Monday, May 4, 2015

Firm Balance Sheets and Unemployment in the Great Recession

The balance sheets of households and financial firms have received a lot of emphasis in research on the Great Recession. The balance sheets of non-financial firms, in contrast, have received less attention. At first glance, this is perfectly reasonable; households and financial firms had high and rising leverage in the years leading up to the Great Recession, while non-financial firms' leverage remained constant (Figure 1, below).

New research by Xavier Giroud and Holger M. Mueller argues that the flat trendline for non-financial firms' leverage obscures substantial variation across firms, which proves important to understanding employment in the recession. Some firms saw large increases in leverage prior to the recession and others large declines. Using an establishment-level dataset with more than a quarter million observations, Giroud and Mueller find that "firms that tightened their debt capacity in the run-up ('high-leverage firms') exhibit a significantly larger decline in employment in response to household demand shocks than firms that freed up debt capacity ('low-leverage firms')."
The authors emphasize that "we do not mean to argue that household balance sheets or those of financial intermediaries are unimportant. On the contrary, our results are consistent with the view that falling house prices lead to a drop in consumer demand by households (Mian, Rao, and Sufi (2013)), with important consequences for employment (Mian and Sufi (2014)). But households do not lay off workers. Firms do. Thus, the extent to which demand shocks by households translate into employment losses depends on how firms respond to these shocks."

Firms' responses to household demand shocks depend largely on their balance sheets. Low-leverage firms were able to increase their borrowing during the recession to avoid reducing employment, while high-leverage firms were financially constrained and could not raise external funds to avoid reducing employment and cutting back investment:
"In fact, all of the job losses associated with falling house prices are concentrated among establishments of high-leverage firms. By contrast, there is no significant association between changes in house prices and changes in employment during the Great Recession among establishments of low-leverage firms."

Thursday, April 16, 2015

On Bernanke and Citadel

Two weeks ago, I told the Washington Examiner that we don't need to worry about Ben Bernanke's blogging turning him into a "shadow chair." I must confess that I was taken aback this morning to learn that Bernanke will also become a senior adviser to Citadel, a large hedge fund. Let me explain how this announcement modifies some, but not all, of what I wrote in my last post about Bernanke's post-chairmanship role.

I wrote, "We want our top thinkers going into public service at the Fed and other government agencies. These top thinkers place a high value on having a public voice, and the blogosphere is increasingly the forum for that." I still agree with this at gut level. I think Bernanke is an intellectual with the public interest at heart and that he really intends the blog as a public service  Now I also know more about the personal financial interests he has at stake, which I will keep in mind when reading his blogging. (Which we really all should do with whatever we are reading.) I think most people are capable of acting against their best financial interests to maintain ideals and standards, but even the most upright are subject to subconscious suasion.

I also wrote that I hoped Bernanke's blog would increase Fed accountability and transparency. Maybe, but only very indirectly. I don't think Bernanke is personally violating any bounds either by blogging or by joining Citadel, but that his joining Citadel is symptomatic of larger boundary violations in the governance structure of the Fed system and its ties to Wall Street. Bernanke told the New York Times that he was "sensitive to the public's anxieties about the 'revolving door' between Wall Street and Washington and chose to go to Citadel, in part, because it 'is not regulated by the Federal Reserve and I won’t be doing lobbying of any sort.' He added that he had been recruited by banks but declined their offers. 'I wanted to avoid the appearance of a conflict of interest,' he said. 'I ruled out any firm that was regulated by the Federal Reserve.'"

I take him at his word while at the same time expecting and hoping that the public's anxieties about the revolving door will not be calmed by Bernanke's choice of which particular Wall Street firm to join. The public doesn't draw a clear line, nor should they, between Wall Street institutions regulated by the Fed and not regulated by the Fed, or between "lobbying of any sort" and "very public figure saying things to policymakers." Maybe he ruled out conflict of interest to some degree, but certainly not appearance of conflict of interest. So if this looks a little unseemly, I hope that is enough to catalyze change in Fed governance. Even if Bernanke's link to Wall Street is not inherently problematic, the overall role of Wall Street insiders in Fed governance is too large.

Saturday, April 4, 2015

Do Not Fear the Shadow Chair

I was recently interviewed for an article in the Washington Examiner, "Bernanke is Back and Blogging." The author, Joseph Lawler, asked what I thought about a former Federal Reserve chair taking becoming an active blogger, and in particular whether I thought there was a risk of Bernanke becoming a "shadow chairman." Lawler also interviewed Peter Conti-Brown, who said that this was "absolutely" a risk.

I don't share the concern. My response to Lawler was too long for him to include in its entirety, so I'll post it here.
I don't think we need to worry about Ben Bernanke becoming a "shadow chairman." The blog is not as unprecedented as it might seem. Alan Greenspan and Paul Volcker both remain active public figures who not only comment on the economy, but also advocate particular policies. Greenspan has published several books since he was chairman, and Volcker has a think tank, the Volcker Alliance. Neither of them has become a shadow chair. We want our top thinkers going into public service at the Fed and other government agencies. These top thinkers place a high value on having a public voice, and the blogosphere is increasingly the forum for that. If serving precludes them from later participating in the public forum, we will have trouble attracting the best people to these roles in the future. 
I think it is good to have a former Fed chair participating in a forum like a blog, which is freely available to the public and fosters debate. It is also a good thing if this blog brings more attention to the Fed and how it pursues its mandate. Since Fed officials are not elected, the Fed needs to be accountable to the public in other ways, and accountability requires that people are aware of the Fed and really thinking about and challenging its actions. In my dissertation I show that this is not currently the case-- people don't understand the Fed enough to be able to hold it accountable. I argue that the Fed needs a strong new media strategy as part of their communication strategy. If former Fed officials make their opinions public, the public will likely put more pressure on current officials to respond and explain their own views and any differences of opinion. This increases accountability. The Fed also claims to place high value on transparency, which is a change from the central banking philosophy several decades ago, so they should be glad that people formerly at the Fed are trying to explain their thinking in a clear way that helps people understand. 
As a blogger myself, I think it will be very fun to have Bernanke in the blogosphere and to follow him on Twitter. He will bring such an interesting perspective about which topics are really important to think more about. The topics that interest him enough to prompt him to blog will certainly be topics of great interest to the rest of us bloggers. It will be fun to think through and react to what he writes.
Wishing you a very happy Easter!

Saturday, March 28, 2015

Politicians or Technocrats: Who Splits the Cake?

In most countries, non-elected central bankers conduct monetary policy, while fiscal policy is chosen by elected representatives. It is not obvious that this arrangement is appropriate. In 1997, Alan Blinder suggested that Americans leave "too many policy decisions in the realm of politics and too few in the realm of technocracy," and that tax policy might be better left to technocrats. The bigger issue these days is whether an independent, non-elected Federal Reserve can truly be "accountable" to the public, and whether Congress should have more control over monetary policy.

The standard theoretical argument for delegating monetary policy to a non-elected bureaucrat is the time inconsistency problem. As Blinder explains, "the pain of fighting inflation (higher unemployment for a while) comes well in advance of the benefits (permanently lower inflation). So shortsighted politicians with their eyes on elections would be tempted to inflate too much." But time inconsistency problems arise in fiscal policy too. Blinder adds, "Myopia is a serious practical problem for democratic governments because politics tends to produce short time horizons -- often extending only until the next election, if not just the next public opinion poll. Politicians asked to weigh short-run costs against long-run benefits may systematically shortchange the future."

So why do we assign some types of policymaking to bureaucrats and some to elected officials? And could we do better? In a two-paper series on "Bureaucrats or Politicians?," Alberto Alesina and Guido Tabellini (2007) study the question of task allocation between bureaucrats and politicians. In their model, neither bureaucrats nor politicians are purely "benevolent;" each have different objective functions depending on how they are held accountable:
Politicians are held accountable, by voters, at election time. Top-level bureaucrats are accountable to their professional peers or to the public at large, for how they have fulfilled the goals of their organization. These different accountability mechanisms induce different incentives. Politicians are motivated by the goal of pleasing voters, and hence winning elections. Top bureaucrats are motivated by "career concerns," that is, they want to fulfill the goals of their organization because this improves their external professional prospects in the public or private sector.
The model implies that, for the purpose of maximizing social welfare, some tasks are better suited for bureaucrats and others for politicians. When the public can only imperfectly monitor effort and talent, elected politicians are preferable for tasks where effort matters more than ability. Bureaucrats are preferable for highly technical tasks, like monetary policy, regulatory policy, and public debt management. This is in line with Blinder's intuition; he argued that extremely technical judgments ought to be left to technocrats and value judgments to legislators, while recognizing that both monetary and fiscal policy involve substantial amounts of both technical and value judgments.

Alesina and Tabellini's model also helps formalize and clarify Blinder's intuition on what he calls "general vs. particular" effects. Blinder writes:
Some public policy decisions have -- or are perceived to have -- mostly general impacts, affecting most citizens in similar ways. Monetary policy, for example...is usually thought of as affecting the whole economy rather than particular groups or industries. Other public policies are more naturally thought of as particularist, conferring benefits and imposing costs on identifiable groups...When the issues are particularist, the visible hand of interest-group politics is likely to be most pernicious -- which would seem to support delegating authority to unelected experts. But these are precisely the issues that require the heaviest doses of value judgments to decide who should win and lose. Such judgments are inherently and appropriately political. It's a genuine dilemma.
Alesina and Tabellini consider a bureaucrat and an elected official each assigned a task of "splitting a cake." Depending on the nature of the cake splitting task, a bureaucrat is usually preferable; specifically, "with risk neutrality and fair bureaucrats, the latter are always strictly preferred ex ante. Risk aversion makes the bureaucrat more or less desirable ex ante depending on how easy it is to impose fair treatment of all voters in his task description." Nonetheless, politicians prefer to cut the cake themselves, because it helps them get re-elected with less effort through an incumbency advantage:
The incumbent’s redistributive policies reveal his preferences, and voters correctly expect these policies to be continued if he is reelected. As they cannot observe what the opponent would do, voters face more uncertainty if voting for the opponent...This asymmetry creates an incumbency advantage: the voters are more willing to reappoint the incumbent even if he is incompetent... The incumbency advantage also reduces equilibrium effort.
An interesting associated implication is that "it is in the interest of politicians to pretend that they are ideologically biased in favor of specific groups or policies, even if in reality they are purely opportunistic. The ideology of politicians is like their brand name: it keeps voters attached to parties and reduces uncertainty about how politicians would act once in office."

According to this theoretical model, we might be better off leaving both monetary and fiscal policy to independent bureaucratic agencies. But fiscal policy is inherently redistributive, and politicians prefer not to delegate redistributive tasks. "This might explain why delegation to independent bureaucrats is very seldom observed in fiscal policy, even if many fiscal policy decisions are technically very demanding."

Both Blinder and Alesina and Tabellini--writing in 1997 and 2007, respectively-- made the distinction that tax policy, unlike monetary policy, is redistributive or "particularist." Since then, that distinction seems much less obvious. Back in 2012, Mark Spitznagel opined in the Wall Street Journal that "The Fed is transferring immense wealth from the middle class to the most affluent, from the least privileged to the most privileged." Boston Fed President Eric Rosengren countered that "The net effect [of recent Fed policy] is substantially weighted towards people that are borrowers not lenders, towards people that are unemployed versus people that are employed." Other Fed officials and academic economists are also paying increasing attention to the redistributive implications of monetary policy.

Monetary policymakers can no longer ignore the distributional effects of monetary policy-- and neither can voters and politicians. Alesina and Tabellini's model predicts that the more that elected politicians recognize the "cake splitting" aspect of monetary policy, the more they will want to redelegate it to themselves. Expect stronger cries for "accountability." However, the redistributive nature of monetary policy, according to the model, probably strengthens the argument for leaving it to independent technocrats. The caveat is that "the result may be reversed if the bureaucrat is unfair and implements a totally arbitrary redistribution." The Fed's role in redistributing resources strengthens its case for independence if and only if it takes equity concerns seriously.

Wednesday, March 4, 2015

Federal Reserve Communication with Congress

In 2003, Ben Bernanke described a central bank's communication strategy as "regular procedures for communicating with the political authorities, the financial markets, and the general public." The fact that there are three target audiences of monetary policy communication, with three distinct sets of needs and concerns, is an important point. Alan Blinder and coauthors note that most of the research on monetary policy communication has focused on communication with financial markets. In my working paper "Fed Speak on Main Street," I focus on communication with the general public. But with the recent attention on Congressional calls to audit or reform the Fed, communication with the third audience, political authorities, also merits attention.

Bernanke added that "a central bank's communications strategy, closely linked to the idea of transparency, has many aspects and many motivations." One such motivation is accountabilityFederal Reserve communication with political authorities is contentious because of the tension that can arise between accountability and freedom from political pressure. As Laurence Meyer explained in 2000:
Even a limited degree of independence, taken literally, could be viewed as inconsistent with democratic ideals and, in addition, might leave the central bank without appropriate incentives to carry out its responsibilities. Therefore, independence has to be balanced with accountability--accountability of the central bank to the public and, specifically, to their elected representatives. 
It is important to appreciate, however, that steps to encourage accountability also offer opportunities for political pressure. The history of the Federal Reserve's relationship to the rest of government is one marked by efforts by the rest of government both to foster central bank independence and to exert political pressure on monetary policy.
It is worthwhile to take a step back and ask what is meant by accountability. Colloquially and in academic literature, the term accountability has become "an ever-expanding concept." Accountability does not mean that the Fed needs to please every member of Congress, or even some of them, all the time. If it did, there would be no point in having an independent central bank! So what does accountability mean?  A useful synonym is answerability. The Fed's accountability to Congress means the Fed must answer to Congress-- this requires, of course, that Congress ask something of the Fed. David Wessel explains that this can be a problem:
Congress is having a hard time fulfilling its responsibilities to hold the Fed accountable. Too few members of Congress know enough to ask good questions at hearings where the Fed chair testifies. Too many view hearings as a way to get themselves on TV or to score political points against the other party.
Accountability, in the sense of answerability, is a two-way street requiring effort on the parts of both the Fed and Congress. Recent efforts by Congress to impose "accountability" would clear Congress of the more onerous part of its task. The Federal Reserve Accountability and Transparency Act introduced in 2014 would require that the Fed adopt a rules-based policy. The legislation states that "Upon determining that plans…cannot or should not be achieved, the Federal Open Market Committee shall submit an explanation for that determination and an updated version of the Directive Policy Rule.”

In 1976, Senator Hubert Humphrey made a similar proposal: the president would submit recommendations for monetary policy, and the Federal Reserve Board of Governors would have to explain any proposed deviation within fifteen days. This proposal did not pass, but other legislation in the late 1970s did change the Federal Reserve's objectives and standards for accountability. Prompted by high inflation, the Federal Reserve Reform Act of 1977 made price stability an explicit policy goal. Representative Augustus Hawkins and Senator Humphrey introduced the Full Employment and Balanced Growth Act of 1978, also known as the Humphrey-Hawkins Act, which added a full employment goal and obligated the Fed Chair to make biannual reports to Congress. It was signed into law by President Jimmy Carter on October 27, 1978.

The Humphrey-Hawkins Act, though initially resisted by FOMC members, did improve the Fed's accountability or answerability to Congress. The requirement of twice-yearly reports to Congress literally required the Fed Chair to answer Congress' questions (though likely, for a time, in "Fed Speak.") The outlining of the Fed's policy goals defined the scope of what Congress should ask about. In terms of the Fed's communication strategy with Congress, its format, broadly, is question-and-answer. Its content is the Federal Reserve's mandates. Its tone--clear or obfuscatory, helpful or hostile--has varied over time and across Fed officials and members of Congress. 

Since 1978, changes to the communication strategy, such as the announcement of a 2% long-run goal for PCE inflation in 2012, have attempted to facilitate the Fed's answerability to Congress. The proposal to require that the Fed follow a rule-based policy goes beyond the requirements of accountability. The Fed must be accountable for the outcomes of its policy, but that does not mean restricting the flexibility of its actions. Unusual or extreme economic conditions require discretion on the part of monetary policymakers, which they must be prepared to explain as clearly as possible. 

Janet Yellen remarked in 2013 that "By the eve of the recent financial crisis, it was established that the FOMC could not simply rely on its record of systematic behavior as a substitute for communication--especially under unusual circumstances, for which history had little to teach" [emphasis added]. Imposing systematic behavior in the form of rules-based policy is an even poorer substitute. As monetary begins to normalize, Congress' role in monetary policy is to question the Fed, not to bully it.

Wednesday, February 18, 2015

My Job Market Experience

Many of you have been following my blog for a large share of my time in graduate school. I will graduate from Berkeley this May. It is with great pleasure and gratitude that I announce what comes next for me: I have accepted a position as Assistant Professor of Economics at Haverford College.

Haverford is a liberal arts college just a few miles from Philadelphia. One unique aspect of Haverford is that all of the 1,187 undergraduate students complete a senior thesis. I will really enjoy introducing students to the research process and hope to be inspired by their creativity. Haverford is part of a consortium with Bryn Mawr and Swarthmore. It is also in close proximity to the Philadelphia Fed, the University of Pennsylvania, and Villanova. Thus, there is a fantastic network of researchers and scholars that I very much look forward to joining.
The duck pond on Haverford's arboretum campus

The job market process has been an unforgettable experience. I met so many amazing people who impressed me with their energy and dedication to teaching, research, and policy. If the people I met are anything like a representative sample of professors and policymakers, our students and our country are in good hands. I wish I could have all of you as colleagues and hope for many opportunities to see you in the future. 

Wednesday, February 4, 2015

Let's Not Give Up on Mobility

Gregory Clark, an economic historian at UC Davis, writes that "Social mobility barely exists but let’s not give up on equality." His research using rare surnames to track social mobility over several centuries finds that social mobility in England is still just as low in today's "modern noisy meritocracy" as it was in pre-industrial times. He concludes that "Lineage is destiny. At birth, most of your social outcome is predictable from your family history." He emphasizes that this is true not only in the UK, but also in Sweden, China, and the U.S.

The subtitle of Clark's article says that "Too much faith is placed in the idea of movement between the classes. Still, there are other ways to tackle the unfairness of society." He elaborates:
"Given that social mobility rates are immutable, it is better to reduce the gains people make from having high status, and the penalties from low status. The Swedish model of compressed inequality is a realistic option, the American dream of rapid mobility an illusion...While mobility seems governed by a social physics that defies easy intervention, the magnitude of social inequalities varies considerably across societies, and can be strongly influenced by social institutions. We cannot change the winners in the social lottery, but we can change the value of their prizes."
I agree that meritocracy alone does not guarantee high mobility, and therefore that making a society more meritocratic is not the silver bullet solution to inequality. But I wouldn't go so far as to say that social mobility rates are immutable. First, just because social mobility has not improved in the past doesn't mean that it's incapable of improving in the future. Second, the fact that social mobility varies across countries and even within countries implies that it should be possible to increase mobility.

Within the United States, there is substantial geographic variation in social mobility. Raj Chetty, Nathaniel Hendren, Patrick Kline, and Emmanuel Saez use administrative records on the incomes of 40 million children and their parents to study intergenerational mobility in 741 local areas. It turns out that the American dream is more viable in some places than in others. Chetty summarizes:
Looking at the probability that a child who grew up in a bottom-quintile income family reaches the top-quintile of the income distribution across areas of the U.S., we find substantial variation across regions. In some parts of the U.S. – such as the Southeast and the Rust Belt – children in the bottom quintile have less than a 5% chance of reaching the top quintile. In other areas, such as the Great Plains and the West Coast, children in the bottom quintile have more than a 15% chance of reaching the top quintile. 
There is substantial variation in upward mobility even among large cities that have comparable economies and demographics. Cities such as Salt Lake City and San Jose have rates of mobility comparable to Denmark and other countries with the highest rates of mobility in the world. Other cities – such as Charlotte and Milwaukee – offer children very limited prospects of escaping poverty. These cities have lower rates of mobility than any developed country for which data are currently available.
Not only does mobility vary across geographic regions, it varies in systematic ways. Chetty et al. find that proxies for the quality of the K-12 school system are positively correlated with mobility. So are social capital indices, which measure the strength of social networks and community involvement. For example, high upward mobility areas tend to have higher participation in local civic organizations and religious activity. Clark says that low social mobility is here to stay because of "strong transmission within families of the attributes that lead to social success." But certainly there are other methods of transmission, particularly in schools and communities, that could be developed or improved. 

Improving the living conditions of the poor is extremely important regardless of the level of mobility in a society. So I agree with Clark that we shouldn't give up on equality. But I think we shouldn't give up on mobility either. History tells us what has happened, not what can happen. We don't know what could happen under a sustained and ambitious effort to improve upward mobility.