Policy Institutes

Since the financial crisis of 2007-09, and especially in recent months, Europe and the United States have seen zero and even slightly negative short-term nominal interest rates, and sub-zero risk-free real interest rates.  In June I participated in a conference on “Zero Interest Rate Policy and Economic Order” at the University of Leipzig, organized by Gunther Schnabl (U Leipzig), Ansgar Belke (U Duisburg-Essen), and Thomas Mayer(Fossback von Storch Research Institute).  The topic faced participants with the need to make a key judgment call: Are ultralow rates the new normal, i.e. are they long-run equilibrium rates determined by market fundamentals, or are they so low because of ultra-easy monetary policies and other policies?  In Wicksell’s terminology, is the real “natural rate” currently below zero, or are central banks holding market rates below the current natural rate? We cannot directly observe the natural rate, but we can look for indirect indicators.

In Wicksell’s famous and now-standard analysis, a central bank can drive (or hold) the market rate of interest below the natural rate by injecting money, which shifts the supply of loanable funds curve to the right, increasing the quantity of loanable funds and lowering the interest rate (the “liquidity effect”).  As the new money circulates it drives up prices and nominal incomes, however, which shifts the nominal demand for loanable funds curve to the right, raising the market interest rate (the “nominal income effect”).  If the central bank wants to keep the market rate low in the face of the nominal income effect, it must accelerate the money injection.  Short-term real rates have been negative, and nominal rates near zero, for eight years now with little sign of accelerating broad money growth or a rising inflation rate.  Thus the Wicksellian cumulative-process scenario does not seem to be a viable candidate for explaining why current rates have remained so low since 2008.

Lukasz Rachel and Thomas D Smith, in a widely cited Bank of England working paper, spell out the market-fundamentals view: “The co-movement in rates across both advanced and emerging economies suggests a common driver: the global neutral real rate may have fallen.”  They try to quantify changes over the last 30 years in the various factors shifting the supply of loanable funds rightward (population bulge nearing retirement, larger income share of the well-to-do, the “glut” of “precautionary saving by emerging markets”) and the demand leftward (depressed investment, higher risk premia) for loanable funds.  Larry Summers, particularly in his Homer Jones lecture at the St. Louis Fed in April, has proposed that the demand for loanable funds curve has shifted leftward due to “secular stagnation.”

Several participants at the Leipzig conference offered an alternative view, particularly William R. White (formerly of the Bank for International Settlements, now at the OECD, and a member of the CMFA academic advisory board) and Andrew Filardo (BIS).  Their view is spelled out in the new (unsigned) BIS Annual Report released on 26 June, just days after the conference.  The Report argues that zero rates are not the permanent new normal, but are the lingering aftermath of the financial boom-bust cycle that developed economies have gone through.  To quote (p. 14): “unchecked credit booms can be part of the problem and leave a long shadow after the bust, sapping productivity growth.  In addition, debt overhangs depress investment, which weakens productivity further.”  In a passage that bears quoting at length, the Report (p. 14) contrasts its view with the view that secular stagnation is the main force keeping interest rates low.  The secular stagnation view fails to square with the fact that a credit boom preceded the bust:

[Our] interpretation of the post-crisis global growth slowdown differs in key respects from one that has been gaining currency – secular stagnation.  It suggests rather that the world is better regarded as having suffered a series of financial booms gone wrong.  Consider, admittedly in a very stylised form, the main differences in the two views.  The most popular variant of the secular stagnation hypothesis posits that the world has been haunted by a structural deficiency in aggregate demand.  This deficiency predates the crisis and is driven by a range of deep-seated factors, including population ageing, unequal income distribution and technological advances.  In this view, the pre-crisis financial boom was the price to pay for having the economy run at potential.  The key symptom of the malaise is the decline in real interest rates, short and long, which points to endemic disinflationary pressures.  In the hypothesis proposed here, the world has been haunted by an inability to restrain financial booms that, once gone wrong, cause long-lasting damage. The outsize and unsustainable financial boom that preceded the crisis masked and exacerbated the decline in productivity growth.  And rather than being the price to pay for satisfactory economic performance, the boom contributed, at least in part, to its deterioration, both directly and owing to the subsequent policy response.

The BIS, whose clients are the worlds’ central banks, does not directly blame central banks’ easy credit policies for fueling financial booms.  But the reader is free to read the argument that way. When it comes to policy recommendations, the Report (p. 20) does call for tighter monetary policy (that is, tighter than inflation targeting suggests) to avoid feeding incipient booms: “monetary frameworks should allow for the possibility of tightening policy even if near-term inflation appears under control.”  Rather than describe this as “using monetary policy to lean against financial imbalances” of unspecified origin as the Report does, I would characterize such an approach as using indicators other than only consumer prices (namely asset prices and/or nominal GDP) as indicators to judge when monetary policy is too loose.  Rather than describing the practical policy-making task as developing guidelines to help central banks “more effectively tackle the financial booms and busts,” I would say that we need guidelines to stop central banks from fueling financial booms and busts.  Thus the BIS Report supports the case for nominal GDP as a less hazardous central bank target than the CPI or other inflation index, since an NGDP level target does not call for expansionary monetary policy to offset the benign price-lowering effects of productivity improvements.

The BIS Report deserves our serious attention.  Its approach is more promising, to be sure, than the secular stagnation approach of Summers, who judges the last eight years of economic performance sub-par by reference to the extrapolated bubble path (aka the CBO’s 2007-estimated path of real potential output).  His diagnosis: chronically insufficient nominal aggregate demand.  This diagnosis implies that the price level has failed to approach its equilibrium level in the seven to eight years since the 2008-09 velocity shock, which violates our standard understanding about how long the price level takes to adjust to nominal shocks.  It approaches incoherence to suppose that real interest rates have approximately reached long-run equilibrium in intertemporal markets, and simultaneously that the level of prices has not yet approximately reached long-run equilibrium in the spot market where money balances exchange against goods.

Global 10-year real government bond rates

Source: Summers (2015, p. 100)

[Cross-posted from Alt-M.org]

It should surprise no one that the government isn’t particularly good at respecting property rights. Still, the Constitution requires that property owners be provided with “due process of law” against arbitrary and unjustified deprivation of their right to put their property to beneficial use. According to several federal appellate courts, however, landowners lack such protections unless they show that they have a statutory “entitlement” to use their land.

This is circular Humpty Dumpty logic. Indeed, that approach impermissibly presumes the legitimacy of restrictions, without considering whether they are lawfully applied.

Most recently, the New York-based U.S. Court of Appeals for the Second Circuit employed the “entitlement” theory to deprive a small developer of its right to upgrade run-down apartment buildings. The NYC Landmarks Commission deprived Stahl York Avenue Company of its property rights by designating these nondescript buildings as landmarks—this despite a previous ruling that these exact buildings lacked any architectural or cultural merit worth preserving.

Courts across the country are deeply split over landowners due-process rights, so Cato and the National Federation of Independent Business have filed an amicus brief urging the Supreme Court to take up Stahl’s case.

The “entitlement” theory itself contradicts longstanding Supreme Court precedent. “Long before the original States adopted the Constitution, the common law protected an owner’s right to decide how best to use his property,” wrote Justice John Paul Stevens in Moore v. City of East Cleveland (1977). Against that common-law background, the Court in Euclid v. Ambler Realty (1926) held that an infringement on property rights “must find [its] justification in some aspect of the police power, asserted for the public welfare.”

Indeed, 60 years later the Court reaffirmed that such infringements must “substantially advance legitimate state interests.” Agins v. City of Tiburon (1980). That due-process test—whether a proposed land-use regulation substantially advances legitimate state interests—is turned on its head when the regulation is presumed to be valid unless the owner can point to a specific statutory “entitlement” (permission from the legislature to use the land in that particular way).

In addition, regulator-friendly historical-preservation rules have lead to various interests in cities that follow the entitlement approach to over-preserve buildings across the nation. In Manhattan and Baltimore—two major cities within “entitlement” jurisdictions—nearly a third of the city mass is landmarked. Yet in places with different legal rules, like Philadelphia, Chicago, and San Francisco—pretty historic burgs!—only 1-5 percent of the city is landmarked. (See pages 13-19 of our brief for details, including a nifty map of Manhattan that shows more preservation in wealthier, politically more powerful neighborhhods.)

NIMBY (“not in my backyard”) interests abuse preservation powers in permissive jurisdictions to prevent development like Stahl’s. But over-preservation isn’t economically harmless: it imposes significant negative effects on property values, tax revenues, affordable housing, and the environment. It also chills new residential construction and drives up the price of housing and rents, including in surrounding areas. Moreover, it foists highly expensive maintenance costs onto landlords who are required to keep everything appropriately “historic.” The character of cities changes over time, while over-preservation freezes a city in time and ensures that economic redevelopment cannot occur.

In Stahl York Avenue Co. v. City of New York, the Supreme Court should take up this important question regarding a disturbing national trend, and ensure that property rights aren’t subject to the whims of clerks and municipal bureaucrats.

Unable to legislate new restrictions on what kind of arms can be sold, the government has embarked on a long-term effort of adding an untold number of Americans to “no buy” lists—based on the unfounded conjecture that they pose a “danger” to others—and deprive them of a fundamental constitutional right. The Gun Control Act of 1968 and NICS Improvement Amendments Act of 2007 requires that agencies with pertinent records on who is or is not “a mental defective” disclose those records to the attorney general so those people can be excluded from purchasing arms through the National Instant Criminal Background Check System (NICS).

The Social Security Administration (SSA) has proposed a new regulation that would create a process for transferring the records of those who seek a “representative payee” (legal proxy) under Social Security disability benefits programs to NICS, so that they may be considered a “mental defective” and thus lose their Second Amendment rights. The proposed SSA rule is arbitrary—there’s no evidence that someone who needs help with SSA paperwork can’t be trusted with a gun—and inconsistent with the regulatory and statutory scheme, not to mention blatantly unconstitutional.

Accordingly, for the first time ever, Cato’s Center for Constitutional Studies, with the help of law professors Josh Blackman and Gregory Wallace, has filed a public comment objecting to the rule on 10 different grounds. No one disputes that the government has an interest in keeping guns out of the hands of those who could harm themselves or others, but depriving a constitutional right requires due process of law. Under existing law, the root requirement of the Fifth Amendment’s Due Process Clause is that an individual receive a hearing before she is deprived of a constitutional right by a federal agency, one where the government must justify its restriction.

Here, the process entails an SSA bureaucrat making the determination without the expertise necessary to tell if the applicant is a danger to herself or others and without necessarily having the benefit of medical evidence. Indeed, the criterion evaluated—whether a person is “a mental defective”—is the same unscientific and unspecific standard that the Supreme Court approved in 1927 when legalizing the sterilization of the mentally ill and other eugenic treatments. The term is antiquated and vague.

Moreover, it is unconstitutional to condition the receipt of benefits on the sacrifice of rights. The “condition” here could not be more clear: to gain or maintain a representative payee, needy disabled persons must submit to being placed on the NICS list and foregoing their Second Amendment rights. The government is not allowed to foist that Catch-22 onto those who qualify for Social Security disability but need help administering their benefits.

On a more practical level, the SSA is not the agency that should be making this sweeping policy. Determining whether someone satisfies the criteria for obtaining a representative payee is perfectly within SSA’s expertise, but determining who among its recipients is capable of responsible firearm ownership is far, far afield of the SSA’s area of expertise. The SSA’s job is to administer social-insurance benefits, not to implement gun-safety regulations. The agency is simply not staffed with the medical and gun-policy experts necessary to make such determinations on a regular basis.

Finally, the proposed rule treats the entire category of people who express a misgiving about their mental abilities as per se deprived of their right to armed self-defense. Surely the landmark case District of Columbia v. Heller (2008), which confirmed the individual right to keep and bear arms, did not mean to sweep every hypochondriac, arachnophobiac (spiders), coulrophobiac (clowns), or lepidopterophobiac (butterflies) into the federal mental-health gun-prohibition.

The SSA should abandon this ill-devised rule. 

In a prominent article about Islamic State in the Washington Post over the weekend, Carol Morell and Jody Warrick suggest that, by massacring people in various locales, the group was growing in appeal—or “allure” in the words of the headline writer. How this remarkable process comes about is not explained, nor is evidence given to back it up. It is said to be a conclusion reached by “experts,” but only one of these is quoted in the article, and none of the quotes from him seems to fit, much less support, the article’s conclusion.

There is certainly evidence, much of it noted in other articles in the Post, to suggest that the appeal (or allure) of the vicious group actually is, like the scope of the territory it holds in Syria and Iraq, in severe decline. By 2016, the flow of foreign fighters going to join the group may have dropped by 90 percent over the previous year even as opposition to the group among Arab teens and young adults rose from 60 percent to 80 percent. Any allure the group may have in Iraq certainly fails to register on a poll conducted there in January 2016 in which 99 percent of Shiites and 95 percent of Sunnis express opposition to it. And, according to the FBI, the trend for Americans seeking to join Islamic State is decidedly downward.

Indeed, overall, the Islamic State has followed policies and military approaches that have repeatedly proven to be counterproductive in the extreme in enhancing its “appeal” and/or “allure.” High among these was the utterly mindless webcast beheadings of American hostages in 2014 that turned the United States almost overnight from a wary spectator into a dedicated military opponent.

A considerable amount of academic work strongly suggests that the group is following a self-destructive approach. Thus, in her analysis of civil wars, Virginia Page Fortna concludes that insurgencies that employ “a systematic campaign of indiscriminate violence against public civilian targets to influence a wider audience” pretty much never win. Similarly, Max Abrahms finds that the targeting of civilians by terrorists is “highly correlated with political failure.”

The Post article also notes the suggestion of Secretary of State John Kerry that terrorist attacks like those Turkey, Iraq, and Bangladesh are a sign of the group’s desperation as it is pushed back in Iraq and Syria. Yet the article seeks to refute this plausible hypothesis by irrelevantly noting that the group has recently issued its own currency in the territory it controls.

And it gravely relays the grandiloquent ravings of Islamic State forefather Abu Musab al-Zarqawi (who was killed in 2006), that “We fight here, while our goal is Rome.” More recent Islamic State spoutings include its warnings to Russia that “We will make your wives concubines and make your children our slaves…The Kremlin will be ours,” and to the United States, “Know, oh Obama, that we…will cut off your head in the White House and transform America into a Muslim province.” To take such drivel seriously is to exacerbate fear and to play to the monster group’s childish self-infatuation.

A year ago, the Post published a thoughtful analytic perspective on Islamic State by the prominent Middle East specialist, Marc Lynch. He concluded that the group seemed to him to be “a fairly ordinary insurgency that has been unduly mystified and exoticized in the public discourse.”

Lynch’s column generated three comments. The Morello/Warrick article has thus far generated 881. For editors anxious to entice readers, it is clear which perspective has the most allure. Like fear, mystery and the exotic sell.

As Americans enjoy the Fourth of July holiday, I hope we take a few minutes to remember what the Fourth of July is: America’s Independence Day, celebrating our Declaration of Independence, in which we declared ourselves, in Lincoln’s words, “a new nation, conceived in Liberty, and dedicated to the proposition that all men are created equal.”

The fireworks would be today if John Adams had his way. It was on July 2, 1776, that the Continental Congress voted to declare independence from Great Britain. On July 4 Congress approved the final text of the Declaration. As Adams predicted in a letter to his wife Abigail:

The second day of July, 1776, will be the most memorable epoch in the history of America. I am apt to believe that it will be celebrated by succeeding generations as the great anniversary festival. It ought to be commemorated as the day of deliverance, by solemn acts of devotion to God Almighty. It ought to be solemnized with pomp and parade, with shows, games, sports, guns, bells, bonfires, and illuminations, from one end of this continent to the other, from this time forward forever more.

The Declaration of Independence, written by Thomas Jefferson, is the most eloquent libertarian essay in history, especially its philosophical core:

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. — That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, — That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness.

Jefferson moved smoothly from our natural rights to the right of revolution:

Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn, that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security. 

The ideas of the Declaration, given legal form in the Constitution, took the United States of America from a small frontier outpost on the edge of the developed world to the richest country in the world in scarcely a century. The country failed in many ways to live up to the vision of the Declaration, notably in the institution of chattel slavery. But over the next two centuries that vision inspired Americans to extend the promises of the Declaration — life, liberty, and the pursuit of happiness — to more and more people. That process continues to the present day, as with the Supreme Court’s ruling for equal marriage freedom last year.

At the very least this weekend, if you’ve never seen the wonderful film 1776, watch it late on July 4 (actually 1:00 am EDT on July 5) on TCM.

Must come down. Of course, we’re referring to lower atmospheric temperatures measured by satellites.

For months we have been saying that, once they started dropping, the satellite temperatures—our only truly global measure—were going to go down with a vengeance, which is what usually happens after a strong El Niño event spikes a fever. El Niño is a dramatic slowdown (or even a reversal) in the trade winds that diverge surface water away from the South American coast, “upwelling” much colder subsurface waters. When that stops, global temperatures rocket upwards, but that also builds up more and more cold water to be unleashed when the trade winds resume.

If the 1998 El Niño is any guide, global temperatures are going to be back in (or near) “pause” mode by by the turn of the year.

According to University of Alabama-Huntsville’s Roy Spencer, who publishes the satellite data, the drop in the last two months was the second-largest in the entire record, missing the record by only 0.01⁰C. That record was set—not surprisingly—in the decline after the slightly bigger 1997-8 El Niño. In the tropics, where El Niño is most expressed, the drop was the largest in the entire 37-year record. 

For what it’s worth, no one knows what the ultimate cause of an El Niño is. While they are the largest secular oscillation in global surface temperatures,  computer models for global warming can’t simulate them realistically, and even short-term (year in advance) forecasting models are pretty lousy when it comes to initiating one.

Despite the recent peak, the satellite data never lost the “pause” that began in 1996. As far as the surface temperatures go, recent adjustments that “disappeared” that pause are looking more and more suspect as other independent data (like the satellites) do not corroborate them. Stay tuned for more, as we have just submitted an article on this problem.