Tuesday, May 31, 2011

Germany's Nukes and The Limits of "Green" Energy

Germany has announced plans to phase out all its nuclear reactors by 2022.  It's worth taking this pledge with spoonfuls of salt. Sweden has been announcing various plans to phase out its nuclear reactors since the 1970s, but because they provide half of Sweden's electricity, the phase-out hasn't happened. Germany's plan is to move to "renewable" energy sources like solar, wind, and hydroelectric. But Germany's location doesn't make it a natural site for solar or wind-power, and it is unlikely to go on a dam-building spree.

Green energy is worth investigating, researching, and perhaps even subsidizing to some extent because it is green: that is, it has potential to reduce air pollutants like sulfur and particulates, as well as the risks posed by climate change. In addition, it could help in reducing dependence on foreign supplies of oil. But it is extremely unlikely to provide a surge of economic growth.

Germany's Chancellor Angela Merkel said:"We believe that we can show those countries who decide to abandon nuclear power -- or not to start using it -- how it is possible to achieve growth, creating jobs and economic prosperity while shifting the energy supply toward renewable energies."

Green technologies like solar and windpower are not yet cost-competitive in providing major support to a national power-grid. At least in the short- and medium-run, green energy means higher electrical bills or higher government subsidies. Neither is a pathway to economic growth--although they may be worth doing as a cost for meeting environmental goals.Government policies provide high prices for producers of green energy can subsidize job creation in those industries, but just as high prices for oil create jobs in oil-related industries without stimulating economic growth, high prices for alternative energy won't stimulate growth, either. I expect that Germany's industrial sector, which uses about half of the country's electricity, will make that point clear when the time is right.

Perhaps eventually, with sufficient research and technological gains, renewable energy resources can become cost competitive with fossil fuels, hydro, and nuclear. But compare for a moment the productivity gains that have come from technological developments in information technology, including computing and telecommunications and the internet. These gains arise partly because of "Moore's law," which is essentially that the price of computing power falls by half every two years. As computing power has gotten cheaper, it has allowed users of this technology to find an ever-widening array of productivity-enhancing applications. But even the most ardent advocates of green power do not seriously believes that technological breakthroughs will cause the cost of electricity to drop by half every two years for several decades, nor that lower energy costs alone can trigger waves of productivity growth in other industries. Again, the bottom line is that green energy is worth investigating because offers the possibility of environmental gains. However, Germany's Merkel is almost certainly incorrect in believing that it can be a basis for future productivity growth.

Friday, May 27, 2011

Alfred Kahn, Deregulator and Expositor

 Alfred E. Kahn died on December 27, 2010. Kahn was best-known in the economics profession for his academic and practical work on deregulation; in particular, as the final Chairman of the Civil Aeronautics Board, he deregulated his own agency out of existence at the time of airline deregulation.  The website of National Economic Research Associates, Inc., has biography with links to obituaries. It also has a copy of an underground classic—a short “Memorandum” that Kahn wrote to the CAB staff in 1977 on the importance of clear writing

Kahn began: “One of my peculiarities, which I must beg you to indulge if I am to retain my sanity (possibly at the expense of yours!) is an abhorrence of the artificial and hyper-legal language that is sometimes known as bureaucratese or gobbledygook. The disease is almost universal, and the fight against it endless. But it is a fight worth making, and I ask your help in this struggle.” Also available is the text of a longer 1998 talk he gave on “My War Against Bureaucratese.”

The Case Against Reducing the Drinking Age

I'm predisposed to support reducing the legal drinking age from 21 to 18. If you're old enough to volunteer to fight in Afghanistan, seems as if you're old enough to drink. But in the Spring 2011 issue of the Journal of Economic Perspectives, Christopher Carpenter and Carlos Dobkin offer a careful reading of the evidence which leans the other way. Here's my personal summary of some main points:

Two sources of evidence support the claim that lowering the drinking age from 21 to 18 will lead to about 8 more deaths by for every 100,000 person-years in the 18-21 age group. One source of evidence looks at what happened when states were altering their drinking ages in the 1970s and 1980s. The other source of evidence is "regression discontinuity" -- that is, what happens to death rates now when people turn 21.

Carpenter and Dobkin have a lovely figure, reproduced here, to illustrate the intuition behind a "regression discontinuity." Draw a best-fit line through the deaths for motor vehicle fatalities for those in the 18-21 age bracket, and you see that those accidents decline a bit as people move from age 18-21. Draw a best-fit line through the deaths from motor vehicle fatalities for people age 21-23, and again, you see that these accidents decline a bit a people mature. But put these two lines on the same graph, and you see a jump in motor-vehicle fatalities at age 21--when drinking becomes legal. A milder version of the same pattern appears in deaths from by suicide in these age groups, but the "jump" at age 21 is almost nonexistent in deaths from internal causes. Of course, this figure alone isn't conclusive, but it shows what is behind the more detailed statistical calculations in their research. 

In short, the anecdotal stories about how if alcohol wasn't forbidden it would be used more sensibly may be true for some, but for the 18-21 age bracket as a whole, a lower drinking age would probably lead to more deaths, as well as consequences like injuries, crime, and higher-risk sexual behavior.

But that said, an economic calculation always needs to weigh costs against benefits. Many in the 18-21 age bracket would enjoy legal access to alcohol and would not end up as grim statistics. How can the benefits to this group be taken into account? 

Carpenter and Dobkin suggest this approach. They work through a back-of-the-envelope calculation of the costs of drinking in terms of deaths and injuries, and what quantity of drinking would occur it the 18-21 age bracket if would occur if it were legal. They find that if those in the 18-21 age bracket were facing the actual expected average costs of their actions when they buy a drink, those costs would add $15 to the price of each drink for the costs that they themselves would experience, and another $2.63 per drink for the costs that they would inflict on others. In other words, if those in the 18-21 age bracket had to face the actual average costs of alcohol consumption at the time that they purchased a drink, most of them would decide against paying those costs.

Some inventive person can probably craft a clever plan that would try to combine legalizing alcohol for the 18-21 age group with some combination of education, rules, punishments, and rewards to encourage only responsible consumption. But the baseline for any such discussion should be that the Carpenter-Dobkin evidence that reducing the drinking age to 18 would impose large costs.

Thursday, May 26, 2011

Teaching Intro-level Monetary Policy After the 2007-2009 Recession

Andrew T. Hill (Temple University and the Philadelphia Fed) and William C. Wood (James Madison University) offer a thoughtful discussion of how the teaching of monetary economics at the intro level needs to evolve in "It's Not Your Mother and Father's Monetary Policy Anymore: The Federal Reserve and Financial Crisis Relief."

As I see it, Fed actions during the crisis can be summed up in two main categories: 1) Providing liquidity to financial markets in crisis; and 2) Direct Fed purchases of financial securities, both Treasury debt and mortgage-backed securities. In teaching, the issue is to convey these two themes to students, but not get bogged down in institutional details. As Hill and Wood write, "it's very easy to get drawn into the details of the Fed's programs and over teach."

Most intro econ courses already have some discussion of the lender-of-last-resort function for central banks, and of using the discount rate as a tool of monetary policy. It's fairly straightforward to build on these themes to discuss how the Fed extended vast amounts of credit during the worst of the financial crisis: that is, to fulfill its lender-of-last-resort obligations in a complex modern financial economy, the Fed needed to go beyond lending to banks, and extend short-term credit to lots of other market players. A slightly deeper point is that the Fed also figured out ways to extend this credit so that the recipient firms could remain anonymous to the financial market--and thus they didn't need to worry that getting credit from the Fed would send a bad signal about their future prospects. 

Hill and Wood provide a table that may be useful for many instructors listing the new monetary policy tools created during the last few years: Term Auction Facility (TAF), Term Securities Lending Facility (TSLF), Primary Dealer Credit Facility (PDCF), Commercial Paper Funding Facility (CPFF), Term Asset-Backed Seucurities Loan Facility (TALF), and others.  But intro teaching should skip this alphabet soup. All of these agencies were closed by mid-2010; in general, the Fed's short-term lender-of-last-resort was finished by then.

In teaching about the direct Fed purchases of financial securities, this quantitative easing should be presented as a fourth possible tool of monetary policy, along with the standard triumvirate of reserve requirements, discount rate, and open market operations. Some teachers may try here to present the Fed balance sheet to their classes to show this change, and for those who want to take this approach, Hill and Wood present four illustrative and simplified balance sheets at different points in time.

But for intro purposes, I'm not sure much is gained by presenting explicit Fed balance sheets. Instead, this material can be presented pretty clearly at an intuitive level by saying that the Fed feared that financial markets wouldn't absorb these securities without more disruption, so the Fed took them on. In the short run, this probably helped smooth out the crisis. But the Fed can't print money to buy securities continually.So it needs to decide when to stop. It also will need to decide how to wind down the $2 trillion or so in financial securities that it currently owns, either by gradually selling them off or by holding at least some of them to maturity.

One other change that may be important in the next few years is that the Fed traditionally did not pay any interest on bank reserves that it held. As of 2008, the Fed can pay interest. Thus, if it seems like a bank lending boom is getting underway and higher inflation is threatened, the Fed could raise the interest rate that it pays on bank reserves, and limit banks' willingness to lend in this way. This tool doesn't matter much in a world of near-zero interest rates and low inflation, but if inflation beckons, it will be interesting to see how the Fed uses this new power.

Wednesday, May 25, 2011

If Public Pension Funds are in the Stock Market, Why Not Social Security?

State and local governments have assets in their pension funds that they invest and use to pay pensions to their retired employees. The federal government has assets in a trust fund that it will use to help pay for future Social Security benefits. But pension funds put their money in the stock market, and thus assume fairly high future returns: the median plan assumes a future return of 8%, according to a May 2011 "Issue Brief" from the Congressional Budget Office. In contrast, Social Security trust funds can only by law be invested in Treasury bonds, and thus get a much lower rate of return.

There is an ongoing dispute over what assumption is more reasonable. State and local governments can point out that the average rate of return on pension funds over the last 25 years is 9% in nominal terms (6% in real terms). The alternative view is that if these obligations are viewed as certain to happen, then they should be funded with extremely low-risk assets, like Treasury bonds. Using a high-risk asset like investment in stocks to fund a certain future obligation creates a mismatch. In the Fall 2009 issue of the Journal of Economic Perspectives (I'm the managing editor),  Robert Novy-Marx and Joshua Rauh make this case.

If state and local pension funds were required to invest in safe assets, then they would need to assume a much lower rate of return on their pension funds. The CBO, for example, says that instead of state and local pension funds being underfunded by $700 million assuming an 8% rate of return, they would be underfunded by $2.9 trillion assuming a 4% rate of return. Conversely, if Social Security was allowed to fund its certain payments by putting 40% of the trust fund in riskier stock market assets and assuming a 6.4% real return (and phasing in this change over 15 years), then the actuaries estimate that the projected 75-year deficit of Social Security would be reduced by about one-third.

A consistent view should favor either that both state and local pension funds and Social Security can put their money in the stock market and assume high rates of return, or that neither should be able to do so. It can't make logical sense to say that for state and local pension funds, it's fine to invest in the stock market and to assume a high rate of return, but for Social Security it's too risky to invest in the stock market and thus necessary to assume only the low Treasury bond rate of return.

Oddly, however, it's common to find that those of a more liberal political persuasion are horrified by the idea of putting Social Security trust funds in the stock market, but would also be horrified by the enormous financial changes that would be needed if state and local pension funds were forced out of the market. On the other side, many of a more conservative political persuasion advocate putting some of the Social Security funds in the stock market, but like to argue that the deficits of state and local pension funds are overstated because they ought to be based on a lower "safe" rate of return.

Thursday, May 19, 2011

Spring 2011 Journal of Economic Perspectives On-line

I'm the managing editor of the Journal of Economic Perspectives, published by the American Economic Association. It's an academic journal, but it's meant to be a journal that's readable by those who have some background in economics--like those who took several undergraduate courses in college in the subject. The AEA makes all of the articles the journal freely available on-line to all, and the Spring 2011 issue is now available.

I'll comment on the specifics of some of these articles over the next week or so, but here's the table of contents for the issue. It starts with a five paper symposium on "Constraining Healthcare Costs." The papers are:

David M. Cutler and Dan P. Ly, “The (Paper)Work of Medicine: Understanding International Medical Costs”
Amitabh Chandra, Anupam B. Jena, and Jonathan S. Skinner, “The Pragmatist’s Guide to Comparative Effectiveness Research”
Katherine Baicker and Dana Goldman, “Patient Cost-Sharing and Healthcare Spending Growth”
Mark McClellan, “Reforming Payments to Healthcare Providers: The Key to Slowing Healthcare Cost Growth While Improving Quality?”
Daniel P. Kessler, “Evaluating the Medical Malpractice System and Options for Reform”

Other articles in the issue are: 

Susan Houseman, Christopher Kurz, Paul Lengermann, and Benjamin Mandel, “Offshoring Bias in U.S. Manufacturing”
Christopher Carpenter and Carlos Dobkin, “The Minimum Legal Drinking Age and Public Health”
John A. List, “The Market for Charitable Giving”
Philippe Aghion and Richard Holden, “Incomplete Contracts and the Theory of the Firm: What Have We Learned over the Past 25 Years?”
E. Roy Weintraub, “Retrospectives: Lionel W. McKenzie and the Proof of the Existence of a Competitive Equilibrium”
Timothy Taylor, “Recommendations for Further Reading”

Wednesday, May 18, 2011

Taxing High-Income Minnesotans

Here in Minnesota, the Republican-controlled legislature and the Democratic Governor Mark Dayton are locked in a struggle about how to close the $5 billion or so state budget deficit. The Republicans want to do it all with spending cuts--although it's not clear to me that they have actually proposed enough spending cuts to do the job. Dayton wants smaller spending cuts and a healthy dose of tax increases on those with the highest incomes. In an op-ed that appeared in the StarTribune today called Tax the Rich Out of Fairness? Not That Simple, I try to put the arguments about state income tax fairness in the context of other state, local and federal taxes. I argue that a modest bump in the upper tax bracket for high-income Minnesotans might play a part as part of an overall budget solution, but that Minnesota, and state and local governments in general, have good reasons not to be too aggressive in taxing those with high incomes.

The famous economist Milton Friedman used to say: "The problem with standing in the middle of the road is that you get hit by traffic going both directions." I fully expect to get bashed both by those who oppose any additional taxes, and also by those who want to raise state income taxes on those with high incomes very substantially.

In case the link changes at the newspaper, I'll insert the column here below the fold.

Tuesday, May 17, 2011

Three Incompatible Missions for Higher Education

Clayton M. Christensen, Michael B. Horn, Louis Soares, Louis Caldera write in : “Disrupting College:  How Disruptive Innovation Can Deliver Quality and Affordability to Postsecondary Education.”

 “Furthermore, what we see when we examine the existing institutions of higher education through this lens is that for decades now they have offered multiple value propositions around knowledge creation (research), knowledge proliferation and learning (teaching), and preparation for life and careers. They have as a result become conflations of the three generic types of business models—solution shops, value-adding process businesses, and facilitated user networks. This has resulted in extraordinarily complex—some might say confused—institutions where there are significant coordinative overhead costs that take resources away from research and teaching. A typical state university today is the equivalent of having merged consulting firm McKinsey with Whirlpool’s manufacturing operations and Northwestern Mutual Life Insurance Company: three fundamentally different and incompatible business models all housed within the same organization.”

From a February 2011 paper for the Center for American Progress and Innosight Institute.

Two ways of illustrating the financial crisis

When I'm talking about underlying causes of the financial crisis, it's nice to have a vivid graph to display.

For example, I've often used graphs showing how certain key interest rates spiked during the crisis. Here's an example of such a graph from the the CBO's August 2009 The Budget and Economic Outlook: An Update (p. 35). 

The graph shows the spread between the benchmark LIBOR interest rate and the federal funds rate
starts bubbling with the crisis in fall 2007, spikes in September 2008, then drifts down to near-common historical levels by spring 2009.The problem with this figure, of course, is that explaining it to an audience means needing to explain LIBOR, and the federal funds rate, and why a movement of a few percentage points is so important. If I wave my hands a lot, I can sell it. But I'm not sure the audience knows what it's buying.

So here is my new favorite graph for illustrating the financial crisis. It's a graph of net financial lending, taken from the CBO's January 2011 Budget and Economic Outlook: Fiscal Years 2011 to 2021 (p. 33).

This graph needs a short explanation of what net lending is (that is, new lending minus repayments and charge-offs). But seeing a graph that goes up and down over the decades since 1950, but then turns violently negative the aftermath of the crisis, really helps to give a visceral sense of what a financial crisis means.