual fund industry. Rock-bottom interest rates make these funds less attractive to investors, so the funds are shrinking. As a result, some of these funds are testing the limits of what regulators will allow by trying to take greater risk. A gradual reduction in the assets in money market funds is not a macroeconomic problem, but if shrinking funds and higher risks metamorphosize into a run on these funds, it could be a problem. Here\’s the report:

\”With interest rates remaining near zero in the maturities at which MMMFs [money market mutual funds] are permitted to invest, these institutions are experiencing very low (in some cases zero or negative) returns that in many cases fail to cover the costs of fund management. As a consequence, U.S. MMMFs have raised credit risk modestly (within the confines of regulatory restrictions), engaged in more overnight securities lending, granted fee waivers, and turned away new money. The fundamental problem is that to become profitable the MMMF industry needs to shrink further, and the risk is that it may do so in a disorderly fashion. For example, another run on MMMFs may occur if downside credit risks materialize or securities lending suddenly halts, fueling investors’ fear of MMMFs “breaking the buck” (that is, failing to maintain the expected stable net asset value).\”

As investors leave money market mutual funds in a \”search for  yield,\” risks arise in other  markets.

\”Credit easing, quantitative easing, and commitments to prolonged low policy interest rates may trigger flows into other mature asset markets (corporate bonds, equities, commodities, secondary currencies, and even housing). While encouraging a certain degree of risk taking is indeed the purpose of many MP-plus [monetary policy-plus] policies, they could unintentionally lead to pockets of excessive search for yield by investors and to exuberant price developments in certain markets, with the potential  for bubbles. … The sharp rise in investor\\demand for credit products, combined with constrained supply, is supporting a substantial decline in corporate borrowing costs. In turn, investors are accommodating higher corporate leverage and weaker underwriting standards to enhance yield. Some components of the credit market, such as loans with relaxed covenants, are experiencing more robust growth than in the last credit cycle …\”

The lower interest rates have helped the banking sector in the last few years, but they also raise risks for the future. The report points out: \”There is some evidence that unconventional central bank
measures may be supporting a delay in balance sheet cleanup in some banks …  The current
environment may also be encouraging banks to evergreen loans rather than recognize them as nonperforming … The volume and efficiency of interbank lending may adjust to new, lower levels based … With many banks now relying to a significant extent on central bank liquidity and banks withdrawing resources and skills from interbank lending activities, it may be difficult to restart these markets.\”

 Finally, there is the question of how central banks will eventually unwind their very large purchases of financial securities, both in private markets and in public debt. If this unwinding is done in a gradual and preannounced way, it\’s certainly possible to draw up scenarios where it doesn\’t ruffle markets. But it\’s also possible to draw up scenarios where the unwinding of these financial positions become an undesired source of disruption in these markets and in the banks and other financial institutions that hold many of these assets.

\”During 2009 and the first half of 2010, the Federal Reserve purchased close to $1 trillion in mortgage-backed securities (MBS) to support the U.S. housing market and alleviate pressures on the balance sheets of U.S. banks. It made a new commitment to buy MBS in September 2012 in an effort to lower mortgage interest rates further and spur credit extension … In two purchase programs, the ECB [European Central Bank] bought a total nominal amount of €76.4 billion of covered bonds, and the BOE [Bank of England] bought up to £1.5 billion in corporate bonds. The BOJ [Bank of Japan] also maintains a limited program to purchase corporate bonds, real estate investment trusts (J-REITs), and exchange-traded funds (corporate stocks). …

\”Central banks have become substantial holders of government bonds, too. The increasing share of government bonds held by central banks may present risks to financial stability.The Federal Reserve and the BOJ now each hold some 10 percent of their respective governments’ debt, the BOE holds 25 percent, and the ECB holds an estimated 5 percent to 6 percent of the outstanding sovereign debt of Italy and Spain. The shares of Federal Reserve and BOE holdings of longer-dated sovereign bonds are even higher at more than 30 percent.\”

The IMF recommended policy answer to these kinds of concerns is essentially technocratic: that is, keep monetary policy very expansionary until a recovery is well-established, and use financial regulatory policies like well-constructed capital standards, liquidity requirements, and other approaches to limit negative outcomes. Announce all policy changes well in advance, so that surprises are minimized, and slowly phase in all changes to avoid disrupting markets. It\’s all very sensible and prudent at some level. But the belief that well-informed and well-intentioned regulators financial risks will perceive the risks that arising because of the long-extended extreme expansionary monetary policies, and will respond in exquisitely calibrated ways to manage these risks, seems troublesome to me. 

However, those interested in an alternative view might check out this accessible recent speech from Ben Bernanke, in which he discusses \”Long-Term Interest Rates,\” the reasons why they are so low, and the case for keeping them low awhile longer.