There Is No Technocracy: Partisan Bias at the Fed

These are a few months old now, but Christopher Gandrud -- a recent LSE PhD -- has a cool project going. It's spread out over several posts [1, 2, 3] but here's the gist:

So, I have two questions:

1. Have Fed inflation forecast errors been different during Democratic and Republican presidencies?
2. Are Fed inflation forecast errors different for election periods and non-election periods? ...
Question 1: The Fed did tend to overestimate inflation during Democratic presidencies and underestimate it during Republican presidencies (an Error/Actual score of 0 means that the forecasters perfectly predicted actual inflation). Admittedly we have a pretty small sample of Democratic presidencies (only Carter and Clinton), but it is striking how all of the big underestimates were during Republican presidencies and almost all of the big overestimates were when Democrats had power.

Maybe, Federal Reserve staff anticipate--to an incorrect degree--that Democratic presidents will pursue expansionary policies and vice versa.

Question 2: It is not as clear that forecasts systematically differ in election periods as opposed to non-election periods. Though the spread of the errors across parties does shrink very close to the election. I wonder why this might be?

And:

The partisan effect is less obvious than in the earlier graph, but is is clear that during this time period the big over estimations are during Democratic presidencies and the big (actually almost all) underestimations are during Republican ones. The effect would be even stronger if we took out the end of Reagan's first term and his second one, where Fed staff may not have fully adjusted their forecasting to reflect the Volker-Greenspan era of moderate inflation.

Rules vs. Principles in Regulation

Matt Yglesias:

This gets to the heart of the difference between rules-based and principles-based regulation. You could have a version of the Volcker Rule that functions by empowering a set of bank regulators to implement the principle behind the rule. Sloan agrees that "the principle sounds wonderful and simple -- don't let banks use federally insured deposits for risky trades" so you could tell the regulators just that, with no further details or clarification. A college dorm that has a rule against loud noise or music after 10PM on weeknights isn't going to follow that up with a detailed regulatory definitions of "loud", "noise", and "music" that you can then try to find loopholes in. The issue is that if the RA decides you're being too noisy, he tells you to quiet down. 

The problem with principles-based regulation in this context is that you might fear that banks will use their political influence to get regulators to engage in a lot of forebearance. The problem with rules-based regulation in this context is that it's really hard to turn a principle into a rule.

That's not "the" problem. That's "a" problem. Another problem is that regulators will never be given one task. They'll be given multiple tasks. One might be "don't let banks use federally insured deposits for risky trades" and another might be "don't restrict our financial sector so much that foreign firms take market share". Or maybe "force banks to make safe investments" but also "lend to certain interest groups -- e.g. governments -- at privileged rates". Or maybe "regulate the banking sector" and also "manage the macroeconomy". Many of these tasks are contradictory at some margin, and that margin is precisely what is being exposed by the time we get to crisis.

Another question is "what's a risky trade"? I've been watching the Frontline documentary on the financial crisis, and one thing is clear: everybody thought that securitization was reducing risk, not concentrating it. At least at first. When I say "everybody" I mean it. Other than Brooksley Born the regulators, firm managers, journalists, academics... everybody thought this stuff was making the financial system more stable. Some people started calling this into question by the mid-2000s but at that point it was already too late. So a discretionary principle of "reduce risk" -- which is more or less what we had during the 1990s and 2000s, combined with pretty lax capital requirements -- would likely not have led to a reduction in the activity that culminated in crisis and may even have exacerbated it.

This isn't as simple as a dorm RA telling people to turn down their music after 10 pm.

Soapbox

What follows is prompted by the news that the Justice Department has filed suit against Joe Arpaio, Sheriff of Maricopa County, AZ, alleging that he has violated the civil "rights of Hispanic inmates and suspects." 

Every semester when I teach I find 5 or 10 minutes to deliver a rant. It's the only rant on an overtly normative topic that I consistently give, and no component of my students' grade is contingent upon how they respond to it. It's not much, and I'm sure it has no effect. Nevertheless, I feel compelled to give it. It's about immigration, and how bollocksed-up both our public policy and ideological orientation is to immigration. I try to attack on several fronts at once:

1. If you express faith in the utilitarian value of free markets, then you can't be selective. If capital and goods markets are to be free, then labor markets should be as well.

2. If you express concern about development and the plight of the poor, then you can't be selective. If we want to reduce poverty, then we need to encourage things that reduce poverty. Freer immigration is near the top of that list.

3. If you think that corporation are -- on balance -- a force for good in the world, then you should favor things that help corporations form and prosper. Access to an eager labor force is attractive to corporations, as they have repeatedly made clear.

4. If you wish to emancipate the tired, the poor, the huddled masses yearning to breathe free then you should let them breathe free. Let them escape the rule of the corrupt and capricious. Let them engage in the pursuit of happiness. In other words, if the word "solidarity" means anything to you, then show solidarity.

5. If you are not a nativist, nor any other sort of bigot, then you should support policies that are anti-nativist and anti-bigot.

6. If you are concerned about demographic changes, the fiscal balance, the state of the economies of most advanced industrial nations, then you should support actions that will bring young workers into the population, who will pay taxes and help bring the economy and public balance sheet back into a sustainable equilibrium.

7. If you care about the rights of humans, then surely the rights of freedom of movement and association are at the top of your list.

I feel like this little rant gives little room for dissenters to move. They can't be make a market-based argument. They can't make an anti-market-based argument. They can't make a liberty-based argument. Slight objections -- such as "national security" -- are very easily slapped away by both statistics and simple logic.* All that remains is some form of bigotry, either soft or not-so-soft, and these are not restricted to either side of the left-right political spectrum.

There is no good moral, ethical, economic, or pragmatic reason for continuing the horrible immigration policies we currently enforce in the U.S. and throughout the developed world. There are very good reasons to support liberalizing human movement from all over the ideological political spectrum, from the internationalist left to the corporatist right. There are no very good reasons to oppose it other than nativism, which is both ugly and incoherent. This is equally true whether it comes from the left or the right.

In my opinion this is the greatest civil rights issue of our time. And we're failing.

*Statistically, so far as I can tell, almost no immigrants are terrorists or otherwise threaten the integrity of their host countries. It's not even clear that immigration increases rates of crime -- setting aside the abhorrent fact that walking across an imaginary line is a crime in and of itself -- despite the fact that most immigrants are young and poor, which are (statistically) the most likely groups to resort to crime.

The Coming Anarchy?

Ian Bremmer sounds the alarm:

Here are the two irreconcilable facts that shape the United States’ role in foreign policy: first, it is the world’s most powerful and indispensable nation, and will remain so for the foreseeable future, whether or not it is in decline; and second, the United States is unwilling to provide global leadership as it used to, because of domestic economic concerns and war fatigue stemming from two long campaigns in the Middle East.

This is where narcissism comes in. Focusing on the question of American decline is problematic because it means we’re applying an American lens to global problems. Whether or not the United States is in decline, the important thing is that in today’s environment, America is the last best hope for global leadership, which it is unwilling and unable to provide. The United States will not intervene on behalf of the Syrian people. It will not bail out Europe. It will not bomb Iran. These are the facts, decline or not.

This is, of course, a reference to Kindleberger's famous maxim of how the world descended into chaos during the period in between World Wars I and II: the British were unable to lead and the U.S. was unwilling to do so. The resulting anarchy was therefore a unnecessary tragedy which, according to Ikenberry, the U.S. learned from and was determined not to replicate following WWII.

Bremmer believes that that consensus within the U.S. has eroded and that there is no other global actor is ready/willing to step up to the plate. Here's Bremmer again:

Yes, this is absolutely the case. In the G–Zero, we see a combination of unwilling and unable leaders. The United States is dropping the baton of global leadership—and no one is willing to pick it up.

The implication is that, if this continues, calamity is likely in our future.

I'm in broad agreement with Bremmer in theoretical terms, but I don't see as much U.S. retrenchment as he does. The Obama administration may be many things but isolationist is not one of them. The foreign policy orientation of the party challenging Obama is not either. And while "there will be no Marshall Plan for Europe" this time, there is also less need for one. The Federal Reserve has taken many important actions to stabilize the global financial system, and it is not at all clear to me that intervening in Syria or bombing Iran would make the Middle East more stable rather than less. Nor is it clear to me that those options are truly off the table.

In other words, I think the last four years demonstrate that the current global order is actually remarkably durable. More durable than many believed. Global financial and security institutions have worked pretty well, or at least as well as they had previously. I see no reason to expect that to change in the next few years.

Partially because I think Bremmer gets the following wrong, even if I think he's thinking in the correct terms:

But political institutions need a big shock if they’re to be broken to pieces. The collapse of the USSR in 1991 wasn’t big enough; 9/11 didn’t cut it either. The financial crisis of 2008 proved to be the catalyst. So the question is, what comes next? Until the answer emerges, we are stuck with G–Zero—a transition period as the old order crumbles but nothing has yet replaced it.

I'm not actually sure the financial crisis was a catalyst for "creative destruction" (Bremmer's term, via Schumpeter) of the global order. It was a body blow, to be sure, but the structure of the system seems to have held. We haven't descended into anarchy yet, even if the residual effects are still percolating through. Moreover, the U.S. looks better positioned to remain central to the international system now than at any point since 2007 (or perhaps even earlier). So yes, there was a shock, but the center held, and now appears to be reinforcing itself. The wave appears to have crested, broken, and is now rolling back. So I don't expect to see the major changes that Bremmer does.

Redistributive Cooperation, Redux

News regarding global banking regulations:

Bankers and lawyers said the proposals, if approved, would push up capital requirments and could making buying and selling assets – as opposed to holding them to maturity – far less profitable.  

The proposal is expected to hit institutions with large trading desks, such as Barclays, Goldman Sachs and Deutsche Bank, particularly hard.  

Higher capital requirements could also make it harder for some European banks to gain any advantage over their US rivals when they have to stop trading with their own capital under the US Volcker rule.

This should come as no surprise to those who have followed the academic literature on global banking regulations. It's basically following the playbook of an old article by Oatley & Nabors:

1. Financial distress in the U.S. leads to domestic calls for re-regulation.  

2. Some of these regulations would put U.S. firms at a competitive disadvantage vis-a-vis their international competitors. 

3. These regulations get extended into the international arena to shift some of the costs from American firms to their foreign competitors. The U.S. is able to do this because of their relative power within the global financial system.

It's nice when academic research actually helps us understand the world. Timely too, because Dani Rodrik wrote an op-ed arguing that this type of theorizing isn't any good:

The most widely held theory of politics is also the simplest: the powerful get what they want. Financial regulation is driven by the interests of banks, health policy by the interests of insurance companies, and tax policy by the interests of the rich. ...

It’s the same globally. Foreign policy is determined, it is said, first and foremost by national interests – not affinities with other nations or concern for the global community. International agreements are impossible unless they are aligned with the interests of the United States and, increasingly, other rising major powers. ...

Yet this explanation is far from complete, and often misleading. Interests are not fixed or predetermined. They are themselves shaped by ideas – beliefs about who we are, what we are trying to achieve, and how the world works. Our perceptions of self-interest are always filtered through the lens of ideas.

Sure. But sometimes the simple logic works pretty damn well.

(Note that this applies to the post just below this one as well.)

Yet Another for the Materialists (?)

A few months back I briefly commented on the ways in which different political science paradigms approached global issues differently, as illustrated by the TRIPs survey of academics:

IPE folks are the most convinced that at least one country will leave the euro. More than half of us. Meanwhile, only about 37% of IO folks and 30% of Europeanists think a country will exit the common currency. ... 

I find this interesting for a lot of reasons, but mostly because I think provides a pretty stark reminder that political scientists think very differently about politics. This could break down along paradigmatic lines -- the authors of the report note that constructivists tend to be comparativists, while realists tend to be in IR. I still think that a materialist conception of politics carries me farthest down the road I wish to be on, so I think it is fairly likely that a country will drop the euro if things continue to deteriorate. 

Today comes two developments that are relevant to this discussion. First, and as recently expected, Nicholas Sarkozy lost the French presidency to Francois Hollande in an election that was widely viewed as a referendum on the EU's approach to the ongoing debt crisis, and in particular the Franco-German alliance to push Euro-wide austerity. Hollande has promised a new direction that focuses on growth, rather than austerity, and an unwillingness to let French economic policy be determined by Berlin. As such, the vote appears to be a rebuke of Sarkozy's cozy relationship with German Chancellor Angela Merkel, and a reinforcement of French sovereignty over European solidarity. (Ms. Merkel's party lost another local election, indicating that her citizens aren't especially thrilled with her policy course either.) The election was also notable for the fracture in France's right-wing parties, as the far-right nationalist National Front party received nearly one-fifth of all votes.

In Greece, meanwhile, things have taken a disturbing turn:

Greek voters appeared to radically redraw the political map on Sunday, bolstering the far left and neo-Nazi right in a wave of protest against the dominant political parties they blame for the country’s economic collapse. 

The parliamentary elections were the first time that Greece’s foreign loan agreement had been put to a democratic test, and the outcome appeared clear: a rejection of the terms of the bailout and a fragmentation of the vote so severe that the front-runner is expected to have extreme difficulty in forming a government, let alone one that can either enforce or renegotiate the terms of the bailout.

The elections were seen as a pivotal test, determining both the country’s future in Europe and its prospects for economic recovery and the outcome, along with that in France, could resonate far beyond Europe, possibly leading to more upheaval in the euro zone. The early results were also a clear rebuke to European leaders that their strategy for Greece had failed.

You can see what you want to see here. If you think that materialist concerns will dominate European identity in determining the path of the European Union, then there's plenty here for that: the rise of far-right nationalist parties especially, and not just in France and Greece. On the other hand, you could view Hollande's election as a sign that the austerity regime is on the verge of being replaced by a more generous system of transfers that will reinforce European solidarity and identity.

Many Europeanists have been expecting such a transformation of identity, from a nationalist identity to a European identity, over time. This is certainly possible in the long run -- think about how we used to refer "These" United States and now refer to "The" United States -- but there are a lot of short-run pitfalls that the European project will have to overcome first. We've had many reminders of these difficulties over the last few years, and for now it appears that the materialists have the upper hand.

I would be shocked if markets didn't respond negatively to these developments, and ultimately markets (and German voters) will decide the eurozone's future whether anyone wants them to or not. Greek voters have lashed out a number of times, but each new incoming leader finds themselves operating under the same constraints. They need money, and to get it they have to do what the lenders want them to do. If German and French voters decide that they're sick of paying then it doesn't matter who runs the Greek government... they'll have no choice but to default.

That, to me, is still the most likely outcome.

Score Another One for the Materialists

A couple of years ago I posted a link to a paper by Mansfield and Mutz that called into question basic materialist explanations for trade preference formation. The argument of the paper was that attitudes towards trade are formed along sociotropic, rather than individual, lines. I said at the time that I was interested to see whether this study would hold up to future scrutiny. Well, former UNC PhDs Ben Fordham and Katya Kleinberg suggest that it might not in a recent IO article:

Recent research on the sources of individual attitudes toward trade policy comes to very different conclusions about the role of economic self-interest. The skeptical view suggests that long-standing symbolic predispositions and sociotropic perceptions shape trade policy opinions more than one's own material well-being. We believe this conclusion is premature for two reasons. First, the practice of using one attitude to predict another raises questions about direction of causation that cannot be answered with the data at hand. This problem is most obvious when questions about the expected impact of trade are used to predict opinions about trade policy. Second, the understanding of self-interest employed in most studies of trade policy attitudes is unrealistically narrow. In reality, the close relationship between individual economic interests and the interests of the groups in which individuals are embedded creates indirect pathways through which one's position in the economy can shape individual trade policy preferences. We use the data employed by Mansfield and Mutz to support our argument that a more complete account of trade attitude formation is needed and that in such an account economic interests may yet play an important role.

Score One for Materialists

Via MR:

Ask Americans if they are willing to spend more to buy American-made products, and nearly half say they are often willing to do this. But in the latest Economist/YouGov Poll, the country where a product is made trails price, quality, and even convenience, as an important factor in consumer decision-making. The public gives even less importance to a product’s brand, its impact on the environment, or the political leanings of the company that produces it.

More.

Bernanke, Not Borg

Krugman has a good NYT Magazine article on Bernanke. They have an interesting personal history -- as Chair of the Econ department at Princeton, Bernanke hired Krugman (over some opposition I believe) -- and also an interesting intellectual history -- they were both working on the Japan deflation in the late-1990s, with Krugman concluding that Old Keynesianism was still relevant because of its emphasis on the liquidity trap, while Bernanke concluded that the Bank of Japan was merely timid, not impotent.

In the article Krugman argues that Chairman Bernanke has not followed the advice of Professor Bernanke. He offers three possible explanations for this.

The Bernanke Conundrum — the divergence between what Professor Bernanke advocated and what Chairman Bernanke has actually done — can be reconciled in a few possible ways. Maybe Professor Bernanke was wrong, and there’s nothing more a policy maker in this situation can do. Maybe politics are the impediment, and Chairman Bernanke has been forced to hide his inner professor. Or maybe the onetime academic has been assimilated by the Fed Borg and turned into a conventional central banker.

The Ludlum-esque title is unnecessary, as the addition to the pile of "Krugman's Mystical Creatures" (confidence fairy, bond market vigilantes, etc.), but I believe Krugman's framing is correct and I think the second explanation makes the most sense: Bernanke is politically constrained (see here). So naturally Krugman concludes that Bernanke's been assimilated into the Borg, thus continuing our long-running streak of disagreeing on almost everything.

Today Krugman finds support for the Borg view in these words from Bernanke:

We have, uh, we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable, in that we’ve been able to take strong accommodative actions in the last four or five years to support the economy without leading to a, [indiscernible] expectations or destabilization of inflation. To risk that asset, for, what I think would be quite tentative and, uh, perhaps doubtful gains, on the real side would be an unwise thing to do.

In some ways Krugman's selection of Bernanke's comments are a bit disingenuous -- Bernanke starts by pointing out that the U.S. in 2010-12 is very different from Japan in the late-1990s, particularly since one was suffering from deflation and a recession while the other just has unemployment a few percentage points higher than it would like -- but more problematic is his interpretation of them. When Bernanke starts talking about the "credibility" of the Fed there is no a priori reason to think that he's only talking about credibility with markets. He's also talking about credibility with Congress, and in particular a Congress that is incredibly hawkish on inflation lately* and routinely threatens Bernanke in a number of ways.

The Fed likes its authority. It wants to keep it. It likes it's "independence". Ironically, it will only keep it if it does what Congress wants it to do (i.e. "There is no technocracy" + "There is no central bank independence"... common themes around here). That means not throwing away its credibility for inflation-control in pursuit of dropping the unemployment rate by a point or two. Note that this is also why Bernanke would like to see more fiscal stimulus: that would effectively prevent Bernanke from having to make a difficult choice. But if he's forced to make that choice, he'll the choose the path that doesn't jeopardize his authority.

Note: after I wrote the above, but before publishing it, I came across this excellent post by Greg Ip. Highlights:

This means, judging from the projections, that 13 of the FOMC’s 17 members want to tighten sooner than he does, and none want to tighten later. ...

The second problem is that even if Mr Bernanke’s views prevail while he remains chairman, the odds are that he no longer will be after January, 2014. He is unlikely to be reappointed even if Barack Obama is re-elected (even if wanted the job, a big if, he probably couldn’t be confirmed), and certain not to be if Mitt Romney wins.

But all that's irrelevant. Instead, Bernanke's been captured by the Borg.

*Some of the reasons for that may be found in this excellent post by Steve Randy Waldman. I hope to have more to say about it soon, but for now it's worth reading that one in its entirety. The takeaway is that the coalition of political interests that would be harmed by higher inflation is much larger (and much more politically active) than the coalition that would benefit from it.

Not Quite Crony Capitalism?

I haven't read this yet, but Lucas Puente -- a PhD student at Stanford -- has an interesting-looking article in the new PS (I don't see an ungated version). Abstract:

I investigate one mechanism through which financial institutions could have used political influence to receive preferential treatment in the US Department of the Treasury-administered “bailout.” I find that neither proxies of political influence nor other political variables, such as public interest in specific deals, can explain variance in the sale price of warrants (a type of financial asset) Treasury acquired through TARP's Capital Purchase Program. Moreover, I find that the more politically active the firm is, the more likely Treasury is to auction its warrants (thereby receiving fair market value). This conclusion is not consistent with recent studies investigating the role of such variables in the initial administration of TARP and can be interpreted as good news for American taxpayers.

PS summary (bold added):

In the wake of the recent global financial crisis, many have suggested that the US government's administration of the taxpayer-funded rescue of the financial industry offered disproportionate benefits to politically active firms. However, quite the opposite occurred. Puente's research into Treasury's handling of the disposition of warrants (assets similar to stock call options) acquired through the Capital Purchase Program (CPP) shows that, at least in this phase of the "bailout," political variables did not matter. That is, lobbying expenditures, campaign contributions, and connections with Secretary of the Treasury Geithner, among other independent variables, cannot explain variance in the percentage of market value Treasury received for these warrants. Moreover, according to Puente, the more politically active a firm is, the more likely Treasury is to auction its warrants (thereby receiving fair market value). This suggests that Treasury is attempting to counter-act allegations of preferential treatment. Taxpayers should be pleased. By insulating itself from politics and making efforts to maximize the taxpayer return on the warrants, Treasury may have prevented billions of dollars in taxpayer losses.

I personally don't find this very surprising. Nor would I find it surprising if preferential treatment came mainly through less transparent channels, e.g. the Fed. It looks like Puente might be investigating that question in his ongoing research.