In 2011, Tim Harford wrote a whole book called Adapt on how it is important for key decision makers to be humble. He points out that we live an a very complex and uncertain world, and because of this, it is difficult for experts to know in advance what ideas will work best. In his view, the world is full of surprises and the best way to take advantage of this is to explicitly adopt a strategy of trial and error, or what he calls variation and selection, to try a lot of things, expect a certain amount of failure, and then take what you learn and create an even more successful system or idea. He goes on to provide a number of examples where expert opinion fell short, and it was important for organizations to adapt to new insights. He describes in fascinating detail how the War in Iraq, the Battle of Britain in WW II, implementing development programs in poor countries, and fighting climate change all benefited from this process of variation and selection.
I found this book especially delightful because it fits nicely with my own philosophy that it is important to carefully manage what I call epistemological risk whenever designing a new public policy. Many people already know about evidence based policy, where policy makers deliberately use the latest research to improve their policy design process. Managing epistemological risk takes this one step further, where you admit that you might be wrong about something, and develop a policy strategy that allows you to learn what works and what does not as quickly as possible in a way that minimizes the damage to society if you did get something wrong. The idea is to do a lot of small scale trials and state level experiments and then dramatically scale up the successful ones once you learn what works best. Waiting for an experimental trial can slow progress in the short run, but can speed up progress in the long run by reducing the number of policy mistakes that might take decades to fix, and to increase our rate of learning about what works and what does not.
Even if it is very tempting to make change as quickly as possible on the issue you care about most, government as a whole has to deal with hundreds of different policy problems and improving the process by carefully managing epistemological risk has the potential to dramatically improve outcomes across the entire portfolio of issues. Communist Russia showed us a top down approach has its limits, though it did achieve impressive levels of economic growth at the beginning, and America's system of markets that adopts this bottom up approach of variation and selection demonstrates that this strategy is vastly more successful over the long run. Incorporating that into our political and policy strategies now could potentially be a very effective technique for improving the well being of our society for many decades into the future, and Tim Harford's book Adapt makes a very strong argument in its support.
Friday, July 31, 2020
What has the Fed been doing to support the US economy during the pandemic?
The Federal Reserve has gone to incredible lengths to support the economy during the pandemic, where, to their credit, they have promised to do whatever it takes, for as long as it takes, until the economy recovers from the crisis. They have actually been a little coy in what they have announced, because even if they have publicly said that they are doing $700 billion in new quantitative easing (QE) and created a whole bunch of new loan programs to help entities get through the crisis, quietly they have actually been doing much more by pumping trillions more into the economy, which has increased their bond holdings by $2.3 trillion and expanded their balance sheet by about $3 trillion overall. The Brookings Institution created a nice summary of their efforts, and you can find a nice graph of the central bank's balance sheet over at Trading Economics, a website that has data on a bunch of useful economic indicators for countries all across the world.
These extraordinary efforts helped us get through the first phase of the crisis, but now the question is whether the Fed should be doing even more now that a new round of stimulus is being negotiated. My rule of thumb is that the Fed should be buying government bonds with printed money that pays for all the new debt the government is issuing at the very least, and like Japan has done in the past, they could even be buying substantially more debt than the government is issuing at any given time. If they did this, then the overall debt held by the public would be declining and governments could feel free to spend, since there would be no fear of increasing the risk of a future debt crisis. So far the Fed seems to be getting close to following through on this recommendation, where the first round of stimulus increased the expected deficit by $2.2 trillion for fiscal year 2020 (though the overall deficit will be considerably higher than that), and the central banks bought about $2.3 trillion billion in new bonds, but the new round of stimulus currently being negotiated could add trillions more to the deficit this year. The Democrats have a plan that costs more than $3 trillion, and the Republicans are trying to create a plan that costs around $1 trillion, so in order to keep up the with the rise in the deficit, the Fed might have to boost their bond buying and money printing plans to keep up with the surge.
So far the Federal Reserve has done an excellent job responding to the pandemic, but the economy still needs more stimulus and the federal government still hasn't provided all the funds state and local governments need to get through the crisis, so the Fed might need to do even more because of the latest round of negotiations. Many Republicans in the Senate are starting to resist spending more money for fear of creating too much debt, so announcing a surge in new bond buying from the Fed could make it easier for them to agree to new measures. The Fed can't pass new legislation to have the federal government spend more money on the crisis, but they can make it easier for others to do so, and buying even more bonds with printed money could help in that effort.
These extraordinary efforts helped us get through the first phase of the crisis, but now the question is whether the Fed should be doing even more now that a new round of stimulus is being negotiated. My rule of thumb is that the Fed should be buying government bonds with printed money that pays for all the new debt the government is issuing at the very least, and like Japan has done in the past, they could even be buying substantially more debt than the government is issuing at any given time. If they did this, then the overall debt held by the public would be declining and governments could feel free to spend, since there would be no fear of increasing the risk of a future debt crisis. So far the Fed seems to be getting close to following through on this recommendation, where the first round of stimulus increased the expected deficit by $2.2 trillion for fiscal year 2020 (though the overall deficit will be considerably higher than that), and the central banks bought about $2.3 trillion billion in new bonds, but the new round of stimulus currently being negotiated could add trillions more to the deficit this year. The Democrats have a plan that costs more than $3 trillion, and the Republicans are trying to create a plan that costs around $1 trillion, so in order to keep up the with the rise in the deficit, the Fed might have to boost their bond buying and money printing plans to keep up with the surge.
So far the Federal Reserve has done an excellent job responding to the pandemic, but the economy still needs more stimulus and the federal government still hasn't provided all the funds state and local governments need to get through the crisis, so the Fed might need to do even more because of the latest round of negotiations. Many Republicans in the Senate are starting to resist spending more money for fear of creating too much debt, so announcing a surge in new bond buying from the Fed could make it easier for them to agree to new measures. The Fed can't pass new legislation to have the federal government spend more money on the crisis, but they can make it easier for others to do so, and buying even more bonds with printed money could help in that effort.
Thursday, July 30, 2020
Who will Biden choose for VP?
Biden is supposed to announce his choice for VP in just a few days. I originally thought Biden was going to pick former presidential candidate Amy Klobuchar, my home state Senator, as his running mate, but because of the George Floyd protests, she has decided to drop out of the running. I now think Biden is going to pick Susan Rice as his VP, which I think is an excellent choice.
As I see it, there are two primary considerations. First, whoever is his VP has to be able to take over and run the country if for some reason Joe Biden can't do it anymore. Biden will be 78 years old at the beginning of his term if he wins, and even though he seems to be pretty fit and healthy, that means he will be 82 years old by the end of his first term, which is pretty old to still be working at all, let alone at a high stress job like the presidency. With all of her foreign policy experience (including time as Obama's National Security Advisor), Rice can step in and take care of all the national security problems at a moment's notice, and Obama and Biden have built up a large talented team of economic advisors that can help her deal with any difficult domestic issues. Plus selecting a strong African-American women as his running mate would be truly historic and long overdue.
Second, Biden has to set up the next race for president to make sure a strong candidate emerges to run after he leaves office. The VP always has a huge leg up in running for office after the current president leaves, and whoever he picks for VP will likely be the next Democratic candidate for President. That is why I thought Senator Klobuchar was a good choice. She is a highly qualified, moderate candidate who I think would make an excellent president in the future, and since she dropped out and endorsed Biden at a critical time in the Democratic primary, I thought Biden was going to reward her for that important political gesture. I think Susan Rice makes an excellent choice in this regard as well. She is not a career politician, and likely does not want to run for President after Biden leaves office, so the field would be wide open to select whichever candidate the party members decided would be best. That lets voters choose between a liberal candidate like Warren or a moderate candidate like Klobuchar, and doesn't lock in the next choice by making her VP in 2021, ensuring the politician with the most political skill ends up getting picked to run next.
It is also important to point out that Biden might only serve for one term. He is getting old, though is only 3 years older than Trump, and serving until the end of a second term when he is reaching the age of 86 might be a bit too much. There was even a trial balloon sent out early on in his primary race that he was going to select Stacey Abrams as his VP at the beginning of his campaign, and that he was only going to serve one term. Both of those got a negative reaction so they didn't go anywhere, but I think it is possible that Biden will decide soon after the midterms in 2022, that he won't run for a second term, setting up a very vigorous debate over who should take his place in 2024. That seems to be the scenario that makes the most sense to me, and now we will just have to see if my predictions come true.
As I see it, there are two primary considerations. First, whoever is his VP has to be able to take over and run the country if for some reason Joe Biden can't do it anymore. Biden will be 78 years old at the beginning of his term if he wins, and even though he seems to be pretty fit and healthy, that means he will be 82 years old by the end of his first term, which is pretty old to still be working at all, let alone at a high stress job like the presidency. With all of her foreign policy experience (including time as Obama's National Security Advisor), Rice can step in and take care of all the national security problems at a moment's notice, and Obama and Biden have built up a large talented team of economic advisors that can help her deal with any difficult domestic issues. Plus selecting a strong African-American women as his running mate would be truly historic and long overdue.
Second, Biden has to set up the next race for president to make sure a strong candidate emerges to run after he leaves office. The VP always has a huge leg up in running for office after the current president leaves, and whoever he picks for VP will likely be the next Democratic candidate for President. That is why I thought Senator Klobuchar was a good choice. She is a highly qualified, moderate candidate who I think would make an excellent president in the future, and since she dropped out and endorsed Biden at a critical time in the Democratic primary, I thought Biden was going to reward her for that important political gesture. I think Susan Rice makes an excellent choice in this regard as well. She is not a career politician, and likely does not want to run for President after Biden leaves office, so the field would be wide open to select whichever candidate the party members decided would be best. That lets voters choose between a liberal candidate like Warren or a moderate candidate like Klobuchar, and doesn't lock in the next choice by making her VP in 2021, ensuring the politician with the most political skill ends up getting picked to run next.
It is also important to point out that Biden might only serve for one term. He is getting old, though is only 3 years older than Trump, and serving until the end of a second term when he is reaching the age of 86 might be a bit too much. There was even a trial balloon sent out early on in his primary race that he was going to select Stacey Abrams as his VP at the beginning of his campaign, and that he was only going to serve one term. Both of those got a negative reaction so they didn't go anywhere, but I think it is possible that Biden will decide soon after the midterms in 2022, that he won't run for a second term, setting up a very vigorous debate over who should take his place in 2024. That seems to be the scenario that makes the most sense to me, and now we will just have to see if my predictions come true.
Should the Fed target inflation rates or price levels?
Back when I was growing up, I was always quite good at math, but as I got older, I hated doing proofs, so a career as a mathematician didn't really appeal to me. Applied math, however, was fascinating because I could use my math skills to solve useful practical problems, which is why I decided to go to Stanford and become an engineer. After my freshman year, I got a job at Honeywell as an intern and started learning about control theory right away, since the group I got assigned to studied aerospace control systems. I loved control theory because I thought it was a fascinating way to approach problems where you had a complicated dynamic system and wanted to achieve a specific goal. Ultimately, I decided not to pursue engineering because I thought my rational problem solving skills could be used to better ends by pursuing public policy, which is how I ended up with a bachelor's degree in electrical engineering and a bachelor's degree in public policy coming out of Stanford.
Eventually, I realized economics was a useful way to use my skills in applied math, which is why I decided to get a PhD at Berkeley, and always wondered if all my knowledge about control theory might come in handy there. Macroeconomics and monetary policy is the most obvious application, since policymakers are trying to manage a complex dynamic system (through interest rates) in order to achieve a specific desirable outcome (low inflation and low unemployment). At one point, I thought it would be useful to take the most important advances in control theory (like robust control, which deals with models with a lot of uncertainty) and apply them to the problem of macroeconomics. As it turns out, someone already did this, namely Nobel Prize winner Lars Peter Hansen, so there was not much for me to do on top of what was already done.
Then I eventually realized that the whole debate on whether the Federal Reserve should target inflation rates or price levels when managing the economy is basically a problem that has been well studied in engineering. One of the first things you learn when studying control theory is PID control, which stands for proportional (P), integral (I), and derivative (D) control.. In monetary policy, proportional control is just targeting the inflation rate, and targeting the price level is considered integral control, because price level targets worry about all the errors in the inflation rate added up over the entire past (an integral) while targeting the inflation rate only worries about errors in the immediate present. The way this works in practice is if inflation comes in too low, say at 1% with a 2% target, then an inflation rate target will try for 2% in the following year, while a price level target will try for an amount somewhat more than 2% for a while in order to make up for the past differences from the target.
What engineering tells us is that you normally want to start with proportional control, but that sometimes it is useful to add integral control to make sure your system is more precise over the long term. What ends up happening is that targeting the inflation rate gets you fewer errors over the short term, but targeting the the price level in addition gets you fewer errors over the long term. This means that the whole debate about whether to target the inflation rate or the price level is really a false choice since the Federal Reserve should probably be doing both. The trick is to weigh the price level target relatively lightly so you do not get wild swing in inflation over the short term, say by trying for a target close to 2% over the short term, but also an average of 2% over say 5 years. That means if inflation came in 1% too low for a year, then the Fed would target inflation at 2.2% for the following five years to make up the difference.
I describe this in a little more detail in one of the research ideas on my website, and would like to figure out how to turn this into an academic paper, since I do think it sheds some light on an extremely complicated debate that can be difficult to get your mind around.
Eventually, I realized economics was a useful way to use my skills in applied math, which is why I decided to get a PhD at Berkeley, and always wondered if all my knowledge about control theory might come in handy there. Macroeconomics and monetary policy is the most obvious application, since policymakers are trying to manage a complex dynamic system (through interest rates) in order to achieve a specific desirable outcome (low inflation and low unemployment). At one point, I thought it would be useful to take the most important advances in control theory (like robust control, which deals with models with a lot of uncertainty) and apply them to the problem of macroeconomics. As it turns out, someone already did this, namely Nobel Prize winner Lars Peter Hansen, so there was not much for me to do on top of what was already done.
Then I eventually realized that the whole debate on whether the Federal Reserve should target inflation rates or price levels when managing the economy is basically a problem that has been well studied in engineering. One of the first things you learn when studying control theory is PID control, which stands for proportional (P), integral (I), and derivative (D) control.. In monetary policy, proportional control is just targeting the inflation rate, and targeting the price level is considered integral control, because price level targets worry about all the errors in the inflation rate added up over the entire past (an integral) while targeting the inflation rate only worries about errors in the immediate present. The way this works in practice is if inflation comes in too low, say at 1% with a 2% target, then an inflation rate target will try for 2% in the following year, while a price level target will try for an amount somewhat more than 2% for a while in order to make up for the past differences from the target.
What engineering tells us is that you normally want to start with proportional control, but that sometimes it is useful to add integral control to make sure your system is more precise over the long term. What ends up happening is that targeting the inflation rate gets you fewer errors over the short term, but targeting the the price level in addition gets you fewer errors over the long term. This means that the whole debate about whether to target the inflation rate or the price level is really a false choice since the Federal Reserve should probably be doing both. The trick is to weigh the price level target relatively lightly so you do not get wild swing in inflation over the short term, say by trying for a target close to 2% over the short term, but also an average of 2% over say 5 years. That means if inflation came in 1% too low for a year, then the Fed would target inflation at 2.2% for the following five years to make up the difference.
I describe this in a little more detail in one of the research ideas on my website, and would like to figure out how to turn this into an academic paper, since I do think it sheds some light on an extremely complicated debate that can be difficult to get your mind around.
Wednesday, July 29, 2020
A guide to my research
I just setup my new professional website yesterday, as well as my new blog, and over there you can find all the amazing research I've managed to finish recently. The website has so much new work on it that figuring out where to start can be a little intimidating, so I thought I'd offer a little guide on where to begin.
If you are have an PhD in economics check out the page with all my working papers, and if you want to see my best work, start with my paper on deficit bias. If you do not have an PhD in economics, then you would be most interested in the page with all my policy memos. My memo on tax reform gives you a general idea of my views on fiscal policy, while my introduction to helicopter money and recommendations for monetary policy reform in the US details my latest thinking on monetary policy. If foreign policy is your thing, then check out my memo on optimal insurgency theory. If you are currently doing research on economics as part of your job, then the page with all my new research ideas will provide you with a ton of potential opportunities. I am always looking for new collaborators, so if you want to work on any of those ideas, then just let me know.
Please go ahead and check out all my new work, and I would love to hear what you think. Feedback is always appreciated and it is always fun to discuss your ideas with other people. I hope you enjoy all the new ideas and insights that I have to offer.
If you are have an PhD in economics check out the page with all my working papers, and if you want to see my best work, start with my paper on deficit bias. If you do not have an PhD in economics, then you would be most interested in the page with all my policy memos. My memo on tax reform gives you a general idea of my views on fiscal policy, while my introduction to helicopter money and recommendations for monetary policy reform in the US details my latest thinking on monetary policy. If foreign policy is your thing, then check out my memo on optimal insurgency theory. If you are currently doing research on economics as part of your job, then the page with all my new research ideas will provide you with a ton of potential opportunities. I am always looking for new collaborators, so if you want to work on any of those ideas, then just let me know.
Please go ahead and check out all my new work, and I would love to hear what you think. Feedback is always appreciated and it is always fun to discuss your ideas with other people. I hope you enjoy all the new ideas and insights that I have to offer.
Tuesday, July 28, 2020
endeavor
endeavor - n. 1. A conscientious or concerted effort towards an end, an earnest attempt. 2. Purposeful or industrious activity: enterprise.
American Heritage Dictionary, 4th Edition
American Heritage Dictionary, 4th Edition
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