Cato Op-Eds

Individual Liberty, Free Markets, and Peace
Subscribe to Cato Op-Eds feed

This has not been a good week for President Trump’s Iran policy. As the president has indicated, he plans in mid-October to decertify Iranian compliance with the nuclear deal, or the Joint Comprehensive Plan of Action (JCPOA), negotiated and signed in 2015, which rolled back Iran’s nuclear program, placed severe restrictions on it for the foreseeable future, and imposed the world’s most intrusive inspections regime on what remained.

Leaving aside for now the various and profoundly negative ramifications of Trump’s stated intention to declare Iran in violation of the agreement, the most immediate problem for the president has always been that Iran is, in fact, not in violation of the deal. As attested to by the International Atomic Energy Agency (IAEA) and all other signatories to the agreement – including Germany, France, the United Kingdom, China, and Russia – Iran is fully compliant with its obligations under the JCPOA.

But this week brought significant pushback to Trump’s plan. Following the president’s speech to the UN General Assembly on Tuesday, world leaders and diplomats reportedly pressured the president and members of his administration in numerous meetings to reconsider his plan to scuttle the JCPOA. Allies publicly criticized him. “Renouncing [the Iran deal] would be a grave error, not respecting it would be irresponsible,” said the French president Emmanuel Macron, suggesting further that decertification could create another nuclear crisis like North Korea.

In a press conference following a meeting with representatives from every signatory country, Federica Mogherini, High Representative of the European Union, said that if the United States walks out of the deal, Europe would make sure it remains in place anyways. She further indicated, “The international community cannot afford dismantling an agreement that is working and delivering…Iran is complying.”

Mogherini confirmed that all of the parties to the JCPOA, including the United States, agreed in the closed-door meeting that “there is no violation.” This prompted questions for Secretary of State Rex Tillerson, who had to sheepishly admit that “from a technical standpoint, the IAEA reports continue to indicate and confirm that Iran is in technical compliance of the agreement.”

Foreign Policy reported that the Trump administration’s ploy to use the threat of decertification to reopen negotiations on the JCPOA and squeeze more concessions out of Iran “collapsed on Wednesday as key European powers persevered in their effort to rescue the deal from an American walkout, and Iran’s president made clear his government wouldn’t revisit the terms of the pact.” The New York Times reported that Trump’s repudiation of the international consensus and his brash denunciation of the JCPOA was unintentionally generating global sympathy for Iran, while damaging U.S. credibility and trust.

Even members of Trump’s own party began to break ranks. On Tuesday, Rep. Ed Royce, Republican Chairman of the House Foreign Affairs Committee, told CNN that Trump should not withdraw from the Iran deal, but rather continue to “enforce the hell out of it.” Senator Rand Paul (R-KY), who opposed the deal when it was signed in 2015, told reporters, “if [Iran is] complying with it, I think we should stay in it.”

Then, on Wednesday afternoon, the Commander of U.S. Strategic Command, General John Hyten, in a speech at the Hudson Institute, said, “The facts are that Iran is operating under the agreement that we signed up for under JCPOA… We have an agreement that our nation has signed and I believe that if the United States of America signs an agreement, it’s our job to live up to the terms of that agreement, it’s our job to enforce that.”

It’s not clear that this overwhelming resistance to decertification will dissuade President Trump. But the American people should know that if Trump goes through with it, he’ll be doing it in defiance of the facts, the international community, much of his own cabinet, and at least some prominent members of his own party.

This may soon become Congress’s responsibility. According to legislation passed subsequent to the signing of the JCPOA, that requires the president to certify Iranian compliance every 90-days, decertification triggers a 60-day clock for Congress to decide by majority vote whether to re-impose nuclear-related sanctions on Iran. A decision to do so and join President Trump in his misbegotten scheme to unravel the Iran deal would be dangerous and irresponsible.

According to a new national poll just released by the Cato Institute, Americans know very little about the Federal Reserve. Not surprising. But among those who are familiar with its work, most think it should not be setting interest rates.

The poll, conducted in collaboration with YouGov, surveyed a nationally representative sample of 2,000 Americans.[1]

Only 20 percent of those surveyed said they have heard of the Federal Reserve and “understand what it does very well.”  Fifty percent said they had heard of the Fed, and 22 percent said they had heard of it, but were not sure what it does.  Six percent said they had never heard of the Fed before.

We then asked whether Fed officials or the free market should determine interest rates in the economy. Perhaps unsurprisingly, 44 percent said they hadn’t thought enough about the issue to have an answer.  While fewer than one in four said the Fed should manage rates, nearly a third said the free market should. Focusing only on those with an opinion, a majority (58 percent) said they preferred the free market system determine rates.

When asked about the Fed’s independence, 57 percent said that the Fed operates independently while 38 percent said that it is influenced by Congress and the President. These responses were closely tied to education. Among those with post-graduate degrees, 70 percent said the Fed is independent while only 53 percent of those without a college degree thought so.

We also asked whether people thought that the Fed helped to stabilize the economy. The responses were mixed with 38 percent saying it does, 24 percent saying it does not, and another 36 percent saying they hadn’t heard enough to say. Responses were even more equally split when we asked about the Fed’s role in the 2008 financial crisis. While 30 percent said the Fed cut short the crisis, 33 percent said it had no impact, and another 33 percent said that it was a cause of the crisis. These responses were highly correlated with political views. Among those identifying as very liberal, 52 percent said that the Fed helps stabilize the economy and 23 percent said that the Fed was a cause of the financial crisis. Among those identifying as very conservative the views flipped: 50 percent said that the Fed was a cause of the crisis while only 26 percent said that the Fed helps stabilize the economy.

Ultimately, these findings highlight the urgent need for more education about what the Fed does, what it doesn’t do, and what it shouldn’t do. Cato’s Center for Monetary and Financial Alternatives was founded in part to provide just such an education to the public. While it’s disheartening to see how much we’re needed, it seems it’s a good thing we’re here.

Find the full survey results and analysis here.


[1] The Cato Institute 2017 Financial Regulation Survey was designed and conducted by the Cato Institute in collaboration with YouGov. YouGov collected responses online May 24-31, 2017 from a national sample of 2,000 Americans 18 years of age and older. Restrictions are put in place to ensure that only the people selected and contacted by YouGov are allowed to participate. The margin of error for the survey is +/- 2.17 percentage points at the 95% level of confidence.

[Cross-posted from]

The Bureau of Economic Analysis (BEA) has released data on worker compensation for 2016. The data show that wages and benefits for federal-government workers grew faster than for private-sector workers last year. Federal workers now receive 80 percent more compensation, on average, than do workers in the U.S. private sector. I am including federal civilian workers here, not those in the uniformed military.

Average wages for federal workers increased 2.0 percent in 2016, which outpaced the average private increase of 1.3 percent. Federal workers had average wages of $88,809 in 2016, or 49 percent more than the average wages of private workers of $59,458.

However, the federal advantage in overall compensation (wages + benefits) is even larger because of gold-plated federal benefits, such as pension benefits. Total compensation for federal workers increased 2.5 percent last year, on average, more than double the 1.2 percent increase for private workers.

As a consequence, average federal compensation in 2016 was $127,259, which was 80 percent higher than average private compensation of $70,764. The federal advantage of 80 percent is up from just 50 percent in 2000.

The figure below shows that federal compensation grew much faster than private compensation during the 1990s and 2000s. Federal increases slowed during a brief wage freeze under President Obama, but have accelerated again in recent years. Since 2010, federal compensation increases have edged out private increases as a result of the strong growth in federal benefits.

This study examines the latest data and discusses federal compensation issues in more detail.

Donald Trump’s speech to the UN General Assembly underscored his intention to adopt highly confrontational policies toward both North Korea and Iran.  He threatened to “totally destroy” North Korea in the event of war and re-emphasized Washington’s long-standing determination to compel Pyongyang to renounce its nuclear and ballistic missile programs. The president scorned Iran as “an economically depleted rogue state” and described the current multilateral nuclear agreement with Tehran as “an embarrassment” to the United States. If Trump is not merely engaging in bombast, Washington appears to be ginning-up two major foreign policy crises simultaneously.

As I discuss in a new article in the National Interest Online, administration officials and hawks throughout the U.S. foreign policy community increasingly link the issues involving the two countries. Specifically, they seek to use the surge of tensions surrounding Pyongyang’s behavior to scuttle the P5+1 agreement, or Joint Comprehensive Plan of Action (JCPOA), that President Obama and other international leaders negotiated to place limits on Tehran’s nuclear activities.

Hawks contend that their goal is to “renegotiate” the JCPOA and produce a new agreement that would put greater restraints on Iran. However, statements past and present from leading neoconservative militants such as former U.S. Ambassador to the UN John Bolton, Foreign Policy Institute scholar Joshua Muravchik, and Colonel Ralph Peters, the former commander of U.S. forces in Okinawa, intensify suspicions that the real goal is forcible regime change. Those individuals and their ideological allies were in the forefront of the campaign that lured the United States into the disastrous regime-change war in Iraq, and apparently they want a second crusade against a Middle East regime.

The attack on the JCPOA suffers from one embarrassing difficulty: despite the allegations of UN Ambassador Nikki Haley and other Trump administration officials, the bulk of the evidence indicates that Iran has complied with its obligations under the agreement. President Trump and his advisers must resort to expressing complaints that Tehran is violating “the spirit” of the accord. That is an extremely lame argument. A key reason why nations spell out the binding aspects of an agreement through written provisions rather than relying on oral comments and handshakes is that disagreements about the spirit or intentions could be endless.

An increasingly popular line of argument among proponents of a militant policy toward Tehran is that North Korea’s behavior is a harbinger of what the United States will face regarding Iran, if Washington does not harden its approach. Hawks openly excoriate Bill Clinton for concluding the 1994 nuclear agreement with North Korea. Clinton’s naïve decision, they argue, enabled Pyongyang to flout the so-called restraints on its nuclear program, and we now face a much worse situation than we did two decades ago. They emphasize that U.S. leaders must not make the same error by adhering to a similar, fatally flawed, agreement with Iran.

Using North Korea’s conduct as an excuse to trash the nuclear agreement with Iran is dangerous ploy. The alternative to the JCPOA is not “a better agreement.” Both Tehran and the other members of the P5+1 (Britain, France, Germany, Russia, and China) have all made it clear that they vehemently oppose reopening negotiations. The United States stands alone in taking the contrary stance. The real alternatives to the JCPOA are a renewed Iranian nuclear-weapons program and a subsequent U.S. war against Iran. The former would be distressing, the latter would be catastrophic.

Even venturing down that path underscores the broader problem with U.S. policy toward Iran. North Korea is an obnoxious little state, and its nuclear ambitions are worrisome, but the country has little significance beyond its immediate neighborhood. Matters are quite different with Iran. Like it or not, that country is a major diplomatic, military, and economic player throughout the Middle East and even into Central and Southwest Asia. As the principal representative of Islam’s Shia branch, Tehran exercises considerable influence in such countries as Iraq, Lebanon, Syria, Bahrain and Yemen. Trying to isolate Iran has been—and will continue to be—an exercise in futility. And launching a military attack on that country would trigger another disastrous war in the Middle East with far-reaching and entirely negative consequences. The Trump administration needs to ignore the hawks and adopt a more sensible policy.

Peter Jamison, Washington Post

For several years, the nation’s capital has joined other left-leaning cities and states in pushing legislation to improve the plight of the working poor.

Now, facing growing unrest from business owners and internal division over their priorities, D.C. lawmakers are preparing to take a break from further beefing up labor standards.

The retreat, coming after a year in which the District adopted a plan to increase its minimum hourly wage to $15 and enacted a law guaranteeing private-sector workers some of the nation’s most generous family- and medical-leave benefits, is an abrupt shift for a city whose leaders have been in the vanguard of the national campaign for workers’ rights.

In particular, this may mean shelving the next priority on the agenda of the unions and their allied liberal groups, namely a law dictating methods by which employers may schedule workers, following a Seattle model (and editorially opposed by the Washington Post here). 

If the council chair gets his way, employers can look forward to fifteen whole months of not having new legal cinder blocks deposited on their backs: 

“Businesses like certainty, and if we’re constantly changing the tax burden or the tax environments, or constantly changing the regulatory burden, then it becomes more difficult to do business in the District,” said D.C. Council Chairman Phil Mendelson (D), who has proposed a moratorium through the end of 2018 on bills that would negatively affect businesses.

There is little here to surprise libertarians. Coercive employment legislation harms local economies as it does national, and gains no added rationality from being sentiment-based (the $15 number was selected because it made for easier organizing.) While D.C., like Seattle and San Francisco, has the slack to absorb large-scale folly thanks to its role in hosting a booming sector of today’s economy, it is not entirely immune from nearby competition, a few miles away in Virginia and Maryland.

What must worry unions is that the District’s retrenchment could break the momentum among what one analyst calls its “peer group of fairly progressive cities” and states to outdo each other in enacting laws regimenting employment relations and banning various workplace arrangements that are voluntary and desired by both sides. 

Let’s hope it does break that momentum. Washington loves to picture itself as the civic peer of that other capital of broad boulevards, Paris. And as it happens, the French themselves have finally been figuring out that dirigisme in the workplace leads to no good place. D.C. should back off too.

President Trump’s speech at the UN General Assembly yesterday has been getting a lot of attention, mostly for issues other than trade. But he did mention trade briefly:

For too long, the American people were told that mammoth multinational trade deals, unaccountable international tribunals, and powerful global bureaucracies were the best way to promote their success.  But as those promises flowed, millions of jobs vanished and thousands of factories disappeared.  Others gamed the system and broke the rules.  And our great middle class, once the bedrock of American prosperity, was forgotten and left behind, but they are forgotten no more and they will never be forgotten again.  

Almost everything in all of these sentences is misleading or inaccurate, but I’m going to focus on just the first sentence.  The reference to “multinational” trade deals – usually the word “multilateral” is used here – probably means the World Trade Organization (WTO), which has 164 countries in it.  From 1999 through 2001, I worked at the WTO, so I have some familiarity with the system he is criticizing.  Let’s go through his points one by one.

His first complaint is that these multinational trade deals are “mammoth.” He is right in a sense. There are thousands of pages of WTO legal texts. Let’s talk about why that is.

First of all, a large chunk of this is made up of what are referred to as schedules of tariff reductions. Each country in the WTO makes commitments, on a product by product basis, not to charge above a certain tariff (e.g., no higher than 10% on passenger cars). Clearly, it would be simpler and better if each country just agreed, in one sentence, to charge zero tariffs on all products. But for political reasons, this is the best we can do right now.

Beyond the tariff reductions, there are also long substantive texts of trade rules. For example, the Agreement on Trade-Related Aspects of Intellectual Property Rights is 28 pages. The Agreement on the Application of Sanitary and Phytosanitary Measures is 14 pages. But keep in mind here that many of the rules of this sort have been demanded by the U.S. government on behalf of U.S. business interests as a way to open foreign markets. Certainly, you could shorten the trade deals by excluding some of these rules. But they are mostly rules that somebody in the U.S. government or business community thinks are in the U.S. interest.

Trump and his team have been talking about pulling away from the multilateral, towards the bilateral. It’s possible they think this will somehow make trade deals less “mammoth,” but the reality is it would simply mean many more deals, all of which would be around the same length in terms of the rules they establish. If you are pursuing the same policies, for example on intellectual property protection, you would have the same rules in multiple agreements. All this would add to the system is complexity.

The second issue is Trump’s reference to “unaccountable” international tribunals. Unaccountable is a common term used to criticize courts, as judges are not usually elected. But if you want rules enforced, it is necessary to have some sort of judicial system to adjudicate complaints (as Trump does above, the U.S. often complains about other countries breaking the rules). Are the WTO tribunals any more “unaccountable” than domestic courts? It’s a complex comparison, but at the least, the WTO tribunals are accountable to the governments who are the members of the WTO: The WTO appeals judges are appointed directly by the governments themselves. The Trump administration can argue for scaling back the power of WTO tribunals, but it will come at the expense of enforcement of U.S. complaints about foreign protectionism.

Finally, Trump expresses a concern about powerful global bureaucracies. Here, it is important to understand how little power the WTO itself has. It is commonly said that the WTO is a “member driven” organization. People working at the WTO Secretariat are, for the most part, working on behalf of the governments who are members of the WTO. And there really aren’t all that many people there. The total number of staff is 634. That’s a pretty small number, and keep in mind that many of these people are technical and administrative staff, or economists gathering data. One area where you could argue that the bureaucracy has its own power is in the dispute process, discussed in the previous point. But here we should keep in mind the limits of that power. These tribunals can make rulings, but governments can and have ignored them when they disagree. One prominent example is a late 1990s ruling that an EU ban on hormone treated meat violates WTO rules. Well, the EU still bans hormone treated meat, and shows no sign of bowing to this “powerful”global bureaucracy. The U.S. has ignored a few rulings too, sometimes caving in to pressure eventually, but other times simply maintaining laws that violate WTO rules.

Trump and his team have focused much of their attention so far on renegotiating NAFTA, but there is a good chance they will propose changes to the WTO at some point, most likely in relation to the dispute process. There is always room for refinement of trade rules, so there is no need to panic just yet, but Trump’s misunderstandings of the WTO are not a good sign.

Today the Federal Reserve is set to announce the schedule for unwinding its balance sheet. This is a step in the right direction, but it also has the potential to increase the risk of a recession.

It’s past time to reduce the Fed’s balance sheet because its role in the economy is unnecessarily large. But without adding a strategy to eliminate the Fed’s interest payments on excess reserves that discourage bank lending, the Fed risks tightening monetary policy to the point where at best it makes it even harder for the Fed to hit its inflation target – and at worst risks another recession. Ultimately, the Fed must unwind its balance sheet in combination with ending interest on excess reserves in order to put the economy on a more solid monetary foundation.

George Selgin has been writing about the problem extensively in these pages and elsewhere. In particular, see his article “On Shrinking the Fed’s Balance Sheet,” and his American Banker piece with Norbert Michel on the Fed’s precarious balance sheet situation.

Watching the Fed’s announcement closely? The press release will appear here. And Yellen’s press conference can be viewed here.

[Cross-posted at]

Yesterday, Nature Geosciences published an article by Richard Millar of the University of Exeter and nine coauthors that states the climate models have been predicting too much warming. Adjusting for this, along with slight increases in emissions reductions by the year 2030 (followed by much more rapid ones after then) leaves total human-induced warming of around 1.5⁰C by 2100, which conveniently is the aspirational warming target in the Paris Accord. Much of it is a lot like material in our 2016 book Lukewarming.

This represents a remarkable turnaround. At the time of Paris, one of the authors, Michael Grubb, said its goals were “simply incompatible with democracy.” Indeed, the apparent impossibility of Paris was seemingly self-evident. What he hadn’t recognized at the time was the reality of “the pause” in warming that began in the late 1990s and ended in 2015. Taking this into consideration changes things.

If Paris is an admitted failure, then the world is simply not going to take their (voluntary, unenforceable) Paris “Contributions” seriously, but Millar’s new result changes things. He told Jeff Tollefson, a reporter for Nature, “For a lot of people, it would probably be easier if the Paris goal was actually impossible. We’re showing that it’s still possible. But the real question is whether we can create the policy action that would actually be required to realize these scenarios.”

Suddenly it’s feasible, if only we will reduce our emissions even more.

Coincidentally, we just had a peer-reviewed paper accepted for publication by the Air and Waste Management Association and it goes Millar et al. one better. It’s called “Reconciliation of Competing Climate Science and Policy Paradigms,” and you can find an advanced copy here.

We note the increasing discrepancy between the climate models and reality, but what we do, instead of running a series of new models, is rely upon the mathematical form of observed warming. Since the second warming of the 20th century began in the late 1970s, and despite the “pause,” the rate has been remarkably linear, which is actually simulated by most climate models—they just overestimate the slope of the increase. However, one model, the INM-CM4 model from Russia’s E.M. Volodin, indeed does have the right rate of increase.

Figure 1. Despite the “pause”, the warming beginning in the late 1970s is remarkably linear, which is a general prediction of climate models. The models simply overestimated the rate of increase.

The Paris Agreement erroneously assumes all warming since the early 19th century is caused by greenhouse-gas emissions. That is patently absurd, as the warming of the early 20th century, from 1910-45, can have only little to do with them. If it were caused by them, the warming rate now would be astronomical, because the “sensitivity” of temperature to carbon dioxide would have to be inordinately high. Adjusting for the early warming means that the component from human activity is more likely to be about 0.5⁰ of the 0.9⁰C observed to-date. That leaves around 1.5⁰ more truly “permissible” under Paris.

Climate projections based upon past data tend to not be as hot as the models cited in Millar et al. Taking this into account, along with the fact there will be an economically-driven increasing substitution of natural gas for coal in electrical generation (which results in less than half the carbon dioxide emissions), and we come up with a total of 2.0⁰C of warming by 2100, which is the high-end cap in the Paris Agreement, without any more “commitments” to reductions.

So now the battle lines have been redrawn. One argument is that we can meet Paris but we have to reduce emissions dramatically, especially after 2030, and the other is that we will meet Paris because of economic factors, coupled with an adjustment for the overforecasting of the climate models.  

Republicans have promised major tax reform, and Cato has suggestions for policymakers. In today’s Wall Street Journal op-ed, Chris Edwards and I argue for the elimination of the Low Income Housing Tax Credit (LIHTC). For those unfamiliar with the program, LIHTC is a corporate tax loophole that endeavors to create low-income housing. Unfortunately, research suggests the program has substantial difficulty doing that.

In the article, we describe a few of LIHTC’s problems: LIHTC mostly benefits developers and intermediaries, crowds out private market housing development, and receives minimal oversight. The latter issue leads to abuse.

We also point out that there are more effective ways to increase the supply of low-cost housing. Still, LIHTC’s advocates stubbornly overlook its failings.

Although willful blindness might be a natural posture for interest groups, it is a bad look for policymakers. Legislators should use tax reform as an opportunity to reduce loopholes and corporate cronyism, while reducing rates. 

Read the details here

By a vote of 89-8, the Senate yesterday passed a $700 billion defense budget. That isn’t particularly newsworthy. As the New York Times reported, “The vote marked the 56th consecutive year that Congress has passed the defense policy bill—a point of personal pride for Senator John McCain, the Arizona Republican who chairs the Senate Armed Services Committee.”

The important story is that Sen. McCain et al. have no plan for actually raising the necessary funds, either through more taxes, cuts elsewhere, or more debt. Previous budget fights played by the rules—compromising to abide by the bipartisan Budget Control Act caps on discretionary spending. Willfully ignoring the BCA elephant in the room, as the Senate just did, runs the risk of a government shutdown and/or sequestration.

The Trump administration opened the Pentagon funding floodgates when it debuted a $668 billion budget request earlier this year. Trump made good on his promise to rebuild the military by cutting deeply from non-defense accounts, thus creating the illusion of fiscal discipline. But he also called for increasing the BCA defense caps.

At the time, Sen. John McCain declared Trump’s budget “dead on arrival” because it cut too deeply from these other programs. He also declared the Defense Department increase to be insufficient. It was never clear how McCain would square that circle.

It still isn’t. It appears that he expects someone else to solve the BCA problem, or that it will magically disappear.

But he isn’t alone. Many in Congress took Trump’s budget as a signal to spend even more on the military. Until now, Congress used its favorite loophole—the cap-exempt Overseas Contingency Operations account—to offset perceived funding shortfalls at the Pentagon. Congressional abuse of OCO was predictable but shortsighted. It allowed Congress to maintain the fiction that it was adhering to the BCA caps without actually doing so.

Last night’s vote dispensed with the charade. In the just-passed NDAA, funding for the base budget exceeds the $549 billion cap by $91 billion and puts $60 billion in OCO. The House version passed last month also put a majority of its plus-up in base funding, exceeding the BCA cap by $72.5 billion. The Trump administration’s budget seems almost sane in comparison by asking for $54 billion over the cap—which, to be clear, is unnecessary in order to keep Americans safe and maintain the U.S. military as the finest fighting force in the world.

89 Senators, not merely McCain and a handful of outspoken hawks, apparently believe that the Pentagon needs a 16 percent increase over the BCA caps in order to function next year alone. Plus another $60 billion for OCO. But no senator knows where those extra billions will come from.

The BCA was enacted in 2011 to impose some fiscal discipline by providing an upper bound for defense and non-defense discretionary spending. Since then, members of Congress found ways to either budget under or raise (2013, 2015) the caps. The one time they failed to avoid sequestration—the October 2013 government shutdown—lasted only 16 days.

As much as members of Congress bemoan the budget caps and fear sequestration for its damaging effects, you would think they would take the risk of a government shutdown more seriously. Senator Tom Cotton offered the only amendment to the NDAA that would have altered the Budget Control Act for this fiscal year. Rather than trying to strike a bipartisan deal to increase the caps or repeal the legislation entirely, Cotton sought to render the BCA toothless by partially repealing the automatic sequestration mechanism.

Cotton’s amendment was a political non-starter because it failed to reassure Democrats worried about caps on spending for non-defense programs. Even if it miraculously passed in the Senate, the amendment would have faced a tough fight from some House members while in conference. Predictably, Cotton’s proposal, along with several other controversial amendments, was never granted a vote.

Congress can’t afford to ignore the political and fiscal reality forever. A military budget that exceeds the BCA caps, and offers no plan for undoing those caps, should be—as Sen. McCain said of President Trump’s first budget submission— “dead on arrival.”

* Thanks to Cato research associate Caroline Dorminey for her assistance.

Public pensions are complicated beasts. They represent the aggregation of promises made to public employees—both current and former—to pay them benefits from their retirement until their demise. They sum to a growing—albeit somewhat imprecise—stream of payments that presently extends to close to the end of the current century. The predilection of politicians to make promises that won’t come due until long after they’ve left office has resulted in many states with promised benefits far in excess of the money set aside to meet them.    Many state pension authorities managing underfunded pensions—often nudged by their legislatures—have aggressively invested their pension assets in an attempt to achieve supra-normal returns and reduce the shortfall, which would be infinitely preferable to them than increasing taxes, reducing benefits, or trimming other government spending.    But such a strategy amounts to a sucker’s game. On average, putting money in hedge funds—or practically any actively-managed stock fund for that matter—has returned less, after fees, than investing in a diversified stock/bond portfolio and does little to limit the downside risk should a sustained bear market develop, let alone another fiscal crisis.    For this reason, more prudent states have made an earnest attempt to reduce their management costs and risk by embracing passive investing, whereby the bonds and stocks owned consist of a broad-based index of the entire market. In essence, portfolio managers have no real decisions to make when they invest in a market index, so the management costs are minimal.    While a strategy that eschews actively selecting a portfolio may offer the highest long-term returns with the least risk, some object to such a strategy for a government pension. Holding stock of every single member of the S&P 500—the most common index used in passively-managed index funds—entails investing in companies and industries that some find objectionable. Activists have objected to companies that they perceive as being insufficiently welcoming to gay and lesbian workers (Cracker Barrel), or who pay a portion of their workforce below what they deem a livable wage (Walmart), or whose senior management has committed personal peccadillos (Abercrombie & Fitch), or treated women employees poorly (Tesla), or breached one of a number of other myriad precepts put forth by such groups. These days, some non-profits perceive any active participation with the current Trump Administration as being objectionable.   Perhaps the most objectionable sorts of investments for liberal activists these days consist of companies that extract and sell fossil fuels. Many perceive climate change, abetted by the burning of fossil fuels, as an existential threat to the planet and fear the actions taken by the governments across the world—and especially the United States—to be insufficient to effect a change.   The frustration that many feel about climate change inaction by the federal government has led them to pursue change at the state and local level. This political pressure has led to 34 states creating their own climate action plan, and 29 states now mandate that utilities increase the proportion of renewable energy they purchase. California has gone even further and has imposed strict new limits on emissions from new automobiles.    Another way that activists have pushed state and local governments to fight climate change has been to push for government pensions to eschew investments in companies that extract fossil fuels. Such a policy can be complicated since most index funds merely hold a basket of the stocks of companies in the exchange, these become out of bounds. Such a policy asks an important question: Can a pension fund avoid fossil fuel investments or other objectionable investments and still earn a comparable rate of return with minimal risk, as in an ordinary index fund?    The answer is no.   Past Performance Is No Guarantee of Future Returns    These days there are are a number of variants of “socially responsible” funds to help people avoid investing in companies whose business model, industry, or ethical practices they find disagreeable. Some of these funds are also passively managed and come with relatively low fees. For instance, in 2015 the S&P 500 created a fossil-fuel-free index, and investors can effectively invest in it by purchasing a “SPideR” ETF. Vanguard—considered to be the leader in passively-managed funds—offers the Vanguard FTSE Social Index Fund.   Some environmental activists have observed that broad-based, environmentally responsible stock funds that excluded shares of companies that extract fossil fuels outperformed the broader stock market index over the last three years. For instance, Vanguard’s Social Index Fund outperformed its broad market index both in the past 12 months and the past three years. Vanguard’s U.S. fossil-free index, created last year, has also outperformed the broader market since its inception.    These outcomes have led some to suggest that if state pension plans had invested in such vehicles the last few years they could have both higher returns as well as the moral high ground—a win-win situation.    For instance, in 2016 the research firm Corporate Knights concluded that if the New York State Common Retirement Fund, the third largest state fund in the country, had moved away from investing in fossil fuels it would have actually boosted its returns the previous three years by $5.3 billion. It presented these results as an example of one way that states could reduce pension funding shortfalls while helping the environment.    Are public pension managers doing a disservice to pensioners and taxpayers by failing to adapt to a changing economy by investing in companies that are polluting the planet?    In a word, no. Investing in an environmentally or ethically conscious way will invariably impose some sort of cost on an investor. While an individual investor may be willing to receive a lower return to assuage his conscience, asking a state’s current and future retirees—or the taxpayers who support them—to do the same in a world of underfunded pensions is a dangerous precept. And to pretend doing such a thing is costless is misleading.    Narrowing the scope of the stock held in a portfolio necessarily increases its volatility. Holding fewer stocks and industries results in a market basket that is more susceptible to market fluctuations. It is possible that the narrower portfolio works in favor of the investor in certain circumstances, but modern portfolio theory suggests that the probabilities are that it will, in fact, underperform the broader market index.   The rationale against such arithmetic is that such a fund excludes companies that produce an asset that is in decline, leaving it with what ought to be, at first blush, a superior-performing mix of companies. However, there’s no reason to believe this is true. For starters, the fortunes of an individual company are not wholly tied up in the fortunes of the larger industry.    For instance, the tech sector has grown exponentially in the 21st century, and companies such as Facebook, Google, and Apple have made hundreds of billions of dollars for their investors. However, investors in Microsoft, which had the highest market cap in the S&P 500 in 1999, have lost money by holding onto its stock.    In the U.S. smoking has been on a long decline both in the U.S. and elsewhere for the last twenty years, and there are only about half as many smokers in the country today as there were at the turn of the century. A similar trend has occurred in most developed countries.    A world where the popularity of its main product is steadily declining would presumably spell disaster for any company, but that has not been the case at all for Altria, the maker of the immensely popular Marlboro cigarettes. Its profits have grown throughout the 21st century, as has its stock price.    In 2000, The California Public Employee Retirement System (Calpers), the largest public pension fund in America divested its holdings in the tobacco industry, citing moral concerns about supporting a product known to be deadly. A number of other pensions followed suit. With mounting medical evidence of the dangers of tobacco and public consumption declining, it seemed like a financially sound decision as well. As a result Calpers have missed out on as much as $3 billion in gains.   Betting against fossil fuels is no less counterintuitive. ExxonMobil, by far the largest fossil fuel company in the U.S., has a stock price that moves closely with the price of oil, so any success in reducing demand for oil would at first blush harm their bottom line and stock price. However, it has also made a strong play into natural gas—which emits much less carbon dioxide when burned—and it has been increasing its investments in algae biofuels of late. Thus, a political environment less friendly to carbon emissions need not harm its stock price.    It also has a reputation of being an extremely well-managed firm that manages to keep its costs under control under all circumstances, a feat that has earned it the admiration of its industry rivals.    What’s more, the notion that the fortunes—and stock price—of ExxonMobil and other firms in its industry will collectively fall if and when pro-carbon policies and technological changes take off assumes a modicum of market myopia. If there were a collective perspective that carbon taxes are likely in the next five to ten years, the market would have already incorporated such information into its stock price. Given that its stock price is down over 20 percent since its peak in early 2014 suggests that this may indeed have occurred to some extent—which means that Exxonmobil’s fortunes are—as before—subject to its management performance as well as the fortunes of the broader energy markets.    It isn’t Easy Being a Green Index   Besides the impossibility of saying with any certainty that a carbon-free portfolio will outperform a broader internet index, the cost of actually constructing such an index results in management fees significantly higher than a simple index fund that attempts to mimic the behavior of the broader market. A market index can be constructed via a simple computer formula, and management fees tend to be quite low. The Vanguard 500 Index Fund, for instance, has an expense ratio of just .14 percent, compared to the average actively managed fund ratio of 1.25 percent.   However, a fund governed by certain moral or environmental principles requires a constant examination of the companies in the index and their behavior, which unavoidably results in a higher expense ratio. The Vanguard FTSE Social Index Fund has a management fee of .22 percent—lower than nearly all actively- managed funds but still 50 percent higher than Vanguard’s 500 index fund. The S&P 500 Fossil Free SPideR has an expense ratio of .4 percent—thrice that of the regular Vanguard Index Fund.    In its 2015 report on the problems of the Fiduciary rule, the Obama White House embraced the use of index funds for long-term investors because of the ultimate advantage of low expense ratios.    Higher management fees ultimately translate into lower returns and the performance of the Vanguard Social Index bears that out. While it did outperform the broader market index from 2012-2015, a period that coincided with a steep decline in oil and coal prices, the five and ten year comparisons show the broader index with higher returns, consistent with theory.    The idea that a state portfolio manage can improve his investment performance by assuming that the future will entail a substantial reduction in carbon, and that this environment will pull down the fortunes of ExxonMobil and other oil producers is facile. It may very well occur, but to assert that with any degree of certainty borders on hubris.    The Responsibilities of a Public Pension Fund Manager   The fiduciary responsibility of a public pension manager ought to be to pursue the maximum long-term return while minimizing the long-term risk. The fact that a government pension is, in a way, eternal introduces a modicum of complications and freedoms into that equation, but it doesn’t change that goal.    A public pension fund’s extended time horizon can allow the fund manager to pursue relatively illiquid investments that may not have a payoff for decades down the road. The tradeoff for that illiquidity should be, on average, a higher return.    Pension funds—as well as insurance companies and other entities with long-term liabilities—strive to match their long-term liabilities with similarly-lived assets, which serves to further reduce their exposure to risk. This preference for long-lived assets is one reason that the U.S. Treasury has begun considering the sale of fifty-year bonds. However, allowing political exigencies to determine a public pension fund’s portfolio complicates such decisions.    There is one crucial difference between a privately-managed hedge fund and a public pension fund. A private investment firm that performs poorly will ultimately lose clients and money if it fails to perform.    A state-run pension fund has no competition, and the consequences of poor performance are usually less dire for such investment managers. For this reason, the danger of political activism, catering to special interests, and making financial decisions based on rationale that go beyond the best interests of the plan participants is exceedingly problematic. That a government can potentially supplement a financially deficient plan with tax dollars may be true—and something the state of Illinois will soon have to contemplate—but it should not be an invitation to use a public pension to carry out a political agenda in a way that exacerbates volatility and reduces potential returns.   

In school choice circles, a lot of people don’t much care for actor Matt Damon, at least his education politics. (I’m not sure where they stand on The Bourne Identity or Stuck on You.) Damon—son of education professor Nancy Carlsson-Paige—has been a vocal advocate for government schooling, and is the narrator of the documentary Backpack Full of Cash, which you might recall is the film those outraged over Andrew Coulson’s School Inc. say PBS must show to balance out perspectives. But here’s the thing: Damon sends his own kids to private school!

I am supposed to be outraged by the apparent hypocrisy, but I don’t think Damon’s selection falls under that heading. Damon and many progressives love public schooling but don’t like what it has become, especially under the standards-and-testing tidal wave of No Child Left Behind, and the only somewhat less inundating Every Student Succeeds Act. They don’t care for the reduction of education to basically a standardized test score. As Damon, who attended progressive public schools in Cambridge, MA, has said, “I pay for a private education and I’m trying to get the one that most matches the public education that I had, but that kind of progressive education no longer exists in the public system. It’s unfair.”

No doubt lots of people—choice fans and detractors alike—who want education to be more than a score sympathize with Damon’s frustration. The problem is that Damon champions exactly the wrong system to get sustainable change. By its nature, public schooling, if not doomed to reduction to simple metrics, is in constant, near-death peril of it.

When people can’t vote with their feet—which is very tough to do in a system in which where you go to school depends on where you can afford a home—their only hope to make schools do what they want is government action. But government is controlled by politics, which is itself driven by soundbites. And what is ideal for a soundbite on whether schools are “working”? Why test scores, of course! “The scores are up,” or “the scores are down,” or “25 percent of the kids are proficient,” and so on.

The key to escaping such peril is not hoping that nick-of-time, death-defying, Jason Bourne-esque political miracles will constantly save us, but basing education in freedom. Attach cash to students—via “backpacks,” if you must—give educators autonomy to teach and run schools as they see fit, and ground accountability in educators providing schools to which parents willingly entrust those backpack-bearing kids.

Of course, there is much more that is problematic about government education than just simplistic standardization. Far more deeply, if it is “unfair” that Damon can’t find the progressive schools he wants in the public system, it also unfair that many religious people—who by law cannot get the education they want in public schools—or Mexican Americans, or countless other people are also unable to access the education they want. Thankfully, the key to getting fairness for them is the same one to getting fairness for Damon: school choice.

Don’t blame Matt Damon for his choices. Blame the choice-killing system he defends.

The Fed’s persistent failure to reach its 2 percent inflation target ever since that target was first made explicit in 2012 has elicited a great deal of commentary in the last couple months, from economists, journalists, and some Fed officials themselves. And well it ought to, for whatever one may think of the Fed’s choice of target, the fact that the Fed has been persistently falling short of it suggests that something is awry, if not with U.S. monetary policy, then perhaps with the U.S. economy more generally.

Although plenty of explanations have been offered for the inflation shortfall, none of them is even close to being satisfactory. Bias or “noise” in the inflation numbers? Bias would explain things if the Fed were targeting some supposedly “ideal” measure of inflation. But it isn’t: it’s targeting the rate of change of the Personal Consumption Expenditure (PCE) index, and so long as that measure of inflation falls below the Fed’s target, the Fed isn’t “really” hitting its self-assigned target, even if the “real” inflation rate is higher than the PCE index suggests. As for noise, it should make the Fed just as likely to overshoot as to undershoot its target. Unemployment still isn’t quite low enough? Despite what some foolish Phillips-curve reasoning suggests, putting more people to work doesn’t make things more expensive. The public’s long-run inflation expectations are down? No doubt. But surely that’s a result, rather than a cause, of the persistently low values of actual (or measured) inflation?

Aggregate Demand is Part of the Story (But Only Part)

Of existing explanations, the least question-begging emphasize the fact that total spending, or its statistical counterparts such as nominal GDP, just hasn’t been growing rapidly enough to achieve the Fed’s inflation target. As Mickey Levy puts it in a paper he gave at last week’s SOMC meeting,

Obviously, if nominal GDP had accelerated in response to the Fed’s aggressive easing as planned, both wages and inflation would have risen faster, and inflationary expectations would be higher.

Scott Sumner has made essentially the same point: “The only way to have low inflation despite low RGDP growth,” he observes,

is if the Fed has such a tight monetary policy that NGDP growth remains slow. And that’s exactly what they’ve done since 2009. If you produce 4% NGDP growth year after year after year [when the norm has been substantially higher] then why be surprised that inflation remains low?

In fact, as David Beckworth pointed out recently, using the chart reproduced below, since the third quarter of 2009 NGDP has grown at an average rate of just 3.4 percent, compared to 5.4 percent between 1990 and 2007 and 5.7 percent for the full “Great Moderation” period of 1985-2007:

According to Beckworth the decline reflects “a monetary regime change” consisting in part of the Fed’s having failed to allow spending to “bounce back at a higher growth rate during the recovery” as it had done in past recessions.

But while explanations that attribute the Fed’s failure to reach its inflation target to slow NGDP growth have the distinct virtue of taking the equation of exchange (MV = Py) seriously (which is more than can be said for some of the others), they still beg the question: why hasn’t the Fed achieved higher NGDP growth?

To observe that it hasn’t done so because it hasn’t been directly targeting NGDP won’t do. After all, a 2 percent inflation target implicitly calls for whatever NGDP growth rate it takes to achieve 2 percent inflation. Arguments to the effect that the Fed has failed to achieve 2 percent inflation because it has failed to achieve 5 percent NGDP growth (or some such number) instead of 3.4 percent growth do no more than state the original question in slightly modified form.

The Regime Change that Matters

In fingering “regime change” Beckworth gets closer to the truth. Only the regime change that really matters isn’t the shift away from level to rate targeting that he emphasizes. It’s the switch, in October 2008, from the Fed’s conventional monetary control arrangements, with a market-based fed funds target achieved with the help of  open-market operations, to its current IOER-based (leaky) “floor system” — in which the fed funds rate is moved up or down by raising the rate of interest the Fed pays on banks’ excess reserves, either alone or together with the rate it offers in its overnight reverse repurchase (ON-RRP) agreements.

What does the Fed’s switch to a floor system have to do with the low inflation and NGDP numbers we’ve been seeing ever since? Bear with me, and I’ll explain.

To do so I must first explain in a bit more detail how a floor system works. In so doing, I’m going to abstract from the role of ON-RRPs, for those aren’t actually part of an orthodox floor system, in which the IOER rate alone serves as the central bank’s policy rate. In the U.S., the situation is complicated by the fact that various GSEs keep balances at the Fed, but aren’t eligible for interest on those balances. Consequently banks and those GSEs can mutually profit by having the GSEs lend their excess Fed balances to the banks for a rate somewhere between the IOER rate and zero. To partially address this “leak” in what would otherwise have been a solid IOER-based federal funds rate floor, the Fed offered the GSEs and some other non-bank financial institutions the opportunity undertake reverse repos with it, thereby establishing a solid ON-RRP subfloor below the leaky IOER-rate floor. This arrangement serves to limit the extent to which the effective fed funds can fall below the IOER, although it still allows it to vary between that rate and the ON-RRP rate, as can be seen in the chart below. Those two rate therefore serve as upper and lower “bounds” of the Federal Reserve’s post-2008 fed funds rate target “range.”

A Floor System Calls for Substantial Excess Reserves

Abstracting, then, from the “leakiness” of the Fed’s IOER-rate floor, and the presence of an ON-RRP rate sub-floor, the basic idea of a floor system is that the interest rate on excess reserves displaces the fed funds rate as the key monetary policy rate. That’s because, in an ideal (leak-free) floor system, banks would neither lend nor borrow federal funds, whether from other banks or from non-bank financial institutions. Instead, they find it more profitable to hold excess reserves. A necessary and sufficient condition for this is that the IOER rate be sufficiently high relative to equivalent private-market rates of interest. In that case, banks will find it more attractive to hold excess reserves than to lend in private overnight markets, including the fed funds market. So long as they accumulate sufficient excess reserves, they can also protect themselves against any need to borrow funds overnight to meet either their net settlement needs or their legal reserve requirements. Of course the banks will find it especially easy to accumulate excess reserves if the Federal Reserves creates large quantities of fresh reserves, as the Fed did through its various rounds of quantitative easing. Still in the long run what matters most for the existence of a floor system is, not that any particular nominal quantity of reserves should be available, but that banks should have a robust demand for excess reserves, as they will only so long as such reserves yield a sufficiently attractive return.

In an orthodox floor system, such as is established when these conditions hold, the market for bank reserves functions as in the diagram below, taken from Marvin Goodfriend’s locus classicus on the subject:

As the diagram shows, so long as banks hold sufficient excess reserves, monetary policy becomes a matter of making desired changes to the IOER rate alone. Through arbitrage those changes will influence other interest rates. Changes in the actual stock of bank reserves, on the other hand, are neither necessary nor sufficient to influence the general state of interest rates. Instead, banks holdings of excess reserves increase and decline in lock-step with shifts in the supply of total reserves, leaving not only interest rates but lending, spending, and the inflation rate largely unchanged.

Whence the Deflationary Bias?

You’re still wondering what all this has to do with the Fed’s persistent undershooting of inflation. Trust me, I’m getting there!

It might appear that the switch from a conventional to a floor system should make no difference in the Fed’s ability to pursue whatever policy it wishes. After all, all that has changed is the mechanism by which the Fed pursues its policy targets, rather than its ability to set and pursue those targets. Whereas before, to loosen (or tighten) policy, the Fed may have had to increase (or reduce) the available supply of bank reserves, now it only has to lower (or increase) the IOER rate. So, why shouldn’t it be able to lower that rate enough to get inflation to 2 percent, or whatever other figure it prefers?

The answer is that, while in principle it could achieve a higher rate of inflation by lowering its IOER rate sufficiently (or, in the actual case, by lowering both its IOER and ON-RRP rates sufficiently), it cannot generally achieve any inflation rate that it wants while also maintaining a floor system. On the contrary: as I’ll explain in a moment, although the masterminds behind the Fed’s turn to a floor system don’t seem to have realized it, maintaining such a system necessarily introduces a deflationary bias in monetary policy.

To see why, recall that, to maintain a floor system, the IOER rate has to be high relative to corresponding market rates. Otherwise banks won’t be inclined to accumulate and sit on substantial excess reserves. Instead, they’ll increase their lending in wholesale and other markets that offer them better risk-adjusted returns. To serve as a floor (and forgetting about GSE-based leaks), the IOER rate must be an above-market rate.

That the Fed’s IOER rate has in fact been kept above corresponding market rates is easily shown by comparing it to its closest private-market counterparts.  Of those the closest is probably the Depository Trust & Clearing Corporation’s GCF (General Collateral Finance) U.S. Treasury and Agency-Based MBS Repo rate index. The next figure shows how the IOER rate has generally been kept above, and often well above, that comparable market rate:

A comparison of the IOER rate and yields on various shorter-term Treasury securities tells a similar story:

As can be seen, whenever market rates have tended to increase, the Fed has made a point of having its IOER rate keep up with those changes. It has done so, moreover, despite the fact that it has persistently fallen short of its inflation target. Clearly the rate adjustments cannot be justified by appeal to the Fed’s desire to stick to that target. They can, on the other hand, be accounted for as inevitable consequences of the Fed’s determination to keep its shiny new (albeit leaky) floor system going.

A Wicksellian Perspective

I’m still not quite done, for I’ve yet to explain in the clearest way possible why a floor system introduces a low inflation bias in monetary policy. Doing that requires that I appeal to Knut Wicksell’s understanding of how an economy’s rate of inflation depends on the relation between its central bank’s chosen policy rate and the economy’s corresponding “natural” rate of interest.  According to Wicksell, a policy rate set below its “natural” level will tend to promote inflation, while one set above its natural level will tend to promote deflation.

One can quibble with the details of Wicksell’s argument, as I myself have done by noting that a nation’s inflation rate depends, not just on its central bank’s monetary policy stance, but on the state of economic productivity, among other things. (For this reason I think it better to speak of an above-natural policy rate inevitably leading, not necessarily to deflation or disinflation, but to an excessively low rate of NGDP growth.) The point  remains that a central bank that tends to set its policy rate too high will also tend to generate less inflation than it wants.

To see that this is exactly what will happen if a central bank insists on preserving a floor system, imagine that we are back in the pre-2008 monetary control regime, with no IOER and a market-determined fed funds rate. Assume as well that the rate is both on target and at it’s “natural” level — that is, the Fed’s target is consistent with a modest (if not zero) rate of inflation.

Now suppose the Fed decides to switch to a floor system.  To do that, it first has to set an IOER rate at least as high as the established fed funds rate, and therefore either at or above the natural funds rate, so as to encourage banks to accumulate excess reserves, in anticipation of boosting the supply of reserves. These steps are needed to get the fed funds market onto the flat portion of the reserve demand schedule shown in Goodfriend’s diagram above. Thenceforth, to stay in the new regime, as natural rates increase the Fed must increase the IOER as well. While a below-natural IOER rate will undermine the floor system by causing banks to shed their excess reserves, an above-natural IOER rate won’t. A permanent floor system is, for this reason, a recipe for monetary over-tightening.

Obviously, if the Fed decides to introduce a floor system at a time when policy is already tight, so that the going fed funds rate is already an above-natural rate, the switch will tend to result in additional over-tightening, since it must involve introducing an IOER rate that’s at least as high as the already excessively high established fed funds rate. Something like this appears, in retrospect, to be what happened in October 2008.

A Missing Piece

My explanation for the Fed’s persistent tendency to undershoot its inflation target is still not quite complete. For it rests on the underlying premise that the Fed is determined, by hook or by crook, to maintain a floor system of monetary control. What proof have I of that?

It is a good question. My answer is, first of all, that the proof lies at least partly in the pudding. For, as I’ve stated, were it not for its determination to keep a floor system in place, it would be difficult to explain the Fed’s insistence upon raising its policy rate despite falling short of its inflation target. Further evidence consists of the Fed’s present normalization plan, which calls for eventual increases in the federal funds rate by close to 175 basis points. So far as Fed officials have indicated, that increase is to be achieved entirely by means of equivalent increases in the IOER rate. In short, if the Fed has any intention of ever returning to its pre-IOER operating system, or to a true “corridor” system in which the IOER rate serves not as an upper but as a lower bound for the fed funds rate, it has given no indication of it. On the contrary: having spoken to several Fed insiders on the matter, I’m assured that the Fed has every intention of sticking to the present system.

Why it should wish to do so is a different matter. I’m pretty sure that part of the reason is that Fed authorities are themselves unaware of the over-tightening bias present in a floor system. They applaud, on the other hand, the fact that a floor system allows them to separately manage interest rates on the one hand and the state of bank liquidity on the other. In recent Congressional testimony,I likened the Fed’s gain in flexibility in a floor system — its being able to set its policy rate however it likes, while altering the supply of bank reserves however it likes — to the gain an automobile owner might secure, in being able to turn the wheel as much as she likes, while also stepping on the gas peddle however much she likes, by shifting from Drive to Neutral. The problem, of course, is that, while the driver seems to have more options, the car no longer gets her where she wants to go.

The Solution

What do you suppose it is? The Fed has to abandon its misguided floor system, the sooner the better, by moving to reduce its IOER rate, instead of increasing it — as it has been planning to do. As the rate falls from above market to below market, the money multiplier will revive; and that revival will, believe you me, prove more than adequate to boost spending enough to get the PCE inflation rate to 2 percent — and beyond. To keep it from getting too high, the Fed will have to plan on more aggressive balance sheet reductions or resort to its Term Deposit Facility or both. All this is difficult, but not impossible. The Fed can certainly do it if it tries. What it can’t do is stick to the present floor system and reliably hit its inflation target.

[Cross-posted from]

The new Cato Institute 2017 Financial Regulation national survey of 2,000 U.S. adults released today finds that Americans distrust government financial regulators as much as they distrust Wall Street. Nearly half (48%) have “hardly any confidence” in either. 

Click here for full survey report

Americans have a love-hate relationship with regulators. Most believe regulators are ineffective, selfish, and biased:

  • 74% of Americans believe regulations often fail to have their intended effect.
  • 75% believe government financial regulators care more about their own jobs and ambitions than about the well-being of Americans.
  • 80% think regulators allow political biases to impact their judgment.

But most also believe regulation can serve some important functions:

  • 59% believe regulations, at least in the past, have produced positive benefits.
  • 56% say regulations can help make businesses more responsive to people’s needs.

However, Americans do not think that regulators help banks make better business decisions (74%) or better decisions about how much risk to take (68%). Instead, Americans want regulators to focus on preventing banks and financial institutions from committing fraud (65%) and ensuring banks and financial institutions fulfill their obligations to customers (56%).

Americans Are Wary of Wall Street, But Believe It Is Essential

Nearly a decade after the 2008 financial crisis, Americans remain wary of Wall Street.

  • 77% believe bankers would harm consumers if they thought they could make a lot of money doing so and get away with it.
  • 64% think Wall Street bankers “get paid huge amounts of money” for “essentially tricking people.”
  • Nearly half (49%) of Americans worry that corruption in the industry is “widespread” rather than limited to a few institutions.

At the same time, however, most Americans believe Wall Street serves an essential function in our economy.

  • 64% believe Wall Street is “essential” because it provides the money businesses need to create jobs and develop new products.
  • 59% believe Wall Street and financial institutions are important for helping develop life-saving technologies in medicine.
  • 53% believe Wall Street is important for helping develop safety equipment in cars.

Few Americans Want “More” Financial Regulations—They Want the Right Kinds of Regulations, Properly Enforced

Polls routinely find that a plurality or majority of Americans want more oversight of Wall Street banks and financial institutions. This survey is no different. A plurality (41%) of Americans think more oversight of the financial industry is needed. However, only 18% think the problem with federal oversight of the banking industry is that there are “too few” rules on Wall Street. Instead, 63% say the government either fails to “properly enforce existing rules” (40%) or enacts the “wrong kinds” of regulations on big banks (23%).

Most Are Skeptical Dodd-Frank Will Prevent Future Financial Crises

Will Dodd-Frank financial reforms work? Nearly three-fourths (72%) of Americans don’t believe that new regulations on Wall Street and the financial industry passed since the 2008 financial crisis will make future crises less likely. Just over a quarter (26%) believe such regulations will make future financial downturns less likely.

Americans Oppose Too Big to Fail

Americans reject the idea that some banks are so important to the U.S. economy that they should receive taxpayer dollars when facing bankruptcy. Instead, 65% say that “any bank and financial institution” should be allowed to fail if it can no longer meet its obligations. A third (32%), however, believe that some banks are too important to the U.S. financial system to be allowed to fail.

  • Part of the reason most oppose the “Too Big to Fail” model may be that 60% believe that banks would make better financial decisions if they were convinced government would let them go out of business.
  • Clinton voters (41%) are about twice as likely as Trump voters (20%) to believe some banks are too integral to the U.S. economy to fail. Libertarians are most opposed (81%) to bailing out banks. 

Despite Distrust of Wall Street, Americans Like Their Own Banks and Financial Institutions

  • 90% are satisfied with their personal bank; 76% believe their bank has given them good information about the rates and risks associated with their account.
  • 87% are satisfied with their credit card issuer; 81% believe their credit card issuer has given them good information about the rates, fees, and risks associated with their card.
  • 83% are satisfied with their mortgage lender.
  • Of those who have used payday or installment lenders in the past year, 63% believe the lender gave them good information about the fees and risks associated with the loan.[1]

Americans Want Regulators to Prioritize Fraud Protection, Ensure Banks Keep Promises

Financial regulators have a variety of tasks and goals. The public, however, believes that regulation should serve two primary functions: to protect consumers from fraud (65%) and to ensure banks fulfill obligations to their account holders (56%). Other initiatives such as restricting access to risky financial products (13%) is a priority among far fewer people.

Democrats and Republicans Want a Bipartisan Commission to Run CFPB, Divided on CFPB Independence 

  • Most support changing the structure of the Consumer Financial Protection Bureau (CFPB), a new federal agency created by Dodd-Frank in 2011. Nearly two-thirds (63%) of Americans think the CFPB should be run by a bipartisan commission of Democrats and Republicans, rather than by a single director. Support is post-partisan with 67% of Democrats and 64% of Republicans in favor of a bipartisan commission leading the agency.
  • A majority (54%) of Americans think that Congress should not set the CFPB’s budget and should only have limited oversight of the agency. Given that only 7% of the country has confidence in Congress, these numbers are not surprising. A majority of Democrats (58%) support keeping the CFPB independent while a plurality of Republicans (50%) say Congress should closely oversee the new agency and set its budget.
  • Few Americans (26%) believe the CFPB has achieved its mission to make the terms and conditions of credit cards and financial products easier to understand. Instead, 71% say that since the CFPB was created in 2011 credit card terms and conditions have not become easier to understand—including 54% who believe they have stayed the same and 17% who think they have become less clear.

Americans as Likely to Say CEOs, NFL Football and NBA Basketball Players Are Overpaid, But Most Oppose Government Regulating Pay

Americans are about equally likely to think that CEOs (73%) and professional athletes like NBA players (74%) and NFL players (72%) are paid “too much.” Yet, the public doesn’t think the government ought to regulate the salaries of either corporate executives (53%) or professional athletes like NBA players (69%). Nonetheless, there is more support for regulating CEO pay (43%) than NBA salaries (28%).

Notably, compared to CEOs (73%) and NBA players (74%), far fewer believe that major tech company entrepreneurs are overpaid (51%). 

Democrats support (56%) government regulating the salaries of CEOs but oppose regulating salaries of NBA players (66%) and famous actors (69%). In contrast, about 7 in 10 Republicans oppose government regulating the salaries of all three professions, even though they are more likely than Democrats to believe NBA players (60% vs. 47%) and famous actors (59% vs. 37%) are overpaid. 

Most Support Risk-Based Pricing for Loans, Say Low Credit Scores are Due to Irresponsibility

Nearly three-fourths of Americans (74%) say they’d be “unwilling” to pay more for their home mortgage, car loan, or student loan to help those with low credit scores access these loans.

Americans may be unwilling to pay more to help those with low credit scores in part because a majority (58%) believe low credit scores are primarily due to irresponsibility, rather than circumstances beyond a person’s control (41%).

  • Partisans sharply disagree about the cause of a low credit score. Most Democrats (57%) say low scores are primarily the result of “circumstances beyond [one’s] control” while 74% of Republicans and 63% of independents say “irresponsibility” is the primary cause.

Americans are Unsure if Banks Charging Some People Higher Interest Rates is Justified or Predatory

A slim majority (52%) believe banks and financial institutions need to charge some people higher interest rates for loans and credit cards if those individuals present higher credit risks. Another 46% believe banks charge some people higher rates for loans in order to take advantage of those with few other options.

  • Partisans disagree about why banks charge people different rates. A majority (56%) of Democrats believe lenders charge some people higher interest rates because they are predatory and take advantage of the vulnerable. In contrast, two-thirds (67%) of Republicans believe banks need to do this to compensate themselves for some borrowers’ greater credit risk.

Most Oppose Accredited Investor Standard, Say Law Should Not Restrict Investment Options Based on Wealth

Due to current law, some investments are deemed too risky for the common investor and are only available to those with one million dollars in assets or who make $200,000 or more a year. However, a majority of Americans (58%) say the law should not restrict what people are allowed to invest in based on their wealth or income—even if the investments in question are risky. Thirty-nine percent (39%) think the law should restrict access to certain investments deemed risky.

  • Strong liberals are unique in their support (57%) of government restricting access to risky investments based on a person’s wealth. Support drops to 45% among moderate liberals and to a third among conservatives. 

Most Support Helping Low-Income Families Own Homes Unless Policies Escalate Mortgage Defaults

Nearly two-thirds (64%) of the public support government policies intended to make it easier for low-income families to obtain a mortgage. However, a majority (66%) would oppose such policies if they resulted in more mortgage defaults and home foreclosures.

43% of Americans Would Pay for $500 Unexpected Expense with Savings

Less than half (43%) of Americans say they would pay for an unexpected $500 expense using money from savings or checking. The remainder would put the expense on a credit card (23%), ask family and friends for money (8%), sell something (7%), borrow the money from a bank or payday lender (5%), or simply not be able to pay it (12%).[2]

Most Say Bad Financial Decisionmaking Due to Lack of Financial Education and Self-Discipline 

The public says the top three reasons consumers make bad financial decisions include lacking financial education (70%), lacking self-discipline (60%), and facing financial hardship (54%). Less than half say that consumers being “misled or tricked” (43%), taken advantage of (42%), or incapable (30%) are primary causes.

  • Both Democrats (72%) and Republicans (72%) agree that a lack of financial education is key.
  • Republicans (70%) are nearly 20 points more likely than Democrats (51%) to say that a lack of self-discipline is a primary reason for unwise decisionmaking.
  • Democrats are roughly 20 points more likely than Republicans to say that poor financial decisionmaking is due to external circumstances such as financial hardship (66% vs. 45%), being tricked (52% vs. 32%), or being taken advantage of (52% vs. 30%).

Most Say Government Should Allow Individuals to Make Their Own Financial Decisions—Even If They Make the Wrong Ones

When it comes to promoting and managing consumers’ financial health, most believe (58%) that individuals “should be allowed to make their own decisions even if they make the wrong ones.” However, 4 in 10 say that sometimes government regulators “need to write laws that prevent people from making bad decisions.” 

  • A majority of Democrats (57%) believe that sometimes regulators need to write laws that protect people from making bad decisions
  • Majorities of Republicans (73%) and independents (69%) don’t think government should restrict people’s financial choices to protect them.

Few Americans Know a Lot about the Federal Reserve; Among Those Informed, the Fed Polarizes Partisans 

  • Only 20% of Americans say they have heard of the Federal Reserve and understand what it does very well. Half (50%) have heard of the Fed but don’t understand everything it does; 22% have heard of the Fed but don’t know what it does while 6% have never heard of it.
  • Tea Partiers (67%), libertarians (57%) and conservatives (50%) are about three times as likely as liberals (19%) to say the Fed has “too much power.”
  • Pluralities of libertarians (50%) and strong conservatives (50%) believe the Fed helped cause the 2008 financial crisis. In contrast, a plurality of liberals (43%) believe the Fed cut the crisis short.
  • Among those with an opinion, 68% of Democrats want Federal Reserve officials to primarily determine interest rates in the economy. Conversely, 74% of Republicans want the free-market system to do this. 

Click here for full poll results and methodological information

Sign up here to receive forthcoming Cato Institute survey reports

The Cato Institute 2017 Financial Regulation Survey was designed and conducted by the Cato Institute in collaboration with YouGov. YouGov collected responses online May 24-31, 2017 from a national sample of 2,000 Americans 18 years of age and older. Restrictions are put in place to ensure that only the people selected and contacted by YouGov are allowed to participate. The margin of error for the survey is +/- 2.17 percentage points at the 95% level of confidence.

[1] Asked of 4% of respondents who have used payday or installment lenders in the past 12 months, N=71.

[2] One percent (1%) say they would find some other way to pay the unexpected expense.


On the topic of tax reform, I wrote the “opposing view” column yesterday for USA Today. But rather than oppose the newspaper’s editors, I agree with most of their views.

The editors said:

The federal tax code is an unholy mess. It consumes 6 billion hours of Americans’ time each year. It coddles politically entrenched industries. And it burdens America’s blue-chip corporations in their bid to compete with overseas rivals.”

“Some taxes should be cut. The corporate income tax of 35%, for instance, should be set at 20% or lower, with a lot fewer loopholes. The current rate gives an advantage to companies not headquartered in the United States. And its complexity encourages all manner of tax gamesmanship.


The editors continued:

At the same time, everyday Americans need to confront the fact that their rates are far higher than they need be thanks to massive—and highly popular—deductions for such expenditures as mortgage interest, health care, charitable gifts and state and local taxes.

Of these, only the charitable gifts break has a strong case for being left alone. The tax-free status of health plans needs a limit. The deductions for mortgage interest and state and local taxes should be gradually phased out or capped, as they have perverse effects.

I agree with that too. Leave the charity deduction alone, cut or eliminate the mortgage interest and state and local tax deductions, and cap the health insurance exclusion.

My article said that if Republicans cannot agree on substantial offsets to rate reductions, “they should scale back their tax package to just the most pro-growth elements, particularly a corporate tax rate cut.” If the GOP focuses on growth-generating reforms, the deficit may increase in the short term, but the tax base would expand over time offsetting the initial budgetary effect.

The important thing is that America’s businesses and their workers desperately need a more competitive tax code. The Republicans have a rare chance right now to get it done.

In the days before Hurricane Irma made landfall in Florida, the state ordered 6.3 million people to leave their homes. As people in the rest of the nation watched videos and photos of bumper-to-bumper northbound traffic on Interstates 75 and 95, while the southbound lanes were nearly empty, most had one of two reactions. Some said, “If only Florida had large-scale passenger train service that could move those people out,” while others asked, “Why aren’t people allowed to drive north on the empty southbound lanes?” 

The aftermath of the storm has already opened a debate over what Florida should do to increase its resilience in the future: build more roads or build more rail lines. The right answer is neither: instead, state transportation departments in Florida and elsewhere need to develop emergency plans to make better use of the transportation resources they already have. 

Rail advocates like to claim that rail lines have much higher capacities for moving people than roads, but that’s simply not true. After the San Francisco earthquake of 1906, the Southern Pacific Railroad moved 300,000 people–free of charge–out of the city in what was probably the largest mass transportation evacuation in American history. While impressive, it took the railroad five days to move all of those people on three different routes. Even accounting for improvements in rail capacities in the last century, moving 6 million people out of south Florida by rail would take weeks, not the four days available between Florida’s first evacuation orders and the arrival of Hurricane Irma.

At the same time, the state of Florida could have done more to relieve congestion on major evacuation routes. The most it did was to allow vehicles to use the left shoulder lanes on part of I-75 and part of I-4 (which isn’t even a north-south route), but not, so far as I can tell, on I-95. What the state should have done, since there was very little southbound traffic, was to open up all but one of the southbound lanes of I-75 and I-75 to northbound traffic.

A typical four-lane freeway has wide shoulders on both left and right sides of each of the two pairs of lanes. The opposing lanes are often separated by concrete barriers called Jersey Barriers that are designed to be easy to move. The state could have moved a few dozen of those barriers in strategic locations to give northbound traffic access to the southbound lanes. The state could also have put up plastic pylons to separate the north- and southbound traffic in what are normally the south-bound lanes. States take these actions all the time for road construction.

In the case of a four-lane freeway, opening one southbound lane and both center shoulders to northbound traffic would turn two northbound lanes into five. For six-lane freeways, this would turn three northbound lanes into seven. In both cases, there would still be one lane for southbound traffic and the outside shoulders for emergency vehicles. The leaders of every state highway bureau that doesn’t have an evacuation plan reversing some lanes to the prevailing direction of travel should be ashamed of themselves.

Successful private businesses respond rapidly and flexibly to changes in the market. Only the government would say, “Look: travel demand is changing dramatically. Let’s do absolutely nothing about it.”

Rail advocates argue that trains are more egalitarian because not everyone can afford to own a car. In particular, Florida’s older population supposedly meant that fewer than the average number of households have cars. In fact, data from the 2016 American Community Survey indicates that Florida households are more likely to have cars than the national average: 93.4 percent of Florida households have at least one car compared with 91.3 percent nationwide.

The reality is that passenger trains are far more expensive to operate per passenger mile than cars. Amtrak fares average nearly 30 cents a passenger mile and subsidies to Amtrak are another 25 cents a passenger mile. Americans spend an average of about 24 cents a passenger mile driving and those who wish can spend a lot less by buying used cars instead of new. Highway subsidies add only another penny or so. For daily transportation, this makes trains the elitist form of travel while cars are more egalitarian.

Nor do trains offer better service in the event of natural disasters. Tri-Rail, south Florida’s commuter-rail line, shut down 60 hours before Irma hit so employees could tie down trains and facilities for the storm. Amtrak cancelled its Florida trains at the same time as Tri-Rail. 

After the storm, it took Tri-Rail almost five days to clear the tracks of fallen trees and restore power to its electric trains. One part of the rail line was so damaged that the agency is busing people around that part of the line. As of this writing, Amtrak is still not running trains south of Jacksonville.

Using trains to evacuate people after a sudden natural disaster such as an earthquake is even more problematic than before the event. Rail infrastructure, especially for fast trains, requires a high level of precision that is not needed for highways. Vehicles on pavement are far more resilient than trains on inflexible tracks since pavement doesn’t have to be as smooth as tracks. Unlike trains, highway vehicles can drive around obstacles that are partly blocking roads and by-pass roads that are completely blocked.

Natural disasters are going to happen. Eastern and Southern coastal states suffer from hurricanes. The Midwest has tornadoes. The West Coast has earthquakes and the occasional volcanic eruption. What America needs to respond to these events is not more trains but more creative and flexible highway management.

Earlier this week, Sen. Rand Paul put forth an amendment that would sunset the 2001 AUMF and 2002 Iraq AUMF after 6-months. Somewhat unsurprisingly, the amendment was defeated as nearly all Senate Republicans (and a handful of Democrats) voted to strike it down.  

As I looked through the roll call, however, I was surprised by the vote of one Senator in particular: Jeff Flake. In 2015 and again this year, Flake, along with Tim Kaine of Virginia, introduced legislation for a new AUMF. Yet, Flake voted to table (i.e. kill) Paul’s amendment. 

Why would a Senator who clearly wants a new AUMF vote against this measure?

I wouldn’t have to wait long for an answer. Yesterday, I attended a “Conversation with Senator Jeff Flake,” hosted by the Council on Foreign Relations, and was able to ask the Senator directly about the rationale behind his recent vote. Here is an excerpt from Sen. Flake’s response:

I didn’t support the Paul amendment because I’m trying to be a stickler for regular order. And when we have an opportunity to actually move something through in regular order, that’s what I’d like to do. And it is proper for this bill—we have had a hearing on it already—the next move would be a markup to actually amend it and…it will be a bipartisan bill that will move. I spoke to Chairman Corker… just yesterday, and got a commitment that this bill is going to move. So I’m confident that it will. Had I not been confident, then I would have voted for the forcing mechanism.

His justification has merit. And I hope that he is correct, and that Chairman Corker moves on AUMF legislation in the coming months. But if that fails to happen, and Sen. Paul again offers his amendment, Senator Flake is now on record that he would support it.

You can see my exchange with Senator Flake in full here.

Congress may loosen 401(k) rules to allow Harvey and Irma victims to access their retirement savings without the usual 10 percent penalty on early withdrawals. The Washington Post reports mixed views from experts on the idea. In the past, the government has allowed “hardship loans” against 401(k) assets in the wake of disasters.

Individuals own the money in their 401(k) accounts, and after disasters they may need to use it. However, a better way for Congress to address that need is to create Universal Savings Accounts (USAs).  

As Ryan Bourne and I describe in this study, USAs would provide a tax-efficient vehicle for families to save for all purposes, including saving for unplanned costly events. USAs would be simpler and more flexible than current single-purpose accounts in the tax code, including those for retirement, education, and other purposes.

When a disaster happened, families could simply withdraw money from their USAs as needed without government paperwork or penalties. They could leave their retirement accounts untouched.

Ryan and I discuss how current tax policies favor saving for some purposes over others. But all saving is beneficial because it improves financial security and funds capital investment in the economy. USAs would reduce the tax bias against saving in an across-the-board manner for all individuals, and the accounts would encourage people to save for future expenses rather than rely on debt, retirement accounts, or government aid.

In Congress, Senator Jeff Flake (R-AZ) and Representative Dave Brat (R-VA) have introduced companion bills to create USAs. Ryan and I would tweak their plan to allow individuals to build even larger accounts than proposed.

We think USAs would be very popular, a real boon for individual saving and financial stability. Both Britain and Canada have created USA-style accounts, and large shares of people in all age and income groups in those countries use them.

So rather than fiddling with 401(k)s, Congress should be bolder and create a liquid and flexible savings vehicle to help all families. USAs would be a great addition to the tax reform plan that Congress and the Trump administration are assembling.  

For more on USAs, see

President Trump will support legislation to provide legal status to young immigrants who, as he said on Twitter, “have been in the country for many years through no fault of their own—brought in by parents at young age.” The legislation with the most cosponsors in the House and the Senate that would do so is titled the Dream Act. The proposal would help many unauthorized immigrants who deserve help, but for reasons that I cannot explain, the Dream Act prioritizes them above legal immigrant children in virtually the same position who meet all the eligibility criteria.

Most high-skilled immigrants initially enter the United States on temporary H-1B visas. H-1B workers can bring with them their spouses and minor children. As I have explained before, H-1B children live here, attend U.S. schools, grow up and attend U.S. universities, but on their 21st birthday, they lose their legal status, and the law requires them to self-deport if they cannot find another temporary legal status. Most stay at least for a few years longer by switching to a student visa, but this status prohibits work and expires again as soon as they graduate, leaving them in the same position they were before.

These children were “brought in by their parents” through “no fault of their own” and have “been in the country for many years”—the three criteria that President Trump mentioned for his dreamer legislation, yet the Dream Act, which would provide permanent residency, explicitly excludes them. This is not an oversight. The authors—Senators Graham and Durbin in the Senate—had to write that the law would apply only to a person “who is inadmissible or deportable from the United States” (p. 4) or who is in “temporary protective status,” which is typically given to unauthorized immigrants who can’t be deported due to a crisis in their home country.

In other words, the only way for legal dreamers to obtain status under this bill would be to somehow find a way to violate the law in order to become “deportable.” Even then, the Dream Act makes applicants ineligible if they have violated the rules of a student visa (p. 5), which most legal immigrant dreamers have to switch to when they turn 21 to avoid deportation, unless the Secretary of Homeland Security decides that it is necessary for “humanitarian purposes or family unity” or “otherwise in the public interest” to allow them to apply. Who knows whether he would decide that in any particular case? Few legal immigrants would take the chance that he wouldn’t and risk being deported and banned from the United States for life. 

But why is the requirement to violate the law necessary in the first place? What would change if the highlighted of the portion of the bill below was removed? Everyone that the current bill protects would still receive protection. The standards for inclusion would be just as tough. All participants would still have had to reside in the country for 4 years, enter before the age of 18, not have committed any significant crimes, be a high school graduate, etc. So why prioritize unauthorized immigrants over those who are here legally? It creates perverse incentives.

Dream Act Requirements (pp. 4-6)

As I have also explained before, the existence of legal immigrant dreamers is a product of a broken legal immigration system. Current law allows H-1B employers to sponsor H-1B workers, their spouses, and minor children for green cards or legal permanent residency. The green card waits for these workers are decades long (see here for a detailed explanation of that problem), so the law also allows H-1Bs waiting for a green card to extend their status and the status of their spouses and minor children indefinitely while they all wait for green cards. But despite having waited in line for many years, children of H-1B workers still lose their status as soon as they turn 21. Those who don’t self-deport then become foreign students, which provides temporary status but they cannot work and lose status again as soon as they graduate.

Children of other high-skilled immigrants on less used visa categories—primarily L, O, and E—also face the same problem. The Recognizing America’s Children Act in the House, which some 32 Republicans have signed onto, would allow E-2 nonimmigrant children to apply for permanent legal status with unauthorized immigrant dreamers but it would exclude all other legal immigrant dreamers (p. 5). That’s better than nothing, but E-2 nonimmigrant children are only a very small portion of the legal immigrant dreamers. Why would these members open themselves up to prioritizing illegal immigrants over legal immigrants? Many members have explicitly said that they oppose a “special pathway” for illegal immigrants.

It’s not that they want to limit the number of applicants, since both bills dramatically expand eligibility beyond the criteria for the DACA program that President Trump just announced would wind down. DACA protects only unauthorized immigrants who entered under the age of 16 before June 15, 2007 and who were under 31 as of June 15, 2012. The Dream Act would raise the age of entry to 18, the date of entry to 2013 or 2014, and remove any age requirement at the time of application (see above). The RAC Act would move the date of entry to before 2012 (p. 6). These changes would allow far more people to apply.

In any case, the decision to ignore the plight of legal immigrant dreamers is baffling from a political standpoint. Including legal immigrant children in the Dream Act would 1) remove the criticism that the bill is unfair to legal immigrants, 2) create a new constituency to advocate for the bill, and 3) not increase the applicant pool any more than the Act’s existing changes to DACA eligibility. Someone should ask these members why they have chosen to limit their bills in this way.

About a month ago, a Facebook post drew my attention to an attempt, by Casey Pender of Prague’s CEVRO Institute, to test my thesis that free banking contributes to NGDP stability using statistical evidence from Canada, which had a relatively free banking system between 1867, the year of Canada’s confederation, and 1935, when the Bank of Canada was established.

In “Some Odd Data on Free Banking in Canada,” a blog post discussing his preliminary findings, Pender reports that he had hoped to be able to show that Canada, from 1867-1935, had a more stable NGDP percent change from year to year than the U.S. And I thought this would be an easy and quick historical example that I could use to bolster my underlying theory. But things seem like they just ain’t so.

Instead, in comparing the fluctuations of Canadian and U.S. NGDP using data from the Macrohistory database, Pender found that Canadian NGDP was not less but more volatile. Moreover that conclusion held not just for the full 1870-1935 sample period, but also for the sub-period 1870-1914, which omits various extraordinary Canadian government interventions during WWI and the Great Depression.

Here is Pender’s chart showing his results from the full sample period:

Having now been made privy to these findings, I suppose that you are looking forward to seeing ol’ Doc Selgin eat humble pie. Well, you can quit holding your breath ‘cause that won’t be happening anytime soon. In fact, for the moment at least, I remain thoroughly impenitent.

How come? First of all, I never claimed that free banking alone could achieve any particular degree of absolute stability of nominal spending. What I have claimed is that, by tending to offset changes in the velocity of money with opposite changes in its quantity, free banking makes for a more stable relationship between the level of overall spending and the available quantity of base or high-powered money than might exist otherwise. To the extent that the available quantity of base money itself changes, however, the quantity of money will also tend to change independently of its velocity. Total spending will then tend to vary also.

What’s more, under an international gold standard regime like the one in place during Canada’s free banking episode, the amount of base money in any particular gold standard country was hardly likely to remain stable or grow at a very steady rate. On the contrary: changes in trade patterns and international capital flows were bound to routinely alter the distribution of gold among gold standard countries, just as changes in trade patterns and capital flows within individual countries are bound to alter the distribution of gold among those countries’ various regions. To the extent that it consisted of holdings of monetary gold, Canada’s monetary base was no less subject to change than the monetary base of, say, Nova Scotia.

In fact during the free-banking era Canada’s base money consisted of both monetary gold and paper “Dominion notes” first issued by the Canadian government in 1866. While some portion of these had to be fully backed by gold, there was also an un-backed or fiduciary component, the quantity of which rose from just $8 million in 1868 to $30 million by the outbreak of World War I. Until 1885 or so at least, those fiduciary issues, instead of being linked even loosely to gold flows, or otherwise regulated for the sake of economic stability, varied according to the Canadian governments’ fiscal needs. Consequently Dominion note issues tended to be an additional cause of irregular changes to Canadian NGDP.

A proper test of the theory that free banking helped to stabilize Canadian NGDP must therefore consider, not just fluctuations in Canadian NDGP as such, but the relationship between those fluctuations and underlying changes in Canada’s monetary base. So long as Canada’s NGDP fluctuations were driven by underlying changes in Canada’s stock of base money, instead of being independent of such changes, the fluctuations were perfectly consistent with the theory.

So, what does the record have to say about it? To find out, I had Tyler Whirty, the CMFA’s trusty RA, run some simple regressions for me, with Canadian NGDP as their dependent variable, and Canada’s stock of base money (M0) as the independent variable. The NGDP estimates are the same ones employed by Pender, from the Macrohistory database[1], while the monetary base numbers are from Metcalf, Redish, and Shearer (1998). So far we’ve looked only at the pre-WWI record, as that era is most aptly described as one of relatively unblemished free banking. We also ran the regressions both using raw data and after taking logs. I shall report only the log results, as those fit the data best; but the general conclusions to be reported here don’t depend in the least on the log transformations.

The results, shown in the next figure, are not just consistent but remarkably consistent with the theory, and especially so given that Canada’s arrangement involved some not entirely trivial departures from the theory’s assumptions, one of which is that paper money is supplied by commercial banks alone. (In fact, Canada’s banks were prohibited from issuing notes worth less than $5.) The regression R-squared is .980254, while the coefficient on M0, about .80, seems quite reasonable allowing for the fact that some Canadian base money, including smaller Dominion notes, circulated instead of serving as bank reserves.

Although the Canadian results seem perfectly consistent with the theory, we still have to compare them with evidence from the U.S. as a step toward establishing that the stable relationship they point to might be attributable to Canada’s having had a free banking system: were a similarly close relationship to exist in the U.S. data, that would suggest that Canada’s distinct institutional arrangements, including free banking, didn’t really make any difference.

For our base U.S. regression, we drew again upon the Macrohistory database, using its U.S. NGDP estimates (which were originally developed by Louis Johnston and Samuel H. Williamson[2]). For the U.S. monetary base, we subtracted national bank notes from Philip Cagan’s monetary base figures: while Cagan himself justified including those banknotes by noting that they were practically claims against the U.S. Treasury, we exclude them because, despite that, they were neither legal tender nor capable of satisfying banks’ legal reserve requirements.

Because Cagan’s numbers only start in 1875, the U.S. regression covers a somewhat shorter period than the Canadian one.

While the results of the U.S. regression suggest a relationship between U.S. NGDP and M0 that’s broadly similar to the Canadian one (M0 coefficient .825), that relationship, as depicted in the next figure, is considerably less tight, with an R-squared of .908. That the Canadian relation should be so much tighter now seems all the more remarkable, given both the relatively small size and openness of Canada’s economy, and its heavy dependence upon U.S. exports to the U.S.

To check the robustness of these U.S. results, we performed the same regression using Angus Maddison’s NGDP estimates in place of the Johnston-Williamson numbers. Although the R-squared, of about .0935, is a bit higher in that case, the coefficient (.769) is similar:

In brief, both our Canadian regression results themselves, and a comparison of those results with results using U.S. data, seem fully consistent with the theory that free banking helps to stabilize the relationship between NGDP and the monetary base.

Does that mean they confirm the theory? Alas, it doesn’t. Freedom in banking is but one of many differences between the pre-WWI Canadian system and its U.S. counterpart. Furthermore, even if Canada’s more stable NGDP-M0 relationship were in fact due to its having had a relatively free banking system, it wouldn’t follow that my theory is correct. Free banking could well have contributed to the stable relationship in question for reasons apart from the one my theory points to. We know, for example, that branch banking — itself an element of free banking — made Canada’s system less fragile, and therefore less vulnerable to financial crises, than the U.S. system. We also know that financial crises tend to involve a collapse in bank credit and spending. So the relative stability of the Canadian NGDP-M0 relationship, instead of reflecting a tendency for changes in M to offset opposite changes in V, may instead simply have reflected a relative lack of banking crises and associated increases in the ratio of bank reserves to bank credit.  Although all this is still good news for fans of free banking, it leaves my particular hypothesis unproven.

In short, while my theory has yet to be discredited, it also has yet to be confirmed. I hope that either Mr. Pender or some other enterprising econometrician will eventually settle the matter, one way or the other.

[1] Òscar Jordà, Moritz Schularick, and Alan M. Taylor, “Macrofinancial History and the New Business Cycle Facts,” in NBER Macroeconomics Annual 2016, volume 31, edited by Martin Eichenbaum and Jonathan A. Parker. 2017. Chicago: University of Chicago Press.

[2] Louis Johnston and Samuel H. Williamson, “What Was the U.S. GDP Then?” MeasuringWorth, 2017.

[Cross-posted from]